HI/FN INC
10-12G/A, 1998-11-19
SEMICONDUCTORS & RELATED DEVICES
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<PAGE>   1
 
   
   AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 19, 1998
    
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
 
                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
 
                            ------------------------
 
   
                               AMENDMENT NO. 2 TO
    
 
                                    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>
 
                             750 UNIVERSITY AVENUE
                              LOS GATOS, CA 95302
         (Address, Including Zip Code, of Principal Executive Offices)
 
                                 (408) 399-3500
              (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)
 
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<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
- ----                  ------------                           ---------------------------------
<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
- ----                  ------------                           ---------------------------------
<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(1)   Form of Third Amended and Restated Certificate of
          Incorporation of Hi/fn, Inc. (included as Annex I to the
          Information Statement).
 3.2(1)   Form of Amended and Restated Bylaws of Hi/fn, Inc. (included
          as Annex II to the Information Statement).
 4.1(3)   Form of Common Stock Certificate.
10.1(1)   Amended and Restated 1996 Equity Incentive Plan of Hi/fn,
          Inc. (included as Annex III to the Information Statement).
10.2(1)   Assignment, Assumption and License Agreement dated as of
          November 21, 1996 between Stac, Inc. and Hi/fn, Inc.*
10.3(1)   Cross License Agreement dated as of November 21, 1996
          between Stac, Inc. and Hi/fn, Inc.*
10.4(1)   Form of Distribution Agreement.
10.5(3)   Form of Employee Benefits Allocation Agreement.
10.6(3)   Form of Tax Sharing Agreement.
10.7(1)   Form of Transitional Services Agreement.
10.8(1)   Form of Indemnification Agreement.
10.9(1)   Agreement dated as of April 1, 1994 between International
          Business Machines Corporation and Stac, Inc. (Program Patent
          License Agreement).*
10.10(1)  Agreement dated as of April 1, 1994 between International
          Business Machines Corporation and Stac, Inc. (Cross License
          Agreement).*
10.11(1)  License Agreement dated as of June 20, 1994 between
          Microsoft Corporation and Stac, Inc.*
10.12(1)  License Agreement dated as of February 16, 1996 between
          Microsoft Corporation and Stac, Inc.*
10.13(1)  License Agreement dated as of December 15, 1995 between
          Motorola, Inc. and Stac, Inc.*
10.14(1)  Agreement dated as of November 13, 1997 between 750
          University, LLC and Hi/fn, Inc.
10.15(1)  1998 Employee Stock Purchase Plan of Hi/fn, Inc.
10.16(1)  Form of Director Change of Control Agreement.
10.17(3)  Form of Employee Change of Control Agreement.
27.1(2)   Financial Data Schedule.
</TABLE>
    
 
- ---------------
(1) Previously filed.
 
(2) Filed herewith.
 
(3) To be filed by amendment.
 
 *  The Company is seeking confidential treatment with respect to portions of
    this exhibit.
 
                                       ii
<PAGE>   4
 
                               [STAC LETTERHEAD]
 
   
                               December   , 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 has applied 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 December 1, 1998, you will receive as a dividend one share of Hi/fn common
stock for every [3.9051] 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 December 15, 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 December 1, 1998 (the "Record Date"). As of the Record
Date, there were issued and outstanding [486,251] shares of Company Common
Stock, held by 24 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 one share of Company Common Stock for every
[3.9051] 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, [1,277,212] 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 December 15, 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 has
applied 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 DECEMBER   , 1998.
    
<PAGE>   6
 
                             INFORMATION STATEMENT
 
                               TABLE OF CONTENTS
 
   
<TABLE>
<CAPTION>
                                                              PAGE
                                                              ----
<S>                                                           <C>
AVAILABLE INFORMATION.......................................      2
SUMMARY.....................................................      3
RISK FACTORS................................................      9
THE DISTRIBUTION............................................     23
  Background and Reasons for the Distribution...............     23
  Fairness Opinion..........................................     25
  Distribution Agent........................................     27
  Manner of Effecting the Distribution......................     28
  Results of the Distribution...............................     28
  Material Federal Income Tax Consequences of the
     Distribution...........................................     28
  Quotation and Trading of Company Common Stock; Dividend
     Policy.................................................     30
  Conditions; Termination...................................     30
  Reasons for Furnishing the Information Statement..........     31
RELATIONSHIP BETWEEN HI/FN AND STAC AFTER THE
  DISTRIBUTION..............................................     32
REGULATORY APPROVALS........................................     34
SELECTED HISTORICAL FINANCIAL DATA..........................     35
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
  AND RESULTS OF OPERATIONS.................................     36
THE COMPANY.................................................     42
BUSINESS....................................................     43
MANAGEMENT..................................................     57
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..............     64
SECURITIES OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
  MANAGEMENT................................................     67
HI/FN CERTIFICATE OF INCORPORATION AND BYLAWS...............     68
DESCRIPTION OF THE COMPANY'S CAPITAL STOCK..................     69
REPORT OF INDEPENDENT ACCOUNTANTS...........................    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 [486,251] shares of the Company's
                                 common stock, $.001 par value per share (the
                                 "Company Common Stock"), held by 24
                                 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 [3.9051] 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 [486,251] shares of Company Common
                                 Stock and 6,000,000 shares of Series A
                                 Preferred Stock outstanding on the Record Date,
                                 approximately [6,486,251] shares of Company
                                 Common Stock.
    
 
   
Record Date...................   December 1, 1998 (5:00 p.m. Eastern Standard
                                 Time).
    
 
   
Distribution Date.............   On or about December 15, 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 has applied
                                 to have the Company Common Stock approved for
                                 quotation and trading on the Nasdaq National
                                        4
<PAGE>   10
 
                                 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
                                 IV 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; fluctuations in operating
                                 results, no assurance of future profitability;
                                 termination of subsidiary relationship with
                                 Stac; dependence upon development of the market
                                 for packet processors; risks associated with
                                 emerging VPN market; frequent product
                                 introductions and evolving industry standards,
                                 rapid technological change; intensely
                                 competitive markets; 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 and production
                                 defects; 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)
                                 an Employee Benefits Allocation Agreement,
                                 which provides for an allocation of liabilities
                                 for employee benefits between Stac and Hi/fn
                                 and sets forth formulas for adjustments to Stac
                                 options; (iii) 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 will provide certain services to
                                 Hi/fn 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
                                        6
<PAGE>   12
 
                                 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. 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 1,619,811
                                 shares, or approximately 24.4%, 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, 1997 and 1998
and for each of the three years in the period ended September 30, 1998 as
included herein. Financial information as of September 30, 1995 and 1996 and for
the year ended September 30, 1995 has been prepared from audited financial
statements not included herein. The financial information as of and for the year
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 and for the year ended September 30,
1994, 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>
                                                               YEAR ENDED SEPTEMBER 30,
                                                     ---------------------------------------------
                                                      1994     1995     1996      1997      1998
                                                     ------   ------   -------   -------   -------
<S>                                                  <C>      <C>      <C>       <C>       <C>
STATEMENT OF OPERATIONS DATA:
Revenues...........................................  $5,666   $7,342   $12,894   $14,226   $21,533
Cost of revenues...................................   2,302    2,841     5,095     4,762     6,525
                                                     ------   ------   -------   -------   -------
Gross margin.......................................   3,364    4,501     7,799     9,464    15,008
Operating expenses:
Research and development...........................     564      551     1,641     2,985     5,403
Sales and marketing................................     813    1,097     1,677     2,224     3,370
General and administrative.........................     379      492       889     1,203     2,407
                                                     ------   ------   -------   -------   -------
Operating income...................................   1,608    2,361     3,592     3,052     3,828
Interest income....................................                                   16        17
                                                     ------   ------   -------   -------   -------
Provision for income taxes.........................     661      947     1,441     1,235     1,627
                                                     ------   ------   -------   -------   -------
Net income.........................................  $  947   $1,414   $ 2,151   $ 1,833   $ 2,218
                                                     ======   ======   =======   =======   =======
Net income per share, basic(1).....................  $ 0.16   $ 0.24   $  0.36   $  0.30   $  0.35
Net income per share, diluted......................  $ 0.16   $ 0.24   $  0.36   $  0.30   $  0.33
Weighted average shares outstanding, basic.........   6,000    6,000     6,000     6,100     6,308
Weighted average shares outstanding, diluted.......   6,000    6,000     6,000     6,174     6,800
BALANCE SHEET DATA (AS OF SEPTEMBER 30,):
Cash...............................................  $   --   $   --   $    --   $   480   $10,057
Total assets.......................................   1,583    2,254     2,611     5,898   $16,611
Working capital (deficit)..........................    (193)    (223)     (383)    3,520     4,723
Total stockholders' equity(2)......................      --       --        --     4,622     6,952
</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. For all periods prior to
    fiscal 1997, net income generated by Hi/fn has been treated as if it were
    transferred to Stac in the form of dividends. No such dividend transfers
    were made for fiscal 1997 and the periods presented thereafter.
 
                                        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
 
     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,
particularly in the area of research and development, 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; NO ASSURANCE OF FUTURE PROFITABILITY
 
     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 EMERGING VPN MARKET
 
     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
 
FREQUENT PRODUCT INTRODUCTIONS AND EVOLVING INDUSTRY STANDARDS; RAPID
TECHNOLOGICAL CHANGE
 
     The networking, storage and semiconductor industries are characterized by
rapidly changing technology, frequent product introductions, evolving industry
standards and rapid technological change. 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.
 
INTENSELY COMPETITIVE MARKETS
 
     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
1998 and 1997, sales to Quantum accounted for 70% and 61%, respectively, 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. 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
obtain significant orders from new customers, or any significant customer delays
payment or
    
 
                                       13
<PAGE>   19
 
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 84%, 88% and 89% of
revenue in the years ended September 30, 1998 and fiscal 1997 and 1996,
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 this 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 currently subcontracts its semiconductor manufacturing
to Toshiba Corporation ("Toshiba"), Atmel Corporation ("Atmel") and Motorola.
These suppliers currently deliver fully assembled and tested products on a
turnkey basis. None of the Company's products currently is manufactured by more
than one supplier. 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. 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. For example, in June 1995, the Company experienced delays in obtaining
an adequate supply of a now-discontinued product from one of its suppliers. As a
result, the Company switched production of the product to a new manufacturer,
resulting in a three-month delay in shipments to customers. The Company also
experienced yield and test anomalies on a different product manufactured by
another subcontractor that could have caused an interruption in customer
shipments. In this case, the manufacturer was able to correct the problem in a
timely manner and customer shipments were not affected. Any time the Company is
required to change a key supplier or foundry, the process of qualifying the new
supplier or foundry and commencing volume production involves delay and expense,
which can result in lost revenues, reduced operating margins and possible
detriment to customer relationships. Before a new manufacturer can begin
production of a semiconductor part, the Company must (i) conform its part, if
necessary, to the new manufacturer's process, (ii) create a new mask set to
manufacture the part, (iii) have the new manufacturer prepare sample parts so
the Company can verify the product specification and (iv) provide sample parts
to customers for qualification. In general, it takes from three to six months
from the time the Company begins this process with a new manufacturer before the
manufacturer can begin full-scale production of the part. There can be no
assurance that the Company will not have similar or more protracted problems in
the future with existing or new suppliers.
 
     Both Toshiba and Motorola manufacture products for the Company in plants
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.
 
     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
 
                                       15
<PAGE>   21
 
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 AND PRODUCTION DEFECTS
 
     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 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 four foreign patents.
The Company also has two 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.
                                       16
<PAGE>   22
 
     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 -- Intellectual Property."
 
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 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
 
                                       17
<PAGE>   23
 
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.
 
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.
 
                                       18
<PAGE>   24
 
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 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."
 
                                       19
<PAGE>   25
 
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
implementations 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
1,619,911 shares, or approximately 24.4%, 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
20.6% 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,
                                       20
<PAGE>   26
 
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.
 
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 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 1,348,912 shares of
Company Common Stock will be outstanding under the 1996 Plan. See
"MANAGEMENT -- Hi/fn Equity Plans." 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
 
                                       21
<PAGE>   27
 
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."
 
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, 486,151 of which have been
issued to date upon exercise of options and 1,277,212 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.
 
                                       22
<PAGE>   28
 
                                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
                                       23
<PAGE>   29
 
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.
 
  Alternatives to Spin-off Transaction
 
     In December 1997, Stac retained Warburg Dillon Read LLC ("WDR") to provide
advisory services regarding the possible separation of Stac and Hi/fn. Stac also
sought WDR's advice, from a financial perspective, as to the various
alternatives available to it to obtain the financing and operational environment
necessary to enable it to maximize the likelihood of the success of its two
business units. With input from WDR, the Stac Board concluded that Stac's
corporate structure did not represent an acceptable structure for the Company to
obtain the financial resources needed to fully carry out its business plans and
that no alternative to a spin-off represented a viable option for the Company to
achieve its business objectives.
 
     In particular, the Stac Board, with input from WDR, examined the
possibility of (i) Hi/fn conducting an initial public offering of less than 100%
of its outstanding shares, (ii) the sale or merger of Hi/fn, (iii) the creation
and distribution of a tracking stock for Hi/fn and (iv) the establishment of
stock appreciation rights for employees of Hi/fn.
 
     The Board determined that these alternatives involved a variety of problems
and failed to address many of the Company's objectives. First, an initial public
offering of Hi/fn would leave Stac as a majority owner of Hi/fn. This
controlling position maintained by Stac would likely impair the attractiveness
of the Company Common Stock to prospective employees as well as investors, and
could result in a discounted valuation in the public markets due to the
perceived overhang of this large block. Second, the Stac Board believed that
Stac might not get full value in a sale or merger of Hi/fn because the market
for Hi/fn's products directed to the networking market had not yet been
established. Moreover, the sale of the Hi/fn stock by Stac could cause an
onerous tax burden for Stac. Third, the Stac Board believed that the creation of
a separate tracking stock
                                       24
<PAGE>   30
 
would, in addition to being unattractive to prospective employees and directors,
be too complex in light of the relatively small size of Hi/fn. Finally, the
creation of stock appreciation rights ("SARs") or "phantom stock" for Hi/fn
employees tied to the performance of the Hi/fn subsidiary also would not be a
viable alternative to prospective employees. In addition, upon financial
consolidation, the use of SARs or phantom stock could result in an unacceptable
level of compensation expense, which could impair the valuation of Stac and thus
Stac's access to the capital markets. Following this analysis, the Stac Board
concluded that a spin-off was the only viable alternative to enable Stac to
address its employee recruiting and financial needs and maximize stockholder
value.
 
FAIRNESS OPINION
 
     In connection with its analysis of the Distribution, the Stac Board sought
independent advice from WDR as to the advisability from a financial perspective
of completing a spin-off of the Company from Stac. Based on its analyses, WDR
determined that the Stac Board had a reasonable basis for concluding that the
spin-off would create greater value for stockholders than maintaining the
Company as a subsidiary of Stac 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.
 
     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
 
                                       25
<PAGE>   31
 
arriving at its opinion, WDR did not make or obtain any evaluations or
appraisals of the assets or liabilities of Stac or the Company, nor did WDR
express any opinion as to the fairness of the allocation of assets and
liabilities between the two entities. Moreover, WDR did not express any opinion
as to the commercial viability of Stac and the Company operated separately
following the Distribution. 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 the material financial and comparative
analyses performed by WDR and presented to the Stac Board.
    
 
   
     Comparable Company Analysis. WDR compiled financial and stock market
statistics for a number of comparable software and semiconductor companies for
both Stac and the Company. Such financial information and operating statistics
included, among other things, historical and current stock prices, certain
historical profitability margins, certain historical and projected growth rates,
market values of equity, and implied multiples of historical and estimated
earnings per share ("EPS"). For Stac, these comparable 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.
    
 
   
     Among other things, the analysis indicated that the implied multiples for
the comparable companies for Stac were as follows: (i) current stock price as a
multiple of estimated calendar 1998 EPS ranged from 16.1x to 79.6x, with a
median and an average of 28.0x and 34.1x, respectively, and (ii) current stock
price as a multiple of estimated calendar 1999 EPS ranged from 13.3x to 55.7x,
with a median and an average of 23.7x and 26.0x, respectively.
    
 
     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 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.
 
   
     Among other things, this analysis indicated that the implied multiples for
the comparable companies for the Company were as follows: (i) current stock
price as a multiple of estimated calendar 1998 EPS ranged from 17.6x to 134.5x,
with a median and an average of 25.7x and 45.7x, respectively, and (ii) current
stock price as a multiple of estimated calendar 1999 EPS ranged from 13.0x to
100.9x, with a median and an average of 18.6x and 31.6x, respectively.
    
 
                                       26
<PAGE>   32
 
   
     Stock Trading Analysis. WDR also analyzed Stac's historical stock price
performance on an absolute basis and compared to Stac's and the Company's
comparable companies and the Nasdaq Composite Index. WDR observed that over the
period from May 7, 1992 (Stac's Initial Public Offering date) to July 15, 1998
(the "Public Period"), the stock price of Stac decreased approximately 62% and
underperformed all of the common stocks of Stac's and the Company's comparable
companies, and the Nasdaq Composite Index. During the Public Period, the closing
stock price of Stac ranged from $1.88 to $15.00 per share.
    
 
   
     Comparable Spin-Off Transactions. Using publicly available information, WDR
analyzed data for selected spin-off transactions completed in the technology and
other relevant industries ("Selected Spin-off Transactions"). The Selected
Spin_off Transactions included, among others, Samsonite Corporation's spin-off
of Culligan Water Technologies, Inc., Sterling Software, Inc.'s spin-off of
Sterling Commerce, Inc., and WMS Industries Inc.'s spin-off of Midway Games Inc.
WDR reviewed the combined market capitalization of the spun-off company and its
former parent to the market capitalization of the parent one day prior to the
announcement of the spin-off ("Change in Market Value"). WDR then analyzed the
Change in Market Value (i) ten days after the spin-off was announced, and (ii)
one year after the spin-off was announced. WDR noted that (i) the average and
median Change in Market Value ten days after the spin-off was announced were
2.2% and 1.0%, respectively, and (ii) the average and median Change in Market
Value one year after the spin-off was announced were 66.7% and 40.9%,
respectively.
    
 
     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.
 
                                       27
<PAGE>   33
 
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 prior to the Distribution
Date between Stac and the Company.
 
   
     As of the Record Date, the Company had 486,251 shares of Company Common
Stock outstanding, held by 24 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 will distribute one share of Company
Common Stock for every 3.9051 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 6,486,251 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
 
                                       28
<PAGE>   34
 
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.
 
          (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."
 
                                       29
<PAGE>   35
 
     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
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
Plans."
 
     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
 
                                       30
<PAGE>   36
 
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; (vi) Hi/fn's delivery
to the landlord under its headquarters lease of a letter of credit in an amount
and with such other terms that Stac's guaranty of such lease will terminate upon
consummation of the Distribution; and (vii) 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 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.
 
                                       31
<PAGE>   37
 
                      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 seven 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.
 
     Stac has guaranteed Hi/fn's obligations under its headquarters lease. Under
the Distribution Agreement, Hi/fn has agreed to obtain and deliver to its
landlord a $2.0 million letter of credit to replace Stac's guaranty. The
guaranty provides that it will terminate when Stac no longer owns a majority
interest in Hi/fn and when Hi/fn provides the landlord with such a letter of
credit. The Distribution is conditioned on delivery of the letter of credit.
 
     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
                                       32
<PAGE>   38
 
days after the Distribution to retain the intrinsic value of such options after
the Distribution. Following the Distribution, the Stac Board intends to make an
adjustment to such options based on the closing sales price of the Stac Common
Stock on the Nasdaq National Market, less the closing sales price of Company
Common Stock in when-issued trading on the Nasdaq National Market on the
Distribution Date divided by the Distribution Ratio. The adjustment is expected
to result in an increase in the number of Stac options outstanding and a
decrease in their associated exercise price. Douglas L. Whiting, who is a
director of both Stac and Hi/fn, will receive a different adjustment to his
options to purchase Stac Common Stock. Hi/fn will grant Mr. Whiting, under the
1996 Plan, an option to purchase the number of shares of Company Common Stock
equal to the number of shares of Stac Common Stock subject to outstanding
options he holds divided by the Distribution Ratio. The exercise price of Mr.
Whiting's options to purchase Stac Common Stock will be allocated between his
options to purchase Stac Common Stock and his new options to purchase Company
Common Stock based on the ratio of the closing sales price of Stac Common Stock
to Company Common Stock (divided by the Distribution Ratio) on the Nasdaq
National Market on the Distribution Date. 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 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. In addition, pursuant
to the Tax Sharing Agreement, if the Distribution were not to constitute a
tax-free spin-off under Section 355 of the Code, then the Company or Stac, as
the case may be, would be obligated to indemnify the other party for all taxes
resulting from such failure if such failure was attributable to (i) actions of
the Company or Stac after the Distribution, or (ii) the breach of certain
representations with respect to the Company or Stac made in the Tax Sharing
Agreement. However, under the Tax Sharing Agreement, if the Distribution were
not to constitute a tax-free spin-off under Section 355 of the Code, Stac would
be obligated to bear all taxes of Stac resulting from such failure if either (i)
neither Stac nor the Company (a) took actions after the Distribution which
resulted in such failure or (b) breached certain representations made in the Tax
Sharing Agreement, or (ii) if both the Company and Stac (a) took actions after
the Distribution which resulted in such failure, or (b) breached certain
representations made in the Tax Sharing Agreement. Neither the Company nor Stac
will indemnify any holder of Company Common Stock who receives shares in the
Distribution for any such taxes.
    
 
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 on a
transitional basis after the Distribution. The fees for such transitional
services will be $6,500 per month plus any out-of-pocket expenses incurred by
Stac that are attributable to the work done for Hi/fn under the Transition
Services Agreement. 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. Hi/fn will indemnify Stac and its officers, directors,
employees and agents against losses, claims or damages arising out of
allegations that the financial statements and accounting records prepared by
Hi/fn with Stac's assistance are inaccurate or
 
                                       33
<PAGE>   39
 
incomplete. The Transitional Services Agreement will terminate on December 31,
1999 unless extended in writing by the parties.
 
SATISFACTION OF INTERCOMPANY BALANCES AND STAC LOAN
 
   
     On September 28, 1998, Stac paid $4,400,000 million to the Company,
representing payment in full for all amounts due to the Company from Stac as of
September 1, 1998. The Company will pay to Stac, prior to the Distribution, the
amounts due to Stac as of October 31, 1998 and Stac will pay to the Company, on
or prior to December 31, 1998, any amounts due to the Company that are
accumulated after October 31, 1998. On September 28, 1998, Stac also loaned
$5,000,000 million to the Company pursuant to a short-term loan (the "Stac
Loan"). The Stac Loan will become due and payable on September 30, 1999 and may
be prepaid in whole or part without penalty. The Stac Loan bears interest at the
prime rate set by Silicon Valley Bank plus 0.5% per annum, payable quarterly.
The Stac Loan is secured by a first priority security interest in all of the
Company's assets, including the Company's intellectual property.
    
 
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.
 
