<PAGE>   1
                     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 March 31, 2001


        [ ]     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                  (IRS Employer
     Incorporation or Organization)              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 [ ]

The number of shares outstanding of the Registrant's Common Stock, par value
$.001 per share, was 10,123,683 as of April 27, 2001.

<PAGE>   2
                                   HIFN, INC.

                               INDEX TO FORM 10-Q

<TABLE>
<CAPTION>
<S>       <C>                                                                                             <C>
PART I.   FINANCIAL INFORMATION

Item 1.   Financial Statements

          Condensed Consolidated Balance Sheets at March 31, 2001 and September 30, 2000                    3

          Condensed Consolidated Statements of Operations for the three
             and six months ended March 31, 2001 and 2000                                                   4

          Condensed Consolidated Statements of Cash Flows for
             the six months ended March 31, 2001 and 2000                                                   5

          Notes to Condensed Consolidated Financial Statements                                            6-8

Item 2.   Management's Discussion and Analysis of Financial Condition and Results of Operations          9-22

Item 3.   Quantitative and Qualitative Disclosures about Market Risk                                       23


PART II.  OTHER INFORMATION

Item 1.   Legal Proceedings                                                                                24

Item 4.   Submission of Matters to a Vote of Security Holders                                           24-25

Item 6.   Exhibits and Reports on Form 8-K                                                                 25

Signatures                                                                                                 26
</TABLE>


                                       2
<PAGE>   3
PART 1 -- FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

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

<TABLE>
<CAPTION>
                                                         March 31,    September 30,
                                                           2001           2000
                                                       -----------    -------------
                                                       (unaudited)
<S>                                                    <C>            <C>
                                     ASSETS

CURRENT ASSETS:
 Cash and cash equivalents                               $ 61,043       $ 59,688
 Short-term investments                                     9,371          5,127
 Accounts receivable, net                                   4,076          5,748
 Inventory                                                  5,515          1,355
 Deferred income taxes                                        620            620
 Prepaid expenses and other current assets                  6,453          1,221
                                                         --------       --------
    Total current assets                                   87,078         73,759
                                                         --------       --------
Property and equipment, net                                 3,945          3,268
Deferred income taxes                                       3,132          3,132
Intangibles and other assets                               45,976         51,320
                                                         --------       --------
                                                         $140,131       $131,479
                                                         ========       ========
                      LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
 Accounts payable                                        $  3,417       $  2,814
 Income taxes payable                                       1,846             --
 Accrued expenses and other current liabilities             5,557          4,447
                                                         --------       --------
    Total current liabilities                              10,820          7,261
                                                         --------       --------
Long-term capital lease obligations                             5             27
                                                         --------       --------
STOCKHOLDERS' EQUITY:
 Common stock                                                  10             10
 Additional paid-in capital                               116,444        109,251
 Retained earnings                                         12,852         14,930
                                                         --------       --------
       Total stockholders' equity                         129,306        124,191
                                                         --------       --------
                                                         $140,131       $131,479
                                                         ========       ========
</TABLE>

     See accompanying notes to condensed consolidated financial statements.


                                       3
<PAGE>   4
                                   HIFN, INC.
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                      (in thousands, except per share data)
                                   (unaudited)

<TABLE>
<CAPTION>
                                                  Three Months Ended           Six Months Ended
                                                        March 31,                  March 31,
                                                 ----------------------      ----------------------
                                                   2001          2000          2001          2000
                                                 --------      --------      --------      --------
<S>                                              <C>           <C>           <C>           <C>
Net revenues                                     $ 13,828      $  8,130      $ 29,937      $ 18,184
Cost of revenues                                    3,280         1,875         6,928         4,038
                                                 --------      --------      --------      --------
Gross profit                                       10,548         6,255        23,009        14,146
                                                 --------      --------      --------      --------
Operating expenses:
   Research and development                         4,780         4,200         9,143         7,496
   Sales and marketing                              2,587         1,916         5,378         3,615
   General and administrative                       2,261         1,096         4,348         1,875
   Amortization of intangibles and goodwill         2,770            28         5,569            57
                                                 --------      --------      --------      --------
       Total operating expenses                    12,398         7,240        24,438        13,043
                                                 --------      --------      --------      --------
Income (loss) from operations                      (1,850)         (985)       (1,429)        1,103

