<PAGE> 1
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 March 31, 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 [ ] No [X]**
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
At May 10, 1999, 8,595,236 shares of the Registrant's Common Stock, $.001 par
value, were outstanding.
** The Registrant filed a registration statement on Form 10 on December 8, 1998
and became subject to the filing requirements of the Securities Exchange Act
of 1934 on such date. The Registrant filed a Registration Statement on Form
S-3 on March 3, 1999. The Registrant's predecessor, Stac, Inc., has been
subject to the filing requirements of the Securities Exchange Act of 1934 for
the past 90 days.
1
<PAGE> 2
HI/FN, INC.
INDEX TO FORM 10-Q
<TABLE>
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Balance Sheet at March 31, 1999 and September 30, 1998 3
Condensed Statement of Operations for the three months and six months ended
March 31, 1999 and 1998 4
Condensed Statement of Cash Flows for the six months ended March 31,
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 7-22
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 23
Item 4. Submission of Matters to a Vote of Security Holders 23
Item 6. Exhibits and Reports on Form 8-K 23
Signatures 24
</TABLE>
2
<PAGE> 3
ITEM 1. FINANCIAL STATEMENTS
HI/FN, INC.
CONDENSED BALANCE SHEET
(in thousands; unaudited)
<TABLE>
<CAPTION>
March 31, September 30,
1999 1998
---- ----
<S> <C> <C>
ASSETS
Current assets:
Cash & cash equivalents $ 56,553 $ 4,084
Marketable securities -- 5,973
Accounts receivables, net 2,380 3,125
Inventories 708 165
Deferred income taxes 720 720
Prepaid expenses and other current assets 639 315
-------- --------
Total current assets 61,000 14,382
-------- --------
Property and equipment, net 1,733 1,615
Deferred income taxes 229 229
Other assets 332 385
-------- --------
$ 63,294 $ 16,611
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,388 $ 1,610
Due to former parent -- 6,508
Income taxes payable 905 --
Accrued expenses and other current liabilities 1,544 1,541
-------- --------
Total current liabilities 4,837 9,659
-------- --------
Stockholders' equity:
Preferred stock -- 6
Common stock 8 --
Paid in capital 52,313 2,995
Note receivable from stockholder (100) (100)
Retained Earnings 6,236 4,051
-------- --------
Total stockholders' equity 58,457 6,952
-------- --------
-------- --------
$ 63,294 $ 16,611
======== ========
</TABLE>
SEE ACCOMPANYING NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
3
<PAGE> 4
HI/FN, INC.
CONDENSED STATEMENT OF OPERATIONS
(in thousands, except per share amounts; unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------ ----------------
March 31, March 31, March 31, March 31,
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue $ 8,671 $ 5,236 $ 14,810 $ 11,501
Cost of revenue 2,227 1,562 4,045 3,664
-------- -------- -------- --------
Gross margin 6,444 3,674 10,764 7,837
-------- -------- -------- --------
Operating expenses:
Research and development 1,613 1,317 3,058 2,645
Sales and marketing 1,285 713 2,512 1,504
General and administrative 725 593 1,591 1,086
-------- -------- -------- --------
Total operating expenses 3,623 2,623 7,161 5,235
-------- -------- -------- --------
Operating income 2,821 1,051 3,604 2,602
Interest income 125 5 253 11
Interest expense (110) -- (215) --
-------- -------- -------- --------
Income before income taxes 2,836 1,056 3,642 2,613
Provision for income taxes 1,134 426 1,457 1,052
-------- -------- -------- --------
Net income $ 1,702 $ 630 $ 2,185 $ 1,561
======== ======== ======== ========
Net income per share, basic $ 0.25 $ 0.10 $ 0.33 $ 0.25
Net income per share, diluted $ 0.21 $ 0.09 $ 0.28 $ 0.23
Weighted average shares outstanding, basic 6,683 6,285 6,566 6,257
Weighted average shares outstanding, diluted 7,991 6,776 7,690 6,736
</TABLE>
SEE ACCOMPANYING NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
4
<PAGE> 5
HI/FN, INC.