                                       34
<PAGE>   40
 
                       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, 1997
and 1998 and for each of the three years in the period ended September 30, 1998
as included herein. Financial information as of September 30, 1995 and 1996 and
for the year ended September 30, 1995 has been prepared from audited financial
statements not included herein. The financial information as of and for the year
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 and for the year ended September 30,
1994, 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>
                                                               YEAR ENDED SEPTEMBER 30,
                                                     ---------------------------------------------
                                                      1994     1995     1996      1997      1998
                                                     ------   ------   -------   -------   -------
<S>                                                  <C>      <C>      <C>       <C>       <C>
STATEMENT OF OPERATIONS DATA:
Revenues...........................................  $5,666   $7,342   $12,894   $14,226   $21,533
Cost of revenues...................................   2,302    2,841     5,095     4,762     6,525
                                                     ------   ------   -------   -------   -------
Gross margin.......................................   3,364    4,501     7,799     9,464    15,008
Operating expenses:
Research and development...........................     564      551     1,641     2,985     5,403
Sales and marketing................................     813    1,097     1,677     2,224     3,370
General and administrative.........................     379      492       889     1,203     2,407
                                                     ------   ------   -------   -------   -------
Operating income...................................   1,608    2,361     3,592     3,052     3,828
Interest income....................................                                   16        17
                                                     ------   ------   -------   -------   -------
Provision for income taxes.........................     661      947     1,441     1,235     1,627
                                                     ------   ------   -------   -------   -------
Net income.........................................  $  947   $1,414   $ 2,151   $ 1,833   $ 2,218
                                                     ======   ======   =======   =======   =======
Net income per share, basic(1).....................  $ 0.16   $ 0.24   $  0.36   $  0.30   $  0.35
Net income per share, diluted......................  $ 0.16   $ 0.24   $  0.36   $  0.30   $  0.33
Weighted average shares outstanding, basic.........   6,000    6,000     6,000     6,100     6,308
Weighted average shares outstanding, diluted.......   6,000    6,000     6,000     6,174     6,800
BALANCE SHEET DATA (AS OF SEPTEMBER 30,):
Cash...............................................  $   --   $   --   $    --   $   480   $10,057
Total assets.......................................   1,583    2,254     2,611     5,898    16,611
Working capital (deficit)..........................    (193)    (223)     (383)    3,520     4,723
Total stockholders' equity(2)......................      --       --        --     4,622     6,952
</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. For all periods prior to
    fiscal 1997, net income generated by Hi/fn has been treated as if it were
    transferred to Stac in the form of dividends. No such dividend transfers
    were made for fiscal 1997 and the periods presented thereafter.
 
                                       35
<PAGE>   41
 
          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.
 
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>
                                                              YEAR ENDED SEPTEMBER 30,
                                                              ------------------------
                                                              1996      1997      1998
                                                              ----      ----      ----
<S>                                                           <C>       <C>       <C>
Revenues....................................................  100%      100%      100%
Cost of revenues............................................   39        33        30
                                                              ---       ---       ---
Gross margin................................................   61        67        70
                                                              ---       ---       ---
Research and development....................................   13        21        25
Sales and marketing.........................................   13        16        16
General and administrative..................................    7         8        11
                                                              ---       ---       ---
Total operating expenses....................................   33        45        52
                                                              ---       ---       ---
Operating income............................................   28        22        18
Interest income.............................................   --        --        --
                                                              ---       ---       ---
Income before income taxes..................................   28        22        18
Provision for income taxes..................................   11         9         8
                                                              ---       ---       ---
Net income..................................................   17        13        10
                                                              ===       ===       ===
</TABLE>
    
 
                                       36
<PAGE>   42
 
   
  Comparison of Results of Operations
    
 
   
     Revenues. Revenues from sales of semiconductors and licenses of software
libraries increased 51% to $21.5 million in 1998 compared to 1997 revenues, and
increased 10% to $14.2 million in 1997 from revenues of $12.9 million in 1996.
The increase in revenues in each of 1998 and 1997 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 61%, 70% and 43% of revenues in each
of 1998, 1997 and 1996 respectively.
    
 
   
     Gross Margin. Gross margins were 70% in 1998, 67% in 1997, and 61% in 1996.
The increase in gross margins in 1998 from those in 1997 was due primarily to
cost efficiencies achieved through design modifications made to compression
co-processors. 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 $5.4
million for 1998, $3.0 million for 1997, and $1.6 million for 1996, an increase
of 81% in 1998 from 1997 and an increase of 82% in 1997 from 1996. 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 $3.4 million in
1998, $2.2 million in 1997, and $1.7 million in 1996. The increases in marketing
and sales expenses in 1998 over those of 1997 and in 1997 expense over those of
1996 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 $2.4
million in 1998, $1.2 million in 1997, and $0.9 million in 1996. The increase in
1998 expenses over those of 1997 and in 1997 over those of 1996 was 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.
 
     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.
 
                                       37
<PAGE>   43
 
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 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,    SEPTEMBER 30,
                                    1997          1998         1998          1998
                                ------------    ---------    --------    -------------
<S>                             <C>             <C>          <C>         <C>
Revenues......................     6,265          5,236       5,012          5,020
Gross margin..................     4,163          3,674       3,534          3,637
Operating income..............     1,551          1,051         528            698
Net income....................       931            630         291            366
</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, June 30, 1998 and September 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. There can be no assurances that growth of sales to
network equipment companies will continue. See "RISK FACTORS -- Risks Associated
with Emerging VPN Market."
    
 
                                       38
<PAGE>   44
 
LIQUIDITY AND CAPITAL RESOURCES
 
   
     From inception, the Company has depended upon Stac for financing its
operations and capital requirements. For the fiscal year ended September 30,
1996, the Company's net cash provided by operating activities was $3,761,000.
During the same period, $223,000 was used for the purchase of property and
equipment and $1,996,000 was 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 year ended September 30, 1997, the Company generated $2,000,000 of
cash from operations, which was comprised primarily of net income of $1,833,000
(increased for adjustments to net income). Adjustments to net income that
increased cash include $303,000 of depreciation and amortization and $566,000 of
increases in balance sheet liabilities, resulting primarily from $420,000 of
general and administrative services provided by Stac. Adjustments to net income
that reduced cash include $129,000 of benefits from the generation of deferred
tax assets and a $573,000 net increase in all other balance sheet assets.
Hi/fn's transfer of cash to Stac for centralized cash management resulted in a
net decrease to Hi/fn cash of $788,000.
    
 
   
     For the year ended September 30, 1998, the Company generated $3,131,000 of
cash from operations, which was comprised primarily of net income of $2,218,000
(increased for adjustments to net income). Adjustments to net income that
increased cash include $726,000 of depreciation and amortization and $2,451,000
of increases in balance sheet liabilities. Adjustments to net income that
reduced cash include $469,000 of benefits from the generation of deferred tax
assets and a $1,795,000 net increase in all other balance sheet assets. Stac's
transfer of cash to Hi/fn of $9,400,000 as discussed below, offset by transfers
to Stac for centralized cash management, resulted in a net increase to Hi/fn's
cash of $2,439,000.
    
 
   
     On September 28, 1998, Stac paid $4,400,000 to the Company, representing
payment in full for all amounts due to the Company from Stac as of September 1,
1998. Stac also loaned $5,000,000 to the Company pursuant to a short-term loan
described more fully below. Prior to the Distribution, the Company will pay any
amounts due to Stac as of October 31, 1998. Stac will pay to the Company on or
prior to December 31, 1998 any amounts due to the Company that are accumulated
after October 31, 1998. Amounts due to or from the Company arise from transfers
of cash to or from the Company and to or from Stac for centralized cash
management.
    
 
     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. Immediately following the
Distribution, the Company expects to have approximately $9,000,000 in cash,
including the proceeds of the $5,000,000 short-term loan from Stac (the "Stac
Loan"), to finance its operating and capital needs. The Stac Loan will become
due and payable on September 30, 1999 and may be prepaid in whole or part
without penalty. The Stac Loan bears interest at the prime rate set by Silicon
Valley Bank plus 0.5% per annum, payable quarterly. The Stac Loan is secured by
a first priority security interest in all of the Company's assets, including the
Company's intellectual property. During the first year following the
Distribution, the Company expects to enter into a revolving bank
    
 
                                       39
<PAGE>   45
 
   
credit facility and term loan. The Company intends to use its cash balances,
cash from operations and the proceeds from the credit facility and the term loan
to repay the Stac Loan and to fund its operating and capital needs for the
twelve months following the Distribution. The Company also intends to raise
equity capital within the first year following the Distribution and 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 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.
 
   
     To date, the Company's primary focus has been on its own internal systems.
The Company has completed its evaluation of Year 2000 compliance with respect to
all of its computer systems and applications. As a result of this evaluation,
the Company has determined that all business critical systems are compliant or
will be made compliant through available product upgrades. In particular, the
only critical application affected is the Windows NT 4.0 Operating System.
Microsoft has released Service Pack 4, an upgrade to Windows NT 4.0, which makes
the operating system Year 2000 compliant. The Company is currently evaluating
this upgrade and expects to implement it by December 31, 1998. The Company,
currently is also evaluating the following non-business critical applications:
MS DOS 6.22 (a laboratory PC operating system), ACP Voice Messaging (Carlsbad
location voice mail software) and FRX Drill down software (an accounting
productivity tool). The Company will upgrade these applications with existing
upgrades by December 31, 1998. Lastly, there are several Dell Systems PC
workstations shipped prior to January 1, 1997 that will require BIOS upgrades to
become fully Year 2000 compliant. The Company has not incurred, nor does it
expect to incur, material costs for the acquisition and implementation of
product upgrades to achieve Year 2000 compliance.
    
 
     The Company also has reviewed the products it offers to customers. None of
the software or semi-conductor products sold by the Company contain any
date-specific information, nor do they rely upon any such information for their
operation. As a result, the Company does not believe that its products will be
susceptible to Year 2000 problems.
 
     The Company has had initial communications with certain significant third
parties with which it does business to evaluate their Year 2000 compliance plans
and state of readiness and to determine the extent to which the Company's
systems may be affected by the failure of others to remedy their own Year 2000
issues. To date, the Company has received only preliminary feedback from such
parties indicating that they are in the process of implementing measures to
ensure Year 2000 compliance, and further representing that they will achieve
compliance before the close of calendar 1999. The Company has not independently
confirmed any information received from other parties with respect to the Year
2000 issues. As such, there can be no assurance that such other parties will
complete their Year 2000 conversion in a timely fashion or will not suffer a
Year 2000 business disruption that may adversely affect the Company's financial
condition and results of operations.
 
                                       40
<PAGE>   46
 
     To date, the Company has not identified any system which presents a
material risk of not being Year 2000 ready in a timely fashion or for which a
suitable alternative cannot be implemented. However, the Company may ultimately
identify systems that do present a material risk of Year 2000 disruption. Such
disruption may include, among other things, the inability to process
transactions or information, procure inventory or engage in similar normal
business activities. The failure of the Company to identify systems that require
Year 2000 conversion and that are critical to the Company's operations or the
failure of the Company or others with which the Company does business to become
Year 2000 ready in a timely manner could have a material adverse effect on the
Company's financial condition and results of operations.
 
   
     The Company has not yet completed the development of a comprehensive Year
2000 contingency plan. However, as part of its Year 2000 effort, the Company
regularly examines information received from external sources for date integrity
before integrating such information into the Company's internal systems. In
addition, the Company has established a plan to increase inventories of certain
products by December 1999 if the Company determines there is some risk of
interruption of supply from a third party as a result of Year 2000 compliance
issues. This would allow the Company to continue to supply product to its
customers while the third party corrects its problems. The Company has also
incorporated alternatives into its contingency plan to address the possibility
that the software upgrades described above do not fully resolve Year 2000
compliance issues. If the Company determines that its business is at material
risk of disruption due to currently unforeseen Year 2000 issue or anticipates
that its Year 2000 compliance will not be achieved in a timely fashion, the
Company will work to enhance its contingency plan.
    
 
     The discussion above contains certain forward-looking statements. The costs
of the Year 2000 conversion and possible risks associated with the Year 2000
issue are based on the Company's current estimates and are subject to various
uncertainties that could cause the actual results to differ materially from the
Company's expectations. Such uncertainties include, among others, the success of
the Company in identifying systems that are not Year 2000 compliant, the nature
and amount of programming required to upgrade or replace each of the affected
systems, the availability of qualified personnel, consultants and other
resources, and the success of the Year 2000 conversion efforts of others.
 
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.
 
                                       41
<PAGE>   47
 
                                  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.
 
                                       42
<PAGE>   48
 
                                    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
                                       43
<PAGE>   49
 
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 were 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.
 
                                       44
<PAGE>   50
 
     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 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 continues to increase. The opportunity to back
up server disk storage, an administrative operation typically
 
                                       45
<PAGE>   51
 
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. The Company also licenses software implementations of
LZS and MPPC to 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.
 
                                       46
<PAGE>   52
 
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 and 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
                                       47
<PAGE>   53
 
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 several design wins with 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."
 
     At September 30, 1998, the Company has a backlog of semiconductor orders
representing $10.1 million of products deliverable to customers over the next 12
months. The Company quotes product lead times to customers of approximately
three months, with the result that most products shipped during a quarter were
ordered during the previous quarter. Customers may reschedule or cancel orders,
subject to negotiated windows, with the result that orders scheduled for
shipment in a quarter may be moved to a subsequent quarter or cancelled
altogether.
 
     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>
 
                                       48
<PAGE>   54
 
     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
7751                      Encryption processor, DES/Triple-    October 1998
                          DES/RC4 encryption, LZS/MPPC
                          compression, MD5/SHA1 data
                          authentication, operating at 8
                          Mbytes/sec, PCI 2.1 interface, DMA
                          Masker
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.
 
                                       49
<PAGE>   55
 
     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 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 four foreign patents.
The Company also has two 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.
 
     Agreements with IBM. In April 1994, Stac entered into two related patent
cross license agreements with IBM, one related to software products and the
other to hardware products. The term of each agreement continues until all of
the patents licensed under such agreement have expired.
 
     Pursuant to the software patent cross license, IBM granted Stac a
nonexclusive license under certain IBM patents for making, using and selling
software programs designed to operate with all operating systems (and their
extensions or emulations) other than IBM mainframe-type operating systems. IBM
also granted Stac the right to combine products licensed under IBM's patents
with other products and granted Stac's customers the right to use those combined
products.
 
     In exchange for the rights granted to Stac by IBM under the software patent
cross license, Stac granted IBM a nonexclusive license under certain Stac
patents for making, using and selling any software programs used in systems that
process information. Stac also granted IBM the right to combine products
licensed under Stac's patents with other products and granted certain IBM
customers the right to use those combined products.
 
                                       50
<PAGE>   56
 
     Pursuant to the hardware cross license agreement, IBM granted Stac a
nonexclusive license under certain IBM patents for making, using and selling,
and for practicing any methods involved in making or using, lossless data
compression products. The license, however, restricts Stac from incorporating
the IBM patents in the manufacture of lossless data compression products for
third parties that are based upon third-party designs for lossless data
compression. IBM also granted Stac the right to combine the hardware products
with software programs licensed under the software cross license. In addition,
IBM granted to users of Stac's licensed products an immunity from suit for use
of combinations of the licensed hardware products with software programs.
 
     In exchange for the license from IBM, and in exchange for payment of a
one-time license fee by IBM, Stac granted IBM a nonexclusive license under
certain Stac patents for making, using and selling, and for practicing any
methods involved in making or using, hardware products. The license, however,
restricts IBM from incorporating the Stac patents in the manufacture of hardware
products for third parties that are based upon third-party designs for lossless
data compression. Stac also granted IBM the right to combine the hardware
products with software programs licensed under the software cross license. In
addition, Stac granted users of IBM's licensed products an immunity from suit
for use of combinations of the licensed hardware products with software
programs.
 
     Under the terms of the software and hardware patent cross license
agreements between IBM and Stac, the Company is eligible to receive equivalent
license rights from IBM, provided that the licenses may not be further extended
to a Hi/fn subsidiary. Stac has requested that IBM enter into such license
agreements with the Company.
 
     Agreement with Motorola. In December 1995, Stac entered into a cross
license and royalty agreement with Motorola. Pursuant to this agreement,
Motorola granted Stac and Stac's subsidiaries a nonexclusive license under two
Motorola patents and one Motorola patent application for making and having made
products (both hardware and software) for data communications and using, selling
and leasing such products under Stac's trade identity. Stac is also permitted,
with certain exceptions, to grant sublicenses to software and semiconductor
device customers in accordance with a standard agreement available to Stac.
Except for the foregoing sublicensing is prohibited under the agreement.
 
     In exchange for the license under Motorola's patents, and in exchange for
certain royalties, Stac granted Motorola and Motorola's subsidiaries (i) a
nonexclusive license under five Stac patents and a foreign patent application
for (A) making and having made data communications products other than stand
alone semiconductor devices or stand alone software that were to be sold to
entities other than Motorola or Stac or their subsidiaries and (B) using,
leasing and selling products under Stac's trade identity, and (ii) a
nonexclusive license under Stac's copyrights and patents (A) to use, copy and
distribute software for integration into Motorola's products that incorporate
LZS data compression and (B) to distribute LZS data compression software for
integration with Motorola's products that incorporate LZS data compression as
long as the modifications do not change the encoding format of the unmodified
data compression software.
 
     Pursuant to the Motorola agreement, each of Stac and Motorola is required
to pay to the other an annual lump sum royalty based on projected sales, the
amount of which varied depending on the annual sales volume and the net sales
price. All royalties are subject to an overall maximum amount and terminate
after seven years. The term of the agreement continues until all of the licensed
patents have expired. Stac has assigned, and the Company has assumed, all of
Stac's rights and obligations under the Motorola agreement.
 
     Agreement with Microsoft. In February 1996, Stac entered into a license
agreement with Microsoft pursuant to which Microsoft granted Stac a nonexclusive
license to use Microsoft's implementation of the MPPC compression format (i) to
create compression software that performed data compression in accordance with
the MPPC compression format, (ii) to permit third parties to integrate
Microsoft's or Stac's MPPC software, (iii) to permit third parties to exploit
products into which MPPC software is integrated, and (iv) to perform data
compression in Stac's MPPC Software in accordance with the MPPC compression
format. As a condition of the license, Stac must distribute un-optimized
Microsoft compression software on the same terms and conditions, including
price, as those for Stac's LZS software. The term of the agreement
 
                                       51
<PAGE>   57
 
continues until all of the licensed patents have expired. Stac has assigned, and
the Company has assumed, all of Stac's rights and obligations under the
Microsoft agreement.
 
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 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
 
                                       52
<PAGE>   58
 
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 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 -- Intensely Competitive Markets."
 
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 September 30, 1998, the Company's research and development staff
consisted of 26 employees. The Company's research and development expenditures
totaled $5.4 million during fiscal 1998 and $3.0 million in the fiscal year
ended September 30, 1997, representing 25.1% 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.
 
                                       53
<PAGE>   59
 
     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 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 -- Frequent Product Introductions and Evolving
Industry Standards; Rapid 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. The
Company does not have any foreign operations and sales of its products to
foreign companies, other than product shipments to contract manufacturers of
domestic customers, have not been material. 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.
 
                                       54
<PAGE>   60
 
     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.
 
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.
However, the Company expects that in the event one of the Company's suppliers
notifies the Company that it intends to cease manufacturing a product, the
Company will have an adequate opportunity to order sufficient quantities of the
effected products so that shipments to customers will not be adversely affected
while the Company qualifies a new manufacturer.
 
     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 September 30, 1998, Hi/fn employed a total of 56 full-time employees
and 3 part-time contractors. Of the total number of employees, 26 were employed
in research and development, 19 in sales and marketing,
    
                                       55
<PAGE>   61
 
   
6 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."
 
FACILITIES
 
     The Company's corporate and technical headquarters are currently located in
Los Gatos, California. The Company leases approximately 27,000 square feet of
space in Los Gatos, California pursuant to a seven-year lease which expires in
August 2005. Stac has guaranteed Hi/fn's obligations under its headquarters
lease. Under the Distribution Agreement, Hi/fn has agreed to obtain and deliver
to its landlord a $2.0 million letter of credit to replace Stac's guaranty. The
guaranty provides that it will terminate when Stac no longer owns a majority
interest in Hi/fn and when Hi/fn provides the landlord with such a letter of
credit. The Distribution is conditioned on delivery of the letter of credit. 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.
 
LEGAL PROCEEDINGS
 
     The Company is not a party to any material legal proceedings.
 
                                       56
<PAGE>   62
 
                                   MANAGEMENT
 
BOARD OF DIRECTORS
 
   
     The Company Board currently is comprised of four directors: Raymond J.
Farnham, Gary W. Clow, Robert W. Johnson and Douglas L. Whiting. The Company
Board expects to replace Mr. Clow with a non-employee director prior to the
distribution. Upon consummation of the Distribution, the Company Board is
expected to be comprised of up to 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>
Raymond J. Farnham.......  Chairman and Chief Executive Officer     51
Gary W. Clow.............  Director                                 43
Douglas L. Whiting,
  Ph.D...................  Chief Technology Officer and Director    42
Robert W. Johnson,
  Ph.D...................  Director                                 48
</TABLE>
    
 
   
     Raymond J. Farnham has served as Chairman and Chief Executive Officer of
the Company since October 1998. From 1996 through 1998, he served as Executive
Vice President of Integrated Device Technology, Inc., a supplier of
microprocessor, logic and memory integrated circuits to communication and
computer customers worldwide. Mr. Farnham was President and Chief Executive
Officer of OPTi, a fabless semiconductor company, from 1994 through 1995. From
1972 through 1993, he had numerous management responsibilities at National
Semiconductor Corp., with his final position being President of the
Communication and Computing Group from 1991 through 1993. He received his B.S.
in Electrical Engineering from Pennsylvania State University.
    
 
     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.
    
 
   
     Robert W. Johnson, Ph.D. has been a private investor since July 1988. From
1983 to July 1988, he was first a principal and subsequently a general partner
of Southern California Ventures, a private venture capital firm. He is a
director of Proxima Corporation and ViaSat, Inc., both publicly held technology
companies. Dr. Johnson holds undergraduate and graduate degrees from Stanford
University and Harvard University.
    
 
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.
 
                                       57
<PAGE>   63
 
COMPENSATION OF THE BOARD OF DIRECTORS
 
   
     Each non-employee director of the Company will receive $4,000 per year for
serving on the Company Board and an additional $1,000 for each meeting attended
(other than committee meetings). An additional $500 will be paid to any
non-employee director who serves on the Compensation Committee or the Audit
Committee. Each director is eligible to receive stock options pursuant to the
1996 Plan. See "-- Hi/fn Equity Plans; 1996 Equity Incentive Plan." Directors
also will receive reimbursement for travel expenses incurred in connection with
their duties as directors.
    
 
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>
Raymond J. Farnham................  Chairman and Chief Executive Officer      51
William R. Walker.................  Vice President of Finance, Chief          57
                                    Financial Officer and Corporate
                                    Secretary
Stephen A. Farnow, Ph.D...........  Vice President of Operations              49
Thomas F. Griffin.................  Vice President of Sales                   41
Robert A. Monsour.................  Vice President of Marketing               43
Douglas L. Whiting, Ph.D..........  Chief Technology Officer and Director     42
</TABLE>
    
 
   
     Raymond J. Farnham has served as Chairman and Chief Executive Officer of
the Company since October 1998. From 1996 through 1998, he served as Executive
Vice President of Integrated Device Technology, Inc., a supplier of
microprocessor, logic and memory integrated circuits to communication and
computer customers worldwide. Mr. Farnham was President and Chief Executive
Officer of OPTi, a fabless semiconductor company from 1994 through 1995. From
1972 through 1993, he had numerous management responsibilities at National
Semiconductor Corp., with his final position being President of the
Communication and Computing Group from 1991 through 1993. He received his B.S.
in Electrical Engineering from Pennsylvania State University.
    
 
   
     William R. Walker has served as Vice President and Chief Financial Officer
of the Company since November 1997. He was the Company's Acting Chief Executive
Officer and Acting President from July 1998 through October 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, Ph.D. 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
 
                                       58
<PAGE>   64
 
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.
 
   
     Douglas L. Whiting, Ph.D. has served as Chief Technology Officer of the
Company 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.
    
 
EXECUTIVE COMPENSATION
 
   
     The following table sets forth certain information concerning compensation
for the fiscal year ended September 30, 1998 and 1997 received by the Chief
Executive Officer and the four other most highly compensated executive officers
at September 30, 1998 (the "Named Executive Officers").
    
 
                           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)...................   1998      133,382      33,384          0               0
                                            1997      150,000      30,000          0         300,000
Stephen A. Farnow,.......................   1998      132,853      27,183          0               0
  Vice President of Operations              1997      100,000      12,600          0          72,000
William J. Walker(2).....................   1998      128,333      17,850          0         100,000
                                            1997            0           0          0               0
Douglas L. Whiting.......................   1998      140,000      25,918          0               0
                                            1997            0           0          0               0
Robert A. Monsour(3).....................   1998      154,808      69,334          0               0
                                            1997       17,885       2,910          0          97,500
</TABLE>
    
 
- ---------------
(1) Mr. Collmeyer served as President and Chief Executive Officer of the Company
    until July 2, 1998.
 
