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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-K

(Mark One)

Commission file number 0-24765

hi/fn, inc.

Registrant’s telephone number, including area code: (408) 399-3500

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

     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 þ          No o

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     o

      The aggregate market value of the voting stock held by non-affiliates of the Registrant as of December 4, 2001: $84,144,137 based upon the closing price reported for such date on the NASDAQ National Market System. For purposes of this disclosure, shares of Common Stock held by persons who hold more than 5% of the outstanding shares of Common Stock and shares held by officers and directors of the Registrant have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily conclusive.

      The number of shares outstanding of the Registrant’s Common Stock as of December 4, 2001, was 10,262,381.

DOCUMENTS INCORPORATED BY REFERENCE

      Parts of the Proxy Statement for Registrant’s 2002 Annual Meeting of Shareholders to be held February 27, 2002 (the “Proxy Statement”) are incorporated by reference into Part III of this Form 10-K Report.

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

      With the exception of historical facts, the statements contained in this Annual Report on Form 10-K are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and are subject to the safe harbor provisions created by such statutes. Certain statements contained in the following Management’s Discussion and Analysis of Financial Condition and Results of Operations, including, without limitation, statements containing the words “believes,” “anticipates,” “estimates,” “expects,” and words of similar import, constitute forward-looking statements that involve risks and uncertainties. Such statements are based on current expectations and are subject to risk, uncertainties and changes in condition, significance, value and effect, including those discussed under the heading Trends and Uncertainties within the section of this report entitled “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and reports filed by Hifn with the Securities and Exchange Commission, specifically Forms 8-K, 10-Q and S-8. Such risks, uncertainties and changes in condition, significance, value and effect could cause our actual results to differ materially from those anticipated events. Although we believe that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could prove inaccurate, including, but not limited to, statements as to our future operating results and business plans. We disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

PART I

Item 1.     Business

Overview

      hi/fn, inc., together with its subsidiary, (referred to as “Hifn,” “we,” “us” or “our”) is a flow classification and network security specialist company supplying most major network equipment vendors with patented technology to improve network packet processing. Hifn designs, develops and markets high-performance, multi-protocol packet processors — semiconductor devices and software — designed to enable secure, high-bandwidth network connectivity, comprehensive differentiation of business-critical application network traffic from other general purpose network traffic and efficient compression, encryption/compression and public key cryptography, providing our customers with high-performance, interoperable implementations of a wide variety of industry-standard networking and storage protocols. Our products are used in networking and storage equipment such as routers, remote access concentrators, switches, broadband access equipment, network interface cards, firewalls and back-up storage devices.

      Hifn’s encryption/compression and public key processors allow network equipment vendors to add bandwidth enhancement and security capabilities to their products. Our encryption/compression and public key processors provide key algorithms used in virtual private networks (“VPNs”), which enable businesses to reduce wide area networking costs by replacing dedicated leased-lines with lower-cost IP-based networks such as the Internet. Using VPNs, businesses can also provide trading partners and others with secure, authenticated access to the corporate network, increasing productivity through improved communications. Storage equipment vendors use our compression processor products to improve the performance and capacity of mid- to high-end tape back-up systems.

      Hifn’s flow classification technology enables network equipment vendors to add unique traffic differentiation capabilities to their products. Our flow classification solutions provide precise details about packets and data traversing a network and are used in deploying quality of service (“QoS”) and classes of service (“CoS”), which enables businesses to enhance the effectiveness of using the public Internet network. Using QoS- or CoS-enabled network equipment, businesses can maintain more consistent and reliable interactions with their customers and business partners.

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Industry Background

      The need for a more effective use of and efficient communication utilizing the public network infrastructure in a business environment is one of the main drivers of the extensive deployment of network-based communications systems. The resulting increase in connectivity has further driven the need for technology that safeguards and manages the access to information available over these expanding global networks.

      The network computing market has undergone three major transitions over the past decade and it is the convergence of these transitions that contributed to the recent increase in global connectivity. The first of these transitions was the migration of corporate computing environments from centralized mainframe systems to distributed client/server environments. The ability to access and share information through client/server technology expanded the need for connectivity beyond workgroup local area networks (“LANs”) to enterprise-wide networks spanning multiple LANs and wide area networks (“WANs”). The second major transition was the widespread adoption of the Internet for business-to-business communications. Internet-based business applications have expanded beyond e-mail to a broad range of business applications and services including electronic publishing, direct to customer transactions, product marketing, advertising and customer support. The last of these transitions was the emergence of consumer-to-business or e-commerce communications. The convergence of these major transitions led to the need for secure, managed communications and the emergence of virtual private networks that use the public Internet infrastructure and associated protocols and applications to share information and services both within the enterprise and with business partners and customers. As a result, businesses are able to share internal information and run enterprise applications across geographically dispersed facilities as well as enable customers, suppliers and other business partners to inexpensively link into their enterprise information systems. As Internet protocols and infrastructure gain increasing and widespread acceptance for global communication, new wide-area connectivity services such as database access, transaction processing services, audio and telephone services as well as video teleconferencing services are emerging at a rapid rate. This expansion of services and applications is further accelerating the use of networks as global communication systems. The emergence of e-business increased the challenges in enabling secure access to information and applications.

The Complexity of and Need for Network Security

      Driven to provide the tremendous benefits of connectivity and information exchange, organizations potentially expose sensitive information and mission critical applications to unauthorized access, both through connections to the public Internet and from within the enterprise. In addition, transmission of data over the Internet may also expose such data to unauthorized interception. These risks create a critical need for enterprises to protect their information and information systems from unauthorized access and use. Historical methods for securing information resources are no longer adequate to meet the security requirements of today’s global networks. Today’s distributed network environments provide multiple points of access and multiple network resources, making it impractical to individually secure every application and resource on the network. Therefore, additional layers of security at the network level are required to control access to the network and to regulate and protect the flow of data between network segments.

      The increasing demands placed on data communication security systems by the expansion of Internet services and global enterprise networking is quickly outpacing the capabilities of many traditional Internet security appliance architectures. These demands include the need to define and transparently enforce an integrated, enterprise-wide security policy that can be managed centrally and implemented on a distributed basis. An effective network security solution also needs to be open and extensible to enable it to address the rapidly changing requirements of the Internet and intranets, including the addition of new security applications, such as authentication, encryption, URL filtering, anti-virus protection, and Java and ActiveX security services and functions. This increased complexity, along with the higher demand placed by ever-increasing bandwidths and the increasing number of users has driven the creation of data communications semiconductors specifically designed for the security task. These high-performance security integrated circuits create the next generation security platform for the Internet based on a combination of protocol features, customer

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The Hifn Solution

      Hifn is a flow classification and network security specialist company supplying most major network equipment vendors with patented technology to improve network packet processing. We design, develop and market high-performance, multi-protocol packet processors — semiconductor devices and software — designed to enable secure, high-bandwidth network connectivity, comprehensive differentiation of business-critical application network traffic from other general purpose network traffic and efficient compression, encryption/compression and public key cryptography, providing our customers with high-performance, interoperable implementations of a wide variety of industry-standard networking and storage protocols. We believe that our patented compression technology comprises the fundamental know-how for the design and implementation of low-cost, high-performance implementations of lossless data compression and gives our products a strong competitive advantage. By offering a wide range of high-performance implementations of our patented, standards-compliant technology, we are able to sell products to network and storage equipment vendors that allow them to reduce development costs and get their products to market faster.

      Our patented Lempel-Ziv-Stac compression technology (“LZS”) is incorporated into several networking protocol standards, including Point-to-Point Protocol (“PPP”) and the frame relay protocol, allowing network equipment vendors to rapidly integrate proven solutions for mitigating the costs associated with traditional private leased-line network architectures. The Microsoft Point-to-Point Compression (“MPPC”) implementation of our patents, developed by Microsoft, is incorporated into the PPP and Point-to-Point Tunneling Protocol (“PPTP”) implementations of the Windows 95, 98, ME, NT, 2000 and XP operating systems. We offer high-performance compression processors that implement LZS and MPPC. We also license software implementations of LZS and MPPC to industry-leading network equipment vendors for use in their networking products.

      In support of emerging VPN architectures, we have led the industry by introducing the first network security processors, integrating the critical functions of compression, encryption and data authentication in compliance with the Internet Protocol Security (“IPSec”) protocol. This integration allows network equipment vendors to add highly-integrated, high-performance VPN capabilities to their routers, remote access concentrators, switches, broadband access equipment and firewalls. Furthermore, we also license a complete and portable software implementation of the IPSec protocol, allowing network vendors to get to market more quickly with their VPN implementations at a fraction of the cost of internal software development efforts.

      Businesses are increasingly dependent upon the public Internet in conducting their normal business operations. Unlike the traditional telecommunications network used by businesses to communicate, the public Internet is vastly more complex and unreliable. In addition, there is currently an overall lack of differentiation or prioritization of business-critical functions from general use of the Internet. Rather, these functions are bundled together and use the same resources throughout the public Internet. Our flow classification solutions enable the integration of precise differentiation and measurement of business-critical transactions within network equipment vendors’ devices. This feature allows the creation of differentiated services within the public Internet.

