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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED June 30 , 1999.
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _____ TO _____
COMMISSION FILE NUMBER 0-24765
HI/FN, INC.
(Exact Name of Registrant as specified in its Charter)
Delaware 33-0732700
(State or other jurisdiction of (IRS Employer
Incorporation or Organization) Identification Number)
750 University Avenue, Los Gatos, California 95032
(Address of principal executive offices and Zip Code)
Registrant's telephone number, including area code: (408) 399-3500
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
At August 10, 1999, 8,660,619 shares of the Registrant's Common Stock,
$.001 par value, were outstanding.
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HI/FN, INC.
INDEX TO FORM 10-Q
<TABLE>
<CAPTION>
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Balance Sheet at June 30, 1999 and September 30, 1998 3
Condensed Statement of Operations for the three months and nine months ended June 30, 1999 and 1998 4
Condensed Statement of Cash Flows for the nine months ended June 30, 1999 and 1998 5
Notes to Condensed Financial Statements 6-7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 7-20
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 21
Signatures 22
</TABLE>
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ITEM 1: FINANCIAL STATEMENTS
HI/FN, INC.
CONDENSED BALANCE SHEET
(in thousands)
<TABLE>
<CAPTION>
June 30, September 30,
1999 1998
-------- --------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash & cash equivalents $ 68,294 $ 4,084
Marketable securities -- 5,973
Accounts receivable, net 3,989 3,125
Inventories 812 165
Deferred income taxes 720 720
Prepaid expenses and other current assets 816 315
-------- --------
Total current assets 74,631 14,382
-------- --------
Property and equipment, net 1,839 1,615
Deferred income taxes 229 229
Other assets 304 385
-------- --------
$ 77,003 $ 16,611
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,911 $ 1,610
Due to parent -- 6,508
Income taxes payable 1,234 --
Accrued expenses and other current liabilities 2,180 1,541
-------- --------
Total current liabilities 5,325 9,659
-------- --------
Stockholders' equity:
Preferred stock -- 6
Common stock 8 --
Paid in capital 61,996 2,995
Note receivable from stockholder -- (100)
Retained earnings 9,674 4,051
-------- --------
Total stockholders' equity 71,678 6,952
-------- --------
$ 77,003 $ 16,611
======== ========
</TABLE>
See accompanying notes to unaudited financial statements
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HI/FN, INC.
CONDENSED STATEMENT OF OPERATIONS
(in thousands, except per share amounts; unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
---------------------------- ---------------------------
June 30, 1999 June 30, 1998 June 30, 1999 June 30, 1998
<S> <C> <C> <C> <C>
Revenue $ 12,514 $ 5,012 $ 27,324 $ 16,513
Cost of revenue 3,045 1,478 7,090 5,142
-------- -------- -------- --------
Gross margin 9,469 3,534 20,234 11,371
-------- -------- -------- --------
Operating expenses:
Research and development 2,066 1,422 5,124 4,065
Sales and marketing 1,702 933 4,214 2,438
General and administrative 755 651 2,346 1,738
-------- -------- -------- --------
Total operating expenses 4,523 3,006 11,684 8,241
-------- -------- -------- --------
Operating income 4,946 528 8,550 3,130
Interest income 783 4 1,036 14
Interest expense 1 -- (214) --
-------- -------- -------- --------
Income before income taxes 5,730 532 9,372 3,144
Provision for income taxes 2,292 241 3,749 1,292
-------- -------- -------- --------
Net income $ 3,438 $ 291 $ 5,623 $ 1,852
======== ======== ======== ========
Net income per share, basic $ 0.40 $ 0.05 $ 0.74 $ 0.29
Net income per share, diluted $ 0.35 $ 0.04 $ 0.65 $ 0.27
Weighted average shares outstanding, basic 8,534 6,333 7,550 6,282
Weighted average shares outstanding, diluted 9,774 6,880 8,682 6,782
</TABLE>
See accompanying notes to unaudited financial statements
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HI/FN, INC.
