STAC SOFTWARE INC, 10-K405, 1998-12-24

STAC SOFTWARE INC
10-K405, 1998-12-24
PREPACKAGED SOFTWARE

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------

FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1998

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM ___________ TO ___________

COMMISSION FILE NO. 0-20095

STAC SOFTWARE, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

DELAWARE 95-3825313
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)

12636 HIGH BLUFF DRIVE, 4TH FLOOR, SAN DIEGO, CALIFORNIA 92130-2093
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (619) 794-4300

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

COMMON STOCK
(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 (Section 229.405 of this chapter) 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 of any amendment to this Form 10-K. [X]

The aggregate market value of the voting stock held by nonaffiliates of the
Registrant as of December 18, 1998 was $20,483,000.*

The number of shares outstanding of the Registrant's Common Stock was 23,673,170
as of December 18, 1998.

DOCUMENTS INCORPORATED BY REFERENCE

Registrant's Definitive Proxy Statement to be filed with the Securities and
Exchange Commission (the "Commission") pursuant to Regulation 14A in connection
with the 1999 Annual Meeting of Shareholders to be held on February 26, 1999
(the "1999 Annual Meeting") is incorporated herein by reference into Part III of
this Report.

Certain Exhibits filed with the Registrant's Registration Statement on Form S-1
(Registration No. 33-46389), as amended, the Registrant's Annual Report on Form
10-K for the fiscal years ended September 30, 1993, 1994, 1995, and 1996,
Quarterly Report on Form 10-Q for the quarter ended June 30, 1994, as amended,
and Current Reports on Form 8-K filed on November 8, 1994 and October 16, 1995,
as amended, are incorporated herein by reference into Part IV of this Report.

Certain Exhibits filed with the Registration Statement on Form 10 filed by
Hi/fn, Inc. on August 7, 1998, as amended, are incorporated herein by reference
into Part IV of this Report.
____________

* Excludes the Common Stock held by executive officers, directors and
shareholders whose ownership exceeds 5% of the Common Stock outstanding at
December 18, 1998. Exclusion of such shares should not be construed to
indicate that any such person possesses the power, direct or indirect, to
direct or cause the direction of the management or policies of the
Registrant or that such person is controlled by or under common control with
the Registrant.

================================================================================

<PAGE> 2

PART I

ITEM 1. BUSINESS

Except for the historical information contained herein, the following
discussion contains forward-looking statements that involve risk and
uncertainties. The Company's future results could differ materially from those
discussed here. Factors that could cause or contribute to such differences
include but are not limited to; fluctuations in the Company's operating results,
the impact on the Company of its spin-off of Hi/fn, Inc. ("Hi/fn"), continued
new product introductions by the Company, market acceptance of the Company's new
product introductions, new product introductions by competitors, OEM and
distributor inventory levels, technological changes in the personal computer and
communications industries, uncertainties regarding intellectual property rights
and the other factors referred to herein (including, but not limited to, the
factors discussed below in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" under "Revenues," "Quarterly Trends and
Channel Inventories," "Seasonality," "Operating Systems" and "Stock Price
Volatility").

Stac Software, Inc. ("Stac" or the "Company") designs, develops, markets
and supports high-performance, easy to deploy, distributed business systems
recovery software solutions for enterprise customers which implement the
Company's lossless data compression technologies. Stac also supports a remote
access software suite, which is managed as a mature business unit. The Company
has been and intends to continue to focus its development and marketing
resources on the business segments it believes have the highest growth
potential, and to continually evaluate its strategic objectives with respect to
its remote access software business. Stac's products are sold through a variety
of domestic and international channels.

On December 16, 1998 the Company changed its name to Stac Software, Inc.,
from Stac, Inc., by way of a merger pursuant to the Delaware General Corporation
Law of its wholly-owned subsidiary Stac Software, Inc., with and into the
Company. References in this Report on Form 10-K to Stac, Inc. mean the Company.
The Company's symbol on the Nasdaq's Stock Market National Market System
("NMS"), "STAC", was not changed in connection with the name change.

On December 16, 1998, the Company distributed a special dividend of its
stock in its Hi/fn subsidiary to its stockholders. Hi/fn was a majority owned
subsidiary of the Company and is engaged in silicon and software implementations
of data compression and data encryption standards for the network communications
and storage equipment markets. As a result of the spin-off, Hi/fn has been
accounted for as a discontinued operation in the Company's Statement of
Operations and Balance Sheets. Hi/fn is currently traded on Nasdaq under the
symbol HIFN. Please refer to the Registration Statement on Form 10 filed by
Hi/fn with the SEC for a complete discussion of Hi/fn and the spin-off
transaction.

Stac's storage systems recovery software business is comprised of its
Replica 3 and Replica Network Data Manager ("NDM") product lines. Replica 3 and
Replica NDM are high-performance, easy-to-deploy, distributed business systems
recovery software products, which enable fast PC server, desktop and notebook
replication and disaster recovery. Replica for NetWare was introduced in
February 1996, Replica for NT was made available in April 1997 and Replica NDM
was introduced to selected customer sites in April 1998. The Company intends to
focus on the development of relationships with key OEMs in the storage
management software sector and with system integration partners and is investing
the majority of its product development, marketing and sales resources in the
Replica product line and extensions to Replica.

The Company also develops and markets ReachOut Enterprise ("ReachOut")
remote communications software, a remote access software suite which allows
administrators and end users to access a PC using another PC through a network,
the Internet, ISDN lines or modems. ReachOut works with Microsoft Corporation's
("Microsoft") Windows NT, Windows 98/95, Windows 3.x and DOS operating systems.

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further revenues from these agreements. The royalties, net of taxes paid, have
been reinvested in the ReachOut and Replica products which have replaced the
Company's former Stacker disk compression products.

The following discussion should be read in conjunction with the consolidated
financial statements included elsewhere within this annual report. Fluctuations
in annual and quarterly results may occur as a result of factors affecting
demand for the Company's products such as the timing of the Company's and
competitors' new product introductions and upgrades. Due to such fluctuations,
historical results and percentage relationships are not necessarily indicative
of the operating results for any future period.

BACKGROUND

STORAGE MANAGEMENT SOFTWARE

The network server market has grown rapidly as more information is being
shared and processed across networks. Also, the storage capacity of hard disk
drives installed on servers and on workstations has grown dramatically. With
network servers providing shared access to mission critical information
twenty-four hours a day seven days a week, the need for fast, reliable data
backup and disaster recovery has become acute. Traditionally servers have been
backed up a file at a time. If a lost or deleted file needed to be recovered,
specialized software would have to be run by a network systems administrator. If
a server was lost and the files destroyed, a new server would have to be
formatted and the network operating system reinstalled before going to tapes to
try to recover the data. The result has been costly server down time.

Stac began shipping Replica for NetWare in February 1996, Replica for
Windows NT in April 1997 and Replica NDM on a limited test basis in April 1998.
Unlike traditional file-by-file backup technologies, Replica for Windows NT and
NetWare uses Stac's Object Replication Technology to replicate entire servers or
volumes. Replication allows live servers to be backed up and is significantly
faster than file-by-file software because Replica does not have to open and
close each file as it replicates. A replicated volume can be mounted directly as
a volume so that downtime due to a server crash can be minimized. Unlike
disaster recovery routines provided by file-by-file software, Replica creates a
complete server copy and can restore a server without having to reinstall
networking software or rebuild disk partitions. Replica introduced Stac's Object
Replication Technology as a replacement for file-by-file backup software
solutions that do not provide fast, effective disaster recovery for servers.
Stac has also introduced in Replica NDM its proprietary three-tiered lossless
data compression technology, which builds on previous data compression
technology for which the Company is known.

Replica NDM addresses the previously unsolved problem of providing fast,
efficient back-up and disaster recovery to Windows-based desktops and notebooks.
The growth of disk drives and the use of notebooks for work away from the
network has exposed enterprises to having large amounts of unprotected data.
Stac's three-tiered data compression technology allows fast, zero-administration
back-up of desktops and notebooks to enterprise network administrators and
allows end users to recover their own files or to recover from loss of their
disk drive or notebook.

The Company discontinued marketing and sales of its Stacker disk compression
products in September 1997. Stacker products provided the majority of Stac's
software revenues for fiscal years 1991 though 1994. Data compression utilities
provided with Windows NT, Windows 98/95, MS-DOS and PC-DOS under patent or
software licenses from Stac and the rapidly declining cost per megabyte of hard
disk storage have provided customers with the choice of inexpensively upgrading
their hard disk drives or using compression utilities that are included with the
operating systems sold with most personal computers.

COMMUNICATIONS SOLUTIONS SOFTWARE

The Company began marketing ReachOut Remote Control software in 1994 and has
subsequently developed releases of ReachOut for Microsoft's Windows NT, Windows
98/95 and Windows 3.x operating systems. The

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remote access market has developed due to the following trends: i) the need for
users to access from outside the office the programs and data on their work
computer; ii) the need to transfer files from a remote computer to another; iii)
the growth in remote technical support via modem; and iv) the growth in office
PC networks and the need for users to access them remotely.

ReachOut Enterprise provides a complete, high performance remote access
solution comprised of remote control, remote node and rapid file transfer.
ReachOut is designed for enterprise network administrators and supports PCs
using Windows NT, Windows 98/95, Windows 3.x and DOS. ReachOut remote control
effectively allows one PC to take control of another PC by using a connection
made over a modem, an ISDN line, the Internet or an internal network.

Using ReachOut, the remote PC, or host, is operated by the user from another
PC, the viewer. The host accesses files and runs programs using keystrokes and
mouse directions sent by the user from the viewer PC. The viewer PC displays
what is on the host PC's screen and thus gives the user a way to remotely
operate the host PC and see the results of the work. ReachOut includes a remote
access client that allows users to log into a computer network as a remote node.
ReachOut also provides a file transfer utility that performs fast file transfer
from one PC to another and allows a user to efficiently update a file by
transmitting only the changes that have been made since the last time the file
was transferred.

STRATEGY

Stac's strategy is to provide software solutions for information systems
managers of large enterprises to help them better manage and use their personal
computer storage and communications investments through the use of intranet and
Internet enabled disaster recovery, communications and security capabilities.
The Company is partnering with other OEM software developers, systems
integrators and resellers to provide complete data storage and management
solutions for enterprises.

The Company has implemented this strategy through a combination of strategic
technology acquisitions and internal product development. In March 1995 Stac
acquired certain Novell NetWare server disaster recovery and data protection
technology which was the basis for the Company's Replica 3 product line. The
Company has since made substantial investments in further development of those
technologies and has added features together with new, innovative technology.
The result of those development efforts has been Replica 3 for Windows NT,
Replica 3 for NetWare and Replica NDM.

In October 1994, Stac purchased certain ReachOut remote control software
technology which was the basis for the Company's ReachOut product line. The
Company has since introduced new versions of ReachOut, creating a complete
remote access software product targeted for the enterprise.

PRODUCTS

The Company currently licenses its storage management and communications
software solutions to enterprises and OEMs. Software solution sales consist of
the Company's ReachOut and Replica products.

Replica 3 is a backup and disaster recovery software product for Windows NT
and Novell NetWare and IntranetWare servers. Replica 3 uses Stac's Object
Replication Technology to quickly replicate entire servers or volumes and to
provide easy access to backed up files plus fast, dependable disaster recovery.

Replica NDM is Stac's newest addition to the Replica storage management
product group. Replica NDM provides centrally managed enterprise-wide network
data protection and disaster recovery for Windows-based desktops and notebooks.
Replica NDM incorporates Stac's proprietary three-tiered data compression
technology, thereby dramatically lowering network traffic and network storage
administrative overhead and media costs.