CONDENSED STATEMENT OF CASH FLOWS
(in thousands; unaudited)
<TABLE>
<CAPTION>
Six Months Ended
----------------
March 31, March 31,
1999 1998
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 2,185 $ 1,561
Adjustments required to reconcile to net income
to net cash provided by operating activities:
Depreciation and amortization 403 322
Loss on disposal of property and equipment 220 --
Gain on sale of marketable securities (27) --
Changes in assets and liabilities:
Accounts receivable 745 825
Inventories (543) (267)
Prepaid expenses and other current assets (324) (155)
Other assets (4) (307)
Accounts payable 778 219
Income taxes payable 905 --
Accrued expenses and other current liabilities 3 372
-------- --------
Net cash provided by operating activities 4,341 2,570
-------- --------
Cash flows from investing activities:
Sales of marketable securities 6,000 --
Purchases of property and equipment (684) (308)
Net cash provided by/(used) in investing
-------- --------
Activities 5316 (308)
-------- --------
Cash flows from financing activities:
Issuance of common stock 49,320 195
Proceeds from notes payable 5,000 --
Settlement of notes payable (5,000) --
Stockholder note -- (100)
Net transfer of funds to former parent (6,508) (2,547)
-------- --------
Net cash provided by/(used in) financing 42,812 (2,452)
activities
Net increase/(decrease)in cash and cash equivalents 52,469 (190)
Cash and cash equivalents at beginning of period 4,084 480
-------- --------
-------- --------
Cash and cash equivalents at end of period $ 56,553 $ 290
======== ========
</TABLE>
SEE ACCOMPANYING NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
5
<PAGE> 6
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") have 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 10, as amended. 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 March 31, 1999 and its
results of operations for the three and six month periods ended March 31, 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 six month periods ended March 31,
1999 and 1998 are presented below.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------ ----------------
March 31, 1999 March 31, 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 $1,702 $2,185
Basic EPS 6,683 $0.25 6,566 $0.33
Dilutive 1,308 1,124
Securities
Diluted EPS 7,991 $0.21 7,690 $0.28
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------ ----------------
March 31, 1998 March 31, 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 $630 $1,561
Basic EPS 6,285 $0.10 6,257 $0.25
Dilutive 491 479
Securities
Diluted EPS 6,776 $0.09 6,736 $0.23
</TABLE>
6
<PAGE> 7
Note 3. Balance sheet (in thousands):
Inventories
<TABLE>
<CAPTION>
March 31, September 30,
1999 1998
---- ----
<S> <C> <C>
Finished goods $708 $165
---- ----
$708 $165
==== ====
</TABLE>
Accrued expenses and other current liabilities
<TABLE>
<CAPTION>
March 31, September 30,
1999 1998
---- ----
<S> <C> <C>
Deferred revenue $ 470 $ 697
Compensation and employee 647 489
benefits
Accrued royalties -- 175
Other 427 180
--- ---
$1,544 $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 an equity
offering of 1,600,000 shares of common stock at a price of $33 per share and
raised approximately $49.0 million, net of offering expenses. On April 19, 1999
the Company's underwriters exercised their option to purchase and additional
300,000 shares of the Company's common stock which yielded and 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 10
registration statement filed with the Securities and Exchange Commission, as
amended, in connection with the distribution of Hi/fn's Common Stock held by
Stac, Inc. ("Stac").
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
7
<PAGE> 8
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. 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 Six Months Ended
------------------ ----------------
March 31, March 31, March 31, March 31,
1999 1998 1999 1998
----- ----- ----- -----
<S> <C> <C> <C> <C>
Revenue 100 % 100 % 100 % 100 %
Cost of revenue 26 30 27 32
-- -- -- --
Gross margin 74 70 73 68
-- -- -- --
Operating
expenses:
Research and 19 25 21 23
development
Sales and marketing 15 14 17 13
General and
administrative 8 11 11 9
-- -- -- --
Total operating 42 50 49 45
-- -- -- --
expenses
Operating income 32 20 24 23
Interest income 1 0 1 0
-- -- -- --
Income before income taxes 33 20 25 23
Provision for income taxes 13 8 10 9
-- -- -- --
Net income 20 12 15 14
== == == ==
</TABLE>
Revenue. Revenue increased 66% to $8.7 million for the quarter ended March
31, 1999 from $5.2 million for the quarter ended March 31, 1998. The increase in
revenue was due primarily to higher sales of semiconductor units to storage and
networking customers. Sales to the Company's largest customer, Quantum
Corporation ("Quantum") represented 56% of revenue for the second fiscal quarter
of 1999 compared to 71% of revenue for the second fiscal quarter of 1998. Sales
to the networking customers increases as initial volume production commenced at
a major networking OEM. Revenues for the first six months of fiscal 1999 were
$14.8 million, an increase of 29% from the $11.5 million reported for the first
six months of fiscal 1998. The increase is primarily due to growth in unit sales
to networking customers. In contrast to the growth in sales to networking
customers, semiconductor unit sales to storage customers declined during the
first six months of fiscal 1999.
