SECURITIES AND EXCHANGE COMMISSION
                              Washington, DC 20549

                                    FORM 10-K

                        FOR ANNUAL AND TRANSITION REPORTS
                     PURSUANT TO SECTIONS 13 OR 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

(Mark One)

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

FOR THE FISCAL YEAR ENDED OCTOBER 31, 2004

                                       OR

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

For the transition period from _________ to ___________

                           Commission File No. 0-8419


                                    SBE, INC.
             (Exact name of Registrant as specified in its charter)

              Delaware                                94-1517641
   (State or other jurisdiction of           (IRS Employer Identification
   incorporation or organization)                       Number)

            2305 Camino Ramon, Suite 200, San Ramon, California 94583
              (Address of principal executive offices and Zip Code)

                                 (925) 355-2000
              (Registrant's Telephone Number, including Area Code)

           Securities registered pursuant to Section 12(b) of the Act:

                                      None

           Securities registered pursuant to Section 12(g) of the Act:

                                  Common Stock
                                (Title of Class)

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

         Indicate by check mark if disclosure of delinquent  filers  pursuant to
Item 405 of Regulation S-K is not contained herein and will not be contained, to
the best of the  registrant's  knowledge,  in  definitive  proxy or  information
statements  incorporated  by  reference  in Part  III of this  Form  10-K or any
amendment to this Form 10-K. |X|


                                      -1-
<PAGE>

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

         The  approximate  aggregate  market  value of the  common  stock of the
registrant held by non-affiliates of the registrant,  based on the closing price
for the  registrant's  common  stock on April 30, 2004 as reported on the Nasdaq
SmallCap Market, was $19,487,267.  Shares of Common Stock held by each executive
officer, director and stockholder whose ownership exceeds five percent of Common
Stock  outstanding  have been excluded  because such persons may be deemed to be
affiliates  of the  registrant.  This  determination  of  affiliate  status  for
purposes  of  the  foregoing   calculation  is  not   necessarily  a  conclusive
determination of affiliate status for other purposes.

         The number of shares of the registrant's common stock outstanding as of
December 31, 2004 was 5,159,722.

                       DOCUMENTS INCORPORATED BY REFERENCE

         Portions  of  the  registrant's  definitive  proxy  statement  for  the
registrant's Annual Meeting of Stockholders,  scheduled for March 22, 2005, have
been incorporated by reference into Part III of this Annual Report on Form 10-K.



                                      -2-
<PAGE>

                                    SBE, INC.

                                    FORM 10-K

                                TABLE OF CONTENTS


PART I

       Item 1   Business                                                       4
       Item 2   Properties                                                    19
       Item 3   Legal Proceedings                                             19
       Item 4   Submission of Matters to a Vote of Security Holders           19


PART II

       Item 5   Market for Registrant's Common Equity
                     and Related Stockholder Matters                          21
       Item 6   Selected Financial Data                                       22
       Item 7   Management's Discussion and Analysis of
                     Financial Condition and Results of Operations            23
       Item 7A  Quantitative and Qualitative Disclosures about Market Risk    35
       Item 8   Financial Statements and Supplementary Data                   36
       Item 9   Changes in and Disagreements with Accountants
                     on Accounting and Financial Disclosure                   36
       Item 9A  Controls and Procedures                                       36


PART III

       Item 10  Directors and Executive Officers of the Registrant            37
       Item 11  Executive Compensation                                        37
       Item 12  Security Ownership of Certain Beneficial Owners
                     and Management                                           37
       Item 13  Certain Relationships and Related Transactions                37
       Item 15  Exhibits, Financial Statement Schedules
                and Reports on Form 8-K                                       38

SIGNATURES                                                                    42



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<PAGE>

                   SPECIAL NOTE ON FORWARD LOOKING STATEMENTS

Certain  statements  set forth in or  incorporated  by  reference in this Annual
Report on Form 10-K constitute  "forward-looking  statements" within the meaning
of Section 27A of the  Securities  Act of 1933 and Section 21E of the Securities
Exchange  Act  of  1934.  These  statements  include,  without  limitation,  our
expectations   regarding  our  sales  to  The   Hewlett-Packard   Company,   our
expectations  regarding the market for client server  networking  products,  the
adequacy of  anticipated  sources of cash,  planned  capital  expenditures,  the
effect of interest  rate  increases,  and trends or  expectations  regarding our
operations.  Words such as "may," "will," "should,"  "believes,"  "anticipates,"
"expects,"  "intends," "plans," "estimates" and similar expressions are intended
to  identify  forward-looking  statements,  but are not the  exclusive  means of
identifying  such statements.  Such statements are based on currently  available
operating,  financial  and  competitive  information  and are subject to various
risks  and  uncertainties.   Readers  are  cautioned  that  the  forward-looking
statements  reflect  management's  estimates only as of the date hereof,  and we
assume no obligation to update these statements, even if new information becomes
available or other events occur in the future. Actual future results, events and
trends  may  differ  materially  from  those  expressed  in or  implied  by such
statements  depending  on a variety of  factors,  including,  but not limited to
those  set  forth  under  "Item 1 -  Business  -- Risk  Factors"  on page 15 and
elsewhere in this Form 10-K.

                                     PART I

ITEM 1.       BUSINESS

OVERVIEW

SBE, Inc. develops and provides network communications and storage solutions for
original equipment  manufacturers  ("OEM") in the embedded systems  marketplace.
Embedded  networking  technology  is  hardware  or  software  that  serves  as a
component  within a larger  networking  or  storage  device or system  such as a
Gigabit  Ethernet  or a T-1/T-3  input/output  ("I/O")  network  interface  card
("NIC")  that plugs into an  expansion  slot in a high-end  computer  or storage
system.  Embedded networking solutions enable the functionality of many commonly
used devices or equipment,  such as products and  solutions for basic  telephone
and internet services, mobile phones, medical equipment and storage networks.

We deliver a product portfolio comprised of standards-based wide area networking
("WAN"),  local area networking ("LAN") and storage area network ("SAN") network
interface and intelligent  communications  controller cards. All of our products
are coupled with enabling Linux or Solaris  software  drivers.  Our products are
designed  to be  functionally  compatible  with  each  other  and,  since we use
industry  standard  form  factors  and  technologies,   our  products  are  also
compatible with third party standards-based  products. This standard scalability
and modularity offers our customers greater flexibility to develop solutions for
unique product configurations and applications.

Our products are developed  based on industry  standard  form factors  including
those  known  as  Peripheral   Component   Interconnect   ("PCI"),   CompactPCI,
VersaModule  Eurocard  ("VME"),  PCI  Mezzanine  Card  ("PMC"),  and PCI Telecom
Mezzanine Card ("PTMC").  Form factors are the shape and size of interface cards
used to expand the  functionality of standard  computer bus  architectures.  For
example,  a PCI system  includes a 32 or 64-bit local bus  architecture  used to
transfer data from a computer's main  microprocessor to peripherals such as hard
disks and video  adapter.  CompactPCI  is an adaptation of the standard PCI on a
larger  rugged design and expands the number of available  slots for  peripheral
devices from four to eight, improves a computer's ability to withstand adverse


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conditions such as extreme vibration and offers "hot swap" capability - allowing
the user to insert and take out the board without turning off the system.  A PMC
card plugs on to a standard PCI, CompactPCI, VME or the new AdvancedTCA ("ACTA")
card enabling it to provide  differing  input/output or computing  functions.  A
PTMC is a PMC card designed specifically for telecommunication applications.

Our  solutions  have been  integrated  into a wide spectrum of  applications  to
enable network and storage connectivity,  including Voice over Internet Protocol
("VoIP"), Wi-Fi, Enhanced 911, enterprise servers, data storage, data messaging,
process  control,  media gateways,  routers,  internet  access devices,  medical
imaging,  CAE/automated test equipment,  government/military defense systems and
telecommunications  networks.  We distribute  our products  worldwide  through a
direct sales force, distributors, independent manufacturers' representatives and
value-added resellers.

SBE was  incorporated in 1961 as Linear Systems,  Inc. In 1976, we completed our
initial  public  offering.  In July  2000,  we  acquired  LAN Media  Corporation
("LMC"),  a  privately  held  company,  to  complement  and grow our WAN adapter
product line from both a hardware and software  perspective.  In August 2003, we
acquired the products and  technologies of Antares  Microsystems to increase the
functionality  of our PCI product  line.  We continue to operate  under a single
business unit.

BUSINESS STRATEGY

Our  objective  is  to  be  a  leading  provider  of  high-performance   network
communications  solutions  by  delivering  reliable,  flexible,   cost-efficient
products in a timely  manner to our  customers,  thus  allowing them to focus on
their core competencies.

During  fiscal  2004,  we made  noteworthy  steps in achieving  this  objective,
including:

o     Making our commitment to existing customers our number one priority

As a proponent of continuous improvement,  we are always identifying new ways to
better serve our  customers.  Over the past year,  to ensure that we fulfill our
commitments to our customers, we strengthened our operations team, including the
addition  of  resources  in the  manufacturing,  technical  support  and quality
departments. In addition, we have implemented a "WebCall" system on our web site
which allows  customers  to address  technical  product  issues with us at their
convenience,  24 hours a day.  Upon  implementation  of this system in the third
quarter  of 2004,  the  average  time to  resolution  for  technical  issues has
improved by 50% from one quarter to the next.

o     New Product Introductions

In  order  to  meet  the  ever-changing  requirements  of the  industry  and our
customers,  we  believe  it is  important  to  maintain  a strong  and  flexible
portfolio of products  designed for easy and quick  deployment into a variety of
unique applications.

      -     TCP/IP  Offload  Engine  ("TOE").  As  Ethernet  speeds  continue to
            increase,  a  progressively  higher  load  is  placed  on the CPU to
            process the messaging traffic and deal with the interface  protocol,
            leaving little computing power left for user applications. SBE's TOE
            board is designed to offload the interface protocol ("TCP/IP stack")
            and manage  messaging  traffic  normally  processed  by the  Central
            Processing  Unit  ("CPU").   This  interface   protocol   offloading


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<PAGE>

            increases user  application  performance  and alleviates  networking
            bottlenecks. We expect that demand for TOE will continue to increase
            as network bandwidth requirements escalate.

      -     ISCSI (Internet Small Computer  System  Interface).  A new market is
            emerging using Ethernet  infrastructure  allowing  "virtual storage"
            flexibility and lower costs. Our Internet Protocol ("IP") management
            solution bundles our dual port Gigabit Ethernet TOE board with PyX's
            enterprise level, high availability iSCSI software  protocol.  Fully
            compliant with IETF iSCSI  standards,  this iSCSI solution  delivers
            multi-path   migration   and  Error   Recovery   Level  Two   (ERL2)
            functionality.  Our iSCSI  product  ensures  that there is no single
            point of failure on the  storage  transport  layer  between  any two
            iSCSI nodes while  simultaneously  offloading  the network  protocol
            processing from the CPU.

      -     Security  Offload Engine.  In September 2004, we announced the first
            in a growing series of board-level  encryption solutions designed to
            accelerate SSL and IPsec cryptographic operations. These are the two
            most common encryption solutions used to provide electronic security
            in use today. Our securePMC-L is a PMC-based security offload engine
            using Cavium Networks' NITROX Lite security processor,  and designed
            to meet the United States  federal  government's  mandated  security
            FIPS  140-2  Level  3  requirements  to be  used  in all  government
            security related applications.

      -     Channelized T3 PMC Adapter.  We launched the wanPMC-C1T3 WAN adapter
            in the first  quarter of fiscal  2004.  Designed to enable  advanced
            voice and data applications,  such as VoIP,  video-on-demand,  voice
            conferencing,  Internet  routing,  and SAN  pipes,  our  wanPMC-C1T3
            integrates a fully  channelized,  single port T3  interface  with an
            HDLC/transparent controller on a PMC slot.

      -     Channelized  24-port  T1/E1:  In  August  2004,  we  introduced  the
            wanPTMC-24TE1,   a  fully  channelized  24-port  T1/E1  PCI  Telecom
            Mezzanine  Card (PTMC) and Rear  Transition  Module (RTM) board set.
            This  solution is designed  for high density  applications,  such as
            VoIP gateways,  computer telephony  softswitches,  TDM switches/PBX,
            and voice conferencing systems.

      -     Linux  "On  Demand".  Recognizing  the  value to our  customers,  we
            continue  developing  Linux software  drivers for SBE products using
            internal resources and those from partnering software companies.  In
            addition to standard  enterprise  level  drivers,  we offer products
            with "real-time" enhancements.

o     Strategic Alliances and Investments

We are committed to expanding our product  offerings by entering into  strategic
business  agreements where we combine our products with those of our partners to
present a cost-effective, completely integrated solution to our customers.


                                      -6-
<PAGE>

      o     PYX  TECHNOLOGIES:  PyX  provides  enterprise  level iSCSI  software
            protocol with Error Recovery Level 2 ("ERL2")  functionality,  tuned
            to operate with our TCP/IP Offload Engine card.  ERL2  functionality
            is required to provide seamless guaranteed delivery of critical data
            whenever storage data is transmitted over the Internet.

      o     TIMESYS:  In a collaborative  effort, SBE and TimeSys, a pioneer and
            leader in Embedded Linux and Java development technologies, continue
            to team to provide the  high-performance and modularity of SBE's WAN
            modules and HighWire carrier-class core processing platforms bundled
            with  the  scalable   computing  power  of  TimeSys  Linux  GPL  and
            cross-platform development tools.

      o     CAVIUM  NETWORKS:  SBE teamed  with  Cavium to  provide  board-level
            encryption   solutions   designed   to   accelerate   SSLand   IPsec
            cryptographic  operations  and  significantly  improve  secure  data
            transmissions for Linux and other applications.

      o     NCOMM: SBE and NComm formed an alliance to provide comprehensive WAN
            solutions   coupling  our  WAN  hardware   interfaces  with  NComm's
            intelligent   top-level  software  drivers  and  tools.  This  joint
            solution  results in significant cost savings for OEMs and speeds up
            time-to-market by 6-12 months.

     ATCA  PARTNER  PROGRAM.  This is our  program  to  align  our PMC and  PTMC
     interface  products with  AdvancedTCA  ("ATCA") system providers to provide
     powerful  telecommunications  networking  solutions.  The ACTA products are
     based on a new standard  industry  form factor that has been  developed for
     use by the telecommunications industry. This form factor allows for greater
     flexibility and network transmission speeds.

      o     DIVERSIFIED  TECHNOLOGIES,  INC ("DTI"): DTI is integrating multiple
            SBE network  interface cards with the Diversified  Technologies ATCA
            system level  platforms to build powerful ATCA platforms for service
            providers in the telecommunications and networking marketplace.

      o     GNP: GNP will complement its product mix by bundling SBE's portfolio
            of  network  interface  cards  into  its  ready-to-deploy  ATCA  and
            CompactPCI  system  solutions  for  its  customer  base  of  network
            equipment manufacturers and large systems integrators.

      o     CONCURRENT TECHNOLOGIES, INC ("CONCURRENT"): SBE and Concurrent have
            entered  into an  agreement  to merge  our  PMC-based  modules  with
            Concurrent's ATCA system solutions. This new alliance is expected to
            result in expanded market coverage for our products.

In fiscal 2005, we plan to further build on the momentum that has been generated
over the past two years by  turning  our  technology  investments  into  strong,
customer-driven  product  solutions,  continuing to diversify our customer base,
and actively seeking out new market opportunities.  Specifically,  our key focus
areas for the upcoming year include:

o     Build  and  Strengthen   Awareness  of  Expanded  Product   Portfolio  and
      Capabilities within Target Markets

With the  recent  release of the TOE,  Encryption  and iSCSI  products,  we will
present our customers with an enhanced line of board-level I/O choices.  We have
launched  an  aggressive  sales and  marketing  campaign  to develop and enhance
awareness of our portfolio of products and capabilities to target audiences. Our
marketing initiatives include print/online advertising,  direct marketing, joint
partner  marketing,  public  relations,  industry  tradeshow  presence,  and web
marketing.


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<PAGE>

o     Broaden Market and Customer Diversification

 With the expansion of our products, we intend to further penetrate existing
territories  and  capture  opportunities  in new markets  and  applications.  In
addition,  we  evaluate  and  reinforce  our  distribution  channels  to broaden
coverage  both  domestically  and  internationally  and allow for a wider set of
application and market targets.

o     Continue to Invest in New Products and Technologies

Continued investment in new products and technologies is critical in driving the
long-term growth and success of the business.  Areas of technological focus over
the next year include:

      o     Voice over IP ("VoIP") PTMC Solution.  Recognizing the opportunities
            in the VoIP marketplace,  we are engaged in the conceptual  research
            and planning for a VoIP media gateway solution.  In the coming year,
            we plan to aggressively execute on our VoIP strategy which leverages
            compatibility with current product offerings.

      o     Expansion   of   HighWire   Line   of   Intelligent   Communications
            Controllers.  We are in the process of completing development on the
            next generation  HighWire  CompactPCI  controller  with  Intelligent
            Platform  Management  Interface ("IPMI") to the backplane,  Ethernet
            switch,  and dual  PTMC  support.  As with our  currently  available
            platforms,  SBE's  future  processors  will be  designed  to provide
            embedded  Linux with the intent to offer  complete  interoperability
            with a broad selection of WAN, LAN, and Storage PMCs.

      o     ATCA Mezzanine Card ("AMC").  ATCA is a new platform that is gaining
            significant momentum in the marketplace.  It is touted to offer OEMs
            in the telecommunications space many benefits,  including new levels
            of scalability and performance. Our wide range of PMC/PTMC-based WAN
            and LAN I/O boards are available for  integration  into today's ATCA
            deployments.  When the AMC specification has been ratified,  it will
            be a natural  progression  for us to evolve our PMC and PTMC modules
            to AMC.

PRODUCTS

We design and provide  network  interface  cards and  communication  controllers
serving the  embedded  markets.  With the  exception  of the TOE  products,  our
network  interface  adapters are open  standards  interface  adapter  cards that
generally do not have a microprocessor onboard ("state machine products").  They
are  designed  to  provide  developers  of  networking  and data  communications
equipment a simple and cost effective way to integrate  WAN, LAN,  SCSI,  iSCSI,
and/or Fibre  Channel  interfaces  into their  systems.  All of our products are
supported  by  communications  software  developed  by SBE and a select group of
third party partners.

Although  SBE  continues  to sell and  manufacture  products  such as  Multibus,
VMEbus,  and ISA, we emphasize  six principal  lines of products:  WAN adapters,
LAN/Ethernet  adapters,  storage network  interface cards ("NICs"),  intelligent
communications controllers,  iSCSI software and custom and specialty I/O and CPU
processing protocol offload products such as TOE and Encryption cards.


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WIDE AREA NETWORKING ADAPTERS

A wide area network is a computer  network that spans a relatively large
geographical  area.  Computers  connected to a WAN are often  connected  through
dedicated  networks,  such as the telephone system,  leased lines or satellites.
Our series of WAN  adapter  products  is  designed  to address  the need for WAN
interfaces  in data  communication  products  such as those used in internet and
other  communications  routers,  security  firewalls,  virtual  private  network
("VPN")  servers  and VoIP  gateways.  We provide a broad  range of  interfaces,
including synchronous serial, T1/E1, High Speed Serial Interface ("HSSI") and T3
in PCI, PMC, and PTMC industry standard form factors.

LOCAL AREA NETWORKING  ADAPTERS

A  local  area  network  is a  computer  network  spanning  a  relatively  small
geographical  area.  Often confined to a single  building or group of buildings,
most LANs connect workstations and personal computers.  Each computer in the LAN
is able to access data and devices,  such as printers,  located  anywhere on the
LAN.  There are many  different  types of LANs but  Ethernet is the most common.
Ethernet LAN  connectivity is utilized by virtually every market segment in both
the embedded and enterprise space.

Our LAN  adapter  products  are  focused  on LAN  connectivity  using high speed
Ethernet technology.  We offer single, dual or quad port LAN adapter PCI and PMC
modules that feature connectivity speeds of up to 10 Mb/second, 100 Mb/second or
1000 Mb/second.  Our Gigabit Ethernet NICs include trunking and failover.  These
features allow our customers' systems to take advantage of static load balancing
and failure recovery within a user-defined  communications trunk. It is designed
to distribute  traffic across the aggregated links,  detects port failures,  and
increases  throughput.  In  the  event  of a link  failure,  the  software  will
automatically redistribute outgoing loads across the remaining links.

STORAGE NETWORK INTERFACE CARDS

Our storage NICs are  comprised of SCSI and Fibre  Channel  products.  SCSI is a
parallel interface standard used by personal computers and many UNIX systems for
attaching  peripheral  devices,  such as printers and disk drives, to computers.
SCSI  interfaces  are  designed  to allow for  faster  transmission  rates  than
standard  serial  ports,  which  transfer  data one bit at a time,  and parallel
ports,  which  simultaneously  transfer  data more  than one bit at a time.  Our
series of SCSI host bus adapters are  specifically  designed for the  enterprise
Sun UNIX market.  With transfer rates ranging from 40 Megabyte ("MB")/sec to 320
MB/sec,  our SCSI  adapters  have been  utilized in data centers and  enterprise
environments  within the financial,  government,  manufacturing,  and healthcare
sectors.  These SCSI  boards are also  utilized in  UNIX-based  SCSI tape backup
systems.

Fibre Channel is a serial data transfer  architecture  developed by a consortium
of computer and mass storage device  manufacturers and is now being standardized
by the American National Standards  Institute  ("ANSI").  Our Fibre Channel host
bus  adapters  are  available  in single or dual port,  1-Gigabit  or  2-Gigabit
versions with copper and/or optical Gigabit transceivers.

iSCSI STORAGE MANAGEMENT SOLUTIONS

iSCSI is an Internet Protocol based storage networking standard for linking data
storage  facilities  which was developed by the Internet  Engineering Task Force
(IETF). By carrying SCSI commands over IP networks,  iSCSI is used to facilitate
data  transfers  over LAN  intranets and to manage  storage over long  distances
(internet).  The iSCSI protocol is among the key  technologies  expected to help


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<PAGE>

further the rapid development of the SAN market space by dramatically increasing
the capabilities  and performance of storage data  transmission at a fraction of
the cost of current SANs.  Because of the ubiquity of IP networks,  iSCSI can be
used to transmit data over LANs,  WANs, or the Internet and can enable  location
independent data storage and retrieval.

