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 June 30, 2002

          |_| 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)

               855 Jarvis Drive, Suite 100, Morgan Hill, CA 95037
          (Address of principal executive offices, including zip code)

                                 (408) 852-8000
              (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 the Registrant's Common Stock outstanding as of August
2, 2002 was 4,754,795.



                                   CASTELLE
                                    FORM 10-Q
                                TABLE OF CONTENTS

                                                                          PAGE

SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS                                  2

PART I.  FINANCIAL INFORMATION

 Item 1.  Condensed Consolidated Financial Statements:                      3

          Condensed Consolidated Balance Sheets                             3

          Condensed Consolidated Statements of Operations                   4

          Condensed Consolidated Statements of Cash Flows                   5

          Notes to Condensed Consolidated Financial Statements              6

 Item 2.  Management's Discussion and Analysis of Financial Condition
          and Results of Operations                                        11

 Item 3.  Quantitative and Qualitative Disclosure About Market Risk        22

PART II. OTHER INFORMATION

 Item 1.  Legal Proceedings                                                23

 Item 2.  Changes in Securities and Use of Proceeds                        23

 Item 3.  Defaults Upon Senior Securities                                  23

 Item 4.  Submission of Matters to a Vote of Security Holders              23

 Item 5.  Other Information                                                23

 Item 6.  Exhibits and Reports on Form 8-K                                 23

Signatures                                                                 24

Exhibit 99.1 - Certification pursuant to Section 906 of the Public
               Company Accounting Reform and Investor Protection
               Act of 2002 (18 U.S.C.ss. 1350, as adopted)                 E-1

Exhibit 99.2 - Press Release dated July 29, 2002                           E-2


                                       1


                   SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS

This document contains forward-looking statements that involve risks and
uncertainties. The Company's operating results may vary significantly from
quarter to quarter due to a variety of factors, including changes in the
Company's product and customer mix, constraints in the Company's manufacturing
and assembling operations, shortages or increases in the prices of raw materials
and components, changes in pricing policy by the Company or its competitors, a
slowdown in the growth of the networking market, seasonality, timing of
expenditures and economic conditions in the United States, Europe and Asia.
Words such as "believes," "anticipates," "expects," "intends" and similar
expressions are intended to identify forward-looking statements, but are not the
exclusive means of identifying such statements. Unless the context otherwise
requires, references in this Form 10-Q to "we," "us," or the "Company" refer to
Castelle. Readers are cautioned that the forward-looking statements reflect
management's analysis only as of the date hereof, and the Company assumes no
obligation to update these statements. Actual events or results may differ
materially from the results discussed in the forward-looking statements. Factors
that might cause such a difference include, but are not limited to the risks and
uncertainties discussed herein, as well as other risks set forth under the
caption "Risk Factors" in the Company's Annual Report on Form 10-K and Form
10-K/A for the fiscal year ended December 31, 2001.


                                       2


                         PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

                                    CASTELLE
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                                 (in thousands)
                                   (Unaudited)



                                                                     June 30, 2002    December 31, 2001
                                                                     -------------    -----------------
                                                                                    
  Assets:
     Current assets:
       Cash and cash equivalents                                       $    4,311         $    4,568
       Accounts receivable, net of allowances for doubtful
           accounts of $189 in 2002 and $206 in 2001                          649                680
       Inventories, net                                                       842                926
       Prepaid expense and other current assets                               121                130
                                                                       ----------         ----------
          Total current assets                                              5,923              6,304
     Property, plant & equipment, net                                         510                598
     Other assets, net                                                        108                108
                                                                       ----------         ----------
          Total assets                                                 $    6,541         $    7,010
                                                                       ==========         ==========

  Liabilities and Shareholders' Equity:
     Current liabilities:
       Long-term debt, current portion                                 $       19         $       18
       Accounts payable                                                       149                280
       Accrued liabilities                                                  2,019              2,446
                                                                       ----------         ----------
          Total current liabilities                                         2,187              2,744
       Long-term debt, net of current portion                                  55                 64
                                                                       ----------         ----------
          Total liabilities                                                 2,242              2,808

     Shareholders' equity:
       Common stock, no par value:
          Authorized: 25,000 shares
          Issued and outstanding: 4,755 and 4,745, respectively            28,980             28,977
       Deferred compensation                                                   (1)                (1)
       Accumulated deficit                                                (24,680)           (24,774)
                                                                       ----------         ----------
          Total shareholders' equity                                        4,299              4,202
                                                                       ----------         ----------
          Total liabilities and shareholders' equity                   $    6,541         $    7,010
                                                                       ==========         ==========


     See accompanying notes to condensed consolidated financial statements.


                                       3


                                 CASTELLE
              CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                 (in thousands, except per share amounts)
                                (Unaudited)



                                                         Three months ended                  Six months ended
                                                    ------------------------------    -------------------------------
                                                    June 30, 2002    June 29, 2001    June 30, 2002    June 29, 2001
                                                    -------------    -------------    -------------    -------------
                                                                                           
Net sales                                           $       2,261    $       2,313    $       4,629    $       4,606
Cost of sales                                                 669              842            1,446            1,540
                                                    -------------    -------------    -------------    -------------
    Gross profit                                            1,592            1,471            3,183            3,066
                                                    -------------    -------------    -------------    -------------

Operating expenses:
    Research and development                                  349              481              762              866
    Sales and marketing                                       780              982            1,543            2,052
    General and administrative                                450              255              854              699
    Restructuring charges                                     (40)              58              (40)             238
                                                    -------------    -------------    -------------    -------------
       Total operating expenses                             1,539            1,776            3,119            3,855
                                                    -------------    -------------    -------------    -------------
Income (loss) from operations                                  53             (305)              64             (789)

    Interest income, net                                       12               25               22               58
    Other income (expense), net                                (3)              12                8               55
                                                    -------------    -------------    -------------    -------------
Income (loss) before provision for income taxes                62             (268)              94             (676)
    Provision for income taxes                                 --               --               --               --
                                                    -------------    -------------    -------------    -------------
Net income (loss)                                   $          62    $        (268)   $          94    $        (676)
                                                    =============    =============    =============    =============



Income (loss) per share:
                                                                                           
   Net income (loss) per common share - basic       $        0.01    $       (0.06)   $        0.02    $       (0.14)
   Shares used in per share calculation - basic             4,749            4,744            4,747            4,742
   Net income (loss) per common share - diluted     $        0.01    $       (0.06)   $        0.02    $       (0.14)
   Shares used in per share calculation - diluted           4,765            4,744            4,769            4,742


     See accompanying notes to condensed consolidated financial statements.