CONDENSED STATEMENT OF CASH FLOWS
(in thousands; unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
------------------------------
June 30, 1999 June 30, 1998
<S> <C> <C>
Cash flows from operating activities:
Net income $ 5,623 $ 1,852
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization 622 563
Loss on disposal of property and equipment 226 --
Gain on sale of marketable securities (27) --
Changes in assets and liabilities:
Accounts receivable (864) (123)
Inventories (647) 154
Prepaid expenses and other current assets (501) (80)
Other assets (4) (1,207)
Accounts payable 301 297
Income taxes payable 1,234 --
Accrued expenses and other current liabilities 639 963
-------- --------
Net cash provided by operating activities 6,602 2,419
-------- --------
Cash flows from investing activities:
Sales of marketable securities 6,000 --
Purchases of property and equipment (987) (484)
Net cash provided/(used) by investing -------- --------
Activities 5,013 (484)
-------- --------
Cash flows from financing activities:
Issuance of common stock 59,003 212
Proceeds from notes payable 5,000 --
Settlement of notes payable (5,000) --
Stockholder note -- (100)
Settlement of stockholder note 100 --
Net transfer of funds to former parent (6,508) (2,458)
-------- --------
Net cash provided/(used) by financing activities 52,595 (2,346)
-------- --------
Net increase/(decrease) in cash and cash equivalents 64,210 (411)
Cash and cash equivalents at beginning of period 4,084 480
-------- --------
-------- --------
Cash and cash equivalents at end of period $ 68,294 $ 69
======== ========
</TABLE>
See accompanying notes to unaudited financial statements
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HI/FN, INC.
NOTES TO CONDENSED UNAUDITED FINANCIAL STATEMENTS
Note 1. Basis of Presentation:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
The accompanying condensed unaudited financial statements of hi/fn, inc.
("Hi/fn" or the "Company") has been prepared pursuant to the rules and
regulations of the Securities and Exchange Commission regarding interim
financial reporting. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements and should be read in conjunction with the Financial
Statements and notes thereto included in the Company's Registration Statement on
Form S-3 (No. 333-72537). In the opinion of management, the accompanying
condensed unaudited financial statements contain all adjustments, consisting
only of normal recurring items, which the Company believes is necessary for a
fair statement of the Company's financial position as of June 30, 1999 and its
results of operations for the three and nine month periods ended June 30, 1999
and 1998, respectively. These condensed unaudited financial statements are not
necessarily indicative of the results to be expected for the entire year.
Note 2. Net Income 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 for 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. A reconciliation of the numerators and denominators of the basic and
diluted EPS calculations for the three and nine month periods ended June 30,
1999 and 1998 are presented below.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------ -----------------
June 30, 1999 June 30, 1999
(in thousands, except per share amounts)
Per-Share Per-Share
Net Income Shares Amount Net Income Shares Amount
---------- ------ --------- ---------- ------ ---------
<S> <C> <C> <C> <C> <C> <C>
Net Income $3,438 $5,623
Basic EPS 8,534 $0.40 7,550 $0.74
Dilutive Securities 1,240 1,132
----- -----
Diluted EPS 9,774 $0.35 8,682 $0.65
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------ -----------------
June 30, 1998 June 30, 1998
(in thousands, except per share amounts)
Per-Share Per-Share
Net Income Shares Amount Net Income Shares Amount
---------- ------ --------- ---------- ------ ----------
<S> <C> <C> <C> <C> <C> <C>
Net Income $291 $1,852
Basic EPS 6,333 $0.05 6,282 $0.29
Dilutive Securities 547 500
---- ----
Diluted EPS 6,880 $0.04 6,782 $0.27
</TABLE>
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Note 3. Balance sheet:
INVENTORIES (IN THOUSANDS)
<TABLE>
<CAPTION>
June 30, September 30,
1999 1998
-------- --------------
(Unaudited)
<S> <C> <C>
Finished Goods $812 $165
===== ====
</TABLE>
ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES (IN THOUSANDS)
<TABLE>
<CAPTION>
June 30, September 30,
1999 1998
-------- --------------
(Unaudited)
<S> <C> <C>
Deferred revenue 603 697
Compensation and employee 804 489
benefits
Accrued royalties 340 175
Other 433 180
------ ------
$2,180 $1,541
</TABLE>
Note 4. Stac Loan:
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, Inc. which
was due and payable on September 30, 1999, but which could be prepaid in whole
or part without penalty. In March 1999, the entire $5.0 million loan was repaid.