Our iSCSI storage  management  solution bundles SBE's dual port Gigabit Ethernet
TOE board with PyX Technologies'  enterprise level, high  availability,  uniform
iSCSI software protocol.  Fully compliant with IETF iSCSI standards,  this iSCSI
product  delivers  multi-path  migration  and ERL2  functionality.  The  SBE/PyX
solution uses active/active  trunking providing seamless connectivity  migration
which supports uninterrupted data flow and aggregation of bandwidth.  This means
that requests from a failed communication path can be automatically  re-assigned
to  active  communication  paths,  allowing  iSCSI  data  to  continue  to  flow
uninterrupted.  As a result,  the solution ensures that there is no single point
of failure on the  storage  transport  layer  between  any two iSCSI nodes while
simultaneously offloading the network protocol processing from the CPU.

CPU OFFLOAD ENGINES

      o   TCP/IP OFFLOAD ENGINE

      Today's  modern  networks  incorporate  packet  communications  for a wide
      variety of applications linking WANs, LANs, and SANs. TCP/IP is the common
      thread  throughout and the de-facto packet standard that was developed for
      the internet.  Ironically,  TCP/IP has also become the major bottleneck in
      high speed networks.

      A TOE is a highly specialized TCP/IP protocol accelerator.  Typically,  in
      the form of a NIC,  it is designed to reduce the amount of host CPU cycles
      required for TCP/IP processing and maximize Ethernet  throughput.  This is
      accomplished  by  offloading  TCP/IP  protocol  processing  from  the host
      processor to the hardware on the TOE.

      Our dual  port  Gigabit  Ethernet  controller  with  full  TCP/IP  offload
      capabilities  for  maximizing  the  performance  of  demanding   TCP-based
      applications  is designed to reduce the amount of CPU cycles  required for
      TCP/IP  processing  while  optimizing  the  Ethernet  throughput.  Our TOE
      solution  processes TCP/IP at network speeds,  provides full  segmentation
      and reassembly,  terminates multiple simultaneous  sessions, and minimizes
      transaction latency - all without host intervention.

      o   SECURITY OFFLOAD ENGINE

      The rapid  changes of the  information  age have put  increasing  security
      demands on enterprise  networks,  such as VPNs,  portals and corporate web
      sites over the last few years.  With the  expansion of network  boundaries
      come  the  inevitable  need  for  effective   solutions  to  secure  these
      enterprise  connections.  In September  2004, we introduced the first in a
      growing  series  of  security  offload   solutions  for  integration  into
      Linux-based  systems.  Based on  Cavium  Networks'  Nitrox  Lite,  our new
      encryption   board  is  designed  to   accelerate   SSL,  WLAN  and  IPsec
      cryptographic operations and significantly improve security,  performance,
      and availability of Linux and other embedded applications.


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INTELLIGENT COMMUNICATIONS CONTROLLERS

The HighWire products are  "intelligent,"  containing their own  microprocessors
and memory. This architecture  allows our communications  controllers to offload
many of the lower-level  communications  tasks that would typically be performed
by the host platform.

In  the  telecommunications   market,  the  HighWire  series  of  communications
controller products provide high bandwidth  intelligent  connectivity to servers
designed to act as gateways and signaling points within  communication  networks
and network devices. The HighWire co-processing  controllers enable operators of
wireline  and  wireless  networks  to  deliver  Intelligent  Network  ("IN") and
Advanced   Intelligent  Network  ("AIN")  services  such  as  Caller  ID,  voice
messaging,  personal number calling,  Service Provider Local Number Portability,
and customized routing and billing, as well as digital wireless services such as
Personal   Communications   Systems   ("PCS")  and  Global   System  for  Mobile
Telecommunications  ("GSM").  The HighWire products are designed for integration
with standard server platforms that enable traditional  carriers and new telecom
entrants to pursue cost-reduced and  performance-enhanced  network architectures
based on Internet Protocol ("IP"), broadband or other "packet" technologies.

We offer embedded Linux operating  system software that enables several HighWire
products to be combined  with any of our WAN and LAN PMC products or other third
party PMC form  factor  products  to provide  core  computing  and  connectivity
solutions to the  communications,  military/government,  medical and  industrial
control  markets.  Utilizing  our HighWire  products in  conjunction  with other
available PMC modules,  such as A-to-D  converters or video capture PMC modules,
opens up new opportunities to market the products for factory/process control or
video surveillance applications.

VMEBUS

Our line of legacy VMEbus products continues to be sold to government,  military
and  industrial  customers.  Our VME  products  are  intelligent  communications
controllers   used  to  provide   connectivity   between  a  system  such  as  a
mini-computer  or  bridge/router  and a local or wide area  network.  Our VMEbus
communications products target four major protocol communications  technologies:
Fiber Distributed Data Interface  ("FDDI"),  Token Ring, Ethernet and high-speed
serial communications.

The  following  table shows sales by major  product type as a percentage  of net
sales for fiscal 2004, 2003 and 2002:

                                      Year Ended October 31,
                              2004              2003               2002
                         ------------------------------------------------
                                      (percentage of net sales)

         VME                    43%                53%              56%
         WAN Adapter            34                 30               31
         LAN Adapter             8                  5                0
         Storage NIC             4                  2                0
         HighWire               11                 10               13
                         ------------------------------------------------
                               100%               100%             100%
                         ================================================


                                      -11-
<PAGE>

DISTRIBUTION, SALES, AND MARKETING

We market our WAN, LAN, storage, intelligent communication controller, specialty
I/O and protocol  processing offload products to OEMs,  distributors and systems
integrators. We sell our products both domestically and internationally, using a
direct  sales  force  as well  as  independent  manufacturers'  representatives,
resellers,  and  distributors.  We believe  that our direct  sales force is well
suited to communicate and promote our products and how they  differentiate  from
those of our competitors.  Since our products  represent a complex and technical
sale,  our  sales  force is  supported  by  application  engineers  who  provide
customers with pre-sale technical assistance.

Our internal  sales and marketing  organization  supports our channel  marketing
partners  by  providing   sales   collateral,   such  as  product  data  sheets,
presentations,  and  other  sales/marketing  resource  tools.  Our  sales  staff
solicits  prospective  customers,  provides technical advice with respect to our
products,  and works closely with marketing  partners to train and educate their
staffs on how to sell, install, and support our product lines.

We have focused our sales and  marketing  efforts in North  America,  Europe and
Asia.  All  of  our   international   sales  are  negotiated  in  U.S.  dollars.
International  sales  constituted  12%, 12% and 13% of net sales in fiscal 2004,
2003 and 2002,  respectively.  International  sales are executed in U.S. dollars
and are principally transacted in Europe.

Our direct sales force is based in three  locations in the United  States and we
conduct  our  marketing  activities  from our  principal  office  in San  Ramon,
California.

RESEARCH AND DEVELOPMENT

We believe  that  continued  research  and  development  in current and emerging
technologies is critical to maintaining our competitive position in the embedded
and enterprise  markets.  Many factors are involved in determining the strategic
direction of our product development focus, including trends and developments in
the  marketplace,  competitive  analyses,  and feedback  from our  customers and
strategic partners.  We actively support and contribute to standards development
organizations  and trade groups,  which define and promote existing and emerging
technologies for both the embedded and enterprise  arenas.  We belong to several
influential industry associations, including VME International Trade Association
("VITA") and PCI Industrial Computers Manufacturers Group ("PICMG").

Our product development efforts are focused principally on our strategic product
lines,  providing high bandwidth connectivity and computing solutions that serve
a wide range of networking applications. Leveraging our experience in high-speed
data  communications  and  telecommunications  enables us to develop  integrated
communications  solutions for our customers.  We believe that the development of
new internetworking products,  high-performance  communications  controllers and
enabling  communications  software is essential to expanding our customer  base,
penetrating new markets, and retaining existing customers.

During the past four years, we have developed  communications  products based on
PCI,  CompactPCI,  PMC, PTMC,  and  HyperTransport  architectures.  We have also
redesigned and upgraded certain communications products to take advantage of new


                                      -12-
<PAGE>

technologies offering improved product performance and lower costs. In addition,
we have acquired or licensed certain hardware products that have been integrated
principally through the addition of software into our product line.

During  fiscal 2004,  we continued to focus on further  expansion of our line of
standards-based WAN adapters,  upgrading/enhancing  software drivers, developing
new products based on emerging technologies, such as TCP/IP Offload, Encryption,
and iSCSI.  These  hardware and software  design efforts have enabled us to more
effectively  target  existing and emerging  markets in areas such as VoIP,  VPN,
security   routers,   telecommunications,   military/government,   medical   and
industrial control

During fiscal 2004,  2003 and 2002,  we incurred $2.4 million,  $1.3 million and
$3.0 million, respectively, in product research and development expenses.

COMMITMENT TO QUALITY

We have been an ISO certified supplier of communications products since 1991. In
December  2001,  we achieved  certification  to the  internationally  recognized
ISO9001:  2000 Standard.  As part of our ongoing  commitment to quality,  we are
regularly  inspected by an audit team from Bureau Veritas Quality  International
(NA) Inc.  ("BVQI").  These audits ensure that our internal quality system meets
internationally recognized quality management systems standards. We believe that
our  customers'  success  depends on the delivery of  high-quality  products and
services.  Our adherence to ISO standards and resulting quality practices is our
way of guaranteeing that customer expectations are met and exceeded.

MANUFACTURING

We do not engage in any  manufacturing  activities.  Instead,  we utilize  third
party  manufacturers  to build our  products.  We currently  have  non-exclusive
manufacturing agreements with ProWorks, Inc. and Sonic Manufacturing Technology.
We believe that  ProWorks and Sonic are equipped to provide more  cost-efficient
and timely product  delivery than could otherwise be obtained if we manufactured
our product internally.  The use of external manufacturing partners allows us to
better respond to fluctuations in customer demand.

COMPETITION

The  market for  networking  and  communications  interface  products  is highly
competitive.  Many of our competitors have greater  financial  resources and are
well established in the space.  Competition within the communications  market is
fragmented  principally by application  segment.  Our HighWire  products compete
with offerings from Radisys Corp,  Performance  Technologies,  Interphase  Corp,
Artesyn Technologies, and Adax, along with various other platform and controller
product  providers.  Our VMEbus,  WAN adapter and LAN adapter  products  compete
primarily  with products from  Performance  Technologies,  Motorola,  Interphase
Corp.,  Themis  Computers,  SBS  Technologies  and various other  companies on a
product-by-product  basis.  Our SCSI products  compete with LSI Logic,  Adaptec,
Qlogic and Sun  Microsystems.  Our Fibre Channel  products compete with products
from QLogic  Corp and Emulex  Corp.  Our TOE  products  compete  with QLogic and


                                      -13-
<PAGE>

Adaptec.  Our encryption  solutions  compete with Extreme  Engineering,  Layer N
Networks,  and InterfaceMasters.  To compete and differentiate  ourselves in our
markets, we emphasize the functionality,  engineering support, quality and price
of our  product  in  relation  to our  competitors,  as well as our  ability  to
customize the product to meet the customer's specific application needs.

Additionally,  we  compete  with  the  internal  engineering  resources  of  our
customers.  As our customers become successful with their products, they examine
methods to reduce costs and  integrate  functions.  To compete with the internal
engineering  resources of our customers,  we work jointly with their engineering
staffs  to  understand  each  customer's  specific  system  requirements  and to
anticipate new product needs versus time-to-market decisions.

INTELLECTUAL PROPERTY

We  believe  that  our  ability  to  innovate  in  product  engineering,  sales,
marketing, support, and customer relations, and then to protect this proprietary
technology and knowledge impacts our future success. We rely on a combination of
copyright,  trademark, trade secret laws and contractual provisions to establish
and protect our  proprietary  rights in our  products.  We  currently  hold four
patents. We typically enter into confidentiality  agreements with our employees,
strategic  partners,   channel  partners  and  suppliers,   and  enforce  strict
limitations and the access to our proprietary information.

BACKLOG

On October 31, 2004, we had a sales backlog of product  orders of  approximately
$2.5  million,  including  $1.0  million in orders from HP,  compared to a sales
backlog of product orders of approximately $4.1 million,  including $2.0 million
in orders from HP, one year ago. Because customer purchase orders are subject to
changes in customer  delivery  schedules,  cancellation,  or price changes,  our
backlog as of any particular date may not be  representative of actual sales for
any succeeding  fiscal period.  We do not anticipate any problems in filling our
current backlog.

EMPLOYEES

On December 31, 2004, we had 36 employees.  None of our employees is represented
by a labor union. We have experienced no work stoppages. We believe our employee
relations are positive.

We believe  that our future  success  will  depend,  in part,  on our ability to
attract and retain qualified technical (particularly engineering), marketing and
management  personnel.  Such experienced  personnel are in great demand,  and we
must compete for their  services  with other  firms,  many of which have greater
financial resources.


                                      -14-
<PAGE>

RISK FACTORS

Our  business is subject  to, but not  limited  to, the risks and  uncertainties
described below.

                          RISKS RELATED TO OUR BUSINESS

WE  DEPEND  UPON A SMALL  NUMBER  OF OEM  CUSTOMERS.  THE  LOSS OF ANY OF  THESE
CUSTOMERS,  OR THEIR FAILURE TO SELL THEIR PRODUCTS,  WOULD LIMIT OUR ABILITY TO
GENERATE REVENUES.

In fiscal  2004,  most of our sales were  derived  from a limited  number of OEM
customers.  In  fiscal  2004,  2003  and  2002,  sales  of VME  products  to The
Hewlett-Packard  Company  (previously Compaq Computer) ("HP") accounted for 45%,
45% and 30%, respectively, of our net sales. A substantial portion of such sales
were  attributable  to sales of VME  products  pursuant  to a  long-term  supply
agreement  with HP that is no longer in effect.  We will ship the remaining $1.0
million of the last order for VME products to HP in the first fiscal  quarter of
fiscal 2005.  We can provide no assurance  that we will succeed in obtaining new
orders from  existing or new  customers  sufficient to replace or exceed the net
sales previously attributable to HP.

Orders  by our OEM  customers  are  affected  by  factors  such  as new  product
introductions,  product life cycles, inventory levels, manufacturing strategies,
contract awards,  competitive  conditions and general economic  conditions.  Our
sales to any single OEM  customer are also  subject to  significant  variability
from quarter to quarter. Such fluctuations may have a material adverse effect on
our operating  results.  A  significant  reduction in orders from any of our OEM
customers,  would  have a  material  adverse  effect on our  operating  results,
financial  condition  and cash flows.  In addition,  we anticipate a significant
portion of future sales will be dependent on a few new OEM customers,  and there
can be no  assurance  that we will  become  a  qualified  supplier  with new OEM
customers  or that  we will  remain  a  qualified  supplier  with  existing  OEM
customers.

THE COMMUNICATIONS AND STORAGE PRODUCTS MARKET IS INTENSELY COMPETITIVE, AND OUR
FAILURE TO COMPETE EFFECTIVELY COULD REDUCE OUR REVENUES AND MARGINS.

We compete directly with traditional vendors of terminal servers, modems, remote
control  software,   terminal   emulation   software  and   application-specific
communications and storage solutions. We also compete with suppliers of routers,
hubs,  network  interface  cards  and  other  data  communications  and  storage
products.   In  the  future,  we  expect  competition  from  companies  offering
client/server  access solutions based on emerging  technologies such as switched
digital  telephone  services,  iSCSI,  SCSI,  TOE  and  other  technologies.  In
addition,  we may encounter  increased  competition  from  operating  system and
network  operating  system  vendors  to the extent  such  vendors  include  full
communications and storage capabilities in their products. We may also encounter
future  competition  from  telephony  service  providers  (such  as  AT&T or the
regional  Bell  operating  companies)  that may  offer  communications  services
through their telephone networks.

Increased  competition with respect to any of our products could result in price
reductions and loss of market share,  which would adversely affect our business,
operating results,  financial  condition and cash flows. Many of our current and
potential  competitors have greater  financial,  marketing,  technical and other


                                      -15-
<PAGE>

resources  than we do. There can be no assurance that we will be able to compete
successfully  with  our  existing   competitors  or  will  be  able  to  compete
successfully with new competitors.

WE HAVE INCURRED  OPERATING  LOSSES IN THE PAST AND MAY NOT BE PROFITABLE IN THE
FUTURE.

The consolidated  financial statements contemplate the realization of assets and
the  satisfaction  of liabilities in the normal course of business.  Although we
had a net loss of $1.7  million  for  fiscal  2004,  we did have net  income  of
$563,000 for fiscal 2003 and had eight consecutive  profitable quarters prior to
the loss in our fourth quarter of fiscal 2004. We generated  negative cash flows
from operations of $140,000,  $84,000 and $2.7 million for fiscal 2004, 2003 and
2002,  respectively  We believe our existing cash plus  additional cash from our
line of credit and continuing  operations will provide  sufficient cash flows to
fund our operations through October 31, 2005. However, these our cash flows from
future operations is dependent on projected sales are to a limited number of new
and existing  OEM  customers  and are based on internal  and  customer  provided
estimates of future  demand,  not firm  customer  orders.  In addition,  we must
successfully  sell and  distribute  for our new TOE and iSCSI  products.  If the
projected sales do not materialize,  we will need to reduce expenses further and
potentially  raise  additional  capital  through  customer  prepayments  or  the
issuance of debt or equity  securities.  If additional  funds are raised through
the issuance of preferred  stock or debt,  these  securities  could have rights,
privileges or  preferences  senior to those of Common Stock,  and debt covenants
could impose  restrictions on our  operations.  The sale of equity or debt could
result in additional  dilution to current  stockholders,  and such financing may
not be available to us on acceptable terms, if at all.

OUR OPERATING  RESULTS IN FUTURE  PERIODS ARE LIKELY TO FLUCTUATE  SIGNIFICANTLY
AND MAY FAIL TO MEET THE  EXPECTATIONS  OF  SECURITIES  ANALYSTS  OR  INVESTORS,
CAUSING OUR STOCK PRICE TO FALL.

Our quarterly  operating  results have fluctuated  significantly in the past and
are likely to fluctuate significantly in the future due to several factors, some
of which are outside our control,  including  timing of significant  orders from
OEM  customers,  fluctuating  market  demand  for,  and  declines in the average
selling prices of, our products, delays in the introduction of our new products,
competitive  product  introductions,  the mix of products  sold,  changes in our
distribution  network,  the  failure to  anticipate  changing  customer  product
requirements,  the cost and  availability  of  components  and general  economic
conditions.  We generally do not operate with a significant order backlog, and a
substantial  portion of our revenue in any quarter is derived from orders booked
in that quarter.  Accordingly,  our sales expectations are based almost entirely
on our internal estimates of future demand and not on firm customer orders.

Due to the adverse economic conditions in the  telecommunications  industry, our
OEM  telecommunications  customers may hold excess inventory of our products.  A
result  of  the   economic   downturn   and   slowness   in   recovery   of  the
telecommunications  market is that certain of our  customers  have  cancelled or
delayed many of their new design projects and new product rollouts that included
our  products.  Due to the  current  economic  uncertainty,  our  customers  now
typically  require a "just-in-time"  ordering and delivery cycle where they will
place a purchase order with us after they receive an order from their  customer.
This  "just-in-time"   inventory  purchase  cycle  by  our  customers  has  made
forecasting of our future sales volumes very difficult.


                                      -16-
<PAGE>

Based on the foregoing,  we believe that quarterly  operating results are likely
to vary significantly in the future and that period-to-period comparisons of our
results of operations  are not  necessarily  meaningful and should not be relied
upon as indications of future  performance.  Further,  it is likely that in some
future quarter our revenue or operating  results will be below the  expectations
of public market analysts and investors.  In such event, the price of our common
stock is likely to fall.

IF WE  ARE  UNABLE  TO  KEEP  UP  WITH  THE  RAPID  TECHNOLOGICAL  CHANGES  THAT
CHARACTERIZE OUR INDUSTRY, OUR BUSINESS WOULD SUFFER.

The markets for our products are characterized by rapidly changing technologies,
evolving industry standards and frequent new product  introductions.  Our future
success  will  depend on our  ability to enhance our  existing  products  and to
introduce  new  products  and  features to meet and adapt to  changing  customer
requirements  and  emerging  technologies  such as VoIP"),  3G Wireless  ("Third
Generation  Wireless Services") SATA ("Serial ATA"), SAS (Serial Attached SCSI")
iSCSI , Gigabit Ethernet, 10 Gigabit Ethernet and TOE. There can be no assurance
that  we  will be  successful  in  identifying,  developing,  manufacturing  and
marketing new products or enhancing our existing  products.  In addition,  there
can be no assurance that services,  products or technologies developed by others
will not render our products noncompetitive or obsolete.

We have focused a significant portion of our research and development, marketing
and sales efforts on HighWire, WAN and LAN adapters,  Encryption,  iSCSI and TOE
products.  The  success of these  products  is  dependent  on  several  factors,
including timely  completion of new product  designs,  achievement of acceptable
manufacturing quality and yields,  introduction of competitive products by other
companies and market acceptance of our products. If the TOE, iSCSI, HighWire and
adapter  products  or other  new  products  developed  by us do not gain  market
acceptance, our business,  operating results, financial condition and cash flows
would be materially adversely affected.

WE DEPEND ON OUR KEY PERSONNEL. IF WE ARE UNABLE TO RETAIN OUR CURRENT PERSONNEL
AND HIRE ADDITIONAL QUALIFIED PERSONNEL AS NEEDED, OUR BUSINESS WOULD BE HARMED.

We are highly dependent on the technical, management, marketing and sales skills
of a limited number of key employees. We do not have employment agreements with,
or life  insurance  on the lives of, any of our key  employees.  The loss of the
services of any key employee could  adversely  affect our business and operating
results.  Our future  success  will depend on our ability to continue to attract
and  retain  highly  talented  personnel  to  the  extent  our  business  grows.
Competition for qualified personnel in the networking  industry,  and in the San
Francisco  Bay  Area,  is  intense.  There can be no  assurance  that we will be
successful  in  retaining  our key  employees  or that we can  attract or retain
additional skilled personnel as required.

BECAUSE OF OUR  DEPENDENCE ON SINGLE  SUPPLIERS FOR SOME  COMPONENTS,  WE MAY BE
UNABLE TO OBTAIN AN ADEQUATE SUPPLY OF SUCH COMPONENTS, OR WE MAY BE REQUIRED TO
PAY HIGHER PRICES OR TO PURCHASE COMPONENTS OF LESSER QUALITY.

