JNI CORP - 10-K Annual Report

FOR ANNUAL AND TRANSITIONAL REPORTS
PURSUANT TO SECTIONS 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

Delaware (State or Other Jurisdiction of Incorporation or Organization)		33-0740004 (I.R.S. Employer Identification No.)
10945 Vista Sorrento Parkway San Diego, California (Address of Principal Executive Offices)		92130 (Zip Code)

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value
(Title of Class)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

Indicate by check mark if disclosure of delinquent filer 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.

As of February 28, 2002, the aggregate market value of the registrant's voting stock held by non-affiliates of the registrant was approximately $187,666,873 based on the closing price of the Company's Common Stock on the Nasdaq National Market on February 28, 2002 of $7.06 per share.

As of February 28, 2002, 26,581,710 shares of registrant's Common Stock, $0.001 par value, were outstanding.

Portions of the Company's definitive Proxy Statement to be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year are incorporated by reference into Part III of this report

We are a leading designer and supplier of enterprise storage connectivity products, including Fibre Channel and InfiniBand products that connect servers and data storage devices. We currently design, market and sell a broad range of Fibre Channel host bus adapters that connect servers to storage subsystems to facilitate the integration and management of devices used in storage area networks, or SANs. We also design, market and sell high-performance application specific integrated circuits, or ASICs, based on our proprietary Fibre Channel technology. Building on our experience of designing products for the most demanding enterprise-level systems, we have launched a major product development and strategic initiative based on the emerging InfiniBand Architecture connectivity standard. We recently released our first InfiniBand products, our InfiniStar host channel adapter modules, or HCA modules, that allow stand-alone servers to cluster with InfiniBand connectivity operating at 2.5 gigabit per second (Gb) or 10 Gb per port. We are currently developing or designing products that will bridge InfiniBand to other storage protocols, such as Fibre Channel and iSCSI.

Our Fibre Channel products operate with most major server operating systems and network configurations used in SANs, and our InfiniBand products are designed to operate with Windows 2000, Linux and Solaris. Our Fibre Channel host bus adapters incorporate our proprietary ASIC technology and can be used both with Unix-based and PC-based server platforms and their associated interfaces. Our software drivers significantly reduce the need for a variety of adapters in heterogeneous environments and ensure interoperability between different sets of platforms and servers.

We have leveraged our success in the market for SAN connectivity products in high-end Sun Solaris operating environments to build a reputation for quality that has enabled us to obtain certifications from leading storage original equipment manufacturers, or OEMs, including Amdahl, Chaparral, Compaq StorageWorks, EMC, Hewlett-Packard, Hitachi Data Systems, IBM, LSI Storage-Metastor, McDATA, StorageTek and Sun Microsystems. We also maintain strategic relationships with SAN and InfiniBand industry leaders, including Brocade, EDS, InfiniSwitch, Mellanox Technologies, Lane15, Nishan Systems and VERITAS Software.

The volume of business-critical data generated, processed, stored and manipulated has grown dramatically over the last decade, and managing the increase in data is one of the most important challenges for organizations. Traditionally, enterprises accessed stored networked data using a server-centric architecture known as direct attached storage. In this architecture, a single server controls access to each storage device, and stored data is only available to applications running on the server directly connected to the storage device. For enterprises that rely on large networks, this creates a bottleneck that can degrade network performance, drain server processing power, complicate network management and increase costs. To address these issues, large enterprises in recent years have deployed emerging storage network architectures, including SANs, to access, share and manage data storage. The rapid adoption of SANs was made possible by the emergence of the Fibre Channel interconnect protocol.

Fibre Channel is a computer communications protocol designed to meet the many requirements related to the increasing demand for high performance information transfer. As a result of its broad range of features, many industry analysts consider Fibre Channel to be the most reliable and scalable gigabit communications technology available today for high speed transmissions of blocks of data.

Because Fibre Channel technology is so effective in handling data block transmissions, it can be implemented in a wide variety of applications, including enterprise resource planning, digital video transmission and editing and data warehousing. To date, Fibre Channel technology has been most widely accepted and deployed in SANs.

A SAN is a dedicated network of interconnected servers and data storage devices enabling data sharing at gigabit speeds. The overall SAN market is expected to grow from $6.6 billion in 2001 to $13.8 billion by 2005, a 20% CAGR, according to an International Data Corporation study published December 2001. SANs provide an open, scalable platform for storage access in data intensive environments. The SAN environment complements the ongoing advancements in local area network technologies by extending the benefits of improved performance and capabilities from the client local area network to servers and storage.

Today, enterprises deploying large networks and managing dramatically increasing volumes of networked stored data are beginning to face costly bottlenecks created by the limitations of the standard server bus architecture, peripheral component interconnect, or PCI. The bus serves as the interface between the central processing unit and the connected peripheral devices. The PCI bus was introduced in 1992 and has seen only one major upgrade since introduction. In the same time, processing speeds and network bandwidths have increased dramatically. As a result, the PCI bus limits a processor's ability to push and retrieve data to external devices quickly. Similarly, the PCI bus limits the ability of the processor to connect to multiple remote devices because all peripherals must be plugged into the same bus and share a single communication path to memory and the processor. Thus, only one device can communicate at a time, which limits access to the processor.

To address these issues, many leading computer and technology manufacturers collaborated to form an open standard to connect servers with remote storage, networking devices and other servers, as well as for use inside servers for interprocessor communications. The result of this collaboration is the InfiniBand Architecture that was released in 2000. Leading server and operating system companies, including Compaq, Dell, Hewlett-Packard, IBM Intel, Microsoft and Sun Microsystems, have announced public support for InfiniBand. Based on this broad industry support among the leading server vendors, IDC estimates that there will be 1.86 million InfiniBand ports in servers shipped in 2004, increasing to 7.69 million ports in 2005.

InfiniBand is an open, serial technology capable of being implemented across either optical fiber or copper cabling. It offers bandwidths substantially greater than the standard PCI bus as well as improved flexibility and scalability. InfiniBand is a point-to-point architecture in which each communication link extends between only two devices which have full and exclusive access to the communication path. In addition, it is a switched fabric architecture in which a communication path can be extended through the network using switches that increase bandwidth and reliability by creating multiple paths between devices.

In the same way that Fibre Channel enabled the removal of storage from the server and the creation of storage area networks, InfiniBand has the potential to separate the server's central processing unit from the PCI bus to create server area networks. InfiniBand connectivity devices can currently allow processors to communicate at speeds of up to 10 Gb with other processors, remote storage and network devices without using the PCI bus. InfiniBand provides for the scalable expansion of processing independent of storage connectivity through a lower cost processing unit with improved density and reduced latency. The powerful combination of InfiniBand-based server environments with today's high performance storage area networks can enable new levels of scalability, performance, flexibility, reliability and manageability in the data center. Thus, InfiniBand is complementary to Fibre Channel and provides a significant opportunity to companies with Fibre Channel expertise to penetrate

a new and rapidly growing market by developing products designed to enable InfiniBand-based server area networking and to bridge those clustered servers to Fibre Channel SANs.

Our products include a suite of Fibre Channel host bus adapters, InfiniBand connectivity modules and proprietary Fibre Channel ASICs. We are one of only two major independent manufacturers that derive the majority of revenue from Fibre Channel host bus adapters.

We design, manufacture and sell a suite of Fibre Channel host bus adapters, management software and related device driver software. A host bus adapter is an electronic circuit card that fits standard sockets on motherboards for servers, workstations, disk arrays and other SAN devices and enables high-speed data transfer within the SAN. Communication between the host bus adapter and the operating system is regulated by device driver software that is included with the host bus adapter. The device driver software also provides a high-reliability data path from a user's application to a storage device across a SAN. Working in conjunction with our device driver software, our host bus adapters work with all SAN topologies, interoperate with all major operating systems and can be used with the PCI, PCI-X, cPCI and SBus interfaces. Our host bus adapters are widely deployed in demanding SAN environments by Global 1000 enterprises.

We offer Fibre Channel host bus adapters at a variety of price, performance and feature sets. Our line of Fibre Channel host bus adapters includes FibreStar PCI-to-Fibre Channel products, FibreStar CompactPCI-to-Fibre Channel products, FibreStar SBus-to-Fibre Channel products and Zentai PCI-to-Fibre Channel products. Our FibreStar products incorporate our proprietary Emerald ASICs. The FibreStar line of products is designed with high performance, cut-through architecture, low CPU utilization, a highly efficient physical layer design and a modular software structure. Our PC Server DriverSuite is a single, integrated software driver platform that enables our FibreStar host bus adapters to operate under all major PC server operating systems, including Microsoft Windows NT and Windows 2000. The Unix DriverSuite complements the PC Server DriverSuite and is designed to allow FibreStar host bus adapters to operate under nearly all Unix server operating systems, including Sun Microsystems Solaris, Red Hat Linux, Hewlett-Packard HP-UX and IBM AIX. We also offer our EZ Fibre management software with our host bus adapters to simplify the installation and configuration of host bus adapters in SANs and to provide diagnostic and monitoring information to SAN administrators.

FibreStar PCI-to-Fibre Channel Host Bus Adapters. Our FibreStar PCI-to-Fibre Channel host bus adapters include single and dual port products that operate at 1 Gb or 2 Gb. The dual port products are designed to enable simultaneous high-speed data transfers between multiple Fibre Channel links and a single PCI-based server. Dual port capability allows a single card to function as two separate single-channel host bus adapters, while taking up only one physical PCI slot. This provides for maximum connectivity on a single system. The 2 Gb products feature "on-demand" 1 Gb or 2 Gb auto rate negotiation that enables them to operate in 1 Gb or 2 Gb storage networks, or networks with a mix of 1 Gb and 2 Gb devices. Automatic topology detection simplifies configuration for switched fabric, arbitrated loop or point-to-point environments. All of these products feature hardware-assisted context switching, which maximizes SAN data throughput and minimizes host CPU utilization, thereby increasing overall SAN performance. We plan to support most major operating systems with the 2 Gb PCI-to-Fibre Channel host bus adapters. Hitachi Data Systems has certified our 2 Gb Ready FibreStar PCI-to-Fibre Channel host bus adapters for use in the Hitachi Freedom Storage Lightning 9900, the first high-end storage system to introduce 2 Gb Fibre Channel speeds, and Brocade has certified these products for use in multi-vendor Brocade-based SAN environments.

FibreStar PCI-X-to-Fibre Channel Host Bus Adapter. Our first FibreStar PCI-X-to-Fibre Channel host bus adapter, announced in November 2001, is a dual port product that operates at 1 Gb or 2 Gb. It offers the same functions and features as the FibreStar 2 Gb dual-port PCI-to-Fibre Channel HBAs, except that it can run on a new version of the PCI protocol called PCI-X. This protocol operates at either 100 MHz or 133 MHz, which is faster than the PCI limitation of 66 MHz. The higher bus speed enables up to 1.024 GB throughput at 133 MHz, versus 528 MB throughput of the PCI bus. Our PCI-X host bus adapter is a native-mode implementation of PCI-X, meaning that other speed-enhancing features of the PCI-X protocol can be implemented. Some competing products use a bridge chip to achieve these speeds, which reduces the overall performance at full PCI-X speeds. Another feature of the PCI-X-to-Fibre Channel host bus adapter is that it is backward compatible with the PCI slot. Since servers today are just beginning to ship with the PCI-X slot, we expect this product will be used in both PCI and PCI-X slots during 2002 and 2003. We plan to support most major operating systems with the 2 Gb PCI-X-to-Fibre Channel host bus adapters, which are currently in qualifications at a number of vendors.

FibreStar CompactPCI Host Bus Adapters. Our FibreStar CompactPCI-to-Fibre Channel products were the first full-featured, switched fabric 2 Gb Fibre Channel cPCI host bus adapters to ship in volume for the Solaris market. These products are well-matched for Sun Microsystems' new line of UltraSPARC III-based Sun Fire 3800 Midframe servers. These host bus adapters are available in both single port and dual-port/dual independent channel configurations and offer high performance and enterprise reliability while delivering a peak performance throughput of 400 MB (full-duplex) per port and a sustained throughput of ~200 MB per port. Each port can be configured as a separate host bus adapter, which enables a single card to be used for both primary and redundant backup.

FibreStar SBus-to-Fibre Channel Host Bus Adapters. Our FibreStar SBus-to-Fibre Channel host bus adapters deliver reliable 64-bit, full-duplex Fibre Channel connections between a Sun server and networked storage on a SAN. Our SBus offering includes single and dual port products operating at both 1 Gb and 2 Gb speeds. All of the 1 Gb SBus host bus adapters and our dual port 2 Gb product are certified "Solaris Ready" by Sun Microsystems and are certified by EMC as "E-Lab Tested" for use with all Symmetrix storage arrays. Hitachi Data Systems has certified our 2 Gb Ready FibreStar SBus-to-Fibre Channel host bus adapters for use in the Hitachi Freedom Storage Lightning 9900.

Zentai PCI-to-Fibre Channel Host Bus Adapters. The Zentai utilizes Path Command Plus software to ensure continuous availability and load balancing across multiple Zentai host bus adapters for Fibre Channel communication in a SAN. Path Command Plus enables multiple independent paths from a server to a storage device to automatically recover from a path or equipment failure in the SAN. The Path Command Plus software currently running on the Zentai products is certified by a number of major SAN vendors in Windows environments, including Hitachi Data Systems 9900 storage solutions environments, Microsoft Windows 2000 certifications for single user, multi-user and clustered server environments, Brocade Fabric Aware programs for its switches and Veritas software.

HCA Modules. We recently introduced our InfiniStar line of InfiniBand 1x and 4x HCA Modules. A host channel adapter (HCA) is an interface that resides within a server and communicates directly with the server's memory and processor as well as with the InfiniBand network fabric. When placed on a printed circuit board card similar to a host bus adapter, it is referred to as an HCA module under the naming guidelines set forth by the InfiniBand Architecture specification. An HCA module guarantees delivery of data, performs advance memory access and can recover from transmission errors. Our initial products are the IBP-1x02 and the IBP-4x02. Our InfiniStar products combine Mellanox Technologies' InfiniBridge 10 Gb silicon with our driver software technology. The dual-port IBP-4x02 achieves 10 Gb data link speeds in each direction for each 4x port. In full duplex mode, the result is a

total of 40 Gb speed per InfiniStar HCA module. The InfiniStar IBP-4x02 is the first high performance 10 Gb InfiniBand HCA module to be delivered to market. The associated dual-port IBP-1x02 offers 2.5 Gb speed in each direction for each 1x port. In full duplex mode it offers 10 Gb speed per HCA module. The total maximum potential data throughput for the IBP-1x02 is 1.25 GB of data per second, at 312 MB in each direction over each port (312 MB × 2 directions × 2 ports). This performance potential is quadrupled for the IBP-4x02 to nearly 5 GB in full duplex mode, although sustained throughput is limited by the PCI bus. These data throughput rates enable simultaneous SAN communication and cluster server-to-server traffic.

InfiniBand-to-Fibre Channel bridging products. We are currently developing or designing products that will bridge InfiniBand to other storage protocols, such as Fibre Channel and iSCSI. Bridging products enable the InfiniBand network to connect to storage devices and storage networks running Fibre Channel or iSCSI. Such products will be necessary to connect a collection of servers in the server area network to the SAN.

All of our Fibre Channel host bus adapters incorporate our proprietary Emerald Fibre Channel controller ASICs. We also sell the Emerald ASICs separately to OEMs for products such as SAN controllers for disk arrays, tape libraries, switches and other SAN devices. Our Emerald ASICs were the first Fibre Channel controllers to operate at a 2 Gb rate. They incorporate an efficient, proprietary data flow architecture and a high performance embedded processor that enables a highly integrated Fibre Channel subsystem design that delivers full Fibre Channel bandwidth. The Emerald ASICs combine full-duplex Fibre Channel data transfers to provide high-speed input/output performance for high-end storage systems used in SAN environments. They are designed for low central processor unit utilization that can enhance performance in high-end servers and external Fibre Channel RAID storage applications. Our most recent release of the Emerald products, our Emerald IV-x, is our fifth generation chip. It provides two fully independent, high performance Fibre Channel ports for high bandwidth paths to a SAN. It can sustain an 800 MB input/output, which we believe is the highest in its class. Furthermore, it can burst to the host system at full PCI-X speed of 1.064 GB. The Emerald IV-x is designed to be an ideal candidate for high-end servers and high-performance embedded storage applications.