Note 5. Equity Offering
During the three month period ended March 31, 1999 the Company issued 1,600,000
shares of common stock at a price of $33 per share an in an equity offering,
which raised approximately $49.0 million, net of offering expenses. On April 19,
1999 the Company's underwriters exercised their option to purchase an additional
300,000 shares of the Company's common stock, which yielded an additional $9.3
million in proceeds to the Company.
ITEM 2 : MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Certain statements contained in the following Management's Discussion and
Analysis of Financial Condition and Results of Operations, including, without
limitation, statements containing the words "believes," "anticipates,"
"estimates," "expects," and words of similar import, constitute forward-looking
statements which involve risks and uncertainties. Hi/fn's actual results and the
timing of events could differ significantly from those anticipated in these
forward looking statements as a result of the factors set forth under "Trends
and Uncertainties" below. Certain risks are also described in Hi/fn's Form
registration statement on Form S-3 (No. 333-72537) filed with the Securities and
Exchange Commission in February 1999.
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
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Company's products are used in networking and storage equipment such as routers,
remote access concentrators, firewalls and back-up storage devices.
The Company's encryption/compression and public key processors allow
network equipment vendors to add bandwidth enhancement and security capabilities
to their products. The Company'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 the Company's products to
improve the performance and capacity of mid- to high-end tape back-up systems.
Prior to December 16, 1998, the Company was a majority-owned subsidiary of
Stac, Inc. ("Stac"). On December 16, 1998, Stac distributed all of the Company's
outstanding shares held by Stac to Stac stockholders.
RESULTS OF OPERATIONS
The following table sets forth the percentage relationship of certain items
to the Company's revenue during the periods shown.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------------------ ------------------------------
June 30, 1999 June 30, 1998 June 30, 1999 June 30, 1998
<S> <C> <C> <C> <C>
Revenue 100 % 100 % 100 % 100 %
Cost of revenue 24 30 26 31
-- -- -- --
Gross margin 76 70 74 69
-- -- -- --
Operating expenses:
Research and development 17 28 19 25
Sales and marketing 14 19 15 15
General and administrative 6 13 9 11
-- -- -- --
Total operating expenses 37 60 43 50
-- -- -- --
Operating income 39 10 31 19
Interest income/expense (Net) 7 -- 3 0
-- -- -- --
Income before income taxes 46 10 34 19
Provision for income taxes 18 5 14 8
-- -- -- --
Net income 28 5 21 11
== == == ==
</TABLE>
Revenue. Revenue increased 149.7% to $12.5 million for the quarter ended
June 30, 1999 from $5.0 million for the quarter ended June 30, 1998. The
increase in revenue was due primarily to higher sales of semiconductor units to
storage and networking customers. Sales to the networking customers increased
due to higher unit volumes to a major networking OEM. Sales to the Company's
largest customer, Quantum Corporation ("Quantum") represented 47.2% of revenue
for the third fiscal quarter of 1999 compared to 62.2% of revenue for the third
fiscal quarter of 1998. Sales to Quantum increased in absolute dollars even
though they decreased as a percent of total revenue. Revenue for the first nine
months of fiscal 1999 were $27.3 million, an increase of 65.5% from the $16.5
million reported for the first nine months of fiscal 1998. The increase is
primarily due to growth in unit sales to both networking and storage customers.
Gross Margin. Cost of revenue consists primarily of semiconductors which
were manufactured to the Company's specifications by third parties for resale by
the Company. Gross margin increased to 75.7% for the quarter ended June 30, 1999
from the 70.5% for the quarter ended June 30, 1998 primarily due to higher
margins associated with networking products and lower unit costs negotiated with
manufacturing partners. Gross margin for the nine months ended June 30, 1999
were 74.1% compared to 68.9% for the nine months ended
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June 30, 1998. The increase is primarily due to the increased mix of higher
gross margin networking customers during the current fiscal year.