      Hifn’s line of compression processors targeted at back-up storage applications provides storage equipment vendors high-performance implementations of our patented compression technology, doubling the capacity and performance of mid- to high-end tape drive systems. The LZS implementation of our patents is used in the Digital Linear Tape (“DLT”) tape drive products from Quantum. The Adaptive Lossless Data Compression (“ALDC”) implementation of our patents, developed by IBM, is used in a variety of tape storage products, including the Travan style of quarter-inch cartridge tape drives.

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Customers and Products

      A number of leading manufacturers of network and storage equipment have designed products that incorporate our products. To date, we have secured several design wins with networking and storage equipment vendors. To qualify as a design win, an equipment vendor must have ordered samples of our packet processors or an evaluation board and initiated a product design that incorporates our packet processors. During the design-in process, we work with each customer, providing training on our products, assisting in resolving technical questions and providing price and delivery information to assist the customer in getting our products into volume production. We cannot assure that any of the design wins we have secured will result in demand for our products. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Trends and Uncertainties — Our Business Depends Upon The Development Of The Packet Processor Market” and “— We Face Risks Associated With Evolving Industry Standards And Rapid Technological Change.”

      At September 30, 2001, we had a backlog of semiconductor orders representing $6.9 million of products deliverable to customers over the 6 months following the placement of these orders. At September 30, 2000, we had a backlog of $18.0 million. Because we quote product lead times to customers of approximately three months, most products shipped during a quarter are ordered during the previous quarter. Since customers may reschedule or cancel orders, subject to negotiated windows, orders scheduled for shipment in a quarter may be moved to a subsequent quarter or cancelled altogether. Therefore, backlog is not necessarily indicative of future sales.

      Hifn’s products — compression processors, encryption/compression processors, public key processors, flow classification processors and software — provide a broad range of price/performance alternatives for the implementation of intelligent, secure, high-performance networks and efficient, high-performance tape storage devices. We also offer evaluation boards to assist customers in the evaluation of our products.

      Network Bandwidth Enhancement Products. Hifn’s 9710, 9711 and 9751 high-performance compression processors provide essential bandwidth-enhancement for network equipment such as routers, remote access concentrators, broadband access equipment and switches. These products provide flexible bus interfaces and a variety of memory configuration options to allow customers to tailor their uses to meet a variety of network system requirements. We license a line of software compression libraries that provide similar functionality to our line of compression processor products for low-performance applications such as modems and ISDN links. The software products are offered in source and object code toolkits.

      Network Security Products. The Hifn 6500 public key processor provides acceleration of the mathematical computations involved in public key cryptography, supporting key exchange algorithms (such as the Rivest Shamir Adelman (“RSA”) public key cryptosystem as developed by RSA Data Security, Inc. and Diffie-Hellman) as well as digital signature algorithms (such as RSA and the Digital Signature Algorithm (“DSA”)). Hifn’s 7711, 7751 and 7811 encryption processors provide essential bandwidth-enhancement and security for network equipment such as routers, remote access concentrators, switches and firewalls. For high-performance security requirements, Hifn’s 7851, 7814 and 7854 processors are the first to incorporate the Hifn Intelligent Packet Processing (“HIPP”) architecture for complete processing from 100 to 700 megabits per second. At the multi-gigabit speed range, Hifn provides the 8154, 8065 and 8165, members of the HIPP II family of security processors. These devices provide public key acceleration for e-commerce secure-session handling as well as secure packet processing for multi-gigabit speeds. For data communication applications such as xDSL and cable modems, the Hifn 7901, 7902 and 7951 provide the industry’s first complete broadband security processors implementing support of data compression, encryption and authentication algorithms. In addition, these devices also include a public key math processor and a true hardware random number generator (“RNG”) to support the public key cryptography required for key generation, exchange and authentication.

      Network Flow Classification Products. Hifn’s MeterFlow products provide comprehensive data to support the differentiation of business-critical application network traffic from other general-purpose network traffic. MeterFlow provides additional information on the performance of these application transactions and flows in network equipment devices to support the deployment of Integrated and Differentiated Services.

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      Storage Enhancement Products. Hifn’s 9600, 9610 and 9732 high-performance compression processors provide a typical doubling of capacity and performance for mid- to high-end tape drive products.

      Evaluation Boards. To facilitate the adoption of our semiconductor devices, we design system-level boards that resemble actual end-products or subsystems. Our evaluation boards include basic hardware and software that enable customers to expedite their designs by using the evaluation boards as a reference or by incorporating portions of them into their own designs. These boards are used as evaluation and development vehicles for each semiconductor device designed by Hifn.

Technology

      Hifn’s multi-protocol packet processors are high-performance compression, encryption/compression, public key and flow classification processors that have been designed to meet the needs of networking and storage equipment vendors. We believe that our patented compression technology, employed in our compression and encryption/compression processors, gives us a strong competitive advantage. In addition to core technologies that we have developed, we enhance the features and functionality of our products through the licensing of certain technologies from third parties.

      Compression Algorithms and Architectures. Hifn holds key patents that cover a wide variety of lossless compression algorithms and their implementations. Specific implementations of our compression patents include the following compression algorithms: LZS, developed by Stac; MPPC, developed by Microsoft; and ALDC, developed by IBM. We have continued to improve the performance, functionality and architectures of these compression techniques. For example, semiconductor implementations of the LZS algorithm have improved in performance by a factor of 40 in under four years. Through the use of various architectural implementations of our compression algorithms, we are able to provide compression solutions over a broad price-performance spectrum.

      Encryption, Data Authentication and Public Key Algorithms. Hifn develops high-performance implementations of industry standard encryption algorithms (e.g., Advanced Encryption Standard (“AES”), Digital Encryption Standard (“DES”), Triple-DES and Alternative Rivest Chiper 4 (“ARC4”)) and data authentication algorithms (e.g., Message Digest 5 (“MD5”) and Secure Hash Algorithm (“SHA1”)). Coupled with our patent position in compression, we are positioned to combine compression with encryption and data authentication as specified in the most widely used network security protocols, such as IPSec and PPTP. In addition, we also implement public key cryptography algorithms which are used in a wide variety of network security protocols. Public key cryptography algorithms implemented by us include the RSA-compatible and Diffie-Hellman algorithms as well as the RSA-compatible and DSA digital signature algorithms. Our semiconductor products, including the RSA-compatible public key cryptosystem and the ARC4 and Alternative Rivest Cipher 5 (“ARC5”) symmetric key encryption algorithms are compatible with RSA Data Security, Inc.’s Rivest Cipher (“RC”) 4 and RC5 algorithms.

      Flow Classification and Measurement Architectures. In August 2000, we extended our reach into the packet processing area through the acquisition of Apptitude. We have incorporated Apptitude’s flow classification technology into a software solution for network equipment vendors. This technology has six patents pending that cover the ability to discover applications within the content of network packets and flows. MeterFlow, our flow classification technology, enables network equipment vendors to add unique traffic differentiation capabilities to their products. Our flow classification solutions provide precise details about packets and data traversing a network and are used in deploying QoS and CoS, which enables businesses to enhance the effectiveness of using the public Internet network. Using QoS- or CoS-enabled network equipment, businesses can maintain more consistent and reliable interactions with their customers and business partners. Further, use of MeterFlow technology can enable firewalls, NAT/ PAT transforms, billing, metering, monitoring and SLA validation applications to be application-aware.

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      Integrated, High-Performance Packet Processing. Hifn is continuing to develop additional packet processing functionality, including the implementation of advanced public key encryption algorithms, continued integration of computation-intensive security protocol processing functions, and integration of the MeterFlow classification capabilities. Ongoing product and technology development is expected to increase product integration and increase product performance in the future.

Intellectual Property

      Our future success and ability to compete are dependent, in part, upon our proprietary technology. We rely in part on patent, trade secret, trademark, maskwork and copyright laws to protect our intellectual property. We own 13 United States patents and four foreign patents. We also have two pending patent applications in Japan. The issued patents and patent applications primarily cover various aspects of our compression, bandwidth management and rate shaping technologies and have expiration dates ranging from 2006 to 2017. In addition to compression, we have six pending patent applications in the United States, four in Europe and Asia (Japan) covering our flow classification technology. We cannot assure that any patents will be issued under our current or future patent applications or that the patents issued under such patent applications will not be invalidated, circumvented or challenged. We cannot assure that any patents issued to us will be adequate to safeguard and maintain our proprietary rights, to deter misappropriation or to prevent an unauthorized third party from copying our technology, designing around the patents we own or otherwise obtaining and using our products, designs or other information. In addition, we cannot assure that others will not develop technologies that are similar or superior to our technology.

      As is typical in the semiconductor industry, we may in the future receive communications from third parties asserting patents, mask work rights, intellectual property or copyrights on certain of our products and technologies. Although we are not currently a party to any material litigation regarding intellectual property, in the event a third party were to make a valid intellectual property claim and a license relating to such intellectual property was not available on commercially reasonable terms, our operating results could be materially and adversely affected. Litigation, which could result in substantial cost to us and diversion of our resources, may also be necessary to enforce our patents or other intellectual property rights or to defend against claimed infringement of the rights of others. The failure to obtain necessary licenses or the occurrence of litigation relating to patent infringement or other intellectual property matters could have a material adverse effect on our business and operating results. We cannot assure that the steps we take to protect our intellectual property will be adequate to prevent misappropriation or that others will not develop competitive technologies or products.