                                       4


                                    CASTELLE
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (in thousands)
                                   (Unaudited)



                                                                        Six months ended
                                                                 -------------------------------
                                                                 June 30, 2002     June 29, 2001
                                                                 -------------     -------------
                                                                             
Cash flows from operating activities:
   Net income (loss)                                             $          94     $        (676)
   Adjustment to reconcile net income (loss) to net cash used
      in operating activities:
     Loss on disposal of fixed assets                                        1                 9
     Depreciation and amortization                                         108               144
     Provision for doubtful accounts and sales returns                      81                52
     Provision for excess and obsolete inventory                           (79)               89
     Compensation expense related to grant of stock options                 --                 4
     Changes in assets and liabilities:
      Accounts receivable                                                  (50)              839
      Inventories                                                          163              (313)
      Prepaid expenses and other current assets                              9              (161)
      Other assets                                                          --                 9
      Accounts payable                                                    (131)             (192)
      Accrued liabilities                                                 (427)             (151)
                                                                 -------------     -------------
        Net cash used in operating activities                             (231)             (347)
                                                                 -------------     -------------

Cash flows from investing activities:
   Return of restricted cash                                                --               125
   Purchase of property and equipment                                      (21)              (66)
                                                                 -------------     -------------
        Net cash provided by (used in) investing activities                (21)               59
                                                                 -------------     -------------

Cash flows from financing activities:
   Repayment of long-term debt                                              (8)               (5)
   Proceeds from issuances of common stock, net of
     repurchases                                                             3                --
                                                                 -------------     -------------
        Net cash used in financing activities                               (5)               (5)
                                                                 -------------     -------------

Net decrease in cash and cash equivalents                                 (257)             (293)

Cash and cash equivalents at beginning of period                         4,568             3,893
                                                                 -------------     -------------
Cash and cash equivalents at end of period                       $       4,311     $       3,600
                                                                 =============     =============


     See accompanying notes to condensed consolidated financial statements.


                                       5


                                    CASTELLE
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

1.    Basis of Presentation and Significant Accounting Policies:

      The accompanying unaudited condensed consolidated financial statements
      include the accounts of Castelle and its wholly-owned subsidiaries in the
      United Kingdom and The Netherlands, and have been prepared in accordance
      with accounting principles generally accepted in the United States of
      America. 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. Because all of the
      disclosures required by accounting principles generally accepted in the
      United States of America are not included in the accompanying unaudited
      condensed 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 and Form 10-K/A for
      the fiscal year-ended December 31, 2001. The December 31, 2001 condensed
      balance sheet data was derived from our audited financial statements and
      does not include all of the disclosures required by accounting principles
      generally accepted in the United States of America. The statements of
      operations for the periods presented are not necessarily indicative of
      results that we expect for any future period, nor for the entire year.
      Certain prior year amounts have been reclassified to conform with the
      current presentation.

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

      The Company believes that its existing cash balances, anticipated cash
      flows from operations and available lines of credit will be sufficient to
      meet its anticipated capital requirements for the next 12 months. However,
      a decline in future orders and revenues might require us to seek
      additional capital to meet our working capital needs during or beyond the
      next 12 months if we are unable to reduce expenses to the degree necessary
      to avoid incurring negative operating cash flow. If we have a need for
      additional capital resources, we may be required to sell additional equity
      or debt securities, secure additional lines of credit or obtain other
      third party 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, if any, and
      changes in technology in the networking industry. There can be no
      assurance that such additional financing will be available on satisfactory
      terms when needed, if at all. To the extent that additional capital is
      raised through the sale of additional equity or convertible debt
      securities, the issuance of such securities would result in additional
      dilution to our shareholders.

      In addition, because the Company is dependent on a small number of
      distributors for a significant portion of the sales of its products, the
      loss of any of the Company's major distributors or their inability to
      satisfy their payment obligations to the Company could have a significant
      adverse effect on the Company's business, operating results and financial
      condition.

      Revenue Recognition

      Castelle recognizes revenue based on the provisions of Staff Accounting
      Bulletin ("SAB") No. 101 "Revenue Recognition in Financial Statements" and
      Statement of Financial Accounting Standards ("SFAS") No. 48 "Revenue
      Recognition When Right of Return Exists."


                                       6


      Product revenue is recognized upon shipment if persuasive evidence of an
      arrangement exists, the fee is fixed and determinable, collection of the
      resulting receivables is probable and product returns are reasonably
      estimable. Shipment generally occurs when product is delivered to a common
      carrier.

      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. Customers who purchase products
      directly from Castelle also have limited return rights, which expire 30
      days from the date of product shipment. Revenues subject to stock rotation
      rights are reduced by management's estimates of anticipated exchanges.
      Castelle establishes its returns allowance for distributors and direct
      customers based on historic return rates from these customers.

      Pursuant to the Company's distributor agreements, the Company also
      protects its distributors' exposure related to the impact of price
      reductions. Price adjustments are recorded at the time products are
      shipped.

      The Company recognizes revenue from support or maintenance contracts,
      including extended warranty programs and post contract support, ratably
      over the period of the contract.

      Castelle recognizes royalties on the sale of LANpress products by a
      Japanese distributor. Royalties are not recognized as revenue until the
      products are sold by the distributor.

      Provisions for estimated warranty costs are recorded at the time products
      are shipped.

2.    Accounting Changes

      Effective January 1, 2002, Castelle has redefined its fiscal quarter and
      year end for financial reporting purposes to conform with calendar month
      ends, i.e., ending on March 31, June 30, September 30 and December 31.
      Previously, Castelle set its fiscal quarter as ending on the Friday of the
      thirteenth week into the quarter. The results of this change did not have
      a significant impact on The Company's financial position, results of
      operations or cash flows for the 2002 periods presented herein.

