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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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 (I.R.S. Employer Identification No.)
incorporation or organization)
750 UNIVERSITY AVENUE, LOS GATOS, CALIFORNIA 95032
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (408) 399-3500
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $0.001 PAR VALUE
(Title of Class)
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 by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant as of December 10, 1999: $336,590,733 based upon the closing price
reported for such date on the NASDAQ National Market System. For purposes of
this disclosure, shares of Common Stock held by persons who hold more than 5% of
the outstanding shares of Common Stock and shares held by officers and directors
of the Registrant have been excluded in that such persons may be deemed to be
affiliates. This determination of affiliate status is not necessarily
conclusive.
The number of shares outstanding of the Registrant's Common Stock as of December
10, 1999, was 8,751,775.
DOCUMENTS INCORPORATED BY REFERENCE
Parts of the Proxy Statement for Registrant's 2000 Annual Meeting of
Shareholders to be held February 25, 2000 (the "Proxy Statement") are
incorporated by reference into Part III of this Form 10-K Report.
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INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K, the exhibits hereto and the information
incorporated by reference herein contain "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. Forward-looking
statements usually contain the words "estimate," "anticipate," "expect" or
similar expressions. All forward-looking statements are inherently uncertain as
they are based on various expectations and assumptions concerning future events
and they are subject to numerous known and unknown risks and uncertainties.
These uncertainties could cause actual results to differ materially from those
expected for the reasons set forth below under Trends and Uncertainties. Readers
are cautioned not to place undue reliance on these forward-looking statements,
which speak only as of the date hereof. hi/fn, inc. ("Hi/fn") undertakes no
obligation to publicly release any revisions to "forward looking statements" to
reflect events or circumstances after the date of this report is filed with the
Securities and Exchange Commission or to reflect the occurrence of anticipated
events.
PART I
ITEM 1. BUSINESS
OVERVIEW
hi/fn, inc, (the "Company" or "Hi/fn") designs, develops and markets
high-performance, multi-protocol packet processors -- semiconductor devices
designed to enable secure, high-bandwidth network connectivity and efficient
storage of business information. Hi/fn's packet processor products perform the
computation-intensive tasks of compression, encryption/compression and public
key cryptography, providing its customers with high-performance, interoperable
implementations of a wide variety of industry-standard networking and storage
protocols. Hi/fn's products are used in networking and storage equipment such as
routers, remote access concentrators, firewalls and back-up storage devices.
Hi/fn's encryption/compression and public key processors allow network
equipment vendors to add bandwidth enhancement and security capabilities to
their products. Hi/fn's encryption/compression and public key processors provide
key algorithms used in virtual private networks ("VPNs"), which enable
businesses to reduce wide area networking costs by replacing dedicated
leased-lines with lower-cost IP-based networks such as the Internet. Using VPNs,
businesses can also provide trading partners and others with secure,
authenticated access to the corporate network, increasing productivity through
improved communications. Storage equipment vendors use Hi/fn's compression
processor products to improve the performance and capacity of mid- to high-end
tape back-up systems.
INDUSTRY BACKGROUND
The dramatic growth in business use of Internet technology has resulted
in the ability to make information available to anyone, from anywhere and at any
time. An increasingly mobile workforce, increased telecommuting and the need to
connect branch offices, customers, suppliers and other trading partners to the
corporate network, have stressed the capabilities of existing network and
storage infrastructures. To deliver on the economic promise of Internet
technology as a business tool, Hi/fn believes that corporations require two
critical capabilities: secure, high-bandwidth network connectivity among
geographically dispersed constituents and efficient storage of business
information.
THE NEED FOR ENHANCED BANDWIDTH AND SECURITY IN CORPORATE NETWORKS
Data traffic over local and wide area networks ("LANs" and "WANs") is
growing at an unprecedented pace, forcing corporate network managers to upgrade
their network architectures to meet these demands. Traditional network
architectures deployed by businesses to meet these needs include leased-line
connections to branch/remote offices and dial-up Integrated Services Digital
Network (e.g., analog modem and ISDN) connections to support mobile workers and
telecommuters.
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THE HI/FN SOLUTION
Hi/fn designs, develops and markets high-performance, multi-protocol
packet processors -- semiconductor devices designed to enable secure,
high-bandwidth network connectivity and efficient storage of business
information. Hi/fn's packet processor products perform the computation-intensive
tasks of compression, encryption/compression and public key cryptography,
providing its customers with high-performance, interoperable implementations of
a wide variety of industry-standard networking and storage protocols. Hi/fn
believes that its patented compression technology comprises the fundamental
know-how for the design and implementation of low-cost, high-performance
implementations of lossless data compression and gives its products a strong
competitive advantage. By offering a wide range of price-performance
implementations of its patented, standards-compliant technology, Hi/fn is able
to sell products to network and storage equipment vendors that allow them to
reduce development costs and get their product to market faster.
Hi/fn's patented Lempel-Ziv-Stac compression technology ("LZS") is
incorporated into several networking protocol standards, including PPP and the
frame relay protocol, allowing network equipment vendors to rapidly integrate
proven solutions for mitigating the costs associated with traditional private
leased-line network architectures. The Microsoft Point-to-Point ("MPPC")
implementation of Hi/fn's patents, developed by Microsoft, is incorporated into
the PPP and PPTP implementations of the Windows 95, 98 and NT operating systems.
Hi/fn offers high-performance compression processors that implement LZS and
MPPC. Hi/fn also licenses software implementations of LZS and MPPC to
industry-leading network equipment vendors for use in their networking products.
In support of emerging VPN architectures, Hi/fn has produced one of the
industry's first network security processors, integrating the critical functions
of compression, encryption and data authentication in compliance with the IPSec
protocol. This integration allows network equipment vendors to add
highly-integrated, high-performance VPN capabilities to their routers, remote
access concentrators, switches, broadband access equipment and firewalls. Hi/fn
also licenses a complete, portable software implementation of the IPSec
protocol, allowing network vendors to get to market more quickly with their VPN
implementations at a fraction of the cost of internal software development
efforts.
Hi/fn's line of compression processors targeted at back-up storage
applications provides storage equipment vendors high-performance implementations
of Hi/fn's patented compression technology, doubling the capacity and
performance of mid- to high-end tape drive systems. Hi/fn's LZS implementation
of Hi/fn's patents is used in the DLT 4000, DLT 7000 and DLT 8000 tape drive
products from Quantum. The Adaptive Lossless Data Compression ("ALDC")
implementation of Hi/fn's patents, developed by IBM, is used in a variety of
tape storage products, including the Travan style of quarter-inch cartridge tape
drives.
CUSTOMERS AND PRODUCTS
A number of leading manufacturers of network and storage equipment have
designed products that incorporate Hi/fn's products. To date, Hi/fn has secured
several design wins with networking and storage equipment vendors. To qualify as
a design win, an equipment vendor must have ordered samples of Hi/fn's packet
processors or an evaluation board and initiated a product design that
incorporates Hi/fn's packet processors. During the design-in process, Hi/fn
works with each customer, providing training on Hi/fn's products, assisting in
resolving technical questions and providing price and delivery information to
assist the customer in getting its products into volume production. There can be
no assurance that any of the design wins secured by Hi/fn will result in demand
for Hi/fn's products. See "Trends and Uncertainties -- Our Business Depends Upon
The Development Of The Packet Processor Market" and "-- We Face Risks Associated
With Evolving Industry Standards And Rapid Technological Change."
At September 30, 1999, Hi/fn had a backlog of semiconductor orders
representing $18.9 million of products deliverable to customers over the next 6
months. Because Hi/fn quotes product lead times to customers of approximately
three months, most products shipped during a quarter are ordered during the
previous quarter. Since customers may reschedule or cancel orders, subject to
negotiated windows, orders scheduled for shipment in a quarter may be moved to a
subsequent quarter or cancelled altogether. Therefore, backlog is not
necessarily indicative of future sales.
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Hi/fn's products -- compression processors, encryption/compression
processors, public key processors and software -- provide a broad range of
price/performance alternatives for the implementation of secure,
high-performance networks and efficient, high-performance tape storage devices.
Hi/fn also offers evaluation boards to assist customers in the evaluation of
Hi/fn's products.
Network Bandwidth Enhancement Products. Hi/fn's 9710, 9711 and 9751
high-performance compression processors provide essential bandwidth-enhancement
for network equipment such as routers, remote access concentrators, broadband
access equipment and switches. These products provide flexible bus interfaces
and a variety of memory configuration options to allow customers to tailor their
uses to meet a variety of network system requirements. Hi/fn licenses a line of
software compression libraries that provide similar functionality to its line of
compression processor products for low-performance applications such as modems
and ISDN links. The software products are offered in source and object code
toolkits.
Network Security Products. The Hi/fn 6500 public key processor provides
acceleration of the mathematical computations involved in public key
cryptography, supporting key exchange algorithms (such as the Rivest Shamir
Adelman public key cryptosystem ("RSA"), as developed by RSA Data Security, Inc.
and Diffie-Hellman) as well as digital signature algorithms (such as RSA and the
Digital Signature Algorithm ("DSA")). Hi/fn's 7711, 7751 and 7811
high-performance encryption processors provide essential bandwidth-enhancement
and security for network equipment such as routers, remote access concentrators,
switches and firewalls. The 7711, 7751 and 7811 provide a flexible bus interface
and a variety of memory configuration options to allow adaptation to meet a
variety of network system requirements. The 7711, 7751 and 7811 are
pin-compatible with the 9711 and 9751 compression processors, respectively,
providing customers with an easy upgrade path from compression to
encryption/compression. Hi/fn also licenses a portable, source code
implementation of the IPSec protocol.
Storage Enhancement Products. Hi/fn's 9610 and 9732 high-performance
compression processors provide a typical doubling of capacity and performance
for mid- to high-end tape drive products.
Evaluation Boards. To facilitate the adoption of its semiconductor
devices, Hi/fn designs system-level boards that resemble actual end-products or
subsystems. Hi/fn's evaluation boards include basic hardware and software that
enable customers to expedite their designs by using the evaluation boards as a
reference or by incorporating portions of them into their own designs. These
boards are used as evaluation and development vehicles for each semiconductor
device designed by Hi/fn.
TECHNOLOGY
Hi/fn's multi-protocol packet processors are high-performance
compression, encryption/compression and public key processors that have been
designed to meet the needs of networking and storage equipment vendors. Hi/fn
believes that its patented compression technology, employed in its compression
and encryption/compression processors, gives it a strong competitive advantage.
In addition to core technologies that Hi/fn has developed, Hi/fn has enhanced
the features and functionality of its products through the licensing of certain
technologies from third parties.
Compression Algorithms and Architectures. Hi/fn is the holder of key
patents that cover a wide variety of lossless compression algorithms and their
implementations. Specific implementations of Hi/fn's compression patents include
the following compression algorithms: LZS, developed by Stac; MPPC, developed by
Microsoft; and ALDC, developed by IBM. Hi/fn has continued to improve the
performance, functionality and architectures of these compression techniques.
For example, semiconductor implementations of the LZS algorithm have improved in
performance by a factor of 40 in under four years. Through the use of various
architectural implementations of its compression algorithms, Hi/fn is able to
provide compression solutions over a broad price-performance spectrum.
Encryption, Data Authentication and Public Key Algorithms. Hi/fn
develops high-performance implementations of industry standard encryption
algorithms (e.g., DES, Triple-DES and RC4) and data authentication algorithms
(e.g., MD5 and SHA1). Coupled with its patent position in compression, Hi/fn is
positioned to combine compression with encryption and data authentication as
specified in the most widely used network security protocols, such as IPSec and
PPTP. In addition, Hi/fn also implements public key cryptography algorithms
which are used in a wide variety of network security
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protocols. Public key cryptography algorithms implemented by Hi/fn include the
RSA and Diffie-Hellman algorithms as well as the RSA and DSA digital signature
algorithms. Hi/fn has licensed the rights to implement three algorithms of RSA
Data Security, Inc. in Hi/fn's semiconductor products, including the RSA public
key cryptosystem and the Rivest Cipher 4 ("RC4") and Rivest Cipher 5 ("RC5")
symmetric key encryption algorithms.
Integrated, High-Performance Packet Processing. Hi/fn is continuing to
develop additional packet processing functionality, including the implementation
of public key encryption algorithms and increased integration of
computation-intensive security protocol processing functions. Performance
improvements of Hi/fn's packet processing functions are expected to support
gigabit speeds in the future.
INTELLECTUAL PROPERTY
Hi/fn's future success and ability to compete are dependent, in part,
upon its proprietary technology. Hi/fn relies in part on patent, trade secret,
trademark, maskwork and copyright law to protect its intellectual property.
Hi/fn owns 12 United States patents and four foreign patents. Hi/fn also has two
pending patent applications in Japan. The issued patents and patent applications
primarily cover various aspects of Hi/fn's compression technology and have
expiration dates ranging from 2006 to 2013. There can be no assurance that any
patents will issue under Hi/fn's current or future patent applications or that
the patents issued under such patent applications will not be invalidated,
circumvented or challenged. There can be no assurance that any patents issued to
Hi/fn will be adequate to safeguard and maintain Hi/fn's proprietary rights, to
deter misappropriation or to prevent an unauthorized third party from copying
Hi/fn's technology, designing around the patents owned by Hi/fn or otherwise
obtaining and using Hi/fn's products, designs or other information. In addition,
there can be no assurance that others will not develop technologies that are
similar or superior to Hi/fn's technology.
