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U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549




---

FORM 10-Q

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

For the Quarterly Period Ended December 31, 2003

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

For the Transition Period From
______________ to ______________

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
Incorporation or Organization) |  | (IRS Employer
Identification Number)

750 University Avenue, Los Gatos, California 95032
(Address of principal executive offices and Zip Code)

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

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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).

Yes [X] No [  ]

The number of shares outstanding of the Registrants Common Stock, par value
$.001 per share, was 13,726,819 at February 12, 2004.



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TABLE OF CONTENTS



|                               |                                                                                               |                                                      |  |  |  |  |  | 
|------------------------------ | --------------------------------------------------------------------------------------------- | ---------------------------------------------------- |  |  |  |  |  | 
|PART 1  FINANCIAL INFORMATION
|                               | Item 1. Financial Statements                                                                 
|                               |                                                                                               | CONDENSED CONSOLIDATED BALANCE SHEETS               
|                               |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS     
|                               |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS     
|                               |                                                                                               | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
|                               | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                               | Item 3. Quantitative and Qualitative Disclosures About Market Risk                           
|                               | Item 4. Controls and Procedures                                                              
|PART II  OTHER INFORMATION   
|                               | Item 1. Legal Proceedings                                                                    
|                               | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURES                    
|INDEX TO EXHIBITS             
|EXHIBIT 31.1                  
|EXHIBIT 31.2                  
|EXHIBIT 32.1                  
|EXHIBIT 32.2                  



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##### Table of Contents



HIFN, INC.

INDEX TO FORM 10-Q

|                  |                                                                                                                                                    |  |         |   
|----------------- | -------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------- | --
|PART I.           | FINANCIAL INFORMATION                                                                                                                              |  |        
|Item 1.           | Financial Statements                                                                                                                               |  |        
|                  | Condensed Consolidated Balance Sheets
as of December 31, 2003 and September 30, 2003                                                               |  | 3      
|                  | Condensed Consolidated Statements of Operations
for the three months ended December 31, 2003 and 2002                                              |  | 4      
|                  | Condensed Consolidated Statements of Cash Flows
for the three months ended December 31, 2003 and 2002                                              |  | 5      
|                  | Notes to Condensed Consolidated Financial Statements                                                                                               |  | 6  9  
|Item 2.           | Managements Discussion and Analysis of Financial Condition and Results of Operations                                                              |  | 10  25
|Item 3.           | Quantitative and Qualitative Disclosure About Market Risks                                                                                         |  | 26     
|Item 4.           | Controls and Procedures                                                                                                                            |  | 26     
|PART II.          | OTHER INFORMATION                                                                                                                                  |  |        
|Item 1.           | Legal Proceedings                                                                                                                                  |  | 27     
|Item 6.           | Exhibits and Reports on Form 8-K                                                                                                                   |  | 27     
|Signatures        |                                                                                                                                                    |  |         | 28
|Index to Exhibits |                                                                                                                                                    |  |        
|Exhibit 31.1      | Certification of Chief Executive Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of
2002.                                             |  |        
|Exhibit 31.2      | Certification of Chief Financial Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of
2002.                                             |  |        
|Exhibit 32.1      | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002. |  |        
|Exhibit 32.2      | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002. |  |        

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PART 1  FINANCIAL INFORMATION




Item 1. Financial Statements




HIFN, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)

|                                     |                                                |                           |        |                            |        |              |        |               |        |  |        | 
|------------------------------------ | ---------------------------------------------- | ------------------------- | ------ | -------------------------- | ------ | ------------ | ------ | ------------- | ------ |  | ------ | 
|                                     |                                                |                           |        |                            |        | December 31, |        | September 30,
|                                     |                                                |                           |        |                            |        | 2003         |        | 2003         
|                                     |                                                |                           |        |                            |        |              |        |              
|ASSETS                               |                                                |                           |        |                            |        |              |        |              
|CURRENT ASSETS:                      |                                                |                           |        |                            |        |              |        |              
|                                     | Cash and cash equivalents                      |                           | $      | 17,697                     |        |              | $      | 41,080        |       
|                                     | Short-term investments                         |                           |        | 7,984                      |        |              |        | 1,994         |       
|                                     | Accounts receivable, net                       |                           |        | 2,002                      |        |              |        | 2,715         |       
|                                     | Inventories                                    |                           |        | 848                        |        |              |        | 355           |       
|                                     | Prepaid expenses and other current assets      |                           |        | 1,795                      |        |              |        | 1,025         |       
|                                     |                                                |                           |        |                            |        |              |        |              
|                                     |                                                | Total current assets      |        |                            | 30,326 |              |        |               | 47,169 | 
|Property and equipment, net          |                                                |                           | 1,999  |                            |        |              | 2,107  |              
|Intangible assets, net               |                                                |                           | 14,302 |                            |        |              | 2,035  |              
|Other assets                         |                                                |                           | 1,319  |                            |        |              | 1,510  |              
|                                     |                                                |                           |        |                            |        |              |        |              
|                                     |                                                | $                         | 47,946 |                            |        | $            | 52,821 |              
|                                     |                                                |                           |        |                            |        |              |        |              
|LIABILITIES AND STOCKHOLDERS
EQUITY |                                                |                           |        |                            |        |              |        |              
|CURRENT LIABILITIES:                 |                                                |                           |        |                            |        |              |        |              
|                                     | Accounts payable                               |                           | $      | 2,116                      |        |              | $      | 2,123         |       
|                                     | Accrued expenses and other current
liabilities |                           |        | 8,535                      |        |              |        | 9,581         |       
|                                     |                                                |                           |        |                            |        |              |        |              
|                                     |                                                | Total current liabilities |        |                            | 10,651 |              |        |               | 11,704 | 
|                                     |                                                |                           |        |                            |        |              |        |              
|STOCKHOLDERS EQUITY:                |                                                |                           |        |                            |        |              |        |              
|                                     | Common stock                                   |                           |        | 11                         |        |              |        | 11            |       
|                                     | Additional paid-in capital                     |                           |        | 128,740                    |        |              |        | 127,473       |       
|                                     | Accumulated deficit                            |                           |        | (91,456                    | )      |              |        | (86,367       | )     
|                                     |                                                |                           |        |                            |        |              |        |              
|                                     |                                                |                           |        | Total stockholders equity |        |              | 37,295 |               |        |  | 41,117 | 
|                                     |                                                |                           |        |                            |        |              |        |              
|                                     |                                                | $                         | 47,946 |                            |        | $            | 52,821 |              
|                                     |                                                |                           |        |                            |        |              |        |              

See accompanying notes to condensed consolidated financial statements.

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HIFN, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)