      Effective January 1, 2002, Castelle implemented Emerging Issues Task Force
      No. 01-9, "Accounting for Consideration Given by a Vendor to a Customer
      (Including a Reseller of the Vendor's Products)" ("EITF 01-9"), which
      presumes consideration from a vendor to a customer or reseller of the
      vendor's products to be a reduction of the selling prices of the vendor's
      products which, therefore, should be characterized as a reduction of
      revenue when recognized in the vendor's income statement and could lead to
      negative revenue under certain circumstances. Revenue reduction is
      required unless consideration relates to a separate identifiable benefit
      and the benefit's fair value can be established. Since Castelle was unable
      to clearly separate the benefits received from certain marketing
      development funds it paid to its resellers, these costs have been
      reclassified as a reduction of sales, and the financial statements for
      prior periods presented for comparative purposes have been reclassified to
      comply with the new accounting standard. The effect of the implementation
      of this new accounting standard was a reduction of sales of $45,000 and
      $133,000 in the three and six months ended June 30, 2002, respectively,
      with an equivalent reduction in operating expenses. This compares to a
      reduction in sales of $57,000 and $113,000 in the three and six months
      ended June 29, 2001, respectively, with an equivalent reduction in
      operating expenses. The new accounting standard has no impact on the
      Company's operating margin, net income or earnings per share. The table
      below reflects the impact of this new accounting standard on fiscal 2001
      revenues.


                                       7




                                               2001 SALES - RESTATED FOR EITF 01-9
                                                    (in thousands, unaudited)
                                                          QUARTER ENDED
                                 Mar 30        Jun 29         Sep 28         Dec 31        TOTAL YEAR
                            --------------  ------------   ------------  -------------  ----------------
                                                                              
     Original                    $2,349        $2,370          $2,559         $2,342         $9,620
     Restated                    $2,293        $2,313          $2,500         $2,248         $9,354
     Difference                   ($56)         ($57)           ($59)          ($94)         ($266)


3.    Income (loss) Per Share

      Basic net income (loss) per share is computed by dividing net income
      (loss) available to common shareholders by the weighted average number of
      common shares outstanding for that period. Diluted net income per share
      reflects the potential dilution from the exercise or conversion of other
      securities into common stock that were outstanding during the period.
      Diluted net loss per share excludes shares that are potentially dilutive
      as their effect is anti-dilutive. Shares that are potentially dilutive to
      the Company's basic income per share consist of incremental shares of
      common stock issuable upon exercise of stock options and warrants.

      Basic and diluted earnings per share are calculated as follows for the
      second quarter and first six months of 2002 and 2001, respectively:



                                                          (in thousands, except per share amounts)
                                                     -----------------------------------------------------
                                                                          (Unaudited)
                                                     -----------------------------------------------------
                                                        Three months ended           Six months ended
                                                     ------------------------     ------------------------
                                                      June 30,      June 29,       June 30,      June 29,
                                                        2002          2001           2002          2001
                                                     ----------    ----------     ----------    ----------
                                                                                    
Basic:
   Weighted average common shares outstanding             4,749         4,744          4,747         4,742
                                                     ==========    ==========     ==========    ==========
   Net income (loss)                                 $       62    $     (268)    $       94    $     (676)
                                                     ==========    ==========     ==========    ==========
   Net income (loss) per common share - basic        $     0.01    $    (0.06)    $     0.02    $    (0.14)
                                                     ==========    ==========     ==========    ==========

Diluted:
   Weighted average common shares outstanding             4,749         4,744          4,747         4,742
   Common equivalent shares from stock options
       and warrants                                          16            --             22            --
                                                     ----------    ----------     ----------    ----------
   Shares used in per share calculation - diluted         4,765         4,744          4,769         4,742
                                                     ==========    ==========     ==========    ==========
   Net income (loss)                                 $       62    $     (268)    $       94    $     (676)
                                                     ==========    ==========     ==========    ==========
   Net income (loss) per common share - diluted      $     0.01    $    (0.06)    $     0.02    $    (0.14)
                                                     ==========    ==========     ==========    ==========


      The calculation of diluted shares outstanding for the three months ended
      June 29, 2001 excludes options to purchase 1,327,089 shares of the
      Company's common stock, as their effect was antidilutive in the period.
      The calculation of diluted shares outstanding for the six months ended
      June 29, 2001, excludes options to purchase 1,319,089 shares of the
      Company's common stock, as their effect was antidilutive in the period.

4.    Inventories:

      Inventories are stated at the lower of standard cost (which approximates
      cost on a first-in, first-out basis) or market and net of reserves for
      excess and obsolete inventory. Inventory details are as follows (in
      thousands):


                                       8




                                                           (Unaudited)
                                     June 30, 2002       December 31,2001
                                     -------------       ----------------
                                                      
  Raw material                         $    178             $    283
  Work in process                           229                  182
  Finished goods                            435                  461
                                       --------             --------
         Total inventories             $    842             $    926
                                       ========             ========


5.    Segment Disclosure and Geographic Information:

      The Company has determined that it operates in one segment. Revenues by
      geographic area are determined by the location of the customer and are
      summarized as follows (in thousands):

                                    (Unaudited)
                    ---------------------------------------------
                     Three months ended       Six months ended
                    --------------------    --------------------
                    June 30,    June 29,    June 30,    June 29,
                        2002        2001        2002        2001
                    --------    --------    --------    --------
Americas            $  1,841    $  1,796    $  3,819    $  3,565
Europe                   172         158         404         542
Pacific Rim              248         359         406         499
                    --------    --------    --------    --------
  Total Revenues    $  2,261    $  2,313    $  4,629    $  4,606
                    ========    ========    ========    ========

6.    Comprehensive Income:

      Under Statement of Financial Accounting Standards ("SFAS") No. 130,
      "Reporting Comprehensive Income," disclosure of comprehensive income and
      its components is required in financial statements. Comprehensive income
      is the change in equity from transactions and other events and
      circumstances other than those resulting from investments by owners and
      distributions to owners. There are no significant components of
      comprehensive income excluded from net income, and therefore, no separate
      statement of comprehensive income has been presented.

7.    Restructuring:

      In April 2001, the Company terminated 17 regular, temporary and contractor
      positions, which at the time, constituted approximately 25% of its
      workforce. This action resulted in a severance charge of $58,000 in the
      second quarter of fiscal 2001. This severance charge was in addition to
      the restructuring charge of $180,000 recorded in the first quarter of
      fiscal 2001, which included an asset write-off and other direct expenses
      associated with the consolidation of our operations in the United Kingdom
      and El Dorado Hills, California. In the second quarter of fiscal 2002, a
      non-recurring benefit of $40,000 arising from the reversal of previously
      recorded restructuring charges was included in the results of operations,
      following the completion of the Company's 2001 restructuring programs for
      less than previously anticipated.

