UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended April 3, 1998
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 0-220-20
CASTELLE
(Exact name of Registrant as specified in its charter)
California 77-0164056
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
3255-3 Scott Boulevard, Santa Clara, California 95054
(Address of principal executive offices, including zip code)
(408) 496-0474
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK,
NO PAR VALUE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No __
The number of shares of Common Stock outstanding as of May 14, 1998 was
4,611,119.
CASTELLE
FORM 10-Q
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets 2
Consolidated Statements of Income 3
Consolidated Statements of Cash Flows 4
Notes to Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 8
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 12
Item 2. Changes in Securities 12
Item 3. Defaults Upon Senior Securities 12
Item 4. Submission of Matters to a Vote of Security Holders 12
Item 5. Other Information 12
Item 6. Exhibits and Reports on Form 8-K 12
Signatures 13
Exhibit 27.1 - Financial Data Schedule E-1
1
PART I - FINANCIAL INFORMATION
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-K for the year-ended
December 31, 1997.
ITEM 1. FINANCIAL STATEMENTS
CASTELLE AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
April 3, 1998 December 31, 1997
(unaudited) (audited)
---------------- ------------------
Assets:
Cash and cash equivalents $ 6,848 $ 6,204
Restricted cash 125 125
Accounts receivable, net of allowance
for doubtful accounts of $485 in 1998
and $490 in 1997 3,981 3,273
Inventories, net 2,714 3,786
Prepaid expense and other current assets 650 573
Deferred income taxes 874 874
---------------- ------------------
Total current assets 15,192 14,835
Property, plant & equipment, net 855 938
Other non-current assets, net 111 93
Deferred income taxes 3,060 3,060
---------------- ------------------
Total assets $19,218 $18,926
================ ==================
Liabilities & Shareholders' Equity:
Current liabilities:
Long-term debt, current $ 87 $ 87
Accounts payable 1,120 1,312
Accrued liabilities 2,794 2,620
---------------- ------------------
Total current liabilities 4,001 4,019
Other long-term liabilities 173 52
---------------- ------------------
Total liabilities 4,174 4,071
---------------- ------------------
Shareholders' equity:
Common stock, no par value:
Authorized: 25,000 shares
Issued and outstanding:
4,493 and 4,490 respectively 28,961 28,955
Note receivable for purchase of
common stock (274) (274)
Accumulated deficit (13,643) (13,826)
---------------- ------------------
Total shareholders' equity 15,044 14,855
---------------- ------------------
Total liabilities & $19,218 $18,926
shareholders' equity ================ ==================
The accompanying notes are an integral part of these consolidated financial
statements.
2.
CASTELLE AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
(unaudited)
First Fiscal Quarter
Three months ended
......................................
April 3, 1998 March 28, 1997
------------------ ------------------
Net sales $ 6,601 $ 6,419
Cost of sales 3,101 2,578
------------------ ------------------
Gross profit 3,500 3,841
------------------ ------------------
Operating expenses:
Research and development 650 830
Sales and marketing 2,132 2,031
General and administrative 479 429
Amortization of intangible assets -- 287
------------------ ------------------
Total operating expense 3,261 3,577
------------------ ------------------
Income from operations 239 264
Interest income, net 57 89
Other income/(expense), net 8 (29)
------------------ ------------------
Income before provision for income 304 324
taxes
Provision for income taxes 121 244
------------------ ------------------
Net Income $ 183 $ 80
================== ==================
Earning per share:
Net income per common share - basic $ 0.04 $ 0.02
Shares used in per share calculation 4,493 4,425
- basic
Net income per common share -diluted $ 0.04 $ 0.02
Shares used in per share calculation 4,639 4,628
- diluted
The accompanying notes are an integral part of these consolidated financial
statements.
3
CASTELLE AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
First Fiscal Quarter
Three months ended
......................................