The  chipsets  used in most of our products are  currently  available  only from
Motorola or in the case of the TOE products from LeWiz Communications,  Inc.. In
addition,  certain other  components  are currently  available  only from single
suppliers.  The inability to obtain sufficient key components as required, or to
develop  alternative  sources if and as required in the future,  could result in


                                      -17-
<PAGE>

delays or reductions in product shipments or margins that, in turn, would have a
material adverse effect on our business,  operating results, financial condition
and cash flows.

OUR FUTURE  CAPITAL  NEEDS MAY EXCEED  OUR  ABILITY TO RAISE  CAPITAL OR USE OUR
EXISTING CREDIT LINE WITH A BANK.

The engineering  development and marketing of our products is capital-intensive.
While we believe that our existing cash balances and our  anticipated  cash flow
from  operations  will  satisfy  our working  capital  needs for the next twelve
months, we cannot assure that this will be the case.  Declines in our sales or a
failure  to keep  expenses  in  line  with  revenues  could  require  us to seek
additional  financing  or force us to draw down on our  existing  line of credit
with a Bank in fiscal 2005.  Due to the net loss in our fourth quarter of fiscal
2004, we are not in compliance  with our Bank line of credit debt  covenants and
may not be able to use that  credit  line  unless  the Bank  agrees to waive the
covenant  violation.  In addition,  should we experience a significant growth in
customer  orders,  we may be  required  to seek  additional  capital to meet our
working capital needs. There can be no assurance that additional  financing,  if
required,  will be available on  reasonable  terms or at all. To the extent that
additional   capital  is  raised  through  the  sale  of  additional  equity  or
convertible  debt  securities,  the issuance of such securities  could result in
additional dilution to our stockholders.

WE MAY BE UNABLE TO PROTECT OUR  INTELLECTUAL  PROPERTY,  WHICH COULD REDUCE ANY
COMPETITIVE ADVANTAGE WE HAVE.

Since we believe  that our future  success will depend  primarily on  continuing
innovation,  sales,  marketing and technical  expertise,  the quality of product
support and customer relations,  we must also protect the proprietary technology
contained  in our  products.  We  currently  hold  two  patents  and two  patent
applications,  and also rely on a  combination  of copyright,  trademark,  trade
secret laws and  contractual  provisions  to establish  and protect  proprietary
rights of our products. There can be no assurance that steps taken by us in this
regard will be adequate to deter  misappropriation  or  independent  third-party
development  of our  technology.  Although  we  believe  that our  products  and
technology do not infringe on the proprietary rights of others,  there can be no
assurance that third parties will not assert infringement claims against us.


               RISKS ASSOCIATED WITH OWNERSHIP OF OUR COMMON STOCK

OUR COMMON STOCK IS AT RISK FOR DELISTING FROM THE NASDAQ SMALLCAP MARKET. IF IT
IS DELISTED, OUR STOCK PRICE AND YOUR LIQUIDITY MAY BE IMPACTED.

Our common stock is currently listed on the Nasdaq SmallCap  Market.  Nasdaq has
requirements  that a company  must meet in order to remain  listed on the Nasdaq
SmallCap Market.  These requirements  include  maintaining a minimum closing bid
price  of  $1.00  and  minimum   stockholders'   equity  of  $2.5  million.  Our
stockholders'  equity as of October 31, 2004 was $4.3  million.  The closing bid
price for our common stock has been below $1.00 for short periods of time in the
past.  If the closing bid price of our common  stock is below $1.00 for a period
of 30  consecutive  trading days, our common stock could be subject to delisting
from the Nasdaq SmallCap Market.

If we fail to  maintain  the  standards  necessary  to be quoted  on the  Nasdaq
SmallCap  Market and our common stock is  delisted,  trading in our common stock
would be  conducted  on the OTC  Bulletin  Board as long as we  continue to file


                                      -18-
<PAGE>

reports  required by the  Securities and Exchange  Commission.  The OTC Bulletin
Board is  generally  considered  to be a less  efficient  market than the Nasdaq
SmallCap  Market,  and our stock price,  as well as the  liquidity of our Common
Stock, may be adversely impacted as a result.

THE MARKET PRICE OF OUR COMMON  STOCK IS LIKELY TO CONTINUE TO BE VOLATILE.  YOU
MAY NOT BE ABLE TO  RESELL  YOUR  SHARES  AT OR ABOVE  THE  PRICE  AT WHICH  YOU
PURCHASED SUCH SHARES.

The  trading  price of our  common  stock is  subject  to wide  fluctuations  in
response to quarter-to-quarter fluctuations in operating results, the failure to
meet  analyst  estimates,  announcements  of  technological  innovations  or new
products  by us or our  competitors,  general  conditions  in the  computer  and
communications  industries  and other  events or  factors.  In  addition,  stock
markets have experienced  extreme price and trading volume  volatility in recent
years.  This  volatility  has had a  substantial  effect on the market prices of
securities of many high technology companies for reasons frequently unrelated to
the  operating  performance  of  the  specific  companies.  These  broad  market
fluctuations may adversely affect the market price of our common stock.

OUR CERTIFICATE OF INCORPORATION AND BYLAWS AND THE DELAWARE GENERAL CORPORATION
LAW CONTAIN PROVISIONS THAT COULD DELAY OR PREVENT A CHANGE IN CONTROL.

Our board of directors  has the  authority  to issue up to  2,000,000  shares of
preferred stock and to determine the price,  rights,  preferences and privileges
of those  shares  without any further  vote or action by the  stockholders.  The
rights of the holders of common stock will be subject to, and may be  materially
adversely affected by, the rights of the holders of any preferred stock that may
be issued in the future.  The issuance of preferred  stock could have the effect
of making it more  difficult  for a third  party to  acquire a  majority  of our
outstanding  voting  stock.   Furthermore,   certain  other  provisions  of  our
certificate  of  incorporation  and bylaws may have the  effect of  delaying  or
preventing  changes in control or management,  which could adversely  affect the
market price of our common stock. In addition,  we are subject to the provisions
of Section 203 of the Delaware General Corporation Law, an anti-takeover law.

ITEM 2.           PROPERTIES

In December 2001, we relocated our engineering and  administrative  headquarters
to 15,000  square feet of leased  space  located in San Ramon,  California.  The
lease expires in 2006. We expect the facility to satisfy our  anticipated  needs
for the  foreseeable  future.  In  conjunction  with the  relocation  to the new
building,  we  assigned  the lease  related to our  former  63,000  square  foot
engineering and  administrative  headquarters to a third party.  The third party
has assumed payment of the remaining  lease payments  through the termination of
the original lease term in 2006 and we are a secondary guarantor.

ITEM 3.           LEGAL PROCEEDINGS

We are not a party to any pending legal proceedings.


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

There  were no matters  submitted  to a vote of our  stockholders  in the fourth
quarter of 2004.


                                      -19-
<PAGE>

IDENTIFICATION OF EXECUTIVE OFFICERS

Our executive officers and their respective ages and positions as of October 31,
2004 are set forth in the following table.  Our Board of Directors  accepted the
retirement of Mr.  William Heye,  Jr. as President and Chief  Executive  Officer
effective  December  31,  2004 and  appointed  Mr.  Dan Grey as his  replacement
effective  January 1, 2005.  Mr. Grey will  continue to serve as the Senior vice
President,  Sales and Marketing.  Executive  officers serve at the discretion of
the  board  of  directors.  There  are no  familial  relationships  between  our
directors or our executive officers and any other director or executive officer.

Name                       Age        Position
--------------------------------------------------------------------------------

William B. Heye, Jr.       66         President and Chief Executive Officer

David W. Brunton           54         Vice President, Finance, Chief Financial
                                      Officer, Treasurer and Secretary

Dan Grey                   49         Senior Vice President, Sales and Marketing

Carl Munio                 54         Vice President, Engineering

Kirk Anderson              45         Vice President, Operations

Yee-Ling Chin              29         Vice President, Marketing

Mr. Heye joined us in November 1991 as President,  Chief  Executive  Officer and
member of the Board of  Directors.  Mr. Heye will retire from active  management
effective  December 31, 2004. From 1989 to November 1991, he served as Executive
Vice President of Ampex Corporation, a manufacturer of high-performance scanning
recording  systems,  and  President  of  Ampex  Video  Systems  Corporation,   a
wholly-owned  subsidiary of Ampex Corporation and a manufacturer of professional
video  recorders and editing systems for the television  industry.  From 1986 to
1989,  Mr.  Heye  served  as  Executive  Vice  President  of  Airborn,  Inc.,  a
manufacturer  of components  for the aerospace  and military  markets.  Prior to
1986,  Mr.  Heye  served  in  various  senior  management   positions  at  Texas
Instruments,  Inc. in the United States and overseas,  including  Vice President
and General  Manager of Consumer  Products and  President  of Texas  Instruments
Asia, Ltd., with headquarters in Tokyo, Japan.

Mr.  Brunton  joined  us in  November  2001 as Vice  President,  Finance,  Chief
Financial Officer,  Secretary and Treasurer.  From 2000 to 2001 he was the Chief
Financial  Officer for NetStream,  Inc., a telephony  broadband  network service
provider.  From 1997 to 2000,  Mr. Brunton was the Chief  Financial  Officer and
Senior Vice President - Operations for ReSourcePhoenix.com, a financial services
outsource provider.  From 1987 to 1997, Mr. Brunton was the Corporate Controller
for  the  Phoenix  American   Companies,   an  equipment   leasing,   cable  TV,
telecommunications  and software development company. Mr. Brunton is a certified
public accountant who prior to 1987 was with Arthur Andersen & Co.

Mr. Grey has served as Senior Vice President Sales and Marketing since May 2001.
For the 18 months  prior to SBE, he was the Senior Vice  President  of Sales for
SBS  Technologies.  From 1999 to 2000,  Mr. Grey was Vice President of Sales for


                                      -20-
<PAGE>

LAN Media Corporation, a company later acquired by SBE. Mr. Grey was the Western
Regional Sales Manager from 1996 to 1999 for Performance Technologies, Inc. From
1989 to 1996, Mr. Grey served as the Director of Western Sales for SBE. Mr. Grey
will assume the additional  positions of President and Chief  Executive  Officer
effective January 1, 2005.

Mr.  Munio  joined SBE in August 2003  following  SBE's  acquisition  of Antares
Microsystems.  From 1996 to August  2003,  Mr.  Munio served as CTO for Antares,
where he drove product developments in emerging and existing technologies. Prior
to joining  Antares,  he was Director of Operations  Product  Engineering at Sun
Microsystems for over 11 years, and served in a variety of management  positions
during a 12-year tenure at Hewlett-Packard.

Mr.  Anderson has served as Vice  President,  Operations  since October 2001. He
joined  us as  Manager  of  Operations  in 1997 and was  promoted  to  Director,
Operations in 1999. Prior to joining us Mr. Anderson was the Manager,  Marketing
Logistics  for  Wesley  Jessen  from 1994 to 1997 where he was  responsible  for
logistical  planning and manufacturing  budgeting and control.  Prior to 1994 he
held various  management  positions in  operations,  finance and  marketing  for
several   high-tech   companies   in   Silicon   Valley,    including   Vitalink
Communications, a pioneer in internetworking products.

Ms. Chin joined us in July 2003 as Vice President, Marketing. From 1998 to 2003,
she served as Director of Marketing Communications for SBS Technologies.


                                     PART II

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

Our common stock is quoted on the Nasdaq  SmallCap Market under the symbol SBEI.
The following  table  presents  quarterly  information on the price range of our
common  stock,  indicating  the high and low bid prices  reported  by the Nasdaq
SmallCap  Market.  These  prices do not include  retail  markups,  markdowns  or
commissions.  As of December 31, 2004, there were  approximately  394 holders of
record of our common stock.

There are no  restrictions  on our  ability  to pay  dividends;  however,  it is
currently  the  intention of our Board of Directors to retain all  earnings,  if
any, for use in our business and we do not  anticipate  paying cash dividends in
the foreseeable future. Any future  determination as to the payment of dividends
will depend,  among other  factors,  upon our  earnings,  capital  requirements,
operating results and financial condition.

                                    Fiscal quarter ended
                    ---------------------------------------------------------
Fiscal 2004         January 31        April 30         July 31     October 31
-----------------------------------------------------------------------------
    High                $8.49           $7.34          $4.08           $3.19
    Low                  4.76            3.90           2.81            2.68
Fiscal 2003
    High                $1.26           $0.95          $2.99           $6.00
    Low                  0.56            0.64           0.77            2.42


                                      -21-
<PAGE>

The following table includes information regarding our equity incentive plans as
of the end of fiscal 2004.

                      Equity Compensation Plan Information

<TABLE>
<CAPTION>
                                                                                           Number of securities
                                                                                         remaining available for
                                Number of securities to     Weighted-average exercise     future issuance under
                                be issued upon exercise       price of outstanding      equity compensation plans
                                of outstanding options,         options, warrants         (excluding securities
Plan category                     warrants and rights              and rights            reflected in column (a))
-------------                     -------------------              ----------            ------------------------
                                          (a)                          (b)                         (c)
<S>                                   <C>                             <C>                       <C>
Equity compensation plans
   approved by security
   holders                            1,319,666                       $3.75                     1,091,266
Equity compensation plans
   not approved by security
   holders                              617,453                       $2.53                        26,250
                                     ----------                       -----                    ----------
   Total                              1,937,119                       $3.36                     1,117,516
                                     ----------                       -----                    ----------
</TABLE>


ITEM 6.  SELECTED FINANCIAL DATA

The following selected consolidated financial data should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations"  and the  Consolidated  Financial  Statements  and the Notes thereto
included elsewhere in this Form 10-K.

<TABLE>
<CAPTION>
For years ended October 31,
  and at October 31                        2004            2003           2002           2001            2000
-------------------------------------------------------------------------------------------------------------
(in thousands, except for per share amounts and number of employees)

<S>                                     <C>            <C>             <C>             <C>            <C>
Net sales                               $11,066        $  7,456        $  6,898        $ 7,726        $ 29,178

Net income (loss)                       $(1,679)       $    563        $ (1,731)       $(9,896)       $  3,970

Net income (loss) per share - basic     $( 0.33)       $   0.13        $  (0.46)       $ (2.92)       $   1.24

Net income (loss) per share - diluted   $  1.04        $  (0.33)       $   0.12        $ (0.46)       $  (2.92)

Product research and development        $ 2,411        $  1,330        $  3,027        $ 5,652        $  5,635
Expenses

Working capital                         $ 3,970        $  3,945        $  2,985        $ 7,595        $ 11,793

Total assets                            $ 6,173        $  6,975        $  5,321        $10,690        $ 17,427

Long-term liabilities                   $   139        $    217        $     10        $ 4,870        $    288

Stockholders' equity                    $ 4,303        $  5,387        $  3,696        $ 4,119        $ 13,829

Number of employees                          36              32              24             47              87
</TABLE>


                                      -22-
<PAGE>

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

SBE, Inc.  architects and provides network  communications and storage solutions
to the original  equipment  manufacturers  ("OEM") in the embedded computing and
storage markets.  Our solutions enable data  communications,  telecommunications
and storage  solution  companies in addition to enterprise class high-end server
clients  to  rapidly  deliver  advanced  networking  and  storage  products  and
services.  Our products  include wide area network  ("WAN"),  local area network
("LAN"),  Internet Small Computer System  Interface  ("iSCSI")  software,  SCSI,
Fibre Channel,  intelligent carrier cards,  Encryption and TCP/IP Offload Engine
("TOE") cards. These products perform critical  computing,  processing  offload,
Input/Output  ("I/O") and storage  tasks across both the  enterprise  server and
embedded  markets  such  as  high-end  enterprise  level  servers,  Linux  super
computing  clusters,  workstations,  media  gateways,  routers,  internet access
devices, home location registers, data messaging applications,  network attached
storage  ("NAS") and remote  storage  devices and  networks.  Our  products  are
distributed  worldwide through a direct sales force,  distributors,  independent
manufacturers'  representatives  and value-added  resellers.  Our business falls
primarily within one industry segment.

Our business is  characterized  by a concentration of sales to a small number of
OEMs and  distributors  who  provide  products  and  services to the datacom and
telecommunications  markets in addition to OEM's and system  integrators  in the
storage and high-end  server  markets.  Consequently,  the timing of significant
orders from major  customers and their product  cycles cause  fluctuation in our
operating  results.  The Hewlett  Packard  Company  ("HP") is the largest of our
customers and represented 45%, 45% and 30% of net sales in fiscal 2004, 2003 and
2002,  respectively.  We will ship the remaining  $1.0 million of the last order
for VME  products to HP in the first fiscal  quarter of fiscal  2005.  We do not
expect to receive any future  purchase  orders from HP for our VME products.  If
any of our major  customers  reduces  orders  for our  products,  we could  lose
revenues  and  suffer  damage  to our  business  reputation.  Orders  by our OEM
customers  are  affected by factors such as new product  introductions,  product
life  cycles,  inventory  levels,   manufacturing  strategy,   contract  awards,
competitive conditions and general economic conditions.

During fiscal 2004,  we  introduced  new TOE,  iSCSI,  Encryption,  WAN, and LAN
products  that are targeted at large  growing  enterprise  markets such as super
computing   clusters,   network  storage  clusters,   VPN,  security  and  other
communications devices. Our HighWire products have been focused primarily on the
telecommunications  market and the communications  activities that are driven by
the  convergence of traditional  telephony  applications  with the Internet with
applications  like  VoIP.  While we  believe  the  market  for our  TOE,  iSCSI,
Encryption, HighWire, Adapter and Storage NIC's and software product families is
large,  there can be no assurance that we will be able to succeed in penetrating
these markets and diversifying our sales.

Since the fourth  quarter of fiscal 2001 we have 24 new design  wins,  including
two in fiscal 2004, and have added a substantial  number of new customers to our
growing  base of  customers.  A design win is  defined as a program  with an OEM
customer  that will  generate at least  $400,000 in  recurring  annual net sales
typically within 12 to 18 months after the customer accepts and confirms the use
of our product in their  platform.  We believe the  combination of new customers
and design wins will  provide the basis for future  sales  growth.  A variety of
risks such as schedule delays, cancellations and changes in customer markets and
economic conditions can adversely affect a design win before or after production


                                      -23-
<PAGE>

is reached.  With the current economic climate in the  communications  equipment
marketplace,  design  activity  has slowed and  reaching  production  volumes is
proving to be  elusive  for those  products  that have been  designed.  In these
difficult  economic times, poor customer  visibility is causing ordering delays.
These  factors  often  result in a  substantial  portion of our net sales  being
derived from orders  placed within the quarter and shipped in the final month of
the quarter.

On October 31, 2004, we had a sales backlog of product  orders of  approximately
$2.5 million compared to a sales backlog of product orders of approximately $4.1
million  one year ago.  Included  in these  backlogs  are orders from HP of $1.0
million and $2.0 million, respectively.

The market  environment  for our products is extremely  competitive  and we have
limited visibility into customer activity. In spite of this uncertain market, we
have been  successful in increasing  our adapter  revenues 53% and revenues from
our HighWire  products 77% during fiscal 2004. One of our primary sales goals is
to diversify our customer base and at the same time provide sources of net sales
to fill the gap that will be left after we  process  our final  shipment  of VME
products to HP in the first quarter of fiscal 2005.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The  preparation  of  consolidated   financial  statements  in  conformity  with
generally  accepted  accounting  principles  in the  United  States  of  America
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. Such estimates include levels
of reserves  for  doubtful  accounts,  obsolete  inventory,  warranty  costs and
deferred tax assets. Actual results could differ from those estimates.

Our critical  accounting  policies and  estimates  include the  following:

Revenue Recognition:

Our policy is to  recognize  revenue  for  product  sales upon  shipment  of our
products to our customers  provided that no significant  obligation  remains and
collection  of  the  receivable  is  considered  probable.  Shipping  terms  are
generally FOB shipping point..  We defer and recognize  service revenue over the
contractual  period or as services  are  rendered.  We estimate  expected  sales
returns  and  record  the amount as a  reduction  of  revenue  and cost of goods
("COGS") at the time of shipment. Our policy complies with the guidance provided
by  Staff  Accounting   Bulletin  No.  104,  Revenue  Recognition  in  Financial
Statements,  issued by the  Securities  and Exchange  Commission.  Judgments are
required in evaluating  the credit  worthiness of our  customers.  Credit is not
extended to customers  and revenue is not  recognized  until we have  determined
that   collectibility  is  reasonably   assured.   Our  sales  transactions  are
denominated  in  U.S.  dollars.  The  software  component  of  our  products  is
considered  incidental to our products.  We, therefore do not recognize software
revenue separately from the product sale.

Our  agreements  with  OEMs,  such as HP and  Nortel  Networks  Corp,  typically
incorporate clauses reflecting the following understandings:


                                      -24-
<PAGE>

      -     all prices are fixed and determinable at the time of sale;

      -     title and risk of loss pass at the time of  shipment  (FOB  shipping
            point);

      -     collectibility  of the sales price is probable (the OEM is obligated
            to pay and such obligation is not contingent on the ultimate sale of
            the OEM's integrated solution);

      -     the OEM's obligation to us will not be changed in the event of theft
            or physical destruction or damage of the product;

      -     we do not have  significant  obligations  for future  performance to
            directly assist in the resale of the product by the OEMs; and

      -     there is no  contractual  right of return  other than for  defective
            products.

Our agreements with our distributors  include certain product rotation and price
protection  rights.  All  distributors  have the  right to  rotate  slow  moving
products  once each  fiscal  quarter.  The  maximum  dollar  value of  inventory
eligible for rotation is equal to twenty-five  percent of our products purchased
by the distributor  during the previous  quarter.  In order to take advantage of
their product rotation rights,  the distributors must order and take delivery of
additional  SBE products equal to at least the dollar value of the products that
they want to rotate.

Each distributor is also allowed certain price protection rights. If and when we
reduce or plan to reduce the price of any of our products and the distributor is
holding  any  of  the  affected  products  in  inventory,  we  will  credit  the
distributor  the  difference  in price when it places its next order with us. We
record an  allowance  for price  protection  reducing our net sales and accounts
receivable. The allowance is based on the price difference of the inventory held
by our stocking  distributors  at the time we expect to reduce  selling  prices.
Reserves for the right of return and  restocking  are  established  based on the
requirements of SFAS 48, Revenue Recognition when Right of Return Exists because
we have visibility into our distributor's  inventory and have sufficient history
to estimate returns.

During the year ended  October 31, 2004 and 2003,  $873,000,  or 8% of sales and
$191,000 or 3% of our sales were sold to distributors, respectively.