8.    Commitments and contingencies:

      The Company has been contacted by a third party claiming that the Company
      needs to obtain licenses of certain patents held by that party for certain
      of the Company's fax server products. The Company is continuing to assess
      the validity and strength of the claims, believes it has adequate legal
      defenses and that the ultimate outcome of any possible action will not
      have a material effect on the Company's financial position, results of
      operations or cash flows although there can be no assurance as to the
      outcome of any possible litigation.


                                       9


      From time to time, the Company may have certain contingent liabilities
      that arise in the ordinary course of its business activities. The Company
      accrues contingent liabilities when it is probable that future
      expenditures will be made and such expenditures can be reasonably
      estimated. No estimate of the amount of any potential loss upon resolution
      of these matters can be made at this time. However, depending of the
      amount and timing of such resolution, an unfavorable resolution of some or
      all of these matters could materially affect the Company's financial
      position

9.    New Accounting Pronouncements:

      In April 2002, the Financial Accounting Standards Board ("FASB") issued
      SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment
      of FASB Statement No. 13, and Technical Corrections". SFAS No. 145
      rescinds Statement 4, which required all gains and losses from
      extinguishment of debt to be aggregated and, if material, classified as an
      extraordinary item, net of related income tax effect. As a result, the
      criteria in APB Opinion 30 will now be used to classify those gains and
      losses. SFAS 145 also amends Statement 13 to require that certain lease
      modifications that have economic effects similar to sale-leaseback
      transactions be accounted for in the same manner as sale-leaseback
      transactions. The Company does not believe that the adoption of this
      statement will have a material impact on its results of operations,
      financial position or cash flows.

      In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
      Associated with Exit or Disposal Activities." SFAS No. 146 requires that a
      liability for a cost associated with an exit or disposal activity be
      recognized when the liability is incurred. SFAS No. 146 eliminates the
      definition and requirement for recognition of exit costs in Emerging
      Issues Task Force Issue No. 94-3 where a liability for an exit cost was
      recognized at the date of an entity's commitment to an exit plan. This
      statement is effective for exit or disposal activities initiated after
      December 31, 2002. The Company does not believe that the adoption of this
      statement will have a material impact on its results of operations,
      financial position or cash flows.


                                       10


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

This Management's Discussion and Analysis of Financial Condition and Results of
Operations contains forward-looking statements that are subject to many risks
and uncertainties that could cause actual results to differ significantly from
expectations. For more information on forward-looking statements, refer to the
"Special Note on Forward-Looking Statements" at the front on this Form 10-Q. The
following discussion should be read in conjunction with the Financial Statements
and the Notes thereto included in Item 1 of this Quarterly Report on Form 10-Q
and in the Company's Form 10-K and Form 10-K/A for the fiscal year ended
December 31, 2001.

Critical Accounting Policies

Castelle's financial statements and accompanying notes are prepared in
accordance with generally accepted accounting principles in the United States of
America. Preparing financial statements requires management to make estimates
and assumptions that affect the reported amounts of assets, liabilities, sales,
and expenses. These estimates and assumptions are affected by management's
application of accounting policies. Critical accounting policies for Castelle
include revenue recognition; credit, collection and allowances for doubtful
accounts; inventories and related allowance for obsolete and excess inventory,
which are discussed in more detail in Item 7, "Management's Discussion and
Analysis of Financial Conditions and Results of Operations," and Note 2 of
"Notes to Consolidated Financial Statements" in the Company's Annual Report on
Form 10-K and Form 10-K/A for the fiscal year ended December 31, 2001.

Consolidated Statements of Operations - As a Percentage of Net Sales



                                                                   (Unaudited)
                                             Three months ended                    Six months ended
                                      --------------------------------      --------------------------------
                                      June 30, 2002      June 29, 2001      June 30, 2002      June 29, 2001
                                      -------------      -------------      -------------      -------------

                                                                                         
Net sales                                       100%               100%               100%               100%
Cost of sales                                    30%                36%                31%                33%
                                      -------------      -------------      -------------      -------------
    Gross profit                                 70%                64%                69%                67%
                                      -------------      -------------      -------------      -------------

Operating expenses:
    Research and development                     15%                21%                17%                19%
    Sales and marketing                          35%                42%                33%                45%
    General and administrative                   20%                11%                19%                15%
    Restructuring charges                        (2%)                3%                (1%)                5%
                                      -------------      -------------      -------------      -------------
       Total operating expenses                  68%                77%                68%                84%
                                      -------------      -------------      -------------      -------------
Income (loss) from operations                     2%               (13%)                1%               (17%)

    Interest income, net                          1%                 1%                 1%                 1%
    Other income, net                             *                  *                  *                  1%
                                      -------------      -------------      -------------      -------------
Income (loss) before provision for
         income taxes                             3%               (12%)                2%               (15%)
    Provision for income taxes                   --                 --                 --                  *
                                      -------------      -------------      -------------      -------------
Net income (loss)                                 3%               (12%)                2%               (15%)
                                      =============      =============      =============      =============


*     Less than 1%


                                       11


      Results of Operations

      Net Sales

            Net sales for the second quarter of fiscal 2002 were $2.3 million,
      as compared to $2.3 million for the same period in fiscal 2001.

            Net sales for first the six months of fiscal 2002 were $4.6 million,
      as compared to $4.6 million for the same period in fiscal 2001.

            Domestic sales in the second quarter of fiscal 2002 were $1.8
      million, or 81% of total net sales, as compared to $1.8 million, or 78% of
      total net sales, in the same period in fiscal 2001. For the first six
      months of fiscal 2002, domestic sales were $3.8 million, or 83% of total
      net sales, an increase of $254,000 as compared to $3.6 million, or 77% of
      total net sales, in fiscal 2001, primarily due to higher sales in the
      FaxPress fax server products.

            International sales in the second quarter of fiscal 2002 decreased
      to $420,000 from $517,000 for the same period in fiscal 2001, representing
      19% and 22%, respectively, of total net sales. International sales for the
      first six months of fiscal 2002 and 2001 were $810,000 and $1.0 million,
      representing 17% and 23%, respectively, of total net sales. These declines
      in international sales were mainly the result of reduced demand for our
      print server products in the Asia Pacific region.

