UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 27, 1997 OR [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Commission File Number 0-220-20 CASTELLE (Exact name of registrant as specified) ---------------------------------------------- California 77-0164056 (State of other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 3255-3 Scott Boulevard, Santa Clara, California 95054 (Address of principal executive offices) Issuer's telephone number, including area code: (408) 496-0474 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No The number of shares of Common Stock outstanding as of August 1, 1997 was 4,486,123. CASTELLE INDEX Page No. -------- Part I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets 2 Consolidated Statements of Income 3 Consolidated Statements of Cash Flows 5 Notes to Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 7 Part II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 10 Signatures 12 Except for the historical information contained herein, the following contains forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially from those discussed here. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this document, as well as those discussed in the Company's Form SB-2 filed November 17, 1995, as amended and, Form 10-KSB for the year ended December 31, 1996 and Form 10-Q for the quarter ended March 28, 1997. PART 1 - FINANCIAL INFORMATION ITEM 1 - FINANCIAL STATEMENTS CASTELLE CONSOLIDATED BALANCE SHEETS (in thousands) ASSETS June 27, December 31, 1997 1996 (unaudited) Current assets: Cash and cash equivalents ............................ $ 7,703 $ 8,161 Accounts receivable, net of allowance for doubtful accounts of $669 in 1997 and $467 in 1996 ... 5,574 5,783 Inventories .......................................... 3,778 2,841 Prepaid expenses and other current assets ............ 776 626 Deferred income taxes ................................ 1,510 1,439 -------- -------- Total current assets ................................. 19,341 18,850 Property plant and equipment, net .................... 745 593 Other assets, net .................................... 135 84 Deferred income taxes ................................ 2,860 2,860 -------- -------- Total assets ......................................... $ 23,081 $ 22,387 ======== ======== LIABILITIES Current liabilities: Accounts payable ..................................... $ 2,593 $ 1,862 Accrued liabilities .................................. 3,198 3,825 -------- -------- Total current liabilities ............................ 5,791 5,687 SHAREHOLDERS' EQUITY Common stock ......................................... 23,845 23,698 Notes receivable for purchase of common stock ......................... (296) (296) Accumulated deficit .................................. (6,259) (6,702) -------- -------- Total shareholders' equity ........................... 17,290 16,700 -------- -------- Total liabilities and shareholders' equity $ 23,081 $ 22,387 ======== ======== The accompanying notes are an integral part of these financial statements 2 CASTELLE CONSOLIDATED STATEMENTS OF INCOME (in thousands, except per share data) 3 MONTHS ENDED 3 MONTHS ENDED June 27, 1997 June 28, 1996 (unaudited) (unaudited) Net sales .......................................... $ 7,002 $ 8,403 Cost of sales ...................................... 3,218 4,001 ------- ------- Gross profit ....................................... 3,784 4,402 ------- ------- Operating expenses: Research and development ........................... 864 695 Sales and marketing ................................ 2,366 2,079 General and administrative ......................... 490 510 ------- ------- Total operating expenses ........................... 3,720 3,284 ------- ------- Operating income .................................. 64 1,118 Interest income, net ............................... 74 94 Other expense , net ................................ (14) (48) ------- ------- Income before provision for income taxes .......... 124 1,164 Provision for income taxes ......................... 50 177 ------- ------- Net income ......................................... $ 74 $ 987 ======= ======= Net income per share ............................... $ 0.02 $ 0.21 ======= ======= Shares used in per share calculation ............... 4,628 4,793 ======= ======= The accompanying notes are an integral part of these financial statements 3 CASTELLE CONSOLIDATED STATEMENTS OF INCOME YEAR-TO-DATE (in thousands, except per share data) 6 MONTHS ENDED 6 MONTHS ENDED June 27, 1997 June 28, 1996 (unaudited) (unaudited) Net sales .......................................... $ 13,421 $ 15,500 Cost of sales ...................................... 5,796 7,561 ------- ------- Gross profit ....................................... 7,625 7,939 ------- ------- Operating expenses: Research and development ........................... 1,694 1,399 Sales and marketing ................................ 4,397 3,959 General and administrative ......................... 919 871 ------- ------- Total operating expenses ........................... 7,010 6,229 ------- ------- Operating income .................................. 