We intend to continue working closely with leaders in the storage, networking and computing industries to develop new and enhanced SAN and InfiniBand connectivity products. We believe that establishing strategic relationships with technology partners is essential to ensure that we continue to develop competitive products that integrate well with solutions from other leading participants in the SAN and InfiniBand markets. Our recent strategic transaction with Troika Networks, in which we licensed the exclusive rights to Troika's Fibre Channel software and hardware products that provide high availability SAN solutions for enterprise class servers running under Windows NT, Windows 2000 and Solaris operating systems, is an example of this strategy.

We have created the JNI SAN partners program, helping us form strategic relationships and industry alliances with leading technology companies. In addition to many of our OEMs, members of our SAN partners program include Brocade, Crossroads Systems, Inc., Legato Systems, Inc., Nishan Systems and VERITAS Software Corporation.

We believe that strategic relationships will enable us to leverage our technical and market strengths to facilitate our early entry into the InfiniBand market. We have established relationships with early leaders in the InfiniBand market including Mellanox Technologies, a developer of semiconductor technologies for InfiniBand, InfiniSwitch, an InfiniBand switch designer and IBM, which is developing a

number of InfiniBand products. We believe that the emerging InfiniBand industry will present numerous opportunities to employ an acquisition or partnering strategy with key software and hardware companies.

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 and to participate in the development of industry standards. Our research and development expenses in the year ended December 31, 2001 were $24.6 million compared to $18.9 million in the year ended December 31, 2000. As of December 31, 2001, we had 103 employees in our research and development department.

We have made a significant investment in our ASIC technologies through research and development. We intend to focus our development efforts on Fibre Channel ASICs, host bus adapters and related software drivers and tools and on InfiniBand technologies and products. Before a new product is developed, our research and development engineers work with marketing managers and customers to develop a comprehensive requirements specification. After the product is designed and commercially released, our engineers continue to work with customers on early design-in efforts to understand requirements for future generations and upgrades.

At our principal offices in San Diego, we have established the JNI system integration lab, or SIL, to provide comprehensive functional and system level integration/interoperability testing between our connectivity products and various computer platforms and network environments. To facilitate expanded market penetration of our products and technology, our integration test methodologies and software are continually evolving to replicate qualification processes used by major SAN suppliers and OEMs. We conduct functionality testing at our SIL in formal, repeatable processes using documented product specifications and features to verify the operation of both our hardware and our software. The overall goal is to ensure enterprise class performance and interoperability in real world deployments.

We sell domestically and internationally to OEMs, distribution channel customers, which include distributors, system integrators and value-added resellers, and directly to end-users. We principally target OEMs and value added resellers who resell our products as a part of complete SAN solutions to end-users. Our selling and marketing strategy will continue to focus on the development of the SAN connectivity market. We have continued expanding internationally by partnering with additional OEMs and resellers who have a strong international presence and are capable of selling and installing complex SAN solutions. Our marketing efforts are focused on increasing awareness of our Fibre Channel and InfiniBand products and our JNI brand, promoting SAN-based solutions, and advocating industry-wide standards and interoperability.

As of December 31, 2001, our selling and marketing organization consisted of 51 employees, including field sales representatives, applications engineers, customer service personnel, product marketing, product management, marketing communications and inside sales personnel. Our field sales personnel are located in San Diego and Fremont, California, Denver, Colorado, Atlanta, Georgia, Chicago, Illinois, Newark, New Jersey, New York, New York, Raleigh, North Carolina, London, England, Brussels, Belgium, Munich, Germany and Singapore.

We offer a wide range of standard support programs that includes telephone support 24 hours a day, seven days a week. In addition, we have designed our products to allow easy diagnosis of problems

and easy system administration. Our customer service and support organization provides technical support to our OEM and systems integrator customers, enabling them to provide technical support to their end-users. We prepare our OEMs and systems integrator customers for product launch through a comprehensive training program. In addition, we employ systems engineers for pre- and post-sales support and technical support engineers and field applications engineers for field support. Our OEM and systems integrator customers provide primary technical support to end-users of our products. We have developed an extensive training course for our OEM and distribution channel customers. The curriculum includes Fibre Channel configuration, SAN implementation and JNI product training. Most of our OEM and channel customers attend our training courses to learn Fibre Channel configuration and SAN reliability design.

We outsource the majority of our manufacturing, and we conduct quality assurance, manufacturing engineering, documentation control and certain finish assembly operations at our headquarters facility in San Diego, California. This approach enables us to reduce fixed costs and to provide flexibility in meeting market demands. All of our contract manufacturers are ISO 9002 certified. We are planning to achieve 9000-2000 certification in 2003.

Taiwan Semiconductor Manufacturing Company fabricates our Emerald ASIC wafers in Asia. Various subcontractors, such as Amkor Technology, Caesar International Inc. and Siliconware USA Inc., perform assembly, packaging and testing of our ASICs, allowing us to purchase and receive only finished product. Sanmina-SCI Corporation in Rapid City, South Dakota, and SMS in San Diego, California perform substantially all assembly operations for our adapter products. We anticipate that a third contract manufacture, FinePitch Systems, Inc., will begin performing services for us in the second quarter of 2002. Our contract manufacturers purchase the components of our products, including printed circuit boards, third party ASICs and memory integrated circuits, and assemble them to our specifications. The contract manufacturers deliver the assembled products to us, and we perform certain finish assembly procedures before testing and packaging the final products with software and manuals in our San Diego facility.

We believe most component parts used in our Fibre Channel host bus adapters are standard off-the-shelf items, which are, or can be, purchased from two or more sources. Similarly, most of the components in our host channel adapter modules, other than our proprietary ASICs and the integrated circuits supplied by Mellanox Technologies, are readily available from multiple sources. We select suppliers on the basis of functionality, manufacturing capacity, quality and cost. Whenever possible and practicable, we strive to have at least two manufacturing locations for each product. Nevertheless, our reliance on third-party manufacturers involves risks, including possible limitations on availability of products due to market abnormalities, unavailability of, or delays in obtaining access to, certain product technologies and the absence of complete control over delivery schedules, manufacturing yields, and total production costs. The inability of our suppliers to deliver products of acceptable quality and in a timely manner or our inability to procure adequate supplies of our products could have a material adverse effect on our business, financial condition or operating results.

The markets in which we compete are intensely competitive and characterized by frequent new product introductions, changing customer preferences and evolving technology and industry standards. Our competitors continue to introduce products with improved functionality, quality and performance characteristics, and we will have to do the same to remain competitive. Increased competition could result in significant price competition, reduced revenues, lower profit margins or loss of market share, any of which would have a material adverse effect on our business, operating results and financial condition.

Our principal competitors in the Fibre Channel host bus adapter market are Emulex, QLogic and Agilent. We face competition for our ASICs from Agilent and QLogic. Our products may also compete at the end-user level with other technology alternatives that are available from companies such as Adaptec, LSI Logic and QLogic as well as a number of smaller companies. Some of our OEM customers could develop products internally that would replace our products. The resulting reduction in sales of our products to any such OEM customers, in addition to the increased competition presented by these customers, could have a material adverse effect on our business.

Because the market for InfiniBand products is in the early stages of development, there are few products available today. We expect that competition in this market will increase significantly. We also expect that a number of large technology companies, such as Intel and IBM, will enter this market with host channel adapter and other InfiniBand products. In addition, other companies, including QLogic, have announced their intention to enter the InfiniBand market with products competitive to our current and planned offering. A significant part of our InfiniBand strategy is to partner with other InfiniBand equipment vendors who will incorporate our products into theirs. If our potential partners design their own components to perform the functionality offered by our products, or if they select components offered by our competitors, we may not be able to achieve planned levels of market penetration. If we are not successful, for competitive or other reasons, in achieving market penetration with our InfiniBand products, we may not be able to recover the significant investment we intend to make in pursuing this market.

We believe that the principal bases of competition in both the Fibre Channel and InfiniBand markets presently include reliability, performance, time-to-market and price. We believe that other competitive factors include pricing and technical support. We believe that we compete favorably with respect to each of these factors. We also believe that we have a competitive strength in the alliances we have built with customers, particularly our close relationships with OEM customers. Some of our other competitive advantages include our early entry into Fibre Channel and InfiniBand technology, the synergistic relationship between Fibre Channel and InfiniBand, our workforce of highly experienced researchers and designers and our intellectual property.

The intellectual property rights we have in our technology, which generally consist of ASIC designs, product designs, software and know-how associated with our product portfolio, principally arise from exclusive licenses and our own internal development efforts. We attempt to protect our technology through a combination of copyrights, trade secret laws, trademarks and contractual obligations. There can be no assurance that our intellectual property protection measures will be sufficient to prevent misappropriation of our technology or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technology. In addition, the laws of many foreign countries do not protect our intellectual property rights to the same extent as the laws of the United States. Our failure to protect our proprietary information could have a material adverse effect on our business, financial condition or operating results. In order to avoid disclosure of key elements of our technology, we have not sought patent protection which may be available to us. The lack of patent protection may make it more difficult for us to prevent other parties from developing or using technology substantially similar to ours. Our software products are protected by copyright laws, and we have several common law trademarks.

We may need to initiate litigation in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. Litigation could result in substantial costs and diversion of our resources and could materially harm our business. We may receive in the future notice of infringement claims of other parties' proprietary rights. Infringement or other claims could be asserted or prosecuted against us in the future, and it is possible that such assertions or prosecutions could harm our business. Any such claims, with or without merit,

could be time-consuming, result in costly litigation and diversion of technical and management personnel, cause delays in the development and release of our products, or require us to develop non-infringing technology or enter into royalty or licensing arrangements. Such royalty or licensing arrangements, if required, may not be available on terms acceptable to us, or at all. For these reasons, infringement claims could materially harm our business.

At December 31, 2001, backlog for our products was approximately $2.8 million, substantially all of which is scheduled for delivery to customers during the quarter ending March 31, 2002, compared to backlog of approximately $8.3 million at December 31, 2000, substantially all of which was scheduled for delivery to customers during the quarter ended March 31, 2001. Typically, our OEM customers forecast expected purchases on a three to six month rolling basis, as compared to distributor customers which order as required with minimal order fulfillment time. All orders are subject to cancellation or delay by the customers with limited or no penalty. Therefore, our backlog is not necessarily indicative of actual sales for any succeeding period.

As of December 31, 2001, we had 219 employees, including 29 in administration, 51 in sales and marketing, 103 in engineering and 36 in operations. None of our employees are represented by a labor union. We have not experienced any work stoppages and consider our relations with our employees to be good.

A long lasting downturn in information technology spending could negatively affect our revenues and operating results.

Since late 2000, large enterprises throughout the global economy have significantly reduced their spending on information technology products, which has had a negative effect on our revenues and operating results. We cannot predict the depth or duration of this downturn in spending, and if it grows more severe or continues for a long period of time, our ability to increase or maintain our revenues and operating results may be impaired. In addition, because we intend to continue to make significant investments in research and development and to maintain our customer service and support capabilities, any resulting decline in our revenues will have a significant adverse impact on our operating results.

We may not be able to achieve and maintain profitability on a consistent basis.

You should consider the risks and difficulties frequently encountered by companies such as ours in new and rapidly evolving markets. We have failed to achieve profitability in each of the last three completed fiscal quarters. We may not realize sufficient net revenues in future periods to achieve and maintain profitability. In addition, because of the competition in and the evolving nature of the enterprise data connectivity markets, as well as the early stage of the InfiniBand market, achieving and sustaining profitability may be extremely challenging.

Our quarterly operating results are volatile and may cause our stock price to fluctuate.

Our future revenues and operating results are likely to vary significantly from quarter to quarter due to a number of factors, many of which are outside of our control. Accordingly, you should not rely on quarter-to-quarter comparisons of our operating results as an indication of future performance. It is possible that in some future periods our operating results will be below the expectations of public market analysts and investors. In this event, the price of our common stock will likely decline. Factors that may cause our revenues, gross margins and operating results to fluctuate include the following:

Because our revenues in a given quarter depend substantially on orders booked in that quarter, a decrease in the number of orders we receive is likely to adversely and disproportionately affect our quarterly operating results. This is because our expense levels are partially based on our expectations of future sales, and we may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall. As a result, our expenses may be disproportionately large as compared to sales in a quarter with reduced orders. Any shortfall in sales in relation to our quarterly expectations or any delay of customer orders would likely have an immediate and adverse impact on our quarterly operating results.

Because we depend on a small number of OEM and distribution channel customers for a significant portion of our revenues in each period, the loss of any of these customers, the failure to obtain certifications or any cancellation or delay of a large purchase by any of these customers could significantly reduce our net revenues.

Historically, a limited number of OEMs and distribution channel customers has accounted for a significant majority of our total net revenues. The loss of any of our key customers, or a significant reduction in sales to those customers, could significantly reduce our net revenues. In 2001, Info X, Inc. accounted for 18% of our net revenues and Acal Electronics accounted for 14% of our net revenues. A significant portion of the products sold to these distributors was utilized by our OEM customers. We anticipate that our operating results in any given period will continue to depend to a significant extent upon revenues from a small number of customers.

Before we can sell our products to an OEM, either directly or through its associated distribution channel, that OEM must certify our products. The certification process can take up to 12 months. This process requires the commitment of OEM personnel and test equipment, and we compete with other suppliers for these resources. Any delays in obtaining these certifications or any failure to obtain these certifications would adversely affect our ability to sell our products. In addition, because none of our customers is contractually obligated to purchase any fixed amount of products from us in the future, they may stop placing orders with us at any time, regardless of any forecast they may have previously provided. If any of our large customers stops or delays purchases, our revenues and profitability would be adversely affected, which could cause our stock price to decline. We cannot be certain that we will retain our current OEM or distribution channel customers or that we will be able to recruit additional or replacement customers. As is common in the technology industry, our agreements with OEMs and distribution channel customers typically are non-exclusive and often may be terminated by either party without cause. Moreover, many of our OEM and distribution channel customers utilize or carry competing product lines. If we were to suddenly lose one or more important OEM or distribution channel customers to a competitor, our business, operating results or financial condition could be materially adversely affected. Furthermore, some of our OEM customers could develop products internally that would replace our products. The resulting reduction in sales of our products to any such OEM customers, in addition to the increased competition presented by these customers, could have a material adverse effect on our business.

Because a significant portion of our products is designed to work with servers from Sun Microsystems, Inc., our business could suffer if demand for Sun servers does not increase or if we are unable to adapt quickly to changes in the market for such equipment.

Our host bus adapters have achieved their greatest market acceptance in computing environments built with high-end servers from Sun Microsystems due to our products' interoperability with the Sun Solaris operating system. Further, a significant portion of our products is currently used to connect

high-end Sun servers that incorporate SBus interfaces to SANs, and these products have accounted for the substantial majority of our historical revenues. Sun has experienced a material decrease in demand for its high-end servers during the current economic slowdown, which has adversely affected demand for our products. If the demand for Sun's high-end servers does not expand, our revenue growth may suffer. In addition, Sun has released new midrange and new high-end server products that do not include the SBus interface. Accordingly, even if demand for Sun servers increases, we will not experience a resulting increase in our revenue growth unless we are successful in marketing and selling host bus adapters that build on our Solaris expertise but that utilize our proprietary Emerald ASICs and the PCI, PCI-X and cPCI bus architectures. Because our SBus host bus adapters have a higher average selling price than our PCI host bus adapters, a rapid decline in SBus shipments could adversely affect our revenue levels even if we maintained our market share through increased shipments of other host bus adapters.

If we do not develop, market and sell host bus adapters that interoperate with operating systems other than the Sun Solaris operating system our business will suffer.

We have derived a substantial majority of our historical revenues from sales of host bus adapters that include software designed to work with the Sun Microsystems Solaris operating system. To increase our revenues and grow our business we must maintain our leading position in Solaris environments and build market share with our newer products that interoperate with other operating systems. These products have not obtained market penetration comparable to what we have achieved in the Solaris environment, and our ability to increase market share is subject to the risks inherent in the commercialization of new products. In particular, competition in the market for non-Solaris Fibre Channel host bus adapters is fierce. We may not be successful in marketing and selling the new products we develop, and we cannot assure you that our intended customers will purchase our products instead of competing products. Our failure to obtain a significant share of the market for host bus adapters compatible with operating systems other than the Solaris operating system would impair our growth and harm our operating results.