|                                                       |                                                |                                    |        |                    |        |      |        |       |       | 
|------------------------------------------------------ | ---------------------------------------------- | ---------------------------------- | ------ | ------------------ | ------ | ---- | ------ | ----- | ----- | 
|                                                       |                                                |                                    |        | Three Months Ended
|                                                       |                                                |                                    |        | December 31,      
|                                                       |                                                |                                    |        |                   
|                                                       |                                                |                                    |        | 2003               |        | 2002
|                                                       |                                                |                                    |        |                    |        |     
|Net revenues                                           |                                                |                                    |        |                    |        |      |        |      
|                                                       | Processors                                     |                                    | $      | 4,722              |        |      | $      | 3,772 |      
|                                                       | Software licenses and other                    |                                    |        | 2,415              |        |      |        | 643   |      
|                                                       |                                                |                                    |        |                    |        |      |        |      
|                                                       |                                                | Total net revenues                 |        |                    | 7,137  |      |        |       | 4,415 | 
|                                                       |                                                |                                    |        |                    |        |      |        |      
|Costs and operating expenses:                          |                                                |                                    |        |                    |        |      |        |      
|                                                       | Cost of revenues  processors                  |                                    |        | 1,350              |        |      |        | 1,335 |      
|                                                       | Cost of revenues  software licenses and
other |                                    |        | 120                |        |      |        | 99    |      
|                                                       | Research and development                       |                                    |        | 4,689              |        |      |        | 5,214 |      
|                                                       | Sales and marketing                            |                                    |        | 1,688              |        |      |        | 1,775 |      
|                                                       | General and administrative                     |                                    |        | 993                |        |      |        | 987   |      
|                                                       | Amortization of intangible assets              |                                    |        | 151                |        |      |        | 358   |      
|                                                       | Purchased in-process research and
development  |                                    |        | 3,337              |        |      |        |      |      
|                                                       |                                                |                                    |        |                    |        |      |        |      
|                                                       |                                                | Total costs and operating expenses |        |                    | 12,328 |      |        |       | 9,768 | 
|                                                       |                                                |                                    |        |                    |        |      |        |      
|Loss from operations                                   |                                                |                                    | (5,191 | )                  |        |      | (5,353 | )    
|Interest and other income, net                         |                                                |                                    | 102    |                    |        |      | 230    |      
|                                                       |                                                |                                    |        |                    |        |      |        |      
|Loss before income taxes                               |                                                |                                    | (5,089 | )                  |        |      | (5,123 | )    
|Provision for (benefit from) income taxes              |                                                |                                    |       |                    |        |      |       |      
|                                                       |                                                |                                    |        |                    |        |      |        |      
|Net loss                                               |                                                | $                                  | (5,089 | )                  |        | $    | (5,123 | )    
|                                                       |                                                |                                    |        |                    |        |      |        |      
|Net loss per share, basic and diluted                  |                                                | $                                  | (0.45  | )                  |        | $    | (0.48  | )    
|                                                       |                                                |                                    |        |                    |        |      |        |      
|Weighted average shares outstanding, basic and
diluted |                                                |                                    | 11,390 |                    |        |      | 10,584 |      
|                                                       |                                                |                                    |        |                    |        |      |        |      

See accompanying notes to condensed consolidated financial statements.

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HIFN, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

|                                                 |                                                                             |                                                |                                                     |         |                    |         |        |        |        |        |  
|------------------------------------------------ | --------------------------------------------------------------------------- | ---------------------------------------------- | --------------------------------------------------- | ------- | ------------------ | ------- | ------ | ------ | ------ | ------ | -
|                                                 |                                                                             |                                                |                                                     |         | Three Months Ended
|                                                 |                                                                             |                                                |                                                     |         | December 31,      
|                                                 |                                                                             |                                                |                                                     |         |                   
|                                                 |                                                                             |                                                |                                                     |         | 2003               |         | 2002  
|                                                 |                                                                             |                                                |                                                     |         |                    |         |       
|Cash flows from operating activities:            |                                                                             |                                                |                                                     |         |                    |         |        |       
|                                                 | Net loss                                                                    |                                                | $                                                   | (5,089  | )                  |         | $      | (5,123 | )     
|                                                 | Adjustments to reconcile net loss to
net cash used in operating activities: |                                                |                                                     |         |                    |         |        |        |       
|                                                 |                                                                             | Depreciation and amortization                  |                                                     |         | 346                |         |        |        | 398    |       
|                                                 |                                                                             | Amortization of intangible assets              |                                                     |         | 151                |         |        |        | 607    |       
|                                                 |                                                                             | Amortization of deferred stock
compensation    |                                                     |         | 44                 |         |        |        | 129    |       
|                                                 |                                                                             | Purchased in-process research and
development  |                                                     |         | 3,337              |         |        |        |       |       
|                                                 | Changes in assets and liabilities:                                          |                                                |                                                     |         |                    |         |        |        |       
|                                                 |                                                                             | Accounts receivable                            |                                                     |         | 713                |         |        |        | 329    |       
|                                                 |                                                                             | Inventories                                    |                                                     |         | (493               | )       |        |        | (36    | )     
|                                                 |                                                                             | Prepaid expenses and other current assets      |                                                     |         | (770               | )       |        |        | (1,084 | )     
|                                                 |                                                                             | Other assets                                   |                                                     |         | 191                |         |        |        | 183    |       
|                                                 |                                                                             | Accounts payable                               |                                                     |         | (7                 | )       |        |        | (1     | )     
|                                                 |                                                                             | Accrued expenses and other current
liabilities |                                                     |         | (1,046             | )       |        |        | (418   | )     
|                                                 |                                                                             |                                                |                                                     |         |                    |         |        |       
|                                                 |                                                                             |                                                | Net cash used in operating activities               |         |                    | (2,623  | )      |        |        | (5,016 | )
|                                                 |                                                                             |                                                |                                                     |         |                    |         |        |       
|Cash flows from investing activities:            |                                                                             |                                                |                                                     |         |                    |         |        |       
|                                                 | Purchase of certain assets and intellectual
property                        |                                                |                                                     | (15,755 | )                  |         |        |       |       
|                                                 | Sale (purchase) of short-term investments,
net                              |                                                |                                                     | (5,990  | )                  |         |        | 1,606  |       
|                                                 | Purchases of property and equipment                                         |                                                |                                                     | (238    | )                  |         |        | (94    | )     
|                                                 |                                                                             |                                                |                                                     |         |                    |         |        |       
|                                                 |                                                                             |                                                | Net cash provided by (used in) investing activities |         |                    | (21,983 | )      |        |        | 1,512  |  
|                                                 |                                                                             |                                                |                                                     |         |                    |         |        |       
|Cash flows from financing activities:            |                                                                             |                                                |                                                     |         |                    |         |        |       
|                                                 | Proceeds from issuance of common stock,
net                                 |                                                |                                                     | 1,223   |                    |         |        | 476    |       
|                                                 |                                                                             |                                                |                                                     |         |                    |         |        |       
|                                                 |                                                                             |                                                | Net cash provided by financing activities           |         |                    | 1,223   |        |        |        | 476    |  
|                                                 |                                                                             |                                                |                                                     |         |                    |         |        |       
|Net decrease in cash and cash equivalents        |                                                                             |                                                | (23,383                                             | )       |                    |         | (3,028 | )     
|Cash and cash equivalents at beginning of
period |                                                                             |                                                | 41,080                                              |         |                    |         | 53,060 |       
|                                                 |                                                                             |                                                |                                                     |         |                    |         |        |       
|Cash and cash equivalents at end of
period       |                                                                             | $                                              | 17,697                                              |         |                    | $       | 50,032 |       
|                                                 |                                                                             |                                                |                                                     |         |                    |         |        |       

See accompanying notes to condensed consolidated financial statements.

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HIFN, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 1 - Basis of Presentation

The condensed consolidated financial statements of hi/fn, inc. (Hifn
or
the Company) include the accounts of the Company and its subsidiaries,
Apptitude Acquisition Corporation, Hifn Limited and Hifn Netherlands B.V. All
significant intercompany accounts and transactions have been eliminated. The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities at the date of the
financial statements and reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

The accompanying condensed consolidated financial statements have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission regarding interim financial reporting. Accordingly, they do not
include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements and should be read in
conjunction with the Financial Statements and notes thereto included in the
Companys Form 10-K for period ending September 30, 2003. In the opinion of
management, the accompanying condensed consolidated financial statements
contain all adjustments, consisting only of normal recurring items, which the
Company believes is necessary for a fair statement of the Companys financial
position as of December 31, 2003 and its results of operations for the three
months ended December 31, 2003 and 2002, respectively. These condensed
consolidated financial statements are not necessarily indicative of the results
to be expected for the entire year.