Allowance for Doubtful Accounts:

Our policy is to maintain  allowances  for estimated  losses  resulting from the
inability  of our  customers  to  make  required  payments.  Credit  limits  are
established  through a process of reviewing the financial  history and stability
of each  customer.  Where  appropriate,  we obtain  credit  rating  reports  and
financial  statements of the customer when determining or modifying their credit
limits.  We  regularly  evaluate  the  collectibility  of our  trade  receivable
balances based on a combination of factors.  When a customer's  account  balance
becomes past due, we initiate dialogue with the customer to determine the cause.
If it is  determined  that the  customer  will be unable  to meet its  financial
obligation to us, such as in the case of a bankruptcy  filing,  deterioration in
the customer's  operating results or financial position or other material events
impacting  its  business,  we record a specific  allowance to reduce the related
receivable to the amount we expect to recover.

We also record an allowance  for all  customers  based on certain  other factors
including  the  length  of time the  receivables  are  past  due and  historical
collection  experience  with customers.  We believe our reported  allowances are
adequate.  If the financial  conditions of those  customers were to deteriorate,
however,  resulting in their  inability to make payments,  we may need to record
additional   allowances   which   would   result  in   additional   general  and


                                      -25-
<PAGE>

administrative   expenses   being   recorded   for  the  period  in  which  such
determination was made.

Warranty Reserves:

We accrue the estimated costs to be incurred in performing  warranty services at
the time of  revenue  recognition  and  shipment  of the  products  to the OEMs.
Because  there  is no  contractual  right of  return  other  than for  defective
products,  we can reasonably estimate such returns and record a warranty reserve
at the  point  of  shipment.  Our  estimate  of costs to  service  our  warranty
obligations  is  based  on  historical  experience  and  expectation  of  future
conditions.  To the extent we experience  increased  warranty  claim activity or
increased costs  associated with servicing  those claims,  the warranty  accrual
will increase, resulting in decreased gross margin.

Inventories:

We are exposed to a number of economic and industry factors that could result in
portions of our inventory  becoming  either obsolete or in excess of anticipated
usage, or subject to lower of cost or market issues.  These factors include, but
are not limited to,  technological  changes in our markets,  our ability to meet
changing customer  requirements,  competitive  pressures in products and prices,
and the  availability  of key components  from our  suppliers.  Our policy is to
establish  inventory  reserves  when  conditions  exist  that  suggest  that our
inventory may be in excess of  anticipated  demand or is obsolete based upon our
assumptions  about  future  demand for our products  and market  conditions.  We
regularly  evaluate our ability to realize the value of our inventory based on a
combination  of  factors  including  the  following:   historical  usage  rates,
forecasted sales or usage,  product  end-of-life  dates,  estimated  current and
future market  values and new product  introductions.  Purchasing  practices and
alternative  usage  avenues are  explored  within  these  processes  to mitigate
inventory  exposure.  When  recorded,  our  reserves  are intended to reduce the
carrying  value of our inventory to its net realizable  value.  If actual demand
for our products  deteriorates,  or market  conditions  are less  favorable than
those that we project,  additional  inventory  reserves may be required.  In the
fourth  quarter of 2004,  we reviewed our  inventory  balances and increased our
reserves on specific products by $547,000.

Inventories  are  stated at the lower of cost,  using  the  first-in,  first-out
method, or market value.

Acquisitions:

All business  acquisitions  have been accounted for using the purchase method of
accounting  and,  accordingly,  the  statements of income include the results of
each acquired  business since the date of  acquisition.  The assets acquired and
liabilities  assumed are recorded at estimates of fair values as  determined  by
management  based on  information  available.  Management  considers a number of
factors,  including  third-party  valuations  or  appraisals,  when making these
determinations.  We finalize the  allocation of purchase price to the fair value
of the  assets  acquired  and  liabilities  assumed  when we obtain  information
sufficient to complete the  allocation,  but in any case,  within one year after
acquisition.  Our  acquisition  of Antares in fiscal year ended October 31, 2003
resulted in intangible assets of approximately  $1.2 million.  These assets were
fully written off in the current year.


                                      -26-
<PAGE>

Intangible Assets:

We adopted the  Financial  Accounting  Standards  Board  ("FASB")  Statements of
Financial Accounting Standards ("SFAS") No. 141, Business  Combinations and SFAS
No.  142,  Goodwill  and Other  Intangible  Assets on  accounting  for  business
combinations and goodwill as of the beginning of fiscal year 2002.  Accordingly,
we do not amortize  goodwill from  acquisitions,  but continue to amortize other
acquisition-related  intangibles and costs. All of the intangible assets that we
currently own are intellectual property acquired in the Antares acquisition.

For  identifiable  intangible  assets,  we amortize the cost over the  estimated
useful life and assess any  impairment by  estimating  the future cash flow from
the  associated  asset in  accordance  with  SFAS No.  144,  Accounting  for the
Impairment or Disposal of Long-Lived Assets. If the estimated  undiscounted cash
flow  related to these  assets  decreases  in the  future or the useful  life is
shorter than originally estimated,  we may incur charges for impairment of these
assets. The impairment is based on the estimated discounted cash flow associated
with the asset. An impairment could result if the underlying technology fails to
gain  market  acceptance,  we fail to  deliver  new  products  related  to these
technology  assets,  the products fail to gain expected market  acceptance or if
market conditions are unfavorable.

Intellectual  property costs consist of the allocation of costs  associated with
the  purchase  of  current  and the  design  of  future  products  from  Antares
Microsystems  on August 7,  2003.  As  required  by these  rules,  we perform an
impairment  review  annually,  or earlier if indicators of potential  impairment
exist. The impairment analysis requires  significant judgment to identify events
or circumstances that would likely have a significant adverse effect on the fair
value of the intangible asset. Our annual impairment review was completed during
the fourth quarter of fiscal 2004, and we determined that there was considerable
doubt that the remaining unamortized balance of $713,000 of the intangible asset
at October 31, 2004 would be  recoverable.  The  indicators  we used to identify
those events and circumstances included: revenue and earnings trends relative to
predefined   milestones  and  overall  business  prospects;   the  technological
feasibility of the Antares  products;  and  technologies  and the general market
conditions  in the market for SUN  Microsystems  compatible  products with which
Antares products  compete.  Our impairment review was based on a discounted cash
flow approach that uses  estimates of future market share and revenues and costs
for the Antares  products as well as appropriate  discount rates.  The estimates
used are  consistent  with the plans  and  estimates  that we use to manage  the
underlying  business.  We determined that the estimated fair market value of the
balance of the intangible  asset related to the Antares  acquisition was nominal
and as a result, we recorded an impairment charge of $713,000, during the fourth
fiscal quarter ended October 31, 2004,  thus writing off the remaining  value of
the intellectual property asset.

The  non-cash  expense  related  to  the  amortization  and  write-down  of  the
intellectual  property in fiscal 2004 was $1.1  million and consists of $408,000
of regularly  scheduled  annual  amortization  expense plus $713,000  write down
related to the impairment valuation analysis. This write-down plus the regularly
scheduled  amortization is included in our cost of goods sold. The  amortization
expense  for  the  one  quarter  that  we  owned  Antares  in  fiscal  2003  was
approximately $102,000.


                                      -27-
<PAGE>

Deferred Taxes:

We record a valuation  allowance to reduce our deferred taxes to the amount that
is more  likely  than not to be  realized.  Based on the  uncertainty  of future
pre-tax income, we have fully reserved our deferred tax assets as of October 31,
2004.  In the event we were to  determine  that we would be able to realize  our
deferred tax assets in the future, an adjustment to the deferred tax asset would
increase income in the period such determination was made.

New Accounting Pronouncements:

In  December  2004,  the FASB  issued  SFAS No.  123R that  amends  SFAS No. 123
Accounting for Stock-Based Compensation,  to require public entities (other than
those  filing  as  small  business  issuers)  to  report  stock-based   employee
compensation in their financial statements. Unless modified, we will be required
to comply with the  provisions of SFAS No. 123R as of the first  interim  period
that begins  after June 15, 2005  (August 1, 2005 for us). We  currently  do not
record  compensation  expense related to our stock-based  employee  compensation
plans in our financial statements.

RESULTS OF OPERATIONS

The  following  table  sets  forth,  as  a  percentage  of  net  sales,  certain
consolidated  statements of  operations  data for the fiscal years ended October
31, 2004, 2003 and 2002. These operating results are not necessarily  indicative
of our operating results for any future period.

                                                    YEAR ENDED OCTOBER 31,
                                              ---------------------------------
                                               2004          2003         2002
                                              -----         -----        ------
  Net sales                                    100%          100%          100%
  Cost of sales                                 60            37            46
                                              -----         -----        ------
     Gross profit                               40            63            54
  Operating expenses:
     Product research and development           22            18            44
     Sales and marketing                        19            20            31
     General and administrative                 16            23            34
     Loan reserve (benefit)                     (2)           (3)            7
     Restructuring costs (benefit)              --            (2)            6
                                              -----         -----        ------
      Total operating expenses                  55            56          (122)
                                              -----         -----        ------
  Operating income (loss)                      (15)            7           (68)
  Forfeited deposit, net                        --            --            39
  Interest  and other income                    --            --             2
                                              -----        ------        ------
  Income (loss) before income taxes            (15)            7           (27)
  Income tax benefit                            --            --             2
                                              -----        ------        ------
  Net income (loss)                            (15)%           7%          (25)%
                                              =====        ======        ======


NET SALES

Net sales for fiscal 2003 were $11.1  million,  a 48% increase from $7.5 million
for fiscal  2003.  Net sales for fiscal 2003 were $7.5  million,  an 8% decrease
from $6.9  million in fiscal  2002.  The  increase in fiscal 2004 as compared to


                                      -28-
<PAGE>

fiscal  2003 was  primarily  attributable  to an  increase  in sales to numerous
customers including our largest, HP. Net sales to HP were $4.9 million in fiscal
2004 as  compared to $3.4  million  for fiscal  2003 and $2.1  million in fiscal
2002. Sales to HP,  primarily of VMEBus  products,  represented 45% of net sales
for fiscal  2004,  compared to 45% during  fiscal 2003 and 30% in fiscal 2002. A
substantial  portion of such sales were  attributable  to sales of VME  products
pursuant to a long-term supply agreement with HP that is no longer in effect. We
have one  remaining  order with HP for $1.0 million of VME products that will be
shipped in the first  quarter of fiscal 2005.  At this time, we do not expect to
receive any future orders for VME products from HP. Nortel Networks was the only
other customer that  represented  greater than 10% of our sales,  accounting for
13% of our sales in fiscal 2004. For fiscal 2003 and 2002,  Lockheed  Martin was
the only other customer  representing  10% or more of our sales,  accounting for
11% of net sales in fiscal  2002.  In fiscal  2004  after one  complete  year of
operations,  we derived  $1.2  million in sales from  products we acquired  from
Antares  compared to $459,000 in Antares  product sales from  acquisition  date,
August 7, 2003 through October 31, 2003.

Sales of our adapter  products were $4.9 million for fiscal 2004, as compared to
$2.6  million  in fiscal  2003 and $2.1  million  in fiscal  2002.  Sales of our
HighWire  products were $1.3 million in fiscal 2004, as compared to $0.8 million
in fiscal 2003 and $1.0  million in fiscal 2002.  Our adapter  products are used
primarily in  edge-of-the-network  applications  such as VPN and other  routers,
VoIP gateways and security devices,  whereas our HighWire products are primarily
targeted    at    core-of-the-network    applications    used    primarily    by
telecommunications central offices. In the future, we expect our net sales to be
generated  predominantly  by sales of our adapter and  encryption  products with
Linux and Solaris  software,  followed by our recently released TOE products and
storage products,  primarily iSCSI. We expect to see a continued steady increase
in the sale of our Highwire  products due to the recent  adoption and release of
OEM products that have  incorporated our Highwire series of intelligent  carrier
cards. All of our design wins and new customers are for applications using these
product  families.  In addition,  we will continue to sell and support our older
VME  products,  but expect them to become a declining  portion of our future net
sales.

We  anticipate  that our net sales for fiscal 2005 will  increase  when compared
with  fiscal  2004,  as certain of our design  wins from the last two year to go
into production and that our customers will increase the rate of product rollout
such as edge of the network routers,  VoIP gateways and WiFi applications.  As a
result of these  design wins moving to  production  stage,  sales of our Adapter
products increased 53% and sales of our Highwire products increase 77% in fiscal
2004 as  compared to fiscal  2003.  One of our major  challenges  on a long term
basis  continues to be replacement  of the net sales of VME products  previously
provided to HP. HP  (including  its  predecessors,  Tandem  Computer  and Compaq
Computer), has accounted for a substantial portion of our net sales for the past
five  years.  We expect to  continue  to  increase  the sales of our Adapter and
Highwire products and that these increases as a percentage of total revenue will
replace the sales to HP. Even though the market  environment  for our customers'
activities  continues to be uncertain we have been  successful  in extending our
reach with new customers.  We have been  successful in increasing our network of
distributors and value-added  resellers in the United States and Europe and have
rolled out some new products such as high density  multi-ported  adapter  cards,
Encryption  cards,  the TOE product  and iSCSI  storage  software.  We have also
entered into some new strategic  partnerships  that will expand the reach of our
products to a new base of customers using AdvanceTCA ("ATCA") products.  We have


                                      -29-
<PAGE>

continued  to add new  customers  and design wins over the course of fiscal 2004
and we believe the  combination  of new customers and past design wins beginning
to  go  into  production  will  provide  future  growth  in  net  sales  in  the
communications, computing and storage marketplaces.

Our sales backlog at October 31, 2004 was $2.5 million,  including  $1.0 million
from HP,  compared to $4.1 million,  including  $2.0 million from HP, at October
31, 2003. While we anticipate an increase in our sales volume in our Adapter and
Highwire  products  over the course of fiscal 2005 as certain of our design wins
from the last two year to go into production and our customers  gradually return
to new product design and product rollout,  there can be no assurances that such
increase  will  occur.  Our  customers  typically  operate  on a  "just-in-time"
ordering and delivery cycle where they will place a purchase order with us after
they  receive  an order  from  their  customer.  This  "just-in-time"  inventory
purchase cycle by our customers has made forecasting of our future sales volumes
very difficult.  Because our sales are generally concentrated with a small group
of OEM customers, we could experience significant  fluctuations in our quarterly
sales volumes due to fluctuating  demand from any major customer or delay in the
rollout of any significant new product by a major customer.

International  sales  constituted  12%, 12% and 13% of net sales in fiscal 2004,
2003 and 2002,  respectively.  International  sales are executed in U.S. dollars
and are principally transacted in Europe.

GROSS PROFIT

Gross profit as a  percentage  of net sales was 40%, 63% and 54% in fiscal 2004,
2003 and 2002, respectively.  Gross profit as a percentage of sales increased in
fiscal 2003  primarily  as a result of sales of $409,000 of inventory to HP that
had been fully  written  down in fiscal  2002 when HP placed its final order for
end-of-life  VME products  under its  then-existing  contract.  Our gross profit
would have been 58% after  excluding the effect of the HP inventory  write-down.
The decrease in our gross profit margin in fiscal 2004 is due primarily to lower
than expected gross margins from the Antares  product,  the addition of $547,000
expense  related  to the  valuation  adjustment  for slow  moving  and  obsolete
inventory  and the  inclusion  of  $408,000  of  amortization  and  $713,000  of
impairment  charges relating to the August 2003 intellectual  property purchased
with Antares. We expect our gross profit to range between 50% and 53% for fiscal
2005 based on our current  product  sales prices and cost to  manufacture  those
products.  However,  if market  and  economic  conditions,  particularly  in the
telecommunications  sector,  deteriorate  or fail to recover as expected,  gross
profit as a percentage of net sales may decline from the current level.

PRODUCT RESEARCH AND DEVELOPMENT

Product research and development expenses were $2.4 million in fiscal 2004, $1.3
million in fiscal 2003, and $3.0 million in fiscal 2002,  representing  22%, 18%
and 44% of net sales,  respectively.  The increase in fiscal 2004 as compared to
fiscal 2003 is primarily the result of three factors:

      o     the  inclusion  of three  personnel  hired in  conjunction  with the
            Antares acquisition;

      o     the addition of five  additional  design  engineers hired during the
            year;

      o     a 160% increase in expenditures for new product development.


                                      -30-
<PAGE>

The decrease in research and development expense as a percentage of revenue from
fiscal  2002 to fiscal 2003 was the direct  result of  headcount  reductions  of
fifteen full-time equivalent personnel combined with other  project-related cost
containment  measures  During fiscal 2004, we began the  development of the next
generation of our Highwire  products,  designed and released several new WAN and
LAN products including three new encryption products,  continued development and
released  our new TOE product  and  integrated  our TOE product  with a partners
enterprise  based iSCSI software.  We also continued to port our products to new
versions of Linux and Solaris  software  expanding  their  market  reach.  These
hardware and software design efforts have enabled us to more effectively  target
enterprise  markets such as Internet based storage,  TCP offload,  VoIP, VPN and
security   routers,   as   well   as   expand   market   coverage   within   the
telecommunications, military/government, medical and industrial control markets.

We expect  overall  spending for our product  research and  development to range
between  15% and 18% of net sales in fiscal 2005 as we remain  committed  to the
development and enhancement of new and existing products.  We did not capitalize
any internal software development costs in fiscal 2004, 2003 or 2002.

SALES AND MARKETING

Sales and marketing  expenses for fiscal 2004 were $2.2 million,  a 47% increase
over fiscal 2003. This increase is primarily  related to higher headcount in the
sales and marketing departments for the majority of the year increasing by three
people  plus an  increases  in  travel  and  product  marketing  activities.  We
increased our marketing  expenditures by 142% in fiscal 2004 as we attended more
industry  trade  shows  and  increased  our  advertising  in  industry  relevant
magazines.  Fiscal 2003 expense was $1.5  million,  a 31%  decrease  over fiscal
2002.  The  decrease in fiscal 2003 as compared to 2002 is the direct  result of
headcount  reductions  in our sales and  marketing  departments  combined with a
reduction in our overall marketing  programs.  Sales and marketing  programs are
focused on design wins with new customers and, therefore,  as new customer sales
increase,  sales and marketing  expenses will increase.  New customers'  product
design  sales  cycles may span over periods as long as  twenty-four  months.  We
expect our sales and  marketing  expenses  to range  between  15% and 17% of net
sales in fiscal 2005 as we continue our product  marketing  efforts,  especially
for the TOE and iSCSI  products,  and attend an  increasing  number of  industry
specific trade shows.

GENERAL AND ADMINISTRATIVE

General and  administrative  expenses for fiscal 2004 remained  constant at $1.8
million  as  compared  to  fiscal  2003.   Fiscal  2004  includes   $259,000  in
compensation  expense related to the severance  package provide to the company's
retiring president and chief executive  officer.  Fiscal 2003 expenses decreased
to $1.8  million  from $2.4 million in fiscal 2002 or, 26%. The decrease was due
to headcount from eight to five  individuals and expense  containment  measures,
primarily rent and depreciation,  put into place in the fourth quarter of fiscal
2002,  with the cost savings  fully  realized in fiscal 2003 and 2004. We expect
general and administrative  expense for fiscal 2005 to increase from fiscal 2004
levels  partly  due to  the  increase  in  insurance  and  expenses  related  to
compliance with the Sarbanes-Oxley Act. General and administrative  expenses are
expected to range between 12% and 15% of sales for fiscal 2005.


                                      -31-
<PAGE>

LOAN RESERVE (BENEFIT)

On November 6, 1998, we made a loan to our retiring  President and CEO which was
used by him to exercise an option to purchase 139,400 shares of our common stock
and related taxes.  The loan, as amended,  was  collateralized  by shares of our
common stock, bore interest at a rate of 2.48% per annum and was due on December
14, 2003.

On October 31, 2002, we determined  that it was probable that we would be unable
to fully  recover the balance of the loan on its due date of December  14, 2003.
Accordingly,  a valuation allowance of $474,000 was recorded against the loan at
October 31, 2002.

During the fourth  quarter of fiscal 2003,  the officer  repaid  $362,800 of the
loan and as a  result,  we  recognized  a benefit  of  $235,000  related  to the
reversal of the loan  impairment  charge taken by us in fiscal 2002.  During the
first quarter of fiscal 2004,  the officer  repaid the remaining loan balance in
full and as a result, we recorded a benefit of $239,000 relating to the reversal
of the remaining loan impairment charge.

RESTRUCTURING COSTS(BENEFIT)

In response to the economic  slowdown,  we  implemented  restructuring  plans in
fiscal 2002 and recorded restructuring charges of $446,000.  Restructuring costs
for  fiscal  2002 were  comprised  of  severance  costs  associated  with  staff
reductions totaling $115,000,  leasehold  improvements and equipment write-downs
related to the  abandonment  of our  Madison,  Wisconsin  office of $185,000 and
estimated  losses related to future rents,  net of estimated  future  recoveries
from potential sublease, of $146,000. We reduced our headcount from 47 employees
to 24 employees during fiscal 2002.

In the third quarter of fiscal 2003, we  recognized a  restructuring  benefit of
$154,000 after the final  settlement of costs  associated with prior real estate
and equipment leases.

As of October 31, 2004 and 2003, $21,000 and $58,000 of the restructuring  costs
were included in other current liabilities, respectively.

INTEREST AND OTHER INCOME

Interest and other  income in fiscal 2004  decreased  slightly  from 2003 due to
lower average cash  balances in fiscal 2004 coupled with lower average  interest
rates.  Fiscal  2003  income  decreased  slightly  from fiscal 2002 due to lower
average cash balances in fiscal 2003 coupled with lower average  interest rates.
A refundable  deposit  associated with a multi-year  supply agreement with HP of
$4.9  million was  received in April 2001.  This  deposit was  refundable  as we
delivered certain quantities of products to HP over a four year period ending in
2005.  The supply  contact  was  restructured  in fiscal 2002 to include a final
purchase order for $1.6 million of our products to be shipped to HP in the first
two quarters of fiscal 2003 and the forfeiture by HP of $4.4 million of the $4.9
million refundable deposit.  Under the agreement,  we are required to retain for
future  production or repair all VCOM finished  goods and spare parts  inventory
through  October 31, 2005 unless notified  otherwise by HP.  Concurrent with the
forfeiture of the $4.4 million refundable deposit, we recorded a reserve of $1.7
million  related to the  potentially  obsolete  inventory we held at October 31,


                                      -32-
<PAGE>

2002. The $2.7 million of forfeiture of the refundable  deposit net of inventory
reserve  is  presented  under  "Forfeited  deposit,  net"  on  the  fiscal  2002
Consolidated Statements of Operations.