      Cost of Sales; Gross Profit

            Gross profit increased to $1.6 million, or 70% of net sales, for the
      second quarter of fiscal 2002, as compared to $1.5 million, or 64% of net
      sales, for the same period in fiscal 2001. The improvement was primarily
      due to the mix of products sold and product cost reductions.

            Gross profits for the first six months of fiscal 2002 and 2001 were
      $3.2 million, or 69% of net sales and $3.1 million, or 67% of net sales,
      respectively. The increase in gross profit for the six months of fiscal
      2002 was primarily due to higher sales of our fax server products, which
      carry higher gross margins.

            The reduction in gross profit as a percentage of sales resulting
      from the implementation of EITF No. 01-9 was insignificant for the three
      and six month periods ended June 30, 2002 and June 29, 2001.

      Research & Development

            Research and product development expenses were $349,000, or 15% of
      net sales, for the second quarter of fiscal 2002, as compared to $481,000,
      or 21% of net sales, for the same period in fiscal 2001, due to decreases
      in outside consulting expenses of $50,000 and other support costs of
      $74,000. Research and product development expenses for the first six
      months of fiscal 2002 were $762,000, or 17% of net sales, as compared to
      $866,000, or 19% of net sales, for the same period in fiscal 2001. This
      reduction of $104,000 in the six-month period was primarily due to
      decreases in outside consulting expenses of $70,000 and other support
      costs of $116,000, offset in part by higher compensation costs of $92,000.

      Sales & Marketing

            Sales and marketing expenses were $780,000, or 35% of net sales, for
      the second quarter of fiscal 2002, as compared to $982,000, or 42% of net
      sales, for the same period in fiscal 2001. The reduction of $202,000 was
      primarily attributable to reduced payroll and related costs. For the first
      six months of fiscal 2002, sales and marketing expenses were $1.5 million,
      or 33% of


                                       12


      net sales, as compared to $2.1 million, or 45% of net sales, for the same
      period in fiscal 2001. This reduction of sales and marketing spending by
      $509,000 was primarily due to lower compensation and other payroll related
      expenses of $331,000 and reduced promotional expenses of $178,000.

      General & Administrative

            General and administrative expenses were $450,000, or 20% of net
      sales, for the second quarter of fiscal 2002, as compared to $255,000, or
      11% of net sales, for the same period in fiscal 2001. The increase in
      general and administrative expenses in the second quarter of fiscal 2002
      was principally due to the increase in legal and accounting fees of
      $44,000, outside consulting expenses of $53,000 and the absence of benefit
      obtained from the collection of previously written-off bad debts during
      the quarter ended June 29, 2001. General and administrative expenses for
      the first six months of fiscal 2002 were $854,000, or 18% of net sales, as
      compared to $699,000, or 15% of net sales for the same period in fiscal
      2001. The increase in general and administrative expenses of $155,000 was
      primarily due to higher legal and accounting expenses of $69,000, an
      increase in the allowance for doubtful accounts from customers of $40,000
      and an increase in outside consulting expenses of $53,000.

      Restructuring

            In April 2001, we terminated 17 regular, temporary and contractor
      positions, which constituted approximately 25% of our workforce. This
      action resulted in a severance charge of $58,000 in the second quarter of
      fiscal 2001. This severance charge is in addition to the restructuring
      charge of $180,000 recorded in the first quarter of fiscal 2001, which
      included an asset write-off and other direct expenses associated with the
      consolidation of our operations in the United Kingdom and El Dorado Hills,
      California. In the second quarter of fiscal 2002, a non-recurring benefit
      of $40,000 arising from the reversal of previously recorded restructuring
      charges was included in the results of operations, following the
      completion of the Company's 2001 restructuring programs for less than
      previously anticipated.

Liquidity and Capital Resources

      As of June 30, 2002, we had approximately $4.3 million of cash and cash
equivalents, as compared to $4.6 million at December 31, 2001. The decrease in
cash and cash equivalents of $257,000 was primarily due to employees cashing out
unused vacation of $140,000 and the payment of $105,000 of incentive
compensation earned in fiscal 2001 and the first quarter of fiscal 2002 to our
former Chief Executive Officer who retired in April 2002.

      The Company leases its corporate headquarters in Morgan Hill, California.
The lease on the Morgan Hill facility has an initial term of five years,
expiring in December 2005, with one conditional three-year option, which if
exercised, would extend the lease to December 2008 commencing with rent at 95%
of fair market value. As of June 30, 2002, the future minimum payments under the
lease were approximately $917,000.

      In December 2000, as a source of capital asset financing, we entered into
a loan and security agreement with a finance company for an amount of $75,000.
This loan is subject to interest of 12.8% per annum and is repayable by December
2006. As of June 30, 2002, the future minimum payments were $77,000.

      In April 2001, as a source of capital asset financing, we entered into a
loan and security agreement with a finance company for an amount of $25,000.
This loan is subject to interest of 12.5% per annum and is repayable by April
2004. As of June 30, 2002, the future minimum payments were $17,000.


                                       13


      In addition to the commitments shown above, we have a $3.0 million
collateralized revolving line of credit with a bank, which expires in March
2003, pursuant to which we may borrow 100% against pledges of cash at the bank's
prime rate. Borrowings under this line of credit agreement are collateralized by
all of our assets. We are in compliance with the terms of the agreement, and as
of June 30, 2002, had no borrowings under the line of credit.

      As of June 30, 2002, net accounts receivable were $649,000, down from
$680,000 at December 31, 2001. The decrease in net accounts receivable was
largely attributable to improved collection of outstanding balances in the first
six months of fiscal 2002.

      Net inventory as of June 30, 2002 was $842,000, a decrease from the
$926,000 at December 31, 2001. The lower inventory was primarily due to more
components being used in production than purchases in the same period.

      Although we believe that our existing capital resources, anticipated cash
flows from operations and available lines of credit will be sufficient to meet
our capital requirements for at least the next 12 months, we may be required to
seek additional equity or debt financing. The timing and amount of such
additional capital requirements cannot be determined at this time and will
depend on a number of factors, including demand for our 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.

      We believe that, for the periods presented, inflation has not had a
material effect on our operations.

