<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 7, 1998
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10
GENERAL FORM FOR REGISTRATION OF SECURITIES
Pursuant to Section 12(b) or 12(g) of the Securities Exchange Act of 1934
------------------------
HI/FN, INC.
(Exact Name of Registrant as Specified in its Charter)
<TABLE>
<S> <C>
DELAWARE 33-0732700
(State of Incorporation or Organization) (I.R.S. Employer Identification No.)
</TABLE>
2105 HAMILTON AVENUE, SUITE 230
SAN JOSE, CA 95125
(Address, Including Zip Code, of Principal Executive Offices)
(408) 558-8066
(Registrant's Telephone Number, Including Area Code)
------------------------
Securities to be registered pursuant to Section 12(b) of the Act: None
Securities to be registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.001 per share
(Title of Class)
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<PAGE> 2
INFORMATION REQUIRED IN REGISTRATION STATEMENT
CROSS-REFERENCE SHEET BETWEEN INFORMATION STATEMENT
AND ITEMS OF FORM 10
<TABLE>
<CAPTION>
ITEM
NO. ITEM CAPTION LOCATION IN INFORMATION STATEMENT
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<C> <S> <C>
1. Business..................................... "SUMMARY"; "THE DISTRIBUTION -- Background and
Reasons for the Distribution"; "MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS"; "THE COMPANY" and
"BUSINESS."
2. Financial Information........................ "SUMMARY"; "RISK FACTORS"; "SELECTED HISTORICAL
FINANCIAL DATA"; "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS" and "FINANCIAL STATEMENTS."
3. Properties................................... "BUSINESS."
4. Security Ownership of Certain Beneficial
Owners and Management........................ "MANAGEMENT" and "SECURITIES OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT."
5. Directors and Executive Officers............. "SUMMARY"; "RISK FACTORS" and "MANAGEMENT."
6. Executive Compensation....................... "MANAGEMENT -- Executive Compensation."
7. Certain Relationships and Related
Transactions................................. "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS."
8. Legal Proceedings............................ "BUSINESS -- Legal Proceedings."
9. Market Price of and Dividends on the
Registrant's Common Equity and Related
Stockholder Matters.......................... "SUMMARY"; "RISK FACTORS -- Dividend Policy" and
"THE DISTRIBUTION -- Quotation and Trading of
Company Common Stock; Dividend Policy."
10. Recent Sales of Unregistered Securities...... "THE COMPANY" and "CERTAIN RELATIONSHIPS AND
RELATED TRANSACTIONS."
11. Description of Registrant's Securities to be
Registered................................... "DESCRIPTION OF THE COMPANY'S CAPITAL STOCK."
12. Indemnification of Directors and Officers.... "MANAGEMENT -- Indemnification Agreements" and
"HI/FN CERTIFICATE OF INCORPORATION AND BYLAWS."
13. Financial Statements and Supplementary
Data......................................... "SUMMARY"; "SELECTED HISTORICAL FINANCIAL DATA";
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS"
and "FINANCIAL STATEMENTS."
</TABLE>
i
<PAGE> 3
<TABLE>
<CAPTION>
ITEM
NO. ITEM CAPTION LOCATION IN INFORMATION STATEMENT
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<C> <S> <C>
14. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure....... None.
15. Financial Statements and Exhibits............
(a) Financial Statements and Schedules
(1) Financial Statements: "FINANCIAL STATEMENTS" and Schedule II.
(b) Exhibits:
</TABLE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
3.1(2) Form of Third Amended and Restated Certificate of
Incorporation of Hi/fn, Inc. (included as Annex I to the
Information Statement).
3.2(2) Form of Amended and Restated Bylaws of Hi/fn, Inc. (included
as Annex II to the Information Statement).
4.1(2) Form of Common Stock Certificate.
10.1(2) Amended and Restated 1996 Equity Incentive Plan of Hi/fn,
Inc. (included as Annex III to the Information Statement).
10.2(2) Assignment, Assumption and License Agreement dated as of
November 21, 1996 between Stac, Inc. and Hi/fn, Inc.
10.3(2) Cross License Agreement dated as of November 21, 1996
between Stac, Inc. and Hi/fn, Inc.
10.4(2) Form of Distribution Agreement.
10.5(2) [Form of Employee Benefits Allocation Agreement.]
10.6(2) Form of Tax Sharing Agreement.
10.7(2) Form of Transitional Services Agreement.
10.8(2) Form of Indemnification Agreement.
10.9(2) Agreement dated as of April 1, 1994 between International
Business Machines Corporation and Stac Electronics (Program
Patent License Agreement).
10.10(2) Agreement dated as of April 1, 1994 between International
Business Machines Corporation and Stac Electronics (Cross
License Agreement).
10.11(2) License Agreement dated as of June 20, 1994 between Stac
Electronics and Microsoft Corporation.
10.12(2) License Agreement dated as of February 16, 1996 between
Microsoft Corporation and Stac, Inc.
10.13(2) License Agreement dated as of December 15, 1995 between
Motorola, Inc. and Stac, Inc.
10.14(2) Agreement dated as of November 13, 1997 between 750
University, LLC and Hi/fn, Inc.
27.1(1) Financial Data Schedule.
</TABLE>
- ---------------
(1) Filed herewith.
(2) To be filed by amendment.
ii
<PAGE> 4
[STAC LETTERHEAD]
November , 1998
Dear Stockholder:
The Board of Directors of Stac, Inc. ("Stac") has approved the distribution
(the "Distribution") to holders of Stac common stock, through a special
dividend, of all of the common stock of hi/fn, inc. ("Hi/fn") owned by Stac.
Hi/fn was organized in August 1996 to own and operate the semiconductor business
previously operated as a division of Stac. Stac transferred the semiconductor
business (along with the associated technology, assets and liabilities) to Hi/fn
on November 21, 1996.
The Board of Directors of Stac believes that the Distribution is in the
best interests of Stac stockholders. The completion of the Distribution will
permit each of Hi/fn and Stac to concentrate on its core business. The Board of
Directors of Stac believes that the Distribution also will allow financial
markets to better understand and recognize the merits of the two businesses and
enhance their abilities to raise equity capital. The common stock of Stac will
continue to be listed on The Nasdaq Stock Market's Nasdaq National Market (the
"Nasdaq National Market"). Hi/fn intends to apply to have the shares of Hi/fn
common stock approved for quotation and trading on the Nasdaq National Market
under the symbol "HIFN."
If you are a holder of Stac common stock of record at the close of business
on October 15, 1998, you will receive as a dividend one share of Hi/fn common
stock for every [4.0029] shares of Stac common stock you hold. It is a condition
for the completion of the Distribution that Stac obtain a ruling from the
Internal Revenue Service or a favorable opinion from PricewaterhouseCoopers LLP
that the Distribution will not result in recognition of taxable income or gain
to Stac or its stockholders under Section 355 of the Internal Revenue Code of
1986, as amended, although the Stac Board of Directors may waive receipt of the
ruling or opinion as a condition to consummation of the Distribution. The
Distribution is scheduled to occur on or about November 19, 1998. We expect to
mail the Hi/fn common stock certificates shortly thereafter. Stockholders of
Stac on the record date must retain their Stac stock certificates which will
continue to represent shares of Stac common stock.
The enclosed Information Statement contains information about the
Distribution and about Hi/fn. We urge you to read it carefully. Holders of Stac
common stock are not required to take any action to participate in the
Distribution. A stockholder vote is not required in connection with this matter
and, accordingly, your proxy is not being sought.
We are optimistic about the prospects for Stac and Hi/fn and appreciate
your continued support.
Sincerely,
Gary W. Clow
Chairman of the Board and Chief
Executive Officer
Stac, Inc.
<PAGE> 5
INFORMATION STATEMENT
HI/FN, INC.
COMMON STOCK
This Information Statement ("Information Statement") is being furnished in
connection with the distribution (the "Distribution") to holders of common
stock, par value $.001 per share ("Stac Common Stock"), of Stac, Inc., a
Delaware corporation ("Stac"), of the shares of common stock, par value $.001
per share ("Company Common Stock"), of hi/fn, inc., a Delaware corporation
("Hi/fn" or the "Company"), that are currently outstanding and owned by Stac,
pursuant to the terms of a Distribution Agreement to be entered into between
Stac and Hi/fn (the "Distribution Agreement"). Hi/fn was organized in August
1996 to own and operate Stac's semiconductor business, which previously was
operated as a division of Stac. Stac transferred the semiconductor business
(along with the associated technology, assets and liabilities) to Hi/fn on
November 21, 1996. See "RISK FACTORS"; "THE COMPANY" and "BUSINESS."
The shares of Company Common Stock held by Stac immediately prior to the
Distribution will be distributed to holders of record of Stac Common Stock as of
the close of business on October 15, 1998 (the "Record Date"). As of the Record
Date, there were issued and outstanding [482,906] shares of Company Common
Stock, held by 21 stockholders of record including Stac, and 6,000,000 shares of
the Company's Series A Preferred Stock, par value $.001 per share (the "Series A
Preferred Stock"), all of which were held by Stac. Immediately prior to the
Distribution, Stac will convert all shares of Series A Preferred Stock into
Company Common Stock, resulting in Stac's owning 6,000,100 shares of Company
Common Stock. Stac will distribute approximately one share of Company Common
Stock for every four shares of Stac Common Stock held by Stac stockholders on
the Record Date (the "Distribution Ratio") and will not retain any shares of
Company Common Stock following the Distribution. The Distribution Ratio is
determined by dividing, as of the Record Date, the number of shares of Stac
Common Stock outstanding by the number of shares of Company Common Stock (on an
as-converted basis) held by Stac. As of the Record Date, [858,395] shares of
Company Common Stock were issuable upon exercise of options granted under the
1996 Equity Incentive Plan of Hi/fn, Inc., as amended (the "1996 Plan").
It is a condition for the completion of the Distribution that Stac obtain a
ruling from the Internal Revenue Service ("IRS") or a favorable opinion from
PricewaterhouseCoopers LLP that the Distribution will not result in recognition
of taxable income or gain to Stac or its stockholders under Section 355 of the
Internal Revenue Code of 1986, as amended (the "Code"), although the Stac Board
of Directors may waive receipt of the ruling or opinion as a condition to
consummation of the Distribution. See "THE DISTRIBUTION -- Material Federal
Income Tax Consequences of the Distribution." The date of the Distribution (the
"Distribution Date") is scheduled to be on or about November 19, 1998. No
consideration will be paid by holders of Stac Common Stock for shares of Company
Common Stock. See "THE DISTRIBUTION -- Manner of Effecting the Distribution."
There is no current trading market for the Company Common Stock, although a
"when issued" market may develop prior to the Distribution Date. The Company
intends to apply to have the shares of Company Common Stock approved for
quotation and trading on The Nasdaq Stock Market's Nasdaq National Market (the
"Nasdaq National Market") under the symbol "HIFN." See "THE
DISTRIBUTION -- Quotation and Trading of Company Common Stock; Dividend Policy."
------------------------
NO STOCKHOLDER APPROVAL OF THE DISTRIBUTION IS REQUIRED OR SOUGHT. WE ARE NOT
ASKING YOU FOR A PROXY AND YOU ARE REQUESTED
NOT TO SEND US A PROXY.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS INFORMATION STATEMENT.
------------------------
THIS INFORMATION STATEMENT DOES NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY ANY SECURITIES.
------------------------
Stockholders of Stac with inquiries related to the Distribution should
contact John R. Witzel, Vice President of Finance, Chief Financial Officer and
Secretary, Stac, Inc., 12636 High Bluff Drive, 4th Floor, San Diego, California
92130, telephone: (619) 794-4300; or Stac's stock transfer agent, American Stock
Transfer & Trust Company, 40 Wall Street, New York, New York 10005. American
Stock Transfer also is acting as distribution agent for the Distribution.
THE DATE OF THIS INFORMATION STATEMENT IS NOVEMBER , 1998.
<PAGE> 6
INFORMATION STATEMENT
TABLE OF CONTENTS
<TABLE>
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PAGE
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<S> <C>
AVAILABLE INFORMATION....................................... 2
SUMMARY..................................................... 3
RISK FACTORS................................................ 9
THE DISTRIBUTION............................................ 23
Background and Reasons for the Distribution............... 23
Fairness Opinion.......................................... 24
Distribution Agent........................................ 26
Manner of Effecting the Distribution...................... 26
Results of the Distribution............................... 27
Material Federal Income Tax Consequences of the
Distribution........................................... 27
Quotation and Trading of Company Common Stock; Dividend
Policy................................................. 28
Conditions; Termination................................... 29
Reasons for Furnishing the Information Statement.......... 30
RELATIONSHIP BETWEEN HI/FN AND STAC AFTER THE
DISTRIBUTION.............................................. 31
REGULATORY APPROVALS........................................ 32
SELECTED HISTORICAL FINANCIAL DATA.......................... 33
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS................................. 34
THE COMPANY................................................. 40
BUSINESS.................................................... 41
MANAGEMENT.................................................. 54
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.............. 59
SECURITIES OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT................................................ 62
HI/FN CERTIFICATE OF INCORPORATION AND BYLAWS............... 63
DESCRIPTION OF THE COMPANY'S CAPITAL STOCK.................. 64
FINANCIAL STATEMENTS........................................ F-1
GLOSSARY.................................................... G-1
ANNEX I -- THIRD AMENDED AND RESTATED CERTIFICATE OF
INCORPORATION OF HI/FN........................... I-1
ANNEX II -- AMENDED AND RESTATED BYLAWS OF HI/FN............ II-1
ANNEX III -- AMENDED AND RESTATED 1996 EQUITY INCENTIVE PLAN
OF HI/FN.................................................. III-1
ANNEX IV -- OPINION OF WARBURG DILLON READ LLC.............. IV-1
</TABLE>
1
<PAGE> 7
AVAILABLE INFORMATION
Hi/fn has filed a Registration Statement on Form 10 (the "Registration
Statement") with the Securities and Exchange Commission (the "Commission") under
the Securities Exchange Act of 1934, as amended (the "Exchange Act"), with
respect to the Company Common Stock. This Information Statement does not contain
all of the information set forth in the Registration Statement and the exhibits
and schedules thereto. For further information, reference is made hereby to the
Registration Statement and such exhibits and schedules. Statements contained
herein concerning any documents are not necessarily complete and, in each
instance, reference is made to the copies of such documents filed as exhibits to
the Registration Statement. Each such statement is qualified in its entirety by
such reference. Copies of these documents may be inspected without charge at the
principal office of the Commission at 450 Fifth Street, N.W., Washington, D.C.
20549, and at the Regional Offices of the Commission at Seven World Trade
Center, Suite 1300, New York, New York 10048 and at 500 West Madison Street,
Suite 1400, Chicago, Illinois 60661, and copies of all or any part thereof may
be obtained from the Commission upon payment of the charges prescribed by the
Commission. Copies of this material also should be available through the
Internet by using the SEC EDGAR Archive, the address of which is
http://www.sec.gov.
Following the Distribution, the Company will be required to comply with the
reporting requirements of the Exchange Act and will file annual, quarterly and
other reports with the Commission. The Company also will be subject to the proxy
solicitation requirements of the Exchange Act and, accordingly, will furnish
audited financial statements to its stockholders in connection with its annual
meetings of stockholders.
NO PERSON IS AUTHORIZED BY STAC OR THE COMPANY TO GIVE ANY INFORMATION OR
TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS INFORMATION
STATEMENT, AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT
BE RELIED UPON AS HAVING BEEN AUTHORIZED.
Stac, Hi/fn, Replica and LZS are registered trademarks of Stac, Inc. or
Hi/fn, inc. All other product names are trademarks of their respective owners.
2
<PAGE> 8
SUMMARY
This Summary is qualified by the more detailed information and financial
statements set forth elsewhere in this Information Statement. Capitalized terms
used but not defined in this Summary are defined elsewhere in this Information
Statement. Unless the context otherwise requires, references to the Company or
Hi/fn prior to November 21, 1996 include the assets, liabilities and results of
operations of Stac's semiconductor division and references in this Information
Statement to Stac include its consolidated subsidiaries other than Hi/fn.
THE DISTRIBUTION
Distributing Company.......... Stac, Inc., a Delaware corporation ("Stac").
Distributed Company........... hi/fn, inc., a Delaware corporation ("Hi/fn" or
the "Company"). Hi/fn was organized in August
1996 to own and operate Stac's semiconductor
business, which previously was operated as a
division of Stac. Stac transferred the
semiconductor business (along with the
associated technology, assets and liabilities)
to the Company on November 21, 1996. See "RISK
FACTORS"; "THE COMPANY" and "BUSINESS."
The Distribution and
Distribution Ratio............ As of the Record Date, there were issued and
outstanding [482,906] shares of the Company's
common stock, $.001 par value per share (the
"Company Common Stock"), held by 21
stockholders of record including Stac, and
6,000,000 shares of the Company's Series A
Preferred Stock, $.001 par value per share,
(the "Series A Preferred Stock"), all of which
were held by Stac. Immediately prior to the
Distribution, Stac will convert all shares of
Series A Preferred Stock into Company Common
Stock, resulting in Stac's owning 6,000,100
shares of Company Common Stock. Stac will
distribute one share of Company Common Stock
for every [4.0029] shares of Stac Common Stock
held by Stac stockholders on the Record Date
(the "Distribution Ratio"). Stac will not
retain any shares of Company Common Stock
following the Distribution.
Fractional Share Interests.... Fractional shares of Company Common Stock will
not be distributed. Fractional shares of
Company Common Stock will be aggregated and
sold in the public market by the Distribution
Agent and the aggregate net cash proceeds will
be distributed ratably to those stockholders
entitled to fractional interests. See "THE
DISTRIBUTION -- Manner of Effecting the
Distribution."
Shares to be Outstanding
Following the Distribution.... Based on [482,906] shares of Company Common
Stock and 6,000,000 shares of Series A
Preferred Stock outstanding on the Record Date,
approximately [6,482,906] shares of Company
Common Stock.
Record Date................... October 15, 1998 (5:00 p.m. Eastern Standard
Time).
Distribution Date............. On or about November 19, 1998.
Mailing Date.................. Certificates representing the shares of Company
Common Stock to be distributed pursuant to the
Distribution will be delivered to the
Distribution Agent on the Distribution Date.
The Distribution Agent will mail certificates
representing the shares of Company
3
<PAGE> 9
Common Stock to holders of Stac Common Stock as
soon as practicable thereafter. Holders of Stac
Common Stock should not send stock certificates
to Stac, the Company or the Distribution Agent.
See "THE DISTRIBUTION -- Manner of Effecting
the Distribution."
Conditions to the
Distribution.................. The Distribution is conditioned upon, among
other things, declaration of the special
dividend by the Board of Directors of Stac (the
"Stac Board") and receipt of a ruling from the
Internal Revenue Service ("IRS") or a favorable
opinion from PricewaterhouseCoopers LLP that
the Distribution will not result in recognition
of taxable income or gain to Stac or its
stockholders under Section 355 of the Internal
Revenue Code of 1986, as amended (the "Code").
The Stac Board has reserved the right to waive
any conditions to the Distribution or, even if
the conditions to the Distribution are
satisfied, to abandon, defer or modify the
Distribution at any time prior to the
Distribution Date. See "THE
DISTRIBUTION -- Conditions; Termination."
Reasons for the
Distribution.................. The Distribution is designed to separate the
semiconductor business of Hi/fn from the
software business of Stac. The Distribution
will result in the formation of two publicly
traded companies, each of which will pursue an
independent strategic path. The Stac Board
believes the separation will offer both new
entities the opportunity to pursue strategic
objectives appropriate to different business
objectives, offer each entity the financial
flexibility to raise capital on a more
cost-effective basis and create targeted
incentives for each company's management and
key employees.
Fairness Opinion.............. In connection with its approval of the
Distribution, the Stac Board received an
opinion from Warburg Dillon Read LLC ("WDR") to
the effect that as of the date of the WDR
opinion, and based on and subject to the
assumptions, limitations and qualifications set
forth therein, from a financial point of view,
the Distribution is fair to the stockholders of
Stac. See "THE DISTRIBUTION -- Fairness
Opinion." The opinion of WDR is set forth in
full in Annex IV hereto.
Business Strategy of the
Company....................... See "BUSINESS -- Business Strategy."
Federal Income Tax
Consequences to Stac and Stac
Stockholders................ Stac has requested a letter ruling from the IRS
confirming that, among other things, the
Distribution will not result in recognition of
taxable income or gain to Stac or its
stockholders under Section 355 of the Code
(except to the extent of cash received in lieu
of fractional shares). The Distribution is
conditioned upon receipt of a ruling or a
favorable opinion of PricewaterhouseCoopers LLP
as to the tax-free treatment of the
Distribution prior to the Distribution Date,
although the Stac Board may waive receipt of
the ruling or opinion as a condition to
consummation of the Distribution. See "THE
DISTRIBUTION -- Material Federal Income Tax
Consequences of the Distribution."
Trading Market................ There is currently no public market for the
Company Common Stock. The Company intends to
apply to have the Company Common Stock approved
for quotation and trading on the Nasdaq
4
<PAGE> 10
National Market under the symbol "HIFN." See
"THE DISTRIBUTION -- Quotation and Trading of
the Company Common Stock; Dividend Policy" and
"RISK FACTORS -- Absence of Prior Trading
Market for Company Common Stock; Potential
Volatility."
Distribution Agent and
Transfer Agent and Registrar
for the Company Common
Stock....................... American Stock Transfer & Trust Company.
Dividends..................... The Company's dividend policy will be
established by the Board of Directors of the
Company (the "Company Board") from time to time
based on the financial condition and results of
operations of the Company and such other
business considerations as the Company Board
considers relevant. The Company presently
intends to retain future earnings to finance
the growth and development of its business;
therefore, the Company does not currently
anticipate paying any cash dividends. Any
future determination relating to dividend
policy will be made at the discretion of the
Company Board. See "RISK FACTORS -- Dividend
Policy" and "THE DISTRIBUTION -- Quotation and
Trading of Company Common Stock; Dividend
Policy."
Antitakeover Provisions....... The Third Amended and Restated Certificate of
Incorporation of the Company (the "Company
Certificate") and the Amended and Restated
Bylaws of the Company (the "Company Bylaws") to
be adopted by the Company prior to the
Distribution, as well as Delaware statutory
law, contain provisions that may have the
effect of discouraging an acquisition of
control of the Company not approved by the
Company Board. Such provisions include Article
Fourth of the Company Certificate which
authorizes the Company Board to issue shares of
preferred stock of the Company ("Company
Preferred Stock"), in one or more series,
without further action by Company stockholders,
and to establish the rights and preferences
(including the convertibility of such shares of
Company Preferred Stock into Company Common
Stock) of any series of Company Preferred Stock
so issued. These provisions have been designed
to enable the Company to develop its business
and foster its long-term growth without
disruptions caused by the threat of a takeover
not deemed by the Company Board to be in the
best interests of the Company and its
stockholders. Such provisions also may have the
effect of discouraging third parties from
making proposals involving an acquisition or
change of control of the Company, although such
proposals, if made, might be considered
desirable by a majority of the Company's
stockholders. Such provisions could further
have the effect of making it more difficult for
third parties to cause the replacement of the
current management of the Company without the
concurrence of the Company Board. See "RISK
FACTORS -- Effect of Antitakeover Provisions";
"HI/FN CERTIFICATE OF INCORPORATION AND
BYLAWS"; "DESCRIPTION OF THE COMPANY'S CAPITAL
STOCK" and Annexes I and II.
Risk Factors.................. See "RISK FACTORS" for a discussion of factors
that should be considered in connection with
the Company Common Stock re-
5
<PAGE> 11
ceived in the Distribution. Such factors
include: limited operating history as
independent company, no assurance of future
profitability; fluctuations in operating
results; termination of subsidiary relationship
with Stac; dependence upon development of the
market for packet processors; risks associated
with new and evolving markets; new product
development and evolving industry standards,
technological change; competition; dependence
on growth in demand for network and storage
equipment; absence of future funding
commitments, need for future capital; customer
concentration; product concentration; lengthy
sales cycle; erosion of average selling prices;
risks associated with independent manufacturers
and sole-source supply; product complexity;
order and shipment uncertainties; protection
and enforcement of intellectual property;
dependence on key personnel and hiring of
additional personnel; management of growth;
risks associated with expansion of
international business activities; export
restrictions on encryption algorithms; risks
associated with potential acquisitions;
cyclicality of semiconductor industry; year
2000 compliance; tax risks of the Distribution;
possible conflicts with Stac after the
Distribution; control by executive officers and
directors; absence of prior trading market for
Company Common Stock, potential volatility;
effect of antitakeover provisions; shares
eligible for future sale; dividend policy;
dilution; and potential adverse effects of the
Distribution on Stac Common Stock.
Relationship with Stac after
the Distribution.............. Stac will have no stock ownership in the
Company upon consummation of the Distribution.
For purposes of governing the ongoing
relationship between the Company and Stac after
the Distribution and to provide for an orderly
transition, the Company and Stac have entered
into or will enter into certain agreements.
Such agreements include: (i) the Distribution
Agreement providing for, among other things,
the Distribution and certain indemnification
obligations of each company to the other; (ii)
a Tax Sharing Agreement pursuant to which the
Company and Stac will agree to allocate tax
liabilities that relate to periods prior to the
Distribution Date; and (iii) a Transitional
Services Agreement pursuant to which Stac and
Hi/fn will provide certain services to each
other on a transitional basis. See
"RELATIONSHIP BETWEEN HI/FN AND STAC AFTER THE
DISTRIBUTION."
Policies and Procedures for
Addressing Conflicts.......... The Company and Stac intend to pursue separate
and distinct business strategies to minimize
potential conflicts of interest between the two
companies. Nonetheless, the ongoing
relationship between the Company and Stac may
present conflict situations for certain
directors. Certain persons will serve as
directors of both the Company and Stac, and
also will own (or have options or other rights
to acquire) a significant number of shares of
common stock in both companies. The Company and
Stac will adopt appropriate policies and
procedures on or prior to the Distribution Date
to be followed by the Board of Directors of
each company to address potential conflicts.
Such procedures include requiring the persons
serving as directors of both companies to
abstain from voting as
6
<PAGE> 12
directors with respect to matters that present
a significant conflict of interest between the
companies. See "RISK FACTORS -- Possible
Conflicts with Stac after the Distribution";
"RELATIONSHIP BETWEEN HI/FN AND STAC AFTER THE
DISTRIBUTION -- Policies and Procedures for
Addressing Conflicts."
Interests of Certain Persons
in the Distribution........... Based on their ownership of Stac Common Stock,
Company Common Stock and options to acquire
Company Common Stock as of the Record Date, the
executive officers and directors of the Company
will beneficially own an aggregate of
shares, or approximately %, of
the outstanding Company Common Stock
immediately following the Distribution. See
"RISK FACTORS -- Control by Executive Officers
and Directors" and "SECURITIES OWNERSHIP OF
CERTAIN BENEFICIAL OWNERS AND MANAGEMENT."
7
<PAGE> 13
SUMMARY FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The summary financial data of the Company has been prepared from the
audited financial statements of the Company as of September 30, 1996 and 1997
and for each of the three years in the period ended September 30, 1997 and the
unaudited financial statements as of June 30, 1998 and for the nine months ended
June 30, 1997 and 1998 included herein. Financial information as of September
30, 1993 and 1994 and for each of the two years in the period ended September
30, 1994 has been prepared from unaudited financial statements not included
herein. The financial information may not reflect the Company's future
performance or the future financial position or results of operations of the
Company, nor does it provide or reflect data as if the Company had actually
operated as a separate, stand-alone entity during the periods covered. The
summary financial data should be read in conjunction with the financial
statements and related notes and "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS," included elsewhere in this
Information Statement. In the opinion of the Company's and Stac's management,
the unaudited financial statements as of September 30, 1993 and 1994, as of June
30, 1998, for the years ended September 30, 1993 and 1994 and for the nine
months ended June 30, 1997 and 1998 contain all adjustments, consisting only of
normal recurring adjustments, necessary to present fairly the financial
condition and results of operations for these periods.
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
YEAR ENDED SEPTEMBER 30, JUNE 30,
-------------------------------------------- ----------------
1993 1994 1995 1996 1997 1997 1998
------ ------ ------ ------- ------- ------ -------
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues............................ $5,472 $5,666 $7,342 $12,894 $14,226 $8,991 $16,513
Cost of revenues.................... 2,116 2,302 2,841 5,095 4,762 2,955 5,142
------ ------ ------ ------- ------- ------ -------
Gross margin........................ 3,356 3,364 4,501 7,799 9,464 6,036 11,371
Operating expenses:
Research and development............ 1,008 564 551 1,641 2,985 1,873 4,066
Sales and marketing................. 1,222 813 1,097 1,677 2,224 1,585 2,438
General and administrative.......... 447 379 492 889 1,203 851 1,737
------ ------ ------ ------- ------- ------ -------
Operating income.................... 679 1,608 2,361 3,592 3,052 1,727 3,130
Interest income..................... 16 7 14
------ ------ ------ ------- ------- ------ -------
Provision for income taxes.......... 275 661 947 1,441 1,235 699 1,292
------ ------ ------ ------- ------- ------ -------
Net income.......................... $ 404 $ 947 $1,414 $ 2,151 $ 1,833 $1,035 $ 1,852
====== ====== ====== ======= ======= ====== =======
Net income per share, basic(1)...... $ 0.07 $ 0.16 $ 0.24 $ 0.36 $ 0.30 $ 0.17 $ 0.29
Net income per share, diluted....... $ 0.07 $ 0.16 $ 0.24 $ 0.36 $ 0.30 $ 0.17 $ 0.27
Weighted average shares outstanding,
basic............................. 6,000 6,000 6,000 6,000 6,100 6,075 6,282
Weighted average shares outstanding,
diluted........................... 6,000 6,000 6,000 6,000 6,174 6,075 6,782
BALANCE SHEET DATA:
At September 30,
Cash................................ $ -- $ -- $ -- $ -- $ 480 $ 69
Total assets........................ 1,172 1,583 2,254 2,611 5,898 8,773
Working capital (deficit)........... (143) (193) (223) (383) 3,520 4,770
Total stockholders' equity(2)....... -- -- -- -- 4,622 6,682
</TABLE>
- ---------------
(1) Since the Company's Series A Preferred Stock represents a primary equity
security, it is included in the calculation of basic net income per share.
(2) The balance sheets prior to September 30, 1997 reflect Hi/fn's structure
prior to its formation as a subsidiary. Periods subsequent to September 30,
1996 reflect the net assets contributed by Stac in establishing the Hi/fn
subsidiary. The transfer was recorded at the historical net book value of
the transferred assets and liabilities. In exchange for the net assets
contributed to Hi/fn, Stac received 6,000,000 shares of Series A Preferred
Stock and 100 shares of Company Common Stock.
8
<PAGE> 14
RISK FACTORS
This Information Statement contains forward-looking statements within the
meaning of the Securities Act of 1933, as amended (the "Securities Act").
Discussions containing such forward-looking statements may be found throughout
this Information Statement, including without limitation in the materials set
forth under "SUMMARY"; "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS"; "THE COMPANY" and "BUSINESS." Actual
events or results may differ materially from those discussed in the
forward-looking statements as a result of various factors, including without
limitation the risk factors set forth below and the matters set forth in this
Information Statement generally.
LIMITED OPERATING HISTORY AS INDEPENDENT COMPANY; NO ASSURANCE OF FUTURE
PROFITABILITY
On August 14, 1996, the Company was incorporated by Stac, which transferred
the semiconductor business (along with the associated technology, assets and
liabilities) to the Company on November 21, 1996 in exchange for 6,000,000
shares of the Series A Preferred Stock and 100 shares of Company Common Stock.