      In addition, we claim copyright protection for certain proprietary software and documentation. We attempt to protect our trade secrets and other proprietary information through agreements with our customers, suppliers, employees and consultants, and through other security measures. Although we intend to protect our rights vigorously, we cannot assure that these measures will be successful. Furthermore, the laws of certain countries in which our products are or may be manufactured or sold may not protect our products and intellectual property.

Export Restrictions on Encryption Algorithms

      A key element of Hifn’s packet processor architecture is the encryption algorithms embedded in our semiconductor and software products. These products are subject to export control regulations administered by the U.S. Department of Commerce. The regulations permit our domestic network equipment customers to export non-military specific products incorporating our encryption technology only after the finished product has received a one-time technical review from the Department of Commerce. In addition, those U.S. export control laws prohibit the export of many products, including any products with encryption, to a number of countries deemed hostile by the U.S. government (currently there are nine such countries). Furthermore, U.S. government regulations require export licenses from the Department of State for all military-specific products.

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      U.S. export regulations have recently been liberalized to allow for the export of most encryption hardware, software, and technology to foreign non-government entities after the product receives a one-time technical review from the Commerce Department. The technical review process generally takes 30 days from the date the government logs the application into its computer system. In addition, the U.S. government now allows U.S. exporters to immediately ship products to both government and non-government end-users in the European Union (“EU”) and eight other friendly countries (“EU + 8”) immediately upon submission of the required technical review paperwork. If exports to government end-users are required to countries outside of the EU + 8 group, an individual export license is required from the Department of Commerce. As a result of the recent liberalizations, our network equipment customers may be able to effectively compete with EU competitors. However, foreign competitors facing less stringent controls and who may have effectively established markets for their products prior to the relaxation of U.S. export restrictions may be able to compete more effectively than our network equipment customers in the global market. Furthermore, U.S. regulations are constantly changing and we cannot assure that the liberalizing trends will continue, that the list of products and countries for which export approval is required, or the regulatory policies with respect thereto, will not be revised from time to time, or that laws limiting the domestic use of encryption will not be enacted. The sale of our packet processors could be hindered or harmed by the failure of our network equipment customers to obtain the required technical reviews or by the costs of compliance. See “Sales, Marketing & Technical Support.”

Competition

      The networking and storage equipment markets into which we sell our products are intensely competitive and are subject to frequent product introductions with improved price-performance characteristics, rapid technological change, unit price erosion and the continued emergence of new industry standards. The semiconductor industry is also intensely competitive and is characterized by rapid technological change, product obsolescence and unit price erosion. We expect competition to increase in the future from existing competitors and from companies that may enter our existing or future markets, including certain customers, with similar or substitute solutions that may be less costly or provide better performance or features than our products. To be successful in the future, we must continue to respond promptly and effectively to changing customer performance, feature and pricing requirements, technological change and competitors’ innovations. We cannot assure that we will be able to compete successfully against current and future competitors or that competitive pressures faced by us will not materially adversely affect our business, financial condition and results of operations.

      Our products compete with products from companies such as Analog Devices, Inc., Safenet, Inc., International Business Machines (“IBM”), Broadcom Corporation, Motorola, Inc. and Philips Corporation. In 1994, Stac entered into two license agreements with IBM where Stac granted IBM the right to use, but not sublicense, our patented compression technology in IBM hardware and software products. Stac also entered into a license agreement with Microsoft in 1994 whereby Stac granted Microsoft the right to use, but not sublicense, our compression technology in their software products. Stac’s license agreement with Microsoft, however, prohibits Microsoft from creating hardware implementations of our patents. We also compete against software solutions that use general purpose microprocessors to run encryption algorithms and our software compression libraries. In addition, as noted above, our encryption/compression and public key processors are subject to export control restrictions administered by the U.S. Department of Commerce, which permit our network equipment customers to export products incorporating encryption technology only after receiving a one-time technical review. As a result of these regulations, sales by foreign competitors facing less stringent controls on their encryption products could hinder or harm the sale of our encryption/compression and public key processors to network equipment customers in the global market. We believe that the recent change to the U.S. export regulations will enable us and our network equipment customers to obtain comparable footing with our European competitors. However, we expect significant future competition from major domestic and international semiconductor suppliers. Several established electronics and semiconductor suppliers have recently entered or indicated an intent to enter the network equipment market. We may also face competition from suppliers of products based on new or emerging technologies. Furthermore, many

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      Many of our current and potential competitors have longer operating histories, greater name recognition, access to larger customer bases and significantly greater financial, technical, marketing and other resources than us. As a result, they may be able to adapt more quickly to new or emerging technologies and changes in customer requirements or to devote greater resources to the promotion and sale of their products than us. In particular, companies such as Intel Corporation, Lucent Technologies Inc., Motorola, National Semiconductor Corporation and Texas Instruments Incorporated have proprietary semiconductor manufacturing ability, preferred vendor status with many of our customers, extensive marketing power and name recognition, greater financial resources than us and other significant advantages over us. In addition, current and potential competitors may determine, for strategic reasons, to consolidate, to lower the price of their products substantially or to bundle their products with other products. Current and potential competitors have established or may establish financial or strategic relationships among themselves or with existing or potential customers, resellers or other third parties. Accordingly, it is possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. We cannot assure that we will be able to compete successfully against current and future competitors. Increased competition may result in price reductions, reduced gross margins and loss of market share, any of which could materially adversely affect our business, financial condition and results of operations.

      We believe that important competitive factors in our markets are price-performance characteristics, rapid technological change, the continued emergence of new industry standards, length of development cycles, design wins with major network and storage equipment vendors, support for new network and storage standards, features and functionality, adaptability of products to specific applications, reliability, technical service and support and protection of products by effective utilization of intellectual property laws. Our failure to successfully develop products that compete successfully with those of other suppliers in the market would harm our business, financial condition and results of operations. In addition, we must compete for the services of qualified distributors and sales representatives. To the extent that our competitors offer such distributors or sales representatives more favorable terms on a higher volume of business, such distributors or sales representatives may decline to carry, or discontinue carrying, our products. Our business, financial condition and results of operations could be harmed by any failure to maintain and expand our distribution network. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Trends and Uncertainties — Our Markets Are Highly Competitive.”

Research and Development

      Our success will depend to a substantial degree upon our ability to develop and introduce in a timely fashion new products and enhancements to our existing products that meet changing customer requirements and emerging industry standards. We have made, and plan to continue to make, substantial investments in research and development. Extensive product development input is obtained from customers and through our participation in industry organizations and standards setting bodies such as the Internet Engineering Task Force (“IETF”).

      As of September 30, 2001, our research and development staff consisted of 79 employees. Our research and development expenditures were $18.6 million in the fiscal year ended September 30, 2001, $14.6 million in the fiscal year ended September 30, 2000 and $8.0 million in the fiscal year ended September 30, 1999, representing 43%, 33% and 19% of revenues for such periods, respectively. Research and development expenses primarily consist of salaries and related costs of employees engaged in ongoing research, design and development activities, costs of fabricating chip mask sets and subcontracting costs. Research and development costs in fiscal 2001 and 2000 also include amortization of deferred stock compensation related to the acquisition of Apptitude. We perform our research and product development activities at our facilities in Los Gatos, California and Carlsbad, California. We seek to hire additional skilled development engineers.

      The acquisition of Apptitude in August 2000 further strengthened our development efforts, adding to our pool of software expertise and intellectual properties. Furthermore, we are able to expand our product base to

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      In April 1998, we acquired a software implementation of the IPSec protocol from CyLAN Technologies, Inc. As part of the acquisition, we gained expertise in the development of software implementations of a wide range of networking protocol functions, including IPSec and Transmission Control Protocol/ Internet Protocol (“TCP/IP”).

      Our future performance depends on a number of factors, including our ability to identify emerging technological trends in our target markets, develop and maintain competitive products, enhance our products by adding innovative features that differentiate our products from those of our competitors, bring products to market on a timely basis at competitive prices, properly identify target markets and respond effectively to new technological changes or new product announcements by others. In evaluating new product decisions, we must anticipate well in advance the future demand for product features and performance characteristics, as well as available supporting technologies, manufacturing capacity, industry standards and competitive product offerings. We cannot assure that our design and introduction schedules for any additions and enhancements to our existing and future products will be able to be sold at prices that are favorable to us.

      We must also continue to make significant investments in research and development in order to continue enhancing the performance and functionality of our products to keep pace with competitive products and customer demands for improved performance, features and functionality. The technical innovations required for us to remain competitive are inherently complex and require long development cycles. Such innovations must be completed before developments in networking technologies or standards render them obsolete and must be sufficiently compelling to induce network and storage equipment vendors to favor them over alternative technologies. Moreover, we must generally incur substantial research and development costs before the technical feasibility and commercial viability of a product line can be ascertained.