Interest and other income, net                        791         1,036         1,588         2,003
                                                 --------      --------      --------      --------
Income (loss) before income taxes                  (1,059)           51           159         3,106
Provision for income taxes                            663            21         2,237         1,243
                                                 --------      --------      --------      --------
Net income (loss)                                $ (1,722)     $     30      $ (2,078)     $  1,863
                                                 ========      ========      ========      ========
Net income (loss) per share, basic               $  (0.17)     $   0.00      $  (0.21)     $   0.21
                                                 ========      ========      ========      ========
Net income (loss) per share, diluted             $  (0.17)     $   0.00      $  (0.21)     $   0.19
                                                 ========      ========      ========      ========
Weighted average shares outstanding, basic         10,120         8,860        10,108         8,798
                                                 ========      ========      ========      ========
Weighted average shares outstanding, diluted       10,120         9,871        10,108         9,846
                                                 ========      ========      ========      ========
</TABLE>

     See accompanying notes to condensed consolidated financial statements.


                                       4
<PAGE>   5
                                   HIFN, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (in thousands)
                                   (unaudited)

<TABLE>
<CAPTION>
                                                              Six Months Ended
                                                                  March 31,
                                                           ----------------------
                                                             2001          2000
                                                           --------      --------
<S>                                                        <C>           <C>
Cash flows from operating activities:
      Net income (loss)                                    $ (2,078)     $  1,863
      Adjustments to reconcile net income (loss)
         to net cash provided by operating activities:
        Depreciation and amortization                           711           557
        Amortization of intangibles and goodwill              5,569            57
        Amortization of deferred stock compensation           2,683           544
        Tax benefit from employee stock plans                 3,870            --
      Changes in assets and liabilities:
        Accounts receivable                                   1,672         2,337
        Inventory                                            (4,160)         (878)
        Prepaid expenses and other current assets            (5,232)        1,388
        Other assets                                           (173)          (77)
        Accounts payable                                        603          (359)
        Income taxes payable                                  1,846        (1,300)
        Accrued expenses and other current liabilities        1,084        (1,182)
                                                           --------      --------
          Net cash provided by operating activities           6,395         2,950
                                                           --------      --------
Cash flows from investing activities:
      Purchase of short-term investments                     (4,244)           --
      Purchases of property and equipment                    (1,388)         (923)
                                                           --------      --------
          Net cash used in investing activities              (5,632)         (923)
                                                           --------      --------
Cash flows from financing activities:
      Proceeds from issuance of common stock, net               628           867
      Payment on capital lease obligations                      (36)           --
                                                           --------      --------
          Net cash provided by financing activities             592           867
                                                           --------      --------
Net increase in cash and cash equivalents                     1,355         2,894
Cash and cash equivalents at beginning of period             59,688        70,086
                                                           --------      --------
Cash and cash equivalents at end of period                 $ 61,043      $ 72,980
                                                           ========      ========
</TABLE>

     See accompanying notes to condensed consolidated financial statements.


                                       5
<PAGE>   6
                                   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 subsidiary, Apptitude
Acquisition Corp. 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.

      Certain reclassifications have been made to the prior year consolidated
financial statements to conform to the current year's presentation. Such
reclassifications had no effect on previously reported results of operations or
retained earnings.

      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, 2000. 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 March 31, 2001 and its results of operations for the three and six month
periods ended March 31, 2001 and 2000, respectively. These condensed
consolidated financial statements are not necessarily indicative of the results
to be expected for the entire year.

NOTE 2 - NET INCOME 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 3,556,224 shares of common stock, or 509,245 and 626,097 average
shares, for the three and six months ended March 31, 2001, respectively, were
not included in the computation of diluted earnings per share because their
impact would be anti-dilutive. A reconciliation of the numerators and
denominators of the basic and diluted earnings per share calculations for the
three and six months ended March 31, 2001 and 2000 are presented below (in
thousands, except per share amounts):

<TABLE>
<CAPTION>
                                                            Three Months Ended          Six Months Ended
                                                                 March 31,                  March 31,
                                                          ----------------------     ----------------------
                                                            2001          2000         2001          2000
                                                          --------      --------     --------      --------
<S>                                                       <C>           <C>          <C>           <C>
Net income (loss)                                         $ (1,722)     $     30     $ (2,078)     $  1,863
                                                          ========      ========     ========      ========
Shares used in computing net income (loss) per share:
    Basic                                                   10,120         8,860       10,108         8,798
    Dilutive effect of stock options                            --         1,011           --         1,048
                                                          --------      --------     --------      --------
    Diluted                                                 10,120         9,871       10,108         9,846
                                                          ========      ========     ========      ========
Net income (loss) per share:
    Basic                                                 $  (0.17)     $   0.00     $  (0.21)     $   0.21
                                                          ========      ========     ========      ========
    Diluted                                               $  (0.17)     $   0.00     $  (0.21)     $   0.19
                                                          ========      ========     ========      ========
</TABLE>


