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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-24765
HI/FN, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 33-0732700
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
750 UNIVERSITY AVENUE, LOS GATOS, CALIFORNIA 95032
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 399-3500
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $0.001 PAR VALUE
(TITLE OF CLASS)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the Registrant as of December 11, 2000: $336,068,886 based upon the closing
price reported for such date on the NASDAQ National Market System. For purposes
of this disclosure, shares of Common Stock held by persons who hold more than 5%
of the outstanding shares of Common Stock and shares held by officers and
directors of the Registrant have been excluded in that such persons may be
deemed to be affiliates. This determination of affiliate status is not
necessarily conclusive.
The number of shares outstanding of the Registrant's Common Stock as of
December 11, 2000, was 10,079,353.
DOCUMENTS INCORPORATED BY REFERENCE
Parts of the Proxy Statement for Registrant's 2001 Annual Meeting of
Shareholders to be held February 23, 2001 (the "Proxy Statement") are
incorporated by reference into Part III of this Form 10-K Report.
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
With the exception of historical facts, the statements contained in this
Annual Report on Form 10-K are forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), and are
subject to the safe harbor provisions created by such statutes. Certain
statements contained in the following Management's Discussion and Analysis of
Financial Condition and Results of Operations, including, without limitation,
statements containing the words "believes," "anticipates," "estimates,"
"expects," and words of similar import, constitute forward-looking statements
that involve risks and uncertainties. Such statements are based on current
expectations and are subject to risk, uncertainties and changes in condition,
significance, value and effect, including those discussed under the heading
Trends and Uncertainties within the section of this report entitled "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations" and reports filed by Hifn with the Securities and Exchange
Commission, specifically Forms 8-K, 10-Q and S-8. Such risks, uncertainties and
changes in condition, significance, value and effect could cause our actual
results to differ materially from those anticipated events. Although we believe
that the assumptions underlying the forward-looking statements are reasonable,
any of the assumptions could prove inaccurate, including, but not limited to,
statements as to our future operating results and business plans. We disclaim
any intention or obligation to update or revise any forward-looking statements,
whether as a result of new information, future events or otherwise.
PART I
ITEM 1. BUSINESS
OVERVIEW
hi/fn, inc., together with its subsidiary, (the "Company" or "Hifn") is a
flow classification and network security specialist company supplying most major
network equipment vendors ("NEVs") with patented technology to improve network
packet processing. Hifn designs, develops and markets high-performance,
multi-protocol packet processors -- semiconductor devices designed to enable
secure, high-bandwidth network connectivity, comprehensive differentiation of
business-critical application network traffic from other general purpose network
traffic and efficient compression, encryption/compression and public key
cryptography, providing its customers with high-performance, interoperable
implementations of a wide variety of industry-standard networking and storage
protocols. Hifn's products are used in networking and storage equipment such as
routers, remote access concentrators, switches, broadband access equipment,
network interface cards, firewalls and back-up storage devices.
Hifn's encryption/compression and public key processors allow network
equipment vendors to add bandwidth enhancement and security capabilities to
their products. Hifn's encryption/compression and public key processors provide
key algorithms used in virtual private networks ("VPNs"), which enable
businesses to reduce wide area networking costs by replacing dedicated
leased-lines with lower-cost IP-based networks such as the Internet. Using VPNs,
businesses can also provide trading partners and others with secure,
authenticated access to the corporate network, increasing productivity through
improved communications. Storage equipment vendors use Hifn's compression
processor products to improve the performance and capacity of mid- to high-end
tape back-up systems.
Hifn's flow classification technology enables network equipment vendors to
add unique traffic differentiation capabilities to their products. Hifn's flow
classification solutions provide precise details about packets and data
traversing a network and is used in deploying quality of service ("QoS") and
classes of service ("CoS"), which enables businesses to enhance the
effectiveness of using the public Internet network. Using QoS- or CoS-enabled
network equipment, businesses can maintain more consistent and reliable
interactions with their customers and business partners.
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INDUSTRY BACKGROUND
The dramatic growth in business use of Internet technology has resulted in
the ability to make information available to anyone, from anywhere and at any
time. An increasingly mobile workforce, increased telecommuting and the need to
connect branch offices, customers, suppliers and other business partners to the
corporate network, have stressed the capabilities of existing network and
storage infrastructures. To deliver on the economic promise of Internet
technology as a business tool, Hifn believes that corporations require three
critical capabilities: secure, high-bandwidth network connectivity among
geographically dispersed constituents, increased services related directly to
business-critical functions and applications, and efficient storage of business
information.
THE NEED FOR ENHANCED BANDWIDTH AND SECURITY IN CORPORATE NETWORKS
Data traffic over local and wide area networks ("LANs" and "WANs") is
growing at an unprecedented pace, forcing corporate network managers to upgrade
their network architectures to meet these demands. Traditional solutions
businesses utilize to meet these means include leased-line connections to
branch/remote offices and dial-up Integrated Services Digital Network (ISDN)
(e.g. analog modem, broadband or cable access devices, Digital Subscriber Line
(DSL)) connections to support mobile workers and telecommuters. As businesses
migrate from using traditional solutions toward using the public Internet the
need to differentiate between business-critical functions and general use of the
public Internet becomes vital.
THE HIFN SOLUTION
Hifn is a flow classification and network security specialist company
supplying most major NEVs with patented technology to improve network packet
processing. Hifn designs, develops and markets high-performance, multi-protocol
packet processors -- semiconductor devices designed to enable secure, high-
bandwidth network connectivity, comprehensive differentiation of
business-critical application network traffic from other general purpose network
traffic and efficient compression, encryption/compression and public key
cryptography, providing its customers with high-performance, interoperable
implementations of a wide variety of industry-standard networking and storage
protocols. Hifn believes that its patented compression technology comprises the
fundamental know-how for the design and implementation of low-cost,
high-performance implementations of lossless data compression and gives its
products a strong competitive advantage. By offering a wide range of
high-performance implementations of its patented, standards-compliant
technology, Hifn is able to sell products to network and storage equipment
vendors that allow them to reduce development costs and get their products to
market faster.
Hifn's patented Lempel-Ziv-Stac compression technology ("LZS") is
incorporated into several networking protocol standards, including
Point-to-Point Protocol ("PPP") and the frame relay protocol, allowing network
equipment vendors to rapidly integrate proven solutions for mitigating the costs
associated with traditional private leased-line network architectures. The
Microsoft Point-to-Point ("MPPC") implementation of Hifn's patents, developed by
Microsoft, is incorporated into the PPP and Point-to-Point Tunneling Protocol
("PPTP") implementations of the Windows 95, 98, ME, NT and 2000 operating
systems. Hifn offers high-performance compression processors that implement LZS
and MPPC. Hifn also licenses software implementations of LZS and MPPC to
industry-leading network equipment vendors for use in their networking products.
In support of emerging VPN architectures, Hifn has led the industry by
introducing the first network security processors, integrating the critical
functions of compression, encryption and data authentication in compliance with
the Internet Protocol Security ("IPSec") protocol. This integration allows
network equipment vendors to add highly-integrated, high-performance VPN
capabilities to their routers, remote access concentrators, switches, broadband
access equipment and firewalls. Hifn also licenses a complete and portable
software implementation of the IPSec protocol, allowing network vendors to get
to market more quickly with their VPN implementations at a fraction of the cost
of internal software development efforts.
Businesses are increasingly dependent upon the public Internet in
conducting their normal business operations. Unlike the traditional
telecommunications network used by businesses communicate, the public
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Internet is vastly more complex and unreliable. In addition, there is currently
an overall lack of differentiation or prioritization of business-critical
functions from general use of the Internet. Rather, these functions are bundled
together and use the same resources throughout the public Internet. Hifn's flow
classification solutions enable the integration of precise differentiation and
measurement of business-critical transactions within NEV devices. This feature
allows the creation of differentiated services within the public Internet.
Hifn's line of compression processors targeted at back-up storage
applications provides storage equipment vendors high-performance implementations
of Hifn's patented compression technology, doubling the capacity and performance
of mid-to high-end tape drive systems. The LZS implementation of Hifn's patents
is used in the Digital Linear Tape ("DLT") tape drive products from Quantum. The
Adaptive Lossless Data Compression ("ALDC") implementation of Hifn's patents,
developed by IBM, is used in a variety of tape storage products, including the
Travan style of quarter-inch cartridge tape drives.
ACQUISITION
Hifn's acquisition of flow classification technology enhances its offering
of network packet processing products, enabling its NEVs to add unique traffic
differentiation capabilities to their products. In August 2000, Hifn completed
its acquisition of Apptitude, Inc. ("Apptitude"), a provider of embedded
Internet traffic analysis solutions. The transaction was achieved through a
merger of Apptitude with and into a wholly-owned subsidiary of Hifn. In
connection with the acquisition, Hifn issued an aggregate 972,362 shares of
common stock to the shareholders of Apptitude. Hifn assumed all outstanding
options of Apptitude and provided for the issuance of 230,540 shares of Hifn
common stock upon exercise of such options. Hifn further provided for the
issuance of an additional 456,612 Hifn shares relating to stock options granted
to Apptitude employees for retention purposes. The acquisition resulted in a
$4.1 million write-off of in-process research and development in the fourth
quarter of fiscal 2000.
In addition to the tangible assets and liabilities assumed with the
acquisition of Apptitude, Hifn also acquired the following intangible assets:
- Developed and core technology. Developed and core technology was
comprised of all technology used in the existing products of Apptitude at
the time of the acquisition and which had reached technological
feasibility. This includes Apptitude's MeterFlow and MeterWorks products.
- In-process research and development. Apptitude was in the process of
developing its MeterFlow application specific integrated circuit ("ASIC")
product and, as this product was not developed at the time of the
acquisition, was determined to be in-process technology.
- Workforce. Apptitude's workforce consisted primarily of highly
skilled engineers with specialized experience in flow classification and
traffic analysis. This workforce has been valued as an intangible asset of
the acquisition as it would be difficult and expensive to recreate.
- Patents. As of the acquisition date, Apptitude had pending patent
applications for its existing products. Value was allocated to such patents
as it was determined that the patents were for the developed and core
technologies of Apptitude for which future revenue streams are expected.
CUSTOMERS AND PRODUCTS
A number of leading manufacturers of network and storage equipment have
designed products that incorporate Hifn's products. To date, Hifn has secured
several design wins with networking and storage equipment vendors. To qualify as
a design win, an equipment vendor must have ordered samples of Hifn's packet
processors or an evaluation board and initiated a product design that
incorporates Hifn's packet processors. During the design-in process, Hifn works
with each customer, providing training on Hifn's products, assisting in
resolving technical questions and providing price and delivery information to
assist the customer in getting its products into volume production. There can be
no assurance that any of the design wins secured by Hifn will result in demand
for Hifn's products. See "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Trends and Uncertainties -- Our
Business
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Depends Upon The Development Of The Packet Processor Market" and "-- We Face
Risks Associated With Evolving Industry Standards And Rapid Technological
Change."