ReachOut Enterprise has been redesigned to provide a remote control solution
for the enterprise. ReachOut Enterprise is a communications software program
that allows one PC to remotely control another PC by replicating the visual
display and controlling the keyboard and mouse. Using ReachOut over a network
connection, an

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administrator can control or monitor another PC on the same Local Area Network
(LAN) or Wide-Area Network (WAN) to provide helpdesk services. Using ReachOut
over a modem, a user can operate a distant PC, synchronize it with their local
PC, transfer files or establish a remote node connection.

The following table lists each of the Company's principal products and their
current pricing.

<TABLE>
<CAPTION>
DATE OF
PRODUCT DESCRIPTION SUGGESTED PRICE FIRST SHIPMENT
------- ----------- --------------- --------------
<S> <C> <C> <C>
Replica 3 Single Server Secure disaster recovery and $624 per server April 1997
Edition for Windows NT volume backup software for Windows
NT servers

Replica 3 Intranetwork Secure disaster recovery, $1,995 per server December 1997
Edition for Windows NT volume backup, and central
management software for
Windows NT servers

Replica 3 Single Server Secure disaster recovery and $624 per server February 1996
Edition for NetWare volume backup software for
Novell NetWare servers

Replica 3 Intranetwork Secure disaster recovery, $1,995 per server March 1996
Edition for NetWare volume backup and central
management software for
Novell NetWare servers

Replica Network Data Centrally managed $100 per client, September 1998
Manager enterprise-wide network at 1,000 client
protection and disaster license
recovery for Windows-based
client desktops and notebooks

ReachOut Enterprise Remote access software for $219 per user September 1991
Windows NT, Windows 98/95, license
Windows 3.x and DOS-based
computers
</TABLE>

RESEARCH AND DEVELOPMENT

The market for the Company's products is characterized by rapid
technological change, requiring continuous investment to develop and bring to
market new products. The Company has invested the majority of its software
development resources in its Replica product line over the past two fiscal
years. The Company believes that significant factors in its future success will
be its ability to identify and respond to customer needs, to enhance its
existing products, to introduce new products on a timely and cost-effective
basis, to extend its core technology into new platforms and applications, and to
anticipate and respond to emerging standards and other technological changes.

The Company intends to continue to develop its software products as market
conditions warrant and to invest in the development or acquisition of new
products. Foreign language versions of products will be developed as market
conditions warrant. The Company has developed, with the assistance of partners,
German and Japanese versions of its Replica and ReachOut software products for
sale in foreign markets and intends to continue its work with partners to
produce other language translations as market conditions warrant.

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The Company's research and development is conducted primarily by its
internal product development staff and through contractors. Research and
development expenses were $7.6 million in 1998 and $8.6 million in 1997, which
represented 39% and 26% of revenues in those periods, respectively.

MARKETING AND SALES

The Company markets and sells its storage management and communications
software products domestically and internationally through Stac Europe, Limited
("Stac Europe"), a wholly owned subsidiary of the Company. The Company sells its
products principally through: i) its internal sales and marketing staffs which,
primarily with partners, corporate resellers, value added resellers and systems
integrators, sell to corporations, government entities and other enterprises and
ii) distributors that sell primarily to software resellers. The Company's
distributors resell the Company's products in North America and Europe on a
nonexclusive basis and in Japan on an exclusive basis pursuant to distribution
agreements that generally have one-year terms with automatic one-year renewal
periods. The Company retains ownership of its proprietary rights associated with
its products and agrees to indemnify the distributor for third-party claims of
proprietary rights infringement to the extent such claims are brought against
the distributor.

International sales accounted for revenues of $4.8 million and $5.1 million
in fiscal 1998 and 1997, respectively. Technical support for Stac products is
provided by Stac, Stac Europe or through contracts with third parties. The
Company's international operations are subject to certain risks common to
international activities, such as changes in foreign governmental regulations,
currency exchange rates, tariffs and taxes, export license requirements, the
imposition of trade barriers, difficulties in staffing and managing foreign
operations, and political and economic instability.

In addition to the above channels used for marketing and selling the
Company's software products, the Company licenses its software products to
software and hardware OEMs such as Legato Systems, Inc., Hewlett Packard, Inc.
and Seagate Software, Inc. for incorporation into their own products.

The Company's current software return policy allows its distributors to
return any new, unused product in the distributor's inventory within a
contractually defined period of up to 180 days from the notice of discontinuance
of any product, or of any new version of a product, for a credit against
balancing orders for other products of the Company. In addition, distributors
may participate quarterly in a stock balancing program which, subject to certain
limitations, allows them to return purchased products within the second month of
each calendar quarter for credit towards future purchases or a cash refund. The
Company believes that this stock balancing provision is customary in the
industry and should not materially increase risks associated with the
relationship. End users may return defective products pursuant to policies
established by their dealer or directly to the Company within ninety days of
purchase. The Company reviews its allowances for returns and distributor
inventory levels on a monthly basis and believes its allowances for returns are
adequate. However, due to uncertainty regarding end user demand and competitive
product introductions, there can be no assurance that actual returns in excess
of recorded allowances will not occur and result in a material adverse effect on
the Company's business, operating results or financial condition.

COMPETITION AND RISKS ASSOCIATED WITH NEW PRODUCT INTRODUCTIONS

The market for the Company's products is intensely competitive. Increased
competition could result not only in a decline in sales volume, but also in
price reductions that could have a material adverse effect on the Company's
business, operating results and financial condition.

The Company's Replica product line competes with well established back-up
products from Computer Associates, Inc., and Seagate Software (currently owned
by Seagate Technologies, Inc. but in the process of being acquired by Veritas),
Legato and Veritas Software Corporation, all of which have established channels
of distribution and installed customer bases. The Company has entered into OEM
licenses with Legato and Seagate which authorize those companies to resell
Replica products under certain conditions. While the Company hopes to expand its
sales and marketing reach through these agreements, the Company expects to
realize less revenue per

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unit that it would if it sold the products itself. As a result, the Company
could realize less revenue from sales of Replica than if it might have otherwise
obtained by only directly selling Replica. In addition, resellers could choose
not to sell Replica over competitors' products with the result that significant
sales of Replica could fail to materialize, or products similar to Replica could
be successfully introduced to resellers by the Company's competitors. In
addition, Microsoft's current operating systems incorporate back-up
functionality and future operating systems are expected to include some disaster
recovery functionality. Also, Replica is being introduced into sophisticated
server environments and, while the Company has invested significant resources in
testing Replica under a variety of conditions, configurations and circumstances,
there are likely to be environments which have not been anticipated for which
additional development of Replica will be necessary.

The Company's ReachOut product competes in the remote control software
market against more established products such as Symantec Corporation's
pcAnywhere and Traveling Software, Inc.'s Laplink. ReachOut also competes
against remote access products from companies such as Citrix, Inc. Further,
Microsoft could elect to incorporate remote control or additional remote access
capabilities into its operating systems which are pre-installed on most personal
computers. The Company believes that the rate of growth of the remote control
market it serves has decreased from prior years' growth rates or may actually be
declining and that it will have a difficult time gaining further sales growth
against its competitors.

MANUFACTURING AND BACKLOG

The majority of the Company's software products are manufactured in
accordance with the Company's specifications by third parties that specialize in
the duplication and assembly of software products. The principal materials and
components used in the Company's software products include diskettes and/or CD's
which are used for distribution of the software code and the related user
manuals. The software manufacturing process involves the duplication of media,
the printing of user manuals, assembly of components, and final packaging. The
Company believes there is an adequate supply of and source for the raw materials
used in its software products and that multiple sources are available for media
duplication, manual printing and final packaging.

The Company generally ships software products within ten days after the
receipt of an order, although rapid increases in demand as the result of the
release of a new product or product upgrade could cause shipping delays.
Generally, the Company has relatively little, if any, backlog of orders for its
software products at any given time and does not consider backlog to be a
measure of sales for any future period.

PATENTS, TRADEMARKS AND PRODUCT PROTECTION

The Company attempts to protect its products with a combination of trade
secret, patent, copyright, and trademark laws and with license agreements. The
Company owns one issued United States patent relating to its storage management
products, which expires in 2015 and has other patents pending in the U.S. and
Europe. One or more of the patents are employed in the Company's Replica
products. The Company also has a license from Hi/fn to implement in Stac
products the patents assigned by Stac to Hi/fn and to license and sublicense the
resulting products to the Company's customers.

The status of patents covering technology is highly uncertain, involving
complex legal and factual questions. There can be no assurance that patent
applications filed by the Company will result in patents being issued or that
its patents, and any patents that may be issued to it in the future, will afford
protection against competitors with similar technology; nor can there be any
assurance that patents issued to the Company will not be infringed upon or
designed around by others or that others will not obtain patents that the
Company would need to license or design around or that the Company's competitors
will not independently develop non-infringing technologies or products that are
equivalent or superior in function or performance. If patents held by
competitors or others are upheld by the courts and found to be infringed by
Stac's products, the holders of such patents might be in a position to require
the Company to stop manufacturing, using or selling the infringing products and
to pay up to three times damages to the holders of the infringed patents. There
can be no assurance that any licenses that might be required for the Company's
products would be available on reasonable terms, if at all.

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<PAGE> 8

The Company often licenses its software products to end user customers by
use of a "shrink-wrap" license (a "shrink-wrap" license agreement is a printed
license agreement included within packaged software or that appears during the
installation of software that sets forth the terms and conditions under which
the end user can use the product). The terms of this license agreement determine
how the software may be used and generally limit the user to use of the software
on a limited number of computers and to make a back-up copy. Shrink-wrap
licenses are unenforceable under the laws of certain jurisdictions. Judicial
enforcement of copyright laws is also uncertain. Policing unauthorized use of
computer software is difficult, and software piracy is a persistent problem for
the packaged software industry. These problems may be particularly acute in
international markets. There can be no assurance that misappropriation will not
occur.

The Company's trademark rights include rights associated with its use of its
trademarks and rights obtained by registrations of its trademarks. The Company
has obtained United States trademark registrations for certain trademarks, and
has applied for or obtained registration in various international jurisdictions.
The Company's rights to register and use its trademarks do not ensure that the
Company has superior rights to others that may have registered or used identical
or related trademarks on related goods or services, nor that such registrations
or uses will not be used to attempt to foreclose use of a particular trademark
by the Company.

Because the computer industry is characterized by rapid technological
change, the policing of the unauthorized use of computer software is a difficult
task and software piracy is expected to continue to be a persistent problem for
the packaged software industry. Despite steps taken by Stac to protect its
software products, third parties may still make unauthorized copies of Stac's
products for their own use or for sale to others. The Company believes that the
knowledge, abilities and experience of its employees, its timely product
enhancements and upgrades and the availability and quality of the support
services it provides to users are more significant factors in influencing end
users to buy its products than are patent, trade secret and copyright protection
laws.

EMPLOYEES

As of December 18, 1998, Stac employed approximately 132 full-time
employees, of whom approximately 75 were employed in research and development,
36 in sales, marketing and customer support and 21 in operations and
administration. None of the Company's employees is represented by a labor union
or subject to a collective bargaining agreement. Stac has never experienced a
work stoppage due to labor difficulties and believes that its employee relations
are good.