The Company anticipates that its existing cash resources will fund any
anticipated operating losses, purchases of capital equipment and provide
adequate working capital for the next twelve months. The Companys liquidity is
affected by many factors including, among others, the extent to which the
Company pursues additional capital expenditures, the level of the Companys
product development efforts, and other factors related to the uncertainties of
the industry and global economies. Accordingly, there can be no assurance that
events in the future will not require the Company to seek additional capital
sooner or, if so required, that such capital will be available on terms
acceptable to the Company.

On February 6, 2004, the Company entered into a securities purchase
agreement with certain investors for the private placement of approximately 2.2
million shares of the Companys Common Stock at a price of $15.00 per share for
aggregate proceeds of approximately $33 million. The shares were issued and
paid for on February 6, 2004. The Company intends to apply the net proceeds for
working capital and general corporate purposes, as well as for strategic
purposes in connection with selected acquisitions that may be considered in the
future to expand its product and service offerings.

Note 2 - Stock Options

The Company has adopted Statement of Financial Accounting Standards No.
148 (SFAS 148), Accounting for Stock-Based Compensation  Transition and
Disclosure, issued by the Financial Accounting Standards Board (FASB) which
amends Statement of Financial Accounting Standards No. 123 (SFAS 123),
Accounting for Stock-Based Compensation, and provides alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. SFAS 148 requires prominent disclosures
in both annual and interim financial statements about the method of accounting
for stock-based employee compensation and the effect of the method used on
reported results. SFAS 148 also amends certain disclosure requirements under
Accounting Principle Board Opinion No. 25, Accounting for Stock Issued to
Employees (APB 25).

In accordance with the provisions of SFAS 148, the Company has elected to
continue to account for stock-based compensation plans using the intrinsic
value method prescribed in APB 25 and related interpretations.

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Accordingly, the Company does not recognize compensation expense for stock
options when the stock price at the grant date is equal to or greater than the
fair market value of the stock at that date.

Had compensation expense for the Companys stock-based compensation plans
been determined based on the fair value method, the Companys net loss and net
loss per share would have been as follows (in thousands, except per share
information):

|                    |             |                                                                                |   |             |        |                    |       |        |        |   |       |  
|------------------- | ----------- | ------------------------------------------------------------------------------ | - | ----------- | ------ | ------------------ | ----- | ------ | ------ | - | ----- | -
|                    |             |                                                                                |   |             |        | Three Months Ended
|                    |             |                                                                                |   |             |        | December 31,      
|                    |             |                                                                                |   |             |        |                   
|                    |             |                                                                                |   |             |        | 2003               |       | 2003  
|                    |             |                                                                                |   |             |        |                    |       |       
|Net loss:           |             |                                                                                |   |             |        |                    |       |       
|                    | As reported |                                                                                | $ | (5,089      | )      |                    | $     | (5,123 | )     
|                    |             | Add: stock-based employee compensation recorded
in the Statement of Operations |   |             | 44     |                    |       |        | 129    |  
|                    |             | Less: fair value of stock-based employee
compensation                          |   |             | (2,183 | )                  |       |        | (3,185 | )
|                    |             |                                                                                |   |             |        |                    |       |       
|                    | Pro forma   |                                                                                | $ | (7,228      | )      |                    | $     | (8,179 | )     
|                    |             |                                                                                |   |             |        |                    |       |       
|Net loss per share: |             |                                                                                |   |             |        |                    |       |       
|                    |             | Basic and diluted                                                              |   |             |        |                    |       |        |        |  
|                    |             |                                                                                |   | As reported |        | $                  | (0.45 | )      |        | $ | (0.48 | )
|                    |             |                                                                                |   | Pro forma   |        |                    | (0.63 | )      |        |   | (0.77 | )

The weighted average fair value of options granted during the three months
ended December 31, 2003 and 2002 were $6.92 and $2.93, respectively. The fair
value of each stock award is estimated on the date of grant using the
Black-Scholes model with the following assumptions used for grants during the
respective periods: annual dividend yield of 0.0% for all periods; a weighted
average expected stock award term of 4.0 years for all periods; during the
three months ended December 31, 2003 and 2002, risk-free annual interest rates
of 2.81% and 2.50%, respectively; and an expected volatility factor of 90% in
each of the three months ended December 31, 2003 and 2002.

Note 3 - Net Loss Per Share

Basic earnings per share is computed using the weighted average number of
common shares outstanding for the period, without consideration for the
dilutive impact of potential common shares that were outstanding during the
period. Diluted earnings per share is computed using the weighted average
number of common and common equivalent shares outstanding for the period.
Common equivalent shares consist of incremental common shares issuable upon the
exercise of stock options, using the treasury method, and are excluded from the
calculation of diluted net loss per share if anti-dilutive. Outstanding options
to purchase shares of common stock and their weighted shares equivalents were
excluded from the computation of diluted earnings because of their
anti-dilutive impact to the following periods:

|                                             |  |                    |           |      |  |  |           | 
|-------------------------------------------- |  | ------------------ | --------- | ---- |  |  | --------- | 
|                                             |  | Three Months Ended
|                                             |  | December 31,      
|                                             |  |                   
|                                             |  | 2003               |           | 2002
|                                             |  |                    |           |     
|Outstanding options to purchase common stock |  |                    | 4,001,296 |      |  |  | 4,177,740 | 
|Weighted equivalent shares                   |  |                    | 675,394   |      |  |  | 224,698   | 

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Note 4 - Detailed Balance Sheet:

|                                                |                                         |             |              |        |               |   |       |        |  
|----------------------------------------------- | --------------------------------------- | ----------- | ------------ | ------ | ------------- | - | ----- | ------ | -
|                                                |                                         |             | December 31, |        | September 30,
|(in thousands)                                  |                                         | 2003        |              | 2003  
|                                                |                                         |             |              |       
|                                                |                                         | (unaudited) |              |        |               |  
|Property and equipment:                         |                                         |             |              |        |               |   |       |       
|                                                | Computer equipment                      |             | $            | 5,778  |               |   | $     | 5,557  |  
|                                                | Furniture and fixtures                  |             |              | 1,167  |               |   |       | 1,161  |  
|                                                | Leasehold improvements                  |             |              | 1,196  |               |   |       | 1,188  |  
|                                                | Office equipment                        |             |              | 639    |               |   |       | 636    |  
|                                                |                                         |             |              |        |               |   |       |       
|                                                |                                         |             | 8,780        |        |               |   | 8,542 |       
|                                                | Less: accumulated depreciation          |             |              | (6,781 | )             |   |       | (6,435 | )
|                                                |                                         |             |              |        |               |   |       |       
|                                                |                                         | $           | 1,999        |        |               | $ | 2,107 |       
|                                                |                                         |             |              |        |               |   |       |       
|Intangible assets:                              |                                         |             |              |        |               |   |       |       
|                                                | Developed and core technology           |             | $            | 15,672 |               |   | $     | 3,903  |  
|                                                | Workforce                               |             |              | 255    |               |   |       | 255    |  
|                                                | Patents                                 |             |              | 600    |               |   |       | 600    |  
|                                                | Contract backlog                        |             |              | 649    |               |   |       |       |  
|                                                |                                         |             |              |        |               |   |       |       
|                                                |                                         |             | 17,176       |        |               |   | 4,758 |       
|                                                | Less: accumulated amortization          |             |              | (3,903 | )             |   |       | (3,752 | )
|                                                |                                         |             |              |        |               |   |       |       
|                                                |                                         |             | 13,273       |        |               |   | 1,006 |       
|                                                | Goodwill                                |             |              | 1,029  |               |   |       | 1,029  |  
|                                                |                                         |             |              |        |               |   |       |       
|                                                |                                         | $           | 14,302       |        |               | $ | 2,035 |       
|                                                |                                         |             |              |        |               |   |       |       
|Accrued expenses and other current
liabilities: |                                         |             |              |        |               |   |       |       
|                                                | Accrued vacant facility lease cost      |             | $            | 3,305  |               |   | $     | 3,492  |  
|                                                | Accrued non-recurring engineering costs |             |              | 1,236  |               |   |       | 2,120  |  
|                                                | Deferred revenue                        |             |              | 2,328  |               |   |       | 2,013  |  
|                                                | Compensation and employee benefits      |             |              | 1,091  |               |   |       | 1,486  |  
|                                                | Other                                   |             |              | 575    |               |   |       | 470    |  
|                                                |                                         |             |              |        |               |   |       |       
|                                                |                                         | $           | 8,535        |        |               | $ | 9,581 |       
|                                                |                                         |             |              |        |               |   |       |       