Research and Development. The cost of product development consists
primarily of salaries, employee benefits, overhead, outside contractors and
non-recurring engineering fees. Such research and development expenses were
approximately $2.1 million and $1.4 million for the quarters ended June 30, 1999
and 1998, respectively and $5.1 million and $4.1 million for the nine month
periods ended June 30, 1999 and 1998, respectively. The increase was due
primarily to activities associated with the development of semiconductor
products. The Company 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 the Company
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 $1.7 million and $933,000 for the three month periods ended June
30, 1999 and 1998, respectively, and $4.2 million and $2.4 million for the nine
month periods ended June 30, 1999 and 1998, respectively. The increases for the
three and nine month periods ended June 30, 1999 are due primarily to additional
personnel costs and overhead as the Company operated 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 $755,000 and
$651,000 for the three month periods ended June 30, 1999 and 1998, respectively
and $2.3 million and $1.7 million for the nine month periods ended June 30, 1999
and 1998, respectively. The increases for the three and nine month periods ended
June 30, 1999 are due primarily to additional personnel costs, overhead and fees
and expenses associated with operating as an independent stand-alone entity
following the spin-off from Stac.
Interest Income and Expense. Net interest income was $784,000 for the three
month period ended June 30, 1999 and $4,000 for the three month period ended
June 30, 1998. Net interest income was $822,000 and $14,000 for the nine months
ended June 30, 1999 and 1998. The increase in interest income for the three
month periods ended June 30, 1999 and 1998 was due to the higher availability of
cash during the periods. During the three months ended December 31, 1998, the
Company entered into a $5.0 million loan agreement with its former parent
company, Stac, which was due and payable on September 30, 1999, but which could
be prepaid in whole or part without penalty. In March 1999, the entire $5.0
million loan was repaid.
Income Taxes. The effective income tax rate for nine month periods ended
June 30, 1999 and 1998 was 40% and 41%, respectively.
LIQUIDITY AND CAPITAL RESOURCES
From inception until the spin-off from Stac, in December 1998, the Company
depended upon Stac for financing its operations and capital requirements. At
June 30, 1999, cash and cash equivalents, and marketable securities were
approximately $68.3 million compared to $10.0 million at September 30, 1998.
During the three month period ended March 31, 1999 the Company issued 1,600,000
shares of common stock at a price of $33 per share in an equity offering, which
raised $49.0 million, net of offering expenses. On April 19, 1999, the Company's
underwriters exercised their option to purchase an additional 300,000 shares of
the company's common stock, which yielded an additional $9.3 million to the
Company.
Net cash provided by operating activities was $6.6 million and $2.4 million
for the nine month periods ended June 30, 1999 and 1998, respectively. Net cash
provided by operating activities in each of these periods was primarily the
result of net income before non-cash charges and increases in accounts payable,
income taxes payable and accrued expenses and other liabilities, offset by
increases in accounts receivable, inventories and prepaid expenses and other
assets.
Net cash provided by (used in) investing activities was $5.0 million and
$(484,000) for the nine month periods ended June 30, 1999 and 1998,
respectively. During the nine month period ended June 30, 1999, the company sold
marketable securities totaling $6.0 million, offset by the purchase of $987,000
of property and equipment. Net cash used in investing activities for the nine
month period ended June 30, 1998 was related to the purchase of property and
equipment.
Net cash provided by (used in) financing activities was $52.6 million and
$(2.3) million for the nine month periods ended June 30, 1999 and 1998,
respectively. The net cash provided by financing activities during the nine
month period ended June 30, 1999 was due to the
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proceeds from issuance of common stock, proceeds from notes payable of $5.0
million and proceeds from a stockholder note of $100,000, offset by the
settlement of the notes payable of $5.0 million and net transfer of funds to the
former parent of $6.5 million. Net cash used in financing activities during the
nine month period ended June 30, 1998 was primarily related to the transfer of
funds to the former parent.