April 3, 1998 March 28, 1997
------------------ ------------------
Cash flows from operating activities:
Net Income $ 183 $ 80
Adjustment to reconcile net income to
net cash provided by operating
activities:
Depreciation and amortization 127 359
Provision for doubtful accounts
and sales returns 81 --
Provision for excess and obsolete
inventory 35 --
Changes in assets and liabilities:
Accounts receivable (789) 366
Inventories 1,037 (882)
Prepaid expenses and other
current assets (95) (161)
Accounts payable (192) 1,277
Accrued liabilities and other
long-term liabilities 174 (491)
------------------ ------------------
Net cash provided by
operating activities 561 548
------------------ ------------------
Cash flows from investing activities:
------------------ ------------------
Acquisition of property and equipment (44) (117)
------------------ ------------------
Cash flows from financing activities:
Proceeds from notes payable 142 --
Repayment of notes payable (21) --
Proceeds from issuance of
common stock and warrants,
net of repurchases 6 93
------------------ ------------------
Net cash provided by
financing activities 127 93
------------------ ------------------
Net increase in cash and cash equivalents 644 524
Cash and cash equivalents at beginning
of period 6,204 8,161
------------------ ------------------
Cash and cash equivalents at end of
period $ 6,848 $ 8,685
================== ==================
The accompanying notes are an integral part of these consolidated financial
statements.
4
CASTELLE AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Basis of Presentation:
The accompanying unaudited consolidated financial statements include the
accounts of Castelle and its wholly owned subsidiaries in the United States
and the Netherlands, and have been prepared in accordance with generally
accepted accounting principles. All intercompany balances 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 result of operations for the interim period presented is not
necessarily indicative of the results for the year ending December 31,
1998. Because all of the disclosures required by generally accepted
accounting principles are not included in the accompanying consolidated
financial statements and related notes, they should be read in conjunction
with the audited consolidated financial statements and related notes
included in the Company's Form 10-K for the fiscal year-ended December 31,
1997.
2. Net Income Per Share
The Company has adopted Statement of Financial Accounting Standards No.128
(SFAS 128), "Earnings per Share," which supersedes APB Opinion No. 15 (APB
No. 15), "Earnings per Share," and which is effective for all periods
ending after December 15, 1997. SFAS 128 requires dual presentation of
basic and diluted earnings per share (EPS) for complex capital structures
on the face of the Statements of Operations. Basic EPS is computed by
dividing net income by the weighted-average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution
from the exercise or conversion of other securities into common stock.
Basic and diluted earnings per share are calculated as follows for first
quarters of 1998 and 1997:
(in thousands,
except per share amounts)
..........................
April 3, March 28,
1998 1997
----------- ----------
Basic:
Weighted average common shares outstanding 4,493 4,425
=========== ==========
Net income $ 183 $ 80
=========== ==========
Net income per common share - basic $ 0.04 $ 0.02
=========== ==========
Diluted:
Weighted average common shares outstanding 4,493 4,425
Common equivalent shares from stock options 146 203
----------- ----------
Shares used in per share calculation - diluted 4,639 4,628
=========== ==========
Net income $ 183 $ 80
=========== ==========
Net income per common share - diluted $ 0.04 $ 0.02
=========== ==========
5
3. Inventories:
Inventories are stated at the lower of standard cost (which approximates
cost on a first-in, first-out basis) or market. Inventory details are as
follows:
(in thousands)
..............................
April 3, December 31,
1998 1997
-------------- --------------
Raw material $ 1,050 $ 1,544
Work in process 71 486
Finished goods 1,593 1,756
-------------- --------------
Total Inventory $ 2,714 $ 3,786
============== ==============
4. Revenue Recognition:
Product revenue is recognized upon shipment provided no significant vendor
obligations remain and collection of the resulting receivable is deemed
probable by management. The Company enters into agreements with certain of
its distributors which permit limited stock rotation rights. These stock
rotation rights allow the distributor to return products for credit but
require the purchase of additional products of equal value. Revenues
subject to stock rotation rights are reduced by management's estimates of
anticipated exchanges. Provisions for estimated warranty costs,
insignificant vendor obligations and anticipated retroactive price
adjustments are recorded at the time products are shipped.