Note 5 - Acquisition

In December 2003, the Company acquired certain assets and intellectual
property related to International Business Machine (IBM)s Picoprocessor
PowerNP (PowerNP) for approximately $15.7 million in cash. The purchase price
of the acquisition of $15.9 million, which included $200,000 in estimated
acquisition related costs, was used to acquire the technical designs to the
PowerNP. The purchase price was allocated by management to assets acquired
based on the book value of inventory and fixed assets, which management believes approximates
its fair value, and after considering input provided by an independent
appraisal, to all other identifiable assets. The excess of the purchase price
over the net tangible and intangible assets acquired has been allocated to the
intangible assets and fixed assets. The allocation of the purchase price was as
follows (in thousands):

|                                              |  |   |        | 
|--------------------------------------------- |  | - | ------ | 
|Developed and core technology                 |  | $ | 11,769 | 
|Contract backlog                              |  |   | 649    | 
|Fixed assets                                  |  |   | 48     | 
|Inventory                                     |  |   | 67     | 
|Purchased in-process research and development |  |   | 3,337  | 
|                                              |  |   |        | 
|                                              |  | $ | 15,870 | 
|                                              |  |   |        | 

The acquired backlog, developed and core technology are recorded on the
balance sheet as intangibles and other assets. Acquired backlog will be
amortized based upon fulfillment of the identifiable backlog. Developed and
core technology will be amortized on a straight-line basis over a period of
five years.

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The amount allocated to purchased in-process research and development was
determined based on established valuation methods and was expensed at the
time of the acquisition as a one-time charge because technological feasibility
had not been established and no alternative future uses exist. The fair value
of two projects containing in-process technology in development was determined
using the income approach, which discounts expected future cash flows to present value.
The discount rates used in the present value calculations was derived from a
weighted-average cost of capital analysis adjusted to reflect additional risks inherent in
the development life cycle including the failure to achieve technical viability,
rapid changes in customer markets and required standards for new products as well as
potential competition in the market for such products.

Note 6 - Recent Accounting Pronouncements

In April 2003, the FASB issued Statement of Accounting Standards No. 149
(SFAS 149), Amendment of Statement 133 on Derivative Instruments and Hedging
Activities. SFAS 149 amends and clarifies financial accounting and reporting
of derivative instruments and hedging activities under Statement of Accounting
Standards No. 133 (SFAS 133), Accounting for Derivative Instruments and
Hedging Activities. SFAS 149 amends SFAS 133 for decisions made: (i) as part
of the Derivatives Implementation Group process that require amendment to SFAS
133, (ii) in connection with other FASB projects dealing with financial
instruments, and (iii) in connection with the implementation issues raised
related to the application of the definition of a derivative. SFAS 149 is
effective for contracts entered into or modified after June 30, 2003 and for
designated hedging relationships after June 30, 2003. SFAS 149 will be applied
prospectively. The Companys adoption of SFAS 149 did not have a material
impact on its financial position, cash flows or results of operations.

Note 7 - Subsequent Events

On February 6, 2004, the Company entered into a securities purchase
agreement with certain investors for the private placement of approximately 2.2
million shares of the Companys Common Stock at a price of $15.00 per share for
aggregate proceeds of approximately $33 million. The shares were issued and
paid for on February 6, 2004. The Company intends to apply the net proceeds for
working capital and general corporate purposes, as well as for strategic
purposes in connection with selected acquisitions that may be considered in the
future to expand its product and service offerings. The Company has agreed to
file a registration statement covering resales of these shares.

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Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations

Cautionary Statement Regarding Forward-Looking Statements

The section entitled Managements Discussion and Analysis of
Financial
Condition and Results of Operations set forth below contains 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). Words such as believes, anticipates, estimates,
expects, and words of similar expressions are intended to identify
forward-looking statements that involve risks and uncertainties. Such
statements are expectations based on information currently available and are
subject to risk, uncertainties and changes in condition, significance, value
and effect, including those discussed under the heading Trends, Risks and
Uncertainties below and reports filed by Hifn with the Securities and Exchange
Commission, specifically Forms 10-K, 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.

Overview

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

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

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

In December 2003, Hifn acquired certain assets and intellectual property
related to International Business Machine (IBM)s Picoprocessor PowerNP
(PowerNP). With this acquisition, we expanded our product offerings to
include programmable network processors designed for network traffic. These
products feature efficient programming models that eliminate stage processing
and reduce packet latency, thereby optimizing packet processing at high speeds.

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Critical Accounting Policies

The financial statements are prepared in conformity with accounting
principles generally accepted in the United States of America and requires
management to make estimates and assumptions in certain circumstances that
affect amounts reported in the accompanying consolidated financial statements
and related footnotes. As such, we are required to make certain estimates,
judgments and assumptions that we believe are reasonable based upon the
information available. These estimates and assumptions affect the reported
amounts of assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the periods presented. The
significant accounting policies which we believe are the most critical to aid
in fully understanding and evaluating our reported financial results include
the following:

Revenue recognition.We derive our revenue from the sale of processors and
software license fees. Customers comprise primarily of original equipment
manufacturers (OEMs) and, to a lesser extent, distributors. Revenue from the
sale of processors is recognized upon shipment when persuasive evidence of an
arrangement exists, the price is fixed or determined and collection of the
resulting receivables is reasonably assured. Revenue from processors sold to
distributors under agreements allowing certain rights of return is deferred
until the distributor sells the product to a third party.

Software license revenue is generally recognized when a signed agreement
or other persuasive evidence of an arrangement exists, vendor-specific
objective evidence exists to allocate a portion of the total fee to any
undelivered elements of the arrangement, the software has been shipped or
electronically delivered, the license fee is fixed or determinable and
collection of the resulting receivables is reasonably assured. Returns,
including exchange rights for unsold licenses, are estimated based on
historical experience and are deferred until the return rights expire. We base
the levels of returns on historical experience. To the extent we experience
increased levels of returns, revenue will decrease resulting in decreased gross
profit.

We receive software license revenue from OEMs that sublicense our software
shipped with their products. The OEM sublicense agreements are generally valid
for a term of one year and include rights to unspecified future upgrades and
maintenance during the term of the agreement. License fees under these
agreements are recognized ratably over the term of the agreement. Revenues from
sublicenses sold in excess of the specified volume in the original license
agreement are recognized when they are reported as sold to end customers by the
OEM. Our deferred revenue balance as of December 31, 2003 was $2.3 million and
included approximately $195,000 in exchange rights for unsold licenses.

Management judgments and estimates must be made regarding the
collectibility of fees charged. Should changes in conditions cause management
to determine the collectibility criteria are not met for certain future
transactions, revenue recognized for any reporting period could be adversely
affected.

Inventories.We value our inventory at the lower of cost (determined on a
first-in, first-out cost method) or market. Inventories are comprised solely of
finished goods, which are manufactured by third party foundries for resale by
us. We provide for obsolete, slow moving or excess inventories, based on
forecasts prepared by management, in the period when obsolescence or inventory
in excess of expected demand is first identified. Reserves are established to
reduce the cost basis of inventory for excess and obsolete inventory. As of
December 31, 2003, inventories of $2.6 million that were previously written
down were still on hand as compared to $2.7 million at September 30, 2003. The
decrease in reserve resulted from the sale of previously reserved inventories.
Subsequent increases in projected demand will not result in a reversal of these
reserves until the sale of the related inventory.