The Company is a recently-formed entity with a limited operating history. There
can be no assurance that the Company will not encounter financial, managerial or
other difficulties as a result of its lack of operating history. In addition,
due to the anticipated increases in the Company's operating expenses, the
Company's operating results will be adversely affected if the Company's revenues
and gross margins do not increase in tandem with its increased expenses. The
Company's prospects must be considered in light of the risks, challenges and
difficulties frequently encountered by companies in their early stage of
development, particularly companies in rapidly evolving markets such as the
networking and semiconductor industries. To address these risks, the Company
must, among other things, successfully increase the scope of its operations,
respond to competitive developments, continue to attract, retain and motivate
qualified personnel and continue to commercialize products incorporating
innovative technologies. There can be no assurance that the Company will be
successful in addressing these risks and challenges.
FLUCTUATIONS IN OPERATING RESULTS
Fluctuations in the Company's operating results have occurred in the past
and are likely to occur in the future due to a variety of factors, any of which
may have a material adverse effect on the Company's operating results. In
particular, the Company's quarterly results of operations may vary significantly
due to general business conditions in the network, storage and semiconductor
industries, changes in demand for the network and storage equipment products of
the Company's customers, the timing and amount of orders from the Company's
customers, changes in customer mix, cancellations or delays of customer product
orders, new product introductions by the Company or its competitors,
cancellations, changes or delays of deliveries of products to the Company by its
suppliers, increases in the costs of products from the Company's suppliers,
fluctuations in product life cycles, price erosion, competition, changes in the
mix of products sold by the Company, availability of semiconductor foundry
capacity, variances in the timing and amount of nonrecurring engineering fees
and operating expenses, seasonal fluctuations in demand, intellectual property
disputes and general economic conditions. See "-- Customer Concentration." All
of the above factors are difficult for the Company to forecast, and these and
other factors could have a material adverse effect on the Company's business,
financial condition and results of operations. The Company has at times
recognized a substantial portion of its revenues in the last month of a quarter.
Since a large portion of the Company's operating expenses, including rent,
salaries and capital lease expenses, is fixed and difficult to reduce or modify
if the Company's revenue does not meet the Company's expectations, the adverse
effect of any revenue shortfall will be magnified by the fixed nature of these
operating expenses. In addition, the Company's lengthy sales cycle limits its
ability to forecast accurately its future financial performance. As a result of
all of the foregoing, there can be no assurance that the Company will be able to
sustain profitability on a quarterly or an annual basis. Moreover, the Company
believes that period-to-period comparisons are not necessarily meaningful and
should not be relied upon as indicative of future operating results. The
Company's operating results in a future quarter or quarters are likely to fall
below the expectations of public market analysts or investors. In such event,
the price of the Company's Common Stock will likely be materially adversely
affected.
9
<PAGE> 15
TERMINATION OF SUBSIDIARY RELATIONSHIP WITH STAC
As a subsidiary of Stac, the Company has been able to benefit from Stac's
financial strength and extensive network of business relationships with
companies. The Company has drawn on this resource in developing its own contacts
and relationships. After completion of the Distribution, Hi/fn will be a stand-
alone company and thus will no longer be able to benefit from Stac's
relationships to the same extent that it could as a majority-owned subsidiary of
Stac. Although Stac and the Company will enter into certain intercompany
agreements in connection with the Distribution pursuant to which Stac will
continue to provide certain services to the Company, such agreements will be of
short duration (generally one year) and will require the Company to begin
promptly to replace services currently being provided by Stac. There can be no
assurance that the Company will be able to replace such services on terms at
least as favorable as those negotiated with Stac or that the termination of
Stac's relationship with the Company will not adversely affect the Company's
business, financial condition and results of operations.
DEPENDENCE UPON DEVELOPMENT OF THE MARKET FOR PACKET PROCESSORS
The Company's future prospects are dependent upon the acceptance of packet
processors as an alternative to the Application Specific Integrated Circuit
("ASIC") components, software and general purpose microprocessors traditionally
utilized by network and storage equipment vendors. The Company's future
prospects are also dependent upon acceptance by the Company's customers of
third-party sourcing for packet processors as an alternative to in-house
development of such technology. Many of the Company's current and potential
customers have substantial technological capabilities and financial resources
and currently develop internally the ASIC components and program the general
purpose microprocessors utilized in their products. These customers may in the
future continue to utilize internally-developed ASIC components and general
purpose microprocessors or may determine to develop or acquire components,
technologies or packet processors that are similar to, or that may be
substituted for, the Company's products. The Company must anticipate market
trends and the price, performance and functionality requirements of such network
and storage equipment vendors and must successfully develop and manufacture
products that meet these requirements. In addition, the Company must make
products available to such customers on a timely basis and at competitive
prices. If the Company's customers fail to accept packet processors as an
alternative, if they develop or acquire the technology to develop such
components internally rather than purchase the Company's products, or if the
Company is otherwise unable to develop strong relationships with network and
storage equipment vendors, the Company's business, financial condition and
results of operations would be materially and adversely affected.
RISKS ASSOCIATED WITH NEW AND EVOLVING MARKETS
The Company seeks to be a leading supplier of packet processors that
implement the network security protocols necessary to support the deployment of
Virtual Private Networks ("VPNs"). The market for networking products designed
to support VPNs is still emerging, and there can be no assurance that it will
continue to grow, or that even if the market grows, the Company's products that
address this market will be successful. The Company's success in generating
significant revenue in this evolving market will depend upon, among other
things, its ability to demonstrate the benefits of its technology to potential
distributors, original equipment manufacturers ("OEMs") and end users. The
success of the Company's products designed to support VPNs will rely, to a large
degree, on the increased use of the Internet by businesses as replacements for,
or enhancements to, their private networks. There can be no assurance that
businesses will develop sufficient confidence in the Internet to deploy products
incorporating the Company's packet processors. The inability of the Company to
penetrate the VPN market or the failure of the current VPN market to grow or new
markets to develop and be receptive to the Company's products could have a
material adverse effect on the Company's business, financial condition and
results of operations. The emergence of the VPN market for the Company's
products will be affected by a number of factors beyond the Company's control.
For example, the Company's products are designed to conform to certain
standards-based network security protocols. There can be no assurance that these
protocols will be widely adopted or that competing protocols will not emerge
that will be preferred by the Company's customers.
10
<PAGE> 16
NEW PRODUCT DEVELOPMENT AND EVOLVING INDUSTRY STANDARDS; TECHNOLOGICAL CHANGE
The networking, storage and semiconductor industries are characterized by
rapidly changing technology, frequent product introductions and evolving
industry standards. Accordingly, the Company's future performance depends on a
number of factors, including the Company's ability to: properly identify
emerging target markets; identify emerging technological trends within such
markets; develop and maintain competitive products; enhance its products by
adding innovative features that differentiate its products from those of
competitors; bring products to market on a timely basis at competitive prices
and respond effectively to new technological changes or new product
announcements by others. The Company's past success has been dependent in part
upon its ability to develop products that have been selected for design into new
products ("design wins") of leading equipment manufacturers. The development of
the Company's packet processors, however, is highly complex, and from time to
time the Company has experienced delays in completing the development and
introduction of new products. No assurance can be given that the Company's
design and introduction schedules for any additions and enhancements to its
existing and future products will be met, that these products will achieve
market acceptance, that the Company will be able to sell these products at
average selling prices ("ASPs") that are favorable to the Company or that the
Company will achieve future design wins.
In evaluating new product decisions, the Company must anticipate well in
advance future demand for product features and performance characteristics, as
well as available supporting technologies, manufacturing capacity, competitive
product offerings and industry standards. For instance, in response to the
emergence of VPNs as an alternative, cost-effective network architecture, the
Company has made a substantial investment in products that support the IP
Security protocol (the "IPSec protocol"). The IPSec protocol is a networking
protocol developed by the Internet Engineering Task Force (the "IETF") that
provides data integrity and confidentiality for data transmitted over the
Internet. The failure of the IPSec protocol to become an industry standard, or
the emergence or evolution of new industry standards, through either adoption by
official standards committees or widespread use by network equipment vendors,
could require the Company to redesign its products, resulting in delays in the
introduction of such products.
The Company must also continue to make significant investments in research
and development in order to continue to enhance the performance and
functionality of its products to keep pace with competitive products and
customer demands for improved performance, features and functionality. The
technical innovations required for the Company to remain competitive are
inherently complex and require long development cycles. Such innovations must be
completed before developments in networking and storage technologies or
standards render them obsolete and must be sufficiently compelling to induce
network and storage equipment vendors to favor them over alternative
technologies. The rapid development of new competing technologies and standards
increases the risk that current or new competitors could develop products that
would reduce the competitiveness of the Company's products. Moreover, the
Company generally must incur substantial research and development costs before
the technical feasibility and commercial viability of a product line can be
ascertained. There can be no assurance that the introduction of future products
or product enhancements will be timely, that revenues from future products or
product enhancements will be sufficient to recover the development costs
associated with such products or enhancements, or that the Company will be able
to secure the financial resources necessary to fund future development. Market
acceptance of new technologies or the failure of the Company to develop and
introduce new products or enhancements directed at new industry standards could
have a material adverse effect on the Company's business, financial condition
and results of operations.
COMPETITION
The networking and storage markets into which the Company sells its
products are intensely competitive and are subject to frequent product
introductions with improved price-performance characteristics, rapid
technological change, unit price erosion and the continued emergence of new
industry standards. The semiconductor industry is also intensely competitive and
is characterized by rapid technological change, product obsolescence and unit
price erosion. The Company's products compete with products from companies such
as International Business Machines Corporation ("IBM"), VLSI Technology, Inc.
("VLSI"), Rainbow
11
<PAGE> 17
Technologies, Inc. ("Rainbow"), Information Resource Engineering Inc. ("IRE")
and Analog Devices, Inc. ("Analog Devices"). In 1994, Stac entered into two
license agreements with IBM pursuant to which Stac granted IBM the right to
implement, but not sublicense, the Company's patented compression technology in
IBM hardware and software products. Stac also entered into a license agreement
with Microsoft Corporation ("Microsoft") in 1994 pursuant to which Stac granted
Microsoft the right to create software implementations of the Company's patented
compression technology in Microsoft's software products. The Company also
competes against software solutions that use general purpose microprocessors to
run encryption algorithms and the Company's software compression libraries. The
Company expects significant future competition from major domestic and
international semiconductor suppliers. Several established electronics and
semiconductor suppliers have recently entered or indicated an intent to enter
the network equipment market. The Company also may face competition from
suppliers of products based on new or emerging technologies. Furthermore, many
of the Company's existing and potential customers internally develop ASICs,
general purpose microprocessors and other devices which attempt to perform all
or a portion of the functions performed by the Company's products.
A key element of the Company's packet processor architecture is the
encryption algorithms embedded in its semiconductor and software products. These
products are subject to export control restrictions administered by the U.S.
Department of Commerce, which permit the Company's network equipment customers
to export products incorporating encryption technology only with the appropriate
export license. As a result of these restrictions, foreign competitors facing
less stringent controls on their encryption products could inhibit the sale of
the Company's encryption/compression processors to network equipment customers
in the global market.
Many of the Company's current and prospective competitors offer broader
product lines and have significantly greater financial, technical, manufacturing
and marketing resources than the Company. As a result, they may be able to adapt
more quickly to new or emerging technologies and changes in customer
requirements or to devote greater resources to the promotion and sale of their
products than the Company. In particular, companies such as Texas Instruments
Incorporated ("Texas Instruments"), National Semiconductor Corporation
("National Semiconductor"), Lucent Technologies Inc. ("Lucent"), Intel
Corporation ("Intel") and Motorola, Inc. ("Motorola") have proprietary
semiconductor manufacturing ability, preferred vendor status with many of the
Company's customers, extensive marketing power and name recognition, greater
financial resources than the Company and other significant advantages over the
Company. In addition, current and potential competitors may determine, for
strategic reasons, to consolidate, to lower the prices of their products or to
bundle their products with other products. Current and potential competitors
have established or may establish financial or strategic relationships among
themselves or with existing or potential customers, resellers or other third
parties. Accordingly, it is possible that new competitors or alliances among
competitors could emerge and rapidly acquire significant market share. There can
be no assurance that the Company will be able to compete successfully against
current and future competitors. Increased competition may result in price
reductions, reduced gross margins and loss of market share, any of which could
materially adversely affect the Company's business, financial condition and
results of operations.
The Company believes that important competitive factors in its markets are
performance, price, length of development cycle, design wins with major network
and storage equipment vendors, support for new network and storage standards,
features and functionality, adaptability of products to specific applications,
support of product differentiation, reliability, technical service and support
and protection of products by effective utilization of intellectual property
laws. The failure of the Company to successfully develop and market products
that compete successfully with those of other suppliers in the market would have
a material adverse effect on the Company's business, financial condition and
results of operations. In addition, the Company must compete for the services of
qualified distributors and sales representatives. To the extent that the
Company's competitors offer such distributors or sales representatives more
favorable terms or a higher volume of business, such distributors or sales
representatives may decline to carry, or discontinue carrying, the Company's
products. The Company's business, financial condition and results of operations
could be adversely affected by any failure to maintain and expand its
distribution network. See "BUSINESS -- Competition."
12
<PAGE> 18
DEPENDENCE ON GROWTH IN DEMAND FOR NETWORK AND STORAGE EQUIPMENT
The Company's future success is in large measure dependent on continued
growth in the market for network security equipment, in particular the markets
for remote access concentrators, firewalls and server network interface cards
which are manufactured and sold by the Company's customers. In addition, the
Company's success also depends upon storage equipment vendors incorporating the
Company's packet processors into tape back-up systems. The market for these
products has in the past and may in the future fluctuate significantly based
upon numerous factors, including the lack of industry standards, adoption of
alternative technologies, capital spending levels and general economic
conditions. There can be no assurance with respect to the rate or extent to
which the networking or storage equipment markets will grow, if at all, nor can
there be any assurance that the Company will not experience a decline in demand
for its products. Any decrease in the growth of the network or storage equipment
markets or decline in demand for the Company's products could have a material
adverse effect on the Company's business, financial condition and results of
operations.
ABSENCE OF FUTURE FUNDING COMMITMENTS; NEED FOR FUTURE CAPITAL
The success of the Company's business strategy is dependent upon being able
to access equity capital markets and to obtain proceeds from borrowings on terms
financially advantageous to the Company. Currently the Company has no external
source of financing and the Company has not received any commitment with respect
to any funds needed in the future. Following the Distribution, the Company
intends to access equity capital markets and may seek other financing;
nevertheless, there can be no assurance that it will be able to do so at all or
in amounts or on terms acceptable to the Company. Failure to obtain additional
capital on acceptable terms could result in the delay or abandonment of some or
all of the Company's plans and could have a material adverse effect on the
Company. In the absence of such additional capital, there can be no assurance
that the Company will have sufficient working capital to finance future
acquisitions, to pursue business opportunities and to ensure customer, supplier
and employee credibility. Stac is not obligated to provide any additional funds
to the Company or to assist it in obtaining additional financing.
CUSTOMER CONCENTRATION
The Company's customer base is highly concentrated. A relatively small
number of customers has accounted for a significant portion of the Company's
revenues to date, and the Company expects that this trend will continue for the
foreseeable future. The Company has been, and continues to be, substantially
dependent upon sales to Quantum Corporation ("Quantum"). For example, in fiscal
1997, sales to Quantum accounted for 70% of the Company's revenues. Quantum is
not under any binding obligation to order products from the Company, and a
decline in sales to that customer would have a material adverse effect on the
Company's business, financial condition and results of operations. In fiscal
1996, two customers, Quantum and Ascend Communications, Inc., accounted for 43%
and 14% of the Company's revenues, respectively. In fiscal 1995, two customers,
Quantum and Exabyte Corporation, accounted for 35% and 19% of the Company's
revenues, respectively. For the nine months ended June 30, 1998, Quantum
accounted for 64% of revenues. The Company expects that its most significant
customers in future periods could be different from its largest customers in
prior periods due to a variety of factors, including customers' deployment
schedules and budget considerations. As a result, the Company expects to
experience significant fluctuations in its results of operations on a quarterly
and an annual basis. Because limited numbers of network and storage equipment
vendors account for a majority of packet processor purchases in their respective
markets, the Company's future success will depend upon its ability to establish
and maintain relationships with these companies. Many of the Company's current
and potential customers currently develop internally the ASIC components and
program the general purpose microprocessors utilized in their products as an
alternative to using the Company's packet processors. There can be no assurance
that current customers will continue to purchase products from the Company as
opposed to developing such products internally or that the Company will be able
to obtain orders from new customers. The Company's future success will depend in
significant part upon the decision of the Company's current and prospective
customers to continue to purchase products from the Company. If orders from
current customers are cancelled, decreased or delayed, or the Company fails to
13
<PAGE> 19
obtain significant orders from new customers, or any significant customer delays
payment or fails to pay, the Company's business, financial condition and results
of operations could be materially and adversely affected.
The market for network equipment that would include the Company's packet
processors, such as routers, remote access concentrators and firewalls,
currently is dominated by a few large vendors, including Cisco Systems, Inc.,
Ascend Communications, Inc., 3Com Corporation and Bay Networks, Inc. The failure
of such network equipment vendors to incorporate the Company's packet processors
into their products could have a material adverse effect on the Company's
business, financial condition and results of operations.
PRODUCT CONCENTRATION
The Company derives substantially all of its revenue from sales of its
compression processor products that, together, accounted for 87%, 88%, 89% and
75% of revenue in the nine months ended June 30, 1998 and fiscal 1997, 1996 and
1995, respectively. The Company expects that its compression processor products
will continue to account for a significant portion of the Company's revenue for
the foreseeable future. There can be no assurance that the Company will continue
to derive revenue from its compression processor products, and a decline in
revenue from such products would have a material adverse effect on the Company's
business, financial condition and results of operation. Moreover, the Company
believes that the emergence of VPNs provides a market opportunity for the
Company's packet processor products. The Company intends to leverage its
expertise in the compression processor market to provide network equipment
products that include both compression and encryption capability. There can be
no assurance that the Company will be successful in leveraging its core
compression technologies to gain market share in the network security market.
The Company's future financial performance will depend in significant part on
the successful development, introduction and customer acceptance of new
products. See "-- New Product Development and Evolving Industry Standards;
Technological Change."
LENGTHY SALES CYCLE
The Company sells its products to network and storage equipment vendors.
The Company's sales cycle involves test and evaluation of its products by the
potential customer, design of the customer's equipment to incorporate the
Company's products and the customer's own sales cycle. The sales cycle for the
test and evaluation of the Company's products can range from 3 to 6 months or
more with an additional 9 to 18 months or more before a customer commences
volume production of equipment which incorporates the Company's products.
Because of such lengthy sales cycle, the Company may experience a delay between
increasing expenses for research and development and sales and marketing efforts
and the generation of higher revenues, if any, from such expenditures. In
addition, the delays inherent in such lengthy sales cycle raise additional risks
of customer decisions to cancel or change product plans, which could result in
the loss of anticipated sales by the Company. Achieving a design win with a
network or storage equipment vendor provides no assurance that such network or
storage equipment vendor will ultimately ship products incorporating the
Company's packet processors. The Company's business, financial condition and
results of operations could be materially adversely affected if customers
curtail, reduce or delay orders during the Company's sales cycle or choose not
to release products employing the Company's packet processors.
EROSION OF AVERAGE SELLING PRICES
The networking, storage and semiconductor industries have experienced rapid
erosion of ASPs due to a number of factors, including rapid technological
change, price-performance enhancements and product obsolescence. The Company may
experience substantial period-to-period fluctuations in future operating results
due to ASP erosion. The Company anticipates that ASPs will decrease in the
future in response to product introductions by competitors of the Company or
other factors, including price pressures from significant customers. Therefore,
the Company must continue to develop and introduce on a timely basis new
products that incorporate features that can be sold at higher ASPs. Failure to
achieve any or all of the foregoing could cause the Company's revenues and gross
margins to decline, which would have a material adverse effect on the Company's
business, financial condition and results of operations.
14
<PAGE> 20
RISKS ASSOCIATED WITH INDEPENDENT MANUFACTURERS AND SOLE-SOURCE SUPPLY
The Company subcontracts all manufacturing, assembly and test of its packet
processors. The Company's suppliers currently deliver fully assembled and tested
products on a turnkey basis. The semiconductor industry is highly cyclical and,
in the past, foundry capacity has been very limited at times and may become
limited in the future. Currently, each of the Company's products is manufactured
by only one supplier. The Company depends on its suppliers to deliver sufficient
quantities of finished product to the Company in a timely manner. Since the
Company places its orders on a purchase order basis and does not have a
long-term volume purchase agreement with any of its existing suppliers, these
suppliers may allocate, and in the past have allocated, capacity to the
production of other products while reducing deliveries to the Company on short
notice. The Company has recently experienced delays in obtaining an adequate
supply of certain of its products from one supplier, as well as certain problems
regarding the quality of the products delivered by that supplier, and as a
result has begun obtaining such products from an alternative supplier. There can
be no assurance that the Company will not have similar or more protracted
problems in the future with existing or new suppliers. In addition, certain of
the Company's suppliers are located in Asia. To date, the Company has not
experienced any negative impact as a result of the financial and stock market
dislocations that have occurred in the Asian financial markets. There can be no
assurance, however, that present or future dislocations or other international
business risks, such as currency exchange fluctuations or recessionary
conditions, will not force the Company to seek new suppliers of its products. In
the event of a loss of, or a decision by the Company to change, a key supplier
or foundry, qualifying a new supplier or foundry and commencing volume
production could involve delay and expense, resulting in lost revenues, reduced
operating margins and possible detriment to customer relationships.
The Company must place orders approximately 12 to 14 weeks in advance of
expected delivery. As a result, the Company has only a limited ability to react
to fluctuations in demand for its products, which could cause the Company to
have an excess or a shortage of inventory of a particular product. Moreover, any
failure of global semiconductor manufacturing capacity to increase in line with
demand could cause foundries to allocate available capacity to larger customers
or customers with long-term supply contracts. The inability of the Company to
obtain adequate foundry capacity at acceptable prices, or any delay or
interruption in supply, could reduce the Company's product revenues or increase
the Company's cost of revenues and could have a material adverse effect on the
Company's business, financial condition and results of operations.
The Company continuously evaluates the benefits, on a product-by-product
basis, of migrating to a smaller semiconductor geometry process in order to
reduce costs, and has commenced migration of certain products to smaller
geometries. The Company believes that transitioning its products to increasingly
smaller geometries will be important for the Company to remain competitive. No
assurance can be given that future process migration will be achieved or
achieved without difficulty.
In the future, the Company may change its supply arrangements to assume
more of the product manufacturing responsibilities. Such changes could include
contracting for wafer manufacturing and subcontracting for assembly and test
rather than purchasing finished product. The assumption of greater manufacturing
responsibilities involves additional risks that include not only the risks
discussed above, but also risks associated with variances in production yields,
obtaining adequate test and assembly capacity at reasonable cost and other
general risks associated with the manufacture of semiconductors. In addition,
the Company also expects that it may enter into volume purchase agreements
pursuant to which the Company must commit to minimum levels of purchases and
which may require up-front investments. The inability of the Company to
effectively assume greater manufacturing responsibilities or manage volume
purchase arrangements could have a material adverse effect on the Company's
business, financial condition and results of operations. See
"BUSINESS -- Manufacturing."
PRODUCT COMPLEXITY
Products as complex as those offered by the Company frequently contain
errors, defects and bugs when first introduced or as new versions are released.
The Company has in the past experienced such errors, defects and bugs. Delivery
of products with production defects or reliability, quality or compatibility
problems could
15
<PAGE> 21
significantly delay or hinder market acceptance of such products, which could
damage the Company's reputation and adversely affect the Company's ability to
retain its existing customers and to attract new customers. Moreover, such
errors, defects or bugs could cause problems, interruptions, delays or a
cessation of sales to the Company's customers. Alleviating such problems may
require significant expenditures of capital and resources by the Company. There
can be no assurance that, despite testing by the Company, its suppliers or its
customers, errors, defects or bugs will not be found in new products after
commencement of commercial production, resulting in additional development
costs, loss of, or delays in, market acceptance, diversion of technical and
other resources from the Company's other development efforts, claims by the
Company's customers or others against the Company, or the loss of credibility
with the Company's current and prospective customers. Any such event would have
a material adverse effect on the Company's business, financial condition and
results of operations.
ORDER AND SHIPMENT UNCERTAINTIES
The Company's sales generally are made pursuant to individual purchase
orders that may be canceled or deferred by customers on short notice without
significant penalty. Cancellation or deferral of product orders could result in
the Company holding excess inventory, which could have a material adverse effect
on the Company's profit margins and restrict its ability to fund its operations.
The Company recognizes revenue upon shipment of products to the customer, net of
an allowance for estimated returns. Should the Company encounter an
unanticipated level of returns, this could have a material adverse effect on the
Company's business, financial condition and results of operations.
PROTECTION AND ENFORCEMENT OF INTELLECTUAL PROPERTY
The Company's future success and ability to compete are dependent, in part,
upon its proprietary technology. The Company relies in part on patent, trade
secret, trademark, maskwork and copyright law to protect its intellectual
property. The Company owns 12 United States patents and 4 foreign patents. The
Company also has 2 pending patent applications in Japan. The issued patents and
patent applications primarily cover various aspects of the Company's compression
technology and have expiration dates ranging from 2006 to 2013. There can be no
assurance that any patents will issue pursuant to the Company's current or
future patent applications or that the patents issued pursuant to such patent
applications will not be invalidated, circumvented or challenged, nor can there
be any assurance that infringement claims will not be made by third parties in
the future. Moreover, there can be no assurance that such claims, if made, will
not result in costly litigation or that the Company would prevail in any such
litigation or be able to license any valid and infringed patents from third
parties on commercially reasonable terms, if at all. Litigation, regardless of
the outcome, is likely to result in substantial cost and diversion of resources
to the Company. Any infringement claim or other litigation against or by the
Company could materially adversely affect the Company's business, financial
condition and results of operations.
There can be no assurance that any patents issued to the Company will be
adequate to safeguard and maintain the Company's proprietary rights, to deter
misappropriation or to prevent an unauthorized third party from copying the
Company's technology, designing around the patents owned by the Company or
otherwise obtaining and using the Company's products, designs or other
information. In addition, there can be no assurance that others will not develop
technologies that are similar or superior to the Company's technology.
Moreover, the Company claims copyright protection for certain proprietary
software and documentation. The Company attempts to protect its trade secrets
and other proprietary information through agreements with its customers,
suppliers, employees and consultants, and through other security measures.
Although the Company intends to protect its rights vigorously, there can be no
assurance that these measures will be successful. Furthermore, the laws of
certain countries in which the Company's products are or may be manufactured or
sold may not protect the Company's products and intellectual property. See
"BUSINESS -- Protection and Enforcement of Intellectual Property."
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DEPENDENCE ON KEY PERSONNEL AND HIRING OF ADDITIONAL PERSONNEL
The Company's success depends to a significant degree upon the continued
contributions of its key management and other personnel, many of whom would be
difficult to replace. The Company does not have employment contracts with any of
its key personnel and does not maintain any key man life insurance on any of its
personnel. In addition, the Company believes that its success depends to a
significant extent on the ability of its directors and officers to operate
effectively, both individually and as a group. Several members of the Company's
management team have joined the Company in the last 12 months. The Company
currently is conducting a search for a new Chief Executive Officer, and expects
one to take office prior to the Distribution. The Company may experience
difficulty in integrating members of its management team, and there can be no
assurance that the new executives will succeed in their roles in a timely and
efficient manner. The Company also must attract and retain highly skilled
managerial and other personnel. Competition for such personnel is intense, and
there can be no assurance that the Company will be successful in attracting and
retaining such personnel. The loss of the services of any key personnel, the
inability to attract or retain qualified personnel in the future or delays in
hiring required personnel, particularly engineers, could have a material adverse
effect on the Company's business, financial condition and results of operations.
In addition, companies in technology industries whose employees accept positions
with competitive companies have in the past claimed that their competitors have
engaged in unfair hiring practices. There can be no assurance that the Company
will not receive such claims in the future as it seeks to hire qualified
personnel or that such claims will not result in material litigation involving
the Company. The Company could incur substantial costs in defending itself
against any such claims, regardless of their merits.
MANAGEMENT OF GROWTH
The Company has experienced a period of rapid growth and expansion which
has placed, and continues to place, a significant strain on its resources. To
accommodate this growth, the Company will be required to implement a variety of
new and upgraded operational and financial systems, procedures and controls,
including the improvement of the accounting and other internal management
systems currently provided by Stac, all of which may require substantial
management effort. There can be no assurance that such efforts can be
accomplished successfully. In addition, this growth as well as the Company's
product development activities have necessitated an increase in the number of
the Company's employees, resulting in increased responsibilities for the
Company's management. There can be no assurance that the Company's systems,
procedures and controls will be adequate to support the Company's operations.
Any failure to improve the Company's operational, financial and management
information systems, or to hire, train, motivate or manage its employees could
have a material adverse effect on the Company's business, financial condition
and results of operations.
RISKS ASSOCIATED WITH EXPANSION OF INTERNATIONAL BUSINESS ACTIVITIES
Substantially all of the Company's sales to date have been to customers
located in the United States, including sales to U.S.-based affiliates of
non-U.S. network equipment vendors. If the Company's international sales
increase, the Company will be subject to additional risks inherent in
international operations. All of the Company's international sales to date are
U.S. dollar-denominated. As a result, an increase in the value of the U.S.
dollar relative to foreign currencies could make the Company's products less
competitive in international markets. In addition, the Company procures a
portion of its manufacturing, assembly and test services from suppliers located
outside the United States. International business activities may be limited or
disrupted by the imposition of governmental controls, export license
requirements, restrictions on the export of encryption technology, currency
exchange fluctuations, political instability, financial and stock market
dislocations, trade restrictions and changes in tariffs. Demand for the
Company's products also could be adversely affected by seasonality of
international sales and economic conditions in the Company's primary overseas
markets. These international factors could have a material adverse effect on
future sales of the Company's products to international customers and,
consequently, on the Company's business, financial condition and results of
operations.
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EXPORT RESTRICTIONS ON ENCRYPTION ALGORITHMS
A key element of the Company's packet processor architecture is the
encryption algorithms embedded in its semiconductor and software products. These
products are subject to export control restrictions administered by the U.S.
Department of Commerce, which permit the Company's network equipment customers
to export products incorporating encryption technology only with the appropriate
export license. In addition, these U.S. export laws prohibit the export of
encryption products to a number of countries deemed hostile by the U.S.
government. U.S. export regulations regarding the export of encryption
technology require either a transactional export license or the granting of
Department of Commerce Commodity jurisdiction. As a result of these
restrictions, foreign competitors facing less stringent controls on their
products may be able to compete more effectively than the Company's network
equipment customers in the global market. There can be no assurance that the
U.S. government will approve any pending or future export license requests.
Further, there can be no assurance that the list of products and countries for
which export approval is required, or the regulatory policies with respect
thereto, will not be revised from time to time, or that laws limiting the
domestic use of encryption will not be enacted. Failure of the Company's network
equipment customers to obtain the required licenses or the costs of compliance
could inhibit the sale of the Company's packet processors.