615 1,710 Interest income, net ............................... 153 177 Other expense , net ................................ (33) (75) ------- ------- Income before provision for income taxes .......... 735 1,812 Provision for income taxes ......................... 294 226 ------- ------- Net income ......................................... $ 441 $ 1,586 ======= ======= Net income per share ............................... $ 0.10 $ 0.34 ======= ======= Shares used in per share calculation ............... 4,628 4,741 ======= ======= The accompanying notes are an integral part of these financial statements 4 CASTELLE CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) 6 MONTHS ENDED 6 MONTHS ENDED June 27, 1997 June 28, 1996 (unaudited) (unaudited) (unaudited) Cash flows from operating activities: Net income ......................................... $ 441 $ 1,586 Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization ...................... 162 192 Deferred tax provision ............................. (71) 29 Write off of other assets and property and equipment 1 11 Provision for excess and obsolete inventory ........ 0 (248) Changes in assets and liabilities: Accounts receivable ................................ 209 185 Inventories ........................................ (936) (1,098) Prepaid income taxes ............................... 1 Prepaid expenses and other assets .................. (157) (58) Accounts payable ................................... 731 (768) Accrued liabilities ................................ (626) (296) Income tax payable ................................. 0 123 Deferred revenue ................................... 0 48 ------- ------- Net cash used in operating activities .............. (246) (293) ------- ------- Cash flows from investing activities: Acquisition of property and equipment .............. (358) (206) Acquisition of intangible assets ................... (1) (23) ------- ------- Net cash used in investing activities .............. (359) (229) ------- ------- Cash flows from financing activities: Repayment of notes payable ......................... 0 (216) Principal payments on capitalized leases ........... 0 (31) Proceeds from issuance of common stock and warrants 147 975 Proceeds from collection of notes receivable for Stock ...................... ....................... 83 ------- ------- Net cash provided by financing activities .......... 147 811 ------- ------- Net increase (decrease) in cash and cash equivalents (458) 289 Cash and cash equivalents at beginning of period ... 8,161 7,406 ------- ------- Cash and cash equivalents at end of period ......... $ 7,703 $ 7,695 ======= ======= The accompanying notes are an integral part of these financial statements 5 CASTELLE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Basis of Presentation The accompanying unaudited consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, and have been prepared in accordance with generally accepted accounting principles. All intercompany accounts and transactions have been eliminated. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the Company's financial position, results of operations and cash flows at the dates and for the periods indicated have been included. The results of operations for the interim periods presented are not necessarily indicative of the results for the year ending December 31, 1997. Because all of the disclosures required by generally accepted accounting principles are not included in the accompanying consolidated financial statements, they should be read in conjunction with the audited consolidated financial statements and related notes included in the Company's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1996. 2. Net Income Per Share Net income per share is based upon the weighted average number of common and common equivalent shares outstanding. 3. Inventories Inventories are stated at the lower of standard cost (which approximates cost on a first-in, first-out basis) or market. JUNE 27, DECEMBER 31, 1996 1996 (unaudited) Raw material . $2,170 $ 878 Work in process 386 212 Finished goods 1,222 1,751 ------ ------ $3,778 $2,841 ====== ====== 4. Recent Accounting Pronouncements In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128 (SFAS 128), "Earnings Per Share," which specifies the computation, presentation and disclosure requirements for earnings per share. SFAS 128 supersedes Accounting Principles Board Opinion No. 15 and is effective for financial statements issued for periods ending after December 15, 1997. SFAS 128 requires restatement of all prior-period earnings per share data presented after the effective date. Management does not expect the adoption of SFAS 128 to have a material impact on the Company's financial position, results of operations or cash flows. In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130 (SFAS130), " Reporting Comprehensive Income." This statement establishes requirements for disclosure of comprehensive income and becomes effective for the Company for fiscal years beginning after December 15, 1997, with reclassification of earlier financial statements for comparative purposes. Comprehensive