New Accounting Pronouncements:

      In April 2002, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of
FASB Statement No. 13, and Technical Corrections". SFAS No. 145 rescinds
Statement 4, which required all gains and losses from extinguishment of debt to
be aggregated and, if material, classified as an extraordinary item, net of
related income tax effect. As a result, the criteria in APB Opinion 30 will now
be used to classify those gains and losses. SFAS 145 also amends Statement 13 to
require that certain lease modifications that have economic effects similar to
sale-leaseback transactions be accounted for in the same manner as
sale-leaseback transactions. The Company does not believe that the adoption of
this statement will have a material impact on its results of operations,
financial position or cash flows.

      In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
when the liability is incurred. SFAS No. 146 eliminates the definition and
requirement for recognition of exit costs in Emerging Issues Task Force Issue
No. 94-3 where a liability for an exit cost was recognized at the date of an
entity's commitment to an exit plan. This statement is effective for exit or
disposal activities initiated after December 31, 2002. The Company does not
believe that the adoption of this statement will have a material impact on its
results of operations, financial position or cash flows.


                                       14


                                  RISK FACTORS

      The risks and uncertainties described below are not the only ones facing
the Company. Additional risks and uncertainties not presently known to the
Company or that the Company currently deems immaterial also may impair the
Company's business operations. If any of the following risks or such other risks
actually occur, our business could be adversely affected.

Fluctuations in Operating Results

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

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

      Other factors contributing to fluctuations in the Company's quarterly
operating results include changes in the demand for the Company's products,
customer order deferrals in anticipation of new versions of the Company's
products, the introduction of new products and product enhancements by the
Company or its competitors, the effects of filling the distribution channels
following such introductions, potential delays in the availability of announced
or anticipated products, the mix of product revenue, the commencement or
conclusion of significant development projects, changes in foreign currency
exchange rates, the timing of acquisitions and associated costs, and the timing
of significant marketing and sales promotions. Based on the foregoing, the
Company believes that quarterly operating results are likely to vary
significantly in the future and that period-to-period comparisons of its results
of operations are not necessarily meaningful and should not be viewed upon as
indications of future performance.

History of Losses; Accumulated Deficit

      The Company has experienced significant operating losses and, as of June
30, 2002, had an accumulated deficit of $24.7 million. The development and
marketing by the Company of its current and new products will continue to
require substantial expenditures. There can be no assurance that growth in net
sales or profitability will be achieved or sustained in future years. Related
risk factors are discussed elsewhere in the caption "Management's Discussion and
Analysis of Financial Condition and Results of Operations" in this Quarterly
Report on Form 10-Q and in the Annual Report on Form 10-K and Form 10-K/A for
the fiscal year ended December 31, 2001.

Nasdaq SmallCap Listing; Risk associated with Limited Market

      The Company's Common Stock has been listed on the Nasdaq SmallCap Market
since April 1999. In order to maintain its listing on the Nasdaq SmallCap
Market, the Company must maintain total assets, capital and public float at
specified levels and generally must maintain a minimum bid


                                       15


price of $1.00 per share. If the Company fails to maintain the standard
necessary to be quoted on the Nasdaq SmallCap Market, the Company's Common Stock
could become subject to delisting. On March 12, 2002, the Company received a
notice from the Nasdaq Stock Market that its common stock had failed to maintain
the minimum bid price of $1.00 per share required for continued listing on the
Nasdaq SmallCap Market. If the Company's Common Stock fails to meet the $1.00
bid price per share for a minimum of ten consecutive trading days prior to
September 9, 2002, the Company's Common Stock will be delisted from the Nasdaq
SmallCap Market. If the Common Stock is delisted, trading in the Common Stock
could be conducted on the OTC Bulletin Board or in the over-the-counter market
in what is commonly referred to as the "pink sheets." If this occurs, a
shareholder will find it more difficult to dispose of the Common Stock or to
obtain accurate quotations as to the price of the Common Stock. Lack of any
active trading market would have an adverse effect on a shareholder's ability to
liquidate an investment in the Company's Common Stock easily and quickly at a
reasonable price. It might also contribute to volatility in the market price of
the Company's Common Stock and could adversely affect the Company's ability to
raise additional equity or debt financing on acceptable terms or at all. Failure
to obtain desired financing on acceptable terms could adversely affect the
Company's business, financial condition and results of operations.

Rapid Technological Change; Risks Associated with New Products

      The market for the Company's products is affected by rapidly changing
networking technology, evolving industry standards, increasing internet usage
and the emergence of other new communication technologies. The Company believes
that its future success will depend upon its ability to enhance its existing
products and to identify, develop, manufacture and introduce new products which
conform to or support emerging network telecommunications standards, are
compatible with a growing array of computer and peripheral devices, support
popular computer and network operating systems and applications, meet a wide
range of evolving user needs and achieve market acceptance. There can be no
assurance that the Company will be successful in these efforts.

The Company has incurred, and the Company expects to continue to incur,
substantial expenses associated with the introduction and promotion of new
products. There can be no assurance that the expenses incurred will not exceed
research and development cost estimates or that new products will achieve market
acceptance and generate sales sufficient to offset development costs. In order
to develop new products successfully, the Company is dependent upon timely
access to information about new technological developments and standards. There
can be no assurance that the Company will have such access or that it will be
able to develop new products successfully and respond effectively to
technological change or new product announcements by others. Furthermore, the
Company expects that printer and other peripheral manufacturers will add
features to their products that make them more network accessible, which may
reduce demand for the Company's print servers. There can be no assurance that
products or technologies developed by others will not render the Company's
products non-competitive or obsolete. The fax-on-demand market in general has
been negatively affected by the growth of the Internet. Although the Company has
new Web/fax/email products in development, there can be no assurance these
products will compete successfully. Complex products such as those offered by
the Company may contain undetected or unresolved hardware defects or software
errors when they are first introduced or as new versions are released. Changes
in the Company's or its suppliers' manufacturing processes or the inadvertent
use of defective components by the Company or its suppliers could adversely
affect the Company's ability to achieve acceptable manufacturing yields and
product reliability. The Company has in the past discovered hardware defects and
software errors in certain of its new products and enhancements after their
introduction. There can be no assurance that despite testing by the Company and
by third-party test sites, errors will not be found in future releases of the
Company's products, which would result in adverse product reviews and negatively
affect market acceptance of these products.