RISKS ASSOCIATED WITH POTENTIAL ACQUISITIONS
As part of its business strategy, the Company has in the past and expects
to continue to review acquisition prospects that would complement its existing
product offerings, augment its market coverage or enhance its technological
capabilities, or that may otherwise offer growth opportunities. While the
Company has no current agreements or negotiations underway with respect to any
such acquisitions, the Company may make acquisitions of businesses, products or
technologies in the future. Future acquisitions by the Company, which may be
effected without stockholder approval, could result in potentially dilutive
issuances of equity securities, the incurrence of debt and contingent
liabilities and amortization expenses related to goodwill and other intangible
assets, any of which could materially adversely affect the Company's operating
results and/or the price of the Company Common Stock. Acquisitions entail
numerous risks, including difficulties in the assimilation of acquired
operations, technologies and products, diversion of management's attention to
other business concerns, risks of entering markets in which the Company has no
or limited prior experience and potential loss of key employees of acquired
organizations. No assurance can be given as to the ability of the Company to
successfully integrate any businesses, products, technologies or personnel that
might be acquired in the future, and the failure of the Company to do so could
have a material adverse effect on the Company's business, financial condition
and results of operations.
CYCLICALITY OF SEMICONDUCTOR INDUSTRY
The semiconductor industry has historically been characterized by
significant downturns and wide fluctuations in supply and demand. From time to
time, the industry has also experienced significant fluctuations in anticipation
of changes in general economic conditions. This cyclicality has been
characterized by significant variances in product demand, production capacity
and accelerated erosion of unit ASPs. Industry-wide fluctuations in the future
could have a material adverse effect on the Company's business, financial
condition and results of operations.
YEAR 2000 COMPLIANCE
Many existing computer systems and applications, and other control devices,
use only two digits to identify a year in the date field, without considering
the impact of the upcoming change in the century. As a result, such systems and
applications could fail or create erroneous results unless corrected so that
they can process data related to the year 2000. The Company relies on its
systems, applications and devices in operating and monitoring all major aspects
of its business, including financial systems (such as general ledger, accounts
payable and payroll modules), customer services, networks and telecommunications
equipment and end products. The Company also relies, directly and indirectly, on
external systems of business enterprises such as customers, suppliers,
creditors, financial organizations, and of governmental entities, both domestic
and
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<PAGE> 24
international, for accurate exchange of data. Even if the internal systems of
the Company are not materially affected by the year 2000 issue, the Company
could be affected by disruptions in the operation of the enterprises with which
the Company interacts or year 2000 disruptions that affect the Company's
customers. Despite the Company's efforts to address the year 2000 impact on its
internal systems and business operations, there can be no assurance that such
impact will not result in a material disruption of its business or have a
material adverse effect on the Company's business, financial condition and
results of operations.
TAX RISKS OF THE DISTRIBUTION
The declaration of the Distribution dividend by the Stac Board is
conditioned upon, among other things, the receipt of a ruling from the IRS or a
favorable opinion from PricewaterhouseCoopers LLP as to the tax-free nature of
the Distribution, although the Stac Board may waive receipt of the ruling or the
opinion as a condition to consummation of the Distribution. See "THE
DISTRIBUTION -- Material Federal Income Tax Consequences of the Distribution"
and "-- Conditions; Termination." While a ruling has been requested, the IRS has
not yet issued a ruling and there can be no assurance that the IRS will issue a
ruling prior to the Distribution or at all.
A tax ruling, while generally binding upon the IRS, is subject to certain
factual representations and assumptions. A tax opinion, in addition to being
subject to the accuracy of the same representations and assumptions as a tax
ruling, is not binding on the IRS and merely reflects the best judgment of the
author. If such factual representations and assumptions were incorrect in a
material respect, the rights of taxpayers to rely on a tax ruling or Stac's
ability to rely on the tax opinion would be jeopardized. Stac is not aware of
any facts or circumstances which would cause such representations and
assumptions to be untrue.
If the Distribution were not to constitute a tax-free spin-off, then Stac
would be treated as recognizing a taxable gain equal to the difference between
(i) the fair market value of the distributed Company Common Stock on the
Distribution Date and (ii) Stac's adjusted basis of such Company Common Stock.
In addition, under the consolidated tax return rules of the Code, each member of
Stac's consolidated group (including Hi/fn) would be severally liable for such
tax liability. This resulting tax liability would have a material adverse effect
on the cash flows, business, financial condition and results of operations of
Stac and possibly Hi/fn.
Furthermore, if the Distribution were not to qualify under Section 355 of
the Code, each stockholder of Stac who receives shares of Company Common Stock
in the Distribution would be treated as if such stockholder had received a
taxable distribution in an amount equal to the fair market value of Company
Common Stock received, which would result in (i) a dividend to the extent of
such stockholder's pro rata share of Stac's current and accumulated earnings and
profits, (ii) a reduction in such stockholder's basis in such holder's shares of
Stac Common Stock to the extent that the amount received exceeds such
stockholder's share of earnings and profits and (iii) a gain from the deemed
sale or exchange of such shares of Stac Common Stock to the extent the amount
received exceeds both such stockholder's share of earnings and profits and such
stockholder's basis in such shares of Stac Common Stock. See "THE
DISTRIBUTION -- Material Federal Income Tax Aspects of the Distribution."
POSSIBLE CONFLICTS WITH STAC AFTER THE DISTRIBUTION
Conflicts of interest may arise between Stac and Hi/fn in a number of areas
relating to their past and ongoing relationships, including potential
competitive business activities, tax and employee benefit matters, indemnity
arrangements and the existence of certain dual management capacities of
directors who continue to serve both companies. See "RELATIONSHIP BETWEEN STAC
AND HI/FN AFTER THE DISTRIBUTION -- Policies and Procedures for Addressing
Conflicts." Currently, two individuals are members of the Board of Directors of
both Stac and Hi/fn. Directors of Stac who are also directors of Hi/fn may have
conflicts of interest with respect to matters potentially or actually involving
or affecting Stac and Hi/fn. There can be no assurance that conflicts will be
resolved without detriment to the interests of one company or the other.
Further, although neither Stac nor Hi/fn presently intends to engage in the
businesses presently conducted by the other, neither company is contractually
obligated not to do so, except for the provision in the Cross License Agreement
between Stac and Hi/fn prohibiting Stac from creating any hardware implementa-
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<PAGE> 25
tions of the technology subject to the license or selling the software subject
to the license as a stand-alone product for a period of ten years from the date
of the Cross License Agreement. See "RELATIONSHIP BETWEEN STAC AND HI/FN AFTER
THE DISTRIBUTION -- Policies and Procedures for Addressing Conflicts."
CONTROL BY EXECUTIVE OFFICERS AND DIRECTORS
Based solely on their ownership of Stac Common Stock, Company Common Stock
and options to acquire Company Common Stock as of the Record Date, the executive
officers and directors of the Company will beneficially own an aggregate of
shares, or approximately %, of the outstanding Company Common
Stock immediately following the Distribution. See "SECURITIES OWNERSHIP OF
CERTAIN BENEFICIAL OWNERS AND MANAGEMENT." Such persons will have substantial
influence over the Company and on the outcome of matters submitted to the
Company's stockholders for approval. In addition, such ownership could
discourage acquisition of Company Common Stock by potential investors, and could
have an antitakeover effect, possibly depressing the trading price of the
Company Common Stock.
ABSENCE OF PRIOR TRADING MARKET FOR COMPANY COMMON STOCK; POTENTIAL VOLATILITY
There is no existing market for the Company Common Stock. Although the
Company has applied for quotation and trading of the Company Common Stock on the
Nasdaq National Market, no assurance can be given that an active trading market
for the Company Common Stock will develop following the Distribution or, if
developed, that any such market will be sustained. In the absence of a public
trading market, an investor may be unable to liquidate his investment in the
Company. Prices at which the Company Common Stock may trade cannot be predicted.
Nothing herein should be construed to suggest that the trading price of Stac
Common Stock at any point in time may be used as a substitute for the trading
price of Company Common Stock. The prices at which the Company Common Stock
trades will be determined by the marketplace and may be influenced by many
factors, including, among others, the success of the Company's business, the
depth and liquidity of the market for the Company Common Stock, investor
perception of the Company and its assets, the Company's dividend policy, and
general economic and market conditions. The depth and liquidity of the market
for the Company Common Stock may be affected by the aggregate beneficial
ownership by executive officers and directors of the Company of approximately
% of the Company Common Stock immediately following the Distribution. See
"-- Control by Executive Officers and Directors." The prices at which the
Company Common Stock trades also may be affected by certain provisions of the
Company Certificate and the Company Bylaws, as each will be in effect following
the Distribution, which may have an antitakeover effect. See "-- Effect of
Antitakeover Provisions."
In addition, in recent years the stock market in general, and the market
for shares of high technology, networking, storage and semiconductor companies
in particular, have experienced extreme price fluctuations, which have often
been unrelated to the operating performance of affected companies. The trading
price of the Company Common Stock is expected to be subject to extreme
fluctuations in response to both business-related issues, such as quarterly
variations in operating results, announcements of new products by the Company or
its competitors, the gain or loss of significant network or storage equipment
vendor customers, and stock market-related influences, such as changes in
analysts' estimates, the presence or absence of short-selling of the Company
Common Stock and events affecting other companies that the market deems to be
comparable to the Company. Moreover, technology stocks have from time to time
experienced extreme price and volume fluctuations that often have been unrelated
or disproportionate to the operating performance of these companies. These broad
market fluctuations may adversely affect the market price of the Company Common
Stock. Moreover, the trading prices of many high technology, networking, storage
and semiconductor stocks are at or near their historical highs and reflect
price/earnings ratios substantially above historical norms.
EFFECT OF ANTITAKEOVER PROVISIONS
Certain provisions of the Company Certificate and Company Bylaws, as each
will be in effect following the Distribution, and of Delaware law could
discourage potential acquisition proposals and could delay or
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<PAGE> 26
prevent a change in control of the Company. Such provisions could diminish the
opportunities for a stockholder to participate in tender offers, including
tender offers at a price above the then current market value of the Company
Common Stock. Such provisions may also inhibit increases in the market price of
the Company Common Stock that could result from takeover attempts. The Company
Certificate authorizes 10,000,000 shares of undesignated Company Preferred
Stock. The Company Board, without further stockholder approval, may issue this
Company Preferred Stock with such terms as the Board of Directors may determine,
which could have the effect of delaying or preventing a change in control of the
Company. The issuance of Company Preferred Stock could also adversely affect the
voting power of the holders of Company Common Stock, including the loss of
voting control to others. Such Company Preferred Stock could be utilized to
implement, without stockholder approval, a stockholders' rights plan that could
be triggered by certain change in control transactions, which could delay or
prevent a change in control of the Company or could impede a merger,
consolidation, takeover or other business combination involving the Company, or
discourage a potential acquiror from making a tender offer or otherwise
attempting to obtain control of the Company. The Company has no current plans to
issue shares of Company Preferred Stock. The Company Bylaws and indemnification
agreements provide that the Company will indemnify officers and directors
against losses that they may incur in legal proceedings resulting from their
service to the Company. In addition, the Company's charter documents provide for
a classified Board of Directors and eliminate the right of stockholders to call
special meetings of stockholders and to take action by written consent.
Moreover, Section 203 of the Delaware General Corporation Law restricts certain
business combinations with "interested stockholders" as defined by that statute.
The provisions of the Company Certificate and of Delaware law are intended to
encourage potential acquirors to negotiate with the Company and allow the Board
the opportunity to consider alternative proposals in the interest of maximizing
stockholder value. However, such provisions may also have the effect of
discouraging acquisition proposals or delaying or preventing a change in control
of the Company, which in turn may have an adverse effect on the market price of
the Company Common Stock. See "HI/FN CERTIFICATE OF INCORPORATION AND BYLAWS."
SHARES ELIGIBLE FOR FUTURE SALE
The approximately 6,000,100 shares of Company Common Stock distributed to
Stac stockholders in the Distribution will be freely transferable, except for
the shares distributed to persons who may be deemed to be "affiliates" of the
Company under the Securities Act. Such affiliates will be permitted to sell
their shares of Company Common Stock pursuant to Rule 144 under the Securities
Act immediately following the Distribution, subject to certain volume
limitations, manner of sale limitations, notice requirements and the
availability of current public information about the Company. In addition,
immediately following the Distribution, options to purchase 858,395 shares of
Company Common Stock will be outstanding under the 1996 Plan. See
"MANAGEMENT -- Hi/fn Equity Plan." The Company intends to file a Registration
Statement on Form S-8 with respect to such shares following the Distribution.
Consequently, shares issued pursuant to the exercise of options granted under
the 1996 Plan will be freely transferable without restriction, subject, in the
case of sales by affiliates, to compliance with Rule 144.
The Company is unable to estimate the number of shares that may be sold in
the future by its stockholders or the effect, if any, that sales of shares by
such stockholders will have on the market price of the Company Common Stock
prevailing from time to time. Sales of substantial amounts of Company Common
Stock, or the prospect of such sales, could adversely affect the market price of
the Company Common Stock.
DIVIDEND POLICY
The future payment of dividends by the Company will depend on decisions
that will be made by the Company Board from time to time based on the results of
operations and financial condition of the Company and such other business
considerations as the Company Board considers relevant. The Company presently
anticipates that it will retain all available funds for use in the operation and
expansion of its business and does not anticipate paying any dividends in the
foreseeable future. See "THE DISTRIBUTION -- Quotation and Trading of Company
Common Stock; Dividend Policy."
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DILUTION
Following the Distribution, the Company intends to access the capital
markets and may seek other financing through the issuance and sale of equity
securities See "-- Absence of Future Funding Commitments; Need for Further
Capital." Moreover, the Company has authorized options to purchase 1,949,900
shares of Company Common Stock under the 1996 Plan, 482,806 of which have been
issued to date upon exercise of options and 858,395 of which were subject to
options outstanding on the Record Date. Any such issuances, including the
exercise of any outstanding options, may significantly dilute the interests of
the existing holders of Company securities, including the Company Common Stock.
POTENTIAL ADVERSE EFFECTS OF DISTRIBUTION ON STAC COMMON STOCK
After the Distribution, the Stac Common Stock will continue to be traded on
the Nasdaq National Market. As a result of the Distribution, the trading price
of Stac Common Stock is expected to be lower than the trading price of Stac
Common Stock prior to the Distribution to reflect the value of the Company
Common Stock distributed to holders of Stac Common Stock as of the record date.
The combined trading prices of Stac Common Stock and Company Common Stock after
the Distribution may be less than, equal to or greater than the trading prices
of Stac Common Stock prior to the Distribution. In addition, until the market
has fully analyzed the operations of Stac without the Company's assets, the
price at which the Stac Common Stock trades may fluctuate significantly.
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THE DISTRIBUTION
BACKGROUND AND REASONS FOR THE DISTRIBUTION
The Distribution is designed to separate the semiconductor business of
Hi/fn from the software business of Stac. The Distribution will result in the
formation of two publicly traded companies, each of which will pursue an
independent strategic path. The Stac Board believes the separation will offer
both new entities the opportunity to pursue strategic objectives appropriate to
different business objectives, offer each entity the financial flexibility to
raise capital on a more cost-effective basis and create targeted incentives for
each company's management and key employees. The Stac Board considered the
following in making its decision to approve the Distribution:
Business and Market Rationale
The Distribution will enable two companies with distinct strategic,
financial and operating goals to adopt strategies and pursue objectives
appropriate to their respective core businesses. The Distribution will allow
each entity to pursue its corporate objectives independent of the operations and
policies of the other. Following the Distribution, Stac will continue to focus
on its software business. The Company, in turn, will focus on its semiconductor
business.
Access to Equity Capital
The Company intends to engage in a public offering of Company Common Stock
as soon as possible following the Distribution, assuming business and market
conditions support such an offering. Stac also may elect to raise additional
capital after the Distribution. The Stac Board believes that, as independent
publicly traded entities, Stac and the Company will each have greater
flexibility in their ability to raise equity capital and will be able to more
efficiently pursue their respective capital raising strategies in both the
private and public markets.
In the near term, the Company will have substantial cash needs for (i)
working capital, (ii) funding the continued expansion of its business and (iii)
maintaining sufficient cash reserves to ensure customer, supplier and employee
credibility. In order to compete with its larger, direct competitors, the
Company will need to raise additional capital to fund its growing inventory and
accounts receivable balances, fund increased technology research and
development, fund technology acquisitions and fund an increased marketing and
sales infrastructure. Stac's existing cash is not available to the Company,
except for limited debt or equity financing prior to the Distribution. Stac
intends to utilize its cash to fund its continued development, marketing and
sales efforts with respect to its Replica product line. Further, Stac
anticipates that with increasing advances in technology, it will need to fund
acquisitions of technology to be able to successfully compete in the
marketplace.
The Stac Board believes that the Company's ability to raise capital will be
enhanced to the extent that the investment community can evaluate the Company on
a stand-alone basis. Market analysts are increasingly focusing their coverage on
specific types of businesses, such as semiconductor or software. As a result of
this tendency for analysts to specialize, there are few analysts that have the
industry expertise to value both the semiconductor and software components of
Stac and the Company as a combined entity. Accordingly, representative analyst
coverage for Stac has been extremely low compared to other software and
semiconductor companies. The Stac Board believes this lack of sufficient and
reliable analyst coverage significantly impairs Stac's and the Company's
abilities to raise capital efficiently and effectively.
Management Focus and Employee Incentives
The Distribution will enable both companies to focus on their respective
businesses. Stac's software business and the Company's semiconductor business
are sufficiently distinct in terms of technology, stage of product development
and commercialization, market focus and other factors such that it is more
advantageous for both to operate and be managed as separate entities. The
Distribution is expected to allow management and employees of each company to
focus on their respective paths of innovation in product development and
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marketing, thereby enhancing the ability of each to optimize productivity and
growth. In addition, the Distribution is intended to allow each company to
provide both management and employees with targeted equity compensation
arrangements thereby optimizing the economic incentives each entity will be able
to provide its employees.
Attraction and Retention of Key Employees
The Company competes for talented managers and skilled employees in
California's Silicon Valley against other large, established semiconductor
companies and against venture capital-funded technology start-ups that
traditionally provide significant stock options to key employees. Given this
competition, the Stac Board believes it is critical to provide a structure that
will be attractive to employees and provide them with opportunities similar to
those offered to them by other companies in Silicon Valley. The Stac Board
believes that to attract talented and skilled employees, a company must provide
equity-based compensation in a stand-alone entity to provide opportunities for
employees and management to maximize the value of their equity interests through
their actions.
To date, Stac has attempted to achieve such goals with limited success. As
an interim solution, Stac created the Company as a separate legal entity and
established the 1996 Plan. This approach established a direct link between
employee compensation and the semiconductor division's operations. However, the
Company's status as a subsidiary of Stac has limited the flexibility and
perceived independence of the Company's management to operate the Company and
its ability to maximize the value of the Company's equity. In addition, the
absence of a market for the Company's shares limits liquidity for option
holders. Without registered shares and a ready market, Company employees face
the prospect of having to pay substantial withholding tax upon exercise of
options without a ready means of obtaining cash to pay such tax.
The Stac Board believes that for Stac and the Company to succeed in two
highly competitive and rapidly changing areas, they must be able to hire and
retain experts in the software and semiconductor fields. In order to do this,
they must be able to offer those employees the types of positions and
compensation incentives that stand-alone public companies can offer candidates.
Specifically, Stac and the Company must be able to offer compensation that (i)
is linked directly to the separate performance of the software and semiconductor
businesses, (ii) provides maximum liquidity to the employees and (iii) provides
operational freedom and incentive to grow the two businesses independently.
FAIRNESS OPINION
Warburg Dillon Read LLC ("WDR") has served as financial advisor to Stac in
connection with the Distribution and delivered a written opinion (the "WDR
Opinion") to the Stac Board dated July 17, 1998, to the effect that, as of the
date of the WDR Opinion and based on and subject to the assumptions, limitations
and qualifications set forth therein, from a financial point of view, the
Distribution is fair to the stockholders of Stac.
THE FULL TEXT OF THE WDR OPINION IS ATTACHED AS ANNEX IV TO THIS
INFORMATION STATEMENT AND IS INCORPORATED HEREIN BY REFERENCE. REFERENCE SHOULD
BE MADE TO THE WDR OPINION FOR ASSUMPTIONS MADE, PROCEDURES FOLLOWED AND OTHER
MATTERS CONSIDERED BY WDR. THE SUMMARY OF THE WDR OPINION SET FORTH HEREIN IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THE FULL TEXT OF THE WDR OPINION.
No limitations were imposed by Stac on the scope of WDR's investigation or
the procedures to be followed by WDR in rendering its opinion. In arriving at
its opinion, WDR did not ascribe a specific range of values to Stac, but rather
made its determination as to the fairness of the Distribution to the Stac
stockholders, from a financial point of view, on the basis of the financial and
comparative analyses described below. The WDR Opinion is for the use and benefit
of the Stac Board and was rendered to the Stac Board in connection with its
consideration of the Distribution. WDR was not requested to opine as to, and its
opinion does not address, Stac's underlying business decision to proceed with or
effect the Distribution.
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<PAGE> 30
In arriving at its opinion, WDR reviewed and analyzed: (i) the terms of the
Distribution, (ii) Stac's annual report on Form 10-K for the year ended
September 30, 1997 and such other publicly available information concerning Stac
that WDR believed to be relevant to its analysis, (iii) financial and operating
information with respect to the business, operations and prospects of Stac and
the Company, furnished to WDR by Stac and the Company, (iv) a trading history of
Stac Common Stock and a comparison of that trading history with those of other
companies that WDR deemed relevant, (v) a comparison of the historical financial
results and present financial condition of Stac with those of other companies
that WDR deemed relevant and (vi) a comparison of the historical financial
results and present financial condition of the Company with those of other
companies that WDR deemed relevant. In addition, WDR had discussions with the
management of both Stac and the Company concerning the businesses, operations,
assets, financial conditions and prospects of Stac and the Company (including on
a pro forma basis) and undertook such other studies, analyses and investigations
as it deemed appropriate.
In arriving at its opinion, WDR assumed and relied upon the accuracy and
completeness of the financial and other information used by it without assuming
any responsibility for independent verification of such information and further
relied upon the assurances of management of Stac that they were not aware of any
facts or circumstances that would make such information inaccurate or
misleading. With respect to the financial projections of Stac and the Company
following the Distribution, upon advice of Stac, WDR assumed that such
projections were reasonably prepared on a basis reflecting the best currently
available estimates and judgments of the management of Stac and the Company as
to the future financial performance of Stac and the Company and that Stac and
the Company will perform substantially in accordance with such projections. In
arriving at its opinion, WDR did not make or obtain any evaluations or
appraisals of the assets or liabilities of Stac or the Company. WDR has assumed
that the Distribution will be a tax-free transaction to the stockholders of
Stac. The WDR Opinion necessarily is based upon forecast financial information
provided by Stac and the Company to WDR as well as market, economic and other
conditions as they exist on, and can be evaluated as of, the date of the WDR
Opinion.
The process by which securities trading markets establish a market price
for any security is complex, involving the interaction of numerous factors, and
market prices will fluctuate with changes of, among other factors, the financial
condition, business and prospects of the issuer and comparable companies and
economic and financial market conditions. In addition, trading in shares of the
Company Common Stock will likely be characterized by a period of redistribution
among stockholders of Stac who receive such shares in the Distribution, which
may temporarily depress the market price of such shares during such period.
Accordingly, WDR expresses no opinion as to the prices at which shares of Stac
Common Stock or Company Common Stock actually will trade following the
consummation of the Distribution. The WDR Opinion should not be viewed as
providing any assurances that the combined market value of the shares of Stac
Common Stock after consummation of the Distribution and the shares of Company
Common Stock to be received by a stockholder of Stac pursuant to the
Distribution will be in excess of the market value of the shares of Stac Common
Stock owned by such stockholder at any time prior to announcement of
consummation of the Distribution.
The following is a summary of certain financial and comparative analyses
performed by WDR and presented to the Stac Board.
WDR compiled financial and stock market statistics for a number of
comparable software and semiconductor companies for both Stac and the Company.
For Stac, these companies were divided into: (i) back-up and disaster recovery
software companies, such as Veritas Software Corporation, Legato Systems, Inc.
and Computer Associates International, Inc. and (ii) remote control software
companies, such as Symantec Corporation. No single company or group of companies
is directly comparable to Stac's business. Based on publicly available
information and various assumptions and estimates as published by securities
analysts, WDR calculated various arithmetic and statistical comparisons,
including market values and price to earnings ratios.
A separate comparable company analysis was developed for the Company. These
comparable companies consisted of semiconductor companies that supply integrated
circuits and other related products, but not necessarily products that compete
with those of the Company, to the networking equipment industry. These
25
<PAGE> 31
companies included MMC Networks, Inc., Level One Communications, Inc., Broadcom
Corporation, Galileo Technology Ltd., VLSI, Altera Corporation and Xilinx
Corporation. Based on publicly available information and various assumptions and
estimates as published by securities analysts, WDR calculated various arithmetic
and statistical comparisons, including market values and a comparison of
technology platforms.
WDR also analyzed Stac's historical stock price performance on an absolute
basis and compared to its comparable companies. The analysis indicated that the
market price of Stac Common Stock has underperformed the equally weighted index
of the common stocks of the comparable companies relative to most of the ratios
and comparisons analyzed.
The preparation of a fairness opinion involves various determinations as to
the most appropriate and relevant methods of financial and comparative analysis
and the application of those methods to the particular circumstances and,
therefore, such an opinion is not readily susceptible to summary description.
Furthermore, in arriving at its opinion, WDR did not attribute any particular
weight to any analysis or factor considered by it, but rather made qualitative
judgments as to the significance and relevance of each factor and analysis.
Accordingly, WDR believes that its analyses must be considered as a whole and
that considering any portion of such analyses and factors, without considering
all analyses and factors, could create a misleading or incomplete view of the
process underlying its opinion. In its analyses, WDR made numerous assumptions
with respect to industry performance, general business and economic conditions
and other matters, many of which are beyond the control of Stac or the Company.
Any estimates contained in these analyses are not necessarily indicative of
actual values or predictive of future results or values, which may be
significantly more or less favorable than as set forth therein. In addition,
analyses relating to the value of businesses do not purport to be appraisals or
to reflect the prices at which businesses actually may be sold.
WDR is an internationally recognized investment banking and financial
advisory firm and, as part of its investment banking activities, is regularly
engaged in the evaluation of businesses and their securities in connection with
mergers and acquisitions, negotiated underwritings, competitive bids, secondary
distributions of listed and unlisted securities, private placements and
valuations for corporate and other purposes. The Stac Board selected WDR because
of its expertise, reputation and familiarity with Stac in particular and the
software and semiconductor industries in general and because its investment
banking professionals have substantial experience in transactions similar to the
Distribution.
As compensation for its services in connection with the Distribution, WDR
has a signed engagement letter from Stac which includes a fee of $750,000
payable upon the consummation of the Distribution. In addition, Stac has agreed
to reimburse WDR for its reasonable expenses incurred in connection with its
engagement and to indemnify WDR and certain related persons for certain
liabilities that may arise out of its engagement by Stac and the rendering of
the WDR Opinion.
In the ordinary course of its business, WDR may actively trade in the
equity securities of Stac for its own account and for the accounts of WDR's
customers and, accordingly, may at any time hold a long or short position in
such securities.
DISTRIBUTION AGENT
The Distribution Agent is American Stock Transfer & Trust Company, 40 Wall
Street, New York, New York 10005.
MANNER OF EFFECTING THE DISTRIBUTION
The general terms and conditions relating to the Distribution are set forth
in the Distribution Agreement that will be executed on or prior to the
Distribution Date between Stac and the Company.
As of the Record Date, the Company had [471,007] shares of Company Common
Stock outstanding, held by 21 stockholders of record including Stac. The Company
also had 6,000,000 shares of Series A Preferred Stock outstanding, all of which
were held by Stac. Immediately prior to the Distribution, Stac will convert all
shares of Series A Preferred Stock into Company Common Stock, resulting in
Stac's owning 6,000,100 shares of Company Common Stock. All of such shares will
be distributed to Stac stockholders. Stac
26
<PAGE> 32
will distribute one share of Company Common Stock for every [4.0029] shares of
Stac Common Stock held by Stac stockholders on the Record Date (the
"Distribution Ratio"). Stac will effect the Distribution on the Distribution
Date by delivering all of the outstanding shares of Company Common Stock held by
Stac to the Distribution Agent on behalf of, and for distribution to, the
holders of record of Stac Common Stock as of the close of business on the Record
Date. The shares of Company Common Stock will be fully paid and nonassessable,
and the holders thereof will not be entitled to preemptive rights. See
"DESCRIPTION OF THE COMPANY'S CAPITAL STOCK." It is expected that certificates
representing shares of the Company Common Stock will be mailed to holders of
Stac Common Stock as soon as practicable after the Distribution Date.
HOLDERS OF STAC COMMON STOCK SHOULD NOT SEND CERTIFICATES TO THE COMPANY,
STAC OR THE DISTRIBUTION AGENT. THE DISTRIBUTION AGENT WILL MAIL THE STOCK
CERTIFICATES REPRESENTING SHARES OF COMPANY COMMON STOCK AS SOON AS PRACTICABLE
AFTER THE DISTRIBUTION DATE. STAC STOCK CERTIFICATES WILL CONTINUE TO REPRESENT
SHARES OF STAC COMMON STOCK AFTER THE DISTRIBUTION IN THE SAME AMOUNT SHOWN ON
THE CERTIFICATES.
No certificates or scrip representing fractional interests in shares of the
Company Common Stock will be issued to holders of Stac Common Stock as part of
the Distribution. The Distribution Agent, acting as agent for holders of Stac
Common Stock otherwise entitled to receive in the Distribution certificates
representing fractional shares, will aggregate and sell in the open market all
fractional shares at then prevailing prices and distribute the net proceeds to
the stockholders entitled thereto. Stac will pay the fees and expenses of the
Distribution Agent in connection with such sales.
No holder of Stac Common Stock will be required to pay any cash or other
consideration for the shares of Company Common Stock to be received in the
Distribution or to surrender or exchange shares of Stac Common Stock or to take
any other action in order to receive the Company Common Stock pursuant to the
Distribution.
RESULTS OF THE DISTRIBUTION
After the Distribution, the Company will be a separate public company which
will continue to operate its semiconductor business. See "THE COMPANY" and
"BUSINESS." The number and identity of the holders of Company Common Stock
immediately after the Distribution will be substantially the same as the number
and identity of the holders of Company Common Stock (other than Stac) prior to
the Distribution plus the number and identity of the holders of Stac Common
Stock on the Record Date. Immediately after the Distribution, the Company
expects to have approximately 450 holders of record of the Company Common Stock
and approximately 6,471,007 shares of the Company Common Stock outstanding based
on the number of shares of Company Common Stock and Series A Preferred Stock
outstanding on the Record Date.
MATERIAL FEDERAL INCOME TAX CONSEQUENCES OF THE DISTRIBUTION
The declaration of the Distribution dividend by the Stac Board is
conditioned upon, among other things, the receipt of a ruling from the IRS or a
favorable opinion from PricewaterhouseCoopers LLP as to the tax-free nature of
the Distribution, although the Stac Board may waive receipt of the ruling or the
opinion as a condition to consummation of the Distribution. See "-- Conditions;
Termination." The IRS has not issued a ruling letter and there can be no
assurance that the IRS will issue a ruling prior to the Distribution.
On April 16, 1998, Stac requested a private ruling from the IRS that the
Distribution will qualify as a tax free spin-off under Section 355 of the Code,
and that, for federal income tax purposes:
(1) No gain or loss will be recognized by Stac upon the Distribution
of all the outstanding stock of Hi/fn then held by Stac to the Stac
stockholders.
(2) No gain or loss will be recognized by (and no amount will be
included in the income of) the stockholders of Stac upon receipt of the
Company Common Stock distributed to them in the Distribution.
