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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-K

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

(Mark One)

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

For the fiscal year ended October 31, 2003

OR

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

For the transition period from _________ to ___________

Commission File No. 0-8419

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

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

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

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

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

None
-----------------------------------------------------------
Securities registered pursuant to Section 12(g) of the Act:

Common Stock
----------------
(Title of Class)

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

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


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

The approximate aggregate market value of the common stock of the
registrant held by non-affiliates of the registrant, based on the closing price
for the registrant's common stock on April 30, 2003 as reported on the Nasdaq
SmallCap Market, was $3,122,522. Shares of Common Stock held by each executive
officer, director and stockholder whose ownership exceeds five percent of Common
Stock outstanding have been excluded because such persons may be deemed to be
affiliates of the registrant. This determination of affiliate status for
purposes of the foregoing calculation is not necessarily a conclusive
determination of affiliate status for other purposes.

The number of shares of the registrant's common stock outstanding as of
December 31, 2003 was 4,944,127.

Documents incorporated by reference

Portions of the registrant's definitive proxy statement for the
registrant's Annual Meeting of Stockholders, scheduled for March 16, 2004, have
been incorporated by reference into Part III of this Annual Report on Form 10-K.


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SBE, INC.

FORM 10-K

TABLE OF CONTENTS

PART I

Item 1 Business 4
Item 2 Properties 17
Item 3 Legal Proceedings 17
Item 4 Submission of Matters to a Vote of Security Holders 18

PART II

Item 5 Market for Registrant's Common Equity
and Related Stockholder Matters 19
Item 6 Selected Financial Data 20
Item 7 Management's Discussion and Analysis of
Financial Condition and Results of Operations 21
Item 7A Quantitative and Qualitative Disclosures about Market Risk 33
Item 8 Financial Statements and Supplementary Data 33
Item 9 Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure 33
Item 9A Controls and Procedures 33

PART III

Item 10 Directors and Executive Officers of the Registrant 35
Item 11 Executive Compensation 35
Item 12 Security Ownership of Certain Beneficial Owners
and Management 35
Item 13 Certain Relationships and Related Transactions 35
Item 15 Exhibits, Financial Statement Schedules
and Reports on Form 8-K 36

SIGNATURES 40


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SPECIAL NOTE ON FORWARD LOOKING STATEMENTS

Certain statements set forth in or incorporated by reference in this Annual
Report on Form 10-K constitute "forward-looking statements" within the meaning
of Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. These statements include, without limitation, our
expectations regarding our sales to The Hewlett-Packard Company, our
expectations regarding the market for client server networking products, the
adequacy of anticipated sources of cash, planned capital expenditures, the
effect of interest rate increases, and trends or expectations regarding our
operations. Words such as "may," "will," "should," "believes," "anticipates,"
"expects," "intends," "plans," "estimates" and similar expressions are intended
to identify forward-looking statements, but are not the exclusive means of
identifying such statements. Such statements are based on currently available
operating, financial and competitive information and are subject to various
risks and uncertainties. Readers are cautioned that the forward-looking
statements reflect management's estimates only as of the date hereof, and we
assume no obligation to update these statements, even if new information becomes
available or other events occur in the future. Actual future results, events and
trends may differ materially from those expressed in or implied by such
statements depending on a variety of factors, including, but not limited to
those set forth under "Item 1 - Business -- Risk Factors" on page 13 and
elsewhere in this Form 10-K.

PART I

ITEM 1. BUSINESS

Overview

SBE, Inc. develops and provides network communications solutions for original
equipment manufacturers ("OEM") in both the embedded and enterprise-level
information technology ("IT") computing markets. Embedded networking technology
is hardware or software that serves as a component within a larger networking
device or system such as a Gigabit Ethernet input/output card with Linux or
Solaris software drivers that plugs into an expansion slot in a high-end
computer. Embedded networking solutions enable the functionality of many
commonly used devices or equipment, such as products and solutions for basic
telephone and internet services, mobile phones, medical equipment, airplanes,
and automobiles. Enterprise/IT refers to all of the equipment, processes,
procedures and systems used to provide and support computing and other
information systems used within an organization including those reaching out to
customers and suppliers. Enterprise computing technologies power
mission-critical data management/processing and networking applications within a
corporation, such as order entry, accounts receivable, payroll, inventory,
email/voicemail management, internet and intranet access.

We deliver a product portfolio comprised of standards-based wide area networking
("WAN"), local area networking ("LAN"), storage area network ("SAN") interface
cards, communications controllers with its own microprocessor and memory on
board, and enabling communications software. Our products are designed to be
functionally compatible with each other and, because we use industry standard
form factors and technologies, our products are compatible with other industry
standard products. This standard scalability and modularity offers our customers
greater flexibility to develop solutions for unique product configurations and
applications. Our products are designed using industry standard form factors
including those known as peripheral component interconnect ("PCI"), CompactPCI,
VersaModule- Eurocard ("VME"), PCI Mezzanine card ("PMC"), and PCI Telecom
Mezzanine Card ("PTMC"). Form factors are the shape and size of interface cards
used to expand the functionality of standard computer bus architectures. A PCI
is a 32-bit local bus architecture used to transfer data from a computer's main
microprocessor to peripherals such as hard disks and video adapter. CompactPCI
is an adaptation of the PCI 32-bit bus architecture designed to expand the
number of available slots for peripheral devices from four to eight and to
improve a computer's ability to withstand adverse conditions such as extreme
vibration. VME is a mechanical and electrical bus architecture developed in
Germany by Motorola in the late 1970s. A PMC card plugs into a standard PCI or
CompactPCI card enabling it to provide differing input/output or computing
functions. A PTMC is a PMC card designed specifically for telecommunication
applications.


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

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

Business Strategy

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

During fiscal 2003, we made significant steps in achieving this objective,
including:

o Maintained Business Viability and Profitability

We took steps in fiscal 2002 to reduce our operating expenses while continuing
to invest in key product development initiatives. Realigning our business
strategy and implementing cost controls allowed us to maintain profitability in
fiscal year 2003.

o Strategic Acquisitions and Investments

We believe that joining the products and technologies of Antares with those of
SBE has strengthened our ability to provide solutions to both the embedded and
enterprise markets. The addition of Antares products extended our portfolio of
products to include field-tested Ethernet, SCSI, Fibre Channel and specialty
input/output ("I/O") boards for the enterprise Sun and Linux arena. The Antares
products have been integrated into a variety of applications, including SAN and
data centers. Our expanded portfolio of products has resulted in a wide-ranging
collection of WAN, LAN, storage, and intelligent communication controller boards
with Linux and Solaris software driver support for both the embedded and
enterprise server markets. We believe this expanded technology portfolio opens
up opportunities for further penetration into existing customers accounts as
well as into new markets and applications.


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o Expanded Market Focus

Although we have traditionally focused on telecommunications applications, we
have also identified and pursued opportunities in other market sectors,
including finance/banking, industry and government. For example, in May 2003,
our HW400c/M product was selected for use in connection with a Federal Aviation
Agency base station upgrade.

o Ongoing New Product Developments

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

- Linux "On Demand". Recognizing the value to our customers, we began
developing Linux software drivers for SBE products using internal
resources and those from partnering software companies.

- HyperTransport(TM) Ethernet Adapter. SBE developed a dual port
Gigabit Ethernet adapter based on HyperTransport(TM) technology to
complement its family of LAN interface cards. HyperTransport(TM)
technology is designed to transfer data at 6.4 Gigabytes per second
and is approximately 48 times faster than PCI, 6 times faster than
PCI-X and 5 times faster than InfiniBand using 4 channels.
HyperTransport(TM) technology is designed to provide more bandwidth
than current interconnect technologies, use low-latency responses,
be compatible with legacy PC buses, be extensible to new Systems
Network Architecture buses, be compatible with existing and future
operating systems and be software compatible with PCI. Its
electrical design is intended to improve reliability and reduce
board design complexity.

- Passive PMC-to-PCI Adapter. In July 2003, we introduced
adaptPCI-1PMC, a single slot PCI card to facilitate the integration
of PMC or PTMC boards into standard PCI systems. The adaptPCI-1PMC
is designed to reduce the time required to integrate PMC or PTMC
boards into PCI systems, thus allowing our customers to focus on
their core competencies. Well-suited for enterprise
router/switch/gateway providers and system integrators,
adaptPCI-1PMC can be conveniently bundled with SBE's PMC and PTMC
modules or sold individually for use with any standard third-party
module.

In fiscal 2004, we plan to further build on the momentum that was generated over
the past year by turning our technology investments into strong, customer-driven
product solutions, continuing to diversify our customer base, and actively
seeking out new market opportunities. Specifically, our key focus areas for the
upcoming year include:

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

With the acquisition of Antares' products, we have entered the enterprise arena
with an enhanced line of LAN and Storage products. We intend to launch an
aggressive sales and marketing campaign to develop and enhance awareness of our
portfolio of products and capabilities.

o Expand Market and Customer Diversification

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


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o Continue to Invest in New Products and Technologies

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

Evolution of WAN Product Line. We are currently planning several additions to
our WAN product line, including a fully channelized T3 adapter supporting 672
channels and a PMC module featuring 8 or 16 T1/E1 ports.

Expansion of HighWire Line of Intelligent Communications Controllers. We plan to
enhance the HW400c/R product, a 6U CompactPCI intelligent SS7 protocol processor
with interfaces to 8 T1/E1/J1 ports, to include PICMG 2.16 Packet Switched
Backplane and Intelligent Platform Management Interface ("IPMI") specifications.
We are also developing the next generation HighWire CompactPCI controller with
IPMI to the backplane, Ethernet switch, and dual PTMC support. As with our
currently available platforms, SBE's future processors will be designed to
provide embedded Linux with the intent to offer 100% interoperability with a
wide array of WAN, LAN, and Storage PMCs.

TCP/IP Offload Engine ("TOE"). As Ethernet speeds continue to increase, the need
for significant offloading of protocol processing becomes increasingly
important. TOE is designed to offload CPU processing in order to increase
application performance and alleviate networking bottlenecks. Given the
prevalence of TCP/IP networking equipment in today's global electronic
communications, we expect the opportunities to deploy the board-level TOE
solutions that we have in development to increase. We expect that demand for TOE
will continue to increase as network bandwidth requirements escalate.

Serial Attached SCSI. As we grow and evolve our broad line of ("SCSI") or Small
Computer System Interface adapters, we will focus on the next generation of
SCSI, namely Serial Attached SCSI. As enterprise storage requirements increase
and become more complex, factors such as larger capacity, greater density,
security, scalability and accessibility will become more critical. There will be
a greater need for enterprise data centers to be online at all times, fulfill
requests from numerous users simultaneously, allow for constant growth and
expansion, and be maintained while in operation. Serial Attached SCSI is
designed to meet these demands.

Products

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


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Although SBE continues to sell and manufacture products such as multibus,
VMEbus, and ISA, we emphasize five principal lines of products: WAN adapters,
LAN/Ethernet adapters, storage network interface cards ("NICs"), intelligent
communications controllers, and custom and specialty I/O.

Wide Area Networking Adapters

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

Local Area Networking Adapters

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

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

Storage Network Interface Cards

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

Fibre Channel is a serial data transfer architecture developed by a consortium
of computer and mass storage device manufacturers and is now being standardized
by the American National Standards Institute ("ANSI"). Our Fibre Channel host
bus adapters are available in single or dual port, 1-Gigabit or 2-Gigabit
versions with copper and/or optical Gigabit Interface Converter ("GBIC"). A GBIC
is a small removable I/O device that allows the customer to convert the I/O
interface from different interface medium, like copper to optical, by simply
sliding out and replacing the GBIC. Our Fibre Channel adapters offer active port
failover software designed to enable a system to detect a failure and
automatically use the backup port without the traditional use of a switch or
router.


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Intelligent Communications Controllers

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

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

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

VMEbus

Our line of VMEbus products is designed for high reliability industrial
applications and these products are used in wireline, wireless and satellite
based communications networks. Our VME products are intelligent communications
controller products used to provide connectivity between a system such as a
mini-computer or bridge/router and a local or wide area network. Our VMEbus
communications products target all four major protocol communications
technologies for each of the bus architectures: Fiber Distributed Data Interface
("FDDI"), Token Ring, Ethernet and high-speed serial communications. The latter
is a WAN technology that enables computers to talk to one another using
telephone lines. FDDI, Token Ring and Ethernet are LAN technologies that offer a
wide range of speed and reliability options.


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The following table shows sales by major product type as a percentage of net
sales for fiscal 2003, 2002 and 2001:



Year Ended October 31,
--------------------------------
2003 2002 2001
--------------------------------
(percentage of net sales)

VME 53% 56% 64%
WAN Adapter 30 31 31
LAN Adapter 5 0 0
Storage NIC 2 0 0
HighWire 10 13 5
--------------------------------
100% 100% 100%
================================


Distribution, Sales, and Marketing

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

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

We have focused our sales and marketing efforts in North America, Europe and
Asia. All of our international sales are negotiated in U.S. dollars.
International sales constituted 12%, 13% and 9% of net sales in fiscal 2003,
2002 and 2001, respectively. International sales are executed in U.S. dollars
and are principally transacted in Europe.