At September 30, 2000, Hifn had a backlog of semiconductor orders
representing $18.0 million of products deliverable to customers over the 6
months following the placement of these orders. Because Hifn quotes product lead
times to customers of approximately three months, most products shipped during a
quarter are ordered during the previous quarter. Since customers may reschedule
or cancel orders, subject to negotiated windows, orders scheduled for shipment
in a quarter may be moved to a subsequent quarter or cancelled altogether.
Therefore, backlog is not necessarily indicative of future sales.
Hifn's products -- compression processors, encryption/compression
processors, public key processors, flow classification software -- provide a
broad range of price/performance alternatives for the implementation of
intelligent, secure, high-performance networks and efficient, high-performance
tape storage devices. Hifn also offers evaluation boards to assist customers in
the evaluation of Hifn's products.
Network Bandwidth Enhancement Products. Hifn's 9710, 9711 and 9751
high-performance compression processors provide essential bandwidth-enhancement
for network equipment such as routers, remote access concentrators, broadband
access equipment and switches. These products provide flexible bus interfaces
and a variety of memory configuration options to allow customers to tailor their
uses to meet a variety of network system requirements. Hifn licenses a line of
software compression libraries that provide similar functionality to its line of
compression processor products for low-performance applications such as modems
and ISDN links. The software products are offered in source and object code
toolkits.
Network Security Products. The Hifn 6500 public key processor provides
acceleration of the mathematical computations involved in public key
cryptography, supporting key exchange algorithms (such as the Rivest Shamir
Adelman ("RSA") public key cryptosystem as developed by RSA Data Security, Inc.
and Diffie-Hellman) as well as digital signature algorithms (such as RSA and the
Digital Signature Algorithm ("DSA")). Hifn's 7711, 7751, 7811 and 7851
high-performance encryption processors provide essential bandwidth-enhancement
and security for network equipment such as routers, remote access concentrators,
switches and firewalls. The 7711, 7751, 7811 and 7851 provide a flexible bus
interface and a variety of memory configuration options to allow adaptation to
meet a variety of network system requirements. The 7711 and 7751 are
pin-compatible with the 9711 and 9751 compression processors, respectively,
providing customers with an easy upgrade path from compression to
encryption/compression. Hifn also licenses a portable, source code
implementation of the IPSec protocol. For data communication applications such
as xDSL and cable modems, the Hifn 7901 and 7951 provide the industry's first
complete broadband security processors implementing support of data compression,
encryption and authentication algorithms. In addition, the 7901 and 7951 also
include a public key math processor and a true hardware random number generator
(RNG) to support the public key cryptography required for key generation,
exchange and authentication. Both allow the customer to reduce chip count and
design time by offering a glueless interface to well known bus interfaces. The
7901 comes equipped with a glueless interface to the Motorola MPC850/860
processors, and the 7951 has a PCI Revision 2.1-compliant interface allowing
direct connection to a PCI-based system.
Network Flow Classification Products. Hifn's MeterFlow software provides
comprehensive data to support the differentiation of business-critical
application network traffic from other general-purpose network traffic.
MeterFlow provides additional information on the performance of these
application transactions and flows in network equipment devices to support the
deployment of Integrated and Differentiated Services. These functions are the
key to enabling QoS and CoS in routers, switches and network security
appliances.
Storage Enhancement Products. Hifn's 9600, 9610 and 9732 high-performance
compression processors provide a typical doubling of capacity and performance
for mid-to high-end tape drive products.
Evaluation Boards. To facilitate the adoption of its semiconductor devices,
Hifn designs system-level boards that resemble actual end-products or
subsystems. Hifn's evaluation boards include basic hardware and software that
enable customers to expedite their designs by using the evaluation boards as a
reference or by incorporating portions of them into their own designs. These
boards are used as evaluation and development vehicles for each semiconductor
device designed by Hifn.
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TECHNOLOGY
Hifn's multi-protocol packet processors are high-performance compression,
encryption/compression, public key and flow classification processors that have
been designed to meet the needs of networking and storage equipment vendors.
Hifn believes that its patented compression technology, employed in its
compression and encryption/compression processors, gives it a strong competitive
advantage. In addition to core technologies that Hifn has developed, Hifn
enhances the features and functionality of its products through the licensing of
certain technologies from third parties.
Compression Algorithms and Architectures. Hifn is the holder of key patents
that cover a wide variety of lossless compression algorithms and their
implementations. Specific implementations of Hifn's compression patents include
the following compression algorithms: LZS, developed by Stac; MPPC, developed by
Microsoft; and ALDC, developed by IBM. Hifn has continued to improve the
performance, functionality and architectures of these compression techniques.
For example, semiconductor implementations of the LZS algorithm have improved in
performance by a factor of 40 in under four years. Through the use of various
architectural implementations of its compression algorithms, Hifn is able to
provide compression solutions over a broad price-performance spectrum.
Encryption, Data Authentication and Public Key Algorithms. Hifn develops
high-performance implementations of industry standard encryption algorithms
(e.g., Digital Encryption Standard ("DES"), Triple-DES and Alternative Rivest
Chiper 4 ("ARC4")) and data authentication algorithms (e.g., Message Digest 5
("MD5") and Secure Hash Algorithm ("SHA1")). Coupled with its patent position in
compression, Hifn is positioned to combine compression with encryption and data
authentication as specified in the most widely used network security protocols,
such as IPSec and PPTP. In addition, Hifn also implements public key
cryptography algorithms which are used in a wide variety of network security
protocols. Public key cryptography algorithms implemented by Hifn include the
RSA-compatible and Diffie-Hellman algorithms as well as the RSA-compatible and
DSA digital signature algorithms. Hifn's semiconductor products, including the
RSA-compatible public key cryptosystem and the ARC4 and Alternative Rivest
Cipher 5 ("ARC5") symmetric key encryption algorithms are compatible with RSA
Data Security, Inc.'s Rivest Chiper ("RC")4 and RC5 algorithms.
Flow Classification and Measurement Architectures. In August 2000, Hifn
extended its reach into the packet processing area through the acquisition of
Apptitude. Hifn has incorporated Apptitude's flow classification technology into
a software solution for network equipment vendors. This technology has six
patents pending that cover the ability to discover applications within the
content of network packets and flows. MeterFlow, Hifn's flow classification
technology, enables network equipment vendors to add unique traffic
differentiation capabilities to their products. Hifn's flow classification
solutions provide precise details about packets and data traversing a network
and are used in deploying quality of service ("QoS") and classes of service
("CoS"), which enables businesses to enhance the effectiveness of using the
public Internet network. Using QoS- or CoS-enabled network equipment, businesses
can maintain more consistent and reliable interactions with their customers and
business partners.
Integrated, High-Performance Packet Processing. Hifn is continuing to
develop additional packet processing functionality, including the implementation
of public key encryption algorithms and increased integration of
computation-intensive security protocol processing functions. Performance
improvements of Hifn's packet processing functions are expected to support
gigabit speeds in the future.
INTELLECTUAL PROPERTY
Hifn's future success and ability to compete are dependent, in part, upon
its proprietary technology. Hifn relies in part on patent, trade secret,
trademark, maskwork and copyright laws to protect its intellectual property.
Hifn owns 12 United States patents and four foreign patents. Hifn also has two
pending patent applications in Japan. The issued patents and patent applications
primarily cover various aspects of Hifn's compression technology and have
expiration dates ranging from 2006 to 2013. In addition to compression, Hifn has
six pending patent applications in the United States, four in Europe and Asia
(Japan) covering its flow classification technology. There are 2 pending patent
applications in the United States covering Hifn's
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bandwidth management and rate shaping technology. There can be no assurance that
any patents will be issued under Hifn's current or future patent applications or
that the patents issued under such patent applications will not be invalidated,
circumvented or challenged. There can be no assurance that any patents issued to
Hifn will be adequate to safeguard and maintain Hifn's proprietary rights, to
deter misappropriation or to prevent an unauthorized third party from copying
Hifn's technology, designing around the patents owned by Hifn or otherwise
obtaining and using Hifn's products, designs or other information. In addition,
there can be no assurance that others will not develop technologies that are
similar or superior to Hifn's technology.
As is typical in the semiconductor industry, Hifn may in the future receive
communications from third parties asserting patents, mask work rights,
intellectual property or copyrights on certain of Hifn's products and
technologies. Although Hifn is not currently a party to any material litigation
regarding intellectual property, in the event a third party were to make a valid
intellectual property claim and a license relating to such intellectual property
was not available on commercially reasonable terms, Hifn's operating results
could be materially and adversely affected. Litigation, which could result in
substantial cost to Hifn and diversion of its resources, may also be necessary
to enforce patents or other intellectual property rights of Hifn or to defend
Hifn against claimed infringement of the rights of others. The failure to obtain
necessary licenses or the occurrence of litigation relating to patent
infringement or other intellectual property matters could have a material
adverse effect on Hifn's business and operating results. There can be no
assurance that the steps taken by Hifn to protect its intellectual property will
be adequate to prevent misappropriation or that others will not develop
competitive technologies or products.
In addition, Hifn claims copyright protection for certain proprietary
software and documentation. Hifn attempts to protect its trade secrets and other
proprietary information through agreements with its customers, suppliers,
employees and consultants, and through other security measures. Although Hifn
intends to protect its rights vigorously, there can be no assurance that these
measures will be successful. In addition, the laws of certain countries in which
Hifn's products are or may be manufactured or sold may not protect Hifn's
products and intellectual property.
EXPORT RESTRICTIONS ON ENCRYPTION ALGORITHMS
A key element of Hifn's packet processor architecture is the encryption
algorithms embedded in its semiconductor and software products. These products
are subject to export control regulations administered by the U.S. Department of
Commerce. The regulations permit Hifn's domestic network equipment customers to
export non-military specific products incorporating Hifn's encryption technology
only after the finished product has received a one-time technical review from
the Department of Commerce. In addition, those U.S. export control laws prohibit
the export of many products, including any products with encryption, to a number
of countries deemed hostile by the U.S. government (currently there are nine
such countries). Furthermore, U.S. government regulations require export
licenses from the Department of State for all military-specific products.
U.S. export regulations have recently been liberalized to allow for the
export of most encryption hardware, software, and technology to foreign
non-government entities after the product receives a one-time technical review
from the Commerce Department. The technical review process generally takes 30
days from the date the government logs the application into its computer system.