income generally represents all changes in stockholders' equity except those resulting from investments or contributions by stockholders. The Company is evaluating alternative formats for presenting this information, but does not expect this pronouncement to materially impact the Company's results of operations. In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131 (SFAS131)," Disclosures about Segments of an Enterprise and Related Information." This statement establishes standards for disclosure about operating segments in annual financial statements and selected information in interim financial reports. It also establishes standards for related disclosures about products and services, geographic areas and major customers. This statement supersedes Statement of Financial Accounting Standards No. 14, "Financial Reporting for Segments of a Business Enterprise." The new standard becomes effective for fiscal years beginning after December 15, 1997, and requires that comparative information from earlier years be restated to conform to the requirements of this standard. The Company is evaluating the requirements of SFAS 131 and the effects, if any, on the Company's current reporting and disclosures. 6 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Except for the historical information contained herein, the following discussion contains forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially from those discussed here. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this section, as well as those discussed in the Company's Form SB-2 filed November 17, 1995, as amended and, Form 10-KSB for the year ended December 31, 1996 and Form 10-Q for the quarter ended March 28, 1997. Quarterly Results As a percentage of Net Revenues 3 MONTHS ENDED 3 MONTHS ENDED JUNE 27, 1997 JUNE 28, 1996 (unaudited) (unaudited) Net sales ................ 100 100 Cost of sales ............ 46 48 --- --- Gross profit ............. 54 52 --- --- Operating expenses: Research and development . 12 8 Sales and marketing ...... 34 25 General and administrative 7 6 --- --- Total operating expenses . 53 39 --- --- Operating income ........ 1 13 Interest income, net ..... 1 1 Other expense, net ....... 0 0 --- --- Income before provision for income taxes ........ 2 14 Provision for income taxes 1 2 --- --- Net income ............... 1 12 === === 7 Results as a percentage of Net Revenues 6 MONTHS ENDED 6 MONTHS ENDED JUNE 27, 1997 JUNE 28, 1996 (unaudited) (unaudited) Net sales ................ 100 100 Cost of sales ............ 43 49 --- --- Gross profit ............. 57 51 --- --- Operating expenses: Research and development . 12 9 Sales and marketing ...... 33 25 General and administrative 7 6 --- --- Total operating expenses . 52 40 --- --- Operating income ........ 5 11 Interest income, net ..... 1 1 Other expense, net ....... 0 0 --- --- Income before provision for income taxes ........ 6 12 Provision for income taxes 3 2 --- --- Net income ............... 3 10 === === Net Sales Net sales for the second quarter and first six months of fiscal 1997 of $7.0 million and $13.4 million, respectively, decreased compared with $8.4 million and $15.5 million, respectively, for the corresponding periods of fiscal 1996. The decrease in net sales was a result of lower sales of the Company's fax-on-demand and print server products which were offset, in part, by an increase in the Company's fax server product line. Net sales from the fax-on-demand and print server product lines declined 75% and 20% for the second quarter and 57% and 20%, respectively, for the first six months of 1997 compared with the same periods of the previous year. Net sales for fax servers increased 9% in the second quarter and 10%, respectively, for the first six months of 1997 compared to the same periods in the previous year. Sales of the Company's products outside North America totaled $3.5 million and $6.8 million or 50% and 51%, respectively, for the second quarter and first six months of 1997 of total net sales. Sales of the Company's products outside North America during the same periods in 1996 was $4.1 million and $7.8 million, respectively, or 49% and 50% of total net sales. Gross Profit Gross profit of 54% and 57%, respectively, for the second quarter and first six months of fiscal 1997 increased compared to gross profit of 52% and 51%, respectively, for the same periods in 1996. The increase in gross profit is primarily attributable to the lower cost of components incorporated in the Company's products and to the sole of a higher proportion of fax servers which have higher gross margins than do print servers; however this increase in the gross profit margin was partially offset by a decrease in sales of fax-on-demand products which have historically enjoyed higher gross profit margins. 