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

Research and Development

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


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

During the past four years, we have developed communications products based on
PCI, CompactPCI, PMC, PTMC, and HyperTransport architectures. We have also
redesigned and upgraded certain communications products to take advantage of new
technologies offering improved product performance and lower costs. In addition,
we have acquired or licensed certain hardware products that have been integrated
principally through the addition of software into our product line.

During fiscal 2003, we continued to focus on further developing our line of
standards-based LAN adapters, designing a custom LAN adapter that combines
Gigabit Ethernet and HyperTransport technology, enhancing functionality in our
current WAN adapter products, and developing software drivers for our WAN and
LAN adapters. These hardware and software design efforts have enabled us to more
effectively target enterprise markets such as VoIP, VPN and security routers, as
well as expand market coverage within the telecommunications,
military/government, medical and industrial control markets.

In August 2003, we acquired the products and technologies of Antares
Microsystems, Inc. This acquisition added a full line of field-tested, PCI-based
Ethernet, SCSI, and Fibre Channel products to our portfolio. We are continuing
to focus on investments in next generation technologies, such as TCP/IP Offload
Engine ("TOE"). As Ethernet speeds increase and end-user performance
expectations grow, the need to maximize bandwidth and the efficiency of the
connection is becoming increasingly important. TOE is designed to offload CPU
processing to increase application performance and alleviate networking
bottlenecks.

During fiscal 2003, 2002 and 2001, we incurred $1.3 million, $3.0 million and
$5.7 million, respectively, in product research and development expenses.

Commitment to Quality

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


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Manufacturing

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

Competition

The market for networking and communications interface products is highly
competitive. Many of our competitors have greater financial resources and are
well established in the space. Competition within the communications market is
fragmented principally by application segment. Our HighWire products compete
with offerings from Radisys Corp, Performance Technologies Inc, Interphase Corp,
Artesyn Technologies Inc, and Adax, along with various other platform and
controller product providers. Our VMEbus, WAN adapter and LAN adapter
communications controller products compete primarily with products from Digi
International Inc, Motorola Inc, Interphase Corp., Themis Computers Inc, SBS
Technologies Inc and various other companies on a product-by-product basis. Our
SCSI products compete with LSI Logic and Sun Microsystems Inc. Our Fibre Channel
products compete with products from Qlogic Corp and Emulex Corp. To compete and
differentiate ourselves in our markets, we emphasize the functionality,
engineering support, quality and price of our product in relation to our
competitors, as well as our ability to customize the product to meet the
customer's needs.

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

Intellectual Property

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

Backlog

On October 31, 2003, we had a sales backlog of product orders of approximately
$4.1 million compared to a sales backlog of product orders of approximately $2.2
million one year ago. Because customer purchase orders are subject to changes in
customer delivery schedules, cancellation, or price changes, our backlog as of
any particular date may not be representative of actual sales for any succeeding
fiscal period. We do not anticipate any problems in filling our current backlog.


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Employees

On December 31, 2003, we had 32 employees. None of our employees is represented
by a labor union. We have experienced no work stoppages. We believe our employee
relations are good.

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

Risk Factors

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

Risks Related to Our Business

We depend upon a small number of OEM customers. The loss of any of these
customers, or their failure to sell their products, would limit our ability to
generate revenues.

In fiscal 2003, most of our sales were derived from a limited number of OEM
customers. In fiscal 2003, 2002 and 2001, sales of VME products to The
Hewlett-Packard Company (previously Compaq Computer) ("HP") accounted for 45%,
30% and 34%, respectively, of our net sales. A substantial portion of such sales
were attributable to sales of VME products pursuant to a long-term supply
agreement with HP that is no longer in effect. We shipped $1.6 million of VME
products to HP over the first two quarters of fiscal 2003 pursuant to an
end-of-life product discontinuation purchase order under such contract. After
termination of the contract, we received additional orders for an aggregate of
$3.6 million of which $1.6 million was shipped in fiscal 2003 with the remaining
$2.0 million of these orders for VME products to be shipped in the first two
fiscal quarters of fiscal 2004. We can provide no assurance that we will succeed
in obtaining new orders from existing or new customers sufficient to replace or
exceed the net sales previously attributable to HP.

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


-13-


The communications and storage products market is intensely competitive, and our
failure to compete effectively could reduce our revenues and margins.

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

Increased competition with respect to any of our products could result in price
reductions and loss of market share, which would adversely affect our business,
operating results, financial condition and cash flows. Many of our current and
potential competitors have greater financial, marketing, technical and other
resources than we do. There can be no assurance that we will be able to compete
successfully with our existing competitors or will be able to compete
successfully with new competitors.

We have incurred operating losses in the past and may not be profitable in the
future.

The consolidated financial statements contemplate the realization of assets and
the satisfaction of liabilities in the normal course of business. Although we
had net income of $563,000 for fiscal 2003 and have had five consecutive
profitable quarters, we did incur net losses of $1.7 million and $9.9 million
for the years ended October 31, 2002 and 2001, respectively, and generated
negative cash flows from operations of $84,000, $2.7 million and $1.5 million in
the years ended October 31, 2003, 2002 and 2001, respectively. We believe that
prior cost reductions and a projected increase in sales during fiscal 2004 will
generate sufficient cash flows to fund our operations through October 31, 2004.
However, these projected sales are to a limited number of new and existing OEM
customers and are based on internal and customer provided estimates of future
demand, not firm customer orders. If the projected sales do not materialize, we
will need to reduce expenses further and potentially raise additional capital
through customer prepayments or the issuance of debt or equity securities. If
additional funds are raised through the issuance of preferred stock or debt,
these securities could have rights, privileges or preferences senior to those of
Common Stock, and debt covenants could impose restrictions on our operations.
The sale of equity or debt could result in additional dilution to current
stockholders, and such financing may not be available to us on acceptable terms,
if at all.

Our operating results in future periods are likely to fluctuate significantly
and may fail to meet the expectations of securities analysts or investors,
causing our stock price to fall.

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


-14-


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

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

If we are unable to keep up with the rapid technological changes that
characterize our industry, our business would suffer.

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

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


-15-


We depend on our key personnel. If we are unable to retain our current personnel
and hire additional qualified personnel as needed, our business would be harmed.

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

Because of our dependence on single suppliers for some components, we may be
unable to obtain an adequate supply of such components, or we may be required to
pay higher prices or to purchase components of lesser quality.

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

Our future capital needs may exceed our ability to raise capital.

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

We may be unable to protect our intellectual property, which could reduce any
competitive advantage we have.

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


-16-


Risks Associated with Ownership of Our Common Stock

Our common stock is at risk for delisting from the Nasdaq SmallCap Market. If it
is delisted, our stock price and your liquidity may be impacted.

Our common stock is currently listed on the Nasdaq SmallCap Market. Nasdaq has
requirements that a company must meet in order to remain listed on the Nasdaq
SmallCap Market. These requirements include maintaining a minimum closing bid
price of $1.00 and minimum stockholders' equity of $2.5 million. The closing bid
price for our common stock has been below $1.00 for short periods of time during
fiscal 2003. If the closing bid price of our common stock is below $1.00 for a
period of 30 consecutive trading days, our common stock could be subject to
delisting from the Nasdaq SmallCap Market. Our stockholders' equity as of
October 31, 2003 was $5.4 million.

If we fail to maintain the standards necessary to be quoted on the Nasdaq
SmallCap Market and our common stock is delisted, trading in our common stock
would be conducted on the OTC Bulletin Board as long as we continue to file
reports required by the Securities and Exchange Commission. The OTC Bulletin
Board is generally considered to be a less efficient market than the Nasdaq
SmallCap Market, and our stock price, as well as the liquidity of our Common
Stock, may be adversely impacted as a result.

The market price of our common stock is likely to continue to be volatile. You
may not be able to resell your shares at or above the price at which you
purchased such shares.

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

Our certificate of incorporation and bylaws and the Delaware General Corporation
Law contain provisions that could delay or prevent a change in control.

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


-17-


ITEM 2. PROPERTIES

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

We previously leased 6,100 square feet of office space in Madison, Wisconsin for
various product development activities. At the end of 2002, we abandoned the
office in Madison, Wisconsin and negotiated a termination of the lease releasing
us from further financial obligations effective December 31, 2002.

Additionally, through the acquisition of LAN Media Corp. in July 2000, we leased
approximately 3,650 square feet of office space in Sunnyvale, California. The
Sunnyvale lease expired without renewal in May 2003.

ITEM 3. LEGAL PROCEEDINGS

We are not a party to any pending legal proceedings.

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

There were no matters submitted to a vote of our stockholders in the fourth
quarter of 2003.

IDENTIFICATION OF EXECUTIVE OFFICERS

Our executive officers and their respective ages and positions as of October 31,
2003 are set forth in the following table. Executive officers serve at the
discretion of the board of directors. There are no familial relationships
between our directors or our executive officers and any other director or
executive officer.

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

William B. Heye, Jr. 65 President and Chief Executive Officer

David W. Brunton 53 Vice President, Finance, Chief Financial
Officer, Treasurer and Secretary

Daniel Grey 48 Senior Vice President, Sales and Marketing

Carl Munio 53 Vice President, Engineering

Kirk Anderson 44 Vice President, Operations

Yee-Ling Chin 28 Vice President, Marketing


-18-


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

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

Mr. Grey has served as Senior Vice President Sales and Marketing since May 2001.
For the 18 months prior to SBE, he was the Senior Vice President of Sales for
SBS Technologies. From 1999 to 2000, Mr. Grey was Vice President of Sales for
LAN Media Corporation, a company later acquired by SBE. Mr. Grey was the Western
Regional Sales Manager from 1996 to 1999 for Performance Technologies, Inc. From
1989 to 1996, Mr. Grey served as the Director of Western Sales for SBE.

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

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

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


-19-


PART II

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

Our common stock is quoted on the Nasdaq SmallCap Market under the symbol SBEI.
The following table presents quarterly information on the price range of our
common stock, indicating the high and low bid prices reported by the Nasdaq
SmallCap Market. These prices do not include retail markups, markdowns or
commissions. As of December 31, 2003, there were approximately 409 holders of
record of our common stock.

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

Fiscal quarter ended
-------------------------------------------------
Fiscal 2003 January 31 April 30 July 31 October 31
- --------------------------------------------------------------------------------
High $1.26 $0.95 $2.99 $6.00
Low 0.56 0.64 0.77 2.42
Fiscal 2002
High $1.43 $2.35 $2.18 $1.50
Low 0.49 1.15 1.21 0.80

The following table includes information regarding our equity incentive plans as
of the end of fiscal 2003.

Equity Compensation Plan Information



Number of securities
remaining available for
Number of securities to Weighted-average exercise future issuance under
be issued upon exercise price of outstanding equity compensation plans
of outstanding options, options, warrants (excluding securities
Plan category warrants and rights and rights reflected in column (a))
- ------------- ------------------- ---------- ------------------------
(a) (b) (c)

Equity compensation plans
approved by security
holders 1,043,754 $2.88 273,964
Equity compensation plans
not approved by security
holders 792,180 $2.64 3,939
--------- ----- -------
Total 1,835,934 $2.78 175,717
========= ===== =======



-20-


ITEM 6. SELECTED FINANCIAL DATA

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



For years ended October 31,
and at October 31 2003 2002 2001 2000 1999
- ----------------------------------------------------------------------------------------------
(in thousands, except for per share amounts and number of employees)

Net sales $ 7,456 $ 6,898 $ 7,726 $29,178 $19,854

Net income (loss) $ 563 $(1,731) $(9,896) $ 3,970 $ (254)

Net income (loss) per share - basic $ 0.13 $ (0.46) $ (2.92) $ 1.24 $ (0.08)

Net income (loss) per share - diluted $ 0.12 $ (0.46) $ (2.92) $ 1.04 $ (0.08)

Product research and development $ 1,330 $ 3,027 $ 5,652 $ 5,635 $ 5,167

Working capital $ 3,945 $ 2,985 $ 7,595 $11,793 $ 7,191

Total assets $ 6,975 $ 5,321 $10,690 $17,427 $11,264

Long-term liabilities $ 217 $ 10 $ 4,870 $ 288 $ 503

Stockholders' equity $ 5,387 $ 3,696 $ 4,119 $13,829 $ 8,636

Number of employees 32 24 47 87 72


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

SBE, Inc. architects and provides network communications solutions for original
equipment manufacturers ("OEM") in both the embedded and enterprise-level
information technology ("IT") computing markets. Our solutions enable both data
communications and telecommunications companies in addition to enterprise class
high-end server clients to rapidly deliver advanced networking and storage
products and services. The addition of the Antares product line in August 2003
enables us to introduce an impressive collection of WAN, LAN, SCSI, Fibre
Channel, and carrier cards across both the enterprise server and embedded
markets. Our products with Linux and Solaris drivers and software now include
wide area network ("WAN") and local area network ("LAN") interface adapters,
storage network interface cards ("NIC'S") products such as SCSI and Fibre
Channel and high performance intelligent communications controllers for high-end
enterprise level servers, workstations, media gateways, routers, internet access
devices, home location registers and data messaging applications. Our products
are distributed worldwide through a direct sales force, distributors,
independent manufacturers' representatives and value-added resellers.