The Company uses a number of independent suppliers to manufacture
substantially all of its products. As a result, the Company relies on these
suppliers to allocate to the Company a sufficient portion of foundry capacity to
meet the Company's needs and deliver sufficient quantities of the Company's
products on a timely basis. These arrangements allow the Company to avoid
utilizing its capital resources for manufacturing facilities and work-in-process
inventory and to focus substantially all of its resources on the design,
development and marketing of its products.
The Company requires substantial working capital to fund its business,
particularly to finance accounts receivable and inventory, and for investments
in property and equipment. The Company's need to raise capital in the future
will depend on many factors including the rate of sales growth, market
acceptance of the Company's existing and new products, the amount and timing of
research and development expenditures, the timing and size of acquisitions of
businesses or technologies, the timing of the introduction of new products and
the expansion of sales and marketing efforts.
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. The Company relies on its
systems, applications and devices in operating and monitoring all major aspects
of its business, including financial systems (such as general ledger, accounts
payable and payroll modules), customer services, networks and telecommunications
equipment and end products. Because a large portion of the Company's software is
obtained from its vendors on a non-custom basis, the Company believes that
upgrades for its commercial programs are currently available. The Company also
relies, directly and indirectly, on external systems of business enterprises
such as customers, suppliers, creditors, financial organizations, and of
governmental entities, both domestic and international, for accurate exchange of
data. Even if the internal systems of the Company are not materially affected by
the Year 2000 issue, the Company could be affected by disruptions in the
operation of the enterprises with which the Company interacts or Year 2000
disruptions that affect the Company's customers. As of December 31, 1998, the
Company has completed its internal and vendor assessment. As of June 30, 1999,
the Company has completed its assessment of the Company's customers' Year 2000
compliance. Questionnaires have been sent to and received from the Company's
major customers to ascertain their Year 2000 compliance.
The Company has focused on its internal systems. The Company has completed
its evaluation of Year 2000 compliance with respect to all of its computer
systems and applications. As a result of this evaluation, the Company has
determined that all business critical systems are compliant or will be made
compliant through available product upgrades. In particular, the only critical
application affected was the Windows NT 4.0 Operating System. The Company has
since implemented Service Pack 4, an upgrade to Windows NT 4.0 release by
Microsoft, which makes the operating system Year 2000 compliant. The Company
completed compliance testing by June 30, 1999. The Company 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). The Company has not
incurred, nor does it expect to incur, material costs for the acquisition and
implementation of product upgrades to achieve Year 2000 compliance.
The Company also has reviewed the products it offers to customers. None of
the software or semiconductor products sold by the Company contain any
date-specific information, nor do they rely upon any such information for their
operation. As a result, the Company does not believe that its products will be
susceptible to Year 2000 problems.
The Company has had communications with certain significant third parties
with which it does business to evaluate their Year 2000 compliance plans and
state of readiness and to determine the extent to which the Company's systems
may be affected by the failure of others to remedy their own Year 2000 issues.
To date, the Company has received written feedback from such parties indicating
that they are in the process of implementing measures to ensure Year 2000
compliance, and further representing that they will achieve compliance before
the close of calendar 1999. The Company has not independently confirmed any
information received from other parties with respect to the Year 2000 issues. As
such, there can be no assurance that such other parties will complete their Year
2000 conversion in a timely fashion or will not suffer a Year 2000 business
disruption that may adversely affect the Company's business, financial condition
and results of operations.
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To date, the Company has not identified any system which presents a
material risk of not being Year 2000 ready in a timely fashion or for which a
suitable alternative cannot be implemented. However, the Company may ultimately
identify systems that do present a material risk of Year 2000 disruption. Such
disruption may include, among other things, the inability to process
transactions or information, procure inventory or engage in similar normal
business activities. The failure of the Company to identify systems that require
Year 2000 conversion and that are critical to the Company's operations or the
failure of the Company or others with which the Company does business to become
Year 2000 ready in a timely manner could have a material adverse effect on the
Company's business, financial condition and results of operations.