As is typical in the semiconductor industry, Hi/fn may in the future
receive, communications from third parties asserting patents, mask work rights,
intellectual property or copyrights on certain of Hi/fn's products and
technologies. Although Hi/fn is not currently a party to any material
litigation, in the event a third party were to make a valid intellectual
property claim and a license relating to such intellectual property was not
available on commercially reasonable terms, Hi/fn's operating results could be
materially and adversely affected. Litigation, which could result in substantial
cost to Hi/fn and diversion of its resources, may also be necessary to enforce
patents or other intellectual property rights of Hi/fn or to defend Hi/fn
against claimed infringement of the rights of others. The failure to obtain
necessary licenses or the occurrence of litigation relating to patent
infringement or other intellectual property matters could have a material
adverse effect on Hi/fn's business and operating results. There can be no
assurance that the steps taken by Hi/fn to protect its intellectual property
will be adequate to prevent misappropriation or that others will not develop
competitive technologies or products.
In addition, Hi/fn claims copyright protection for certain proprietary software
and documentation. Hi/fn attempts to protect its trade secrets and other
proprietary information through agreements with its customers, suppliers,
employees and consultants, and through other security measures. Although Hi/fn
intends to protect its rights vigorously, there can be no assurance that these
measures will be successful. In addition, the laws of certain countries in which
Hi/fn's products are or may be manufactured or sold may not protect Hi/fn's
products and intellectual property.
EXPORT RESTRICTIONS ON ENCRYPTION ALGORITHMS
A key element of Hi/fn's packet processor architecture is the encryption
algorithms embedded in its semiconductor and software products. These products
are subject to export control restrictions administered by the U.S. Department
of Commerce, which permit Hi/fn's network equipment customers to export products
incorporating encryption technology only with the appropriate export license. In
addition, these U.S. export laws prohibit the export of encryption products to a
number of countries deemed hostile by the U.S. government. U.S. export
regulations regarding the export of encryption technology require either a
transactional export license or the granting of Department of Commerce commodity
jurisdiction. As a result of this regulatory regime, foreign competitors facing
less stringent controls on their products may be able to compete more
effectively than Hi/fn's network equipment customers in the global market. There
can be no assurance that the U.S. government will approve any pending or future
export license requests. Further, there can be no assurance that the list of
products and countries for which export approval is required, or the regulatory
policies with respect thereto, will not be revised from time to time, or that
laws limiting the domestic use of encryption will not be
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enacted. The sale of Hi/fn's packet processors could be harmed by the failure of
Hi/fn's network equipment customers to obtain the required licenses or by the
costs of compliance. See "Sales, Marketing & Technical Support."
COMPETITION
The networking and storage equipment markets into which Hi/fn sells its
products are intensely competitive and are subject to frequent product
introductions with improved price-performance characteristics, rapid
technological change, unit price erosion and the continued emergence of new
industry standards. The semiconductor industry is also intensely competitive and
is characterized by rapid technological change, product obsolescence and unit
price erosion. Hi/fn expects competition to increase in the future from existing
competitors and from companies that may enter Hi/fn's existing or future
markets, including certain customers, with similar or substitute solutions that
may be less costly or provide better performance or features than Hi/fn's
products. To be successful in the future, Hi/fn must continue to respond
promptly and effectively to changing customer performance, feature and pricing
requirements, technological change and competitors' innovations. There can be no
assurance that Hi/fn will be able to compete successfully against current and
future competitors or that competitive pressures faced by Hi/fn will not
materially adversely affect Hi/fn's business, financial condition and results of
operations.
Hi/fn's products compete with products from companies such as Analog
Devices, Inc., Information Resource Engineering Inc., IBM, Rainbow Technologies,
Inc., and VLSI Technology, Inc. In 1994, Stac entered into two license
agreements with IBM where Stac granted IBM the right to use, but not sublicense,
Hi/fn's patented compression technology in IBM hardware and software products.
Stac also entered into a license agreement with Microsoft in 1994 whereby Stac
granted Microsoft the right to use, but not sublicense, Hi/fn's compression
technology in their software products. Stac's license agreement with Microsoft,
however, prohibits Microsoft from creating hardware implementations of Hi/fn's
patents. Hi/fn also competes against software solutions that use general purpose
microprocessors to run encryption algorithms and Hi/fn's software compression
libraries. Moreover, Hi/fn's encryption/compression and public key processors
are subject to export control restrictions administered by the U.S. Department
of Commerce, which permit Hi/fn's network equipment customers to export products
incorporating encryption technology only with the appropriate export license. As
a result of these restrictions, sales by foreign competitors facing less
stringent controls on their encryption products could harm the sale of Hi/fn's
encryption/compression and public key processors to network equipment customers
in the global market. In addition, Hi/fn expects significant future competition
from major domestic and international semiconductor suppliers. Several
established electronics and semiconductor suppliers have recently entered or
indicated an intent to enter the network equipment market. Hi/fn may also face
competition from suppliers of products based on new or emerging technologies.
Furthermore, many of Hi/fn's existing and potential customers internally develop
ASICs, general purpose microprocessors and other devices which attempt to
perform all or a portion of the functions performed by Hi/fn's products.
Many of Hi/fn's current and potential competitors have longer operating
histories, greater name recognition, access to larger customer bases and
significantly greater financial, technical, marketing and other resources than
Hi/fn. As a result, they may be able to adapt more quickly to new or emerging
technologies and changes in customer requirements or to devote greater resources
to the promotion and sale of their products than Hi/fn. In particular, companies
such as Intel Corporation, Lucent Technologies Inc., Motorola, National
Semiconductor Corporation and Texas Instruments Incorporated have proprietary
semiconductor manufacturing ability, preferred vendor status with many of
Hi/fn's customers, extensive marketing power and name recognition, greater
financial resources than Hi/fn and other significant advantages over Hi/fn. In
addition, current and potential competitors may determine, for strategic reasons
to consolidate, to lower the price of their products substantially or to bundle
their products with other products. Current and potential competitors have
established or may establish financial or strategic relationships among
themselves or with existing or potential customers, resellers or other third
parties. Accordingly, it is possible that new competitors or alliances among
competitors could emerge and rapidly acquire significant market share. There can
be no assurance that Hi/fn will be able to compete successfully against current
and future competitors. Increased competition may result in price reductions,
reduced gross margins and loss of market share, any of which could materially
adversely affect Hi/fn's business, financial condition and results of
operations.
Hi/fn believes that important competitive factors in its markets are
price-performance characteristics, rapid technological change, the continued
emergence of new industry standards, length of development cycle, design wins
with major network and storage equipment vendors, support for new network and
storage standards, features and functionality,
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adaptability of products to specific applications, reliability, technical
service and support and protection of products by effective utilization of
intellectual property laws. The failure of Hi/fn to successfully develop
products that compete successfully with those of other suppliers in the market
would harm Hi/fn's business, financial condition and results of operations. In
addition, Hi/fn must compete for the services of qualified distributors and
sales representatives. To the extent that Hi/fn's competitors offer such
distributors or sales representatives more favorable terms on a higher volume of
business, such distributors or sales representatives may decline to carry, or
discontinue carrying, Hi/fn's products. Hi/fn's business, financial condition
and results of operations could be harmed by any failure to maintain and expand
its distribution network. See "Trends and Uncertainties -- Our Markets Are
Highly Competitive."
RESEARCH AND DEVELOPMENT
Hi/fn's success will depend to a substantial degree upon its ability to
develop and introduce in a timely fashion new products and enhancements to its
existing products that meet changing customer requirements and emerging industry
standards. Hi/fn has made and plans to continue to make substantial investments
in research and development. Extensive product development input is obtained
from customers and through Hi/fn's participation in industry organizations and
standards setting bodies such as the IETF ("Internet Engineering Task Force").
As of September 30, 1999, Hi/fn's research and development staff
consisted of 55 employees. Hi/fn's research and development expenditures were
$8.1 million in the fiscal year ended September 30, 1999, $5.4 million in the
fiscal year ended September 30, 1998 and $3.0 million in the fiscal year ended
September 30, 1997, representing 19%, 25% and 21% of revenues for such periods,
respectively. Research and development expenses primarily consist of salaries
and related costs of employees engaged in ongoing research, design and
development activities, costs of fabricating chip mask sets and subcontracting
costs. Hi/fn performs its research and product development activities at its
facilities in Los Gatos, California and Carlsbad, California. Hi/fn is seeking
to hire additional skilled development engineers.
In April 1998, Hi/fn acquired a software implementation of the IPSec
protocol from CyLAN Technologies, Inc. As part of the acquisition, Hi/fn gained
expertise in the development of software implementations of a wide range of
networking protocol functions, including IPSec and TCP/IP.
Hi/fn's future performance depends on a number of factors, including its
ability to identify emerging technological trends in its target markets, develop
and maintain competitive products, enhance its products by adding innovative
features that differentiate its products from those of its competitors, bring
products to market on a timely basis at competitive prices, properly identify
target markets and respond effectively to new technological changes or new
product announcements by others. In evaluating new product decisions, Hi/fn must
anticipate well in advance the future demand for product features and
performance characteristics, as well as available supporting technologies,
manufacturing capacity, industry standards and competitive product offerings. No
assurance can be given that Hi/fn's design and introduction schedules for any
additions and enhancements to its existing and future products will be able to
be sold at prices that are favorable to Hi/fn.
Hi/fn must also continue to make significant investments in research and
development in order to continue enhancing the performance and functionality of
its products to keep pace with competitive products and customer demands for
improved performance, features and functionality. The technical innovations
required for Hi/fn to remain competitive are inherently complex and require long
development cycles. Such innovations must be completed before developments in
networking technologies or standards render them obsolete and must be
sufficiently compelling to induce network and storage equipment vendors to favor
them over alternative technologies. Moreover, Hi/fn must generally incur
substantial research and development costs before the technical feasibility and
commercial viability of a product line can be ascertained.
There can be no assurance that revenues from future products or product
enhancements will be sufficient to recover the development costs associated with
such products or enhancements or that Hi/fn will be able to secure the financial
resources necessary to fund future development. The failure to successfully
develop new products on a timely basis could have a material adverse affect on
Hi/fn's business, financial condition and results of operations. See "Trends and
Uncertainties -- We Face Risks Associated With Evolving Industry Standards And
Rapid Technological Change."
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SALES, MARKETING & TECHNICAL SUPPORT
Hi/fn markets its products through a direct sales and marketing
organization, headquartered in Los Gatos, California, with a sales office in
Massachusetts, Colorado and North Carolina, and through independent contract
sales representatives in the United States, Europe, Japan and other areas. Hi/fn
has also recently hired account managers to focus on individual customer
relationships. Hi/fn does not have any foreign operations and sales of its
products to foreign companies, other than product shipments to contract
manufacturers of domestic customers, have not been material. Sales
representatives are selected for their understanding of the marketplace and
their ability to provide effective field sales support for Hi/fn's products.
Hi/fn's relationships with some of its sales representatives have been
established within the last year, and Hi/fn is unable to predict the extent to
which some of these representatives will be successful in marketing and selling
Hi/fn's products.
Sales to U.S. customers account for the substantial majority of Hi/fn's
revenues. Due to the export controls imposed on encryption products by the U.S.
government, Hi/fn's shipments to international customers are limited to
compression processors and comprehension software. Hi/fn is actively working
with its network equipment customers and the National Security Agency to comply
with U.S. export controls to facilitate the export of Hi/fn's customer's
products which incorporate Hi/fn's encryption products. There can be no
assurance that Hi/fn will be successful in these efforts and that competitors
outside of the U.S. will not develop encryption products to meet the needs of
Hi/fn's customers, thereby reducing the opportunity for Hi/fn to sell its
products. See "Trends and Uncertainties -- Our Products Are Subject To Export
Restrictions."
Hi/fn has a number of marketing programs designed to inform network and
storage equipment vendors about the capabilities and benefits of Hi/fn's
products. Hi/fn's marketing efforts include participation in industry trade
shows, technical conferences, preparation of competitive analyses, sales
training, publication of technical and educational articles in industry
journals, maintenance of Hi/fn's website, advertising and direct mail
distribution of Hi/fn literature.
Technical support to customers is provided through field and factory
applications engineers and, if necessary, product designers. Local field support
is provided in person or by telephone. Hi/fn believes that providing customers
with comprehensive product service and support is critical to maintaining a
competitive position in the market and is critical to shortening the time
required to design in Hi/fn's products. Hi/fn works with its customers to
monitor the performance of its product designs and to provide support at each
stage of customer product development.
MANUFACTURING
Currently, Hi/fn subcontracts all of its semiconductor manufacturing on
a turnkey basis, with Hi/fn's suppliers delivering fully assembled and tested
products based on Hi/fn's proprietary designs. The use of the fabless model
allows Hi/fn to focus substantially all of its resources on determining customer
requirements and on the design, development and support of its products. This
model allows Hi/fn to have significantly reduced capital requirements.
Hi/fn subcontracts its semiconductor manufacturing to Atmel Corporation,
Motorola and Toshiba Corporation. The selection of these manufacturers was based
on the breadth of available technology, quality, manufacturing capacity and
support for design tools used by Hi/fn. None of Hi/fn's products is currently
manufactured by more than one supplier. However, Hi/fn expects that in the event
one of Hi/fn's suppliers notifies Hi/fn that it intends to cease manufacturing a
product, Hi/fn will have an adequate opportunity to order sufficient quantities
of the effected products so that shipments to customers will not be adversely
affected while Hi/fn qualifies a new manufacturer.
At any given time, Hi/fn uses mainstream processes for the manufacture
of its products, avoiding dependence on the latest process technology available.