-21-


With the addition of Antares, we now offer an increased portfolio of
field-tested products of Ethernet, SCSI, Fibre Channel, and specialty I/O
adapter cards for the Enterprise Sun and Linux markets. The Antares products
have been integrated into a variety of applications, including storage area
networks and mission-critical data centers. We continue to operate under a
single segment.

Our business is characterized by a concentration of sales to a small number of
OEMs and distributors who provide products and services to the datacom and
telecommunications markets in addition to the enterprise high-end server IT
markets. Consequently, the timing of significant orders from major customers and
their product cycles cause fluctuation in our operating results. The Hewlett
Packard Company ("HP") is the largest of our customers and represented 45%, 30%
and 34% of net sales in fiscal 2003, 2002 and 2001, respectively. If any of our
major customers reduces orders for our products, we could lose revenues and
suffer damage to our business reputation. Orders by our OEM customers are
affected by factors such as new product introductions, product life cycles,
inventory levels, manufacturing strategy, contract awards, competitive
conditions and general economic conditions.

We shipped $1.6 million of VME products to HP over the first two quarters of
fiscal 2003 pursuant to an end-of-life purchase order under a product supply
contract. After termination of the contract, we received additional orders for
$3.6 million of VME products. Of these new orders $1.6 million shipped in fiscal
2003 with the remaining $2.0 million in VME products to be shipped in the first
two fiscal quarters of fiscal 2004. We also signed a three year product support
agreement with HP with an annual fee of $135,000, effective May 1, 2003, which
stipulates that we will provide ongoing engineering and product warranty support
for the VME products sold under the HP product supply contract. We expect to
continue to sell our adapter products to HP.

During fiscal 2003, we introduced new WAN and LAN products and acquired the LAN
and Storage products of Antares that are targeted at large growing enterprise
markets such as VPN, security and other communications devices. Our HighWire
products have been focused primarily on the telecommunications market and the
communications activities that are driven by the convergence of traditional
telephony applications with the Internet. With the introduction of embedded
Linux operating system on the HighWire products, we are now able to market the
HighWire products to the military/government, medical and industrial control
application markets. We introduced our LAN Adapter products in January 2003 and
are beginning to penetrate the Gigabit Ethernet LAN market. While we believe the
market for our HighWire, Adapter and Storage NIC's product families is large,
there can be no assurance that we will be able to succeed in penetrating these
markets and diversifying our sales.

In the year ended October 31, 2003 we had nine new "design wins". Since the
fourth quarter of fiscal 2001 we have 22 new design wins and have added a
substantial number of new customers to our growing base of customers. A design
win is defined as a program with an OEM customer that will generate at least
$400,000 in recurring annual net sales typically within 12 to 18 months after
the customer accepts and confirms the use of our product in their platform. We
believe the combination of new customers and design wins will provide the basis
for future sales growth. A variety of risks such as schedule delays,
cancellations and changes in customer markets and economic conditions can
adversely affect a design win before or after production is reached. With the
current economic climate in the communications equipment marketplace, design
activity has slowed and reaching production volumes is proving to be elusive for
those products that have been designed. In these difficult economic times, poor
customer visibility is causing ordering delays. These factors often result in a
substantial portion of our net sales being derived from orders placed within the
quarter and shipped in the final month of the quarter.


-22-


We have taken aggressive steps to reduce overall operating costs over the past
two years, including reducing headcount, relocating our engineering and
headquarters facilities and closing our office in Madison, Wisconsin. We have
begun to see a slight recovery in our markets and customers have been increasing
their ordering levels. As a result we have begun to increase our headcount in
our engineering and production departments. We continue to focus on cost
containment and cash preservation and monitor our expense levels very closely.

On October 31, 2003, we had a sales backlog of product orders of approximately
$4.1 million compared to a sales backlog of product orders of approximately $2.2
million one year ago.

The market environment for our products is extremely competitive and we have
limited visibility into customer activity due to the downturn in the
communications equipment marketplace. In spite of this uncertain market, we have
been successful in selling and shipping our adapter and HighWire products to 46
new customers during fiscal 2003. One of our primary sales goals is to diversify
our customer base and at the same time provide sources of net sales to fill the
gap that will be left when HP makes its final end-of-life purchase of our VME
products.

On June 27, 2003, to fund the cash portion of the acquisition of certain assets
of Antares Microsystems, we completed a private placement of shares of our
common stock and a warrant to purchase common stock resulting in gross cash
proceeds of approximately $550,000, and on May 14, 2003, we renewed our $1.0
million line of credit from a bank for one year.

Critical Accounting Policies and Estimates

The preparation of consolidated financial statements in conformity with
generally accepted accounting principles in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Such estimates include levels
of reserves for doubtful accounts, obsolete inventory, warranty costs and
deferred tax assets. Actual results could differ from those estimates.

Our critical accounting policies and estimates include the following:

Revenue Recognition

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


-23-


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

- all prices are fixed and determinable at the time of sale;
- title and risk of loss pass at the time of shipment (FOB shipping
point);
- collectibility of the sales price is probable (the OEM is obligated
to pay and such obligation is not contingent on the ultimate sale of
the OEM's integrated solution);
- the OEM's obligation to us will not be changed in the event of theft
or physical destruction or damage of the product;
- we do not have significant obligations for future performance to
directly assist in the resale of the product by the OEMs; and
- there is no contractual right of return other than for defective
products.

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

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

During the year ended October 31, 2003, $191,000 or 0.3 % of our sales were sold
to distributors.

Allowance for Doubtful Accounts:

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


-24-


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

Warranty Reserves

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

Inventories

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

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

Acquisitions:

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


-25-


As a result of acquisitions, we incur at the time of acquisition expenses to
exit and consolidate activities at the acquired companies' locations, to
involuntarily terminate employees, and other costs. These acquisition expenses,
to the extent that they are not associated with the generation of future
revenues and have no future economic benefit were part of the purchase price.
Acquisition liabilities for the above items totaled $161,000 and were
substantially complete by October 31, 2003.

Deferred Taxes

We record a valuation allowance to reduce our deferred taxes to the amount that
is more likely than not to be realized. Based on the uncertainty of future
pre-tax income, we have fully reserved our deferred tax assets as of October 31,
2003. In the event we were to determine that we would be able to realize our
deferred tax assets in the future, an adjustment to the deferred tax asset would
increase income in the period such determination was made.

Results of Operations

The following table sets forth, as a percentage of net sales, certain
consolidated statements of operations data for the fiscal years ended October
31, 2003, 2002 and 2001. These operating results are not necessarily indicative
of our operating results for any future period.



Year Ended October 31,
----------------------------
2003 2002 2001
---- ---- ----

Net sales 100% 100% 100%
Cost of sales 37 46 63
--- --- ---
Gross profit 63 54 37
Operating expenses:
Product research and development 18 44 73
Sales and marketing 20 31 40
General and administrative 23 34 42
Loan reserve (benefit) (3) 7 --
Restructuring costs (benefit) (2) 6 12
--- --- ---
Total operating expenses 56 (122) (168)
--- --- ---
Operating income (loss) 7 (68) (131)
Forfeited deposit, net -- 39 --
Interest and other income -- 2 3
--- --- ---
Income (loss) before income taxes 7 (27) (128)
Income tax benefit -- 2 --
--- --- ---
Net income (loss) 7% (25)% (128)%
=== === ===



-26-


Net Sales

Net sales for fiscal 2003 were $7.5 million, an 8% increase from $6.9 million
for fiscal 2002. Net sales for fiscal 2002 were $6.9 million, an 11% decrease
from fiscal 2001. The increase in fiscal 2003 as compared to fiscal 2002 was
primarily attributable to an increase in sales to HP. Net sales to HP were $3.4
million in fiscal 2003 as compared to $2.1 million for fiscal 2002 and $2.6
million in fiscal 2001. Sales to HP, primarily of VMEBus products, represented
45% of net sales for fiscal 2003, compared to 30% during fiscal 2002 and 34% in
fiscal 2001. A substantial portion of such sales were attributable to sales of
VME products pursuant to a long-term supply agreement with HP that is no longer
in effect. We shipped $1.6 million of VME products to HP over the first two
quarters of fiscal 2003 pursuant to an end-of-life product discontinuation
purchase order under a product supply contract. After termination of the
contract, we received additional orders for $3.6 million of VME products, of
which $1.6 million was shipped in the second and third quarters of fiscal 2003
with the remaining $2.0 million to be shipped in the first two fiscal quarters
of fiscal 2004. No other customer represented more than 10% of our sales in
fiscal 2003. In the previous two years, Lockheed Martin was the only other
customer representing 10% or more of our sales, accounting for 11% of net sales
in fiscal 2002 and 20% in fiscal 2001. Antares product sales from acquisition
date, August 7, 2003 through October 31, 2003, were $459,000.

Sales of our adapter products were $2.6 million for fiscal 2003, as compared to
$2.1 million in fiscal 2002 and $2.0 million in fiscal 2001. Sales of our
HighWire products were $0.8 million in fiscal 2003, as compared to $1.0 million
in fiscal 2002 and $350,000 in fiscal 2001. Our adapter products are used
primarily in edge-of-the-network applications such as VPN and other routers,
Voice over Internet Protocol ("VoIP") gateways and security devices, whereas our
HighWire products are primarily targeted at core-of-the-network applications
used primarily by telecommunications central offices. In the future, we expect
our net sales to be generated predominantly by sales of our adapter products
with Linux and Solaris software, followed by the Antares storage products. We
expect to see a continued slowness in the sale of our Highwire products due to
the continued downturn in the communications equipment markets. All of our
design wins and new customer are for applications using these product families.
In addition, we will continue to sell and support our older VME products, but
expect them to become a declining portion of our future net sales.

Due to the continued adverse economic conditions in the communications equipment
industry, our customers have cancelled or delayed many of their new design
projects and new product rollouts that included our products. With the
acquisition of the Antares products, we have moved into the enterprise IT
market, selling storage and LAN adapter products directly to users through a
network of distributors. We anticipate that our net sales for fiscal 2004 will
increase when compared with fiscal 2003, as we expect our customers to deploy
existing inventory and return to new product design and product rollout. One of
our major challenges on a long term basis continues to be replacement of the net
sales of VME products previously provided by HP. HP (including its predecessors,
Tandem Computer and Compaq Computer), has accounted for a substantial portion of
our net sales for the past five years. The market environment for our customers'
activities continues to be uncertain. However, during fiscal 2003, we were
successful in selling and shipping our WAN, LAN and storage products to 46 new
customers in addition to extending our reach towards new customers by adding a
network of distributors and value-added resellers in the United States, Europe
and Asia. Many of these new customers are in the beginning stages of product
development, but with their addition we have increased our base of customers to
an all time high. In addition, since the fourth quarter of fiscal 2001, we have
added 22 new "design wins." We believe the combination of new customers and
design wins will provide future growth in net sales in the communications and
enterprise equipment marketplace.


-27-


Our sales backlog at October 31, 2003 was $4.1 million compared to $2.2 million
at October 31, 2002. While we anticipate an increase in our sales volume over
the course of fiscal 2004 as our customers deploy existing inventory and
gradually return to new product design and product rollout, there can be no
assurances that such increase will occur. Our customers typically operate on a
"just-in-time" ordering and delivery cycle where they will place a purchase
order with us after they receive an order from their customer. This
"just-in-time" inventory purchase cycle by our customers has made forecasting of
our future sales volumes very difficult. Because our sales are generally
concentrated with a small group of OEM customers, we could experience
significant fluctuations in our quarterly sales volumes due to fluctuating
demand from any major customer or delay in the rollout of any significant new
product by a major customer.

International sales constituted 12%, 13% and 9% of net sales in fiscal 2003,
2002 and 2001, respectively. International sales are executed in U.S. dollars
and are principally transacted in Europe.

Gross Profit

Gross profit as a percentage of net sales was 63%, 54% and 37% in fiscal 2003,
2002 and 2001, respectively. Gross profit in 2001 includes the effect of
inventory write-downs of $1.0 million. The increase in the gross profit from
fiscal 2001 to fiscal 2002 was primarily attributable to lower materials costs
combined with a more profitable product mix in fiscal 2002. Gross profit as a
percentage of sales increased in fiscal 2003 primarily as a result of sales of
$409,000 of inventory to HP that had been fully written down in fiscal 2002 when
HP placed its final order for end-of-life VME products under its then-existing
contract. Our gross profit would have been 58% after excluding the effect of the
HP inventory write-down. We expect our gross profit to range between 54% and 57%
for fiscal 2004 based on our current product sales prices and cost to
manufacturer those products. We expect our cost of goods to increase in 2004 due
to the addition of approximately $102,000 of non-cash quarterly amortization of
the intellectual property acquired in the Antares transaction. We will continue
to amortize this intellectual property at the rate of $102,000 per quarter for
the next 11 quarters. However, if market and economic conditions, particularly
in the telecommunications sector, deteriorate or fail to recover as expected,
gross profit as a percentage of net sales may decline from the current level.