      We cannot assure that revenues from future products or product enhancements will be sufficient to recover the development costs associated with such products or enhancements or that we will be able to secure the financial resources necessary to fund future development. The failure to successfully develop new products on a timely basis could have a material adverse effect on our business, financial condition and results of operations. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Trends and Uncertainties — We Face Risks Associated With Evolving Industry Standards And Rapid Technological Change.”

Sales, Marketing & Technical Support

      We market our products through a direct sales and marketing organization, headquartered in Los Gatos, California, with sales offices in Massachusetts, Colorado, North Carolina and Quebec, Canada, and through independent contract sales representatives in the United States, Europe, Japan and other areas. We also retain account managers to focus on individual customer relationships. We do not have any foreign operations and sales of our products to foreign companies, other than product shipments to contract manufacturers of domestic customers, have not been material. Sales representatives are selected for their understanding of the marketplace and their ability to provide effective field sales support for our products. Our relationships with some of our sales representatives have been established within the last two years, and we are unable to predict the extent to which some of these representatives will be successful in marketing and selling our products.

      Sales to U.S. customers account for the substantial majority of our revenues. Due to the export controls imposed by the U.S. government until recently on encryption products, our shipments to international customers have been limited to compression processors and compression software. The recent relaxation of controls has opened new opportunities for our products’ sales around the world. In early 2000, we entered into a distribution agreement with a worldwide electronics distribution company which we believe provides us with the ability to respond to significant pent-up demand for network security products around the world. We continue to actively work with our network equipment customers and the U.S. government to comply with U.S. export controls to facilitate the export of our customers’ products which incorporate our encryption

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      Hifn has a number of marketing programs designed to inform network and storage equipment vendors about the capabilities and benefits of our products. Our marketing efforts include participation in industry trade shows, technical conferences, preparation of competitive analyses, sales training, publication of technical and educational articles in industry journals, maintenance of our website, advertising and direct mail distribution of our literature.

      Technical support to customers is provided through field applications engineers and, if necessary, product designers. Local field support is provided in person or by telephone. We believe that providing customers with comprehensive product service and support is critical to maintaining a competitive position in the market and is critical to shortening the time required to design in our products. We work with our customers to monitor the performance of our product designs and to provide support at each stage of customer product development.

Manufacturing

      Currently, we subcontract all semiconductor manufacturing on a turnkey basis, with our suppliers delivering fully assembled and tested products based on our proprietary designs. The use of the fabless model allows us to focus substantially all of our resources on determining customer requirements and on the design, development and support of our products. This model also allows us to have significantly reduced capital requirements.

      We subcontract our semiconductor manufacturing to Atmel Corporation, Motorola and Toshiba Corporation. The selection of these manufacturers was based on the breadth of available technology, quality, manufacturing capacity and support for design tools used by us. None of our products are currently manufactured by more than one supplier. However, we expect that in the event one of our suppliers notifies us that it intends to cease manufacturing a product, we will have an adequate opportunity to order sufficient quantities of the affected products so that shipments to customers will not be adversely affected while we qualify a new manufacturer.

      At any given time, we use mainstream processes for the manufacture of our products, avoiding dependence on the latest process technology available. This approach reduces our technical risks and avoids the risks related to production capacity constraints typically associated with leading-edge semiconductor processes. This approach allows us to focus on providing differentiated functionality, the primary value-add in our products. Our current main products are manufactured using .6, .4, .3 and .25 micron Complementary Metal Oxide Semiconductor (“CMOS”) processes. Products under development are being designed with the .18 micron CMOS process. We believe that transitioning our products to increasingly smaller semiconductor dimensions will be important for us to remain competitive. We cannot assure that future process migration will be achieved without difficulty.

      We intend to continue for the foreseeable future to rely on our subcontract manufacturers for substantially all of our manufacturing, assembly and test requirements. All of our subcontract manufacturers produce products for other companies. We do not have long-term manufacturing agreements with any of our subcontract manufacturers. Our subcontract manufacturers are not obligated to supply products to us for any specific period, in any specific quantity or at any specific price, except as may be provided in a particular purchase order that has been accepted by one of our subcontract manufacturers.

      We must place orders approximately 20 to 23 weeks in advance of expected delivery. As a result, we have only a limited ability to react to fluctuations in demand for our products, which could cause us to have an excess or a shortage of inventory of a particular product. Failure of worldwide semiconductor manufacturing capacity to rise along with a rise in demand could result in our subcontract manufacturers allocating available capacity to customers that are larger or have long-term supply contracts in place. Our inability to obtain adequate foundry capacity at acceptable prices, or any delay or interruption in supply, could reduce our

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Employees

      As of September 30, 2001, Hifn employed a total of 136 full-time employees. Of the total number of employees, 79 were employed in research and development, 29 in sales and marketing, nine in operations and 19 in finance and administration. Our employees are not represented by any collective bargaining agreement and we have never experienced a work stoppage. We believe our employee relations are good.

      Our future success is heavily dependent upon our ability to hire and retain qualified technical, marketing, sales and management personnel. The competition for such personnel is intense, particularly for engineering personnel with related security, networking and integrated circuit design expertise, and applications support personnel with networking product design expertise. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Trends and Uncertainties — We Depend Upon Key Personnel.”

      Hifn’s corporate and technical headquarters are located in Los Gatos, California. We lease approximately 35,000 and 11,500 square feet of space in Los Gatos, California, under leases that expire in September 2005 and December 2007, respectively. We also lease other facilities including 14,000 square feet of space for our design and operations center in Carlsbad, California and small field sales offices in Charlotte, North Carolina and Westford, Massachusetts as well as in Monument, Colorado and Quebec, Canada.

      In October and November 1999, six purported class action complaints were filed in the United States District Court for the Northern District of California against Hifn and certain of its officers and directors. These complaints were consolidated into In re Hi/fn Sec. Litig., No. 99-04531 SI. The consolidated complaint was filed on behalf of a class of purchasers of Hifn’s stock during the period July 26, 1999 through October 7, 1999 (the “class period”). The complaint seeks unspecified money damages and alleges that Hifn and certain of its officers and directors violated federal securities laws in connection with various public statements made by Hifn and certain of its officers and directors during the class period. In August 2000, the Court dismissed the complaint as to all defendants, other than Raymond J. Farnham and Hifn. Mr. Farnham and Hifn answered the complaint in September 2000. Discovery has commenced. A trial date has been tentatively scheduled for October 2002. We believe that the allegations contained in the complaint are without merit and intend to defend the action vigorously. Due to the nature of the allegations, management cannot estimate the possible loss, if any, or range of loss that may ultimately be incurred in connection with the allegations. However, based on the facts currently known, management does not believe that these matters will have a material adverse effect on our financial position.

      In December 2000, a former employee of Hifn filed suit against Hifn and one of its former employees alleging wrongful termination, invasion of privacy, violation of Fair Employment and Housing Act, based on sexual harassment, sexual discrimination and retaliation, defamation, breach of the covenant of good faith and fair dealing, negligence and conversion. On April 16, 2001, we filed an answer to the complaint, generally denying its allegations and asserting various affirmative defenses. Discovery has recently commenced, and no trial date has been set. The parties have voluntarily agreed to participate in a mediation session in an effort to amicably resolve the matter. In the event the matter is not amicably resolved, we intend to defend the matter vigorously. While the ultimate outcome of this matter cannot be determined at this time, management does not believe that this matter will have a material adverse effect on our financial position.

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      No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.

PART II

Item 5.     Market for the Registrant’s Common Equity and Related Stockholder Matters

Price Range of Common Stock

      Hifn’s Common Stock is traded on the Nasdaq National Market under the symbol “HIFN.” The only class of Hifn securities that is traded is Hifn Common Stock. The following table lists quarterly information on the price range of the Common Stock based on the high and low reported closing bid prices for the Common Stock as reported on the Nasdaq National Market for the periods indicated below:

      On December 4, 2001, the reported last sale price of Common Stock on the Nasdaq National Market was $16.69 per share and there were approximately 349 holders of record of our Common Stock.

Dividend Policy

      We have never declared or paid any dividends on our capital stock. We intend to retain any future earnings to finance the growth and development of our business and do not expect to pay any cash dividends in the foreseeable future.

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Item 6.     Selected Financial Data

      The following selected financial data should be read in conjunction with the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and Notes included elsewhere in this Annual Report on Form 10-K:

(1)	In August 2000, we completed our acquisition of Apptitude in a transaction accounted for as a purchase. The Statement of Operations for fiscal year ended September 30, 2000 include the operating results of Apptitude from the date of acquisition.
(2)	On March 31, 1999, we issued 1,600,000 shares of common stock at a price of $33 per share in an equity offering, which raised approximately $49.2 million, net of offering expenses. On April 19, 1999 our underwriters exercised their option to purchase an additional 300,000 shares of our common stock, which yielded an additional $9.3 million in proceeds to us.
(3)	We operated as a division of our parent company, Stac, until September 30, 1996 and as a subsidiary of Stac until December 16, 1998. Accordingly, our selected financial data as of and for the fiscal year ended September 30, 1998 and 1997 has been derived from audited financial statements not included herein. The financial information may not reflect our future performance or our future financial position or results of operations, nor does it provide or reflect data as if we had actually operated as a separate, stand-alone entity during all of the periods covered.