In addition, the U.S. government now allows U.S. exporters to immediately ship
products to both government and non-government end-users in the European Union
and eight other friendly countries ("EU + 8") immediately upon submission of the
required technical review paperwork. If exports to government end-users are
required to countries outside of the EU + 8 group, an individual export license
is required from the Department of Commerce. As a result of the recent
liberalizations, Hifn's network equipment customers may be able to effectively
compete with EU competitors. However, foreign competitors facing less stringent
controls and who may have effectively established markets for their products
prior to the relaxation of U.S. export restrictions may be able to compete more
effectively than Hifn's network equipment customers in the global market.
Furthermore, U.S. regulations are constantly changing and there is no assurance
that the liberalizing trends will continue, that the list of products and
countries for which export approval is required, or the regulatory policies with
respect thereto, will not be revised from time to time, or that laws limiting
the domestic use of encryption will not be enacted. The sale of Hifn's packet
processors could be
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hindered or harmed by the failure of Hifn's network equipment customers to
obtain the required technical reviews or by the costs of compliance. See "Sales,
Marketing & Technical Support."
COMPETITION
The networking and storage equipment markets into which Hifn sells its
products are intensely competitive and are subject to frequent product
introductions with improved price-performance characteristics, rapid
technological change, unit price erosion and the continued emergence of new
industry standards. The semiconductor industry is also intensely competitive and
is characterized by rapid technological change, product obsolescence and unit
price erosion. Hifn expects competition to increase in the future from existing
competitors and from companies that may enter Hifn's existing or future markets,
including certain customers, with similar or substitute solutions that may be
less costly or provide better performance or features than Hifn's products. To
be successful in the future, Hifn must continue to respond promptly and
effectively to changing customer performance, feature and pricing requirements,
technological change and competitors' innovations. There can be no assurance
that Hifn will be able to compete successfully against current and future
competitors or that competitive pressures faced by Hifn will not materially
adversely affect Hifn's business, financial condition and results of operations.
Hifn's products compete with products from companies such as Analog
Devices, Inc., Safenet, Inc., International Business Machines ("IBM"), Broadcom
Corporation, Motorola, Inc. and Philips Corporation. In 1994, Stac entered into
two license agreements with IBM where Stac granted IBM the right to use, but not
sublicense, Hifn's patented compression technology in IBM hardware and software
products. Stac also entered into a license agreement with Microsoft in 1994
whereby Stac granted Microsoft the right to use, but not sublicense, Hifn's
compression technology in their software products. Stac's license agreement with
Microsoft, however, prohibits Microsoft from creating hardware implementations
of Hifn's patents. Hifn also competes against software solutions that use
general purpose microprocessors to run encryption algorithms and Hifn's software
compression libraries. In addition, as noted above, Hifn's
encryption/compression and public key processors are subject to export control
restrictions administered by the U.S. Department of Commerce, which permit
Hifn's network equipment customers to export products incorporating encryption
technology only after receiving a one-time technical review. As a result of
these regulations, sales by foreign competitors facing less stringent controls
on their encryption products could hinder or harm the sale of Hifn's
encryption/compression and public key processors to network equipment customers
in the global market. We believe that the recent change to the U.S. export
regulations will enable Hifn and its network equipment customers to obtain
comparable footing with its European competitors. However, Hifn expects
significant future competition from major domestic and international
semiconductor suppliers. Several established electronics and semiconductor
suppliers have recently entered or indicated an intent to enter the network
equipment market. Hifn may also face competition from suppliers of products
based on new or emerging technologies. Furthermore, many of Hifn's existing and
potential customers internally develop ASICs, general purpose microprocessors
and other devices which attempt to perform all or a portion of the functions
performed by Hifn's products.
Many of Hifn's current and potential competitors have longer operating
histories, greater name recognition, access to larger customer bases and
significantly greater financial, technical, marketing and other resources than
Hifn. As a result, they may be able to adapt more quickly to new or emerging
technologies and changes in customer requirements or to devote greater resources
to the promotion and sale of their products than Hifn. In particular, companies
such as Intel Corporation, Lucent Technologies Inc., Motorola, National
Semiconductor Corporation and Texas Instruments Incorporated have proprietary
semiconductor manufacturing ability, preferred vendor status with many of Hifn's
customers, extensive marketing power and name recognition, greater financial
resources than Hifn and other significant advantages over Hifn. In addition,
current and potential competitors may determine, for strategic reasons, to
consolidate, to lower the price of their products substantially or to bundle
their products with other products. Current and potential competitors have
established or may establish financial or strategic relationships among
themselves or with existing or potential customers, resellers or other third
parties. Accordingly, it is possible that new competitors or alliances among
competitors could emerge and rapidly acquire significant market share. There can
be no
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assurance that Hifn will be able to compete successfully against current and
future competitors. Increased competition may result in price reductions,
reduced gross margins and loss of market share, any of which could materially
adversely affect Hifn's business, financial condition and results of operations.
Hifn believes that important competitive factors in its markets are
price-performance characteristics, rapid technological change, the continued
emergence of new industry standards, length of development cycle, design wins
with major network and storage equipment vendors, support for new network and
storage standards, features and functionality, adaptability of products to
specific applications, reliability, technical service and support and protection
of products by effective utilization of intellectual property laws. The failure
of Hifn to successfully develop products that compete successfully with those of
other suppliers in the market would harm Hifn's business, financial condition
and results of operations. In addition, Hifn must compete for the services of
qualified distributors and sales representatives. To the extent that Hifn's
competitors offer such distributors or sales representatives more favorable
terms on a higher volume of business, such distributors or sales representatives
may decline to carry, or discontinue carrying, Hifn's products. Hifn's business,
financial condition and results of operations could be harmed by any failure to
maintain and expand its distribution network. See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Trends and Uncertainties -- Our Markets Are Highly Competitive."
RESEARCH AND DEVELOPMENT
Hifn's success will depend to a substantial degree upon its ability to
develop and introduce in a timely fashion new products and enhancements to its
existing products that meet changing customer requirements and emerging industry
standards. Hifn has made and plans to continue to make substantial investments
in research and development. Extensive product development input is obtained
from customers and through Hifn's participation in industry organizations and
standards setting bodies such as the Internet Engineering Task Force ("IETF").
As of September 30, 2000, Hifn's research and development staff consisted
of 78 employees. Hifn's research and development expenditures were $14.6 million
in the fiscal year ended September 30, 2000, $8.0 million in the fiscal year
ended September 30, 1999 and $5.4 million in the fiscal year ended September 30,
1998, representing 33%, 19% and 25% of revenues for such periods, respectively.
Research and development expenses primarily consist of salaries and related
costs of employees engaged in ongoing research, design and development
activities, costs of fabricating chip mask sets and subcontracting costs.
Research and development costs in fiscal 2000 also includes amortization of
deferred stock compensation related to the acquisition of Apptitude. Hifn
performs its research and product development activities at its facilities in
Los Gatos, California and Carlsbad, California. Hifn is seeking to hire
additional skilled development engineers.
The acquisition of Apptitude in August 2000 enables Hifn to expand its
product base to include acceleration for firewall applications, bandwith
management, load balancing and QoS. In addition, also in August 2000, Hifn
purchased unique traffic flow control technology to further enhance the bandwith
management features of Apptitude's technology.
In April 1998, Hifn acquired a software implementation of the IPSec
protocol from CyLAN Technologies, Inc. As part of the acquisition, Hifn gained
expertise in the development of software implementations of a wide range of
networking protocol functions, including IPSec and Transmission Control
Protocol/Internet Protocol ("TCP/IP").
Hifn's future performance depends on a number of factors, including its
ability to identify emerging technological trends in its target markets, develop
and maintain competitive products, enhance its products by adding innovative
features that differentiate its products from those of its competitors, bring
products to market on a timely basis at competitive prices, properly identify
target markets and respond effectively to new technological changes or new
product announcements by others. In evaluating new product decisions, Hifn must
anticipate well in advance the future demand for product features and
performance characteristics, as well as available supporting technologies,
manufacturing capacity, industry standards and competitive product offerings. No
assurance can be given that Hifn's design and introduction schedules for any
additions and enhancements to its existing and future products will be able to
be sold at prices that are favorable to Hifn.
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Hifn must also continue to make significant investments in research and
development in order to continue enhancing the performance and functionality of
its products to keep pace with competitive products and customer demands for
improved performance, features and functionality. The technical innovations
required for Hifn to remain competitive are inherently complex and require long
development cycles. Such innovations must be completed before developments in
networking technologies or standards render them obsolete and must be
sufficiently compelling to induce network and storage equipment vendors to favor
them over alternative technologies. Moreover, Hifn must generally incur
substantial research and development costs before the technical feasibility and
commercial viability of a product line can be ascertained.
There can be no assurance that revenues from future products or product
enhancements will be sufficient to recover the development costs associated with
such products or enhancements or that Hifn will be able to secure the financial
resources necessary to fund future development. The failure to successfully
develop new products on a timely basis could have a material adverse effect on
Hifn's business, financial condition and results of operations. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Trends and Uncertainties -- We Face Risks Associated With Evolving
Industry Standards And Rapid Technological Change."
SALES, MARKETING & TECHNICAL SUPPORT
Hifn markets its products through a direct sales and marketing
organization, headquartered in Los Gatos, California, with sales offices in
Massachusetts, Colorado, North Carolina and Quebec, Canada, and through
independent contract sales representatives in the United States, Europe, Japan
and other areas. Hifn also retains account managers to focus on individual
customer relationships. Hifn does not have any foreign operations and sales of
its products to foreign companies, other than product shipments to contract
manufacturers of domestic customers, have not been material. Sales
representatives are selected for their understanding of the marketplace and
their ability to provide effective field sales support for Hifn's products.
Hifn's relationships with some of its sales representatives have been
established within the last year, and Hifn is unable to predict the extent to
which some of these representatives will be successful in marketing and selling
Hifn's products.
Sales to U.S. customers account for the substantial majority of Hifn's
revenues. Due to the export controls imposed until recently on encryption
products by the U.S. government, Hifn's shipments to international customers has
been limited to compression processors and compression software. The recent
relaxation of controls has opened new opportunities for Hifn product sales
around the world. Earlier in the year, Hifn entered into a distribution
agreement with a worldwide electronics distribution company which Hifn believes
provides it with the ability to respond to significant pent-up demand for
network security products around the world. Hifn continues to actively work with
its network equipment customers and the U.S. government to comply with U.S.
export controls to facilitate the export of Hifn's customer's products which
incorporate Hifn's encryption products. There can be no assurance that Hifn will
be successful in these efforts and that competitors outside of the U.S. will not
develop encryption products to meet the needs of Hifn's customers, thereby
reducing the opportunity for Hifn to sell its products. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Trends and Uncertainties -- Our Products Are Subject To Export
Restrictions."