5. Segments Disclosure:
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 131 - "Disclosure About Segments of an
Enterprise and Related Information" ("SFAS 131"). Although the Company
adopted SFAS 131 beginning January 1, 1998, Castelle has elected not to
report segment information in interim financial statements in the first
year of application consistent with the provisions of the statement.
6. Comprehensive Income:
As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130 - "Reporting Comprehensive Income" ("SFAS
130"). SFAS 130 establishes new rules for the reporting and display of
comprehensive income and its components; however, the adoption of SFAS 130
had no impact on the Company, as there is no comprehensive income to
report.
7. Software Revenue:
In October 1997, the Accounting Standards Executive Committee issued
Statement of Position 97-2 (SOP 97-2), "Software Revenue Recognition,"
which delineates the accounting for software product and maintenance
revenues. SOP 97-2 supersedes the Accounting Standards Executive Committee
Statement of Position 91-1, "Software Revenue Recognition," and is
effective for the Company beginning in fiscal 1998. The Company has
recognized revenue for the first quarter of 1998 in accordance with this
new SOP. Based on its reading and interpretation of SOP 97-2, the Company
believes it is currently in compliance with the final standard. However,
detailed implementation guidelines for this standard have not yet been
issued. Once issued, such detailed implementation guidance could lead to
unanticipated changes in the Company's current revenue accounting
practices, and such changes could be material to the Company's revenue and
earnings.
6
8. Subsequent Events:
In April 1998, the Company completed its acquisition of the Object-Fax NT
product line, a facsimile software application designed for LAN's, WAN's
and Internet-based networks, from Tolvusamskipti HF, an Icelandic
corporation, in exchange for $300,000 in cash and 100,000 shares of
Castelle common stock and the right to receive the number of additional
shares of Castelle common stock on the date six months after the
acquisition necessary to make the fair market value of the common stock
received in the transaction not less than $500,000 (the "Acquisition"). In
connection with the Acquisition, Castelle also entered into asset
acquisition agreements with Traffic USA, Inc. and Traffic Software USA,
Inc. in which Castelle acquired fixed assets and intellectual property
rights associated with the marketing, sales, distribution and support of
the Object-Fax NT software. In exchange for these assets Castelle paid
$135,000 and agreed to pay a royalty on sales of the Object-Fax NT
software, neither to exceed $75,000 nor to be paid beyond 24 months after
the Acquisition. Additionally, Castelle entered into consulting and
non-competition agreements with key employees of Traffic USA, Inc. and
Traffic Software USA, Inc. The Acquisition is being accounted for as a
purchase of assets and is valued at approximately $1.1 million including
acquisition-related expenses. A portion of the purchase price will be
allocated to in-process research and development, and accordingly the
Company will record a one-time charge against earnings in the second
quarter of 1998 estimated to be in the range of between $600,000 to
$900,000 upon completion of a purchase price valuation report.
7
ITEM 2. 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-K for the
year-ended December 31, 1997.
Consolidated Statements of Income - As a Percentage of Net Sales
FIRST FISCAL QUARTER
THREE MONTHS ENDED
......................................
April 3, 1998 March 28, 1997
------------------ ------------------
Net sales 100% 100%
Cost of sales 47% 40%
------------------ ------------------
Gross profit 53% 60%
------------------ ------------------
Operating expenses:
Research and development 10% 13%
Sales and marketing 32% 32%
General and administrative 7% 7%
Amortization of intangible assets -- 4%
------------------ ------------------
Total operating expense 49% 56%
------------------ ------------------
Income from operations 4% 4%
Interest income, net 1% 1%
Other income/(expense), net 0% 0%
------------------ ------------------
Income before provision for income
taxes 5% 5%
Provision for income taxes 2% 4%
------------------ ------------------
Net Income 3% 1%
================== ==================
Results of Operations
Net Sales
Net sales for the first quarter 1998 grew to $6.6 million from
$6.4 for the same period in 1997. The growth in net sales was the result of
higher service and warranty revenues and a 26% increase in fax server
product sales, this was partially off-set by lower sales of the Company's
fax-on-demand and print server products.