8
<PAGE> 9
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 74% for the quarter ended March 31, 1999 from
the 70% for the quarter ended March 31, 1998 primarily due to higher margins
associated with networking products and lower unit costs negotiated with
manufacturing partners. Gross margin for the six months ended March 31, 1999
were 73% compared to 68% for the six months ended March 31, 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 expenses were approximately $1.6 million and $1.3 million
for the quarters ended March 31, 1999 and 1998, respectively and $3.1 million
and $2.6 million for the six month periods ended March 31, 1999 and 1998 . 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 $1.3 million and $713,000 for the three month periods ended March
31, 1999 and 1998, respectively and $2.5 million and $1.5 million for the six
month periods ended March 31, 1999 and 1998. The increase is 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 $725,000 and $593,000 for the
three month periods ended March 31, 1999 and1998, respectively and $1.6 million
and $1.1 million for the six month periods ended March 31, 1999 and 1998. The
increase was due primarily to additional personnel costs, overhead and fees and
expenses associated with operating as an independent standalone entity following
the spin-off from Stac.
Interest Income and Expense. Net interest income was $15,000 for the three
month period ended March 31, 1999 and $5,000 for the three month period ended
March 31, 1998. Net interest income was $38,000 and $10,000 for the six months
ended March 31, 1999 and 1998. The increase in interest income 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 is due and payable on September 30, 1999
however may 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 each of the periods ended
March 31, 1999 and 1998 was 40%.
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
March 31, 1999, cash and cash equivalents, and marketable securities were
approximately $56.6 million compared to $10.1 million at September 30, 1998.
During the three month period ended March 31, 1999 the Company issued an equity
offering of 1.6 million shares of common stock at a price of $33 per share and
raised $49.0 million, net of offering expenses. On April 19, 1999 the Company's
underwriters exercised their option to purchase and additional 300,000 shares of
the company's common stock which yielded and additional $9.3 million to the
Company. During the six month period ended March 31, 1999, the company purchased
a total of $684,000 of property and equipment.
The Company uses a number of independent suppliers to manufacture
substantially all of its products. As a result, the Company relies on these
suppliers to allocate to the Company a sufficient portion of foundry capacity to
meet the Company's needs and deliver sufficient quantities of the Company's
products on a timely basis. These
9
<PAGE> 10
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. The Company is in the process
of completing an assessment of the impact these matters might have on the
Company; and as of December 31, 1998, the Company has completed its internal and
vendor assessment. The Company expects to complete its assessment of the
Company's customers' Year 2000 compliance by the end of June 1999.
To date, the Company's primary focus has been on its own internal systems.
The Company has completed its evaluation of Year 2000 compliance with respect to
all of its computer systems and applications. As a result of this evaluation,
the Company has determined that all business critical systems are compliant or
will be made compliant through available product upgrades. In particular, the
only critical application affected 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 expects to complete 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). Lastly, there are
several Dell Systems PC workstations shipped prior to January 1, 1997 that will
require BIOS upgrades to become fully Year 2000 compliant. The Company has not
incurred, nor does it expect to incur, material costs for the acquisition and
implementation of product upgrades to achieve Year 2000 compliance.
The Company also has reviewed the products it offers to customers. None of
the software or 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
10
<PAGE> 11
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.
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 not yet completed the development of a comprehensive Year
2000 contingency plan. However, as part of its Year 2000 effort, the Company
regularly examines information received from external sources for date integrity
before integrating such information into the Company's internal systems. In
addition, the Company has established a plan to increase inventories of certain
products by December 1999 if the Company determines there is some risk of
interruption of supply from a third party as a result of Year 2000 compliance
issues. This would allow the Company to continue to supply products to its
customers while the third party corrects its problems. The Company 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 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 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 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 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.