Hifn has a number of marketing programs designed to inform network and
storage equipment vendors about the capabilities and benefits of Hifn's
products. Hifn's marketing efforts include participation in industry trade
shows, technical conferences, preparation of competitive analyses, sales
training, publication of technical and educational articles in industry
journals, maintenance of Hifn's website, advertising and direct mail
distribution of Hifn literature.
Technical support to customers is provided through field and factory
applications engineers and, if necessary, product designers. Local field support
is provided in person or by telephone. Hifn believes that providing customers
with comprehensive product service and support is critical to maintaining a
competitive position in the market and is critical to shortening the time
required to design in Hifn's products. Hifn works
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with its customers to monitor the performance of its product designs and to
provide support at each stage of customer product development.
MANUFACTURING
Currently, Hifn subcontracts all of its semiconductor manufacturing on a
turnkey basis, with Hifn's suppliers delivering fully assembled and tested
products based on Hifn's proprietary designs. The use of the fabless model
allows Hifn to focus substantially all of its resources on determining customer
requirements and on the design, development and support of its products. This
model allows Hifn to have significantly reduced capital requirements.
Hifn subcontracts its semiconductor manufacturing to Atmel Corporation,
Motorola and Toshiba Corporation. The selection of these manufacturers was based
on the breadth of available technology, quality, manufacturing capacity and
support for design tools used by Hifn. None of Hifn's products is currently
manufactured by more than one supplier. However, Hifn expects that in the event
one of Hifn's suppliers notifies Hifn that it intends to cease manufacturing a
product, Hifn will have an adequate opportunity to order sufficient quantities
of the affected products so that shipments to customers will not be adversely
affected while Hifn qualifies a new manufacturer.
At any given time, Hifn uses mainstream processes for the manufacture of
its products, avoiding dependence on the latest process technology available.
This approach reduces Hifn's technical risks and avoids the risks related to
production capacity constraints typically associated with leading-edge
semiconductor processes. This approach allows Hifn to focus on providing
differentiated functionality, the primary value-add in Hifn's products. Hifn's
current main products are manufactured using .6, .4, .3 and .25 micron
Complementary Metal Oxide Semiconductor ("CMOS") processes. Products under
development are being designed with the .18 micron CMOS process. Hifn believes
that transitioning its products to increasingly smaller semiconductor dimensions
will be important for Hifn to remain competitive. No assurance can be given that
future process migration will be achieved without difficulty.
Hifn intends to continue for the foreseeable future to rely on its
subcontract manufacturers for substantially all of its manufacturing, assembly
and test requirements. All of Hifn's subcontract manufacturers produce products
for other companies. Hifn does not have long-term manufacturing agreements with
any of its subcontract manufacturers. Hifn's subcontract manufacturers are not
obligated to supply products to Hifn for any specific period, in any specific
quantity or at any specific price, except as may be provided in a particular
purchase order that has been accepted by one of its subcontract manufacturers.
Hifn must place orders approximately 20 to 23 weeks in advance of expected
delivery. As a result, Hifn has only a limited ability to react to fluctuations
in demand for its products, which could cause Hifn to have an excess or a
shortage of inventory of a particular product. Failure of worldwide
semiconductor manufacturing capacity to rise along with a rise in demand could
result in Hifn's subcontract manufacturers allocating available capacity to
customers that are larger or have long-term supply contracts in place. The
inability of Hifn to obtain adequate foundry capacity at acceptable prices, or
any delay or interruption in supply, could reduce Hifn's product revenue or
increase Hifn's cost of revenue and could harm Hifn's business, financial
condition and results of operations. See "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Trends and
Uncertainties -- We Depend Upon Independent Manufacturers And Limited Sources Of
Supply."
EMPLOYEES
As of September 30, 2000 Hifn employed a total of 134 full-time employees.
Of the total number of employees, 78 were employed in research and development,
30 in sales and marketing, nine in operations and 17 in finance and
administration. Hifn's employees are not represented by any collective
bargaining agreement and Hifn has never experienced a work stoppage. Hifn
believes its employee relations are good.
Hifn's future success is heavily dependent upon its ability to hire and
retain qualified technical, marketing, sales and management personnel. The
competition for such personnel is intense, particularly for
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engineering personnel with related security, networking and integrated circuit
design expertise, and applications support personnel with networking product
design expertise. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Trends and Uncertainties -- We Depend
Upon Key Personnel."
ITEM 2. PROPERTIES
Hifn's corporate and technical headquarters are located in Los Gatos,
California. Hifn leases approximately 27,000 square feet of space in Los Gatos,
California under a seven-year lease which expires in August 2005. Hifn also
leases other facilities including a design and operations center in Carlsbad,
California and small field sales offices in Charlotte, North Carolina and
Westford, Massachusetts as well as in Monument, Colorado and Quebec, Canada.
These facilities occupy an aggregate of approximately 7,000 square feet. In
conjunction with the acquisition of Apptitude, Hifn assumed a facility lease for
approximately 19,000 square feet of office and manufacturing space in San Jose,
California. The lease expires in March 2001.
In October 2000, the Company entered into a new seven-year lease
arrangement for additional 11,500 square feet of space in Los Gatos, California.
The lease expires in December 2007. Also in October 2000, Hifn entered into a
21 1/2 month lease agreement for the expansion of its design and operations
center in Carlsbad, California. The lease expires in June 2002.
ITEM 3. LEGAL PROCEEDINGS
In October and November 1999, six purported class action complaints were
filed in the United States District Court for the Northern District of
California against the Company and certain of its officers and directors. These
complaints were consolidated into In re Hi/fn Sec. Litig., No. 99-04531 SI. The
consolidated complaint was filed on behalf of a class of purchasers of the
Company's stock during the period July 26, 1999 through October 7, 1999 (the
"class period"). The complaint seeks unspecified money damages and allege that
the Company and certain of its officers and directors violated federal
securities laws in connection with various public statements made by the Company
and certain of its officers and directors during the class period. In August
2000, the Court dismissed the complaint as to all defendants, other than Raymond
J. Farnham and the Company. Mr. Farnham and the Company answered the complaint
in September 2000. Discovery has commenced. No trial date has been scheduled.
The Company believes that the allegations contained in the complaint are without
merit and intends to defend the action vigorously. Due to the nature of the
allegations, management cannot estimate the possible loss, if any, or range of
loss that may ultimately be incurred in connection with the allegations.
However, based on the facts currently known, management does not believe that
these matters will have a material adverse effect on the financial position of
the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
PRICE RANGE OF COMMON STOCK
The Common Stock has been quoted on the Nasdaq National Market under the
symbol "HIFN" since December 16, 1998, the date upon which Stac, Hifn's former
parent company, consummated the dividend distribution of the Common Stock to
Stac stockholders. The following table lists quarterly information on the price
range of the Common Stock based on the high and low reported closing bid prices
for the Common Stock as reported on the Nasdaq National Market for the periods
indicated below:
HIGH LOW
---- ---
FISCAL YEAR ENDED SEPTEMBER 30, 2000:
First Quarter............................................. $112 1/2 $35 9/16
Second Quarter............................................ 100 39 1/2
Third Quarter............................................. 61 7/16 27 9/16
Fourth Quarter............................................ 74 1/16 42 3/8
FISCAL YEAR ENDED SEPTEMBER 30, 1999:
First Quarter............................................. $ 24 $17 1/2
Second Quarter............................................ 39 7/8 22 1/2
Third Quarter............................................. 76 1/8 37
Fourth Quarter............................................ 145 3/16 65 3/8
On December 11, 2000, the reported last sale price of Common Stock on the
Nasdaq National Market was $43 15/16 per share. As of December 11, 2000, there
were approximately 418 holders of record of our Common Stock.
DIVIDEND POLICY
Hifn has never declared or paid any dividends on its capital stock. Hifn
intends to retain any future earnings to finance the growth and development of
its business and does not expect to pay any cash dividends in the foreseeable
future.
RECENT SALES OF UNREGISTERED SECURITIES
On August 11, 2000, in connection with our acquisition of Apptitude, we
issued 972,362 shares of our Common Stock and options to purchase 250,540 shares
of our Common Stock to the security holders of Apptitude in exchange for all
outstanding securities of Apptitude. In addition, we reserved an additional
456,612 shares of Common Stock for options granted to Apptitude employees for
retention purposes. We obtained a permit for the issuance of these securities
after a fairness hearing conducted by the California Department of Corporations,
and therefore, this transaction is exempt from registration under the Securities
Act of 1933 pursuant to Section 3 (a)(10) of the Securities Act of 1933.
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ITEM 6. SELECTED FINANCIAL DATA
The selected financial data of Hifn as of and for each of the three fiscal
years ended September 30, 2000, have been derived from Hifn's audited financial
statements as included herein. The selected financial data of Hifn as of and for
the fiscal years ended September 30, 1997 and 1996 have been derived from
audited financial statements not included herein. Hifn operated as a division of
its parent company Stac, until September 30, 1996 and as a subsidiary of Stac
until December 16, 1998. The financial information may not reflect Hifn's future
performance or the future financial position or results of operations of Hifn,
nor does it provide or reflect data as if Hifn had actually operated as a
separate, stand-alone entity during all of the periods covered. The following
selected financial data should be read in conjunction with the "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Consolidated Financial Statements and Notes included elsewhere in this
Annual Report on Form 10-K.
YEAR ENDED SEPTEMBER 30,
---------------------------------------------------
2000 1999 1998 1997 1996
------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
STATEMENT OF OPERATIONS DATA(2):
Net revenues............................. $44,838 $42,351 $21,533 $14,226 $12,894
Cost of revenues......................... 10,004 10,498 6,525 4,762 5,095
------- ------- ------- ------- -------
Gross profit............................. 34,834 31,853 15,008 9,464 7,799
Operating expenses:
Research and development............... 14,577 8,022 5,346 2,985 1,641
Sales and marketing.................... 8,172 5,963 3,370 2,224 1,677
General and administrative............. 5,147 2,993 2,407 1,203 889
Amortization of intangibles and
goodwill............................ 1,619 113 57 -- --
Purchased in-process research &
development......................... 4,085 -- -- -- --
------- ------- ------- ------- -------
Income from operations................... 1,234 14,762 3,828 3,052 3,592
Interest income (expense), net........... 4,211 1,720 17 16 --
Other income (expense), net.............. (66) (14) -- -- --
Provision for income taxes............... 4,381 6,587 1,627 1,235 1,441
------- ------- ------- ------- -------
Net income............................... $ 998 $ 9,881 $ 2,218 $ 1,833 $ 2,151
======= ======= ======= ======= =======
Net income per share, basic.............. $ 0.11 $ 1.22 $ 0.35 $ 0.30 $ 0.36
Net income per share, diluted............ $ 0.10 $ 1.06 $ 0.33 $ 0.30 $ 0.36
Weighted average shares outstanding,
basic.................................. 9,017 8,115 6,308 6,100 6,000
Weighted average shares outstanding,
diluted................................ 10,055 9,295 6,800 6,174 6,000
SEPTEMBER 30,
--------------------------------------------------
2000 1999 1998 1997 1996
-------- ------- ------- ------ ------
(IN THOUSANDS)
BALANCE SHEET DATA (1):
Cash and short-term investments........... $ 64,815 $70,086 $ 4,084 $ 480 $ --
Total assets.............................. 131,479 83,530 16,611 5,898 2,611
Working capital (deficit)................. 66,498 73,153 4,723 3,520 (383)
Total debt................................ 27 -- -- -- --
Total stockholders' equity................ 124,191 76,049 6,952 4,622 --
- ---------------
(1) The balance sheet prior to September 30, 1997 reflect Hifn's structure as a
division of Stac prior to its formation as a subsidiary of Stac. Periods
subsequent to September 30, 1996 reflect the net assets contributed by Stac
in establishing the Hifn subsidiary. The transfer was recorded at the
historical net book value of the transferred assets and liabilities. In
exchange for the net assets contributed to Hifn, Stac received 6,000,000
shares of Series A Preferred Stock and 100 shares of Common Stock of Hifn.