                                       6
<PAGE>   7
NOTE 3 - DETAILED BALANCE SHEET:

<TABLE>
<CAPTION>
                                                           March 31,         September 30,
                                                             2001                2000
                                                           ---------         -------------
                                                                  (in thousands)
                                                                    (unaudited)
<S>                                                        <C>               <C>
Accounts receivable:
   Trade receivables                                       $  4,400             $  6,117
   Less: allowance for doubtful accounts                       (324)                (369)
                                                           --------             --------
                                                           $  4,076             $  5,748
                                                           ========             ========
Property and equipment:
   Computer equipment                                      $  4,228             $  3,399
   Furniture and fixtures                                     1,139                  718
   Leasehold improvements                                       765                  724
   Office equipment                                             498                  401
                                                           --------             --------
                                                              6,630                5,242
   Less: accumulated depreciation                            (2,685)              (1,974)
                                                           --------             --------
                                                           $  3,945             $  3,268
                                                           ========             ========
Intangibles and other assets:
   Developed and core technology                           $  3,263             $  3,263
   Workforce                                                    599                  599
   Patents                                                      600                  600
   Goodwill                                                  47,121               47,121
   Purchased intellectual property                            1,049                1,049
   Other                                                        690                  477
                                                           --------             --------
                                                             53,322               53,109
   Less: accumulated amortization                            (7,346)              (1,789)
                                                           --------             --------
                                                           $ 45,976             $ 51,320
                                                           ========             ========
Accrued expenses and other current liabilities:
   Deferred revenue                                        $  2,550             $  1,646
   Compensation and employee benefits                         1,865                1,760
   Accrued royalties                                             --                  124
   Other                                                      1,142                  917
                                                           --------             --------
                                                           $  5,557             $  4,447
                                                           ========             ========
</TABLE>

NOTE 4 -- APPTITUDE ACQUISITION

      In August 2000, the Company acquired all the outstanding stock of
Apptitude, Inc. ("Apptitude"), a software development company, for $20 million
in cash and 1.2 million shares of the Company's Common Stock in a transaction
accounted for under the purchase method. The purchase agreement also states that
any and all outstanding options of Apptitude will be assumed by the Company. The
results of operations of Apptitude have been included in the condensed
consolidated statement of operations of the Company from the date of
acquisition. The purchase price of the acquisition of $58.5 million, which
included $127,000 in estimated acquisition related costs, was used to acquire
the net assets of Apptitude. The purchase price was allocated to assets acquired
and liabilities assumed based on the book value of Apptitude's current assets,
liabilities and property and equipment, which management believes approximates
their fair value, and an independent appraisal for all other identifiable
assets. The excess of the purchase price over the net tangible and intangible
assets acquired and liabilities assumed has been allocated to goodwill.


                                       7
<PAGE>   8
NOTE 5 -- EMPLOYEE STOCK OPTION PLAN

      In February 2001, the Board of Directors of the Company adopted the 2001
NonStatutory Stock Option Plan (the "Plan") whereby 1,500,000 shares of Common
Stock were reserved for issuance pursuant to nonqualified stock options. The
Plan is administered by the Company's Board of Directors or its designees and
provides generally that nonqualified stock options granted under the Plan may
have a maximum life of 10 years. The terms and conditions of each stock option
grant under the Plan are determined by a committee of the Board and are set
forth in agreements between the recipient and the Company. As of March 31, 2001,
options to purchase an aggregate of 665,500 shares were granted under the Plan.

NOTE 6 -- LEGAL MATTERS

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

      In December 2000, a former employee of the Company filed suit against the
Company and one of its former employees alleging wrongful termination, invasion
of privacy, violation of Fair Employment and Housing Act, based on sexual
harassment, sexual discrimination and retaliation, defamation, breach of the
covenant of good faith and fair dealing, negligence and conversion. On April 16,
2001, the Company filed an answer to the complaint, generally denying its
allegations and asserting various affirmative defenses. The parties have
voluntarily agreed to participate in a mediation session in an effort to
amicably resolve the matter. In the event the matter is not amicably resolved,
the Company intends to defend the matter vigorously. The ultimate outcome of
this matter cannot be determined at this time, however, management does not
believe that this matter will have a material adverse effect on the financial
position of the Company.