   
(2) Mr. Walker joined the Company in November 1997 at an annual salary rate of
    $140,000.
    
 
   
(3) Mr. Monsour's 1998 bonus includes $50,000 for reimbursement of relocation
    expenses.
    
 
                           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,
1998 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>
William J. Walker......   100,000          25.8%           $2.00         11/03/07      $125,780     $318,740
Thomas F. Griffin......    80,000          20.6%           $2.25          4/06/08      $113,202     $286,866
</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.
    
 
                                       59
<PAGE>   65
 
            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, 1998, and the unexercised options held and the value thereof at
that date, for each of the Named Executive Officers.
    
 
   
<TABLE>
<CAPTION>
                                                           NUMBER OF SHARES UNDERLYING               VALUE OF UNEXERCISED
                                                           UNEXERCISED OPTIONS HELD AT              IN-THE-MONEY OPTIONS AT
                          SHARES                                SEPTEMBER 30, 1998                   SEPTEMBER 30, 1998(1)
                        ACQUIRED ON       VALUE        ------------------------------------   -----------------------------------
         NAME           EXERCISE(#)   REALIZED($)(2)   EXERCISEABLE(#)    UNEXERCISEABLE(#)   EXERCISEABLE($)   UNEXERCISEABLE($)
         ----           -----------   --------------   ----------------   -----------------   ---------------   -----------------
<S>                     <C>           <C>              <C>                <C>                 <C>               <C>
Arthur J. Collmeyer...         0            0                 0                     0                0                     0
Stephen A. Farnow.....         0            0                 0                36,000                0                86,400
William J. Walker.....    50,000            0                 0                50,000                0                50,000
Douglas L. Whiting....         0            0                 0                     0                0                     0
Robert A. Monsour.....    56,250            0                 0                48,750                0               117,000
</TABLE>
    
 
- ---------------
 
   
(1) Calculated by determining the difference between the fair market value of
    the securities underlying the options at September 30, 1998 ($3.00 per share
    as determined by the Company Board) and the exercise price of the options.
    
 
   
(2) Mr. Walker and Mr. Monsour exercised options pursuant to an early-exercise
    feature at an exercise price equal to fair market value.
    
 
HI/FN EQUITY PLANS
 
  1996 Equity Incentive 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 November 10, 1998, 486,151 shares had been issued upon exercise
of stock options granted under the 1996 Plan, 1,277,212 shares were subject to
options granted under the 1996 Plan and 186,537 shares were available for future
grants. Mr. Whiting will receive options to purchase 71,700 shares of Company
Common Stock under the 1996 Plan as an adjustment to options to purchase Stac
Common Stock that he currently holds. See "RELATIONSHIP BETWEEN HI/FN AND STAC
AFTER THE DISTRIBUTION -- Employee Benefits Allocation Agreement." Unless
terminated sooner, the 1996 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
 
                                       60
<PAGE>   66
 
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
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.
 
     The 1996 Plan provides that each non-employee director shall automatically
be granted a nonstatutory stock option to purchase 10,000 shares of Company
Common Stock (the "First Option") on the date that such person first becomes a
non-employee director. In addition to the First Option, each non-employee
director shall automatically be granted an option to purchase 2,000 shares (a
"Subsequent Option") on the date of the Company's annual meeting of stockholders
if on such date he or she has served on the Board for at least six months. Each
First Option and Subsequent Option shall have a term of 10 years. The shares
subject to the First Option shall vest as to 20% of the optioned stock one year
from the date of grant, and 1/60 of the optioned stock shall vest each month
thereafter, provided the person continues to serve as a director on such dates.
The shares subject to the Subsequent Option shall vest as to 100% of the
optioned stock on the one-year anniversary of the date of grant thereafter,
provided the person continues to serve as a director on such date. The exercise
price of each First Option and each Subsequent Option shall be 100% of the fair
market value per share of the Common Stock.
 
     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.
 
                                       61
<PAGE>   67
 
  1998 Employee Stock Purchase Plan
 
     The Company's 1998 Employee Stock Purchase Plan (the "1998 Purchase Plan")
is expected to be adopted by the Company Board and approved by the Company's
stockholders in October 1998. A total of 400,000 shares of Company Common Stock
have been reserved for issuance under the 1998 Purchase Plan. As of the date of
this Information Statement, no shares have been issued under the 1998 Purchase
Plan.
 
     The 1998 Purchase Plan, which is intended to qualify under Section 423 of
the Code, provides for successive six-month offering periods. The offering
periods generally start on the first trading day on or after May 1 and November
1 of each year, except for the first such offering period which commences on the
first day of regular way trading of Company Common Stock on the Nasdaq National
Market and ends on the last trading day on or before April 30, 1999.
 
     Employees are eligible to participate if they are customarily employed by
the Company or any participating subsidiary for at least 20 hours per week and
more than five months in any calendar year. However, any employee who (i)
immediately after grant owns stock possessing 5% or more of the total combined
voting power or value of all classes of the capital stock of the Company or (ii)
whose right to purchase stock under all employee stock purchase plans of the
Company accrues at a rate that exceeds $25,000 worth of stock for each calendar
year may be not be granted an option to purchase stock under the 1998 Purchase
Plan. The 1998 Purchase Plan permits participants to purchase Company Common
Stock through payroll deductions of up to 15% of the participant's
"compensation." Compensation is defined as the participant's base straight time
gross earnings and commissions, but exclusive of payments for overtime, bonuses,
shift premium, incentive compensation or any other compensation. The maximum
number of shares a participant may purchase during a single offering period is
5,000 shares.
 
     Amounts deducted and accumulated by the participant are used to purchase
shares of Company Common Stock at the end of each offering period. The price of
stock purchased under the 1998 Purchase Plan is 85% of the lower of the fair
market value of the Company Common Stock at the beginning or end of the offering
period. Participants may end their participation at any time during an offering
period, and they will be paid their payroll deductions to date. Participation
ends automatically upon termination of employment with the Company.
 
     Rights granted under the 1998 Purchase Plan are not transferable by a
participant other than by will, the laws of descent and distribution, or as
otherwise provided under the 1998 Purchase Plan. The 1998 Purchase Plan 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 outstanding option
may be assumed or substituted for by the successor corporation. If the successor
corporation refuses to assume or substitute for the outstanding options, the
offering period then in progress will be shortened and a new exercise date will
be set.
 
     The Company Board may at any time and for any reason amend or terminate the
1998 Purchase Plan. With certain limited exceptions, no such action may
adversely affect any outstanding rights to purchase stock under the 1998
Purchase Plan, provided that the Company Board may terminate an offering period
on any exercise date if the Company Board determines that the termination of the
1998 Purchase Plan is in the best interests of the Company and its stockholders.
Notwithstanding anything to the contrary, the Company Board may in its sole
discretion amend the 1998 Purchase Plan to the extent necessary and desirable to
avoid unfavorable financial accounting consequences by altering the purchase
price for any offering period, shortening any offering period or allocating
remaining shares among the participants. The 1998 Purchase Plan will terminate
in August 2008 unless sooner terminated by the Company.
 
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,
 
                                       62
<PAGE>   68
 
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.
 
     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
 
   
     Prior to the Distribution, the Company will enter into a Change of Control
Agreement with each of Raymond J. Farnham, the Company's Chairman and Chief
Executive Officer, William R. Walker, the Company's Vice President of Finance
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 unvested 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) the
consummation of a merger or consolidation of the Company with any other
corporation, other than a merger or consolidation which would result in the
voting securities of the Company outstanding immediately prior thereto
continuing to represent more than 50% of the total voting power represented by
the voting securities of the surviving entity outstanding immediately after such
merger or consolidation; (ii) the consummation of a plan of complete liquidation
of the Company or an agreement for the sale or disposition by the Company of all
or substantially all of the Company's assets; or (iii) any "person" (as such
term is used in
    
                                       63
<PAGE>   69
 
Sections 13(d) and 14(d) of the Exchange Act) becoming the "beneficial owner"
(as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of
securities of the Company representing 25% or more of the total voting power
represented by the Company's then outstanding securities.
 
     Prior to the Distribution, the Company will enter into a Change of Control
Agreement with each of its directors pursuant to which, upon a change of control
of the Company, the directors will receive accelerated vesting (and/or a lapse
of the Company's repurchase option) with respect to all unvested options,
warrants or rights to purchase shares of the Company's Common Stock held at the
time of such change of a control. For purposes of each such agreement, a change
of control is defined as: (i) the consummation of a merger or consolidation of
the Company with any other corporation, other than a merger or consolidation
which would result in the voting securities of the Company outstanding
immediately prior thereto continuing to represent more than 50% of the total
voting power represented by the voting securities of the surviving entity
outstanding immediately after such merger or consolidation; (ii) the
consummation of a plan of complete liquidation of the Company or an agreement
for the sale or disposition by the Company of all or substantially all of the
Company's assets; or (iii) any "person" (as such term is used in Sections 13(d)
and 14(d) of the Exchange Act) becoming the "beneficial owner" (as defined in
Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the
Company representing 25% or more of the total voting power represented by the
Company's then outstanding securities.
 
                 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 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,
 
                                       64
<PAGE>   70
 
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. Stac has guaranteed Hi/fn's obligations under its
headquarters lease. Under the Distribution Agreement, Hi/fn has agreed to obtain
and deliver to its landlord a $2.0 million letter of credit to replace Stac's
guaranty. The guaranty provides that it will terminate when Stac no longer owns
a majority interest in Hi/fn and when Hi/fn provides the landlord with such a
letter of credit. The Distribution is conditioned on delivery of the letter of
credit. 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
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.
 
   
     On September 28, 1998, Stac paid $4.4 million to the Company, representing
payment in full for all amounts due to the Company from Stac as of September 1,
1998. The Company will pay to Stac prior to the Distribution any amounts due to
Stac as of October 31, 1998 and Stac will pay to the Company on or prior to
December 31, 1998 any amounts due to the Company that are accumulated after
October 31, 1998. On September 28, 1998, Stac also loaned $5.0 million to the
Company pursuant to a short-term loan (the "Stac Loan"). The Stac Loan will
become due and payable on September 30, 1999 and may be prepaid in whole or part
without penalty. The Stac Loan bears interest at the prime rate set by Silicon
Valley Bank plus 0.5% per annum, payable quarterly. The Stac Loan is secured by
a first priority security interest in all of the Company's assets, including the
Company's intellectual property.
    
 
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)
November 3, 2001, or (ii) the date
    
                                       65
<PAGE>   71
 
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."
 
                                       66
<PAGE>   72
 
        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 November 10, 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........................    629,625          9.7%
One Microsoft Way
Redmond, WA 98052-6399
Idanta Partners..............................    538,016          8.3%
Gary W. Clow(2)..............................    384,600          5.9%
Robert W. Johnson(3).........................    452,486          7.0%
Douglas L. Whiting(4)........................    407,800          5.9%
Arthur J. Collmeyer..........................    225,000          3.5%
Stephen A. Farnow............................     36,000            *
Robert A. Monsour............................     56,250            *
William R. Walker............................     50,000            *
All directors and officers as a group (8
  persons)...................................  1,387,136         21.2%
</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 with regard to Stac Common Stock. 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. Applicable percentages are based on 6,486,251 shares
    outstanding on November 10, 1998, adjusted as required by rules promulgated
    by the Commission.
    
 
   
(2) Includes 4,635 shares held of record by Mr. Clow's minor daughter, of which
    Mr. Clow disclaims beneficial ownership.
    
 
   
(3) Includes 450,437 shares held by the Robert W. Johnson Revocable Trust, of
    which Dr. Johnson is Trustee.
    
 
   
(4) Includes 354,025 shares held by the Whiting Family Trust, of which Mr.
    Whiting serves as Trustee and 53,775 shares issuable upon exercise of
    options to purchase Company Common Stock that will be issued to Mr. Whiting
    in connection with the Distribution and that will be exercisable within 60
    days of November 10, 1998.
    
 
                                       67
<PAGE>   73
 
                 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
                                       68
<PAGE>   74
 
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.
 
                                       69
<PAGE>   75
 
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
                                       70
<PAGE>   76
 
"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.
 
                                       71
<PAGE>   77
 
                       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, 1998 and 1997, and the results of its
operations and its cash flows for each of the three years in the period ended
September 30, 1998, in conformity with generally accepted accounting principles.
In addition, in our opinion, the financial statement schedule appearing on page
F-15 presents fairly, in all material respects, the information set forth
therein when read in conjunction with the related financial statements. These
financial statements and financial statement schedule are the responsibility of
the Company's management; our responsibility is to express an opinion on these
financial statements and financial statement schedule based on our audits. We
conducted our audits of these statements in accordance with 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
   
October 23, 1998
    
 
                                       F-1
<PAGE>   78
 
                                  HI/FN, INC.
 
                                 BALANCE SHEET
                      (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
 
                                     ASSETS
 
   
<TABLE>
<CAPTION>
                                                                SEPTEMBER 30,
                                                              -----------------
                                                               1997      1998
                                                              ------    -------
<S>                                                           <C>       <C>
Current assets:
  Cash and cash equivalents.................................  $  480    $ 4,084
  Marketable securities.....................................      --      5,973
  Accounts receivable, net..................................   1,823      3,125
  Due from parent...........................................   1,507         --
  Inventories...............................................     409        165
  Deferred income taxes.....................................     385        720
  Prepaid expenses and other current assets.................     192        315
                                                              ------    -------
          Total current assets..............................   4,796     14,382
  Property and equipment, net...............................     959      1,615
  Deferred income taxes.....................................      95        229
  Other assets..............................................      48        385
                                                              ------    -------
                                                              $5,898    $16,611
                                                              ======    =======
 
                     LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable..........................................  $  660    $ 1,610
  Due to parent.............................................      --      6,508
  Accrued expenses and other current liabilities............     616      1,541
                                                              ------    -------
          Total current liabilities.........................   1,276      9,659
                                                              ------    -------
Commitments and contingencies (Note 8 and Note 11)
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; 100,000,000 shares
     authorized; 280,799 and 483,014 shares issued and
     outstanding at September 30, 1997 and 1998,
     respectively...........................................      --         --
  Paid-in capital...........................................   2,783      2,995
  Note receivable from stockholder..........................      --       (100)
  Retained earnings.........................................   1,833      4,051
                                                              ------    -------
Total stockholders' equity..................................   4,622      6,952
                                                              ------    -------
                                                              $5,898    $16,611
                                                              ======    =======
</TABLE>
    
 
                See accompanying notes to financial statements.
                                       F-2
<PAGE>   79
 
                                  HI/FN, INC.
 
                            STATEMENT OF OPERATIONS
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
 
   
<TABLE>
<CAPTION>
                                                                YEAR ENDED SEPTEMBER 30,
                                                              -----------------------------
                                                               1996       1997       1998
                                                              -------    -------    -------
<S>                                                           <C>        <C>        <C>
Revenues....................................................  $12,894    $14,226    $21,533
Cost of revenues............................................    5,095      4,762      6,525
                                                              -------    -------    -------
Gross margin................................................    7,799      9,464     15,008
                                                              -------    -------    -------
Operating expenses:
Research and development....................................    1,641      2,985      5,403
Sales and marketing.........................................    1,677      2,224      3,370
General and administrative..................................      889      1,203      2,407
                                                              -------    -------    -------
Total operating expenses....................................    4,207      6,412     11,180
                                                              -------    -------    -------
Operating income............................................    3,592      3,052      3,828
Interest income.............................................       --         16         17
                                                              -------    -------    -------
Income before income taxes..................................    3,592      3,068      3,845
Provision for income taxes..................................    1,441      1,235      1,627
                                                              -------    -------    -------
Net income..................................................  $ 2,151    $ 1,833    $ 2,218
                                                              =======    =======    =======
 
Net income per share, basic.................................  $   .36    $   .30    $   .35
                                                              =======    =======    =======
Net income per share, diluted...............................  $   .36    $   .30    $   .33
                                                              =======    =======    =======
Weighted average shares outstanding, basic..................    6,000      6,100      6,308
                                                              =======    =======    =======
Weighted average shares outstanding, diluted................    6,000      6,174      6,800
                                                              =======    =======    =======
</TABLE>
    
 
                See accompanying notes to financial statements.
                                       F-3
<PAGE>   80
 
                                  HI/FN, INC.
 
                            STATEMENT OF CASH FLOWS
                                 (IN THOUSANDS)
 
   
<TABLE>
<CAPTION>
                                                                  YEAR ENDED SEPTEMBER 30,
                                                                -----------------------------
                                                                 1996       1997       1998
                                                                -------    -------    -------
<S>                                                             <C>        <C>        <C>
Cash flows from operating activities:
  Net income................................................    $ 2,151    $ 1,833    $ 2,218
  Adjustments required to reconcile net income to net cash
     provided by operating activities:
     Depreciation and amortization..........................         68        303        726
     Benefit from deferred income taxes.....................       (190)      (129)      (469)
     Changes in assets and liabilities:
     Accounts receivable....................................        546       (642)    (1,302)
     Inventories............................................       (554)       299        244
     Prepaid expenses and other current assets..............         (5)      (186)      (123)
     Other assets...........................................          1        (44)      (614)
     Accounts payable.......................................        409         60        950
     Due to parent for general and administrative
       allocations..........................................        889        420        576
     Accrued expenses and other current liabilities.........        446         86        925
                                                                -------    -------    -------
          Net cash provided by operating activities.........      3,761      2,000      3,131
                                                                -------    -------    -------
Cash flows from investing activities:
  Purchases of marketable securities........................         --         --     (5,973)
  Purchases of property and equipment.......................       (223)      (901)    (1,105)
                                                                -------    -------    -------
          Net cash used by investing activities.............       (223)      (901)    (7,078)
                                                                -------    -------    -------
Cash flows from financing activities:
  Issuance of common stock..................................         --        169        112
  Proceeds of loan from parent..............................         --         --      5,000
  Net transfer of funds from (to) parent....................     (1,542)      (788)     2,439
  Dividends to Parent Company...............................     (1,996)        --         --
                                                                -------    -------    -------
          Net cash provided (used) by financing
            activities......................................     (3,538)      (619)     7,551
                                                                -------    -------    -------
Net increase in cash and cash equivalents...................         --        480      3,604
Cash and cash equivalents at beginning of year..............         --         --        480
                                                                -------    -------    -------
Cash and cash equivalents at end of period..................    $    --    $   480    $ 4,084
                                                                =======    =======    =======
Supplemental non-cash financing activities:
  Issuance of preferred stock for net assets contributed....    $    --    $ 2,620    $    --
                                                                =======    =======    =======
  Settlement of interdivisional accounts....................    $  (155)   $    --    $    --
                                                                =======    =======    =======
</TABLE>
    
 
                See accompanying notes to financial statements.
                                       F-4
<PAGE>   81
 
                                  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, 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................     202        --      --        --        212         --        212
Note receivable from stockholder.....      --        --      --        --       (100)        --       (100)
Net income...........................      --        --      --        --         --      2,218      2,218
                                       ------   -------   -----    ------     ------    -------    -------
Balance at September 30, 1998........     483   $    --   6,000    $    6     $2,895    $ 4,051    $ 6,952
                                       ======   =======   =====    ======     ======    =======    =======
</TABLE>
    
 
                See accompanying notes to financial statements.
                                       F-5
<PAGE>   82
 
                                  HI/FN, INC.
 
                         NOTES TO FINANCIAL STATEMENTS
   
     (TABLE AMOUNTS IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS.)
    
 
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 year ended September 30, 1996, Hi/fn conducted business as a
division of Stac. For the fiscal years ended September 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 reflects 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 6). 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, for periods prior to
September 1998, Hi/fn participated 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 represent cash amounts in Hi/fn accounts that had yet to be liquidated
by payment obligations, or transferred to Stac. Cash balances at September 30,
1998 reflect a short-term loan of $5,000,000 by Stac to Hi/fn as well as the
settlement of intercompany accounts. 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.
    
 
   
     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.
These allocated expenses primarily represent the costs of services required by
Hi/fn for accounting, management information systems, human resources,
warehouse, executive and professional fees. For the years ended September 30,
1997 and 1998, general and administrative allocations totaled $420,000 and
$576,000, respectively. As more fully described in Notes 2 and 5, 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.
                                       F-6
<PAGE>   83
                                  HI/FN, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
   
     (TABLE AMOUNTS IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS.)
    
   
    
 
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.
 
   
  Marketable Securities
    
 
   
     The Company's marketable securities are comprised of funds on deposit with
a liquid asset manager that have been invested principally in commercial paper.
The carrying amount of these investments approximates fair value due to the
short maturities or demand nature of the investments. At September 30, 1998, all
marketable securities are classified as available-for-sale and carried at fair
value. Unrealized gains or losses at September 30, 1998 are not material.
    
 
  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 $68,000, $303,000 and $449,000 in fiscal 1996, 1997, and
1998, respectively. Leasehold improvements are amortized over the shorter of the
asset life or lease term.
    
 
  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
 
                                       F-7
<PAGE>   84
                                  HI/FN, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
   
     (TABLE AMOUNTS IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS.)
    
   
    
 
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 September 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
contingently 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 6) 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 years ended September 30, 1997 and 1998, respectively, is
presented below. Earnings per share for the year ended September 30, 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.
    
 
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>
 
                                       F-8
<PAGE>   85
                                  HI/FN, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
   
     (TABLE AMOUNTS IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS.)
    
   
    
 
   
YEAR ENDED SEPTEMBER 30, 1998
    
 
   
<TABLE>
<CAPTION>
                                                                        PER-SHARE
                                             NET INCOME     SHARES       AMOUNT
                                             ----------     ------      ---------
<S>                                          <C>           <C>          <C>
Net Income.................................    $2,218
Basic EPS..................................                6,308,000      $0.35
Dilutive Securities........................                  492,000
                                                           ---------
Diluted EPS................................                6,800,000      $0.33
                                                           =========
</TABLE>
    
 
   
  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 financial position, results of operations
or cash flows.
    
 
   
NOTE 3 -- CYLAN ACQUISITION:
    
 
   
     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 of $340,000 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.
    
 
   
NOTE 4 -- COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS:
    
 
   
<TABLE>
<CAPTION>
                                                              SEPTEMBER 30,
                                                             ----------------
                                                              1997      1998
                                                             ------    ------
<S>                                                          <C>       <C>
Accounts receivable:
  Trade receivables........................................  $1,873    $3,325
  Less allowance for doubtful accounts.....................     (50)     (200)
                                                             ------    ------
                                                             $1,823    $3,125
                                                             ======    ======
</TABLE>
    
 
                                       F-9
<PAGE>   86
                                  HI/FN, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
   
     (TABLE AMOUNTS IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS.)
    
   
    
 
   
     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, 1997, and 1998, one customer accounted for 78% and 52%
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 1996, 1997 and 1998.
    
 
   
<TABLE>
<CAPTION>
                                                                YEAR ENDED
                                                              SEPTEMBER 30,
                                                             ----------------
                                                              1997      1998
                                                             ------    ------
<S>                                                          <C>       <C>
Property and equipment:
  Computer equipment.......................................  $1,093    $1,445
  Furniture and fixtures...................................     172       419
  Leasehold improvements...................................      81       346
  Office equipment.........................................      43       287
                                                             ------    ------
                                                              1,389     2,497
  Less accumulated depreciation............................    (430)     (882)
                                                             ------    ------
                                                             $  959    $1,615
                                                             ======    ======
Accrued expenses and other current liabilities:
  Deferred revenue.........................................  $  323    $  697
  Compensation and employee benefits.......................     288       489
  Accrued royalties........................................               175
  Other....................................................       5       180
                                                             ------    ------
                                                             $  616    $1,541
                                                             ======    ======
</TABLE>
    
 
   
NOTE 5 -- 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,
                                                   --------------------------
                                                    1996      1997      1998
                                                   ------    ------    ------
<S>                                                <C>       <C>       <C>
Current tax expense:
  Federal......................................    $1,386    $1,159    $1,676
  State........................................       245       205       420
                                                   ------    ------    ------
                                                    1,631     1,364    $2,096
                                                   ------    ------    ------
Deferred tax (benefit):
  Federal......................................      (162)     (109)     (411)
  State........................................       (28)      (20)      (58)
                                                   ------    ------    ------
                                                     (190)     (129)     (469)
                                                   ------    ------    ------
                                                   $1,441    $1,235    $1,627
                                                   ======    ======    ======
</TABLE>
    
 
                                      F-10
<PAGE>   87
                                  HI/FN, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
   
     (TABLE AMOUNTS IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS.)
    