Product Research and Development

Product research and development expenses were $1.3 million in fiscal 2003, $3.0
million in fiscal 2002, and $5.7 million in fiscal 2001, representing 18%, 44%
and 73% of net sales, respectively. The decrease in research and development
expense as a percentage of revenue from fiscal 2001 to fiscal 2002 and
subsequently to fiscal 2003 is the direct result of headcount reductions of
fifteen full-time equivalent personnel combined with other project-related cost
containment measures. During fiscal 2001, we emphasized completion of the
development programs for the HighWire product line and WAN product lines. During
fiscal 2002, we completed the HighWire product line, including the addition of
the embedded Linux operating system software, and we added several new products
to our WAN adapter line designed to expand and enhance the adapter product
lines' capabilities at a reduced cost point. We also began work on the new LAN
adapter Gigabit Ethernet product line that was released to production in January
2003. During fiscal 2003, we focused on continued development of the growing
line of standards-based LAN adapters, designing a custom LAN adapter that
combines Gigabit Ethernet and HyperTransport technology, enhancing functionality
on current WAN adapter products, and developing software drivers for our WAN and
LAN adapters. These hardware and software design efforts have enabled us to more
effectively target enterprise markets such as VoIP, VPN and security routers, as
well as expand market coverage within the telecommunications,
military/government, medical and industrial control markets. With the
acquisition of the Antares products in August 2003, we continued the development
of storage NIC's and the TOE products.


-28-


We expect overall spending for our product research and development to range
between 15% and 18% of net sales in fiscal 2004 as we remain committed to the
development and enhancement of new and existing products. We did not capitalize
any internal software development costs in fiscal 2003, 2002 or 2001.

Sales and Marketing

Sales and marketing expenses for fiscal 2003 were $1.5 million, a 31% decrease
over fiscal 2002. This decrease is primarily related to lower headcount in the
marketing department for the majority of the year declining from three people to
one person in addition to reductions in travel, sales commissions and product
marketing activities. Fiscal 2002 expense was $2.2 million, a 31% decrease over
fiscal 2001. Sales and marketing programs are focused on design wins with new
customers and, therefore, as new customer sales increase, sales and marketing
expenses will increase. New customers' product design sales cycles may span over
periods as long as twenty-four months. During the latter part of fiscal 2003, we
hired a Vice President of Marketing in addition to hiring a product manager and
technical support engineer in conjunction with the acquisition of the Antares
products. In addition, our quarterly sales and marketing expenses increased by
10% to 20% during the last quarter of fiscal 2003 as we began to renew our
product market efforts with trade magazine advertising and trade show
attendance. We expect our sales and marketing expenses to range between 16% and
18% of net sales in fiscal 2004 as we continue to accelerate our product
marketing efforts and attend an increasing number of industry specific trade
shows.

General and Administrative

General and administrative expenses for fiscal 2003 decreased to $1.8 million, a
26% decrease over fiscal 2002. The decrease was due to headcount from eight to
five individuals and expense containment measures, primarily rent, and
depreciation, put into place in the fourth quarter of fiscal 2002, with the cost
savings fully realized in fiscal 2003. Fiscal 2002 expenses decreased to $2.4
million from $3.3 million in fiscal 2001 or, 28%, as a result of headcount and
expense containment measures. We expect general and administrative expense for
fiscal 2004 to increase slightly from fiscal 2003 levels partly due to the
increase in insurance and other general operating expenses. General and
administrative expenses are expected to range between 14% and 18% of sales for
fiscal 2004.

Loan Reserve (Benefit)

On November 6, 1998, we made a loan to an officer and stockholder in the amount
of $622,800 pursuant to a two-year recourse promissory note bearing an interest
rate of 4.47% and secured by 145,313 shares of our common stock. The loan was
used to pay for the exercise of an option to purchase 139,400 shares of our
common stock and the related taxes. On April 16, 1999, the loan was increased to
$743,800. The loan was extended for one year under the same terms and conditions
as the original note on November 6, 2000. On December 14, 2001, the note was
amended, restated and consolidated to extend the term to December 2003 and to
require certain mandatory repayments of principal of up to $100,000 a year while
the note is outstanding. The loan bears interest at a rate of 2.48% per annum,
with interest due annually and the outstanding principal was due on December 14,
2003.


-29-


On October 31, 2002 we determined that it was probable that we would be unable
to fully recover the balance of the loan on its due date of December 14, 2003.
Accordingly, a valuation allowance of $474,000 was recorded generally based on
the fair value of the common stock securing the note as of October 31, 2002 and
the amount of the officer's personal assets considered likely to be available in
the future. During the fourth quarter of fiscal 2003, the officer sold 139,400
shares of our common stock and used the proceeds from the stock sale to repay a
portion of the loan. As a result of the fiscal 2003 payment, we recognized a
$235,000 benefit related to the reversal of the loan impairment charge taken by
us in fiscal 2002. Subsequent to fiscal 2003, the officer sold additional shares
of our common stock in November 2003 and used the proceeds to pay the remaining
loan balance in full. As a result, we expect to reflect a benefit of $239,000 in
our results of operations for the first quarter of fiscal 2004 resulting from
the reversal of the remaining loan impairment charge.

Restructuring Costs (Benefit)

In response to the economic slowdown, we implemented restructuring plans in
fiscal 2002 and 2001 and recorded restructuring charges of $446,000 and
$964,000, respectively. Restructuring costs for fiscal 2002 were comprised of
severance costs associated with staff reductions totaling $115,000, leasehold
improvements and equipment write-downs related to the abandonment of our
Madison, Wisconsin office of $185,000 and estimated losses related to future
rents, net of estimated future recoveries from potential sublease, of $146,000.
We reduced our headcount from 47 employees to 24 employees during fiscal 2002.

Restructuring costs for fiscal 2001 were comprised of severance costs associated
with staff reductions totaling $52,000, leasehold improvements and equipment
write-downs related to the relocation of our headquarters of $337,000 and losses
related to its sublease of $575,000, which is net of the reversal of a $281,000
liability associated with deferred rent. We reduced our headcount from 87
employees to 47 employees during fiscal 2001.

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

As of October 31, 2003 and 2002, $58,000 and $249,000 of the restructuring costs
were included in other current liabilities, respectively.

Interest and Other Income

Interest and other income in fiscal 2003 decreased slightly from 2002 due to
lower average cash balances in fiscal 2003 coupled with lower average interest
rates. Fiscal 2002 income decreased slightly from fiscal 2001 due to lower
average cash balances in fiscal 2001 coupled with lower average interest rates.
A refundable deposit associated with a multi-year supply agreement with HP of
$4.9 million was received in April 2001. This deposit was refundable as we
delivered certain quantities of products to HP over a four year period ending in
2005. The supply contact was restructured in fiscal 2002 to include a final
purchase order for $1.6 million of our products to be shipped to HP in the first
two quarters of fiscal 2003 and the forfeiture by HP of $4.4 million of the $4.9
million refundable deposit. Under the agreement, we are required to retain for
future production or repair all VCOM finished goods and spare parts inventory
through October 31, 2005 unless notified otherwise by HP. Concurrent with the
forfeiture of the $4.4 million refundable, we recorded a reserve of $1.7 million
related inventory we held at October 31, 2002 but may not be able to sell. The
$2.7 million of forfeiture of refundable deposit net of inventory reserve is
presented under Forfeited deposit, net on the fiscal 2002 Consolidated
Statements of Operations.


-30-


Income Taxes

On March 9, 2002, the President of the United States signed into law the Job
Creation and Workers Assistance Act of 2002, which extends the net operating
loss carryback from two to five years for losses generated in tax years ending
in 2001 and 2002. As a result, we recorded a benefit for income taxes of $22,000
in the second quarter of fiscal 2003 and a tax benefit of $91,000 in fiscal 2002
due to a refund of federal income taxes related to this Act. The net benefit
recorded for the 2003 and 2002 periods were $17,000 and $177,000, respectively.
In fiscal 2002 we also filed amended federal and state tax returns to claim
$86,000 in research and development credits related to LAN Media Corporation
("LMC"), a company we acquired in July 2000. We recorded tax provisions of
$1,000 in fiscal 2001. Our effective tax rate was 0%, (8)% and 0% in fiscal
2003, 2002 and 2001, respectively. We recorded a valuation allowance in fiscal
2003, 2002, and 2001 for deferred tax assets due to the uncertainty of
realization. In the event of future taxable income, our effective income tax
rate in future periods could be lower than the statutory rate as such tax assets
are realized.

Net Income (Loss)

As a result of the factors discussed above, we recorded net income of $563,000
in fiscal 2003 compared to a net loss of $1.7 million in fiscal 2002, and a net
loss of $9.9 million in fiscal 2001.

Contractual Obligations and Commercial Commitments

The following table sets forth a summary of our material contractual obligations
and commercial commitments as of October 31, 2003:



Payments due by period (Dollars in thousands)
-----------------------------------------------------------------
Less than 1-3 3-5 More than
Contractual Obligations Total 1 year Years Years 5 Years
- ----------------------- ----- ------ ----- ----- ---------

Building leases $1,027 $ 336 $ 692 $ -- $ --
Equipment leases 116 39 77 -- --
------ ------ ------ ------ ------
Total $1,143 $ 375 $ 769 $ -- $ --
====== ====== ====== ====== ======



-31-


Off-Balance Sheet Arrangements

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

Liquidity and Capital Resources

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

- actual versus anticipated sales of our products;
- our actual versus anticipated operating expenses and results of
ongoing cost control actions;
- the timing of product shipments, which occur primarily during the
last month of the quarter;
- our actual versus anticipated gross profit margin;
- our ability to raise additional capital, if necessary; and
- our ability to secure credit facilities, if necessary.

We had cash and cash equivalents of $1.4 million and $1.6 million on October 31,
2003 and October 31, 2002, respectively. In fiscal 2003, $84,000 of cash was
used by operating activities, primarily as a result of a reduction in
liabilities and other current assets coupled with an increase in our trade
accounts receivable. The decrease in other current liabilities was primarily the
result of the $447,000 payment to HP related to the long-term product supply
agreement cancellation. The decrease in inventory is reflective of our focus on
just-in-time inventory practices where we place orders with our contract
manufacturers as we receive purchase orders from our customers. The increase in
trade accounts receivable is due to an increase in sales during the fourth
quarter of fiscal 2003 as compared to the third fiscal quarter combined with the
fact that the majority of product shipments occurred in the last month of the
quarter. Working capital (current assets less current liabilities) at October
31, 2003 was $4.0 million, as compared to $3.0 million at October 31, 2002.

In fiscal 2003, we purchased $172,000 of fixed assets, consisting primarily of
computers and engineering equipment. Purchased software costs amounting to
$48,000 were capitalized in fiscal 2003. We expect to increase our levels of
capital expenditures in fiscal 2004 in order to purchase test and design
equipment upgrades.

We received $12,000 in fiscal 2003 from payments related to common stock
purchases made by employees pursuant to the employee stock purchase plan. On
June 27, 2003, we completed a private placement of 500,000 shares of common
stock at $1.10 per share, plus a warrant to purchase 50,000 shares of common
stock, resulting in gross cash proceeds of approximately $550,000 and net
proceeds after offering expenses of approximately $464,000. The proceeds from
this private placement were used to fund the acquisition of certain assets from
Antares discussed below.


-32-


On October 9, 2003 we received cash proceeds of $222,222 from Stonestreet L.P.
for the purchase of 111,111 shares of our Common Stock pursuant to a warrant
they received in conjunction with a private placement of common stock
transaction that was completed in fiscal 2002.

During the fourth quarter of fiscal 2003, an officer and shareholder sold
139,400 shares of our common stock and used the proceeds from the stock sale to
repay $362,800 of an outstanding $743,800 loan we made to the officer. In
November 2003, we received an additional loan payment of $142,000 from stock
that was sold prior to October 31, 2002. The officer sold an additional 43,100
shares of our common stock in November 2003 and used proceed totaling $381,000
to repay the remaining loan balance in full.

On August 7, 2003, we purchased substantially all of the assets of Antares
Microsystems, Inc., a California corporation ("Antares"), excluding cash and
accounts receivable, from the Assignee for the Benefit of Creditors of Antares
("Assignee") for a purchase price of $75,000 in cash plus $582,000 in costs
associated with the payment of certain loan guarantees, legal fees, accounting
fees, broker fees, contract transfer fees and moving expenses and $211,000 in
cash to the selling shareholders of Antares. We also issued 90,628 shares of our
common stock with a market value at the time of issuance of $259,000 to one of
the selling shareholders and committed to issue 98,945 shares of our common
stock, with a value of $283,000 at the time of the purchase of Antares was
completed, in 20,000 share increments beginning January 2004 and ending March
2005 to a selling shareholder of Antares.

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

On May 13, 2003, we renewed our working capital line of credit for twelve months
until May 14, 2004. The credit line is secured by a first lien on all our assets
and carries a floating annual interest rate equal to the bank's prime rate of
4.00%, at October 31, 2003, plus 1.50%. Draw-downs on the credit line are based
on a formula equal to 80% of our domestic accounts receivable. As of October 31,
2003, we are in compliance with all the covenants of our credit line and have
not drawn down on this line of credit.

Our future commitments consist principally of future minimum lease payments
related to our office facilities. Minimum lease payments are as follows: fiscal
2004: $1.0 million; 2005: $1.0 million; and 2006: $0.7 million. Related minimum
reimbursement from sublease payments are as follows: fiscal 2004: $0.6 million;
2005: $0.6 million; and 2006: $0.3 million.