International sales were $2.8 million and $3.1 million in the
first quarter of 1998 and 1997, respectively, representing 42% and 48%,
respectively, of total net sales. This 10% decline in international sales
was mainly the result of reduced demand for the Company's products in Asia.
8
Gross Profit
Gross profit of 53% for the first quarter of fiscal 1998 decreased
compared to gross profit of 60% for the same period in 1997. The decrease
in gross profit is primarily attributable to unfavorable manufacturing
variances, a decline in sales of fax-on-demand software which have
historically enjoyed high gross profit margins and lower gross profit in
print server products in Asia.
Research & Development
Research and product development expenses declined 22% to $650,000
or 10% of net sales for the first quarter 1998 as compared to $830,000 or
13% of net sales for the same period in 1997. This reduction is the result
of lower personnel-related expenses.
Sales & Marketing
Sales and marketing expenses were $2.1 million or 32% of net sales
for the first quarter of 1998, as compared to $2.0 million or 32% of net
sales for the same period in 1997.
General & Administrative
General and administrative expenses were $479,000 or 7% of net
sales for the first quarter of 1997, as compared to $429,000 or 7% of net
sales for the same period in 1997. The increase is primarily due to higher
legal expenses.
Interest & Other income/expense, net
Interest and other income/expenses, net, comprised income of
$65,000 or 1% of net sales for the first quarter of 1998, as compared to
income of $60,000 or 1% of net sales for the same period in 1997.
Liquidity and Capital Resources
Since its inception in 1987, Castelle has funded its operations
primarily through the sale of capital stock and bank debt. As of April 3, 1998,
the Company had $6.8 million of cash and cash equivalents, up from $6.2 million
at December 31, 1997. Working capital increased to $11.2 million at April 3,
1998 from $10.8 million at December 31, 1997. The increase in cash, cash
equivalents and working capital is primarily due to cash derived from net income
and a reduction in inventory on hand, partially off-set by increased accounts
receivable associated with the higher revenues in the first quarter of 1998.
The Company has a $3.0 million secured revolving line of credit with a
bank, which expires in July 1998, and at April 3, 1998 had no borrowings under
the line of credit.
In December 1997, as a source of capital asset financing, the Company
entered into a loan and security agreement with a finance company, which allowed
loans to the Company of up to $288,000. As of April 3, 1998, the Company had
drawn down the entire $288,000. The loan is repayable by December 2000 and is
collateralized by a certificate of deposit of $125,000, which is classified as
restricted cash on the Company's balance sheet.
9
As of April 3, 1998, net accounts receivable were $4.0 million, up from
$3.3 million at December 31, 1997. The increase in accounts receivable is
attributed to higher sales in the first quarter of 1998, partially off-set by an
improvement in days sales outstanding from 55 at the end of 1997 to 54 days at
April 3, 1998.
Net inventories as of April 3, 1998 were $2.7 million, down from $3.8
million at December 31, 1997. The decrease was the result of increased unit
shipments, which significantly improved the level of inventory turnover in the
quarter compared to the end of 1997.
The Company had not made any material capital commitments during the
first quarter ended April 3, 1998.
Although the Company believes that its existing capital resources,
anticipated cash flows from operations and available lines of credit will be
sufficient to meet its capital requirements at least through the next 12 months,
the Company may be required to seek additional equity or debt financing. The
timing and amount of such capital requirements cannot be determined at this time
and will depend on a number of factors, including demand for the Company's
existing and new products and the pace of technological change in the networking
industry. There can be no assurance that such additional financing will be
available on satisfactory terms when needed, if at all.
Management believes that, for the periods presented, inflation has not
had a material effect on the Company's operations.
Subsequent Events - Acquisition
In April 1998, the Company announced and completed its acquisition of
the Object-Fax NT product line from Tolvusamskipti HF, an Icelandic corporation.
