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Filed Pursuant to Rule 424(b)(4)
Registration No. 333-72537
LOGO
2,000,000 SHARES
COMMON STOCK
hi/fn, inc. is offering 1,600,000 shares of its Common Stock and the
Selling Stockholder is selling an additional 400,000 shares. hi/fn, inc.'s
Common Stock is traded on the Nasdaq National Market under the symbol "HIFN."
The last reported sale price of the Common Stock on the Nasdaq National Market
on March 25, 1999 was $33.375 per share.
-------------------------
INVESTING IN THE COMMON STOCK INVOLVES RISKS.
SEE "RISK FACTORS" BEGINNING ON PAGE 5.
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<TABLE>
<CAPTION>
PER SHARE TOTAL
--------- ------------
<S> <C> <C>
Public Offering Price....................................... $ 33.00 $ 66,000,000
Underwriting Discounts and Commissions...................... $ 1.98 $ 3,960,000
Proceeds to hi/fn, inc...................................... $ 31.02 $ 49,632,000
Proceeds to the Selling Stockholder......................... $ 31.02 $ 12,408,000
</TABLE>
THE SECURITIES AND EXCHANGE COMMISSION AND STATE SECURITIES REGULATORS HAVE
NOT APPROVED OR DISAPPROVED THESE SECURITIES, OR DETERMINED IF THIS PROSPECTUS
IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
hi/fn, inc. has granted the underwriters a 30-day option to purchase up to
an additional 300,000 shares of Common Stock to cover over-allotments.
BancBoston Robertson Stephens Inc. expects to deliver the shares of Common Stock
to purchasers on March 31, 1999.
-------------------------
BANCBOSTON ROBERTSON STEPHENS
SOUNDVIEW TECHNOLOGY GROUP
THOMAS WEISEL PARTNERS LLC
The date of this prospectus is March 26, 1999.
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YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE
HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH INFORMATION DIFFERENT FROM THAT
CONTAINED IN THIS PROSPECTUS. WE ARE OFFERING TO SELL, AND SEEKING OFFERS TO
BUY, SHARES OF COMMON STOCK ONLY IN JURISDICTIONS WHERE OFFERS AND SALES ARE
PERMITTED. THE INFORMATION CONTAINED IN THIS PROSPECTUS IS ACCURATE ONLY AS OF
THE DATE OF THIS PROSPECTUS, REGARDLESS OF THE TIME OF DELIVERY OF THIS
PROSPECTUS OR OF ANY SALE OF THE COMMON STOCK. IN THIS PROSPECTUS, REFERENCES TO
"HI/FN," "WE," "OUR" AND "US" REFER TO HI/FN, INC.
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C>
Summary..................................................... 1
Risk Factors................................................ 5
Use of Proceeds............................................. 18
Price Range of Common Stock................................. 19
Dividend Policy............................................. 19
Capitalization.............................................. 20
Selected Financial Data..................................... 21
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 23
Business.................................................... 32
Management.................................................. 49
Principal and Selling Stockholders.......................... 51
Description of Capital Stock................................ 53
Recent Spin-Off and Relationship with Stac.................. 55
Underwriting................................................ 57
Legal Matters............................................... 59
Experts..................................................... 59
Where You Can Find Additional Information................... 59
Index to Financial Statements............................... F-1
Glossary.................................................... G-1
</TABLE>
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We own or have rights to the product names, trade names and trademarks that
we use in conjunction with the sale of our products. This prospectus also
contains product names, trade names and trademarks that belong to other
organizations.
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SUMMARY
Because this is only a summary, it does not contain all the information
that may be important to you. You should read the entire prospectus, especially
"Risk Factors" and the Financial Statements and Notes, before deciding to invest
in our Common Stock. Some of the technical terms used in this prospectus are
defined in the Glossary of Terms beginning on page G-1.
HI/FN
We design, develop and market high-performance, multi-protocol packet
processors -- semiconductor devices designed to enable secure, high-bandwidth
network connectivity and efficient storage of business information. Our packet
processor products perform the computation-intensive tasks of compression,
encryption/compression and public key cryptography, providing our customers with
high-performance, interoperable implementations of a wide variety of
industry-standard networking and storage protocols. Our products are used in
networking and storage equipment like routers and back-up storage devices.
The dramatic growth of Internet technology has made it possible for anyone,
from anywhere to access information at any time. Businesses today are facing an
increasingly mobile workforce, increased telecommuting and the need to connect
branch offices, customers, suppliers and other trading partners to their
corporate network. Efforts to address these issues typically burden the
capabilities of existing network and storage systems. Therefore, to deliver on
the economic promise of Internet technology as a business tool and to address
these issues, we believe that businesses require two critical capabilities:
secure, high-bandwidth network connectivity among geographically dispersed
parties and efficient storage of business information.
Our encryption/compression and public key processors allow network
equipment vendors to add bandwidth enhancement and security capabilities to
their products. Our processors also provide key algorithms used in virtual
private networks, or "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 can provide secure,
authenticated access to their corporate networks, increasing productivity
through improved communications. Storage equipment vendors use our products to
improve the performance and capacity of mid- to high-end tape back-up systems.
We believe that our patented compression technology comprises the
fundamental know-how for the design and deployment of low-cost, high-performance
implementations of lossless data compression and gives our products a strong
competitive advantage. By offering a wide range of price-performance
implementations of our patented, standards-compliant technology, we are able to
sell products to network and storage equipment vendors that allow them to reduce
development costs and get their products to market faster. For example, our
patented Lempel-Ziv-Stac ("LZS") compression technology is incorporated into
several networking protocol standards, including the point-to-point protocol and
the frame relay protocol, allowing network equipment vendors to quickly
integrate proven solutions for lowering the costs associated with traditional
private leased-line network architectures. In addition, our IPSec protocol
network security processors with encryption and compression capabilities make it
possible to implement secure network connectivity in support of emerging VPNs.
Also, our line of compression processors targeted at back-up storage
applications provides storage equipment vendors high-
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performance implementations of our patented compression technology, doubling the
capacity and performance of mid- to high-end tape drive systems, thus making it
possible to store business information efficiently. For example, our LZS
compression technology is used in the DLT 4000 and DLT 7000 tape drive products
from Quantum. These encryption and compression technologies allow for secure,
high-bandwidth network connectivity and efficient storage of business
information.
Our goal is to become a leading provider of high-performance,
multi-protocol packet processors that enable our customers to create products
with enhanced bandwidth and high-performance security capabilities. We plan to
achieve this goal by:
- Focusing on network equipment markets;
- Leveraging our patented compression technology;
- Strengthening our presence in the storage equipment market;
- Maintaining our technology leadership;
- Contributing to the development of industry standards;
- Leveraging a "fabless" business model by continuing to subcontract all of
our semiconductor manufacturing; and
- Strengthening and expanding our customer relationships.
Prior to December 16, 1998, we were a subsidiary of Stac, Inc. ("Stac"). On
December 16, 1998, Stac distributed all of our outstanding shares held by Stac
to Stac stockholders. Our executive offices are located at 750 University
Avenue, Los Gatos, California 95032, and our telephone number is (408) 399-3500.
Our website is located at www.hifn.com. Information contained on our website is
not a prospectus or part of this prospectus.
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THE OFFERING
COMMON STOCK OFFERED BY HI/FN....... 1,600,000 shares
COMMON STOCK OFFERED BY THE SELLING
STOCKHOLDER....................... 400,000
COMMON STOCK TO BE OUTSTANDING AFTER
THE OFFERING...................... 8,156,781 shares
USE OF PROCEEDS..................... For repayment of short-term
indebtedness, working capital and
general corporate purposes. See "Use of
Proceeds."
NASDAQ NATIONAL MARKET SYMBOL....... HIFN
Unless otherwise stated in this prospectus, all information contained in
this prospectus assumes no exercise of the over-allotment option granted to the
underwriters.
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SUMMARY FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The balance sheets prior to September 30, 1997 reflect Hi/fn's structure as
a division of Stac prior to its formation as a subsidiary of Stac. 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 Common Stock of Hi/fn. The 6,000,000 shares of
Series A Preferred Stock were converted into 6,000,000 shares of Common Stock of
Hi/fn prior to the spin-off of Hi/fn from Stac on December 16, 1998. 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 transfers were
made for fiscal 1997 and the periods presented thereafter. The balance sheet
data for the three months ended December 31, 1998 is adjusted to reflect the
receipt and application of the net proceeds from the sale of 1,600,000 shares of
Common Stock by Hi/fn at a public offering price, after deducting the
underwriting discount and estimated offering expenses, of $31.02 per share. See
"Use of Proceeds" and "Capitalization."
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
YEAR ENDED SEPTEMBER 30, DECEMBER 31,
--------------------------------------------- ---------------
1994 1995 1996 1997 1998 1997 1998
------ ------ ------- ------- ------- ------ ------
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue........................................ $5,666 $7,342 $12,894 $14,226 $21,533 $6,265 $6,139
Cost of revenue................................ 2,302 2,841 5,095 4,762 6,525 2,102 1,818
------ ------ ------- ------- ------- ------ ------
Gross margin................................... 3,364 4,501 7,799 9,464 15,008 4,163 4,321
Operating expenses:
Research and development....................... 564 551 1,641 2,985 5,403 1,326 1,445
Sales and marketing............................ 813 1,097 1,677 2,224 3,370 792 1,227
General and administrative..................... 379 492 889 1,203 2,407 494 866
------ ------ ------- ------- ------- ------ ------
Operating income............................... 1,608 2,361 3,592 3,052 3,828 1,551 783
Interest income................................ -- -- -- 16 17 5 128
Interest expense............................... -- -- -- -- -- -- 105
Provision for income taxes..................... 661 947 1,441 1,235 1,627 625 323
------ ------ ------- ------- ------- ------ ------
Net income..................................... $ 947 $1,414 $ 2,151 $ 1,833 $ 2,218 $ 931 $ 483
====== ====== ======= ======= ======= ====== ======
Net income per share, basic.................... $ 0.16 $ 0.24 $ 0.36 $ 0.30 $ 0.35 $ 0.15 $ 0.07
Net income per share, diluted.................. $ 0.16 $ 0.24 $ 0.36 $ 0.30 $ 0.33 $ 0.14 $ 0.07
Weighted average shares outstanding, basic..... 6,000 6,000 6,000 6,100 6,308 6,228 6,449
Weighted average shares outstanding, diluted... 6,000 6,000 6,000 6,174 6,800 6,707 7,274
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30, DECEMBER 31, 1998
------------------------------------------ ---------------------
1994 1995 1996 1997 1998 ACTUAL AS ADJUSTED
----- ------ ------ ------ ------- ------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents.................... $ -- $ -- $ -- $ 480 $ 4,084 $ 8,484 $ 52,684
Total assets................................. 1,583 2,254 2,611 5,898 16,611 14,773 58,978
Working capital (deficit).................... (193) (223) (383) 3,520 4,723 5,499 49,704
Total debt................................... -- -- -- -- -- 5,000 --
Total stockholders' equity................... -- -- -- 4,622 6,952 7,510 51,715
</TABLE>
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RISK FACTORS
You should carefully consider the risks described below before making an
investment decision. The risks and uncertainties described below are not the
only ones facing our company. Additional risks and uncertainties not presently
known to us or that we currently deem immaterial may also impair our operations.
If any of the following risks actually occur, our business, financial condition
or results of operations could suffer. In such case, the trading price of our
Common Stock could decline, and you may lose all or part of your investment.
This prospectus also contains forward-looking statements that involve risks
and uncertainties. Our actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including the risks faced by us described below and elsewhere in this
prospectus.
WE HAVE A LIMITED OPERATING HISTORY AS AN INDEPENDENT COMPANY.
On August 14, 1996, we were incorporated by Stac, which transferred its
semiconductor business to us in exchange for shares of our Preferred Stock and
Common Stock. Because we are a relatively new company with a limited operating
history, we may experience financial and other difficulties as we attempt to
grow our business. For example, to expand our business we are increasing our
research and development and other operating expenses. This increase in expenses
will negatively affect our financial performance unless we are able to sustain
and grow revenues. In making an investment decision, you should evaluate this
risk, as well as the other difficulties and uncertainties frequently encountered
by early stage companies that operate in competitive markets. If we are not able
to evolve and expand our business, we may not remain profitable and therefore
may not be able to sustain a viable business.
OUR OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY.
Our operating results have fluctuated significantly in the past and we
expect that they will continue to fluctuate in the future. This fluctuation is a
result of a variety of factors including the following:
- General business conditions in our markets as well as global economic
uncertainty;
- Reductions in demand for our customers' products;
- The timing and amount of orders we receive from our customers;
- Cancellations or delays of customer product orders;
- Any new product introductions by us or our competitors;
- Our suppliers increasing costs or changing the delivery of products to
us;
- Increased competition or reductions in the prices that we are able to
charge;
- The variety of the products that we sell as well as seasonal demand for
our products; and
- The availability of manufacturing capacity necessary to make our
products.
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Our revenues and operating results depend upon the amount and timing of
customer orders that we receive in a given quarter. In the past we have
recognized a substantial portion of our revenues in the last month of a quarter.
If this trend continues, any failure or delay to fulfill orders by the end of a
particular quarter will harm our business, financial condition and results of
operations. As a result of these and other factors, we believe that
period-to-period comparisons of our historical results or operations are not a
good predictor of our future performance. If our future operating results are
below the expectations of stock market analysts, our stock price may decline.
WE DEPEND UPON A SMALL NUMBER OF CUSTOMERS.
Quantum Corporation ("Quantum") accounted for approximately 61% and 70%,
respectively, of our revenues in fiscal 1998 and 1997. Quantum is not under any
binding obligation to order from us. If our sales to Quantum decline, our
business, financial condition and results of operations could suffer. We expect
that our most significant customers in the future could be different from our
largest customers today for a number of reasons, including customers' deployment
schedules and budget considerations. As a result, we believe we may experience
significant fluctuations in our results of operations on a quarterly and an
annual basis.
Limited numbers of network and storage equipment vendors account for a
majority of packet processor purchases in their respective markets. In
particular, the market for network equipment that would include packet
processors, such as routers, remote access concentrators and firewalls, is
dominated by a few large vendors, including Ascend Communications, Inc., Cisco
Systems, Inc., Lucent Technologies Inc., Nortel Networks, Inc. and 3Com
Corporation. As a result, our future success will depend upon our ability to
establish and maintain relationships with these companies. If these network
equipment vendors do not incorporate our packet processors into their products,
our business, financial condition and results of operations could suffer.
OUR BUSINESS DEPENDS UPON THE DEVELOPMENT OF THE PACKET PROCESSOR MARKET.
Our prospects are dependent upon the acceptance of packet processors as an
alternative to other technology traditionally utilized by network and storage
equipment vendors. Many of our current and potential customers have substantial
technological capabilities and financial resources and currently develop
internally the application specific integrated circuit components and program
the general purpose microprocessors utilized in their products as an alternative
to our packet processors. These customers may in the future continue to rely on
these solutions or may determine to develop or acquire components, technologies
or packet processors that are similar to, or that may be substituted for, our
products. In order to be successful we 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 their requirements. In addition, we must make products available to these
large customers on a timely basis and at competitive prices. If orders from
customers are cancelled, decreased or delayed, or if we fail to obtain
significant orders from new customers, or if any significant customer delays or
fails to pay, our business, financial condition and results of operations could
suffer.
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OUR BUSINESS DEPENDS UPON THE CONTINUED GROWTH AND OUR PENETRATION OF THE
VIRTUAL PRIVATE NETWORK MARKET.