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Item 7.     Management’s Discussion and Analysis of Financial Condition and Results of Operations

      The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes included elsewhere in this Annual Report on Form 10-K. The results shown in this report are not necessarily indicative of the results to be expected in any future periods. This discussion contains forward-looking statements based on current expectations which involve risks and uncertainties. Actual results and the timing of certain events may differ significantly from those projected in such forward-looking statements due to the factors set forth in the section entitled “Trends and Uncertainties” and appearing elsewhere in this report.

Overview

      hi/fn, inc., together with its subsidiary (referred to as “Hifn,” “we,” “us” or “our”), is a flow classification and network security specialist company supplying most major network equipment vendors with patented technology to improve network packet processing. We design, develop and market high-performance, multi-protocol packet processors — semiconductor devices and software — designed to enable secure, high-bandwidth network connectivity, comprehensive differentiation of business-critical application network traffic from other general purpose network traffic and efficient compression, encryption/compression and public key cryptography, providing our customers with high-performance, interoperable implementations of a wide variety of industry-standard networking and storage protocols. Our products are used in networking and storage equipment such as routers, remote access concentrators, switches, broadband access equipment, network interface cards, firewalls and back-up storage devices.

      Hifn’s encryption/compression and public key processors allow network equipment vendors to add bandwidth enhancement and security capabilities to their products. Our encryption/compression and public key processors provide key algorithms used in VPNs, which enable businesses to reduce wide area networking costs by replacing dedicated leased-lines with lower-cost IP-based networks such as the Internet. Using VPNs, businesses can also provide trading partners and others with secure, authenticated access to the corporate network, increasing productivity through improved communications. Storage equipment vendors use our compression processor products to improve the performance and capacity of mid-to high-end tape back-up systems.

      Hifn’s flow classification technology enables network equipment vendors to add unique traffic differentiation capabilities to their products. Our flow classification solutions provide precise details about packets and data traversing a network and are used in deploying quality of service (“QoS”) and classes of service (“CoS”), which enables businesses to enhance the effectiveness of using the public Internet network. Using QoS- or CoS-enabled network equipment, businesses can maintain more consistent and reliable interactions with their customers and business partners.

      Revenues from one customer and its manufacturing subcontractor represented 36%, 36% and 45% of our net revenues for fiscal years ended September 30, 2001, 2000 and 1999, respectively. Revenues from another customer and its manufacturing subcontractors represented 17%, 35% and 38% of our net revenues for fiscal years ended September 30, 2001, 2000 and 1999, respectively.

      In August 2000, Hifn completed its acquisition of Apptitude, a provider of embedded Internet traffic analysis solutions through a merger of Apptitude with and into a wholly-owned subsidiary of Hifn. The aggregate purchase consideration was $58.5 million, $20 million in cash and $38.5 million in stock. In exchange, we received tangible assets and assumed liabilities as well as intangible assets including developed and core technology, workforce and patents. Additionally, we acquired in-process research and development costs which were expensed at the time of the acquisition.

      Hifn’s quarterly and annual operating results are affected by a wide variety of factors that could materially and adversely affect net sales, gross margins and operating income. These factors include the volume and timing of orders received, changes in the mix of proprietary and second source products sold, market acceptance of our and our customers’ products, competitive pricing pressures, our ability to introduce new products on a timely basis, the timing and extent of research and development expenses, fluctuations in

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Results of Operations

      The following table sets forth certain statement of operations data as a percentage of total revenue for the periods indicated:

Years Ended September 30, 2001, 2000 and 1999

      Net Revenues. Revenue from sales of semiconductors and licenses of software libraries decreased 4% in fiscal 2001 to $43.0 million compared to $44.8 million in fiscal 2000. In fiscal 2000, revenue increased 6% compared to $42.4 million in fiscal 1999. The decrease in revenue in fiscal 2001 from fiscal 2000 was primarily due to a decrease in sales of our data compression and encryption processors to network equipment manufacturers partially offset by an increase in license and software revenues. The increase in revenue in fiscal 2000 from fiscal 1999 was primarily due to increasing sales of our data compression and encryption processors to network equipment manufacturers. Semiconductor sales to Quantum, an original equipment manufacturer of high-performance tape storage devices, through its manufacturing subcontractor, comprised 36%, 36% and 45% of revenue in each of fiscal years 2001, 2000 and 1999, respectively. Semiconductor sales to Lucent, an original equipment manufacturer of networking equipment, through its manufacturing subcontractors, comprised 17%, 35% and 38% of revenue in fiscal years 2001, 2000 and 1999, respectively.

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      Cost of Revenues. Cost of revenues consists primarily of semiconductors which were manufactured to our specifications by third parties for resale by us. Cost of revenues as a percentage of net revenues increased to 32% for fiscal 2001 from 22% for fiscal 2000. The increase in cost of revenues as a percentage of net revenues in fiscal 2001 primarily reflects a $3.4 million charge during the third quarter of fiscal 2001 for excess inventory. This charge resulted from a decrease in demand below our previous expectations. Excluding the excess inventory charge, cost of revenues for fiscal 2001 was 24% of net revenues. In addition to the charge there was a shift in the revenue mix from 2000 to 2001 and an increase in overhead expenses including supplies and facility rental costs.

      Research and Development. Research and development expenses were $18.6 million, or 43% of revenues, in fiscal 2001, $14.6 million, or 33% of revenues, in fiscal 2000 and $8.0 million, or 19% of revenues, in fiscal 1999. Research and development expenses increased 27% in fiscal 2001 and 82% in fiscal 2000. The increase in research and development costs in each successive period was due to increases in labor, benefits, building expenses and depreciation costs related to the addition of research and development personnel related to the acquisition of Apptitude in August 2000, offset by a reduction in outside services costs for contractors previously used to develop new products. Amortization of deferred stock compensation related to the acquisition of Apptitude of $1.8 million and $259,000 in fiscal 2001 and 2000, respectively, also contributed to the increase in research and development expense in each of these fiscal years. We expect our investments in research and development to continue to increase in coming periods on an absolute basis as we continue to develop products targeted at meeting market needs. However, we cannot assure that product development programs invested in by us will be successful or that products resulting from such programs will achieve market acceptance.

      Sales and Marketing. Sales and marketing expenses were $9.5 million, or 22% of revenues, in fiscal 2001, $8.2 million, or 18% of revenues, in fiscal 2000 and $6.0 million, or 14% of revenues, in fiscal 1999. The increase in sales and marketing expenses in each successive fiscal year was primarily due to increased headcount and outside services to support sales and marketing efforts.

      General and Administrative. General and administrative expenses were approximately $7.7 million, or 18% of revenues, in fiscal 2001, $5.1 million, or 11% of revenues, in fiscal 2000 and $3.0 million, or 7% of revenues, in fiscal 1999. The continued increase in general and administrative expenses is mainly due to higher salaries and benefits costs as a result of increased headcount as well as office administration and depreciation costs. Additionally, amortization of deferred stock compensation related to the acquisition of Apptitude of $1.8 million and $503,000 for fiscal 2001 and 2000, respectively, contributed to the increase. Legal and accounting costs for the fiscal years ended 2001, 2000 and 1999 were $604,000, $810,000 and $703,000, respectively.

      Amortization of Intangibles and Goodwill. Amortization of intangibles and goodwill of $11.1 million, or 26% of net revenues, in fiscal 2001 and $1.6 million, or 4% of revenues, in fiscal 2000 related to the acquisition of Apptitude and other intellectual property in August 2000.

      Purchased In-Process Research and Development. Purchased in-process research and development (“IPR&D”) related to the acquisition of Apptitude in August 2000 was $4.1 million or 9% of revenues. Purchased IPR&D related to the value assigned to Apptitude’s MeterFlow ASIC product which had not reached technological feasibility at the time of the acquisition.

      Interest and Other Income (Expense), Net. Interest and other income (expense), net, for fiscal 2001 were $2.6 million, or 6% of revenues, as compared to $4.1 million, or 9% of revenues, for fiscal 2000 and $1.7 million, or 4% of revenues, for fiscal 1999. The decrease was primarily a result of a shift in the investment mix from stock instruments to commercial paper and municipal bonds, lower average cash and short-term investments balance during fiscal 2001 as compared to fiscal 2000 as well as an overall decrease in interest rates.

      Income Taxes. The effective tax rates for fiscal 2001, 2000 and 1999 were 11%, 81% and 40%, respectively. We recorded a benefit from income taxes of $1.7 million in fiscal 2001 and income tax provisions of $4.4 million in fiscal 2000 and $6.6 million in fiscal 1999. The resulting effective tax rates are primarily the

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      We recognize deferred income tax asset for the expected future benefits attributable to the differences between the financial reporting and income tax basis of assets and liabilities and from net operating loss and credit carryforwards. Deferred income tax expense or benefit represents the net change during the year in the deferred income tax liability or asset.