   
    
 
     The principal components of deferred income tax assets are as follows:
 
   
<TABLE>
<CAPTION>
                                                              SEPTEMBER 30,
                                                              --------------
                                                              1997     1998
                                                              -----    -----
<S>                                                           <C>      <C>
Revenue recognition.........................................  $260     $339
Inventory valuation accounts................................    82      166
Depreciation and amortization...............................    95      148
Accrued severance...........................................    --      122
Bad debts allowance.........................................    20       84
Other.......................................................    23       90
                                                              ----     ----
                                                              $480     $949
                                                              ====     ====
</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,
                                                   --------------------------
                                                    1996      1997      1998
                                                   ------    ------    ------
<S>                                                <C>       <C>       <C>
Amount computed at statutory Federal rate of
  34%............................................  $1,221    $1,043    $1,307
State income taxes, net of Federal benefit.......     216       184       235
Expenses not deductible for tax purposes.........       4         8        85
                                                   ------    ------    ------
                                                   $1,441    $1,235    $1,627
                                                   ======    ======    ======
</TABLE>
    
 
   
NOTE 6 -- 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 September 30, 1998, no such dividends have been declared.
    
 
   
NOTE 7 -- 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 1,949,900 shares of Hi/fn common stock have been reserved for
issuance pursuant to nonqualified and incentive stock options and restricted
stock awards. 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 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.
    
 
                                      F-11
<PAGE>   88
                                  HI/FN, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
   
     (TABLE AMOUNTS IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS.)
    
   
    
 
     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...................................    388,000        $2.29
  Options exercised.................................   (202,315)       $1.05
  Options canceled..................................   (187,361)       $0.60
                                                      ---------
Balance at September 30, 1998.......................    875,187        $1.46
                                                      =========
</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 SEPTEMBER 30, 1998
Price Range
$0.60.....................................    398,187        8.38          $0.60
$1.20-$2.00...............................    235,500        8.98          $1.88
$2.25-$3.00...............................    241,500        9.51          $2.47
                                            ---------
                                              875,187        8.85          $1.46
                                            =========
</TABLE>
    
 
                                      F-12
<PAGE>   89
                                  HI/FN, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
   
     (TABLE AMOUNTS IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS.)
    
   
    
 
     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 SEPTEMBER 30, 1998
Price Range
$0.60-$2.00...........................................  129,833      $0.89
                                                        =======
</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
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       YEAR ENDED
                                                     SEPTEMBER 30,   SEPTEMBER 30,
                                                         1997             1998
                                                     -------------   --------------
<S>                                                  <C>             <C>
Net income:
As reported........................................     $1,833           $2,218
                                                        ======           ======
Pro forma..........................................     $1,683           $1,981
                                                        ======           ======
Net income per share, basic:
As reported........................................     $  .30           $  .35
                                                        ======           ======
Pro forma..........................................     $  .28           $  .32
                                                        ======           ======
Net income per share, diluted:
As reported........................................     $ 0.30           $  .33
                                                        ======           ======
Pro forma..........................................     $ 0.27           $  .30
                                                        ======           ======
</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; and for the year ended September 30, 1998:
dividend yield of 0.0%, risk free interest rate of 5,48%, expected volatility of
64%, and expected life of .58 years.
    
 
                                      F-13
<PAGE>   90
                                  HI/FN, INC.
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
     (TABLE AMOUNTS IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS.)
 
   
NOTE 8 -- 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>
  1999..............................  $1,026
  2000..............................     844
  2001..............................     799
  2002..............................     838
Thereafter..........................   2,588
                                      ------
                                      $6,095
                                      ======
</TABLE>
    
 
   
     Rent expense under operating leases was approximately $50,000, $113,000,
and $467,000 in fiscal 1996, 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 9 -- SIGNIFICANT CUSTOMERS:
    
 
   
     A significant portion of the Company's revenues has been derived from sales
to major OEM's. 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 61% of fiscal 1998 revenues.
    
 
   
NOTE 10 -- RELATED PARTY TRANSACTIONS:
    
 
   
     On September 30, 1998 Stac loaned the Company $5,000,000. The note matures
on September 30, 1999 and carries an interest rate of an index rate plus 0.5%.
The loan is secured by a first priority security interest in all of the
Company's assets, including the Company's intellectual property. The index rate
is defined as the prime rate for Silicon Valley Bank, and was 8.5% on September
30, 1998.
    
 
   
NOTE 11 -- CONTINGENCIES:
    
 
   
     Various claims arising in the course of business, seeking monetary damages
and other relief, are pending. The amount of the liability, if any, from such
claims cannot be determined with certainty. However, in the opinion of
management, the ultimate liability for such claims will not have a material
adverse effect on the Company's financial position, results of operations or
cash flows.
    
 
                                      F-14
<PAGE>   91
 
                                  HI/FN, INC.
 
                                  SCHEDULE II
 
                 VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
   
                  FOR THE THREE YEARS ENDED SEPTEMBER 30, 1998
    
                                 (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, 1996(a)......     193            --           (34)           --             159
  Year ended September 30, 1997.........     159          (109)           --            --              50
  Year ended September 30, 1998.........      50           150            --            --             200
 
DEDUCTED FROM INVENTORY
Reserve for inventory obsolescence:
  Year ended September 30, 1996(a)......     123            --           265            --             388
  Year ended September 30, 1997.........     388          (183)           --            --             205
  Year ended September 30, 1998.........     205           190            --            --             395
</TABLE>
    
 
- ---------------
(a) Activity represents changes in period end allocations of consolidated
balances.
 
                                      F-15
<PAGE>   92
 
                                    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.
 
                                       G-1
<PAGE>   93
 
     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.
 
     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.
 
     Mask set -- The tooling required in the fabrication process for
semiconductor products. Such tooling typically takes the form of one "mask" for
each layer of the manufacturing process, where each layer defines where specific
materials are used in each layer of the product.
 
     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.
 
                                       G-2
<PAGE>   94
 
     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.
 
     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>   95
 
                                                                         ANNEX I

                           THIRD AMENDED AND RESTATED
                          CERTIFICATE OF INCORPORATION
                                       OF
                                  HI/FN, INC.
                             A DELAWARE CORPORATION
 
     hi/fn, inc., a corporation organized and existing under the General
Corporation Law of the State of Delaware
 
     DOES HEREBY CERTIFY:
 
     FIRST: This corporation's original Certificate of Incorporation was filed
with the Secretary of State of the State of Delaware on August 14, 1996; this
corporation's Amended and Restated Certificate of Incorporation was filed with
the Secretary of State of the State of Delaware on August 29, 1996; this
corporation's Second Amended and Restated Certificate of Incorporation was filed
with the Secretary of State of the State of Delaware on November 12, 1996.
 
     SECOND: The Third Amended and Restated Certificate of Incorporation of
hi/fn, inc., in the form set forth below, has been duly adopted in accordance
with the provisions of Sections 228, 242, and 245 of the Delaware General
Corporation Law by the directors and the stockholders of the corporation.
 
     THIRD: The text of this corporation's Certificate of Incorporation, as
amended, is hereby amended and restated in its entirety as follows:
 
                                   ARTICLE I
 
     The name of this corporation is hi/fn, inc.
 
                                   ARTICLE II
 
     The address of the registered office of this corporation in the State of
Delaware is 1209 Orange Street, Wilmington, County of New Castle, Delaware
19801. The name of its registered agent at such address is The Corporation Trust
Company.
 
                                  ARTICLE III
 
     The nature of the business or purposes to be conducted or promoted is to
engage in any lawful act or activity for which corporations may be organized
under the Delaware General Corporation Law.
 
                                   ARTICLE IV
 
     A. This corporation is authorized to issue two classes of stock to be
designated, respectively, "Common Stock" and "Preferred Stock." The total number
of shares which the corporation is authorized to issue is one hundred ten
million (110,000,000) shares. One hundred million (100,000,000) shares shall be
Common Stock, each having a par value of one-tenth of one cent ($.001). Ten
million (10,000,000) shares shall be Preferred Stock, each having a par value of
one-tenth of one cent ($.001).
 
     B. The Preferred Stock may be issued from time to time in one or more
series. The Board of Directors is hereby authorized, by filing a certificate (a
"Preferred Stock Designation") pursuant to the Delaware General Corporation Law,
to fix or alter from time to time the designation, powers, preferences and
rights of the shares of each such series and the qualifications, limitations or
restrictions of any wholly unissued series of Preferred Stock, and to establish
from time to time the number of shares constituting any such series or any of
them; and to increase or decrease the number of shares of any series subsequent
to the issuance of shares of that
 
                                       I-1
<PAGE>   96
 
series, but not below the number of shares of such series then outstanding. In
case the number of shares of any series shall be decreased in accordance with
the foregoing sentence, the shares constituting such decrease shall resume the
status that they had prior to the adoption of the resolution originally fixing
the number of shares of such series.
 
                                   ARTICLE V
 
     For the management of the business and for the conduct of the affairs of
the corporation, and in further definition, limitation and regulation of the
powers of the corporation, of its directors and of its stockholders or any class
thereof, as the case may be, it is further provided that:
 
     A.
 
          (1) The management of the business and the conduct of the affairs of
     the corporation shall be vested in its Board of Directors. The number of
     directors which shall constitute the whole Board of Directors shall be
     fixed exclusively by one or more resolutions adopted by the Board of
     Directors. The Board of Directors shall be divided into three classes
     designated as Class I, Class II, and Class III, respectively. Directors
     shall be assigned to each class in accordance with a resolution or
     resolutions adopted by the Board of Directors. At the first annual meeting
     of stockholders following the date hereof, the term of office of the Class
     I directors shall expire and Class I directors shall be elected for a full
     term of three years. At the second annual meeting of stockholders following
     the date hereof, the term of office of the Class II directors shall expire
     and Class II directors shall be elected for a full term of three years. At
     the third annual meeting of stockholders following the date hereof, the
     term of office of the Class III directors shall expire and Class III
     directors shall be elected for a full term of three years. At each
     succeeding annual meeting of stockholders, directors shall be elected for a
     full term of three years to succeed the directors of the class whose terms
     expire at such annual meeting.
 
          (2) Notwithstanding the foregoing provisions of this Article, each
     director shall serve until his successor is duly elected and qualified or
     until his death, resignation or removal.
 
          (3) Subject to the rights of the holders of any series of Preferred
     Stock, the Board of Directors or any individual director may be removed
     from office at any time (i) with cause by the affirmative vote of the
     holders of a majority of the voting power of all the then-outstanding
     shares of voting stock of the corporation, entitled to vote at an election
     of directors (the "Voting Stock") or (ii) without cause by the affirmative
     vote of the holders of at least sixty-six and two-thirds percent (66 2/3%)
     of the voting power of all the then-outstanding shares of the Voting Stock.
 
          (4) Subject to the rights of the holders of any series of Preferred
     Stock, any vacancies on the Board of Directors resulting from death,
     resignation, disqualification, removal or other causes and any newly
     created directorships resulting from any increase in the number of
     directors, shall, unless the Board of Directors determines by resolution
     that any such vacancies or newly created directorships shall be filled by
     the stockholders, except as otherwise provided by law, be filled only by
     the affirmative vote of a majority of the directors then in office, even
     though less than a quorum of the Board of Directors, and not by the
     stockholders. Any director elected in accordance with the preceding
     sentence shall hold office for the remainder of the full term of the
     director for which the vacancy was created or occurred and until such
     director's successor shall have been elected and qualified.
 
     B.
 
          (1) Subject to paragraph (h) of Section 43 of the Bylaws, the Bylaws
     may be altered or amended or new Bylaws adopted by the affirmative vote of
     at least sixty-six and two-thirds percent (66 2/3%) of the voting power of
     all of the then-outstanding shares of the Voting Stock. The Board of
     Directors shall also have the power to adopt, amend, or repeal Bylaws.
 
          (2) The directors of the corporation need not be elected by written
     ballot unless the Bylaws so provide.
 
                                       I-2
<PAGE>   97
 
          (3) At any time following the first distribution of Common Stock of
     the corporation pursuant to a registration statement on Form 10 declared
     effective by the Securities and Exchange Commission under the Securities
     Exchange Act of 1934, as amended, no action shall be taken by the
     stockholders of the corporation except at an annual or special meeting of
     stockholders called in accordance with the Bylaws.
 
          (4) Special meetings of the stockholders of the corporation may be
     called, for any purpose or purposes, by (i) the Chairman of the Board of
     Directors, (ii) the Chief Executive Officer, (iii) the Board of Directors
     pursuant to a resolution adopted by a majority of the total number of
     authorized directors (whether or not there exist any vacancies in
     previously authorized directorships at the time any such resolution is
     presented to the Board of Directors for adoption) or (iv) by the holders of
     the shares entitled to cast not less than ten percent (10%) of the votes at
     the meeting, and shall be held at such place, on such date, and at such
     time as the Board of Directors shall fix.
 
          (5) Advance notice of stockholder nominations for the election of
     directors and of business to be brought by stockholders before any meeting
     of the stockholders of the corporation shall be given in the manner
     provided in the Bylaws of the corporation.
 
                                   ARTICLE VI
 
     A. A director of the corporation shall not be personally liable to the
corporation or its stockholders for monetary damages for any breach of fiduciary
duty as a director, except for liability (i) for any breach of the director's
duty of loyalty to the corporation or its stockholders, (ii) for acts or
omissions not in good faith or which involve intentional misconduct or a knowing
violation of law (iii) under Section 174 of the Delaware General Corporation
Law, or (iv) for any transaction from which the director derived an improper
personal benefit. If the Delaware General Corporation Law is amended after
approval by the stockholders of this Article to authorize corporate action
further eliminating or limiting the personal liability of directors, then the
liability of a director shall be eliminated or limited to the fullest extent
permitted by the Delaware General corporation Law, as so amended.
 
     B. Any repeal or modification of this Article VI shall be prospective and
shall not affect the rights under this Article VI in effect at the time of the
alleged occurrence of any act or omission to act giving rise to liability or
indemnification.
 
                                  ARTICLE VII
 
     A. The corporation reserves the right to amend, alter, change or repeal any
provision contained in this Certificate of Incorporation, in the manner now or
hereafter prescribed by statute, except as provided in paragraph B of this
Article VII, and all rights conferred upon the stockholders herein are granted
subject to this reservation.
 
     B. Notwithstanding any other provisions of this Certificate of
Incorporation or any provision of law which might otherwise permit a lesser vote
or no vote, but in addition to any affirmative vote of the holders of any
particular class or series of the Voting Stock required by law, this Certificate
of Incorporation or any Preferred Stock Designation, the affirmative vote of the
holders of at least sixty-six and two-thirds percent (66 2/3%) of the voting
power of all of the then-outstanding shares of the Voting Stock, voting together
as a single class, shall be required to alter, amend or repeal Articles V, VI
and VII.
 
                                       I-3
<PAGE>   98
 
     IN WITNESS WHEREOF, this Third Amended and Restated Certificate of
Incorporation has been subscribed this        day of             , 1998 by the
undersigned who affirms that the statements made herein are true and correct.
 
                                          HI/FN, INC.
 
                                          By:
                                          --------------------------------------
                                          [Name & Title]
 
                                       I-4
<PAGE>   99
 
                                                                        ANNEX II
 
                                     BYLAWS
                                        
                                       OF
                                        
                                  HI/FN, INC.
                                        
                            (A DELAWARE CORPORATION)
 
                                      II-1
<PAGE>   100
 
                                     BYLAWS
                                       OF
                                  HI/FN, INC.
                            (A DELAWARE CORPORATION)
                                        
                                   ARTICLE I
                                        
                                    OFFICERS
 
     SECTION 1. Registered Office. The registered office of the corporation in
the State of Delaware shall be in the City of Wilmington, County of New Castle.
 
     SECTION 2. Other Offices. The corporation shall also have and maintain an
office or principal place of business at such place as may be fixed by the Board
of Directors, and may also have offices at such other places, both within and
without the State of Delaware as the Board of Directors may from time to time
determine or the business of the corporation may require.
 
                                   ARTICLE II
 
                                 CORPORATE SEAL
 
     SECTION 3. Corporate Seal. The corporate seal shall consist of a die
bearing the name of the corporation and the inscription, "Corporate
Seal-Delaware." Said seal may be used by causing it or a facsimile thereof to be
impressed or affixed or reproduced or otherwise.
 
                                  ARTICLE III
 
                             STOCKHOLDERS' MEETINGS
 
     SECTION 4. Place of Meetings. Meetings of the stockholders of the
corporation shall be held at such place, either within or without the State of
Delaware, as may be designated from time to time by the Board of Directors, or,
if not so designated, then at the office of the corporation required to be
maintained pursuant to Section 2 hereof.
 
     SECTION 5. Annual Meeting.
 
          (a)  The annual meeting of the stockholders of the corporation, for
     the purpose of election of directors and for such other business as may
     lawfully come before it, shall be held on such date and at such time as may
     be designated from time to time by the Board of Directors.
 
          (b)  At an annual meeting of the stockholders, only such business
     shall be conducted as shall have been properly brought before the meeting.
     To be properly brought before an annual meeting, business must be: (A)
     specified in the notice of meeting (or any supplement thereto) given by or
     at the direction of the Board of Directors, (B) otherwise properly brought
     before the meeting by or at the direction of the Board of Directors, or (C)
     otherwise properly brought before the meeting by a stockholder. For
     business to be properly brought before an annual meeting by a stockholder,
     the stockholder must have given timely notice thereof in writing to the
     Secretary of the corporation. To be timely, a stockholder's notice must be
     delivered to or mailed and received at the principal executive offices of
     the corporation not less than one hundred twenty (120) calendar days in
     advance of the date of the corporation's proxy statement released to
     stockholders in connection with the preceding year's annual meeting;
     provided, however, that in the event that no annual meeting was held in the
     previous year or the date of the annual meeting has been changed by more
     than thirty (30) days from the date contemplated at the time of the
     previous year's proxy statement, notice by the stockholder to be timely
     must be so received a reasonable time before the solicitation is made. A
     stockholder's notice to the Secretary shall set forth as to each matter the
     stockholder proposes to bring before the annual meeting: (i) a brief
     description of the business desired to be brought before the annual meeting
     and the reasons for conducting such business at the annual
 
                                      II-2
<PAGE>   101
 
     meeting, (ii) the name and address, as they appear on the corporation's
     books, of the stockholder proposing such business, (iii) the class and
     number of shares of the corporation which are beneficially owned by the
     stockholder, (iv) any material interest of the stockholder in such business
     and (v) any other information that is required to be provided by the
     stockholder pursuant to Regulation 14A under the Securities Exchange Act of
     1934, as amended (the "1934 Act"), in his capacity as a proponent to a
     stockholder proposal. Notwithstanding the foregoing, in order to include
     information with respect to a stockholder proposal in the proxy statement
     and form of proxy for a stockholder's meeting, stockholders must provide
     notice as required by the regulations promulgated under the 1934 Act.
     Notwithstanding anything in these Bylaws to the contrary, no business shall
     be conducted at any annual meeting except in accordance with the procedures
     set forth in this paragraph (b). The chairman of the annual meeting shall,
     if the facts warrant, determine and declare at the meeting that business
     was not properly brought before the meeting and in accordance with the
     provisions of this paragraph (b), and, if he should so determine, he shall
     so declare at the meeting that any such business not properly brought
     before the meeting shall not be transacted.
 
          (c)  Only persons nominated in accordance with the procedures set
     forth in this paragraph (c) shall be eligible for election as directors.
     Nominations of persons for election to the Board of Directors of the
     corporation may be made at a meeting of stockholders by or at the direction
     of the Board of Directors or by any stockholder of the corporation entitled
     to vote in the election of directors at the meeting who complies with the
     notice procedures set forth in this paragraph (c). Such nominations, other
     than those made by or at the direction of the Board of Directors, shall be
     made pursuant to timely notice in writing to the Secretary of the
     corporation in accordance with the provisions of paragraph (b) of this
     Section 5. Such stockholder's notice shall set forth (i) as to each person,
     if any, whom the stockholder proposes to nominate for election or
     re-election as a director: (A) the name, age, business address and
     residence address of such person, (B) the principal occupation or
     employment of such person, (C) the class and number of shares of the
     corporation which are beneficially owned by such person, (D) a description
     of all arrangements or understandings between the stockholder and each
     nominee and any other person or persons (naming such person or persons)
     pursuant to which the nominations are to be made by the stockholder, and
     (E) any other information relating to such person that is required to be
     disclosed in solicitations of proxies for election of directors, or is
     otherwise required, in each case pursuant to Regulation 14A under the 1934
     Act (including without limitation such person's written consent to being
     named in the proxy statement, if any, as a nominee and to serving as a
     director if elected); and (ii) as to such stockholder giving notice, the
     information required to be provided pursuant to paragraph (b) of this
     Section 5. At the request of the Board of Directors, any person nominated
     by a stockholder for election as a director shall furnish to the Secretary
     of the corporation that information required to be set forth in the
     stockholder's notice of nomination which pertains to the nominee. No person
     shall be eligible for election as a director of the corporation unless
     nominated in accordance with the procedures set forth in this paragraph
     (c). The chairman of the meeting shall, if the facts warrant, determine and
     declare at the meeting that a nomination was not made in accordance with
     the procedures prescribed by these Bylaws, and if he should so determine,
     he shall so declare at the meeting, and the defective nomination shall be
     disregarded.
 
     SECTION 6. Special Meetings.
 
          (a) Special meetings of the stockholders of the corporation may be
     called, for any purpose or purposes, by (i) the Chairman of the Board of
     Directors, (ii) the Chief Executive Officer, (iii) the Board of Directors
     pursuant to a resolution adopted by a majority of the total number of
     authorized directors (whether or not there exist any vacancies in
     previously authorized directorships at the time any such resolution is
     presented to the Board of Directors for adoption) or (iv) by the holders of
     shares entitled to cast not less than ten percent (10%) of the votes at the
     meeting, and shall be held at such place, on such date, and at such time as
     the Board of Directors, shall fix.
 
          (b) If a special meeting is called by any person or persons other than
     the Board of Directors, the request shall be in writing, specifying the
     general nature of the business proposed to be transacted, and shall be
     delivered personally or sent by registered mail or by telegraphic or other
     facsimile transmission to
                                      II-3
<PAGE>   102
 
     the Chairman of the Board of Directors, the Chief Executive Officer, or the
     Secretary of the corporation. No business may be transacted at such special
     meeting otherwise than specified in such notice. The Board of Directors
     shall determine the time and place of such special meeting, which shall be
     held not less than thirty-five (35) nor more than one hundred twenty (120)
     days after the date of the receipt of the request. Upon determination of
     the time and place of the meeting, the officer receiving the request shall
     cause notice to be given to the stockholders entitled to vote, in
     accordance with the provisions of Section 7 of these Bylaws. If the notice
     is not given within sixty (60) days after the receipt of the request, the
     person or persons requesting the meeting may set the time and place of the
     meeting and give the notice. Nothing contained in this paragraph (b) shall
     be construed as limiting, fixing, or affecting the time when a meeting of
     stockholders called by action of the Board of Directors may be held.
 