Because a significant portion of our host bus adapters is designed for integration with storage devices manufactured by Hitachi Data Systems, EMC and Storagetek, our future revenue growth depends on our ability to obtain OEM certifications for the new and existing products of these manufacturers and on the increased demand for such products.

We believe that the majority of our host bus adapters are used to form connections to storage arrays manufactured by Hitachi Data Systems, EMC or Storagetek. To a material extent, our future revenue growth depends upon the continued acceptance of and increased demand for the storage products offered by these vendors. To maintain and expand our position with these vendors, we must continue to provide high quality, early-to-market, high performance host bus adapters at competitive prices. Even if we are able to meet the demands of these vendors, it is possible that they will develop or acquire products or technologies that make our products uncompetitive. Further, these vendors may form alliances with other industry participants or competitive suppliers of host bus adapters that could adversely impact the demand for our products. In addition, if we are unable to timely obtain OEM certifications for new storage products offered by these vendors, they could make arrangements with competing host bus adapter manufacturers that would make our products less competitive for both existing and new storage arrays. If we are unable to maintain or expand our relationships with Hitachi Data Systems, EMC or Storagetek, our revenues may suffer.

Because we depend on sole source and limited source suppliers for key components, we are susceptible to supply shortages and quality problems that could adversely affect our operating results.

We rely on third-party suppliers for components that are used in our products, and we have experienced delays and difficulty in securing components in the past. In times of shortage, we have been required to pay, and may in the future be required to pay, substantial premiums for components, which could adversely affect our gross margins. Key components that we use in our products may, from time to time, only be available from single sources with which we do not have long-term contracts. Any inability to supply products due to a lack of components or to redesign products to incorporate alternative components in a timely manner could materially adversely affect our business. The components we use for our products are based on advanced technology and may not be available with the performance characteristics or in the quantities that we require. In addition, because the third party components we use for our products are complex, they may contain errors or defects that are not discovered until after our products are installed in end-user SANs. Any such errors or defects discovered by our customers could harm our reputation and cause us to lose customers.

Our future success will depend to a certain extent upon our ability to develop new products based upon new technologies such as InfiniBand that leverage our Fibre Channel experience.

We have recently launched a significant product development and strategic initiative based on the InfiniBand Architecture standard. We released our first InfiniBand product, a host channel adapter module, in the first quarter of 2002, but we have not yet earned any significant revenues from InfiniBand products. We intend to devote a significant portion of our research and development resources to developing InfiniBand products. InfiniBand is a new standard that has not been widely deployed and is in the very early stages of commercialization. We cannot assure you that InfiniBand will ever achieve widespread market acceptance. In addition, InfiniBand provides more bandwidth than is commonly used in many servers, and it is possible that the existing PCI standard, or enhancements such as PCI-X, will adequately satisfy most customer demands for several years. As a result, it is possible that, even if InfiniBand does achieve market acceptance, it will not occur for a significant period of time. Because we intend to devote significant resources to InfiniBand in the near term, a delay in the proliferation of InfiniBand would harm our business, financial condition and operating results.

The markets in which we compete are intensely competitive. As a result, we will face a variety of significant challenges, including rapid technological advances, price erosion, changing customer preferences and evolving industry standards. Our competitors continue to introduce products with improved price/performance characteristics, and we will have to do the same to remain competitive. Increased competition could result in significant price competition, reduced revenues, lower profit margins or loss of market share, any of which would have a material adverse effect on our business. We cannot be certain that we will be able to compete successfully in the future.

Many of our current and potential competitors in the Fibre Channel market, including Emulex Corporation, QLogic Corporation, Agilent Technologies, Inc., Intel Corporation, IBM and Adaptec, Inc., have substantially greater financial, technical, marketing and distribution resources than we have. We face the threat of potential competition from new entrants into the Fibre Channel market, particularly the Sun Solaris segment of that market that continues to represent the substantial majority of our revenues. These potential new entrants include large technology companies that may develop or acquire differentiating technology and then apply their resources, including established distribution channels and brand recognition, to obtain significant market share. Emerging companies attempting to obtain a share of the existing market also may compete with us. Our Fibre Channel products may also compete at the end-user level with other current or future technology alternatives, such as; SCSI,

InfiniBand and Gigabit Ethernet. Further, businesses that implement SANs may select fully-integrated SAN systems that are offered by large product solution companies. Because such systems do not interoperate with products from independent open system suppliers, like us, customers that invest in these systems will be less likely to purchase our products. Other technologies designed to address the applications served by Fibre Channel today are under development. Because most of our current products are based on Fibre Channel, unless we are able to develop products based on InfiniBand or other emerging connectivity technologies, our business could suffer if the market for Fibre Channel products grows more slowly than we anticipate as a result of competition from such technologies.

Because the market for InfiniBand products is the early stages of development, there are few products available today. We expect that competition in this market will increase significantly. We also expect that a number of large technology companies, such as Intel and IBM, will enter this market with host channel adapter module and other InfiniBand products. In addition, other companies, including QLogic, have announced their intention to enter the InfiniBand market with products competitive to our current and planned offerings. A significant part of our InfiniBand strategy is to partner with other InfiniBand equipment vendors who will incorporate our products into theirs. If our potential partners design their own components to perform the functionality offered by our products, or if they select components offered by our competitors, we may not be able to achieve planned levels of market penetration. If we are not successful, for competitive or other reasons, in achieving market penetration with our InfiniBand products, we may not be able to recover the significant investment we intend to make in pursuing this market.

Delays in product development could adversely affect our market position or customer relationships.

We have experienced delays in product development in the past and may experience similar delays in the future. Given the short product life cycles in the markets for our products, any delay or unanticipated difficulty associated with new product introductions or product enhancements could cause us to lose customers and damage our competitive position. Further, we are devoting significant resources to developing InfiniBand products in order to achieve an early-mover advantage in the InfiniBand market. Delays in development of our InfiniBand products could result in a failure to achieve such an advantage. Delays may result from numerous factors, such as:

In our industry, technology and other standards change rapidly, and we must keep pace with the changes to compete successfully.

The market for our products is characterized by rapidly changing technology, evolving industry standards and the frequent introduction of new products and enhancements. Our future success

depends in large part on our ability to enhance our existing products and to introduce new products and technologies on a timely basis to meet changes in customer preferences and evolving industry standards. Additionally, changes in technology and customer preferences could potentially render our current products uncompetitive or obsolete. We cannot be certain that we will be successful in designing, supplying and marketing new products or product enhancements that respond to such changes in a timely manner and achieve market acceptance. We also cannot be certain that we will be able to develop the underlying core technologies necessary to create new products and enhancements, or that we will be able to license the core technologies from third parties. In addition, because our products are designed to work with software produced by third parties, our operating results could be adversely affected if such third parties delay introduction of new versions of their software for which we have designed new products or if they make unanticipated modifications to such software. If we are unable, for technological or other reasons, to develop new products or enhance existing products in a timely manner in response to technological and market changes, our business, operating results and financial condition would be materially adversely affected.

If the market for Fibre Channel-based SANs does not expand as we anticipate, our business will suffer.

The growth of the market for our current products depends upon the continued deployment of Fibre Channel technology in SANs. Accordingly, increasing rates of deployment of Fibre Channel-based SANs is crucial to our future revenue growth. If this market does not expand as rapidly as we anticipate, our operating results may be below the expectations of public market analysts and investors, which would likely cause our stock price to decline.

The sales cycle for our products is long, and we may incur substantial, non-recoverable expenses or devote significant resources to sales that do not occur when anticipated or at all.

Our sales cycle, particularly to OEMs, typically involves a lengthy certification process during which we generally invest significant resources in addressing customer specifications. The purchase of our products or solutions that incorporate our products typically involves significant internal procedures associated with the evaluation, testing, implementation and acceptance of new technologies. This evaluation process frequently results in a lengthy sales process, typically ranging from three months to longer than a year, and is subject to a number of significant risks, including budgetary constraints and internal acceptance reviews. The length of our sales cycle also varies substantially from customer to customer. Because of the length of the sales cycle, we may experience a delay between increasing expenses for research and development and selling and marketing efforts and the generation of higher revenues, if any, from such expenditures.

The failure of our OEM customers to keep pace with rapid technological change and to successfully develop and introduce new products could adversely affect our revenues.

Our ability to generate increased revenues depends significantly upon the ability and willingness of our OEM customers to develop and promote products on a timely basis that incorporate our technology. OEMs must commit significant resources each time they develop a product that incorporates one of our new products. If our OEM customers do not invest in the development and marketing of solutions that incorporate our products and successfully market these solutions, then sales of our products to the OEM customers will be adversely affected. The ability and willingness of OEM customers to develop and promote such products is based upon a number of factors beyond our control.

We expect that the average selling prices of each of our products will decrease over time, which may reduce our gross margins or revenues.

We expect that we will continue to experience downward pricing pressure on our products. We anticipate that the average selling prices of each of our products will decrease over time in response to competitive pricing pressures, increased sales discounts, new product introductions by us or our competitors or other factors. Therefore, to maintain our gross margins, we must develop and introduce on a timely basis new products and product enhancements and continually reduce our product costs. Our failure to do so would cause our revenue and gross margins to decline, which could materially adversely affect our operating results and cause the price of our common stock to decline.

Our failure to attract and retain key managerial, technical, selling and marketing personnel could adversely affect our business.

Our success depends upon our retention of key managerial, technical, selling and marketing personnel. The loss of the services of key personnel might significantly delay or prevent the achievement of our development and strategic objectives. We do not maintain key person life insurance on any of our employees, and none of our employees is under any obligation to continue providing services to JNI.

We must continue to attract, train and retain managerial, technical, selling and marketing personnel. In particular, we are currently seeking to hire additional skilled development engineers who are currently in limited supply. Competition for such highly skilled employees in our industry is high, and we cannot be certain that we will be successful in recruiting or retaining such personnel. We also believe that our success depends to a significant extent on the ability of our key personnel to operate effectively, both individually and as a group. If we are unable to identify, hire and integrate new employees in a timely and cost-effective manner, our operating results may suffer.

Our product cycles may be short, and from time to time we may need to write off excess and obsolete inventory.

In the rapidly changing technology environment in which we operate, product cycles tend to be short. However, we must have sufficient quantities of our products available to satisfy our customers' demands. Accordingly, we order significant quantities of our products from our manufacturers prior to receiving customer orders. Although we expect to sell the inventory within a short period of time, products may remain in inventory for extended periods and may become obsolete because of the passage of time and the introduction of new products. For example, as we introduce successive generations of ASICs, we may experience excess inventory of host bus adapters that incorporate the prior generation of ASICs. In these situations, we would be required to write off obsolete inventory, which could have a material adverse effect on our results of operations.

We may engage in future acquisitions of complementary businesses, products or technologies that dilute our stockholders' equity or cause us to incur debt or assume contingent liabilities.

We may pursue acquisitions that could provide new technologies or products. We recently completed a strategic transaction with Troika Networks pursuant to which we acquired an exclusive license to Troika's Path Command Plus software and manufacturing and distribution rights to its Zentai family of Fibre Channel host bus adapters. We may not be able to achieve the anticipated benefits of this transaction if the technology and products we acquired do not achieve market acceptance or if Troika fails to complete its development obligations under the transaction agreements. Future acquisitions may involve the use of significant amounts of cash, potentially dilutive issuances of equity or equity-linked securities, the incurrence of debt, or amortization expenses related to intangible assets.

We currently have no commitments or agreements with respect to any such acquisition. In the event that such an acquisition does occur and we are unable to successfully integrate businesses, products, technologies or personnel that we acquire, our business, operating results or financial condition could be materially adversely affected.

Because we rely on third parties, and in some cases, a sole manufacturer, for substantially all of our manufacturing and assembly, failures by these third parties to provide products of sufficient quality and quantity could cause us to delay product shipments, which could result in delayed or lost revenues or customer dissatisfaction.

Taiwan Semiconductor Manufacturing Company, or TSMC, is currently our sole manufacturer for all of our Emerald ASIC wafers, and various subcontractors, such as Amkor Technology, Inc., Caesar International Inc. and Siliconware USA Inc., perform assembly, packaging and testing of our ASICs so that we purchase and receive only finished product. Sanmina-SCI Corporation in Rapid City, South Dakota, and SMS Technologies, Inc. in San Diego, California perform substantially all assembly operations for our host bus adapters and host channel adapter modules. We anticipate that a third contract manufacture, FinePitch Systems, Inc., will begin performing services for us in the second quarter of 2002. We have no firm long-term commitments from any of these companies to supply products to us for any specific period, or in any specific quantity, except as may be provided in a particular purchase order.

Our reliance on TSMC for fabrication of our Emerald ASIC wafers involves particular risks. The semiconductor industry is highly cyclical and, in the past, foundry capacity has been very limited at times and may become limited in the future. Our dependence on TSMC increases our exposure to this cyclicality and to possible shortages of key components, product performance shortfalls and reduced controls over delivery schedules, manufacturing capability, quality assurance, quantity and costs. If TSMC or any of our other third-party manufacturers experiences delays, disruptions, earthquakes, capacity constraints or quality control problems in its manufacturing operations, then product shipments to our customers could be delayed, which would negatively impact our net revenues, competitive position and reputation.

Further, our business would be harmed if we fail to effectively manage the manufacture of our products. Because we place orders with our manufacturers based on our forecasts of expected demand for our products, if we inaccurately forecast demand, we may be unable to obtain adequate manufacturing capacity or adequate quantities of components to meet our customers' delivery requirements, or we may accumulate excess inventories.

We may in the future need to find new contract manufacturers in order to increase our volumes or to reduce our costs. We may not be able to find contract manufacturers that meet our needs, and even if we do, qualifying a new contract manufacturer and commencing volume production is expensive and time consuming. If we are required or elect to change contract manufacturers, we may lose revenues, and our customer relationships may suffer.

Our reliance on manufacturers outside the U.S. subjects us to risks inherent in doing business on an international level that could harm our operating results.

Currently, our ASIC products are manufactured by a third party located in Asia, and we may expand our manufacturing, assembly and testing activities abroad. Accordingly, we are subject to risks inherent in international operations, which include:

In particular, many Asian countries have in recent years experienced significant economic difficulties, including currency devaluation and instability, business failures and a generally depressed business climate, particularly in the semiconductor industry. In view of our reliance on Asian manufacturers, and our expanded international operations, any future economic downturns in the Asian economy may seriously harm our business.

Because our intellectual property is critical to the success of our business, our operating results would suffer if we were unable to adequately protect our intellectual property.

Our proprietary technologies are crucial to our success and ability to compete. We rely primarily on a combination of copyrights, trademarks, trade secret laws and contractual provisions to establish and protect our intellectual property rights in our proprietary technologies, including the source code for our software and the reference designs for our ASICs. We presently have no patents. We generally enter into confidentiality or license agreements with employees, consultants and customers and seek to control access to and distribution of our source code, documentation and other proprietary information. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. Policing unauthorized use of our proprietary information is difficult. Other parties also may independently develop or otherwise acquire equivalent or superior technology. In addition, the laws of some of the countries in which our products are or may be developed, manufactured or sold may not protect our intellectual property rights to the same extent as the laws of the United States, or at all. Our failure to protect our intellectual property rights could have a material adverse effect on our business.

We may become involved in costly and lengthy patent infringement or intellectual property litigation which could seriously harm our business.

In recent years, there has been significant litigation in the United States and in foreign countries involving patents and other intellectual property rights. We may become party to litigation in the future as a result of an alleged infringement of others' intellectual property. From time to time, we receive inquiries from other companies concerning whether we used their proprietary information. Any claims that we improperly use another party's proprietary information or that we infringe another party's intellectual property, with or without merit, could adversely affect or delay sales of our products that use the technology in question, result in costly and time-consuming litigation, divert our technical and management personnel, or require us to develop non-infringing technology or enter into royalty or

licensing arrangements, any of which would adversely affect our business. It also is possible that patent holders will assert patent rights which apply broadly to our industry, and that such patent rights, if valid, may apply to our products or technology. These or other claims may require us to stop using the challenged intellectual property or to enter into royalty or licensing agreements. We cannot be certain that the necessary licenses will be available or that they can be obtained on commercially reasonable terms. If we were to fail to obtain such royalty or licensing agreements in a timely manner or on reasonable terms, our business could be materially adversely affected.

Our export sales subject us to risks that could adversely affect our business.