We are subject to technological change, new product development, and
product obsolescence. Actual demand may differ from forecasted demand and such
differences may have a material effect on our financial position and results of
operations.

Valuation of long-lived and intangible assets and goodwill.We evaluate
the recovery of finite lived intangible assets and other finite long-lived
assets whenever events or changes in circumstances indicate that their carrying
value may not be recoverable through the estimated undiscounted future cash
flows resulting from the use of the assets. If we determine that the carrying
value of goodwill, other intangible assets and other long-lived assets may

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not be recoverable, we measure impairment by using the projected
discounted cash flow method. Our judgments regarding the existence of
impairment indicators are based on market conditions and operational
performance of our business. During the first quarter of fiscal 2004, the
Company acquired certain assets and intellectual property related to IBMs
Picoprocessor PowerNP. Long-lived and intangibles assets associated with the
acquisition include contract backlog valued at $649,000, developed and core
technology of $11.8 million. Long-lived assets are amortized over periods
ranging from two to five years from the date the assets are acquired. In
accordance with SFAS 142, Goodwill and Other Intangible Assets, goodwill and
intangible assets deemed to have indefinite lives are not amortized but instead
are subject to annual impairment tests or interim impairment tests whenever
events or circumstances indicate that their carrying value may not be
recoverable. Asset impairment charges could have a material effect on our
consolidated financial position and results of operations.

Accounting for income taxes.As part of the process of preparing our
consolidated financial statements we are required to estimate our income taxes,
which involves estimating our actual current tax exposure together with
assessing temporary differences resulting from differing treatment of items for
tax and accounting purposes. These differences result in deferred tax assets
and liabilities. Significant management judgment is required to assess the
likelihood that our deferred tax assets will be recovered from future taxable
income. Continuing losses in recent reporting periods increase the
uncertainties regarding realizability of deferred tax assets. While we have
considered future taxable income and ongoing prudent and feasible tax planning
strategies in assessing the need for the valuation allowance, in the event we
were to determine that we would be able to realize our deferred tax assets in
the future in excess of its net recorded amount, an adjustment to the deferred
tax asset would increase income in the period such determination is made.

Litigation.From time to time, we may become involved in litigation
relating to claims arising from the ordinary course of business. Management
considers such claims on a case-by-case basis. We accrue for loss contingencies
if both of the following conditions are met: (a) information available prior to
the issuance of the financial statements indicates that it is probable that an
asset has been impaired or a liability has been incurred at the date of the
financial statements; and (b) the amount of loss can be reasonably estimated.

Results of Operations

The following table sets forth the percentage relationship of certain
items to the Companys revenue during the periods shown:

|                                          |                                               |                                    |     |                    |     |      |      |     |     | 
|----------------------------------------- | --------------------------------------------- | ---------------------------------- | --- | ------------------ | --- | ---- | ---- | --- | --- | 
|                                          |                                               |                                    |     | Three Months Ended
|                                          |                                               |                                    |     | December 31,      
|                                          |                                               |                                    |     |                   
|                                          |                                               |                                    |     | 2003               |     | 2002
|                                          |                                               |                                    |     |                    |     |     
|Net revenues                              |                                               |                                    | 100 | %                  |     |      | 100  | %  
|                                          |                                               |                                    |     |                    |     |      |      |    
|Costs and operating expenses:             |                                               |                                    |     |                    |     |      |      |    
|                                          | Cost of revenues                              |                                    |     | 21                 |     |      |      | 33  |    
|                                          | Research and development                      |                                    |     | 65                 |     |      |      | 118 |    
|                                          | Sales and marketing                           |                                    |     | 24                 |     |      |      | 40  |    
|                                          | General and administrative                    |                                    |     | 14                 |     |      |      | 22  |    
|                                          | Amortization of intangibles and goodwill      |                                    |     | 2                  |     |      |      | 8   |    
|                                          | Purchased in-process research and
development |                                    |     | 47                 |     |      |      |    |    
|                                          |                                               |                                    |     |                    |     |      |      |    
|                                          |                                               | Total costs and operating expenses |     |                    | 173 |      |      |     | 221 | 
|                                          |                                               |                                    |     |                    |     |      |      |    
|Loss from operations                      |                                               |                                    | (73 | )                  |     |      | (121 | )  
|Interest and other income, net            |                                               |                                    | 2   |                    |     |      | 5    |    
|                                          |                                               |                                    |     |                    |     |      |      |    
|Loss before income taxes                  |                                               |                                    | (71 | )                  |     |      | (116 | )  
|Provision for (benefit from) income taxes |                                               |                                    |    |                    |     |      |     |    
|                                          |                                               |                                    |     |                    |     |      |      |    
|Net loss                                  |                                               |                                    | (71 | )%                 |     |      | (116 | )% 
|                                          |                                               |                                    |     |                    |     |      |      |    

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Net Revenues.Net revenues increased 61.7% to $7.1 million for the
quarter ended December 31, 2003 from $4.4 million for the quarter ended
December 31, 2002. The increase in revenues was primarily due to an increase in
Hifns software license and royalty revenues of $1.8 million as well as
increased sales of Hifns data compression and encryption processors to network
equipment manufacturers of $950,000. Processor sales to Quantum, an original
equipment manufacturer of high-performance tape storage devices, through its
manufacturing subcontractor, comprised 24% and 33% of net revenues for the
three months ended December 31, 2003 and 2002, respectively. Processor and
software sales to Cisco, an original equipment manufacturer of network
equipment, comprised 53% and less than 10% of net revenues for the three months
ended December 31, 2003 and 2002, respectively.

Cost of Revenues.Cost of revenues consists primarily of semiconductors
which were manufactured to our specifications by third parties for resale by
us. Cost of processor revenues as a percentage of net processor revenues
decreased to 28.6% for the three months ended December 31, 2003
from 35.4% for the same period in fiscal 2002 primarily as a result of the mix of processor
revenues sold during the respective periods. During the three months ended
December 31, 2003 and 2002, we sold $186,000 and $272,000, respectively, in
inventories that had previously been written down. Cost of software licenses
and other revenues is primarily comprised of engineering labor related to
support and maintenance of sold licenses and was $120,000 and $99,000 during
the three months ended December 31, 2003 and 2002, respectively.

Research and Development.The cost of product development consists
primarily of salaries, employee benefits, overhead, outside contractors and
non-recurring engineering fees. Such research and development expenses
decreased to $4.7 million for the quarter ended December 31, 2003 from $5.2
million for the quarter ended December 31, 2002. The decrease is primarily
attributable to a decrease in nonrecurring engineering costs of $538,000 as a
result of the timing of new product development and in salaries and benefits of
$265,000 as a result of lower average headcount.

Sales and Marketing.Sales and marketing expenses consist primarily of
salaries, commissions and benefits of sales, marketing and support personnel as
well as consulting, advertising, promotion and overhead expenses. Such expenses
remained relatively flat at $1.7 million and $1.8 million for the three months
ended December 31, 2003 and 2002, respectively. The fluctuation in sales and
marketing cost is the net effect of a decrease in salaries and benefits,
facilities and advertising costs aggregating $170,000 offset by an increase in
sales representative commissions of $85,000 due to higher level of sales made
through sales representatives.