      The introduction of new or enhanced products requires the Company to
manage the transition, both internally and for customers, from the older
products to the new or enhanced


                                       16


products or versions. The Company must manage new product introductions so as to
minimize disruption in customer ordering patterns, avoid excessive levels of
older product inventories and ensure that adequate supplies of new products can
be delivered to meet customer demands. The Company has from time to time
experienced delays in the shipment of new products. There can be no assurance
that future product transitions will be managed successfully by the Company.

Key Personnel

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

Competition and Price Erosion

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

      The principal competitive factors affecting the market for the Company's
products include product functionality, performance, quality, reliability, ease
of use, quality of customer training and support, name recognition, price, and
compatibility and conformance with industry standards and changing operating
system environments. Several of the Company's existing and potential
competitors, most notably the Hewlett-Packard Company ("Hewlett-Packard") and
Intel Corporation ("Intel"), have substantially greater financial, engineering,
manufacturing and marketing resources than the Company. The Company also
experiences competition from a number of other software, hardware and service
companies. In addition to its current competitors, the Company may face
substantial competition from new entrants into the network enhancement market,
including established and emerging computer, computer peripherals,
communications and software companies. In the fax server market the Company
competes with companies such as Captaris Inc., Omtool, Ltd. and Computer
Associates International, Inc. There can be no assurance that competitors will
not introduce products incorporating technology more advanced than the
technology used by the Company in its products. In addition, certain competing
methods of communication such as the Internet or electronic mail could adversely
affect the market for fax products. Certain of the Company's existing and
potential competitors in the print server market are manufacturers of printers
and other peripherals, and these competitors may develop closed systems
accessible only through their own proprietary servers. There can be no assurance
that the Company will be able to compete successfully or that competition will
not have a material adverse effect on the Company's business, operating results
and financial condition.


                                       17


International Sales

      Sales to customers located outside Canada and the United States accounted
for approximately 20%, 25% and 31% of the Company's net sales in fiscal 2001,
2000 and 1999, respectively, and 18% for the six months ended June 30, 2002. The
Company sells its products in approximately 40 foreign countries through
approximately 50 international distributors. Macnica, the Company's principal
Japanese distributor, accounted for approximately 46%, 60% and 60% of the
Company's international sales in fiscal 2001, 2000 and 1999, respectively, and
10%, 15% and 18% of the Company's total net sales in fiscal 2001, 2000 and 1999,
respectively. Sales to Macnica accounted for approximately 8% of the Company's
total net sales in the six months ended June 30, 2002. The Company expects that
international sales will continue to represent a significant portion of the
Company's product revenues and that the Company will be subject to the normal
risks of international sales, such as export laws, currency fluctuations, longer
payment cycles, greater difficulties in accounts receivable collections and the
requirement of complying with a wide variety of foreign laws. There can be no
assurance that the Company will not experience difficulties resulting from
changes in foreign laws relating to the export of its products in the future. In
addition, because the Company primarily invoices its foreign sales in U.S.
dollars, fluctuations in exchange rates could affect demand for the Company's
products by causing its prices to be out of line with products priced in the
local currency. Additionally, any such difficulties would have a material
adverse effect on the Company's international sales and a resulting material
adverse effect on the Company's business, operating results and financial
condition. In fiscal 2001, the Company downsized its operations in the United
Kingdom and entered into an agreement with a distributor to service the region.
In addition, the Company entered into a separate agreement in fiscal 2001 with a
Japanese distributor to sell the Company's LANpress products in Japan, from
which the Company is entitled to receive a royalty on sales of these products.
The Company may experience fluctuations in European sales on a quarterly basis
because European sales may be weaker during the third quarter than the second
quarter due to extended holiday shutdowns in July and August. There can be no
assurance that the Company will be able to maintain the historical level of
international sales in the future. Any fluctuations in international sales will
greatly affect the Company's operating results and financial condition.

Lack of Product Revenue Diversification

      The Company derives substantially all of its sales from its fax and print
server products, with its fax server products accounting for 91% of its total
sales in fiscal 2001 and 93% of its total sales for the six months ended June
30, 2002. The Company is leveraging its expertise in these areas to develop new
messaging features and products to support greater integration into corporate
network environments and with Internet communications. The Company expects that
its current products will continue to account for a majority of the Company's
sales in the near future. A decline in demand for these products as a result of
competition, technological change or other factors, or a delay in the
development and market acceptance of new features and products, would have a
material adverse effect on the Company's business, operating results and
financial condition.

Product Transition; Risk of Product Returns and Inventory Obsolescence

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


                                       18


Concentration of Distributors; Distribution Risks

      The Company sells its products primarily through a two-tier domestic and
international distribution network. The Company's distributors sell Castelle's
products to VARs, e-commerce vendors and other resellers. The distribution of
personal computers and networking products has been characterized by rapid
change, including consolidations due to the financial difficulties of
distributors and the emergence of alternative distribution channels. In
addition, an increasing number of companies are competing for access to these
channels. The Company's distributors typically represent other products that are
complementary to, or compete with, those of the Company. In particular, certain
of the Company's competitors, including Hewlett-Packard and Intel, sell a
substantially higher dollar volume of products through several of the Company's
large U.S. distributors, and as a result, the Company believes such distributors
give higher priority to products offered by such competitors. The Company's
distributors are not contractually committed to future purchases of the
Company's products and could discontinue carrying the Company's products at any
time for any reason. In addition, because the Company is dependent on a small
number of distributors for a significant portion of the sales of its products,
the loss of any of the Company's major distributors or their inability to
satisfy their payment obligations to the Company could have a significant
adverse effect on the Company's business, operating results and financial
condition. The Company has a stock rotation policy with certain of its
distributors that allows them to return marketable inventory against offsetting
orders. Should the Company reduce its prices, the Company credits certain of its
distributors for the difference between the purchase price of products remaining
in their inventory and the Company's reduced price for such products. In
addition, due to industry conditions or the actions of competitors, inventory
levels of the Company's products held by distributors could become excessive,
resulting in product returns and inventory write-downs. Although the Company
provides an allowance for anticipated returns and for price protection, and
believes its existing policy results in the establishment of an allowance that
is adequate, there can be no assurance that in the future returns and price
protection will not have a material adverse effect on the Company's business,
operating results and financial condition.