The
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6,000,000 shares of Series A Preferred Stock were converted into 6,000,000
shares of Common Stock of Hifn prior to the spin-off of Hifn from Stac on
December 16, 1998. For the period prior to fiscal 1997, net income generated
by Hifn has been treated as if it were transferred to Stac in the form of
dividends. No such transfers were made for fiscal 1997 and the periods
presented thereafter. See Note 1 to the Consolidated Financial Statements.
(2) In August 2000, Hifn completed its acquisition of Apptitude in a transaction
accounted for as a purchase. The Statement of Operations for fiscal year
ended September 30, 2000 include the operating results of Apptitude from the
date of acquisition.
On March 31, 1999 the Company issued 1,600,000 shares of common stock at a
price of $33 per share in an equity offering, which raised approximately $49.2
million, net of offering expenses. On April 19, 1999 the Company's underwriters
exercised their option to purchase an additional 300,000 shares of the Company's
common stock, which yielded an additional $9.3 million in proceeds to the
Company.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
Consolidated Financial Statements and Notes included elsewhere in this Annual
Report on Form 10-K. The results shown in this report are not necessarily
indicative of the results to be expected in any future periods. This discussion
contains forward-looking statements based on current expectations which involve
risks and uncertainties. Actual results and the timing of certain events may
differ significantly from those projected in such forward-looking statements due
to the factors set forth in the section entitled "Trends and Uncertainties" and
appearing elsewhere in this report.
OVERVIEW
Hifn is a flow classification and network security specialist company
supplying most major NEVs with patented technology to improve network packet
processing. Hifn designs, develops and markets high-performance, multi-protocol
packet processors -- semiconductor devices designed to enable secure, high-
bandwidth network connectivity, comprehensive differentiation of business
critical application network traffic from other general purpose network traffic
and efficient compression, encryption/compression and public key cryptography,
providing its customers with high-performance, interoperable implementations of
a wide variety of industry-standard networking and storage protocols. Hifn's
products are used in networking and storage equipment such as routers, remote
access concentrators, switches, broadband access equipment, network interface
cards, firewalls and back-up storage devices.
Hifn's encryption/compression and public key processors allow network
equipment vendors to add bandwidth enhancement and security capabilities to
their products. Hifn's encryption/compression and public key processors provide
key algorithms used in VPNs, which enable businesses to reduce wide area
networking costs by replacing dedicated leased-lines with lower-cost IP-based
networks such as the Internet. Using VPNs, businesses can also provide trading
partners and others with secure, authenticated access to the corporate network,
increasing productivity through improved communications. Storage equipment
vendors use Hifn's compression processor products to improve the performance and
capacity of mid- to high-end tape back-up systems.
Hifn's flow classification technology enables network equipment vendors to
add unique traffic differentiation capabilities to their products. Hifn's flow
classification solutions provide precise details about packets and data
traversing a network and is used in deploying QoS and CoS, which enables
businesses to enhance the effectiveness of using the public Internet network.
Using QoS- or CoS-enabled network equipment, businesses can maintain more
consistent and reliable interactions with their customers and business partners.
Revenues from one customer and its manufacturing subcontractor represented
36%, 45% and 61% of the Company's net revenues for fiscal years ended September
30, 2000, 1999 and 1998, respectively. Revenues from another customer and its
manufacturing subcontractors represented 35% and 38% of the Company's net
revenues for fiscal years ended September 30, 2000 and 1999, respectively.
In August 2000, Hifn completed its acquisition of Apptitude, a provider of
embedded Internet traffic analysis solutions. The transaction was achieved
through a merger of Apptitude with and into a wholly-owned subsidiary of Hifn.
In connection with the acquisition, Hifn issued an aggregate 972,362 shares of
common stock to the shareholders of Apptitude. Hifn assumed all outstanding
options of Apptitude and provided for the issuance of 230,540 shares of Hifn
common stock upon exercise of such options. Hifn further provided for the
issuance of 456,612 additional Hifn shares relating to stock options granted to
Apptitude employees for retention purposes. The acquisition resulted in a $4.1
million write-off of in-process research and development in the fourth quarter
of fiscal 2000.
In addition to the tangible assets and liabilities assumed with the
acquisition of Apptitude, Hifn also acquired the following intangible assets:
- Developed and core technology. Developed and core technology was
comprised of all technology used in the existing products of Apptitude at
the time of the acquisition and which had reached technological
feasibility. This includes Apptitude's MeterFlow and MeterWorks products.
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- In-process research and development. Apptitude was in the process of
developing its MeterFlow ASIC product and, as this product was not
developed at the time of the acquisition, was determined to be in-process
technology.
- Workforce. Apptitude's workforce consisted primarily of highly
skilled engineers with specialized experience in flow classification and
traffic analysis. This workforce has been valued as an intangible assets of
the acquisition as it would be difficult and expensive to recreate.
- Patents. As of the acquisition date, Apptitude had pending patent
applications for its existing products. Value was allocated to such patents
as it was determined that the patents were for the developed and core
technologies of Apptitude for which future revenue streams are expected.
The Company's quarterly and annual operating results are affected by a wide
variety of factors that could materially and adversely affect net sales, gross
margins and operating income. These factors include the volume and timing of
orders received, changes in the mix of proprietary and second source products
sold, market acceptance of the Company's and its customers' products,
competitive pricing pressures, the Company's ability to introduce new products
on a timely basis, the timing and extent of research and development expenses,
fluctuations in manufacturing yields, cyclical semiconductor industry
conditions, the Company's access to advanced process technologies and the timing
and extent of process development costs. Historically in the semiconductor
industry, average selling prices of products have decreased over time. If the
Company is unable to introduce new products with higher margins, maintain its
product mix between proprietary and second source products, or reduce
manufacturing cost to offset decreases in the prices of its existing products,
then the Company's operating results will be adversely affected. The Company's
business is characterized by short-term orders and shipment schedules, and
customer orders typically can be canceled or rescheduled without penalty to the
customer. Since most of the Company's backlog is cancelable without penalty, the
Company typically plans its production and inventory levels based on internal
forecasts of customer demand. Customer demand remains highly unpredictable and
variances to the forecast can fluctuate substantially. In addition, because of
high fixed costs on the semiconductor industry, the Company is limited in its
ability to reduce costs quickly in response to any revenue shortfalls. As a
result of the foregoing or other factors, the Company has experienced and may in
the future experience material adverse fluctuations in its operating results on
a quarterly or annual basis, which have in the past and would in the future
materially affect the Company's business, financial condition and results of
operations.
Prior to December 16, 1998, Hifn was a majority-owned subsidiary of Stac,
Inc. ("Stac"). On December 16, 1998, Stac distributed all of Hifn's outstanding
shares held by Stac to Stac stockholders.
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RESULTS OF OPERATIONS
The following table sets forth certain statement of operations data as a
percentage of total revenue for the periods indicated:
YEAR ENDED SEPTEMBER 30,
------------------------
2000 1999 1998
---- ---- ----
Net revenues................................................ 100% 100% 100%
Cost of revenues............................................ 22 25 30
--- --- ---
Gross profit................................................ 78 75 70
--- --- ---
Operating expenses:
Research and development.................................. 33 19 25
Sales and marketing....................................... 18 14 16
General and administrative................................ 11 7 11
Amortization of intangibles and goodwill.................. 4 -- --
Purchased in-process research & development............... 9 -- --
--- --- ---
Total operating expenses.................................... 75 40 52
--- --- ---
Income from operations...................................... 3 35 18
Interest and other income (expense), net.................... 9 4 --
--- --- ---
Income before income taxes.................................. 12 39 18
Provision for income taxes.................................. 10 16 8
--- --- ---
Net income.................................................. 2% 23% 10%
=== === ===
YEARS ENDED SEPTEMBER 30, 2000, 1999 AND 1998
Net Revenues. Revenue from sales of semiconductors and licenses of software
libraries increased 6% in fiscal 2000 to $44.8 million compared to $42.4 million
in fiscal 1999. In fiscal 1999, revenue increased 97% compared to $21.5 million
in fiscal 1998. The increase in revenue in fiscal 2000 from fiscal 1999 was
primarily due to increasing sales of Hifn's data compression and encryption
processors to network equipment manufacturers. The increase in revenue in fiscal
1999 compared to the prior year was due primarily to increased sales of Hifn's
data compression processors to original equipment manufacturer ("OEM") providers
of storage devices and manufacturers of networking equipment. Semiconductor
sales to Quantum, an OEM producer of high-performance tape storage devices,
through its manufacturing subcontractor, comprised 36%, 45% and 61% of revenue
in each of fiscal years 2000, 1999 and 1998, respectively. Semiconductor sales
to Lucent, an OEM producer of networking equipment, through its manufacturing
subcontractors, comprised 35% and 38% of revenue in fiscal years 2000 and 1999,
respectively.
Gross Margin. Gross margin was 78% in fiscal 2000, 75% in fiscal 1999 and
70% in fiscal 1998. The increase in gross margin in fiscal 2000 as compared to
fiscal 1999 was due primarily to a shift in the mix of the Company's revenues
with a higher percentage of networking products as compared to the prior year
coupled with a decrease in product costs in most of the company's product lines.
The increase in gross margin in fiscal 1999 from that of fiscal 1998 was due
primarily to the higher percentage of products that combine compression and
encryption. The combined compression and encryption products tend to command
higher gross margins than the products which only offer the compression
function.