This approach reduces Hi/fn's technical risks and avoids the risks related to
production capacity constraints typically associated with leading edge
semiconductor processes. This approach allows Hi/fn to focus on providing
differentiated functionality, the primary value-add in Hi/fn's products. Hi/fn's
current main products are manufactured using a .5 micron CMOS process. Products
under development are being designed for .35 and .25 micron CMOS processes.
Hi/fn believes that transitioning its products to increasingly smaller
semiconductor dimensions will be important for Hi/fn to remain competitive. No
assurance can be given that future process migration will be achieved without
difficulty.
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Hi/fn intends to continue for the foreseeable future to rely on its
subcontract manufacturers for substantially all of its manufacturing, assembly
and test requirements. All of Hi/fn's subcontract manufacturers produce products
for other companies. Hi/fn does not have long-term manufacturing agreements with
any of its subcontract manufacturers. Hi/fn's subcontract manufacturers are not
obligated to supply products to Hi/fn for any specific period, in any specific
quantity or at any specific price, except as may be provided in a particular
purchase order that has been accepted by one of its subcontract manufacturers.
Hi/fn must place orders approximately 12 to 14 weeks in advance of
expected delivery. As a result, Hi/fn has only a limited ability to react to
fluctuations in demand for its products, which could cause Hi/fn to have an
excess or a shortage of inventory of a particular product. Failure of worldwide
semiconductor manufacturing capacity to rise along with a rise in demand could
result in Hi/fn's subcontract manufacturers allocating available capacity to
customers that are larger or have long-term supply contracts in place. The
inability of Hi/fn to obtain adequate foundry capacity at acceptable prices, or
any delay or interruption in supply, could reduce Hi/fn's product revenue or
increase Hi/fn's cost of revenue and could harm Hi/fn's business, financial
condition and results of operations. See "Trends and Uncertainties -- We Depend
Upon Independent Manufacturers And Limited Sources Of Supply."
EMPLOYEES
As of September 30, 1999 Hi/fn employed a total of 96 full-time
employees. Of the total number of employees, 55 were employed in research and
development, 24 in sales and marketing, seven in operations and ten in finance
and administration. Hi/fn's employees are not represented by any collective
bargaining agreement and Hi/fn has never experienced a work stoppage. Hi/fn
believes its employee relations are good.
Hi/fn's future success is heavily dependent upon its ability to hire and
retain qualified technical, marketing, sales and management personnel. The
competition for such personnel is intense, particularly for engineering
personnel with related security, networking and integrated circuit design
expertise, and applications support personnel with networking product design
expertise. See "Trends and Uncertainties -- We Depend Upon Key Personnel."
ITEM 2. PROPERTIES
Hi/fn's corporate and technical headquarters are located in Los Gatos,
California. Hi/fn leases approximately 27,000 square feet of space in Los Gatos,
California under a seven-year lease which expires in August 2005. Hi/fn also
leases two other facilities, a satellite design center in Carlsbad, California
and a small field sales office in Westborough, Massachusetts. These facilities
occupy an aggregate of approximately 7,000 square feet.
ITEM 3. LEGAL PROCEEDINGS
For information regarding legal proceedings, refer to Note 10 of the
Notes to Financial Statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
fourth quarter of the fiscal year covered by this report
ITEM 5. 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, Inc. ("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
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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:
- General business conditions in our markets as well as global economic
uncertainty;
- Reductions in demand for our customers' products;
- The timing and amount of orders we receive from our customers;
- Cancellations or delays of customer product orders;
- Any new product introductions by us or our competitors;
- Our suppliers increasing costs or changing the delivery of products to
us;
- Increased competition or reductions in the prices that we are able to
charge;
- The variety of the products that we sell as well as seasonal demand
for our products; and
- The availability of manufacturing capacity necessary to make our
products.
On October 7, 1999 we announced that two of our major customers had told
us that they will reduce demand for Hi/fn products from previously ordered
amounts. As a result, we expect revenues for the first quarter to be in the $10
million range as compared to the $15 million revenues reported in the September
1999 quarter. We believe the reductions are primarily due to inventory
adjustments.
WE DEPEND UPON A SMALL NUMBER OF CUSTOMERS.
Quantum Corporation ("Quantum"), through its manufacturing
subcontractor, accounted for approximately 45%, 61% and 70%, respectively, of
our revenues in fiscal 1999, 1998 and 1997. During 1999, Lucent, through its
manufacturing subcontractors, accounted for approximately 38% of our revenues
for fiscal 1999. Neither Quantum nor Lucent are under any binding obligation to
order from us. If our sales to Quantum or Lucent 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
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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:
- Our ability to demonstrate the benefits of our technology to
distributors, original equipment manufacturers and end users; and
- The increased use of the Internet by businesses as replacements for,
or enhancements to, their private networks.
If we are unable to penetrate the virtual private network market, or if
that market fails to develop, our business, financial condition and results of
operations could suffer.
WE FACE RISKS ASSOCIATED WITH EVOLVING INDUSTRY STANDARDS AND RAPID
TECHNOLOGICAL CHANGE.
The markets in which we compete are characterized by rapidly changing
technology, frequent product introductions and evolving industry standards. Our
performance depends on a number of factors, including our ability to do the
following:
- Properly identify emerging target markets and related technological
trends;
- Develop and maintain competitive products;
- Enhance our products by adding innovative features that differentiate
our products from those of competitors;
- Bring products to market on a timely basis at competitive prices; and
- Respond effectively to new technological changes or new product
announcements by others.
Our past success has been dependent in part upon our ability to develop
products that have been selected for design into new products of leading
equipment manufacturers. However, the development of our packet processors is
complex and, from time to time, we have experienced delays in completing the
development and introduction of new products. We may not be able to adhere to
our new product design and introduction schedules and our products may not be
accepted in the market at favorable prices, if at all.
In evaluating new product decisions, we must anticipate future demand
for product features and performance characteristics, as well as available
supporting technologies, manufacturing capacity, competitive product offerings
and industry standards. We must also continue to make significant investments in
research and development in order to continue to enhance the performance and
functionality of our products to keep pace with competitive products and
customer demands for improved performance, features and functionality. The
technical innovations required for 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
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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:
- Performance;
- Price;
- The time that is required to develop a new product or enhancements to
existing products;
- The ability to achieve product acceptance with major network and
storage equipment vendors;
- The support that exists for new network and storage standards;
- Features and functionality;
- Adaptability of products to specific applications;
- Reliability; and
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- 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.
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 54%, 79%, and 88%,
respectively, of revenue in the fiscal years ended September 30, 1999, 1998 and
1997. 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
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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.
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:
- Adapting our product design, if necessary, to the new manufacturer's
process
- Creating a new mask set to manufacture the product
- Having the new manufacturer prepare sample products so we can verify
the product specification; and
- Providing sample products to customers for qualification.
In general, it takes from 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
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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:
- Rapidly changing technologies;
- Price-performance enhancements; and
- Product obsolescence.
The decline in the average selling prices of our products may cause
substantial fluctuations in our operating results. We anticipate that the
average selling prices of our products will decrease in the future due to
product introductions by our competitors, price pressures from significant
customers and other factors. Therefore, we must continue to develop and
introduce new products that incorporate features which we can sell at higher
prices. If we fail to do so, our revenues and gross margins could decline, which
would harm our business, financial condition and results of operations.
WE FACE PRODUCT RETURN, PRODUCT LIABILITY AND PRODUCT DEFECT RISKS.
Complex products such as ours frequently contain errors, defects and
bugs when first introduced or as new versions are released. We have discovered
such errors, defects and bugs in the past. Delivery of products with production
defects or reliability, quality or compatibility problems could hinder market
acceptance of our products. This could damage our reputation and harm our
ability to attract and retain customers. Errors, defects or bugs could also
cause interruptions, delays or a cessation of sales to our customers. We would
have to expend significant capital and resources to remedy these problems.
Errors, defects or bugs could be discovered in our new products after we begin
commercial production of them, despite testing by us and our suppliers and
customers. This could result in additional development costs, loss of, or delays
in, market acceptance, diversion of technical and other resources from our other
development efforts, claims by our customers or others against us or the loss of
credibility with our current and prospective customers. Any such event would
harm our business, financial condition and results of operations.
WE FACE ORDER AND SHIPMENT UNCERTAINTIES.
We generally make our sales under individual purchase orders that may be
canceled or deferred by customers on short notice without significant penalty,
if any. Cancellation or deferral of product orders could cause us to hold excess
inventory, which could harm our profit margins and restrict our ability to fund
our operations. We recognize revenue upon shipment of products to our customers,
net of an allowance for estimated returns. An unanticipated level of returns
could harm our business, financial condition and results of operations.
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
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qualified personnel. These claims could result in material litigation. We could
incur substantial costs in defending against any such claims, regardless of
their merits.
OUR RAPID GROWTH MAY STRAIN OUR OPERATIONS.
We have experienced a period of rapid growth and expansion which has
placed, and continues to place, a significant strain on our resources. To
accommodate this growth, we must implement a variety of new and upgraded
operational and financial systems, procedures and controls, including the
improvement of the accounting and other internal management systems which were
provided by Stac. This may require substantial management effort, and our
efforts to do so may not be successful. In addition, we have had to hire
additional employees to accommodate this growth and our product development
activities. This has resulted in increased responsibilities for our management.
Our systems, procedures and controls may not be adequate to support our
operations. If we fail to improve our operational, financial and management
information systems, or to hire, train, motivate or manage our employees, our
business, financial condition and results of operations could suffer.
OUR PRODUCTS ARE SUBJECT TO EXPORT RESTRICTIONS.
The encryption algorithms embedded in our products are a key element of
our packet processor architecture. These products are subject to U.S. Department
of Commerce export control restrictions. Our network equipment customers may
only export products incorporating encryption technology if they obtain an
export license. These U.S. export laws also prohibit the export of encryption
products to a number of countries deemed by the U.S. to be hostile. U.S. export
regulations regarding the export of encryption technology require either a
transactional export license or the granting of Department of Commerce commodity
jurisdiction. These restrictions may make foreign competitors facing less
stringent controls on their products more competitive in the global market than
our network equipment customers. The U.S. government may not approve any pending
or future export license requests. In addition, the list of products and
countries for which export approval is required, and the regulatory policies
with respect thereto, could be revised, and laws limiting the domestic use of
encryption could be enacted. The sale of our packet processors could be harmed
by the failure of our network equipment customers to obtain the required
licenses or by the costs of compliance.
WE FACE RISKS ASSOCIATED WITH OUR INTERNATIONAL BUSINESS ACTIVITIES.
We sell most of our products to customers in the United States. If our
international sales increase, we may encounter risks inherent in international
operations. All of our international sales to date are denominated in U.S.
dollars. As a result, if the value of the U.S. dollar increases relative to
foreign currencies, our products could become less competitive in international
markets. We also obtain some of our manufacturing, assembly and test services
from suppliers located outside the United States. International business
activities could be limited or disrupted by any of the following:
- The imposition of governmental controls;
- Export license requirements;
- Restrictions on the export of technology;
- Currency exchange fluctuations;
- Political instability;
- Financial and stock market dislocations;
- Trade restrictions; and
- Changes in tariffs.
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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 contingent liabilities and amortize
acquisition expenses related to goodwill and other intangible assets, any of
which could harm our operating results and/or the price of our Common Stock.
Acquisitions entail numerous risks, including:
- Difficulties in assimilating acquired operations, technologies and
products;
- Diversion of management's attention from other business concerns;
- Risks of entering markets in which we have little or no prior
experience; and
- Loss of key employees of acquired organizations.
We may not be able to successfully integrate businesses, products,
technologies or personnel that we acquire. If we fail to do so, our business,
financial condition and results of operations could suffer.
In addition, if we are a party to a transaction or series of
transactions that result in 50% or more of our outstanding stock being
transferred to one or more persons, the IRS may claim that our spin-off from
Stac was a taxable event to Stac and its stockholders. Under the Tax Allocation
and Indemnity Agreement that we entered into with Stac, we may be obligated to
pay the taxes of Stac if we caused the spin-off to be a taxable event. Our cash
flows, business, financial condition and results of operations would suffer if
we became liable for any such tax liability. See "Recent Spin-Off and
Relationship with Stac."
THE CYCLICALITY OF THE SEMICONDUCTOR INDUSTRY MAY HARM OUR BUSINESS.
The semiconductor industry has experienced significant downturns and
wide fluctuations in supply and demand. The industry has also experienced
significant fluctuations in anticipation of changes in general economic
conditions. This has
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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:
- Quarterly variations in operating results;
- Announcements of new products by us or our competitors;
- The gain or loss of significant customers;
- Changes in analysts' estimates;
- Short-selling of our Common Stock; and
- Events affecting other companies that investors deem to be comparable
to us.
WE ARE CURRENTLY ENGAGED IN SEVERAL SECURITIES CLASS-ACTION LAWSUITS.
The Company and certain of its officers and directors have been named as
defendants in several substantially similar securities class action lawsuits
filed in October 1999 in the United States District Court for the Northern
District of California. The plaintiffs in these actions purport to represent a
class of all persons who purchased the Company's common
18
<PAGE> 19
stock between July 26, 1999 through October 7, 1999. The complaints allege that
the defendants made misleading statements in violation of the federal securities
laws, including Section 10(b) of the Securities Exchange Act of 1934. The
Company expects the Court to appoint a lead plaintiff and consolidate the
complaints in the near future.
The Company believes that the complaints are without merit and intends
to defend against them vigorously. Nevertheless, litigation is subject to
inherent uncertainties and thus there can be no assurance that these suits will
be resolved favorably to the Company or will not have a material adverse effect
on the Company's financial position or results of operations.