ITEM 2. PROPERTIES

The Company's principal domestic administrative, marketing, sales and
product development activities are located in approximately 38,000 square feet
of leased facilities in San Diego, California. The space is occupied under lease
agreements that expire in March 2000. The Company has options to renew the
leases for an additional five year period on terms specified in the current
lease agreements. The Company's subsidiary in the United Kingdom leases 5,200
square feet of office space near London under a five year lease expiring in
November 2003. See Note 9 of Notes to Financial Statements for information
regarding the Company's obligations under its facilities leases.

ITEM 3. LEGAL PROCEEDINGS

The Company from time to time is engaged in legal actions arising in the
ordinary course of its business and believes that the resolution of these
actions will not have a material adverse effect on the Company's results of
operations, liquidity, or financial position.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the quarter
ended September 30, 1998.

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PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER
MATTERS

The Common Stock of Stac is traded on the Nasdaq Stock Market's National
Market System ("NMS") under the symbol "STAC." The following table sets forth
the range of high and low sales prices on the NMS for the Common Stock for the
periods indicated and since January 1, 1996. Such quotations represent
inter-dealer prices without retail markup, markdown or commission and may not
necessarily represent actual transactions.

<TABLE>
<CAPTION>
COMMON STOCK PRICES
-----------------------------
HIGH LOW
--------- --------
<S> <C> <C>
CALENDAR YEAR 1996:
First Quarter ............................ $ 14.50 $ 8.75
Second Quarter ........................... $ 13.88 $ 9.88
Third Quarter ............................ $ 11.25 $ 6.88
Fourth Quarter ........................... $ 8.63 $ 6.38

CALENDAR YEAR 1997:
First Quarter ............................ $ 7.13 $ 4.75
Second Quarter ........................... $ 5.13 $ 3.38
Third Quarter ............................ $ 5.31 $ 3.19
Fourth Quarter ........................... $ 7.19 $ 4.13

CALENDAR YEAR 1998:
First Quarter ............................ $ 6.00 $ 4.38
Second Quarter ........................... $ 5.38 $ 4.25
Third Quarter ............................ $ 4.75 $ 2.63
Fourth Quarter (through December 17, 1998) $ 6.50 $ 1.47
</TABLE>

The Company has not paid cash dividends on its Common Stock and presently
intends to continue this policy in order to retain earnings for use in its
business. The Company had approximately 412 stockholders of record as of
December 18, 1998. The Company believes it has in excess of 500 beneficial
stockholders. The last sales price for the Company's Common Stock, as reported
on the NMS on December 16, 1998, was $5.81.

On December 16, 1998, the Company distributed a special dividend of its
stock in its Hi/fn subsidiary to its stockholders. On December 17, 1998, the
Company's Common Stock traded ex-dividend, and its closing price on the NMS on
such date was $1.47.

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ITEM 6. SELECTED FINANCIAL DATA

The following data, insofar as it relates to each of the fiscal years 1994
through 1998, have been derived from audited financial statements, including the
balance sheets at September 30, 1998 and 1997 and the related statements of
operations for each of the three years ended September 30, 1998 and notes
thereto included herein. This data should be read in conjunction with the
consolidated financial statements of the Company and related notes thereto for
the corresponding periods.

The Company's consolidated financial statements have been restated to
present Hi/fn as a discontinued operation. Accordingly, Hi/fn's assets and
liabilities; revenues, costs and expenses; and cash flows have been excluded
from the respective captions in the Consolidated Financial Statements, and have
been reported as "Net assets of discontinued operations"; "Income from
discontinued operations, net of taxes"; and "Net cash used in discontinued
operations", for all periods presented.

<TABLE>
<CAPTION>
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

FISCAL YEAR ENDED SEPTEMBER 30, 1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Statement of Operations:
Revenues ............................................ $ 19,403 $ 33,190 $ 33,871 $ 38,462 $ 25,659
Operating income (loss) ............................. (4,437) 2,933 (1,240) (3,396) (2,358)
Income (loss) from continuing operations ............ (7,882) 3,862 (3,826) 82 (614)
Net income (loss) ................................... (5,815) 5,660 (1,675) 1,496 333
Net income (loss) available for common stockholders . (5,815) 5,660 (1,843) (102) (116)

Earnings per common share:
Income (loss) from continuing operations ............ $ (0.31) $ 0.12 $ (0.13) $ 0.00 $ (0.02)
Net income (loss) available for common stockholders . $ (0.23) $ 0.18 $ (0.06) $ 0.00 $ 0.00
Common shares used to compute per share data ........ 25,349 30,926 30,585 25,391 24,643

Balance Sheet:
Working capital ..................................... $ 22,557 $ 50,474 $ 68,864 $ 65,381 $ 71,979
Total assets ........................................ 43,866 70,111 81,079 78,357 76,369
Stockholders' equity .............................. 39,213 64,123 78,999 76,355 74,633
</TABLE>

The Company has never declared or paid any cash dividends on its common
stock. The company currently intends to retain remaining future earnings to
finance the growth and development of its business.

9
<PAGE> 11

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

OVERVIEW

Stac's storage systems recovery software business is comprised of its
Replica 3 and Replica Network Data Manager ("NDM") product lines. Replica 3 and
Replica NDM are high-performance, easy-to-deploy, distributed business systems
recovery software products, which enable fast PC server, desktop and notebook
replication and disaster recovery. Replica for NetWare was introduced in
February 1996, Replica for NT was made available in April 1997 and Replica NDM
was introduced to selected customer sites in April 1998. The Company intends to
focus on the development of relationships with key OEMs in the storage
management software sector and with system integration partners, and is
investing the majority of its product development, marketing and sales resources
in the Replica product line and extensions to Replica.

Stac received royalties from Microsoft and IBM Corporation ("IBM") for
licenses of its data compression technology from June 1994 through January 1998
after which the licenses became paid in full. The Company does not expect
further revenues from these agreements. The royalties, net of taxes paid, have
been reinvested in the ReachOut and Replica products which have replaced the
Company's former Stacker disk compression products.

10
<PAGE> 12

RESULTS OF OPERATIONS

The following table sets forth for the Company's results of operations and
the percentage relationship of certain items to revenues during the periods
shown. Unless otherwise indicated, references to years are to fiscal years which
ended September 30.

<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Revenues ........................................ 100% 100% 100%
Cost of revenues ................................ 5 5 4
---- ---- ----

Gross margin .................................... 95 95 96
---- ---- ----

Research and development ........................ 39 26 20
Purchased research and development .............. -- -- 36
Sales and marketing ............................. 54 44 33
General and administrative ...................... 23 14 10
Restructuring ................................... 2 2 --
---- ---- ----
118 86 99
---- ---- ----

Operating income (loss) ......................... (23) 9 (3)
Interest income ................................. 13 7 6
---- ---- ----

Income before (loss) income taxes ............... (10) 16 3
Provision for income taxes ...................... 31 4 14
---- ---- ----

Income (loss) from continuing operations ........ (41) 12 (11)
Income from discontinued operations, net of taxes 11 5 6
---- ---- ----
Net income (loss) ............................... (30)% 17% (5)%
==== ==== ====
</TABLE>

REVENUES

Revenues decreased by 42% to $19.4 million in 1998 compared to 1997, and
decreased by 2% in 1997 to $33.2 million compared to $33.9 million in 1996. The
decrease in 1998 revenues from those of 1997 is due primarily to the lower
revenues received from licenses of Stac's data compression technology to
operating system vendors. These license revenues were $5.1 million in 1998 and
$16.0 million in each of 1997 and 1996. In 1998, 1997 and 1996, royalty revenues
were solely from license agreements with Microsoft and IBM, who were obligated
to continue paying royalties under those licenses at the rate of $4.0 million
per quarter through December 1997, with a final payment of $1.1 million in the
March 1998 quarter. The Company expects no further royalty revenues under its
agreements with Microsoft and IBM.

Software sales also declined from 1997 to 1998 and from 1996 to 1997. Those
decreases are discussed below.

<TABLE>
<CAPTION>
1998 1997 1996
------------------- ------------------- -------------------
<S> <C> <C> <C> <C> <C> <C>
Net Revenue ($millions):
Software ............. $ 14.3 74% $ 17.2 52% $ 17.9 53%
Licenses ............. 5.1 26 16.0 48 16.0 47
------- ------- ------- ------- ------- -------
Total ............. $ 19.4 100% $ 33.2 100% $ 33.9 100%
======= ------- ======= ======= ======= =======
</TABLE>

11
<PAGE> 13

Software sales, which are comprised of domestic and international sales and
licenses through distributors, retailers, solution providers, OEM and direct
channels, accounted for $14.3 million of revenues in 1998, $17.2 million of
revenues in 1997 and $17.9 million of revenues in 1996. Software sales decreased
by 17% in 1998 from 1997, and by 4% from in 1997 from 1996, due primarily in
each case to declining sales of ReachOut, which has reached a mature phase of
the product life cycle, and declining sales of Stacker which was discontinued in
1997. Stacker sales declined from comparable previous periods due primarily to
the inclusion of disk compression in Windows and DOS and the availability of
large capacity, low cost per megabyte hard disk drives. These declines were
partially offset by increased sales of Replica 3 due to the new releases of that
product discussed above. The Company expects revenues from OEM licenses and end
user multiple license agreements ("MLAs") for its Replica 3 and Replica NDM
product to increase in the latter half of fiscal 1999 as the product is made
generally available and as OEMs complete integration of Replica NDM into their
products. However, due to the long sales cycles of three months to a year for
MLAs and the uncertainty of the quantity of initial licenses, the Company does
not expect revenues to grow significantly during the first half of fiscal 1999.

International revenues, which are included above, were $4.8 million or 25%
of revenues in 1998, $5.1 million, or 15% of revenues in 1997, and $4.8 million,
or 14% of revenues in 1996. The decrease in international revenues in 1998
compared to 1997 was primarily due to declining sales of ReachOut, and to a
lesser extent, Stacker, offset in part by increasing sales of Replica 3. The
increase in international revenues in 1997 over 1996 was primarily due to sales
of Replica 3 in the European marketplace. The increase in international revenues
as a percentage of revenues in 1998 as compared to 1997 was primarily due to the
decrease in license revenues as a result of the completion of the Company's
license agreements with Microsoft and IBM. Stac markets and sells to its
European accounts from its office in the United Kingdom and markets and sells
primarily to Japan and Australia through relationships with distributors and
resellers abroad.

GROSS MARGIN

Cost of revenues consists primarily of the user manuals, packaging, media
and assembly associated with the Company's software products. Gross margins were
95% in 1998 and 1997, and 96% in 1996.

RESEARCH AND DEVELOPMENT

The cost of product development consists primarily of salaries, employee
benefits, overhead and outside contractors. Such expenses were $7.6 million for
1998, $8.6 million for 1997 and $6.7 million for 1996. The decrease in product
development in 1998 from 1997 is due to a decreased level of activity in
development of ReachOut, consistent with its mature phase in its life cycle. The
decrease in ReachOut development spending has been partially offset by increased
spending related to development of the Replica product line. The increase in
product development expense as a percentage of revenues was primarily due to the
Company's lower revenues in fiscal 1998 as compared to 1997. The increase in
product development in 1997 from that of 1996 was due to the addition of
personnel for development of new versions of ReachOut, and development of the
Company's Replica product line. The Company expects to continue to invest in the
development of products for which it believes there is a need in the market,
however, there can be no assurance that product development programs invested in
by the Company will be successful or that products resulting from such programs
will achieve market acceptance.

Purchased research and development for 1996 includes $12.2 million
recognized in connection with the October 1995 acquisition of California
Software, Inc. and the related investment in DynaNet, Inc.