Liquidity and Capital Resources

      Operating Activities. In fiscal 2001, we generated cash from operating activities of approximately $1.3 million comprised of net loss as adjusted for non-cash items including amortization of intangibles and deferred stock compensation of $15.0 million, depreciation and amortization costs of $1.7 million, tax benefit from employee stock plans of $3.9 million and an increase in deferred income taxes of $3.5 million as well as a decrease in accounts receivable of $2.1 million and an increase in accrued expenses and other current liabilities of $122,000. These adjustments were offset mainly by increases in prepaid expenses and other current assets of $2.4 million, other assets of $1.3 million, inventory of $330,000 and a decrease in accounts payable of $410,000. In fiscal 2000, we generated cash from operating activities of approximately $14.9 million comprised of net income as adjusted for non-cash items including purchased in-process research and development of $4.1 million, amortization of intangibles and deferred stock compensation of $3.0 million, deferred income taxes of $1.9 million, depreciation and amortization costs of $1.1 million and tax benefit from employee stock plans of $5.2 million as well as a decrease in accounts receivable of $1.3 million. These adjustments were offset mainly by decreases in income taxes payable of $1.3 million and in accrued expenses and other liabilities of $1.7 million.

      Investing Activities. Cash used in investing activities in fiscal 2001 was $7.5 million, resulting from the purchase of short-term investments of $5.0 million and the acquisition of $2.5 million in property and equipment. Cash used in investing activities in fiscal 2000 was $27.5 million, consisting primarily of the acquisition of Apptitude and the purchase of intellectual property aggregating $20.5 million, the purchase of short-term investments of $5.1 million and the acquisition of $1.8 million in property and equipment. Our capital expenditures in fiscal 2001 reflect costs incurred in relation to the consolidation of our northern California facilities as well as the additional facilities in Los Gatos and Carlsbad. We expect capital expenditures in the foreseeable future to approximate those levels as in fiscal 1999.

      Financing Activities. Cash provided by financing activities in fiscal 2001 and fiscal 2000 of $1.2 million and $2.1 million, respectively, reflect proceeds from the issuance of common stock for stock option exercises and stock purchase plan purchases slightly offset by payments on debt obligations.

      In March 1999, Hifn paid a $5.0 million loan and paid a total of $1.5 million in transfers to our former parent, Stac. Also during 1999, we raised approximately $50.0 million in an equity offering. In April 1999, our underwriters exercised their option to purchase additional shares of our common stock, which yielded an additional $9.3 million in proceeds to us.

      We use a number of independent suppliers to manufacture substantially all of our products. As a result, we rely on these suppliers to allocate to us a sufficient portion of foundry capacity to meet our needs and deliver sufficient quantities of our products on a timely basis. These arrangements allow us to avoid utilizing our capital resources for manufacturing facilities and work-in-process inventory and to focus a substantial proportion of our resources on the design, development and marketing of our products.

      We require funds to finance our working capital, particularly accounts receivable and manufactured inventory, and to finance investments in property and equipment. Our need to raise capital in the future will depend on many factors including the rate of sales growth, market acceptance of our existing and new products, the amount and timing of research and development expenditures, the timing and size of acquisitions

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      In August 2000, we completed our acquisition of Apptitude. The purchase price of the acquisition of $58.5 million, which included $127,000 in estimated acquisition related costs, was used to acquire the net assets of Apptitude. The allocation of the purchase price was as follows:

      The goodwill, acquired developed and core technology, workforce and patents are recorded on the balance sheet as intangibles and other assets and are being amortized on a straight-line basis over periods ranging from two to five years. The purchased in-process research and development was expensed at the time of the acquisition as a one-time charge. However, as a result of scheduled adoption of SFAS 142 (see Note 2 of Notes to Consolidated Financial Statements), we will cease amortization of goodwill beginning October 1, 2002. Goodwill amortization expense aggregated $9.4 million and $1.3 million in fiscal 2001 and 2000, respectively.

Trends and Uncertainties

      In future periods, Hifn’s business, financial condition and results of operations may be affected by many factors, including but not limited to the following:

      Our operating results have fluctuated significantly in the past and we expect that they will continue to fluctuate in the future. This fluctuation is a result of a variety of factors including the following:

	•	General business conditions in our markets as well as global economic uncertainty;
	•	Increases or reductions in demand for our customers’ products;
	•	The timing and volume of orders we receive from our customers;
	•	Cancellations or delays of customer product orders;
	•	Acquisitions or mergers involving us, our competitors or customers;
	•	Any new product introductions by us or our competitors;
	•	Our suppliers increasing costs or changing the delivery of products to us;
	•	Increased competition or reductions in the prices that we are able to charge;
	•	The variety of the products that we sell as well as seasonal demand for our products; and
	•	The availability of manufacturing capacity necessary to make our products.

      Quantum Corporation (“Quantum”), through its manufacturing subcontractor, accounted for approximately 36%, 36% and 45%, respectively, of our revenues in fiscal 2001, 2000 and 1999. Lucent, through its manufacturing subcontractors, accounted for approximately 17%, 35% and 38% of our revenues during fiscal

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      Limited numbers of network and storage equipment vendors account for a majority of packet processor purchases in their respective markets. In particular, the market for network equipment that would include packet processors, such as routers, remote access concentrators and firewalls, is dominated by a few large vendors, including Cisco Systems, Inc., Lucent Technologies Inc., Nortel Networks, Inc. and 3Com Corporation. As a result, our future success will depend upon our ability to establish and maintain relationships with these companies. If these network equipment vendors do not incorporate our packet processors into their products, our business, financial condition and results of operations could suffer.

      Our prospects are dependent upon the acceptance of packet processors as an alternative to other technology traditionally utilized by network and storage equipment vendors. Many of our current and potential customers have substantial technological capabilities and financial resources and currently develop internally the application specific integrated circuit components and program the general purpose microprocessors utilized in their products as an alternative to our packet processors. These customers may in the future continue to rely on these solutions or may determine to develop or acquire components, technologies or packet processors that are similar to, or that may be substituted for, our products. In order to be successful, we must anticipate market trends and the price, performance and functionality requirements of such network and storage equipment vendors and must successfully develop and manufacture products that meet their requirements. In addition, we must make products available to these large customers on a timely basis and at competitive prices. If orders from customers are cancelled, decreased or delayed, or if we fail to obtain significant orders from new customers, or any significant customer delays or fails to pay, our business, financial condition and results of operations could suffer.

      We want to be a leading supplier of packet processors that implement the network security protocols necessary to support the deployment of virtual private networks. This emerging market, which is still evolving, may not grow and if it does continue to grow, our products may not successfully serve this market. Our ability to generate significant revenue in the virtual private network market will depend upon, among other things, the following:

	•	Our ability to demonstrate the benefits of our technology to distributors, original equipment manufacturers and end users; and
	•	The increased use of the Internet by businesses as replacements for, or enhancements to, their private networks.

      If we are unable to penetrate the virtual private network market, or if that market fails to develop, our business, financial condition and results of operations could suffer.

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      The markets in which we compete are characterized by rapidly changing technology, frequent product introductions and evolving industry standards. Our performance depends on a number of factors, including our ability to do the following:

	•	Properly identify emerging target markets and related technological trends;
	•	Develop and maintain competitive products;
	•	Enhance our products by adding innovative features that differentiate our products from those of competitors;
	•	Bring products to market on a timely basis at competitive prices; and
	•	Respond effectively to new technological changes or new product announcements by others.

      Our past success has been dependent in part upon our ability to develop products that have been selected for design into new products of leading equipment manufacturers. However, the development of our packet processors is complex and, from time to time, we have experienced delays in completing the development and introduction of new products. We may not be able to adhere to our new product design and introduction schedules and our products may not be accepted in the market at favorable prices, if at all.

      In evaluating new product decisions, we must anticipate future demand for product features and performance characteristics, as well as available supporting technologies, manufacturing capacity, competitive product offerings and industry standards. We must also continue to make significant investments in research and development in order to continue to enhance the performance and functionality of our products to keep pace with competitive products and customer demands for improved performance, features and functionality. The technical innovations required for us to remain competitive are complicated and require a significant amount of time and money. We may experience substantial difficulty in introducing new products and we may be unable to offer enhancements to existing products on a timely or cost-effective basis, if at all. For instance, the performance of our encryption/compression and public key processors depends upon the integrity of our security technology. If any significant advances in overcoming cryptographic systems are made, then the security of our encryption/compression and public key processors will be reduced or eliminated unless we are able to develop further technical innovations that adequately enhance the security of these products. Our inability to develop and introduce new products or enhancements directed at new industry standards could harm our business, financial condition and results of operations.

      We compete in markets that are intensely competitive and are expected to become more competitive as current competitors expand their product offerings and new competitors enter the market. The markets that we compete in are subject to frequent product introductions with improved price-performance characteristics, rapid technological change, and the continued emergence of new industry standards. Our products compete with offerings from companies such as Analog Devices, Inc., Safenet, Inc., IBM, Broadcom Corporation, Motorola, Inc. and Philips Corporation. In 1994, Stac entered into two license agreements with IBM in which Stac granted IBM the right to use, but not sublicense, our patented compression technology in IBM hardware and software products. Stac also entered into a license agreement with Microsoft Corporation (“Microsoft”) in 1994 whereby Stac granted Microsoft the right to use, but not sublicense, our compression technology in their software products. We expect significant future competition from major domestic and international semiconductor suppliers. Several established electronics and semiconductor suppliers have recently entered, or expressed an interest to enter, the network equipment market. We also may face competition from suppliers of products based on new or emerging technologies. Furthermore, many of our existing and potential customers internally develop solutions which attempt to perform all or a portion of the functions performed by our products.