19
<PAGE> 20
PART II
ITEM 6. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
PRICE RANGE OF COMMON STOCK
The Common Stock has been quoted on the Nasdaq National Market under the
symbol "HIFN" since December 16, 1998, the date upon which Stac,
Hi/fn's former parent company, consummated the dividend distribution of the
Common Stock to Stac stockholders. The following table lists quarterly
information on the price range of the Common Stock based on the high and low
reported closing bid prices for the Common Stock as reported on the Nasdaq
National Market for the periods indicated below:
<TABLE>
<CAPTION>
HIGH LOW
--------- --------
<S> <C> <C>
FISCAL YEAR ENDED SEPTEMBER 30, 1999:
First Quarter............................. $ 24 $17 1/2
Second Quarter ........................... 39 7/8 22 1/2
Third Quarter ............................ 76 1/8 37
Fourth Quarter ........................... 145 3/16 65 3/8
</TABLE>
On December 10, 1999, the reported last sale price of Common Stock on
the Nasdaq National Market was $47 per share. As of December 10, 1999, there
were approximately 323 holders of record of our Common Stock.
DIVIDEND POLICY
Hi/fn has never declared or paid any dividends on its capital stock.
Hi/fn intends to retain any future earnings to finance the growth and
development of its business and does not expect to pay any cash dividends in the
foreseeable future.
RECENT SALES OF UNREGISTERED SECURITIES
During the period from October 1, 1998 through September 30, 1999, the
Registrant granted options to purchase an aggregate of 1,158,875 shares of
Common Stock to an aggregate of 99 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. During the period from October 1, 1998 through
September 30, 1999, options to purchase an aggregate of 304,230 shares of Common
Stock were exercised by an aggregate of 48 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 7. SELECTED FINANCIAL DATA
The selected financial data of Hi/fn as of and for each of the three
years ended September 30, 1999, have been derived from Hi/fn's audited financial
statements as included herein. The selected financial data of Hi/fn as of and
for the year ended September 30, 1996, have been derived from audited financial
statements not included herein. Hi/fn operated as a division of its parent
company Stac, until September 30, 1996 and as a subsidiary of Stac until
December 16, 1998. The financial information may not reflect Hi/fn's future
performance or the future financial position or results of operations of Hi/fn,
nor does it provide or reflect data as if Hi/fn had actually operated as a
separate, stand-alone entity during all of the periods covered. The following
selected financial data should be read in conjunction with the "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Financial Statements and Notes included elsewhere in this Annual Report on
Form 10-K.
20
<PAGE> 21
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
------------------------------------------------------------
1999 1998 1997 1996 1995
------- ------- ------- ------- ------
(in thousands, except per share amounts)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net revenues ....................... $42,351 $21,533 $14,226 $12,894 $7,342
Cost of revenues ................... 10,498 6,525 4,762 5,095 2,841
------- ------- ------- ------- ------
Gross profit ....................... 31,853 15,008 9,464 7,799 4,501
Operating expenses:
Research and development ........ 8,135 5,403 2,985 1,641 551
Sales and marketing ............. 5,963 3,370 2,224 1,677 1,097
General and administrative ...... 2,993 2,407 1,203 889 492
------- ------- ------- ------- ------
Income from operations ............. 14,762 3,828 3,052 3,592 2,361
Interest income (expense), net ..... 1,720 17 16 -- --
Other income (expense), net ........ (14) -- -- -- --
Provision for income taxes ......... 6,587 1,627 1,235 1,441 947
------- ------- ------- ------- ------
Net income ......................... $ 9,881 $ 2,218 $ 1,833 $ 2,151 $1,414
======= ======= ======= ======= ======
Net income per share, basic ........ $ 1.22 $. 0.35 $ 0.30 $ 0.36 $ 0.24
Net income per share, diluted ...... $ 1.06 $. 0.33 $ 0.30 $ 0.36 $ 0.24
Weighted average shares
outstanding, basic .............. 8,115 6,308 6,100 6,000 6,000
Weighted average shares
outstanding, diluted ............ 9,295 6,800 6,174 6,000 6,000
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
------------------------------------------------------------
1999 1998 1997 1996 1995
------- ------- ------- ------- ------
(in thousands)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA(1):
Cash and cash equivalents .......... $70,086 $ 4,084 $ 480 $ -- $ --
Total assets ....................... 83,530 16,611 5,898 2,611 2,254
Working capital (deficit) .......... 73,153 4,723 3,520 (383) (223)
Total debt ......................... -- -- -- -- --
Total stockholders' equity ......... 76,049 6,952 4,622 -- --
</TABLE>
(1) The balance sheets prior to September 30, 1997 reflect Hi/fn's structure as
a division of Stac prior to its formation as a subsidiary of Stac. Periods
subsequent to September 30, 1996 reflect the net assets contributed by Stac in
establishing the Hi/fn subsidiary. The transfer was recorded at the historical
net book value of the transferred assets and liabilities. In exchange for the
net assets contributed to Hi/fn, Stac received 6,000,000 shares of Series A
Preferred Stock and 100 shares of Common Stock of Hi/fn. The 6,000,000 shares of
Series A Preferred Stock were converted into 6,000,000 shares of Common Stock of
Hi/fn prior to the spin-off of Hi/fn from Stac on December 16, 1998. For all
periods prior to fiscal 1997, net income generated by Hi/fn has been treated as
if it were transferred to Stac in the form of dividends. No such transfers were
made for fiscal 1997 and the periods presented thereafter. See Note 1 to the
Financial Statements.
On 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 approximately $49.2
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 8. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the Financial
Statements and Notes included elsewhere in this Annual Report on Form 10-K. The
results shown in this report are not necessarily indicative of the results to be
expected in any future periods. This discussion contains forward-looking
statements based on current expectations which involve risks and uncertainties.
Actual results and the timing of certain events may differ significantly from
those projected in such forward-looking statements due to the factors set forth
in the section entitled "Trends and Uncertainties" and appearing elsewhere in
this report.
21
<PAGE> 22
OVERVIEW
Hi/fn designs, develops and markets high-performance multi-protocol
packet processors -- semiconductor devices designed to enable secure,
high-bandwidth network connectivity and efficient storage of business
information. Hi/fn's packet processor products perform the computation-intensive
tasks of compression, encryption/compression and public key cryptography,
providing its customers with high-performance, interoperable implementations of
a wide variety of industry-standard networking and storage protocols. Hi/fn's
products are used in networking and storage equipment such as routers, remote
access concentrators, firewalls and back-up storage devices.
Hi/fn's encryption/compression and public key processors allow network
equipment vendors to add bandwidth enhancement and security capabilities to
their products. Hi/fn's encryption/compression and public key processor products
provide key algorithms used in virtual private networks ("VPNs"), which enable
businesses to reduce wide area networking costs by replacing dedicated
leased-lines with lower-cost IP-based networks such as the Internet. Using VPNs,
businesses can also provide trading partners and others with secure,
authenticated access to the corporate network, increasing productivity through
improved communications. Storage equipment vendors use Hi/fn's compression
processor products to improve the performance and capacity of mid- to high-end
tape back-up systems.
Revenues from one customer and its manufacturing subcontractor
represented 45%, 61% and 70% of the Company's net revenues for the years ended
September 30, 1999, 1998 and 1997, respectively. Revenues from another customer
and its manufacturing subcontractors represented 38% of the Company's net
revenues for the year ended September 30, 1999.
The Company's quarterly and annual operating results are affected by a
wide variety of factors that could materially and adversely affect net sales,
gross margins and operating income. These factors include the volume and timing
of orders received, changes in the mix of proprietary and second source products
sold, market acceptance of the Company's and its customers' products,
competitive pricing pressures, the Company's ability to introduce new products
on a timely basis, the timing and extent of research and development expenses,
fluctuations in manufacturing yields, cyclical semiconductor industry
conditions, the Company's access to advanced process technologies and the timing
and extent of process development costs. Historically in the semiconductor
industry, average selling prices of products have decreased over time. If the
Company is unable to introduce new products with higher margins, maintain its
product mix between proprietary and second source products, or reduce
manufacturing cost to offset decreases in the prices of its existing products,
then the Company's operating results will be adversely affected. The Company's
business is characterized by short-term orders and shipment schedules, and
customer orders typically can be canceled or rescheduled without penalty to the
customer. Since most of the Company's backlog is cancelable without penalty, the
Company typically plans its production and inventory levels based on internal
forecasts of customer demand. Customer demand remains highly unpredictable and
variances to the forecast can fluctuate substantially. In addition, because of
high fixed costs on the semiconductor industry, the Company is limited in its
ability to reduce costs quickly in response to any revenue shortfalls. As a
result of the foregoing or other factors, the Company has experienced and may in
the future experience material adverse fluctuations in its operating results on
a quarterly or annual basis, which have in the past and would in the future
materially affect the Company's business, financial condition and results of
operations.
Prior to December 16, 1998, Hi/fn was a majority-owned subsidiary of
Stac, Inc. ("Stac"). On December 16, 1998, Stac distributed all of Hi/fn's
outstanding shares held by Stac to Stac stockholders.
RESULTS OF OPERATIONS
The following table sets forth certain statement of operations data as a
percentage of total revenue for the periods indicated.
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
--------------------------
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Revenues.......................... 100% 100% 100%
Cost of revenues.................. 25 30 33
--- --- ---
Gross profit...................... 75 70 67
--- --- ---
Operating expenses:
Research and development........ 19 25 21
</TABLE>
22
<PAGE> 23
<TABLE>
<S> <C> <C> <C>
Sales and marketing............. 14 16 16
General and administrative...... 7 11 8
--- --- ---
Total operating expenses.......... 40 52 45
--- --- ---
Income from operations............ 35 18 22
Interest and other income
(expense), net.................. 4 -- --
--- --- ---
Income before income taxes........ 39 18 22
Provision for income taxes........ 16 8 9
--- --- ---
Net income........................ 23% 10% 13%
=== === ===
</TABLE>
YEARS ENDED SEPTEMBER 30, 1999, 1998 AND 1997
Revenue. Revenue from sales of semiconductors and licenses of software
libraries increased 97% in fiscal 1999 to $42.4 million compared to $21.5
million in fiscal 1998. In fiscal 1998, revenue increased 51% to 21.5 million
compared to fiscal 1999 revenue. The increase in revenue in fiscal 1999 compared
to the prior year was primarily due to increased sales of Hi/fn's data
compression and encryption processors to network equipment manufacturers. The
increase in revenue in fiscal 1998 compared to the prior year was due primarily
to increased sales of Hi/fn's data compression processors to original equipment
manufacturer ("OEM") providers of storage devices and manufacturers of
networking equipment. Semiconductor sales to Quantum, an OEM producer of
high-performance tape storage devices, through its manufacturing subcontractor
comprised 45%, 61% and 70% of revenue in each of fiscal 1999, fiscal 1998 and
fiscal 1997 respectively. Semiconductor sales to Lucent, an OEM producer of
networking equipment, through its manufacturing subcontractors, comprised 38% of
revenue in fiscal 1999.
Gross Margin. Gross margin was 75% in fiscal 1999, 70% in fiscal 1998
and 67% in fiscal 1997. The increase in gross margin in fiscal 1999 from that of
fiscal 1998 was due primarily to the higher percentage of products that combine
compression and encryption. The combined compression and encryption products
tend to command higher gross margins than the products which only offer the
compression function. The increase in gross margin in fiscal 1998 from that of
fiscal 1997 was due primarily to cost efficiencies achieved through design
modifications made to compression processors.
Research and Development. Research and development expenses were $8.1
million or 19% of revenues in fiscal 1999, $5.4 million or 25% of revenues in
fiscal 1998 and $3.0 million or 21% or revenues in fiscal 1997. Research and
development expenses increased 51% in fiscal 1999 and 81% in fiscal 1998 from
fiscal 1997. The increase in research and development costs in each successive
period was due to the addition of personnel and retention of outside contractors
used to develop new products which combine data compression and data encryption
for the network security markets and to develop additional products for the
storage market. Hi/fn expects its investments in research and development to
increase in coming periods on an absolute basis as it continues to develop
products targeted at meeting market needs. However, there can be no assurance
that product development programs invested in by Hi/fn will be successful or
timely, or that products resulting from such programs will achieve market
acceptance.
Sales and Marketing. Sales and marketing expenses were $6.0 million or
14% of revenues in 1999, $3.4 million or 16% of revenues in fiscal 1998 and $2.2
million or 16% of revenues in fiscal 1997. The increases in sales and marketing
expenses in fiscal 1999 over those of fiscal 1998 and in fiscal 1998 expense
over those of fiscal 1997 resulted from the addition of sales and marketing
personnel and program costs intended to increase customer awareness of Hi/fn's
products.
General and Administrative. General and administrative expenses were
approximately $3.0 million or 7% of revenues in fiscal 1999, $2.4 million or 11%
of revenues in fiscal 1998 and $1.2 million or 8% of revenues in fiscal 1997.
General and administrative expenses increased in fiscal 1999 over those of
fiscal 1998 and in fiscal 1998 over those of fiscal 1997 primarily due to the
addition of executive management personnel and increased legal and accounting
costs. Legal and accounting costs for the fiscal years ended 1999, 1998 and 1997
were $810,000, $703,000 and $130,000, respectively.
Interest and Other Income (expense), net . Interest and Other Income
(expense), net for fiscal 1999 were $1.7 million or 4% of revenues. The increase
was a primarily a result of interest income earned on the net proceeds of $58.5
million raised in an equity offering of 1,900,000 shares of common stock in
March and April 1999.