11
<PAGE> 12
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.
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.
12
<PAGE> 13
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 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:
13
<PAGE> 14
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 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.
14
<PAGE> 15
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.
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.
15
<PAGE> 16
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 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.
16
<PAGE> 17
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
17
<PAGE> 18
o 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.
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.
18
<PAGE> 19
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.
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.
19
<PAGE> 20
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 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.
20
<PAGE> 21
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:
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.
21
<PAGE> 22
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:
o A requirement that certain procedures must be followed before matters can
be proposed for consideration at meetings of our stockholders;
o 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
o 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.
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.
22
<PAGE> 23
Part II. OTHER INFORMATION
ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) Sales of Unregistered Securities. During the period covered by this
report, the Registrant has issued and sold the following unregistered
securities:
1. During the period from October 1, 1998 through December 15, 1998, the
Registrant granted options to purchase an aggregate of 736,775 shares of Common
Stock to an aggregate of 43 directors and employees pursuant to the Registrant's
1996 Equity Incentive Plan in reliance on Rule 701 promulgated under the
Securities Act or an exemption from registration provided by Section 4(2) of the
Securities Act.
2. During the period from October 1, 1998 through December 15, 1998, options to
purchase an aggregate of 43,971 shares of Common Stock were exercised by an
aggregate of 13 directors and employees pursuant to the Registrant's 1996 Equity
Incentive Plan in reliance on Rule 701 promulgated under the Securities Act or
an exemption from registration provided by Section 4(2) of the Securities Act.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On December 7, 1998, stockholders of the Registrant holding 6,223,949 out of
a total of 6,485,910 outstanding shares adopted and approved resolutions by
written consent approving (i) the election of each of Raymond J. Farnham, Robert
W. Johnson, Taher Elgamal, Douglas L. Whiting and Albert E. Sisto as a director
of the Registrant; (ii) the creation of a classified Board of Directors
comprised as follows: (A) Class I, to be reelected in 2000, consisting of
Raymond J. Farnham; (B) Class II, to be reelected in 2001, consisting of Robert
W. Johnson and Taher Elgamal; and (C) Class III, to be reelected in 2002,
consisting of Douglas L. Whiting and Albert E. Sisto; (iii) the amendment and
restatement of the Registrant's Certificate of Incorporation creating a
classified Board of Directors and establishing a new class of Preferred Stock
with the rights, preferences, privileges and restrictions as determined by the
Board of Directors; (iv) the amendment and restatement of the Registrant's 1996
Equity Incentive Plan, which, among other things, included an increase in the
number of shares of Common Stock for which options may be granted under such
plan to 3,049,900 shares; and (v) the adoption of the 1998 Employee Stock
Purchase Plan and the reservation of 400,000 shares of Common Stock thereunder.
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27 Financial Data Schedule
(b) Reports on Form 8-K
None.
ITEMS 1, 3 AND 5 ARE NOT APPLICABLE.
23
<PAGE> 24
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: May 10, 1999 By: /s/ William R. Walker
------------------------------------------
William R. Walker Vice President, Finance,
Chief Financial Officer and Secretary
(principal financial and accounting officer)
24
<PAGE> 25
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit
Number Description
------ -----------
<S> <C>
27 Financial Data Schedule
</TABLE>
25
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> SEP-30-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 56,553
<SECURITIES> 0
<RECEIVABLES> 2,995
<ALLOWANCES> 615
<INVENTORY> 708
<CURRENT-ASSETS> 61,000
<PP&E> 3,181
<DEPRECIATION> 1,448
<TOTAL-ASSETS> 63,294
<CURRENT-LIABILITIES> 4,837
<BONDS> 0
0
0
<COMMON> 8
<OTHER-SE> 58,449
<TOTAL-LIABILITY-AND-EQUITY> 63,294
<SALES> 8,671
<TOTAL-REVENUES> 8,671
<CGS> 2,227
<TOTAL-COSTS> 5,850
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 110
<INCOME-PRETAX> 2,836
<INCOME-TAX> 1,154
<INCOME-CONTINUING> 1,702
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,702
<EPS-PRIMARY> 0.25
<EPS-DILUTED> 0.21
</TABLE>