8 Research & Development Research and development expenses were $864,000 and $1.7 million or 12%, respectively, of net sales for the second quarter and first six months of fiscal 1997 as compared to $695,000 and $1.4 million or 8% and 9%, respectively, of net sales for the same periods in 1996. The increase in the interim periods of 1997 compared to the interim periods of 1996 is primarily due to an increase in the number of engineers employed by the Company. Sales and Marketing Sales and marketing expenses were $2.4 million and $4.4 million or 34% and 33%, respectively, of net sales for the second quarter and first six months of fiscal 1997 as compared to $2.1 million and $4.0 million or 25%, respectively, of net sales for the same periods in 1996. The increase in the interim periods of 1997 compared to the interim periods of 1996 is primarily due to an increase in the number of sales and customer service employees and travel expense. General and Administrative General and administrative expenses were $490,000 and $919,000 or 7%, respectively, of net sales for the second quarter and first six months of fiscal 1997 as compared to $510,000 and $871,000 or 6%, respectively, of net sales for the same periods in 1996. Interest income and Other expense, net Interest income, net of other expense, was $60,000 and $120,000 or 1%, respectively, of net sales for the second quarter and first six months of fiscal 1997 as compared to $46,000 and $102,000 or 1% respectively, of net sales for the same periods in 1996. Liquidity and Capital resources. Net cash used in operating activities was $246,000 for the first six months of fiscal 1997, primarily as a result of an increase in inventories and a decrease in accrued liabilities, offset to some extent by an increase in accounts payable and net income. This compares to net cash used in operating activities of $293,000 for the first six months of fiscal 1996, primarily as a result of an increase in inventories and a decrease in accounts payable, offset to some extent by net income. Cash used in investing activities in the first six months of fiscal 1997 was $359,000 and primarily from acquisition of computer equipment as compared to $229,000 in 1996 which was associated with purchases of computer equipment and an intangible asset. Net cash provided by financing activities in the first six months of fiscal 1997 was $147,000 due to the exercise of stock options as compared to $811,000 in 1996 which included proceeds from an over-allotment of common stock associated with the Company's initial public offering offset somewhat by repayment of notes payable. As of June 27, 1997, the Company had $7.7 million of cash and cash equivalents. Working capital increased to $13.6 million at June 27, 1997 from $13.2 million at December 31, 1996. The Company is in the process of entering into a $3.0 million secured revolving line of credit with a bank. The Company believes that existing sources of liquidity, capital resources and funds from operations will satisfy the Company's anticipated cash needs for the next 12 months. There can be no assurance, however, that the Company's actual needs will not exceed anticipated levels, or that the Company will generate sufficient sales to fund its operations in the absence of other sources. There also can be no assurance that any additional required financing will be available through bank borrowings, debt or equity offerings or otherwise or that, if such financing is available, it will be available on terms favorable to the Company. The Company had no material capital commitments at June 27, 1997. Management believes that, for the periods presented, inflation has not had a material effect on the Company's operations. 9 PART II - OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 11.1 Computation of Net Income Per Share 27 Financial Data Schedule (b) Reports on Form 8-K No reports on Form 8-K were filed by the Company during the quarter ended June 27, 1997. 10 Exhibit 11.1 CASTELLE COMPUTATION OF NET INCOME PER SHARE (in thousands, except per share amounts) 3 MONTHS ENDED 3 MONTHS ENDED June 27, 1997 June 28, 1996 (unaudited) (unaudited) Primary and Fully Diluted: Weighted average common shares outstanding for the period 4,536 4,471 Common equivalent shares assuming conversion of stock options under the treasury stock method 92 322 ----- ----- Shares used in per share calculation .................... 4,628 4,793 ===== ===== Net income .............................................. 74 987 ----- ----- Net income per share .................................... 0.02 0.21 ===== ===== 6 MONTHS ENDED 6 MONTHS ENDED June 27, 1997 June 28, 1996 (unaudited) (unaudited) Primary and Fully Diluted: Weighted average common shares outstanding for the period 4,480 4,451 Common equivalentshares assuming conversion of stock options under the treasury stock method 148 290 ----- ----- Shares used in per share calculation .................... 4,628 4,741 ===== ===== Net income .............................................. 441 1,586 ----- ----- Net income per share .................................... 0.10 0.34 ===== ===== 11 SIGNATURES Pursuant to the requirements 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. CASTELLE By: /s/ Roy V. Prasad Date: Aug 11, 1997 Roy V. Prasad Chief Executive Officer and President (Principal Executive Officer) By: /s/ Randall I. Bambrough Date: Aug 11, 1997 Randall I. Bambrough Vice President of Finance and Administration Chief Financial Officer (Principal Financial and Accounting Officer) 12