Export sales accounted for 30% of our net revenues in 2001, 23% of our net revenues in 2000, and 17% of our net revenues in 1999. Accordingly, we encounter risks inherent in international operations. Because all of our sales are currently denominated in U.S. dollars, if the value of the U.S. dollar increases relative to foreign currencies, our products could become less competitive in international markets. Our export sales could also be limited or disrupted by any of the following factors:

Failure to comply with governmental regulations by us or our OEM customers could reduce our sales or require design modifications.

Our products are subject to U.S. Department of Commerce and Federal Communications Commission regulations as well as various standards established by authorities in other countries. Failure to comply with existing or evolving U.S. or foreign governmental regulation or to obtain timely domestic or foreign regulatory approvals or certificates could materially harm our business by reducing our sales or requiring design modifications to our products or the products of our OEM customers. Neither we nor our customers may export such products without obtaining an export license. United States export laws also prohibit the export of our products to a number of countries deemed by the U.S. to be hostile. These restrictions may make foreign competitors facing less stringent controls on their products more competitive in the global market than we or our customers are. The U.S. government may not approve any pending or future export license requests. In addition, the list of products and countries for which export approval is required, and the regulatory policies with respect thereto, could be revised.

Our products are complex and may contain undetected software or hardware errors that could lead to an increase in our costs, reduce our net revenues or damage our reputation.

Products as complex as ours frequently contain undetected software or hardware errors when first introduced or as new versions are released. We have from time to time found errors in existing products, and we may from time to time find errors in our existing, new or enhanced products. The occurrence of hardware or software errors could adversely affect sales of our products, cause us to incur significant warranty and repair costs, divert the attention of our engineering personnel from our product development efforts and cause us to lose credibility with current or prospective customers.

We may need additional capital in the future to fund the growth of our business, and financing may not be available.

We currently anticipate that our available capital resources and expected interest income will be sufficient to meet our expected working capital and capital expenditure requirements for at least the next 12 months. However, we cannot assure you that such resources will be sufficient to fund the long-term growth of our business. We may raise additional funds through public or private debt or equity financings if such financings become available on favorable terms, but such financings would likely dilute our stockholders. We cannot assure you that any additional financing we may need will be available on terms favorable to us, or at all. If adequate funds are not available or are not available on acceptable terms, we may not be able to take advantage of unanticipated opportunities, develop new products or otherwise respond to competitive pressures. In any such case, our business, operating results or financial condition could be materially adversely affected.

Our stock price is volatile, which has and may result in lawsuits against us and our officers and directors.

The stock market in general, and the stock prices in technology-based companies in particular, have experienced extreme volatility that often has been unrelated to the operating performance of any specific public company. The market price of our common stock has fluctuated in the past and is likely to fluctuate in the future as well. Factors which could have a significant impact on the market price of our common stock include, but are not limited to, the following:

In the past, companies that have experienced volatility in the market price of their stock have been the object of securities class action litigation. In this regard, we and certain of our officers and directors have been named as defendants in securities class action lawsuits filed in the United States District Court for the Southern District of California and the United States District Court for the Southern District of New York. Such lawsuits allege that we and certain of our officers and directors made misrepresentations and omissions in violation of sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and sections 11, 12(a)(2) and 15 of the Securities Act of 1933. As a result of the Southern District of California lawsuits, a derivative case has been filed in California alleging that certain of our officers and directors breached their fiduciary duties to the Company in connection with the events alleged in the class action lawsuits. The complaints generally seek compensatory damages, costs and attorney's fees in an unspecified amount. Such litigation could result in substantial costs to us and a diversion of our management's attention and resources. While we believe that the lawsuits are without legal merit and intend to defend them vigorously, because the lawsuits are at an early stage, it is not possible to predict whether we will incur any material liability in connection with such lawsuits.

Future changes in financial accounting standards may cause adverse unexpected revenue fluctuations and affect our reported results of operations.

A change in accounting policies can have a significant effect on our reported results and may even affect our reporting of transactions completed before a change is announced. New pronouncements and varying interpretations of pronouncements have occurred with frequency and may occur in the future. Changes to existing rules or the questioning of current practices may adversely affect our reported financial results or the way we conduct our business.

Our stockholder rights plan could adversely affect the performance of our stock.

We have distributed a dividend of one right for each outstanding share of our common stock pursuant to the terms of our preferred share purchase rights plan. These rights will cause substantial dilution to the ownership of a person or group that attempts to acquire us on terms not approved by our board of directors and may have the effect of deterring hostile takeover attempts. In addition, our board of directors has the authority to fix the rights and preferences of and issue shares of preferred stock. This right may have the effect of delaying or preventing a change in our control.

We lease approximately 85,329 square feet in San Diego, California as our corporate headquarters, for product development and test laboratories, for manufacturing operations, and for administrative, engineering, marketing and sales offices. The term of the lease expires March 31, 2011. We lease approximately 19,727 square feet in Fremont, California primarily for our ASICs team under a lease that expires in May 2005.

We lease approximately 500 square feet of office space in Munich, Germany under a lease that expires in March 2002. We lease approximately 2,200 square feet in Singapore under a lease that expires in November 2002. We believe that our current facilities will be adequate to meet our needs until at least the end of 2002.

We are also committed to a five year lease for a building adjacent to our current corporate headquarters which is for 57,323 square feet and is located at 10955 Vista Sorrento Parkway, San Diego, California 92130. This new lease commences in June 2002. The Company does not intend to occupy this space and is actively seeking a tenant to sub-lease or assume the lease obligation. See Note 9, "Commitments" in the Notes to the Financial Statements for further discussion.

In April 2001, an alleged stockholder of the Company filed an alleged class action complaint against the Company and certain of its officers and directors in the United States District Court for the Southern District of California on behalf of purchasers of the Company's common stock during the period between October 16, 2000 and January 24, 2001. Thereafter, five additional and virtually identical lawsuits have been filed. The most recent of these lawsuits allege claims on behalf of purchasers of the Company's common stock during the period between October 16, 2000 and March 28, 2001 (the "Class Period"). The cases allege that during the Class Period, the Company made false statements about its business and results causing its stock to trade at artificially inflated levels. Based on these allegations, the cases allege that the Company and the others named in the cases violated the Securities Exchange Act of 1934. The Company has retained counsel to defend these cases. On February 8, 2002, the Court appointed a lead plaintiff and lead counsel and ordered the consolidation of the cases. The court has given the plaintiffs until March 25, 2002 to file a consolidated amended complaint. On March 25, 2002, plaintiffs filed a first consolidated and amended complaint. The first consolidated and amended complaint alleges a new class period of July 13, 2000 through March 28, 2001 and adds alleged claims under Securities Act of 1933 arising from the Company' secondary public offering in October 2000. The Company believes that these cases are without merit and intends to defend the cases vigorously.

In October 2001, an alleged stockholder of the Company filed an alleged stockholder derivative lawsuit against the Company and certain present and former members of the Company's board of directors in the San Diego County Superior Court. The lawsuit alleges that during the Class Period, the present and former members of the Company's board failed to adequately oversee the activities of management and, as a result, the Company allegedly made false statements about its business and results causing its stock to trade at artificially inflated levels. Based on these allegations, the plaintiff alleges that the present and former members of the Company's board breached their fiduciary duties to the Company. The alleged stockholders filed the lawsuit without first making a demand upon the board of directors. The Company has retained counsel to defend this case. On February 1, 2002, the Court sustained the Company's demurrer to the plaintiff's complaint with leave to amend. On March 8, 2002, the plaintiff filed an first amended complaint. On March 22, 2002, the Company filed a demurrer to the first amended complaint and the hearing on the demurrer is set for April 12, 2002. The Company believes that this case lacks merit and intends to defend the case vigorously.

On November 29, 2001, an alleged stockholder of the Company filed a class action lawsuit in the United States District Court for the Southern District of New York. The lawsuit also names as defendants the underwriters on the Company's initial public offering and secondary offering. The plaintiff alleges that defendants violated Securities Act of 1933 and the Securities Exchange Act of 1934 in connection with the Company's public offerings. This case is among the over 300 class action lawsuits pending in the United States District Court for the Southern District of New York that have come to be known as the IPO laddering cases. The complaint in this case has not been served on the Company. The Company believes that this case lacks merit and intends to defend the case vigorously.

The Company is involved in certain legal proceedings, including various employee related lawsuits, generally incidental to its normal business activities. While the outcome of any such proceedings cannot be accurately predicted, the Company does not believe the ultimate resolution of any such existing matters should have a material effect on its financial position, results of operations or cash flows.

No matters were submitted to a vote of security holders during the quarter ended December 31, 2001.

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

The Company's Common Stock, $0.001 par value per share, has traded on The Nasdaq National Market under the symbol "JNIC" since October 27, 1999. The following table sets forth the high and low sale prices for the Common Stock as reported by the Nasdaq National Market for the periods indicated:

	High		Low
Year ended December 31, 2000
First Quarter	$	88.00	$	48.00
Second Quarter	$	52.13	$	20.00
Third Quarter	$	96.75	$	28.88
Fourth Quarter	$	126.00	$	16.13
Year ended December 31, 2001
First Quarter	$	31.41	$	7.19
Second Quarter	$	18.48	$	5.75
Third Quarter	$	14.50	$	5.08
Fourth Quarter	$	11.40	$	5.66

As of February 28, 2002 there were 26,581,710 shares of common stock outstanding held by approximately 187 holders of record. The Company has never declared or paid cash dividends on its common stock. The Company currently anticipates that it will retain all future earnings for use in its business and does not anticipate paying any cash dividends in the foreseeable future.

The selected financial data as of December 31, 2001 and 2000 and for each of the three years in the period ended December 31, 2001 have been derived from the Company's audited financial statements included elsewhere in this report. The selected financial data as of December 31, 1999, 1998 and 1997 and for the years ended December 31, 1998 and 1997 have been derived from audited financial statements for the Company not included herein. The selected financial data set forth below is qualified in its entirety by reference to, and should be read in conjunction with, "Management's

Discussion and Analysis of Financial Condition and Results of Operations" and the Financial Statements and related notes thereto included elsewhere in this report.

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

Except for the historical information contained herein, the discussions in this Report on Form 10-K in general may contain certain forward-looking statements. In addition, when used in this Form 10-K, the words "anticipates," "in the opinion," "believes," "intends," "expects" and similar expressions are intended to identify forward-looking statements. Actual future results could differ materially from those described in the forward-looking statements as a result of factors discussed in Management's Discussion and Analysis of Financial Condition and Results of Operations set forth below, as well as in "Risk Factors" set forth herein. The Company expressly disclaims any obligation or undertaking to release publicly any updates or changes to these forward-looking statements that may be

made to reflect any future events or circumstances. References contained herein to "JNI," the "Company," "we," "our" and "us" refer to JNI Corporation.

We are a leading designer and supplier of enterprise storage connectivity products, including Fibre Channel and InfiniBand products that connect servers and data storage devices. We currently market and sell a broad range of Fibre Channel host bus adapters that connect servers to storage subsystems to facilitate the integration and management of devices used in storage area networks, or SANs. We also design and market high-performance application specific integrated circuits, or ASICs, based on our proprietary Fibre Channel technology. We recently released our first InfiniBand products, called host channel adapter modules, that allow stand-alone servers to cluster with InfiniBand connectivity operating at 2.5 Gb or 10 Gb per port. We are currently developing or designing products that will bridge InfiniBand to other storage protocols, such as Fibre Channel and iSCSI.

Revenues are comprised principally of sales of our host bus adapter products. Additionally, sales of our ASICs and revenue received from our ASIC development agreements, which represented less than five percent of total revenues for the year ended December 31, 2001, are also included in revenues.

Cost of revenues is comprised principally of payments to our contract manufacturers, costs of components, material expediting charges, final assembly costs, manufacturing and quality-related costs, inventory management costs, warranty and support costs. We expect our gross margin to be affected by many factors, including changes in average unit selling price, fluctuations in demand for our products, the mix of products sold, the mix of sales channels through which our products are sold, the timing and size of customer orders, fluctuations in manufacturing volumes, changes in costs of components, and new product introductions both by us and our competitors. We reserve for warranty claims at the time of sale based on historical experience.

Research and development expenses consist primarily of salaries and related expenses for engineering personnel, fees paid to consultants and outside service providers, depreciation of development and test equipment, prototyping expenses related to the design, development, testing and enhancements of our products and the cost of computer support services. We expense all research and development costs as incurred.

Selling and marketing expenses consist primarily of salaries, commissions and related expenses for personnel engaged in marketing, sales and customer support functions, public relations, advertising, promotional and trade show costs and travel expenses.

General and administrative expenses include salaries and related expenses for personnel engaged in finance, human resources, information technology, administrative activities and legal and accounting fees.

Amortization of intangible assets is attributed to the amortization of intangible assets acquired in connection with the purchase of products and technology from Adaptec. As a result of the consideration paid to Adaptec, we recorded $11.6 million in intangible assets related to the core technology acquired, which was amortized over an estimated useful life of three years. Amortization of this amount was completed during the year ended December 31, 2001.

Amortization of stock-based compensation relates to deferred compensation recorded in connection with the grant of stock options to employees in all operating expense categories where the option exercise price was less than the fair value of the underlying shares of common stock as determined for financial reporting purposes. We have recorded $2.2 million of deferred compensation within stockholders' equity, which is being amortized over the vesting period of the related stock options, generally four years. The amortization of stock-based compensation will be completed in 2002.

In January 2002, we acquired an exclusive license to Troika Networks' Fibre Channel software and hardware products that provide high-availability SAN solutions for enterprise class servers running under Windows NT, Windows 2000 and Solaris operating systems. The purchase price included an initial payment of $7.5 million and contingent consideration of $3.0 million. The $7.5 million consideration includes payment for the software license, research and development services, transition services and a covenant not to compete. The $3.0 million contingent payment may be due if we reach certain revenue or unit sales levels and upon completion of certain OEM certification requirements. Additionally, if we attain certain revenue or unit sales levels of the related products, we will be obligated to make royalty payments based on revenue for one year from the royalty payment start date or until June 30, 2004, whichever occurs earlier. To the extent that we do not achieve certain revenue or unit levels by January 1, 2004, Troika is obligated to reimburse us for a portion of the initial purchase price, up to $3.5 million. We are in the process of evaluating the accounting treatment for this transaction, and an independent valuation of the transaction is being performed for accounting purposes.

Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate these estimates, including those related to customer programs and incentives, product returns, bad debts, inventories, investments, intangible assets, income taxes, warranty obligations, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We consider the following accounting policies to be both those most important to the portrayal of our financial condition and that require the most subjective judgment:

Revenue recognition. We sell our products domestically and internationally primarily through OEM and distribution channel customers including distributors, system integrators and value added resellers who sell directly to end-users. Our significant customers include leading storage solution providers, server OEMs and storage OEMs.

We recognize revenue from product sales upon shipment except for sales to distributor customers that have contractual rights of return. Revenue from sales to distributors that have contractual rights of return is recognized when these distributors ship our products to their end-user customers based on reports that we receive from such distributors. Allowances for estimated sales returns are provided at the time revenue is recognized. We reserve for uncollectible accounts and product returns based on our historical experience and expected future returns related to products shipped. Revenue from our ASIC development agreements is generally recognized as the services are performed using the percentage of completion method based on costs incurred to date compared to total estimated costs at completion.

For all sales, we use either a binding purchase order or signed agreement as evidence of an arrangement. Sales through our distributors and major OEMs are evidenced by a master agreement governing the relationship together with binding purchase orders on a transaction by transaction basis.

Our products sold are generally covered by a warranty of three years for our adapter products and a one year warranty for our ASICs. We accrue a warranty reserve for the estimated costs to provide warranty services. Our estimate of costs to service our warranty obligations is based on historical experience and expectation of future conditions. To the extent we experience increased warranty claim activity or increased costs associated with servicing those claims, our warranty accrual will increase resulting in decreased gross profit.

Accounting for marketable securities. We classify our investments in marketable securities as "available for sale." We carry these investments at fair value, based on quoted market prices, and unrealized gains and losses are included in accumulated other comprehensive income (loss), which is reflected as a separate component of stockholders' equity. Realized gains and losses are recognized upon the sale of our marketable securities in our statements of operations. Our investments in marketable securities are managed and held in the custody of three domestic financial institutions. We have established investment policy guidelines that we have provided to each of these financial institutions. Based on our guidelines, our investments generally consist of fixed and variable A or higher graded U.S. government, state and local, and corporate debt obligations with maturities ranging from one to twenty-four months. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes. The fair market value of our investments in marketable securities may be adversely affected due to a rise in interest rates, and we may suffer losses in principal if forced to sell securities that have declined in market value due to changes in interest rates. Additionally, the amount of interest income that we earn on our investments may be adversely affected by changes in interest rates.