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<PAGE> 33
(3) The aggregate basis of the stock of Stac and Hi/fn in the hands of
each Stac stockholder after the Distribution will, in each instance, equal
the aggregate basis of the Stac Common Stock held by such stockholder
immediately before the Distribution, allocated in proportion to the fair
market value of each.
(4) The holding period of the Company Common Stock which each Stac
stockholder receives will include the holding period of the Stac Common
Stock with respect to which the Distribution will be made, provided the
Stac Common Stock is held as a capital asset by such stockholder.
(5) Where cash is received by a Stac stockholder in lieu of fractional
share interests of Company Common Stock, such fractional share interests
will be treated as having been received and disposed of by such stockholder
in a taxable sale in which gain (or loss) will be treated as capital gain
(or loss), provided such stock is held as a capital asset by the selling
Stac stockholder.
(6) Earnings and profits will be properly allocated between Stac and
Hi/fn.
As of the date hereof, the IRS has not issued a ruling letter, and there
can be no assurance that the IRS will issue a favorable ruling in response to
Stac's request. Moreover, even if such a ruling is obtained, it should be noted
that private letter rulings, while generally binding on the IRS, are subject to
certain factual representations and assumptions. If such factual representations
and assumptions were incorrect in any material respect, the ability to rely on
such a ruling would be jeopardized. However, Stac is not aware of any facts or
circumstances that would cause such representations and assumptions to be
untrue.
If a timely ruling is not issued by the IRS, the Stac Board may decide to
effect the Distribution in reliance on a favorable opinion of
PricewaterhouseCoopers LLP or to delay the Distribution until the IRS has
granted the requested ruling. A tax opinion, in addition to being subject to
certain factual representations and assumptions (as in the case of a ruling), is
not binding on the IRS and merely reflects the best judgment of the author.
If the Distribution were not to constitute a tax-free spin-off, then Stac
would be treated as recognizing a taxable gain equal to the difference between
(i) the fair market value of the distributed Company Common Stock on the
Distribution Date and (ii) Stac's adjusted basis of such Company Common Stock.
In addition, under the consolidated tax return rules of the Code, each member of
Stac's consolidated group (including Hi/fn) would be severally liable for such
tax liability. This resulting tax liability would have a material adverse effect
on the cash flows, business, financial condition and results of operations of
Stac and possibly Hi/fn.
Furthermore, if the Distribution were not to qualify under Section 355 of
the Code, each stockholder of Stac who receives shares of Company Common Stock
in the Distribution would be treated as if such stockholder had received a
taxable distribution in an amount equal to the fair market value of Company
Common Stock received, which would result in (i) a dividend to the extent of
such stockholder's pro rata share of Stac's current and accumulated earnings and
profits, (ii) a reduction in such stockholder's basis in such holder's shares of
Stac Common Stock to the extent that the amount received exceeds such
stockholder's share of earnings and profits and (iii) a gain from the deemed
sale or exchange of such shares of Stac Common Stock to the extent the amount
received exceeds both such stockholder's share of earnings and profits and such
stockholder's basis in such shares of Stac Common Stock. See "RISK
FACTORS -- Tax Risks of the Distribution."
THE SUMMARY OF FEDERAL INCOME TAX CONSEQUENCES SET FORTH ABOVE DOES NOT
PURPORT TO COVER ALL FEDERAL INCOME TAX CONSEQUENCES THAT MAY APPLY TO ALL
CATEGORIES OF STOCKHOLDERS. ALL STOCKHOLDERS SHOULD CONSULT THEIR OWN TAX
ADVISORS REGARDING THE PARTICULAR FEDERAL, FOREIGN, STATE AND LOCAL TAX
CONSEQUENCES OF THE DISTRIBUTION TO SUCH STOCKHOLDERS.
QUOTATION AND TRADING OF COMPANY COMMON STOCK; DIVIDEND POLICY
There currently is not a public market for the Company Common Stock. Prices
at which the Company Common Stock may trade prior to the Distribution on a
"when-issued" basis or after the Distribution cannot be predicted. Until the
Company Common Stock is fully distributed and an orderly market develops, the
28
<PAGE> 34
prices at which trading in such stock occurs may fluctuate significantly. The
prices at which the Company Common Stock trades will be determined by the
marketplace and may be influenced by many factors, including, among others, the
success of the Company's business, the depth and liquidity of the market for the
Company Common Stock, investor perception of the Company and its assets, the
Company's dividend policy, and general economic and market conditions. Such
prices also may be affected by certain provisions of the Company Certificate and
the Company Bylaws, as each will be in effect following the Distribution, which
may have an antitakeover effect. See "RISK FACTORS -- Absence of Prior Trading
Market for Company Common Stock; Potential Volatility" and "HI/FN CERTIFICATE OF
INCORPORATION AND BYLAWS."
The Company intends to apply to have the Company Common Stock approved for
quotation and trading on the Nasdaq National Market. Immediately after the
Distribution, the Company expects to have approximately 450 stockholders of
record based upon the number of stockholders of record of the Company (other
than Stac) and the number of stockholders of record of Stac on the Record Date.
For certain information regarding options to purchase the Company Common Stock
that will be outstanding after the Distribution, see "MANAGEMENT -- Hi/fn Equity
Plan."
Nothing herein should be construed to suggest that the trading price of
Stac Common Stock at any point in time may be used as a substitute for the
trading price of Company Common Stock. No assurance can be given that the
Company Common Stock will trade at a price per share reflecting the earnings per
share or other multiple, or other attributes, of Stac. See "RISK
FACTORS -- Absence of Prior Trading Market for Company Common Stock; Potential
Volatility."
It is the Company's belief that the Company Common Stock distributed to
Stac's stockholders in the Distribution will be freely transferable, except for
securities received by persons who may be deemed to be "affiliates" of Stac
within the meaning of Rule 144 under the Securities Act, in which case such
persons may not publicly offer or sell the Company Common Stock received in
connection with the Distribution except pursuant to a registration statement
under the Securities Act or pursuant to Rule 144. There can be no assurance that
the Commission will not take a contrary view, and no ruling from the Commission
has been or will be sought. See "RISK FACTORS -- Shares Eligible for Future
Sale."
The Company presently intends to retain future earnings to finance the
growth and development of its business; and, therefore, the Company does not
currently anticipate paying any cash dividends. Any future determination
relating to dividend policy will be made at the discretion of the Company Board.
Such determinations will depend on a number of factors, including the future
earnings, capital requirements, financial condition and prospects of the
Company, possible loan or financing covenant restrictions and such other factors
as the Company Board may deem relevant. See "RISK FACTORS -- Dividend Policy."
CONDITIONS; TERMINATION
The Stac Board has conditioned the Distribution upon, among other things,
(i) the Company Board having been elected by the stockholders of the Company,
and the Company Certificate and the Company Bylaws, as each will be in effect
after the Distribution, having been adopted and being in effect; (ii) receipt by
Stac of an IRS ruling or a favorable opinion of PricewaterhouseCoopers LLP that,
for U.S. federal income tax purposes, the Distribution will not result in
recognition of taxable income or loss by Stac or its stockholders; (iii) the
Registration Statement on Form 10 with respect to the Company Common Stock held
by Stac immediately prior to the Distribution having become effective under the
Exchange Act; (iv) receipt of any necessary consents to the Distribution from
third parties, except for those the failure of which to obtain would not have a
material adverse effect on the Company or Stac; (v) no pending order, injunction
or decree preventing the consummation of the Distribution; and (vi) no event
having occurred that, in the judgment of the Stac Board, would result in the
Distribution having a material adverse effect on Stac or its stockholders. The
Company believes that there are no third-party consents which if not obtained
would have a material adverse effect on the Company, Stac or the Distribution.
Any of the conditions to the Distribution may be waived in the discretion of the
Stac Board. Even if all of the above conditions are satisfied, the Stac Board
has reserved the right to abandon, defer or modify the Distribution or the other
elements of the Distribution at any time prior to the Distribution Date;
however, the Stac Board will not waive any of the conditions to the Distribution
or make any changes in the terms of the Distribution unless the Stac Board
determines that such
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<PAGE> 35
changes would not be materially adverse to the Stac stockholders. See
"RELATIONSHIP BETWEEN HI/FN AND STAC AFTER THE DISTRIBUTION -- Distribution
Agreement."
REASONS FOR FURNISHING THE INFORMATION STATEMENT
This Information Statement is being furnished by Stac solely to provide
information to Stac stockholders who will receive Company Common Stock in the
Distribution. It is not, and is not to be construed as, an inducement or
encouragement to buy or sell any securities of Stac or the Company. The
information contained in this Information Statement is believed by Stac and the
Company to be accurate as of the date set forth on the cover of this Information
Statement. Changes may occur after that date, and neither the Company nor Stac
will update the information except in the normal course of their respective
public disclosure practices.
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<PAGE> 36
RELATIONSHIP BETWEEN HI/FN AND STAC
AFTER THE DISTRIBUTION
For the purpose of governing certain of the ongoing relationships between
the Company and Stac after the Distribution and to provide mechanisms for an
orderly transition, the Company and Stac have entered or will enter into various
agreements, and will adopt policies, as described in this section.
DISTRIBUTION AGREEMENT
Prior to the Distribution Date, the Company and Stac will enter into the
Distribution Agreement, which provides for, among other things, the Distribution
and certain other agreements governing the relationship between the Company and
Stac following the Distribution. Subject to certain exceptions, the Distribution
Agreement provides for, among other things, assumptions of liabilities and
cross-indemnities designed to allocate to the Company, effective as of the
Distribution Date, financial responsibility for the liabilities arising out of
or in connection with the Hi/fn business. Other agreements to be executed in
connection with the Distribution Agreement set forth certain specific
allocations of liabilities between the Company and Stac. See "-- Employee
Benefits Allocation Agreement" "-- Tax Sharing Agreement" and "-- Transitional
Services Agreement."
The Distribution Agreement also provides that by the Distribution Date, the
Company Certificate and the Company Bylaws shall be in the forms attached hereto
as Annex I and II, respectively, and that the Company and Stac will take all
actions which may be required to elect or otherwise appoint, as directors of the
Company, the persons indicated herein. See "MANAGEMENT -- Board of Directors"
and "HI/FN CERTIFICATE OF INCORPORATION AND BYLAWS."
The Distribution Agreement also provides that each of the Company and Stac
will be granted access to certain records and information in the possession of
the other, and requires the retention by each of the Company and Stac for a
period of ten years following the Distribution of all such information in its
possession, and thereafter requires that each party give the other prior notice
of its intention to dispose of such information. In addition, the Distribution
Agreement provides for the allocation of shared privileges with respect to
certain information and requires each of the Company and Stac to obtain the
consent of the other prior to waiving any shared privilege.
The Distribution Agreement provides that, except as otherwise set forth
therein or in any related agreement, all costs and expenses incurred in
connection with the Distribution will be charged to the party for whose benefit
the expenses are incurred, with any expenses that cannot be allocated on such
basis to be split equally between the parties.
EMPLOYEE BENEFITS ALLOCATION AGREEMENT
The Distribution Agreement calls for Stac and the Company to enter into an
Employee Benefits Allocation Agreement containing a number of provisions
relating to employees of Stac and Hi/fn. The Employee Benefits Allocation
Agreement generally contemplates that the Company will assume and retain all
obligations and liabilities with respect to Hi/fn employee plans and benefits
and that Stac will retain all obligations and liabilities with respect to Stac
employee plans and benefits.
Pursuant to the Employee Benefits Allocation Agreement, and consistent with
the terms of The Stac Electronics 1992 Stock Option Plan, as amended (the "Stac
Stock Option Plan"), and Stac, Inc. 1992 Non-Employee Directors' Stock Option
Plan (the "Stac Directors Plan"), vested and unvested options held by employees,
officers and directors of Stac who will remain with Stac will be equitably
adjusted for the effects of the Distribution on such options. The Stac Board
intends to make an adjustment to such options within 30 days after the
Distribution based on, among other factors, the trading prices of Stac and Hi/fn
after the Distribution. No adjustments will be made to options outstanding under
the 1996 Plan.
The Company retains, with respect to Hi/fn employees, all responsibility
for liabilities and obligations as of the Distribution Date for medical and
dental plan coverage and for vacation and welfare plans. Stac will
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<PAGE> 37
retain, with respect to Stac employees, all responsibilities for all liabilities
and obligations as of the Distribution Date for medical and dental plan coverage
and for vacation and welfare plans.
TAX SHARING AGREEMENT
Prior to the Distribution Date, Stac and the Company will enter into a Tax
Sharing Agreement defining the parties' rights and obligations with respect to
tax returns and tax liabilities, including, in particular, federal and state
income tax returns and liabilities, for taxable years and other taxable periods
ending on or before the Distribution Date. In general, Stac will be responsible
for (i) filing all federal and state income tax returns of Stac, the Company and
any of their subsidiaries for all taxable years ending on or before the
Distribution Date, and (ii) paying the taxes relating to such returns (including
any deficiencies proposed by applicable taxing authorities). For
post-Distribution periods, Stac and the Company will each be responsible for
filing its own returns and paying its own taxes relating to such returns
(including any deficiencies proposed by applicable taxing authorities). Stac and
the Company will cooperate with each other and share information in preparing
income tax returns and in dealing with other tax matters.
TRANSITIONAL SERVICES AGREEMENT
Prior to the Distribution Date, the Company and Stac will enter into a
Transitional Services Agreement (the "Transitional Services Agreement") pursuant
to which Stac will provide certain accounting services to Hi/fn, and each of
Stac and Hi/fn will provide certain other services to the other, on a
transitional basis after the Distribution. The fees for such transitional
services will be based on rates designed to reflect the actual costs (including
indirect costs) of providing such services. The Company will be free to procure
such services from outside vendors or to develop in-house capabilities in order
to provide such services internally. The Transitional Services Agreement will
terminate on December 31, 1999 unless extended in writing by the parties.
POLICIES AND PROCEDURES FOR ADDRESSING CONFLICTS
The Company and Stac intend to pursue separate and distinct business
strategies to minimize potential conflicts of interest between the two
companies. Nonetheless, the ongoing relationships between the Company and Stac
may present conflict situations for certain directors. Certain persons will
serve as directors of both the Company and Stac, and also will own (or have
options or other rights to acquire) a significant number of shares of common
stock in both companies. The Company and Stac will adopt appropriate policies
and procedures on or prior to the Distribution Date to be followed by the Board
of Directors of each company to address potential conflicts. Such procedures
include requiring the persons serving as directors of both companies to abstain
from voting as directors with respect to matters that present a significant
conflict of interest between the companies.
REGULATORY APPROVALS
The Company does not believe that any material federal or state regulatory
approvals will be necessary in connection with the Distribution.
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SELECTED HISTORICAL FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The selected historical financial data of the Company has been prepared
from the audited financial statements of the Company as of September 30, 1996
and 1997 and for each of the three years in the period ended September 30, 1997
and the unaudited financial statements as of June 30, 1998 and for the nine
months ended June 30, 1997 and 1998 included herein. Financial information as of
September 30, 1993 and 1994 and for each of the two years in the period ended
September 30, 1994 has been prepared from unaudited financial statements not
included herein. The financial information may not reflect the Company's future
performance or the future financial position or results of operations of the
Company, nor does it provide or reflect data as if the Company had actually
operated as a separate, stand-alone entity during the periods covered. The
summary financial data should be read in conjunction with the financial
statements and related notes and "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS," included elsewhere in this
Information Statement. In the opinion of the Company's and Stac's management,
the unaudited financial statements as of September 30, 1993 and 1994, as of June
30, 1998, for the years ended September 30, 1993 and 1994 and for the nine
months ended June 30, 1997 and 1998 contain all adjustments, consisting only of
normal recurring adjustments, necessary to present fairly the financial
condition and results of operations for these periods.
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
YEAR ENDED SEPTEMBER 30, JUNE 30,
-------------------------------------------- ----------------
1993 1994 1995 1996 1997 1997 1998
------ ------ ------ ------- ------- ------ -------
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues............................ $5,472 $5,666 $7,342 $12,894 $14,226 $8,991 $16,513
Cost of revenues.................... 2,116 2,302 2,841 5,095 4,762 2,955 5,142
------ ------ ------ ------- ------- ------ -------
Gross margin........................ 3,356 3,364 4,501 7,799 9,464 6,036 11,371
Operating expenses:
Research and development............ 1,008 564 551 1,641 2,985 1,873 4,066
Sales and marketing................. 1,222 813 1,097 1,677 2,224 1,585 2,438
General and administrative.......... 447 379 492 889 1,203 851 1,737
------ ------ ------ ------- ------- ------ -------
Operating income.................... 679 1,608 2,361 3,592 3,052 1,727 3,130
Interest income..................... 16 7 14
------ ------ ------ ------- ------- ------ -------
Provision for income taxes.......... 275 661 947 1,441 1,235 699 1,292
------ ------ ------ ------- ------- ------ -------
Net income.......................... $ 404 $ 947 $1,414 $ 2,151 $ 1,833 $1,035 $ 1,852
====== ====== ====== ======= ======= ====== =======
Net income per share, basic(1)...... $ 0.07 $ 0.16 $ 0.24 $ 0.36 $ 0.30 $ 0.17 $ 0.29
Net income per share, diluted....... $ 0.07 $ 0.16 $ 0.24 $ 0.36 $ 0.30 $ 0.17 $ 0.27
Weighted average shares outstanding,
basic............................. 6,000 6,000 6,000 6,000 6,100 6,075 6,282
Weighted average shares outstanding,
diluted........................... 6,000 6,000 6,000 6,000 6,174 6,075 6,782
BALANCE SHEET DATA:
At September 30,
Cash................................ $ -- $ -- $ -- $ -- $ 480 $ 69
Total assets........................ 1,172 1,583 2,254 2,611 5,898 8,773
Working capital (deficit)........... (143) (193) (223) (383) 3,520 4,770
Total stockholders' equity(2)....... -- -- -- -- 4,622 6,682
</TABLE>
- ---------------
(1) Since the Company's Series A Preferred Stock represents a primary equity
security, it is included in the calculation of basic net income per share.
(2) The balance sheets prior to September 30, 1997 reflect Hi/fn's structure
prior to its formation as a subsidiary. Periods subsequent to September 30,
1996 reflect the net assets contributed by Stac in establishing the Hi/fn
subsidiary. The transfer was recorded at the historical net book value of
the transferred assets and liabilities. In exchange for the net assets
contributed to Hi/fn, Stac received 6,000,000 shares of Series A Preferred
Stock and 100 shares of Company Common Stock.
33
<PAGE> 39
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
Except for the historical information contained herein, the following
discussion contains forward-looking statements that involve risk and
uncertainties. The Company's future results could differ materially from those
discussed here. Factors that could cause or contribute to such differences
include, but are not limited to, fluctuations in the Company's operating
results, continued new product introductions by the Company, market acceptance
of the Company's new product introductions, new product introductions by
competitors, OEM and distributor inventory levels and customer demand for the
products incorporating Hi/fn packet processors, customer concentration,
technological changes in the personal computer and communications industries,
uncertainties regarding intellectual property rights and the other factors
referred to herein including, but not limited to, the factors discussed below
under "Revenues," "Quarterly Trends and Channel Inventories," and the "Risk
Factors" discussed beginning on Page 9 of this document.
Hi/fn designs, develops and markets high-performance multi-protocol packet
processors -- semiconductor devices that enable secure, high-bandwidth network
connectivity and efficient storage of business information. The Company's packet
processor products perform the computation-intensive tasks of compression and
encryption/compression, providing its customers with high-performance,
interoperable implementations of a wide variety of industry-standard networking
and storage protocols. The Company's products are used in a variety of
networking and storage equipment such as routers, remote access concentrators,
firewalls and back-up storage devices.
The Company's encryption/compression packet processors allow network
equipment vendors to add bandwidth enhancement and security capabilities to
their products. The Company's encryption/compression products provide
high-performance implementations of key algorithms used in the implementation of
Virtual Private Networks ("VPNs"), which enable businesses to reduce wide area
networking costs by replacing dedicated leased lines with lower cost IP-based
networks such as the Internet. Using VPNs, businesses also can provide trading
partners and other constituents with secure, authenticated access to the
corporate network, increasing productivity through improved communications.
Storage equipment vendors use the Company's products to improve the performance
and capacity of mid- to high-end tape back-up systems.
34
<PAGE> 40
RESULTS OF OPERATIONS
The following table sets forth the percentage relationship of certain items
to the Company's revenues during the periods shown. Unless otherwise indicated,
references to years are to fiscal years which ended September 30.
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
YEAR ENDED SEPTEMBER 30, JUNE 30,
------------------------ --------------
1995 1996 1997 1997 1998
---- ---- ---- ---- ----
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues........................................... 100% 100% 100% 100% 100%
Cost of revenues................................... 39 39 33 33 31
--- --- --- --- ---
Gross margin....................................... 61 61 67 67 69
--- --- --- --- ---
Research and development........................... 7 13 21 21 25
Sales and marketing................................ 15 13 16 18 15
General and administrative......................... 7 7 8 9 10
--- --- --- --- ---
Total operating expenses........................... 29 33 45 48 50
--- --- --- --- ---
Operating income................................... 32 28 22 19 19
Interest income.................................... -- -- -- -- --
--- --- --- --- ---
Income before income taxes......................... 32 28 22 19 19
Provision for income taxes......................... 13 11 9 8 8
--- --- --- --- ---
Net income......................................... 19 17 13 11 11
=== === === === ===
</TABLE>
Comparison of Results of Operations -- Nine Months Ended June 30, 1997 and
1998
Revenues. Revenues from sales of semiconductors and licenses of software
libraries increased 84% from $9.0 million for the nine months ended June 30,
1997 to $16.5 million for the same period of 1998. The increase in revenues from
1997 to 1998 was due primarily to increased sales of the Company's data
compression processors to Quantum, an OEM provider of digital linear tape
("DLT") tape drives, and manufacturers of high-speed network equipment. The
majority of semiconductor sales during the nine-month periods ended June 30,
1997 and 1998 were from shipments of data compression processors to Quantum.
Gross Margin. Cost of revenues consists primarily of the costs of
purchasing completed semiconductors manufactured by third party foundries to the
Company's specifications for resale by the Company. Gross margins were 67% for
the nine months ended June 30, 1997 and 69% for the same period of 1998. The
increase in gross margin percent from 1997 to that of 1998 was due to shipments
of higher speed data compression processors in the 1998 period that carry higher
gross margins than the processors shipped in the 1997 period, and an increase in
licenses of the Company's software libraries which carry a relatively high gross
margin.
Research and Development. The costs of research and development consist
primarily of salaries, employee benefits, overhead, outside contractors and
non-recurring engineering fees related to design and development of new
semiconductor products and maintenance of the Company's software libraries. Such
expenses increased 117% from $1.9 million for the nine months ended June 30,
1997 to $4.1 million for the same period of 1998. The increase in research and
development costs was due to the Company's adding personnel and retaining
outside contractors to develop new products that combine data compression and
data encryption for the network security markets and to develop additional
products for the storage market.
The Company expects its investments in research and development to increase
in coming periods as it continues to develop products targeted at meeting market
needs. However, there can be no assurance that product development programs
invested in by the Company will be successful or timely, or that products
resulting from such programs will achieve market acceptance.
Sales and Marketing. Sales and marketing expenses consist primarily of
salaries, commissions and benefits paid to sales and marketing personnel, and of
consulting, market communications and overhead expenses. Such expenses increased
by 54% from $1.6 million for the nine months ended June 30, 1997 to
35
<PAGE> 41
$2.4 million for the same period of 1998. The increase in marketing and sales
expense from 1997 to 1998 was the result of the addition of marketing and sales
personnel and program costs intended to increase customer awareness of the
Company's products.
General and Administrative. General and administrative expenses consist
primarily of salaries for administrative and corporate services personnel, as
well as legal and other professional fees. Such expenses increased by 104% from
$0.9 million for the nine months ended June 30, 1997 to $1.7 million for the
same period of 1998. The increase in general and administrative expenses from
1997 to 1998 was due primarily to the addition of executive management personnel
and increased legal and accounting costs.
Comparison of Results of Operations -- Years Ended September 30, 1995, 1996
and 1997
Revenues. Revenues from sales of semiconductors and licenses of software
libraries increased 10% to $14.2 million in 1997 compared to 1996 revenues, and
increased 76% to $12.9 million in 1996 from revenues of $7.3 million in 1995.
The increase in revenues in each of 1997 and 1996 compared to the prior year was
due primarily to increased sales of the Company's data compression processors to
OEM providers of storage devices and manufacturers of high speed networking
equipment. Semiconductor sales to Quantum Corporation, an OEM producer of high
performance tape storage devices, comprised 70%, 43% and 35% of revenues in each
of 1997, 1996 and 1995 respectively.
Gross Margin. Gross margins were 67% in 1997, 61% in 1996 and 61% in 1995.
The increase in gross margins in 1997 from those of 1996 was due to shipments of
higher speed data compression processors in 1997 that carry higher gross margins
than the processors shipped in 1996 and an increase in licenses of the Company's
software libraries which carry a relatively high gross margin.
Research and Development. Research and development expenses were $3.0
million for 1997, $1.6 million for 1996 and $0.6 million for 1995, an increase
of 82% in 1997 from 1996 and an increase of 198% in 1996 from 1995. The increase
in research and development costs in each successive period was due to the
Company's adding personnel and retaining outside contractors used to develop new
products which combine data compression and data encryption for the network
security markets and to develop additional products for the storage market.
The Company expects its investments in research and development to increase
in coming periods as it continues to develop products targeted at meeting market
needs. However, there can be no assurance that product development programs
invested in by the Company will be successful or timely, or that products
resulting from such programs will achieve market acceptance.
Sales and Marketing. Sales and marketing expenses were $2.2 million in
1997, $1.7 million in 1996 and $1.1 million in 1995. The increases in marketing
and sales expenses in 1997 over those of 1996 and in 1996 expense over those of
1995 were the result of the addition of marketing and sales personnel and
program costs intended to increase customer awareness of the Company's products.
General and Administrative. General and administrative expenses were $1.2
million in 1997, $0.9 million in 1996 and $0.5 million in 1995. The increase in
1997 expenses over those of 1996 and in 1996 expenses over those of 1995 were
primarily due to the addition of executive management personnel and increased
legal and accounting costs.
INCOME TAXES
For all periods presented, deferred income taxes and related tax expense
have been allocated to the Company by applying the asset and liability approach
as if Hi/fn were a separate taxpayer. Under this approach, a deferred income tax
liability or asset, net of valuation allowance, is established for the expected
future consequences resulting from the differences between the financial
reporting and income tax bases of assets and liabilities and from net operating
loss and credit carryforwards. Deferred income tax expense or benefit represents
the net change during the year in the deferred income tax liability or asset.
36
<PAGE> 42
Income taxes currently payable are deemed to have been remitted by Stac on
behalf of the Company in the period that the liability arose. Income taxes
currently receivable are deemed to have been received by Stac in the period that
a refund could have been recognized by the Company, had the Company been a
separate taxpayer. Amounts due to or from the Company and Stac for income tax
payments and refunds are included in the related party receivable and payable
components of the balance sheet.
QUARTERLY TRENDS AND CHANNEL INVENTORIES
Hi/fn's customers order semiconductor products to meet production schedules
based on forecasts of demand for their products. Additionally, OEMs contract
with third party manufacturers to build their products in large lot sizes to
achieve manufacturing efficiencies. As a result of these practices, OEM
semiconductor and finished product inventories can vary significantly depending
on actual sales, the continuation of sales trends, and the timing of contractor
manufacturing cycles with the result that demand for the Company's semiconductor
products may have cyclical increases and decreases.
SELECTED QUARTERLY FINANCIAL DATA
The following table sets forth certain unaudited quarterly condensed
statement of operations data for each of the quarters during the year ended
September 30, 1997 and the nine months ended June 30, 1998. In the opinion of
management, this information has been prepared substantially on the same basis
as the audited financial statements appearing elsewhere in this Information
Statement, and all necessary adjustments, consisting only of normal recurring
adjustments, have been included in the amounts stated below to present fairly
the unaudited quarterly results. The quarterly data should be read in
conjunction with the Company's audited Financial Statements appearing elsewhere
in this Information Statement. The operating results for any quarter are not
necessarily indicative of the operating results for any future period.
(IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31, JUNE 30,
1997 1998 1998
------------ --------- --------
<S> <C> <C> <C> <C>
Revenues...................... 6,265 5,236 5,012
Gross margin.................. 4,163 3,674 3,534
Operating income.............. 1,551 1,051 528
Net income.................... 931 630 291
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30,
1996 1997 1997 1997
------------ --------- -------- -------------
<S> <C> <C> <C> <C>
Revenues...................... 2,067 3,017 3,908 5,234
Gross margin.................. 1,343 1,975 2,719 3,427
Operating income.............. 199 605 923 1,325
Net income.................... 118 361 555 799
</TABLE>
The sequential decline in revenues, gross margin, operating income and net
income in the quarters ended March 31, 1998 and June 30, 1998 is primarily due
to a decline in sales to the Company's most significant customer, Quantum, and
other non-networking customers. During late 1997 and early 1998, Quantum
accumulated inventories of compression devices that Quantum used during the
quarters ended March 31, 1998 and June 30, 1998. The Company does not believe
that Quantum has purchased components from alternative sources. Although there
can be no assurance as to Quantum's future purchase levels from the Company or
as to the time that Quantum will have reduced its inventories of compression
components to a level sufficient to cause Quantum to issue renewed purchase
orders to the Company, the Company has no current reason to believe Quantum will
obtain an alternative or second source for such components. See "RISK
FACTORS -- Customer Concentration."
During the quarters ended March 31, 1998 and June 30, 1998, the Company's
sales to network equipment companies increased, partially offsetting the decline
in sales to Quantum. The growth of these sales reflects initial production
volumes of encryption/compression processors from selected network equipment
customers.
37
<PAGE> 43
There can be no assurances that growth of sales to network equipment companies
will continue. See "RISK FACTORS -- Risks Associated with New and Evolving
Markets."
LIQUIDITY AND CAPITAL RESOURCES
From inception, the Company has depended upon Stac for financing its
operations and capital requirements. For the fiscal years ended September 30,
1995 and 1996, the Company's net cash provided by operating activities was
$1,372,000 and $3,761,000, respectively. During the same respective periods,
$63,000 and $223,000 were used for the purchase of property and equipment and
$1,394,000 and $1,996,000 were remitted to Stac as dividends.
In November 1996, the Company and Stac entered into an Assignment,
Assumption and Licensing Agreement which provided for the transfer of certain
assets, the assumption of certain liabilities and a cross licensing agreement of
certain intellectual properties. See "THE COMPANY -- Assignment Agreement." The
results of this agreement are reflected in the Company's financial statements.
For the fiscal year ending September 30, 1997, the Company's net cash provided
by operating activities was $2,000,000. The issuance of Company Common Stock
provided $169,000, and $901,000 was used for the purchase of property and
equipment.
For the nine months ended June 30, 1998, the Company's net cash provided by
operating activities was $2,573,000. The issuance of Company Common Stock
provided $208,000, and $484,000 was used for the purchase of property and
equipment.
The Company uses a number of independent suppliers to manufacture
substantially all of its products. As a result, the Company relies on these
suppliers to allocate to the Company a sufficient portion of foundry capacity to
meet the Company's needs and deliver sufficient quantities of the Company's
products on a timely basis. These arrangements allow the Company to avoid
utilizing its capital resources for manufacturing facilities and work-in-process
inventory and to focus substantially all of its resources on the design,
development and marketing of its products. See "RISK FACTORS -- Risks Associated
with Independent Manufacturers and Sole-Source Supply."