Dependence on Third-Party Suppliers and Subcontractors

      The Company's products incorporate or require components or sub-assemblies
procured from third-party suppliers. Certain of these components or
sub-assemblies are available only from a single source, and others are available
only from limited sources. Certain key components of the Company's products,
including a modem chip set from Conexant Systems, Inc. and a microprocessor from
Motorola, Inc., are currently available from single sources. Other product
components are currently available from only a limited number of sources. In
addition, the Company subcontracts a substantial portion of its manufacturing to
third parties, and there can be no assurance that these subcontractors will be
able to support the manufacturing requirements of the Company. Other than an
agreement with Sercomm Corporation to manufacture certain print server products,
the Company does not have material long-term supply contracts with third parties
or any other sole or limited source vendors and subcontractors. The Company
purchases components or sub-assemblies on a purchase order basis. The Company's
ability to obtain these components and sub-assemblies is dependent upon its
ability to accurately forecast customer demand for its products and to
anticipate shortages of critical components or sub-assemblies created by
competing demands upon suppliers. If the Company were unable to obtain a
sufficient supply of high-quality components or sub-assemblies from its current
sources, the Company could experience delays in obtaining such components or
sub-assemblies from other sources. Resulting delays or reductions in product
shipments could adversely affect the Company's business, operating results and
financial condition and damage customer relationships. Furthermore, a
significant increase in the price of one or more of these components or
sub-assemblies or the Company's inability to lower component or sub-assembly
prices in response to competitive price reductions could adversely affect the
Company's business, operating results and financial condition.


                                       19


      The Company augments its product offerings by obtaining access to
third-party products and technologies in areas outside of its core competencies
or where the Company believes internal development of products and technologies
is not cost-effective. The Company's third-party supplier of certain print
server products is SerComm. There can be no assurance that these products will
produce gross margins comparable to those of the Company's internally generated
products or that the parties with which the Company contracts will continue to
provide the quantities and quality of products needed by the Company or that
they will upgrade their respective products on a timely basis. The termination
of the Company's relationships with third-party product suppliers and with
SerComm, in particular, could result in delays or reductions in product
shipments, which could have a material adverse effect on the Company's business,
operating results and financial condition.

Government Regulation

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

Dependence on Proprietary Rights; Uncertainty of Obtaining Licenses

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


                                       20


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

Possible Volatility of the Company's Common Stock Price

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

Future Capital Requirements

      The development and marketing of the Company's products requires
significant amounts of capital. The Company believes that its existing cash
balances, anticipated cash flows from operations and available lines of credit
will be sufficient to meet its anticipated capital requirements for the next 12
months. However, a decline in future orders and revenues might require us to
seek additional capital to meet our working capital needs during or beyond the
next twelve months if we are unable to reduce expenses to the degree necessary
to avoid incurring losses. If we have a need for additional capital resources,
we may be required to sell additional equity or debt securities, secure
additional lines of credit or obtain other third party financing. The timing and
amount of such additional capital requirements cannot be determined at this time
and will depend on a number of factors, including demand for the Company's
existing and new products and changes in technology in the networking industry.
There can be no assurance that such additional financing will be available on
satisfactory terms when needed, if at all. To the extent that additional capital
is raised through the sale of additional equity or convertible debt securities,
the issuance of such securities would result in additional dilution to our
shareholders. Related risk factors are discussed elsewhere in this Quarterly
Report on Form 10-Q and in the Annual Report on Form 10-K and Form 10-K/A for
the fiscal year ended December 31, 2001.


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Voting Control by Officers, Directors and Affiliates

      As of August 5, 2002, to the Company's knowledge and based on public
filings, the Company's officers and directors and their affiliates beneficially
owned approximately 28% of the outstanding shares of the Company's Common Stock.
Accordingly, together they had the ability to significantly influence the
election of the Company's directors and other corporate actions requiring
shareholder approval. Such concentration of ownership may have the effect of
delaying, deferring or preventing a change in control of the Company.

Certain Charter Provisions

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

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

      We had no holdings of derivative financial or commodity instruments at
June 30, 2002. However, we are exposed to financial market risks, including
changes in interest rates and foreign currency exchange rates. While most of our
sales are transacted in U.S dollars, some revenues and capital spending are
transacted in Pounds Sterling. These amounts are not currently material to our
financial statements, and therefore we believe that fluctuations in foreign
currency exchange rates should not materially affect our overall financial
position, results of operations or cash flows. The fair value of our money
market account and related interest income would not be significantly impacted
by changes in interest rates due mainly to the highly liquid nature of this
investment. The Company believes that there have been no material changes in the
reported market risks faced by the Company since the fiscal year ended December
31, 2001. These and other risk factors are discussed above under the caption
"Risk Factors" and elsewhere in this Quarterly Report on Form 10-Q and in our
Form 10-K and Form 10-K/A for the fiscal year ended December 31, 2001 under the
section "Risk Factors."


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                           PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

      The Company has been contacted by a third party claiming that the Company
needs to obtain licenses of certain patents held by that party for certain of
the Company's fax server products. The Company is continuing to assess the
validity and strength of the claims, believes it has adequate legal defenses and
that the ultimate outcome of any possible action will not have a material effect
on the Company's financial position, results of operations or cash flows
although there can be no assurance as to the outcome of any possible litigation.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

      None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

      None.

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

      None.

ITEM 5. OTHER INFORMATION

      In April 2002, Donald L. Rich, retired as the CEO, a post he has held
since November of 1998 and Scott C. McDonald, a member of the Board of Directors
since April of 1999, was appointed President and CEO and continues to serve on
the Board. Mr. Rich will continue as Chairman of the Board, a post he has held
since May 1999, and will stay active with the Company in that role.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)   Exhibits:

      99.1  Certification pursuant to Section 906 of the Public Company
            Accounting Reform and Investor Protection Act of 2002 (18 U.S.C.ss.
            1350, as adopted)

      99.2  Press Release dated July 29, 2002

(b)   Reports on Form 8-K

      On April 23, 2002, we filed a report on Form 8-K announcing the
      appointment of Scott C. McDonald as our Chief Executive Officer replacing
      Donald L. Rich who was retiring.


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                                   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/ Scott C. McDonald                                Date: August 13, 2002
   ------------------------------------------
      Scott C. McDonald
      Chief Executive Officer and President
      (Principal Executive Officer)

By:   /s/ Paul Cheng                                       Date: August 13, 2002
   ------------------------------------------
      Paul Cheng
      Vice President of Finance and Administration
      Chief Financial Officer
      (Principal Financial and Chief Accounting Officer)
      Secretary


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