      A key element of our packet processor architecture is our encryption technology. Until recently, in order to export our encryption-related products, the U.S. Department of Commerce required us to obtain a license.

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      Many of our current and prospective competitors offer broader product lines and have significantly greater financial, technical, manufacturing and marketing resources than us. As a result, they may be able to adapt more quickly to new or emerging technologies and changes in customer requirements or to devote greater resources to promote the sale of their products. In particular, companies such as Intel Corporation, Lucent Technologies Inc., Motorola, Inc., National Semiconductor Corporation, and Texas Instruments Incorporated have a significant advantage over us given their relationships with many of our customers, their extensive marketing power and name recognition and their much greater financial resources. In addition, current and potential competitors may decide to consolidate, lower the prices of their products or to bundle their products with other products. Any of the above would significantly and negatively impact our ability to compete and obtain or maintain market share. If we are unable to successfully compete against our competitors, our business, results of operations and financial condition will suffer.

      We believe that the important competitive factors in our markets are the following:

	•	Performance;
	•	Price;
	•	The time that is required to develop a new product or enhancements to existing products;
	•	The ability to achieve product acceptance with major network and storage equipment vendors;
	•	The support that exists for new network and storage standards;
	•	Features and functionality;
	•	Adaptability of products to specific applications;
	•	Reliability; and
	•	Technical service and support as well as effective intellectual property protection.

      If we are unable to successfully develop and market products that compete with those of other suppliers, our business, financial condition and results of operations could be harmed. In addition, we must compete for the services of qualified distributors and sales representatives. To the extent that our competitors offer distributors or sales representatives more favorable terms, these distributors and sales representatives may decline to carry, or discontinue carrying, our products. Our business, financial condition and results of operations could be harmed by any failure to maintain and expand our distribution network.

      Our success is largely dependent upon continued growth in the market for network security equipment, such as routers, remote access concentrators, switches, broadband access equipment, security gateways, firewalls and network interface cards. In addition, our success depends upon storage equipment vendors incorporating our packet processors into their systems. The network security equipment market has in the past, and may in the future, fluctuate significantly based upon numerous factors, including the lack of industry standards, adoption of alternative technologies, capital spending levels and general economic conditions. We are unable to determine the rate or extent to which these markets will grow, if at all. Any decrease in the growth of the network or storage equipment market or a decline in demand for our products could harm our business, financial condition and results of operations.

      Our proprietary technology is critical to our future success. We rely in part on patent, trade, trademark, maskwork and copyright law to protect our intellectual property. We own 12 United States patents and four

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      We also claim copyright protection for certain proprietary software and documentation. We attempt to protect our trade secrets and other proprietary information through agreements with our customers, employees and consultants, and through other security measures. However, our efforts may not be successful. Furthermore, the laws of certain countries in which our products are or may be manufactured or sold may not protect our products and intellectual property.

      Our customers typically take a long time to evaluate our products. In fact, it usually takes our customers 3 to 6 months or more to test our products with an additional 9 to 18 months or more before they commence significant production of equipment incorporating our products. As a result of this lengthy sales cycle, we may experience a delay between increasing expenses for research and development and sales and marketing efforts on the one hand, and the generation of higher revenues, if any, on the other hand. In addition, the delays inherent in such a lengthy sales cycle raise additional risks of customer decisions to cancel or change product plans, which could result in the loss of anticipated sales. Our business, financial condition and results of operations could suffer if customers reduce or delay orders or choose not to release products using our technology.

      We rely on subcontractors to manufacture, assemble and test our packet processors. We currently subcontract our semiconductor manufacturing to Atmel Corporation, Toshiba Corporation and Motorola, Inc. Since we depend upon independent manufacturers, we do not directly control product delivery schedules or product quality. None of our products are manufactured by more than one supplier. Since the semiconductor industry is highly cyclical, foundry capacity has been very limited at times in the past and may become limited in the future.

      We depend on our suppliers to deliver sufficient quantities of finished product to us in a timely manner. Since we place orders on a purchase order basis and do not have long-term volume purchase agreements with any of our suppliers, our suppliers may allocate production capacity to other products while reducing deliveries to us on short notice. For example, in June 1995, one of our suppliers delayed the delivery of one of our products. As a result, we switched production of the product to a new manufacturer. This caused a 3-month delay in shipments to customers. We also experienced yield and test anomalies on a different product manufactured by another subcontractor that could have interrupted our customer shipments. In this case, the manufacturer was able to correct the problem in a timely manner and customer shipments were not affected. The delay and expense associated with qualifying a new supplier or foundry and commencing volume

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	•	Adapting our product design, if necessary, to the new manufacturer’s process;
	•	Creating a new mask set to manufacture the product;
	•	Having the new manufacturer prepare sample products so we can verify the product specification; and
	•	Providing sample products to customers for qualification.

      In general, it takes from 3 to 6 months for a new manufacturer to begin full-scale production of one of our products. We could have similar or more protracted problems in the future with existing or new suppliers.

      Both Toshiba Corporation and Motorola, Inc. manufacture products for us in plants located in Asia. To date, the financial and stock market dislocations that have occurred in the Asian financial markets in the past have not harmed our business. However, present or future dislocations or other international business risks, such as currency exchange fluctuations or recessions, could force us to seek new suppliers. We must place orders approximately 20 to 23 weeks in advance of expected delivery. This limits our ability to react to fluctuations in demand for our products, and could cause us to have an excess or a shortage of inventory of a particular product. In addition, if global semiconductor manufacturing capacity fails to increase in line with demand, foundries could allocate available capacity to larger customers or customers with long-term supply contracts. If we cannot obtain adequate foundry capacity at acceptable prices, or our supply is interrupted or delayed, our product revenues could decrease or our cost of revenues could increase. This could harm our business, financial condition and results of operations.

      We regularly consider using smaller semiconductor dimensions for each of our products in order to reduce costs. We have begun to decrease the dimensions in our new product designs, and believe that we must do so to remain competitive. We may have difficulty decreasing the dimensions of our products. In the future, we may change our supply arrangements to assume more product manufacturing responsibilities. We may subcontract for wafer manufacturing, assembly and test rather than purchase finished products. However, there are additional risks associated with manufacturing, including variances in production yields, the ability to obtain adequate test and assembly capacity at reasonable cost and other general risks associated with the manufacture of semiconductors. We may also enter into volume purchase agreements that would require us to commit to minimum levels of purchases and which may require up-front investments. If we fail to effectively assume greater manufacturing responsibilities or manage volume purchase arrangements, our business, financial condition and results of operations will suffer.

     Network And Storage Equipment Prices Typically Decrease.

      Average selling prices in the networking, storage and semiconductor industries have rapidly declined due to many factors, including:

	•	Rapidly changing technologies;
	•	Price-performance enhancements; and
	•	Product obsolescence.

      The decline in the average selling prices of our products may cause substantial fluctuations in our operating results. We anticipate that the average selling prices of our products will decrease in the future due to product introductions by our competitors, price pressures from significant customers and other factors. Therefore, we must continue to develop and introduce new products that incorporate features which we can sell at higher prices. If we fail to do so, our revenues and gross margins could decline, which would harm our business, financial condition and results of operations.

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      Complex products such as ours frequently contain errors, defects and bugs when first introduced or as new versions are released. We have discovered such errors, defects and bugs in the past. Delivery of products with production defects or reliability, quality or compatibility problems could hinder market acceptance of our products. This could damage our reputation and harm our ability to attract and retain customers. Errors, defects or bugs could also cause interruptions, delays or a cessation of sales to our customers. We would have to expend significant capital and resources to remedy these problems. Errors, defects or bugs could be discovered in our new products after we begin commercial production of them, despite testing by us and our suppliers and customers. This could result in additional development costs, loss of, or delays in, market acceptance, diversion of technical and other resources from our other development efforts, claims by our customers or others against us or the loss of credibility with our current and prospective customers. Any such event would harm our business, financial condition and results of operations.

      We generally make our sales under individual purchase orders that may be canceled or deferred by customers on short notice without significant penalty, if any. Cancellation or deferral of product orders could cause us to hold excess inventory, which could harm our profit margins and restrict our ability to fund our operations. We recognize revenue upon shipment of products to our customers, net of an allowance for estimated returns. An unanticipated level of returns could harm our business, financial condition and results of operations.

      Our operations are vulnerable to interruption by fire, earthquake, power loss, telecommunications failure, acts of terrorism and other events beyond our control. Our facilities and the facilities of our subcontractors in the State of California have in the past and may again in the future be subject to electrical black outs as a consequence of a shortage of available electrical power. In the event these blackouts resume or increase in severity, they could disrupt the operation of our facilities and the affected facilities of our subcontractors and such disruptions could have an adverse effect on our results of operations.