The Company requires substantial working capital to fund its business,
particularly to finance accounts receivable and inventory, and for investments
in property and equipment. The Company's need to raise capital in the future
will depend on many factors including the rate of sales growth, market
acceptance of the Company's existing and new products, the amount and timing of
research and development expenditures, the timing and size of acquisitions of
businesses or technologies, the timing of the introduction of new products and
the expansion of sales and marketing efforts. After the Distribution, the
Company intends to access equity capital markets and may enter into a revolving
bank credit facility and a term loan. In addition, the Company may enter into a
lease line for certain capital spending needs. There can be no assurance that
additional equity or debt financing will be available on terms satisfactory to
the Company, if at all.
YEAR 2000 COMPLIANCE
Many existing computer systems and applications, and other control devices,
use only two digits to identify a year in the date field, without considering
the impact of the upcoming change in the century. As a result, such systems and
applications could fail or create erroneous results unless corrected so that
they can process data related to the year 2000. The Company relies on its
systems, applications and devices in operating and monitoring all major aspects
of its business, including financial systems (such as general ledger, accounts
payable and payroll modules), customer services, networks and telecommunications
equipment and end products. Because a large portion of the Company's software is
obtained from its vendors on a non-custom basis, the Company believes that
upgrades for its commercial programs are currently available. The Company also
relies, directly and indirectly, on external systems of business enterprises
such as customers, suppliers, creditors, financial organizations, and of
governmental entities, both domestic and international, for accurate exchange of
data. Even if the internal systems of the Company are not materially affected by
the year 2000 issue, the Company could be affected by disruptions in the
operation of the enterprises with which the Company interacts or year 2000
disruptions that affect the Company's customers. The Company is in the
38
<PAGE> 44
process of completing a thorough assessment of the impact that these matters
might have on the Company, and expects to complete its assessment prior to the
end of calendar 1998. Once the Company has completed its assessment, management
expects to develop its plans (including contingency plans) and budgets to
perform remediation actions, if any are required. Despite the Company's efforts
to address the year 2000 impact on its internal systems and business operations,
there can be no assurance that such efforts will be successful. If such efforts
were unsuccessful, then these matters might result in a material disruption of
its business or have a material adverse effect on the Company's business,
financial condition and results of operations.
NEW PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards (FAS) No. 130, "Reporting Comprehensive Income,"
and Financial Accounting Standard (FAS) No. 131, "Disclosures about Segments of
an Enterprise and Related Information," which will be required to be adopted by
the Company in fiscal 1999. Adoption of these statements is not expected to have
a significant impact on the Company's consolidated financial position, results
of operations or cash flows.
39
<PAGE> 45
THE COMPANY
GENERAL
Stac incorporated Hi/fn as a wholly owned subsidiary of Stac on August 14,
1996. On November 21, 1996, Stac transferred its semiconductor business (along
with the associated technology, assets and liabilities) to Hi/fn in exchange for
6,000,000 shares of Series A Preferred Stock and 100 shares of Company Common
Stock pursuant to a Stock Purchase Agreement.
ASSIGNMENT AGREEMENT
Stac effected the transfer of the semiconductor business to Hi/fn pursuant
to an Assignment, Assumption and License Agreement dated as of November 21, 1996
(the "Assignment Agreement"). The assets transferred to the Company pursuant to
the Assignment Agreement included, without limitation, $1,000,000 of available
cash, the accounts receivable and inventory of the semiconductor business,
Stac's rights under certain sales and license agreements and the fixed assets,
trademarks, patents and proprietary technology specified on schedules attached
to the Assignment Agreement. The Assignment Agreement also provided for the
assignment by Stac and the assumption by Hi/fn of the accounts payable relating
to the semiconductor business, the obligations under the sales and license
agreements assigned to Hi/fn, and current and unpaid payroll and related
benefits expenses related to former employees of Stac who became employees of
Hi/fn.
CROSS LICENSE AGREEMENT
At the time of the transfer of the semiconductor business to Hi/fn, Stac
and Hi/fn entered into a Cross License Agreement pursuant to which Hi/fn granted
to Stac a limited, worldwide, perpetual, non-exclusive, non-transferable,
royalty-free license to the patents previously transferred by Stac to Hi/fn
pursuant to the Assignment Agreement. The Cross License Agreement permits Stac,
among other things, to use, modify, create derivative works, reproduce, license
and sublicense the technology to end users of Stac's products that incorporate
the technology licensed to Stac by Hi/fn. Stac, however, may not create hardware
implementations of the technology subject to the Cross License Agreement or
license or sell any of the software subject to the Cross License Agreement as a
stand-alone product for a period of ten years after the date of the Cross
License Agreement. Under the Cross License Agreement, Stac also sublicensed or
assigned to Hi/fn certain third-party licenses held by Stac. The parties further
agreed that for a ten-year period (i) Stac would transfer ownership to Hi/fn of
any derivative works created by Stac from the licensed technology and (ii) Hi/fn
would transfer ownership to Stac of all future commercial releases of software
implementations of the licensed technology developed by the Company.
40
<PAGE> 46
BUSINESS
OVERVIEW
Hi/fn designs, develops and markets high-performance, multi-protocol packet
processors -- semiconductor devices that enable secure, high-bandwidth network
connectivity and efficient storage of business information. The Company's packet
processor products perform the computation-intensive tasks of compression and
encryption/compression, providing its customers with high-performance,
interoperable implementations of a wide variety of industry-standard networking
and storage protocols. The Company's products are used in a variety of
networking and storage equipment such as routers, remote access concentrators,
firewalls and back-up storage devices.
The Company's encryption/compression packet processors allow network
equipment vendors to add bandwidth enhancement and security capabilities to
their products. The Company's encryption/compression products provide
high-performance implementations of key algorithms used in the implementation of
Virtual Private Networks ("VPNs"), which enable businesses to reduce wide area
networking costs by replacing dedicated leased lines with lower cost IP-based
networks such as the Internet. Using VPNs, businesses also can provide trading
partners and other constituents with secure, authenticated access to the
corporate network, increasing productivity through improved communications.
Storage equipment vendors use the Company's products to improve the performance
and capacity of mid- to high-end tape back-up systems.
INDUSTRY BACKGROUND
The dramatic growth in corporations' use of Internet technology has
resulted in the ability to make information available to anyone, from anywhere
and at any time. An increasingly mobile workforce, increased telecommuting and
the need to connect branch offices, customers, suppliers and other trading
partners to the corporate network, have stressed the capabilities of existing
network and storage infrastructures. To deliver on the economic promise of
Internet technology as a business tool, the Company believes that corporations
require two critical capabilities: secure, high-bandwidth network connectivity
among geographically dispersed constituents and efficient storage of business
information.
The Need for Enhanced Bandwidth and Security in Corporate Networks
Data traffic over local and wide area networks ("LANs" and "WANs") is
growing at an unprecedented pace, forcing corporate network managers to upgrade
their network architectures to meet these demands. Traditional network
architectures deployed by corporations to meet these needs include leased line
connections to branch/remote offices and dial-up (e.g., analog modem and ISDN)
connections to support mobile workers and telecommuters.
Private Networks -- Traditional Network Architectures. Data traffic over
corporate networks often is facilitated by the use of leased line connections,
which enable the interconnection of LANs. Typically, routers are used at each
end of such leased line connections. These interconnections often take the form
of point-to-point links, which are fully managed by the corporate network
management staff. The advantage to this approach is that the bandwidth of the
link is known, and the corporation can use up to the maximum bandwidth of the
link because it is not shared by other users. In addition, because the line is
not shared, security is assured without encryption. The primary disadvantage of
leased-line connections is the high cost of dedicated bandwidth. The cost is
also based on the distance separating the two end points of the link. For large
networks involving dedicated connections from corporate headquarters to each
remote site, such networks carry significant operating costs.
With respect to the corporate data networking traffic via dial-up
connections, the remote user or telecommuter "dials" to connect his or her
workstation to the corporate network over analog modem or digital (e.g., ISDN)
lines. The costs associated with these connections are also based on the
bandwidth and the distance of the link. Moreover, corporate support for dial-up
users requires significant equipment and service because the network manager
must accommodate the appropriate number of service lines needed to support the
remote user population. Like most networking equipment, the equipment needed to
provide these services
41
<PAGE> 47
is often complex and demands careful monitoring and management. As a result, the
service and management costs associated with supporting a large dial-up user
population can be significant.
As traditional private network architectures have been broadly adopted,
corporate network managers began to demand that network equipment be easier to
deploy and more cost-effective to operate. Network equipment vendors responded
to these requirements by adopting standards-based, interoperable networking
protocols and implementing compression technology that allowed data to be
reduced in size prior to transmission without losing any of the data upon
receipt ("lossless compression").
Prior to the emergence of standard networking protocols, equipment used at
each of the two terminating points of leased line and dial-up connections was
provided by the same vendor due to the proprietary nature of the data networking
protocols employed. As network equipment vendors implemented standards-based,
interoperable networking protocols, corporate customers could purchase products
from a variety of vendors, thereby increasing competition among vendors and
reducing equipment costs for the customer. One of the primary networking
protocol standards deployed to support leased line connections is the
Point-to-Point Protocol ("PPP"), developed by the Internet Engineering Task
Force (the "IETF"), the organization responsible for development of network
protocols for the Internet. PPP, which is implemented at layer two of the
network protocol model, is a widely deployed standard and is embedded in most of
today's routers, remote access concentrators and personal computers.
Bandwidth enhancement, through the use of lossless compression, allows
corporations to reduce the costs of leased line and dial-up connections.
Lossless compression is a feature of several standard networking protocols,
including PPP. The use of lossless compression provides the effect of an
approximate doubling of network bandwidth, thereby reducing the cost of
transmission by about half.
While traditional private network architectures have become more
cost-effective over time, the ubiquity of the Internet and its standard
protocols is ushering in a new era of more cost-effective and productive access
to corporate information resources.
Virtual Private Networks -- Emerging Cost-Effective Network
Architectures. Substantial economic benefits can be achieved by substituting
dedicated leased lines and long distance dial-up lines, commonly used for
connecting branch offices and mobile/remote users to the corporate network, with
"local" connections (i.e., low-toll or no-toll) to the Internet. For leased
lines, use of local Internet connections provides savings because of shorter
distance links. For dial-up lines, remote users can make local phone calls to
connect to the Internet and subsequently connect to the corporate network. The
corporate savings on dial-up access by remote users comes from two sources: the
avoidance of long distance toll charges and the "outsourcing" to Internet
service providers of the purchase, installation and management of the network
equipment. The use of the Internet also facilitates access to corporate
information resources by the users of broadband access technologies such as
cable modems and digital subscriber line services, which typically are connected
directly to the Internet.
The use of Internet connections also permits companies to greatly expand
the number and types of people who can access their networks. Internet
connections can be used to connect suppliers, customers and other constituents
to the corporate network in ways that are not practical using leased lines or
dial-up links. However, when corporations use the Internet in place of leased
lines and dial-up links, the corporation must use network security protocols
incorporating encryption technology to maintain the privacy of data transmitted
over the network. Corporate networks implemented using network security
protocols are known as VPNs because they are implemented using a shared network
such as the Internet, but achieve their status as "private" through the use of
encryption technology.
One example of a VPN is the Automotive Network Exchange ("ANX") project.
The ANX is being developed by the Automotive Industry Action Group, a trade
association of North American vehicle manufacturers and suppliers. The goal of
the project is to establish a VPN to improve business communications among the
North American vehicle manufacturers and their suppliers and trading partners.
The ANX network is expected to provide a dramatic reduction in the costs of
doing business among participating trading partners.
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<PAGE> 48
Broad implementation of VPNs requires that standards-based network security
protocols be deployed in a wide variety of networking products, including
routers, remote access concentrators, switches, broadband access equipment,
network interface cards, security gateways and firewalls. The IETF has developed
a networking protocol called IP Security (the "IPSec protocol"), which is
implemented at layer three in the network protocol model. The IPSec protocol
provides bandwidth enhancement through the use of compression and data integrity
and confidentiality through the use of encryption. Encryption makes data appear
random by removing any detectable patterns. Compression searches data for
patterns and replaces them with shorter representations of the information.
Accordingly, compression must occur prior to encryption. Thus, the use of
encryption at layer three in the network model has the effect of rendering PPP
(layer two) compression ineffective. The IPSec protocol is more scalable and has
more robust security capabilities than other network security protocols, such as
the Point-to-Point Tunneling Protocol ("PPTP") developed by Microsoft. The
Company believes that the IPSec protocol, which can be deployed in both LAN and
WAN equipment, will become the most widely used protocol for the implementation
of VPNs.
Implementation of network security protocols, however, places great
processing demands on networking equipment architectures. When compared to
processing of unsecured data packets, where only a small portion of the data
packet requires processing, each byte of a secure packet must be processed using
computation-intensive algorithms, stealing processing bandwidth from other
critical network processing functions such as routing, switching and packet
filtering. Processing of secure packets involves three distinct operations:
compression for bandwidth enhancement, encryption for data privacy, and data
authentication to ensure data integrity.
The traditional approach to the implementation of new network protocols has
been to provide the new capabilities in software. The processing demands of
security protocols, particularly the IPSec protocol, however, exceed the
capabilities of today's general purpose microprocessors that support unsecured
network routing and switching protocols. Software implementation of the IPSec
protocol in a router, firewall or in other network equipment often results in a
significant degradation in the performance of the equipment. These processing
demands are driving network equipment vendors to develop new protocol processing
architectures. One approach is to divide the security protocol processing
elements of compression, encryption and data authentication into separate,
interconnected processing elements where the processing for each function can be
performed either by a general purpose microprocessor, a custom-designed
Application Specific Integrated Circuit ("ASIC"), or other logic circuit.
However, the use of separate processing elements for each function results in
more complex system designs that require higher performance interconnections to
support data movements in and out of each processing element.
Networking equipment vendors are responding to the VPN opportunity by
building a variety of products that integrate the IPSec protocol. The
technological challenges and the significant time-to-market pressures such
vendors face, however, have made it increasingly difficult for them to develop
internally the semiconductor devices necessary to implement the IPSec protocol
in their products. As a result, the Company expects a market to develop for
high-performance, integrated, multi-protocol packet processors that perform the
computation-intensive tasks of compression, encryption and data authentication,
that comply with industry standard network security protocols and that can be
easily integrated into vendors' systems.
The Need for Efficient Storage of Corporate Data
The increasing connectivity of the corporate workforce also has caused
dramatic increases in the need to share data across locations, with the need for
online data to be available at all times and at all locations. Network servers,
based on the Unix and Microsoft Windows NT operating system platforms, are
proliferating because of the need to distribute data throughout the enterprise
for access and update at the lowest levels in the organizational hierarchy.
The growth in hard disk storage on network servers and user workstations
has stressed the capability of currently available back-up subsystems. While
there are a number of approaches to providing back-up, particularly for servers,
most revolve around the use of tape drives. Either stand-alone, or with multiple
drives configured in tape libraries or jukeboxes, the demand for capacity and
performance of these subsystems
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continues to increase. The opportunity to back up server disk storage, an
administrative operation typically performed during "off hours," has dwindled.
Thus, the suitability for a tape subsystem to back up server storage is
increasingly dependent on the rate at which the tape subsystem can accept data
from host systems and subsequently write it to the media.
Today's mid- to high-end tape drive architectures consist of three key
elements: (i) a host interface such as a Small Computer Systems Interface
("SCSI"), (ii) a processing element that typically includes a general-purpose
microprocessor and an ASIC for tape formatting and memory management functions,
and (iii) motor control and front-end head interface electronics. The
performance requirements of mid- to high-end tape drives require that
compression functions, which typically provide doubling of capacity and
performance, be performed by dedicated semiconductor implementations within the
tape drive electronics.
Accordingly, the Company expects mid- to high-end tape back-up equipment
vendors to continue to demand high-performance, standards-based, interoperable
implementations of compression processors that can be easily integrated into
their tape drive architectures.
THE HI/FN SOLUTION
Hi/fn designs, develops and markets high-performance, multi-protocol packet
processors -- semiconductor devices that enable secure, high-bandwidth network
connectivity and efficient storage of business information. The Company's packet
processor products perform the computation-intensive tasks of compression and
encryption/compression, providing its customers with high-performance,
interoperable implementations of a wide variety of industry-standard networking
and storage protocols. The Company believes that its patented compression
technology comprises the fundamental know-how for the design and implementation
of low-cost, high-performance implementations of lossless compression and gives
its products a decisive competitive advantage. By offering a wide range of
price-performance implementations of its patented, standards-compliant
technology, the Company is able to sell products to network and storage
equipment vendors that allow them to reduce development costs and
time-to-market.
The Company's patented Lempel-Ziv-Stac compression technology ("LZS") is
incorporated into several networking protocol standards, including PPP and the
frame relay protocol, allowing network equipment vendors to rapidly integrate
proven solutions for mitigating the costs associated with traditional private
leased-line network architectures. The Microsoft Point-to-Point ("MPPC")
implementation of the Company's patents, developed by Microsoft, is incorporated
into the PPP and PPTP implementations of the Windows 95, 98 and NT operating
systems. The Company offers high-performance compression processors that
implement LZS and MPPC. Software implementations of LZS and MPPC are licensed by
industry-leading network equipment vendors for use in their networking products.
In support of emerging VPN architectures, the Company has produced one of
the industry's first network security processors, integrating the critical
functions of compression, encryption and data authentication in compliance with
the IPSec protocol. This integration allows network equipment vendors to add
highly-integrated, high-performance VPN capabilities to their routers, remote
access concentrators, switches, broadband access equipment and firewalls. The
Company also licenses a complete, portable software implementation of the IPSec
protocol, allowing network vendors to get to market quickly with their VPN
implementations at a fraction of the cost of internal software development
efforts.
The Company's line of compression processors targeted at back-up storage
applications provides storage equipment vendors high-performance implementations
of the Company's patented compression technology, doubling the capacity and
performance of mid- to high-end tape drive systems. Hi/fn's LZS implementation
of the Company's patents is used in the market-leading DLT 4000 and DLT 7000
tape drive products from Quantum. The Adaptive Lossless Data Compression
("ALDC") implementation of the Company's patents, developed by IBM, is used in a
variety of tape storage products, including the Travan style of quarter-inch
cartridge tape drives.
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BUSINESS STRATEGY
Hi/fn's objective is to become a leading provider of high-performance,
multi-protocol packet processor products that enable its customers to provide
products with enhanced bandwidth and high-performance security capabilities. Key
elements of the Company's strategy include the following:
Focus on Network Equipment Markets. Hi/fn has targeted and intends to
continue to target the network equipment market, including the markets for
remote access concentrators, routers, switches, broadband access equipment,
network interface cards and firewalls, which are characterized by intense
time-to-market pressures, demanding performance requirements and demands for
interoperable, standards-based solutions. The Company's 7711 encryption
processor, which incorporates compression, encryption and data authentication
capabilities, was designed specifically to allow the Company's network equipment
customers to add high-performance VPN capabilities to their networking products.
Leverage Proprietary Compression Technology. The Company intends to
leverage its proprietary portfolio of compression technologies to establish a
leadership position in the market for integrated processors that perform the
task of compression, encryption, data authentication. The Company's core
compression technology has been adopted throughout its target markets in a wide
variety of networking and storage standards. The Company believes that its
patents provide the fundamental know-how for the design of high-performance,
cost-effective implementations of lossless compression of data.
Emphasize Storage Equipment Market. The Company intends to continue to
emphasize the development of high-performance packet processor products that
serve the mid- to high-end back-up storage equipment market. In addition, the
Company intends to continue to leverage technologies developed for storage
applications in its products designed for network equipment markets because the
performance requirements of the back-up storage equipment market often exceed
the requirements of the network equipment market. For example, the Company is
developing a compression packet processor expected to perform at 100Mbytes per
second, faster than most networking products available today.
Maintain Technology Leadership. Hi/fn has made and intends to continue to
make substantial investments in the technologies that form the core of its
packet processors, with the goal of providing price-performance product
alternatives and enabling broad adoption and deployment of packet processing
functionality. Hi/fn intends to continue to develop higher performance and more
fully integrated packet processing functionality. The Company also intends to
continue to leverage its engineering resources and intellectual property
portfolio to develop additional products.
Contribute to Industry Standards. Hi/fn has been and intends to continue to
be an active contributor in the development of several industry standards in
networking and storage applications. The Company has participated in a wide
variety of standards groups, including American National Standards Institute,
the IETF, the Frame Relay Forum, the ADSL Forum, Quarter-Inch Cartridge Drive
Standards and others. Various implementations of the Company's patented
compression technology have been specified in a variety of networking and
storage protocols. The Company believes this is due to the wide range of
price-performance options available for integrating the Company's compression
technology into equipment vendors' products, including software implementations
and high-performance semiconductor implementations. The Company's early
involvement in these standards activities provides it with insight into and
influence over the technical directions of emerging technologies. As a result,
the Company is able to evaluate market and technical opportunities at early
stages in the market development cycle.
Leverage the Fabless Semiconductor Business Model. The Company intends to
continue to subcontract all of its semiconductor manufacturing. The use of
outside manufacturing partners, a "fabless" model, allows the Company to focus
substantially all of its resources on the design, development and support of its
products. The Company believes this approach lowers technology and production
risks, reduces time-to-market and increases profitability.
Strengthen and Expand Customer Relationships. Hi/fn intends to maintain a
customer-oriented approach that stresses relationships with leading network and
storage equipment vendors and emphasizes strong customer input in the product
definition process. Hi/fn has developed relationships with several leading
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network and storage equipment vendors, enabling the Company to achieve design
wins in new systems at the time of initial product definition. Beyond the design
stage, Hi/fn's field applications engineering group offers full service
technical support and training. By working with customers throughout the entire
product life-cycle, the Company is able to gain insights into its customers'
future plans and needs, identify emerging industry trends and consequently
deliver high-performance, cost-effective products.
CUSTOMERS AND PRODUCTS
A number of leading manufacturers of network and storage equipment have
designed products that incorporate the Company's products. To date, the Company
has secured over 50 design wins representing more than 30 networking and storage
equipment vendors. To qualify as a design win, an equipment vendor must have
ordered samples of the Company's packet processors or an evaluation board and
initiated a product design that incorporates the Company's packet processors.
During the design-in process, the Company works with each customer, providing
training on the Company's products, assisting in resolving technical questions
and providing price and delivery information to assist the customer in getting
its products into volume production. There can be no assurance that any of the
design wins secured by the Company will result in demand for the Company's
products. See "RISK FACTORS -- Dependence Upon Development of the Market for
Packet Processors" and "-- New Product Development and Evolving Industry
Standards; Technological Change."
The Company's products -- compression processors, encryption/compression
processors and software -- provide a broad range of price/performance
alternatives for the implementation of secure, high-performance networks and
efficient, high-performance tape storage devices. Hi/fn also offers evaluation
boards to assist customers in the evaluation of the Company's products.
Network Bandwidth Enhancement Products. Hi/fn's 9710 and 9711
high-performance compression processors provide essential bandwidth-enhancement
for network equipment such as routers, remote access concentrators, broadband
access equipment and switches. These products provide flexible bus interfaces
and a variety of memory configuration options to allow customers to tailor their
uses to meet a variety of network system requirements. Hi/fn licenses a line of
software compression libraries that provide similar functionality to its line of
compression processor products for low-performance applications such as modems
and ISDN links. The software products are offered in source and object code
toolkits.
<TABLE>
<CAPTION>
PRODUCT DESCRIPTION DATE OF INTRODUCTION
------- ----------- --------------------
<S> <C> <C>
9710 Compression processor, September 1996
multi-history LZS, operating at 8
Mbytes/sec
9711 Compression processor, February 1997
multi-history LZS and MPPC,
operating at 8Mbytes/sec
LZS221 Compression software, November 1995
multi-history, LZS offered in C
source code and other
microprocessor-specific
implementations
MPPC Compression software, July 1996
multi-history, MPPC, offered in C
source code
</TABLE>
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<PAGE> 52
Network Security Products. Hi/fn's 7711 high-performance encryption
processor provides essential bandwidth-enhancement and security for network
equipment such as routers, remote access concentrators, switches and firewalls.
The 7711 provides a flexible bus interface and a variety of memory configuration
options to allow adaptation to meet a variety of network system requirements.
The 7711 is pin-compatible with the 9711 compression processor, providing
customers with an easy upgrade path from compression to encryption/compression.
Hi/fn also licenses a portable, source code implementation of the IPSec
protocol.
<TABLE>
<CAPTION>
PRODUCT DESCRIPTION DATE OF INTRODUCTION
------- ----------- --------------------
<S> <C> <C>
7711 Encryption processor, DES/Triple- October 1997
DES/RC4 encryption, LZS/MPPC
compression, MD5/SHA1 data
authentication, operating at 8
Mbytes/sec
IPSECure IPSEC Source code toolkit, providing May 1998
packet processing functions of the
IPSec protocol
IPSECure ISAKMP Source code toolkit, providing key May 1998
management protocol functions of
the IPSec protocol
</TABLE>
Storage Enhancement Products. The Company's 9610 and 9732 high-performance
compression processors provide a typical doubling of capacity and performance
for mid- to high-end tape drive products.
<TABLE>
<CAPTION>
PRODUCT DESCRIPTION DATE OF INTRODUCTION
------- ----------- --------------------
<S> <C> <C>
9732 Compression processor, single June 1994
history LZS, operating at 32
Mbytes/sec
9610 Compression processor, single May 1997
history LZS, operating at 50
Mbytes/sec
</TABLE>
Evaluation Boards. To facilitate the adoption of its semiconductor devices,
the Company designs system-level boards that resemble actual end-products or
subsystems. The Company's evaluation boards include basic hardware and software
that enable customers to expedite their designs by using the evaluation boards
as a reference or by incorporating portions of them into their own designs.
These boards are used as evaluation and development vehicles for each
semiconductor device designed by the Company.
TECHNOLOGY
Hi/fn's multi-protocol packet processors are high-performance compression
and encryption/compression processors that have been designed to meet the needs
of networking and storage equipment vendors. The Company believes that its
patented compression technology, employed in all of its packet processors, gives
it a substantial competitive advantage. In addition to core technologies
developed by the Company, the Company has enhanced the features and
functionality of its products through the licensing of certain technologies from
third parties.
Compression Algorithms and Architectures. The Company is the holder of key
patents that cover a wide variety of lossless compression algorithms and their
implementations. Specific implementations of the Company's compression patents
include the following compression algorithms: LZS, developed by Stac; MPPC,
developed by Microsoft; and ALDC, developed by IBM. The Company has continued to
improve the performance, functionality and architectures of these compression
techniques. For example, semiconductor implementations of the LZS algorithm have
improved in performance by a factor of 40 in under four years. Through the use
of various architectural implementations of its compression algorithms, the
Company is able to provide compression solutions over a broad price-performance
spectrum.
Encryption and Data Authentication Algorithms. The Company develops
high-performance implementations of industry standard encryption algorithms
(e.g., DES, Triple-DES and RC4) and data authentication algorithms (e.g., MD5
and SHA1). Coupled with its patent position in compression, the Company is
positioned to combine compression with encryption and data authentication as
specified in the most widely
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<PAGE> 53
used network security protocols, such as IPSec and PPTP. In addition, the
Company has licensed the rights to implement three encryption algorithms of RSA
Data Security in the Company's semiconductor products, including the Rivest
Shamir Adelman ("RSA") public key encryption system and the Rivest Cipher 4
("RC4") and Rivest Cipher 5 ("RC5") symmetric key encryption algorithms.
Integrated, High-Performance Packet Processing. The Company is continuing
to develop additional packet processing functionality, including the
implementation of public key encryption algorithms and increased integration of
computation-intensive security protocol processing functions. Performance
improvements of the Company's packet processing functions are expected to
support gigabit speeds in the future.
INTELLECTUAL PROPERTY
The Company's future success and ability to compete are dependent, in part,
upon its proprietary technology. The Company relies in part on patent, trade
secret, trademark, maskwork and copyright law to protect its intellectual
property. The Company owns 12 United States patents and 4 foreign patents. The
Company also has 2 pending patent applications in Japan. The issued patents and
patent applications primarily cover various aspects of the Company's compression
technology and have expiration dates ranging from 2006 to 2013. There can be no
assurance that any patents will issue pursuant to the Company's current or
future patent applications or that the patents issued pursuant to such patent
applications will not be invalidated, circumvented or challenged. There can be
no assurance that any patents issued to the Company will be adequate to
safeguard and maintain the Company's proprietary rights, to deter
misappropriation or to prevent an unauthorized third party from copying the
Company's technology, designing around the patents owned by the Company or
otherwise obtaining and using the Company's products, designs or other
information. In addition, there can be no assurance that others will not develop
technologies that are similar or superior to the Company's technology.
In addition, the Company claims copyright protection for certain
proprietary software and documentation. The Company attempts to protect its
trade secrets and other proprietary information through agreements with its
customers, suppliers, employees and consultants, and through other security
measures. Although the Company intends to protect its rights vigorously, there
can be no assurance that these measures will be successful. In addition, the
laws of certain countries in which the Company's products are or may be
manufactured or sold may not protect the Company's products and intellectual
property.
In 1996 and 1997, the Company entered into agreements with RSA Data
Security, Inc., a subsidiary of Security Dynamics, Inc., granting the Company
the rights to implement three encryption algorithms licensed by RSA,
specifically the RSA public key encryption system and the RC4 and RC5 symmetric
key encryption algorithms.
In 1995, Stac entered into an agreement with Motorola, granting the Company
the rights to sublicense two Motorola-owned patents to customers of the
Company's products. Based on the terms of the agreement, the agreement may be,
and has been, assigned to Hi/fn by Stac.
In 1994, Stac entered into two patent cross license agreements with IBM,
granting Stac the rights to practice certain patents in the IBM patent
portfolio. Based on terms of the agreement, the Company, upon separation from
Stac, expects to obtain certain continuing rights to those same IBM patents. In
return, the Company is obligated to provide IBM with the licenses to certain
patents owned, or licensable, by the Company.
In 1996, Stac entered into a software license agreement with Microsoft,
granting Stac and its subsidiaries non-exclusive distribution and derivative
works rights to Microsoft's MPPC compression software. Based on the terms of the
agreement, the agreement may be, and has been, assigned to Hi/fn by Stac. See
"RISK FACTORS -- Protection and Enforcement of Intellectual Property."
EXPORT RESTRICTIONS ON ENCRYPTION ALGORITHMS
A key element of the Company's packet processor architecture is the
encryption algorithms embedded in its semiconductor and software products. These
products are subject to export control restrictions adminis-
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<PAGE> 54
tered by the U.S. Department of Commerce, which permit the Company's network
equipment customers to export products incorporating encryption technology only
with the appropriate export license. In addition, these U.S. export laws
prohibit the export of encryption products to a number of countries deemed
hostile by the U.S. government. U.S. export regulations regarding the export of
encryption technology require either a transactional export license or the
granting of Department of Commerce Commodity jurisdiction. As a result of this
regulatory regime, foreign competitors facing less stringent controls on their
products may be able to compete more effectively than the Company's network
equipment customers in the global market. There can be no assurance that the
U.S. government will approve any pending or future export license requests.
Further, there can be no assurance that the list of products and countries for
which export approval is required, or the regulatory policies with respect
thereto, will not be revised from time to time, or that laws limiting the
domestic use of encryption will not be enacted. Failure of the Company's network
equipment customers to obtain the required licenses or the costs of compliance
could inhibit the sale of the Company's packet processors.