As of December 31, 2001, our marketable securities available, which consisted of $82,974 in short-term investments and $30,558 in long-term investments, represented 75% of our total assets.

Inventory valuation and related reserves. Inventories are valued at the lower of cost or market on a first-in, first-out basis. We use a standard cost system for purposes of determining cost; the standards are adjusted as necessary to ensure they approximate actual costs. We write down or reserve for estimated obsolete or excess inventory based upon assumptions about future demand and market conditions. We compare current inventory levels on a product basis to our current sales forecast in order to assess our inventory reserve balance. Our sales forecasts are based on economic conditions and trends (both current and projected), anticipated customer demand and acceptance of our products, current products, expected future products and various other assumptions. If actual market conditions are less favorable than those projected by management, additional write-downs may be required.

During the second quarter of 2001, we recorded an excess inventory charge of $7.7 million based on the anticipated demand for our 1 gigabit products. We increased our 1 gigabit products and associated component inventory levels during the fourth quarter of 2000 in anticipation of continued strong sales momentum for these products which did not materialize. Additionally, information technology spending continued to slow down also contributing to the excess inventory charge.

Accounting for income taxes. Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We have recorded a full valuation allowance on our net deferred tax assets as of December 31, 2001, due to uncertainties related to our ability to utilize our deferred tax assets, primarily consisting of certain net operating losses carried forward and research and development tax credits, before they expire.

The following discussion should be read in conjunction with the financial statements and the related notes contained elsewhere in this report.

Net Revenues. Net revenues decreased $27.4 million, or 26.6%, to $75.8 million in the year ended December 31, 2001 from $103.2 million in the year ended December 31, 2000. The decrease was due to a $28.6 million decrease in sales of our SBus host bus adapter products and a $0.5 million decrease in sales of our PCI host bus adapter products partially offset by a $1.6 million increase in sales of our ASICs and revenue received under ASIC development agreements. The total revenue recognized under research and development agreements for the year ended December 31, 2001 was $1.1 million as compared to no revenues in 2000. The overall decrease in revenues for the year ended December 31, 2001 is primarily a result of the slowdown in information technology spending in 2001 coupled with weakness in the Solaris market, which is the principal market for our products. Additionally, the decrease in SBus sales resulted from the transition of our Solaris based products from the SBus to the PCI interface. The decline in net revenues is also attributable to a decrease in the average selling price for our host bus adapters primarily as a result of continued pricing pressure and discounts provided to our major OEM partners as well as the transition to PCI products which have lower average selling prices than SBus products. Sales to customers outside of the United States accounted for 30% of net revenues in 2001 compared to 23% of net revenues in 2000. As our dependency on SBus continues to decline, we expect an increasing percentage of our net revenues will be from sales of our PCI products, including Solaris, Windows NT, Windows 2000 and other operating systems.

Gross Margin. Gross margin decreased $24.9 million, or 40.8%, to $36.2 million in the year ended December 31, 2001 from $61.1 million in the year ended December 31, 2000. Gross margin as a percentage of net revenues decreased to 47.7% during the year ended December 31, 2001 from 59.2% during the year ended December 31, 2000. The decrease is primarily attributed to a $7.7 million charge recorded for excess inventory. In the second quarter of 2001, we recorded an excess inventory charge of $7.7 million against cost of revenues based on the determination that current inventory levels were in excess of projected future demand. Excluding the $7.7 million excess inventory charge, gross margin as a percentage of net revenues decreased to 57.9% during the year ended December 31, 2001 from 59.2% during the year ended December 31, 2000. The allocation of fixed manufacturing costs over a lower revenue base also contributed to the decrease in gross margins. Additionally, the decrease in the average selling price for our host bus adapters contributed to the decline in gross margins. We expect our gross margin to continue to decline as we continue to experience pricing pressure on host bus adapter products and to generate an increasing percentage of sales from our PCI based products which carry a lower gross margin than our SBus products.

Research and Development. Research and development expenses increased $5.7 million, or 29.8%, to $24.6 million for the year ended December 31, 2001 from $18.9 million for the year ended December 31, 2000. The increase was due primarily to higher personnel costs, resulting from an increase in the number of personnel needed in order to staff a higher level of research and development, and higher depreciation expense, resulting from an increase in capital expenditures necessary to expand our research and development efforts and continued investments in our system integration lab. The increase in office and lab space for our research and development team resulted in higher rent and occupancy related expenses. Additionally, we opened up an office for a research and development team in Singapore in January of 2001 to assist in the design and development of our ASICs which also contributed to the increase in research and development expenses. As a percentage of net revenues, research and development expenses increased to 32.4% for the year ended December 31, 2001 from 18.3% for the year ended December 31, 2000. This increase was primarily attributable to the decrease in revenues. Although we will continue to invest significant resources in our

research development efforts, including both our Fibre Channel and InfiniBand development, we anticipate that research and development expenses will decrease in absolute dollars in 2002 due to a headcount reduction in the first quarter of 2002 and a planned decrease in consulting expenses.

Selling and Marketing. Selling and marketing expenses increased $3.7 million, or 29.8%, to $16.0 million for the year ended December 31, 2001 from $12.3 million for the year ended December 31, 2000. The increase in selling and marketing expenses was due primarily to an increase in personnel costs, an increase in business development and marketing programs, an increase in travel expenses by our sales people, an increase in public relations expenses and reproduction and printing costs as we continued our efforts to increase our brand awareness and increased costs associated with opening new sales offices in the United States and Europe, partially offset by a decrease in sales commissions due to the decrease in net revenues. Selling and marketing expenses as a percentage of net revenues increased to 21.1% for the year ended December 31, 2001 from 11.9% for the year ended December 31, 2000. This increase was primarily attributable to the decrease in revenues. We anticipate that selling and marketing expenses will decrease in absolute dollars in 2002 due to a headcount reduction in the first quarter of 2002 and cost improvement measures in discretionary spending, such as advertising, trade shows, public relations and recruiting expenses.

General and Administrative. General and administrative expenses increased $1.2 million, or 14.2%, to $9.1 million for the year ended December 31, 2001 from $7.9 million for the year ended December 31, 2000. The increase was primarily due to higher personnel costs arising from costs associated with changes in senior management, an increase in legal fees mainly as a result of the class action lawsuit filed in April 2001 and an increase in insurance and consulting expenses. General and administrative expenses as a percentage of net revenues increased to 12.0% for the year ended December 31, 2001 from 7.7% for the year ended December 31, 2000. This increase was primarily attributable to the decrease in revenues. We anticipate that general and administrative expenses will decrease in absolute dollars in 2002 due to a headcount reduction in the first quarter of 2002 and an expected decrease in legal and consulting expenses.

Amortization of Intangible Assets. We amortized $4.7 million of intangible assets during the year ended December 31, 2001 compared to $5.4 million during the year ended December 31, 2000. The decrease relates to the balance being fully amortized during the year ended December 31, 2001. The intangible assets related to additional consideration we issued to Adaptec in the third quarter of 1999 for Fibre Channel technology we acquired from Adaptec in November 1998.

Interest Income. Interest income increased $2.2 million, or 73.7%, to $5.1 million for the year ended December 31, 2001 from $2.9 million for the year ended December 31, 2000. Interest income for the year ended December 31, 2001 primarily represents interest earned on our investments in marketable securities resulting from the proceeds from our public offering completed in October 2000. Interest income for the year ended December 31, 2000, primarily represents interest earned on our investments in marketable securities resulting from the proceeds from our initial public offering completed in October 1999.

Income Tax Provision (Benefit). We recognized an income tax provision of $0 during the year ended December 31, 2001 as a result of the taxable loss during the fiscal year 2001. The difference between our effective tax rate of 0% and the statutory tax rate is primarily a result of the net change in the deferred tax asset valuation allowance. We recognized an income tax provision of $4.6 million, with an effective tax rate of 24.5%, during the year ended December 31, 2000 as a result of the taxable income generated in the year ended December 31, 2000. The difference between our effective tax rate of 24.5% and the statutory tax rate is primarily a result of research and development tax credits generated. We recorded a valuation allowance on our net deferred tax assets as of December 31, 2001 because of uncertainty regarding their realizability.

Net Revenues. Net revenues increased $63.0 million, or 157%, to $103.2 million in the year ended December 31, 2000 from $40.2 million in the year ended December 31, 1999. The increase was due to an increase in sales of SBus and PCI host bus adapter products with a $46.6 million increase in SBus sales and a $16.9 million increase in PCI sales, partially offset by a decrease in sales of our ASICs. The increase in revenues was attributable to increased demand for our products and growth in the market for Fibre Channel products. Sales to customers outside of the United States accounted for 23% of net revenues in 2000 compared to 17% of net revenues in 1999.

Gross Margin. Gross margin increased $36.4 million, or 147%, to $61.1 million in the year ended December 31, 2000 from $24.8 million in the year ended December 31, 1999. Gross margin as a percentage of net revenues decreased to 59.2% during the year ended December 31, 2000 from 61.7% during the year ended December 31, 1999. The decrease was due to increased sales of our PCI host bus adapter products which generally have lower gross margins than our SBus host bus adapter products. Gross margins for the year ended December 31, 2000 also decreased as a result of inventory reserves recorded for slow moving and obsolete inventory and higher prices on certain components due to industry-wide shortages.

Research and Development. Research and development expenses increased $7.0 million, or 58%, to $18.9 million for the year ended December 31, 2000 from $12.0 million for the year ended December 31, 1999. The increase was due primarily to higher personnel costs and contracted services, resulting from an increase in the number of personnel needed in order to staff a higher level of research and development, and higher depreciation expense, resulting from an increase in capital expenditures necessary to expand our research and development efforts. As a percentage of net revenues, research and development expenses decreased to 18.3% for the year ended December 31, 2000 from 29.8% for the year ended December 31, 1999. This decrease was primarily attributable to the increase in revenues.

Selling and Marketing. Selling and marketing expenses increased $7.5 million, or 156%, to $12.3 million for the year ended December 31, 2000 from $4.8 million for the year ended December 31, 1999. The increase in selling and marketing expenses was due primarily to an increase in personnel costs resulting from the expansion of our sales and marketing staff, increased trade show participation and continued spending on an advertising and marketing program which we launched in the first quarter to focus on our premium branding and channel expansion. Selling and marketing expenses as a percentage of net revenues decreased to 11.9% for the year ended December 31, 2000 from 12.0% for the year ended December 31, 1999.

General and Administrative. General and administrative expenses increased $4.5 million, or 128%, to $7.9 million for the year ended December 31, 2000 from $3.5 million for the year ended December 31, 1999. The increase was primarily due to higher personnel costs arising from the addition of new employees and additional expenses associated with being a public company. Expenses associated with the hiring of a new chief executive officer and vice president of human resources in 2000 also contributed to the increase in general and administrative expenses. General and administrative expenses as a percentage of net revenues decreased to 7.7% for the year ended December 31, 2000 from 8.7% for the year ended December 31, 1999.

Amortization of Intangible Assets. We amortized $5.4 million of intangible assets during the year ended December 31, 2000 compared to $1.5 million during the year ended December 31, 1999. The increase in amortization expense relates to the significant increase in intangible assets that resulted from the additional consideration we issued to Adaptec in the third quarter of 1999 for Fibre Channel technology we acquired from Adaptec in November 1998.

Interest Income. Interest income of $2.9 million primarily represents interest earned on our investments in marketable securities during the year ended December 31, 2000, resulting primarily from the proceeds from the initial public offering completed in October 1999. Interest income of $352,000 in 1999 primarily represents interest earned in November and December 1999 on our investments in marketable securities, resulting from the proceeds from our initial public offering completed at the end of October 1999.

Interest Expense. Interest expense for the year ended December 31, 1999 represents interest associated with our intercompany revolver borrowings from Jaycor. Subsequent to our initial public offering, we repaid the outstanding balance to Jaycor in full. Accordingly, we had no interest expense in the year ended December 31, 2000.

Income Tax Provision (Benefit). We recognized an income tax provision of $4.6 million, with an effective tax rate of 24.5%, during the year ended December 31, 2000 as a result of the taxable income generated in the year ended December 31, 2000. The difference between our effective tax rate of 24.5% and the statutory tax rate is primarily a result of research and development tax credits generated. We recorded a valuation allowance on our net deferred tax assets as of December 31, 2000 because of uncertainty regarding their realizability due to the expectation that deductions from future employee stock option exercises and related deductions will exceed future taxable income.

We recognized an income tax benefit of $673,000 in the year ended December 31, 1999 due primarily to the utilization of net operating loss carryforwards and the release of a deferred tax asset valuation allowance. The valuation allowance was released during the second quarter of 1999 based on management's determination at the time that our ability to realize such a benefit was more likely than not. This determination was based on our historical operating results, which included the fourth consecutive quarter of pre-tax net income (before non-deductible stock-based compensation), and anticipated future operating results. Excluding the effect for the release of the valuation allowance, the tax rate for 1999 would have been approximately 35%.

Net Revenues. Net revenues increased $28.0 million, or 230%, to $40.2 million for the year ended December 31, 1999 from $12.2 million for the year ended December 31, 1998. The substantial majority of the increase was due to an increase in sales of SBus host bus adapters. To a lesser extent, the increase in net revenues was due to an increase in sales of PCI host bus adapters. The increase in revenues also reflects the growth in the market for Fibre Channel products and the increased market acceptance of our products. In 1999, our top five customers accounted for 60% of net revenues compared to 56% of net revenues for the top five customers in 1998. Sales to customers outside of the United States accounted for 17% of net revenues in 1999 compared to 14% of net revenues in 1998.

Gross Margin. Gross margin increased $17.9 million, or 263%, to $24.8 million in 1999 from $6.8 million in 1998. Gross margin as a percentage of net revenues increased to 61.7% in 1999 from 56.0% in 1998. The increase was due to lower component and manufacturing costs and the allocation of fixed manufacturing costs over a greater revenue base.

Research and Development. Research and development expenses increased $9.0 million, or 309%, to $12.0 million in 1999 from $2.9 million in 1998. The increase was due primarily to higher personnel costs and contracted services, resulting from an increase in the number of personnel in order to staff a higher level of research and development activities and the payment of incentive bonuses in 1999. In addition, equipment purchases and rentals and prototyping expenses increased to complete development of products based on the technology we acquired from Adaptec in November 1998. We also incurred increased research and development expenses related to improvements in our SBus host bus adapters and the development of new drivers for our PCI host bus adapters. As a percentage of net revenues, research and development expenses increased to 29.8% in 1999 from 23.9% in 1998.

Selling and Marketing. Selling and marketing expenses increased $3.3 million, or 215%, to $4.8 million in 1999 from $1.5 million in 1998. The increase was primarily due to higher personnel costs, trade shows and promotional items, and travel expenses resulting from an increase in the number of selling and marketing personnel and increased trade show participation. Selling and marketing expenses as a percentage of net revenues decreased to 12.0% in 1999 from 12.5% in 1998 primarily due to the increase in our revenues.

General and Administrative. General and administrative expenses increased $1.8 million, or 105%, to $3.5 million in 1999 from $1.7 million in 1998. The increase was primarily due to higher personnel costs arising from the addition of new employees and higher legal and accounting costs resulting from increased business activity. General and administrative expenses as a percentage of net revenues decreased to 8.7% in 1999 from 13.9% in 1998 due to the increase in revenues.

Amortization of Intangible Assets. We amortized $1.5 million of intangible assets during the year ended December 31, 1999 compared to $47,000 during the year ended December 31, 1998. The increase in amortization expense is attributed to the significant increase in intangible assets resulting from the additional consideration issued to Adaptec in the third quarter of fiscal 1999 for Fibre Channel technology acquired from Adaptec in November 1998.

Interest Income. Interest income of $352,000 primarily represents interest earned in November and December 1999 on our investments in marketable securities.

Interest Expense. Interest expense increased by $190,000 to $455,000 for the year ended December 31, 1999 from $265,000 for the year ended December 31, 1998. The increase resulted from higher intercompany revolver borrowings from Jaycor to finance increased inventory and accounts receivable, reflecting the rapid growth in revenues during that period. Subsequent to our initial public offering, the outstanding balance to Jaycor was paid in full.