Income Taxes. The Company recorded an income tax provision of $6.6
million in fiscal 1999 at an effective rate of 40% compared to $1.6 million in
fiscal 1998 at an effective rate of 42% and compared to $1.2 million in fiscal
1997 at an
23
<PAGE> 24
effective rate of 40%. The increase in the effective tax rate for fiscal 1998
was due to the non deductibility of certain spin-off related costs incurred
during fiscal 1998. For the period up to December 16, 1998 and for fiscal 1998
and 1997, deferred income taxes and related tax expense have been allocated to
Hi/fn by applying the asset and liability approach as if Hi/fn were a separate
taxpayer. Under this approach, a deferred income tax liability or asset, net of
valuation allowance, is established for the expected future consequences
resulting from the differences between the financial reporting and income tax
basis of assets and liabilities and from net operating loss and credit
carryforwards. Deferred income tax expense or benefit represents the net change
during the year in the deferred income tax liability or asset. Income taxes
currently payable are deemed to have been remitted by Stac on behalf of Hi/fn in
the period that the liability arose. Income taxes currently receivable are
deemed to have been received by Stac in the period that a refund could have been
recognized by Hi/fn, had Hi/fn been a separate taxpayer. Amounts due to or from
Hi/fn and Stac for income tax payments and refunds are included in the related
party receivable and payable components of the balance sheet.
LIQUIDITY AND CAPITAL RESOURCES
From inception until the spin-off from Stac in December 1998, Hi/fn
depended upon Stac for financing its operations and capital requirements. In
November 1996, Hi/fn and Stac entered into an Assignment, Assumption and License
Agreement (the "Assignment Agreement") which provided for the transfer of Stac's
semiconductor business to Hi/fn in exchange for 6,000,000 shares of Series A
Preferred Stock and 100 shares of Common Stock of Hi/fn. Concurrent with the
transfer of the semiconductor business, Hi/fn and Stac also entered into a Cross
License Agreement under which Hi/fn granted Stac a limited, worldwide,
perpetual, non-exclusive, non-transferable, royalty-free license to the patents
transferred by Stac to Hi/fn under the Assignment Agreement.
In fiscal 1999, the Company generated approximately $9.0 million from
operating activities, principally attributable to net income from operations,
increases in taxes payable of $1.3 million and accrued and other liabilities of
$2.2 million, offset by increase in accounts receivable of $3.6 million and
inventories of $1.4 million. During fiscal 1999, the Company generated $6.0
million from the sale of marketable securities and invested $1.7 million in the
acquisition of property and equipment. Hi/fn expects capital expenditures in the
foreseeable future to remain at approximately the same level.
On September 28, 1998, Stac paid $4.4 million to Hi/fn, representing
payment in full for all amounts due to Hi/fn from Stac as of September 1, 1998.
Stac also loaned $5.0 million to Hi/fn under a short-term loan that became due
and payable on September 30, 1999, but which could be prepaid in whole or part
without penalty. The loan accrued interest at the prime rate set by Silicon
Valley Bank plus 0.5% per annum, payable quarterly, and was secured by a first
priority security interest in all of Hi/fn's assets, including Hi/fn's
intellectual property. In March 1999, the entire $5.0 million loan was repaid.
In March 1999 the Company issued 1.6 million shares of common stock at a
price of $33 per share in an equity offering, which raised approximately $49.2
million, net of offering expenses. In April 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.
In fiscal 1999, the Company received $0.1 million in proceeds from the
repayment of a loan to a related party and paid a total of $1.5 million in
transfers to the Company's former parent, Stac. At September 30, 1999, cash and
cash equivalents were approximately $70.1 million.
In fiscal 1998, the Company generated approximately $3.1 million from
operating activities, principally attributable to net income from operations,
depreciation charges of $0.7 million, increases in accounts payable of $1.0
million, amounts due to related party of $0.6 million and accrued and other
liabilities of $1.0 million, offset by increase in accounts receivable of $1.3
million and prepaid and other assets of $0.7 million. During fiscal 1998, the
Company purchased $6.0 million of marketable securities and invested $1.1
million in the acquisition of property and equipment. The Company received
proceeds of $0.1 million from the sale of common stock, $5.0 million from a loan
from the former parent, Stac and $2.4 million in cash transfers from the former
parent, Stac. At September 30, 1998, cash and cash equivalents were
approximately $4.1 million.
In fiscal 1997, the Company generated approximately $2.0 million from
operating activities, principally attributable to net income from operations,
depreciation charges of $0.3 million, decrease in inventory of $0.3 million and
increase in
24
<PAGE> 25
amounts due to related party of $0.4 million, offset by increase in accounts
receivable of $0.6 million and prepaid and other assets of $0.2 million. During
fiscal 1997, the Company invested $0.9 million in the acquisition of property
and equipment. The Company received proceeds of $0.2 million from the sale of
common stock and received $0.8 million in cash transfers from the former parent,
Stac. At September 30, 1997, cash and cash equivalents were approximately $0.5
million.
Hi/fn uses a number of independent suppliers to manufacture
substantially all of its products. As a result, Hi/fn relies on these suppliers
to allocate to Hi/fn a sufficient portion of foundry capacity to meet Hi/fn's
needs and deliver sufficient quantities of Hi/fn's products on a timely basis.
These arrangements allow Hi/fn to avoid utilizing its capital resources for
manufacturing facilities and work-in-process inventory and to focus
substantially all of its resources on the design, development and marketing of
its products.
Hi/fn requires substantial working capital to fund its business,
particularly to finance accounts receivable and inventory, and for investments
in property and equipment. Hi/fn's need to raise capital in the future will
depend on many factors including the rate of sales growth, market acceptance of
Hi/fn's existing and new products, the amount and timing of research and
development expenditures, the timing and size of acquisitions of businesses or
technologies, the timing of the introduction of new products and the expansion
of sales and marketing efforts.
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
25
<PAGE> 26
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.
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's costs to become Year 2000 compliant has been less than
$10,000, and the Company believes that additional costs to become Year 2000
compliant will not be material.
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.
ITEM 8A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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. A 10% move in interest rates as of September 30, 1999 would have an
immaterial effect on the Company's pre-tax earnings and the carrying value of
its investments over the next fiscal year.
Foreign Currency Exchange Rate Risk
All of the Company's sales, cost of manufacturing and marketing are
transacted in U.S. 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.
26
<PAGE> 27
ITEM 9. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Financial Statements:
Report of Independent Accountants............................................................ 28
Balance Sheets as of September 30, 1999 and 1998............................................. 29
Statements of Operations for the years ended September 30, 1999, 1998 and 1997............... 30
Statements of Stockholders' Equity for the years ended September 30, 1999, 1998 and 1997..... 31
Statements of Cash Flows for the years ended September 30, 1999, 1998 and 1997............... 32
Notes to Financial Statements................................................................ 33-42
Financial Statement Schedules:
Schedule II Valuation and Qualifying Accounts and Reserves for the years ended
September 30, 1999, 1998 and 1997..................................................... 46
</TABLE>
27
<PAGE> 28
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of hi/fn, inc.
In our opinion, the financial statements listed in the accompanying
index present fairly, in all material respects, the financial position of hi/fn,
inc. at September 30, 1999 and 1998, and the results of its operations and its
cash flows for each of the three years in the period ended September 30, 1999 in
conformity with accounting principles generally accepted in the United States.
In addition, in our opinion, the financial statement schedules listed in the
accompanying index present fairly, in all material respects, the information set
forth therein when read in conjunction with the related financial statements.
These financial statements and financial statement schedules are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements and financial statement schedules based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States, which require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for the opinion expressed above.
PricewaterhouseCoopers LLP
San Jose, California
October 22, 1999
28
<PAGE> 29
HI/FN, INC.
BALANCE SHEETS
(in thousands, except share and per share amounts)
<TABLE>
<CAPTION>
September 30,
----------------------
1999 1998
------- -------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $70,086 $ 4,084
Marketable securities -- 5,973
Accounts receivable, net 6,720 3,125
Inventory 1,568 165
Deferred income taxes 1,559 720
Prepaid expenses and other current assets 701 315
------- -------
Total current assets 80,634 14,382
------- -------
Property and equipment, net 2,389 1,615
Deferred income taxes 218 229
Other assets 289 385
------- -------
$83,530 $16,611
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 2,461 $ 1,610
Due to related party -- 6,508
Income taxes payable 1,300 --
Accrued expenses and other current liabilities 3,720 1,541
------- -------
Total current liabilities 7,481 9,659
------- -------
Commitments and contingencies (Note 9 and Note 10)
STOCKHOLDERS' EQUITY:
Convertible preferred stock, $0.001 par value; 10,000,000 shares
authorized; none and 6,000,000 shares issued; none and
6,000,000 shares outstanding -- 6
Common stock, $0.001 par value; 100,000,000 shares authorized;
8,699,000 and 483,000 shares issued and outstanding 9 --
Additional paid-in capital 62,316 2,995
Deferred stock compensation (208) --
-- (100)
Retained earnings 13,932 4,051
------- -------
Total stockholders' equity 76,049 6,952
------- -------
$83,530 $16,611
======= =======
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS
29
<PAGE> 30
HI/FN, INC.
STATEMENTS OF OPERATIONS
(in thousands, except per share data)
<TABLE>
<CAPTION>
Year ended September 30,
----------------------------------
1999 1998 1997
------- ------- -------
<S> <C> <C> <C>
Net revenues $42,351 $21,533 $14,226
Cost of revenues 10,498 6,525 4,762
------- ------- -------
Gross profit 31,853 15,008 9,464
------- ------- -------
Operating expenses:
Research and development 8,135 5,403 2,985
Sales and marketing 5,963 3,370 2,224
General and administrative 2,993 2,407 1,203
------- ------- -------
Total operating expenses 17,091 11,180 6,412
------- ------- -------
Income from operations 14,762 3,828 3,052
Interest income 1,934 17 16
Interest expense (214) -- --
Other income (expense), net (14) -- --
------- ------- -------
Income before income taxes 16,468 3,845 3,068
Provision for income taxes 6,587 1,627 1,235
------- ------- -------
Net income $ 9,881 $ 2,218 $ 1,833
======= ======= =======
Net income per share:
Basic $ 1.22 $ 0.35 $ 0.30
======= ======= =======
Diluted $ 1.06 $ 0.33 $ 0.30
======= ======= =======
Shares used in computing net income per share:
Basic 8,115 6,308 6,100
======= ======= =======
Diluted 9,295 6,800 6,174
======= ======= =======
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS
30
<PAGE> 31
HI/FN, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
<TABLE>
<CAPTION>
Note
Receiv-
Convertible Deferred able Total
Preferred Stock Common Stock Stock from Additional Stock-
----------------- ---------------- Compen- Stock- Paid-in Retained holders'
Shares Amount Shares Amount sation holder Capital Earnings Equity
------ ------ ------ ------ -------- ------- ------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT SEPTEMBER 30, 1996 -- $ -- -- $-- $ -- $ -- $ -- $ -- $ --
Issuance of convertible
preferred stock 6,000 6 -- -- -- -- 2,614 -- 2,620
Issuance of common stock -- -- 75 -- -- -- 45 -- 45
Issuance of common stock
upon exercise of options -- 206 -- -- -- -- 124 -- 124
Net income -- -- -- -- -- -- -- 1,833 1,833
------ ---- ------ --- ----- ----- ------- ------- -------
BALANCE AT SEPTEMBER 30, 1997 6,000 6 281 -- -- -- 2,783 1,833 4,622
Issuance of common stock
upon exercise of options -- 202 -- -- -- -- 212 -- 212
Note receivable from stockholder -- -- -- -- -- (100) -- -- (100)
Net income -- -- -- -- -- -- -- 2,218 2,218
------ ---- ------ --- ----- ----- ------- ------- -------
BALANCE AT SEPTEMBER 30, 1998 6,000 6 483 -- -- (100) 2,995 4,051 6,952
Conversion of convertible
preferred stock to common
stock (6,000) (6) 6,000 6 -- -- -- -- --
Issuance of common stock
upon initial public offering,
net of issuance costs -- -- 1,900 2 -- -- 58,53 -- 58,536
Payment on note receivable
from stockholder -- -- -- -- -- 100 -- -- 100
Issuance of common stock
upon exercise of options 304 1 -- -- 372 -- 373
Deferred stock compensation -- -- -- -- (239) -- 239 -- --
Amortization of deferred
stock compensation -- -- -- -- 31 -- -- -- 31
Issuance of common stock
under employee stock
purchase plan -- -- 12 -- -- -- 176 -- 176
Net income -- -- -- -- -- -- -- 9,881 9,881
------ ---- ------ --- ----- ----- ------- ------- -------
BALANCE AT SEPTEMBER 30, 1999 -- $ -- 8,699 $ 9 $(208) $ -- $62,316 $13,932 $76,049
====== ==== ====== === ===== ===== ======= ======= =======
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS
31
<PAGE> 32
HI/FN, INC.
STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Year ended September 30,
----------------------------------
1999 1998 1997
------- ------- ------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 9,881 $ 2,218 $1,833
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization 813 726 303
Amortization of deferred stock compensation 31 -- --
Benefit from deferred income taxes (828) (469) (129)
Loss on disposal of fixed assets 236 -- --
Gain on sale of marketable securities (27) -- --
Changes in assets and liabilities:
Accounts receivable (3,595) (1,302) (642)
Inventory (1,403) 244 299
Prepaid expenses and other current assets (386) (123) (186)
Other assets (17) (614) (44)
Accounts payable 851 950 60
Income taxes payable 1,300 -- --
Due to related party for general and
administrative allocations -- 576 420
Accrued expenses and other current liabilities 2,179 925 86
------- ------- ------
Net cash provided by operating activities 9,035 3,131 2,000
------- ------- ------
Cash flows from investing activities:
Purchases of marketable securities -- (5,973) --
Sales of marketable securities 6,000 -- --
Purchases of property and equipment (1,710) (1,105) (901)
------- ------- ------
Net cash provided by (used in) investing activities 4,290 (7,078) (901)
------- ------- ------
Cash flows from financing activities:
Proceeds from issuance of common stock, net 59,085 112 169
Proceeds of loan from related party -- 5,000 --
Payment on note receivable from stockholder 100 -- --
Principal payments on note payable to related party (5,000) -- --
Transfer of funds to related party, net (1,508) 2,439 (788)
------- ------- ------
Net cash provided by (used in) financing activities 52,677 7,551 (619)
------- ------- ------
Net increase in cash and cash equivalents 66,002 3,604 480
Cash and cash equivalents at beginning of period 4,084 480 --
------- ------- ------
Cash and cash equivalents at end of period $70,086 $ 4,084 $ 480
======= ======= ======
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the year for interest $ 214 $ -- $ --
======= ======= ======
Cash paid during the year for income taxes $ 5,528 $ -- $ --
======= ======= ======
SUPPLEMENTAL NON-CASH FINANCING ACTIVITY:
Issuance of convertible stock for net assets contributed $ -- $ -- $2,620
======= ======= ======
Conversion of convertible preferred stock to common stock $ 2,620 $ -- $ --
======= ======= ======
Issuance of common stock for note $ -- $ 100 $ --
======= ======= ======
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS
32
<PAGE> 33
NOTE 1 -- THE COMPANY AND BASIS OF PRESENTATION
hi/fn, inc. ("Hi/fn" or the "Company") designs, develops and markets
high-performance, multi-protocol packet processors -- semiconductor devices
designed to enable secure, high-bandwidth network connectivity and efficient
storage of business information. Hi/fn's packet processor products perform the
computation-intensive tasks of compression, encryption/compression and public
key cryptography, providing its customers with high-performance, interoperable
implementations of a wide variety of industry-standard networking and storage
protocols. Hi/fn's products are used in networking and storage equipment such as
routers, remote access concentrators, firewalls and back-up storage devices.
Hi/fn's encryption/compression and public key processors allow network
equipment vendors to add bandwidth enhancement and security capabilities to
their products. Hi/fn's encryption/compression and public key processors provide
key algorithms used in virtual private networks ("VPNs"), which enable
businesses to reduce wide area networking costs by replacing dedicated
leased-lines with lower-cost IP-based networks such as the Internet. Using VPNs,
businesses can also provide trading partners and others with secure,
authenticated access to the corporate network, increasing productivity through
improved communications. Storage equipment vendors use Hi/fn's compression
processor products to improve the performance and capacity of mid- to high-end
tape back-up systems.
The financial statements for the periods prior to December 16, 1998
include carved-out balance sheets, statements of operations, of cash flows, and
of changes in stockholders' equity for Hi/fn, a majority owned semiconductor
products subsidiary of Stac, Inc. ("Stac" or "the Parent") before December 16,
1998. Prior to December 16, 1998, Stac converted 6,000,000 shares of Series A
Convertible Preferred Stock of Hi/fn into 6,000,000 shares of Common Stock of
Hi/fn. On December 16, 1998, Stac distributed all outstanding shares of Hi/fn
held by Stac to Stac stockholders. For the period from October 1, 1998 through
December 16, 1998 and the fiscal years ended September 30, 1998 and 1997, Hi/fn
conducted business as a majority owned subsidiary of Stac. Financial statements
for the periods had not been previously prepared for Hi/fn. These financial
statements have been prepared from the historical accounting records of Stac.
The balance sheet as of September 30, 1998 reflects the net assets
contributed by Stac in establishing the Hi/fn subsidiary. The transfer was
recorded at the historical net book value of the transferred assets and
liabilities of $2,620,000. In exchange for the net assets contributed to Hi/fn,
Stac received 6,000,000 shares of Series A Preferred Stock and 100 shares of
common stock (Note 6). For periods prior to December 16, 1998, Hi/fn
participated with Stac in centralized cash management. In general, the cash
funding requirements of Hi/fn were met by, and all cash generated by the
business was transferred to Stac. Cash balances at September 30, 1998 reflect a
short-term loan of $5,000,000 by Stac to Hi/fn as well as the settlement of
intercompany accounts. Related party receivables and payables are a result of
the cash management practices, as well as allocations of general and
administrative costs.
Amounts shown on the statement of operations for the years ended
September 30, 1998 and 1997 as well as for the period from October 1, 1998
through December 16, 1998 are based on specific identification of costs directly
associated with Hi/fn's business for all components except for general and
administrative costs and income tax expense. For periods including and
subsequent to 1997 through December 16, 1998, general and administrative
allocations are based on specific identification of costs directly associated
with Hi/fn's business, in addition to allocations of (i) costs for
administrative functions and services performed on behalf of the Company by
staff groups within Stac (ii) a portion of Stac's management expense and (iii)
certain general corporate expenses of Stac. These allocated expenses primarily
represent the costs of services required by Hi/fn for accounting, management
information systems, human resources, warehouse, executive and professional
fees. As more fully described in Note 8, current and deferred income taxes and
related tax expense have been allocated to Hi/fn as if it were a separate
taxpayer for all periods presented through December 16, 1998.
On March 25, 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
$49.2 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 an additional $9.3 million in proceeds
to the Company.
33
<PAGE> 34
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
MANAGEMENT ESTIMATES AND ASSUMPTIONS
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 at the
date of the financial statements and reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
REVENUE RECOGNITION
Revenues from the sale of hardware products is recognized upon shipment,
net of an allowance for estimated returns. Revenue on software products is
recognized in accordance with the provisions of Statement of Position 97-2
"Software Revenue Recognition" ("SOP 97-2"). Revenue for software licenses for
all products, except the IPSECure family, is recorded on a subscription basis
over the license period, which is generally one year. License revenue from
IPSECure products is recognized upon shipment (provided that no significant
vendor obligations remain and collection is considered probable), with an amount
for maintenance revenue deferred and recognized over the term of the maintenance
agreement, which is generally one year.
REVENUES FROM SIGNIFICANT CUSTOMERS
Revenues from one customer represented 45%, 61% and 70% of the Company's
net revenues for the years ended September 30, 1999, 1998 and 1997,
respectively. Revenues from another customer represented 35% of the Company's
net revenues for the year ended September 30, 1999.
CASH EQUIVALENTS AND MARKETABLE SECURITIES
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents. These
investments consist of money-market funds and commercial paper, which are
readily convertible to cash and are stated at cost, which approximates market.
At September 30, 1999, all investments were cash and cash equivalents.
The Company's marketable securities consisted of funds on deposit with
liquid asset managers that were invested principally in commercial paper. The
carrying amount of these investments approximated fair value due to the short
maturities or demand nature of the investments. At September 30, 1998, all
marketable securities were classified as available-for-sale and carried at fair
value. Unrealized gains or losses at September 30, 1998 were not material. There
were no marketable securities at September 30, 1999.
CONCENTRATION OF CREDIT RISK
Financial instruments, which potentially subject the Company to credit
risk, consist principally of cash and cash equivalents and trade accounts
receivable. The Company places it temporary cash investments in money market
funds and commercial paper with high credit quality financial institutions.
Substantially all of the Company's customers are OEM's or the
manufacturing subcontractors of OEM's, which results in concentrated credit risk
with respect to the Company's trade receivables. At September 30, 1999 one
customer accounted for 49% of the total accounts receivable balance. At
September 30, 1999 another customer accounted for 16% of the total accounts
receivable balance. Management believes that its credit policies substantially
mitigate such concentrated credit risk. Bad debt expenses were not significant
in fiscal 1999, 1998 and 1997.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments, including cash, cash equivalents,
short-term investments, accounts receivable, accounts payable and capital lease
obligations are carried at cost, which approximates their fair value because of
the short-term maturity of these instruments. The Company does not hold or issue
financial instruments for trading purposes.
34
<PAGE> 35
INVENTORIES
Inventories are stated at the lower of cost (determined on a first-in,
first-out cost method) or market. The Company provides for obsolete, slow moving
or excess inventories in the period when obsolescence or inventory in excess of
expected demand is first identified. Inventories are comprised solely of
finished goods, which are manufactured by third party foundries for resale by
the Company.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is computed
using the straight-line method with the estimated useful lives of the assets
ranging from three to five years. Amortization of leasehold improvements is
computed using the straight-line method and the shorter of the remaining lease
term or the estimated useful life of the related improvements. Repair and
maintenance costs are expensed as incurred.
LONG-LIVED ASSETS
The Company reviews long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. The Company assesses the impairment of its long-lived assets
based on expected undiscounted cash flows and recognizes impairment from the
carrying value of long-lived assets, if any, based on the fair value of such
assets.
RESEARCH AND DEVELOPMENT COSTS
Expenditures for research and development are charged to expense as
incurred. Under Statement of Financial Accounting Standards No. 86. "Accounting
for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed,"
certain software development costs are capitalized after technological
feasibility has been established. Development costs incurred in the period from
achievement of technological feasibility, which the Company defines as the
establishment of a working model, until the general availability of such
software to customers, has been short, and therefore software development costs
qualifying for capitalization have been insignificant. Accordingly, the Company
has not capitalized any software development costs as of September 30, 1999 or
1998.
WARRANTY AND SALES RETURNS ALLOWANCES
The Company provides a limited warranty for its products. A provision
for the estimated warranty cost and a provision for sales returns are recorded
at the time revenue is recognized based on the Company's historical experience.
INCOME TAXES
Deferred tax assets and liabilities are recognized for the expected tax
consequences of temporary differences between the income tax bases of assets and
liabilities and the amounts reported for financial reporting purposes for all
periods presented. (See Note 8).
STOCK-BASED COMPENSATION
The Company accounts for its employee and stock option plans and
employee stock purchase plans in accordance with provisions of the Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB 25"). Additional pro forma disclosures as required under Statement of
Financial Accounting Standards No. 123 "Accounting for Stock-Based Compensation"
("SFAS 123") are presented in Note 7.
COMPREHENSIVE INCOME
Effective October 1, 1998, the Company adopted the provision of
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" ("SFAS 130"). SFAS 130 establishes standards for reporting comprehensive
income and its components in financial statements. Comprehensive income, as
defined, includes all changes in equity
35
<PAGE> 36
during a period from non-owner sources. To date, the Company has not had any
components of other comprehensive income.
SEGMENT REPORTING
Effective October 1, 1998, the Company adopted the provisions of
Statement of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosures
about Segments of an Enterprise and Related Information." SFAS supersedes SFAS
14, "Financial Reporting for Segments of a Business Enterprise", replacing the
"Industry Segment" approach with the "Management" approach. The management
approach designates the internal organization that is used by management for
making operating decisions and assessing performance as the source of the
Company's reportable segments. SFAS 131 also requires disclosures about products
and services, geographic areas, and major customers. The Company operates in one
industry segment comprising the design, development and marketing of
high-performance, multi-protocol packet processors -- semiconductor devices. The
Company operates in on geographic area, being the U.S. The adoption of SFAS 131
did not affect the results of the Company's operations or financial position.
ACCOUNTING FOR DERIVATIVES
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS No. 133") "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes standards for
accounting and reporting on derivative instruments for periods beginning after
June 15, 2000 and early adoption is permitted. SFAS No. 133 requires that all
derivative instruments be recognized in the balance sheet as either assets or
liabilities and measured at fair value. Furthermore, SFAS no. 133 requires
current recognition in earnings of changes in the fair value of derivative
instruments depending on the intended use of the derivative and the resulting
designation. As the Company does not purchase or use derivative instruments,
management does not believe that the adoption of SFAS No. 133 will have any
significant impact on its financial statements.
NET INCOME PER SHARE
The Company adopted Statement of Financial Accounting Standards No. 128,
"Earnings Per Share" ("SFAS 128") during the fiscal 1998. All prior-period
earnings per share data have been restated in accordance with SFAS 128. SFAS 128
requires presentation of both Basic EPS and Diluted EPS on the face of the
income statement. Basic EPS is computed by dividing net income available to
common stockholders by the weighted average number of common shares outstanding
during the period. Weighted average shares exclude shares subject to repurchase
by the Company. Since the Company's Series A Convertible Preferred Stock (Note
6) represents a primary equity security , it is included in the calculation of
Basic EPS. Diluted EPS gives effect to all dilutive potential common shares
outstanding during the period including stock options, using the treasury
method, and convertible preferred stock, using the if-converted method. In
computing Diluted EPS, the average stock price for the period is used in
determining the number of shares assumed to be purchased from the exercise of
stock options.
Following is a reconciliation of the calculation of basic and diluted
earnings per share for the periods presented below (in thousands, except for per
share amounts):
<TABLE>
<CAPTION>
Year ended September 30,
------------------------------
1999 1998 1997
------ ------ ------
<S> <C> <C> <C>
Net income $9,881 $2,218 $1,833
====== ====== ======
Shares used in computing net income per share:
Basic 8,115 6,308 6,100
Dilutive effect of stock options 1,180 492 74
------ ------ ------
Diluted 9,295 6,800 6,174
====== ====== ======
Net income per share:
Basic $ 1.22 $ 0.35 $ 0.30
====== ====== ======
Diluted $ 1.06 $ 0.33 $ 0.30
====== ====== ======
</TABLE>
36
<PAGE> 37
Options to purchase 195,500 shares of common stock at a weighted average
exercise price of $100.98 per share were outstanding at September 30, 1999 , but
were not included in the computation of diluted net income per share because
their impact would be anti-dilutive.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 1998, the AICPA issued Statement of Position 98-9,
Modification of SOP 97-2, "Software Revenue Recognition, with respect to certain
transactions" ("SOP 98-9"), which amends certain elements of SOP 97-2 and
provides additional authoritative guidance on software revenue recognition. SOP
98-9 is effective for fiscal years beginning after March 15, 1999. The Company
does not expect that the adoption of SOP 98-9 will have a material effect on its
financial statements.