We want to be a leading supplier of packet processors that implement the
network security protocols necessary to support the deployment of virtual
private networks. In making an investment decision, you should consider the
possibility that this market, which is still emerging, may not grow or that our
products may not successfully serve this market. Our ability to generate
significant revenue in the virtual private network market will depend upon,
among other things, the following:
- Our ability to demonstrate the benefits of our technology to
distributors, original equipment manufacturers and end users; and
- The increased use of the Internet by businesses as replacements for, or
enhancements to, their private networks.
If we are unable to penetrate the virtual private network market, or if
that market fails to develop, our business, financial condition and results of
operations could suffer.
WE FACE RISKS ASSOCIATED WITH EVOLVING INDUSTRY STANDARDS AND RAPID
TECHNOLOGICAL CHANGE.
The markets in which we compete are characterized by rapidly changing
technology, frequent product introductions and evolving industry standards. Our
performance depends on a number of factors, including our ability to do the
following:
- Properly identify emerging target markets and related technological
trends;
- Develop and maintain competitive products;
- Enhance our products by adding innovative features that differentiate our
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.
Our past success has been dependent in part upon our ability to develop
products that have been selected for design into new products of leading
equipment manufacturers. However, the development of our packet processors is
complex and, from time to time, we have experienced delays in completing the
development and introduction of new products. We may not be able to adhere to
our new product design and introduction schedules and our products may not be
accepted in the market at favorable prices, if at all.
In evaluating new product decisions, we must anticipate future demand for
product features and performance characteristics, as well as available
supporting technologies, manufacturing capacity, competitive product offerings
and industry standards. We must also continue to make significant investments in
research and development in order to continue to enhance the performance and
functionality of our products to keep pace with competitive products and
customer demands for improved performance, features and functionality. The
technical innovations required for us to remain competitive are complicated and
require a significant amount of time and money. We may experience substantial
difficulty in introducing new products and we may be unable to offer
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enhancements to existing products on a timely or cost-effective basis, if at
all. For instance, the performance of our encryption/compression and public key
processors depends upon the integrity of our security technology. If any
significant advances in overcoming cryptographic systems are made, then the
security of our encryption/compression and public key processors will be reduced
or eliminated unless we are able to develop further technical innovations that
adequately enhance the security of these products. Our inability to develop and
introduce new products or enhancements directed at new industry standards could
harm our business, financial condition and results of operations.
OUR MARKETS ARE HIGHLY COMPETITIVE.
We compete in markets that are intensely competitive and are expected to
become more competitive as current competitors expand their product offerings
and new competitors enter the market. The markets in which we compete are
subject to frequent product introductions with improved price-performance
characteristics, rapid technological change, and the continued emergence of new
industry standards. Our products compete with offerings from companies such as
Analog Devices, Inc., Information Resource Engineering Inc., International
Business Machines Corporation ("IBM"), Rainbow Technologies, Inc. and VLSI
Technology, Inc. In 1994, Stac entered into two license agreements with IBM in
which Stac granted IBM the right to use, but not sublicense, our patented
compression technology in IBM hardware and software products. Stac also entered
into a license agreement with Microsoft Corporation ("Microsoft") in 1994
whereby Stac granted Microsoft the right to use, but not sublicense, our
compression technology in their software products. We expect significant future
competition from major domestic and international semiconductor suppliers.
Several established electronics and semiconductor suppliers have recently
entered, or expressed an interest to enter, the network equipment market. We
also may face competition from suppliers of products based on new or emerging
technologies. Furthermore, many of our existing and potential customers
internally develop solutions which attempt to perform all or a portion of the
functions performed by our products.
A key element of our packet processor architecture is our encryption
technology. In order to export our encryption-related products, we must obtain a
license from the U.S. Department of Commerce. Foreign competitors that are not
subject to similar requirements have an advantage over us in their ability to
rapidly respond to the requests of customers in the global market.
Many of our current and prospective competitors offer broader product lines
and have significantly greater financial, technical, manufacturing and marketing
resources than us. 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 promote the sale of their products. In particular, companies such
as Intel Corporation, Lucent Technologies Inc., Motorola, Inc., National
Semiconductor Corporation and Texas Instruments Incorporated have a significant
advantage over us given their relationships with many of our customers, their
extensive marketing power and name recognition and their much greater financial
resources. In addition, current and potential competitors may decide to
consolidate, lower the prices of their products or bundle their products with
other products. Any of the above would significantly and negatively impact our
ability to compete and obtain or maintain market share. If we are unable to
successfully compete against our competitors, our business, results of
operations and financial condition will suffer.
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We believe that the important competitive factors in our markets are the
following:
- Performance;
- Price;
- The time that is required to develop a new product or enhancements to
existing products;
- The ability to achieve product acceptance with major network and storage
equipment vendors;
- The support that exists for new network and storage standards;
- Features and functionality;
- Adaptability of products to specific applications;
- Reliability; and
- Technical service and support as well as effective intellectual property
protection.
If we are unable to successfully develop and market products that compete
with those of other suppliers, our business, financial condition and results of
operations could be harmed. In addition, we must compete for the services of
qualified distributors and sales representatives. To the extent that our
competitors offer distributors or sales representatives more favorable terms,
these distributors and sales representatives may decline to carry, or
discontinue carrying, our products. Our business, financial condition and
results of operations could be harmed by any failure to maintain and expand our
distribution network. See "Business -- Competition."
OUR BUSINESS DEPENDS UPON THE GROWTH OF THE NETWORK EQUIPMENT AND STORAGE
EQUIPMENT MARKETS.
Our success is largely dependent upon continued growth in the market for
network security equipment, such as routers, remote access concentrators,
switches, broadband access equipment, security gateways, firewalls and network
interface cards. In addition, our success depends upon storage equipment vendors
incorporating our packet processors into their systems. The network security
equipment market 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, changes in capital spending levels and general
economic conditions. We are unable to determine the rate or extent to which
these markets will grow, if at all. Any decrease in the growth of the network or
storage equipment markets or a decline in demand for our products could harm our
business, financial condition and results of operations.
OUR OPERATING RESULTS HAVE BEEN SUBSTANTIALLY DEPENDENT ON ONE PRODUCT FAMILY.
Historically, substantially all of our revenue has come from sales of our
compression processor products which accounted for 84%, 88% and 89% of revenue
in the fiscal years ended September 30, 1998, 1997 and 1996. A significant
decline in revenue from our compression processor products, which is not
adequately replaced by increased sales of our encryption/compression and public
key processors, would harm our business, financial condition and results of
operations.
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OUR SUCCESS DEPENDS UPON PROTECTING OUR INTELLECTUAL PROPERTY.
Our proprietary technology is critical to our future success. We rely in
part on patent, trade secret, trademark, maskwork and copyright law to protect
our intellectual property. We own 12 United States patents and four foreign
patents. We also have two pending patent applications in Japan. Our patents and
patent applications cover various aspects of our compression technology and have
expiration dates ranging from 2006 to 2013. Patents may not issue under our
current or future patent applications, and the patents issued under such patent
applications could be invalidated, circumvented or challenged. In addition,
third parties could make infringement claims against us in the future. Such
infringement claims could result in costly litigation. We may not 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. Regardless of the outcome,
an infringement claim would likely result in substantial cost and diversion of
our resources. Any infringement claim or other litigation against us or by us
could harm our business, financial condition and results of operations. The
patents issued to us may not be adequate to protect our proprietary rights, to
deter misappropriation or to prevent an unauthorized third party from copying
our technology, designing around the patents we own or otherwise obtaining and
using our products, designs or other information. In addition, others could
develop technologies that are similar or superior to our technology.
We also claim copyright protection for certain proprietary software and
documentation. We attempt to protect our trade secrets and other proprietary
information through agreements with our customers, employees and consultants,
and through other security measures. However, our efforts may not be successful.
Furthermore, the laws of certain countries in which our products are or may be
manufactured or sold may not protect our products and intellectual property. See
"Business -- Intellectual Property."
THE LENGTH OF TIME IT TAKES TO DEVELOP OUR PRODUCTS AND MAKE A SALE TO OUR
CUSTOMERS MAY IMPAIR OUR OPERATING RESULTS.
Our customers typically take a long time to evaluate our products. In fact,
it usually takes our customers three to six months or more to test our products
with an additional nine to 18 months or more before they commence significant
production of equipment incorporating our products. As a result of this lengthy
sales cycle, we may experience a delay between increasing expenses for research
and development and sales and marketing efforts, on the one hand, and the
generation of higher revenues, if any, on the other hand. In addition, the
delays inherent in such a lengthy sales cycle raise additional risks of customer
decisions to cancel or change product plans, which could result in the loss of
anticipated sales. Our business, financial condition and results of operations
could suffer if customers reduce or delay orders or choose not to release
products using our technology.
WE DEPEND UPON INDEPENDENT MANUFACTURERS AND LIMITED SOURCES OF SUPPLY.
We rely on subcontractors to manufacture, assemble and test our packet
processors. We currently subcontract our semiconductor manufacturing to Atmel
Corporation, Motorola, Inc. and Toshiba Corporation. Since we depend upon
independent manufacturers, we do not directly control product delivery schedules
or product quality. None of our products are manufactured by more than one
supplier. Since the semiconductor industry is highly cyclical, foundry capacity
has been very limited at times in the past and may become limited in the future.
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We depend on our suppliers to deliver sufficient quantities of finished
products to us in a timely manner. We place orders on a purchase order basis and
do not have long-term volume purchase agreements with any of our suppliers. As a
result, our suppliers may allocate production capacity to other products while
reducing deliveries to us on short notice. For example, in June 1995, one of our
suppliers delayed the delivery of one of our products. As a result, we switched
production of the product to a new manufacturer. This caused a three month delay
in shipments to customers. We also experienced yield and test anomalies on a
different product manufactured by another subcontractor that could have
interrupted our customer shipments. In this case, the manufacturer was able to
correct the problem in a timely manner and customer shipments were not affected.
The delay and expense associated with qualifying a new supplier or foundry and
commencing volume production can result in lost revenue, reduced operating
margins and possible harm to customer relationships. The steps required for a
new manufacturer to begin production of a semiconductor product include:
- Adapting our product design, if necessary, to the new manufacturer's
process;
- Creating a new mask set to manufacture the product;
- Having the new manufacturer prepare sample products so we can verify the
product specification; and
- Providing sample products to customers for qualification.
In general, it takes from three to six months for a new manufacturer to
begin full-scale production of one of our products. We could have similar or
more protracted problems in the future with existing or new suppliers.
Toshiba Corporation manufactures products for us in plants located in Asia.
To date, the financial and stock market dislocations that have occurred in the
Asian financial markets have not harmed our business. However, present or future
dislocations or other international business risks, such as currency exchange
fluctuations or recessions, could force us to seek new suppliers. We must place
orders approximately 12 to 14 weeks in advance of expected delivery. This limits
our ability to react to fluctuations in demand for our products, and could cause
us to have an excess or a shortage of inventory of a particular product. In
addition, if global semiconductor manufacturing capacity does not increase as
quickly as demand, foundries could allocate available capacity to larger
customers or customers with long-term supply contracts. If we cannot obtain
adequate foundry capacity at acceptable prices, or our supply is interrupted or
delayed, our product revenues could decrease or our cost of revenues could
increase. This could harm our business, financial condition and results of
operations.
We regularly consider using smaller semiconductor dimensions for each of
our products to reduce costs. We have begun to decrease the dimensions in our
new product designs, and believe that we must do so to remain competitive. We
may have difficulty decreasing the dimensions of our products since, in the
future, we may change our supply arrangements to assume more product
manufacturing responsibilities. We may subcontract for wafer manufacturing,
assembly and test rather than purchase finished products. However, there are
additional risks associated with manufacturing, including variances in
production yields, the ability to obtain adequate test and assembly capacity at
reasonable cost and other general risks associated with the manufacture of
semiconductors. We may also enter into volume purchase agreements that require
us to commit to minimum purchase levels and which may require up-front
investments. If we fail to effectively
11
<PAGE> 14
assume greater manufacturing responsibilities or manage volume purchase
arrangements, our business, financial condition and results of operations will
suffer. See "Business -- Manufacturing."
NETWORK AND STORAGE EQUIPMENT PRICES TYPICALLY DECREASE.
Average selling prices in the networking, storage and semiconductor
industries have rapidly declined due to many factors, including:
- Rapidly changing technologies;
- Price-performance enhancements; and
- Product obsolescence.
The decline in the average selling prices of our products may cause
substantial fluctuations in our operating results. We anticipate that the
average selling prices of our products will decrease in the future due to
product introductions by our competitors, price pressures from significant
customers and other factors. Therefore, we must continue to develop and
introduce new products that incorporate features which we can sell at higher
prices. If we fail to do so, our revenues and gross margins could decline, which
would harm our business, financial condition and results of operations.
WE FACE PRODUCT RETURN, PRODUCT LIABILITY AND PRODUCT DEFECT RISKS.
Complex products such as ours frequently contain errors, defects and bugs
when first introduced or as new versions are released. We have discovered such
errors, defects and bugs in the past. Delivery of products with production
defects or reliability, quality or compatibility problems could hinder market
acceptance of our products. This could damage our reputation and harm our
ability to attract and retain customers. Errors, defects or bugs could also
cause interruptions, delays or a cessation of sales to our customers. We would
have to expend significant capital and resources to remedy these problems.
Errors, defects or bugs could be discovered in our new products after we begin
commercial production of them, despite testing by us and our suppliers and
customers. This could result in additional development costs, loss of, or delays
in, market acceptance, diversion of technical and other resources from our other
development efforts, claims by our customers or others against us or the loss of
credibility with our current and prospective customers. Any such event would
harm our business, financial condition and results of operations.
WE FACE ORDER AND SHIPMENT UNCERTAINTIES.
We generally make our sales under individual purchase orders that may be
canceled or deferred by customers on short notice without significant penalty,
if any. Cancellation or deferral of product orders could cause us to hold excess
inventory, which could harm our profit margins and restrict our ability to fund
our operations. We recognize revenue upon shipment of products to our customers,
net of an allowance for estimated returns. An unanticipated level of returns
could harm our business, financial condition and results of operations.
12
<PAGE> 15
WE DEPEND UPON KEY PERSONNEL.
Our success greatly depends on the continued contributions of our key
management and other personnel, many of whom would be difficult to replace. We
do not have employment contracts with any of our key personnel, nor do we
maintain any key man life insurance on any of our personnel. Several members of
our management team have joined us in the last 12 months. It may be difficult
for us to integrate new members of our management team. We must also attract and
retain experienced and highly skilled engineering, sales and marketing and
managerial personnel. Competition for such personnel is intense in the
geographic areas and market segments in which we compete, and we may not be
successful in hiring and retaining such people. If we lose the services of any
key personnel, or cannot attract or retain qualified personnel, particularly
engineers, our business, financial condition and results of operations could
suffer. In addition, companies in technology industries whose employees accept
positions with competitors have in the past claimed that their competitors have
engaged in unfair competition or hiring practices. We could receive such claims
in the future as we seek to hire qualified personnel. These claims could result
in material litigation. We could incur substantial costs in defending against
any such claims, regardless of their merits.
OUR RAPID GROWTH MAY STRAIN OUR OPERATIONS.
We have experienced a period of rapid growth and expansion which has
placed, and continues to place, a significant strain on our resources. To
accommodate this growth, we must 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 which were
provided by Stac. This may require substantial management effort, and our
efforts to do so may not be successful. In addition, we have had to hire
additional employees to accommodate this growth and our product development
activities. This has resulted in increased responsibilities for our management.
Our systems, procedures and controls may not be adequate to support our
operations. If we fail to improve our operational, financial and management
information systems, or to hire, train, motivate or manage our employees, our
business, financial condition and results of operations could suffer.
OUR PRODUCTS ARE SUBJECT TO EXPORT RESTRICTIONS.