COMPETITION
The networking and storage equipment markets into which the Company sells
its products are intensely competitive and are subject to frequent product
introductions with improved price-performance characteristics, rapid
technological change, unit price erosion and the continued emergence of new
industry standards. The semiconductor industry is also intensely competitive and
is characterized by rapid technological change, product obsolescence and unit
price erosion. The Company expects competition to increase in the future from
existing competitors and from companies that may enter the Company's existing or
future markets, including certain customers, with similar or substitute
solutions that may be less costly or provide better performance or features than
the Company's products. To be successful in the future, Hi/fn must continue to
respond promptly and effectively to changing customer performance, feature and
pricing requirements, technological change and competitors' innovations. There
can be no assurance that the Company will be able to compete successfully
against current and future competitors or that competitive pressures faced by
the Company will not materially adversely affect the Company's business.
The Company's products compete with products from companies such as IBM,
VLSI, Rainbow, IRE and Analog Devices. In 1994, Stac entered into two license
agreements with IBM pursuant to which Stac granted IBM the right to implement,
but not sublicense, the Company's patented compression technology in IBM
hardware and software products. Stac also entered into a license agreement with
Microsoft in 1994 pursuant to which Stac granted Microsoft the right to create
software implementations of the Company's patented compression technology in
Microsoft's software products. Stac's license agreement with Microsoft, however,
prohibits Microsoft from creating hardware implementations of the Company's
patents. The Company also competes against software solutions that use general
purpose microprocessors to run encryption algorithms and the Company's software
compression libraries. Moreover, the Company's encryption/ compression
processors are subject to export control restrictions administered by the U.S.
Department of Commerce, which permit the Company's network equipment customers
to export products incorporating encryption technology only with the appropriate
export license. As a result of these restrictions, foreign competitors facing
less stringent controls on their encryption products could inhibit the sale of
the Company's encryption/compression processors to network equipment customers
in the global market. In addition, the Company expects significant future
competition from major domestic and international semiconductor suppliers.
Several established electronics and semiconductor suppliers have recently
entered or indicated an intent to enter the network equipment market. The
Company may also face competition from suppliers of products based on new or
emerging technologies. Furthermore, many of the Company's existing and potential
customers internally develop ASICs, general purpose microprocessors and other
devices which attempt to perform all or a portion of the functions performed by
the Company's products.
Many of Hi/fn's current and potential competitors have longer operating
histories, greater name recognition, access to larger customer bases and
significantly greater financial, technical, marketing and other resources than
the Company. As a result, they may be able to adapt more quickly to new or
emerging technologies and changes in customer requirements or to devote greater
resources to the promotion and sale of
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<PAGE> 55
their products than the Company. In particular, companies such as Texas
Instruments, National Semiconductor, Lucent, Intel and Motorola have proprietary
semiconductor manufacturing ability, preferred vendor status with many of the
Company's customers, extensive marketing power and name recognition, greater
financial resources than the Company and other significant advantages over the
Company. In addition, current and potential competitors may determine, for
strategic reasons, to consolidate, to lower the price of their products
substantially or to bundle their products with other products. Current and
potential competitors have established or may establish financial or strategic
relationships among themselves or with existing or potential customers,
resellers or other third parties. Accordingly, it is possible that new
competitors or alliances among competitors could emerge and rapidly acquire
significant market share. There can be no assurance that the Company will be
able to compete successfully against current and future competitors. Increased
competition may result in price reductions, reduced gross margins and loss of
market share, any of which could materially adversely affect the Company's
business, financial condition and results of operations.
The Company believes that important competitive factors in its markets are
performance, price, length of development cycle, design wins with major network
and storage equipment vendors, support for new network and storage standards,
features and functionality, adaptability of products to specific applications,
support of product differentiation, reliability, technical service and support
and protection of products by effective utilization of intellectual property
laws. The failure of the Company to successfully develop products that compete
successfully with those of other suppliers in the market would have a material
adverse effect on the Company's business, financial condition and results of
operations. In addition, the Company must compete for the services of qualified
distributors and sales representatives. To the extent that the Company's
competitors offer such distributors or sales representatives more favorable
terms on a higher volume of business, such distributors or sales representatives
may decline to carry, or discontinue carrying, the Company's products. The
Company's business, financial condition and results of operations could be
adversely effected by any failure to maintain and expand its distribution
network. See "RISK FACTORS -- Competition."
RESEARCH AND DEVELOPMENT
The Company's success will depend to a substantial degree upon its ability
to develop and introduce in a timely fashion new products and enhancements to
its existing products that meet changing customer requirements and emerging
industry standards. Hi/fn has made and plans to continue to make substantial
investments in research and development. Extensive product development input is
obtained from customers and through the Company's participation in industry
organizations and standards setting bodies such as the IETF.
As of June 30, 1998, the Company's research and development staff consisted
of 27 employees. The Company's research and development expenditures totaled
$4.0 million in the first 9 months of fiscal 1998 and $3.0 million in the fiscal
year ended September 30, 1997, representing 24.6% and 21.0% of revenues for such
periods, respectively. Research and development expenses primarily consist of
salaries and related costs of employees engaged in ongoing research, design and
development activities, costs of fabricating chip mask sets and subcontracting
costs. The Company performs its research and product development activities at
its facilities in San Jose, California and Carlsbad, California. The Company is
seeking to hire additional skilled development engineers.
In April 1998, Hi/fn acquired a software implementation of the IPSec
protocol from CyLAN Technologies, Inc. As part of the acquisition, the Company
gained expertise in the development of software implementations of a wide range
of networking protocol functions, including IPSec and TCP/IP.
The Company's future performance depends on a number of factors, including
its ability to identify emerging technological trends in its target markets,
develop and maintain competitive products, enhance its products by adding
innovative features that differentiate its products from those of its
competitors, bring products to market on a timely basis at competitive prices,
properly identify target markets and respond effectively to new technological
changes or new product announcements by others. In evaluating new product
decisions, the Company must anticipate well in advance the future demand for
product features and performance characteristics, as well as available
supporting technologies, manufacturing capacity, industry
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<PAGE> 56
standards and competitive product offerings. No assurance can be given that the
Company's design and introduction schedules for any additions and enhancements
to its existing and future products will be able to be sold at prices that are
favorable to the Company.
The Company must also continue to make significant investments in research
and development in order to continue enhancing the performance and functionality
of its products to keep pace with competitive products and customer demands for
improved performance, features and functionality. The technical innovations
required for the Company to remain competitive are inherently complex and
require long development cycles. Such innovations must be completed before
developments in networking technologies or standards render them obsolete and
must be sufficiently compelling to induce network and storage equipment vendors
to favor them over alternative technologies. Moreover, the Company must
generally incur substantial research and development costs before the technical
feasibility and commercial viability of a product line can be ascertained.
There can be no assurance that revenues from future products or product
enhancements will be sufficient to recover the development costs associated with
such products or enhancements or that the Company will be able to secure the
financial resources necessary to fund future development. The failure to
successfully develop new products on a timely basis could have a material
adverse affect on the Company's business, financial condition and results of
operations. See "RISK FACTORS -- New Product Development and Evolving Industry
Standards; Technological Change."
SALES, MARKETING & TECHNICAL SUPPORT
The Company markets its products through a direct sales and marketing
organization, to be headquartered in Los Gatos, California following the
Distribution, with a sales office in Boston, and through independent contract
sales representatives in the United States, Europe, Japan and other areas. Sales
representatives are selected for their understanding of the marketplace and
their ability to provide effective field sales support for Hi/fn's products. The
Company's relationships with some of its sales representatives have been
established within the last year, and the Company is unable to predict the
extent to which some of these representatives will be successful in marketing
and selling the Company's products.
Sales to U.S. customers account for the substantial majority of Hi/fn's
revenues. Due to the export controls imposed on encryption products by the U.S.
government, the Company's shipments to international customers are limited to
compression processors and compression software. The Company is actively working
with its network equipment customers and the National Security Agency to comply
with U.S. export controls to facilitate the export of the Company's customer's
products which incorporate the Company's encryption products. There can be no
assurance that the Company will be successful in these efforts and that
competitors outside of the U.S. will not develop encryption products to meet the
needs of the Company's customers, thereby reducing the opportunity for the
Company to sell its products.
The Company has a number of marketing programs designed to inform network
and storage equipment vendors about the capabilities and benefits of the
Company's products. The Company's marketing efforts include participation in
industry trade shows, technical conferences, preparation of competitive
analyses, sales training, publication of technical and educational articles in
industry journals, maintenance of Hi/fn's world wide web site, advertising and
direct mail distribution of Company literature.
Technical support to customers is provided through field and factory
applications engineers and, if necessary, product designers. Local field support
is provided in person or by telephone. The Company believes that providing
customers with comprehensive product service and support is critical to
maintaining a competitive position in the market and is critical to shortening
the time required to design in the Company's products. The Company works with
its customers to monitor the performance of its product designs and to provide
support at each stage of customer product development.
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MANUFACTURING
Currently, Hi/fn subcontracts all of its semiconductor manufacturing on a
turnkey basis, with the Company's suppliers delivering fully assembled and
tested products based on the Company's proprietary designs. The use of the
fabless model allows the Company to focus substantially all of its resources on
determining customer requirements and on the design and development and support
of its products. This model allows the Company to have significantly reduced
capital requirements.
The Company subcontracts its semiconductor manufacturing to Toshiba
Corporation, Atmel Corporation, and Motorola. The selection of these
manufacturers was based on the breadth of available technology, quality,
manufacturing capacity and support for design tools used by the Company. None of
the Company's products is currently manufactured by more than one supplier.
At any given time, Hi/fn uses mainstream processes for the manufacture of
its products, avoiding dependence on the latest process technology available.
This approach reduces the Company's technical risks and avoids the risks related
to production capacity constraints typically associated with leading edge
semiconductor processes. This approach allows the Company to focus on providing
differentiated functionality, the primary value-added in the Company's products.
The Company's current main products are manufactured using a .5 micron CMOS
process. Products under development are being designed for .35 micron CMOS
processes. The Company believes that transitioning its products to increasingly
smaller semiconductor geometries will be important for the Company to remain
competitive. No assurance can be given that future process migration will be
achieved without difficulty.
Hi/fn intends to continue for the foreseeable future to rely on its
subcontract manufacturers and their subcontractors for substantially all of its
manufacturing, assembly and testing requirements. All of the Company's
subcontract manufacturers produce products for other companies. The Company does
not have long-term manufacturing agreements with any of its subcontract
manufacturers. The Company's subcontract manufacturers are not obligated to
supply products to the Company for any specific period, in any specific quantity
or at any specific price, except as may be provided in a particular purchase
order that has been accepted by one of its subcontract manufacturers.
The Company must place orders approximately 12 to 14 weeks in advance of
expected delivery. As a result, the Company has only a limited ability to react
to fluctuations in demand for its products, which could cause the Company to
have an excess or a shortage of inventory of a particular product. Failure of
worldwide semiconductor manufacturing capacity to rise along with a rise in
demand could result in the Company's subcontract manufacturers to allocate
available capacity to customers that are larger or have long-term supply
contracts in place. The inability of the Company to obtain adequate foundry
capacity at acceptable prices, or any delay or interruption in supply, could
reduce the Company's product revenues or increase the Company's cost of revenues
and could have a material adverse effect on the Company's business, financial
condition and results of operations. See "RISK FACTORS -- Risks Associated with
Independent Manufacturers and Sole-Source Supply."
EMPLOYEES
As of June 30, 1998, Hi/fn employed a total of 53 full-time employees and 3
part-time contractors. Of the total number of employees, 27 were employed in
research and development, 17 in sales and marketing, 7 in operations and 5 in
finance and administration. The Company's employees are not represented by any
collective bargaining agreement and the Company has never experienced a work
stoppage. The Company believes its employee relations are good.
The Company's future success is heavily dependent upon its ability to hire
and retain qualified technical, marketing, sales and management personnel. The
competition for such personnel is intense, particularly for engineering
personnel with related security, networking and integrated circuit design
expertise and for applications support personnel with networking product design
expertise. See "RISK FACTORS -- Dependence on Key Personnel and Hiring of
Additional Personnel."
52
<PAGE> 58
FACILITIES
The Company's corporate and technical headquarters are currently located in
San Jose, California. The San Jose facility consists of an aggregate of
approximately 6,000 square feet. The Company also leases two other facilities, a
satellite design center in Carlsbad, California and a small field sales office
in Westborough, Massachusetts. These facilities occupy an aggregate of
approximately 7,000 square feet. The Company has entered into an agreement to
lease approximately 27,000 square feet of space in Los Gatos, California for a
period of seven years commencing on September 1, 1998, and intends to move its
San Jose operations to that location.
LEGAL PROCEEDINGS
The Company is not a party to any material legal proceedings.
53
<PAGE> 59
MANAGEMENT
BOARD OF DIRECTORS
The Company Board currently is comprised of two directors: Gary W. Clow and
Douglas L. Whiting. Upon consummation of the Distribution, the Company Board is
expected to be comprised of five directors, who will be elected prior to the
Distribution. Such directors will serve until the next Annual Meeting of
Stockholders of the Company and until their respective successors have been duly
elected and qualified.
The table below indicates the name, position with the Company and age of
each director of the Company.
<TABLE>
<CAPTION>
NAME POSITION WITH HI/FN AGE
---- ------------------- ---
<S> <C> <C>
Gary W. Clow.......................... Chairman 43
Douglas L. Whiting.................... Chief Technology Officer 42
</TABLE>
Gary W. Clow has been Chairman of the Board of Directors of the Company
since November 1996. He also has served as Chairman of the Board of Directors
and Chief Executive Officer of Stac since March 1992 and a director since 1983.
Mr. Clow also served as President of Stac from 1986 through 1996. Mr. Clow
received an M.A.S. in Computer Systems from Florida Atlantic University and an
M.S. in Electrical Engineering from the California Institute of Technology.
Douglas L. Whiting, Ph.D. has served as Chief Technology Officer since
October 1997 and as a director of the Company since November 1996. He also has
served as Vice President of Technology of Stac since 1985 and has served as a
director of Stac since 1983. He was President of Stac from 1984 to 1986. Dr.
Whiting received a Ph.D. in Computer Science from the California Institute of
Technology.
COMMITTEES OF THE BOARD OF DIRECTORS
AUDIT COMMITTEE. Prior to the Distribution, the Company Board will
establish an Audit Committee of at least two non-employee directors. The Audit
Committee will review the annual audits of the Company's independent public
accountants, review and evaluate internal accounting controls, recommend the
selection of the Company's independent public accountants, review and pass upon
(or ratify) related party transactions, and conduct such reviews and
examinations as it deems necessary with respect to the practices and policies
of, and the relationship between, the Company and its independent public
accountants.
COMPENSATION COMMITTEE. Prior to the Distribution, the Company Board will
establish a Compensation Committee of at least two non-employee directors. The
Compensation Committee will review salaries, bonuses and stock options of senior
officers of the Company, and administer the Company's executive compensation
policies and stock option plans.
COMPENSATION OF THE BOARD OF DIRECTORS
Each non-employee director of the Company will receive $ per year for
serving on the Company Board and an additional $ for each meeting
attended (other than committee meetings). An additional $ will be paid
to any non-employee director who serves on the Executive Committee. Each
director is eligible to receive stock options pursuant to the 1996 Plan. See
"-- Hi/fn Equity Plan." Directors also will receive reimbursement for travel
expenses incurred in connection with their duties as directors.
54
<PAGE> 60
EXECUTIVE OFFICERS
Set forth below are the names, positions and ages of the individuals who
will become executive officers of the Company upon consummation of the
Distribution:
<TABLE>
<CAPTION>
NAME POSITION WITH HI/FN AGE
---- ------------------- ---
<S> <C> <C>
William R. Walker................. Vice President, Acting Chief Executive 57
Officer, Acting President, Chief
Financial Officer and Corporate
Secretary
Stephen A. Farnow................. Vice President of Operations 49
Thomas F. Griffin................. Vice President of Sales 41
Robert A. Monsour................. Vice President of Marketing 43
</TABLE>
William R. Walker has served as Vice President and Chief Financial Officer
of the Company since November 1997. He has been the Company's Acting Chief
Executive Officer and Acting President since July 1998. From 1996 to 1997, Mr.
Walker was Vice President, Chief Financial Officer and Secretary at MMC
Networks, Inc., a networking Company. From 1984 to 1996, Mr. Walker held the
position of Senior Vice President and Chief Financial Officer at Zilog, Inc., a
semiconductor supplier. Mr. Walker has a B.S. in Economics from University of
Wisconsin and an M.B.A. from University of Maryland, and he is a certified
public accountant.
Stephen A. Farnow has served as Vice President of Operations at the Company
since 1996. From 1990 through 1996, he worked as an independent consultant in
the area of general management with an emphasis on setting up or re-engineering
operations functions. From 1986 through 1990, he was Vice President of
Operations at Weitek Corp., a semiconductor supplier. He received a B.S. in
Physics from UCLA and Ph.D. from Stanford University.
Thomas F. Griffin has been Vice President of Sales since joining the
Company in April 1998. From 1996 to 1998, he was Vice President of Sales and
Marketing at Cartesian Data, Inc., a supplier of storage devices. From 1994 to
1996, Mr. Griffin was Business Development Manager at Quantum Corporation. Mr.
Griffin holds a B.S. in Chemical Engineering from University of California,
Berkeley.
Robert A. Monsour has served as Vice President of Marketing of the Company
since August 1997. He also served as Vice President of Sales from August 1997
through April 1998. From 1996 to 1997, he worked as an independent consultant in
the area of high-technology marketing. From 1993 to 1996, Mr. Monsour, a co-
founder of Stac, held the position of Vice President of Business Development
there. He was also Vice President of Product Development from 1990 to 1993. From
1988 to 1990 he was Vice President of Marketing at Stac. Mr. Monsour has a
B.A.S. and M.A.S. in Computer Systems from Florida Atlantic University and holds
an M.B.A. from UCLA.
55
<PAGE> 61
EXECUTIVE COMPENSATION
The following table sets forth certain information concerning compensation
for the fiscal year ended September 30, 1997 received by the Chief Executive
Officer and the only other executive officer of the Company whose compensation
exceeded $100,000 for that year (the "Named Executive Officers"). No other
executive officer of the Company meets the definition of "highly compensated"
within the meaning of the executive compensation disclosure rules of the
Commission.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
ANNUAL COMPENSATION COMPENSATION AWARDS
------------------------------- ------------------------
NUMBER OF
RESTRICTED SECURITIES
FISCAL STOCK UNDERLYING
NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) AWARDS($) OPTIONS(#)
--------------------------- ------ --------- -------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Arthur J. Collmeyer(1)................... 1997 150,000 30,000 0 300,000
Stephen A. Farnow,....................... 1997 100,000 12,600 0 72,000
Vice President of Operations
</TABLE>
- ---------------
(1) Mr. Collmeyer served as President and Chief Executive Officer of the Company
until July 2, 1998.
STOCK OPTION GRANTS TABLE
The following table sets forth certain information with respect to options
to purchase Company Common Stock granted during the year ended September 30,
1997 to each of the Named Executive Officers. The Company does not have any
outstanding stock appreciation rights.
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT ASSUMED
NUMBER OF % OF ANNUAL RATES OF STOCK
SECURITIES TOTAL OPTIONS PRICE APPRECIATION FOR
UNDERLYING GRANTED TO EXERCISE OR OPTION TERM(1)
OPTIONS EMPLOYEES IN BASE PRICE PER EXPIRATION -----------------------
NAME GRANTED(#) FISCAL YEAR(%) SHARE($/SH) DATE 5% 10%
---- ---------- -------------- -------------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Arthur J. Collmeyer.... 300,000 19.6% $0.60 11/22/06 $113,202 $286,866
Stephen A. Farnow...... 72,000 4.7% $0.60 (2) $ 27,168 $ 68,848
</TABLE>
- ---------------
(1) The potential realizable values are based on an assumption that the stock
price of the Company Common Stock will appreciate at the annual rate shown
(compounded annually) from the date of grant until the end of the option
term. These values do not take into account amounts required to be paid as
income taxes under the Code and any applicable state laws or option
provisions providing for termination of an option following termination of
employment, non-transferability or vesting. These amounts are calculated
based on the requirements promulgated by the Commission and do not reflect
the Company's estimate of future stock price growth of the shares of the
Company Common Stock.
(2) Mr. Farnow was granted an option to purchase 60,000 shares of Company Common
Stock at a price of $0.60 each, which expires on November 22, 2006, and was
granted an additional option to purchase 12,000 shares of Company Common
Stock at a price of $0.60 each, which expires on May 22, 2007.
56
<PAGE> 62
OPTION EXERCISES AND FISCAL YEAR-END OPTION VALUE TABLE
The following table sets forth certain information with respect to the
exercise of options to purchase Company Common Stock during the year ended
September 30, 1997, and the unexercised options held and the value thereof at
that date, for each of the Named Executive Officers.
<TABLE>
<CAPTION>
NUMBER OF
SECURITIES VALUE OF
UNDERLYING UNEXERCISED
UNEXERCISED IN-THE-MONEY
OPTIONS AT OPTIONS AT
FISCAL YEAR FISCAL YEAR
END(#) END($)(1)
SHARES ACQUIRED VALUE EXERCISABLE/ EXERCISABLE/
NAME ON EXERCISE(#) REALIZED($)(2) UNEXERCISABLE UNEXERCISABLE
---- --------------- -------------- ------------- -------------
<S> <C> <C> <C> <C>
Arthur J. Collmeyer................. 150,000 $0.00 0/150,000 $0/$210,000
Stephen A. Farnow................... 36,000 $0.00 0/36,000 $ 0/$50,400
</TABLE>
- ---------------
(1) Calculated by determining the difference between the fair market value of
the securities underlying the options at September 30, 1997 ($2.00 per share
as determined by the Company Board) and the exercise price of the options.
(2) Mr. Collmeyer and Mr. Farnow exercised options pursuant to an early-exercise
feature at an exercise price equal to fair market value.
HI/FN EQUITY PLAN
The Company's Amended and Restated 1996 Equity Incentive Plan (the "1996
Plan") was adopted by the Company Board and approved by Stac as the sole
stockholder in November 1996. The 1996 Plan was recently amended by the Company
Board and stockholders to, among other things, increase the number of Company
Common Stock shares reserved for issuance pursuant to the 1996 Plan to
1,949,900. As of August 1, 1998, 482,806 shares had been issued upon exercise of
stock options granted under the 1996 Plan, 858,395 shares were subject to
options granted under the 1996 Plan and 608,699 shares were available for future
grants. Unless terminated sooner, the 1998 Plan will terminate automatically in
November 2006.
The 1996 Plan provides for the grant of (i) incentive stock options, within
the meaning of Section 422 of the Internal Revenue Code of 1986, as amended
("Section 422"), to employees of the Company, (ii) nonstatutory stock options,
(iii) stock bonuses, (iv) stock purchase rights ("SPRs"), and (v) stock
appreciation rights (collectively, "Stock Awards") to employees, directors and
consultants of the Company, provided that incentive stock options and stock
appreciation rights appurtenant thereto may be granted to employees of the
Company. Unless terminated sooner, the 1996 Plan will terminate automatically in
November 2006.
The 1996 Plan may be administered by the Company Board or a committee of
the Company Board (as applicable, the "Administrator"). The Administrator has
the power to determine the terms of Stock Awards granted, including the exercise
price, the number of shares subject to each Stock Award, the exercisability
thereof, and the form of consideration payable upon such exercise. In addition,
the Administrator has the authority to amend, suspend or terminate the 1996
Plan, provided that no such action may affect any share of Company Common Stock
previously issued and sold or any Stock Award previously granted under the 1996
Plan.
In the case of options, the exercise price of all incentive stock options
granted under the 1996 Plan must be at least equal to the fair market value of
the Company Common Stock on the date of grant and the term of such incentive
stock option must not exceed ten years. The exercise price of nonstatutory stock
options granted under the 1996 Plan is determined by the Administrator. With
respect to any participant who owns stock possessing more than 10% of the voting
power of all classes of the Company's outstanding capital stock, the exercise
price of any incentive stock option granted must be at least equal 110% of the
fair market value on the grant date and the term of such incentive stock option
must not exceed five years. The term of all other options granted under the 1996
Plan shall be stated in the option agreement. Options granted under the 1996
Plan
57
<PAGE> 63
must generally be exercised within three months after the end of optionee's
continuous status as an employee, or consultant of the Company, or within 12
months after such optionee's termination by disability, or within 18 months
after such optionee's termination by death, but in no event later than the
expiration of the option's term. The Administrator may include a re-load option
as part of any option agreement. The reload option shall be for the number of
shares surrendered as part of an exercise price of the option, shall have an
expiration date which is the same as the expiration date of the original option,
and shall have an exercise price on the date of exercise of the original option
as set forth above.
In the case of stock bonuses and SPRs, the Administrator may provide that
the Company be granted a repurchase option exercisable upon the voluntary or
involuntary termination of the purchaser's employment or consulting relationship
with the Company for any reason (including death or disability). The purchase
price for shares repurchased pursuant to the repurchase option shall be
determined by the Administrator. The repurchase option shall lapse at a rate
determined by the Administrator.
The 1996 Plan authorizes three types of stock appreciation rights: tandem
stock appreciation rights, concurrent stock appreciation rights and independent
stock appreciation rights. The Administrator has the sole discretion and
authority to grant stock appreciation rights. Tandem stock appreciation rights
are granted appurtenant to an option and require the holder to elect between the
exercise of the option or the stock appreciation right. The appreciation of the
tandem stock purchase right is payable in cash (or, if provided for in the
agreement, in shares) in an amount not to exceed the fair market value on the
date the option is surrendered over the aggregate exercise price payable.
Concurrent stock appreciation rights are granted appurtenant to an option and
are exercised automatically upon exercise of the option. The appreciation of the
concurrent stock appreciation right is payable in cash (or, if provided for in
the agreement, in shares) in an amount equal aggregate fair market value on the
date of exercise of the option over the aggregate exercise price paid for the
shares. Independent Stock Appreciation Rights are denominated in share
equivalents. The appreciation of the independent stock appreciation right is
payable in cash (or, if provided for in the agreement, in shares) in an amount
not to exceed the fair market value on the date the stock appreciation right is
surrendered over the fair market value on the date the stock appreciation right
is granted.
Stock Awards granted under the 1996 Plan are generally not transferable by
the optionee, and each Stock Award is exercisable during the lifetime of the
optionee only by such optionee. The 1996 Plan also provides that in the event of
a merger of the Company with or into another corporation, or a sale of
substantially all of the Company's assets, each Stock Award shall be assumed or
an equivalent award substituted for by the successor corporation. If the
outstanding Stock Awards are not assumed or substituted for by the successor
corporation, the Stock Award shall terminate.
INDEMNIFICATION AGREEMENTS
The Company has entered, or will enter, into indemnification agreements
with its directors and executive officers (each, an "Indemnified Person") prior
to the Distribution. An Indemnified Person is specifically indemnified and held
harmless under such agreements for costs and expenses, including without
limitation, damages, judgments, amounts paid in settlement, reasonable costs of
investigation, reasonable attorneys' fees, costs of investigative, judicial or
administrative proceedings or appeals, costs or attachment of similar bonds,
fines, penalties, and excise taxes assessed with respect to employee benefit
plans actually and reasonably incurred in connection with a threatened, pending
or completed claim, action, suit or proceeding by reason of the fact that (i) he
is or was a director, officer, employee and/or agent of the Company, or (ii) he
is or was serving as a director, officer, employee, trustee and/or agent of
another corporation or entity at the request of the Company. To qualify for
indemnification, the claim must not be (i) based solely upon an Indemnified
Person's gaining in fact any personal profit or advantage to which he was not
legally entitled, (ii) an accounting for profits made from the purchase or sale
of securities pursuant to Section 16(b) of the Exchange Act or (iii) based
solely upon knowingly fraudulent, deliberately dishonest, or willful misconduct
on the part of the Indemnified Person. The Company will indemnify the
Indemnified Person to the extent that (i) the Indemnified Person gives the
Company prompt written notice of any claim, (ii) the Indemnified Person has not
already received payment pursuant to collectible insurance policies and (iii)
indemnification is not unlawful.
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<PAGE> 64
Under such indemnification agreements, the Company will advance costs and
expenses incurred by the Indemnified Person in advance of the final disposition
of an action, suit or proceeding if he undertakes to repay amounts advanced if
it is ultimately determined by a court of competent jurisdiction that he is not
entitled to be indemnified by the Company. The Company will advance costs and
expenses related to defending or investigating an action, suit or proceeding
unless a determination is made that (i) the Indemnified Person did not act in
good faith and in a manner he reasonably believed to be in or not opposed to the
best interests of the Company, (ii) the Indemnified Person intentionally
breached his duty to the Company or its stockholders or (iii) with respect to
any criminal action or proceeding, the Indemnified Person had reasonable cause
to believe his conduct was unlawful. Such determination will be made by a
majority vote of a quorum of the Company Board consisting of directors not a
party to the suit, action or proceeding, by a written opinion of independent
legal counsel, by the stockholders or by a final, nonappealable adjudication in
a court of competent jurisdiction. If the Company advances costs and expenses of
any action, suit or proceeding, the Company reserves the right to assume the
defense of such action, suit or proceeding upon written notice to the
Indemnified Person of its intention to do so. After delivery of such notice, the
Company shall not be liable for any costs or expenses incurred by the
Indemnified Person in retaining separate counsel unless (i) the employment of
separate counsel was previously authorized by the Company, (ii) the Indemnified
Person reasonably concludes that joint representation would entail a conflict of
interest or (iii) the Company shall not, in fact, have employed counsel to
assume the defense of such action, suit or proceeding. The indemnification
provisions and provisions for advancing expenses in such agreements are
expressly not exclusive of any other rights of indemnification or advancement of
expenses pursuant to the Delaware General Corporation Law (the "DGCL"), the
Company Certificate or the Company Bylaws.
CHANGE OF CONTROL ARRANGEMENTS
The Company has entered into a Change of Control Agreement with each of
William R. Walker, the Company's Vice President and Chief Financial Officer,
Stephen A. Farnow, the Company's Vice President of Operations, and Robert A.
Monsour, the Company's Vice President of Marketing. Pursuant to each such
agreement, if, within 12 months following a change of control, the executive
officer is (i) terminated by the Company or successor Company, other than for
acts of dishonesty, conviction of a felony or willful misconduct, or (ii)
constructively terminated as a result of a material dimunition in salary, a
material change in responsibility or a change in work location of more than 30
miles from the then current job location (each an "Involuntary Termination"),
then he receives accelerated vesting (and/or a lapse of the Company's repurchase
option) with respect to 50% of the options (and/or stock purchase rights) held
at the time of the Involuntary Termination. For purposes of each such agreement,
a change of control is defined as (i) a sale of all or substantially all of the
assets of the Company or a stock tender or a merger, consolidation or similar
event pursuant to a transaction or series of transactions in which a third party
acquires more than 50% of the voting equity securities of the Company
outstanding immediately prior to such change of control, or (ii) a repurchase of
the minority equity interest in the Company by Stac by way of any means which
results in the Company becoming a wholly-owned subsidiary of Stac.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
TRANSACTIONS WITH STAC
Stac incorporated Hi/fn as a wholly owned subsidiary of Stac on August 14,
1996. On November 21, 1996, Stac transferred its semiconductor business (along
with the associated technology, assets and liabilities) to the Company pursuant
to an Assignment, Assumption and License Agreement (the "Assignment Agreement")
in exchange for 6,000,000 shares of Series A Preferred Stock and 100 shares of
Company Common Stock issued by the Company to Stac pursuant to a Stock Purchase
Agreement.
The assets transferred to the Company pursuant to the Assignment Agreement
included, without limitation, $1,000,000 of available cash, the accounts
receivable and inventory of the semiconductor business, Stac's rights under
certain sales and license agreements, and the fixed assets, trademarks, patents
and proprietary technology specified on schedules attached to the Assignment
Agreement. The Assignment
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<PAGE> 65
Agreement also provided for the assignment by Stac and the assumption by the
Company of the accounts payable relating to the semiconductor business, the
obligations under the sales and license agreements assigned to the Company, and
current and unpaid payroll and related benefits expenses related to former
employees of Stac who became employees of the Company.