General and Administrative.General and administrative expenses are
comprised primarily of salaries for administrative and corporate services
personnel, legal and other professional fees. Such expenses were approximately
$1.0 million in each of the three months ended December 31, 2003 and 2002. The
slight decrease during the first quarter of fiscal 2003 was the net result of a
reduction in legal expenses of $65,000 offset by an increase in facility costs
of $54,000 as a result of lower amortization of previously recorded charges
related to vacant facility lease obligations.

Amortization of Intangibles.Amortization of intangibles was $151,000 for
the three months ended December 31, 2003 and $358,000 for the three months
ended December 31, 2002. The decrease in amortization of intangibles is the
result of full amortization of certain intangible assets as they reached their
estimated useful lives.

Purchased In-Process Research and Development.Purchased in-process
research and development (IPR&D) during the three months ended December 31,
2003 related to the purchase of certain assets and intellectual property for
programmable network processors designed for network traffic related to the IBM
Picoprocessor PowerNP. The allocated amount was determined by management after considering, among other factors, input provided by an independent appraisal based on established valuation techniques in the semiconductor industry and was expensed upon acquisition because technological feasibility had not been established and no alternative future uses exist. The fair value of two projects containing in-process technology in development was determined using the income approach, which discounts expected future cash flows to present value. The discount rates used in the present value calculations was derived from a weighted-average cost of capital analysis adjusted to reflect additional risks inherent in the development life cycle including the failure to achieve technical viability, rapid changes in customer markets and required standards for new products as well as potential competition in the market for such products.

Interest and Other Income, net.Net interest and other income was $102,000
for the three months ended December 31, 2003 and $230,000 for the three months
ended December 31, 2002. The decrease in interest and other income for the
three months ended December 31, 2003 compared to the same period in the prior
fiscal year was primarily a result of a shift in the investment mix from stock
instruments to commercial paper and municipal bonds,

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lower average cash and
short-term investments balance during the past three fiscal years as well as a
decrease in market interest rates.

Income Taxes.In fiscal 2002, we recorded a valuation allowance of $9.8
million to reduce the carrying value of our deferred tax assets and in fiscal
2003, we recognized a tax benefit of $1.8 million related to carry back of net
operating losses to prior years. As a result of continuing losses over a longer
period than previously expected, we have not recognized tax benefits for the
three months ended December 31, 2003 and 2002. We continue to consider future
taxable income and ongoing prudent and feasible tax planning strategies in
assessing the valuation allowance.

Liquidity and Capital Resources

Net cash used in operating activities of $2.6 million for the three months
ended December 31, 2003 was the result of net loss of $5.1 million as adjusted
for non-cash items including purchased in-process research and development of
$3.3 million, depreciation and amortization costs of $346,000, amortization of
intangibles of $151,000, amortization of deferred stock compensation of
$44,000, as well as a decrease in accounts receivable of $713,000 and in
other assets of $191,000. These adjustments were offset by an
increase in inventories of $493,000 and in prepaid expenses and other current
assets of $770,000 as well as a decrease in accounts payable and accrued
expenses and other current liabilities of approximately $1.0 million.

Net cash used in operating activities of $5.0 million for the three months
ended December 31, 2002 was the result of net loss of $5.1 million as adjusted
for non-cash items including amortization of intangibles of $607,000,
amortization of deferred stock compensation of $129,000, depreciation and
amortization costs of $398,000 as well as a decrease in accounts receivable of
$329,000 and in other assets of $183,000. These adjustments
were offset by increases in inventories of $36,000 and in prepaid expenses and
other current assets of $1.1 million and a decrease in accounts payable and
accrued expenses and other current liabilities of $419,000.

Net cash used in investing activities of $22.0 million for the three
months ended December 31, 2003 primarily reflects the purchase of certain
assets and intellectual property from IBM for $15.8 million, the purchase of
short-term investments of $6.0 million and the purchase of property and
equipment of $238,000. Net cash provided by investing activities of $1.5
million for the three months ended December 31, 2002 primarily reflects a
decrease in short-term investments partially offset by the purchase of property
and equipment.

Net cash provided by financing activities was $1.2 million and $476,000
for the three months ended December 31, 2003 and 2002, respectively. The net
cash provided by financing activities for both periods was attributable to
proceeds from issuance of common stock.

The Company uses a number of independent suppliers to manufacture
substantially all of its products. As a result, the Company relies on these
suppliers to allocate to the Company a sufficient portion of foundry capacity
to meet the Companys needs and deliver sufficient quantities of the Companys
products on a timely basis. These arrangements allow the Company 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.

The Company requires substantial working capital to fund its business,
particularly to finance accounts receivable and inventory, and for investments
in property and equipment. The Companys need to raise capital in the future
will depend on many factors including the rate of sales growth, market
acceptance of the Companys existing and new products, the amount and timing of
research and development expenditures, the timing and size of acquisitions of
businesses or technologies, the timing of the introduction of new products and
the expansion of sales and marketing efforts. We anticipate that our existing
cash resources will fund any anticipated operating losses, purchases of capital
equipment and provide adequate working capital for the next twelve months. Our
liquidity is affected by many factors including, among others, the extent to
which we pursue additional capital expenditures, the level of our product
development efforts, and other factors related to the uncertainties of the
industry and global economies. Accordingly, there can be no assurance that
events in the future will not require us to seek additional capital sooner or,
if so required, that such capital will be available on terms acceptable to us.

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On February 6, 2004, the Company entered into a securities purchase
agreement with certain investors for the private placement of approximately 2.2
million shares of the Companys Common Stock at a price of $15.00 per share for
aggregate proceeds of approximately $33 million. The shares were issued and
paid for on February 6, 2004.
The Company intends to apply the net proceeds for working capital and
general corporate purposes, as well as for strategic purposes in connection
with selected acquisitions that may be considered in the future to expand its
product and service offerings. The Company will file a registration statement
covering resales of these shares.

The Company occupies its facilities under several non-cancelable operating
leases that expire at various dates through December 2007, and which contain
renewal options. Future minimum lease payments for operating leases as of
December 31, 2003 are as follows (in thousands):

|                                 |            |                              |   |                 |       | 
|-------------------------------- | ---------- | ---------------------------- | - | --------------- | ----- | 
|                                 |            |                              |   | Operating Lease
|                                 |            |                              |   | Commitments    
|                                 |            |                              |   |                
|Fiscal year ending September 30, |            |                              |   |                
|                                 | 2004       |                              | $ | 2,138           |      
|                                 | 2005       |                              |   | 2,430           |      
|                                 | 2006       |                              |   | 1,037           |      
|                                 | 2007       |                              |   | 973             |      
|                                 | Thereafter |                              |   | 242             |      
|                                 |            |                              |   |                
|                                 |            | Total minimum lease payments |   | $               | 6,820 | 
|                                 |            |                              |   |                

Recent Accounting Pronouncements

In April 2003, the FASB issued Statement of Accounting Standards No. 149
(SFAS 149), Amendment of Statement 133 on Derivative Instruments and Hedging
Activities. SFAS 149 amends and clarifies financial accounting and reporting
of derivative instruments and hedging activities under Statement of Accounting
Standards No. 133 (SFAS 133), Accounting for Derivative Instruments and
Hedging Activities. SFAS 149 amends SFAS 133 for decisions made: (i) as part
of the Derivatives Implementation Group process that require amendment to SFAS
133, (ii) in connection with other FASB projects dealing with financial
instruments, and (iii) in connection with the implementation issues raised
related to the application of the definition of a derivative. SFAS 149 is
effective for contracts entered into or modified after June 30, 2003 and for
designated hedging relationships after June 30, 2003. SFAS 149 will be applied
prospectively. The Companys adoption of SFAS 149 did not have a material
impact on its financial position, cash flows or results of operations.