      Our success greatly depends on the continued contributions of our key management and other personnel, many of whom would be difficult to replace. We do not have employment contracts with any of our key personnel, nor do we maintain any key man life insurance on any of our personnel. Several members of our management team have joined us in the last 12 months. It may be difficult for us to integrate new members of our management team. We must also attract and retain experienced and highly skilled engineering, sales and marketing and managerial personnel. Competition for such personnel is intense in the geographic areas and market segments in which we compete, and we may not be successful in hiring and retaining such people. If we lose the services of any key personnel, or cannot attract or retain qualified personnel, particularly engineers, our business, financial condition and results of operations could suffer. In addition, companies in technology industries whose employees accept positions with competitors have in the past claimed that their competitors have engaged in unfair competition or hiring practices. We could receive such claims in the future as we seek to hire qualified personnel. These claims could result in material litigation. We could incur substantial costs in defending against any such claims, regardless of their merits.

      We have experienced a period of rapid growth and expansion which has placed, and continues to place, a significant strain on our resources. To accommodate this growth, in fiscal 2000, we implemented a variety of new and upgraded operational and financial systems, procedures and controls, including the improvement of the retained accounting and other internal management systems which were provided by Stac. This required and may continue to require substantial management effort, and our efforts to do so may not continue to be

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      The encryption algorithms embedded in our products are a key element of our packet processor architecture. These products are subject to U.S. Department of Commerce export control restrictions. Our network equipment customers may only export products incorporating encryption technology if they obtain a one-time technical review. These U.S. export laws also prohibit the export of encryption products to a number of countries deemed by the U.S. to be hostile. Many foreign countries also restrict exports to many of these countries deemed to be “terrorist-supporting” states by the U.S. government. Because the restrictions on exports of encryption products have been liberalized, we, along with our network equipment customers have an opportunity to effectively compete with our foreign competitors. The existence of these restrictions until recently may have enabled foreign competitors facing less stringent controls on their products to become more established and, therefore, more competitive in the global market than our network equipment customers. In addition, the list of products and countries for which export approval is required, and the regulatory policies with respect thereto, could be revised, and laws limiting the domestic use of encryption could be enacted. While the U.S. government now allows U.S. companies to assume that exports to non-government end-users will be approved within 30 days of official registration with the Department of Commerce, the sale of our packet processors could be harmed by the failure of our network equipment customers to obtain the required approvals or by the costs of compliance.

      We sell most of our products to customers in the United States. If our international sales increase, particularly in light of decreased export restrictions, we may encounter risks inherent in international operations. All of our international sales to date are denominated in U.S. dollars. As a result, if the value of the U.S. dollar increases relative to foreign currencies, our products could become less competitive in international markets. We also obtain some of our manufacturing, assembly and test services from suppliers located outside the United States. International business activities could be limited or disrupted by any of the following:

	•	The imposition of governmental controls;
	•	Export license/technical review requirements;
	•	Restrictions on the export of technology;
	•	Currency exchange fluctuations;
	•	Political instability;
	•	Financial and stock market dislocations;
	•	Military and related activities;
	•	Trade restrictions; and
	•	Changes in tariffs.

      Demand for our products also could be harmed by seasonality of international sales and economic conditions in our primary overseas markets. These international factors could harm future sales of our products to international customers and our business, financial condition and results of operations in general.

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      We continually evaluate strategic acquisitions of businesses and technologies that would complement our product offerings or enhance our market coverage or technological capabilities. While we are not currently negotiating any acquisitions, we may make additional acquisitions in the future. Future acquisitions could be effected without stockholder approval, and could cause us to dilute shareholder equity, incur debt and contingent liabilities and amortize acquisition expenses related to goodwill and other intangible assets, any of which could harm our operating results and/or the price of our Common Stock. Acquisitions entail numerous risks, including:

	•	Difficulties in assimilating acquired operations, technologies and products, in particular, if we fail to successfully integrate the acquisition of Apptitude, the anticipated benefits of this transaction will not occur;
	•	Diversion of management’s attention from other business concerns;
	•	Risks of entering markets in which we have little or no prior experience; and
	•	Loss of key employees of acquired organizations.

      We may not be able to successfully integrate businesses, products, technologies or personnel that we acquire. If we fail to do so, our business, financial condition and results of operations could suffer.

      The semiconductor industry has experienced significant downturns and wide fluctuations in supply and demand. The industry has also experienced significant fluctuations in anticipation of changes in general economic conditions. This has caused significant variances in product demand, production capacity and rapid erosion of average selling prices. Industry-wide fluctuations in the future could harm our business, financial condition and results of operations.

      The market price of our Common Stock has fluctuated in the past and is likely to fluctuate in the future. In addition, the securities markets have experienced significant price and volume fluctuations and the market prices of the securities of technology-related companies including networking, storage and semiconductor companies have been especially volatile. Such fluctuations can result from:

	•	Quarterly variations in operating results;
	•	Announcements of new products by us or our competitors;
	•	The gain or loss of significant customers;
	•	Changes in analysts’ estimates;
	•	Short-selling of our Common Stock; and
	•	Events affecting other companies that investors deem to be comparable to us.

      In October and November 1999, six purported class action complaints were filed in the United States District Court for the Northern District of California against Hifn and certain of its officers and directors. These complaints were consolidated into In re Hi/fn Sec. Litig., No. 99-04531 SI. The consolidated complaint was filed on behalf of a class of purchasers of Hifn’s stock during the period July 26, 1999 through October 7, 1999 (the “class period”). The complaint seeks unspecified money damages and alleges that Hifn and certain of its officers and directors violated federal securities laws in connection with various public statements made by Hifn and certain of its officers and directors during the class period. In August 2000, the Court dismissed the complaint as to all defendants, other than Raymond J. Farnham and Hifn. Mr. Farnham

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      In December 2000, a former employee of Hifn filed suit against Hifn and one of its former employees alleging wrongful termination, invasion of privacy, violation of Fair Employment and Housing Act, based on sexual harassment, sexual discrimination and retaliation, defamation, breach of the covenant of good faith and fair dealing, negligence and conversion. On April 16, 2001, we filed an answer to the complaint, generally denying its allegations and asserting various affirmative defenses. Discovery has recently commenced, and no trial date has been set. The parties have voluntarily agreed to participate in a mediation session in an effort to amicably resolve the matter. In the event the matter is not amicably resolved, we intend to defend the matter vigorously. While the ultimate outcome of this matter cannot be determined at this time, management does not believe that this matter will have a material adverse effect on our financial position.

Recent Accounting Pronouncements

      In June 2001, the FASB issued SFAS No. 141, “Business Combinations” (“SFAS 141”) and SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). SFAS 141 will apply to all business combinations that we enter into after June 30, 2001, and eliminates the pooling-of-interests method of accounting. SFAS 142 is effective for fiscal years beginning after December 15, 2001. Under the new Statements, goodwill and intangible assets deemed to have indefinite lives will no longer be amortized but will be subject to annual impairment tests in accordance with the Statements. Other intangible assets will continue to be amortized over their useful lives. In addition, the Statements include provisions upon adoption for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the testing for impairment of existing goodwill and other intangibles. We are required to adopt these Statements for accounting for goodwill and other intangible assets beginning October 1, 2002 at which time the Company will cease amortization of goodwill. Goodwill amortization expense aggregated $9.4 million and $1.3 million in fiscal 2001 and 2000, respectively. As of September 30, 2001, we have not determined the effect the adoption of these Statements and we intend to continue to perform an impairment analysis of the remaining goodwill through the end of fiscal year 2002. Upon adoption on October 1, 2002, we will perform the required impairment tests of goodwill and has not yet determined the effect of these tests on our earnings and financial position.

      In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”). SFAS 144 supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,” and provides further guidance regarding the accounting and disclosure of long-lived assets. We are required to adopt SFAS 144 effective October 1, 2002, and have not yet determined the impact, if any, of adoption.

      We do not use derivative financial instruments in our investment portfolio. Our investment portfolio is generally comprised of commercial paper and municipal bonds. We place investments in instruments that meet high credit quality standards. These securities are subject to interest rate risk, and could decline in value if interest rates fluctuate. Due to the short duration and conservative nature of our investment portfolio, we do not expect any material loss with respect to our investment portfolio. A 10% move in interest rates as of September 30, 2001 would have an immaterial effect on our pre-tax earnings and the carrying value of our investments over the next fiscal year.

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      All of our sales, cost of manufacturing and marketing are transacted in U.S. dollars. Accordingly, our results of operations are not subject to foreign exchange rate fluctuations. Gains and losses from such fluctuations have not been incurred by us to date.

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Item 8.     Financial Statements and Supplementary Data

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

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REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of hi/fn, inc.

      In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of hi/fn, inc. and its subsidiary at September 30, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2001 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, 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 our opinion.

PRICEWATERHOUSECOOPERS LLP

San Jose, California

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HIFN, INC.

The accompanying notes are an integral part of these consolidated financial statements.

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HIFN, INC.

The accompanying notes are an integral part of these consolidated financial statements.

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HIFN, INC.