The encryption algorithms embedded in our products are a key element of our
packet processor architecture. These products are subject to U.S. Department of
Commerce export control restrictions. Our network equipment customers may only
export products incorporating encryption technology if they obtain an export
license. These U.S. export laws also prohibit the export of encryption products
to a number of countries deemed by the U.S. to be hostile. 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. These restrictions may make foreign competitors facing less
stringent controls on their products more competitive in the global market than
our network equipment customers. The U.S. government may not approve any pending
or future export license requests. In addition, the list of products and
countries for which export approval is required, and the regulatory policies
with respect thereto, could be revised, and laws limiting the domestic use of
encryption could be enacted. The sale of our packet processors could be harmed
by the failure of our network equipment customers to obtain the required
licenses or by the costs of compliance.
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<PAGE> 16
WE FACE RISKS ASSOCIATED WITH OUR INTERNATIONAL BUSINESS ACTIVITIES.
We sell most of our products to customers in the United States. If our
international sales increase, we may encounter risks inherent in international
operations. All of our international sales to date are denominated in U.S.
dollars. As a result, if the value of the U.S. dollar increases relative to
foreign currencies, our products could become less competitive in international
markets. We also obtain some of our manufacturing, assembly and test services
from suppliers located outside the United States. International business
activities could be limited or disrupted by any of the following:
- The imposition of governmental controls;
- Export license requirements;
- Restrictions on the export of technology;
- Currency exchange fluctuations;
- Political instability;
- Financial and stock market dislocations;
- Trade restrictions; and
- Changes in tariffs.
Demand for our products also could be harmed by seasonality of
international sales and economic conditions in our primary overseas markets.
These international factors could harm future sales of our products to
international customers and our business, financial condition and results of
operations in general.
YEAR 2000 ISSUES MAY HARM OUR BUSINESS.
Many existing computer systems and applications, and other control devices,
use only two digits to identify a year. These programs were designed without
considering the impact of the upcoming change in the century. If not corrected,
many computer software applications could fail or create erroneous results by,
at or beyond the year 2000. We utilize software, computer technology and other
services internally developed and provided by third-party vendors that may fail
due to the Year 2000 phenomenon, such as financial systems (including accounts
payable and payroll modules), customer services, networks and telecommunications
equipment and end products. We rely on external systems of business enterprises
such as customers, suppliers, financial organizations, and on governmental
entities, both domestic and international, for accurate exchange of data. Even
if our internal systems are not materially affected by Year 2000 issues, we
could be affected by disruptions in the operation of entities with which we
interact. Despite our efforts to address the Year 2000 impact on our internal
systems and business operations, this impact could disrupt our business and our
business, financial condition and results of operations could suffer. Our
efforts to address this issue are described in more detail in "Management's
Discussion and Analysis of Financial Condition and Results of Operations -- Year
2000 Issues."
Customers' purchasing plans could be affected by Year 2000 issues as they
may need to expend significant resources to correct their existing systems. This
situation may result in reduced funds available to purchase our products.
14
<PAGE> 17
WE FACE RISKS ASSOCIATED WITH ACQUISITIONS.
We continually evaluate strategic acquisitions of businesses and
technologies that would complement our product offerings or enhance our market
coverage or technological capabilities. We are not currently negotiating any
acquisitions, but we may make acquisitions in the future. Future acquisitions
could be effected without stockholder approval, and could cause us to dilute
shareholder equity, incur debt and contingent liabilities and amortize
acquisition expenses related to goodwill and other intangible assets, any of
which could harm our operating results and/or the price of our Common Stock.
Acquisitions entail numerous risks, including:
- Difficulties in assimilating acquired operations, technologies and
products;
- Diversion of management's attention from other business concerns;
- Risks of entering markets in which we have little or no prior experience;
and
- Loss of key employees of acquired organizations.
We may not be able to successfully integrate businesses, products,
technologies or personnel that we acquire. If we fail to do so, our business,
financial condition and results of operations could suffer.
In addition, if we are a party to a transaction or series of transactions
that result in 50% or more of our outstanding stock being transferred to one or
more persons, the IRS may claim that our spin-off from Stac was a taxable event
to Stac and its stockholders. Under the Tax Allocation and Indemnity Agreement
that we entered into with Stac, we may be obligated to pay the taxes of Stac if
we caused the spin-off to be a taxable event. Our cash flows, business,
financial condition and results of operations would suffer if we became liable
for any such tax liability. See "Recent Spin-Off and Relationship with Stac."
THE CYCLICALITY OF THE SEMICONDUCTOR INDUSTRY MAY HARM OUR BUSINESS.
The semiconductor industry has experienced significant downturns and wide
fluctuations in supply and demand. The industry has also experienced significant
fluctuations in anticipation of changes in general economic conditions. This has
caused significant variances in product demand, production capacity and rapid
erosion of average selling prices. Industry-wide fluctuations in the future
could harm our business, financial condition and results of operations.
WE FACE CERTAIN RISKS AS A RESULT OF OUR SPIN-OFF FROM STAC.
On December 8, 1998, Stac received a private letter ruling from the
Internal Revenue Service ("IRS") stating, among other things, that the
distribution of our Common Stock held by Stac on December 16, 1998 to Stac
stockholders would 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 ("Code") (except to the extent of cash received in lieu of fractional
shares). A tax ruling, while generally binding upon the IRS, is subject to
certain factual representations and assumptions. If the factual representations
and assumptions made by Stac 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.
15
<PAGE> 18
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 our Common Stock that was distributed to Stac
stockholders on December 16, 1998 and (ii) Stac's adjusted basis of such 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. Furthermore, in connection with the spin-off we entered
into a Tax Allocation and Indemnity Agreement with Stac whereby each of us
agreed that if either party took actions after the spin-off that caused Section
355(e) of the Code to apply to Hi/fn's Common Stock, then whichever party first
caused Section 355(e) of the Code to apply to Hi/fn's Common Stock would be
obligated to bear all taxes of Stac resulting from such action. Under recently
enacted Section 355(e) of the Code, if the spin-off were considered to be part
of a plan or series of related transactions (a "Plan") in which, after the
spin-off, a 50% or greater interest in Hi/fn or Stac was acquired by one or more
persons, the IRS would claim that the spin-off was taxable at the corporate
level. Although neither we nor Stac believes the spin-off is part of a Plan to
effect a 50% change in ownership of either Hi/fn or Stac, the IRS has issued no
guidance on the definition of a Plan and for the first two years following the
spin-off, any cumulative 50% change of ownership within the two-year period will
be rebuttably presumed to be the result of a Plan. Our cash flows, business,
financial condition and results of operations would suffer if we became liable
for any such tax liability. See "Recent Spin-Off and Relationship with Stac."
MANAGEMENT AND CERTAIN STOCKHOLDERS CAN EXERCISE SIGNIFICANT INFLUENCE
OVER HI/FN.
The present executive officers and directors and certain other stockholders
will beneficially own approximately 28% of our outstanding Common Stock
immediately following this offering. These stockholders, if acting together,
would be able to significantly influence all matters requiring approval of our
stockholders, including the election of directors and the approval of mergers or
other business combination transactions. See "Principal and Selling
Stockholders."
FUTURE SALES OF SHARES COULD AFFECT OUR STOCK PRICE.
If our stockholders sell substantial amounts of our Common Stock (including
shares issued upon the exercise of outstanding options) in the public market
following this offering, the market price of our Common Stock could fall. Such
sales also might make it more difficult for us to sell equity securities in the
future at a time and price we deem appropriate. Upon completion of this
offering, we will have outstanding 8,156,781 shares of Common Stock (based upon
shares outstanding as of December 31, 1998) assuming no exercise of the
underwriters' over-allotment option and no exercise of outstanding options after
December 31, 1998. Of these shares, 6,943,604 are currently eligible for sale in
the public market. After the lock-up agreements with the underwriters expire 120
days from the date of this prospectus (or earlier if the underwriters terminate
the lock-up agreements before the lock-up period ends), an additional 1,213,177
shares will be eligible for public sale, subject to the volume limitations and
other conditions of Rule 144. These share numbers exclude 1,545,887 shares
subject to outstanding stock options and 947,262 shares reserved for future
issuance under our stock plans as of December 31, 1998.
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<PAGE> 19
OUR STOCK PRICE MAY BE VOLATILE.
The market price of our Common Stock has fluctuated in the past and is
likely to fluctuate in the future. In addition, the securities markets have
experienced significant price and volume fluctuations and the market prices of
the securities of technology-related companies including networking, storage and
semiconductor companies have been especially volatile. Such fluctuations can
result from:
- Quarterly variations in operating results;
- Announcements of new products by us or our competitors;
- The gain or loss of significant customers;
- Changes in analysts' estimates;
- Short-selling of our Common Stock; and
- Events affecting other companies that investors deem to be comparable to
us.
Investors may be unable to resell their shares of our Common Stock at or
above the offering price. In the past, companies that have experienced
volatility in the market price of their stock have been the object of securities
class action litigation. If we were the object of securities class action
litigation, it could result in substantial costs and a diversion of management's
attention and resources. See "Price Range of Common Stock."
OUR CERTIFICATE OF INCORPORATION AND BYLAWS AND DELAWARE LAW CONTAIN PROVISIONS
THAT COULD DISCOURAGE A TAKEOVER.
Our Certificate of Incorporation and Bylaws contain provisions which may
discourage takeover attempts, including transactions in which stockholders might
receive a premium for their shares. This may limit stockholders' ability to
approve a transaction that stockholders may think is in their best interests.
Such provisions include:
- A requirement that certain procedures must be followed before matters can
be proposed for consideration at meetings of our stockholders;
- The ability of the Board of Directors to fix the rights and preferences
of and issue 10,000,000 shares of Preferred Stock without stockholder
action; and
- A classified Board of Directors.
Provisions of the Delaware General Corporation Law also restrict certain
business combinations with interested stockholders. The provisions of our
Certificate of Incorporation and Bylaws and of Delaware law are intended to
encourage potential acquirers to negotiate with us and allow the Board the
opportunity to consider alternative proposals in the interest of maximizing
stockholder value. However, such provisions may also discourage acquisition
proposals or delay or prevent a change in control, which could harm our stock
price. See "Description of Capital Stock."
In addition, if we are a party to a transaction or series of transactions
that result in 50% or more of our outstanding stock being transferred to one or
more persons, the IRS may claim that our spin-off from Stac was a taxable event
to Stac and its stockholders. Under the Tax Allocation and Indemnity Agreement
that we entered into with Stac, we may be obligated to pay the taxes of Stac if
we caused the spin-off to be a taxable event.
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<PAGE> 20
Our cash flows, business, financial condition and results of operations would
suffer if we became liable for any such tax liability. See "Recent Spin-Off and
Relationship with Stac."
MANAGEMENT HAS BROAD DISCRETION IN THE USE OF PROCEEDS.
After repaying the $5.0 million short-term loan we received from Stac prior
to our spin-off from Stac, we plan to use the proceeds from this offering
primarily for working capital and general corporate purposes. Therefore, we will
have discretion as to how we will spend the proceeds, which could be in ways
with which the stockholders may not agree. We cannot predict that the proceeds
will be invested to yield a favorable return. See "Use of Proceeds."
WE DO NOT PLAN TO PAY CASH DIVIDENDS ON OUR COMMON STOCK.
We intend to retain any future earnings to finance the growth and
development of our business. We no not plan to pay cash dividends in the
foreseeable future. See "Dividend Policy."
USE OF PROCEEDS
The net proceeds from the sale of the 1,600,000 shares of Common Stock
offered by Hi/fn are $49.6 million ($58.9 million if the underwriters'
over-allotment option is exercised in full) after deducting the underwriting
discount and estimated offering expenses payable by Hi/fn. Hi/fn will not
receive any proceeds from the sale of the shares by the Selling Stockholder.
Hi/fn intends to use approximately $5.0 million of the proceeds to repay
the short-term loan received from Stac prior to the spin-off in order to finance
Hi/fn's operating and capital needs. The loan becomes due and payable on
September 30, 1999, but may be prepaid in whole or part without penalty. The
loan bears interest at the prime rate set by Silicon Valley Bank plus 0.5% per
annum, payable quarterly, and is secured by a first priority security interest
in all of Hi/fn's assets, including Hi/fn's intellectual property. The remaining
proceeds will be used for working capital and general corporate purposes. In
addition, Hi/fn may use a portion of the net proceeds to acquire complementary
products, technologies or businesses. Hi/fn currently has no commitments or
agreements and is not involved in any negotiations with respect to any such
transactions. Pending use of the net proceeds of this offering, Hi/fn intends to
invest the net proceeds in short-term, interest-bearing securities. See
"Principal and Selling Stockholders" and "Recent Spin-Off and Relationship with
Stac."
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<PAGE> 21
PRICE RANGE OF COMMON STOCK
The Common Stock has been quoted on the Nasdaq National Market under the
symbol "HIFN" since December 16, 1998, the date upon which Stac consummated the
dividend distribution of the Common Stock to Stac stockholders. The following
table lists quarterly information on the price range of the Common Stock based
on the high and low reported closing bid prices for the Common Stock as reported
on the Nasdaq National Market for the periods indicated below:
<TABLE>
<CAPTION>
HIGH LOW
---- ---
<S> <C> <C>
FISCAL YEAR ENDED SEPTEMBER 30, 1999:
First Quarter............................................. $24 $17 1/2
Second Quarter............................................ $34 $22 1/2
</TABLE>
The last reported sale price for the Common Stock on the Nasdaq National
Market was $33.375 per share on March 25, 1999. As of March 25, 1999, there were
approximately 394 holders of record of our Common Stock.
DIVIDEND POLICY
Hi/fn has never declared or paid any dividends on its capital stock. Hi/fn
intends to retain any future earnings to finance the growth and development of
its business and does not expect to pay any cash dividends in the foreseeable
future.
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<PAGE> 22
CAPITALIZATION
The following table sets forth the actual capitalization of Hi/fn as of
December 31, 1998, and such capitalization as adjusted to reflect the receipt
and application by Hi/fn of the net proceeds from the sale of 1,600,000 shares
of Common Stock offered hereby by Hi/fn at a public offering price, after
deducting the underwriting discount and estimated offering expenses, of $31.02
per share. The capitalization information set forth in the table below is
qualified by the more detailed Financial Statements and Notes beginning on page
F-1 of this prospectus. The table should be read in conjunction with such
Financial Statements and Notes.
<TABLE>
<CAPTION>
DECEMBER 31, 1998
---------------------
ACTUAL AS ADJUSTED
------- -----------
(IN THOUSANDS)
<S> <C> <C>
Cash and short-term investments............................ $ 8,484 $ 52,684
======= =========
Notes payable.............................................. 5,000 --
------- ---------
Stockholders' equity:
Preferred Stock, $0.001 par value; 10,000,000 shares
authorized;
no shares outstanding.................................... -- --
Common Stock(1), $0.001 par value; 100,000,000 shares
authorized; 6,556,781 shares issued, actual; 8,156,781
shares issued, as adjusted............................... 7 8
Additional paid-in capital................................. 3,069 47,223
Stockholder's note receivable.............................. (100) (100)
Retained earnings.......................................... 4,534 4,534
------- ---------
Total stockholders' equity....................... 7,510 51,715
------- ---------
Total capitalization............................. $12,510 $ 51,715
======= =========
</TABLE>
- -------------------------
(1) Excludes 1,545,887 shares of Common Stock issuable upon exercise of stock
options at a weighted average exercise price of $2.645 per share outstanding
as of December 31, 1998.