Income Tax Provision (Benefit). We recognized an income tax benefit of $673,000 during the year ended December 31, 1999 due primarily to the utilization of net operating loss carryforwards and the release of a deferred tax asset valuation allowance. The valuation allowance was released during the second quarter of 1999 based on management's determination that it became more likely than not that our net deferred tax assets will be realized. This determination was based on our historical operating results, which included the fourth consecutive quarter of pre-tax net income (before non-deductible stock-based compensation), and anticipated future operating results. Excluding the effect of the release of the valuation allowance, the tax rate for 1999 would have been approximately 35%. In 1998, we recorded an income tax provision of $27,000 which represented a current tax liability for alternative minimum taxes.

During the year ended December 31, 2001, cash provided by operating activities was $12.7 million, compared to $4.8 million and $2.6 million of cash provided by operating activities during 2000 and 1999, respectively. The cash provided by operations during the year ended December 31, 2001 reflects a $13.0 million decrease in accounts receivable and a $10.0 million decrease in inventory, which includes the $7.7 million charge recorded for excess inventory in the second quarter of 2001, partially offset by a net loss before depreciation and amortization of approximately $3.4 million and $7.0 million of cash used for other working capital items such as other assets, accounts payable, accrued liabilities and deferred revenue.

Net cash used in investing activities was $9.5 million in the year ended December 31, 2001 and consisted of capital expenditures of $8.7 million and purchases of marketable securities available for sale of $9.9 million partially offset by the proceeds from the sale of marketable securities of $9.1 million. Net cash used in investing activities was $79.2 million in the year ended December 31, 2000 and consisted of capital expenditures and purchases of marketable securities available for sale. Net cash used in investing activities was $43.1 million in 1999 and consisted of purchases of marketable securities available for sale and capital expenditures partially offset by proceeds from the sale of marketable securities. The capital expenditures in 2001 primarily reflect our investment in computer and lab equipment to build out our system integration lab as well as investment in software development tools and equipment for our engineering operations.

Net cash used in financing activities was $2.8 million in the year ended December 31, 2001, which consisted of a treasury stock repurchase of $5.1 million or 900,000 shares of our common shares partially offset by the net proceeds of $2.3 million from the issuance of common stock consisting of proceeds from the exercise of stock options and purchases of shares under our employee stock purchase plan. Net cash provided by financing activities was $73.3 million in the year ended December 31, 2000, which resulted primarily from the net proceeds from our second public offering in October 2000. In addition, the proceeds from the exercise of stock options and purchases of shares under our employee stock purchase plan also provided cash from financing activities in 2000. Net cash provided by financing activities was $45.5 million in 1999, which was generated primarily from our initial public offering in October 1999, partially offset by net payments to affiliates.

We had $118.0 million of cash and cash equivalents and investments and $97.2 million of working capital at December 31, 2001.

We believe that our cash and investments position will be sufficient to meet our working capital needs at least through the next 12 months. In the first quarter of 2002, we used a total of $9.5 million of our investments in marketable securities for the Troika transaction and our investment in Mellanox. Additionally, we may be required to make a further payment of $3.0 million as contingent consideration in the Troika transaction. See Note 12, "Subsequent Events" in the Notes to the Financial Statements for further discussion. Our significant obligations and commitments to make

future payments under contracts consist of noncancelable operating and capital leases. Our future annual minimum lease payments due under noncancelable operating leases totals $35.3 million over the next ten years, including a five year lease commitment for a building adjacent to our current corporate headquarters. This five year lease commences in June 2002 with a total commitment of approximately $8.8 million. Our future payments due under our capital lease totals $759,000 as of December 31, 2001. See Note 9, "Commitments" in the Notes to the Financial Statements for further discussion, including a schedule of the timing of payments due. In the third quarter of 2001, we implemented a stock repurchase program whereby the Board of Directors authorized us to repurchase up to $15.0 million of our outstanding common stock over a twelve-month period ending September 18, 2002. As of December 31, 2001, we have repurchased an aggregate of 900,000 shares at a cost of $5.1 million. Should we decide to make additional repurchases of stock in 2002, we would be required to liquidate some of our investments in marketable securities. Depending on our levels of revenue in the future, we may be required to use cash to fund our operating activities.

Our future capital requirements will depend on many factors, including the potential acquisition of or investment in complementary businesses, products, services and technologies, the rate of revenue growth, the timing and extent of spending to support product development efforts, the timing of introductions of new products and enhancements to existing products, and market acceptance of our products. There can be no assurance that additional equity or debt financing, if required, will be available on acceptable terms, or at all.

In June 2001 the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, Business Combinations. SFAS No. 141 addresses financial accounting and reporting for business combinations and supersedes APB Opinion No. 16, Business Combinations, and FASB Statement No. 38, Accounting for Preacquisition Contingencies of Purchased Enterprises. All business combinations in the scope of this Statement are to be accounted for using one method, the purchase method. The provisions of this Statement are effective for all business combinations initiated after June 30, 2001. This accounting pronouncement is not expected to have a material impact on the Company's financial position or results of operations.

In June 2001 the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17, Intangible Assets. It addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. This Statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. The provisions of this Statement are effective for financial statements issued for fiscal years beginning after December 15, 2001. This accounting pronouncement is not expected to have a material impact on the Company's financial position or results of operations.

In August 2001 the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets, supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, supersedes the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business (as previously defined in that Opinion), and amends ARB No. 51, Consolidated Financial Statements, to eliminate the exception to consolidation for a subsidiary for which control is likely to be temporary. The provisions of this Statement are effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those

fiscal years. This accounting pronouncement is not expected to have a material impact on the Company's financial position or results of operations.

Our exposure to market risk for changes in interest rates relates primarily to changes in the fair market value of our investments and the amount of interest income earned on our investment portfolio. In the normal course of business, we employ established policies and procedures to manage our exposure to changes in the fair market value of our investments. However, the fair market value of our investments in marketable securities may be adversely affected due to a rise in interest rates, and we may suffer losses in principal if forced to sell securities that have declined in market value due to changes in interest rates.

Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes. We ensure the safety and preservation of our invested principal funds by limiting default risks, market risk and reinvestment risk. We mitigate default risk by investing in investment grade securities. A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair value of our interest sensitive financial instruments at December 31, 2001.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

The information required by this Item will be set forth in the section headed "Proposal 1—Election of Directors" in the Company's definitive Proxy Statement for the Annual Meeting of Stockholders of the Company (the "Proxy Statement") which is expected to be filed not later than 120 days after the end of the Company's fiscal year ended December 31, 2001, and is incorporated in this report by reference.

The information required by this Item is set forth in the section headed "Executive Compensation" in the Company's definitive Proxy Statement and is incorporated in this report by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management

The information required by this Item is set forth in the section headed "Security Ownership of Certain Beneficial Owners and Management" in the Company's definitive Proxy Statement and is incorporated in this report by reference.

The information required by this Item is set forth in the sections headed "Certain Relationships and Related Transactions" and "Compensation Committee Interlocks and Insider Participation" in the Company's definitive Proxy Statement and is incorporated in this report by reference.

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K

Exhibit Number		Description
3.1	(2)	Fourth Amended and Restated Certificate of Incorporation of the Company
3.2	(2)	By-laws of the Company
4.1	(2)	Specimen Common Stock Certificate
10.1	(2)	Form of Indemnity Agreement for directors and executive officers
10.2	(2)	1997 Stock Option Plan, as amended, and forms of Incentive Stock Option Agreement and Nonstatutory Stock Option Agreement thereunder
10.3	(5)	Amended and Restated 1999 Stock Option Plan, terms of Stock Option Agreement and form of Stock Option Grant Agreement thereunder
10.4	(2)	1999 Employee Stock Purchase Plan and form of subscription agreement thereunder
10.5	(6)	2000 Non-Qualified Stock Option Plan, terms of Stock Option Agreement and form of Stock Option Grant Agreement thereunder
10.12	(2)	Form of Severance and Change of Control Agreement, dated September 1, 1999, entered into by JNI Corporation and each of Terry M. Flanagan, Thomas K. Gregory, Charles McKnett and Gloria Purdy
10.16	(3)	Lease dated, July 11, 2000 between Pacific Plaza Carmel Valley LLC and JNI Corporation (Building A)
10.17	(3)	Lease dated, July 11, 2000 between Pacific Plaza Carmel Valley LLC and JNI Corporation (Building B)
10.18	(4)	Asset Acquisition and Plan of Reorganization, dated July 24, 2000, among JNI Corporation, Jaymark, Inc., Jaycor, Inc. and California Tube Labratories, Inc.
10.19	(5)	Severance Agreement, dated September 13, 2000, between JNI Corporation and Terry M. Flanagan
10.20	(5)	Amendment No. 1 to Severance and Change of Control Agreement, dated September 14, 2000, between JNI Corporation and Gloria Purdy
10.21	(7)	Loan Agreement and Promissory Note between JNI and Neal Waddington, dated January 9, 2001
10.22	(8)	Secured Recourse Promissory Note between JNI and Thomas Gregory dated April 5, 2001
10.23	(8)	Stock Pledge and Security Agreement by Thomas Gregory dated April 5, 2001
10.24	(8)	Secured Recourse Promissory Note between JNI and Charles McKnett dated April 5, 2001
10.25	(8)	Stock Pledge and Security Agreement by Charles McKnett dated April 5, 2001
23.1	(1)	Consent of PricewaterhouseCoopers LLP

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.

Signature	Title	Date

/s/ NEAL WADDINGTON Neal Waddington	President, Chief Executive Officer and Director (Principal Executive Officer)	March 28, 2002
/s/ GLORIA PURDY Gloria Purdy	Chief Financial Officer (Principal Financial and Accounting Officer)	March 28, 2002
/s/ PAUL KIM Paul Kim	Vice President Finance — Corporate Controller	March 28, 2002
/s/ ERIC WENAAS Eric Wenaas	Chairman of the Board of Directors	March 28, 2002
/s/ JOHN BOLGER John Bolger	Director	March 28, 2002
/s/ JOHN STISKA John Stiska	Director	March 28, 2002
/s/ TOM ST. DENNIS Tom St. Dennis	Director	March 28, 2002
/s/ SYLVIA SUMMERS-DUBREVIL Sylvia Summers-Dubrevil	Director	March 28, 2002

		Page
Report of Independent Accountants		F-2
Balance Sheets as of December 31, 2001 and 2000		F-3
Statements of Operations for the Years Ended December 31, 2001, 2000 and 1999		F-4
Statements of Stockholders' Equity and Comprehensive Income (Loss) for the Years Ended December 31, 2001, 2000 and 1999		F-5
Statements of Cash Flows for the Years Ended December 31, 2001, 2000 and 1999		F-6
Notes to Financial Statements		F-7

In our opinion, the accompanying balance sheets and the related statements of operations, of stockholders' equity and comprehensive income (loss) and of cash flows present fairly, in all material respects, the financial position of JNI Corporation at December 31, 2001 and December 31, 2000, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with 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.

JNI Corporation

BALANCE SHEETS

(In thousands, except share and per share data)

JNI Corporation

STATEMENTS OF OPERATIONS

(In thousands, except share and per share data)

JNI Corporation

STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS)
(In thousands, except share data)

JNI Corporation

NOTES TO FINANCIAL STATEMENTS

(In thousands, except share and per share data)

JNI Corporation ("JNI" or the "Company") commenced operations in 1993 as a division of Jaycor, Inc. ("Jaycor"). In February 1997, Jaycor effected a corporate reorganization in which it formed two new corporations: Jaymark, Inc. ("Jaymark") and the Company. Jaymark became the parent of Jaycor and of the Company in that reorganization transaction. Jaycor then transferred technology and assets relating to its Fibre Channel division to Jaymark, which in turn contributed these to the Company in exchange for shares of the Company's common and preferred stock, which automatically converted into common stock upon the closing of the Company's initial public offering. In July 2000, Jaymark distributed its shares totaling 14,175,000 to its stockholders in a reorganization transaction which resulted in Jaymark's liquidation and dissolution and eliminated control of JNI by Jaymark.

The Company is a leading designer and supplier of enterprise storage connectivity products, including Fibre Channel and InfiniBand products that connect servers and data storage devices. The Company currently markets and sells a broad range of Fibre Channel host bus adapters that connect servers to storage subsystems to facilitate the integration and management of devices used in storage area networks, or SANs. The Company also designs and markets high-performance application specific integrated circuits, or ASICs, based on its proprietary Fibre Channel technology. The Company recently released its first InfiniBand products, called host channel adapter modules, that allow stand-alone servers to cluster with InfiniBand connectivity operating at 2.5 Gb or 10 Gb per port and is currently developing or designing products that will bridge InfiniBand to other storage protocols, such as Fibre Channel and iSCSI. The Company operates in one business segment.

The accompanying financial statements reflect the financial position, results of operations, changes in stockholders' equity and cash flows as if the Company was a separate entity for all periods presented. The financial statements have been prepared using the historical basis in the assets and liabilities and historical results of operations related to the Company's business. When the Company was a division of Jaycor, the cash used by the Company was funded by Jaycor. Subsequent to incorporation, the Company's cash receipts and disbursements continued to be processed by Jaycor until the Company completed its initial public offering (Note 5). Subsequent to its initial public offering, the Company commenced processing its cash receipts and disbursements.

Prior to the Company's initial public offering, general corporate overhead related to Jaymark's corporate headquarters and common support divisions have been allocated to the Company generally based on the proportion of the Company's total labor costs to the total of all of Jaymark's subsidiaries' total labor costs. Allocated charges included in operating expenses totaled $1,086 for the year ended December 31, 1999. Management believes these allocations fairly and reasonably approximate costs incurred by Jaymark on behalf of the Company's operations.

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

The Company considers cash equivalents to be only those investments which are highly liquid, readily convertible to cash and which mature within three months from the date of purchase. The carrying value of cash and cash equivalents approximates fair value due to the nature of their short-term maturities.

The Company's marketable securities consist of money markets, certificates of deposit, commercial paper, and fixed and variable A or higher graded U.S. government, state and local, and corporate debt obligations with maturities ranging from one to twenty-four months, all of which are managed by three domestic financial institutions. The Company has classified its marketable securities as "available for sale" and carries them at fair value with net unrealized holding gains and losses reported in accumulated other comprehensive income (loss).

Inventories are stated at the lower of cost (computed using standard cost, which approximates actual cost, on a first-in, first-out method) or market. Provisions, when necessary, are made to reduce excess and obsolete inventories to their estimated net realizable values.

Property and equipment are stated at cost and are depreciated over their estimated useful lives, using the straight-line method. Useful lives range from three to seven years for equipment and furniture and the shorter of the useful lives or the terms of the leases (three to ten years) for leasehold improvements. Additions to property and equipment together with major renewals and betterments are capitalized. Maintenance, repairs and minor renewals and betterments are charged to expense as incurred.

Property under capital leases is amortized over the lives of the respective leases or the estimated useful lives of the assets. Amortization expense for property acquired under capital leases is included in depreciation expense. The total accumulated amortization as of December 31, 2001 totaled $19.

The Company evaluates the carrying value of its long-lived assets when events or changes in circumstances indicate that an asset's carrying value may not be recoverable. An impairment loss is recognized when the sum of the expected future undiscounted net cash flows is less than the carrying value of the asset. An impairment loss would be measured by comparing the amount by which the carrying value exceeds the fair value of the asset being evaluated for impairment. No such losses have been identified by the Company.

Intangible assets represent certain products and technology purchased in November 1998 (Note 2) and were being amortized over their estimated useful lives of three years using the straight-line

method. At December 31, 2001, the intangible assets were fully amortized with accumulated amortization of $11,582. Accumulated amortization totaled $6,894 at December 31, 2000.

Revenue from product sales is recognized upon shipment except for sales to distributor customers that have contractual rights of return. Revenue from sales to distributors that have contractual rights of return is recognized when these distributors ship the Company's products to their end-user customers. Allowances for estimated sales returns are provided at the time revenue is recognized. The Company reserves for uncollectable accounts and warranty claims based on past history and expected future returns related to products shipped.

Revenue from our ASIC development agreements is generally recognized as the services are performed using the percentage of completion method based on costs incurred to date compared to total estimated costs at completion.