The purchase, valued at approximately $1.1 million, included the exchange of
$300,000 in cash and 100,000 shares of Castelle common stock, as well as,
entering into various agreements in support of the acquisition. A portion of the
purchase price will be allocated to in-process research and development, and
accordingly the Company will record a one-time charge against earnings in the
second quarter of 1998 estimated to be in the range of between $600,000 to
$900,000 upon completion of a purchase price valuation report. See "Notes to
Consolidated Financial Statements - Note 8" thereto included elsewhere in this
Report.
Year 2000 Issue
The Company is in the process of conducting a comprehensive review of
its computer systems to identify those that could be adversely affected by the
Year 2000 issue and is developing an implementation plan to resolve any problem.
The Year 2000 issue refers to the inability of many computer systems to process
accurately dates later than December 31, 1999. Date codes in many programs are
abbreviated to allow only two digits for the year, e.g. "98" for the year 1998.
Unless these programs are modified to handle the century date change, they will
likely interpret the year "00", that is, the year 2000, as the year 1900. The
Year 2000 issue creates risk for the Company from unforeseen problems in its own
computer systems as well as in computer systems of third parties with whom the
Company does business worldwide, including banks and credit processing entities,
factories and others. The Company presently believes that, with modifications to
existing software and conversions to new software that the Company plans to
implement over the next year, the Year 2000 issue will not pose significant
operational problems for the Company's own computer systems as so modified and
converted. However, if such modifications and conversions are not completed
timely, the Year 2000 issue may have a material adverse impact on the operations
of the Company. In addition, the Company cannot give assurance the third parties
with whom it does business will address any Year 2000 issues in their own
systems on a timely basis. Their failure to do so could also have a material
adverse impact on the Company.
10
The Company has completed a comprehensive review of its products, both
firmware and software, to insure that they are Year 2000 compliant. This was
done to insure that the Company's products are free of any Year 2000 issues
discussed above. The Company believes that the more recent versions of its
products are Year 2000 compliant, meaning that users of its products should not
experience performance difficulties as a result of the need to process dates
later than December 31, 1999. In order to avoid difficulties, users will need to
install the versions of the Company's software which are Year 2000 compliant.
For example, FaxPress systems require a software and firmware release of at
least version 3.7.3 and InfoPress requires that at least version 2.0 be
installed for compliance with Year 2000 requirements. The Company provides
upgrade kits to allow customers to install these versions. The Company's
products work in conjunction with network operating systems such as Novell
NetWare and Microsoft Windows 95/NT, and while these products appear to be Year
2000 compliant, the Company does not accept responsibility for Year 2000
compliance of any network operating system. If modifications and upgrades to
these network operating systems are not completed timely, the Year 2000 issue
may have a material adverse impact on the Company's business, operating results
and financial condition.
11
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS
The Company held an Annual Meeting of Shareholders on April 29, 1998.
The shareholders elected the Board's nominees as directors by the votes
indicated:
Nominee Votes in Favor Votes Withheld
Arthur H. Bruno 3,500,377 39,010
John Freidenrich 3,501,405 37,982
Robert Hambrecht 3,501,405 37,982
Alan Kessman 3,501,405 37,982
The Company's 1988 Incentive Stock Plan, as amended, to increase the
aggregate number of shares of Common Stock authorized for issuance under such
plan by 981,935 and to add provisions with respect to Section 162(m) of the
Internal Revenue Code of 1986, as amended, was approved with 2,654,084 votes in
favor, 95,905 against, 3,350 abstentions and 786,048 broker non-votes.
The selection of Coopers & Lybrand LLP as the Company's independent
auditors was ratified with 3,537,122 votes in favor, 1,115 against and 1,150
abstentions.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
27.1 Financial Data Schedule
(b) Reports on Form 8-K
None.
12
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/ Arthur H. Bruno Date: May 15, 1998
Arthur H. Bruno
Chairman of the Board,
Chief Executive Officer and Director
By: /s/ Randall I. Bambrough Date: May 15, 1998
Randall I. Bambrough
Vice President of Finance and Administration
Chief Financial Officer
(Principal Financial and Accounting Officer)
13