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<PAGE> 23
SELECTED FINANCIAL DATA
The selected financial data of Hi/fn as of and for each of the three years
ended September 30, 1998, have been derived from Hi/fn's audited financial
statements as included herein. The selected financial data of Hi/fn as of and
for the year ended September 30, 1995, have been derived from audited financial
statements not included herein. The selected financial data of Hi/fn as of and
for the year ended September 30, 1994, have been derived from unaudited
financial statements not included herein. The selected financial data of Hi/fn
as of and for the three months ended December 31, 1997 and 1998, have been
derived from unaudited financial statements included elsewhere in this
prospectus and contain all adjustments, consisting only of normal recurring
accruals, which Hi/fn believes is necessary for a fair statement of Hi/fn's
financial position and results of operations for such periods. The financial
information may not reflect Hi/fn's future performance or the future financial
position or results of operations of Hi/fn, nor does it provide or reflect data
as if Hi/fn had actually operated as a separate, stand-alone entity during all
of the periods covered. The financial information for the three months ended
December 31, 1997 and 1998 may not be indicative of the results that may be
expected for the entire fiscal year ended September 30, 1999. The following
selected financial data should be read in conjunction with the "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Financial Statements and Notes beginning on page F-1 of this prospectus.
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
YEAR ENDED SEPTEMBER 30, DECEMBER 31,
--------------------------------------------- ---------------
1994 1995 1996 1997 1998 1997 1998
------ ------ ------- ------- ------- ------ ------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue........................................ $5,666 $7,342 $12,894 $14,226 $21,533 $6,265 $6,139
Cost of revenue................................ 2,302 2,841 5,095 4,762 6,525 2,102 1,818
------ ------ ------- ------- ------- ------ ------
Gross margin................................... 3,364 4,501 7,799 9,464 15,008 4,163 4,321
Operating expenses:
Research and development....................... 564 551 1,641 2,985 5,403 1,326 1,445
Sales and marketing............................ 813 1,097 1,677 2,224 3,370 792 1,227
General and administrative..................... 379 492 889 1,203 2,407 494 866
------ ------ ------- ------- ------- ------ ------
Operating income............................... 1,608 2,361 3,592 3,052 3,828 1,551 783
Interest income................................ -- -- -- 16 17 5 128
Interest expense............................... -- -- -- -- -- -- 105
Provision for income taxes..................... 661 947 1,441 1,235 1,627 625 323
------ ------ ------- ------- ------- ------ ------
Net income..................................... $ 947 $1,414 $ 2,151 $ 1,833 $ 2,218 $ 931 $ 483
====== ====== ======= ======= ======= ====== ======
Net income per share, basic.................... $ 0.16 $ 0.24 $ 0.36 $ 0.30 $ 0.35 $ 0.15 $ 0.07
Net income per share, diluted.................. $ 0.16 $ 0.24 $ 0.36 $ 0.30 $ 0.33 $ 0.14 $ 0.07
Weighted average shares outstanding, basic..... 6,000 6,000 6,000 6,100 6,308 6,228 6,449
Weighted average shares outstanding, diluted... 6,000 6,000 6,000 6,174 6,800 6,707 7,274
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30, DECEMBER 31, 1998
------------------------------------------ ------------------------
1994 1995 1996 1997 1998 ACTUAL AS ADJUSTED(1)
----- ------ ------ ------ ------- ------- --------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA(2):
Cash and cash equivalents................. $ -- $ -- $ -- $ 480 $ 4,084 $ 8,484 $ 52,684
Total assets.............................. 1,583 2,254 2,611 5,898 16,611 14,773 58,978
Working capital (deficit)................. (193) (223) (383) 3,520 4,723 5,499 49,704
Total debt................................ -- -- -- -- -- 5,000 --
Total stockholders' equity................ -- -- -- 4,622 6,952 7,510 51,715
</TABLE>
- -------------------------
(1) The balance sheet data for the three months ended December 31, 1998 is
adjusted to reflect the receipt and application of the net proceeds from the
sale of 1,600,000 shares of Common Stock by Hi/fn at a public offering
price, after deducting the underwriting discount and estimated offering
expenses, of $31.02 per share. See "Use of Proceeds" and "Capitalization."
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<PAGE> 24
(2) The balance sheets prior to September 30, 1997 reflect Hi/fn's structure as
a division of Stac prior to its formation as a subsidiary of Stac. 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 Common Stock of Hi/fn.
The 6,000,000 shares of Series A Preferred Stock were converted into
6,000,000 shares of Common Stock of Hi/fn prior to the spin-off of Hi/fn
from Stac on December 16, 1998. 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 transfers were made for fiscal 1997 and
the periods presented thereafter. See Note 1 to the Financial Statements.
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<PAGE> 25
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Financial
Statements and Notes beginning on page F-1 of this prospectus. The results shown
in this prospectus are not necessarily indicative of the results to be expected
in any future periods. This discussion contains forward-looking statements based
on current expectations which involve risks and uncertainties. Actual results
and the timing of certain events may differ significantly from those projected
in such forward-looking statements due to the factors set forth in the section
entitled "Risk Factors" and appearing elsewhere in this prospectus.
OVERVIEW
Hi/fn designs, develops and markets high-performance multi-protocol packet
processors -- semiconductor devices designed to enable secure, high-bandwidth
network connectivity and efficient storage of business information. Hi/fn's
packet processor products perform the computation-intensive tasks of
compression, encryption/compression and public key cryptography, providing its
customers with high-performance, interoperable implementations of a wide variety
of industry-standard networking and storage protocols. Hi/fn's products are used
in networking and storage equipment such as routers, remote access
concentrators, firewalls and back-up storage devices.
Hi/fn's encryption/compression and public key processors allow network
equipment vendors to add bandwidth enhancement and security capabilities to
their products. Hi/fn's encryption/compression and public key processor products
provide key algorithms used in 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 can also provide trading partners and others with secure,
authenticated access to the corporate network, increasing productivity through
improved communications. Storage equipment vendors use Hi/fn's compression
processor products to improve the performance and capacity of mid- to high-end
tape back-up systems.
Prior to December 16, 1998, Hi/fn was a majority-owned subsidiary of Stac,
Inc. ("Stac"). On December 16, 1998, Stac distributed all of Hi/fn's outstanding
shares held by Stac to Stac stockholders.
23
<PAGE> 26
RESULTS OF OPERATIONS
The following table sets forth certain statement of operations data as a
percentage of total revenue for the periods indicated.
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED ENDED
SEPTEMBER 30, DECEMBER 31,
-------------------- ------------
1996 1997 1998 1997 1998
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Revenue.................................. 100% 100% 100% 100% 100%
Cost of revenue.......................... 39 33 30 33 30
--- --- --- --- ---
Gross margin............................. 61 67 70 67 70
--- --- --- --- ---
Research and development................. 13 21 25 21 23
Sales and marketing...................... 13 16 16 13 20
General and administrative............... 7 8 11 8 14
--- --- --- --- ---
Total operating expenses................. 33 45 52 42 57
--- --- --- --- ---
Operating income......................... 28 22 18 25 13
Interest income.......................... -- -- -- -- --
--- --- --- --- ---
Income before income taxes............... 28 22 18 25 13
Provision for income taxes............... 11 9 8 10 5
--- --- --- --- ---
Net income............................... 17% 13% 10% 15% 8%
=== === === === ===
</TABLE>
THREE MONTHS ENDED DECEMBER 31, 1998 AND 1997
Revenue. Revenue decreased 2% to $6.1 million for the quarter ended
December 31, 1998 from $6.3 million for the quarter ended December 31, 1997. The
decline in revenue was due primarily to lower sales of semiconductor units to
storage customers, partially offset by higher sales of semiconductors to
networking customers. During the fourth calendar quarter of 1998, sales to the
only storage customer, Quantum Corporation ("Quantum"), represented 58% of total
revenue as compared to 82% of total revenue represented by sales to storage
customers (including Quantum) for the quarter ended December 31, 1997. In the
quarter ended December 31, 1997, storage customers were building inventory,
which was subsequently reduced over the next several quarters. By the fourth
calendar quarter of 1998, storage customers had reduced their inventory levels
and were receiving semiconductor products at a rate which we believe more
closely matched production needs. Revenue from networking customers represented
42% of total revenue in the quarter ended December 31, 1998 as compared to 18%
of total revenue for the quarter ended December 31, 1997. This increase was
attributable to increased shipments of semiconductor products to networking
customers to accommodate their increased installations of network equipment for
VPNs and Internet infrastructure.
Gross Margin. Cost of revenue consists primarily of semiconductors which
were manufactured to Hi/fn's specifications by third parties for resale by
Hi/fn. Gross margin increased to 70% for the quarter ended December 31, 1998
from 66% for the quarter ended December 31, 1997 primarily due to the increase
in the portion of total sales of semiconductors to networking customers.
Semiconductors sold to networking customers
24
<PAGE> 27
typically have been recently introduced and generate higher gross margins than
the older products which are currently sold to customers manufacturing storage
devices.
Research and Development. The cost of product development consists
primarily of salaries, employee benefits, overhead, outside contractors and
non-recurring engineering fees. Such expenses were approximately $1.4 million
and $1.3 million for the quarters ended December 31, 1998 and 1997,
respectively. The increase was due primarily to activities associated with the
development of semiconductor products. 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. However, there can be no assurance that product development
programs invested in by Hi/fn will be successful or that the products resulting
from such programs will achieve market acceptance.
Sales and Marketing. Sales and marketing expenses consist primarily of the
salaries, commissions and benefits of sales, marketing and support personnel,
and consulting, advertising, promotion and overhead expenses. Such expenses were
approximately $1.2 million and $792,000 for the quarters ended December 31, 1998
and 1997, respectively. The increase was due primarily to additional personnel
costs and overhead as Hi/fn prepared for operations as an independent, stand
alone entity following the spin-off from Stac.
General and Administrative. General and administrative expenses are
comprised primarily of salaries for administrative and corporate services
personnel, legal and other professional fees. Such expenses were $866,000 and
$494,000 for the quarters ended December 31, 1998 and 1997, respectively. The
increase was due primarily to additional personnel costs, overhead and fees and
expenses associated with the spin-off from Stac.
Interest Income and Expense. Net interest income was $23,000 for the
quarter ended December 31, 1998 and $5,000 for the quarter ended December 31,
1997. The increase in interest income was due to the higher availability of cash
during the quarter ended December 31, 1998. Interest expense during the quarter
ended December 31, 1998 partially offset the increase in interest income. During
the quarter ended December 31, 1998, Hi/fn entered into a $5.0 million loan
agreement with its former parent company, Stac. The loan will become due and
payable on September 30, 1999 and may be prepaid in whole or part without
penalty. The loan bears interest at the prime rate set by Silicon Valley Bank
plus 0.5% per annum, payable quarterly, and is secured by a first priority
security interest in all of Hi/fn's assets, including Hi/fn's intellectual
property.
Income Taxes. The effective income tax rate for each of the quarters ended
December 31, 1998 and 1997 was 40%.
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
Revenue. Revenue from sales of semiconductors and licenses of software
libraries increased 51% to $21.5 million in 1998 compared to 1997 revenue, and
increased 10% to $14.2 million in 1997 from revenue of $12.9 million in 1996.
The increase in revenue in each of 1998 and 1997 compared to the prior year was
due primarily to increased sales of Hi/fn's data compression processors to
original equipment manufacturer ("OEM") providers of storage devices and
manufacturers of networking equipment. Semiconductor
25
<PAGE> 28
sales to Quantum, an OEM producer of high-performance tape storage devices,
comprised 61%, 70% and 43% of revenue in each of 1998, 1997 and 1996,
respectively.
Gross Margin. Gross margin was 70% in 1998, 67% in 1997, and 61% in 1996.
The increase in gross margin in 1998 from that of 1997 was due primarily to cost
efficiencies achieved through design modifications made to compression
processors. The increase in gross margin in 1997 from that of 1996 was due to
shipments of higher speed compression processors in 1997 that carry higher gross
margins than the compression processors shipped in 1996 and an increase in
licenses of Hi/fn's software libraries which carry relatively high gross
margins.
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
addition of personnel and retention of 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.
Hi/fn expects its investments in research and development to increase in coming
periods on an absolute basis as it continues to develop products targeted at
meeting market needs. However, there can be no assurance that product
development programs invested in by Hi/fn 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 sales and
marketing expenses in 1998 over those of 1997 and in 1997 expense over those of
1996 resulted from the addition of sales and marketing personnel and program
costs intended to increase customer awareness of Hi/fn's products.
General and Administrative. General and administrative expenses were
approximately $2.4 million in 1998, $1.2 million in 1997, and $900,000 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 Hi/fn 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 basis 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 Hi/fn 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 Hi/fn, had Hi/fn been a separate
taxpayer. Amounts due to or from Hi/fn and Stac for income tax payments and
refunds are included in the related party receivable and payable components of
the balance sheet.
QUARTERLY FINANCIAL DATA
The following table sets forth certain unaudited quarterly condensed
statement of operations data for each of the quarters during the fiscal years
ended September 30, 1997 and 1998, and the three months ended December 31, 1998.
In the opinion of management,
26
<PAGE> 29
this information has been prepared substantially on the same basis as the
Financial Statements appearing elsewhere in this prospectus, 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 Financial Statements
and Notes beginning on page F-1 of this prospectus. The operating results for
any quarter are not necessarily indicative of the operating results for any
future period.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------------------------------------------------------------------------------
DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31,
1996 1997 1997 1997 1997 1998 1998 1998 1998
-------- -------- -------- --------- -------- -------- -------- --------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenue..................... $2,067 $3,017 $3,908 $5,234 $6,265 $5,236 $5,012 $5,020 $6,139
Gross margin................ 1,343 1,975 2,719 3,427 4,163 3,674 3,534 3,637 4,321
Operating income............ 199 605 923 1,325 1,551 1,051 528 698 783
Net income.................. $ 118 $ 361 $ 555 $ 799 $ 931 $ 630 $ 291 $ 366 $ 483
====== ====== ====== ====== ====== ====== ====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
AS A PERCENTAGE OF TOTAL REVENUE
--------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenue..................... 100% 100% 100% 100% 100% 100% 100% 100% 100%
Gross margin................ 65 65 70 65 67 70 71 72 70
Operating income............ 10 20 24 25 25 20 11 14 13
Net income.................. 6% 12% 14% 15% 15% 12% 6% 7% 8%
====== ====== ====== ====== ====== ====== ====== ====== ======
</TABLE>
The sequential decline in revenue, 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 Hi/fn's most significant customer, Quantum, and other
non-networking customers. During late 1997 and early 1998, Quantum accumulated
inventories of compression processors that Quantum used during the quarters
ended March 31, 1998 and June 30, 1998. Hi/fn does not believe that Quantum has
purchased processors from alternative sources. Although there can be no
assurance as to Quantum's future purchase levels from Hi/fn, Hi/fn has no
current reason to believe Quantum will obtain an alternative or second source
for such processors.
During the quarters ended March 31, 1998, June 30, 1998, September 30, 1998
and December 31, 1998, Hi/fn'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 -- Our
Operating Results May Fluctuate Significantly."
LIQUIDITY AND CAPITAL RESOURCES
From inception until the spin-off from Stac, Hi/fn depended upon Stac for
financing its operations and capital requirements. In November 1996, Hi/fn and
Stac entered into an Assignment, Assumption and License Agreement (the
"Assignment Agreement") which provided for the transfer of Stac's semiconductor
business to Hi/fn in exchange for 6,000,000 shares of Series A Preferred Stock
and 100 shares of Common Stock of Hi/fn. Concurrent with the transfer of the
semiconductor business, Hi/fn and Stac also entered into a Cross License
Agreement under which Hi/fn granted Stac a limited, worldwide, perpetual,
non-exclusive, non-transferable, royalty-free license to the patents transferred
by Stac to Hi/fn under the Assignment Agreement.
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<PAGE> 30
For the fiscal year ended September 30, 1997, Hi/fn generated approximately
$2.0 million of cash from operations, which was comprised primarily of net
income of approximately $1.8 million (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 fiscal year ended September 30, 1998, Hi/fn generated approximately
$3.1 million of cash from operations, which was comprised primarily of net
income of approximately $2.2 million (increased for adjustments to net income).