The Company's current practice is generally to warrant its adapter products against defects in materials and workmanship for a three-year period from the date of shipment and its Application Specific Integrated Circuits ("ASICs") products for a one-year period from the date of shipment. The estimated cost of warranty obligations is accrued at the time revenue is recognized.

The Company is involved in a large and continuing research and development effort that includes the continual development of new products and the improvement of existing products. All research and development costs are expensed as incurred.

The Company capitalizes eligible computer software development costs upon the establishment of technological feasibility, which is defined as completion of designing, coding and testing activities. The amount of costs eligible for capitalization, after consideration of factors such as net realizable value, have not historically been material and, accordingly, all software development costs have been charged to research and development expense as incurred in the accompanying statements of operations.

Until the consummation of the initial public offering, the Company was a member of the Jaymark affiliated group of corporations which filed a consolidated federal income tax return and certain combined and consolidated state income tax returns. Beginning October 27, 1999, the Company files its own federal and state income tax returns. Income taxes are calculated as if the Company had filed separate tax returns for federal and state purposes for all periods presented. In connection with the separation from the Jaymark consolidated tax group, the Company realized a deferred tax asset related to the transfer of certain technology from Jaymark and accounted for this as additional paid-in capital.

Current income tax expense is the amount of income taxes expected to be payable for the current year. A deferred tax asset and/or liability is computed for both the expected future impact of differences between the financial statement and tax bases of assets and liabilities and for the expected future tax benefit to be derived from tax loss and tax credit carryforwards. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be "more likely than not" realized in future tax returns. Tax rate changes are reflected in income in the period such changes are enacted.

The Company measures compensation costs related to stock option plans using the intrinsic value method and provides pro forma disclosures of net income (loss) and earnings (loss) per common share as if the fair value based method had been applied in measuring compensation costs. Accordingly, compensation cost for stock options is measured as the excess, if any, of the deemed fair value of the Company's common stock at the date of grant over the amount an employee must pay to acquire the stock and is amortized over the vesting period, generally four years.

Earnings (loss) per share is computed using the weighted average number of shares of common stock outstanding and is presented for basic and diluted earnings (loss) per share. Basic earnings (loss) per share is computed by dividing income (loss) available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per share is computed by dividing income (loss) available to common stockholders by the weighted average number of common shares outstanding during the period increased to include, if dilutive, the number of additional common shares that would have been outstanding if the potential common shares had been issued. The dilutive effect of outstanding stock options is reflected in diluted earnings (loss) per share by application of the treasury stock method. The Company has excluded all outstanding stock options from the calculation of diluted loss per share for the year ended December 31, 2001 because such securities are antidilutive for this period. The total number of potential common shares excluded from the calculations of diluted loss per common share for the year ended December 31, 2001 was 477,000.

The following table sets forth the computation of basic and diluted earnings (loss) per share:

In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, Business Combinations. SFAS No. 141 addresses financial

accounting and reporting for business combinations and supersedes APB Opinion No. 16, Business Combinations, and FASB Statement No. 38, Accounting for Preacquisition Contingencies of Purchased Enterprises. All business combinations in the scope of this Statement are to be accounted for using one method, the purchase method. The provisions of this Statement are effective for all business combinations initiated after June 30, 2001. This accounting pronouncement is not expected to have a material impact on the Company's financial position or results of operations.

In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17, Intangible Assets. It addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. This Statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. The provisions of this Statement are effective for financial statements issued for fiscal years beginning after December 15, 2001. This accounting pronouncement is not expected to have a material impact on the Company's financial position or results of operations.

In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets, supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, supersedes the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business (as previously defined in that Opinion), and amends ARB No. 51, Consolidated Financial Statements, to eliminate the exception to consolidation for a subsidiary for which control is likely to be temporary. The provisions of this Statement are effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years. This accounting pronouncement is not expected to have a material impact on the Company's financial position or results of operations.

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

In November 1998, the Company purchased certain Fibre Channel technology, products and property and equipment from Adaptec, Inc. ("Adaptec"). As consideration for the purchase, the Company issued to Adaptec 1,132,895 shares of the Company's Series A Convertible Preferred Stock with a fair value, as determined for financial reporting purposes, of approximately $1.383 per share for an aggregate purchase price of approximately $1,567. The Company also issued three series of warrants to purchase shares of the Company's Series A Convertible Preferred Stock as additional consideration to Adaptec.

On September 30, 1999, the Company and Adaptec amended the first of the Series A warrants to fix the number of shares issuable thereunder at 840,000. No shares were issuable under the second and third warrants as a result of the actual revenues earned by the Company on sales of products based on the acquired technology during the period from February 1, 1999 to the date of the Company's initial public offering. As a result of the issuance of the 840,000 warrants, additional purchase price

consideration of $10,920 was recorded on September 30, 1999. This additional purchase price was allocated to intangible assets and was fully amortized at December 31, 2001.

The 1,132,895 shares of the Company's Series A Convertible Preferred Stock converted to common stock as of the date of the Company's initial public offering. During the first quarter of 2000, Adaptec exercised its warrant to purchase 840,000 shares of the Company's common stock. Adaptec performed a net exercise of the warrant, pursuant to which the Company issued a total of 839,998 common shares to Adaptec after taking into consideration the one hundred dollar exercise price.

At December 31, 2001 and 2000, the amortized cost and estimated fair value of marketable securities available for sale were as follows:

The cost of securities sold is based on the specific identification method. Realized gains on the sale of available for sale securities during the year ended December 31, 2001 were $88. Realized losses on the sale of available for sale securities during the year ended December 31, 2000 were $41. No gains or losses were realized on the sale of available for sale securities during the year ended December 31, 1999. The Company's short-term instruments consist primarily of money markets, certificates of deposit, and commercial paper.

During October 1999, the Company completed its initial public offering for the sale of 5,635,000 shares of common stock (of which 2,800,000 shares were sold by the Company and 2,835,000 were sold by the Company's former principal stockholder, Jaymark) at a price to the public of $19.00 per share, which resulted in net proceeds to the Company of $49,476 after the payment of underwriters' commission but before the deduction of offering expenses. Upon the closing of the Company's initial public offering, all the outstanding Series A Convertible Preferred Stock was automatically converted into 17,722,895 shares of common stock.

During October 2000, the Company completed a public offering of 5,175,000 shares of common stock (of which 1,000,000 shares were sold by the Company and 4,175,000 were sold by selling stockholders) at a price to the public of $74.00 per share, which resulted in net proceeds to the Company of $69,930 after the payment of underwriters' commission but before the deduction of offering expenses.

The Board of Directors of the Company (the "Board") is authorized to issue up to 5,000,000 shares of preferred stock or other senior securities and determine the series and number of preferred shares to be issued and any related designations, powers, preferences, rights, qualifications, limitations or restrictions.

On September 19, 2001, the Board of Directors authorized the Company to repurchase up to $15,000 of its outstanding common stock in open market and private transactions over a twelve-month period ending September 18, 2002. The timing and price of stock purchases are made at the discretion of management. As of December 31, 2001, the Company had repurchased an aggregate of 900,000 shares at a cost of $5,130.

On February 1, 2001, the Board of Directors of the Company adopted a Stockholder Rights Plan (the "Plan"). Under the terms of the Plan, stockholders of record as of February 28, 2001 received a dividend of one Preferred Stock Purchase Right ("Right(s)") for each share of common stock held on that date. The Rights will expire ten years after issuance and will be exercisable only if a person or group becomes the beneficial owner of 15% or more of the common stock or commences a tender or exchange offer which would result in the offeror beneficially owning 15% or more of the common stock. Each Right will entitle stockholders to purchase one one-hundredth of a share of Series A Preferred Stock of the Company at an exercise price of $250.00 per Right.

If a person or group accumulates 15% or more of the common stock, each Right (other than Rights held by a 15% acquiror) allows the stockholder to purchase common stock having a market value of twice the exercise price of the Right. In addition, in the event of certain business combinations, the Rights allow the holders to purchase common stock of an acquiror at a 50% discount. The Board of Directors is entitled to redeem the Rights at $.001 per Right at any time prior to the public announcement of the existence of a 15% holder.

The Company has a savings plan under Section 401(k) of the Internal Revenue Code under which all employees are eligible to participate on the first day of the month following their hire date. The plan allows for a Company matching contribution (the "Match") in which employees vest one-third per year on the first through third anniversaries of their hire date. The Match is 100% of the employee's first five percentage points of salary contributed. During the years ended December 31, 2001, 2000 and 1999, the charge to operations for the Match was $703, $621 and $256, respectively.

During February 1997, the Company adopted an option plan (the "1997 Plan") which provides for the issuance of 4,396,441 shares of the Company's common stock. The 1997 Plan provides for the grant to employees and directors of the Company of incentive stock options and non-qualified stock options to purchase shares of the Company's common stock. Options granted under the 1997 Plan became exercisable upon the Company's initial public offering and have a ten year term from the date of grant.

The exercise price of all options granted under the 1997 Plan are not less than the fair market value of the Company's common stock as determined by the Board on the date of grant. As a result of the reorganization agreement with Jaymark on July 24, 2000, vesting of options granted under the 1997 Plan was accelerated to a three-year vesting period. At December 31, 2001, there were 170,362 shares of the Company's common stock available for future grant under the 1997 Plan.

In April 1999, the Company adopted a second option plan (the "1999 Plan"), as amended, which provides for the issuance of up to 3,812,800 shares of the Company's common stock. The 1999 Plan provides for the grant to employees, consultants and directors of the Company of incentive stock options and non-qualified stock options to purchase shares of the Company's common stock. Options granted under the 1999 Plan shall be exercisable at such time or upon such event and subject to the terms, conditions and restrictions as determined by the Board; provided, however, that no option shall be exercisable after ten years from the date of grant. The exercise price of all incentive stock options granted under the 1999 Plan are not less than the fair market value of the Company's common stock on the date of grant. Options granted under the 1999 Plan generally vest over a four-year period. At December 31, 2001, there were 876,549 shares of the Company's common stock available for future grant under the 1999 Plan.

In August 2000, the Company adopted a third option plan (the "2000 Plan"), which provides for the issuance of up to 1,400,000 shares of the Company's common stock. The 2000 Plan provides for the grant to employees and consultants of the Company of non-qualified stock options to purchase shares of the Company's common stock. Options granted under the 2000 Plan shall be exercisable at such time or upon such event and subject to the terms, conditions and restrictions as determined by the Board; provided, however, that no option shall be exercisable after ten years from the date of grant. Options granted under the 2000 Plan generally vest over a four-year period. At December 31, 2001, there were 4,820 shares of the Company's common stock available for future grant under the 2000 Plan. In January 2002, the Company's Board of Directors approved an increase in the number of shares that may be issued under the 2000 Plan by 1,100,000 shares, from 1,400,000 shares to 2,500,000 shares.

In February 2001, the Company's compensation committee of its Board of Directors approved a voluntary stock option exchange program for the Company's employees, officers and directors. Under the program, the Company's employees, officers and directors were given the opportunity to cancel stock options granted to them between January 2000 and December 2000 in exchange for an equal number of new options to be granted in the future, on a date more than six months after the date of cancellation of the original options. The new options were granted on August 21, 2001 with an exercise price of $6.50, which was the fair market value of the Company's common stock on that date. Cancelled options total 1,145,450 shares with an average exercise price of $57 per share.

A summary of the Company's stock option plans as of December 31, 2001, 2000 and 1999 and changes during the periods is as follows:

The following table summarizes information regarding employee stock options outstanding at December 31, 2001:

Stock-based compensation is recognized using the intrinsic value method. In connection with the grant of stock options to employees, the Company recorded unearned stock-based compensation within stockholders' equity of $1,183 during the year ended December 31, 1999, representing the difference between the estimated fair value of the common stock determined for financial reporting purposes and the exercise price of these options at the date of grant. Amortization of unearned stock-based compensation, net of any charges reversed during the period for the forfeiture of unvested options, was $433, $623 and $842 for the years ended December 31, 2001, 2000 and 1999, respectively.

At December 31, 2001, the remaining unearned stock-based compensation of approximately $166 will be fully amortized by the fourth quarter of 2002. The amount of stock-based compensation expense to be recorded in the future period could decrease if options for which accrued but unvested compensation has been recorded are forfeited.

During October 1999, the Company adopted the 1999 Employee Stock Purchase Plan (the "Purchase Plan"). A total of 262,500 shares of the Company's common stock have been reserved for issuance under the Purchase Plan. As of December 31, 2001, 246,565 shares of common stock have been issued under the Purchase Plan. The number of shares reserved for issuance under the Purchase Plan is subject to an annual increase on January 1 of each year beginning in 2001 equal to the lesser of (a) 87,500 shares, (b) 1.0% of the outstanding shares on such date or (c) a lesser amount as determined by the Board. The Purchase Plan permits eligible employees to purchase shares of common stock at a fifteen percent (15%) discount through payroll deductions during sequential 24-month offering periods. Each such offering period is divided into four consecutive six-month purchase periods. Unless the Board establishes a higher price, the price at which shares are purchased under the Purchase Plan for such offering period is equal to 85% of the lesser of the fair market value of the common stock on the first day of such offering period or the last day of the applicable purchase period within such offering period.

Had compensation cost for the Company's stock-based compensation plans been determined based on the fair value at the grant dates for awards under those plans, the Company's net income (loss) and diluted earnings (loss) per common share would have been as follows:

The fair value of each option grant was estimated as of the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants during the years ended December 31, 2001, 2000 and 1999: no dividend yield; risk-free interest rate of 4.09%, 6.03% and 5.56% and expected terms of 3.0 years, 3.3 years and 7.4 years, respectively. The volatility of the Company's common stock underlying the options was 107%, 115% and 95% during the years ended December 31, 2001, 2000 and 1999, respectively. The fair value of the employees' purchase rights pursuant to the Purchase Plan was estimated using the Black-Scholes model with the following assumptions for the years ended December 31, 2001, 2000 and 1999: no dividend yield; risk-free interest rate of 3.19%, 5.36% and 5.08%; expected term of 1.4 years, 1.3 years and 6 months and expected volatility of 104%, 97% and 95%, respectively. The weighted average fair value of those purchase rights granted in 2001, 2000 and 1999 was $7.64, $13.80 and $8.00, respectively.

The following is a reconciliation of the statutory federal income tax rate to the Company's effective tax rate:

The components of the Company's net deferred tax assets (liabilities) are as follows:

At December 31, 2001, the Company provided a valuation allowance for its net deferred tax assets because of uncertainty regarding their realizability. At December 31, 2001, the deferred tax asset includes $20,463 related to the tax benefit for the exercise of stock options. If or when recognized, the tax benefit of the deferred tax assets related to stock option exercises will be accounted for as a credit to stockholders' equity rather than as a reduction of the income tax provision.

As of December 31, 2001, the Company had federal and state net operating loss carryforwards of approximately $35,227 and $21,551 expiring from 2005 to 2021. The net operating loss includes the tax benefit related to the exercise of stock options, which benefit was recorded to additional paid-in capital. The Company also had federal and state research and development tax credit carryforwards of approximately $2,133 and $1,905, expiring from 2019 to 2021.

On January 9, 2001, the Company entered into a loan agreement with its chief executive officer in the amount of $500 which has been recorded as an other asset. Concurrent with the loan agreement, the Company's chief executive officer executed a promissory note to pay off the loan with $250 of principal and accrued interest due and payable at each anniversary date of the loan agreement or payment of all unpaid or unforgiven principal and accrued interest due upon termination of employment with the Company. The loan bears interest at a 5% rate. In the event the chief executive officer's employment with the Company is terminated without cause, all outstanding principal and interest would be forgiven. Additionally, the Company will forgive an amount equal to $250 of principal and all accrued interest on the first and second anniversary dates of the loan provided the chief executive officer is an employee of the Company on the relevant forgiveness date and has not given notice of resignation or been given notice of termination for cause. On January 9, 2002 (the first anniversary date), the Company forgave $250 of principal and $25 in accrued interest which was recorded as compensation expense during the year ended December 31, 2001. In the first quarter of 2002, the Company's chief executive officer executed a promissory note for $99 for payroll taxes which the Company paid on his behalf on January 9, 2002. The promissory note is due by April 15, 2003 and bears interest at a 5% rate.

In April 2001, the Company's chief technology officer and chief operating officer received loans from the Company in the amount of $1,200 and $400, respectively, payable in full on or before April 5, 2002, at an interest rate of 5%. In the fourth quarter of 2001, the chief operating officer paid his loan and all accrued interest in full. As of December 31, 2001, accrued interest on the chief technology officer's loan totaled $45. The remaining loan is collateralized by Company stock owned by this individual.