     SECTION 7. Notice of Meetings. Except as otherwise provided by law or the
Certificate of Incorporation, written notice of each meeting of stockholders
shall be given not less than ten (10) nor more than sixty (60) days before the
date of the meeting to each stockholder entitled to vote at such meeting, such
notice to specify the place, date and hour and purpose or purposes of the
meeting. Notice of the time, place and purpose of any meeting of stockholders
may be waived in writing, signed by the person entitled to notice thereof,
either before or after such meeting, and will be waived by any stockholder by
his attendance thereat in person or by proxy, except when the stockholder
attends a meeting for the express purpose of objecting, at the beginning of the
meeting, to the transaction of any business because the meeting is not lawfully
called or convened. Any stockholder so waiving notice of such meeting shall be
bound by the proceedings of any such meeting in all respects as if due notice
thereof had been given.
 
     SECTION 8. Quorum. At all meetings of stockholders, except where otherwise
provided by statute or by the Certificate of Incorporation, or by these Bylaws,
the presence, in person or by proxy duly authorized, of the holders of a
majority of the outstanding shares of stock entitled to vote shall constitute a
quorum for the transaction of business. In the absence of a quorum, any meeting
of stockholders may be adjourned, from time to time, either by the chairman of
the meeting or by vote of the holders of a majority of the shares represented
thereat, but no other business shall be transacted at such meeting. The
stockholders present at a duly called or convened meeting, at which a quorum is
present, may continue to transact business until adjournment, notwithstanding
the withdrawal of enough stockholders to leave less than a quorum. Except as
otherwise provided by law, the Certificate of Incorporation or these Bylaws, all
action taken by the holders of a majority of the vote cast, excluding
abstentions, at any meeting at which a quorum is present shall be valid and
binding upon the corporation; provided, however, that directors shall be elected
by a plurality of the votes of the shares present in person or represented by
proxy at the meeting and entitled to vote on the election of directors. Where a
separate vote by a class or classes or series is required, except where
otherwise provided by the statute or by the Certificate of Incorporation or
these Bylaws, a majority of the outstanding shares of such class or classes or
series, present in person or represented by proxy, shall constitute a quorum
entitled to take action with respect to that vote on that matter and, except
where otherwise provided by the statute or by the Certificate of Incorporation
or these Bylaws, the affirmative vote of the majority (plurality, in the case of
the election of directors) of the votes cast, including abstentions, by the
holders of shares of such class or classes or series shall be the act of such
class or classes or series.
 
     SECTION 9. Adjournment and Notice of Adjourned Meetings. Any meeting of
stockholders, whether annual or special, may be adjourned from time to time
either by the chairman of the meeting or by the vote of a majority of the shares
casting votes, excluding abstentions. When a meeting is adjourned to another
time or place, notice need not be given of the adjourned meeting if the time and
place thereof are announced at the meeting at which the adjournment is taken. At
the adjourned meeting, the corporation may transact any business which might
have been transacted at the original meeting. If the adjournment is for more
than thirty (30) days or if after the adjournment a new record date is fixed for
the adjourned meeting, a notice of the adjourned meeting shall be given to each
stockholder of record entitled to vote at the meeting.
 
     SECTION 10. Voting Rights. For the purpose of determining those
stockholders entitled to vote at any meeting of the stockholders, except as
otherwise provided by law, only persons in whose names shares stand on the stock
records of the corporation on the record date, as provided in Section 12 of
these Bylaws, shall be entitled to vote at any meeting of stockholders. Every
person entitled to vote shall have the right to do so either
                                      II-4
<PAGE>   103
 
in person or by an agent or agents authorized by a proxy granted in accordance
with Delaware law. An agent so appointed need not be a stockholder. No proxy
shall be voted after three (3) years from its date of creation unless the proxy
provides for a longer period.
 
     SECTION 11. Joint Owners of Stock. If shares or other securities having
voting power stand of record in the names of two (2) or more persons, whether
fiduciaries, members of a partnership, joint tenants, tenants in common, tenants
by the entirety, or otherwise, or if two (2) or more persons have the same
fiduciary relationship respecting the same shares, unless the Secretary is given
written notice to the contrary and is furnished with a copy of the instrument or
order appointing them or creating the relationship wherein it is so provided,
their acts with respect to voting shall have the following effect: (a) if only
one (1) votes, his act binds all; (b) if more than one (1) votes, the act of the
majority so voting binds all; (c) if more than one (1) votes, but the vote is
evenly split on any particular matter, each faction may vote the securities in
question proportionally, or may apply to the Delaware Court of Chancery for
relief as provided in the General Corporation Law of Delaware, Section 217(b).
If the instrument filed with the Secretary shows that any such tenancy is held
in unequal interests, a majority or even-split for the purpose of subsection (c)
shall be a majority or even-split in interest.
 
     SECTION 12. List of Stockholders. The Secretary shall prepare and make, at
least ten (10) days before every meeting of stockholders, a complete list of the
stockholders entitled to vote at said meeting, arranged in alphabetical order,
showing the address of each stockholder and the number of shares registered in
the name of each stockholder. Such list shall be open to the examination of any
stockholder, for any purpose germane to the meeting, during ordinary business
hours, for a period of at least ten (10) days prior to the meeting, either at a
place within the city where the meeting is to be held, which place shall be
specified in the notice of the meeting, or, if not specified, at the place where
the meeting is to be held. The list shall be produced and kept at the time and
place of meeting during the whole time thereof and may be inspected by any
stockholder who is present.
 
     SECTION 13. Action Without Meeting. No action shall be taken by the
stockholders except at an annual or special meeting of stockholders called in
accordance with these Bylaws, and no action shall be taken by the stockholders
by written consent.
 
     SECTION 14. Organization.
 
          (a) At every meeting of stockholders, the Chairman of the Board of
     Directors, or, if a Chairman has not been appointed or is absent, the Vice
     Chairman of the Board of Directors, or, if a Chairman has not been
     appointed or is absent and a Vice Chairman has not been appointed or is
     absent, the Chief Executive Officer, or, if a Chairman has not been
     appointed or is absent and a Vice Chairman has not been appointed or is
     absent and a Chief Executive Officer has not been appointed or is absent,
     the President, or, if all of such officers are absent, a chairman of the
     meeting chosen by a majority in interest of the stockholders entitled to
     vote, present in person or by proxy, shall preside over the meeting. The
     Secretary, or, in his absence, an Assistant Secretary directed to do so by
     the presiding officer, shall act as secretary of the meeting.
 
          (b) The Board of Directors of the corporation shall be entitled to
     make such rules or regulations for the conduct of meetings of stockholders
     as it shall deem necessary, appropriate or convenient. Subject to such
     rules and regulations of the Board of Directors, if any, the chairman of
     the meeting shall have the right and authority to prescribe such rules,
     regulations and procedures and to do all such acts as, in the judgment of
     such chairman, are necessary, appropriate or convenient for the proper
     conduct of the meeting, including, without limitation, establishing an
     agenda or order of business for the meeting, rules and procedures for
     maintaining order at the meeting and the safety of those present,
     limitations on participation in such meeting to stockholders of record of
     the corporation and their duly authorized and constituted proxies and such
     other persons as the chairman shall permit, restrictions on entry to the
     meeting after the time fixed for the commencement thereof, limitations on
     the time allotted to questions or comments by participants and regulation
     of the opening and closing of the polls for balloting on matters which are
     to be voted on by ballot. Unless and to the extent determined by the Board
     of Directors
 
                                      II-5
<PAGE>   104
 
     or the chairman of the meeting, meetings of stockholders shall not be
     required to be held in accordance with rules of parliamentary procedure.
 
                                   ARTICLE IV
 
                                   DIRECTORS
 
     SECTION 15. Number and Term of Office. The number of directors of the
corporation shall be set at five (5). This number may be changed, within the
limits specified above, by a duly adopted amendment to the Certificate of
Incorporation or by an amendment to this Bylaw duly adopted by the vote or
written consent of the holders of a majority of the stock issued and outstanding
and entitled to vote or by resolution of a majority of the Board of Directors,
except as may be otherwise specifically provided by statute or by the
Certificate of Incorporation. No reduction of the authorized number of directors
shall have the effect of removing any director before that director's term of
office expires. If for any cause, the directors shall not have been elected at
an annual meeting, they may be elected as soon thereafter as convenient at a
special meeting of the stockholders called for that purpose in the manner
provided in these Bylaws.
 
     SECTION 16. Powers. The powers of the corporation shall be exercised, its
business conducted and its property controlled by the Board of Directors, except
as may be otherwise provided by statute or by the Certificate of Incorporation.
 
     SECTION 17. Election of Directors. The Board of Directors shall be divided
into three classes designated as Class I, Class II, and Class III, respectively.
Directors shall be assigned to each class in accordance with a resolution or
resolutions adopted by the Board of Directors. At the first annual meeting of
stockholders following the date hereof, the term of office of the Class I
directors shall expire and Class I directors shall be elected for a full term of
three years. At the second annual meeting of stockholders following the date
hereof, the term of office of the Class II directors shall expire and Class II
directors shall be elected for a full term of three years. At the third annual
meeting of stockholders following the date hereof, the term of office of the
Class III directors shall expire and Class III directors shall be elected for a
full term of three years. At each succeeding annual meeting of stockholders,
directors shall be elected for a full term of three years to succeed the
directors of the class whose terms expire at such annual meeting.
Notwithstanding the foregoing provisions of this Section 17, each director shall
serve until his successor is duly elected and qualified or until his death,
resignation or removal. No decrease in the number of directors constituting the
Board of Directors shall shorten the term of any incumbent director.
 
     SECTION 18. Vacancies. Unless otherwise provided in the Certificate of
Incorporation, any vacancies on the Board of Directors resulting from death,
resignation, disqualification, removal or other causes and any newly created
directorships resulting from any increase in the number of directors, shall
unless the Board of Directors determines by resolution that any such vacancies
or newly created directorships shall be filled by stockholders, be filled only
by the affirmative vote of a majority of the directors then in office, even
though less than a quorum of the Board of Directors. Any director elected in
accordance with the preceding sentence shall hold office for the remainder of
the full term of the director for which the vacancy was created or occurred and
until such director's successor shall have been elected and qualified. A vacancy
in the Board of Directors shall be deemed to exist under this Bylaw in the case
of the death, removal or resignation of any director.
 
     SECTION 19. Resignation. Any director may resign at any time by delivering
his written resignation to the Secretary, such resignation to specify whether it
will be effective at a particular time, upon receipt by the Secretary or at the
pleasure of the Board of Directors. If no such specification is made, it shall
be deemed effective at the pleasure of the Board of Directors. When one or more
directors shall resign from the Board of Directors, effective at a future date,
a majority of the directors then in office, including those who have so
resigned, shall have power to fill such vacancy or vacancies, the vote thereon
to take effect when such resignation or resignations shall become effective, and
each Director so chosen shall hold office for the unexpired portion of the term
of the Director whose place shall be vacated and until his successor shall have
been duly elected and qualified.
 
                                      II-6
<PAGE>   105
 
     SECTION 20. Removal. Subject to the rights of the holders of any series of
Preferred Stock, the Board of Directors or any individual director may be
removed from office at any time (i) with cause by the affirmative vote of the
holders of a majority of the voting power of all the then-outstanding shares of
voting stock of the corporation, entitled to vote at an election of directors
(the "Voting Stock") or (ii) without cause by the affirmative vote of the
holders of at least sixty-six and two-thirds percent (66 2/3%) of the voting
power of all the then-outstanding shares of the Voting Stock.
 
     SECTION 21. Meetings.
 
          (a) Annual Meetings. The annual meeting of the Board of Directors
     shall be held immediately before or after the annual meeting of
     stockholders and at the place where such meeting is held. No notice of an
     annual meeting of the Board of Directors shall be necessary and such
     meeting shall be held for the purpose of electing officers and transacting
     such other business as may lawfully come before it.
 
          (b) Regular Meetings. Except as hereinafter otherwise provided,
     regular meetings of the Board of Directors shall be held in the office of
     the corporation required to be maintained pursuant to Section 2 hereof.
     Unless otherwise restricted by the Certificate of Incorporation, regular
     meetings of the Board of Directors may also be held at any place within or
     without the State of Delaware which has been designated by resolution of
     the Board of Directors or the written consent of all directors.
 
          (c) Special Meetings. Unless otherwise restricted by the Certificate
     of Incorporation, special meetings of the Board of Directors may be held at
     any time and place within or without the State of Delaware whenever called
     by the Chairman of the Board, the President or any two of the directors
 
          (d) Telephone Meetings. Any member of the Board of Directors, or of
     any committee thereof, may participate in a meeting by means of conference
     telephone or similar communications equipment by means of which all persons
     participating in the meeting can hear each other, and participation in a
     meeting by such means shall constitute presence in person at such meeting.
 
          (e) Notice of Meetings. Notice of the time and place of all special
     meetings of the Board of Directors shall be orally or in writing, by
     telephone, facsimile, telegraph or telex, during normal business hours, at
     least twenty-four (24) hours before the date and time of the meeting, or
     sent in writing to each director by first class mail, charges prepaid, at
     least three (3) days before the date of the meeting. Notice of any meeting
     may be waived in writing at any time before or after the meeting and will
     be waived by any director by attendance thereat, except when the director
     attends the meeting for the express purpose of objecting, at the beginning
     of the meeting, to the transaction of any business because the meeting is
     not lawfully called or convened.
 
          (f) Waiver of Notice. The transaction of all business at any meeting
     of the Board of Directors, or any committee thereof, however called or
     noticed, or wherever held, shall be as valid as though had at a meeting
     duly held after regular call and notice, if a quorum be present and if,
     either before or after the meeting, each of the directors not present shall
     sign a written waiver of notice. All such waivers shall be filed with the
     corporate records or made a part of the minutes of the meeting.
 
     SECTION 22. Quorum and Voting.
 
          (a) Unless the Certificate of Incorporation requires a greater number
     and except with respect to indemnification questions arising under Section
     43 hereof, for which a quorum shall be one-third of the exact number of
     directors fixed from time to time in accordance with the Certificate of
     Incorporation, a quorum of the Board of Directors shall consist of a
     majority of the exact number of directors fixed from time to time by the
     Board of Directors in accordance with the Certificate of Incorporation;
     provided, however, at any meeting whether a quorum be present or otherwise,
     a majority of the directors present may adjourn from time to time until the
     time fixed for the next regular meeting of the Board of Directors, without
     notice other than by announcement at the meeting.
 
          (b) At each meeting of the Board of Directors at which a quorum is
     present, all questions and business shall be determined by the affirmative
     vote of a majority of the directors present, unless a different vote be
     required by law, the Certificate of Incorporation or these Bylaws.
                                      II-7
<PAGE>   106
 
     SECTION 23. Action Without Meeting. Unless otherwise restricted by the
Certificate of Incorporation or these Bylaws, any action required or permitted
to be taken at any meeting of the Board of Directors or of any committee thereof
may be taken without a meeting, if all members of the Board of Directors or
committee, as the case may be, consent thereto in writing, and such writing or
writings are filed with the minutes of proceedings of the Board of Directors or
committee.
 
     SECTION 24. Fees and Compensation. Directors shall be entitled to such
compensation for their services as may be approved by the Board of Directors,
including, if so approved, by resolution of the Board of Directors, a fixed sum
and expenses of attendance, if any, for attendance at each regular or special
meeting of the Board of Directors and at any meeting of a committee of the Board
of Directors. Nothing herein contained shall be construed to preclude any
director from serving the corporation in any other capacity as an officer,
agent, employee, or otherwise and receiving compensation therefor.
 
     SECTION 25. Committees.
 
          (a) Executive Committee. The Board of Directors may by resolution
     passed by a majority of the whole Board of Directors appoint an Executive
     Committee to consist of one (1) or more members of the Board of Directors.
     The Executive Committee, to the extent permitted by law and provided in the
     resolution of the Board of Directors shall have and may exercise all the
     powers and authority of the Board of Directors in the management of the
     business and affairs of the corporation, including without limitation the
     power or authority to declare a dividend, to authorize the issuance of
     stock and to adopt a certificate of ownership and merger, and may authorize
     the seal of the corporation to be affixed to all papers which may require
     it; but no such committee shall have the power or authority in reference to
     amending the Certificate of Incorporation (except that a committee may, to
     the extent authorized in the resolution or resolutions providing for the
     issuance of shares of stock adopted by the Board of Directors fix the
     designations and any of the preferences or rights of such shares relating
     to dividends, redemption, dissolution, any distribution of assets of the
     corporation or the conversion into, or the exchange of such shares for,
     shares of any other class or classes or any other series of the same or any
     other class or classes of stock of the corporation or fix the number of
     shares of any series of stock or authorize the increase or decrease of the
     shares of any series), adopting an agreement of merger or consolidation,
     recommending to the stockholders the sale, lease or exchange of all or
     substantially all of the corporation's property and assets, recommending to
     the stockholders a dissolution of the corporation or a revocation of a
     dissolution, or amending the bylaws of the corporation.
 
          (b) Other Committees. The Board of Directors may, by resolution passed
     by a majority of the whole Board of Directors, from time to time appoint an
     audit committee, nominating committee and such other committees as may be
     permitted by law. Such other committees appointed by the Board of Directors
     shall consist of one (1) or more members of the Board of Directors and
     shall have such powers and perform such duties as may be prescribed by the
     resolution or resolutions creating such committees, but in no event shall
     such committee have the powers denied to the Executive Committee in these
     Bylaws.
 
          (c) Term. Each member of a committee of the Board of Directors shall
     serve a term on the committee coexistent with such member's term on the
     Board of Directors. The Board of Directors, subject to the provisions of
     subsections (a) or (b) of this Bylaw may at any time increase or decrease
     the number of members of a committee or terminate the existence of a
     committee. The membership of a committee member shall terminate on the date
     of his death or voluntary resignation from the committee or from the Board
     of Directors. The Board of Directors may at any time for any reason remove
     any individual committee member and the Board of Directors may fill any
     committee vacancy created by death, resignation, removal or increase in the
     number of members of the committee. The Board of Directors may designate
     one or more directors as alternate members of any committee, who may
     replace any absent or disqualified member at any meeting of the committee,
     and, in addition, in the absence or disqualification of any member of a
     committee, the member or members thereof present at any meeting and not
     disqualified from voting, whether or not he or they constitute a quorum,
     may unanimously
 
                                      II-8
<PAGE>   107
 
     appoint another member of the Board of Directors to act at the meeting in
     the place of any such absent or disqualified member.
 
          (d) Meetings. Unless the Board of Directors shall otherwise provide,
     regular meetings of the Executive Committee or any other committee
     appointed pursuant to this Section 25 shall be held at such times and
     places as are determined by the Board of Directors, or by any such
     committee, and when notice thereof has been given to each member of such
     committee, no further notice of such regular meetings need be given
     thereafter. Special meetings of any such committee may be held at any place
     which has been determined from time to time by such committee, and may be
     called by any director who is a member of such committee, upon written
     notice to the members of such committee of the time and place of such
     special meeting given in the manner provided for the giving of written
     notice to members of the Board of Directors of the time and place of
     special meetings of the Board of Directors. Notice of any special meeting
     of any committee may be waived in writing at any time before or after the
     meeting and will be waived by any director by attendance thereat, except
     when the director attends such special meeting for the express purpose of
     objecting, at the beginning of the meeting, to the transaction of any
     business because the meeting is not lawfully called or convened. A majority
     of the authorized number of members of any such committee shall constitute
     a quorum for the transaction of business, and the act of a majority of
     those present at any meeting at which a quorum is present shall be the act
     of such committee.
 
     SECTION 26. Organization. At every meeting of the directors, the Chairman
of the Board of Directors, or, if a Chairman has not been appointed or is
absent, the Vice Chairman of the Board of Directors, or, if a Chairman has not
been appointed or is absent and a Vice Chairman has not been appointed or is
absent, the Chief Executive Officer, or, if a Chairman has not been appointed or
is absent and a Vice Chairman has not been appointed or is absent and a Chief
Executive Officer has not been appointed or is absent, the President, or, if all
of such officers are absent, a chairman of the meeting chosen by a majority of
the directors present, shall preside over the meeting. The Secretary, or in his
absence, an Assistant Secretary directed to do so by the presiding officer,
shall act as secretary of the meeting.
 
                                   ARTICLE V
 
                                    OFFICERS
 
     SECTION 27. Officers Designated. The officers of the corporation shall
include, if and when designated by the Board of Directors, the Chairman of the
Board of Directors, the Chief Executive Officer, the Vice Chairman of the Board
of Directors, the President, one or more Vice Presidents, the Secretary, the
Chief Financial Officer, the Treasurer, the Controller, all of whom shall be
elected at the annual organizational meeting of the Board of Directors. The
Board of Directors may also appoint one or more Assistant Secretaries, Assistant
Treasurers, Assistant Controllers and such other officers and agents with such
powers and duties as it shall deem necessary. The Board of Directors may assign
such additional titles to one or more of the officers as it shall deem
appropriate. Any one person may hold any number of offices of the corporation at
any one time unless specifically prohibited therefrom by law. The salaries and
other compensation of the officers of the corporation shall be fixed by or in
the manner designated by the Board of Directors.
 
     SECTION 28. Tenure and Duties of Officers.
 
          (a) General. All officers shall hold office at the pleasure of the
     Board of Directors and until their successors shall have been duly elected
     and qualified, unless sooner removed. Any officer elected or appointed by
     the Board of Directors may be removed at any time by the Board of
     Directors. If the office of any officer becomes vacant for any reason, the
     vacancy may be filled by the Board of Directors.
 
          (b) Duties of Chairman of the Board of Directors. The Chairman of the
     Board of Directors, when present, shall preside at all meetings of the
     stockholders and the Board of Directors. The Chairman of the Board of
     Directors shall perform other duties commonly incident to his office and
     shall also perform such other duties and have such other powers as the
     Board of Directors shall designate from time to time. If there is no Chief
     Executive Officer or President, then the Chairman of the Board of Directors
     shall also
 
                                      II-9
<PAGE>   108
 
     serve as the Chief Executive Officer of the corporation and shall have the
     powers and duties prescribed in paragraph (c) of this Section 28.
 
          (c) Duties of Chief Executive Officer. The Chief Executive Officer
     shall preside at all meetings of the stockholders and at all meetings of
     the Board of Directors, unless the Chairman of the Board of Directors has
     been appointed and is present or, in the absence of the Chairman of the
     Board of Directors, the Vice Chairman of the Board of Directors has been
     appointed and is present. The Chief Executive Officer shall be the chief
     executive officer of the corporation and shall, subject to the control of
     the Board of Directors, have general supervision, direction and control of
     the business and officers of the corporation. The Chief Executive Officer
     shall also perform such other duties and have such other powers as the
     Board of Directors shall designate from time to time.
 
          (d) Duties of Vice Chairman of the Board of Directors. The Vice
     Chairman of the Board of Directors shall preside at all meetings of the
     stockholders and the Board of Directors, unless the Chairman of the Board
     of Directors has been appointed and is present. The Vice Chairman of the
     Board of Directors shall perform other duties commonly incident to his
     office and shall also perform such other duties and have such other powers
     as the Board of Directors shall designate from time to time.
 
          (e) Duties of President. The President shall preside at all meetings
     of the stockholders and at all meetings of the Board of Directors, unless
     the Chairman of the Board of Directors has been appointed and is present
     or, in the absence of the Chairman of the Board of Directors, the Vice
     Chairman of the Board has been appointed and is present or, in the absence
     of the Chairman and Vice Chairman of the Board of Directors, the Chief
     Executive Officer has been appointed and is present. If there is no Chief
     Executive Officer, then the President shall also serve as the Chief
     Executive Officer of the corporation and shall have the powers and duties
     prescribed in paragraph (c) of this Section 28. The President shall perform
     other duties commonly incident to his office and shall also perform such
     other duties and have such other powers as the Board of Directors shall
     designate from time to time.
 
          (f) Duties of Vice Presidents. The Vice Presidents may assume and
     perform the duties of the President in the absence or disability of the
     President or whenever the office of President is vacant. The Vice
     Presidents shall perform other duties commonly incident to their office and
     shall also perform such other duties and have such other powers as the
     Board of Directors or the President shall designate from time to time.
 