Adjustments to net income that increased cash include $726,000 of depreciation
and amortization and approximately $2.4 million 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 $1.7 million net
increase in all other balance sheet assets. Stac's transfer of cash to Hi/fn of
$9.4 million as discussed below, offset by transfers to Stac for centralized
cash management, resulted in a net increase to Hi/fn's cash of approximately
$2.4 million.
On September 28, 1998, Stac paid $4.4 million to Hi/fn, representing
payment in full for all amounts due to Hi/fn from Stac as of September 1, 1998.
Stac also loaned $5.0 million to Hi/fn under a short-term loan that becomes due
and payable on September 30, 1999, but which may be prepaid in whole or part
without penalty. The loan bears interest at the prime rate set by Silicon Valley
Bank plus 0.5% per annum, payable quarterly, and is secured by a first priority
security interest in all of Hi/fn's assets, including Hi/fn's intellectual
property. Hi/fn intends to use a portion of the proceeds from this offering to
repay this loan.
At December 31, 1998, cash and cash equivalents were approximately $8.5
million compared to $10.1 million at September 30, 1998. During the quarter
ended December 31, 1998, $2.1 million was used to pay 1998 income taxes due to
federal and state authorities. During the quarter ended December 31, 1998,
capital expenditures were $193,000. Hi/fn expects capital expenditures in the
foreseeable future to remain at approximately the same level.
Hi/fn uses a number of independent suppliers to manufacture substantially
all of its products. As a result, Hi/fn relies on these suppliers to allocate to
Hi/fn a sufficient portion of foundry capacity to meet Hi/fn's needs and deliver
sufficient quantities of Hi/fn's products on a timely basis. These arrangements
allow Hi/fn 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.
Hi/fn requires substantial working capital to fund its business,
particularly to finance accounts receivable and inventory, and for investments
in property and equipment. Hi/fn's need to raise capital in the future will
depend on many factors including the rate of sales growth, market acceptance of
Hi/fn'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. Hi/fn intends to use its cash balances, cash
from operations and the proceeds from this offering to repay the Stac loan and
to fund its operating and capital needs. Although Hi/fn believes the proceeds
from this offering will be sufficient to fund
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<PAGE> 31
Hi/fn's operating and capital needs for at least 12 months following this
offering, there can be no assurance that additional financing will not be
required or, if required, that additional financing will be available on terms
satisfactory to Hi/fn, if at all.
YEAR 2000 ISSUES
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. Hi/fn 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 Hi/fn's software is
obtained from its vendors on a non-custom basis, Hi/fn believes that upgrades
for its commercial programs are currently available. Hi/fn 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 Hi/fn are not materially affected by the Year 2000 issue,
Hi/fn could be affected by disruptions in the operation of the enterprises with
which Hi/fn interacts or Year 2000 disruptions that affect Hi/fn's customers.
Hi/fn is in the process of completing an assessment of the impact these matters
might have on Hi/fn; and as of December 31, 1998, Hi/fn has completed its
internal and vendor assessments. Hi/fn expects to complete its assessment of its
customers' Year 2000 compliance by the end of June 1999.
To date, Hi/fn's primary focus has been on its own internal systems. Hi/fn
has completed its evaluation of Year 2000 compliance with respect to all of its
computer systems and applications. As a result of this evaluation, Hi/fn 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 was the Windows NT 4.0 Operating System. Hi/fn has since
implemented Service Pack 4, an upgrade to Windows NT 4.0 released by Microsoft,
which makes the operating system Year 2000 compliant. Hi/fn expects to complete
compliance testing by June 30, 1999. Hi/fn has also finished evaluating and
implementing Year 2000 compliant upgrades to 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). 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. Hi/fn has not incurred, nor does it expect to
incur, material costs for the acquisition and implementation of product upgrades
to achieve Year 2000 compliance.
Hi/fn also has reviewed the products it offers to customers. None of the
software or semiconductor products sold by Hi/fn contain any date-specific
information, nor do they rely upon any such information for their operation. As
a result, Hi/fn does not believe that its products will be susceptible to Year
2000 problems.
Hi/fn has had 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 Hi/fn's systems may be affected
by the failure of others to remedy their own Year 2000 issues. To date, Hi/fn
has received written feedback from
29
<PAGE> 32
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. Hi/fn 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 Hi/fn's business,
financial condition and results of operations.
To date, Hi/fn 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, Hi/fn 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 Hi/fn to identify systems that require Year 2000 conversion and
that are critical to Hi/fn's operations or the failure of Hi/fn or others with
which Hi/fn does business to become Year 2000 ready in a timely manner could
have a material adverse effect on Hi/fn's business, financial condition and
results of operations.
Hi/fn has not yet completed the development of a comprehensive Year 2000
contingency plan. However, as part of its Year 2000 effort, Hi/fn regularly
examines information received from external sources for date integrity before
integrating such information into Hi/fn's internal systems. In addition, Hi/fn
has established a plan to increase inventories of certain products by December
1999 if Hi/fn determines there is some risk of interruption of supply from a
third party as a result of Year 2000 compliance issues. This would allow Hi/fn
to continue to supply products to its customers while the third party corrects
its problems. Hi/fn has also incorporated alternatives into the Year 2000
contingency plan it is developing to address the possibility that the software
upgrades described above will not fully resolve Year 2000 compliance issues. If
Hi/fn determines that its business is at material risk of disruption due to
currently unforeseen Year 2000 issues or anticipates that its Year 2000
compliance will not be achieved in a timely fashion, Hi/fn will work to enhance
the Year 2000 contingency plan it develops.
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 Hi/fn's current estimates and are subject to various
uncertainties that could cause the actual results to differ materially from
Hi/fn's expectations. Such uncertainties include, among others, the success of
Hi/fn 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 ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards ("FAS") No. 130, "Reporting Comprehensive
Income," and FAS No. 131, "Disclosures and Segments of an Enterprise and Related
Information," which will be required to be adopted by Hi/fn in fiscal 1999.
Adoption of FAS No. 130 is not expected to have a significant impact on Hi/fn's
financial position, results of operations or cash flows. Adoption of FAS No. 131
is not expected to impact Hi/fn's presentation of its financial statements as
Hi/fn operates in only one segment.
30
<PAGE> 33
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position ("SOP") No. 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use," which will be
required to be adopted by Hi/fn in fiscal 2000. SOP 98-1 requires entities to
capitalize certain costs related to internal-use software once certain criteria
have been met. Adoption of SOP No. 98-1 is not expected to have a significant
impact on Hi/fn's financial position, results of operations or cash flows.
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<PAGE> 34
BUSINESS
OVERVIEW
Hi/fn designs, develops and markets high-performance, multi-protocol packet
processors -- semiconductor devices designed to enable secure, high-bandwidth
network connectivity and efficient storage of business information. Hi/fn's
packet processor products perform the computation-intensive tasks of
compression, encryption/compression and public key cryptography, providing its
customers with high-performance, interoperable implementations of a wide variety
of industry-standard networking and storage protocols. Hi/fn's products are used
in networking and storage equipment such as routers, remote access
concentrators, firewalls and back-up storage devices.
Hi/fn's encryption/compression and public key processors allow network
equipment vendors to add bandwidth enhancement and security capabilities to
their products. Hi/fn's encryption/compression and public key processors provide
key algorithms used in 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 can also provide trading partners and others with secure,
authenticated access to the corporate network, increasing productivity through
improved communications. Storage equipment vendors use Hi/fn's compression
processor products to improve the performance and capacity of mid- to high-end
tape back-up systems.
INDUSTRY BACKGROUND
The dramatic growth in business 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, Hi/fn 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 businesses 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
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<PAGE> 35
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 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 become more broadly adopted,
corporate network managers have begun to demand that network equipment be easier
to deploy and more cost-effective to operate. Network equipment vendors have
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 ("IETF"), the organization responsible for development of network
protocols for the Internet. PPP 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
businesses 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
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<PAGE> 36
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 users 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 businesses use the Internet in place of
leased-lines and dial-up links, they 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.
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 ("IPSec"), which processes packets
prior to being processed by PPP. 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 in the IPSec protocol has the effect of rendering subsequent PPP
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. Hi/fn
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. The initiation of secure
communications between two points in a network involves two processes: the
verification of the identities by each of the communicating parties and the
exchange of encryption keys. The verification step is performed using digital
certificates, an electronic form of identification that each party provides to
the other at the start of the communication process. Both of these processes are
computationally intensive and involve performing computations using very large
numbers, often greater than 150 digits in length. Once the identities of the two
parties are verified and the encryption keys have been exchanged, secure data
packets can be sent and received. When compared to sending and receiving
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
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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
internally develop the semiconductor devices necessary to implement the IPSec
protocol in their products. As a result, Hi/fn 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 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 typically consist of
three key elements: (i) a host interface such as a small computer systems
interface, (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.
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Accordingly, Hi/fn 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 designed to enable secure, high-bandwidth
network connectivity and efficient storage of business information. Hi/fn's
packet processor products perform the computation-intensive tasks of
compression, encryption/compression and public key cryptography, providing its
customers with high-performance, interoperable implementations of a wide variety
of industry-standard networking and storage protocols. Hi/fn believes that its
patented compression technology comprises the fundamental know-how for the
design and implementation of low-cost, high-performance implementations of
lossless data compression and gives its products a strong competitive advantage.
By offering a wide range of price-performance implementations of its patented,
standards-compliant technology, Hi/fn is able to sell products to network and
storage equipment vendors that allow them to reduce development costs and get
their product to market faster.
Hi/fn'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 Hi/fn's patents, developed by Microsoft, is incorporated into
the PPP and PPTP implementations of the Windows 95, 98 and NT operating systems.
Hi/fn offers high-performance compression processors that implement LZS and
MPPC. Hi/fn 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, Hi/fn 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. Hi/fn
also licenses a complete, portable software implementation of the IPSec
protocol, allowing network vendors to get to market more quickly with their VPN
implementations at a fraction of the cost of internal software development
efforts.
Hi/fn's line of compression processors targeted at back-up storage
applications provides storage equipment vendors high-performance implementations
of Hi/fn's patented compression technology, doubling the capacity and
performance of mid- to high-end tape drive systems. Hi/fn's LZS implementation
of Hi/fn's patents is used in the DLT 4000 and DLT 7000 tape drive products from
Quantum. The Adaptive Lossless Data Compression ("ALDC") implementation of
Hi/fn's patents, developed by IBM, is used in a variety of tape storage
products, including the Travan style of quarter-inch cartridge tape drives.
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[HI/FN NETWORKING SOLUTIONS GRAPHIC]
BUSINESS STRATEGY
Hi/fn's objective is to become a leading provider of high-performance,
multi-protocol packet processors that enable its customers to provide products
with enhanced bandwidth and high-performance security capabilities. Key elements
of Hi/fn'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. Hi/fn's 7711 and 7751 encryption
processors, which incorporate compression, encryption and data authentication
capabilities, were designed specifically to allow Hi/fn's network equipment
customers to add high-performance VPN capabilities to their networking products.
Leverage Proprietary Compression Technology. Hi/fn 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. Hi/fn's core compression
technology has been adopted throughout its target markets in a wide variety of
networking and storage standards. Hi/fn believes that its patents provide the
fundamental know-how for the design of high-performance, cost-effective
implementations of lossless compression of data.
Strengthen Presence in the Storage Equipment Market. Hi/fn intends to
continue to emphasize the development of high-performance packet processor
products that serve the
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mid- to high-end back-up storage equipment market. In addition, Hi/fn 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.
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. Hi/fn 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. Hi/fn 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 Hi/fn's patented compression technology have
been specified in a variety of networking and storage protocols. Hi/fn believes
this is due to the wide range of price-performance options available for
integrating Hi/fn's compression technology into equipment vendors' products,
including software implementations and high-performance semiconductor
implementations. Hi/fn believes its early involvement in these standards
activities provides it with insight into and influence over the technical
directions of emerging technologies. As a result, Hi/fn believes it is able to
evaluate market and technical opportunities at early stages in the market
development cycle.
Leverage the Fabless Semiconductor Business Model. Hi/fn intends to
continue to subcontract all of its semiconductor manufacturing. The use of
outside manufacturing partners, a "fabless" business model, allows Hi/fn to
focus substantially all of its resources on the design, development and support
of its products. Hi/fn 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
network and storage equipment vendors, enabling Hi/fn 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, Hi/fn is able to gain insights into its customer's future plans and
needs, identify emerging industry trends and better enable it to deliver high-
performance, cost-effective products.
CUSTOMERS AND PRODUCTS
A number of leading manufacturers of network and storage equipment have
designed products that incorporate Hi/fn's products. To date, Hi/fn 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 Hi/fn's packet
processors or an evaluation board and initiated a product design that
incorporates Hi/fn's packet processors. During the design-in
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process, Hi/fn works with each customer, providing training on Hi/fn'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
Hi/fn will result in demand for Hi/fn's products. See "Risk Factors -- Our
Business Depends Upon The Development Of The Packet Processor Market" and "-- We
Face Risks Associated With Evolving Industry Standards And Rapid Technological
Change."
At December 31, 1998, Hi/fn had a backlog of semiconductor orders
representing $9.8 million of products deliverable to customers over the next 12
months. Because Hi/fn quotes product lead times to customers of approximately
three months, most products shipped during a quarter are ordered during the
previous quarter. Since customers may reschedule or cancel orders, subject to
negotiated windows, orders scheduled for shipment in a quarter may be moved to a
subsequent quarter or cancelled altogether.
Hi/fn's products -- compression processors, encryption/compression
processors, public key 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
Hi/fn's products.
Network Bandwidth Enhancement Products. Hi/fn's 9710, 9711 and 9751 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, multi-history LZS, operating September 1996
at 8 Mbytes/sec
9711 Compression processor, multi-history LZS and MPPC, February 1997
operating at 8 Mbytes/sec
9751 Compression processor, multi-history LZS and MPPC, October 1998
operating at 8 Mbytes/sec, PCI 2.1 interface, DMA
master
LZS221 Compression software, multi-history, LZS offered in November 1995
C source code and other microprocessor-specific
implementations
MPPC Compression software, multi-history, MPPC, offered July 1996
in C source code
</TABLE>
Network Security Products. The Hi/fn 6500 public key processor provides
acceleration of the mathematical computations involved in public key
cryptography, supporting key exchange algorithms (such as the Rivest Shamir
Adelman public key cryptosystem ("RSA"), as developed by RSA Data Security, Inc.
and Diffie-Hellman) as well as digital signature algorithms (such as RSA and the
Digital Signature Algorithm ("DSA")). Hi/fn's 7711 and 7751 high-performance
encryption processors provide essential bandwidth-enhancement and security for
network equipment such as routers, remote access concentrators, switches and
firewalls. The 7711 and 7751 provide a flexible bus interface
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and a variety of memory configuration options to allow adaptation to meet a
variety of network system requirements. The 7711 and 7751 are pin-compatible
with the 9711 and 9751 compression processors, respectively, 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>
6500 Public key processor, RSA and January 1999
Diffie-Hellman key exchange algorithms,
RSA & DSA signature algorithms, random
number generator
7711 Encryption processor, DES/Triple-DES/RC4 October 1997
encryption, LZS/MPPC compression, MD5/
SHA1 data authentication, operating at 8
Mbytes/sec
7751 Encryption processor, DES/Triple-DES/RC4 October 1998
encryption, LZS/MPPC compression, MD5/
SHA1 data authentication, operating at 8
Mbytes/sec, PCI 2.1interface, DMA master
IPSECure IPSEC Source code toolkit, providing packet May 1998
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. Hi/fn'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 history LZS, operating June 1994
at 32 Mbytes/sec
9610 Compression processor, single history LZS, operating May 1997
at 50 Mbytes/sec
</TABLE>
Evaluation Boards. To facilitate the adoption of its semiconductor devices,
Hi/fn designs system-level boards that resemble actual end-products or
subsystems. Hi/fn'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 Hi/fn.