NOTE 3 -- CYLAN ACQUISITION
In April 1998, the Company acquired the outstanding stock of CyLAN
Technologies, Inc., a software development company, for $340,000 in cash in a
transaction accounted for under the purchase method. The purchase agreement
calls for the Company to make royalty payments on sales made over a three-year
period that incorporate the acquired technology. In conjunction with the
acquisition, the Company recorded the purchase price of $340,000 as capitalized
software, which is being amortized on a straight-line basis over a three-year
period. Pro forma data has not been presented, as such results would not differ
materially from the historical results presented.
Royalty payments under the agreement above were $0 and $721,000 during the years
ended September 30, 1998 and 1999, respectively.
NOTE 4 -- NOTES PAYABLE
In September 1998, the Company entered into a $5.0 million loan
agreement with Stac, Inc. which was due and payable on September 30, 1999, but
which could be prepaid in whole or part without penalty. The loan accrued
interest at prime rate plus 0.5%. On March 31, 1999, the entire $5.0 million
loan was repaid.
NOTE 5 -- BALANCE SHEET DETAILS
<TABLE>
<CAPTION>
September 30,
---------------------
1999 1998
-------- -------
<S> <C> <C>
Accounts receivable:
Trade receivables $ 6,971 $3,325
Less: allowance for doubtful accounts (251) (200)
------- ------
$ 6,720 $3,125
======= ======
Property and equipment:
Computer equipment $ 1,999 $1,445
Furniture and fixtures 524 419
Leasehold improvements 562 346
Office equipment 324 287
------- ------
3,409 2,497
Less: accumulated depreciation (1,020) (882)
------- ------
$ 2,389 $1,615
======= ======
Accrued expenses and other current liabilities:
Deferred revenue $ 1,353 $ 697
Compensation and employee benefits 1,557 489
Accrued Royalties 377 175
Other 433 180
------- ------
$ 3,720 $1,541
======= ======
</TABLE>
37
<PAGE> 38
NOTE 6 -- CONVERTIBLE PREFERRED STOCK
The Company issued 6,000,000 shares of voting, participating,
convertible Series A Preferred Stock ("Series A Preferred Stock") and 100 shares
of Common Stock to Stac in exchange for the net assets contributed. The transfer
was recorded at the historical net book value of the transferred assets and
liabilities of $2,620,000. Each share of Series A Preferred Stock was converted
by Stac into one share of Common Stock in connection with the spin-off. See Note
1.
NOTE 7 -- STOCK OPTIONS AND EMPLOYEE BENEFITS
EMPLOYEE STOCK OPTION PLAN
During fiscal 1997, the Company adopted the 1996 Equity Incentive Plan
(the "1996 Plan") whereby 1,949,900 shares of the Company's common stock has
been reserved for issuance pursuant to nonqualified and incentive stock options
and restricted stock awards. In December 1998, the Company reserved an
additional 1,100,000 shares for issuance under the 1996 Plan so that a total of
3,049,900 shares of the Company's common stock are reserved for issuance under
the 1996 Plan. The 1996 Plan is administered by the Board of Directors of the
Company or its designees and provides generally that nonqualified stock options
and restricted stock may be awarded at a price not less than 85% of the fair
market value of the stock at the date of the award. Incentive stock options must
be awarded at a price not less than 100% of the fair market value of the stock
at the date of the award, or 110% of fair market value for awards to more than
10% stockholders. Options granted under the 1996 Plan may have a term of up to
10 years. Options typically vest at a rate of 25% of the total grant per year
over a four-year period. However, the Company may, at its discretion implement a
different vesting schedule with respect to any new stock option grant. As a
result of early exercise features as provided for by the 1996 Plan, options
granted are immediately exercisable subject to the Company's repurchase rights
which expire as options vest.
The following table summarizes the activity and related information
under the 1996 Plan:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
EXERCISE PRICE OF
OPTIONS AVAILABLE OPTIONS OPTIONS (PER SHARE)
FOR GRANT OUTSTANDING OUTSTANDING
----------------- ----------- -------------------
<S> <C> <C> <C>
BALANCE AT SEPTEMBER 30, 1996
Shares reserved upon adoption of 1996 Plan 1,949,900 -- --
Options granted (1,112,000) 1,112,000 0.77
Options exercised -- (205,699) 0.60
Options cancelled 29,438 (29,438) 0.60
---------- --------- -----
BALANCE AT SEPTEMBER 30, 1997 867,338 876,863 0.82
Options granted (388,000) 388,000 2.29
Options exercised -- (202,315) 1.05
Options cancelled 187,361 (187,361) 1.60
---------- --------- -----
BALANCE AT SEPTEMBER 30, 1998 666,699 875,187 1.46
Additional shares authorized 1,100,000 --
Options granted (1,158,875) 1,158,875 26.50
Options exercised -- (304,230) 1.23
Options cancelled 71,438 (71,438) 11.13
---------- --------- -----
BALANCE AT SEPTEMBER 30, 1999 679,262 1,658,394 18.57
========== ========= =====
</TABLE>
38
<PAGE> 39
The following table summarizes options outstanding at September 30, 1999
and related weighted average exercise prices and lives as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING AND EXERCISABLE OPTIONS VESTED AND EXERCISABLE
--------------------------------------------------------- ------------------------------
RANGE OF WEIGHTED AVERAGE WEIGHTED AVERAGE WEIGHTED AVERAGE
EXERCISE PRICES NUMBER REMAINING LIFE (IN YEARS) EXERCISE PRICE NUMBER EXERCISE PRICE
- ---------------- -------- ------------------------- ---------------- ------ -----------------
<S> <C> <C> <C> <C> <C>
$ 0.60 - $ 2.50 416,568 7.76 $ 1.28 49,199 $1.07
$ 3.00 472,751 9.06 $ 3.00 5,424 $3.00
$ 5.00 389,275 9.18 $ 5.00 -- --
$ 26.75 - $ 42.00 180,300 9.51 $ 37.40 -- --
$ 53.00 - $127.88 164,500 9.84 $ 93.44 -- --
$130.31 - $142.50 37,000 9.95 $136.46 -- --
--------- ---- ------- ------ -----
1,658,394 8.91 $ 18.57 54,623 $1.26
========= ==== ======= ====== =====
</TABLE>
The weighted average fair value of options granted during 1999, 1998 and
1997 were $15.71, $1.20 and $0.68, respectively. The fair value of each stock
award is estimated on the date of grant using the Black-Scholes model with the
following assumptions used for grants during 1999, 1998 and 1997: annual
dividend yield of 0.0% for all periods; risk-free annual interest rates of
5.05%, 5.48% and 6.46%, respectively; a weighted average expected stock award
term of 4.0 years for all periods; and an expected volatility factor of 80%, 64%
and 250%, respectively.
EMPLOYEE STOCK PURCHASE PLAN
In December 1998, the Company adopted an employee stock purchase plan
(the "ESPP"), through which qualified employees of the Company may participate
in stock ownership of the Company. Shares of common stock reserved for the ESPP
total 400,000. The price of shares purchased under the ESPP is the lower of 85%
of the fair market value of the shares on the first day of each semi-annual
offering period, or 85% of the fair market value of the shares on the last day
of the semi-annual offering period. Pursuant to the ESPP, 12,008 shares were
issued at a weighted average price of $14.66 per share during fiscal 1999.
The fair value of shares issued during 1999 was $10.66. The fair value
of each stock award is estimated on the date of grant using the Black-Scholes
model with the following assumptions used for grants during 1999: annual
dividend yield of 0.0%; risk-free annual interest rates of 5.05%; a weighted
average expected stock award term of .41 years; and an expected volatility
factor of 80%.
DEFERRED STOCK COMPENSATION
In connection with certain employee stock option grants made during the
year ended September 30, 1999, the Company recognized deferred compensation
totaling $239,000, which is being amortized over the vesting period of the
related options, usually four years. Amortization of deferred stock compensation
of $31,000 was recorded during the year ended September 30, 1999. Future
compensation charges are subject to reduction for any employee who terminates
prior to expiration of such employee's option vesting period.
FAIR VALUE DISCLOSURES
Had compensation expense for the Company's stock-based compensation
plans been determined based on the method prescribed by SFAS No. 123, the
Company's net income and net income per share would have been as follows:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
------------------------------------
1999 1998 1997
------ ------ ------
<S> <C> <C> <C>
Net income:
As reported ....... $9,881 $2,218 $1,833
Pro forma ......... $8,375 $1,981 $1,683
As reported
Basic ........ $ 1.22 $ 0.35 $ 0.30
</TABLE>
39
<PAGE> 40
<TABLE>
<S> <C> <C> <C>
Diluted ...... $1.06 $0.33 $0.30
Pro forma
Basic ........ $1.03 $0.32 $0.28
Diluted ...... $0.90 $0.30 $0.27
</TABLE>
NOTE 8 -- INCOME TAXES
The Company accounts for income taxes under an asset and liability
approach that requires recognition of deferred tax assets and liabilities for
the expected future tax consequences of events that have been recognized in the
Company's financial statements or income tax returns.
The components of the provision for income taxes were as follows (in
thousands):
<TABLE>
<CAPTION>
Year ended September 30,
-----------------------------------
1999 1998 1997
------- ------- -------
<S> <C> <C> <C>
Current:
Federal $ 5,784 $ 1,676 $ 1,159
State 1,631 420 205
------- ------- -------
7,415 2,096 1,364
------- ------- -------
Deferred:
Federal (707) (411) (109)
State (121) (58) (20)
------- ------- -------
(828) (469) (129)
------- ------- -------
Provision for income taxes $ 6,587 $ 1,627 $ 1,235
======= ======= =======
</TABLE>
The components of deferred taxes are as follows (in thousands):
<TABLE>
<CAPTION>
September 30,
--------------------
1999 1998
------ -----
<S> <C> <C>
Property and equipment $ 155 $ 148
Inventory valuation accounts 166 166
Sales and receivables reserves 263 286
Accruals and reserves 958 117
Other 235 232
------ -----
$1,777 $ 949
====== =====
</TABLE>
The provision for income taxes differs from the amount computed by
applying the U.S. statutory federal rate to income before extraordinary item as
a result of the following (in thousands):
<TABLE>
<CAPTION>
Year ended September 30,
----------------------------------
1999 1998 1997
------- ------ ------
<S> <C> <C> <C>
Tax at statutory rate $ 5,599 $1,307 $1,043
State taxes 1,031 235 184
Other (43) 85 8
------- ------ ------
$ 6,587 $1,627 $1,235
======= ====== ======
</TABLE>
40
<PAGE> 41
NOTE 9 -- COMMITMENTS
LEASES
The Company occupies its facilities under several non-cancelable
operating leases that expire at various dates through September 2005, and which
contain renewal options. Future minimum lease payments for operating leases are
as follows (in thousands):
<TABLE>
<CAPTION>
Fiscal year ending September 30,
<S> <C>
2000............................................................... $1,370
2001............................................................... 1,299
2002............................................................... 1,133
2003............................................................... 1,015
Thereafter......................................................... 2,017
------
Total...................................................... $6,834
======
</TABLE>
Total rental expense under operating leases was $1.1 million, $467,000, and
$113,000 for the years ended September 30, 1999, 1998 and 1997, respectively.
The Company recorded sub-lease income of $293,000 during the year ended
September 30, 1999.
NOTE 10 -- SUBSEQUENT EVENTS
The Company and certain of its officers and directors have been named
as defendants in several substantially similar class action lawsuits filed in
October 1999 in the United States district Court for the Northern District of
California. The plaintiffs in theses actions purport to represent a class of all
persons who purchased the Company's common stock between July 26, 1999 through
October 7, 1999. The complaints allege that the defendants made misleading
statements in violation of the federal securities laws, including Section 10(b)
of the Securities Exchange Act of 1934. The Company expects the Court to appoint
a lead plaintiff and consolidate the complaints in the near future.
The Company believes that the complaints are without merit and intends to
defend against them vigorously. Nevertheless, litigation is subject to inherent
uncertainties and thus there can be no assurance that these suits will be
resolved favorably to the Company or will not have a material adverse effect on
the Company's financial position or results of operations.
41
<PAGE> 42
ITEM 10. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 11. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Certain information required by this item is incorporated by reference to
hi/fn's Proxy Statement. The following table sets forth certain information
concerning the executive officers and directors of Hi/fn as of September 30,
1999:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Raymond J. Farnham......................... 52 President, Chief Executive Officer, Director and Chairman
William R. Walker.......................... 58 Vice President of Finance, Chief Financial Officer and Secretary
Stephen A. Farnow, Ph.D.................... 50 Vice President of Operations
Robert C. Harrah........................... 54 Vice President of Sales
Robert A. Monsour.......................... 44 Vice President of Marketing
Douglas L. Whiting, Ph.D................... 43 Chief Technology Officer and Director
Taher Elgamal, Ph.D.(2).................... 44 Director
Robert W. Johnson(1)....................... 50 Director
Albert E. Sisto(1)(2)...................... 50 Director
</TABLE>
- -------------
(1) Member of the Audit Committee.
(2) Member of the Compensation Committee.