The Company has completed the development of a comprehensive Year 2000
contingency plan. The contingency plan addresses both logistics and internal
operations. Logistically, the Company has designed manual procedures to insure
continuation of order processing, order fulfillment and order shipment. Internal
contingency plans have been developed for both accounting and communication
functions. Manual procedures have been developed for the accounts receivable,
accounts payable and general ledger functions. Both primary facilities have
alternation outside communication lines, cell phones and overnight parcel
delivery service between sites to insure continued communications. As part of
its Year 2000 effort, the Company also regularly examines information received
from external sources for date integrity before integrating such information
into the Company's internal systems. In addition, the Company has established a
plan to increase inventories of certain products by December 1999 if the Company
determines there is some risk of interruption of supply from a third party as a
result of Year 2000 compliance issues. This would allow the Company to continue
to supply products to its customers while the third party corrects its problems.
The Company has also incorporated alternatives into the Year 2000 contingency
plan it has developed to address the possibility that the software upgrades
described above will not fully resolve Year 2000 compliance issues. If the
Company determines that its business is at material risk of disruption due to
currently unforeseen Year 2000 issues or anticipates that its Year 2000
compliance will not be achieved in a timely fashion, the Company will work to
enhance the Year 2000 contingency plan it has developed.
The discussion above contains certain forward-looking statements. The costs
of the Year 2000 conversion and possible risks associated with the Year 2000
issue are based on the Company's current estimates and are subject to various
uncertainties that could cause the actual results to differ materially from the
Company's expectations. Such uncertainties include, among others, the success of
the Company in identifying systems that are not Year 2000 compliant, the nature
and amount of programming required to upgrade or replace each of the affected
systems, the availability of qualified personnel, consultants and other
resources, and the success of the Year 2000 conversion efforts of others.
MARKET RISK DISCLOSURE
Interest Rate Risk - The Company does not use derivative financial instruments
in its investment portfolio. The Company's investment portfolio is generally
comprised of commercial paper. The Company places investments in instruments
that meet high credit quality standards. These securities are subject to
interest rate risk, and could decline in value if interest rates fluctuate. Due
to the short duration and conservative nature of the Company's investment
portfolio, the Company does not expect any material loss with respect to its
investment portfolio.
Foreign Currency Exchange Rate Risk - All of the Company's sales, cost of
manufacturing and marketing are transacted in US dollars. Accordingly, the
Company's results of operations are not subject to foreign exchange rate
fluctuations. Gains and losses from such fluctuations have not been incurred by
the Company to date.
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 has been adopted by the Company in fiscal 1999. Adoption of
FAS No. 130 did not have a significant impact on the Company's financial
position, results of operations or cash flows. Adoption of FAS No. 131 did not
impact the Company's presentation of its financial statements as the Company
operates in only one segment.
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 the Company 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 the Company's financial position, results of operations or
cash flows.
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TRENDS AND UNCERTAINTIES
In future periods, Hi/fn's business, financial condition and results of
operations may be affected by many factors, including but not limited to the
following:
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. 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:
o General business conditions in our markets as well as global economic
uncertainty;
o Reductions in demand for our customers' products;
o The timing and amount of orders we receive from our customers;
o Cancellations or delays of customer product orders;
o Any new product introductions by us or our competitors;
o Our suppliers increasing costs or changing the delivery of products to us;
o Increased competition or reductions in the prices that we are able to
charge;
o The variety of the products that we sell as well as seasonal demand for our
products; and
o The availability of manufacturing capacity necessary to make our products.
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
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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 any significant customer delays or
fails to pay, our business, financial condition and results of operations could
suffer.
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. This market, which is still emerging, may not grow and if it
does continue to grow, 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:
o Our ability to demonstrate the benefits of our technology to distributors,
original equipment manufacturers and end users; and
o 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:
o Properly identify emerging target markets and related technological trends;
o Develop and maintain competitive products;
o Enhance our products by adding innovative features that differentiate our
products from those of competitors;
o Bring products to market on a timely basis at competitive prices; and
o 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 the Company 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 enhancements to existing products on a timely
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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 that we compete in 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, the U.S.
Department of Commerce requires us to obtain a license. 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 to 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.