TECHNOLOGY
Hi/fn's multi-protocol packet processors are high-performance compression,
encryption/compression and public key processors that have been designed to meet
the needs of networking and storage equipment vendors. Hi/fn believes that its
patented compression technology, employed in its compression and
encryption/compression processors, gives it a strong competitive advantage. In
addition to core technologies that Hi/fn has developed, Hi/fn has enhanced the
features and functionality of its products through the licensing of certain
technologies from third parties.
Compression Algorithms and Architectures. Hi/fn is the holder of key
patents that cover a wide variety of lossless compression algorithms and their
implementations. Specific
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implementations of Hi/fn's compression patents include the following compression
algorithms: LZS, developed by Stac; MPPC, developed by Microsoft; and ALDC,
developed by IBM. Hi/fn 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, Hi/fn is able to provide compression solutions
over a broad price-performance spectrum.
Encryption, Data Authentication and Public Key Algorithms. Hi/fn 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, Hi/fn 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, Hi/fn also implements public key cryptography algorithms which are
used in a wide variety of network security protocols. Public key cryptography
algorithms implemented by Hi/fn include the RSA and Diffie-Hellman algorithms as
well as the RSA and DSA digital signature algorithms. Hi/fn has licensed the
rights to implement three algorithms of RSA Data Security, Inc. in Hi/fn's
semiconductor products, including the RSA public key cryptosystem and the Rivest
Cipher 4 ("RC4") and Rivest Cipher 5 ("RC5") symmetric key encryption
algorithms.
Integrated, High-Performance Packet Processing. Hi/fn 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 Hi/fn's packet processing functions are expected to support
gigabit speeds in the future.
INTELLECTUAL PROPERTY
Hi/fn's future success and ability to compete are dependent, in part, upon
its proprietary technology. Hi/fn relies in part on patent, trade secret,
trademark, maskwork and copyright law to protect its intellectual property.
Hi/fn owns 12 United States patents and four foreign patents. Hi/fn also has two
pending patent applications in Japan. The issued patents and patent applications
primarily cover various aspects of Hi/fn's compression technology and have
expiration dates ranging from 2006 to 2013. There can be no assurance that any
patents will issue under Hi/fn's current or future patent applications or that
the patents issued under such patent applications will not be invalidated,
circumvented or challenged. There can be no assurance that any patents issued to
Hi/fn will be adequate to safeguard and maintain Hi/fn's proprietary rights, to
deter misappropriation or to prevent an unauthorized third party from copying
Hi/fn's technology, designing around the patents owned by Hi/fn or otherwise
obtaining and using Hi/fn'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 Hi/fn's technology.
In addition, Hi/fn claims copyright protection for certain proprietary
software and documentation. Hi/fn 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 Hi/fn
intends to protect its rights vigorously, there can be no assurance that these
measures will be successful. In addition,
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the laws of certain countries in which Hi/fn's products are or may be
manufactured or sold may not protect Hi/fn's products and intellectual property.
In 1996 and 1997, Hi/fn entered into agreements with RSA Data Security,
Inc., a subsidiary of Security Dynamics, Inc., granting Hi/fn the rights to
implement three encryption algorithms licensed by RSA Data Security, Inc.,
specifically the RSA public key cryptosystem 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.
Under 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.
Under 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, Hi/fn 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 Hi/fn.
Agreement with Motorola. In December 1995, Stac entered into a cross
license and royalty agreement with Motorola. Under this agreement, Motorola
granted Stac and Stac's
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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.
Under 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 Hi/fn 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 whereby 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 continues until all of the
licensed patents have expired. Stac has assigned, and Hi/fn has assumed, all of
Stac's rights and obligations under the Microsoft agreement.
EXPORT RESTRICTIONS ON ENCRYPTION ALGORITHMS
A key element of Hi/fn'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 Hi/fn'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 Hi/fn's network equipment customers in the global market. There
can be no assurance
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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. The sale of Hi/fn's packet
processors could be harmed by the failure of Hi/fn's network equipment customers
to obtain the required licenses or by the costs of compliance. See "-- Sales,
Marketing & Technical Support."
COMPETITION
The networking and storage equipment markets into which Hi/fn 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. Hi/fn expects competition to increase in the future from existing
competitors and from companies that may enter Hi/fn'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 Hi/fn'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 Hi/fn will be able to compete successfully against current and
future competitors or that competitive pressures faced by Hi/fn will not
materially adversely affect Hi/fn's business, financial condition and results of
operations.
Hi/fn's products compete with products from companies such as Analog
Devices, Inc., Information Resource Engineering Inc., IBM, Rainbow Technologies,
Inc., and VLSI Technology, Inc. In 1994, Stac entered into two license
agreements with IBM where Stac granted IBM the right to use, but not sublicense,
Hi/fn's patented compression technology in IBM hardware and software products.
Stac also entered into a license agreement with Microsoft in 1994 whereby Stac
granted Microsoft the right to use, but not sublicense, Hi/fn's compression
technology in their software products. Stac's license agreement with Microsoft,
however, prohibits Microsoft from creating hardware implementations of Hi/fn's
patents. Hi/fn also competes against software solutions that use general purpose
microprocessors to run encryption algorithms and Hi/fn's software compression
libraries. Moreover, Hi/fn's encryption/compression and public key processors
are subject to export control restrictions administered by the U.S. Department
of Commerce, which permit Hi/fn's network equipment customers to export products
incorporating encryption technology only with the appropriate export license. As
a result of these restrictions, sales by foreign competitors facing less
stringent controls on their encryption products could harm the sale of Hi/fn's
encryption/compression and public key processors to network equipment customers
in the global market. In addition, Hi/fn 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. Hi/fn may also face
competition from suppliers of products based on new or emerging technologies.
Furthermore, many of Hi/fn'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 Hi/fn'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
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financial, technical, marketing and other resources than Hi/fn. 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 Hi/fn. In particular, companies such as Intel
Corporation, Lucent Technologies Inc., Motorola, National Semiconductor
Corporation and Texas Instruments Incorporated have proprietary semiconductor
manufacturing ability, preferred vendor status with many of Hi/fn's customers,
extensive marketing power and name recognition, greater financial resources than
Hi/fn and other significant advantages over Hi/fn. 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 Hi/fn
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 Hi/fn's
business, financial condition and results of operations.
Hi/fn believes that important competitive factors in its markets are
price-performance characteristics, rapid technological change, the continued
emergence of new industry standards, 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, reliability, technical service and support and protection
of products by effective utilization of intellectual property laws. The failure
of Hi/fn to successfully develop products that compete successfully with those
of other suppliers in the market would harm Hi/fn's business, financial
condition and results of operations. In addition, Hi/fn must compete for the
services of qualified distributors and sales representatives. To the extent that
Hi/fn'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, Hi/fn's products.
Hi/fn's business, financial condition and results of operations could be harmed
by any failure to maintain and expand its distribution network. See "Risk
Factors -- Our Markets Are Highly Competitive."
RESEARCH AND DEVELOPMENT
Hi/fn'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 Hi/fn's participation in industry organizations and
standards setting bodies such as the IETF.
As of December 31, 1998, Hi/fn's research and development staff consisted
of 28 employees. Hi/fn's research and development expenditures totaled $1.4
million for the quarters ended December 31, 1998 and 1997, respectively. Such
expenses were $5.4 million in the fiscal year ended September 30, 1998 and $3.0
million in the fiscal year ended September 30, 1997, representing 25% and 21% 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
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<PAGE> 48
fabricating chip mask sets and subcontracting costs. Hi/fn performs its research
and product development activities at its facilities in Los Gatos, California
and Carlsbad, California. Hi/fn 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, Hi/fn gained
expertise in the development of software implementations of a wide range of
networking protocol functions, including IPSec and TCP/IP.
Hi/fn'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, Hi/fn 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 Hi/fn'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 Hi/fn.
Hi/fn 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 Hi/fn 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, Hi/fn 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 Hi/fn 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
Hi/fn's business, financial condition and results of operations. See "Risk
Factors -- We Face Risks Associated With Evolving Industry Standards And Rapid
Technological Change."
SALES, MARKETING & TECHNICAL SUPPORT
Hi/fn markets its products through a direct sales and marketing
organization, headquartered in Los Gatos, California, with a sales office in
Boston, and through independent contract sales representatives in the United
States, Europe, Japan and other areas. Hi/fn has also recently hired account
managers to focus on individual customer relationships. Hi/fn 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. Hi/fn's relationships with some of its sales representatives
have been
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<PAGE> 49
established within the last year, and Hi/fn is unable to predict the extent to
which some of these representatives will be successful in marketing and selling
Hi/fn'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, Hi/fn's shipments to international customers are limited to
compression processors and comprehension software. Hi/fn 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 Hi/fn's customer's
products which incorporate Hi/fn's encryption products. There can be no
assurance that Hi/fn will be successful in these efforts and that competitors
outside of the U.S. will not develop encryption products to meet the needs of
Hi/fn's customers, thereby reducing the opportunity for Hi/fn to sell its
products. See "Risk Factors -- Our Products Are Subject To Export Restrictions."
Hi/fn has a number of marketing programs designed to inform network and
storage equipment vendors about the capabilities and benefits of Hi/fn's
products. Hi/fn'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 website, advertising and direct mail
distribution of Hi/fn literature.
Technical support to customers is provided through field and factory
applications engineers and, if necessary, product designers. Local field support
is provided in person or by telephone. Hi/fn 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 Hi/fn's products. Hi/fn 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 Hi/fn's suppliers delivering fully assembled and tested
products based on Hi/fn's proprietary designs. The use of the fabless model
allows Hi/fn to focus substantially all of its resources on determining customer
requirements and on the design, development and support of its products. This
model allows Hi/fn to have significantly reduced capital requirements.
Hi/fn subcontracts its semiconductor manufacturing to Atmel Corporation,
Motorola and Toshiba Corporation. The selection of these manufacturers was based
on the breadth of available technology, quality, manufacturing capacity and
support for design tools used by Hi/fn. None of Hi/fn's products is currently
manufactured by more than one supplier. However, Hi/fn expects that in the event
one of Hi/fn's suppliers notifies Hi/fn that it intends to cease manufacturing a
product, Hi/fn will have an adequate opportunity to order sufficient quantities
of the effected products so that shipments to customers will not be adversely
affected while Hi/fn 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 Hi/fn's technical risks and avoids the risks related to
production capacity constraints typically associated with leading edge
semiconductor processes. This approach allows Hi/fn to focus on providing
differentiated functionality, the primary value-add in Hi/fn's products. Hi/fn's
current main products are manufactured using a .5 micron
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CMOS process. Products under development are being designed for .35 and .25
micron CMOS processes. Hi/fn believes that transitioning its products to
increasingly smaller semiconductor dimensions will be important for Hi/fn 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 for substantially all of its manufacturing, assembly
and test requirements. All of Hi/fn's subcontract manufacturers produce products
for other companies. Hi/fn does not have long-term manufacturing agreements with
any of its subcontract manufacturers. Hi/fn's subcontract manufacturers are not
obligated to supply products to Hi/fn 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.
Hi/fn must place orders approximately 12 to 14 weeks in advance of expected
delivery. As a result, Hi/fn has only a limited ability to react to fluctuations
in demand for its products, which could cause Hi/fn 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 Hi/fn's subcontract manufacturers to allocate available capacity to
customers that are larger or have long-term supply contracts in place. The
inability of Hi/fn to obtain adequate foundry capacity at acceptable prices, or
any delay or interruption in supply, could reduce Hi/fn's product revenue or
increase Hi/fn's cost of revenue and could harm Hi/fn's business, financial
condition and results of operations. See "Risk Factors -- We Depend Upon
Independent Manufacturers And Limited Sources Of Supply."
EMPLOYEES
As of December 31, 1998, Hi/fn employed a total of 58 full-time employees
and two part-time contractors. Of the total number of employees, 26 were
employed in research and development, 19 in sales and marketing, six in
operations and seven in finance and administration. Hi/fn's employees are not
represented by any collective bargaining agreement and Hi/fn has never
experienced a work stoppage. Hi/fn believes its employee relations are good.
Hi/fn'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 applications support personnel with networking product design
expertise. See "Risk Factors -- We Depend Upon Key Personnel."
FACILITIES
Hi/fn's corporate and technical headquarters are currently located in Los
Gatos, California. Hi/fn leases approximately 27,000 square feet of space in Los
Gatos, California under a seven-year lease which expires in August 2005. Hi/fn
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
Hi/fn is not a party to any material legal proceedings.
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MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth certain information concerning the executive
officers and directors of Hi/fn as of December 31, 1998:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Raymond J. Farnham................... 51 President, Chief Executive Officer,
Director and Chairman
William R. Walker.................... 57 Vice President of Finance, Chief Financial
Officer and Secretary
Stephen A. Farnow, Ph.D. ............ 49 Vice President of Operations
Robert C. Harrah..................... 53 Vice President of Sales
Robert A. Monsour.................... 43 Vice President of Marketing
Douglas L. Whiting, Ph.D. ........... 42 Chief Technology Officer and Director
Taher Elgamal, Ph.D.(2).............. 43 Director
Robert W. Johnson(1)................. 49 Director
Albert E. Sisto(1)(2)................ 49 Director
</TABLE>
- -------------------------
(1) Member of the Audit Committee.
(2) Member of the Compensation Committee.
Raymond J. Farnham has served as Chairman of the Board of Directors and
President and Chief Executive Officer of Hi/fn 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 a B.S. in Electrical Engineering from Pennsylvania State University.
William R. Walker has served as Vice President and Chief Financial Officer
of Hi/fn since November 1997. He was Hi/fn'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
Hi/fn 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 a Ph.D. from Stanford University.
Robert C. Harrah has served as Vice President of Sales of Hi/fn since
December 1998. From 1995 to 1998, Mr. Harrah served as Vice President of
Worldwide Sales for the
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Peripheral Technology Solutions Group at Adaptec, Inc. From 1988 to 1995, Mr.
Harrah held marketing management and sales management positions at Symbios Inc.
Mr. Harrah received a B.S. degree from College of Notre Dame in Belmont,
California and an M.B.A. from Golden Gate University in San Francisco,
California.
Robert A. Monsour has served as Vice President of Marketing of Hi/fn 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 at Stac. He
was also Vice President of Product Development from 1990 to 1993, and from 1988
to 1990 he served as 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 Hi/fn
since October 1997 and as a director of Hi/fn since November 1996. He also
served as Vice President of Technology of Stac from 1985 to 1998 and has served
as a director of Stac since 1983. Mr. Whiting will not stand for re-election as
a director at Stac's 1999 annual meeting of stockholders. He was President of
Stac from 1984 to 1986. Dr. Whiting received a Ph.D. in Computer Science from
the California Institute of Technology.
Taher Elgamal, Ph.D. has served as a director of Hi/fn since December 1998.
He has also served as president of Kroll-O'Gara since January 1999. Dr. Elgamal
is the founder and Chairman of Securify, a private company providing assessments
of companies' Internet security efforts and a subsidiary of Kroll-O'Gara. He
served as Chairman and Chief Executive Officer of Securify from March 1998 to
January 1999. From 1995 to 1998, Dr. Elgamal held the position of Chief
Scientist of Netscape Communications Corp., a provider of Internet software and
services, where he pioneered Internet security technologies such as SSL, the
standard for web security. From 1991 to 1993, he served as Director of
Engineering at RSA Data Security, Inc., a provider of encryption technology and
a subsidiary of Security Dynamics Technologies, Inc., where he produced the RSA
cryptographic toolkits, the industry standards for developers of
security-enabled applications and systems. Dr. Elgamal received a Ph.D. from
Stanford University.