INCOME TAXES

On March 9, 2002,  the Job Creation and Workers  Assistance Act of 2002 extended
the net operating loss carryback from two to five years for losses  generated in
tax years ending in 2001 and 2002. As a result, we recorded a benefit for income
taxes of  $22,000  in the second  quarter  of fiscal  2003 and a tax  benefit of
$91,000 in fiscal 2002 due to refunds of federal  income  taxes  related to this
Act.  The net benefit  recorded  for the 2003 and 2002  periods were $17,000 and
$177,000,  respectively.  In fiscal 2002 we also filed amended federal and state
tax returns to claim $86,000 in research and development  credits related to LAN
Media Corporation ("LMC"), a company we acquired in July 2000. Our effective tax
rate was 0%,  0% and  (8)% in  fiscal  2004,  2003 and  2002,  respectively.  We
recorded  valuation  allowances  in fiscal 2004 and 2003 for deferred tax assets
due to the  uncertainty of  realization.  In the event of future taxable income,
our  effective  income  tax rate in  future  periods  could  be  lower  than the
statutory rate as such tax assets are realized.

NET INCOME (LOSS)

As a result of the  factors  discussed  above,  we  recorded  a net loss of $1.7
million in fiscal  2004  compared to net income of $563,000 in fiscal 2003 and a
net loss of $1.7 million in fiscal 2002.

CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS

The following table sets forth a summary of our material contractual obligations
and commercial commitments as of October 31, 2004:

                                Payments due by period (Dollars in thousands)
                             ---------------------------------------------------
                                       Less than     1-3        3-5    More than
 Contractual Obligations      Total      1 year     Years      Years    5 Years
                             -------    -------    -------    -------   -------
Building leases              $ 1,649    $   963    $   686    $    --   $    --
Reimbursements from lease
  assignment                    (902)      (637)      (265)        --        --
                             -------    -------    -------    -------   -------
Total net lease payments     $   747    $   326    $   421    $    --   $    --
                             =======    =======    =======    =======   =======

In  connection  with the  acquisition  of Antares,  we committed to issue 98,945
shares of our  Common  Stock in 10,000  and 20,000  share  increments  beginning
January 2004 and ending March 2005 to a selling  shareholder of Antares.  During
fiscal 2004, we issued  30,000 shares of our Common Stock of a committed  98,945
to an employee who was one of the owners of Antares Microsystems,  Inc. pursuant
to the original  purchase  agreement.  We will issue the remaining 68,945 during
fiscal  2005.  The value of the Common  Stock  issued in fiscal  2004 under this
commitment was $85,600.

In  connection  with the  retirement of Mr.  William Heye,  Jr. as the company's
President and Chief Executive Officer, the Company will pay Mr. Heye $250,000 at
the rate of $20,833 each month for the period  January 1, 2005 through  December


                                      -33-
<PAGE>

31, 2005. The commitment to pay $250,000 has been accrued as of October 31, 2004
and is included in General and  Administrative  expense and Accrued  Payroll and
Employee Benefits liability.

OFF-BALANCE SHEET ARRANGEMENTS

We do not have any  transactions,  arrangements,  or  other  relationships  with
unconsolidated  entities that are  reasonably  likely to affect our liquidity or
capital  resources  other than the  operating  leases  noted  above.  We have no
special  purpose or limited  purpose  entities  that provide  off-balance  sheet
financing,  liquidity,  or market or credit risk support;  or engage in leasing,
hedging,  research and development  services, or other relationships that expose
us to liability that is not reflected on the face of the financial statements.

LIQUIDITY AND CAPITAL RESOURCES

Our liquidity is dependent on many factors,  including  sales volume,  operating
profit and the efficiency of asset use and turnover.  Our future  liquidity will
be affected by, among other things:

      -     actual versus anticipated sales of our products;

      -     our actual  versus  anticipated  operating  expenses  and results of
            ongoing cost control actions;

      -     the timing of product  shipments,  which occur primarily  during the
            last month of each quarter;

      -     our actual versus anticipated gross profit margin;

      -     our ability to raise additional capital, if necessary; and

      -     our ability to secure credit facilities, if necessary.

We had cash and cash equivalents of $1.8 million and $1.4 million on October 31,
2004 and October 31, 2003,  respectively.  In fiscal 2004,  $140,000 of cash was
used by operating activities,  primarily as a result of net losses, the reversal
of a valuation allowance on a loan from an officer and an increase in inventory.
The cash  receipt from the  repayment  of the loan is included in the  financing
activities  section  of the  cash  flow  statement.  Cash  was  provided  by the
inclusion  of $1.1 million of  amortization  expense and the  write-down  of the
intellectual  property plus $420,000 of amortization  and  depreciation  expense
related to property and equipment and capitalized  software included in the $1.7
million  net loss.  Cash flow was also  provided  by a $150,000  decrease in our
accounts  receivable.  Working capital (current assets less current liabilities)
at October 31, 2004 was $3.9 million, as compared to $4.0 million at October 31,
2003.

In fiscal 2004, we purchased  $87,000 of fixed assets,  consisting  primarily of
computers and  engineering  equipment.  Purchased  software  costs  amounting to
$136,000 were  capitalized  in fiscal 2004.  We expect to slightly  increase our
levels of capital  expenditures  in fiscal  2005 in order to  purchase  test and
design equipment upgrades.

We  received  $18,000  in fiscal  2004 from  payments  related  to common  stock
purchases  made by employees  pursuant to the employee  stock  purchase plan and
$233,000 from proceeds  related the exercise of employee  stock  options,  for a
total of $251,000.


                                      -34-
<PAGE>

On December 19, 2003 we received  cash  proceeds of $116,000  from Puglisi & Co.
for the purchase of 70,000 shares of our Common Stock pursuant to a warrant they
received in  conjunction  with a private  placement of common stock  transaction
that was completed in fiscal 2003.

During the fourth  quarter of fiscal 2003,  our retiring  president and CEO sold
139,400  shares of our common stock and used the proceeds from the stock sale to
repay  $362,800  of an  outstanding  $743,800  loan we made to the  officer.  In
November  2003 the loan was repaid in full when we received an  additional  loan
payment of $381,000 from proceeds from the sale of stock.

On May 13, 2004, we renewed our working capital line of credit for twelve months
until May 14, 2005. The credit line is secured by a first lien on all our assets
and carries a floating  annual  interest  rate equal to the bank's prime rate of
4.75%, at October 31, 2004, plus 1.50%.  Draw-downs on the credit line are based
on a formula equal to 80% of our domestic accounts receivable. As of October 31,
2004,  due to the net loss for our fourth fiscal  quarter of 2004, we are not in
compliance  with all the covenants of our credit line.  The Bank agreed to waive
the  non-compliance  with this covenant.  We have not drawn down on this line of
credit and have no amounts payable at October 31, 2004.

We believe the projected  revenue  during  fiscal 2005 will generate  sufficient
cash flows to fund our  operations  through  October 31,  2005 and  beyond.  Our
projected future quarterly  operational cash flow breakeven point is expected to
be $2.7  million to $2.8  million in net sales at an  expected  50% to 53% gross
margin.  Our current year's sales to HP of $4.9 million at a gross margin of 73%
are  expected  to  significantly  decline.  Our  projected  sales are based on a
combination of increasing  demand for existing products and market acceptance of
recently released products to a limited number of new and existing OEM customers
and are based on internal and customer provided  estimates of future demand, not
firm customer orders. If the projected sales do not materialize, we will need to
reduce  expenses   further  and  raise   additional   capital  through  customer
prepayments or the issuance of debt or equity  securities.  If additional  funds
are raised  through the issuance of preferred  stock or debt,  these  securities
could  have  rights,  privileges  or  preferences  senior to those of our common
stock, and debt covenants could impose restrictions on our operations.  The sale
of equity or debt could result in additional  dilution to current  stockholders,
and such financing may not be available to us on acceptable terms, if at all.

ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our cash and cash  equivalents  are  subject to  interest  rate risk.  We invest
primarily on a short-term  basis. Our financial  instrument  holdings at October
31, 2004 were analyzed to determine their  sensitivity to interest rate changes.
The fair values of these  instruments were determined by net present values.  In
our  sensitivity  analysis,  the same change in  interest  rate was used for all
maturities and all other factors were held constant. If interest rates increased
by 10%,  the  expected  effect on net income  (loss)  related  to our  financial
instruments would be immaterial. We hold no assets or liabilities denominated in
a foreign currency.


                                      -35-
<PAGE>

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The  financial  statements  and  supplementary  data  required  under Item 8 are
provided under Item 15.

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

None.

ITEM 9A. CONTROLS AND PROCEDURES

         (a)   Evaluation of Disclosure Controls and Procedures

         An  evaluation  as of  October  31,  2004 was  carried  out  under  the
supervision of and with the participation of the Company's management, including
the  Company's  Chief  Executive  Officer and Chief  Financial  Officer,  of the
effectiveness of the design and operation of the Company's  "disclosure controls
and  procedures,"  which  are  defined  under SEC  rules as  controls  and other
procedures of a company that are designed to ensure that information required to
be  disclosed  by a company in the reports  that it files  under the  Securities
Exchange Act of 1934 (the "Exchange Act") is recorded, processed, summarized and
reported within required time periods. Based upon that evaluation, the Company's
Chief Executive Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures were effective.

         (b)   Changes in Internal Controls over Financial Reporting

             The Company's  management,  including the Company's Chief Executive
Officer and Chief Financial Officer,  has evaluated any changes in the company's
internal control over financial reporting that occurred during the quarter ended
October 31, 2004, and has concluded that there was no change during such quarter
that has materially affected,  or is reasonably likely to materially affect, the
Company's internal control over financial reporting.


                                      -36-
<PAGE>

                                    PART III


ITEM 10.          DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Identification of Directors;  Audit Committee  Financial  Expert;  Section 16(a)
Beneficial Ownership Reporting Compliance; Code of Ethics

The  information  required by Item 10 concerning  our executive  officers is set
forth in the section entitled  "Identification of Executive  Officers" appearing
in Part I of this annual report. The information  required by Item 10 concerning
our directors is  incorporated  by reference from the information in the section
entitled "Election of Directors"  appearing in our definitive Proxy Statement to
be filed with the Securities  and Exchange  Commission for the Annual Meeting of
Stockholders  scheduled  for March 22,  2005 (the "2005 Proxy  Statement").  The
information  required by Item 10 concerning  the  compliance of certain  persons
with the beneficial ownership reporting requirements of Section 16(a) of the Act
is  incorporated  by  reference  from the  information  in the section  entitled
"Compliance  with  Section  16(a) of the  Securities  and  Exchange Act of 1934"
appearing  in the 2005 Proxy  Statement.  The  information  required  by Item 10
concerning  the  disclosure  of the  existence of an audit  committee  financial
expert  sitting on the Audit  Committee is  incorporated  by reference  from the
information in the section entitled "Audit Committee Financial Expert" appearing
in the 2005 Proxy Statement.  The information required by Item 10 concerning the
adoption of a code of ethics is  incorporated  by reference from the information
in the section entitled "Code of Ethics" appearing in the 2005 Proxy Statement.

ITEM 11.   EXECUTIVE COMPENSATION

The  information  required  by Item 11 is  incorporated  by  reference  from the
information in the section entitled  "Executive  Compensation"  appearing in the
2005 Proxy Statement.

ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
           RELATED STOCKHOLDER MATTERS

The  information  required by Item 12 is found under the heading "Equity
Compensation  Plan  Information"  in  Item 5 of this  report  and  otherwise  is
incorporated by reference from the information in the section entitled "Security
Ownership of Certain  Beneficial  Owners and  Management"  appearing in the 2005
Proxy Statement.

ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The  information  required  by Item 13 is  incorporated  by  reference  from the
information  in the sections  entitled  "Certain  Transactions"  and  "Executive
Compensation" appearing in the 2005 Proxy Statement.


                                      -37-
<PAGE>

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

The following documents are filed as part of this Report:

(a)(1)   Financial Statements
                                                                           Page
                                                                           -----

         Report of Independent Registered Public Accounting Firm             44

         Report of Independent Registered Public Accounting Firm             45

         Consolidated Balance Sheets at October 31, 2004 and 2003            46

         Consolidated Statements of Operations for fiscal years 2004, 2003
                  and 2002                                                   47

         Consolidated Statements of Stockholders' Equity for fiscal
                  years 2004, 2003 and 2002                                  48

         Consolidated Statements of Cash Flows for fiscal years 2004, 2003
                  and 2002                                                   49

         Notes to Consolidated Financial Statements                          50

(a)(2)   Financial Statement Schedule

         Schedule II -- Valuation and Qualifying Accounts                    70

         All other  schedules  are omitted as the  required  information  is not
         applicable  or  has  been  included  in  the   consolidated   financial
         statements or the notes thereto.

(a)(3)   List of Exhibits

         Exhibit
         Number         Description
         -------        -----------

         2.1 (1)        Asset  Purchase  Agreement  dated August 8, 2003, by and
                        between D.R. Barthol & Company and SBE, Inc.

          3.1(2)        Certificate  of   Incorporation,   as  amended   through
                        December 15, 1997.

          3.2(3)        Bylaws, as amended through December 8, 1998.

        10.1(4)*        1996 Stock Option Plan, as amended.


                                      -38-
<PAGE>

        10.2(4)*        1991  Non-Employee  Directors'  Stock  Option  Plan,  as
                        amended.

         10.3(4)        1992 Employee Stock Purchase Plan, as amended.

         10.4(4)        1998 Non-Officer Stock Option Plan as amended.

         10.5(5)        Lease for 4550 Norris Canyon Road, San Ramon, California
                        dated  November  2, 1992  between the Company and PacTel
                        Properties.

         10.6(6)        Amendment  dated  June 6, 1995 to lease for 4550  Norris
                        Canyon Road, San Ramon, California,  between the Company
                        and CalProp L.P. (assignee of PacTel Properties).

        10.7(4)*        Full  Recourse  Promissory  Note  executed by William B.
                        Heye,  Jr. in favor of the  Company  dated  November  6,
                        1998, as amended and restated on December 14, 2001.

        10.8(4)+        Letter Agreement,  dated October 30, 2001,  amending (i)
                        Amendment  No.  S/M018-4  dated April 3, 2001,  and (ii)
                        Purchase  Agreement dated May 6, 1991, each between SBE,
                        Inc. and Compaq Computer Corporation

         10.9(7)        Stock  subscription  agreement  and  warrant to purchase
                        111,111 of SBE,  Inc.  Common Stock dated April 30, 2002
                        between SBE, Inc. and Stonestreet Limited Partnership.

        10.10(8)        Amendment  dated  August 22, 2002 to stock  subscription
                        agreement  dated April 20, 2002  between  SBE,  Inc. and
                        Stonestreet LP.

        10.11(9)        Securities  Purchase  Agreement,  dated  July 27,  2003,
                        between SBE,  Inc. and  purchasers of SBE's common stock
                        thereunder, including form of warrant issued thereunder

        10.12(9)        Form of warrant  issued to  associates  of Puglisi & Co.
                        ($1.50 exercise price)

        10.13(9)        Form of warrant  issued to  associates  of Puglisi & Co.
                        ($1.75 and $2.00 exercise price)

            23.1        Consent of BDO Seidman LLP, Independent
                        Registered Public Accounting Firm
            23.2        Consent of PricewaterhouseCoopers LLP, Independent
                        Registered Public Accounting Firm
            31.1        Certification of Chief Executive Officer
            31.2        Certification of Chief Financial Officer


                                      -39-
<PAGE>

            32.1        Certification of Chief Executive  Officer pursuant to 18
                        U.S.C.  Section 1350, as adopted pursuant to Section 906
                        of the Sarbanes-Oxley Act of 2002
            32.2        Certification of Chief Financial  Officer pursuant to 18
                        U.S.C.  Section 1350, as adopted pursuant to Section 906
                        of the Sarbanes-Oxley Act of 2002

             *          Indicates  management  contract or compensation plans or
                        arrangements   filed  pursuant  to  Item  601(b)(10)  of
                        Regulation SK.

             +          Certain  confidential  information has been deleted from
                        this exhibit pursuant to a confidential  treatment order
                        that has been granted.

             (1)        Filed as an exhibit to Current Report on Form 8-K, dated
                        April 30, 2002 and incorporated herein by reference.

             (2)        Filed as an  exhibit  to Annual  Report on Form 10-K for
                        the year ended October 31, 1997 and incorporated  herein
                        by reference.

             (3)        Filed as an  exhibit  to Annual  Report on Form 10-K for
                        the year ended October 31, 1998 and incorporated  herein
                        by reference.

             (4)        Filed as an  exhibit  to Annual  Report on Form 10-K for
                        the year ended October 31, 2002 and incorporated  herein
                        by reference.

             (5)        Filed as an  exhibit  to Annual  Report on Form 10-K for
                        the year ended October 31, 1993 and incorporated  herein
                        by reference.

             (6)        Filed as an  exhibit  to Annual  Report on Form 10-K for
                        the year ended October 31, 1995 and incorporated  herein
                        by reference.

             (7)        Filed as an exhibit to  Registration  Statement  on Form
                        S-3  dated  May 23,  2002  and  incorporated  herein  by
                        reference.

             (8)        Filed as an exhibit to Quarterly Report on Form 10-Q for
                        the quarter ended July 31, 2002 and incorporated  herein
                        by reference.

             (9)        Filed as an exhibit to  Registration  Statement  on Form
                        S-3  dated  July 11,  2003 and  incorporated  herein  by
                        reference.


                                      -40-
<PAGE>

(b)      REPORTS ON FORM 8-K

On August 25, 2004, we filed a Form 8-K to report our earnings for the three and
nine months ended July 31, 2004.

(c)      EXHIBITS REQUIRED BY ITEM 601

         Please refer to Part IV, Item 15(a)(3).

(d)      FINANCIAL STATEMENTS

         Please refer to Part IV, Item 15(a)(2).



                                      -41-
<PAGE>

                                   SIGNATURES

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


                                             SBE, Inc.


Date:  January 14, 2005                      By:  /s/ William B. Heye, Jr.
                                                  --------------------------
                                                  William B. Heye, Jr.
                                                  Chief Executive Officer and
                                                  President
                                                  (Principal Executive Officer)


Date:  January 14, 2005                      By:  /s/ David W. Brunton
                                                  --------------------------
                                                  David W. Brunton
                                                  Chief Financial Officer,
                                                  Vice President, Finance
                                                  and Secretary
                                                  (Principal Financial and
                                                  Accounting Officer)


                                POWER OF ATTORNEY

         KNOW  ALL  PERSONS  BY THESE  PRESENTS,  that  each of the  undersigned
officers and directors of the registrant  constitutes and appoints,  jointly and
severally,  William B.  Heye,  Jr. and David W.  Brunton,  and each of them,  as
lawful  attorneys-in-fact  and agents for the  undersigned and for each of them,
each with full power of substitution  and  resubstitution,  for and in the name,
place and stead of each of the  undersigned  officers and directors,  in any and
all capacities,  to sign any and all amendments to this report,  and to file the
same, with all exhibits thereto and all 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  necessary or appropriate to be done in
and about the  premises,  as fully to all  intents  and  purposes as he might or
could do in  person,  hereby  ratifying  and  confirming  all that  each of said
attorneys-in-fact  or any of them, or any of their substitutes,  may lawfully do
or cause to be done by virtue hereof.

         Pursuant to the requirements  for the Securities  Exchange Act of 1934,
this  report  has  been  signed  by the  following  persons  in  the  capacities
indicated, as of January 14, 2005.



                                      -42-
<PAGE>

      Signature                                      Title
      ---------                                      -----

/s/ William B. Heye, Jr.              Chief Executive Officer and President
------------------------              (Principal Executive Officer)
William B. Heye Jr.


/s/ David W. Brunton                  Chief Financial Officer, Vice President,
------------------------              Finance and Secretary (Principal Financial
David W. Brunton                      and Accounting Officer)


/s/ Ronald J. Ritchie                 Director, Chairman of the Board
------------------------
Ronald J. Ritchie


/s/ John Reardon                      Director
------------------------
John Reardon


/s/ Marion M. Stuckey                 Director
------------------------
Marion M. Stuckey



                                      -43-
<PAGE>

             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


Board of Directors
SBE, Inc.
San Ramon, California

We have audited the accompanying  consolidated balance sheets of SBE, Inc. as of
October 31, 2004 and 2003 and the related consolidated statements of operations,
stockholders'  equity,  and cash  flows for the years then  ended.  We have also
audited  the  schedule  listed  in  the  accompanying   index.  These  financial
statements and schedule are the responsibility of the Company's management.  Our
responsibility  is to  express  an opinion  on these  financial  statements  and
schedule based on our audit.

We conducted our audits in accordance  with the standards of the Public  Company
Accounting  Oversight Board (United States of America).  Those standards require
that we plan and perform the audits 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  and schedule.  An audit also includes  assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall presentation of the financial statements and schedule.
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  financial  position of SBE, Inc. as of
October 31, 2004 and 2003,  and the results of its operations and its cash flows
for the years then ended in  conformity  with  accounting  principles  generally
accepted in the United States of America.

Also, in our opinion,  the schedule presents fairly,  in all material  respects,
the  information  relating to the years  ended  October 31, 2004 and 2003 as set
forth therein.

/s/  BDO Seidman, LLP

December 10, 2004 San Francisco,  California



                                      -44-
<PAGE>

             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


To the Board of Directors and Stockholders of SBE, Inc.:

In our  opinion,  the  consolidated  statements  of  operations,  of  changes in
stockholders'  equity  and of cash  flows for the year ended  October  31,  2002
(appearing on pages 47 through 49 of the SBE,  Inc.  Annual Report on Form 10-K)
present  fairly,  in all material  respects,  the results of operations and cash
flows of SBE, Inc. and its  subsidiaries for the year ended October 31, 2002, in
conformity with accounting principles generally accepted in the United States of
America. In addition, in our opinion, the financial statement schedule listed in
the index  appearing  under Item  15(a)(2)  on page 38 presents  fairly,  in all
material respects,  the information  relating to the year ended October 31, 2002
set  forth  therein  when  read in  conjunction  with the  related  consolidated
financial  statements.   These  financial  statements  and  financial  statement
schedule are the responsibility of the Company's management.  Our responsibility
is to express an opinion on these financial  statements and financial  statement
schedule  based on our audit.  We  conducted  our audit of these  statements  in
accordance with the standards of the Public Company  Accounting  Oversight Board
(United States).  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,  assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall  financial  statement  presentation.  We believe that our
audit provides a reasonable basis for our opinion.