          (g) Duties of Secretary. The Secretary shall attend all meetings of
     the stockholders and of the Board of Directors and shall record all acts
     and proceedings thereof in the minute book of the corporation. The
     Secretary shall give notice in conformity with these Bylaws of all meetings
     of the stockholders and of all meetings of the Board of Directors and any
     committee thereof requiring notice. The Secretary shall perform all other
     duties given him in these Bylaws and other duties commonly incident to his
     office and shall also perform such other duties and have such other powers
     as the Board of Directors shall designate from time to time. The President
     may direct any Assistant Secretary to assume and perform the duties of the
     Secretary in the absence or disability of the Secretary, and each Assistant
     Secretary shall perform other duties commonly incident to his office and
     shall also perform such other duties and have such other powers as the
     Board of Directors or the President shall designate from time to time.
 
          (h) Duties of Chief Financial Officer. The Chief Financial Officer
     shall keep or cause to be kept the books of account of the corporation in a
     thorough and proper manner and shall render statements of the financial
     affairs of the corporation in such form and as often as required by the
     Board of Directors or the President. The Chief Financial Officer, subject
     to the order of the Board of Directors, shall have the custody of all funds
     and securities of the corporation. The Chief Financial Officer shall
     perform other duties commonly incident to his office and shall also perform
     such other duties and have such other powers as the Board of Directors or
     the President shall designate from time to time. The President may direct
     the Treasurer or any Assistant Treasurer, or the Controller or any
     Assistant Controller to assume and perform the duties of the Chief
     Financial Officer in the absence or disability of the Chief Financial
     Officer, and each Treasurer and Assistant Treasurer and each Controller and
     Assistant Controller shall
                                      II-10
<PAGE>   109
 
     perform other duties commonly incident to his office and shall also perform
     such other duties and have such other powers as the Board of Directors or
     the Chief Executive Officer shall designate from time to time.
 
     SECTION 29. Delegation of Authority. The Board of Directors may from time
to time delegate the powers or duties of any officer to any other officer or
agent, notwithstanding any provision hereof.
 
     SECTION 30. Resignations. Any officer may resign at any time by giving
written notice to the Board of Directors or to the President or to the
Secretary. Any such resignation shall be effective when received by the person
or persons to whom such notice is given, unless a later time is specified
therein, in which event the resignation shall become effective at such later
time. Unless otherwise specified in such notice, the acceptance of any such
resignation shall not be necessary to make it effective. Any resignation shall
be without prejudice to the rights, if any, of the corporation under any
contract with the resigning officer.
 
     SECTION 31. Removal. Any officer may be removed from office at any time,
either with or without cause, by the affirmative vote of a majority of the
directors in office at the time, or by the unanimous written consent of the
directors in office at the time, or by any committee or superior officers upon
whom such power of removal may have been conferred by the Board of Directors.
 
                                   ARTICLE VI
 
    EXECUTION OF CORPORATE INSTRUMENTS AND VOTING OF SECURITIES OWNED BY THE
                                  CORPORATION
 
     SECTION 32. Execution of Corporate Instruments. The Board of Directors may,
in its discretion, determine the method and designate the signatory officer or
officers, or other person or persons, to execute on behalf of the corporation
any corporate instrument or document, or to sign on behalf of the corporation
the corporate name without limitation, or to enter into contracts on behalf of
the corporation, except where otherwise provided by law or these Bylaws, and
such execution or signature shall be binding upon the corporation.
 
     Unless otherwise specifically determined by the Board of Directors or
otherwise required by law, promissory notes, deeds of trust, mortgages and other
evidences of indebtedness of the corporation, and other corporate instruments or
documents requiring the corporate seal, and certificates of shares of stock
owned by the corporation, shall be executed, signed or endorsed by the Chairman
of the Board of Directors, or the President or any Vice President, and by the
Secretary or Treasurer or any Assistant Secretary or Assistant Treasurer. All
other instruments and documents requiring the corporate signature, but not
requiring the corporate seal, may be executed as aforesaid or in such other
manner as may be directed by the Board of Directors.
 
     All checks and drafts drawn on banks or other depositories on funds to the
credit of the corporation or in special accounts of the corporation shall be
signed by such person or persons as the Board of Directors shall authorize so to
do.
 
     Unless authorized or ratified by the Board of Directors or within the
agency power of an officer, no officer, agent or employee shall have any power
or authority to bind the corporation by any contract or engagement or to pledge
its credit or to render it liable for any purpose or for any amount.
 
     SECTION 33. Voting of Securities Owned by the Corporation. All stock and
other securities of other corporations owned or held by the corporation for
itself, or for other parties in any capacity, shall be voted, and all proxies
with respect thereto shall be executed, by the person authorized so to do by
resolution of the Board of Directors, or, in the absence of such authorization,
by the Chairman of the Board of Directors, the Chief Executive Officer, the
President, or any Vice President.
 
                                      II-11
<PAGE>   110
 
                                  ARTICLE VII
 
                                SHARES OF STOCK
 
     SECTION 34. Form and Execution of Certificates. Certificates for the shares
of stock of the corporation shall be in such form as is consistent with the
Certificate of Incorporation and applicable law. Every holder of stock in the
corporation shall be entitled to have a certificate signed by or in the name of
the corporation by the Chairman of the Board of Directors, or the President or
any Vice President and by the Treasurer or Assistant Treasurer or the Secretary
or Assistant Secretary, certifying the number of shares owned by him in the
corporation. Any or all of the signatures on the certificate may be facsimiles.
In case any officer, transfer agent, or registrar who has signed or whose
facsimile signature has been placed upon a certificate shall have ceased to be
such officer, transfer agent, or registrar before such certificate is issued, it
may be issued with the same effect as if he were such officer, transfer agent,
or registrar at the date of issue. Each certificate shall state upon the face or
back thereof, in full or in summary, all of the powers, designations,
preferences, and rights, and the limitations or restrictions of the shares
authorized to be issued or shall, except as otherwise required by law, set forth
on the face or back a statement that the corporation will furnish without charge
to each stockholder who so requests the powers, designations, preferences and
relative, participating, optional, or other special rights of each class of
stock or series thereof and the qualifications, limitations or restrictions of
such preferences and/or rights. Within a reasonable time after the issuance or
transfer of uncertificated stock, the corporation shall send to the registered
owner thereof a written notice containing the information required to be set
forth or stated on certificates pursuant to this section or otherwise required
by law or with respect to this section a statement that the corporation will
furnish without charge to each stockholder who so requests the powers,
designations, preferences and relative participating, optional or other special
rights of each class of stock or series thereof and the qualifications,
limitations or restrictions of such preferences and/or rights. Except as
otherwise expressly provided by law, the rights and obligations of the holders
of certificates representing stock of the same class and series shall be
identical.
 
     SECTION 35. Lost Certificates. A new certificate or certificates shall be
issued in place of any certificate or certificates theretofore issued by the
corporation alleged to have been lost, stolen, or destroyed, upon the making of
an affidavit of that fact by the person claiming the certificate of stock to be
lost, stolen, or destroyed. The corporation may require, as a condition
precedent to the issuance of a new certificate or certificates, the owner of
such lost, stolen, or destroyed certificate or certificates, or his legal
representative, to advertise the same in such manner as it shall require or to
give the corporation a surety bond in such form and amount as it may direct as
indemnity against any claim that may be made against the corporation with
respect to the certificate alleged to have been lost, stolen, or destroyed.
 
     SECTION 36. Transfers.
 
          (a) Transfers of record of shares of stock of the corporation shall be
     made only upon its books by the holders thereof, in person or by attorney
     duly authorized, and upon the surrender of a properly endorsed certificate
     or certificates for a like number of shares.
 
          (b) The corporation shall have power to enter into and perform any
     agreement with any number of stockholders of any one or more classes of
     stock of the corporation to restrict the transfer of shares of stock of the
     corporation of any one or more classes owned by such stockholders in any
     manner not prohibited by the General Corporation Law of Delaware.
 
     SECTION 37. Fixing Record Dates.
 
          (a) In order that the corporation may determine the stockholders
     entitled to notice of or to vote at any meeting of stockholders or any
     adjournment thereof, the Board of Directors may fix, in advance, a record
     date, which record date shall not precede the date upon which the
     resolution fixing the record date is adopted by the Board of Directors, and
     which record date shall not be more than sixty (60) nor less than ten (10)
     days before the date of such meeting. If no record date is fixed by the
     Board of Directors, the record date for determining stockholders entitled
     to notice of or to vote at a meeting of stockholders shall be at the close
     of business on the day next preceding the day on which notice is given, or
     if notice is waived, at the close of business on the day next preceding the
     day on which the meeting is held. A
                                      II-12
<PAGE>   111
 
     determination of stockholders of record entitled to notice of or to vote at
     a meeting of stockholders shall apply to any adjournment of the meeting;
     provided, however, that the Board of Directors may fix a new record date
     for the adjourned meeting.
 
          (b) In order that the corporation may determine the stockholders
     entitled to receive payment of any dividend or other distribution or
     allotment of any rights or the stockholders entitled to exercise any rights
     in respect of any change, conversion or exchange of stock, or for the
     purpose of any other lawful action, the Board of Directors may fix, in
     advance, a record date, which record date shall not precede the date upon
     which the resolution fixing the record date is adopted, and which record
     date shall be not more than sixty (60) days prior to such action. If no
     record date is fixed, the record date for determining stockholders for any
     such purpose shall be at the close of business on the day on which the
     Board of Directors adopts the resolution relating thereto.
 
     SECTION 38. Registered Stockholders. The corporation shall be entitled to
recognize the exclusive right of a person registered on its books as the owner
of shares to receive dividends, and to vote as such owner, and shall not be
bound to recognize any equitable or other claim to or interest in such share or
shares on the part of any other person whether or not it shall have express or
other notice thereof, except as otherwise provided by the laws of Delaware.
 
                                  ARTICLE VIII
 
                      OTHER SECURITIES OF THE CORPORATION
 
     SECTION 39. Execution of Other Securities. All bonds, debentures and other
corporate securities of the corporation, other than stock certificates (covered
in Section 34), may be signed by the Chairman of the Board of Directors, the
President or any Vice President, or such other person as may be authorized by
the Board of Directors, and the corporate seal impressed thereon or a facsimile
of such seal imprinted thereon and attested by the signature of the Secretary or
an Assistant Secretary, or the Chief Financial Officer or Treasurer or an
Assistant Treasurer; provided, however, that where any such bond, debenture or
other corporate security shall be authenticated by the manual signature, or
where permissible facsimile signature, of a trustee under an indenture pursuant
to which such bond, debenture or other corporate security shall be issued, the
signatures of the persons signing and attesting the corporate seal on such bond,
debenture or other corporate security may be the imprinted facsimile of the
signatures of such persons. Interest coupons appertaining to any such bond,
debenture or other corporate security, authenticated by a trustee as aforesaid,
shall be signed by the Treasurer or an Assistant Treasurer of the corporation or
such other person as may be authorized by the Board of Directors, or bear
imprinted thereon the facsimile signature of such person. In case any officer
who shall have signed or attested any bond, debenture or other corporate
security, or whose facsimile signature shall appear thereon or on any such
interest coupon, shall have ceased to be such officer before the bond, debenture
or other corporate security so signed or attested shall have been delivered,
such bond, debenture or other corporate security nevertheless may be adopted by
the corporation and issued and delivered as though the person who signed the
same or whose facsimile signature shall have been used thereon had not ceased to
be such officer of the corporation.
 
                                   ARTICLE IX
 
                                   DIVIDENDS
 
     SECTION 40. Declaration of Dividends. Dividends upon the capital stock of
the corporation, subject to the provisions of the Certificate of Incorporation,
if any, may be declared by the Board of Directors pursuant to law at any regular
or special meeting. Dividends may be paid in cash, in property, or in shares of
the capital stock, subject to the provisions of the Certificate of
Incorporation.
 
     SECTION 41. Dividend Reserve. Before payment of any dividend, there may be
set aside out of any funds of the corporation available for dividends such sum
or sums as the Board of Directors from time to time, in their absolute
discretion, think proper as a reserve or reserves to meet contingencies, or for
equalizing
 
                                      II-13
<PAGE>   112
 
dividends, or for repairing or maintaining any property of the corporation, or
for such other purpose as the Board of Directors shall think conducive to the
interests of the corporation, and the Board of Directors may modify or abolish
any such reserve in the manner in which it was created.
 
                                   ARTICLE X
 
                                  FISCAL YEAR
 
     SECTION 42. Fiscal Year. The fiscal year of the corporation shall be fixed
by resolution of the Board of Directors.
 
                                   ARTICLE XI
 
                                INDEMNIFICATION
 
     SECTION 43. Indemnification Of Directors, Executive Officers, Other
Officers, Employees And Other Agents.
 
          (a) Directors and Executive Officers. The corporation shall indemnify
     its directors and executive officers (for the purposes of this Article XI,
     "executive officers" shall have the meaning defined in Rule 3b-7
     promulgated under the 1934 Act) to the fullest extent not prohibited by the
     Delaware General Corporation Law; provided, however, that the corporation
     may modify the extent of such indemnification by individual contracts with
     its directors and executive officers; and, provided, further, that the
     corporation shall not be required to indemnify any director or executive
     officer in connection with any proceeding (or part thereof) initiated by
     such person unless (i) such indemnification is expressly required to be
     made by law, (ii) the proceeding was authorized by the Board of Directors
     of the corporation, (iii) such indemnification is provided by the
     corporation, in its sole discretion, pursuant to the powers vested in the
     corporation under the Delaware General Corporation Law or (iv) such
     indemnification is required to be made under subsection (d).
 
          (b) Other Officers, Employees and Other Agents. The corporation shall
     have power to indemnify its other officers, employees and other agents as
     set forth in the Delaware General Corporation Law.
 
          (c) Expenses. The corporation shall advance to any person who was or
     is a party or is threatened to be made a party to any 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 executive officer, of the corporation, or is or was serving at
     the request of the corporation as a director or executive officer of
     another corporation, partnership, joint venture, trust or other enterprise,
     prior to the final disposition of the proceeding, promptly following
     request therefor, all expenses incurred by any director or executive
     officer in connection with such proceeding upon receipt of an undertaking
     by or on behalf of such person to repay said amounts if it should be
     determined ultimately that such person is not entitled to be indemnified
     under this Bylaw or otherwise.
 
     Notwithstanding the foregoing, unless otherwise determined pursuant to
     paragraph (e) of this Bylaw, no advance shall be made by the corporation to
     an executive officer of the corporation (except by reason of the fact that
     such executive officer is or was a director of the corporation in which
     event this paragraph shall not apply) in any action, suit or proceeding,
     whether civil, criminal, administrative or investigative, if a
     determination is reasonably and promptly made (i) by the Board of Directors
     by a majority vote of a quorum consisting of directors who were not parties
     to the proceeding, or (ii) if such quorum is not obtainable, or, even if
     obtainable, a quorum of disinterested directors so directs, by independent
     legal counsel in a written opinion, that the facts known to the
     decision-making party at the time such determination is made demonstrate
     clearly and convincingly that such person acted in bad faith or in a manner
     that such person did not believe to be in or not opposed to the best
     interests of the corporation.
 
          (d) Enforcement. Without the necessity of entering into an express
     contract, all rights to indemnification and advances to directors and
     executive officers under this Bylaw shall be deemed to be
 
                                      II-14
<PAGE>   113
 
     contractual rights and be effective to the same extent and as if provided
     for in a contract between the corporation and the director or executive
     officer. Any right to indemnification or advances granted by this Bylaw to
     a director or executive officer shall be enforceable by or on behalf of the
     person holding such right in any court of competent jurisdiction if (i) the
     claim for indemnification or advances is denied, in whole or in part, or
     (ii) no disposition of such claim is made within ninety (90) days of
     request therefor. The claimant in such enforcement action, if successful in
     whole or in part, shall be entitled to be paid also the expense of
     prosecuting his claim. In connection with any claim for indemnification,
     the corporation shall be entitled to raise as a defense to any such action
     that the claimant has not met the standards of conduct that make it
     permissible under the Delaware General Corporation Law for the corporation
     to indemnify the claimant for the amount claimed. In connection with any
     claim by an executive officer of the corporation (except in any action,
     suit or proceeding, whether civil, criminal, administrative or
     investigative, by reason of the fact that such executive officer is or was
     a director of the corporation) for advances, the corporation shall be
     entitled to raise a defense as to any such action clear and convincing
     evidence that such person acted in bad faith or in a manner that such
     person did not believe to be in or not opposed to the best interests of the
     corporation, or with respect to any criminal action or proceeding that such
     person acted without reasonable cause to believe that his conduct was
     lawful. Neither the failure of the corporation (including its Board of
     Directors, independent legal counsel or its stockholders) to have made a
     determination prior to the commencement of such action that indemnification
     of the claimant is proper in the circumstances because he has met the
     applicable standard of conduct set forth in the Delaware General
     Corporation Law, nor an actual determination by the corporation (including
     its Board of Directors, independent legal counsel or its stockholders) that
     the claimant has not met such applicable standard of conduct, shall be a
     defense to the action or create a presumption that claimant has not met the
     applicable standard of conduct.
 
          (e) Non-Exclusivity of Rights. The rights conferred on any person by
     this Bylaw shall not be exclusive of any other right which such person may
     have or hereafter acquire under any statute, provision of the Certificate
     of Incorporation, Bylaws, agreement, vote of stockholders or disinterested
     directors or otherwise, both as to action in his official capacity and as
     to action in another capacity while holding office. The corporation is
     specifically authorized to enter into individual contracts with any or all
     of its directors, officers, employees or agents respecting indemnification
     and advances, to the fullest extent not prohibited by the Delaware General
     Corporation Law.
 
          (f) Survival of Rights. The rights conferred on any person by this
     Bylaw shall continue as to a person who has ceased to be a director,
     officer, employee or other agent and shall inure to the benefit of the
     heirs, executors and administrators of such a person.
 
          (g) Insurance. To the fullest extent permitted by the Delaware General
     Corporation Law, the corporation, upon approval by the Board of Directors,
     may purchase insurance on behalf of any person required or permitted to be
     indemnified pursuant to this Bylaw.
 
          (h) Amendments. Any repeal or modification of this Bylaw shall only be
     prospective and shall not affect the rights under this Bylaw in effect at
     the time of the alleged occurrence of any action or omission to act that is
     the cause of any proceeding against any agent of the corporation.
 
          (i) Saving Clause. If this Bylaw or any portion hereof shall be
     invalidated on any ground by any court of competent jurisdiction, then the
     corporation shall nevertheless indemnify each director and executive
     officer to the full extent not prohibited by any applicable portion of this
     Bylaw that shall not have been invalidated, or by any other applicable law.
 
          (j) Certain Definitions. For the purposes of this Bylaw, the following
     definitions shall apply:
 
             (i) The term "proceeding" shall be broadly construed and shall
        include, without limitation, the investigation, preparation,
        prosecution, defense, settlement, arbitration and appeal of, and the
        giving of testimony in, any threatened, pending or completed action,
        suit or proceeding, whether civil, criminal, administrative or
        investigative.
 
                                      II-15
<PAGE>   114
 
             (ii) The term "expenses" shall be broadly construed and shall
        include, without limitation, court costs, attorneys' fees, witness fees,
        fines, amounts paid in settlement or judgment and any other costs and
        expenses of any nature or kind incurred in connection with any
        proceeding.
 
             (iii) The term the "corporation" shall include, in addition to the
        resulting corporation, any constituent corporation (including any
        constituent of a constituent) absorbed in a consolidation or merger
        which, if its separate existence had continued, would have had power and
        authority to indemnify its directors, officers, and employees or agents,
        so that any person who is or was a director, officer, employee or agent
        of such constituent corporation, or is or was serving at the request of
        such constituent corporation as a director, officer, employee or agent
        of another corporation, partnership, joint venture, trust or other
        enterprise, shall stand in the same position under the provisions of
        this Bylaw with respect to the resulting or surviving corporation as he
        would have with respect to such constituent corporation if its separate
        existence had continued.
 
             (iv) References to a "director," "executive officer," "officer,"
        "employee," or "agent" of the corporation shall include, without
        limitation, situations where such person is serving at the request of
        the corporation as, respectively, a director, executive officer,
        officer, employee, trustee or agent of another corporation, partnership,
        joint venture, trust or other enterprise.
 
             (v) References to "other enterprises" shall include employee
        benefit plans; references to "fines" shall include any excise taxes
        assessed on a person with respect to an employee benefit plan; and
        references to "serving at the request of the corporation" shall include
        any service as a director, officer, employee or agent of the corporation
        which imposes duties on, or involves services by, such director,
        officer, employee, or agent with respect to an employee benefit plan,
        its participants, or beneficiaries; and a person who acted in good faith
        and in a manner he reasonably believed to be in the interest of the
        participants and beneficiaries of an employee benefit plan shall be
        deemed to have acted in a manner "not opposed to the best interests of
        the corporation" as referred to in this Bylaw.
 
                                  ARTICLE XII
 
                                    NOTICES
 
     SECTION 44. Notices.
 
          (a) Notice to Stockholders. Whenever, under any provisions of these
     Bylaws, notice is required to be given to any stockholder, it shall be
     given in writing, timely and duly deposited in the United States mail,
     postage prepaid, and addressed to his last known post office address as
     shown by the stock record of the corporation or its transfer agent.
 
          (b) Notice to Directors. Any notice required to be given to any
     director may be given by the method stated in subsection (a), or by
     facsimile, telex or telegram, except that such notice other than one which
     is delivered personally shall be sent to such address as such director
     shall have filed in writing with the Secretary, or, in the absence of such
     filing, to the last known post office address of such director.
 
          (c) Affidavit of Mailing. An affidavit of mailing, executed by a duly
     authorized and competent employee of the corporation or its transfer agent
     appointed with respect to the class of stock affected, specifying the name
     and address or the names and addresses of the stockholder or stockholders,
     or director or directors, to whom any such notice or notices was or were
     given, and the time and method of giving the same, shall in the absence of
     fraud, be prima facie evidence of the facts therein contained.
 
          (d) Time Notices Deemed Given. All notices given by mail, as above
     provided, shall be deemed to have been given as at the time of mailing, and
     all notices given by facsimile, telex or telegram shall be deemed to have
     been given as of the sending time recorded at time of transmission.
 
          (e) Methods of Notice. It shall not be necessary that the same method
     of giving notice be employed in respect of all directors, but one
     permissible method may be employed in respect of any one or more, and any
     other permissible method or methods may be employed in respect of any other
     or others.
 
                                      II-16
<PAGE>   115
 
          (f) Failure to Receive Notice. The period or limitation of time within
     which any stockholder may exercise any option or right, or enjoy any
     privilege or benefit, or be required to act, or within which any director
     may exercise any power or right, or enjoy any privilege, pursuant to any
     notice sent him in the manner above provided, shall not be affected or
     extended in any manner by the failure of such stockholder or such director
     to receive such notice.
 
          (g) Notice to Person With Whom Communication is Unlawful. Whenever
     notice is required to be given, under any provision of law or of the
     Certificate of Incorporation or Bylaws of the corporation, to any person
     with whom communication is unlawful, the giving of such notice to such
     person shall not be required and there shall be no duty to apply to any
     governmental authority or agency for a license or permit to give such
     notice to such person. Any action or meeting which shall be taken or held
     without notice to any such person with whom communication is unlawful shall
     have the same force and effect as if such notice had been duly given. In
     the event that the action taken by the corporation is such as to require
     the filing of a certificate under any provision of the Delaware General
     Corporation Law, the certificate shall state, if such is the fact and if
     notice is required, that notice was given to all persons entitled to
     receive notice except such persons with whom communication is unlawful.
 