Robert W. Johnson 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. Mr. Johnson holds undergraduate and graduate degrees from Stanford
University and Harvard University.
Albert E. Sisto has served as a director of Hi/fn since December 1998.
Since November, 1997, he has been Chief Operating Officer of RSA Data Security,
Inc., a provider of encryption technology and a subsidiary of Security Dynamics
Technologies, Inc. From September 1994 to October 1997, Mr. Sisto was Chairman,
President and CEO of Documagix, a software developer of document imaging
software. Mr. Sisto is a director of Jetfax, Inc., Insignia Solutions plc and
Tekgraf, Inc., all publicly traded technology companies, and also is a director
of nCipher Corporation Ltd. and Trintech Group Ltd. Mr. Sisto holds a B.E.
degree from the Stevens Institute of Technology.
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<PAGE> 53
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information with respect to the
beneficial ownership of Hi/Fn's Common Stock as of December 31, 1998, and as
adjusted to reflect the sale of the Common Stock being offered hereby, by (i)
each of Hi/fn's executive officers and directors, (ii) all of Hi/fn's executive
officers and directors as a group and (iii) the Selling Stockholder. Except as
otherwise noted in the footnotes, the beneficial owners named in the table have
sole voting and investing power with respect to all shares of Common Stock shown
as beneficially owned by them, subject to community property laws where
applicable.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY OWNED SHARES BENEFICIALLY OWNED
PRIOR TO OFFERING NUMBER AFTER OFFERING
------------------------- OF SHARES -------------------------
NAMES OF BENEFICIAL OWNERS NUMBER PERCENT(1) OFFERED NUMBER PERCENT(1)
- -------------------------- ---------- ----------- --------- ---------- -----------
<S> <C> <C> <C> <C> <C>
Microsoft Corporation(2).. 623,177 9.5% 400,000 223,177 2.7%
Robert W. Johnson(3).... 445,823 6.8 -- 445,823 5.5
Douglas L. Whiting(4)... 350,398 5.3 -- 350,398 4.3
Arthur J. Collmeyer(5)... 225,000 3.4 -- 225,000 2.8
Robert A. Monsour....... 130,029 2.0 -- 130,029 1.6
William R. Walker....... 25,000 * -- 25,000 *
Stephen A. Farnow(6).... 40,308 * -- 40,308 *
Raymond J. Farnham(7)... 0 * -- 0 *
Robert C. Harrah........ 0 * -- 0 *
Taher Elgamal........... 0 * -- 0 *
Albert E. Sisto......... 0 * -- 0 *
All executive officers and
directors as a group (10
persons)(6)........... 1,216,558 18.5% -- 1,216,558 14.9%
</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
Securities and Exchange Commission ("SEC") with regard to our Common Sock.
Percentage of beneficial ownership is based on 6,556,781 shares outstanding
as of December 31, 1998, and 8,156,781 shares of Common Stock outstanding
after this offering. Shares of Common Stock subject to options currently
exercisable or exercisable within 60 days of December 31, 1998 are deemed
outstanding for computing the percentage of the beneficial owner holding
such securities, but are not deemed outstanding for computing the percentage
of any other beneficial owner. Except as otherwise indicated, the address of
each of the beneficial owners in this table is as follows: c/o hi/fn, inc.,
750 University Avenue, Los Gatos, California 95032.
(2) The address for Microsoft Corporation is One Microsoft Way, Redmond,
Washington 98052-6399.
(3) Includes 445,823 shares held by Robert W. Johnson Revocable Trust, of which
Mr. Johnson is trustee.
(4) Includes 350,398 shares held by Whiting Family Trust, of which Mr. Whiting
serves as trustee.
(5) Mr. Collmeyer served as President and Chief Executive Officer of Hi/fn until
July 2, 1998. His beneficial ownership includes 56,250 shares held by Mr.
Collmeyer's
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<PAGE> 54
children. Mr. Collmeyer disclaims beneficial ownership of these shares. The
address for Mr. Collmeyer is 350 Bean Avenue, Los Gatos, California, 95030.
(6) Includes options exercisable for 1,558 shares of Common Stock.
(7) On October 28, 1998, Mr. Farnham was granted an option to purchase 375,000
shares of Hi/fn's Common Stock. None of such options are exercisable within
60 days of December 31, 1998.
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<PAGE> 55
DESCRIPTION OF CAPITAL STOCK
Hi/fn is authorized to issue 110,000,000 shares of its capital stock,
consisting of 100,000,000 shares of Common Stock, $.001 par value, and
10,000,000 shares of Preferred Stock, $.001 par value. As of December 31, 1998,
there were 6,556,781 shares of Common Stock outstanding held of record by
approximately 404 stockholders. No shares of Preferred Stock are outstanding and
Hi/fn has no current plans to issue shares of Preferred Stock.
COMMON STOCK
The holders of 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 Common Stock vote together with the
holders of Preferred Stock as one class. Subject to preferences that may be
applicable to any then outstanding shares of Preferred Stock, holders of Common
Stock are entitled to receive ratably such dividends as may be declared by the
Board of Directors out of funds legally available therefore. See "Dividend
Policy." Subject to the rights of creditors and holders of Preferred Stock which
may be outstanding from time to time, holders of Common Stock are entitled, in
the event of Hi/fn's liquidation, dissolution or winding up, to share in the
distribution of all remaining assets. The Common Stock is not subject to any
preemptive rights and is not convertible into any other security. There are also
no redemption or sinking fund provisions applicable to the Common Stock.
PREFERRED STOCK
The Board of Directors has the authority, without further action by the
stockholders, to issue up to 10,000,000 shares of Preferred Stock, from time to
time, in one or more series and to fix the rights, preferences, designations and
powers thereof, including dividend rights, conversion rights, voting rights,
terms of redemption, liquidation preferences, sinking fund terms and the number
of shares constituting any series or the designation of such series, without any
further vote or action by stockholders.
CERTAIN CHARTER AND BYLAW PROVISIONS AND DELAWARE ANTI-TAKEOVER LAW
Certain provisions of Hi/fn's Certificate of Incorporation and Bylaws could
discourage potential acquisition proposals and could delay or prevent a change
in control of Hi/fn. The Certificate of Incorporation and Bylaws provide, among
other things, for a classified Board of Directors and eliminates the right of
stockholders to take action by written consent. The issuance of Preferred Stock
authorized in the Certificate of Incorporation could have the effect of delaying
or preventing a change in control of Hi/fn. Such Preferred Stock could be used
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 Hi/fn or could impede a merger, consolidation,
takeover or other business combination involving Hi/fn. In addition, Hi/fn's
Bylaws provide, among other things, that special meetings of the stockholders
may be called only by the Board of Directors, the Chairman of the Board, the
Chief Executive Officer of Hi/fn or by a person or group of persons representing
at least 10% of the outstanding capital stock of Hi/fn. The Bylaws also include
advance notice procedures with regard to the nomination, other than by the Board
of Directors, of candidates for director elections.
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Hi/fn is also subject to the provisions of Section 203 of the Delaware
General Corporation Law, an anti-takeover law. In general, the statute prohibits
a publicly held Delaware corporation from entering into a "business combination"
with an "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 an 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 Hi/fn's
voting capital stock. The provisions of Hi/fn's Certificate of Incorporation and
Bylaws and Delaware law are intended to encourage potential acquirers to
negotiate with Hi/fn and to allow the Board of Directors 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 Hi/fn, which may have
an adverse effect on Hi/fn's stock price.
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<PAGE> 57
RECENT SPIN-OFF AND RELATIONSHIP WITH STAC
Creation of Hi/fn. Hi/fn was incorporated as a wholly owned subsidiary of
Stac on August 14, 1996 to operate Stac's semiconductor business. On November
21, 1996, Stac transferred its semiconductor business to Hi/fn under the
Assignment Agreement in exchange for 6,000,000 shares of Series A Preferred
Stock and 100 shares of Common Stock of Hi/fn. The 6,000,000 shares of Series A
Preferred Stock were converted into 6,000,000 shares of Common Stock of Hi/fn
prior to the spin-off of Hi/fn from Stac on December 16, 1998. The assets
transferred to Hi/fn included $1.0 million 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. Hi/fn also assumed the accounts payable relating to the semiconductor
business, and current and unpaid payroll and related benefits expenses related
to former Stac employees who became Hi/fn employees.
Concurrent with the transfer of the semiconductor business, Hi/fn and Stac
also entered into a Cross License Agreement under which Hi/fn granted Stac a
limited, worldwide, perpetual, non-exclusive, non-transferable, royalty-free
license to the patents previously transferred by Stac to Hi/fn under the
Assignment Agreement. 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 Hi/fn.
Stac's Spin-Off of Hi/fn. On December 16, 1998, Stac distributed all of
Hi/fn's Common Stock held by Stac to Stac stockholders. The spin-off was
designed to separate the semiconductor business of Hi/fn from the software
business of Stac, and to offer each company the financial flexibility to raise
capital on a more cost-effective basis and create targeted incentives for each
company's management and employees. Prior to the spin-off, Stac received a
letter ruling from the IRS confirming that, among other things, the distribution
of Hi/fn's Common Stock to Stac stockholders would 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).
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 Hi/fn's Common Stock that was distributed to Stac
stockholders on December 16, 1998 and (ii) Stac's adjusted basis of such 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. Furthermore, in connection with the spin-off we entered
into a Tax Allocation and Indemnity Agreement with Stac whereby each of us
agreed that if either party took actions after the spin-off that caused Section
355(e) of the Code to apply to Hi/fn's Common Stock, then whichever party first
caused Section 355(e) of the Code to apply to Hi/fn's Common Stock would be
obligated to bear all taxes of Stac resulting from such action. Under recently
enacted Section 355(e) of the Code, if the spin-off were considered to be part
of a plan or series of related transactions (a "Plan") in which, after the
spin-off, a 50% or greater interest in Hi/fn or Stac was acquired by one or more
persons, the IRS would claim that the spin-off was taxable at the corporate
level. Although neither Hi/fn nor Stac believes the spin-off is part of a Plan
to effect a 50% change in ownership of either Hi/fn or Stac, the IRS has issued
no guidance on the definition of a Plan and for the first two years following
the
55
<PAGE> 58
spin-off, any cumulative 50% change of ownership within the two-year period will
be rebuttably presumed to be the result of a Plan.
Hi/fn's Relationship With Stac After the Spin-Off. As of December 16, 1998,
Stac ceased to own any shares of Hi/fn. In order to provide for an orderly
transition to becoming an independent company, Hi/fn and Stac entered into the
following agreements prior to the spin-off: (i) Distribution Agreement, which
provided for, among other things, the distribution of the Hi/fn Common Stock
held by Stac to Stac stockholders and certain indemnification obligations of
each company to the other; (ii) Employee Benefits Allocation Agreement, which
provided for an allocation of liabilities for employee benefits between Hi/fn
and Stac and set forth formulas for adjustments to Stac options; (iii) Tax
Allocation and Indemnity Agreement whereby Hi/fn and Stac agreed to allocate tax
liabilities that related to periods prior to December 16, 1998; and (iv)
Transitional Services Agreement under which Stac agreed to provide certain
services to Hi/fn on a transitional basis. Hi/fn has since transitioned from all
of Stac's administrative systems other than its financial accounting system.
56
<PAGE> 59
UNDERWRITING
The underwriters named below, acting through their representatives,
BancBoston Robertson Stephens Inc., SoundView Technology Group, Inc. and Thomas
Weisel Partners LLC (the "Representatives"), have severally agreed with Hi/fn
and the Selling Stockholder, subject to the terms and conditions of an
underwriting agreement, to purchase the number of shares of Common Stock set
forth opposite their respective names below. The underwriters are committed to
purchase and pay for all such shares, if any are purchased.
<TABLE>
<CAPTION>
UNDERWRITERS NUMBER OF SHARES
------------ ----------------
<S> <C>
BancBoston Robertson Stephens Inc...................... 800,000
SoundView Technology Group, Inc........................ 700,000
Thomas Weisel Partners LLC............................. 500,000
---------
Total........................................ 2,000,000
---------
</TABLE>
The Representatives have advised Hi/fn and the Selling Stockholder that the
underwriters propose to offer the shares of Common Stock to the public at the
public offering price set forth on the cover page of this prospectus and to
certain dealers at such price less a concession of not more than $1.19 per
share, of which $0.10 may be reallowed to other dealers. After the completion of
this offering, the public offering price, concession and reallowance to dealers
may be reduced by the Representatives. No such reduction shall change the amount
of proceeds to be received by Hi/fn and the Selling Stockholder as set forth on
the cover page of this prospectus.
Over-Allotment Option. Hi/fn has granted to the underwriters an option,
exercisable during the 30-day period after the date of this prospectus, to
purchase up to 300,000 additional shares of Common Stock at the same price per
share as Hi/fn and the Selling Stockholder will receive for the 2,000,000 shares
that the underwriters have agreed to purchase. To the extent that the
underwriters exercise such option, each of the underwriters will have a firm
commitment, subject to certain conditions, to purchase approximately the same
percentage of such additional shares that the number of shares of Common Stock
to be purchased by it shown in the above table represents as a percentage of the
2,000,000 shares offered hereby. If purchased, such additional shares will be
sold by the underwriters on the same terms as those on which the 2,000,000
shares are being sold.
Indemnity. The underwriting agreement contains covenants of indemnity among
the underwriters, Hi/fn and the Selling Stockholder against certain civil
liabilities, including liabilities under the Securities Act and liabilities
arising from breaches of representations and warranties contained in the
underwriting agreement.
Lock-up Agreements. Under the terms of lock-up agreements, each officer and
director and the holders of 1,213,177 shares of Common Stock (including the
Selling Stockholder) have agreed with the Representatives, for a period of 120
days after the date of this prospectus, that, subject to certain exceptions,
they will not contract to sell or otherwise dispose of any shares of Common
Stock, any options to purchase shares of Common Stock or any securities
convertible into, or exchangeable for, shares of Common Stock, owned directly by
such holders or with respect to which they have the power of disposition,
without the prior written consent of BancBoston Robertson Stephens Inc. However,
BancBoston Robertson Stephens Inc. may, in its sole discretion, and at any time
or from time to time, without notice, release all or any portion of the
securities subject to lock-up agreements. All of the shares of Common Stock
subject to the lock-up agreements will be eligible for sale in the public market
upon the expiration of the lock-up agreements, subject to the volume limitations
and other conditions of Rule 144.
57
<PAGE> 60
Future Sales. In addition, Hi/fn has agreed that until 120 days after the
date of this prospectus, Hi/fn will not, without prior written consent of
BancBoston Robertson Stephens Inc., subject to certain exceptions, offer, sell,
contract to sell or otherwise dispose of any shares of Common Stock, any options
to purchase any share of Common Stock or any securities convertible into,
exercisable for or exchangeable for shares of Common Stock other than Hi/fn's
sale of shares in this offering, the issuance of shares of Common Stock upon the
exercise of outstanding options and the grant of options to purchase shares of
Common Stock under existing employee stock option or stock purchase plans.
The underwriters do not intend to confirm sales to any accounts over which
they exercise discretionary authority.
Stabilization. The Representatives have advised Hi/fn that, under
Regulation M of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), certain persons participating in the offering may engage in transactions,
including stabilizing bids, syndicate covering transactions or the imposition of
penalty bids which may have the effect of stabilizing or maintaining the market
price of the Common Stock at a level above that which might otherwise prevail in
the open market. A "stabilizing bid" is a bid for or the purchase of the Common
Stock on behalf of the underwriters for the purpose of fixing or maintaining the
price of the Common Stock. A "syndicate covering transaction" is the bid for or
the purchase of the Common Stock on behalf of the underwriters to reduce a short
position incurred by the underwriters in connection with the offering. A
"penalty bid" is an arrangement permitting the Representatives to reclaim the
selling concession otherwise accruing to an underwriter or syndicate member in
connection with the offering if the Common Stock originally sold by such
underwriter or syndicate member is purchased by the Representatives in a
syndicate covering transaction and has therefore not been effectively placed by
such underwriter or syndicate member. The Representatives have advised Hi/fn
that such transactions may be effected on the Nasdaq National Market or
otherwise and, if commenced, may be discontinued at any time.