SELLING AND MARKETING EXPENSE

Selling and marketing expenses consist primarily of salaries, commissions
and benefits of sales, marketing and customer support personnel, and consulting,
advertising, promotional and overhead expenses. Such expenses were $10.5 million
for 1998, $14.6 million for 1997 and $11.2 million for 1996. The decrease in
marketing and sales expense in 1998 from that in 1997 was due to a corporate
restructuring of these functional areas. The restructuring refocused sales and
marketing efforts towards developing corporate enterprise customers, rather than
individual end users. Conversely, the increase in sales and marketing expenses
in 1997 over those in 1996 was the result of the

12
<PAGE> 14

addition of personnel and program costs intended to create end user demand for
the Company's products. The increase in selling and marketing expense as a
percentage of revenues was primarily due to the Company's lower revenues in
fiscal 1998 as compared to 1997. Sales and marketing expenses are expected to
remain the Company's most significant ongoing operating expense.

GENERAL AND ADMINISTRATIVE

General and administrative expenses are comprised primarily of salaries for
administrative and corporate services personnel, legal and other professional
fees. Such expenses were $4.4 million for 1998, $4.7 million for 1997 and $3.5
million for 1996. The decrease in 1998 expenses compared to those in 1997 was
primarily due to the conclusion of an outside strategic assessment review
conducted in and charged to fiscal 1997 expenses. The increase in general and
administrative expenses as a percentage of revenues was primarily due to the
Company's lower revenues in fiscal 1998 as compared to 1997. The increase in
1997 expenses over those in 1996 was primarily due to the addition of management
personnel and the costs of the outside strategic assessment review.

RESTRUCTURING CHARGES

As discussed above, in fiscal 1997 the Company reorganized its sales and
marketing departments and recorded a restructuring charge of $0.8 million. The
principal components of the charge include $0.5 million for losses on property
and equipment disposals, $0.3 million for severance and employee related
liabilities and $0.1 million for lease termination and closure costs.

In fiscal 1998 the Company incurred an additional $0.4 million related
to the above mentioned restructuring. This additional amount represented
severance and employee related liabilities which the Company was not
permitted to expense until the affected employees were notified of the
termination and the Company had committed to provide for such costs.

INTEREST INCOME

Interest income was $2.4 million in 1998 and 1997 and $2.1 million in 1996.
The amount did not change from 1997 to 1998 despite lower balances available for
investment, due to a change in investment policy, away from tax-exempt
securities, towards higher-yielding commercial paper. The increase in interest
income in 1997 over that of 1996 was primarily due to interest earned on higher
investment balances as a result of net positive cash flow from operations. The
Company invests the majority of its funds in high quality commercial paper and
tax exempt securities.

INCOME TAXES

For 1998, the Company reported a provision for income taxes of $5.9 million,
which is inclusive of a valuation allowance of $6.4 million taken against
deferred tax assets. Before the valuation allowance, the benefit for income
taxes was $0.5 million for an effective tax rate of 25%. The valuation allowance
was recorded as a result of an assessment made of future taxable income as
required by accounting standards, made in conjunction with the anticipated
spin-off of the Company's Hi/fn subsidiary. The effective tax rate is lower than
the statutory federal and state rates primarily due to non-deductible expenses
related to the spin-off and due to differences in tax rules impacting foreign
operations. For 1997, the Company reported a provision for income for taxes of
$1.5 million on income before income taxes of $5.3 million, an effective rate of
28%. For 1996, the effective tax rate was 36% prior to recording purchased
research and development expenses of $12.2 million for which, consistent with
statutory guidelines, no tax benefit was recognized. The effective tax rates for
both 1997 and 1996 are lower than the statutory federal and state rates due
primarily to tax-exempt interest earned on cash equivalents and marketable
securities. Differences in effective tax rates among years is also affected by
the proportion of earnings from interest income and foreign operations to total
earnings and the different statutory tax rates associated with them.

13
<PAGE> 15

QUARTERLY TRENDS AND CHANNEL INVENTORIES

The Company historically has experienced significant fluctuations in its
revenues and operating results, including net income, and anticipates that these
fluctuations will continue. The Company operates with relatively little backlog
of its software sales, and the majority of its software revenues each quarter
result from orders received in that quarter. Consequently, if near-term demand
for the Company's products weakens in a given quarter or if inventory of the
Company's products in the retail and distribution channels satisfies near-term
demand, the Company's operating results for that quarter would be adversely
affected. In addition, when the Company announces enhanced versions of its
software products, the announcement may have the effect of slowing sales of the
current version of the product as buyers delay their purchase. Quarterly results
have been or may in the future be influenced by the timing of announcements or
introductions of new products and product upgrades by the Company or its
competitors, distributor ordering patterns, product returns, delays in product
development and licensing of the Company's products and core technology. In
addition, the Company's new products typically have a lengthy evaluation period
before any purchase is made.

SEASONALITY

The software industry has typically experienced some seasonal variations in
demand, with sales declining somewhat in the summer months. The Company believes
that its software sales are subject to similar seasonal variations which, when
combined with the other factors described above, are likely to result in
fluctuations in the Company's quarterly results. As a result, historical
quarter-to-quarter comparisons should not be relied upon as indicative of future
performance.

OPERATING SYSTEMS

Stac's ReachOut, Replica 3 and Replica NDM products currently operate on a
limited number of personal computer and network operating systems. ReachOut
supports Microsoft Windows NT, Windows 98, Windows 95, Windows 3.x and DOS,
while Replica 3 supports Windows NT and Novell NetWare servers. Replica 3
customers may require support of the Unix operating system, which the Company
does not currently provide. Replica NDM server component supports only Windows
NT with client support for Windows 98, Windows 95 and Windows NT workstation. In
addition, future versions of Microsoft's Windows operating systems may require
significant changes to the Company's products in order to maintain
compatibility.

STOCK PRICE VOLATILITY

Due to the factors noted above, the Company's future earnings and stock
price may be subject to significant volatility, particularly on a quarterly
basis. Any shortfall in earnings from levels expected by securities analysts
could have an immediate and significant adverse effect on the trading price of
the Company's common stock in any given period. Shortfalls could be caused by
shortfalls in revenues, timing of the receipt of technology license fees, and/or
increased levels of expenditures. Additionally, the Company participates in a
highly dynamic industry, which often results in significant volatility of the
Company's stock price.

LIQUIDITY AND CAPITAL RESOURCES

The Company's cash, cash equivalents and marketable securities decreased by
$27.2 million to $24.4 million at September 30, 1998 from $51.6 million at
September 30, 1997. The decrease was primarily attributable to cash used to
purchase treasury stock of $20.0 million and payments to the Company's Hi/fn
subsidiary of $9.4 million, representing a loan of $5.0 million and the payment
of intercompany balances of $4.4 million, partially offset by cash generated
from operations. Accounts receivable decreased by $2.0 million to $0.8 million
at September 30, 1998 from that at September 30, 1997, primarily attributable to
lower revenues in the September 1998 quarter. Working capital decreased by $27.9
million to $22.6 million at September 30, 1998 from that at September 30, 1997,
primarily as a result of the changes in cash and marketable securities discussed
above.

During 1996, the Company paid $0.2 million in dividends on its Series A
Preferred Stock. The obligation to pay the preferred dividend terminated when
the preferred stock was converted to common stock in November 1995.

14
<PAGE> 16

The Company believes that existing cash balances and funds provided by
operations will be sufficient to finance the working capital requirements of the
consolidated companies for the foreseeable future.

YEAR 2000

The term "Year 2000 issue" is a general term used to describe the various
problems that may result from the improper processing of dates and
date-sensitive calculations by computers and other machinery as the year 2000 is
approached and reached. These problems generally arise from the fact that most
of the world's computer hardware and software have historically used only two
digits to identify the year in a date, often meaning that the computer will fail
to distinguish dates in the "2000's" from dates in the "1900's." These problems
may also arise from other sources as well, such as the use of special codes and
conventions in software that make use of the date field.

To date, the Company's primary focus in its analysis of its Year 2000 issue
has been on its product offerings. Stac has performed extensive year 2000
compliance testing of its current products and believes, to its best knowledge,
that Replica 3 3.03 for Windows NT, Replica 3 3.05 for NetWare, Replica NDM 1.41
and ReachOut Enterprise (the "Products") are year 2000 compliant; provided that
the underlying operating system and other software are Year 2000 compliant.

The Company has also completed its initial evaluation of Year 2000
compliance with respect to all of its internal computer, telephone and security
systems (hardware and software). As a result of this evaluation, the Company has
determined that all business critical systems are Year 2000 compliant, or will
be made compliant through available product upgrades prior to the end of the
June 1999 quarter at an estimated cost to the Company of $100,000.

In addition, the Company has had initial communications with certain
significant third parties with which it does business to discuss and 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 remediate their own Year 2000 issues. To date, the Company has received only
preliminary feedback from such parties indicating that they are in the process
of implementing measures to ensure Year 2000 compliance, and further
representing that they will achieve compliance before the close of calendar
1999. The Company has not independently confirmed any information received from
other parties with respect to Year 2000 issues. As such, there can be no
assurance that such other parties will complete their Year 2000 conversion in a
timely fashion or will not suffer a Year 2000 business disruption that may
adversely affect the Company's financial condition and results of operations.

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 which 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 which
require Year 2000 conversion that are critical to the Company's operations or
the failure of the Company or others with which the Company does business to
become Year 2000 ready in a timely manner could have a material adverse effect
on the Company's financial condition and results of operations.

The Company has not yet completed the development of a comprehensive Year
2000-specific contingency plan. However, as part of its contingency Year 2000
effort, information received from external sources is examined for date
integrity before being brought into the Company's internal systems. The Company
will incorporate alternatives into its contingency plan, should the software
upgrades described above prove to not fully resolve Year 2000 compliance issues.
If the Company determines that its business is at material risk of disruption
due to currently unforeseen Year 2000 issue or anticipates that its Year 2000
compliance will not be achieved in a timely fashion, the Company will work to
enhance its contingency plan.

The discussion above contains certain forward-looking statements. The costs
of the Year 2000 conversion, and possible risks associated with the Year 2000
issue are based on the Company's current estimates and are subject to various
uncertainties that could cause the actual results to differ materially from the
Company's expectations. Such uncertainties include, among others, the success of
the Company in identifying systems that are not Year 2000

15
<PAGE> 17

compliant, the nature and amount of programming required to upgrade or replace
each of the affected systems, the availability of qualified personnel,
consultants and other resources, and the success of the Year 2000 conversion
efforts of others.

MARKET RISK

The Company is exposed to a variety of risks, including foreign currency
fluctuations and changes in the market value of its investments. In the normal
course of business, the Company employs established policies and procedures to
manage its exposure to fluctuations in foreign currency values and changes in
the market value of its investments.

The Company's foreign currency risks are mitigated principally by
maintaining only nominal foreign currency cash balances. Working funds necessary
to facilitate the short term operations of the Company's Subsidiary in the
United Kingdom are kept in the local currencies for the European countries in
which they do business, with excess funds transferred to Stac's offices in the
United States for investment.

The fair value of the Company's investments in marketable securities at
September 30, 1998 was $12,859,000. The Company's investment policy is to manage
its portfolio of marketable securities in order to preserve principal and
liquidity while maximizing the return. At September 30, 1998 the Company's
portfolio is primarily invested in high quality commercial paper, typically with
maturities of less than six months. These investments are distributed among
several issuers to minimize the credit risk associated with any single
institution.