The accompanying  consolidated  financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated  financial  statements,  the Company has suffered  recurring losses
from operations and has generated negative cash flows from operations that raise
substantial doubt about its ability to continue as a going concern. Management's
plans in regard to these matters are also described in Note 1. The  consolidated
financial  statements do not include any adjustments  that might result from the
outcome of this uncertainty.


/s/ PricewaterhouseCoopers LLP

San Francisco, California
January 13, 2003



                                      -45-
<PAGE>

SBE, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
October 31                                                               2004             2003
------------------------------------------------------------------------------------------------
<S>                                                                  <C>             <C>
ASSETS

Current assets:
    Cash and cash equivalents                                        $     1,849     $     1,378
    Trade accounts receivable, net of allowance for
       doubtful accounts of $42 and $90                                    1,668           1,818
    Inventories                                                            1,926           1,880
    Other                                                                    227             240
                                                                     -----------     -----------
             Total current assets                                          5,670           5,316

Property and equipment, net                                                  427             389
Capitalized software costs, net                                               48             120
Intellectual property, net                                                    --           1,122
Other                                                                         28              28
                                                                     -----------     -----------

             Total assets                                            $     6,173     $     6,975
                                                                     ===========     ===========

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
    Trade accounts payable                                           $       856     $       696
    Accrued payroll and employee benefits                                    391             184
    Capital lease obligations - current portion                               25              --
    Other                                                                    459             491
                                                                     -----------     -----------
             Total current liabilities                                     1,701           1,371

Capital lease obligations and long term liabilities,
  net of current portion                                                     139             217
                                                                     -----------     -----------

             Total liabilities                                             1,870           1,588
                                                                     -----------     -----------

Commitments  (Notes 7 and 8)

Stockholders' equity:
    Convertible preferred stock:
         ($0.001 par value) authorized  2,000,000 shares; none
         outstanding                                                          --              --
    Common stock and additional paid-in capital
         ($0.001 par value); authorized 25,000,000 and 10,000,000
         shares; issued and outstanding 5,094,118 and 4,808,650           15,755          15,302
    Note receivable from stockholder                                          --            (142)
    Accumulated  deficit                                                 (11,452)         (9,773)
                                                                     -----------     -----------

             Total stockholders' equity                                    4,303           5,387
                                                                     -----------     -----------

             Total liabilities and stockholders' equity              $     6,173     $     6,975
                                                                     ===========     ===========
</TABLE>


  The accompanying notes are an integral part of these consolidated financial
                                  statements.


                                      -46-
<PAGE>

SBE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
For the years ended October 31,                  2004             2003             2002
------------------------------------------------------------------------------------------

<S>                                         <C>              <C>              <C>
Net sales                                   $     11,066     $      7,456     $      6,898
Cost of sales                                      6,646            2,749            3,170
                                            ------------     ------------     ------------

     Gross profit                                  4,420            4,707            3,728
                                            ------------     ------------     ------------

Product research and development                   2,411            1,330            3,027
Sales and marketing                                2,177            1,484            2,151
General and administrative                         1,755            1,752            2,364
Shareholder note valuation (benefit)                (239)            (235)             474
Restructuring costs (benefit)                         --             (154)             446
                                            ------------     ------------     ------------

     Total operating expenses                      6,104            4,177            8,462
                                            ------------     ------------     ------------

     Operating income (loss)                      (1,684)             530           (4,734)

Interest income                                        5               26               51
Forfeited deposit, net                                --               --            2,712
Other income (expense)                                --              (10)              63
                                            ------------     ------------     ------------
     Income (loss) before income taxes            (1,679)             546           (1,908)

Income tax benefit                                    --               17              177
                                            ------------     ------------     ------------

Net income (loss)                           $     (1,679)    $        563     $     (1,731)
                                            ============     ============     ============

Basic earnings (loss) per common share      $      (0.33)    $       0.13     $      (0.46)
                                            ============     ============     ============

Diluted earnings (loss) per common share    $      (0.33)    $       0.12     $      (0.46)
                                            ============     ============     ============

Basic - Shares used in per share
     computations                                  5,022            4,259            3,759
                                            ============     ============     ============

Diluted - Shares used in per share
     computations                                  5,022            4,709            3,759
                                            ============     ============     ============
</TABLE>


  The accompanying notes are an integral part of these consolidated financial
                                  statements.


                                      -47-
<PAGE>

SBE, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands, except shares)

<TABLE>
<CAPTION>
                                                                                                 Notes
                                                                      Common Stock and        Receivable
                                                                 Additional Paid-in Capital      from           Treasury Stock
                                                                    Shares        Amount      Stockholder    Shares       Amount
                                                                  ----------    ----------    ----------    ---------    -------
<S>                                                                <C>          <C>           <C>              <C>       <C>
Balance, October 31, 2001                                          3,521,035    $   13,877    $     (744)      79,500    $  (409)
Stock issued in connection with stock purchase plan                   47,596            31            --           --         --
Stock and warrant issued in connection with private placement        555,556           782            --           --         --
Stock issued to Directors in lieu of cash payments                    13,425            21            --           --         --
Valuation allowance on note receivable from officer                       --            --           474           --         --
Net loss                                                                  --            --            --           --         --
                                                                  ---------------------------------------------------------------
Balance, October 31, 2002                                          4,137,612        14,711          (270)      79,500       (409)
                                                                  ---------------------------------------------------------------
Stock issued in connection with stock purchase plan                   11,012            12            --           --         --
Stock and warrant issued in connection with private placement        500,000           464            --           --         --
Stock issued to Directors in lieu of cash payments                    37,787            43            --           --         --
Stock issued in connection with the acquisition of Antares            90,628           259            --           --         --
Stock issued in connection with warrant exercise                     111,111           222            --           --         --
Retirement of treasury stock                                         (79,500)         (409)           --      (79,500)       409
Reversal of valuation allowance on note receivable from officer           --            --           128           --         --
Net income                                                                --            --            --           --         --
                                                                  ---------------------------------------------------------------
Balance, October 31, 2003                                          4,808,650        15,302          (142)          --         --
                                                                  ---------------------------------------------------------------
Stock issued in connection with stock purchase plan                    9,903            18            --           --         --
Stock issued in connection with Stock Option Plans                   164,136           233            --           --         --
Stock issued in connection with warrant exercise                      81,429           116            --           --         --
Stock issued in connection with the acquisition of Antares            30,000            86            --           --         --
Reversal of valuation allowance on note receivable from officer           --            --          (239)          --         --
Collection of note receivable from officer                               381           381
Net loss                                                                  --            --            --           --         --
                                                                  ---------------------------------------------------------------
Balance, October 31, 2004                                          5,094,118    $   15,755    $       --           --    $    --
                                                                  ===============================================================

<CAPTION>
                                                                    Retained
                                                                    Earnings
                                                                 (Accumulated
                                                                    deficit)      Total
                                                                  ----------    --------
<S>                                                               <C>           <C>
Balance, October 31, 2001                                         $   (8,605)   $  4,119
Stock issued in connection with stock purchase plan                       --          31
Stock and warrant issued in connection with private placement             --         782
Stock issued to Directors in lieu of cash payments                        --          21
Valuation allowance on note receivable from officer                       --         474
Net loss                                                              (1,731)     (1,731)
                                                                 -----------------------
Balance, October 31, 2002                                            (10,336)      3,696
                                                                 -----------------------
Stock issued in connection with stock purchase plan                       --          12
Stock and warrant issued in connection with private placement             --         464
Stock issued to Directors in lieu of cash payments                        --          43
Stock issued in connection with the acquisition of Antares                --         259
Stock issued in connection with warrant exercise                          --         222
Retirement of treasury stock                                              --          --
Reversal of valuation allowance on note receivable from officer           --         128
Net income                                                               563         563
                                                                 -----------------------
Balance, October 31, 2003                                             (9,773)      5,387
                                                                 -----------------------
Stock issued in connection with stock purchase plan                       --          18
Stock issued in connection with Stock Option Plans                        --         233
Stock issued in connection with warrant exercise                          --         116
Stock issued in connection with the acquisition of Antares                --          86
Reversal of valuation allowance on note receivable from officer           --        (239)
Collection of note receivable from officer
Net loss                                                              (1,679)     (1,679)
                                                                 -----------------------
Balance, October 31, 2004                                         $  (11,452)   $  4,303
                                                                 =======================
</TABLE>


  The accompanying notes are an integral part of these consolidated financial
                                  statements.


                                      -48-
<PAGE>

SBE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

<TABLE>
<CAPTION>
For the years ended October 31                                           2004        2003        2002
-------------------------------------------------------------------------------------------------------
<S>                                                                    <C>         <C>         <C>
Cash flows from operating activities:
       Net income (loss)                                               $(1,679)    $   563     $(1,731)
       Adjustments to reconcile net income (loss) to net cash
                provided by (used in) operating activities:
            Depreciation and amortization                                  829         443         730
            Impairment of intellectual property                            713          --          --
            Non-cash restructuring (benefit)                                --        (154)        185
            Stock-based compensation expense                                21
                                                                                        --          43
            Non-cash valuation allowance (recovery) on loan from          (240)       (142)        474
            officer
            Effect of re-measured warrant                                   --          --         (83)
            Loss on sale of assets                                          --          13          19
            Changes in operating assets and liabilities:
                    Trade accounts receivable                              150        (930)       (128)
                    Inventories                                            (46)         30       2,518
                    Other assets                                            13          30         238
                    Trade accounts payable                                 208         (57)
                                                                                                   160
                    Other current liabilities                              (41)       (184)
                                                                                                   (29)
                    Non-current liabilities                                 --          (4)     (4,860)
                                                                       -------     -------     -------

                       Net cash used in operating activities              (140)        (84)     (2,703)
                                                                       -------     -------     -------
Cash flows from investing activities:
            Purchases of property and equipment                            (87)       (172)       (149)
            Cash payments related to purchase of Antares assets
              and related costs                                             --        (868)         --
            Purchased software                                            (136)        (48)       (105)
                                                                       -------     -------     -------

                       Net cash used in investing activities              (223)     (1,088)       (254)
                                                                       -------     -------     -------
Cash flows from financing activities:
            Proceeds from stock plans                                      251          12          31
            Proceeds from issuance of common stock and warrants            202         686         864
            Proceeds from repayment of shareholder note                    382         270          --
                                                                       -------     -------     -------

                       Net cash provided by financing activities           834         968         895
                                                                       -------     -------     -------

                       Net increase (decrease) in cash and cash            471        (204)     (2,062)

Cash and cash equivalents at beginning of year                           1,378       1,582       3,644
                                                                       -------     -------     -------

Cash and cash equivalents at end of year                               $ 1,849     $ 1,378     $ 1,582
                                                                       =======     =======     =======

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

Cash paid during the year for:
       Interest                                                        $    --     $    --     $    --
                                                                       =======     =======     =======
       Income taxes                                                    $     1     $     1     $     1
                                                                       =======     =======     =======
SUPPLEMENTAL SCHEDULE OF NON CASH INVESTING AND FINANCING
ACTIVITIES

Assets acquired under capital leases                                   $   164     $    --     $    --
                                                                       =======     =======     =======
Non-cash stock portion of Antares purchase price                       $    --     $   542     $    --
                                                                       =======     =======     =======
</TABLE>


  The accompanying notes are an integral part of these consolidated financial
                                  statements.


                                      -49-
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The Company and Basis of Presentation:

SBE,  Inc.,  headquartered  in San Ramon,  California,  architects  and provides
network   communications   and  storage  solutions  to  the  original  equipment
manufacturers  ("OEM")  in the  embedded  computing  and  storage  markets.  Our
solutions enable both data  communications and  telecommunications  companies in
addition to enterprise class high-end server clients to rapidly deliver advanced
networking  and storage  products and services.  Our products  include wide area
network  ("WAN"),  local area network  ("LAN"),  Internet Small Computer  System
Interface ("iSCSI"), SCSI, Fibre Channel,  intelligent carrier cards, Encryption
and TCP/IP  Offload  Engine  ("TOE")  cards.  These  products  perform  critical
computing,  Input/Output  ("I/O") and storage  tasks across both the  enterprise
server and embedded  markets such as high-end  enterprise  level servers,  Linux
super computing clusters, workstations, media gateways, routers, internet access
devices, home location registers,  data messaging  applications network attached
storage  ("NAS")  and remote  storage  devices.  Our  products  are  distributed
worldwide through a direct sales force, distributors, independent manufacturers'
representatives  and  value-added  resellers.  Our  business  falls  within  one
industry segment and product group.

Liquidity

We had a net loss of $1.7  million in fiscal  2004.  The net loss  includes  the
following expenses:

      o     $1.1  million  of  amortization   and  impairment   charges  of  the
            intellectual  property  associated  with the  acquisition of Antares
            MicroSystems, Inc. on August 7, 2003;

      o     $259,000  accrual  for  severance  pay  for  the  retirement  of the
            Company's president and CEO;

      o     $421,000 of depreciation  and  amortization  expense and $547,000 in
            inventory valuation charges.

We believe our existing  cash plus  additional  cash from our line of credit and
continuing operations will provide sufficient cash flows to fund our operations.

Principles of Consolidation:

The consolidated  financial statements include the accounts of SBE, Inc. and its
wholly-owned subsidiaries.  All intercompany balances and transactions have been
eliminated in consolidation.

Use of Estimates:

The  preparation  of  consolidated   financial  statements  in  conformity  with
generally  accepted  accounting  principles  in the  United  States  of  America
requires us 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.  Such estimates include levels of reserves


                                      -50-
<PAGE>

for  doubtful  accounts,  obsolete  inventory,  warranty  costs and deferred tax
assets. Actual results could differ from those estimates.

Fair Value of Financial Instruments:

The fair value of our cash and cash equivalents,  accounts receivable,  accounts
payable and accrued  liabilities  approximate  their  carrying  value due to the
short-term maturity rate structure of those instruments.

Cash and Cash Equivalents:

We consider all highly liquid investments  readily convertible into cash with an
original maturity of three months or less to be cash equivalents.  Substantially
all of our  cash  and  cash  equivalents  are  held  with  one  large  financial
institution and may at times be above insured limits.

Inventories:

We are exposed to a number of economic and industry factors that could result in
portions of our inventory  becoming  either obsolete or in excess of anticipated
usage, or subject to lower of cost or market issues.  These factors include, but
are not limited to,  technological  changes in our markets,  our ability to meet
changing customer  requirements,  competitive  pressures in products and prices,
and the  availability  of key components  from our  suppliers.  Our policy is to
establish  inventory  reserves  when  conditions  exist  that  suggest  that our
inventory may be in excess of  anticipated  demand or is obsolete based upon our
assumptions  about  future  demand for our products  and market  conditions.  We
regularly  evaluate our ability to realize the value of our inventory based on a
combination  of  factors  including  the  following:   historical  usage  rates,
forecasted sales or usage,  product  end-of-life  dates,  estimated  current and
future market  values and new product  introductions.  Purchasing  practices and
alternative  usage  avenues are  explored  within  these  processes  to mitigate
inventory  exposure.  When  recorded,  our  reserves  are intended to reduce the
carrying  value of our inventory to its net realizable  value.  If actual demand
for our products  deteriorates,  or market  conditions  are less  favorable than
those that we project,  additional  inventory  reserves may be required.  In the
fourth quarter of fiscal 2004, we reviewed our inventory  balances and increased
our reserves on specific products by $547,000.

Inventories  are  stated at the lower of cost,  using  the  first-in,  first-out
method, or market value.

Property and Equipment:

Property and equipment are carried at cost. We record depreciation  charges on a
straight-line  basis over the assets'  estimated useful lives of three years for
computers  and related  equipment  to eight years for  manufacturing  equipment.
Leasehold  improvements  are amortized  over the lesser of their useful lives or
the remaining term of the related leases.

When  assets  are sold or  otherwise  disposed  of,  the  cost  and  accumulated
depreciation  are  removed  from  the  accounts  and any gain or loss on sale or
disposal is recognized in  operations.  Maintenance,  repairs and minor renewals
are charged to expense as incurred. Expenditures which substantially increase an
asset's useful life are capitalized.


                                      -51-
<PAGE>

We review  property and equipment for impairment  whenever  events or changes in
circumstances indicate the carrying value of an asset may not be recoverable. In
performing  the review for  recoverability,  we would  estimate the future gross
cash  flows  expected  to  result  from the use of the  asset  and its  eventual
disposition.  If such gross cash flows are less than the carrying  amount of the
asset, the asset is considered  impaired.  The amount of the impairment loss, if
any, would then be calculated  based on the excess of the carrying amount of the
asset over its fair value.

Intangible Assets:

We adopted the  Financial  Accounting  Standards  Board  ("FASB")  Statements of
Financial Accounting Standards ("SFAS") No. 141, Business  Combinations and SFAS
No.  142,  Goodwill  and Other  Intangible  Assets on  accounting  for  business
combinations and goodwill as of the beginning of fiscal year 2002.  Accordingly,
we  do  not  amortize   goodwill   from   acquisitions,   but   amortize   other
acquisition-related  intangibles and costs. All of the intangible assets that we
currently own are intellectual property acquired in the Antares acquisition.

For  identifiable  intangible  assets,  we amortize the cost over the  estimated
useful life and assess any  impairment by  estimating  the future cash flow from
the  associated  asset in  accordance  with  SFAS No.  144,  Accounting  for the
Impairment or Disposal of Long-Lived Assets. If the estimated  undiscounted cash
flow  related to these  assets  decreases  in the  future or the useful  life is
shorter than originally estimated,  we may incur charges for impairment of these
assets. The impairment is based on the estimated discounted cash flow associated
with the asset. An impairment could result if the underlying technology fails to
gain  market  acceptance,  we fail to  deliver  new  products  related  to these
technology  assets,  the products fail to gain expected market  acceptance or if
market conditions are unfavorable.

Intellectual  property costs consist of the allocation of costs  associated with
the  purchase  of  current  and the  design  of  future  products  from  Antares
Microsystems  on August 7,  2003.  As  required  by these  rules,  we perform an
impairment  review  annually,  or earlier if indicators of potential  impairment
exist. The impairment analysis requires  significant judgment to identify events
or circumstances that would likely have a significant adverse effect on the fair
value of the intangible asset. Our annual impairment review was completed during
the fourth quarter of fiscal 2004, and we determined that there was considerable
doubt  that the  unamortized  balance of  $713,000  of the  intangible  asset at
October 31, 2004 would be recoverable.  The indicators we used to identify those
events and  circumstances  include  revenue  and  earnings  trends  relative  to
predefined   milestones  and  overall  business  prospects;   the  technological
feasibility  of the Antares  products and  technologies  and the general  market
conditions  in the market for SUN  Microsystems  compatible  products with which
Antares  product  compete.  Our impairment  review is based on a discounted cash
flow approach that uses  estimates of future market share and revenues and costs
for the Antares  products as well as appropriate  discount rates.  The estimates
used are  consistent  with the plans  and  estimates  that we use to manage  the
underlying  business.  We determined that the estimated fair market value of the
balance of the intangible  asset related to the Antares  acquisition was nominal
and as a result, we recorded an impairment charge of $713,000 during the quarter
ended October 31, 2004 thus writing off the remaining value of the  intellectual
property asset.

The non-cash amortization expense related to the intellectual property in fiscal
2004 was $1.1  million and consists of $408,000 of  regularly  scheduled  annual
amortization  expense plus $713,000  write down related to impairment  valuation


                                      -52-
<PAGE>

analysis.  This write-down plus the regularly scheduled amortization is included
as an expense item in our cost of goods sold. The  amortization  expense for the
one quarter that we owned Antares in fiscal 2003 was approximately $102,000.

Acquisitions:

All business  acquisitions  have been accounted for using the purchase method of
accounting and, accordingly,  the consolidated  statements of operations include
the results of each acquired business since the date of acquisition.  The assets
acquired  and  liabilities  assumed are  recorded at estimates of fair values as
determined by management based on information  available we consider a number of
factors,  including  third-party  valuations  or  appraisals,  when making these
determinations.  We finalize the  allocation of purchase price to the fair value
of the  assets  acquired  and  liabilities  assumed  when we obtain  information
sufficient to complete the  allocation,  but in any case,  within one year after
acquisition.

Revenue Recognition:

Our policy is to  recognize  revenue  for  product  sales upon  shipment  of our
products to our customers  provided that no significant  obligations  remain and
collection  of  the  receivable  is  considered  probable.  Shipping  terms  are
generally FOB shipping  point.  We defer and recognize  service revenue over the
contractual  period or as services are  rendered.  Service  revenue has not been
significant  in any period.  We estimate  expected  sales returns and record the
amount as a reduction  of revenue at the time of shipment.  Our policies  comply
with the  guidance  provided  by Staff  Accounting  Bulletin  No.  104,  Revenue
Recognition  in  Financial  Statements,  issued by the  Securities  and Exchange
Commission.  Judgments are required in evaluating  the credit  worthiness of our
customers.  Credit is not  extended to customers  and revenue is not  recognized
until we have  determined that the  collectibility  is reasonably  assured.  Our
sales transactions are generally denominated in U.S. dollars.

Our agreements with our distributors  include certain product rotation and price
protection  rights.  All  distributors  have the  right to  rotate  slow  moving
products  once each  fiscal  quarter.  The  maximum  dollar  value of  inventory
eligible for rotation is equal to twenty-five  percent of our products purchased
by the distributor  during the previous  quarter.  In order to take advantage of
their product rotation rights,  the distributors must order and take delivery of
additional  SBE products equal to at least the dollar value of the products that
they want to rotate.

Each distributor is also allowed certain price protection rights. If and when we
reduce the price of any of our  products and the  distributor  is holding any of
the  affected  products  in  inventory,  we  will  credit  the  distributor  the
difference  in price  when it  places  its next  order  with us.  We  record  an
allowance for price protection  reducing our net sales and accounts  receivable.
The  allowance is based on the price  difference  of the  inventory  held by our
distributors  at the time we expect to reduce selling  prices.  Reserves for the
right of return and restocking are established based on the requirements of SFAS
48, Revenue  Recognition  when Right of Return Exists because we have visibility
into our  distributor's  inventory  and have  significant  history  to  estimate
returns.

During the year ended  October  31,  2004,  $874,000  or 8% of our sales were to
distributors compared to $191,000 or 3% in fiscal 2003.