Research and Development. Research and development expenses were $14.6
million, or 33% of revenues, in fiscal 2000, $8.0 million, or 19% of revenues,
in fiscal 1999 and $5.3 million, or 25% of revenues, in fiscal 1998. Research
and development expenses increased 82% in fiscal 2000 and 50% in fiscal 1999
from fiscal 1998. The increase in research and development costs in each
successive period was due to increases in labor, benefits, office administration
and depreciation costs related to the addition of personnel, including engineers
acquired from Apptitude in fiscal 2000, and retention of outside contractors
used to develop new products which combine data compression and data encryption
for the network security markets and to develop additional products for the
storage market. In addition, amortization of deferred stock compensation related
to the acquisition of Apptitude also contributed to the increase in research and
development expense in
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fiscal 2000 as compared to fiscal 1999. Hifn expects its investments in research
and development to increase in coming periods on an absolute basis as it
continues to develop products targeted at meeting market needs. However, there
can be no assurance that product development programs invested in by Hifn will
be successful or timely, or that products resulting from such programs will
achieve market acceptance.
Sales and Marketing. Sales and marketing expenses were $8.2 million, or 18%
of revenues, in fiscal 2000, $6.0 million, or 14% of revenues, in fiscal 1999
and $3.4 million, or 16% of revenues, in fiscal 1998. The increase in sales and
marketing expenses in fiscal 2000 over fiscal 1999 was primarily due to
increased costs related to increased headcount, commissions and outside services
to support marketing efforts. The increase in sales and marketing expenses in
fiscal 1999 over those of fiscal 1998 resulted from the addition of sales and
marketing personnel and program costs intended to increase customer awareness of
Hifn's products.
General and Administrative. General and administrative expenses were
approximately $5.1 million, or 11% of revenues, in fiscal 2000, $3.0 million, or
7% of revenues, in fiscal 1999 and $2.4 million, or 11% of revenues, in fiscal
1998. The increase in general and administrative expenses in fiscal 2000 as
compared to fiscal 1999 is mainly due to higher salaries and benefits costs as
well as office administration and depreciation costs as a result of increased
headcount. Additionally, increased legal and accounting costs and amortization
of deferred stock compensation related to the Apptitude acquisition contributed
to the increase. General and administrative expenses increased in fiscal 1999
over those of fiscal 1998 primarily as a result of the addition of executive
management personnel and increased legal and accounting costs. Legal and
accounting costs for the fiscal years ended 2000, 1999 and 1998 were $810,000,
$703,000 and $130,000, respectively.
Amortization of Intangibles and Goodwill. Amortization of intangibles and
goodwill in fiscal 2000 of $1.6 million, or 4% of revenues, was a result of the
acquisition of Apptitude and other intellectual property. Amortization of
intangibles of $113,000 and $57,000 in fiscal 1999 and 1998, respectively,
related to the acquired technology from CyLAN.
Purchased In-Process Research and Development. Purchased in-process
research and development ("IPR&D") related to the acquisition of Apptitude was
$4.1 million or 9% of revenues. Purchased IPR&D relates to the value assigned to
Apptitude's MeterFlow ASIC product which had not reached technological
feasibility at the time of the acquisition.
Interest and Other Income (Expense), Net. Interest and other income
(expense), net for fiscal 2000 were $4.1 million, or 9% of revenues, as compared
to $1.7 million, or 4% of revenues, in fiscal 1999. The increase was primarily a
result of interest income earned on the net proceeds of $58.5 million raised in
an equity offering of 1,900,000 shares of common stock in March and April 1999.
Income Taxes. The Company recorded an income tax provision of $4.4 million
in fiscal 2000 at an effective rate of 81%. In fiscal 1999, the Company recorded
an income tax provision of $6.6 million at an effective rate of 40% compared to
$1.6 million in fiscal 1998 at an effective rate of 42%. The increase in the
effective rate for fiscal 2000 was due to the non-deductibility of certain
acquisition-related costs incurred during fiscal 2000. The decrease in the
effective tax rate in fiscal 1999 as compared to fiscal 1998 was due to the
non-deductibility of certain spin-off related costs incurred during fiscal 1998.
For the period up to December 16, 1998 and for fiscal 1998, deferred income
taxes and related tax expense have been allocated to Hifn by applying the asset
and liability approach as if Hifn were a separate taxpayer. Under this approach,
a deferred income tax liability or asset, net of valuation allowance, is
established for the expected future consequences resulting from the differences
between the financial reporting and income tax basis of assets and liabilities
and from net operating loss and credit carryforwards. Deferred income tax
expense or benefit represents the net change during the year in the deferred
income tax liability or asset. Income taxes currently payable are deemed to have
been remitted by Stac on behalf of Hifn in the period that the liability arose.
Income taxes currently receivable are deemed to have been received by Stac in
the period that a refund could have been recognized by Hifn, had Hifn been a
separate taxpayer. Amounts due to or from Hifn and Stac for income tax payments
and refunds are included in the related party receivable and payable components
of the balance sheet.
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LIQUIDITY AND CAPITAL RESOURCES
From inception until the spin-off from Stac in December 1998, Hifn depended
upon Stac for financing its operations and capital requirements. In November
1996, Hifn and Stac entered into an Assignment, Assumption and License Agreement
(the "Assignment Agreement") which provided for the transfer of Stac's
semiconductor business to Hifn in exchange for 6,000,000 shares of Series A
Preferred Stock and 100 shares of Common Stock of Hifn. Concurrent with the
transfer of the semiconductor business, Hifn and Stac also entered into a Cross
License Agreement under which Hifn granted Stac a limited, worldwide, perpetual,
non-exclusive, non-transferable, royalty-free license to the patents transferred
by Stac to Hifn under the Assignment Agreement.
Operating Activities. In fiscal 2000, the Company generated cash from
operating activities of approximately $14.9 million comprised of net income as
adjusted for non-cash items including purchased in-process research and
development of $4.1 million, amortization of intangibles and deferred stock
compensation of $3.0 million, deferred income taxes of $1.9 million,
depreciation and amortization costs of $1.1 million and tax benefit from
employee stock plans of $5.2 million as well as a decrease in accounts
receivable of $1.4 million. These adjustments were offset mainly by decreases in
income taxes payable of $1.3 million and in accrued expenses and other
liabilities of $1.7 million. In fiscal 1999, the Company generated cash from
operating activities of approximately $9.0 million, principally attributable to
net income from operations, increases in taxes payable of $1.3 million and
accrued and other liabilities of $2.2 million, offset by increases in accounts
receivable of $3.6 million and inventory of $1.4 million.
Financing Activities. Cash used in investing activities in fiscal 2000 was
$27.5 million, primarily for the acquisition of Apptitude and the purchase of
intellectual property aggregating $20.1 million, the purchase of short-term
investments of $5.1 million and the acquisition of $1.8 million in property and
equipment. During fiscal 1999, the Company generated $6.0 million from the sale
of marketable securities and invested $1.7 million in the acquisition of
property and equipment. Hifn expects capital expenditures in the foreseeable
future to remain at approximately the same levels.
Investing Activities. Cash provided by financing activities in fiscal 2000
of $2.1 million reflects proceeds from the issuance of common stock for stock
option exercises and stock purchase plan of $2.2 million slightly offset by
payments on debt obligations.
On September 28, 1998, Stac paid $4.4 million to Hifn, representing payment
in full for all amounts due to Hifn from Stac as of September 1, 1998. Stac also
loaned $5.0 million to Hifn under a short-term loan that became due and payable
on September 30, 1999, but which could be prepaid in whole or part without
penalty. The loan accrued interest at the prime rate set by Silicon Valley Bank
plus 0.5% per annum, payable quarterly, and was secured by a first priority
security interest in all of Hifn's assets, including Hifn's intellectual
property. In March 1999, the entire $5.0 million loan was repaid. Also in March
1999, the Company issued 1.6 million shares of common stock at a price of $33
per share in an equity offering, which raised approximately $49.2 million, net
of offering expenses. In April 1999, the Company's underwriters exercised their
option to purchase an additional 300,000 shares of the Company's common stock,
which yielded an additional $9.3 million in proceeds to the Company.
In fiscal 1999, the Company received $0.1 million in proceeds from the
repayment of a loan to a related party and paid a total of $1.5 million in
transfers to the Company's former parent, Stac.
Hifn uses a number of independent suppliers to manufacture substantially
all of its products. As a result, Hifn relies on these suppliers to allocate to
Hifn a sufficient portion of foundry capacity to meet Hifn's needs and deliver
sufficient quantities of Hifn's products on a timely basis. These arrangements
allow Hifn to avoid utilizing its capital resources for manufacturing facilities
and work-in-process inventory and to focus substantially all of its resources on
the design, development and marketing of its products.
Hifn requires substantial working capital to fund its business,
particularly to finance accounts receivable and inventory, and for investments
in property and equipment. Hifn's need to raise capital in the future will
depend on many factors including the rate of sales growth, market acceptance of
Hifn's existing and new products, the amount and timing of research and
development expenditures, the timing and size of acquisitions
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of businesses or technologies, the timing of the introduction of new products
and the expansion of sales and marketing efforts.
In August 2000, Hifn completed its acquisition of Apptitude. The purchase
price of the acquisition of $58.5 million, which included $127,000 in estimated
acquisition related costs, was used to acquire the net assets of Apptitude. The
allocation of the purchase price was as follows:
Property and equipment...................................... $ 205
Current and other assets.................................... 1,081
Deferred tax asset.......................................... 3,905
Liabilities assumed......................................... (2,404)
Goodwill.................................................... 47,121
Purchased in-process research and development............... 4,085
Acquired developed and core technology, workforce and
patents................................................... 4,462
-------
$58,455
=======
The goodwill, acquired developed and core technology, workforce and patents
are recorded on the balance sheet as intangibles and other assets and will be
amortized on a straight-line basis over periods ranging from two to five years.
The purchased in-process research and development was expensed at the time of
the acquisition as a one-time charge.
TRENDS AND UNCERTAINTIES
In future periods, Hifn's business, financial condition and results of
operations may be affected by many factors, including but not limited to the
following:
WE HAVE A LIMITED OPERATING HISTORY AS AN INDEPENDENT COMPANY.
On August 14, 1996, we were incorporated by Stac, Inc. ("Stac") which
transferred its semiconductor business to us in exchange for shares of our
Preferred Stock and Common Stock. Because we are a relatively new company with a
limited operating history, we may experience financial and other difficulties as
we attempt to grow our business. For example, to expand our business we are
increasing our research and development and other operating expenses. This
increase in expenses will negatively affect our financial performance unless we
are able to sustain and grow revenues. If we are not able to evolve and expand
our business, we may not remain profitable and therefore may not be able to
sustain a viable business.
OUR OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY.
Our operating results have fluctuated significantly in the past and we
expect that they will continue to fluctuate in the future. This fluctuation is a
result of a variety of factors including the following:
- General business conditions in our markets as well as global economic
uncertainty;
- Increases or reductions in demand for our customers' products;
- The timing and volume of orders we receive from our customers;
- Cancellations or delays of customer product orders;
- Any new product introductions by us or our competitors;
- Our suppliers increasing costs or changing the delivery of products to
us;
- Increased competition or reductions in the prices that we are able to
charge;
- The variety of the products that we sell as well as seasonal demand for
our products; and
- The availability of manufacturing capacity necessary to make our
products.