The Company leases its operating facilities and certain office equipment under noncancelable operating leases. The facility leases require the payment of taxes, maintenance, utilities and insurance.

Future annual minimum lease payments due under noncancelable capital and operating leases consists of the following at December 31, 2001:

Rent expense under all operating leases for the years ended December 31, 2001, 2000 and 1999 was $3,172, $1,560 and $1,002, respectively.

The Company currently occupies 85,329 square feet in San Diego, California as its corporate headquarters under a lease that expires on March 31, 2011. Additionally, the Company is committed to a five year lease for a building adjacent to its current headquarters which is 57,323 square feet. This new lease commences in June 2002 with a total commitment of approximately $8,770 which is included in the lease commitment schedule above. The Company does not intend to occupy this space and is actively seeking a tenant to sub-lease or assume the lease obligation. To the extent the Company is unable to sub-lease the space prior to the commencement of the lease term, or sub-lease rentals are below that of the lease commitment, a loss will be incurred. As of December 31, 2001 the Company has not recorded a loss provision related to this lease obligation as any potential loss cannot be reasonably estimated.

In October 2001, an alleged stockholder of the Company filed an alleged stockholder derivative lawsuit against the Company and certain present and former members of the Company's board of directors in the San Diego County Superior Court. The lawsuit alleges that during the Class Period, the present and former members of the Company's board failed to adequately oversee the activities of management and, as a result, the Company allegedly made false statements about its business and results causing its stock to trade at artificially inflated levels. Based on these allegations, the plaintiff alleges that the present and former members of the Company's board breached their fiduciary duties to the Company. The alleged stockholders filed the lawsuit without first making a demand upon the board of directors. The Company has retained counsel to defend this case. The Company believes that this case lacks merit and intends to defend the case vigorously.

The Company's products are concentrated in the storage area network industry which is highly competitive and subject to rapid technological change. The Company's revenues are concentrated with several major customers and certain vital components of the Company's products are manufactured by a small number of key suppliers. The loss of a major customer, the interruption of product supply from a contract manufacturer, a change of suppliers or a significant technological change in the industry could affect operating results adversely.

The Company sells its products to original equipment manufacturers, distribution channel customers and directly to end users and extends credit based on an evaluation of the customer's financial condition, generally without requiring collateral. Exposure to losses on receivables is principally dependent on each customer's financial condition. The Company monitors its exposure for credit losses and maintains allowances for anticipated losses.

Sales to customers outside of the United States accounted for 30%, 23% and 17% of the Company's net revenues for the years ended December 31, 2001, 2000 and 1999, respectively. In relation to the Company's net revenues, 9%, 7% and 6% were to customers located in the Asia-Pacific region and 21%, 16% and 11% were to customers located in the Europe region.

	Year Ended December 31,
	2001		2000		1999
Customer A	7	%	16	%	16	%
Customer B	7		8		11
Customer C	18		21		18
Customer D	14		13		11

In January 2002, the Company acquired an exclusive license to Troika Networks' Fibre Channel software and hardware products that provide high-availability storage area network solutions for enterprise class servers running under Windows NT, Windows 2000 and Solaris operating systems. The purchase price included an initial payment of $7,500 and contingent consideration of $3,000. The $7,500 consideration includes payment for the software license, research and development services, transition services and a covenant not to compete. The $3,000 contingent payment may be due if the Company reaches certain revenue or unit sales levels and upon completion of certain OEM certification requirements. Additionally, if the Company attains certain revenue or unit sales levels of the related products, the Company will be obligated to make royalty payments based on revenue for one year from the royalty payment start date or until June 30, 2004, whichever occurs earlier. To the extent that the Company does not achieve certain revenue or unit levels by January 1, 2004, Troika is obligated to reimburse the Company for a portion of the initial purchase price, up to $3,500. The Company is in the process of evaluating the accounting treatment for this transaction, and an independent valuation of the transaction is being performed for accounting purposes.

In January 2002, the Company invested $2,000 in Mellanox Technologies Ltd, a privately held InfiniBand semiconductor developer. This investment will be accounted for under the cost method of accounting.

	Quarter Ended
	March 31		June 30		September 30		December 31
2000
Net revenues	$	18,477		$	24,024		$	30,013		$	30,667
Gross margin		11,130			14,136			17,812			18,053
Operating income		1,620			3,155			5,918			5,277
Net income	$	1,324		$	2,292		$	4,353		$	6,287
Net income per share	$	0.05		$	0.09		$	0.16		$	0.22
2001
Net revenues	$	21,142		$	23,057		$	18,080		$	13,485
Gross margin		12,554			5,986			10,499			7,129
Operating loss		(973	)		(9,336	)		(3,259	)		(5,007	)
Net income (loss)	$	301		$	(7,854	)	$	(1,989	)	$	(3,982	)
Net income (loss) per share	$	0.01		$	(0.29	)	$	(0.07	)	$	(0.15	)

Our audits of the financial statements referred to in our report dated February 4, 2002 appearing in the 2001 Annual Report to the Stockholders on Form 10-K of JNI Corporation also included an audit of the financial statement schedule listed in Item 14(a)(2) of this Form 10-K. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related financial statements.

				Year Ended December 31,
				2001			2000		1999			1998			1997
				(In thousands, except per share data)
Statement of Operations Data:
	Net revenues			$	75,764		$	103,181	$	40,171		$	12,189		$	2,903
	Cost of revenues				39,596			42,050		15,402			5,361			1,252

		Gross margin			36,168			61,131		24,769			6,828			1,651
	Operating expenses:
		Research and development			24,564			18,918		11,951			2,919			1,202
		Selling and marketing			15,995			12,323		4,806			1,526			681
		General and administrative			9,063			7,938		3,476			1,698			822
		Amortization of intangible assets			4,688			5,359		1,506			47			—
		Amortization of stock-based compensation			433			623		842			35			—

			Total operating expenses		54,743			45,161		22,581			6,225			2,705

	Operating income (loss)				(18,575	)		15,970		2,188			603			(1,054	)
	Interest income				5,051			2,908		352			—			—
	Interest expense				—			—		(455	)		(265	)		(130	)

	Income (loss) before income taxes				(13,524	)		18,878		2,085			338			(1,184	)
	Income tax provision (benefit)				—			4,622		(673	)		27			—

	Net income (loss)			$	(13,524	)	$	14,256	$	2,758		$	311		$	(1,184	)

Earnings (loss) per common share:
	Basic			$	(0.50	)	$	0.61	$	0.64		$	0.74		$	(2.82	)

	Diluted			$	(0.50	)	$	0.53	$	0.12		$	0.02		$	(2.82	)

Number of shares used in per share computations:
	Basic				26,938			23,541		4,285			420			420
	Diluted				26,938			27,009		23,789			17,977			420
Balance Sheet Data:
	Cash, cash equivalents and marketable securities			$	118,022		$	116,445	$	44,829		$	—		$	—
	Working capital				97,194			142,446		49,346			(1,830	)		(923	)
	Total assets				151,872			178,094		72,825			7,814			1,900
	Due to affiliate				—			—		—			3,061			1,950
	Stockholders' equity (deficit)				141,228			156,689		65,222			1,173			(740	)

		JNI CORPORATION
		March 28, 2002
		By:		/s/ NEAL WADDINGTON Neal Waddington President, Chief Executive Officer and Director

			December 31,
			2001			2000
ASSETS
Current assets:
	Cash and cash equivalents		$	4,490		$	4,095
	Marketable securities available for sale			82,974			112,350
	Accounts receivable, net			8,605			21,635
	Inventories			9,270			19,262
	Other current assets			1,968			6,509

		Total current assets		107,307			163,851
	Marketable securities available for sale			30,558			—
	Property and equipment, net			13,371			8,995
	Intangible assets, net			—			4,688
	Other assets			636			560

			$	151,872		$	178,094

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
	Accounts payable		$	2,769		$	9,126
	Accrued liabilities			5,448			7,575
	Deferred revenue			1,896			4,704

		Total current liabilities		10,113			21,405
Other liabilities				531			—

		Total liabilities		10,644			21,405

Commitments and Contingencies (Notes 9 and 10)
Stockholders' equity:
	Preferred stock, undesignated series, 5,000,000 shares authorized; none issued			—			—
	Common stock, par value $.001 per share; 100,000,000 shares authorized; 26,574,873 and 25,551,749 shares issued and outstanding			27			26
	Additional paid-in capital			145,854			143,610
	Unearned stock-based compensation			(166	)		(665	)
	Accumulated other comprehensive income			455			6
	Retained earnings			188			13,712
	Common stock in treasury, at cost — 900,000 shares in 2001			(5,130	)		—

		Total stockholders' equity		141,228			156,689

			$	151,872		$	178,094

			Year Ended December 31,
			2001			2000		1999
Net revenues			$	75,764		$	103,181	$	40,171
Cost of revenues				39,596			42,050		15,402

		Gross margin		36,168			61,131		24,769

Operating expenses:
	Research and development			24,564			18,918		11,951
	Selling and marketing			15,995			12,323		4,806
	General and administrative			9,063			7,938		3,476
	Amortization of intangible assets			4,688			5,359		1,506
	Amortization of stock-based compensation			433			623		842

		Total operating expenses		54,743			45,161		22,581

Operating income (loss)				(18,575	)		15,970		2,188
Interest income				5,051			2,908		352
Interest expense — affiliate				—			—		(455	)

Income (loss) before income taxes				(13,524	)		18,878		2,085
Income tax provision (benefit)				—			4,622		(673	)

		Net income (loss)	$	(13,524	)	$	14,256	$	2,758

Earnings (loss) per share:
	Basic		$	(0.50	)	$	0.61	$	0.64

	Diluted		$	(0.50	)	$	0.53	$	0.12

Number of shares used in per share computations:
	Basic			26,938,000			23,541,000		4,285,000
	Diluted			26,938,000			27,009,000		23,789,000

	Convertible Preferred Stock, Series A
						Common Stock										Accumulated Other Comprehensive Income (Loss)
						Common Stock				Additional Paid-In Capital			Unearned Stock-Based Compensation						Retained Earnings (Deficit)			Treasury Stock			Total Stockholders' Equity			Comprehensive Income (Loss)
	Shares		Amount			Shares		Amount		Additional Paid-In Capital			Unearned Stock-Based Compensation						Retained Earnings (Deficit)			Treasury Stock			Total Stockholders' Equity			Comprehensive Income (Loss)
Balance—December 31, 1998	17,722,895		$	18		420,000		$	—	$	5,427		$	(970	)	$	—		$	(3,302	)	$	—		$	1,173
Issuance of warrants											10,920															10,920
Stock-based compensation											1,183			(341	)											842
Issuance of common stock in IPO, net of issuance costs						2,800,000			3		48,049															48,052
Conversion of convertible preferred stock into common stock	(17,722,895	)		(18	)	17,722,895			18																	—
Common stock options exercised						895,784			1		151															152
Unrealized gain (loss) on marketable securities																	(23	)								(23	)	$	(23	)
Tax benefit from stock option transactions											490															490
Tax benefit from technology transfer from parent											858															858
Net income																				2,758						2,758			2,758

Balance—December 31, 1999	—			—		21,838,679			22		67,078			(1,311	)		(23	)		(544	)		—			65,222			2,735

Exercise of warrants by Adaptec						839,998			1																	1
Stock-based compensation														646												646
Common stock options exercised						1,789,409			2		3,047															3,049
Common stock issued under Employee Stock Purchase Plan						83,663					1,381															1,381
Unrealized gain (loss) on marketable securities																	29									29			29
Tax benefit from stock option transactions											3,187															3,187
Issuance of common stock in public offering, net of issuance costs						1,000,000			1		68,917															68,918
Net income																				14,256						14,256			14,256

Balance—December 31, 2000	—			—		25,551,749			26		143,610			(665	)		6			13,712			—			156,689			14,285

Stock-based compensation											(66	)		499												433
Common stock options exercised						1,760,222			1		1,111															1,112
Common stock issued under Employee Stock Purchase Plan						162,902					1,199															1,199
Unrealized gain (loss) on marketable securities																	449									449			449
Repurchase of common stock						(900,000	)																(5,130	)		(5,130	)
Net loss																				(13,524	)					(13,524	)		(13,524	)

Balance — December 31, 2001	—		$	—		26,574,873		$	27	$	145,854		$	(166	)	$	455		$	188		$	(5,130	)	$	141,228		$	(13,075	)

			As of December 31,
			2001			2000
Accounts receivable:
	Accounts receivable		$	9,431		$	22,461
	Less allowance for doubtful accounts			(826	)		(826	)

		Total	$	8,605		$	21,635

			As of December 31,
			2001		2000
Inventories:
	Raw materials		$	6,566	$	14,149
	Work in process			1,299		2,260
	Finished goods			1,405		2,853

		Total	$	9,270	$	19,262

			As of December 31,
			2001			2000
Property and equipment, net:
	Computer and test equipment		$	17,893		$	10,177
	Leasehold improvements			831			706
	Office furniture and other equipment			3,416			1,869

				22,140			12,752
Less accumulated depreciation and amortization				(8,769	)		(3,757	)

		Total	$	13,371		$	8,995

			As of December 31,
			2001		2000
Accrued liabilities:
	Payroll and payroll related costs		$	3,128	$	4,447
	Other			2,320		3,128

		Total	$	5,448	$	7,575

	December 31, 2001
	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value
U.S. government and agency debt	$	16,497	$	175	$	(102	)	$	16,570
State, municipal, and county government debt.		45,663		—		—			45,663
Corporate debt		35,552		376		—			35,928
Short-term instruments		15,371		—		—			15,371

	$	113,083	$	551	$	(102	)	$	113,532

		OPTIONS OUTSTANDING			OPTIONS EXERCISABLE
Exercise prices	Number Outstanding	Weighted average remaining contractual life (years)	Weighted average exercise price		Number Exercisable	Weighted average exercise price
December 31, 2001:
$0.17	120,300	6.94	$	0.17	84,425	$	0.17
$0.71 — $6.95	1,775,647	9.62		6.32	252,831		6.26
$7.05 — $11.80	801,997	8.68		9.66	160,819		10.42
$12.06 — $19.84	863,477	8.76		13.78	128,015		15.22
$20.19 — $35.44	250,750	8.80		25.84	46,185		29.34
$39.00 — $69.00	299,924	8.50		54.77	112,297		53.71

$0.17 — $69.00	4,112,095	9.05	$	13.08	784,572	$	16.07

			December 31,
			2001			2000
Deferred tax assets:
	Net operating loss carryforwards		$	13,166		$	9,432
	Research and development credit carryforwards			3,390			2,396
	Allowances and reserves			4,387			1,602
	Accrued payroll and payroll related costs			334			290
	Intangible assets			4,379			2,976
	Deferred revenue			745			1,848
	Depreciation			315			—
	Other			723			569

		Total deferred tax assets	$	27,439		$	19,113
Deferred tax liabilities:
	Deferred costs		$	(353	)	$	(622	)
	Depreciation		$	—		$	(357	)

		Net deferred tax asset		27,086			18,134
		Less valuation allowance		(27,086	)		(18,134	)

			$	-		$	—

Years Ending December 31,		Capital Leases			Operating Leases
2002		$	190		$	3,923
2003			253			4,614
2004			253			4,674
2005			63			4,541
2006			—			4,478
Thereafter			—			13,021

	Total minimum lease payments	$	759		$	35,251

Amount representing interest			(81	)

Obligations under capital leases			678
Obligations due within one year			(147	)

Long-term obligations under capital leases		$	531

		Balance at Beginning of Period	Charged to Costs and Expenses	Deductions Taken Against Allowance	Balance at End of Period
Allowance For Doubtful Accounts:
	Year Ended December 31, 1999	133	416	54	495
	Year Ended December 31, 2000	495	677	346	826
	Year Ended December 31, 2001	826	—	—	826

		Year Ended December 31,
		2001			2000			1999
Current:
	Federal	$	—		$	7,618		$	619
	State		—			854			1

			-			8,472			620

Deferred:
	Federal		(4,284	)		(3,170	)		(1,008	)
	State		(2,339	)		(680	)		(285	)

			(6,623	)		(3,850	)		(1,293	)
Change in valuation allowance			6,623			—			—

		$	-		$	4,622		$	(673	)