                                      -53-
<PAGE>

Product Warranty:

Our  products  are sold  with  warranty  provisions  that  require  us to remedy
deficiencies  in quality or performance of our products over a specified  period
of time,  generally  12 months,  at no cost to our  customers.  Our policy is to
establish  warranty  reserves at levels that represent our estimate of the costs
that will be incurred to fulfill those  warranty  requirements  at the time that
revenue is recognized.  We believe that our recorded liabilities are adequate to
cover our future cost of materials,  labor and overhead for the servicing of our
products  sold through that date.  If actual  product  failures,  or material or
service delivery costs differ from our estimates,  our warranty  liability would
need to be revised accordingly.

Allowance for Doubtful Accounts:

Our policy is to maintain  allowances  for estimated  losses  resulting from the
inability  of our  customers  to  make  required  payments.  Credit  limits  are
established  through a process of reviewing the financial  history and stability
of each  customer.  Where  appropriate,  we obtain  credit  rating  reports  and
financial  statements of the customer when determining or modifying their credit
limits.  We  regularly  evaluate  the  collectibility  of our  trade  receivable
balances based on a combination of factors.  When a customer's  account  balance
becomes past due, we initiate dialogue with the customer to determine the cause.
If it is  determined  that the  customer  will be unable  to meet its  financial
obligation  to us,  such as in the  case  of a  bankruptcy  filing,  significant
deterioration in the customer's operating results or financial position or other
material events impacting its business, we record a specific allowance to reduce
the related receivable to the amount we expect to recover.

We also record an allowance  for all  customers  based on certain  other factors
including  the  length  of time the  receivables  are  past  due and  historical
collection  experience  with customers.  We believe our reported  allowances are
adequate.  If the financial  conditions of those  customers were to deteriorate,
however,  resulting in their  inability to make payments,  we may need to record
additional   allowances   which   would   result  in   additional   general  and
administrative   expenses   being   recorded   for  the  period  in  which  such
determination is made.

Product Research and Development Expenditures:

Product  research  and  development  ("R&D")  expenditures,  other than  certain
software  development  costs,  are charged to expense as  incurred.  Contractual
reimbursements for R&D expenditures under joint R&D contracts with customers are
accounted for as revenue when received.

Capitalized  software  costs consist of costs to purchase  software and costs to
internally  develop  software.  Capitalization of software costs begins upon the
establishment of technological  feasibility.  All capitalized software costs are
amortized  as related  sales are  recorded  on a  per-unit  basis with a minimum
amortization  to cost of goods  sold  based  on a  straight-line  method  over a
two-year  estimated  useful life. We evaluate the estimated net realizable value
of each  software  product  and  record  provisions  to the asset  value of each
product for which the net book value is in excess of the net  realizable  value.
No  internal  software  development  costs were  capitalized  in the years ended
October 31, 2004, 2003 and 2002.


                                      -54-
<PAGE>

Refundable Deposit:

A refundable  deposit  associated with a multi-year  supply agreement with HP of
$4.9 million was received in April 2001. This deposit was refundable to HP as we
delivered certain quantities of products to HP over a four year period ending in
2005. The supply contract was  restructured in fiscal 2002 to include a purchase
order for $1.6 million of our  products  that was shipped to HP in the first two
quarters of fiscal  2003 and the  forfeiture  by HP of $4.4  million of the $4.9
million refundable deposit.  Under the agreement,  we are required to retain for
future  production  or repair all VME finished  goods and spare parts  inventory
through  October 31, 2005 unless notified  otherwise by HP.  Concurrent with the
forfeiture of the $4.4 million refundable deposit, we recorded a reserve of $1.7
million related to certain HP specific inventory we held at October 31, 2002 but
may not be able to sell.  The $2.7 million of forfeiture  of refundable  deposit
net of  inventory  reserve is  presented  under  Forfeited  deposit,  net on the
Consolidated Statements of Operations. The remaining $447,000 of the deposit was
repaid to HP in the third quarter of fiscal 2003.

Stock-based Compensation:

We account for stock-based employee compensation arrangements in accordance with
Accounting  Principles  Board  Opinion No. 25,  Accounting  for Stock  Issued to
Employees,  ("APB 25") and comply with the disclosure provisions of Statement of
Financial  Accounting  Standards  ("SFAS") No. 123,  Accounting for  Stock-Based
Compensation  and SFAS No.  148,  Accounting  for  Stock  Based  Compensation  -
Transition and Disclosure.  Under APB 25,  compensation  expense is based on the
difference, if any, on the date of the grant between the fair value of our stock
and the exercise price of the option. We account for equity  instruments  issued
to  non-employees in accordance with SFAS No. 123 and Emerging Issues Task Force
("EITF") 96-18,  Accounting for Equity Instruments that are Issued to Other than
Employees for  Acquiring,  or in  Conjunction  with Selling,  Goods or Services,
which require that such equity instruments be recorded at their fair value.

Had compensation cost for these plans been determined pursuant to the provisions
of SFAS No. 123, our pro forma net income  (loss) would have been as follows (in
thousands):

                                               For the Year Ended October 31,
                                            -----------------------------------
                                               2004          2003        2002
                                            ---------     ---------   ---------
Net income (loss) - as reported ..........  $  (1,679)    $     563   $  (1,731)
Stock based employee compensation
  (recovery) expense included in reported
  net loss, net of related tax effects ...         --            --          --
Less total stock based employee
  compensation expense determined
  under fair value based method for
  all awards, net of related tax
  effects ................................     (1,177)         (231)       (721)
                                            ---------     ---------   ---------

Pro forma net income (loss) ..............  $  (2,856)    $     332   $  (2,452)
                                            =========     =========   =========

Income (loss) per share:
Basic - as reported ......................  $   (0.33)    $    0.13   $   (0.46)

Basic - pro forma ........................  $   (0.57)    $    0.08   $   (0.65)

Diluted - as reported ....................  $   (0.33)    $    0.12   $   (0.46)

Diluted - pro forma ......................  $   (0.57)    $    0.07   $   (0.65)


                                      -55-
<PAGE>

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

Options granted in years ended October 31       2004         2003        2002
------------------------------------------------------------------------------
Expected life (in years)                        4.00         5.00        5.00
Risk-free interest rate                         3.29%        2.00%       2.00%
Volatility                                    120.20%      126.00%     148.00%
Dividend yield                                  0.00%        0.00%       0.00%

The weighted  average fair value of options granted during 2004,  2003, and 2002
was $2.93, $1.79 and $0.92 per option, respectively.

Advertising Costs:

Advertising  expenditures  are  expensed  as  incurred.  Advertising  costs were
$204,000 in fiscal 2004 and $79,000 in fiscal 2003.

Income Taxes:

We account for income  taxes in  accordance  with SFAS No. 109,  Accounting  for
Income Taxes. SFAS No. 109 requires  recognition of deferred tax liabilities and
assets for the expected future tax consequences of items that have been included
in the consolidated  financial statements or tax returns.  Deferred income taxes
represent  the future  net tax  effects  resulting  from  temporary  differences
between the financial  statement and tax bases of assets and liabilities,  using
enacted tax rates in effect for the year in which the  differences  are expected
to reverse.  Valuation  allowances are recorded  against net deferred tax assets
where, in our opinion,  realization is uncertain. The provision for income taxes
represents the net change in deferred tax amounts, plus income taxes payable for
the current period.

Net Earnings (Loss) Per Common Share:

Basic earnings per common share is computed by dividing net income (loss) by the
weighted average number of shares of common stock outstanding.  Diluted earnings
per common  share is  computed  by dividing  net income  (loss) by the  weighted
average  number  of  shares  of  common  stock  and  common  stock   equivalents
outstanding.  Common  stock  equivalents  relate to stock  options and  warrants
include:

      o     397,000 employee options to purchase common stock;

      o     23,000 shares of common stock; and

      o     30,000  warrants to purchase common stock for the year ended October
            31, 2003.

Common  stock  equivalents  of  approximately  792,000 and  809,000  options are
excluded  from the diluted  earnings per share  calculation  for fiscal 2004 and
2002, respectively, due to their anti-dilutive effect.


                                      -56-
<PAGE>

Comprehensive Income:

Comprehensive income is defined as the change in equity of a business enterprise
during a period  from  transactions  and other  events  and  circumstances  from
non-owner  sources.  Through October 31, 2004, we have not had any  transactions
that  were  required  to  be  reported  in  other   comprehensive   income  and,
accordingly, comprehensive income (loss) is the same as net income (loss).

New Accounting Pronouncements:

In  December  2004,  the FASB  issued  SFAS No.  123R that  amends  SFAS No. 123
Accounting for Stock-Based Compensation,  to require public entities (other than
those  filing  as  small  business  issuers)  to  report  stock-based   employee
compensation  in their  financial  statements.  SFAS No. 123R will require us to
expense the fair value of unvested options and future grants of options over the
remaining  vesting period.  Unless modified,  we will be required to comply with
the provisions of SFAS No. 123R as of the first interim period that begins after
June 15, 2005 (August 1, 2005 for us). We  currently do not record  compensation
expense related to our stock-based employee  compensation plans in our financial
statements.

Reclassifications:

Certain  reclassifications have been made to the financial statements to conform
to the prior  presentation  with no effect on net income (loss) or stockholders'
equity as previously reported.

2.  INVENTORIES

Inventories at October 31, comprise the following (in thousands):

                                                2004              2003
-------------------------------------------------------------------------
         Finished goods                    $      1,343      $        726
         Parts and materials                        583             1,154
                                           ------------      ------------

         Total inventory                   $      1,926      $      1,880
                                           ============      ============


3.  PROPERTY AND EQUIPMENT

Property  and  equipment  at October  31, are  comprised  of the  following  (in
thousands):

                                                2004              2003
-------------------------------------------------------------------------
         Machinery and equipment           $      4,708      $      4,482
         Furniture and fixtures                     284               278
         Leasehold improvements                     118               118
                                           ------------      ------------
                                                  5,110             4,878
         Less accumulated depreciation
           and amortization                      (4,683)           (4,489)
                                           ------------      ------------

                                           $        427      $        389
                                           ============      ============


                                      -57-
<PAGE>

Depreciation and amortization  expense totaled  $213,000,  $303,000 and $649,000
for the years ended October 31, 2004, 2003 and 2002, respectively.  There was no
deprecation expense on capital leases in 2004.

The  following is a schedule by years of future  minimum  lease  payments  under
capital leases together with the present value of the net minimum lease payments
as of October 31, 2004: (in thousands)

Year ending October 31:
                             2005                $ 44
                             2006                  44
                             2007                  44
                             2008                  44
                             2009                  43

Total minimum lease payments                      219

Less: Amount representing interest(1)             (55)
                                                 ----

Present value of net minimum lease payments(2)   $164
                                                 ====

      ----------
      (1)   Amount  necessary  to reduce net minimum  lease  payments to present
            value  calculated at the actual lease interest rate at the inception
            of the leases.

      (2)   Reflected  in the balance  sheet as other  current  liabilities  and
            other long-term liabilities of $25,000 and $139,000, respectively.


4.  CAPITALIZED SOFTWARE COSTS

Capitalized  software  costs at October 31, 2004 and 2003 comprise the following
(in thousands):

                                                   2004            2003
--------------------------------------------------------------------------
Purchased software                              $    1,065      $      929
Less accumulated amortization                       (1,017)           (809)
                                                -----------     -----------
                                                $       48      $      120
                                                ==========      ==========

We  capitalized  $136,000,  $48,000 and $105,000 of purchased  software costs in
2004, 2003, and 2002  respectively.  Amortization of capitalized  software costs
totaled  $208,000,  $38,000,  and $81,000 for the years ended  October 31, 2004,
2003, and 2002,  respectively.  Included in the $208,000  software  amortization
expense  for fiscal  2004 is  $126,000  related to  write-downs  of  capitalized
software during the fourth quarter of fiscal 2004.


                                      -58-
<PAGE>

5. STOCKHOLDERS' EQUITY

In May 1999,  our Board of Directors  authorized  us to repurchase up to 100,000
shares of our issued and outstanding Common Stock.  During fiscal 1999 and 2000,
we  repurchased  79,500  shares of our  Common  Stock in the open  market for an
aggregate purchase price of approximately $409,000. We retired the 79,500 shares
of our Common Stock that we purchased under this  repurchase  program on October
16, 2003.

On April 30, 2002, we completed a private  placement of 555,556 shares of Common
Stock at $1.80 per share plus a warrant  to  purchase  111,111  shares of common
stock, resulting in net cash proceeds of approximately $0.8 million. The warrant
has a term of three  years and is  exercisable  at $2.00 per  share.  The equity
investment  was made by  Stonestreet  L.P.,  of Ontario,  Canada.  The shares of
Common Stock and the shares of Common Stock  associated  with the warrants  were
registered  with the  Securities and Exchange  Commission  and the  registration
statement was declared  effective on June 14, 2002.  Stonestreet L.P.  exercised
its warrant to purchase  111,111  shares of our Common  Stock on October 9, 2003
for cash consideration of $222,222.

The fair value of the Stonestreet L.P. warrant of $164,000 on its issue date was
computed  using the  Black-Scholes  option  pricing  model and was recorded as a
liability pursuant to EITF No. 00-19,  Determination of Whether Share Settlement
is Within the Control of the Issuer for Purposes of Applying Issue 96-3, as cash
penalties  could have been payable to Stonestreet LP in the event a registration
statement  related to the  private  placement  was not  declared  effective  and
maintained.  The registration statement was declared effective on June 14, 2002.
On August 22, 2002,  the private  placement  subscription  agreement was amended
such  that no cash  penalties  are now  payable  with  respect  to the  warrant.
Accordingly,   as  of  August  22,  2002,  the  warrant  was  reclassified  from
liabilities  to equity at its fair  value of  $81,000,  resulting  in $83,000 of
other income.

In connection with the private placement we paid Vintage Partners a finder's fee
of $60,000 and warrants to purchase 21,429 shares of Common Stock.  The warrants
have a three year term and are  exercisable  at $3.50 per share.  During  fiscal
2004,  Vintage  Partners  exercised a portion of their  warrants  and  purchased
11,429 shares of common stock for a total purchase price of $40,001.

On June 27, 2003, we completed a private  placement of 500,000  shares of common
stock plus a warrant to purchase  50,000  shares of common  stock,  resulting in
gross cash proceeds of $550,000 and net cash proceeds of approximately $464,000.
The warrant  has a term of five years and bears an  exercise  price of $1.50 per
share subject to certain adjustment provisions.

In  connection  with  the  private  placement  we  paid  Puglisi  & Co.  and its
associates a placement fee of $33,000 and warrants to purchase 150,000 shares of
common  stock.  The  warrants  have a five-year  term and bear  exercise  prices
between $1.50 and $2.00 per share, subject to certain adjustment provisions. The
warrants to purchase a total of 200,000 shares of common stock have a calculated
fair  value  of  approximately  $225,000.  This  value  was  derived  using  the
"Black-Scholes"  pricing  model.  We registered  for resale all of the shares of
common stock sold in this  offering and the shares  subject to sale  pursuant to
the exercise of the warrants with the Securities and Exchange Commission on Form
S-3.  During  fiscal  2004,  Puglisi  exercised a portion of their  warrants and
purchased 70,000 shares of common stock for a total purchase price of $116,000.


                                      -59-
<PAGE>

During  fiscal  2003,  we  issued  37,787  shares  of our  Common  Stock  to the
non-employee  members  of our Board of  Directors  in lieu of 50% of their  cash
compensation. The value of the Common Stock of $43,000 was recorded as a general
and administrative expense.

During  fiscal 2003,  we issued  90,628 shares of our Common Stock to one of the
owners  of  Antares  Microsystems,   Inc.  pursuant  to  the  original  purchase
agreement. The value of the Common Stock of $259,000

During  fiscal 2004,  we issued 30,000 shares of our Common Stock to an employee
who was one of the owners of Antares Microsystems, Inc. pursuant to the original
purchase agreement. The value of the Common Stock of $85,600.

In fiscal year 2004 and 2003 9,903 and11,012  shares of Common Stock were issued
under the Employee Stock Purchase Plan, respectively.

6.  INCOME TAXES

The  components  of the benefit for income taxes for the years ended October 31,
2004, 2003 and 2002, comprise the following:

                                                  2004        2003        2002
--------------------------------------------------------------------------------
    Federal:
         Current                                 $   --      $  (18)     $ (161)
         Deferred                                    --          --          --
    State:
         Current                                     --           1         (16)
         Deferred                                    --          --          --
                                                 ------      ------      ------
              Total benefit for income taxes     $   --      $  (17)     $ (177)
                                                 ======      ======      ======

We  recorded  a tax  benefit  of $18,000  and  $91,000 in fiscal  2003 and 2002,
respectively, due to refunds of federal income taxes related to the Job Creation
and  Workers  Assistance  Act of  2002  which  extends  the net  operating  loss
carryback period from two to five years for losses generated in tax years ending
in 2002. We also filed amended federal and state tax returns to claim $86,000 in
research and  development  credits  related to LMC in fiscal 2002. As of October
31, 2003, we received all of these tax refunds.

The effective income tax rate differs from the statutory federal income tax rate
for the following reasons:

                                                2004        2003        2002
------------------------------------------------------------------------------
       Statutory federal income tax rate        (34.0)%     (34.0)%     (34.0)%
       Change in valuation allowance             34.0        34.0        25.0
       Other                                       --          --         1.0
                                               ------      ------      ------
                                                   (0)%        (0)%      (8.0)%
                                               ======      ======      ======


                                      -60-
<PAGE>

Significant  components  of our deferred tax balances as of October 31, 2004 and
2003 are as follows:

                                                          2004           2003
--------------------------------------------------------------------------------
     Deferred tax assets:
         Current
               Accrued employee benefits                $      25     $      36
               Inventory allowances                           924           828
               Allowance for doubtful accounts                 17            39
               Distributor reserves                             8            --

         Noncurrent
               R&D credit carryforward                      2,663         2,871
               Net operating loss carryforwards             4,569         4,619
               Refundable deposit                              --           191
               Reserve on shareholder note receivable         313           103
               Depreciation and amortization, net             416            --
               Restructuring costs                              9           (25)
                                                        ---------     ---------
                  Total deferred tax assets                 8,944         8,662
                                                        ---------     ---------
     Deferred tax liabilities:

     Deferred tax asset valuation allowance                (8,944)       (8,662)
                                                        ---------     ---------
         Net deferred tax assets                        $      --     $      --
                                                        =========     =========


Valuation  allowances are recorded to offset certain  deferred tax assets due to
management's  uncertainty of realizing the benefit of these items. The valuation
allowance  increased  by  $282,000  in  fiscal  2004  primarily  as a result  of
increases in inventory  allowances,  depreciation and amortization expense and a
reduction in the reserve on shareholder  note  receivable.  These were have been
partially offset by decreases in net operating loss  carryforwards  and research
and development credit carryforwards.  At October 31, 2004, we have research and
experimentation  tax credit  carryforwards  of $1.8 million and $1.2 million for
federal and state tax purposes,  respectively. These carryforwards expire in the
periods  ending 2011 through 2024.  The State R&D tax credits do not expire.  We
have net operating loss  carryforwards for federal and state income tax purposes
of approximately $12.7 million and $5.7 million,  respectively,  which expire in
periods ending 2005 through 2024.

Under the Tax Reform Act of 1986,  the  amounts of benefits  from net  operating
loss  carryforwards  may be impaired or limited as we have incurred a cumulative
ownership change of more than 50%, as defined, over a three-year period.

7.  WARRANTY OBLIGATIONS AND OTHER GUARANTEES:

The following is a summary of our agreements  that we have determined are within
the  scope of FIN 45,  ("FIN")  No. 45  Guarantor's  Accounting  and  Disclosure
Requirements for Guarantees,  including  Indirect  Guarantees of Indebtedness of
Others -- an  interpretation of FASB Statements No. 5, 57 and 107 and rescission
of FIN 34.

We accrue the estimated costs to be incurred in performing  warranty services at
the time of revenue  recognition  and shipment of the products to our customers.
Our estimate of costs to service our warranty obligations is based on historical
experience  and  expectation of future  conditions.  To the extent we experience
increased  warranty claim activity or increased costs  associated with servicing


                                      -61-
<PAGE>

those claims,  the warranty accrual will increase,  resulting in decreased gross
margin.

The following table sets forth an analysis of our warranty reserve at October 31
(in thousands):

                                                              2004     2003
                                                              ----     ----
         Warranty reserve at beginning of period              $ 53     $ 55
             Less: Cost to service warranty obligations        (33)     (13)
             Plus: Increases to reserves                        --       11
                                                              ----     ----
         Total warranty reserve included in other accrued
           expenses                                           $ 20     $ 53
                                                              ====     ====


We have agreed to indemnify  each of our  executive  officers and  directors for
certain  events or  occurrences  arising as a result of the  officer or director
serving  in such  capacity.  The term of the  indemnification  period is for the
officer's  or  director's  lifetime.  The  maximum  potential  amount  of future
payments we could be required to make under these indemnification  agreements is
unlimited.  However,  we have a directors'  and  officers'  liability  insurance
policy that should  enable us to recover a portion of future  amounts paid. As a
result of our insurance policy coverage,  we believe the estimated fair value of
these indemnification agreements is minimal and have no liabilities recorded for
these agreements as of October 31, 2004 and 2003, respectively.

We enter  into  indemnification  provisions  under  our  agreements  with  other
companies in the ordinary course of business,  typically with business partners,
contractors,  customers  and  landlords.  Under these  provisions  we  generally
indemnify  and hold  harmless  the  indemnified  party for  losses  suffered  or
incurred  by the  indemnified  party as a result of our  activities  or, in some
cases, as a result of the indemnified  party's  activities  under the agreement.
These  indemnification  provisions  often include  indemnifications  relating to
representations  made by us with regard to intellectual  property rights.  These
indemnification  provisions  generally  survive  termination  of the  underlying
agreement.  The maximum potential amount of future payments we could be required
to make  under  these  indemnification  provisions  is  unlimited.  We have  not
incurred  material  costs to defend  lawsuits or settle claims  related to these
indemnification  agreements. As a result, we believe the estimated fair value of
these agreements is minimal.  Accordingly,  we have no liabilities  recorded for
these agreements as of October 31, 2004 and 2003, respectively.

As  discussed  below,  we are the  secondary  guarantor  on the  sublease of our
previous headquarters.  We believe we will have no liabilities on this guarantee
and have not recorded a liability at October 31, 2004.