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Trends, Risks and Uncertainties

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

Our Operating Results 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;                                      
|
| |  |  | Acquisitions or mergers involving us, our competitors or customers;                      
|
| |  |  | Any new product introductions by us or our competitors;                                  
|
| |  |  | Our suppliers increasing costs or changing the delivery of products to us;               
|
| |  |  | Increased competition or reductions in the prices that we are able to charge;            
|
| |  |  | The variety of the products that we sell as well as seasonal demand for our products; and
|
| |  |  | The availability of manufacturing capacity necessary to make our products.               

If We Determine That Our Long-Lived Assets Have Been Impaired Or That Our
Goodwill Has Been Further Impaired Our Financial Condition and Results of
Operations May Suffer.

During the quarter ended December 31, 2003, we completed the acquisition
of certain assets and intellectual property related to the IBM Picoprocessor
Power NP for approximately $15.7 million in cash. The purchase price of the
acquisition of $15.9 million, which included $200,000 in estimated acquisition
related costs, was used to acquire the technical designs to the PowerNP. The
purchase price was allocated to assets acquired based on the book value of
inventory and fixed assets, which management believes approximates their fair value, and after considering input provided by an
independent appraisal, to all other identifiable assets. The excess of the
purchase price over the net tangible and intangible assets acquired has been
allocated to the intangibles and fixed assets. Pursuant to SFAS 142, Goodwill
and Other Intangible Assets, we will perform an annual impairment test and if,
as a result of this analysis, we determine that there has been an impairment of
our goodwill and other long-lived and intangible assets, asset impairment
charges will be recognized. As of December 31, 2003, we have approximately $1.0
million of goodwill related to the acquisition of Apptitude in August
2000.

We Depend Upon A Small Number Of Customers.

Quantum Corporation (Quantum), through its manufacturing
subcontractor,
accounted for approximately 24%, 33% and 34% of our net revenues during the
quarters ended December 31, 2003 and 2002 and in fiscal 2003, respectively.
Cisco, an OEM producer of network equipment, comprised 53% and 23% of our net
revenues for the quarter ended December 31, 2003 and the year ended September
30, 2003. Neither Quantum nor Cisco is under any binding obligation to order
from us. If our sales to

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Quantum or Cisco 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 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., 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 continues to evolve, may not grow.
Alternatively, if it continues to grow, our products may not successfully serve
this market. Our ability to generate significant revenue in the virtual private
network market will depend upon, among other things, the following:



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

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

We Face Risks Associated With Evolving Industry Standards And Rapid
Technological Change.

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



| |  |  | Properly identify emerging target markets and related technological trends;
| | - |  | ---------------------------------------------------------------------------
|
| |  |  | Develop and maintain competitive products;                                 

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| |  |  | Develop end-to-end, ubiquitous systems solutions;                                                            
| | - |  | -------------------------------------------------------------------------------------------------------------
|
| |  |  | Develop, or partner with providers of, security services processors;                                         
|
| |  |  | Develop both hardware and software security services solutions;                                              
|
| |  |  | Enhance our products by adding innovative features that
differentiate our products from those of competitors;
|
| |  |  | Bring products to market on a timely basis at competitive prices; and                                        
|
| |  |  | Respond effectively to new technological changes or new product announcements by others.                     

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

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

Our Markets Are Highly Competitive.

We compete in markets that are intensely competitive and are expected to
become increasingly competitive as current competitors expand their product
offerings and new competitors enter the market. The markets that we compete in
are subject to frequent product introductions with improved price-performance
characteristics, rapid technological change, and the continued emergence of new
industry standards. Our products compete with offerings from companies such as
Analog Devices, Inc., SafeNet, Inc., IBM, Broadcom Corporation, Motorola, Inc.
and Cavium Networks. Hifn was a wholly-owned subsidiary of Stac, Inc. until
Hifns spin-off from Stac in 1996 upon which Stac assigned two license
agreements entered into with IBM in 1994 in which Stac granted IBM the right to
use, but not sublicense, our patented compression technology in IBM hardware
and software products. Stac also assigned its 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. 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

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the
export restriction has been liberalized, we may not be successful in entering
or competing in 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 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.

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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 eighteen (18) United States patents and
seven foreign patents. We also have two pending patent applications in
Japan. Our issued patents and patent applications primarily cover various
aspects of our compression, flow classification, bandwidth management and rate
shaping technologies and have expiration dates ranging from 2006 to 2020. We
have five pending patent applications in the United States, four in Europe and
Asia (Japan) covering our flow classification 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, Philips Semiconductor and IBM. 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. In the past, 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 that caused a 3-month delay in
shipments to customers. We have also experienced yield and test anomalies on a
different product manufactured by another subcontractor that could have
interrupted our customer shipments. In this case, the manufacturer was able to
correct the problem in a timely manner and customer shipments were not
affected. The delay and expense associated with qualifying a new supplier or
foundry and commencing volume production can result in lost revenue, reduced
operating margins and possible

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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.

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

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

Network And Storage Equipment Prices Typically Decrease.

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



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

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

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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. During fiscal 2002, we recorded an excess inventory
reserve of $3.4 million as a result of a significant decrease in forecasted
demand for our products. 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. 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 has, in the
past, been 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 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, we, along with our network equipment customers have an opportunity
to effectively compete with our foreign competitors. The existence of these
restrictions until recently may have enabled foreign competitors facing less
stringent controls on their products to become more established and, therefore,
more competitive in the global market than our network equipment customers. In
addition, the list of products and countries for which export approval is
required, and the regulatory policies with respect thereto, could be revised,
and laws limiting the domestic use of encryption could be enacted. While the
U.S. government now allows U.S. companies to assume that exports to
non-government end-users will be approved within 30 days of official
registration with the Department of

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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;     
|
| |  |  | Military and related activities;             
|
| |  |  | Trade restrictions; and                      
|
| |  |  | Changes in tariffs.                          

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

We Face Risks Associated With Acquisitions.

During the fiscal quarter ended December 31, 2003, we acquired certain
assets and intellectual property related to IBMs Picoprocessor PowerNP. We
continually evaluate strategic acquisitions of businesses and technologies that
would complement our product offerings or enhance our market coverage or
technological capabilities and may make additional acquisitions in the future.
Future acquisitions could be effected without stockholder approval, and could
cause us to dilute shareholder equity, incur debt and contingent liabilities
and amortize acquisition expenses related to intangible assets, any of which
could harm our operating results and/or the price of our Common Stock.
Acquisitions entail numerous risks, including:



| |  |  | Difficulties in assimilating acquired operations, technologies and products; 
| | - |  | -----------------------------------------------------------------------------
|
| |  |  | Diversion of managements attention from other business concerns;            
|
| |  |  | Risks of entering markets in which we have little or no prior experience; and
|
| |  |  | Loss of key employees of acquired organizations.                             

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

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We Face Risks Associated With Required 1934 Act Filings as a Result of our
Recent Acquisition of Certain Assets of IBM.

We filed a Current Report on Form 8-K on January 6, 2004 in connection
with our acquisition of certain assets and our licensing of certain
intellectual property related to IBMs PicoProcessor Power NP. On January 14,
2004 we filed Amendment No. 1 to the Form 8-K. We believe that we are not
required to file financial statements or pro forma financial information
regarding these assets we acquired from IBM under applicable rules and
regulations of the SEC, and we are seeking the SECs concurrence with that
view. We cannot assure you that the SEC will agree with our view. If the SEC
disagrees with our view, under applicable rules and regulations of the SEC, we
may be required to file, by March 16, 2004, certain financial statements and
pro forma financial information regarding the assets we acquired from IBM. In
that case, we will be reliant upon IBM to assist us with the preparation of the
required financial statements. If we fail to file any required financial
statements or pro forma financial information by March 16, 2004, we could be
rendered ineligible to file registration statements with the SEC on Form S-3
for up to one (1) year. In lieu of filing registration statements on Form
S-3, we could file them on Form S-1, but we would incur additional
administrative costs in doing so. Moreover, the SEC will not declare effective
any registration statements that we file until such time as we have filed any
required financial statements and pro forma financial information regarding the
assets that we acquired from IBM. Any such delays in the effectiveness of our
registration statements could harm the Companys ability to raise additional
capital. In addition, pursuant to that certain Securities Purchase Agreement
dated February 6, 2004 (the Securities Purchase Agreement), filed with the
SEC on Form 8-K on February 9, 2004, the Company is obligated to file a
registration statement. A delay in the effectiveness of such registration
statement could result in the payment by the Company to each Purchaser (as
defined in the Securities Purchase Agreement) of certain liquidated damages, as
set forth in the Securities Purchase Agreement.