          (h) Notice to Person with Undeliverable Address. Whenever notice is
     required to be given, under any provision of law or the Certificate of
     Incorporation or Bylaws of the corporation, to any stockholder to whom (i)
     notice of two consecutive annual meetings, and all notices of meetings or
     of the taking of action by written consent without a meeting to such person
     during the period between such two consecutive annual meetings, or (ii)
     all, and at least two, payments (if sent by first class mail) of dividends
     or interest on securities during a twelve-month period, have been mailed
     addressed to such person at his address as shown on the records of the
     corporation and have been returned undeliverable, the giving of such notice
     to such person shall not be required. Any action or meeting which shall be
     taken or held without notice to such person shall have the same force and
     effect as if such notice had been duly given. If any such person shall
     deliver to the corporation a written notice setting forth his then current
     address, the requirement that notice be given to such person shall be
     reinstated. In the event that the action taken by the corporation is such
     as to require the filing of a certificate under any provision of the
     Delaware General Corporation Law, the certificate need not state that
     notice was not given to persons to whom notice was not required to be given
     pursuant to this paragraph.
 
                                  ARTICLE XIII
 
                                   AMENDMENTS
 
     SECTION 45. Amendments. Subject to paragraph (h) of Section 43 of these
Bylaws, the Bylaws may be amended or repealed and new Bylaws adopted by (a) the
affirmative vote of at least sixty-six and two-thirds percent (66 2/3%) of the
voting power of all of the then-outstanding shares of the Voting Stock or (b)
the Board of Directors.
 
                                  ARTICLE XIV
 
                               LOANS TO OFFICERS
 
     SECTION 46. Loans to Officers. The corporation may lend money to, or
guarantee any obligation of, or otherwise assist any officer or other employee
of the corporation or of its subsidiaries, including any officer or employee who
is a Director of the corporation or its subsidiaries, whenever, in the judgment
of the Board of Directors, such loan, guarantee or assistance may reasonably be
expected to benefit the corporation. The loan, guarantee or other assistance may
be with or without interest and may be unsecured, or secured in such manner as
the Board of Directors shall approve, including, without limitation, a pledge of
shares of stock of the corporation. Nothing in these Bylaws shall be deemed to
deny, limit or restrict the powers of guaranty or warranty of the corporation at
common law or under any statute.
 
                                      II-17
<PAGE>   116
 
                                   ARTICLE XV
 
                                 MISCELLANEOUS
 
     SECTION 47. Annual Report.
 
          (a) Subject to the provisions of paragraph (b) of this Bylaw, the
     Board of Directors shall cause an annual report to be sent to each
     stockholder of the corporation not later than one hundred twenty (120) days
     after the close of the corporation's fiscal year. Such report shall include
     a balance sheet as of the end of such fiscal year and an income statement
     and statement of changes in financial position for such fiscal year,
     accompanied by any report thereon of independent accounts or, if there is
     no such report, the certificate of an authorized officer of the corporation
     that such statements were prepared without audit from the books and records
     of the corporation. When there are more than 100 stockholders of record of
     the corporation's shares, as determined by the General Corporation Law of
     Delaware, additional information as required by the 1934 Act shall also be
     contained in such report. Such report shall be sent to stockholders at
     least fifteen (15) days prior to the next annual meeting of stockholders
     after the end of the fiscal year to which it relates.
 
          (b) If and so long as there are fewer than 100 holders of record of
     the corporation's shares, the requirement of sending of an annual report to
     the stockholders of the corporation is hereby expressly waived.
 
                                      II-18
<PAGE>   117
 
                                                                       ANNEX III
 
                                  HI/FN, INC.
 
                           1996 EQUITY INCENTIVE PLAN
                           ADOPTED NOVEMBER 21, 1996
 
            (AS AMENDED AND RESTATED EFFECTIVE NOVEMBER [19], 1998)
 
     1. Purposes
 
          (a) The purpose of the Plan is to provide a means by which selected
     Employees and Directors of and Consultants to the Company, and its
     Affiliates, may be given an opportunity to benefit from increases in value
     of the stock of the Company through the granting of (i) Incentive Stock
     Options, (ii) Nonstatutory Stock Options, (iii) stock bonuses, (iv) rights
     to purchase restricted stock, and (v) stock appreciation rights, all as
     defined below.
 
          (b) The Company, by means of the Plan, seeks to retain the services of
     persons who are now Employees or Directors of or Consultants to the Company
     or its Affiliates, to secure and retain the services of new Employees,
     Directors and Consultants, and to provide incentives for such persons to
     exert maximum efforts for the success of the Company and its Affiliates.
 
          (c) The Company intends that the Stock Awards issued under the Plan
     shall, in the discretion of the Board or any Committee to which
     responsibility for administration of the Plan has been delegated pursuant
     to subsection 3(c), be either (i) Options granted pursuant to Section 6
     hereof, including Incentive Stock Options and Nonstatutory Stock Options,
     (ii) stock bonuses or rights to purchase restricted stock granted pursuant
     to Section 7 hereof, or (iii) stock appreciation rights granted pursuant to
     Section 8 hereof. All Options shall be separately designated Incentive
     Stock Options or Nonstatutory Stock Options at the time of grant, and in
     such form as issued pursuant to Section 6, and a separate certificate or
     certificates will be issued for shares purchased on exercise of each type
     of Option.
 
     2. Definitions
 
          (a) "Administrator" means the Board or any of its Committees as shall
     be administering the Plan, in accordance with Section 3 of the Plan.
 
          (b) "Affiliate" means any parent corporation or subsidiary
     corporation, whether now or hereafter existing, as those terms are defined
     in Sections 424(e) and (f) respectively, of the Code.
 
          (c) "Applicable Laws" means the requirements relating to the
     administration of stock plans under U.S. state corporate laws, U.S. federal
     and state securities laws, the Code, any stock exchange or quotation system
     on which the Common Stock is listed or quoted and the applicable laws of
     any foreign country or jurisdiction where Stock Awards are, or will be,
     granted under the Plan.
 
          (d) "Board" means the Board of Directors of the Company.
 
          (e) "Code" means the Internal Revenue Code of 1986, as amended.
 
          (f) "Committee" means a committee appointed by the Board in accordance
     with Section 3 of the Plan.
 
          (g) "Common Stock" means the common stock of the Company.
 
          (h) "Company" means hi/fn, inc., a Delaware corporation.
 
          (i) "Concurrent Stock Appreciation Right" or "Concurrent Right" means
     a right granted pursuant to subsection 9(c)(ii) of the Plan.
 
          (j) "Consultant" means any person, including an advisor, engaged by
     the Company or an Affiliate to render consulting services; provided,
     however that a Consultant shall not include a Director.
 
                                      III-1
<PAGE>   118
 
          (k) "Continuous Status as an Employee, Director or Consultant" means
     that the service of an individual to the Company, whether as an Employee,
     Director or Consultant, is not interrupted or terminated.
 
          (l) "Director" means a member of the Board.
 
          (m) "Disability" means total and permanent disability as defined in
     Section 22(e)(3) of the Code.
 
          (n) "Employee" means any person, including Officers and Directors,
     employed by the Company or any Affiliate of the Company. An individual's
     continuous status as an Employee shall not be deemed to be interrupted or
     terminated in the case of (i) any leave of absence approved by the Company
     or (ii) transfers between locations of the Company or between the Company
     and its Affiliates, or any successor. For purposes of Incentive Stock
     Options, no such leave may exceed ninety days, unless reemployment upon
     expiration of such leave is guaranteed by statute or contract. If
     reemployment upon expiration of a leave of absence approved by the Company
     is not so guaranteed, on the 181st day of such leave any Incentive Stock
     Option held by the Optionee shall cease to be treated as an Incentive Stock
     Option and shall be treated for tax purposes as a Nonstatutory Stock
     Option. Neither service as a Director nor payment of a director's fee by
     the Company shall be sufficient to constitute "employment" by the Company.
 
          (o) "Exchange Act" means the Securities Exchange Act of 1934, as
     amended.
 
          (p) "Fair Market Value" means, as of any date, the value of Common
     Stock determined as follows:
 
             (i) If the Common Stock is listed on any established stock exchange
        or a national market system, including without limitation the Nasdaq
        National Market or The Nasdaq SmallCap Market of The Nasdaq Stock
        Market, its Fair Market Value shall be the closing sales price for such
        stock (or the closing bid, if no sales were reported) as quoted on such
        exchange or system for the last market trading day prior to the time of
        determination, as reported in The Wall Street Journal or such other
        source as the Administrator deems reliable;
 
             (ii) If the Common Stock is regularly quoted by a recognized
        securities dealer but selling prices are not reported, the Fair Market
        Value of a share of Common Stock shall be the mean between the high bid
        and low asked prices for the Common Stock on the last market trading day
        prior to the day of determination, as reported in The Wall Street
        Journal or such other source as the Administrator deems reliable; or
 
             (iii) In the absence of an established market for the Common Stock,
        the Fair Market Value shall be determined in good faith by the
        Administrator.
 
          (q) "Incentive Stock Option" means an Option intended to qualify as an
     incentive stock option within the meaning of Section 422 of the Code and
     the regulations promulgated thereunder.
 
          (r) "Independent Stock Appreciation Right" or "Independent Right"
     means a right granted pursuant to subsection 9(c)(iii) of the Plan.
 
          (s) "Inside Director" means a Director who is an Employee.
 
          (t) "Nonstatutory Stock Option" means an Option not intended to
     qualify as an Incentive Stock Option.
 
          (u) "Officer" means a person who is an officer of the Company within
     the meaning of Section 16 of the Exchange Act and the rules and regulations
     promulgated thereunder.
 
          (v) "Option" means a stock option granted pursuant to the Plan.
 
          (w) "Option Agreement" means a written agreement between the Company
     and an Optionee evidencing the terms and conditions of an individual Option
     grant. Each Option Agreement shall be subject to the terms and conditions
     of the Plan.
 
          (x) "Optionee" means a person who holds an outstanding Option.
                                      III-2
<PAGE>   119
 
          (y) "Option Exchange Program" means a program whereby outstanding
     Options are surrendered in exchange for Options with a lower exercise
     price.
 
          (z) "Outside Director" means a Director who is not an Employee.
 
          (aa) "Plan" means this hi/fn, inc. 1996 Equity Incentive Plan.
 
          (bb) "Rule 16b-3" means Rule 16b-3 of the Exchange Act or any
     successor to Rule 16b-3, as in effect when discretion is being exercised
     with respect to the Plan.
 
          (cc) "Stock Appreciation Right" means any of the various types of
     rights which may be granted under Section 9 of the Plan.
 
          (dd) "Stock Award" means any right granted under the Plan, including
     any Option, any stock bonus, any right to purchase restricted stock, and
     any Stock Appreciation Right.
 
          (ee) "Stock Award Agreement" means a written agreement between the
     Company and a holder of a Stock Award evidencing the terms and conditions
     of an individual Stock Award grant. Each Stock Award Agreement shall be
     subject to the terms and conditions of the Plan.
 
          (ff) "Tandem Stock Appreciation Right" or "Tandem Right" means a right
     granted pursuant to subsection 9(c)(i) of the Plan.
 
     3. Administration
 
          (a) Procedure.
 
             (i) Multiple Administrative Bodies. The Plan may be administered by
        different Committees with respect to different groups of Employees,
        Directors or Consultants.
 
             (ii) Section 162(m). To the extent that the Administrator
        determines it to be desirable to qualify transactions hereunder as
        "performance-based compensation" within the meaning of Section 162(m) of
        the Code, the transactions contemplated hereunder shall be administered
        by a Committee of two or more "outside directors" within the meaning of
        Section 162(m) of the Code.
 
             (iii) Rule 16b-3. Except as provided in Section 8, to the extent
        that the Administrator determines it to be desirable to qualify
        transactions hereunder as exempt under Rule 16b-3, the transactions
        contemplated hereunder shall be structured to satisfy the requirements
        for exemption under Rule 16b-3.
 
             (iv) Other Administration. Other than as provided above, the Plan
        shall be administered by (A) the Board or (B) a Committee, which
        committee shall be constituted to satisfy Applicable Laws.
 
          (b) Powers of the Administrator. Subject to the provisions of the
     Plan, and in the case of a Committee, subject to the specific duties
     delegated by the Board to such Committee, the Administrator shall have the
     authority, in its discretion:
 
             (i) to determine the Fair Market Value;
 
             (ii) to select the Employees, Directors and Consultants to whom
        Stock Awards may be granted hereunder;
 
             (iii) to determine the number of shares of Common Stock to be
        covered by each Stock Award granted hereunder;
 
             (iv) to approve forms of agreement for use under the Plan;
 
             (v) to determine the terms and conditions, not inconsistent with
        the terms of the Plan, of any Stock Award granted hereunder. Such terms
        and conditions include, but are not limited to, the exercise price, the
        time or times when Stock Awards may be exercised (which may be based on
        performance criteria), any vesting acceleration or waiver of forfeiture
        restrictions, and any restriction
 
                                      III-3
<PAGE>   120
 
        or limitation regarding any Stock Award or the shares of Common Stock
        relating thereto, based in each case on such factors as the
        Administrator, in its sole discretion, shall determine;
 
             (vi) to reduce the exercise price of any Stock Award to the then
        current Fair Market Value if the Fair Market Value of the Common Stock
        covered by such Stock Award shall have declined since the date the Stock
        Award was granted;
 
             (vii) to institute an Option Exchange Program;
 
             (viii) to construe and interpret the terms of the Plan and awards
        granted pursuant to the Plan;
 
             (ix) to prescribe, amend and rescind rules and regulations relating
        to the Plan, including rules and regulations relating to sub-plans
        established for the purpose of qualifying for preferred tax treatment
        under foreign tax laws;
 
             (x) to modify or amend each Stock Award (subject to Section 15(c)
        of the Plan);
 
             (xi) to allow holders of Stock Awards to satisfy withholding tax
        obligations by electing to have the Company withhold from the shares to
        be issued upon exercise of a Stock Award that number of shares having a
        Fair Market Value equal to the amount required to be withheld. The Fair
        Market Value of the shares to be withheld shall be determined on the
        date that the amount of tax to be withheld is to be determined. All
        elections by a holder of a Stock Award to have shares withheld for this
        purpose shall be made in such form and under such conditions as the
        Administrator may deem necessary or advisable;
 
             (xii) to authorize any person to execute on behalf of the Company
        any instrument required to effect the grant of Stock Award previously
        granted by the Administrator;
 
             (xiii) to make all other determinations deemed necessary or
        advisable for administering the Plan.
 
          (c) Effect of Administrator's Decision. The Administrator's decisions,
     determinations and interpretations shall be final and binding on all
     holders of Stock Awards.
 
     4. Shares Subject to the Plan
 
          (a) Subject to the provisions of the Plan relating to adjustments upon
     changes in stock, the stock that may be issued pursuant to all Stock Awards
     under this Plan shall not exceed in the aggregate one million four hundred
     and ninety-nine thousand nine hundred (1,949,900) shares of the Company's
     Common Stock. If any Stock Award shall for any reason expire or otherwise
     terminate, in whole or in part, without having been exercised in full, or
     is surrendered pursuant to an Option Exchange Program, the stock not
     acquired under such Stock Award shall revert to and again become available
     for issuance under the Plan. Shares subject to Stock Appreciation Rights
     exercised in accordance with Section 9 of the Plan shall not be available
     for subsequent issuance under the Plan.
 
          (b) The stock subject to the Plan may be unissued shares or reacquired
     shares, bought on the market or otherwise.
 
     5. Eligibility
 
          (a) Incentive Stock Options and Stock Appreciation Rights appurtenant
     thereto may be granted only to Employees. Stock Awards other than Incentive
     Stock Options and Stock Appreciation Rights appurtenant thereto may be
     granted only to Employees, Directors or Consultants.
 
     6. Discretionary Option Provisions
 
     Each Option shall be in such form and shall contain such terms and
conditions as the Board shall deem appropriate. The provisions of separate
Options need not be identical, but each Option shall include (through
 
                                      III-4
<PAGE>   121
 
incorporation of provisions hereof by reference in the Option or otherwise) the
substance of each of the following provisions:
 
          (a) Option Designation. Each Option shall be designated in the Option
     Agreement as either an Incentive Stock Option or a Nonstatutory Stock
     Option. However, notwithstanding such designation, to the extent that the
     aggregate Fair Market Value of the shares with respect to which Incentive
     Stock Options are exercisable for the first time by the Optionee during any
     calendar year (under all plans of the Company and any Affiliate) exceeds
     $100,000, such Options shall be treated as Nonstatutory Stock Options. For
     purposes of this Section 6(a), Incentive Stock Options shall be taken into
     account in the order in which they were granted. The Fair Market Value of
     the shares shall be determined as of the time the Option with respect to
     such shares is granted.
 
          (b) Share Limitations. The following limitations shall apply to grants
     of Options:
 
             (i) No Employee, Director or Consultant shall be granted, in any
        fiscal year of the Company, Options to purchase more than 1,000,000
        shares.
 
                (A) In connection with his or her initial service, an Employee,
           Director or Consultant may be granted Options to purchase up to an
           additional 1,000,000 shares which shall not count against the limit
           set forth in subsection (i) above.
 
                (B) The foregoing limitations shall be adjusted proportionately
           in connection with any change in the Company's capitalization as
           described in Section 14.
 
                (C) If an Option is cancelled in the same fiscal year of the
           Company in which it was granted (other than in connection with a
           transaction described in Section 14), the cancelled Option will be
           counted against the limits set forth in subsections (A) and (B)
           above. For this purpose, if the exercise price of an Option is
           reduced, the transaction will be treated as a cancellation of the
           Option and the grant of a new Option.
 
          (c) Term. The term of each Option shall be stated in the Option
     Agreement. In the case of an Incentive Stock Option, the term shall be ten
     (10) years from the date of grant or such shorter term as may be provided
     in the Option Agreement. Moreover, in the case of an Incentive Stock Option
     granted to an Optionee who, at the time the Incentive Stock Option is
     granted, owns stock representing more than ten percent (10%) of the total
     combined voting power of all classes of stock of the Company or any
     Affiliate, the term of the Incentive Stock Option shall be five (5) years
     from the date of grant or such shorter term as may be provided in the
     Option Agreement.
 
          (d) Price. The per share exercise price for the stock to be issued
     pursuant to exercise of an Option shall be determined by the Administrator,
     subject to the following:
 
             (i) In the case of an Incentive Stock Option
 
                (A) granted to an Employee who, at the time the Incentive Stock
           Option is granted, owns stock representing more than ten percent
           (10%) of the voting power of all classes of stock of the Company or
           any Affiliate, the per share exercise price shall be no less than
           110% of the Fair Market Value per share on the date of grant.
 
                (B) granted to any Employee other than an Employee described in
           paragraph (A) immediately above, the per share exercise price shall
           be no less than 100% of the Fair Market Value per share on the date
           of grant.
 
             (ii) In the case of a Nonstatutory Stock Option, the per share
        exercise price shall be determined by the Administrator. In the case of
        a Nonstatutory Stock Option intended to qualify as "performance-based
        compensation" within the meaning of Section 162(m) of the Code, the per
        share exercise price shall be no less than 100% of the Fair Market Value
        per share on the date of grant.
 
                                      III-5
<PAGE>   122
 
             (iii) Notwithstanding the foregoing, Options may be granted with a
        per share exercise price of less than 100% of the Fair Market Value per
        share on the date of grant pursuant to a merger or other corporate
        transaction.
 
          (e) Consideration. The Administrator shall determine the acceptable
     form of consideration for exercising an Option, including the method of
     payment. In the case of an Incentive Stock Option, the Administrator shall
     determine the acceptable form of consideration at the time of grant. Such
     consideration may consist entirely of:
 
             (i) cash;
 
             (ii) check;
 
             (iii) promissory note;
 
             (iv) other shares which (A) in the case of shares acquired upon
        exercise of an option, have been owned by the Optionee for more than six
        months on the date of surrender, and (B) have a Fair Market Value on the
        date of surrender equal to the aggregate exercise price of the shares as
        to which said Option shall be exercised;
 
             (v) consideration received by the Company under a cashless exercise
        program implemented by the Company in connection with the Plan;
 
             (vi) a reduction in the amount of any Company liability to the
        Optionee, including any liability attributable to the Optionee's
        participation in any Company-sponsored deferred compensation program or
        arrangement;
 
             (vii) any combination of the foregoing methods of payment; or
 
             (viii) such other consideration and method of payment for the
        issuance of shares to the extent permitted by Applicable Laws.
 
          (f) Transferability. Unless otherwise provided by the Administrator,
     an Option shall not be transferable except by will or the laws of descent
     and distribution or pursuant to a qualified domestic relations order, and
     shall be exercisable during the lifetime of the person to whom the Option
     is granted only by such person. Notwithstanding the foregoing, the person
     to whom the Option is granted may, by delivering written notice to the
     Company, in a form satisfactory to the Company, designate a third party
     who, in the event of the death of the Optionee, shall thereafter be
     entitled to exercise the Option. If the Administrator makes an Option
     transferable, such Option shall contain such additional terms and
     conditions as the Administrator deems appropriate.
 
          (g) Vesting. The total number of shares of stock subject to an Option
     may, but need not, be allotted in periodic installments (which may, but
     need not, be equal). The Option Agreement may provide that from time to
     time during each of such installment periods, the Option may become
     exercisable ("vest") with respect to some or all of the shares allotted to
     that period, and may be exercised with respect to some or all of the shares
     allotted to such period and/or any prior period as to which the Option
     became vested but was not fully exercised.
 
          (h) Termination of Employment or Relationship as a Director or
     Consultant. In the event an Optionee's Continuous Status as an Employee,
     Director or Consultant terminates (other than upon the Optionee's death or
     Disability), the Optionee may exercise his or her Option (to the extent
     that the Optionee was entitled to exercise it as of the date of
     termination) but only within such period of time ending on the earlier of
     (i) the date three (3) months after the termination of the Optionee's
     Continuous Status as an Employee, Director or Consultant (or such longer or
     shorter period specified in the Option Agreement), or (ii) the expiration
     of the term of the Option as set forth in the Option Agreement. If, after
     termination, the Optionee does not exercise his or her Option within the
     time specified in the Option Agreement, the Option shall terminate, and the
     shares covered by such Option shall revert to and again become available
     for issuance under the Plan.
 
                                      III-6
<PAGE>   123
 
          An Optionee's Option Agreement may also provide that if the exercise
     of the Option following the termination of the Optionee's Continuous Status
     as an Employee, Director, or Consultant (other than upon the Optionee's
     death or Disability) would result in liability under Section 16(b) of the
     Exchange Act, then the Option shall terminate on the earlier of (i) the
     expiration of the term of the Option set forth in the Option Agreement, or
     (ii) the tenth (10th) day after the last date on which such exercise would
     result in such liability under Section 16(b) of the Exchange Act. Finally,
     an Optionee's Option Agreement may also provide that if the exercise of the
     Option following the termination of the Optionee's Continuous Status as an
     Employee, Director or Consultant (other than upon the Optionee's death or
     Disability) would be prohibited at any time solely because the issuance of
     shares would violate the registration requirements under the Act, then the
     Option shall terminate on the earlier of (i) the expiration of the term of
     the Option set forth in the first paragraph of this subsection 6(f), or
     (ii) the expiration of a period of three (3) months after the termination
     of the Optionee's Continuous Status as an Employee, Director or Consultant
     during which the exercise of the Option would not be in violation of such
     registration requirements.
 
          (i) Disability of Optionee. In the event an Optionee's Continuous
     Status as an Employee, Director or Consultant terminates as a result of the
     Optionee's Disability, the Optionee may exercise his or her Option (to the
     extent that the Optionee was entitled to exercise it as of the date of
     termination), but only within such period of time ending on the earlier of
     (i) the date twelve (12) months following such termination (or such longer
     or shorter period specified in the Option Agreement), or (ii) the
     expiration of the term of the Option as set forth in the Option Agreement.
     If, at the date of termination, the Optionee is not entitled to exercise
     his or her entire Option, the shares covered by the unexercisable portion
     of the Option shall revert to and again become available for issuance under
     the Plan. If, after termination, the Optionee does not exercise his or her
     Option within the time specified herein, the Option shall terminate, and
     the shares covered by such Option shall revert to and again become
     available for issuance under the Plan.
 