SELECTED QUARTERLY DATA (in thousands, except per share data)

<TABLE>
<CAPTION>
SEPT. 30, JUNE 30, MAR. 31, DEC. 31,
FISCAL 1998 1998 1998 1998 1997
----------- ------- ------- ------- -------
<S> <C> <C> <C> <C>
Revenues ............................... $ 3,019 $ 3,764 $ 4,915 $ 7,705
Gross margin ........................... 2,747 3,516 4,702 7,458
Operating income (loss) ................ (2,917) (2,171) (384) 1,035
Income (loss) from continuing operations (7,795) (1,015) 134 794
Net income (loss) per common share ..... $ (0.33) $ (0.04) $ .01 $ .03
Common stock price:
High .............................. $ 4.75 $ 5.38 $ 6.00 $ 7.19
Low ............................... $ 2.63 $ 4.25 $ 4.38 $ 4.13
</TABLE>

<TABLE>
<CAPTION>
SEPT. 30, JUNE 30, MAR. 31, DEC. 31,
FISCAL 1997 1997 1997 1997 1996
----------- ------- ------- ------- -------
<S> <C> <C> <C> <C>
Revenues ............................... $ 8,078 $ 7,676 $ 8,607 $ 8,829
Gross margin ........................... 7,721 7,294 8,094 8,500
Operating income (loss) ................ (483) (11) 889 2,538
Income from continuing operations ...... 308 549 919 2,086
Net income per common share ............ $ 0.01 $ 0.02 $ 0.03 $ 0.07
Common stock price:
High .............................. $ 5.31 $ 5.13 $ 7.13 $ 8.63
Low ............................... $ 3.19 $ 3.38 $ 4.75 $ 6.38
</TABLE>

As of December 18, 1998, there were 412 holders of record of the Company's
common stock.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The Company's consolidated financial statements at September 30, 1998 and
1997, and for each of the three fiscal years in the period ended September 30,
1998 and the Report of PricewaterhouseCoopers LLP, Independent Accountants, are
included in this report on pages F-1 through F-15.

16
<PAGE> 18

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this item is incorporated by reference to
Registrant's Definitive Proxy Statement to be filed with the Commission pursuant
to Regulation 14A in connection with the 1999 Annual Meeting (the "Proxy
Statement") under the headings "Nominees" and "Background of Executive Officers
not Described Above."

ITEM 11. EXECUTIVE COMPENSATION

The information required by this item is incorporated by reference to the
Proxy Statement under the heading "Executive Compensation."

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this item is incorporated by reference to the
Proxy Statement under the heading "Security Ownership of Certain Beneficial
Owners and Management."

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this item is incorporated by reference to the
Proxy Statement under the heading "Certain Transactions."

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a) Documents filed as part of the report:

<TABLE>
<CAPTION>
PAGE
NUMBER
------
<S> <C>
(1) Report of Independent Accountants F-1
Consolidated Balance Sheet at
September 30, 1998 and 1997 F-2
Consolidated Statement of Operations for
Fiscal 1998, 1997 and 1996 F-3
Consolidated Statement of Cash Flows for
Fiscal 1998, 1997 and 1996 F-4
Consolidated Statement of Stockholders' Equity
for Fiscal 1998, 1997 and 1996 F-5
Notes to Consolidated Financial Statements F-6
(2) Schedule I -- Marketable Securities S-1
All other schedules have been omitted because they are not
applicable or required, or the information required to be set
forth therein is included in the Financial Statements or notes
thereto.
</TABLE>

(b) The Registrant filed no reports on Form 8-K during the fourth quarter of
the fiscal year ended September 30, 1998.

17
<PAGE> 19

<TABLE>
<CAPTION>
EXHIBIT EXHIBIT
FOOTNOTE NUMBER DESCRIPTION
-------- ------- -----------
<S> <C> <C>
(7) 2.1 Agreement and Plan of Merger, dated April 5, 1996,
between the Registrant and Stac, Inc., a California
corporation.

(7) 3.1 Certificate of Incorporation of the Registrant.

(7) 3.2 Bylaws of the Registrant.

4.1 Reference is made to Exhibits 3.1, 3.2, 10.8, 10.9,
10.10 and 10.12.

(1) 10.1 Form of Indemnity Agreement entered into between the
Registrant and its directors and
officers with related schedule.

(1)(8) 10.2 Registrant's 1992 Stock Option Plan (the "1992
Plan").

(5)(8) 10.3 Registrant's 1992 Non-Employee Directors' Plan, as
amended (the "Directors' Plan").

(1)(8) 10.4 Registrant's Employee Stock Purchase Plan and related
offering document.

(1) 10.5 Securities Purchase Agreement, dated as of March 27,
1990, among the Registrant and the
other persons named therein.

(1)(8) 10.6 Distributor Agreement, between the Registrant and
Merisel, Inc., dated as of March 1, 1991.

(1)(8) 10.7 Distributor Agreement, between the Registrant and
Ingram Micro, Inc., dated as of March 13, 1991.

(3)(8) 10.8 License Agreement, between the Registrant and
Microsoft Corporation, dated as of June 20, 1994.

(5)(8) 10.9 Forms of Non-statutory Stock Option Agreements under
the Directors' Plan.

(6) 10.10 Stock Purchase Agreement dated October 6, 1995
between the Registrant and William T. Baker.

(6) 10.11 Option Purchase Agreement dated October 6, 1995 among
the Registrant and Certain Holders of Options to
Purchase Common Stock of California Software, Inc.

(6) 10.12 Indemnity Agreement dated October 6, 1995 between the
Registrant and William T. Baker.

(6) 10.13 Series A Preferred Stock Purchase Agreement dated
October 6, 1995 by and between DynaNet, Inc. and the
Registrant.
</TABLE>

18
<PAGE> 20

<TABLE>
<CAPTION>
EXHIBIT EXHIBIT
FOOTNOTE NUMBER DESCRIPTION
-------- ------- -----------
<S> <C> <C>
(7) 10.14 Office Lease date March 22, 1994 between the
Registrant and Weyerhaeuser Mortgage Company and Fort
Wyman, Inc.

(7) 10.15 Office Lease date March 22, 1994 between the
Registrant and Weyerhaeuser Mortgage Company and Fort
Wyman, Inc.

(7) 10.16 Office Lease dated July 12, 1994 between the
Registrant and Weyerhaeuser Mortgage Company and Fort
Wyman, Inc.

(7) 10.17 Amendment No. 1 to the Office Lease dated July 12,
1994 between the Registrant and Weyerhaeuser Mortgage
Company and Fort Wyman, Inc.

(7) 10.18 Amendment No. 2 to the Office Lease dated July 12,
1994 between the Registrant and Weyerhaeuser Mortgage
Company and Fort Wyman, Inc.

(9) 10.19 Cross License Agreement dated as of November 21, 1996 between
the Registrant and Hi/fn, Inc.

(9) 10.20 Form of Distribution Agreement.

(9) 10.21 Form of Employee Benefits and Other Matters Allocation Agreement.

(9) 10.22 Form of Tax Allocation and Indemnity Agreement.

21.1 Subsidiaries of the Registrant.

23.1 Consent of Independent Accountants.

24.1 Power of Attorney. Reference is made to page 20.

27.1 Financial Data Schedule
</TABLE>

- ----------

(1) Filed as an exhibit to the Registrant's Registration Statement on Form
S-1 (No. 33-46389) or amendments thereto and incorporated herein by
reference.

(2) Certain confidential portions deleted pursuant to Order Granting
Application Under the Securities Act of 1933, as amended, and Rule 406
thereunder respecting Confidential Treatment dated May 6, 1992.

(3) Filed as exhibit to the Company's Quarterly Report on Form 10-Q for the
Quarter ended June 30, 1994, as amended.

(4) Certain confidential portions deleted pursuant to order Granting
Application for Confidential Treatment pursuant to Rule 24b-2 under the
Securities Exchange Act of 1934 dated October 21, 1994.

(5) Filed as exhibit to the Company's Annual Report on Form 10-K for the
fiscal year ended September 30, 1995.

(6) Filed as an exhibit to the Company's Report on Form 8-K filed on October
16, 1995, relating to the Company's (i) acquisition of all of the
outstanding capital stock and options to purchase the capital stock of
California Software, Inc. and (ii) acquisition of Series A Preferred
Stock of DynaNet, Inc.

(7) Filed as exhibit to the Company's Annual Report on Form 10-K for the
fiscal year ended September 30, 1996.

(8) Indicates management or compensatory plan or arrangement required to be
identified pursuant to Item 14(a)(4).

(9) Filed as an exhibit to the Registration Statement on Form 10, as amended
filed by Hi/fn, Inc. (File No. O-24765) and incorporated herein by
reference.

19
<PAGE> 21

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.

STAC SOFTWARE, INC.

By: /s/ Gary W. Clow
------------------------------------
Gary W. Clow
Chairman of the Board, President and
Chief Executive Officer

Date: December 23, 1998

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Gary W. Clow and John R. Witzel, and each of
them, as his true and lawful attorneys-in-fact and agents, with full power of
substitution and resubstitution, for him and in his name, place, and stead, in
any and all capacities, to sign any and all amendments to this Report, and to
file the same, with all exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
connection therewith, as fully to all intents and purposes as he might or could
do in person, hereby ratifying and confirming that all said attorneys-in-fact
and agents, or any of them or their or his substitute or substituted, may
lawfully 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 on behalf of the
Registrant and in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ Gary W. Clow Chairman of the Board, December 23, 1998
- ------------------------------------------ And Chief Executive
(Gary W. Clow) Officer (Principal
Executive officer)

/s/ John R. Witzel Vice President of Finance, December 23, 1998
- ------------------------------------------ Chief Financial Officer and
(John R. Witzel) Secretary (principal
Financial and accounting
Officer)

/s/ Douglas L. Whiting, Ph.D. Vice President of December 23, 1998
- ------------------------------------------ Technology and Director
(Douglas L. Whiting, Ph.D.)

/s/ Charles H. Gaylord, Jr. Director December 23, 1998
- ------------------------------------------
(Charles H. Gaylord, Jr.)

/s/ Robert W. Johnson Director December 23, 1998
- ------------------------------------------
(Robert W. Johnson)

/s/ Antonio Perez Director December 23, 1998
- ------------------------------------------
(Antonio Perez)
</TABLE>

20
<PAGE> 22

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Shareholders of Stac Software, Inc.

In our opinion, the financial statements listed in the accompanying index
present fairly, in all material respects, the financial position of Stac
Software, Inc. and its subsidiaries at September 30, 1998 and 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended September 30, 1998, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.

PricewaterhouseCoopers LLP

San Diego, California
October 23, 1998, except as to Note 12, which is as of December 16, 1998

F-1
<PAGE> 23

STAC SOFTWARE, INC.

CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
SEPTEMBER 30,
------------------------
1998 1997
-------- --------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ............................................... $ 11,573 $ 18,609
Marketable securities ................................................... 12,859 33,040
Accounts receivable ..................................................... 777 2,745
Inventories ............................................................. 197 181
Deferred income taxes ................................................... -- 1,157
Income taxes receivable ................................................. 1,314 --
Prepaid expenses and other current assets ............................... 317 493
-------- --------
Total current assets .......................................... 27,037 56,225

Property and equipment, net ............................................... 3,329 3,949
Deferred income taxes ..................................................... -- 6,366
Net assets of discontinued operations ..................................... 12,995 2,958
Other assets .............................................................. 505 613
-------- --------
$ 43,866 $ 70,111
======== ========

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Accounts payable ........................................................ $ 1,458 $ 1,091
Income taxes payable .................................................... -- 1,402
Accrued expenses and other current liabilities .......................... 3,022 3,258
-------- --------
Total current liabilities ..................................... 4,480 5,751

Other liabilities ......................................................... 173 237
-------- --------
4,653 5,988
-------- --------
Commitments and contingencies (Notes 9 and 11)

Stockholders' equity:
Common stock, par value $0.001 per share, authorized 100,000,000 shares;
31,166,000 and 30,880,000 shares issued in 1998 and 1997, respectively 31 31
Additional paid in capital .............................................. 75,143 74,319
Treasury stock, at cost; 7,797,000 and 3,828,000 shares in 1998 and 1997,
respectively .......................................................... (41,347) (21,351)
Cumulative translation adjustment ....................................... (29) (106)
Retained earnings ....................................................... 5,415 11,230
-------- --------
Total stockholders' equity ................................... 39,213 64,123
-------- --------
$ 43,866 $ 70,111
======== ========
</TABLE>

See accompanying notes to consolidated financial statements.

F-2
<PAGE> 24

STAC SOFTWARE, INC.

CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
---------------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Revenues ....................................................... $ 19,403 $ 33,190 $ 33,871
Cost of revenues ............................................... 980 1,581 1,436
-------- -------- --------
Gross margin ................................................... 18,423 31,609 32,435

Operating expenses:
Research and development ..................................... 7,555 8,574 6,715
Purchased research and development ........................... -- -- 12,217
Sales and marketing .......................................... 10,509 14,564 11,246
General and administrative ................................... 4,446 4,688 3,497
Restructuring ................................................ 350 850 --
-------- -------- --------
Total operating expenses ................................... 22,860 28,676 33,675

Operating income (loss) ........................................ (4,437) 2,933 (1,240)
Interest income ................................................ 2,434 2,404 2,115
-------- -------- --------

Income (loss) before income taxes .............................. (2,003) 5,337 875
Provision for income taxes ..................................... 5,879 1,475 4,701
-------- -------- --------

Income (loss) from continuing operations ....................... (7,882) 3,862 (3,826)

Discontinued operations:
Income from discontinued operations, net of taxes of $1,627 in
1998, $1,235 in 1997 and $ 1,441 in 1996 ................... 2,067 1,798 2,151
-------- -------- --------

Net income (loss) .............................................. (5,815) 5,660 (1,675)

Less preferred dividends ....................................... -- -- 168
-------- -------- --------
Net income (loss) available for
common stockholders .......................................... $ (5,815) $ 5,660 $ (1,843)
======== ======== ========

Earnings per common share, basic
Income (loss) from continuing operations ....................... $ (0.31) $ 0.13 $ (0.13)
Income from discontinued operations ............................ $ 0.08 $ 0.06 $ 0.07
Net income (loss) .............................................. $ (0.23) $ 0.19 $ (0.06)

Earnings per common share, diluted
Income (loss) from continuing operations ....................... $ (0.31) $ 0.12 $ (0.13)
Income from discontinued operations ............................ $ 0.08 $ 0.06 $ 0.07
Net income (loss) .............................................. $ (0.23) $ 0.18 $ (0.06)

Weighted average common shares
outstanding, basic ........................................... 25,349 30,552 30,585
Weighted average common shares
outstanding, diluted ......................................... 25,349 30,926 30,585
</TABLE>

See accompanying notes to consolidated financial statements.

F-3

<PAGE> 25

STAC SOFTWARE, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)

<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
----------------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) ................................................ $ (5,815) $ 5,660 $ (1,675)
Adjustments required to reconcile net income (loss)
to net cash provided by operating activities:
Depreciation and amortization .................................. 2,073 2,383 1,877
Purchased research and development ............................. -- -- 12,217
Non-cash restructuring charges ................................. -- 636 --
Deferred stock compensation .................................... -- 22 101
Tax benefits from exercise of stock options .................... 164 111 1,853
Loss(gain) on disposals of property and equipment .............. -- 380 (14)
Provision (benefit) for deferred income taxes .................. 7,523 (574) 1,042
Changes in assets and liabilities, net of business acquisitions:
Accounts receivable .......................................... 1,968 3,132 600
Income taxes receivable ...................................... (1,314) -- 251
Inventories .................................................. (16) (135) 284
Prepaid expenses and other current assets .................... 176 (267) (108)
Other assets ................................................. 18 (78) 10
Accounts payable ............................................. 367 302 (27)
Income taxes payable ......................................... (1,402) 1,012 390
Accrued expenses and other current liabilities ............... (236) 466 (720)
-------- -------- --------
Cash provided by operating activities of continuing
operations................................................ 3,506 13,050 16,081
-------- -------- --------

Cash flows from investing activities:
Purchases of marketable securities ............................... (45,348) (25,253) (35,333)
Sales of marketable securities ................................... 65,529 21,676 31,737
Acquisitions, net of cash acquired ............................... -- (400) (11,252)
Acquisitions of treasury stock ................................... (19,996) (21,351) --
Purchases of property and equipment .............................. (1,363) (2,791) (1,324)
-------- -------- --------
Cash used by investing activities of continuing operations . (1,178) (28,119) (16,172)
-------- -------- --------

Cash flows from financing activities:
Issuance of common stock, net .................................... 596 682 1,336
-------- -------- --------
Cash provided by financing activities of continuing
operations ............................................... 596 682 1,336
-------- -------- --------
Effect of exchange rate changes on cash ............................ 77 12 1
-------- -------- --------
Net cash used in discontinued operations ........................... (10,037) (2,958) --
-------- -------- --------

Net increase (decrease) in cash and cash equivalents ............... (7,036) (17,333) 1,246
Cash and cash equivalents at beginning of year ..................... 18,609 35,942 34,696
-------- -------- --------
Cash and cash equivalents at end of year ........................... $ 11,573 $ 18,609 $ 35,942
======== ======== ========

Supplemental disclosures of cash flow information:
Cash paid for income taxes ...................................... $ 3,007 $ 2,288 $ 2,797

Supplemental non-cash activities:
Conversion of preferred stock to common stock .................... -- -- 39,960
Issuance of common stock for business acquisitions ............... -- -- 965
Issuance of preferred stock dividends in common stock ............ -- -- 168
Conversion of deferred compensation to equity
upon exercise of common stock options ......................... 64 10 164
</TABLE>

See accompanying notes to consolidated financial statements.

F-4
<PAGE> 26

STAC SOFTWARE, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(IN THOUSANDS)

<TABLE>
<CAPTION>
CUMULATIVE
COMMON STOCK ADDITIONAL TRANSLATION RETAINED TREASURY
SHARES AMOUNT PAID IN CAPITAL ADJUSTMENT EARNINGS STOCK TOTAL
-------- -------- --------------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at September 30, 1995 25,671 $ 26 $ 29,075 $ (119) $ 7,413 $ -- $ 36,395

Conversion of mandatorily
redeemable preferred stock . 4,440 4 39,956 -- -- -- 39,960
Dividends paid on preferred
stock....................... 19 -- 168 -- (168) -- --
Issuance of common stock for
business acquisitions ...... 105 -- 965 -- -- -- 965
Issuance of common stock upon
exercise of options ........ 412 1 1,203 -- -- -- 1,204
Issuance of common stock under
Employee Stock Purchase Plan 40 -- 296 -- -- -- 296
Tax benefits from exercise of
stock options .............. -- -- 1,853 -- -- -- 1,853
Equity adjustment from foreign
currency translation ....... -- -- -- 1 -- -- 1
Net loss ..................... -- -- -- -- (1,675) -- (1,675)
-------- -------- -------- -------- -------- -------- --------
Balance at September 30, 1996 30,687 31 73,516 (118) 5,570 -- 78,999

Acquisitions of treasury stock (3,828) -- -- -- -- (21,351) (21,351)
Issuance of common stock upon
exercise of options ........ 137 -- 468 -- -- -- 468
Issuance of common stock under
Employee Stock Purchase Plan 56 -- 224 -- -- -- 224
Tax benefits from exercise of
stock options .............. -- -- 111 -- -- -- 111
Equity adjustment from foreign
currency translation ....... -- -- -- 12 -- -- 12
Net income ................... -- -- -- -- 5,660 -- 5,660
-------- -------- -------- -------- -------- -------- --------
Balance at September 30, 1997 27,052 31 74,319 (106) 11,230 (21,351) 64,123

Acquisitions of treasury stock (3,969) -- -- -- -- (19,996) (19,996)
Issuance of common stock upon
exercise of options ........ 249 -- 518 -- -- -- 518
Issuance of common stock under
Employee Stock Purchase Plan 36 -- 142 -- -- -- 142
Tax benefits from exercise of
stock options .............. -- -- 164 -- -- -- 164
Equity adjustment from foreign
currency translation ....... -- -- -- 77 -- -- 77
Net loss ..................... -- -- -- -- (5,815) -- (5,815)
-------- -------- -------- -------- -------- -------- --------
Balance at September 30, 1998 23,368 $ 31 $ 75,143 $ (29) $ 5,415 $(41,347) $ 39,213
======== ======== ======== ======== ======== ======== ========
</TABLE>

See accompanying notes to consolidated financial statements.

F-5

<PAGE> 27

STAC SOFTWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 -- DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES:

Description of Business

Stac Software, Inc. ("Stac" or the "Company") designs, develops, markets and
supports systems management software and applications for the storage and
communication of data for personal computers and computer networks. The Company
was incorporated in February of 1983. The Company's major products include the
Replica product line, encompassing back-up and disaster recovery solutions, and
ReachOut, a remote control software, which are sold world-wide.

Consolidation

The financial statements as of and for the years ended September 30, 1998,
1997 and 1996 consolidate the accounts of the Company and its majority owned
subsidiaries. All significant intercompany accounts and transactions have been
eliminated in consolidation.

Financial Statement Preparation

The preparation of financial statements, in conformity with generally
accepted accounting principles, requires management to make assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.

Revenue Recognition

Revenue from the sale of software is generally recognized upon shipment, net
of an allowance for estimated returns. Recognition of software revenue is
deferred when, in management's opinion, quantities of such products in the
distribution channel are above levels considered appropriate. Revenues from the
sale of semiconductors and board products is recognized upon shipment, net of
an allowance for estimated returns. Royalty revenue and revenue from the
licensing of software and technology developed by the Company is recognized
pursuant to the terms of the underlying agreements.

Cash and Cash Equivalents

The Company considers all highly liquid investments with a maturity of three
months or less at the date of purchase to be cash equivalents.

Marketable Securities

The Company's marketable securities are comprised of funds on deposit with a
liquid asset manager that have been invested principally in commercial paper.
The carrying amount of these investments approximates fair value due to the
short maturities or demand nature of the instruments. At September 30, 1998, all
marketable securities are classified as available-for-sale and carried at fair
value. Unrealized gains or losses at September 30, 1998 and 1997 are not
significant.

Inventories

Inventories are stated at the lower of cost, determined using the first-in,
first-out method, or market.

F-6
<PAGE> 28

Property and Equipment

Property and equipment are stated at cost. Additions to property and
equipment, including significant betterments and renewals, are capitalized.
Maintenance and repair costs are charged to expense as incurred. Depreciation is
computed using the straight-line method over estimated useful lives of three to
five years and totaled $1,966,000, $1,854,000 and $1,313,000 for fiscal 1998,
1997 and 1996, respectively. Leasehold improvements are amortized over the
shorter of the asset life or lease term.