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WE DEPEND UPON A SMALL NUMBER OF CUSTOMERS.
Quantum Corporation ("Quantum"), through its manufacturing subcontractor,
accounted for approximately 36%, 45% and 61%, respectively, of our revenues in
fiscal 2000, 1999 and 1998. Lucent, through its manufacturing subcontractors,
accounted for approximately 35% and 38% of our revenues during fiscal 2000 and
1999, respectively. Neither Quantum nor Lucent are under any binding obligation
to order from us. If our sales to Quantum or Lucent decline, our business,
financial condition and results of operations could suffer. We expect that our
most significant customers in the future could be different from our largest
customers today for a number of reasons, including customers' deployment
schedules and budget considerations. As a result, we believe we may experience
significant fluctuations in our results of operations on a quarterly and an
annual basis.
Limited numbers of network and storage equipment vendors account for a
majority of packet processor purchases in their respective markets. In
particular, the market for network equipment that would include packet
processors, such as routers, remote access concentrators and firewalls, is
dominated by a few large vendors, including Cisco Systems, Inc., Lucent
Technologies Inc., Nortel Networks, Inc. and 3Com Corporation. As a result, our
future success will depend upon our ability to establish and maintain
relationships with these companies. If these network equipment vendors do not
incorporate our packet processors into their products, our business, financial
condition and results of operations could suffer.
OUR BUSINESS DEPENDS UPON THE DEVELOPMENT OF THE PACKET PROCESSOR MARKET.
Our prospects are dependent upon the acceptance of packet processors as an
alternative to other technology traditionally utilized by network and storage
equipment vendors. Many of our current and potential customers have substantial
technological capabilities and financial resources and currently develop
internally the application specific integrated circuit components and program
the general purpose microprocessors utilized in their products as an alternative
to our packet processors. These customers may in the future continue to rely on
these solutions or may determine to develop or acquire components, technologies
or packet processors that are similar to, or that may be substituted for, our
products. In order to be successful, we must anticipate market trends and the
price, performance and functionality requirements of such network and storage
equipment vendors and must successfully develop and manufacture products that
meet their requirements. In addition, we must make products available to these
large customers on a timely basis and at competitive prices. If orders from
customers are cancelled, decreased or delayed, or if we fail to obtain
significant orders from new customers, or any significant customer delays or
fails to pay, our business, financial condition and results of operations could
suffer.
OUR BUSINESS DEPENDS UPON THE CONTINUED GROWTH AND OUR PENETRATION OF THE
VIRTUAL PRIVATE NETWORK MARKET.
We want to be a leading supplier of packet processors that implement the
network security protocols necessary to support the deployment of virtual
private networks. This market, which is still emerging, may not grow and if it
does continue to grow, our products may not successfully serve this market. Our
ability to generate significant revenue in the virtual private network market
will depend upon, among other things, the following:
- Our ability to demonstrate the benefits of our technology to
distributors, original equipment manufacturers and end users; and
- The increased use of the Internet by businesses as replacements for, or
enhancements to, their private networks.
If we are unable to penetrate the virtual private network market, or if
that market fails to develop, our business, financial condition and results of
operations could suffer.
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WE FACE RISKS ASSOCIATED WITH EVOLVING INDUSTRY STANDARDS AND RAPID
TECHNOLOGICAL CHANGE.
The markets in which we compete are characterized by rapidly changing
technology, frequent product introductions and evolving industry standards. Our
performance depends on a number of factors, including our ability to do the
following:
- Properly identify emerging target markets and related technological
trends;
- Develop and maintain competitive products;
- Enhance our products by adding innovative features that differentiate our
products from those of competitors;
- Bring products to market on a timely basis at competitive prices; and
- Respond effectively to new technological changes or new product
announcements by others.
Our past success has been dependent in part upon our ability to develop
products that have been selected for design into new products of leading
equipment manufacturers. However, the development of our packet processors is
complex and, from time to time, we have experienced delays in completing the
development and introduction of new products. We may not be able to adhere to
our new product design and introduction schedules and our products may not be
accepted in the market at favorable prices, if at all.
In evaluating new product decisions, we must anticipate future demand for
product features and performance characteristics, as well as available
supporting technologies, manufacturing capacity, competitive product offerings
and industry standards. We must also continue to make significant investments in
research and development in order to continue to enhance the performance and
functionality of our products to keep pace with competitive products and
customer demands for improved performance, features and functionality. The
technical innovations required for the Company to remain competitive are
complicated and require a significant amount of time and money. We may
experience substantial difficulty in introducing new products and we may be
unable to offer enhancements to existing products on a timely or cost-effective
basis, if at all. For instance, the performance of our encryption/compression
and public key processors depends upon the integrity of our security technology.
If any significant advances in overcoming cryptographic systems are made, then
the security of our encryption/compression and public key processors will be
reduced or eliminated unless we are able to develop further technical
innovations that adequately enhance the security of these products. Our
inability to develop and introduce new products or enhancements directed at new
industry standards could harm our business, financial condition and results of
operations.
OUR MARKETS ARE HIGHLY COMPETITIVE.
We compete in markets that are intensely competitive and are expected to
become more competitive as current competitors expand their product offerings
and new competitors enter the market. The markets that we compete in are subject
to frequent product introductions with improved price-performance
characteristics, rapid technological change, and the continued emergence of new
industry standards. Our products compete with offerings from companies such as
Analog Devices, Inc., Safenet, Inc., International Business Machines Corporation
("IBM"), Broadcom Corporation, Motorola, Inc. and Philips Corporation. In 1994,
Stac entered into two license agreements with IBM in which Stac granted IBM the
right to use, but not sublicense, our patented compression technology in IBM
hardware and software products. Stac also entered into a license agreement with
Microsoft Corporation ("Microsoft") in 1994 whereby Stac granted Microsoft the
right to use, but not sublicense, our compression technology in their software
products. We expect significant future competition from major domestic and
international semiconductor suppliers. Several established electronics and
semiconductor suppliers have recently entered, or expressed an interest to
enter, the network equipment market. We also may face competition from suppliers
of products based on new or emerging technologies. Furthermore, many of our
existing and potential customers internally develop solutions which attempt to
perform all or a portion of the functions performed by our products.
A key element of our packet processor architecture is our encryption
technology. Until recently, in order to export our encryption-related products,
the U.S. Department of Commerce required us to obtain a license.
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Foreign competitors that were not subject to similar requirements have an
advantage over us in their ability to establish existing markets for their
products and rapidly respond to the requests of customers in the global market.
Although the export restriction has been liberalized, the Company may not be
successful in entering or competing the foreign encryption markets. See "Our
Products Are Subject To Export Restrictions."
Many of our current and prospective competitors offer broader product lines
and have significantly greater financial, technical, manufacturing and marketing
resources than us. As a result, they may be able to adapt more quickly to new or
emerging technologies and changes in customer requirements or to devote greater
resources to promote the sale of their products. In particular, companies such
as Intel Corporation, Lucent Technologies Inc., Motorola, Inc., National
Semiconductor Corporation, and Texas Instruments Incorporated have a significant
advantage over us given their relationships with many of our customers, their
extensive marketing power and name recognition and their much greater financial
resources. In addition, current and potential competitors may decide to
consolidate, lower the prices of their products or to bundle their products with
other products. Any of the above would significantly and negatively impact our
ability to compete and obtain or maintain market share. If we are unable to
successfully compete against our competitors, our business, results of
operations and financial condition will suffer.
We believe that the important competitive factors in our markets are the
following:
- Performance;
- Price;
- The time that is required to develop a new product or enhancements to
existing products;
- The ability to achieve product acceptance with major network and storage
equipment vendors;
- The support that exists for new network and storage standards;
- Features and functionality;
- Adaptability of products to specific applications;
- Reliability; and
- Technical service and support as well as effective intellectual property
protection.
If we are unable to successfully develop and market products that compete
with those of other suppliers, our business, financial condition and results of
operations could be harmed. In addition, we must compete for the services of
qualified distributors and sales representatives. To the extent that our
competitors offer distributors or sales representatives more favorable terms,
these distributors and sales representatives may decline to carry, or
discontinue carrying, our products. Our business, financial condition and
results of operations could be harmed by any failure to maintain and expand our
distribution network.
OUR BUSINESS DEPENDS UPON THE GROWTH OF THE NETWORK EQUIPMENT AND STORAGE
EQUIPMENT MARKETS.
Our success is largely dependent upon continued growth in the market for
network security equipment, such as routers, remote access concentrators,
switches, broadband access equipment, security gateways, firewalls and network
interface cards. In addition, our success depends upon storage equipment vendors
incorporating our packet processors into their systems. The network security
equipment market has in the past and may in the future fluctuate significantly
based upon numerous factors, including the lack of industry standards, adoption
of alternative technologies, capital spending levels and general economic
conditions. We are unable to determine the rate or extent to which these markets
will grow, if at all. Any decrease in the growth of the network or storage
equipment market or a decline in demand for our products could harm our
business, financial condition and results of operations.
OUR SUCCESS DEPENDS UPON PROTECTING OUR INTELLECTUAL PROPERTY.
Our proprietary technology is critical to our future success. We rely in
part on patent, trade, trademark, maskwork and copyright law to protect our
intellectual property. We own 12 United States patents and four
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foreign patents. We also have 2 pending patent applications in Japan. Our issued
patents and patent applications primarily cover various aspects of our
compression technology and have expiration dates ranging from 2006 to 2013. In
addition to compression, we have six pending patent applications in the United
States, four in Europe and Asia (Japan) covering our flow classification
technology. There are 2 pending patent applications in the United States
covering our bandwidth management and rate shaping technology. Patents may not
be issued under our current or future patent applications, and the patents
issued under such patent applications could be invalidated, circumvented or
challenged. In addition, third parties could make infringement claims against us
in the future. Such infringement claims could result in costly litigation. We
may not prevail in any such litigation or be able to license any valid and
infringed patents from third parties on commercially reasonable terms, if at
all. Regardless of the outcome, an infringement claim would likely result in
substantial cost and diversion of our resources. Any infringement claim or other
litigation against us or by us could harm our business, financial condition and
results of operations. The patents issued to us may not be adequate to protect
our proprietary rights, to deter misappropriation or to prevent an unauthorized
third party from copying our technology, designing around the patents we own or
otherwise obtaining and using our products, designs or other information. In
addition, others could develop technologies that are similar or superior to our
technology.
We also claim copyright protection for certain proprietary software and
documentation. We attempt to protect our trade secrets and other proprietary
information through agreements with our customers, employees and consultants,
and through other security measures. However, our efforts may not be successful.