We realized significant reductions in our operating expenses due to management's
implementation of a program of controlled spending and headcount reduction
initially instituted in mid-fiscal 2001 and continued into fiscal 2002 with
additional headcount and cost reductions. With these reductions and the addition
of the ongoing operational costs associated with the purchase of the Antares
assets, our future quarterly operational cash flow breakeven point is expected
to be $2.2 million to $2.4 million in net sales at an expected 55% gross margin.
We believe the cost reduction and a projected increase in sales during fiscal
2004 will generate sufficient cash flows to fund our operations through October
31, 2004 and beyond. However, our projected sales are to a limited number of new
and existing OEM customers and are based on internal and customer provided
estimates of future demand, not firm customer orders. If the projected sales do
not materialize, we will need to reduce expenses further and raise additional
capital through customer prepayments or the issuance of debt or equity
securities. If additional funds are raised through the issuance of preferred
stock or debt, these securities could have rights, privileges or preferences
senior to those of our common stock, and debt covenants could impose
restrictions on our operations. The sale of equity or debt could result in
additional dilution to current stockholders, and such financing may not be
available to us on acceptable terms, if at all.


-33-


ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our cash and cash equivalents are subject to interest rate risk. We invest
primarily on a short-term basis. Our financial instrument holdings at October
31, 2003 were analyzed to determine their sensitivity to interest rate changes.
The fair values of these instruments were determined by net present values. In
our sensitivity analysis, the same change in interest rate was used for all
maturities and all other factors were held constant. If interest rates increased
by 10%, the expected effect on net income (loss) related to our financial
instruments would be immaterial. We hold no assets or liabilities denominated in
a foreign currency.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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

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

None.

ITEM 9A. CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures

An evaluation as of October 31, 2003 was carried out under the supervision
of and with the participation of the Company's management, including the
Company's Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of the Company's "disclosure controls
and procedures," which are defined under SEC rules as controls and other
procedures of a company that are designed to ensure that information required to
be disclosed by a company in the reports that it files under the Securities
Exchange Act of 1934 (the "Exchange Act") is recorded, processed, summarized and
reported within required time periods. Based upon that evaluation, the Company's
Chief Executive Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures were effective.


-34-


(b) Changes in Internal Controls over Financial Reporting

The Company's management, including the Company's Chief Executive Officer
and Chief Financial Officer, has evaluated any changes in the company's internal
control over financial reporting that occurred during the quarter ended October
31, 2003, and has concluded that there was no change during such quarter that
has materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.


-35-


PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Identification of Directors; Audit Committee Financial Expert; Section 16(a)
Beneficial Ownership Reporting Compliance; Code of Ethics The information
required by Item 10 concerning our executive officers is set forth in the
section entitled "Identification of Executive Officers" appearing in Part I of
this annual report. The information required by Item 10 concerning our directors
is incorporated by reference from the information in the section entitled
"Election of Directors" appearing in our definitive Proxy Statement to be filed
with the Securities and Exchange Commission for the Annual Meeting of
Stockholders scheduled for March 16, 2004 (the "2004 Proxy Statement"). The
information required by Item 10 concerning the compliance of certain persons
with the beneficial ownership reporting requirements of Section 16(a) of the Act
is incorporated by reference from the information in the section entitled
"Compliance with Section 16(a) of the Securities and Exchange Act of 1934"
appearing in the 2004 Proxy Statement. The information required by Item 10
concerning the disclosure of the existence of an audit committee financial
expert sitting on the Audit Committee is incorporated by reference from the
information in the section entitled "Audit Committee Financial Expert" appearing
in the 2004 Proxy Statement. The information required by Item 10 concerning the
adoption of a code of ethics is incorporated by reference from the information
in the section entitled "Code of Ethics" appearing in the 2004 Proxy Statement.

ITEM 11. EXECUTIVE COMPENSATION

The information required by Item 11 is incorporated by reference from the
information in the section entitled "Executive Compensation" appearing in the
2004 Proxy Statement.

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

The information required by Item 12 is found under the heading "Equity
Compensation Plan Information" in Item 5 of this report and otherwise is
incorporated by reference from the information in the section entitled "Security
Ownership of Certain Beneficial Owners and Management" appearing in the 2004
Proxy Statement.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by Item 13 is incorporated by reference from the
information in the sections entitled "Certain Transactions" and "Executive
Compensation" appearing in the 2004 Proxy Statement.


-36-



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

The following documents are filed as part of this Report:

(a)(1) Financial Statements

Page
----

Report of Independent Accountants 43

Report of Independent Accountants 44

Consolidated Balance Sheets at October 31, 2003 and 2002 45

Consolidated Statements of Operations for fiscal years 2003, 2002
and 2001 46

Consolidated Statements of Stockholders' Equity for fiscal years 2003,
2002 and 2001 47

Consolidated Statements of Cash Flows for fiscal years 2003, 2002
and 2001 48

Notes to Consolidated Financial Statements 49

(a)(2) Financial Statement Schedule

Schedule II-- Valuation and Qualifying Accounts 70

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

(a)(3) List of Exhibits

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

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

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

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

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


-37-


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

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

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

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

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

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

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

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

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

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

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

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

23.1 Consent of BDO Seidman LLP, Independent Accountants

23.2 Consent of PricewaterhouseCoopers LLP, Independent Accountants

31.1 Certification of Chief Executive Officer

31.2 Certification of Chief Financial Officer

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

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

-38-


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

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

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

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

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

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

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

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

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

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

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


-39-



(b) Reports on Form 8-K

On August 14, 2003, we filed a Form 8-K to report our earnings for the three and
nine months ended July 31, 2003.

On August 14, 2003, we filed a Form 8-K to report that effective as of August 7,
2003, we purchased substantially all of the assets of Antares Microsystems,
Inc., a California corporation ("Antares"), excluding cash and accounts
receivables, from D.R. Barthol & Company ("Barthol") as Assignee for the Benefit
of Creditors of Antares for a purchase price of $75,000 in cash plus other cash
payments of $598,000 and non-cash consideration of $542,000.

The amount of consideration we paid in connection with the asset acquisition was
determined by arms length negotiation among the parties. The purchase price for
the assets was funded by SBE from working capital. There was no material
relationship between Barthol or Antares and us or any of our affiliates, any of
our directors or officers, or any associate of any such director or officer.

Antares had used the assets acquired to develop, market and sell Ethernet and
SCSI products. We will continue to use the assets acquired for these or similar
purposes.

(c) Exhibits Required by Item 601

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

(d) Financial Statements

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


-40-


SIGNATURES

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


SBE, Inc.


Date: January 23, 2004 By: /s/ William B. Heye, Jr.
-------------------------------------
William B. Heye, Jr.
Chief Executive Officer and President
(Principal Executive Officer)


Date: January 23, 2004 By: /s/ David W. Brunton
-------------------------------------
David W. Brunton
Chief Financial Officer,
Vice President, Finance and Secretary
(Principal Financial and Accounting
Officer)


POWER OF ATTORNEY

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

Pursuant to the requirements for the Securities Exchange Act of 1934,
this report has been signed by the following persons in the capacities
indicated, as of January 23, 2004.


-41-


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

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


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


/s/ Raimon L. Conlisk Director, Chairman of the Board
- ---------------------------------
Raimon L. Conlisk


/s/ Randall L-W. Caudill Director
- ---------------------------------
Randall L-W. Caudill


/s/ Ronald J. Ritchie Director
- ---------------------------------
Ronald J. Ritchie


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


-42-


Report of Independent Certified Public Accountants

Board of Directors
SBE, Inc.
San Ramon, California

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

We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of SBE, Inc. as of
October 31, 2003, and the results of its operations and its cash flows for the
year then ended in conformity with accounting principles generally accepted in
the United States of America.

Also, in our opinion, the schedules present fairly, in all material respects,
the information as set forth therein.


/s/ BDO Seidman, LLP

December 8, 2003
San Francisco, California


-43-


Report of Independent Accountants

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

In our opinion, the consolidated balance sheet as of October 31, 2002 and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the two years in the period ended October 31, 2002 (appearing
on pages 45 through 48 of the SBE, Inc. Annual Report on Form 10-K) present
fairly, in all material respects, the financial position, results of operations
and cash flows of SBE, Inc. and its subsidiaries at October 31, 2002 and for
each of the two years in the period ended October 31, 2002, in conformity with
accounting principles generally accepted in the United States of America. In
addition, in our opinion, the financial statement schedule listed in the index
appearing under Item 15(a)(2) on page 37 presents fairly, in all material
respects, the information relating to the years ended October 31, 2001 and 2002
set forth therein when read in conjunction with the related consolidated
financial statements. These financial statements and financial statement
schedule are the responsibility of the Company's management; our responsibility
is to express an opinion on these financial statements and financial statement
schedule based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

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


/s/ PricewaterhouseCoopers LLP

San Francisco, California
January 13, 2003


-44-


SBE, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)



October 31 2003 2002
- ------------------------------------------------------------------------------------------------------------------

ASSETS

Current assets:
Cash and cash equivalents $ 1,378 $ 1,582
Trade accounts receivable, net of allowance for
doubtful accounts of $90 and $93 as of October 31, 2003
2002, respectively 1,818 888
Inventories 1,880 1,910
Other 240 220
-------- --------
Total current assets 5,316 4,600
======== ========

Property and equipment, net 389 533
Capitalized software costs, net 120 110
Intellectual property, net 1,122 --
Other 28 78
-------- --------

Total assets $ 6,975 $ 5,321
======== ========

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Trade accounts payable $ 696 $ 488
Accrued payroll and employee benefits 184 159
Current portion of refundable deposit -- 447
Other 491 521
-------- --------
Total current liabilities 1,371 1,615

Other long term liabilities 217 10
-------- --------

Total liabilities 1,588 1,625
-------- --------

Commitments (Notes 7 and 8)

Stockholders' equity:
Convertible preferred stock:
($0.001 par value) authorized 2,000,000 shares; none
outstanding at October 31, 2003 and 2002 -- --
Common stock and additional paid-in capital
($0.001 par value); authorized 10,000,000 shares; issued 4,808,650 and
4,137,612 shares at October 31, 2003 and 2002, respectively (including
treasury shares: 79,500 at October 31, 2002) 15,302 14,711
Note receivable from stockholder (142) (270)
Treasury stock -- (409)
Retained deficit (9,773) (10,336)
-------- --------

Total stockholders' equity 5,387 3,696
-------- --------

Total liabilities and stockholders' equity $ 6,975 $ 5,321
======== ========


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

-45-



SBE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except for per share amounts)



For the years ended October 31 2003 2002 2001
- -------------------------------------------------------------------------------------------

Net sales $ 7,456 $ 6,898 $ 7,726
Cost of sales 2,749 3,170 4,860
-------- -------- --------

Gross profit 4,707 3,728 2,866
-------- -------- --------

Product research and development 1,330 3,027 5,652
Sales and marketing 1,484 2,151 3,105
General and administrative 1,752 2,364 3,265
Shareholder note valuation (benefit) (235) 474 --
Restructuring costs (benefit) (154) 446 964
-------- -------- --------

Total operating expenses 4,177 8,462 12,986
-------- -------- --------

Operating income (loss) 530 (4,734) (10,120)

Interest income 26 51 225
Forfeited deposit, net -- 2,712 --
Other income (expense) (10) 63 --
-------- -------- --------

Income (loss) before income taxes 546 (1,908) (9,895)

Benefit (provision) for income taxes 17 177 (1)
-------- -------- --------

Net income (loss) $ 563 $ (1,731) $ (9,896)
======== ======== ========


Basic earnings (loss) per common share $ 0.13 $ (0.46) $ (2.92)
======== ======== ========

Diluted earnings (loss) per common share $ 0.12 $ (0.46) $ (2.92)
======== ======== ========

Basic - Shares used in per share
computations 4,259 3,759 3,390
======== ======== ========

Diluted - Shares used in per share
computations 4,709 3,759 3,390
======== ======== ========


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

-46-


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



Convertible Common Stock and
Preferred Stock Additional Paid-in Capital
Shares Amount Shares Amount
--------- --------- --------- ---------

Balance, October 31, 2000 -- $ -- 3,389,336 $ 13,855
Stock issued in connection with stock option plans -- -- 99,054 51
Stock issued in connection with stock purchase plan -- -- 32,645 109
Forfeiture of unvested stock options -- -- -- (138)
Amortization of deferred stock compensation -- -- -- --
Net loss -- -- -- --
--------- --------- --------- ---------
Balance, October 31, 2001 -- -- 3,521,035 13,877
Stock issued in connection with stock purchase plan -- -- 47,596 31
Stock and warrant issued in connection with private placement -- -- 555,556 782
Stock issued to Directors in lieu of cash payments -- -- 13,425 21
Valuation allowance on note receivable from officer -- -- -- --
Net loss -- -- -- --
--------- --------- --------- ---------
Balance, October 31, 2002 -- -- 4,137,612 14,711
--------- --------- --------- ---------
Stock issued in connection with stock purchase plan -- -- 11,012 12
Stock and warrant issued in connection with private placement -- -- 500,000 464
Stock issued to Directors in lieu of cash payments -- -- 37,787 43
Stock issued in connection with the acquisition of Antares 90,628 259
Stock issued in connection with warrant exercise 111,111 222
Retirement of treasury stock (79,500) (409)
Reversal of valuation allowance on note receivable from officer -- -- -- --
Net income -- -- -- --
--------- --------- --------- ---------
Balance, October 31, 2003 -- $ -- 4,808,650 $ 15,302
========= ========= ========= =========