8. COMMITMENTS

We lease our  buildings  under  noncancelable  operating  leases which expire at
various dates through the year 2007. Additionally,  we have acquired assets with
capital lease  obligations.  Future minimum lease  payments under  noncancelable
operating leases and capital leases, are as follows (in thousands):


                                      -62-
<PAGE>


                                                      Operating      Capital
                                                      ---------      -------
Year ending October 31:
              2005                                     $   963       $    44
              2006                                         626            44
              2007                                          60            44
              2008                                          --            44
              2009 and thereafter                           --            43
                                                       -------       -------
                                                         1,649           219
              Less: total expected reimbursements
                    from sublease or interest             (902)          (55)
                                                       -------       -------
              Total minimum lease payments             $   747       $   164
                                                       =======       =======

In November  2001, we entered into a facilities  lease for our  engineering  and
administrative  headquarters located in San Ramon, California. The lease expires
in 2006. We expect our current facility to satisfy our anticipated needs through
the  foreseeable  future.  Additionally,  we assigned  the lease  related to our
former 63,000 square foot engineering and administrative  headquarters  facility
to a  third-party  corporation.  The third  party  has  assumed  payment  of the
remaining  lease payments  though the  termination of the original lease in 2006
and we are a secondary guarantor.

Our  rent  expense  under  all  operating  leases,  net  of  reimbursements  for
subleases, for the years ended October 31, 2004, 2003 and 2002 totaled $384,000,
$434,000 and $549,000,  respectively. We had reimbursements of sublease proceeds
of $637,000,  $713,000 and $158,000 for the years ended  October 31, 2004,  2003
and 2002, respectively.

In  connection  with the  acquisition  of Antares,  we committed to issue 98,945
shares of our Common Stock in 20,000 share increments beginning January 2004 and
ending March 2005 to a selling  shareholder  of Antares.  During fiscal 2004, we
issued  30,000  shares of our Common Stock of a committed  98,945 to an employee
who was one of the owners of Antares Microsystems, Inc. pursuant to the original
purchase  agreement.  We will issue the remaining 68,945 during fiscal 2005. The
value of the  Common  Stock  issued in fiscal  2004 under  this  commitment  was
$85,600.

In  connection  with the  retirement of Mr.  William Heye,  Jr. as the company's
President and Chief Executive Officer, the Company will pay Mr. Heye $250,000 at
the rate of $20,833 each month for the period  January 1, 2005 through  December
31, 2005. The commitment to pay $250,000 has been accrued as of October 31, 2004
and is included in General and  Administrative  expense and Accrued  Payroll and
Employee Benefits liability.

On May 13, 2004, we renewed our working capital line of credit for twelve months
until May 14, 2005. The credit line is secured by a first lien on all our assets
and carries a floating  annual  interest  rate equal to the bank's prime rate of
4.75%, at October 31, 2004, plus 1.50%.  Draw-downs on the credit line are based
on a formula equal to 80% of our domestic accounts receivable. As of October 31,
2004,  due to the net loss for our fourth fiscal  quarter of 2004, we are not in
compliance  with all the covenants of our credit line.  The Bank agreed to waive
the  non-compliance  with this covenant.  We have not drawn down on this line of
credit and have no amounts payable at October 31, 2004.


                                      -63-
<PAGE>

At October 31, 2004, we have two  stock-based  employee  compensation  plans, as
more fully described in note 9. We account for these plans under the recognition
and  measurement  principles  of APB No.  25,  Accounting  for  Stock  Issued to
Employees and related  interpretations.  Stock-based employee compensation costs
are not  reflected  in net income  when  options  granted  under the plan had an
exercise price equal to the market value of the  underlying  common stock on the
date of grant.  During the periods  ending  October 31, 2004,  2003 and 2002, we
recorded  no  compensation   expense   related  to  our   stock-based   employee
compensation plans. As discussed earlier, should we have determined compensation
cost  utilizing the fair value  approach,  recorded stock  compensation  expense
would have been approximately $1.2 million, $200,000 and $700,000 in each of the
years ended October 31, 2004, 2003, and 2002, respectively.

9.  STOCK OPTION AND STOCK PURCHASE PLANS

We sponsor two  employee  stock  option  plans,  the 1996 Stock Option Plan (the
"1996 Plan") and the 1998  Non-Officer  Stock Option Plan (the "1998  Plan").  A
total of 2,730,000  shares of Common Stock were reserved  under the 1996 Plan at
October 31, 2003. A total of 650,000  shares of Common Stock are reserved  under
the 1998  Plan.  Stock  options  granted  under  the 1996  and  1998  Plans  are
exercisable  over a maximum  term of ten years  from the date of grant,  vest in
various  installments  over a one to four-year  period and have exercise  prices
reflecting the market value of the shares of Common Stock on the date of grant.

Additionally,  in 1991,  stockholders  approved a  Non-Employee  Director  Stock
Option Plan (the "Director Plan"). A total of 340,000 shares of Common Stock are
reserved  for  issuance  under the  Director  Plan.  Options  granted  under the
Director  Plan vest over a one to four-year  period,  expire five to seven years
after the date of grant and have exercise prices  reflecting market value at the
date of grant.

At October  31,  2004 and 2003,  903,516  and  273,964  shares of Common  Stock,
respectively,  were  available  for grant under the 1996 Plan. A total of 26,250
and 3,939 shares of Common Stock were available for grant under the 1998 Plan at
October 31, 2004 and 2003, respectively. A total of 187,750 and 42,750 shares of
Common Stock were  available  for grant under the  Director  Plan at October 31,
2004 and  2003,  respectively.

A summary of the  combined  activity  under all of the stock option plans is set
forth below:

                                   Weighted
                                   Average
                                   Number of        Price Per          Exercise
                                    Shares            Share              Price
-------------------------------------------------------------------------------
       Outstanding at
           October 31, 2001       1,419,003      $0.51 - $23.50         $  6.18

       Granted                      809,000        $0.90--$1.80         $  0.92
       Cancelled or expired        (458,730)      $0.51--$23.50         $  7.94
                                  ---------------------------------------------
       Outstanding at
           October 31, 2002       1,769,273       $0.90--$19.81         $  3.32

       Granted                      140,500        $0.70--$2.86         $  1.90
       Cancelled or expired        (285,238)      $0.51--$19.81         $  5.13
                                  ---------------------------------------------
       Outstanding at
           October 31, 2003       1,624,505       $0.70--$19.41         $  2.90

       Granted                      422,500        $2.86--$7.13         $  4.99
       Cancelled or expired         (50,750)       $2.86--$7.00         $  3.98
       Exercised                   (182,012)       $0.90--$5.13         $  1.69
                                  ---------------------------------------------
       Outstanding at
           October 31, 2004       1,797,119       $0.70--$19.41         $  3.48
                                  =============================================


                                      -64-
<PAGE>

The  following  table  summarizes  information  with  respect to all  options to
purchase shares of Common Stock  outstanding under the 1996 Plan, the 1998 Plan,
the Director Plan and the LMC Plan at October 31, 2004:

<TABLE>
<CAPTION>
                                      Options Outstanding                        Options Exercisable
=======================================================================================================
                                           Weighted
                                            Average         Weighted                           Weighted
                          Number           Remaining         Average           Number           Average
       Range of         Outstanding    Contractual Life     Exercise         Exercisable       Exercise
    Exercise Price      at 10/31/04         (years)           Price          at 10/31/04         Price
    --------------    --------------  ----------------     -----------     -------------      ---------
<S>                     <C>                   <C>           <C>             <C>                <C>
  $  0.00 - $  1.00       683,742             4.8           $  0.91            653,666         $  0.91
  $  1.01 - $  2.50       144,376             4.5           $  1.61            109,748         $  1.70
  $  2.51 - $  3.50       222,000             4.0           $  2.73            179,557         $  2.68
  $  3.51 - $  5.50       479,802             4.8           $  4.80            183,650         $  5.09
  $  5.51 - $  7.50        88,000             6.0           $  7.01              2,000         $  6.63
  $  7.51 - $  9.50       107,699             1.5           $  8.23            107,699         $  8.23
  $  9.51 - $ 14.50        65,000             0.2           $ 13.23             65,000         $ 13.23
  $ 14.51 - $ 19.85         6,500             2.6           $ 18.27              6,500         $ 18.27
                        ---------                                           ---------
                        1,797,119                                           1,307,820
                        =========                                           =========
</TABLE>

We sponsor an Employee  Stock  Purchase Plan (the  "Purchase  Plan") under which
300,000  shares of Common Stock were  reserved for issuance at October 31, 2004.
The Purchase Plan allows  participating  employees to purchase,  through payroll
deductions, shares of our Common Stock at 85 percent of the fair market value of
the shares at specified  dates.  At October 31, 2004, 32 employees were eligible
to  participate  in the  Purchase  Plan and 58,559  shares  were  available  for
issuance. In fiscal year 2004, 2003 and 2002, 9,903, 11,012 and 47,596 shares of
Common Stock were issued under the Purchase Plan, respectively.

10.  NET INCOME (LOSS) PER SHARE:

Basic net income  (loss) per common share for the years ended  October 31, 2004,
2003 and 2002 was  computed by dividing  the net income  (loss) for the relevant
period by the weighted  average  number of shares of common  stock  outstanding.
Common stock equivalents for the years ended October 31, 2004 and 2002 have been
excluded from shares used in calculating  diluted net loss per share because the
effect would have been anti-dilutive.


                                      -65-
<PAGE>

                                                   YEARS ENDED OCTOBER 31
                                            --------------------------------
                                              2004         2003        2002
                                            --------------------------------
BASIC EARNINGS PER SHARE:

Net income (loss)                           $(1,679)     $   563     $(1,731)

Number of shares for computation of
earnings per share                            5,022        4,259       3,759
                                            ================================

Basic earnings (loss) per share             $ (0.33)     $  0.13     $ (0.46)
                                            ================================

DILUTED EARNINGS PER SHARE:

Weighted average number of common
shares outstanding during the year            5,022        4,259       3,759

Assumed issuance of stock under warrant
plus stock issued the employee and
non-employee stock option plans                 (a)          450         (a)
                                            --------------------------------

Number of shares for computation of
earnings per share                            5,022        4,709       3,759
                                            ================================

Diluted earnings (loss) per share           $ (0.33)     $  0.12     $ (0.46)
                                            ================================

---------
(a)    In loss periods,  common share  equivalents  would have an  anti-dilutive
       effect on net loss per share and therefore have been excluded.


11.  EMPLOYEE SAVINGS AND INVESTMENT PLAN

We  contribute  a  percentage  of income  before  income  taxes into an employee
savings and investment plan. The percentage is determined  annually by the Board
of Directors.  These  contributions are payable annually,  vest over five years,
and cover  substantially all employees who have been employed by us at least one
year.  Additionally,  we make  matching  payments  to the  employee  savings and
investment  plan of 50% of each  employee's  contribution up to three percent of
employees' earnings.

For the years ended  October 31, 2004,  2003 and 2002,  total  expense under the
employee  savings  and  investment  plan  was  $90,099,   $61,730  and  $99,471,
respectively.

12.  CONCENTRATION OF CREDIT AND BUSINESS RISKS

Our  trade  accounts  receivable  are  concentrated  among  a  small  number  of
customers, principally located in the United States. Two customers accounted for
61% of our outstanding accounts receivable at October 31, 2004 compared to three
customers  who  accounted  for more  than 62% of total  accounts  receivable  at
October 31, 2003. Ongoing credit evaluations of customers'  financial  condition
are  performed  and,  generally,  no  collateral  is  required.  We  maintain an
allowance for doubtful  accounts for potential  credit  losses.  Actual bad debt
losses have not been  material  and have not exceeded  our  expectations.  Trade
accounts  receivable  are recorded net of an allowance for doubtful  accounts of
$42,000 and $90,000 at October 31, 2004 and 2003, respectively.

Sales to  individual  customers in excess of 10% of net sales for the year ended
October 31, 2004 included sales to HP of $4.9 million, or 45% and Nortel of $1.5
million  or 13% of net  sales  compared  to sales to HP in  fiscal  2003 of $3.1


                                      -66-
<PAGE>

million, or 45%, and sales to HP of $2.1 million, or 30%, and Lockheed Martin of
$0.8 million, or 12% of net sales, in fiscal 2002. International sales accounted
for  12%,  12% and 13% of  total  sales  during  fiscal  2004,  2003  and  2002,
respectively.

We depend on a limited  number of  customers  for  substantially  all revenue to
date. Failure to anticipate or respond adequately to technological  developments
in our  industry,  changes in customer or  supplier  requirements  or changes in
regulatory  requirements or industry standards, or any significant delays in the
development  or  introduction  of  products or  services,  could have a material
adverse effect on our business, operating results and cash flows.

Substantially  all  of  our  manufacturing   process  is  subcontracted  to  two
independent  companies.  The chipsets used in most of our products are currently
available  only  from  Motorola.  In  addition,  certain  other  components  are
currently  available  only  from  single  suppliers.  The  inability  to  obtain
sufficient key components as required,  or to develop alternative sources if and
as required  in the  future,  could  result in delays or  reductions  in product
shipments or margins that, in turn,  could have a material adverse effect on our
business, operating results, financial condition and cash flows.

13.  ACQUISITION OF ANTARES MICROSYSTEMS, INC.

Effective as of August 7, 2003, we purchased  substantially all of the assets of
Antares Microsystems, Inc., a California corporation ("Antares"), excluding cash
and  accounts  receivable,  from the  Assignee  for the Benefit of  Creditors of
Antares ("Assignee"). The acquisition enabled us to obtain intellectual property
such as the TCP/IP Offload Engine ("TOE") and other intellectual  property which
we consider to be complementary to our business.  While this product has reached
technological  feasibility and is being  capitalized as an intangible  asset, we
continue to  customize it to meet SBE's  specific  customer  needs.  We acquired
Antares  for a  purchase  price  of  $75,000  in cash  plus  $582,000  in  costs
associated with the payment of certain loan guarantees,  legal fees,  accounting
fees,  broker fees,  contract  transfer fees and moving expenses and $211,000 in
cash to the selling shareholders of Antares. We also issued 90,628 shares of our
Common  Stock with a market  value at the time of issuance of $259,000 to one of
the selling  shareholders  and  committed to issue  98,945  shares of our Common
Stock valued at $283,000 in 10,000 and 20,000 share increments beginning January
2004 and ending March 2005 to a selling shareholder of Antares.

A summary of the assets acquired and consideration paid is as follows:

      Tangible assets acquired                                  $  187,000
      Intellectual property                                      1,223,000
                                                                ----------
      Total assets acquired                                      1,410,000
      Liabilities assumed                                             --
                                                                ----------
      Net assets acquired                                       $1,410,000
                                                                ==========

      Cash consideration or costs paid or to be paid            $  868,000
      Fair value of stock provided                                 542,000
                                                                ----------
      Total consideration                                       $1,410,000
                                                                ==========

We used the  purchase  method of  accounting  for the  acquisition  and combined
Antares  results of  operations  beginning  August 7,  2003.  We  allocated  the
purchase price to the tangible  assets based on fair market value at the time of
the acquisition and to intellectual property based on future expected cash flows


                                      -67-
<PAGE>

to be derived from the acquired  product  lines in addition to new products that
have reach technological feasibility, but have not gone into production.

The unaudited pro forma results are provided for  comparative  purposes only and
are not  necessarily  indicative of what actual  results would have been had the
Antares  acquisition,   and  the  private  equity  offering   transactions  been
consummated  on such  dates,  nor do they  give  effect to the  synergies,  cost
savings and other changes expected to result from the acquisitions. Accordingly,
the pro forma  financial  results do not purport to be  indicative of results of
operations  as of the date hereof or for any period  ended on the date hereof or
for any other future date or period.  Had we acquired  Antares at the  beginning
the prior period, our results of operations for would have been as follows:

For the Years ended October 31,              2003                  2002
                                             ----                  ----
Revenues                                    $8,845               $10,702
Net loss                                    (1,173)               (2,665)
Basic loss per common share                  (0.28)                (0.67)
Diluted earnings per common                  (0.25)                (0.67)

We did not assume any of the liabilities  associated with Antares. In connection
with the acquisition, we hired certain employees of Antares in order to continue
the development of the Antares TOE technology,  which is not yet to market,  and
other  products  of  Antares.  The TOE  base  technology  is being  readied  for
commercial  development.   In  the  event  TOE  is  successfully  completed  and
commercialized,  we have committed to make certain payments of cash and/or stock
as bonuses to certain of these employees, as sales of the TOE products occur.

The amount of  consideration  paid in connection with the asset  acquisition was
determined by extensive  "arms-length"  negotiation among the parties. We funded
the  acquisition  of the assets in cash from our working  capital plus  proceeds
from the sale of our common  stock as described in Note 5. There was no material
relationship between Assignee or Antares and us or any of our affiliates, any of
our directors or officers, or any associate of any such director or officer.

We planned  to  amortize  the  intellectual  property  acquired  in the  Antares
acquisition to expense over 36 months which was the estimated useful life at the
time of  acquisition.  In the fourth  quarter of fiscal  2004,  after our annual
asset  impairment  review (see Intangible  Assets in our Significant  Accounting
Policies  section  of this  report),  we are behind in our  roll-out  of the new
product  and with the change in market  competition,  we  determined  that there
exists  considerable  doubt that we would recover the remaining $713,000 balance
of the intellectual  property asset that would have been on our balance sheet as
of October 31, 2004. As a result of this evaluation and  determination  we wrote
off the remaining balance.  Including the normally scheduled amortization of the
intellectual property of $408,000 and the $713,00 write-down, the total non-cash
amortization  expense  included  in our cost of goods  for  fiscal  2004 is $1.1
million. We recorded approximately $102,000 in amortization in fiscal 2003.

14. RESTRUCTURING COSTS

In response to the economic  slowdown,  we  implemented  restructuring  plans in
fiscal 2002 and recorded restructuring charges of $446,000.  Restructuring costs
for  fiscal  2002  are  comprised  of  severance  costs  associated  with  staff
reductions  totaling  $115,000 (we reduced our headcount from 47 employees to 24
employees during fiscal 2002),  leasehold improvements and equipment write-downs


                                      -68-
<PAGE>

related to the  abandonment  of our  Madison,  Wisconsin  office of $185,000 and
accrued lease and brokerage costs totaling  $146,000.  We reached agreement with
the property  owner to  terminate  the Madison  office  lease  releasing us from
further obligations effective December 31, 2002.

As of October 31, 2004 and 2003 $21,000 and $58,000 of the  restructuring  costs
was included in other current liabilities, respectively.

In our third quarter of fiscal 2003, we  recognized a  restructuring  benefit of
$154,000 after the final  settlement of costs  associated with prior real estate
and equipment leases.

The  following   table  sets  forth  an  analysis  of  the   components  of  the
restructuring  reserve and the payments made against it through October 31, 2004
(in thousands):

           Restructuring accrual at October 31, 2003               $    58
           Less:
               Cash paid and adjustment for accrued lease costs        (37)
                                                                   -------
           Total restructuring costs included in liabilities       $    21
                                                                   =======

15. LOAN TO OFFICER

On November 6, 1998, we made a loan to our retiring  president and CEO which was
used by him to exercise an option to purchase 139,400 shares of our common stock
and related taxes.  The loan, as amended,  was  collateralized  by shares of our
common stock,  bore  interest at a rate of 2.48% per annum,  due on December 14,
2003.

On October 31, 2002, we determined  that it was probable that we would be unable
to fully  recover the balance of the loan on its due date of December  14, 2003.
Accordingly,  a valuation allowance of $474,000 was recorded against the loan at
October 31, 2002.

During the fourth  quarter of fiscal 2003,  the officer  repaid  $362,800 of the
loan and as a  result,  we  recognized  a benefit  of  $235,000  related  to the
reversal of the loan  impairment  charge taken by us in fiscal 2002.  During the
first quarter of fiscal 2004,  the officer  repaid the remaining loan balance in
full and as a result, we recorded a benefit of $239,000 relating to the reversal
of the remaining loan impairment charge.


                                      -69-
<PAGE>

QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

(in thousands except                First      Second       Third       Fourth
 per share amounts)                Quarter     Quarter     Quarter      Quarter
--------------------------------------------------------------------------------
2004: Net sales                    $ 2,970     $ 2,977     $ 2,899     $ 2,220
      Gross profit                   1,645       1,560       1,540        (325)
      Net income (loss)                527          54          79      (2,339)
      Basic income (loss) per
      common share                 $  0.11     $  0.01     $  0.02     $ (0.47)
      Diluted income (loss) per
      common share                 $  0.09     $  0.01     $  0.01     $ (0.47)

2003: Net sales                    $ 1,861     $ 1,767     $ 1,621     $ 2,207
      Gross profit                   1,128       1,088       1,062       1,429
      Net income                        91          51         141         280
      Basic income per
      common share                 $  0.02     $  0.01     $  0.03     $  0.07
      Diluted income per
      common share                 $  0.02     $  0.01     $  0.03     $  0.06


                                    SBE, INC.
                 SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
               FOR THE YEARS ENDED OCTOBER 31, 2004, 2003 AND 2002
                             (AMOUNTS IN THOUSANDS)

<TABLE>
<CAPTION>
          Column A                    Column B       Column C        Column D     Column E
          --------                    --------       --------        --------     --------
                                     Balance at      Additions                     Balance
                                     Beginning   charged to costs                  End of
         Description                 of Period     and expenses     Deductions     Period
------------------------------------------------------------------------------------------
<S>                                    <C>            <C>             <C>          <C>
YEAR ENDED OCTOBER 31, 2004

Allowance for Doubtful Accounts
 and sales programs                    $   90         $   --          $  (48)      $   42
Allowance for Warranty Claims              53             --             (33)          20
Allowance for Deferred Tax Assets       8,662            295              --        8,957
Allowance for Stockholder Loan            239             --            (239)          --

YEAR ENDED OCTOBER 31, 2003

Allowance for Doubtful Accounts
 and sales programs                    $   93         $   11          $  (14)      $   90
Allowance for Warranty Claims              55             11             (13)          53
Allowance for Deferred Tax Assets       8,593             69              --        8,662
Allowance for Stockholder Loan            474             --            (235)         239

YEAR ENDED OCTOBER 31, 2002

Allowance for Doubtful Accounts
 and sales programs                    $  225         $   --          $ (132)      $   93
Allowance for Warranty Claims              56             --              (1)          55
Allowance for Deferred Tax Assets       8,080            513              --        8,593
Allowance for Stockholder Loan             --            474              --          474
</TABLE>


                                      -70-