Furthermore, the laws of certain countries in which our products are or may be
manufactured or sold may not protect our products and intellectual property.
THE LENGTH OF TIME IT TAKES TO DEVELOP OUR PRODUCTS AND MAKE A SALE TO OUR
CUSTOMERS MAY IMPAIR OUR OPERATING RESULTS.
Our customers typically take a long time to evaluate our products. In fact,
it usually takes our customers 3 to 6 months or more to test our products with
an additional 9 to 18 months or more before they commence significant production
of equipment incorporating our products. As a result of this lengthy sales
cycle, we may experience a delay between increasing expenses for research and
development and sales and marketing efforts on the one hand, and the generation
of higher revenues, if any, on the other hand. In addition, the delays inherent
in such a lengthy sales cycle raise additional risks of customer decisions to
cancel or change product plans, which could result in the loss of anticipated
sales. Our business, financial condition and results of operations could suffer
if customers reduce or delay orders or choose not to release products using our
technology.
WE DEPEND UPON INDEPENDENT MANUFACTURERS AND LIMITED SOURCES OF SUPPLY.
We rely on subcontractors to manufacture, assemble and test our packet
processors. We currently subcontract our semiconductor manufacturing to Atmel
Corporation, Toshiba Corporation and Motorola, Inc. Since we depend upon
independent manufacturers, we do not directly control product delivery schedules
or product quality. None of our products are manufactured by more than one
supplier. Since the semiconductor industry is highly cyclical, foundry capacity
has been very limited at times in the past and may become limited in the future.
We depend on our suppliers to deliver sufficient quantities of finished
product to us in a timely manner. Since we place orders on a purchase order
basis and do not have long-term volume purchase agreements with any of our
suppliers, our suppliers may allocate production capacity to other products
while reducing deliveries to us on short notice. For example, in June 1995, one
of our suppliers delayed the delivery of one of our products. As a result, we
switched production of the product to a new manufacturer. This caused a 3-month
delay in shipments to customers. We also experienced yield and test anomalies on
a different product manufactured by another subcontractor that could have
interrupted our customer shipments. In this case, the manufacturer was able to
correct the problem in a timely manner and customer shipments were not affected.
The delay and expense associated with qualifying a new supplier or foundry and
commencing volume
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production can result in lost revenue, reduced operating margins and possible
harm to customer relationships. The steps required for a new manufacturer to
begin production of a semiconductor product include:
- Adapting our product design, if necessary, to the new manufacturer's
process;
- Creating a new mask set to manufacture the product;
- Having the new manufacturer prepare sample products so we can verify the
product specification; and
- Providing sample products to customers for qualification.
In general, it takes from 3 to 6 months for a new manufacturer to begin
full-scale production of one of our products. We could have similar or more
protracted problems in the future with existing or new suppliers.
Both Toshiba Corporation and Motorola, Inc. manufacture products for us in
plants located in Asia. To date, the financial and stock market dislocations
that have occurred in the Asian financial markets have not harmed our business.
However, present or future dislocations or other international business risks,
such as currency exchange fluctuations or recessions, could force us to seek new
suppliers. We must place orders approximately 20 to 23 weeks in advance of
expected delivery. This limits our ability to react to fluctuations in demand
for our products, and could cause us to have an excess or a shortage of
inventory of a particular product. In addition, if global semiconductor
manufacturing capacity fails to increase in line with demand, foundries could
allocate available capacity to larger customers or customers with long-term
supply contracts. If we cannot obtain adequate foundry capacity at acceptable
prices, or our supply is interrupted or delayed, our product revenues could
decrease or our cost of revenues could increase. This could harm our business,
financial condition and results of operations.
We regularly consider using smaller semiconductor dimensions for each of
our products in order to reduce costs. We have begun to decrease the dimensions
in our new product designs, and believe that we must do so to remain
competitive. We may have difficulty decreasing the dimensions of our products.
In the future, we may change our supply arrangements to assume more product
manufacturing responsibilities. We may subcontract for wafer manufacturing,
assembly and test rather than purchase finished products. However, there are
additional risks associated with manufacturing, including variances in
production yields, the ability to obtain adequate test and assembly capacity at
reasonable cost and other general risks associated with the manufacture of
semiconductors. We may also enter into volume purchase agreements that would
require us to commit to minimum levels of purchases and which may require
up-front investments. If we fail to effectively assume greater manufacturing
responsibilities or manage volume purchase arrangements, our business, financial
condition and results of operations will suffer.
NETWORK AND STORAGE EQUIPMENT PRICES TYPICALLY DECREASE.
Average selling prices in the networking, storage and semiconductor
industries have rapidly declined due to many factors, including:
- Rapidly changing technologies;
- Price-performance enhancements; and
- Product obsolescence.
The decline in the average selling prices of our products may cause
substantial fluctuations in our operating results. We anticipate that the
average selling prices of our products will decrease in the future due to
product introductions by our competitors, price pressures from significant
customers and other factors. Therefore, we must continue to develop and
introduce new products that incorporate features which we can sell at higher
prices. If we fail to do so, our revenues and gross margins could decline, which
would harm our business, financial condition and results of operations.
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WE FACE PRODUCT RETURN, PRODUCT LIABILITY AND PRODUCT DEFECT RISKS.
Complex products such as ours frequently contain errors, defects and bugs
when first introduced or as new versions are released. We have discovered such
errors, defects and bugs in the past. Delivery of products with production
defects or reliability, quality or compatibility problems could hinder market
acceptance of our products. This could damage our reputation and harm our
ability to attract and retain customers. Errors, defects or bugs could also
cause interruptions, delays or a cessation of sales to our customers. We would
have to expend significant capital and resources to remedy these problems.
Errors, defects or bugs could be discovered in our new products after we begin
commercial production of them, despite testing by us and our suppliers and
customers. This could result in additional development costs, loss of, or delays
in, market acceptance, diversion of technical and other resources from our other
development efforts, claims by our customers or others against us or the loss of
credibility with our current and prospective customers. Any such event would
harm our business, financial condition and results of operations.
WE FACE ORDER AND SHIPMENT UNCERTAINTIES.
We generally make our sales under individual purchase orders that may be
canceled or deferred by customers on short notice without significant penalty,
if any. Cancellation or deferral of product orders could cause us to hold excess
inventory, which could harm our profit margins and restrict our ability to fund
our operations. We recognize revenue upon shipment of products to our customers,
net of an allowance for estimated returns. An unanticipated level of returns
could harm our business, financial condition and results of operations.
WE DEPEND UPON KEY PERSONNEL.
Our success greatly depends on the continued contributions of our key
management and other personnel, many of whom would be difficult to replace. We
do not have employment contracts with any of our key personnel, nor do we
maintain any key man life insurance on any of our personnel. Several members of
our management team have joined us in the last 12 months. It may be difficult
for us to integrate new members of our management team. We must also attract and
retain experienced and highly skilled engineering, sales and marketing and
managerial personnel. Competition for such personnel is intense in the
geographic areas and market segments in which we compete, and we may not be
successful in hiring and retaining such people. If we lose the services of any
key personnel, or cannot attract or retain qualified personnel, particularly
engineers, our business, financial condition and results of operations could
suffer. In addition, companies in technology industries whose employees accept
positions with competitors have in the past claimed that their competitors have
engaged in unfair competition or hiring practices. We could receive such claims
in the future as we seek to hire qualified personnel. These claims could result
in material litigation. We could incur substantial costs in defending against
any such claims, regardless of their merits.
OUR RAPID GROWTH MAY STRAIN OUR OPERATIONS.
We have experienced a period of rapid growth and expansion which has
placed, and continues to place, a significant strain on our resources. To
accommodate this growth, in fiscal 2000, we implemented a variety of new and
upgraded operational and financial systems, procedures and controls, including
the improvement of the retained accounting and other internal management systems
which were provided by Stac. This required and may continue to require
substantial management effort, and our efforts to do so may not continue to be
successful. In addition, we have had to hire additional employees to accommodate
this growth and our product development activities. This has resulted in
increased responsibilities for our management. Our systems, procedures and
controls may not be adequate to support our operations. If we fail to improve
our operational, financial and management information systems, or to hire,
train, motivate or manage our employees, our business, financial condition and
results of operations could suffer.
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OUR PRODUCTS ARE SUBJECT TO EXPORT RESTRICTIONS.
The encryption algorithms embedded in our products are a key element of our
packet processor architecture. These products are subject to U.S. Department of
Commerce export control restrictions. Our network equipment customers may only
export products incorporating encryption technology if they obtain a one-time
technical review. These U.S. export laws also prohibit the export of encryption
products to a number of countries deemed by the U.S. to be hostile. Many foreign
countries also restrict exports to many of these countries deemed to be
"terrorist-supporting" states by the U.S. government. Because the restrictions
on exports of encryption products have been liberalized, Hifn and its network
equipment customers have an opportunity to effectively compete with its foreign
competitors. The existence of these restrictions until recently may have enabled
foreign competitors facing less stringent controls on their products to become
more established and, therefore, more competitive in the global market than our
network equipment customers. In addition, the list of products and countries for
which export approval is required, and the regulatory policies with respect
thereto, could be revised, and laws limiting the domestic use of encryption
could be enacted. While the U.S. government now allows U.S. companies to assume
that exports to non-government end-users will be approved within 30 days of
official registration with the Department of Commerce, the sale of our packet
processors could be harmed by the failure of our network equipment customers to
obtain the required approvals or by the costs of compliance.
WE FACE RISKS ASSOCIATED WITH OUR INTERNATIONAL BUSINESS ACTIVITIES.
We sell most of our products to customers in the United States. If our
international sales increase, particularly in light of decreased export
restrictions, we may encounter risks inherent in international operations. All
of our international sales to date are denominated in U.S. dollars. As a result,
if the value of the U.S. dollar increases relative to foreign currencies, our
products could become less competitive in international markets. We also obtain
some of our manufacturing, assembly and test services from suppliers located
outside the United States. International business activities could be limited or
disrupted by any of the following:
- The imposition of governmental controls;
- Export license/technical review requirements;
- Restrictions on the export of technology;
- Currency exchange fluctuations;
- Political instability;
- Financial and stock market dislocations;
- Trade restrictions; and
- Changes in tariffs.
Demand for our products also could be harmed by seasonality of
international sales and economic conditions in our primary overseas markets.
These international factors could harm future sales of our products to
international customers and our business, financial condition and results of
operations in general.
WE FACE RISKS ASSOCIATED WITH ACQUISITIONS.
We continually evaluate strategic acquisitions of businesses and
technologies that would complement our product offerings or enhance our market
coverage or technological capabilities. While we are not currently negotiating
any acquisitions, we may make additional acquisitions in the fut