Note
Receivable Deferred
from Treasury Stock Stock-Based
Stockholder Shares Amount Compensation
----------- -------- -------- ------------

Balance, October 31, 2000 $ (744) 79,500 $ (409) $ (164)
Stock issued in connection with stock option plans -- -- -- --
Stock issued in connection with stock purchase plan -- -- -- --
Forfeiture of unvested stock options -- -- -- 138
Amortization of deferred stock compensation -- -- -- 26
Net loss -- -- -- --
-------- -------- -------- --------
Balance, October 31, 2001 (744) 79,500 (409) --
Stock issued in connection with stock purchase plan -- -- -- --
Stock and warrant issued in connection with private placement -- -- -- --
Stock issued to Directors in lieu of cash payments -- -- -- --
Valuation allowance on note receivable from officer 474 -- -- --
Net loss -- -- -- --
-------- -------- -------- --------
Balance, October 31, 2002 (270) 79,500 (409) --
-------- -------- -------- --------
Stock issued in connection with stock purchase plan -- -- -- --
Stock and warrant issued in connection with private placement -- -- -- --
Stock issued to Directors in lieu of cash payments -- -- -- --
Stock issued in connection with the acquisition of Antares
Stock issued in connection with warrant exercise
Retirement of treasury stock (79,500) 409
Reversal of valuation allowance on note receivable from officer 128 -- -- --
Net income -- -- -- --
-------- -------- -------- --------
Balance, October 31, 2003 $ (142) -- $ -- $ --
======== ======== ======== ========




Retained
Earnings
(Accumulated
deficit) Total
-------- --------

Balance, October 31, 2000 $ 1,291 $ 13,829
Stock issued in connection with stock option plans -- 51
Stock issued in connection with stock purchase plan -- 109
Forfeiture of unvested stock options -- --
Amortization of deferred stock compensation -- 26
Net loss (9,896) (9,896)
-------- --------
Balance, October 31, 2001 (8,605) 4,119
Stock issued in connection with stock purchase plan -- 31
Stock and warrant issued in connection with private placement -- 782
Stock issued to Directors in lieu of cash payments -- 21
Valuation allowance on note receivable from officer -- 474
Net loss (1,731) (1,731)
-------- --------
Balance, October 31, 2002 (10,336) 3,696
-------- --------
Stock issued in connection with stock purchase plan -- 12
Stock and warrant issued in connection with private placement -- 464
Stock issued to Directors in lieu of cash payments -- 43
Stock issued in connection with the acquisition of Antares 259
Stock issued in connection with warrant exercise 222
Retirement of treasury stock --
Reversal of valuation allowance on note receivable from officer -- 128
Net income 563 563
-------- --------
Balance, October 31, 2003 $ (9,773) $ 5,387
======== ========


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

-47-


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



For the years ended October 31 2003 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------

Cash flows from operating activities:
Net income (loss) $ 563 $(1,731) $(9,896)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 443 730 1,077
Non-cash restructuring (benefit) (154) 185 337
Stock-based compensation expense 21 26 43
Non-cash valuation allowance (recovery) on loan from officer (142) 474 --
Effect of re-measured warrant -- (83) --
Loss on sale of assets 13 19 5
Changes in operating assets and liabilities:
Trade accounts receivable (930) (128) 3,536
Inventories 30 2,518 490
Other assets 30 238 (70)
Trade accounts payable 208 (57) (549)
Other current liabilities (184) (29) (1,060)
Non-current liabilities (4) (4,860) 4,582
------- ------- -------

Net cash used in operating activities (84) (2,703) (1,522)
------- ------- -------

Cash flows from investing activities:
Purchases of property and equipment (172) (149) (299)
Cash payments related to purchase of Antares assets and related costs (868) -- --
Proceeds from sale of assets -- -- 4
Capitalized software costs (48) (105) (10)
------- ------- -------

Net cash used in investing activities (1,088) (254) (305)
------- ------- -------

Cash flows from financing activities:
Proceeds from stock plans 12 31 160
Proceeds from issuance of common stock and warrants 686 864 --
Proceeds from repayment of shareholder note 270 -- --
------- ------- -------

Net cash provided by financing activities 968 895 160
------- ------- -------

Net decrease in cash and cash equivalents (204) (2,062) (1,667)

Cash and cash equivalents at beginning of year 1,582 3,644 5,311
------- ------- -------
Cash and cash equivalents at end of year $ 1,378 $ 1,582 $ 3,644
======= ======= =======

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest $ -- $ -- $ --
======= ======= =======

Income taxes $ 1 $ 1 $ 1
======= ======= =======

SUPPLEMENTAL SCHEDULE OF NON CASH INVESTING AND FINANCING ACTIVITIES

Non-cash stock portion of Antares purchase price $ 542 $ -- $ --
======= ======= =======


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


-48-


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The Company and Basis of Presentation:

SBE, Inc. architects and provides network communications solutions for original
equipment manufacturers ("OEM") in both the embedded and enterprise-level
information technology ("IT") computing markets. Our solutions enable both data
communications and telecommunications companies in addition to enterprise class
high-end server clients to rapidly deliver advanced networking and storage
products and services. The addition of the Antares product line in August 2003
enables us to introduce a collection of WAN, LAN, SCSI, Fibre Channel, and
carrier cards across both the enterprise server and embedded markets. Our
products with Linux and Solaris drivers and software now include wide area
network ("WAN") and local area network ("LAN") interface adapters, storage
products such as SCSI and Fibre Channel and high performance intelligent
communications controllers for high-end enterprise level servers, workstations,
media gateways, routers, internet access devices, home location registers and
data messaging applications. Our products are distributed worldwide through a
direct sales force, stocking distributors, independent manufacturers'
representatives and value-added resellers. Our business falls primarily within
one industry segment.

Liquidity

Fiscal 2003:

We had net income of $563,000 in fiscal 2003 and negative cash flows from
operations of $84,000. We believe the combination of cost reductions and a
projected increase in sales during fiscal 2004 will continue to generate net
income and sufficient cash flows to fund our operations.

Fiscal 2002 and 2001:

The consolidated financial statements contemplate the realization of assets and
the satisfaction of liabilities in the normal course of business. We incurred
net losses of $1.7 million and $9.9 million for the years ended October 31, 2002
and 2001, respectively, and generated negative cash flows from operations of
$2.7 million and $1.5 million in these years. Our plans with respect to this
matter included the restructuring executed in the fourth quarter of fiscal 2002,
which reduced headcount from 47 employees to 24 employees and has reduced our
cost structure going forward. We believe the cost reduction and a projected
increase in sales during fiscal 2003 will generate sufficient cash flows to fund
our operations through October 31, 2003. However, these projected sales are to a
limited number of new and existing OEM customers and are based on internal and
customer provided estimates of future demand, not firm customer orders. If the
projected sales do not materialize, we will need to reduce expenses further and
raise additional capital through customer prepayments or the issuance of debt or
equity securities. If additional funds are raised through the issuance of
preferred stock or debt, these securities could have rights, privileges or
preferences senior to those of Common Stock, and debt covenants could impose
restrictions on our operations. The sale of equity or debt could result in
additional dilution to current stockholders, and such financing may not be
available to us on acceptable terms, if at all. The consolidated financial
statements do not include any adjustments relating to the recoverability and
classification of recorded assets or the amount or classification of liabilities
or any other adjustments that might be necessary should we be unable to continue
as a going concern.


-49-


Principles of Consolidation:

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

Use of Estimates:

The preparation of consolidated financial statements in conformity with
generally accepted accounting principles in the United States of America
requires us to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Such estimates include levels of reserves
for doubtful accounts, obsolete inventory, warranty costs and deferred tax
assets. Actual results could differ from those estimates.

Fair Value of Financial Instruments:

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

Cash and Cash Equivalents:

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

Inventories:

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

-50-


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

Property and Equipment:

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

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

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

During the year ended October 31, 2001, we committed to relocating our
engineering and administrative headquarters located in San Ramon, California and
as a consequence wrote off $337,000 in leasehold improvements and property and
equipment associated with the former headquarters location. During the year
ended October 31, 2002, we abandoned and closed our research facility located in
Madison, Wisconsin, and as a consequence wrote off $185,000 in leasehold
improvements and property and equipment associated with this location. These
write offs are included in restructuring costs in their respective fiscal years.

Intangible Assets:

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

As required by these rules, we will perform an impairment review annually, or
earlier if indicators of potential impairment exist. This annual impairment
review was completed during the fourth quarter of fiscal year 2003, and no
impairment was found. The impairment review is based on a discounted cash flow
approach that uses estimates of future market share and revenues and costs for
our segments as well as appropriate discount rates. The estimates used are
consistent with the plans and estimates that we use to manage the underlying
business. However, if we fail to deliver new products, if the products fail to
gain expected market acceptance, or if market conditions are unfavorable,
revenue and cost forecasts may not be achieved, and we may incur charges for
impairment of goodwill.


-51-


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

Intellectual property costs consist of the allocation of costs associated with
the purchase of current and the design of future products from Antares
Microsystems on August 7, 2003. All capitalized intellectual property is
amortized to expense over thirty-six months which is the expected useful life.
The amortization expense in fiscal 2003 was approximately $102,000.

Acquisitions:

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

As a result of acquisitions, we incur at the time of acquisition expenses for
the incremental costs to exit and consolidate activities at the acquired
companies' locations, to involuntarily terminate employees, and other costs.
These acquisition expenses, to the extent that they are not associated with the
generation of future revenues and have no future economic benefit were part of
the purchase price. Acquisition liabilities for the above items totaled $161,000
and were substantially complete by October 31, 2003.

Revenue Recognition:

Our policy is to recognize revenue for product sales when title transfer and
risk of loss has passed to the customer, which is generally upon shipment of our
products to our customers. We defer and recognize service revenue over the
contractual period or as services are rendered. We estimate expected sales
returns and record the amount as a reduction of revenue at the time of shipment.
Our policies comply with the guidance provided by Staff Accounting Bulletin No.
104, "Revenue Recognition in Financial Statements", issued by the Securities and
Exchange Commission. Judgments are required in evaluating the credit worthiness
of our customers. Credit is not extended to customers and revenue is not
recognized until we have determined that the collectibility is reasonably
assured. Our sales transactions are determined in U.S. dollars.

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


-52-


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

During the year ended October 31, 2003, $191,000 or 0.3 % of our sales were to
distributors.

Product Warranty:

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

Allowance for Doubtful Accounts:

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

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

Product Research and Development Expenditures:

Product research and development ("R&D") expenditures, other than certain
software development costs, are charged to expense as incurred. Contractual
reimbursements for R&D expenditures under joint R&D contracts with customers are
accounted for as a reduction of related expenses as incurred. For the years
ended October 31, 2003, 2002 and 2001, direct costs incurred under R&D contracts
were $109,000, $7,900 and $7,000, respectively, and reimbursements earned were
$109,000, $7,900 and $22,913 , respectively.


-53-


Capitalized software costs consist of costs to purchase software and costs to
internally develop software. Capitalization of software costs begins upon the
establishment of technological feasibility. All capitalized software costs are
amortized as related sales are recorded on a per-unit basis with a minimum
amortization to cost of goods sold based on a straight-line method over a
two-year estimated useful life. We evaluate the estimated net realizable value
of each software product and record provisions to the asset value of each
product for which the net book value is in excess of the net realizable value.
No internal software development costs were capitalized in the years ended
October 31, 2003, 2002 and 2001.

Refundable Deposit:

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

Stock-based Compensation:

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

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


-54-





For the Year Ended October 31,
----------------------------------------------
2003 2002 2001
---------- ---------- ----------

Net income (loss) - as reported ......... $ 563 $ (1,731) $ (9,896)
Stock based employee compensation
(recovery)/expense included in reported
net loss, net of related tax effects .. -- -- --
Less total stock based employee
compensation expense determined
under fair value based method for
all awards, net of related tax
effects ............................... (231) (721) (1,935)
---------- ---------- ----------

Pro forma net loss ...................... $ (332) $ (2,452) $ (11,831)
========== ========== ==========

Income (loss) per share:
Basic - as reported ..................... $ 0.13 $ (0.46) $ (2.92)

Basic - pro forma ....................... $ 0.08 $ (0.65) $ (3.49)

Diluted - as reported ................... $ 0.12 $ (0.46) $ (2.92)

Diluted - pro forma ..................... $ 0.07 $ (0.65) $ (3.49)


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



Options granted in years ended October 31 2003 2002 2001
- -------------------------------------------------------------------------------------

Expected life (in years) 5.00 5.00 5.00
Risk-free interest rate 2.00% 2.00% 6.00%
Volatility 126.00% 148.00% 114.00%
Dividend yield 0.00% 0.00% 0.00%


The weighted average fair value of options granted during 2003, 2002, and 2001
was $1.79, $0.92 and $1.78 per option, respectively.

Advertising Costs:

Advertising expenditures are expensed as incurred. Advertising costs were
$79,000 in fiscal 2003 and $37,000 in fiscal 2002.