          (j) Death of Optionee. In the event of the death of an Optionee
     during, or within a period specified in the Option Agreement after the
     termination of, the Optionee's Continuous Status as an Employee, Director
     or Consultant, the Option may be exercised (to the extent the Optionee was
     entitled to exercise the Option as of the date of death) by the Optionee's
     estate, by a person who acquired the right to exercise the Option by
     bequest or inheritance or by a person designated to exercise the Option
     upon the Optionee's death pursuant to subsection 6(g), but only within the
     period ending on the earlier of (i) the date eighteen (18) months following
     the date of death (or such longer or shorter period specified in the Option
     Agreement), or (ii) the expiration of the term of such Option as set forth
     in the Option Agreement. If, at the time of death, the Optionee was not
     entitled to exercise his or her entire Option, the shares covered by the
     unexercisable portion of the Option shall revert to and again become
     available for issuance under the Plan. If, after death, the Option is not
     exercised within the time specified herein, the Option shall terminate, and
     the shares covered by such Option shall revert to and again become
     available for issuance under the Plan.
 
          (k) Early Exercise. The Option may, but need not, include a provision
     whereby the Optionee may elect at any time while an Employee, Director or
     Consultant to exercise the Option as to any part or all of the shares
     subject to the Option prior to the full vesting of the Option. Any unvested
     shares so purchased shall be subject to a repurchase right in favor of the
     Company, with the repurchase price to be equal to the original purchase
     price of the stock, or to any other restriction the Administrator
     determines to be appropriate.
 
          (l) Re-Load Options. Without in any way limiting the authority of the
     Administrator to make or not to make grants of Options hereunder, the
     Administrator shall have the authority (but not an obligation) to include
     as part of any Option Agreement a provision entitling the Optionee to a
     further Option (a "Re-Load Option") in the event the Optionee exercises the
     Option evidenced by the Option agreement, in whole or in part, by
     surrendering other shares of Common Stock in accordance with this Plan and
     the terms and conditions of the Option Agreement. Any such Re-Load Option
     (i) shall be for a number of shares equal to the number of shares
     surrendered as part or all of the exercise price of such Option;
                                      III-7
<PAGE>   124
 
     (ii) shall have an expiration date which is the same as the expiration date
     of the Option the exercise of which gave rise to such Re-Load Option; and
     (iii) shall have an exercise price on the date of exercise of the Original
     Option which complies with Section 6(d).
 
          Any such Re-Load Option may be an Incentive Stock Option or a
     Nonstatutory Stock Option, as the Administrator may designate at the time
     of the grant of the original Option; provided, however, that the
     designation of any Re-Load Option as an Incentive Stock Option shall be
     subject to the one hundred thousand dollar ($100,000) annual limitation on
     exercisability of Incentive Stock Options described in Section 6(a) of the
     Plan and in Section 422(d) of the Code. There shall be no Re-Load Options
     on a Re-Load Option. Any such Re-Load Option shall be subject to the
     availability of sufficient shares under subsection 4(a) and shall be
     subject to such other terms and conditions as the Administrator may
     determine which are not inconsistent with the express provisions of the
     Plan regarding the terms of Options.
 
     7. Formula Option Provisions. All grants of Options to Outside Directors
pursuant to this Section shall be automatic and nondiscretionary and shall be
made strictly in accordance with the following provisions:
 
          (a) All Options granted pursuant to this Section shall be Nonstatutory
     Stock Options and, except as otherwise provided herein, shall be subject to
     the other terms and conditions of the Plan.
 
          (b) No person shall have any discretion to select which Outside
     Directors shall be granted Options under this Section or to determine the
     number of shares to be covered by such Options.
 
          (c) Each person who first becomes an Outside Director following the
     effective date of the distribution of the Company's Common Stock held by
     Stac, Inc., a Delaware corporation and parent company of the Company,
     pursuant to a registration statement on Form 10 filed with the Securities
     and Exchange Commission shall be automatically granted an Option to
     purchase 10,000 shares (the "First Option") or the date on which such
     person first becomes an Outside Director, whether through election by the
     stockholders of the Company or appointment by the Board to fill a vacancy;
     provided, however, that an Inside Director who ceases to be an Inside
     Director but who remains a Director shall not receive a First Option.
 
          (d) Each Outside Director shall be automatically granted an Option to
     purchase 2,000 shares (a "Subsequent Option") on the date of the annual
     meeting of the stockholders of the Company (beginning in 1999), if as of
     such date, he or she shall have served on the Board for at least the
     preceding six (6) months.
 
          (e) Notwithstanding the provisions of subsections (c) and (d) hereof,
     any exercise of an Option granted before the Company has obtained
     stockholder approval of the Plan in accordance with Section 16 hereof shall
     be conditioned upon obtaining such stockholder approval of the Plan in
     accordance with Section 16 hereof.
 
          (f) The terms of each Option granted pursuant to this Section shall be
     as follows:
 
             (i) the term of the Option shall be ten (10) years.
 
             (ii) the exercise price per share shall be 100% of the Fair Market
        Value per share on the date of grant of the Option.
 
             (iii) subject to Section 14 hereof, the First Option shall vest and
        become exercisable as to 20% of the shares subject to the Option on the
        first anniversary of its date of grant, and as to 1/60th of the shares
        subject to the Option each full month thereafter, provided that the
        Optionee continues to serve as a Director on such dates.
 
             (iv) subject to Section 14 hereof, the Subsequent Option shall vest
        and become exercisable as to 100% of the shares subject to the Option
        the anniversary of its date of grant, provided that the Optionee
        continues to serve as a Director on such date.
 
                                      III-8
<PAGE>   125
 
     8. Terms of Stock Bonuses and Purchases of Restricted Stock
 
     Each stock bonus or restricted stock purchase agreement shall be in such
form and shall contain such terms and conditions as the Administrator shall deem
appropriate. The terms and conditions of stock bonus or restricted stock
purchase agreements may change from time to time, and the terms and conditions
of separate agreements need not be identical, but each stock bonus or restricted
stock purchase agreement shall include (through incorporation of provisions
hereof by reference in the agreement or otherwise) the substance of each of the
following provisions as appropriate:
 
          (a) Purchase Price. The purchase price under each restricted stock
     purchase agreement shall be such amount as the Administrator shall
     determine and designate in such agreement. Notwithstanding the foregoing,
     the Administrator may determine that eligible participants in the Plan may
     be awarded stock pursuant to a stock bonus agreement in consideration for
     past services actually rendered to the Company or for its benefit.
 
          (b) Transferability. Unless otherwise provided by the Administrator,
     no rights under a stock bonus or restricted stock purchase agreement shall
     be transferable except by will or the laws of descent and distribution or
     pursuant to a qualified domestic relations order, provided, however that
     any stock awarded under such agreement remains subject to the terms of the
     applicable agreement. If the Administrator makes a stock bonus or right to
     purchase stock transferable, such stock bonus or right to purchase stock
     shall contain such additional terms and conditions as the Administrator
     deems appropriate.
 
          (c) Consideration. The purchase price of stock acquired pursuant to a
     stock purchase agreement shall be paid either: (i) in cash at the time of
     purchase; (ii) at the discretion of the Administrator, according to a
     deferred payment or other arrangement with the person to whom the stock is
     sold; or (iii) in any other form of legal consideration that may be
     acceptable to the Administrator in its discretion. Notwithstanding the
     foregoing, the Administrator to which administration of the Plan has been
     delegated may award stock pursuant to a stock bonus agreement in
     consideration for past services actually rendered to the Company or for its
     benefit.
 
          (d) Vesting. Shares of stock sold or awarded under the Plan may, but
     need not, be subject to a repurchase option in favor of the Company in
     accordance with a vesting schedule to be determined by the Administrator.
 
          (e) Termination of Employment or Relationship as a Director or
     Consultant. In the event an individual's Continuous Status as an Employee,
     Director or Consultant terminates, the Company may repurchase or otherwise
     reacquire any or all of the shares of stock held by that person which have
     not vested as of the date of termination under the terms of the stock bonus
     or restricted stock purchase agreement between the Company and such person.
 
          (f) Share Limitations. The following limitations shall apply to grants
     of stock bonuses and/or stock purchase right:
 
             (i) No Employee, Director or Consultant shall be granted, in any
        fiscal year of the Company, stock bonuses and/or stock purchase right to
        purchase more than 1,000,000 shares.
 
                (A) In connection with his or her initial service, an Employee,
           Director or Consultant may be granted a stock bonus and/or stock
           purchase right to purchase up to an additional 1,000,000 shares which
           shall not count against the limit set forth in subsection (i) above.
 
                (B) The foregoing limitations shall be adjusted proportionately
           in connection with any change in the Company's capitalization as
           described in Section 14.
 
                (C) If a stock bonus and/or stock purchase right is cancelled in
           the same fiscal year of the Company in which it was granted (other
           than in connection with a transaction described in Section 14), the
           cancelled stock bonus and/or restricted stock will be counted against
           the limits set forth in subsections (A) and (B) above. For this
           purpose, if the exercise price of a stock
 
                                      III-9
<PAGE>   126
 
           purchase right is reduced, the transaction will be treated as a
           cancellation of the stock purchase right and the grant of a new stock
           purchase right.
 
     9. Stock Appreciation Rights
 
          (a) The Administrator shall have full power and authority, exercisable
     in its sole discretion, to grant Stock Appreciation Rights under the Plan
     to Employees or Directors of or Consultants to, the Company or its
     Affiliates. To exercise any outstanding Stock Appreciation Right, the
     holder must provide written notice of exercise to the Company in compliance
     with the provisions of the Stock Award Agreement evidencing such right. If
     a Stock Appreciation Right is granted to an individual who is at the time
     subject to Section 16(b) of the Exchange Act (a "Section 16(b) Insider"),
     the Stock Award Agreement of grant shall incorporate all the terms and
     conditions at the time necessary to assure that the subsequent exercise of
     such right shall qualify for the safe-harbor exemption from short-swing
     profit liability provided by Rule 16b-3 promulgated under the Exchange Act
     (or any successor rule or regulation). No limitation shall exist on the
     aggregate amount of cash payments the Company may make under the Plan in
     connection with the exercise of a Stock Appreciation Rights.
 
          (b) Unless otherwise provided by the Administrator, no Stock
     Appreciation Right shall be transferable except by will or the laws of
     descent and distribution or pursuant to a qualified domestic relations
     order, provided, however, the cash or stock awarded under such agreement
     remains subject to the terms of the Stock Appreciation Right. If the
     Administrator makes a Stock Appreciation Right transferable, such Stock
     Appreciation Right shall contain such additional terms and conditions as
     the Administrator deems appropriate.
 
          (c) Three types of Stock Appreciation Rights shall be authorized for
     issuance under the Plan:
 
             (i) Tandem Stock Appreciation Rights. Tandem Stock Appreciation
        Rights will be granted appurtenant to an Option, and shall, except as
        specifically set forth in this Section 8, be subject to the same terms
        and conditions applicable to the particular Option grant to which it
        pertains. Tandem Stock Appreciation Rights will require the holder to
        elect between the exercise of the underlying Option for shares of stock
        and the surrender, in whole or in part, of such Option for an
        appreciation distribution. The appreciation distribution payable on the
        exercised Tandem Right shall be in cash (or, if so provided, in an
        equivalent number of shares of stock based on Fair Market Value on the
        date of the Option surrender) in an amount up to the excess of (A) the
        Fair Market Value (on the date of the Option surrender) of the number of
        shares of stock covered by that portion of the surrendered Option in
        which the Optionee is vested over (B) the aggregate exercise price
        payable for such vested shares.
 
             (ii) Concurrent Stock Appreciation Rights. Concurrent Rights will
        be granted appurtenant to an Option and may apply to all or any portion
        of the shares of stock subject to the underlying Option and shall,
        except as specifically set forth in this Section 8, be subject to the
        same terms and conditions applicable to the particular Option grant to
        which it pertains. A Concurrent Right shall be exercised automatically
        at the same time the underlying Option is exercised with respect to the
        particular shares of stock to which the Concurrent Right pertains. The
        appreciation distribution payable on an exercised Concurrent Right shall
        be in cash (or, if so provided, in an equivalent number of shares of
        stock based on Fair Market Value on the date of the exercise of the
        Concurrent Right) in an amount equal to such portion as shall be
        determined by the Administrator at the time of the grant of the excess
        of (A) the aggregate Fair Market Value (on the date of the exercise of
        the Concurrent Right) of the vested shares of stock purchased under the
        underlying Option which have Concurrent Rights appurtenant to them over
        (B) the aggregate exercise price paid for such shares.
 
             (iii) Independent Stock Appreciation Rights. Independent Rights
        will be granted independently of any Option and shall, except as
        specifically set forth in this Section 8, be subject to the same terms
        and conditions applicable to Nonstatutory Stock Options as set forth in
        Section 6. They shall be denominated in share equivalents. The
        appreciation distribution payable on the exercised Independent Right
        shall be not greater than an amount equal to the excess of (A) the
        aggregate Fair
 
                                     III-10
<PAGE>   127
 
        Market Value (on the date of the exercise of the Independent Right) of a
        number of shares of Company stock equal to the number of share
        equivalents in which the holder is vested under such Independent Right,
        and with respect to which the holder is exercising the Independent Right
        on such date, over (B) the aggregate Fair Market Value (on the date of
        the grant of the Independent Right) of such number of shares of Company
        stock. The appreciation distribution payable on the exercised
        Independent Right shall be in cash or, if so provided, in an equivalent
        number of shares of stock based on Fair Market Value on the date of the
        exercise of the Independent Right.
 
          (d) Share Limitations. The following limitations shall apply to grants
     of Stock Appreciation Rights:
 
             (i) No Employee, Director or Consultant shall be granted, in any
        fiscal year of the Company, Stock Appreciation Rights to purchase more
        than 1,000,000 shares.
 
                (A) In connection with his or her initial service, an Employee,
           Director or Consultant may be granted Stock Appreciation Rights to
           purchase up to an additional 1,000,000 shares which shall not count
           against the limit set forth in subsection (i) above.
 
                (B) The foregoing limitations shall be adjusted proportionately
           in connection with any change in the Company's capitalization as
           described in Section 14.
 
                (C) If a Stock Appreciation Right is cancelled in the same
           fiscal year of the Company in which it was granted (other than in
           connection with a transaction described in Section 14), the cancelled
           Stock Appreciation Right will be counted against the limits set forth
           in subsections (A) and (B) above. For this purpose, if the exercise
           price of a Stock Appreciation Right is reduced, the transaction will
           be treated as a cancellation of the Stock Appreciation Right and the
           grant of a new Stock Appreciation Right.
 
     10. Cancellation and Re-Grant of Options
 
     The Administrator shall have the authority to effect, at any time and from
time to time, (i) the repricing of any outstanding Options and/or any Stock
Appreciation Rights under the Plan and/or (ii) with the consent of the affected
holders of Options and/or Stock Appreciation Rights, the cancellation of any
outstanding Options and/or any Stock Appreciation Rights under the Plan and the
grant in substitution therefor of new Options and/or Stock Appreciation Rights
under the Plan covering the same or different numbers of shares of stock.
 
     11. Covenants of the Company
 
          (a) During the terms of the Stock Awards, the Company shall keep
     available at all times the number of shares of stock required to satisfy
     such Stock Awards.
 
          (b) The Company shall seek to obtain from each regulatory commission
     or agency having jurisdiction over the Plan such authority as may be
     required to issue and sell shares of stock upon exercise of the Stock
     Award; provided, however, that this undertaking shall not require the
     Company to register under the Securities Act of 1933, as amended (the
     "Securities Act") either the Plan, any Stock Award or any stock issued or
     issuable pursuant to any such Stock Award. If, after reasonable efforts,
     the Company is unable to obtain from any such regulatory commission or
     agency the authority which counsel for the Company deems necessary for the
     lawful issuance and sale of stock under the Plan, the Company shall be
     relieved from any liability for failure to, issue and sell stock upon
     exercise of such Stock Awards unless and until such authority is obtained.
 
     12. Use of Proceeds from Stock
 
          (a) Proceeds from the sale of stock pursuant to Stock Awards shall
     constitute general funds of the Company.
 
                                     III-11
<PAGE>   128
 
     13. Miscellaneous
 
          (a) Neither an Employee, Director or Consultant nor any person to whom
     a Stock Award is transferred under subsection 6(f), 8(b), or 9(b) shall be
     deemed to be the holder of, or to have any of the rights of a holder with
     respect to, any shares subject to such Stock Award unless and until such
     person has satisfied all requirements for exercise of the Stock Award
     pursuant to its terms.
 
          (b) Throughout the term of any Stock Award, the Company shall deliver
     to the holder of such Stock Award, not later than one hundred twenty (120)
     days after the close of each of the Company's fiscal years during the term
     of such Stock Award, a balance sheet and an income statement. This Section
     shall not apply when issuance is limited to key employees whose duties in
     connection with the Company assure them access to equivalent information.
 
          (c) Nothing in the Plan or any instrument executed or Stock Award
     granted pursuant thereto shall confer upon any Employee, Director,
     Consultant or other holder of Stock Awards any right to continue in the
     employ of the Company or any Affiliate (or to continue acting as a Director
     or Consultant) or shall affect the right of the Company or any Affiliate to
     terminate the employment of any Employee with or without cause, to remove
     any Director as provided in the Company's Bylaws and the provisions of the
     General Corporation Law of the State of Delaware or to terminate the
     relationship of any Consultant in accordance with the terms of that
     Consultant's agreement with the Company or Affiliate to which such
     Consultant is providing services.
 
          (d) The Company may require any person to whom a Stock Award is
     granted, or any person to whom a Stock Award is transferred pursuant to
     subsection 6(g), 7(b) or 8(b), as a condition of exercising or acquiring
     stock under any Stock Award, to give written assurances satisfactory to the
     Company, if any, that are necessary to ensure compliance with federal
     securities laws. These requirements, and any assurances given pursuant to
     such requirements, shall be inoperative if (i) the issuance of the shares
     upon the exercise or acquisition of stock under the Stock Award has been
     registered under a then currently effective registration statement under
     the Securities Act, or (ii) as to any particular requirement, a
     determination is made by counsel for the Company that such requirement need
     not be met in the circumstances under the then applicable securities laws.
 
          (e) To the extent provided by the terms of a Stock Award Agreement,
     the person to whom a Stock Award is granted may satisfy any federal, state
     or local tax withholding obligation relating to the exercise or acquisition
     of stock under a Stock Award by any of the following means or by a
     combination of such means: (i) tendering a cash payment; (ii) authorizing
     the Company to withhold shares from the shares of the Common Stock
     otherwise issuable to the participant as a result of the exercise or
     acquisition of stock under the Stock Award; or (iii) delivering to the
     Company owned and unencumbered shares of the Common Stock.
 
     14. Adjustments upon changes in stock
 
          (a) If any change is made in the stock subject to the Plan, or subject
     to any Stock Award, without the receipt of consideration by the Company
     (through merger, consolidation, reorganization, recapitalization,
     reincorporation, stock dividend, dividend in property other than cash,
     stock split, liquidating dividend, combination of shares, exchange of
     shares, change in corporate structure or other transaction not involving
     the receipt of consideration by the Company), the Plan will be
     appropriately adjusted in the class(es) and maximum number of shares
     subject to the Plan pursuant to subsection 4(a), and the outstanding Stock
     Awards will be appropriately adjusted in the class(es) and number of shares
     and price per share of stock subject to such outstanding Stock Awards. (The
     conversion of any convertible securities of the Company shall not be
     treated as a "transaction not involving the receipt of consideration by the
     Company".)
 
          (b) In the event of: (i) a merger or consolidation in which the
     Company is not the surviving corporation or (ii) a reverse merger in which
     the Company is the surviving corporation but the shares of the Company's
     Common Stock outstanding immediately preceding the merger are converted by
     virtue of the merger into other property, whether in the form of
     securities, cash or otherwise, then to the extent not
                                     III-12
<PAGE>   129
 
     prohibited by applicable law: (A) any surviving corporation or an Affiliate
     of such surviving corporation shall assume any Stock Awards outstanding
     under the Plan or shall substitute similar Stock Awards for those
     outstanding under the Plan, or (B) such Stock Awards shall continue in full
     force and effect. In the event any surviving corporation and its Affiliates
     refuse to assume such Stock Awards, or to substitute similar Stock Awards
     for those outstanding under the Plan, then such Stock Awards shall
     terminate if not exercised prior to such event.
 
          (c) In the event of a dissolution or liquidation of the Company, any
     Stock Awards outstanding under the Plan shall terminate if not exercised
     prior to such event.
 
     15. Amendment of the plan and stock awards
 
          (a) Amendment and Termination. The Board may at any time amend, alter,
     suspend or terminate the Plan. Unless sooner terminated, the Plan shall
     terminate on November 20, 2006, which shall be within ten (10) years from
     the date the Plan is adopted by the Board or approved by the stockholders
     of the Company, whichever is earlier. No Stock Awards may be granted under
     the Plan while the Plan is suspended or after it is terminated.
 
          (b) Stockholder Approval. The Company shall obtain stockholder
     approval of any Plan amendment to the extent necessary and desirable to
     comply with Applicable Laws.
 
          (c) Effect of Amendment or Termination. No amendment, alteration,
     suspension or termination of the Plan shall impair the rights of any
     Optionee, unless mutually agreed otherwise between the Optionee and the
     Administrator, which agreement must be in writing and signed by the
     Optionee and the Company. Termination of the Plan shall not affect the
     Administrator's ability to exercise the powers granted to it hereunder with
     respect to Options granted under the Plan prior to the date of such
     termination:
 
     16. Effective Date of Plan
 
     The Plan shall become effective as determined by the Board, but no Stock
Awards granted under the Plan shall be exercised unless and until the Plan has
been approved by the stockholders of the Company, which approval shall be within
twelve (12) months before or after the date the Plan is adopted by the Board,
and, if required, an appropriate permit has been issued by the Commissioner of
Corporations of the State of California.
 
                                     III-13
<PAGE>   130
 
                                                                        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>   131
 
     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. This opinion is for the use and benefit of the
Board of Directors of Stac. This letter is not intended to be and does not
constitute a recommendation to any current or prospective stockholders of Stac
or Hi/fn as to any action or investment decisions which may be taken by such
stockholders with respect to shares owned or to be received by them.
 
     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>   132
 
                                   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: November 18, 1998                  By:     /s/ WILLIAM R. WALKER
    
                                            ------------------------------------
 
   
                                          Name: William R. Walker
    
   
                                          Its:    Vice President, Chief
                                                  Financial Officer and
                                                  Corporate Secretary
    

<TABLE> <S> <C>

<ARTICLE> 5
<MULTIPLIER> 1,000
       
<S>                             <C>
<PERIOD-TYPE>                   YEAR
<FISCAL-YEAR-END>                          SEP-30-1998
<PERIOD-START>                             OCT-01-1997
<PERIOD-END>                               SEP-30-1998
<CASH>                                           4,084
<SECURITIES>                                     5,973
<RECEIVABLES>                                    3,125
<ALLOWANCES>                                       200
<INVENTORY>                                        165
<CURRENT-ASSETS>                                14,382
<PP&E>                                           1,615
<DEPRECIATION>                                     882
<TOTAL-ASSETS>                                  16,611
<CURRENT-LIABILITIES>                            9,659
<BONDS>                                              0
                                0
                                          6
<COMMON>                                         2,995
<OTHER-SE>                                       3,951
<TOTAL-LIABILITY-AND-EQUITY>                    16,611
<SALES>                                         21,533
<TOTAL-REVENUES>                                21,533
<CGS>                                            6,525
<TOTAL-COSTS>                                    6,525
<OTHER-EXPENSES>                                11,105
<LOSS-PROVISION>                                    75
<INTEREST-EXPENSE>                                   0
<INCOME-PRETAX>                                  3,845
<INCOME-TAX>                                     1,627
<INCOME-CONTINUING>                              2,218
<DISCONTINUED>                                       0
<EXTRAORDINARY>                                      0
<CHANGES>                                            0
<NET-INCOME>                                     2,218
<EPS-PRIMARY>                                     0.35
<EPS-DILUTED>                                     0.33
        

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