The Cyclical Nature Of The Semiconductor Industry May Harm Our Business.

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

Our Stock Price May Be Volatile.

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



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

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We Have Been Engaged in Securities Class-Action Lawsuits.

During fiscal 2003, we completed the settlement terms of the class action
complaint and had shareholder derivative actions dismissed. As of December 31,
2003, there were no outstanding claims against us nor do we have any
outstanding obligations related to claims or lawsuits. There can be no
assurance there will not be any actions against us in the future. Any such
actions may have a material adverse effect on our financial condition and
results of operations.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest
Rate Risk - The Company does not use derivative financial
instruments in its investment portfolio. The Companys investment portfolio is
generally comprised of commercial paper. The Company places investments in
instruments that meet high credit quality standards. These securities are
subject to interest rate risk, and could decline in value if interest rates
fluctuate. Due to the short duration and conservative nature of the Companys
investment portfolio, the Company does not expect any material loss with
respect to its investment portfolio. A 10% move in interest rates at December
31, 2003 would not have a material effect on the Companys pre-tax earnings and
the carrying value of its investments over the next fiscal year.

Foreign
Currency Exchange Rate Risk - All of the Companys sales, cost
of
manufacturing and marketing are transacted in US dollars. Accordingly, the
Companys results of operations are not subject to foreign exchange rate
fluctuations. Gains and losses from such fluctuations have not been incurred by
the Company to date.




Item 4. Controls and Procedures

Evaluation of disclosure controls and procedures. Our management
evaluated, with the participation of our Chief Executive Officer and our Chief
Financial Officer, the effectiveness of our disclosure controls and procedures
as of the end of the period covered by this Quarterly Report on Form 10-Q.
Based on this evaluation, our Chief Executive Officer and our Chief Financial
Officer have concluded that our disclosure controls and procedures are
effective to ensure that information we are required to disclose in reports
that we file or submit under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported within the time periods specified in
Securities and Exchange Commission rules and forms.

Changes in internal control over financial reporting. There was no change
in our internal control over financial reporting that occurred during the
period covered by this Quarterly Report on Form 10-Q that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.

26



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##### Table of Contents






PART
II - OTHER INFORMATION




Item 1. Legal Proceedings



| |  |  | None.
| |  |  | -----

Item 2. Changes in Securities



| |  |  | None.
| |  |  | -----

Item 3. Defaults Upon Senior Securities



| |  |  | None.
| |  |  | -----

Item 4. Submission of Matters to a Vote of Security Holders



| |  |  | None.
| |  |  | -----

Item 5. Other Information



| |  |  | None.
| |  |  | -----




Item 6. Exhibits and Reports on Form 8-K



| | (a) |  | Exhibits     
| | --- |  | -------------
|
| |     |  | Exhibit Index

|               |  |                                                                                                                                                                                       
|-------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description                                                                                                                                                                           
|               |  |                                                                                                                                                                                       
|3.1*           |  | Form of Third Amended and Restated
Certificate of Incorporation of hi/fn, inc.                                                                                                        
|              
|3.2*           |  | Amended and Restated Bylaws of hi/fn, inc.
10.1** Asset Purchase Agreement, dated as of December 30, 2003,
by and between hi/fn, inc. and International Business
Machines Corporation.
|              
|10.1**         |  | Asset Purchase Agreement, dated as of December 30, 2003, by and
between hi/fn, inc. and International Business Machines Corporation.                                                  
|              
|10.2**         |  | Intellectual Property Agreement, dated as of December 30,
2003, by and between hi/fn, inc. and International Business
Machines Corporation.                                           
|              
|10.3**         |  | Patent License Agreement, dated as of December 30, 2003,
by and between hi/fn, inc. and International Business
Machines Corporation.                                                  
|              
|31.1           |  | Certification of Chief Executive Officer
pursuant to Section 302(a) of the Sarbanes-Oxley Act of
2002.                                                                                
|              
|31.2           |  | Certification of Chief Financial Officer
pursuant to Section 302(a) of the Sarbanes-Oxley Act of
2002.                                                                                
|              
|32.1           |  | Certification of Chief Executive Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.                                    
|              
|32.2           |  | Certification of Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.                                    



| | (b) |  | Reports on Form 8-K
| | --- |  | -------------------
|
| |     |  | None.              



---

|*  |  | Incorporated by reference from Registrants Registration Statement on
Form 10 (File No. 0-24765) filed with the SEC on August 7, 1998 as
amended.
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------
|  
|** |  | Incorporated by reference to Current Report on Form 8-K/A, filed with the
Securities and Exchange Commission on January 14, 2004.                

27



---



##### Table of Contents






SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

|                        |     |                                                                                                           |                       | 
|----------------------- | --- | --------------------------------------------------------------------------------------------------------- | --------------------- | 
|                        |     | hi/fn, inc.
(Registrant)                                                                                 
|                        |     |                                                                                                           |                       | 
|Date:
February 17, 2004 | By: |                                                                                                           | /s/ WILLIAM R. WALKER
|                        |     |                                                                                                           |                       | 
|                        |     | William R. Walker                                                                                        
|                        |     | Vice
President, Finance, Chief Financial Officerand Secretary
(principal financial and accountingofficer)

28



---



##### Table of Contents






INDEX TO EXHIBITS

|        |  |                                                                                                                                                       
|------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  |                                                                                                                                                       
|Number  |  | Exhibit                                                                                                                                               
|        |  |                                                                                                                                                       
|3.1*    |  | Form of Third Amended and Restated Certificate of Incorporation of hi/fn, inc.                                                                        
|        |  |                                                                                                                                                       
|3.2*    |  | Amended and Restated Bylaws of hi/fn, inc.                                                                                                            
|        |  |                                                                                                                                                       
|10.1**  |  | Asset Purchase Agreement, dated as of December 30, 2003, by and between
hi/fn, inc. and International Business Machines Corporation.                  
|        |  |                                                                                                                                                       
|10.2**  |  | Intellectual Property Agreement, dated as of December 30, 2003, by and
between hi/fn, inc. and International Business Machines Corporation.           
|        |  |                                                                                                                                                       
|10.3**  |  | Patent License Agreement, dated as of December 30, 2003, by and between
hi/fn, inc. and International Business Machines Corporation.                  
|        |  |                                                                                                                                                       
|31.1    |  | Certification of Chief Executive Officer pursuant to Section 302(a) of the
Sarbanes-Oxley Act of 2002.                                                
|        |  |                                                                                                                                                       
|31.2    |  | Certification of Chief Financial Officer pursuant to Section 302(a) of the
Sarbanes-Oxley Act of 2002.                                                
|        |  |                                                                                                                                                       
|32.1    |  | Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|        |  |                                                                                                                                                       
|32.2    |  | Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.



---

|*  |  | Incorporated by reference from Registrants Registration Statement on
Form 10 (File No. 0-24765) filed with the SEC on August 7, 1998 as
amended.
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------
|  
|** |  | Incorporated by reference to Current Report on Form 8-K/A, filed with the
Securities and Exchange Commission on January 14, 2004.                

29