Income Taxes:

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


-55-


Net Earnings Per Common Share:

Basic earnings per common share is computed by dividing net income (loss) by the
weighted average number of shares of common stock outstanding. Diluted earnings
per common share is computed by dividing net income (loss) by the weighted
average number of shares of common stock and common stock equivalents
outstanding. Common stock equivalents relate to stock options and warrants
include 450,000 shares of common stock and warrants for the year ended October
31, 2003. Common stock equivalents are excluded from the diluted earnings per
share calculation for fiscal 2002 and 2001 due to their anti-dilutive effect.

Comprehensive Income:

Comprehensive income is defined as the change in equity of a business enterprise
during a period from transactions and other events and circumstances from
non-owner sources. Through October 31, 2003, we have not had any transactions
that were required to be reported in other comprehensive income and,
accordingly, comprehensive income (loss) is the same as net income (loss).

Recent Accounting Pronouncements:

In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit or Disposal
Activities". SFAS No. 146 addresses significant issues regarding the
recognition, measurement and reporting of costs that are associated with exit
and disposal activities, including restructuring activities that are currently
accounted for under EITF No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)". The scope of SFAS No. 146 also includes
costs related to terminating a contract that is not a capital lease and
termination benefits that employees who are involuntarily terminated receive
under the terms of a one-time benefit arrangement that is not an ongoing benefit
arrangement or an individual deferred-compensation contract. SFAS No. 146 will
be effective for exit or disposal activities that are initiated after December
31, 2002. We adopted SFAS No. 146 for exit or disposal activities that were
initiated after December 31, 2002. The adoption of SFAS No. 146 will change, on
a prospective basis, the timing of when restructuring charges are recorded from
a commitment date approach to when the liability is incurred.

In January 2003, the FASB issued Interpretation No. 46, "Consolidation Of
Variable Interest Entities". This Interpretation requires that if a business
enterprise has a controlling financial interest in a variable interest entity,
the assets, liabilities, and results of activities of the variable interest
entity should be included in the consolidated financial statements of the
business enterprise. This Interpretation is effective immediately for all new
variable interest entities created or acquired after January 31, 2003. For
variable interest entities created or acquired prior to February 1, 2003, the
provisions of this Interpretation must be applied for the first interim or
annual period beginning after June 15, 2003. We currently do not have any
financial interest in variable interest entities. The adoption of this
Interpretation did not have a material impact on our consolidated financial
statements.


-56-


Effective prospectively for arrangements entered into in fiscal periods
beginning after June 15, 2003, EITF Issue 00-21, "Revenue Arrangements with
Multiple Deliverables," addresses the accounting by a vendor for contractual
arrangements in which multiple revenue-generating activities will be performed
by the vendor. In some situations, the different revenue-generating activities
(deliverables) are sufficiently separable and there exists sufficient evidence
of fair values to account separately for the different deliverables (that is,
there are separate units of accounting). In other situations, some or all of the
different deliverables are interrelated closely or there is not sufficient
evidence of fair value to account separately for the different deliverables.
EITF Issue 00-21 addresses when and, if so, how an arrangement involving
multiple deliverables should be divided into separate units of accounting. The
adoption of this Interpretation did not have a material impact on our
consolidated financial statements.

In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities." This statement will be effective in fiscal 2004 for
contracts entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003. Since we do not use derivative
instruments or engage in hedging activities, the adoption of this statement is
not expected to have a material impact on our consolidated financial statements.

In May 2003, the Financial Accounting Standards Board issued SFAS No. 150,
"Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity," which establishes standards for how an issuer
classifies and measures certain financial instruments with characteristics of
both liabilities and equity. Financial instruments that are within the scope of
the statement, which previously were often classified as equity, must now be
classified as liabilities. This statement is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise shall be effective at
the beginning of the first interim period beginning after June 15, 2003. We do
not expect the adoption of this statement to have a material impact on our
financial statements.


Reclassifications:

Certain reclassifications have been made to the 2002 and 2001 financial
statements to conform to the 2003 presentation with no effect on net income
(loss) or stockholders' equity as previously reported.

2. INVENTORIES

Inventories at October 31, 2003 and 2002 comprise the following (in thousands):

2003 2002
- ------------------------------------------------------------------------
Finished goods $ 726 $ 985
Parts and materials 1,154 925
------ ------

Total inventory $1,880 $1,910
====== ======


-57-


3. PROPERTY AND EQUIPMENT

Property and equipment at October 31, 2003 and 2002 are comprised of the
following (in thousands):

2003 2002
- ------------------------------------------------------------------------
Machinery and equipment $ 4,482 $ 4,948
Furniture and fixtures 278 236
Leasehold improvements 118 290
------- -------
4,878 5,474
Less accumulated depreciation
and amortization (4,489) (4,941)
------- -------

$ 389 $ 533
======= =======

Depreciation and amortization expense totaled $303,000, $649,000 and $860,000
for the years ended October 31, 2003, 2002 and 2001, respectively.

4. CAPITALIZED SOFTWARE COSTS

Capitalized software costs at October 31, 2003 and 2002 comprise the following
(in thousands):

2003 2002
- -----------------------------------------------------------------------
Purchased software $ 929 $ 81
Internally developed software 805 805
------- -------
1,734 1,686

Less accumulated amortization (1,614) (1,576)
------- -------
$ 120 $ 110
======= =======

We capitalized $48,000, $105,000 and $10,000 of purchased software costs in
2003, 2002, and 2001 respectively. Amortization of capitalized software costs
totaled $38,000, $81,000, and $217,000 for the years ended October 31, 2003,
2002, and 2001, respectively.

5. STOCKHOLDERS' EQUITY

On December 15, 1997, we reincorporated in the state of Delaware. In connection
with this event, we increased the number of authorized shares of preferred stock
to 2,000,000 shares, and established a par value of $0.001 per share for both
our common and preferred stock.

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


-58-


We acquired LMC on July 14, 2000. As consideration for all outstanding shares of
LMC, we issued 316,101 shares of our Common Stock. In addition, we assumed all
outstanding options held by LMC option holders.

On April 30, 2002, we completed a private placement of 555,556 shares of Common
Stock at $1.80 per share plus a warrant to purchase 111,111 shares of common
stock, resulting in gross cash proceeds of approximately $1.0 million. The
warrant has a term of three years and is exercisable at $2.00 per share. The
equity investment was made by Stonestreet L.P., of Ontario, Canada. The shares
of Common Stock and the shares of Common Stock associated with the Stonestreet
LP warrants were registered with the Securities and Exchange Commission and the
registration statement was declared effective on June 14, 2002. Stonestreet L.P.
exercised its warrant to purchase 111,111 shares of our Common Stock on October
9, 2003 for cash consideration of $222,222.

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

In connection with the private placement, we retained the services of Vintage
Partners LLC of New York, New York and paid to Vintage Partners a finder's fee
of $60,000 and warrants to purchase 21,429 shares of Common Stock. The warrants
have a three year term and are exercisable at $3.50 per share.

On June 27, 2003, we completed a private placement of 500,000 shares of common
stock plus a warrant to purchase 50,000 shares of common stock, resulting in
gross cash proceeds of $550,000 and net cash proceeds of approximately $478,000.
The warrant has a term of five years and bears an exercise price of $1.50 per
share subject to certain adjustment provisions.

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

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


-59-


6. INCOME TAXES

The components of the provision (benefit) for income taxes for the years ended
October 31, 2003, 2002 and 2001, comprise the following:



2003 2002 2001
- -------------------------------------------------------------------------------------------------------

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


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

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



2003 2002 2001
- -----------------------------------------------------------------------------------

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


Significant components of our deferred tax balances as of October 31, 2003 and
2002 are as follows:



2003 2002
- --------------------------------------------------------------------------------------------

Deferred tax assets:
Current
Accrued employee benefits $ 36 $ 230
Inventory allowances 828 944
Allowance for doubtful accounts 39 37
Warranty accruals -- 22

Noncurrent
R&D credit carryforward 2,871 2,475
Alternative minimum tax carryforward -- 80
Net operating loss carryforwards 4,619 4,202
Refundable deposit 191 178
Depreciation and amortization -- 261
Reserve on shareholder note receivable 103 --
Restructuring costs (25) 164
------- -------
Total deferred tax assets 8,662 8,593
------- -------
Deferred tax liabilities:

Deferred tax asset valuation allowance (8,662) (8,593)
------- -------
Net deferred tax assets $ -- $ --
======= =======



-60-


A valuation allowance is recorded to offset certain deferred tax assets due to
management's uncertainty of realizing the benefit of these items. The valuation
allowance increased by $ 0.1 million in fiscal 2003 primarily as a result of
increases in R&D credit carry forwards, NOL carryforwards and the reserve in
shareholder note receivable. These increases were partially offset by decreases
in accrued employee benefits, refundable deposit, depreciation and amortization
timing differences and a reduction in our estimated restructuring costs. The
valuation allowance increased by $0.5 million in fiscal 2002 primarily as a
result of an increase in unbenefited net operating loss carryforwards, an
increase in the inventory allowance and an increase in accrued employee
benefits. The increase was partially offset by the forfeiture of the $4.4
million refundable deposit in fiscal 2002 that was recognized for tax purposes
in fiscal 2001.

At October 31, 2003, we have research and experimentation tax credit
carryforwards of $1.7 million and $1.2 million for federal and state tax
purposes, respectively. These carryforwards expire in the periods ending 2010
through 2023. We have net operating loss carryforwards for federal and state
income tax purposes of approximately $12.7 million and $6.7 million,
respectively, which expire in periods ending 2004 through 2023.

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

7. WARRANTY OBLIGATIONS AND OTHER GUARANTEES:

In November 2002, the FASB issued FASB Interpretation ("FIN") No. 45
"Guarantor's Accounting and Disclosure Requirements for Guarantees, including
Indirect Guarantees of Indebtedness of Others -- an interpretation of FASB
Statements No. 5, 57 and 107 and rescission of FIN 34." The following is a
summary of our agreements that we have determined are within the scope of FIN
45.

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

The following table sets forth an analysis of our warranty reserve at October
31, 2003 (in thousands):




Warranty reserve at October 31, 2002 $ 55
Less: Cost to service warranty obligations (13)
Plus: Warranty accrual 11
----
Total warranty reserve included in other accrued expenses $ 53
====



We have agreed to indemnify each of our executive officers and directors for
certain events or occurrences arising as a result of the officer or director
serving in such capacity. The term of the indemnification period is for the
officer's or director's lifetime. The maximum potential amount of future
payments we could be required to make under these indemnification agreements is
unlimited. However, we have a directors' and officers' liability insurance
policy that should enable us to recover a portion of future amounts paid. As a
result of our insurance policy coverage, we believe the estimated fair value of
these indemnification agreements is minimal and have no liabilities recorded for
these agreements as of October 31, 2003 and 2002, respectively.


-61-


We enter into indemnification provisions under our agreements with other
companies in the ordinary course of business, typically with business partners,
contractors, customers and landlords. Under these provisions we generally
indemnify and hold harmless the indemnified party for losses suffered or
incurred by the indemnified party as a result of our activities or, in some
cases, as a result of the indemnified party's activities under the agreement.
These indemnification provisions often include indemnifications relating to
representations made by us with regard to intellectual property rights. These
indemnification provisions generally survive termination of the underlying
agreement. The maximum potential amount of future payments we could be required
to make under these indemnification provisions is unlimited. We have not
incurred material costs to defend lawsuits or settle claims related to these
indemnification agreements. As a result, we believe the estimated fair value of
these agreements is minimal. Accordingly, we have no liabilities recorded for
these agreements as of October 31, 2003 and 2002, respectively.

As discussed below, we are the secondary guarantor on the sublease of our
previous headquarters. We believe we will have no liabilities on this guarantee
and have not recorded a liability at October 31, 2003.

8. COMMITMENTS

We lease our buildings under noncancelable operating leases which expire at
various dates through the year 2008. Future minimum lease payments under
noncancelable operating leases, are as follows (in thousands):

Year ending October 31:
2004 $ 1,012
2005 1,005
2006 660
2007 6
2008 --
--------
2,683
Less: total reimbursements from sublease (1,539)
--------
Total minimum lease payments $ 1,144
========

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


-62-


Our rent expense under all operating leases, net of reimbursements for
subleases, for the years ended October 31, 2003, 2002 and 2001 totaled $434,000,
$549,000 and $844,000, respectively. We had reimbursements of sublease proceeds
of $713,000, $158,000 and $261,000 for the years ended October 31, 2003, 2002
and 2001, respectively.

In connection with the acquisition of Antares, we committed to issue 98,945
shares of our Common Stock in 20,000 share increments beginning January 2004 and
ending March 2005 to a selling shareholder of Antares.

9. STOCK OPTION AND STOCK PURCHASE PLANS

We sponsor two employee stock option plans, the 1996 Stock Option Plan (the
"1996 Plan") and the 1998 Non-Officer Stock Option Plan (the "1998 Plan"). A
total of 1,730,000 shares of Common Stock were reserved under the 1996 Plan at
October 31, 2003. A total of 650,000 shares of Common Stock are reserved under
the 1998 Plan. Stock options granted under the 1996 and 1998 Plans are
exercisable over a maximum term of ten years from the date of grant, vest in
various installments over a one to four-year period and have exercise prices
reflecting the market value of the shares of Common Stock on the date of grant.