Long-Lived Assets

The Company investigates potential impairments of long-lived assets, certain
identifiable intangibles and associated goodwill, when events or changes in
circumstances have made recovery of an asset's carrying value unlikely. An
impairment loss is recognized when the sum of the expected future undiscounted
net cash flows is less than the carrying amount of the asset. No such
impairments of long-lived assets existed through September 30, 1998.

Research and Development

Expenditures for research and development are charged to expense as
incurred. Financial accounting rules requiring the capitalization of certain
software development costs have not materially affected the Company.

Advertising

Expenditures for advertising costs are charged to expense as incurred and
totaled $97,000, $790,000 and $1,758,000 for fiscal 1998, 1997 and 1996,
respectively.

Stock-Based Compensation

The Company measures compensation expense for its stock-based employee
compensation plans using the intrinsic value method and provides pro forma
disclosures of net income and earnings per share as if the fair value
method had been applied in measuring compensation expense.

Income Taxes

The Company records a provision (benefit) for income taxes using the
liability method. Current income tax expense or benefit represents the amount of
income taxes expected to be payable or refundable for the current year. A
deferred income tax liability or asset, net of valuation allowance, is
established for the expected future consequences resulting from the differences
between the financial reporting and income tax bases of assets and liabilities
and from net operating loss and credit carryforwards. Deferred tax assets are
reduced by a valuation allowance when, in the opinion of management, it is more
likely than not that some portion or all of the deferred tax assets will not be
realized. Deferred income tax expense or benefit represents the net change
during the year in the deferred income tax liability or asset.

Net Income (Loss) Per Common Share

Net income (loss) per share has been computed by dividing net income (loss),
after reduction for preferred dividends, by the weighted average number of
common shares outstanding. Basic EPS is calculated by dividing the income
available to common stockholders by the weighted average number of common shares
outstanding for the period, without consideration for common stock equivalents.
Diluted EPS is calculated by dividing the income available to common
stockholders by the weighted average number of common shares outstanding for the
period, increased by dilutive securities that were outstanding during the
period. Net income remains the same for the calculations of basic EPS and
diluted EPS. For the years ended September 30, 1998 and 1996 the calculation for
basic and diluted EPS were the same as a result of the net losses incurred in
those years. A reconciliation of the

F-7
<PAGE> 29

numerators and denominators of the basic and diluted EPS calculations for the
year ended September 30, 1997 is presented below.

YEAR ENDED SEPTEMBER 30, 1997

<TABLE>
<CAPTION>
PER SHARE
NET INCOME SHARES AMOUNT
(in thousands except per share amounts) ---------- ------ ---------
<S> <C> <C> <C>
Net income from continuing operations $ 3,862
Basic EPS 30,552 $ 0.13
Dilutive securities 374
-------
Diluted EPS 30,926 $ 0.12
=======
</TABLE>

Foreign Currency Translation

The financial statements of the Company's foreign subsidiaries are
translated into U.S. dollars using period-end exchange rates for assets and
liabilities and weighted average exchange rates during the period for revenues
and expenses. Gains and losses from translation are excluded from results of
operations and accumulated as a separate component of stockholders' equity.

Diversification of Credit Risk

The Company's policy is to place its cash, cash equivalents and marketable
securities in high credit quality financial instruments and to limit the amount
of credit exposure.

New Pronouncements

In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard (FAS) No. 130, "Reporting Comprehensive Income."
The Company will adopt FAS 130 as required for fiscal years beginning after
December 15, 1997. This statement establishes standards for reporting and
presentation of comprehensive income and its components in the financial
statements. Comprehensive income is defined as "the change in equity (net
assets) of a business enterprise during a period from transactions and other
events and circumstances from non-owner sources. It includes all changes in
equity during a period except those resulting from investments by owners and
distributions to owners." The adoption of FAS 130 is not expected to have a
significant impact on the Company's consolidated financial statement
disclosures.

In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard (FAS) No. 131, "Disclosures about Segments of an
Enterprise and Related Information." The Company will adopt FAS 131 as required
for fiscal years beginning after December 15, 1997. This statement requires the
disclosure of certain information about operating segments in the financial
statements. It also requires that public companies report certain information
about their products and services, the geographic areas in which they operate,
and their major customers. The adoption of FAS 131 is not expected to have a
significant impact on the Company's consolidated financial statement
disclosures.

Recently, Statement of Position 97-2, "Software Revenue Recognition"
(SOP 97-2) was issued by the Accounting Standards Executive Committee. SOP 97-2
is effective for transactions entered into in fiscal years beginning after
December 15, 1997. Accordingly the Company will adopt SOP 97-2 beginning in
fiscal 1999. The Company's management anticipates that the adoption of SOP 97-2
will not have a material impact on the Company's results of operations.

Reclassifications

Certain prior year amounts have been reclassified to conform with the current
year presentations.

F-8
<PAGE> 30

NOTE 2 -- DISCONTINUED OPERATIONS:

During the September 1998 quarter the Company's management committed to a
plan to spin-off its Hi/fn, Inc. ("Hi/fn") subsidiary. The Company's
consolidated financial statements have been restated to present Hi/fn as a
discontinued operation. Accordingly, Hi/fn's assets and liabilities; revenues,
costs and expenses; and cash flows have been excluded from the respective
captions in the Consolidated Financial Statements, and have been reported as
"Net assets of discontinued operations"; "Income from discontinued operations,
net of taxes"; and "Net cash used in discontinued operations", respectively, for
all periods presented.

Summarized financial information for the discontinued operation is as
follows:

<TABLE>
<CAPTION>
(in thousands) 1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Revenues $21,533 $14,226 $12,894
Income before income taxes 3,845 3,068 3,592
Net income 2,218 1,833 2,151
Current assets 14,382 4,796
Total assets 16,611 5,898
Current liabilities 9,659 1,276
Total liabilities 9,659 1,276
</TABLE>

NOTE 3 -- COMPOSITION OF CERTAIN CONSOLIDATED FINANCIAL STATEMENT CAPTIONS:
(table amounts in thousands)

<TABLE>
<CAPTION>
SEPTEMBER 30,
--------------------
1998 1997
------- -------
<S> <C> <C>
Accounts receivable:
Trade receivables $ 1,092 $ 2,973
Less allowance for doubtful accounts (315) (228)
------- -------
$ 777 $ 2,745
======= =======
</TABLE>

Substantially all of the Company's customers are software distributors,
resellers and OEMs, which results in concentrated credit risk with respect to
the Company's trade receivables. Management believes that its credit policies
substantially mitigate such concentrated credit risk. Bad debt expenses were
$92,000 in fiscal 1998, insignificant in fiscal 1997, and $211,000 in fiscal
1996.

<TABLE>
<CAPTION>
SEPTEMBER 30,
----------------------
1998 1997
-------- --------
<S> <C> <C>
Inventories:
Raw materials ............................... $ 132 $ 140
Finished goods .............................. 65 41
-------- --------
$ 197 $ 181
======== ========

Property and equipment:
Computer equipment .......................... $ 7,409 $ 6,074
Leasehold improvements ...................... 1,313 1,291
Office equipment ............................ 1,131 1,122
Furniture and fixtures ...................... 943 914
Vehicles .................................... 19 51
-------- --------
10,815 9,452
Less accumulated depreciation ............... (7,486) (5,503)
-------- --------
$ 3,329 $ 3,949
======== ========

</TABLE>

F-9
<PAGE> 31

Accrued expenses and other current liabilities:

<TABLE>
<S> <C> <C>
Customer support accrual and deferred
revenue ................................... $ 1,172 $ 1,085
Compensation and employee benefits .......... 902 1,078
Spin-off charges ............................ 523 --
Restructuring ............................... 12 256
Treasury stock acquisition costs ............ -- 463
Other ....................................... 413 376
-------- --------
$ 3,022 $ 3,258
======== ========
</TABLE>

<TABLE>
<CAPTION>
SEPTEMBER 30,
-------------------------------
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Revenues:
Software ............. $14,292 $17,190 $17,871
Royalties and licenses 5,111 16,000 16,000
------- ------- -------
$19,403 $33,190 $33,871
======= ======= =======
</TABLE>

NOTE 4 -- BUSINESS ACQUIRED AND NON-RECURRING CHARGES:

In August 1997 the Company acquired the outstanding stock of Datlin
Software, Ltd. ("Datlin") for $400,000 in cash in a transaction accounted for
under the purchase method. The Company has capitalized the purchase price of
this acquisition for the in place organization and other intangible costs, and
is amortizing it on a straight line basis over a ten year period.

During the fourth quarter of fiscal 1997, the Company recorded a
restructuring charge to operations of $850,000, representing costs incurred in
conjunction with the Company's reorganization of its software business. The
principal components of the charge include $470,000 for losses on property,
plant and equipment, $259,000 for severance and employee related liabilities,
and $121,000 for lease termination costs. Additionally, during the first quarter
of fiscal 1998, the Company charged $350,000 to operations as additional amounts
for severance and employee related liabilities for which the Company was not
permitted to expense until the affected employees were notified of the
termination and the Company had committed to provide for such costs.

NOTE 5 -- MANDATORILY REDEEMABLE PREFERRED STOCK:

On November 7, 1995, Stac's Series A Mandatorily Redeemable Preferred Stock
held by Microsoft Corporation converted into 4,459,000 shares of Stac common
stock pursuant to the provisions of the preferred stock agreement as a result of
Stac's common stock maintaining a price per share in excess of $9.00 for twenty
consecutive trading days.

Preferred dividends of $168,000 were paid during fiscal 1996.

NOTE 6 -- STOCK REPURCHASES:

During the fourth quarter of fiscal 1997 the Company acquired 3,828,000
shares of its common stock, totaling $21,351,000, by tender offer using the
Dutch Auction mechanism, and to a lesser extent, open market share repurchases.
During fiscal 1998, the Company acquired an additional 3,969,000 shares of
Treasury stock totaling $19,996,000 through open market share repurchases.