At the time of the transfer of the semiconductor business to the Company,
Stac and the Company also entered into a Cross License Agreement pursuant to
which the Company granted Stac a limited, worldwide, perpetual, non-exclusive,
non-transferable, royalty-free license to the patents previously transferred by
Stac to the Company pursuant to the Assignment Agreement. The Cross License
Agreement permits Stac, among other things, to use, modify, create derivative
works, reproduce, license and sublicense the technology to end users of Stac's
products that incorporate the technology licensed to Stac by the Company. Stac,
however, may not create hardware implementations of the technology subject to
the Cross License Agreement or license or sell any of the software subject to
the Cross License Agreement as a stand-alone product for a period of ten years
after the date of the Cross License Agreement. Under the Cross License
Agreement, Stac also sublicensed or assigned to the Company certain third-party
licenses held by Stac. The parties further agreed that for a ten year period (i)
Stac would transfer ownership to the Company of any derivative works created by
Stac from the licensed technology and (ii) the Company would transfer ownership
to Stac of all future commercial releases of software implementations of the
licensed technology developed by the Company.
Prior to the Distribution Date, the Company and Stac will enter into a
Distribution Agreement, Employee Benefits Allocation Agreement, Tax Sharing
Agreement and Transitional Services Agreement, which provide for, among other
things, the Distribution and certain other agreements governing the relationship
between the Company and Stac following the Distribution.
Subject to certain exceptions, the Distribution Agreement provides for,
among other things, assumptions of liabilities and cross-indemnities designed to
allocate to the Company, effective as of the Distribution Date, financial
responsibility for the liabilities arising out of or in connection with the
Company's business. The Distribution Agreement also provides that, except as
otherwise set forth therein or in any related agreement, all costs and expenses
incurred in connection with the Distribution will be charged to the party for
whose benefit the expenses are incurred, with any expenses that cannot be
allocated on such basis to be split equally between the parties.
The Employee Benefits Allocation Agreement generally contemplates that the
Company will assume and retain all obligations and liabilities with respect to
Hi/fn employee plans and benefits and that Stac will retain all obligations and
liabilities with respect to Stac employee plans and benefits. The Employee
Benefits Allocation Agreement also provides that the Company will assume and
retain, with respect to Hi/fn employees, all responsibility for liabilities and
obligations as of the Distribution Date for medical and dental plan coverage and
for vacation and welfare plans. Stac will retain, with respect to Stac
employees, all responsibilities for all liabilities and obligations as of the
Distribution Date for medical and dental plan coverage and for vacation and
welfare plans.
The Tax Sharing Agreement defines the parties' rights and obligations with
respect to tax returns and tax liabilities, including, in particular, federal
and state income tax returns and liabilities, for taxable years and other
taxable periods ending on or before the Distribution date. In general, Stac will
be responsible for (i) filing all federal and state income tax returns of Stac,
the Company and any of their subsidiaries for all taxable years ending on or
before the Distribution Date, and (ii) paying the taxes relating to such returns
(including any deficiencies proposed by applicable taxing authorities). For
post-Distribution periods, Stac and the Company will each be responsible for
filing its own returns and paying its own taxes relating to such returns
(including any deficiencies proposed by applicable taxing authorities).
The Company and Stac will also enter into a Transitional Services Agreement
pursuant to which Stac will provide certain accounting services to the Company,
and each of Stac and the Company will provide certain other services to the
other, on a transitional basis after the Distribution. The fees for such
transitional services will be based on rates designed to reflect the actual
costs (including indirect costs) of providing such services. The Company will be
free to procure such services from outside vendors or to develop in-house
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<PAGE> 66
capabilities in order to provide such services internally. The Transitional
Services Agreement will terminate on December 31, 1999 unless extended in
writing by the parties.
LOANS TO OFFICERS
On December 31, 1997, the Company made a loan to William R. Walker, the
Company's Vice President and Chief Financial Officer, in the aggregate principal
amount of $100,000 and bearing interest at the rate of 6.00% per annum, in order
to fund the exercise price of stock options held by him. The loan is evidenced
by a full recourse promissory note, which matures on the earlier to occur of (i)
December 31, 2001, or (ii) the date on which Mr. Walker ceases to be an
employee, director or consultant of the Company. The promissory note is secured
by a pledge of 50,000 shares of Company Common Stock owned by Mr. Walker and
currently held in escrow. The entire principal amount and accrued interest on
the loan to Mr. Walker remains outstanding as of the date of this Information
Statement.
SALE OF SECURITIES
Arthur J. Collmeyer purchased 75,000 shares of Company Common Stock at $.60
per share pursuant to an offer of employment with the Company dated October 16,
1996. The Company sold the shares to Mr. Collmeyer, an accredited investor,
pursuant to an exemption from registration under Section 4(2) of the Securities
Act.
INDEMNIFICATION AGREEMENTS
The Company has entered, or will enter, into indemnification agreements
with each of its directors and executive officers prior to the Distribution. See
"MANAGEMENT -- Indemnification Agreements."
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<PAGE> 67
SECURITIES OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the number of shares of Company Common Stock
expected to be beneficially owned immediately following the Distribution by (i)
the Named Executive Officers and directors of the Company, (ii) all of the
Company's executive officers and directors as a group and (iii) all other
stockholders known by Stac to own beneficially more than five percent of the
Company Common Stock, based upon the expected beneficial ownership by such
persons of Stac Common Stock, Company Common Stock and options to acquire
Company Common Stock as of October 15, 1998. A list of the individuals who are
expected to be executive officers of the Company immediately following the
Distribution is set forth under the heading "MANAGEMENT." Except as otherwise
indicated, each individual named is expected to have sole investment and voting
power with respect to the securities shown.
<TABLE>
<CAPTION>
AMOUNT AND
NATURE OF PERCENT
BENEFICIAL BENEFICIALLY
NAME AND ADDRESS(1) OWNERSHIP OWNED
------------------- ---------- ------------
<S> <C> <C>
Microsoft Corporation........................ 611,872 9.5%
One Microsoft Way
Redmond, WA 98052-6399
Gary W. Clow(2).............................. 373,756 5.8%
Robert W. Johnson(3)......................... 439,727 6.8%
Douglas L. Whiting(4)........................ 344,042 5.3%
Arthur J. Collmeyer..........................
Stephen A. Farnow............................
Robert A. Monsour............................
William R. Walker............................
</TABLE>
- ---------------
* Less than 1%
(1) This table is based upon information supplied by officers, directors and
principal stockholders and Schedules 13D and 13G, if any, filed with the
Commission. Unless otherwise indicated in the footnotes to this table and
subject to community property and marital property laws where applicable,
each of the stockholders named in this table has sole voting and investment
power with respect to the shares indicated as beneficially owned.
(2) Includes 437,736 shares held by the Robert W. Johnson Revocable Trust, of
which Dr. Johnson is Trustee.
(3) Includes 4,504 shares held of record by Mr. Clow's minor daughter, of which
Mr. Clow disclaims beneficial ownership.
(4) Includes 344,402 shares held by the Whiting Family Trust, of which Mr.
Whiting serves as Trustee.
62
<PAGE> 68
HI/FN CERTIFICATE OF INCORPORATION AND BYLAWS
The following is a summary of the Company Certificate and the Company
Bylaws, as each will be in effect following the Distribution, and is qualified
in its entirety by reference to the complete text of the Company Certificate as
set forth in Annex I hereto, and the Company Bylaws as set forth in Annex II
hereto.
AUTHORIZED STOCK
The Company Certificate provides that the Company is authorized to issue
110,000,000 shares of stock, consisting of 100,000,000 shares of Company Common
Stock and 10,000,000 shares of Company Preferred Stock together with the Company
Common Stock, "Company Stock"). Shares of Company Preferred Stock may be issued
from time to time, in one or more series, each of which series shall have such
voting powers, designations, preferences and rights, and the qualifications,
limitations or restrictions relating thereto, as shall be authorized by the
Company Board. See "DESCRIPTION OF THE COMPANY'S CAPITAL STOCK."
DIRECTORS
The Company Certificate provides that the number of directors shall be
fixed exclusively by one or more resolutions adopted by the Company Board.
Presently, the Company Board has two members. At the time of the Distribution,
the Company expects that the Company Board will be comprised of five members.
The Company Bylaws provide that, except as otherwise provided by law or the
Company Certificate, a quorum of the Company Board for the transaction of
business shall consist of a majority of the entire Board of Directors, except
with respect to indemnification of directors, officers and agents of the
Company, for which a quorum shall be one-third of the number of directors
comprising the Company Board. The act of a majority of the directors present at
any meeting at which there is a quorum shall be the act of the Board of
Directors. The Company Certificate do not provide for cumulative voting in the
election of directors to the Company Board. The Company Bylaws will provide that
vacancies and any newly-created directorships resulting from an increase in the
authorized number of directors may be filled by a majority of the directors then
in office, though less than a quorum, or by a sole remaining director.
LIABILITY FOR MONETARY DAMAGES
The Company Certificate provides that no director will be personally liable
to the Company or its stockholders for monetary damages for breach of fiduciary
duty as a director, other than liability for breach of the duty of loyalty to
the Company or its stockholders, acts or omissions not in good faith,
intentional misconduct, a knowing violation of law, certain unlawful dividends,
stock repurchases or redemptions or any transaction from which the director
derived an improper personal benefit. Any repeal or modification of such
provision by the stockholders of the Company will not adversely affect any right
or protection of a director existing at the time of such repeal or modification
with respect to acts or omissions occurring prior to such repeal or
modification.
ANTITAKEOVER EFFECT OF AUTHORIZED BUT UNDESIGNATED PREFERRED STOCK
As described above, the Company Board is authorized to provide for the
issuance of shares of Company Preferred Stock, in one or more series, and to fix
by resolution of the Company Board and to the extent permitted by the DGCL, the
terms and conditions of each such series. The Company believes that the
availability of Company Preferred Stock will provide the Company with increased
flexibility in structuring possible future financings and acquisitions and in
meeting other corporate needs which might arise from time to time. Authorized
but unissued shares of Company Preferred Stock, as well as authorized but
unissued shares of Company Common Stock, will be available for issuance without
further action by Company stockholders, unless such action is required by
applicable law or the rules of any stock exchange or automated quotation system
on which any class of Company Stock may then be listed for trading.
Although the Company Board has no present intention of doing so, it will be
able to issue a series of Company Preferred Stock that could, depending on its
terms, either impede or facilitate the completion of a merger, tender offer or
other takeover attempt. For instance, such new shares might impede a business
63
<PAGE> 69
combination by including class voting rights which would enable the holder to
block such transaction or facilitate a business combination by including voting
rights which would provide a required percentage vote of stockholders. The
Company Board will make any determination to issue such shares based on its
judgment as to the best interests of the Company and its then existing
stockholders. The Company Board, in so acting, will be able to issue Company
Preferred Stock having terms which would discourage an acquisition attempt or
other transaction that some or a majority of the stockholders might believe to
be in their best interests or in which stockholders might receive a premium for
their stock over the then market price of such stock.
INDEMNIFICATION AND ADVANCEMENT OF EXPENSES
The Company Certificate and Bylaws will provide for the indemnification of
present and former directors, officers, employees and agents of the Company and
persons serving as directors, officers, employees or agents of another
corporation or entity at the request of the Company (each, an "Indemnified
Party") to the fullest extent permitted by the DGCL. Indemnified Parties are
specifically indemnified in the Company Bylaws (the "Indemnification
Provisions") for expenses, including attorneys' fees, court costs, witness fees,
judgments, fines and amounts paid in settlement actually and reasonably incurred
by an Indemnified Party in connection with a threatened, pending or completed
action, suit or proceeding (whether civil, criminal, administrative or
investigative) by reason of the fact that he is or was a director or officer of
the Company or is or was serving as a director, officer, employee or agent of
another corporation or entity at the request of the Company. Such Indemnified
Party must have acted in good faith and in a manner he reasonably believed to be
in or not opposed to the best interests of the subject corporation and, with
respect to any criminal action or proceeding, must have had no reasonable cause
to believe his conduct was unlawful.
The Indemnification Provisions and provisions for advancing expenses in the
Company Bylaws are expressly not exclusive of any other rights of
indemnification or advancement of expenses pursuant to any agreement, vote of
the stockholders or disinterested directors or pursuant to judicial direction.
The Company is authorized to purchase insurance on behalf of an Indemnified
Party for liabilities incurred, whether or not the Company would have the power
or obligation to indemnify him pursuant to the Company Certificate, the Company
Bylaws or the DGCL.
In addition, the Company has entered, or will enter, into indemnification
agreements with each of its directors and executive officers pursuant to which
such persons are indemnified for costs and expenses actually and reasonably
incurred by such persons in connection with a threatened, pending or completed
claim arising out of service as a director, officer, employee, trustee and/or
agent of the Company or another entity at the request of the Company. See
"MANAGEMENT -- Indemnification Agreements."
AMENDMENT OF THE COMPANY CERTIFICATE AND BYLAWS
The DGCL provides that approval of a majority of the stockholders entitled
to vote thereon is required to amend the Company Certificate. In addition, the
Company Certificate requires the approval of at least 66 2/3% of the voting
power of stockholders entitled to vote thereon to amend the provisions of the
Company Certificate regarding management, directors, indemnification and
amendments to the Company Certificate. A bylaw may be amended or repealed, or a
new bylaw adopted, by (i) the affirmative vote of the holders of at least
66 2/3% of the stock entitled to vote thereon or (ii) a majority of the entire
Company Board.
DESCRIPTION OF THE COMPANY'S CAPITAL STOCK
Following the Distribution, the authorized capital stock of the Company
will consist of 100,000,000 shares of Company Common Stock, $.001 par value, and
10,000,000 shares of Company Preferred Stock, $.001 par value. The description
set forth below is incomplete and is qualified by reference to the Company's
Third Amended and Restated Certificate of Incorporation (the "Company
Certificate") and Amended and Restated Bylaws (the "Company Bylaws"), which are
set forth in Annex I and Annex II hereto, respectively.
64
<PAGE> 70
COMMON STOCK
The holders of Company Common Stock are entitled to one vote for each share
held of record on all matters submitted to a vote of the stockholders. Except as
otherwise provided by law, the holders of Company Common Stock vote together
with the holders of Company Preferred Stock as one class. Subject to the rights
of holders of any shares of Company Preferred Stock which may at the time be
outstanding, holders of Company Common Stock will be entitled to such dividends
as the Company Board may declare out of funds legally available therefor. See
"RISK FACTORS -- Dividend Policy." Subject to the prior rights of creditors and
holders of any Company Preferred Stock which may be outstanding from time to
time, the holders of Company Common Stock are entitled, in the event of
liquidation, dissolution or winding up of the Company, to share pro rata in the
distribution of all remaining assets. The Company Common Stock is not liable for
any calls or assessments and is not convertible into any other securities. In
addition, there are no redemption or sinking fund provisions applicable to the
Company Common Stock.
PREFERRED STOCK
The Company Certificate provides that the Company Board is authorized to
provide for the issuance of shares of Company Preferred Stock, from time to
time, in one or more series. Prior to the issuance of shares in each series, the
Company Board is required by the Company Certificate and the DGCL to adopt
resolutions and file a Certificate of Designations, Preferences and Relative,
Participating, Optional and Other Special Rights of Preferred Stock and
Qualifications, Limitations and Restrictions Thereof (the "Certificate of
Designation") with the Secretary of State of Delaware, fixing for each such
series the designations, preferences and relative, participating, optional or
other special rights applicable to the shares to be included in any such series
and any qualifications, limitations or restrictions thereon, including, but not
limited to, dividend rights, dividend rate or rates, conversion rights, voting
rights, rights and terms of redemption (including sinking fund provisions), the
redemption price or prices, and the liquidation preferences as are permitted by
Delaware law.
DISTRIBUTION AGENT; TRANSFER AGENT AND REGISTRAR
The Distribution Agent and Transfer Agent and Registrar for the Company
Common Stock and Company Preferred Stock is American Stock Transfer & Trust
Company.
CERTAIN CHARTER AND BYLAW PROVISIONS AND DELAWARE LAW
After the Distribution, certain provisions of the Company Certificate and
Company Bylaws could discourage potential acquisition proposals and could delay
or prevent a change in control of the Company. The Company Certificate provides,
among other things, for a classified Company Board and eliminates the right of
stockholders to take action by written consent. The issuance of Company
Preferred Stock authorized in the Company Certificate could have the effect of
delaying or preventing a change in control of the Company. Such Company
Preferred Stock could be utilized to implement, without stockholder approval, a
stockholders' right plan that could be triggered by certain change in control
transactions, which could delay or prevent a change in control of the Company or
could impede a merger, consolidation, takeover or other business combination
involving the Company. The issuance of Company Preferred Stock with voting and
conversion rights may adversely affect the voting power of the holders of
Company Common Stock, including the loss of voting control to others. The
Company has no current plans to issue shares of Company Preferred Stock.
In addition, the Company Bylaws provide, among other things, that special
meetings of the stockholders of the Company may be called only by the Company
Board, the Chairman of the Company Board, the President of the Company or by any
person or persons holding shares representing at least 10% of the outstanding
capital stock of the Company. The Company Bylaws also establish procedures,
including advance notice procedures with regard to the nomination, other than by
or at the direction of the Company Board, of candidates for election as
directors.
The Company is subject to the provisions of Section 203 of the DGCL, an
antitakeover law. In general, the statute prohibits a publicly held Delaware
corporation from entering into a "business combination" with an
65
<PAGE> 71
"interested stockholder" for a period of three years after the date of the
transaction in which the person became an interested stockholder, unless the
business combination is approved in a prescribed manner. For purposes of Section
203, a "business combination" includes a merger, asset sale or transaction
resulting in a financial benefit to the interested stockholder, and an
"interested stockholder" is a person who, together with affiliates and
associates, owns (or within three years prior, did own) 15% or more of the
Company's voting capital stock.
The provisions of the Company Certificate, Company Bylaws and Delaware law
are intended to encourage potential acquirors to negotiate with the Company and
allow the Company Board the opportunity to consider alternative proposals in the
interest of maximizing stockholder value. Such provisions, however, may also
have the effect of discouraging acquisition proposals or delaying or preventing
a change in control of the Company, which may have an adverse effect on the
market price of the Company Common Stock.
66
<PAGE> 72
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of hi/fn, inc.
In our opinion, the accompanying balance sheet and the related statements
of operations, of cash flows and of changes in stockholders' equity present
fairly, in all material respects, the financial position of hi/fn, inc., a
subsidiary of Stac, Inc., at September 30, 1997 and 1996, and the results of its
operations and its cash flows for each of the three years in the period ended
September 30, 1997, in conformity with generally accepted accounting principles.
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 audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards 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 the opinion expressed
above.
PRICEWATERHOUSECOOPERS LLP
San Diego, California
June 5, 1998
F-1
<PAGE> 73
HI/FN, INC.
BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30,
---------------- JUNE 30,
1996 1997 1998
------ ------ -----------
(UNAUDITED)
<S> <C> <C> <C>
Current assets:
Cash...................................................... $ -- $ 480 $ 69
Accounts receivable, net.................................. 1,181 1,823 1,946
Due from parent........................................... -- 1,507 3,792
Inventories............................................... 708 409 255
Deferred income taxes..................................... 333 385 526
Prepaid expenses and other current assets................. 6 192 273
------ ------ ------
Total current assets.............................. 2,228 4,796 6,861
Property and equipment, net............................... 361 959 1,123
Deferred income taxes..................................... 18 95 127
Other assets.............................................. 4 48 562
------ ------ ------
$2,611 $5,898 $8,673
====== ====== ======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 600 $ 660 $ 947
Due to parent............................................. 1,481 -- --
Accrued expenses and other current liabilities............ 530 616 1,144
------ ------ ------
Total current liabilities......................... 2,611 1,276 2,091
------ ------ ------
Commitments (Note 7)
Stockholders' equity:
Preferred stock, .001 par value; 10,000,000 shares
authorized; 6,000,000 shares issued and outstanding.... -- 6 6
Common stock, .001 par value; 15,000,000 shares
authorized; 280,799 and 478,507 shares issued and
outstanding at September 30, 1997 and June 30, 1998,
respectively........................................... -- -- --
Paid-in capital........................................... -- 2,783 2,991
Note receivable from stockholder.......................... -- -- (100)
Retained earnings......................................... -- 1,833 3,685
------ ------ ------
Total stockholders' equity.................................. -- 4,622 6,582
------ ------ ------
$2,611 $5,898 $8,673
====== ====== ======
</TABLE>
See accompanying notes to financial statements.
F-2
<PAGE> 74
HI/FN, INC.
STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED SEPTEMBER 30, JUNE 30,
---------------------------- -----------------
1995 1996 1997 1997 1998
------ ------- ------- ------ -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues................................... $7,342 $12,894 $14,226 $8,991 $16,513
Cost of revenues........................... 2,841 5,095 4,762 2,955 5,142
------ ------- ------- ------ -------
Gross margin............................... 4,501 7,799 9,464 6,036 11,371
------ ------- ------- ------ -------
Operating expenses:
Research and development................... 551 1,641 2,985 1,873 4,066
Sales and marketing........................ 1,097 1,677 2,224 1,585 2,438
General and administrative................. 492 889 1,203 851 1,737
------ ------- ------- ------ -------
Total operating expenses................... 2,140 4,207 6,412 4,309 8,241
------ ------- ------- ------ -------
Operating income........................... 2,361 3,592 3,052 1,727 3,130
Interest income............................ -- -- 16 7 14
------ ------- ------- ------ -------
Income before income taxes................. 2,361 3,592 3,068 1,734 3,144
Provision for income taxes................. 947 1,441 1,235 699 1,292
------ ------- ------- ------ -------
Net income................................. $1,414 $ 2,151 $ 1,833 $1,035 $ 1,852
====== ======= ======= ====== =======
Net income per share, basic................ $ .24 $ .36 $ .30 $ .17 $ .29
====== ======= ======= ====== =======
Net income per share, diluted.............. $ .24 $ .36 $ .30 $ .17 $ .27
====== ======= ======= ====== =======
Weighted average shares outstanding,
basic.................................... 6,000 6,000 6,100 6,075 6,282
====== ======= ======= ====== =======
Weighted average shares outstanding,
diluted.................................. 6,000 6,000 6,174 6,075 6,782
====== ======= ======= ====== =======
</TABLE>
See accompanying notes to financial statements.
F-3
<PAGE> 75
HI/FN, INC.
STATEMENT OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED SEPTEMBER 30, JUNE 30,
----------------------------- ------------------
1995 1996 1997 1997 1998
------- ------- ------- ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net income............................. $ 1,414 $ 2,151 $ 1,833 $ 1,035 $ 1,852
Adjustments required to reconcile net
income to net cash provided by
operating activities:
Depreciation and amortization....... 43 68 303 124 560
Provision (benefit) for deferred
income taxes...................... 68 (190) (129) 192 (173)
Changes in assets and liabilities:
Accounts receivable................. (920) 546 (642) (1,172) (123)
Inventories......................... 195 (554) 299 384 154
Prepaid expenses and other current
assets............................ 3 (5) (186) (310) (81)
Other assets........................ 3 1 (44) (7) (854)
Accounts payable.................... 139 409 60 (402) 287
Due to parent....................... 492 889 420 315 423
Accrued expenses and other current
liabilities....................... (65) 446 86 85 528
------- ------- ------- ------- -------
Net cash provided (used) by
operating activities......... 1,372 3,761 2,000 244 2,573
------- ------- ------- ------- -------
Cash flows from investing activities:
Purchases of property and equipment.... (63) (223) (901) (612) (484)
------- ------- ------- ------- -------
Net cash used by investing
activities................... (63) (223) (901) (612) (484)
------- ------- ------- ------- -------
Cash flows from financing activities:
Issuance of common stock............... -- -- 169 45 208
Net transfer of funds to parent........ 85 (1,542) (788) 858 (2,708)
Dividends to Parent Company............ (1,394) (1,996) -- -- --
------- ------- ------- ------- -------
Net cash provided (used) by
financing activities......... (1,309) (3,538) (619) 903 (2,500)
------- ------- ------- ------- -------
Net increase (decrease) in cash and cash
equivalents............................ -- -- 480 535 (411)
Cash and cash equivalents at beginning of
year................................... -- -- -- -- 480
------- ------- ------- ------- -------
Cash and cash equivalents at end of
period................................. $ -- $ -- $ 480 $ 535 $ 69
======= ======= ======= ======= =======
Supplemental non-cash financing
activities:
Issuance of preferred stock for net
assets contributed.................. $ -- $ -- $ 2,620 $ 2,620 $ --
======= ======= ======= ======= =======
Settlement of interdivisional
accounts............................ $ (20) $ (155) $ -- $ -- $ --
======= ======= ======= ======= =======
</TABLE>
See accompanying notes to financial statements.
F-4
<PAGE> 76
HI/FN, INC.
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK PREFERRED STOCK
---------------- ---------------- PAID-IN RETAINED
SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS TOTAL
------ ------- ------ ------- -------- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at September 30, 1994........ -- $ -- -- $ -- -- $ -- $ --
Dividends to Parent Company.......... -- -- -- -- -- (1,414) (1,414)
Net income........................... -- -- -- -- -- 1,414 1,414
------ ------- ----- ------ ------ ------- -------
Balance at September 30, 1995........ -- -- -- -- -- -- --
Dividends to Parent Company.......... -- -- -- -- -- (2,151) (2,151)
Net income........................... -- -- -- -- -- 2,151 2,151
------ ------- ----- ------ ------ ------- -------
Balance at September 30, 1996........ -- -- -- -- -- -- --
Issuance of preferred stock.......... -- -- 6,000 6 2,614 -- 2,620
Issuance of common stock............. 75 -- -- -- 45 -- 45
Issuance of common stock upon
exercise of options................ 206 -- -- -- 124 -- 124
Net income........................... -- -- -- -- -- 1,833 1,833
------ ------- ----- ------ ------ ------- -------
Balance at September 30, 1997........ 281 -- 6,000 6 2,783 1,833 4,622
Issuance of common stock upon
exercise of options (unaudited).... 197 -- -- -- 208 -- 208
Note receivable from stockholder
(unaudited)........................ -- -- -- -- (100) -- (100)
Net income (unaudited)............... -- -- -- -- -- 1,852 1,852
------ ------- ----- ------ ------ ------- -------
Balance at June 30, 1998
(unaudited)........................ 478 $ -- 6,000 $ 6 $2,891 $ 3,685 $ 6,582
====== ======= ===== ====== ====== ======= =======
</TABLE>
See accompanying notes to financial statements.
F-5
<PAGE> 77
HI/FN, INC.
NOTES TO FINANCIAL STATEMENTS
(TABLE AMOUNTS IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS.
INFORMATION WITH RESPECT TO THE NINE MONTHS ENDED JUNE 30, 1997 AND 1998,
AND AS OF JUNE 30, 1998 IS UNAUDITED.)
NOTE 1 -- BASIS OF PRESENTATION
The accompanying financial statements present the carved-out balance sheet,
statements of operations, of cash flows, and of changes in stockholders' equity
for hi/fn, inc. ("Hi/fn" or "the Company"), a majority owned semiconductor
products subsidiary of Stac, Inc. ("Stac" or "the Parent"). Management expects
to separate Hi/fn and Stac into two independent, publicly-traded companies. In
connection with the separation, Stac plans to distribute as a dividend to its
stockholders the shares of Hi/fn common stock owned by the Parent (the
"Distribution"). The Distribution is designed to separate two distinct
businesses with significant differences in their markets, products, investment
needs, employee retention and compensation plans and plans for growth. Stac's
Board of Directors believes that the separation into two independent companies
will enhance the ability of each to focus on strategic initiatives and new
business opportunities, improve cost structures and operating efficiencies and
create incentives that are more attractive and appropriate for the recruitment
and retention of key employees. As a consequence, Stac believes that investors
will be able to evaluate better the merits of the two groups of businesses and
their future prospects.
For the fiscal years ended September 30, 1995 and 1996, Hi/fn conducted
business as a division of Stac. For the fiscal year ended September 30, 1997 and
for the nine month periods ended June 30, 1997 and 1998, Hi/fn conducted
business as a majority-owned subsidiary of Stac. Financial statements have not
been previously prepared for Hi/fn. These financial statements have been
prepared from the historical accounting records of Stac.
The balance sheet at September 30, 1996 reflects Hi/fn's structure prior to
its formation as a subsidiary. Periods subsequent to September 30, 1996 reflect
the net assets contributed by Stac in establishing the Hi/fn subsidiary. The
transfer was recorded at the historical net book value of the transferred assets
and liabilities of $2,620,000. In exchange for the net assets contributed to
Hi/fn, Stac received 6,000,000 shares of Series A Preferred Stock and 100 shares
of common stock (Note 5). For purposes of preparing these financial statements
it was assumed that the net income generated from Hi/fn's operations was
remitted in dividends back to Stac for all periods prior to fiscal 1997.
Additionally, Hi/fn participates with Stac in centralized cash management. In
general, the cash funding requirements of Hi/fn were met by, and all cash
generated by the business was transferred to, Stac. Cash balances at September
30, 1997 and June 30, 1998 represent cash amounts in Hi/fn accounts that had yet
to be liquidated by payment obligations, or transferred to Stac. Related party
receivables and payables are a result of these cash management practices, as
well as allocations of general and administrative costs as discussed below.
Balance sheet amounts at September 30, 1996 for accounts receivable,
inventory and accounts payable represent allocations based on specific
identification of the underlying items. Property and equipment, deferred income
taxes, other current and non-current assets, and accrued expenses and other
current liabilities were primarily allocated based on specific identification
and in other cases allocation methodologies influenced largely by proportioning
head counts. At September 30, 1997 and June 30, 1998, all balance sheet amounts
except the due from parent account are the result of specific identification.
Amounts shown on the statement of operations are based on specific
identification of the costs directly associated with Hi/fn's business for all
components except for general and administrative costs and income tax expense.
For all periods prior to fiscal 1997, allocations of general and administrative
costs are based on management's estimates of the underlying level of effort
required to manage and support Hi/fn's activity. For periods including and
subsequent to fiscal 1997, general and administrative allocations are based on
specific identification of costs directly associated with Hi/fn's business, in
addition to allocations of (i) costs for administrative functions and services
performed on behalf of the Company by staff groups within Stac (ii) a portion of
Stac's management expense and (iii) certain general corporate expenses of Stac.
For the year ended September 30, 1997 and nine month periods ended June 30, 1997
and 1998, general and administrative
F-6
<PAGE> 78
HI/FN, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(TABLE AMOUNTS IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS.
INFORMATION WITH RESPECT TO THE NINE MONTHS ENDED JUNE 30, 1997 AND 1998,
AND AS OF JUNE 30, 1998 IS UNAUDITED.)
allocations totaled $420,000, $315,000 and $423,000, respectively. As more fully
described in Notes 2 and 4, current and deferred income taxes and related tax
expense have been allocated to Hi/fn as if it were a separate taxpayer for all
periods presented.
All of the allocations and estimates in the financial statements are based
on assumptions that the management of Stac and Hi/fn believe are reasonable
under the circumstances; however, these allocations and estimates are not
necessarily indicative of the costs and expenses that would have resulted if
Hi/fn had been operated as a separate entity.