We believe that the important competitive factors in our markets are the
following:
o Performance;
o Price;
o The time that is required to develop a new product or enhancements to
existing products;
o The ability to achieve product acceptance with major network and storage
equipment vendors;
o The support that exists for new network and storage standards;
o Features and functionality;
o Adaptability of products to specific applications;
o Reliability; and
o Technical service and support as well as effective intellectual property
protection.
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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.
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, 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 market 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 79%, 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.
Our Success Depends Upon Protecting Our Intellectual Property.
Our proprietary technology is critical to our future success. We rely in
part on patent, trade, trademark, maskwork and copyright law to protect our
intellectual property. We own 12 United States patents and 4 foreign patents. We
also have 2 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.
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 3 to 6 months or more to test our products with
an additional 9 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, Toshiba Corporation and Motorola, Inc. Since we depend upon
independent manufacturers, we do
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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.
We depend on our suppliers to deliver sufficient quantities of finished
product to us in a timely manner. Since we place orders on a purchase order
basis and do not have long-term volume purchase agreements with any of our
suppliers, 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 3 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:
o Adapting our product design, if necessary, to the new manufacturer's
process
o Creating a new mask set to manufacture the product
o Having the new manufacturer prepare sample products so we can verify the
product specification; and
o Providing sample products to customers for qualification.
In general, it takes from 3 to 6 months for a new manufacturer to begin
full-scale production of one of our product. We could have similar or more
protracted problems in the future with existing or new suppliers.
Both Toshiba Corporation and Motorola, Inc. manufacture 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 fails to increase in line with 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 in order 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.
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 would
require us to commit to minimum levels of purchases and which may require
up-front investments. If we fail to effectively assume greater manufacturing
responsibilities or manage volume purchase arrangements, our business, financial
condition and results of operations will suffer.
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:
o Rapidly changing technologies;
o Price-performance enhancements; and
o Product obsolescence.
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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.
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
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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.
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:
o The imposition of governmental controls;
o Export license requirements;
o Restrictions on the export of technology;
o Currency exchange fluctuations;
o Political instability;
o Financial and stock market dislocations;
o Trade restrictions; and
o 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.
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
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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:
o Difficulties in assimilating acquired operations, technologies and
products;
o Diversion of management's attention from other business concerns;
o Risks of entering markets in which we have little or no prior experience;
and
o 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.
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 was 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 were 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.
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:
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o Quarterly variations in operating results;
o Announcements of new products by us or our competitors;
o The gain or loss of significant customers;
o Changes in analysts' estimates;
o Short-selling of our Common Stock; and
o Events affecting other companies that investors deem to be comparable to
us.
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.
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Part II. OTHER INFORMATION
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27 Financial Data Schedule
(b) Reports on Form 8-K
None.
ITEMS 1, 2, 3, 4 AND 5 ARE NOT APPLICABLE.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
hi/fn, inc. (Registrant)
Date: August 10, 1999 By: /s/ William R. Walker
---------------------------------------
William R. Walker Vice President, Finance,
Chief Financial Officer and Secretary
(principal financial and accounting officer)
22
<PAGE> 23
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------ ------------
<S> <C>
27 Financial Data Schedule
</TABLE>
23
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> SEP-30-1999
<PERIOD-START> APR-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 68,294
<SECURITIES> 0
<RECEIVABLES> 4,599
<ALLOWANCES> 670
<INVENTORY> 812
<CURRENT-ASSETS> 74,631
<PP&E> 1,839
<DEPRECIATION> 537
<TOTAL-ASSETS> 77,003
<CURRENT-LIABILITIES> 5,325
<BONDS> 0
0
0
<COMMON> 8
<OTHER-SE> 71,670
<TOTAL-LIABILITY-AND-EQUITY> 77,003
<SALES> 12,514
<TOTAL-REVENUES> 12,514
<CGS> 3,045
<TOTAL-COSTS> 7,568
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1
<INCOME-PRETAX> 5,730
<INCOME-TAX> 2,292
<INCOME-CONTINUING> 3,438
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,438
<EPS-BASIC> .40
<EPS-DILUTED> .35
</TABLE>