Raymond J. Farnham has served as Chairman of the Board of Directors and
President and Chief Executive Officer of Hi/fn since October 1998. From 1996
through 1998, he served as Executive Vice President of Integrated Device
Technology, Inc., a supplier of microprocessor, logic and memory integrated
circuits to communication and computer customers worldwide. Mr. Farnham was
President and Chief Executive Officer of OPTi, a fabless semiconductor company
from 1994 through 1995. From 1972 through 1993, he had numerous management
responsibilities at National Semiconductor Corp., with his final position being
President of the Communication and Computing Group from 1991 through 1993. He
received a B.S. in Electrical Engineering from Pennsylvania State University.
William R. Walker has served as Vice President and Chief Financial Officer of
Hi/fn since November 1997. He was Hi/fn's Acting Chief Executive Officer and
Acting President from July 1998 through October 1998. From 1996 to 1997, Mr.
Walker was Vice President, Chief Financial Officer and Secretary at MMC
Networks, Inc., a networking company. From 1984 to 1996, Mr. Walker held the
position of Senior Vice President and Chief Financial Officer at Zilog, Inc., a
semiconductor supplier. Mr. Walker has a B.S. in Economics from University of
Wisconsin and an M.B.A. from University of Maryland, and he is a certified
public accountant.
Stephen A. Farnow, Ph.D. has served as Vice President of Operations at Hi/fn
since 1996. From 1990 through 1996, he worked as an independent consultant in
the area of general management with an emphasis on setting up or re-engineering
operations functions. From 1986 through 1990, he was Vice President of
Operations at Weitek Corp., a semiconductor supplier. He received a B.S. in
Physics from UCLA and a Ph.D. from Stanford University.
Robert C. Harrah has served as Vice President of Sales of Hi/fn since December
1998. From 1995 to 1998, Mr. Harrah served as Vice President of Worldwide Sales
for the Peripheral Technology Solutions Group at Adaptec, Inc. From 1988 to
1995, Mr. Harrah held marketing management and sales management positions at
Symbios Inc. Mr. Harrah received a B.S. degree from College of Notre Dame in
Belmont, California and an M.B.A. from Golden Gate University in San Francisco,
California.
Robert A. Monsour has served as Vice President of Marketing of Hi/fn since
August 1997. He also served as Vice President of Sales from August 1997 through
April 1998. From 1996 to 1997, he worked as an independent consultant in the
area of
42
<PAGE> 43
high-technology marketing. From 1993 to 1996, Mr. Monsour, a co-founder of Stac,
held the position of Vice President of Business Development at Stac. He was also
Vice President of Product Development from 1990 to 1993, and from 1988 to 1990
he served as Vice President of Marketing at Stac. Mr. Monsour has a B.A.S. and
M.A.S. in Computer Systems from Florida Atlantic University and holds an M.B.A.
from UCLA.
Douglas L. Whiting, Ph.D. has served as Chief Technology Officer of Hi/fn since
October 1997 and as a director of Hi/fn since November 1996. He also served as
Vice President of Technology of Stac from 1985 to 1998 and has served as a
director of Stac from 1983 to 1999. He was President of Stac from 1984 to 1986.
Dr. Whiting received a Ph.D. in Computer Science from the California Institute
of Technology.
Taher Elgamal, Ph.D. has served as a director of Hi/fn since December 1998. He
has also served as president of Kroll-O'Gara since January 1999. Dr. Elgamal is
the founder and Chairman of Securify, a private company providing assessments of
companies' Internet security efforts and a subsidiary of Kroll-O'Gara. He served
as Chairman and Chief Executive Officer of Securify from March 1998 to January
1999. From 1995 to 1998, Dr. Elgamal held the position of Chief Scientist of
Netscape Communications Corp., a provider of Internet software and services,
where he pioneered Internet security technologies such as SSL, the standard for
web security. From 1991 to 1993, he served as Director of Engineering at RSA
Data Security, Inc., a provider of encryption technology and a subsidiary of
Security Dynamics Technologies, Inc., where he produced the RSA cryptographic
toolkits, the industry standards for developers of security-enabled applications
and systems. Dr. Elgamal received a Ph.D. from Stanford University.
Robert W. Johnson has been a private investor since July 1988. From 1983 to July
1988, he was first a principal and subsequently a general partner of Southern
California Ventures, a private venture capital firm. He is a director of Proxima
Corporation and ViaSat, Inc., both publicly held technology companies. Mr.
Johnson holds undergraduate and graduate degrees from Stanford University and
Harvard University.
Albert E. Sisto has served as a director of Hi/fn since December 1998. Since
June 1999 he has been President and Chief Executive Officer of Phoenix
Technology, a provider of Internet platform-enabling software. From November,
1997 to June 1999, he was Chief Operating Officer of RSA Data Security, Inc., a
provider of encryption technology and a subsidiary of Security Dynamics
Technologies, Inc. From September 1994 to October 1997, Mr. Sisto was Chairman,
President and CEO of Documagix, a software developer of document imaging
software. Mr. Sisto is a director of Jetfax, Inc., Insignia Solutions plc and
Tekgraf, Inc., all publicly traded technology companies, and also is a director
of nCipher Corporation Ltd. and Trintech Group Ltd. Mr. Sisto holds a B.E.
degree from the Stevens Institute of Technology.
ITEM 12. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to Hi/fn's
Proxy Statement.
ITEM 13. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference to hi/fn's
Proxy Statement.
ITEM 14. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to hi/fn's
Proxy Statement.
43
<PAGE> 44
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this Report:
1. FINANCIAL STATEMENTS - See Item 8 above.
2. FINANCIAL STATEMENT SCHEDULE - See Item 14(d) below.
3. EXHIBITS
<TABLE>
<CAPTION>
Exhibit
Number Exhibit
------- -------
<S> <C>
3.1* Form of Third Amended and Restated Certificate of
Incorporation of hi/fn, inc.
3.2* Amended and Restated Bylaws of hi/fn, inc.
10.1* Amended and Restated 1996 Equity Incentive Plan of hi/fn,
inc.
10.2* Assignment, Assumption and License Agreement dated as of
November 21, 1996 between Stac, Inc. and hi/fn, inc.
10.3* Cross License Agreement dated as of November 21, 1996
between Stac, Inc. and hi/fn, inc.
10.4* Form of Distribution Agreement.
10.5* Form of Employee Benefits and Other Matters Allocation
Agreement.
10.6* Form of Tax Allocation and Indemnity Agreement.
10.7* Form of Transitional Services Agreement.
10.8* Form of Indemnification Agreement.
10.9* Agreement dated as of April 1, 1994 between International
Business Machines Corporation and Stac, Inc. (Program Patent
License Agreement).
10.10* Agreement dated as of April 1, 1994 between International
Business Machines Corporation and Stac, Inc. (Cross License
Agreement).
10.11* License Agreement dated as of June 20, 1994 between
Microsoft Corporation and Stac, Inc.
10.12* License Agreement dated as of February 16, 1996 between
Microsoft Corporation and Stac, Inc.
10.13* License Agreement dated as of December 15, 1995 between
Motorola, Inc. and Stac, Inc.
10.14* Agreement dated as of November 13, 1997 between 750
University, LLC and hi/fn, inc.
10.15* 1998 Employee Stock Purchase Plan of hi/fn, inc.
10.16* Form of Director Change of Control Agreement.
10.17* Form of Employee Change of Control Agreement.
10.18* Promissory Note dated as of September 28, 1998 made by
hi/fn, inc. in favor of Stac, Inc.
10.19* Security Agreement dated as of September 28, 1998 between
Stac, Inc. and hi/fn, inc.
23.1 Consent of PricewaterhouseCoopers LLP, independent
accountants.
24.1 Power of Attorney (see page II-5).
27.1 Financial Statement Schedule
</TABLE>
- ---------------------------
* Incorporated by reference from Registrant's Registration Statement on Form
10 (File No. 0-24765) filed with the SEC on August 7, 1998, as amended.
(b) Reports on Form 8-K: None.
(c) Exhibits: See Item 14(a) above.
(d) Financial Statement Schedules
<TABLE>
<S> <C>
Schedule II - Valuation Qualifying Accounts ........................................ S-1
</TABLE>
44
<PAGE> 45
HI/FN, INC.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
For the Three years Ended
September 30, 1999
(in thousands)
<TABLE>
<CAPTION>
Additions
Balance at charged to Additions
beginning costs and charged to Balance at
of period expenses other accounts Deductions end of period
---------- ----------- -------------- ---------- -------------
<S> <C> <C> <C> <C> <C>
DEDUCTED FROM ACCOUNTS RECEIVABLE
Allowance for doubtful accounts:
Year ended September 30, 1997............... 159 (109) 50
Year ended September 30, 1998............... 50 150 200
Year ended September 30, 1999............... 200 75 (24) 251
</TABLE>
45
<PAGE> 46
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Dated: December 30, 1999 \s\ Raymond J. Farnham
-----------------------------------------
Raymond J. Farnham
Chairman, President and Chief
Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Raymond J. Farnham and William R. Walker, jointly
and severally, his attorneys-in-fact, each with the power of substitution, for
him in any and all capacities, to sign any amendments to this Report on Form
10-K, and to file the same, with exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, hereby
ratifying and confirming all that each of said attorneys-in-fact, or his
substitute or substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons in the capacities and on December
30, 1999.
<TABLE>
<CAPTION>
Signature Title
- --------- -----
<S> <C>
\s\ RAYMOND J. FARNHAM Chairman of the Board, President and
- ---------------------------------- Chief Executive Officer (Principal
(Raymond J. Farnham) Executive Officer)
\s\ WILLIAM R. WALKER Vice President, Finance, Chief
- ---------------------------------- Financial Officer (Principal Financial
(William R. Walker) and Accounting Officer)
\s\ TAHER ELGAMAL Director
- ----------------------------------
(Taher Elgamal)
\s\ ROBERT W. JOHNSON Director
- ----------------------------------
(Robert W. Johnson)
\s\ ALBERT E. SISTO Director
- ----------------------------------
(Albert E. Sisto)
\s\ DOUGLAS L. WHITING Director
- ----------------------------------
(Douglas L. Whiting)
</TABLE>
46
<PAGE> 47
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Exhibit
------- -------
<S> <C>
3.1* Form of Third Amended and Restated Certificate of
Incorporation of hi/fn, inc.
3.2* Amended and Restated Bylaws of hi/fn, inc.
10.1* Amended and Restated 1996 Equity Incentive Plan of hi/fn,
inc.
10.2* Assignment, Assumption and License Agreement dated as of
November 21, 1996 between Stac, Inc. and hi/fn, inc.
10.3* Cross License Agreement dated as of November 21, 1996
between Stac, Inc. and hi/fn, inc.
10.4* Form of Distribution Agreement.
10.5* Form of Employee Benefits and Other Matters Allocation
Agreement.
10.6* Form of Tax Allocation and Indemnity Agreement.
10.7* Form of Transitional Services Agreement.
10.8* Form of Indemnification Agreement.
10.9* Agreement dated as of April 1, 1994 between International
Business Machines Corporation and Stac, Inc. (Program Patent
License Agreement).
10.10* Agreement dated as of April 1, 1994 between International
Business Machines Corporation and Stac, Inc. (Cross License
Agreement).
10.11* License Agreement dated as of June 20, 1994 between
Microsoft Corporation and Stac, Inc.
10.12* License Agreement dated as of February 16, 1996 between
Microsoft Corporation and Stac, Inc.
10.13* License Agreement dated as of December 15, 1995 between
Motorola, Inc. and Stac, Inc.
10.14* Agreement dated as of November 13, 1997 between 750
University, LLC and hi/fn, inc.
10.15* 1998 Employee Stock Purchase Plan of hi/fn, inc.
10.16* Form of Director Change of Control Agreement.
10.17* Form of Employee Change of Control Agreement.
10.18* Promissory Note dated as of September 28, 1998 made by
hi/fn, inc. in favor of Stac, Inc.
10.19* Security Agreement dated as of September 28, 1998 between
Stac, Inc. and hi/fn, inc.
23.1 Consent of PricewaterhouseCoopers LLP, independent
accountants.
24.1 Power of Attorney (see page II-5).
27.1 Financial Statement Schedule
</TABLE>
- ---------------------------
* Incorporated by reference from Registrant's Registration Statement on Form
10 (File No. 0-24765) filed with the SEC on August 7, 1998, as amended.
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the Registration Statement
on Form S-8 (No. 333-68917) of our report dated October 22, 1999 relating to the
financial statements and financial statement schedules, which appears in hi/fn,
inc.'s Annual Report on Form 10-K for the year ended September 30, 1999.
PricewaterhouseCoopers LLP
San Jose, California
December 30, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> SEP-30-1999
<PERIOD-START> OCT-01-1998
<PERIOD-END> SEP-30-1999
<CASH> 70,086
<SECURITIES> 0
<RECEIVABLES> 6,720
<ALLOWANCES> 251
<INVENTORY> 1,568
<CURRENT-ASSETS> 80,634
<PP&E> 2,389
<DEPRECIATION> 700
<TOTAL-ASSETS> 83,530
<CURRENT-LIABILITIES> 7,481
<BONDS> 0
0
0
<COMMON> 9
<OTHER-SE> 76,040
<TOTAL-LIABILITY-AND-EQUITY> 76,049
<SALES> 42,351
<TOTAL-REVENUES> 42,351
<CGS> 10,498
<TOTAL-COSTS> 10,498
<OTHER-EXPENSES> 17,091
<LOSS-PROVISION> 75
<INTEREST-EXPENSE> 214
<INCOME-PRETAX> 16,468
<INCOME-TAX> 6,587
<INCOME-CONTINUING> 9,881
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 9,881
<EPS-BASIC> 1.22
<EPS-DILUTED> 1.06
</TABLE>