NOTE 2 -- DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES:
OVERVIEW
Hi/fn designs, develops and markets high-performance, multi-protocol packet
processors -- semiconductor devices that enable secure, high-bandwidth network
connectivity and efficient storage of business information. The Company's packet
processor products perform the computation-intensive tasks of compression and
encryption/compression, providing its customers with high-performance,
interoperable implementations of a wide variety of industry-standard networking
and storage protocols. The Company's products are used in a variety of
networking and storage equipment such as routers, remote access concentrators,
firewalls and back-up storage devices.
Financial Statement Preparation
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Revenue Recognition
Revenue from the sale of semiconductors and board products is recognized
upon shipment, net of an allowance for estimated returns. Revenue from periodic
software license and maintenance agreements is generally recognized ratably over
the respective license periods.
Inventories
Inventories are stated at the lower of cost, determined using the first-in,
first-out method, or market. Inventories are comprised solely of finished goods,
which are manufactured by third party foundries for resale by the Company.
Property and Equipment
Property and equipment are stated at cost. Additions to property and
equipment, including significant betterments and renewals, are capitalized.
Maintenance and repair costs are charged to expense as incurred. Depreciation is
computed using the straight-line method over estimated useful lives of three to
five years and totaled $43,000, $68,000, and $303,000 in fiscal 1995, 1996, and
1997, respectively, and $124,000 and $560,000 for the nine months ended June 30,
1997 and 1998, respectively. Leasehold improvements are amortized over the
shorter of the asset life or lease term.
F-7
<PAGE> 79
HI/FN, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(TABLE AMOUNTS IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS.
INFORMATION WITH RESPECT TO THE NINE MONTHS ENDED JUNE 30, 1997 AND 1998,
AND AS OF JUNE 30, 1998 IS UNAUDITED.)
Long-lived Assets
The Company investigates potential impairments of long-lived assets on an
exception basis, when events or changes in circumstances have made recovery of
an asset's carrying value unlikely. An impairment loss is recognized when the
sum of the expected future net cash flows is less than the carrying amount of
the asset. No such impairment losses have been recorded by the Company.
Research and Development
Expenditures for research and development are charged to expense as
incurred; however, development costs for software to be licensed or sold that
are incurred from the time technological feasibility is established until the
product is ready for general release to customers are capitalized and reported
at the lower of cost or net realizable value. Through June 30, 1998, no
significant amounts were expended subsequent to reaching technological
feasibility.
Stock-based Compensation
The Company measures compensation expense for its stock-based employee
compensation plans using the intrinsic value method and provides pro forma
disclosures of net income and earnings per share as if the fair value-based
method had been applied in measuring compensation expense.
Income Taxes
The taxable income of the Company is included in the consolidated tax
return of the Parent. Income taxes are computed on a stand-alone basis as if the
Company were a separate taxpayer for all periods presented. Income taxes
currently payable are deemed to have been remitted by Stac on behalf of the
Company in the period that the liability arose. Amounts due to Stac for income
tax payments are included in the related party components of the balance sheet.
Valuation allowances are established when necessary to reduce deferred tax
assets to the amount expected more likely than not to be realized.
Earnings Per Share
Basic earnings per share ("EPS") is calculated by dividing net income by
the weighted average number of common shares outstanding for the period, without
consideration of the dilutive impact of potential common shares ("dilutive
securities") that were outstanding during the period. Diluted EPS is computed by
dividing net income by the weighted average number of common shares outstanding
for the period, increased by dilutive securities that were outstanding during
the period. Shares subject to repurchase by the Company are considered
contigently issuable based on continued employment and are therefore treated as
potential common shares for the purposes of this calculation. Since the
Company's Series A Preferred Stock (Note 5) represents a primary equity
security, it is included in the calculation of basic earnings per share. Net
income remains the same for the calculations of basic EPS and diluted EPS. A
reconciliation of the numerators and denominators of the basic and diluted EPS
calculations for the year ended September 30, 1997 and nine months ended June
30, 1998, respectively, is presented below. Earnings per share for the years
ended September 30, 1995 and 1996 has been presented on a comparable basis to
the capital structure that came into existence in fiscal 1997 in a manner
similar to that as used for stock splits.
F-8
<PAGE> 80
HI/FN, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(TABLE AMOUNTS IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS.
INFORMATION WITH RESPECT TO THE NINE MONTHS ENDED JUNE 30, 1997 AND 1998,
AND AS OF JUNE 30, 1998 IS UNAUDITED.)
YEAR ENDED SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
PER-SHARE
NET INCOME SHARES AMOUNT
---------- ------ ---------
<S> <C> <C> <C>
Net Income................................. $1,833
Basic EPS.................................. 6,100,000 $0.30
Dilutive Securities........................ 74,000
---------
Diluted EPS................................ 6,174,000 $0.30
=========
</TABLE>
NINE MONTHS ENDED JUNE 30, 1998
<TABLE>
<CAPTION>
PER-SHARE
NET INCOME SHARES AMOUNT
---------- ------ ---------
<S> <C> <C> <C>
Net Income................................. $1,852
Basic EPS.................................. 6,282,000 $0.29
Dilutive Securities........................ 500,000
---------
Diluted EPS................................ 6,782,000 $0.27
=========
</TABLE>
Unaudited interim periods
The interim financial data as of June 30, 1998 and for the nine months
ended June 30, 1997 and June 30, 1998 is unaudited; however, in the opinion of
the Company, the interim data includes all adjustments, consisting only of
normal recurring adjustments, necessary for a fair statement of the results for
the interim periods.
New pronouncements
In June 1997, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards (FAS) No. 130, "Reporting Comprehensive Income,"
and Financial Accounting Standard (FAS) No. 131, "Disclosures about Segments of
an Enterprise and Related Information," which will be required to be adopted by
the Company in fiscal 1999. Adoption of these statements is not expected to have
a significant impact on the Company's consolidated financial position, results
of operations or cash flows.
NOTE 3 -- COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS:
<TABLE>
<CAPTION>
SEPTEMBER 30,
---------------- JUNE 30,
1996 1997 1998
------ ------ --------
<S> <C> <C> <C>
Accounts receivable:
Trade receivables.............................. $1,340 $1,873 $2,087
Less allowance for doubtful accounts........... (159) (50) (141)
------ ------ ------
$1,181 $1,823 $1,946
====== ====== ======
</TABLE>
F-9
<PAGE> 81
HI/FN, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(TABLE AMOUNTS IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS.
INFORMATION WITH RESPECT TO THE NINE MONTHS ENDED JUNE 30, 1997 AND 1998,
AND AS OF JUNE 30, 1998 IS UNAUDITED.)
Substantially all of the Company's customers are OEM's, which results in
concentrated credit risk with respect to the Company's trade receivables. At
September 30, 1996 and 1997 and at June 30, 1998, one customer accounted for
45%, 89% and 78%, respectively, of the accounts receivable balance. Management
believes that its credit policies substantially mitigate such concentrated
credit risk. Bad debt expenses were not significant in fiscal 1995, 1996, 1997
nor in the nine month periods ended June 30, 1997 and 1998.
<TABLE>
<CAPTION>
SEPTEMBER 30,
--------------- JUNE 30,
1996 1997 1998
----- ------ --------
<S> <C> <C> <C>
Property and equipment:
Computer equipment............................. $ 484 $1,093 $1,356
Furniture and fixtures......................... 94 172 339
Leasehold improvements......................... 132 81 87
Office equipment............................... 113 43 92
----- ------ ------
823 1,389 1,874
Less accumulated depreciation.................. (462) (430) (751)
----- ------ ------
$ 361 $ 959 $1,123
===== ====== ======
Accrued expenses and other current liabilities:
Deferred revenue............................... $ 256 $ 323 $ 575
Compensation and employee benefits............. 171 288 326
Other.......................................... 103 5 243
----- ------ ------
$ 530 $ 616 $1,144
===== ====== ======
</TABLE>
NOTE 4 -- INCOME TAXES:
The results of the Company's operations were included in Stac's
consolidated tax returns. The allocation of tax items is discussed in Note 2.
The provision (benefit) for income taxes is comprised of the following:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
------------------------
1995 1996 1997
---- ------ ------
<S> <C> <C> <C>
Current tax expense:
Federal.......................................... $747 $1,386 $1,159
State............................................ 132 245 205
---- ------ ------
879 1,631 1,364
---- ------ ------
Deferred tax expense (benefit):
Federal.......................................... 59 (162) (109)
State............................................ 9 (28) (20)
---- ------ ------
68 (190) (129)
---- ------ ------
$947 $1,441 $1,235
==== ====== ======
</TABLE>
F-10
<PAGE> 82
HI/FN, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(TABLE AMOUNTS IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS.
INFORMATION WITH RESPECT TO THE NINE MONTHS ENDED JUNE 30, 1997 AND 1998,
AND AS OF JUNE 30, 1998 IS UNAUDITED.)
The principal components of deferred income tax assets are as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30,
--------------
1996 1997
----- -----
<S> <C> <C>
Revenue recognition......................................... $102 $260
Depreciation and amortization............................... 18 95
Inventory valuation accounts................................ 155 82
Bad debts allowance......................................... 64 20
Other....................................................... 12 23
---- ----
$351 $480
==== ====
</TABLE>
A reconciliation of the amount computed by applying the statutory federal
income tax rate to income before income taxes to the provision for income taxes
follows:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
------------------------
1995 1996 1997
---- ------ ------
<S> <C> <C> <C>
Amount computed at statutory Federal rate of 34%... $803 $1,221 $1,043
State income taxes, net of Federal benefit......... 141 216 184
Expenses not deductible for tax purposes........... 3 4 8
---- ------ ------
$947 $1,441 $1,235
==== ====== ======
</TABLE>
NOTE 5 -- PREFERRED STOCK:
The Company has issued 6,000,000 shares of voting, participating,
convertible Series A Preferred Stock ("Series A Preferred Stock") and 100 shares
of common stock to Stac in exchange for the net assets contributed. The transfer
was recorded at the historical net book value of the transferred assets and
liabilities of $2,620,000. Each share may be converted, at the option of the
holder, into one share of common stock. The Series A Preferred Stock is entitled
to dividends, if and when declared by the Board of Directors, of $0.12 per
share, per annum. Series A Preferred Stock dividends must be declared prior to
the declaration of dividends on the Company's common stock, and the Series A
Preferred Stock participates fully thereafter with any common stock dividends.
Through June 30, 1998, no such dividends have been declared.
NOTE 6 -- STOCK OPTIONS AND EMPLOYEE BENEFIT PLANS:
1996 Equity Incentive Plan
During fiscal 1997, Hi/fn adopted the 1996 Equity Incentive Plan (the "1996
Plan") whereby 1,499,900 shares of Hi/fn common stock were reserved for issuance
pursuant to nonqualified and incentive stock options and restricted stock
awards. Shares reserved for under the 1996 Plan represent 20% of Hi/fn equity on
a fully diluted basis. Subsequent to September 30, 1997, the number of shares
authorized for issuance under the 1996 Plan was increased by 450,000, resulting
in a total of 1,949,900 shares reserved for issuance. The 1996 Plan is
administered by the Board of Directors of Hi/fn or its designees and provides
generally that nonqualified stock options and restricted stock may be awarded at
a price not less than 85% of the fair market value of the stock at the date of
the award. Incentive stock options must be awarded at a price not less than 100%
of the fair market value of the stock at the date of the award, or 110% of fair
market value for awards to more than 10% stockholders. Options granted under the
1996 Plan may have a term of up to 10 years. Options typically vest at a rate of
25% of the total grant per year over a four-year period. However, the Company
may, at its discretion, implement a different vesting schedule with respect to
any new stock option grant. As a result of early exercise
F-11
<PAGE> 83
HI/FN, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(TABLE AMOUNTS IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS.
INFORMATION WITH RESPECT TO THE NINE MONTHS ENDED JUNE 30, 1997 AND 1998,
AND AS OF JUNE 30, 1998 IS UNAUDITED.)
features as provided for by the 1996 Plan, options granted are immediately
exercisable subject to the Company's repurchase rights which expire as options
vest.
Information for stock option activities is summarized below:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
---------------------------
WEIGHTED-
AVERAGE
SHARES EXERCISE PRICE
--------- --------------
<S> <C> <C>
Balance at September 30, 1996....................... -- --
Options granted................................... 1,112,000 $0.69
Options exercised................................. (205,699) $0.60
Options canceled.................................. (29,438) $0.60
---------
Balance at September 30, 1997....................... 876,863 $0.81
Options granted................................... 366,000 $2.19
Options exercised................................. (197,708) $2.17
Options canceled.................................. (32,517) $0.60
---------
Balance at June 30, 1998............................ 1,012,638 $1.29
=========
</TABLE>
The following is a summary of stock options outstanding:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
--------------------------------------
WEIGHTED-
AVERAGE WEIGHTED-
REMAINING AVERAGE
CONTRACTUAL EXERCISE
NUMBER LIFE (YEARS) PRICE
--------- ------------ ---------
<S> <C> <C> <C>
AT SEPTEMBER 30, 1997
Price Range
$0.60..................................... 702,863 9.36 $0.60
$1.20..................................... 70,000 9.86 $1.20
$2.00..................................... 104,000 9.93 $2.00
---------
876,863 9.47 $0.81
=========
AT JUNE 30, 1998
Price Range
$0.60..................................... 557,638 8.57 $0.60
$1.20-$2.00............................... 235,500 9.24 $1.88
$2.25-$3.00............................... 219,500 9.73 $2.41
---------
1,012,638 8.98 $1.29
=========
</TABLE>
F-12
<PAGE> 84
HI/FN, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(TABLE AMOUNTS IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS.
INFORMATION WITH RESPECT TO THE NINE MONTHS ENDED JUNE 30, 1997 AND 1998,
AND AS OF JUNE 30, 1998 IS UNAUDITED.)
The following is a summary of stock options that are vested and
exercisable, and are accordingly not subject to the Company's repurchase rights:
<TABLE>
<CAPTION>
OPTIONS VESTED AND
EXERCISABLE
--------------------
WEIGHTED-
AVERAGE
EXERCISE
NUMBER PRICE
------- ---------
<S> <C> <C>
AT SEPTEMBER 30, 1997
Price Range
$0.60................................................. 20,900 $0.60
=======
AT JUNE 30, 1998
Price Range
$0.60................................................. 140,520 $0.60
=======
</TABLE>
Pro Forma Disclosure
The Company applies the intrinsic value method in accounting for its stock
based compensation. No compensation expense has been recognized for stock option
grants, which are fixed in nature, as the options have been granted at fair
value as determined by the Company's Board of Directors. Had compensation cost
for the Company's stock based compensation awards issued during fiscal 1997 and
the nine months ended June 30, 1998 been determined based on the fair value at
the grant date, the Company's net income and net income per share would have
been reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS
SEPTEMBER 30, ENDED JUNE 30,
1997 1998
------------- --------------
<S> <C> <C>
Net income:
As reported........................................ $1,833 $1,852
====== ======
Pro forma.......................................... $1,683 $1,635
====== ======
Net income per share, basic:
As reported........................................ $ .30 $ .29
====== ======
Pro forma.......................................... $ .28 $ .26
====== ======
Net income per share, diluted:
As reported........................................ $ 0.30 $ .27
====== ======
Pro forma.......................................... $ 0.27 $ .24
====== ======
</TABLE>
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 used for grants during the year ended September 30, 1997: dividend
yield of 0.0%, risk free interest rate of 6.46%, expected volatility of 250%,
and expected life of 1.5 years; for the nine months ended June 30, 1998:
dividend yield of 0.0%, risk free interest rate of 5.70%, expected volatility of
250%, and expected life of 1.1 years
F-13
<PAGE> 85
HI/FN, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(TABLE AMOUNTS IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS.
INFORMATION WITH RESPECT TO THE NINE MONTHS ENDED JUNE 30, 1997 AND 1998,
AND AS OF JUNE 30, 1998 IS UNAUDITED.)
NOTE 7 -- COMMITMENTS:
The Company occupies its facilities under several non-cancelable operating
leases that expire at various dates through August 2005, and which contain
renewal options. Future minimum lease payments are as follows:
<TABLE>
<CAPTION>
AMOUNT
------
<S> <C>
1998.............................. $ 327
1999.............................. 921
2000.............................. 820
2001.............................. 750
2002.............................. 750
Thereafter.......................... 2,187
------
$5,755
======
</TABLE>
Included in future minimum lease payments are amounts associated with a new
facility lease entered into in November 1997. Rent expense under operating
leases was approximately $40,000, $50,000, and $113,000, in fiscal 1995, 1996,
and 1997, respectively, and $61,000 and $229,000 for the nine months ended June
30,1997 and 1998, respectively. Certain facility leases provide for scheduled
rent increases. The total lease commitment for such leases is being charged
ratably to operations.
NOTE 8 -- SIGNIFICANT CUSTOMERS:
A significant portion of the Company's revenues has been derived from sales
to major OEM's. Two customers accounted for 35% and 19% of fiscal 1995 revenues,
respectively. Two customers accounted for 43% and 14% of fiscal 1996 revenues,
respectively. One customer accounted for 70% of fiscal 1997 revenues. One
customer accounted for 65% of revenues for the nine months ended June 30, 1997
and 64% of revenues for the nine months ended June 30, 1998.
NOTE 9 -- SUBSEQUENT EVENTS:
In November 1997, the Company entered into a non-cancelable operating lease
providing for current and expansion facilities for its corporate offices in Los
Gatos, California. The term of this lease runs through August 2005, with an
option for renewal through 2010. Future minimum lease payments associated with
this lease are included in the schedule in Note 7.
In April 1998, the Company acquired the outstanding stock of CyLAN
Technologies, Inc., a software development company, for $340,000 in cash in a
transaction accounted for under the purchase method. The purchase agreement
calls for the Company to make royalty payments on sales made over a three-year
period that incorporate the acquired technology. Minimum royalties over this
term amount to $450,000, subject to the continued employment at Hi/fn of a
former CyLAN shareholder. In conjunction with the acquisition, the Company
recorded the purchase price as capitalized software, which is being amortized on
a straight-line basis over a three year period. Pro forma data has not been
presented as such results would not differ materially from the historical
results presented.
F-14
<PAGE> 86
HI/FN, INC.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
FOR THE THREE YEARS ENDED SEPTEMBER 30, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONS
BALANCE AT CHARGED TO ADDITIONS
BEGINNING COSTS AND CHARGED TO BALANCE AT
OF PERIOD EXPENSES OTHER ACCOUNTS DEDUCTIONS END OF PERIOD
---------- ---------- -------------- ---------- -------------
<S> <C> <C> <C> <C> <C>
DEDUCTED FROM ACCOUNTS RECEIVABLE
Allowance for doubtful accounts:
Year ended September 30, 1995(a)...... 60 -- 133 -- 193
Year ended September 30, 1996(a)...... 193 -- (34) -- 159
Year ended September 30, 1997......... 159 (109) -- -- 50
DEDUCTED FROM INVENTORY
Reserve for inventory obsolescence:
Year ended September 30, 1995(a)...... 107 -- 16 -- 123
Year ended September 30, 1996(a)...... 123 -- 265 -- 388
Year ended September 30, 1997......... 388 (183) -- -- 205
</TABLE>
- ---------------
(a) Activity represents changes in period end allocations of consolidated
balances.
<PAGE> 87
GLOSSARY
ALDC (Adaptive Lossless Data Compression) -- A compression method invented
by IBM, for which patents are owned by Hi/fn.
Analog Modem -- A communications device used for sending and receiving data
over "normal" telephone lines. These devices use analog signals to transmit and
receive data.
ASIC (Application Specific Integrated Circuit) -- A logic circuit designed
for a specific usage and implemented in an integrated circuit.
Broadband Access Products -- Network equipment that provides access to a
network infrastructure using high-bandwidth network interfaces, for example
cable modems and digital subscriber line products.
Bus -- The set of wires used to interconnect the signals from one
semiconductor device to one or more other devices, either on the same circuit
board or through a connector to another circuit board.
Cable Modem -- A device used typically in a home for connecting a computer
system to the Internet via the cable television network. Such devices typically
offer significantly higher data transmission rates than available from analog
modems.
Compression -- The process of eliminating redundant information from a set
of data, while maintaining complete data integrity such that the compressed data
can be decompressed and returned to its original form.
Data Authentication -- A method of processing data prior to transmission
over a communication link such that on receipt of the data, the recipient can
detect whether or not the data was altered during transmission.
DES (Data Encryption Standard) -- A standard promulgated by the Federal
Information Processing Society (FIPS) that defines a method for processing data
such that it becomes indecipherable to anyone other than the person who holds
the digital data stream, or key, with which it was encrypted. The maximum key
length supported by DES is 56 bits.
Digital Subscriber Line (DSL) -- A type of communication link offered by
telecommunications service providers that provides digital transmission for
voice and data, typically between a home/office and a corporate network, where
the data transmission rates available are significantly greater than those
available from analog modems.
DLT (Digital Linear Tape) -- A type of tape drive manufactured by Quantum
Corporation that provides storage of digital data on magnetic tape. The data is
stored on linear tracks on the tape.
Encryption -- The process of making data indecipherable to anyone other
than the holds the key with which it was enciphered.
Firewall -- A technology used for preventing unwanted inbound or outbound
data at the boundary of a computer network based on a set of rules programmed by
the firewall administrator.
IETF (Internet Engineering Task Force) -- A volunteer organization that
develops architectures practices and protocols for the continued development of
the Internet and its related technologies.
IPSec (IP Security) -- A network security protocol developed by the IETF,
which provides for confidentiality and integrity of data transmitted over a
computer network using the Internet Protocol.
IP (Internet Protocol) -- The fundamental communication protocol used by
computers attached to the global information network known as the Internet. IP
can also be referred to as the layer 3 protocol, or network layer protocol of
the Internet.
IPPCP (IP Payload Compression Protocol) -- An IETF-developed protocol used
in conjunction with IP that allows the payload of each IP data packet to be
compressed prior to transmission and decompressed upon receipt thereby enhancing
network bandwidth.
ISDN (Integrated Services Digital Network) -- A service offered by
telecommunications service providers that provides digital transmission for
voice and data, typically between a home/office and a corporate network.
G-1
<PAGE> 88
LAN (Local Area Network) -- Typically a network consisting of a set of
computers at a common location (office, building, campus, etc.) interconnected
using a common type of wiring and a common networking protocol.
Lossless Data Compression -- A method of processing digital information to
remove redundant data, thereby reducing it in size for subsequent transmission
or storage. Such a method must also have a corresponding method of processing
the "reduced" data in such a way as to return it to its original, uncompressed
state without any loss of information.
LZS (Lempel-Ziv-Stac) -- A compression method, invented and patented by
Stac.
Mbytes/sec (Megabytes per second) -- A rate of data transfer from one
system to another.
Megabyte -- Typically, one million bytes, but sometimes the quantity 1024
times 1024.
MD5 (Message Digest 5) -- A data processing algorithm invented by Ron
Rivest and designed to compute, with great probability, a unique "fingerprint"
for a particular set of data. This type of algorithm is often used in networking
protocols to ensure that transmitted data is not tampered with in transit. This
is done by computing a "fingerprint" for a set of data, sending the data along
with the "fingerprint", after which the receiver can recalculate and verify the
received.
MPPC (Microsoft Point-to-Point Compression) -- A compression method
invented by Microsoft, for which patents are owned by Hi/fn.
Network Interface Card -- A printed circuit card or semiconductor that
provides for the connection of a computer system or other device to a local area
network.
PPP (Point-to-Point Protocol) -- An IETF-developed protocol operating at
what is known as the data link layer, or layer 2, and used for the establishment
of a connection from one computer to another over a wide area network.
PPTP (Point-to-Point Tunneling Protocol) -- A Microsoft-developed protocol,
based on certain aspects of PPP, that was designed to provide confidentiality of
the data transmitted between two computers over a wide area network.
RC4/RC5 (Rivest Cipher 4 and Rivest Cipher 5) -- Developed by Ron Rivest of
the Massachusetts Institute of Technology (MIT), these are symmetric key
encryption algorithms, meaning that the same key is used to encrypt a set of
data as is used to decrypt it.
Remote Access Concentrator -- A networking device, which aggregates, or
concentrates, multiple bi-directional communication links into a single, larger
link. These devices are typically used to provide dial-up access to a corporate
network or to the Internet.
Router -- A networking device that is responsible for processing incoming
and outgoing data packets, typically Internet Protocol packets, and determining
where to "route" the data packet on its journey to its final destination.
RSA (Rivest Shamir Adelman) -- The initials of the 3 inventors of the RSA
public key encryption system and co-founders of RSA Data Security.
SCSI (Small Computer Systems Interface) -- An interface typically used for
connecting storage devices such as tape drives and disk drives to computer
systems.
SHA1 (Secure Hash Algorithm) -- A data processing algorithm designed to
compute, with great probability, a unique "fingerprint" for a particular set of
data. This type of algorithm is often used in networking protocols to ensure
that transmitted data is not tampered with in transit. This is done by computing
a "fingerprint" for a set of data, sending the data along with the
"fingerprint", after which the receiver can recalculate and verify the received.
Tape Drive -- An electro-mechanical computer peripheral with integrated
electronics that enables the storage of computer data on removable magnetic
media.
G-2
<PAGE> 89
TCP (Transmission Control Protocol) -- Along with IP, the next most
fundamental network protocol used for communication of data over the Internet.
Internet applications such as web browsers are known as TCP applications.
Travan -- A tape drive standard, developed by 3M, which uses tape media
that is one quarter-inch in width.
Triple-DES (Triple Data Encryption Standard) -- Based on the DES encryption
algorithm, Triple-DES involves processing a set of data three times using DES. A
method for processing data such that it becomes indecipherable to anyone other
than the person who holds the digital data stream, or key, with which it was
encrypted. The maximum key length supported by Triple-DES is 168 bits.
VPN (Virtual Private Network) -- A network of interconnected computers, all
sharing the same network infrastructure, where the privacy of the communication
between any two computers on the network is maintained through the use of
network security, or encryption, protocols.
WAN (Wide Area Network) -- A network of interconnected computers or LANs
where they are interconnected using a network infrastructure provided by a
service provider such as an telecommunications company or an Internet Service
Provider.
G-3
<PAGE> 90
ANNEX IV
July 17, 1998
Board of Directors
Stac, Inc.
12636 High Bluff Drive
San Diego, CA 92130
Members of the Board of Directors:
We have acted as financial advisor to Stac, Inc., a Delaware corporation
("Stac"), in connection with the proposed distribution (the "Distribution") to
the holders of Stac common stock, par value $.001 per share (the "Stac Common
Stock"), of all of the outstanding shares of common stock, par value $.001 per
share ("Company Common Stock"), of hi/fn, inc., a Delaware corporation ("Hi/fn"
or the "Company"), owned by Stac, pursuant to the terms of a Distribution
Agreement to be entered into between Stac and Hi/fn (the "Distribution
Agreement"). We are advised that Hi/fn was organized in August 1996 to own and
operate Stac's semiconductor business, which previously was operated as a
division of Stac. Stac transferred the semiconductor business (along with the
associated technology, assets and liabilities) to Hi/fn on November 21, 1996. We
have been advised that the purposes of the Distribution are as set forth in the
Information Statement included in the Form 10 filed with the Securities and
Exchange Commission (the "Information Statement") and to be sent to holders of
Stac Common stock. The Distribution is described more fully in the Information
Statement. You have requested our opinion as to whether the Distribution is
fair, from a financial point of view, to the holders of Stac Common Stock.
In connection with our review of the Distribution, and in arriving at our
opinion, we have, among other things:
(i) reviewed the publicly available consolidated financial statements
of Stac for recent years and interim periods to date and certain other
relevant financial and operating data of Stac available from public sources
or provided to us by Stac;
(ii) reviewed the consolidated pro forma financial statements of Hi/fn
and Stac provided to us by Stac;
(iii) reviewed certain internal financial and operating information,
including certain projections, relating to Stac and Hi/fn, provided to us
by Stac;
(iv) discussed the business, financial condition and prospects of Stac
and Hi/fn with certain officers of Stac and certain members of management
of the business to be operated by Hi/fn;
(v) reviewed the terms of the Distribution;
(vi) reviewed certain publicly available transactions we deemed
comparable to the Distribution;
(vii) reviewed certain public information of certain companies we
deemed appropriate in analyzing Stac and Hi/fn;
(viii) reviewed the historical market prices and trading activity for
the common shares of Stac;
(ix) reviewed the historical market prices and trading activity for
equity securities of publicly-traded companies engaged in businesses that
we believed to be generally relevant to an analysis of those of Stac and
Hi/fn;
(x) reviewed Stac's financial and strategic objectives as described to
us by the management of Stac;
(xi) reviewed the Information Statement; and
(xii) performed such other analyses and examinations and considered
such other information, financial studies, analyses and investigations and
financial, economic and market data as we deemed relevant.
IV-1
<PAGE> 91
We have not assumed responsibility for independent verification of any
information, whether publicly available or furnished to us, concerning Stac or
Hi/fn, including, without limitation, any financial information, forecasts or
projections, considered in connection with the rendering of our opinion.
Accordingly, for purposes of our opinion, we have assumed and relied upon the
accuracy and completeness of all such information and we have not conducted a
physical inspection of any of the properties or assets, and have not prepared or
obtained any independent evaluation or appraisal of any of the assets or
liabilities, of Stac or Hi/fn. With respect to the financial forecasts and
projections made available to us and used in our analysis, we have assumed that
they have been reasonably prepared on bases reflecting the best currently
available estimates and judgments of the management of Stac as to the matters
covered thereby and in rendering our opinion we express no view as to the
reasonableness of such forecasts and projections or the assumptions on which
they are based. Our opinion is necessarily based upon economic market and other
conditions as in effect on, and the information made available to us as of, the
date hereof.
In connection with our opinion, we have assumed that the Distribution will
be consummated on the terms and subject to the conditions described in the
Information Statement. In addition, we have, with your consent, assumed that the
Distribution will be tax free to Stac and the holders of Stac Common Stock. We
have also assumed that all necessary governmental and regulatory approvals and
consents of third parties will be obtained on terms and conditions that will not
have a material adverse effect on Stac or Hi/fn. Finally, we make no forecast
and render no opinion as to the trading price of the securities of Stac or Hi/fn
following announcement of the completion of the Distribution, or at any time
thereafter.
Warburg Dillon Read LLC ("WDR") will receive a fee for its financial
advisory services rendered in connection with the currently contemplated
Distribution, which fee is payable upon completion of the Distribution. In
addition, Stac has agreed to reimburse WDR for its reasonable expenses incurred
in connection with its engagement and to indemnify WDR and certain related
persons for certain liabilities that may arise out of its engagement by Stac and
the rendering of the WDR Opinion. It is understood that this letter is solely
for the benefit and use of the Board of Directors of Stac in its consideration
of the transaction, and may not be relied upon by any other person, used for any
other purpose, or reproduced, disseminated, quoted or referred to at any time,
in any manner or for any purpose without our prior written consent, which shall
not be unreasonably withheld.
Based upon and subject to the foregoing, it is our opinion as investment
bankers that, as of the date hereof, the Distribution is fair, from a financial
point of view, to the holders of Stac Common Stock.
Very truly yours,
WARBURG DILLON READ LLC
IV-2
<PAGE> 92
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange Act
of 1934, the Registrant has duly caused this Form 10 to be signed on its behalf
by the undersigned, thereunto duly authorized.
HI/FN, INC.
Dated: August 7, 1998 By: /s/ WILLIAM R. WALKER
------------------------------------
Name: William R. Walker
Its: Vice President, Acting Chief
Executive
Officer, Acting President, Chief
Financial
Officer and Corporate Secretary
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<FISCAL-YEAR-END> SEP-30-1997
<PERIOD-START> OCT-01-1996
<PERIOD-END> SEP-30-1997
<CASH> 480,000
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0
2,620,000
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