NOTE 7 -- INCOME TAXES:
(table amounts in thousands)

For fiscal 1998 the Company recorded a valuation allowance against its
deferred tax assets based on an assessment of future taxable income. Deferred
income taxes are comprised of the following:

F-10
<PAGE> 32
<TABLE>
<CAPTION>
SEPTEMBER 30,
--------------------
1998 1997
------- -------
<S> <C> <C>
Deferred tax assets .... $ 6,912 $ 8,104
Deferred tax liabilities (540) (581)
Valuation allowance .... (6,372) --
------- -------
$ -- $ 7,523
======= =======
</TABLE>

The principal components of deferred income taxes are as follows:

<TABLE>
<CAPTION>
SEPTEMBER 30,
--------------------
1998 1997
------- -------
<S> <C> <C>
Revenue recognition for tax purposes $ 429 $ 355
Bad debts allowance ................ 132 99
Inventory valuation allowance ...... 24 35
Depreciation and amortization ...... 605 465
Purchased research and development . 5,238 5,847
Accrued restructuring .............. -- 364
Accrued compensation and benefits .. 267 --
Other .............................. (323) 358
Valuation allowance ................ (6,372) --
------- -------
$ -- $ 7,523
======= =======
</TABLE>

Components of pre-tax income are as follows:

<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
---------------------------------
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Domestic ........... $(2,329) $ 5,602 $ 999
Foreign ............ 326 (265) (124)
------- ------- -------
$(2,003) $ 5,337 $ 875
======= ======= =======
</TABLE>

The provision (benefit) for income taxes is comprised of the following:

<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
---------------------------------
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Current tax expense (benefit):
Federal .................... $(1,405) $ 1,329 $ 2,585
State ...................... (239) 720 1,074
------- ------- -------
(1,644) 2,049 3,659
------- ------- -------
Deferred tax expense (benefit):
Federal .................... 5,921 (500) 845
State ...................... 1,602 (74) 197
------- ------- -------
7,523 (574) 1,042
------- ------- -------
$ 5,879 $ 1,475 $ 4,701
======= ======= =======
</TABLE>

A reconciliation of the amount computed by applying the statutory federal
income tax rate to income before income taxes, to the provision for income taxes
follows:

<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
---------------------------------
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Amount computed at statutory
Federal rate of 34% ..................... $ (681) $ 1,815 $ 298
State income taxes, net of Federal
benefit ................................. 31 328 52
Expenses not deductible for tax purposes .. 230 64 4,945
Differentials from foreign operations ..... (42) 90 42
Tax credits ............................... -- (25) (12)
Tax exempt interest ....................... (38) (808) (715)
Revision of prior year's tax estimates .... (127) 41 33
Valuation allowance for deferred tax assets 6,372 -- --
Other ..................................... 134 (30) 58
------- ------- -------
$ 5,879 $ 1,475 $ 4,701
======= ======= =======
</TABLE>

F-11
<PAGE> 33

NOTE 8 -- STOCK OPTIONS AND EMPLOYEE BENEFIT PLANS:

1992 Stock Option Plan

In March 1992, the Company adopted a Stock Option Plan (the "1992 Plan"),
which provides for the granting of incentive stock options and non-qualified
stock options to purchase up to 5,000,000 shares of the Company's common stock.
The 1992 Plan is administered by the Compensation Committee of the Board of
Directors and provides for options for the purchase of the Company's common
stock to be granted to employees, officers and consultants of the Company at
prices that are not less than 100% and 50% of the estimated fair market value of
the related shares at the date of grant for incentive stock options and
non-qualified stock options, respectively. Options vest as determined by the
Compensation Committee. The maximum term of options granted under the 1992 Plan
is ten years.

1992 Non-Employee Directors' Stock Option Plan

In March 1992, the Company adopted the 1992 Non-Employee Directors' Stock
Option Plan (the "Directors' Plan"), as amended in February 1995, which provides
for the automatic granting of non-qualified stock options to purchase up to
400,000 shares, as amended, of the Company's common stock. The 1992 Plan is
administered by the Board of Directors and provides for options for the purchase
of the Company's common stock to each director of the Company (or an affiliate
of the Company) who is not otherwise employed by the Company (or an affiliate of
the Company). Such directors will automatically be granted an option to purchase
common stock upon election to the Board and on each anniversary of that date
thereafter so long as the director continues to serve on the Board. Vesting
periods are five years for initial options granted, and four years for options
granted in re-election years. The maximum term of options granted under the
Directors' Plan is ten years.

Combined information for all stock option activities for fiscal 1998, 1997
and 1996 is summarized below:

<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
------------------------
WEIGHTED-
AVERAGE
EXERCISE
SHARES PRICE
---------- --------
<S> <C> <C>
Balance at September 30, 1995 2,105,935 $ 3.72
Options granted ............ 881,041 $ 9.84
Options exercised .......... (413,739) $ 2.52
Options canceled ........... (279,111) $ 5.79
----------
Balance at September 30, 1996 2,294,126 $ 5.97
Options granted ............ 3,035,397 $ 5.11
Options exercised .......... (138,712) $ 3.23
Options canceled ........... (1,894,383) $ 7.54
----------
Balance at September 30, 1997 3,296,428 $ 4.39
Options granted ............ 429,000 $ 4.63
Options exercised .......... (248,882) $ 1.78
Options canceled ........... (632,508) $ 5.24
----------
Balance at September 30, 1998 2,844,038 $ 4.47
==========
</TABLE>

The following is a summary of stock options outstanding at September 30,
1998:

F-12
<PAGE> 34

<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
---------------------------------------------
WEIGHTED-
AVERAGE WEIGHTED-
REMAINING AVERAGE
CONTRACTUAL EXERCISE
Price Range NUMBER LIFE (YEARS) PRICE
--------- ------------ ---------
<S> <C> <C> <C>
$0.25 - $2.625 ......... 85,016 3.65 $ 1.64
$2.75 - $3.563 ......... 1,508,581 7.31 $ 3.36
$3.75 - $5.375 ......... 529,543 8.46 $ 4.50
$5.50 - $10.13 ......... 720,898 8.12 $ 7.10
---------
$0.25 - $10.13 ......... 2,844,038 7.62 $ 4.47
=========
</TABLE>

The following is a summary of stock options exercisable at September 30,
1998:

<TABLE>
<CAPTION>
OPTIONS EXERCISABLE
---------------------------
WEIGHTED-
AVERAGE
EXERCISE
NUMBER PRICE
Price Range --------- ---------
<S> <C> <C>
$0.25 - $2.625 ......... 85,016 $ 1.64
$2.75 - $3.563 ......... 882,230 $ 3.23
$3.75 - $5.375 ......... 163,212 $ 4.44
$5.50 - $10.13 ......... 327,668 $ 7.25
---------
$0.25 - $10.13 ......... 1,458,126 $ 4.18
=========
</TABLE>

Employee Stock Purchase Plan

In March 1992, the Company adopted the Employee Stock Purchase Plan (the
"Purchase Plan") covering an aggregate of 1,000,000 shares of the Company's
common stock. The most recent offering under the Purchase Plan terminated on
October 31, 1998. The Purchase Plan is administered by the Board of Directors
and allows participating employees to have up to 15% of their earnings withheld
and used to purchase shares of common stock on specified dates. The price of the
common stock purchased under the Purchase Plan is equal to 85% of the lower of
the fair market value of the common stock at the commencement date or the
relevant purchase date. During fiscal 1998, 36,540 shares were issued under the
Plan at a price of $3.88 per share. At September 30, 1998, 666,394 shares were
reserved for future issuance.

Pro Forma Disclosure

Had compensation cost for the Company's stock based compensation awards
issued during fiscal 1998 and 1997 been determined based on the fair value at
the grant date, the Company's net income (loss) and net income (loss) per share
would have been reduced to the pro forma amounts indicated below:

<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
------------------------------
(in thousands except per share data) 1998 1997
---------- ----------
<S> <C> <C>
Net income (loss):
As reported .............. $ (5,815) $ 5,660
========== ==========
Pro forma ................ $ (9,205) $ 3,185
========== ==========
</TABLE>

F-13
<PAGE> 35

<TABLE>
<S> <C> <C>
Net income (loss) per share:
As reported .............. $ (0.23) $ 0.18
========== ==========
Pro forma ................ $ (0.38) $ 0.10
========== ==========
</TABLE>

The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted average
assumptions used for grants during the years ended September 30, 1998 and 1997,
respectively: dividend yield of 0.0% for both years, risk free interest rates of
5.48% and 6.46%, expected volatility of 84% and 96%, and expected lives of 2.17
and 2.0 years. The weighted-average fair value of options granted during the
years ended September 30, 1998 and 1997 was $4.63 and $5.11 per share,
respectively. The fair value of the employees' purchase rights pursuant to the
Purchase Plan is estimated using the Black-Scholes model with the following
assumptions: dividend yield of 0.0% for both years, risk-free interest rates of
5.00% and 5.46%, expected volatility of 84% and 96%, and an expected life of six
months for both years. The weighted-average fair value of those purchase rights
granted during the years ended September 30, 1998 and 1997 was $1.78 and $2.71
per share, respectively.

401(k) Plan

In July 1991, the Company adopted an employee savings and retirement plan
(the "401(k) Plan") covering all of the Company's employees. The 401(k) Plan
permits, but does not require matching contributions by the Company on behalf of
all participants. No such contributions were made during fiscal 1998, 1997 or
1996.

NOTE 9 -- COMMITMENTS:

The Company occupies its facilities under several non-cancelable operating
leases that expire at various dates through November 2003, and which contain
renewal options. Future minimum lease payments are as follows:

<TABLE>
<CAPTION>
Fiscal Year AMOUNT
----------- --------
<S> <C>
1999 ......... $545,000
2000 ......... 292,000
2001 ......... 41,000
2002 ......... 43,000
2003 ......... 40,000
Thereafter ... 9,000
--------
$970,000
========
</TABLE>

Rent expense under operating leases was approximately $784,000, $894,000,
and $515,000, in fiscal 1998, 1997, and 1996, respectively. Certain facilities
leases provide for scheduled rent increases. The total lease commitment for such
leases is being charged ratably to operations.

NOTE 10 -- SIGNIFICANT CUSTOMERS AND FOREIGN OPERATIONS:

A significant portion of the Company's revenues has been derived from
technology licenses and sales to major distributors or resellers as follows:

Three customers accounted for 21%, 13% and 12%, respectively, of fiscal 1998
revenues. Three customers accounted for 36%, 13% and 12%, respectively, of
fiscal 1997 revenues. Three customers accounted for 35%, 12% and 12%,
respectively, of fiscal 1996 revenues.

Revenues are inclusive of royalties received from Microsoft and IBM
corporation for licenses of the Company's technology. The Company received
$5,100,000 in such revenues in fiscal 1998, completing all obligations
outstanding related to the underlying license agreements.

In fiscal 1998, 1997 and 1996, international revenues were $4,794,000,
$5,068,000 and $4,766,000, respectively, consisting primarily of sales to
customers in Canada, Europe and the Pacific Rim.

Condensed financial information related to the Company's wholly owned
foreign subsidiaries is as follows:

F-14
<PAGE> 36

<TABLE>
<CAPTION>
(in thousands) 1998 1997 1996
------ ------ ------
<S> <C> <C> <C>
Revenues .............. $3,580 $3,228 $2,893
Operating income ...... $ 307 $ 212 $ 677
Identifiable assets ... $2,894 $1,358 $1,010
</TABLE>

NOTE 11 -- CONTINGENCIES:

The Company may be contingently liable with respect to certain asserted and
unasserted claims that arise during the normal course of business. In the
opinion of management, the outcome of such matters presently known to management
will not have a material adverse effect on the Company's business, financial
position, or results of operations.

NOTE 12 -- SUBSEQUENT EVENTS:

On December 16, 1998, the Company spun-off its majority owned subsidiary
Hi/fn, Inc. by distributing in a tax-free manner the 6,000,000 shares of
preferred Hi/fn stock owned by the Company, to the Company's stockholders in a
ratio of approximately one Hi/fn share for every 4 shares of Company stock
outstanding. Concurrent with the distribution, all outstanding Stac options were
adjusted to restore their intrinsic value to a pre-distribution basis. As a
result, the quantity of options and their associated exercise prices were
increased and decreased respectively.

F-15
<PAGE> 37
STAC INC.

SCHEDULE I - MARKETABLE SECURITIES

AT SEPTEMBER 30, 1998
(IN THOUSANDS)

<TABLE>
<CAPTION>
NAME OF ISSUER PRINCIPAL MARKET CARRYING
TITLE OF ISSUE AMOUNT COST VALUE VALUE
--------- ------ ------ --------
<S> <C> <C> <C> <C>
CP General Electric Cap $ 5,000 $ 4,918 $ 4,968 $ 4,968

CP Prudential Funding 4,000 3,888 3,904 3,904

CP Ford Motor Credit 4,000 3,944 3,987 3,987
------- ------- ------- -------

Total $13,000 $12,750 $12,859 $12,859
======= ======= ======= =======
</TABLE>

S-1

<PAGE> 38

EXHIBIT INDEX