Additionally, in 1991, stockholders approved a Non-Employee Director Stock
Option Plan (the "Director Plan"). A total of 140,000 shares of Common Stock are
reserved for issuance under the Director Plan. Options granted under the
Director Plan vest over a one to four-year period, expire five to seven years
after the date of grant and have exercise prices reflecting market value at the
date of grant.

At October 31, 2003 and 2002, 273,964 and 96,253 shares of Common Stock,
respectively, were available for grant under the 1996 Plan. A total of 3,939 and
36,714 shares of Common Stock were available for grant under the 1998 Plan at
October 31, 2003 and 2002, respectively. A total of 42,750 shares of Common
Stock were available for grant under the Director Plan at October 31, 2003 and
2002, respectively.

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

Weighted
Average
Number of Price Per Exercise
Shares Share Price
-------------------------------------------------
Outstanding at
October 31, 2000 1,246,879 $0.51--$24.81 $ 8.24

Granted 791,000 $0.98--$8.63 $ 2.88
Cancelled or expired (403,023) $0.51--$24.81 $ 8.32
Exercised (99,054) $0.51--$1.27 $ 0.52
-------------------------------------------------

Outstanding at
October 31, 2001 1,419,003 $0.51--$23.50 $ 6.18

Granted 809,000 $0.90--$1.80 $ 0.92
Cancelled or expired (458,730) $0.51--$23.50 $ 7.94
-------------------------------------------------

Outstanding at
October 31, 2002 1,769,273 $0.90--$19.81 $ 3.32

Granted 140,500 $0.70--$2.86 $ 1.90
Cancelled or expired (285,238) $0.51--$19.81 $ 5.13
-------------------------------------------------

Outstanding at
October 31, 2003 1,624,505 $0.70--$19.81 $ 2.88
=================================================


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The following table summarizes information with respect to all options
to purchase shares of Common Stock outstanding under the 1996 Plan, the 1998
Plan, the Director Plan and the LMC Plan at October 31, 2003:



Options Outstanding Options Exercisable
===================================================================================================================================
Weighted
Average Weighted Weighted
Number Remaining Average Number Average
Range of Outstanding Contractual Life Exercise Exercisable Exercise
Exercise Price at 10/31/03 (years) Price at 10/31/03 Price
- -----------------------------------------------------------------------------------------------------------------------------------

$ 0.00 - $ 1.00 817,000 5.9 $ 0.90 751,451 $ 0.91
$ 1.01 - $ 2.50 157,000 5.4 $ 1.65 106,248 $ 1.79
$ 2.51 - $ 3.50 242,000 5.1 $ 2.71 151,213 $ 2.66
$ 3.51 - $ 5.50 227,306 2.9 $ 5.06 204,357 $ 5.08
$ 5.51 - $ 7.50 2,000 3.2 $ 6.63 1,874 $ 6.63
$ 7.51 - $ 9.50 107,699 2.5 $ 8.23 104,365 $ 8.22
$ 9.51 - $14.50 65,000 1.2 $ 13.23 61,250 $ 13.18
$14.51 - $19.85 6,500 3.6 $ 18.44 5,518 $ 18.44
------------ ------------
1,624,505 1,386,276
============ ============


We sponsor an Employee Stock Purchase Plan (the "Purchase Plan") under which
300,000 shares of Common Stock were reserved for issuance at October 31, 2003.
The Purchase Plan allows participating employees to purchase, through payroll
deductions, shares of our Common Stock at 85 percent of the fair market value of
the shares at specified dates. At October 31, 2003, 32 employees were eligible
to participate in the Purchase Plan and 69,862 shares were available for
issuance. In fiscal year 2003, 2002 and 2001, 11,012, 47,596 and 32,645 shares
of Common Stock were issued under the Purchase Plan, respectively.

10. NET INCOME (LOSS) PER SHARE:

Basic net income (loss) per common share for the years ended October 31, 2003,
2002 and 2001 was computed by dividing the net income (loss) for the relevant
period by the weighted average number of shares of common stock outstanding.
Common stock equivalents for the years ended October 31, 2002 and 2001 have been
excluded from shares used in calculating diluted net loss per share because the
effect would have been anti-dilutive.


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Years ended October 31
------------------------------------
2003 2002 2001
------- ------- -------

Basic earnings per share:

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

Number of shares for computation of
earnings per share 4,259 3,759 3,390
======= ======= =======

Basic earnings (loss) per share $ 0.13 $ (0.46) $ (2.92)
======= ======= =======

Diluted earnings per share:

Weighted average number of common
shares outstanding during the year 4,259 3,759 3,390

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

Number of shares for computation of
earnings per share 4,709 3,759 3,390
======= ======= =======

Diluted earnings (loss) per share $ 0.12 $ (0.46) $ (2.92)
======= ======= =======


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

11. EMPLOYEE SAVINGS AND INVESTMENT PLAN

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

For the years ended October 31, 2003, 2002 and 2001, total expense under the
employee savings and investment plan was $61,730, $99,471 and $148,974,
respectively.

12. CONCENTRATION OF CREDIT AND BUSINESS RISKS

Our trade accounts receivable are concentrated among a small number of
customers, principally located in the United States. Three customers accounted
for 62% of our outstanding accounts receivable at October 31, 2003 compared to
two customers who accounted for more than 34% of total accounts receivable at
October 31, 2002. Ongoing credit evaluations of customers' financial condition
are performed and, generally, no collateral is required. We maintain an
allowance for doubtful accounts for potential credit losses. Actual bad debt
losses have not been material and have not exceeded our expectations. Trade
accounts receivable are recorded net of an allowance for doubtful accounts of
$90,000 and $93,000 at October 31, 2003 and 2002, respectively.

Sales to individual customers in excess of 10% of net sales for the year ended
October 31, 2003 included sales to HP of $3.1 million, or 45% of net sales
compared to sales to HP in fiscal 2002 of $2.1 million, or 30%, and sales to
Lockheed Martin of $0.8 million, or 12%, and sales to HP of $2.6 million, or
34%, and Lockheed Martin of $1.5 million, or 19%, in fiscal 2001. International
sales accounted for 12%, 13% and 9% of total sales during fiscal 2003, 2002 and
2001, respectively.


-65-


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

Substantially all of our manufacturing process is subcontracted to two
independent companies.

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

13. ACQUISITION OF ANTARES MICROSYSTEMS, INC.

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

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

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

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

We used the purchase method of accounting for the acquisition and combined
Antares results of operations beginning August 7, 2003. We allocated the
purchase price to the tangible assets based on fair market value at the time of
the acquisition and to intellectual property based on future expected cash flows
to be derived from the acquired product lines in addition to new products that
have reach technological feasibility, but have not gone into production.


-66-


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



For the Years ended October 31, 2003 2002
---------- ----------

Revenues $ 8,845 $ 10,702
Net loss (1,173) (2,665)
Basic loss per common share (0.28) (0.67)
Diluted earnings per common (0.25) (0.67)


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

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

We amortize the intellectual property acquired in the Antares acquisition to
expense over 36 months which is the estimated useful life. We recorded
approximately $102,000 in amortization in fiscal 2003.

14. RESTRUCTURING COSTS

In response to the economic slowdown, we implemented restructuring plans in
fiscal 2002 and 2001 and recorded restructuring charges of $446,000 and
$964,000, respectively. Restructuring costs for fiscal 2002 are comprised of
severance costs associated with staff reductions totaling $115,000 (we reduced
our headcount from 47 employees to 24 employees during fiscal 2002), leasehold
improvements and equipment write-downs related to the abandonment of our
Madison, Wisconsin office of $185,000 and accrued lease and brokerage costs
totaling $146,000. We reached agreement with the property owner to terminate the
Madison office lease releasing us from further obligations effective December
31, 2002. As part of the agreement we paid the lease payments for November and
December 2002 in addition to certain costs and commissions related to releasing
the office space.


-67-


Restructuring costs for fiscal 2001 are comprised of severance costs associated
with staff reductions totaling $52,000, leasehold improvements and equipment
write-downs related to the relocation of our headquarters of $337,000 and losses
related to its sublease of $575,000, net of the reversal of a $281,000 liability
associated with deferred rent. We reduced our headcount from 87 employees to 47
employees during fiscal 2001. The reduction in headcount plus the relocation of
the XeTel manufacturing facility from our engineering and headquarters facility
to Texas left us with excess facility space. We were able to enter into an
agreement with a third party corporation to assign the lease for our 63,000
square foot facility located at 4550 Norris Canyon Rd, San Ramon, California and
simultaneously sublease a 15,000 square foot facility also located in San Ramon,
California. We abandoned the leasehold improvements and certain of our equipment
in conjunction with the relocation. As a result of this transaction, a non-cash
$337,000 write down of leasehold improvements and equipment was expensed in
fiscal 2001. Real estate commissions and building expenses totaling $442,000
were accrued in fiscal 2001 and were paid in fiscal 2002. An additional amount
totaling $133,000 was accrued related to a loss associated with facilities
acquired with the purchase of LMC in fiscal 2000 and subleased to a third party
corporation in fiscal 2001. This amount is being be paid over 36 months
beginning May 2001.

As of October 31, 2003 and 2002, $58,000 and $249,000 of the restructuring costs
were included in other current liabilities, respectively.

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

The following table sets forth an analysis of the components of the
restructuring reserve and the payments made against it through October 31, 2003
(in thousands):




Restructuring accrual at October 31, 2002 $ 249
Less:
Cash paid and adjustment for accrued lease costs (191)
-----
Total restructuring costs included in liabilities $ 58
=====


15. LOAN TO OFFICER

On November 6, 1998, we made a loan to an officer and stockholder in the amount
of $622,800 under a two-year recourse promissory note bearing an interest rate
of 4.47% and collateralized by 145,313 shares of our Common Stock. The loan was
used to pay for the exercise of an option to purchase 139,400 shares of our
Common Stock and related taxes. On April 16, 1999, the loan was increased to
$743,800. The loan was extended for a one-year term under the same terms and
conditions on November 6, 2000. On December 14, 2001, the note was amended,
restated and consolidated to extend the term to December 2003 and to require
certain mandatory repayments of principal of up to $100,000 a year while the
note is outstanding. The loan bears interest at a rate of 2.48% per annum, with
interest due annually and the entire amount of the principal due on December 14,
2003.

On October 31, 2002 we determined that it was probable that we would be unable
to fully recover the balance of the loan on its due date of December 14, 2003.
Accordingly, a valuation allowance of $474,000 was recorded based generally on
the fair value of the Common Stock collateralizing the note at October 31, 2002
and the amount of the officer's personal assets considered likely to be
available to settle the note in December 2003.


-68-


During the fourth quarter of fiscal 2003, an officer and shareholder sold
139,400 shares of our common stock and used the proceeds from the stock sale to
repay $362,800 of an outstanding $743,800 loan we made to the officer. In
November 2003, we received an additional loan payment of $142,000 from stock
that was sold prior to October 31, 2002. The officer sold an additional 43,100
shares of our common stock in November 2003 and used proceed totaling $381,000
to repay the remaining loan balance in full.

As a result of these payments, we expect to reflect a benefit of $239,000 in
our results of operations for the first quarter of fiscal 2004 resulting from
the reversal of the remaining loan impairment charge.


QUARTERLY FINANCIAL INFORMATION (UNAUDITED)



(in thousands except First Second Third Fourth
per share amounts) Quarter Quarter Quarter Quarter
- ---------------------------------------------------------------------------------------------------------

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

2002: Net sales $ 1,283 $ 1,724 $ 2,786 $ 1,105
Gross profit 696 914 1,695 423
Net income (loss) (1,218) (961) (178) 626
Basic income (loss) per
common share $ (0.35) $ (0.28) $ (0.04) $ 0.15
Diluted income (loss) per
common share $ (0.35) $ (0.28) $ (0.04) $ 0.15



-69-


SBE, Inc.
Schedule II - Valuation and Qualifying Accounts
For the Years Ended October 31, 2003, 2002 and 2001




Column A Column B Column C Column D Column E
-------- -------- -------- -------- --------
Balance at Additions Balance
Beginning charged to costs End of
Description of Period and expenses Deductions Period
- --------------------------------------------------------------------------------------------------------------------------

Year ended October 31, 2003

Allowance for Doubtful Accounts
and sales programs $ 93,000 $ 11,000 $ (14,000) $ 93,000
Allowance for Warranty Claims55,315 11,000 (13,000) 53,315
Allowance for Deferred Tax Assets 8,593,000 69,000 -- 8,662,000
Allowance for Stockholder Loan 474,000 -- (235,000) 239,000

Year ended October 31, 2002

Allowance for Doubtful Accounts
and sales programs $ 225,000 $ -- $ (132,000) $ 93,000
Allowance for Warranty Claims55,627 -- (312) 55,315
Allowance for Deferred Tax Assets 8,080,000 513,000 -- 8,593,000
Allowance for Stockholder Loan -- 474,000 -- 474,000

Year ended October 31, 2001

Allowance for Doubtful Accounts
and sales programs $ 251,620 $ -- $ (26,620) $ 225,000
Allowance for Warranty Claims144,676 -- (89,049) 55,627
Allowance for Deferred Tax Assets 3,088,000 4,992,000 -- 8,080,000
Allowance for Stockholder Loan -- -- -- --



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