Passive Market Making. In connection with this offering, certain
underwriter and selling group members (if any) who are qualified market makers
on the Nasdaq National Market may engage in passive market making transactions
in the Common Stock on the Nasdaq National Market in accordance with Rule 103 of
Regulation M under the Exchange Act, during the business day prior to the
pricing of the offering, before the commencement of offers or sales of the
Common Stock. Passive market makers must comply with applicable volume and price
limitations and must be identified as such. In general, a passive market maker
must display its bid at a price not in excess of the highest independent bid for
such security; if all independent bids are lowered below the passive market
maker's bid, however, such bid must then be lowered when certain purchase limits
are exceeded.
New Underwriter. Thomas Weisel Partners LLC, one of the representatives of
the underwriters, was organized and registered as a broker-dealer in December
1998. Since December 1998, Thomas Weisel Partners LLC has co-managed fifteen
public offerings of equity securities and has acted as an underwriter in an
additional five public offerings of equity securities. Thomas Weisel Partners
LLC does not have any material relationship with us or any of our officers,
directors or controlling persons, except with respect to its contractual
relationship with us pursuant to the underwriting agreement entered into in
connection with this offering.
58
<PAGE> 61
LEGAL MATTERS
The validity of the Common Stock offered by this prospectus will be passed
upon for Hi/fn by Wilson Sonsini Goodrich & Rosati, Professional Corporation,
Palo Alto, California. Certain legal matters relating to this offering will be
passed upon for the underwriters by Brobeck, Phleger & Harrison LLP, Palo Alto,
California.
EXPERTS
The financial statements of hi/fn, inc. as of September 30, 1998 and 1997
and for each of the three years in the period ended September 30, 1998,
appearing in this prospectus and Registration Statement, have been audited by
PricewaterhouseCoopers LLP, independent accountants, as set forth in their
report thereon appearing elsewhere in this prospectus, and are included in
reliance upon such report given upon the authority of such firm as experts in
accounting and auditing.
WHERE YOU CAN FIND ADDITIONAL INFORMATION
We file annual, quarterly and special reports, proxy statements and other
information with the SEC. Our SEC filings are available to the public over the
Internet at the SEC's website at http://www.sec.gov. You may also read and copy
any document we file with the SEC at its Public Reference Room at 450 Fifth
Street, N.W., Washington, D.C. 20549. You can also obtain copies of the
documents at prescribed rates by writing to the Public Reference Section of the
SEC at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call the SEC at
1-800-SEC-0330 for further information on the operation of its Public Reference
Room.
The SEC allows us to "incorporate by reference" into the prospectus the
information we have filed with them. The information incorporated by reference
is an important part of this prospectus and the information that we file
subsequently with the SEC will automatically update this prospectus. The
information incorporated by reference is considered to be part of this
prospectus. We incorporate by reference the documents listed below and any
filings we make with the SEC under Sections 13(a), 13(c), 14, or 15(d) of the
Exchange Act after the initial filing of the registration statement that
contains this prospectus and prior to the time that we sell all the securities
offered by this prospectus:
- Hi/fn's Registration Statement on Form 10 filed with the SEC on August 7,
1998, as amended (excluding pages F-1 through F-15 thereof); and
- Hi/fn's Quarterly Report on Form 10-Q for the quarter ended December 31,
1998.
You may request a copy of these filings, at no cost, by writing or
telephoning Hi/fn at the following address:
hi/fn, inc.
Attention: Secretary
750 University Avenue
Los Gatos, California 95032
(408) 399-3500
59
<PAGE> 62
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-16 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 Jose, California
October 23, 1998, except for Note 1,
which is as of December 16, 1998
F-1
<PAGE> 63
HI/FN, INC.
BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
SEPTEMBER 30,
----------------- DECEMBER 31,
1997 1998 1998
------ ------- ------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................... $ 480 $ 4,084 $ 8,484
Marketable securities....................... -- 5,973 --
Accounts receivable, net.................... 1,823 3,125 2,398
Due from parent............................. 1,507 -- --
Inventories................................. 409 165 409
Deferred income taxes....................... 385 720 720
Prepaid expenses and other current assets... 192 315 751
------ ------- -------
Total current assets................ 4,796 14,382 12,762
Property and equipment, net................. 959 1,615 1,425
Deferred income taxes....................... 95 229 229
Other assets................................ 48 385 357
------ ------- -------
$5,898 $16,611 $14,773
====== ======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable............................ $ 660 $ 1,610 $ 708
Due to parent............................... -- 6,508 --
Notes payable............................... -- -- 5,000
Accrued expenses and other current
liabilities.............................. 616 1,541 1,555
------ ------- -------
Total current liabilities........... 1,276 9,659 7,263
------ ------- -------
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 at September 30,
1997 and 1998 and no shares issued and
outstanding at December 31, 1998......... 6 6 --
Common stock, .001 par value; 100,000,000
shares authorized; 280,799, 483,014 and
6,556,781 shares issued and outstanding
at September 30, 1997 and 1998, and
December 31, 1998, respectively.......... -- -- 7
Paid-in capital............................. 2,783 2,995 3,069
Note receivable from stockholder............ -- (100) (100)
Retained earnings........................... 1,833 4,051 4,534
------ ------- -------
Total stockholders' equity.......... 4,622 6,952 7,510
------ ------- -------
$5,898 $16,611 $14,773
====== ======= =======
</TABLE>
See accompanying notes to financial statements.
F-2
<PAGE> 64
HI/FN, INC.
STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
YEAR ENDED SEPTEMBER 30, DECEMBER 31,
----------------------------- ----------------
1996 1997 1998 1997 1998
------- ------- ------- ------ ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenue....................... $12,894 $14,226 $21,533 $6,265 $6,139
Cost of revenue............... 5,095 4,762 6,525 2,102 1,818
------- ------- ------- ------ ------
Gross margin.................. 7,799 9,464 15,008 4,163 4,321
------- ------- ------- ------ ------
Operating expenses:
Research and development...... 1,641 2,985 5,403 1,326 1,445
Sales and marketing........... 1,677 2,224 3,370 792 1,227
General and administrative.... 889 1,203 2,407 494 866
------- ------- ------- ------ ------
Total operating expenses...... 4,207 6,412 11,180 2,612 3,538
------- ------- ------- ------ ------
Operating income.............. 3,592 3,052 3,828 1,551 783
Interest income............... -- 16 17 5 128
Interest expense.............. -- -- -- -- 105
------- ------- ------- ------ ------
Income before income taxes.... 3,592 3,068 3,845 1,556 806
Provision for income taxes.... 1,441 1,235 1,627 625 323
------- ------- ------- ------ ------
Net income.................... $ 2,151 $ 1,833 $ 2,218 $ 931 $ 483
======= ======= ======= ====== ======
Net income per share, basic... $ 0.36 $ 0.30 $ 0.35 $ 0.15 $ 0.07
======= ======= ======= ====== ======
Net income per share,
diluted..................... $ 0.36 $ 0.30 $ 0.33 $ 0.14 $ 0.07
======= ======= ======= ====== ======
Weighted average shares
outstanding, basic.......... 6,000 6,100 6,308 6,228 6,449
======= ======= ======= ====== ======
Weighted average shares
outstanding, diluted........ 6,000 6,174 6,800 6,707 7,274
======= ======= ======= ====== ======
</TABLE>
See accompanying notes to financial statements.
F-3
<PAGE> 65
HI/FN, INC.
STATEMENT OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED SEPTEMBER 30, DECEMBER 31,
-------------------------- ---------------------
1996 1997 1998 1997 1998
------- ------ ------- ------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net income.................................. $ 2,151 $1,833 $ 2,218 $ 931 $ 483
Adjustments required to reconcile net income
to net cash provided by operating
activities:
Depreciation and amortization............. 68 303 726 100 163
Benefit from deferred income taxes........ (190) (129) (469) -- --
Loss on disposal of property and
equipment............................... -- -- -- -- 220
Gain on sale of marketable securities..... -- -- -- -- (27)
Changes in assets and liabilities:
Accounts receivable....................... 546 (642) (1,302) 357 727
Inventories............................... (554) 299 244 (556) (244)
Prepaid expenses and other current
assets.................................. (5) (186) (123) (160) (436)
Other assets.............................. 1 (44) (614) (166) 28
Accounts payable.......................... 409 60 950 1,070 (902)
Due to parent for general and
administrative allocations.............. 889 420 576 -- --
Accrued expenses and other current
liabilities............................. 446 86 925 170 14
------- ------ ------- ------- -------
Net cash provided by operating
activities......................... 3,761 2,000 3,131 1,746 26
------- ------ ------- ------- -------
Cash flows from investing activities:
(Purchases) sales of marketable
securities................................ -- -- (5,973) -- 6,000
Purchases of property and equipment......... (223) (901) (1,105) (126) (193)
------- ------ ------- ------- -------
Net cash used by investing
activities......................... (223) (901) (7,078) (126) 5,807
------- ------ ------- ------- -------
Cash flows from financing activities:
Issuance of common stock.................... -- 169 112 80 75
Proceeds of loan from parent................ -- -- 5,000 -- --
Proceeds from notes payable................. -- -- -- -- 5,000
Net transfer of funds from (to) parent...... (1,542) (788) 2,439 (1,435) (6,508)
Dividends to parent......................... (1,996) -- -- -- --
------- ------ ------- ------- -------
Net cash provided (used) by financing
activities......................... (3,538) (619) 7,551 (1,355) (1,433)
------- ------ ------- ------- -------
Net increase in cash and cash equivalents..... -- 480 3,604 265 4,400
Cash and cash equivalents at beginning of
period...................................... -- -- 480 480 4,084
------- ------ ------- ------- -------
Cash and cash equivalents at end of period.... $ -- $ 480 $ 4,084 $ 745 $ 8,484
======= ====== ======= ======= =======
Supplemental non-cash financing activities:
Issuance of preferred stock for net assets
contributed................................. $ -- $2,620 $ -- $ -- $ --
======= ====== ======= ======= =======
Settlement of interdivisional accounts........ $ (155) $ -- $ -- $ -- $ --
======= ====== ======= ======= =======
Issuance of common stock for note............. $ -- $ -- $ 100 $ 100 $ --
======= ====== ======= ======= =======
</TABLE>
See accompanying notes to financial statements.
F-4
<PAGE> 66
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................. -- -- -- -- -- (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
Issuance of common stock upon
exercise of options............... 74 1 -- -- 74 -- 75
Conversion of preferred to common
stock............................. 6,000 6 (6,000) (6) -- -- --
Net income.......................... -- -- -- -- -- 483 483
----- --- ------ --- ------ ------- -------
Balance at December 31, 1998
(unaudited)....................... 6,557 $ 7 -- $-- $2,969 $ 4,534 $ 7,510
===== === ====== === ====== ======= =======
</TABLE>
See accompanying notes to financial statements.
F-5
<PAGE> 67
HI/FN, INC.
NOTES TO FINANCIAL STATEMENTS
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") before December 16,
1998. Prior to December 16, 1998, Stac converted the 6,000,000 shares of Series
A Preferred Stock of Hi/fn into 6,000,000 shares of Common Stock of Hi/fn. On
December 16, 1998, Stac distributed all outstanding shares of Hi/fn held by Stac
to Stac stockholders.
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.
F-6
<PAGE> 68
HI/FN, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
All of the allocations and estimates in the financial statements are based
on reasonable assumptions made by the management of Stac and Hi/fn under the
circumstances; however, these allocations and estimates are not necessarily
indicative of the costs and expenses that would have resulted if Hi/fn had been
operated as a separate entity.
NOTE 2 -- DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
OVERVIEW
Hi/fn designs, develops and markets high-performance, multi-protocol packet
processors -- semiconductor devices designed to 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, encryption/compression and public key cryptography, 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 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.
F-7
<PAGE> 69
HI/FN, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
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 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.
F-8
<PAGE> 70
HI/FN, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
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 (IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE
AMOUNTS)
<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>
YEAR ENDED SEPTEMBER 30, 1998 (IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE
AMOUNTS)
<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.
F-9
<PAGE> 71
HI/FN, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
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 (IN THOUSANDS)
<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>
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.
F-10
<PAGE> 72
HI/FN, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30,
----------------
1997 1998
------ ------
(IN THOUSANDS)
<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 (in
thousands):
<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-11
<PAGE> 73
HI/FN, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
The principal components of deferred income tax assets are as follows (in
thousands):
<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 (in thousands):
<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 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 of Series A Preferred Stock was converted
by Stac into one share of Common Stock in connection with the spin-off. See Note
1.
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.
F-12
<PAGE> 74
HI/FN, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
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.
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-13
<PAGE> 75
HI/FN, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
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 (in thousands):
<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................................ $ 0.30 $ 0.35
====== ======
Pro forma.................................. $ 0.28 $ 0.32
====== ======
Net income per share, diluted:
As reported................................ $ 0.30 $ 0.33
====== ======
Pro forma.................................. $ 0.27 $ 0.30
====== ======
</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 0.58 years.
F-14
<PAGE> 76
HI/FN, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
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 (in thousands):
<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.
NOTE 12 -- SUBSEQUENT EVENTS (UNAUDITED)
During the three-month period ended December 31, 1998, the Company entered
into a $5.0 million loan agreement with its former parent company, Stac. The
loan will become due and payable on September 30, 1999 and may be prepaid in
whole or in part without penalty. The loan bears interest at the prime rate set
by Silicon Valley Bank plus 0.5% per annum, payable quarterly, and is secured by
a first priority security interest in all of the Company's assets, including the
Company's intellectual property.
F-15
<PAGE> 77
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-16
<PAGE> 78
GLOSSARY OF TERMS
ALDC (Adaptive Lossless Data Compression) -- A compression method invented
by IBM, for which patents are owned by Hi/fn.
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.
Diffie-Hellman -- The Diffie-Hellman cryptosystem is the oldest public key
system still in use. It was published in 1976. The algorithm allows two
individuals to agree on a shared secret key, over an insecure medium without any
prior secrets.
Digital Subscriber Line (DSL) -- A service 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.
DSA (Digital Signature Algorithm) -- A federal standard developed by the
National Institute of Standards and Technology. Digital signatures are used to
detect unauthorized modifications to data and to authenticate the identity of
the user who generates the signature. In addition, the recipient of signed data
can use a digital signature in proving to a third party that the signature was
in fact generated by the signer of the data. This is known as nonrepudiation
since the signer of data cannot, at a later time, repudiate the signature.
G-1
<PAGE> 79
Encryption -- The process of making data indecipherable to any entity other
than the holder of 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.
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.
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.
G-2
<PAGE> 80
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,
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 three inventors of the
RSA public key encryption system and co-founders of RSA Data Security.
Small Computer Systems Interface -- An interface typically used for
connecting storage devices such as tape drives and disk drives to computer
systems.
SHA1 (Secure Hash Algorithm) -- A data processing algorithm designed to
compute, with great probability, a unique "fingerprint" for a particular set of
data. This type of algorithm is often used in networking protocols to ensure
that transmitted data is not tampered with in transit. This is done by computing
a "fingerprint" for a set of data, sending the data along with the
"fingerprint", after which the receiver can recalculate and verify the received.
Tape Drive -- An electro-mechanical computer peripheral with integrated
electronics that enables the storage of computer data on removable magnetic
media.
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, 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.
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<PAGE> 81
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