                                       8
<PAGE>   9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

      With the exception of historical facts, the statements contained in this
Quarterly Report on Form 10-Q are forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), and are
subject to the safe harbor provisions created by such statutes. Certain
statements contained in the following Management's Discussion and Analysis of
Financial Condition and Results of Operations, including, without limitation,
statements containing the words "believes," "anticipates," "estimates,"
"expects," and words of similar import, constitute forward-looking statements
that involve risks and uncertainties. Such statements are based on current
expectations and are subject to risk, uncertainties and changes in condition,
significance, value and effect, including those discussed under the heading
Trends and Uncertainties 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

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

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

      Hifn's flow classification technology enables network equipment vendors to
add unique traffic differentiation capabilities to their products. Hifn's flow
classification solutions provide precise details about packets and data
traversing a network and is used in deploying Quality-of-Service (QoS) and
Cost-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.


                                       9
<PAGE>   10
RESULTS OF OPERATIONS

      The following table sets forth the percentage relationship of certain
items to the Company's net revenues during the periods shown:

<TABLE>
<CAPTION>
                                                   Three Months Ended     Six Months Ended
                                                        March 31,             March 31,
                                                   ------------------     -----------------
                                                   2001          2000     2001         2000
                                                   ----          ----     ----         ----
<S>                                               <C>           <C>      <C>          <C>
Net revenues                                        100%          100%     100%         100%
Cost of revenues ...............................     24            23       23           22
                                                   ----          ----     ----          ---
Gross profit ...................................     76            77       77           78
                                                   ----          ----     ----          ---
Operating expenses:
   Research and development ....................     34            52       30           42
   Sales and marketing .........................     19            24       18           20
   General and administrative ..................     16            13       14           10
   Amortization of intangibles and goodwill ....     20            --       19           --
                                                   ----          ----     ----          ---
Total operating expenses .......................     89            89       81           72
                                                   ----          ----     ----          ---
Income from operations .........................    (13)          (12)      (4)           6
Interest and other income (expense), net .......      6            12        5           11
                                                   ----          ----     ----          ---
Income before income taxes .....................     (7)            0        1           17
Provision for income taxes .....................      5             0        8            7
                                                   ----          ----     ----          ---
Net income (loss) ..............................    (12)%           0%      (7)%         10%
                                                   ====          ====     ====          ===
</TABLE>

      Net Revenues. Net revenues increased 70.1% to $13.8 million for the
quarter ended March 31, 2001 from $8.1 million for the quarter ended March 31,
2000. Revenue for the first six months of fiscal 2001 was $29.9 million, an
increase of 64.6% from the $18.2 million reported for the first six months of
fiscal 2000. The increase in revenues for the three and six months ended March
31, 2001 over the same periods in the prior year was primarily due to increased
sales of Hifn's data compression and encryption processors to network equipment
manufacturers coupled with revenues and royalties related to classification
software acquired from Apptitude. Semiconductor sales to Quantum, an OEM
producer of high-performance tape storage devices, through its manufacturing
subcontractor, comprised 26% and 30% of revenues for the three and six months
ended March 31, 2001, respectively. Semiconductor sales to Lucent, an OEM
producer of networking equipment, through its manufacturing subcontractors,
comprised 22% and 23% of revenues for the three and six months ended March 31,
2001, respectively.

      Gross Margin. Cost of revenues consists primarily of semiconductors which
were manufactured to our specifications by third parties for resale by us. Gross
margin remained relatively the same at 76.3% for the quarter ended March 31,
2001 and 76.9% for the quarter ended March 31, 2000. Gross margin for the six
months ended March 31, 2001 decreased slightly to 76.9%, compared to 77.8% for
the six months ended March 31, 2000, as a result of a shift in the revenue mix
and an increase in overhead expenses relating to additional personnel including
salaries, labor and facility rental costs.

      Research and Development. The cost of product development consists
primarily of salaries, employee benefits, overhead, outside contractors and
nonrecurring engineering fees. Such research and development expenses were
approximately $4.8 million and $4.2 million for the quarters ended March 31,
2001 and 2000, respectively. Research and development costs were approximately
$9.1 million and $7.5 million for the six months ended March 31, 2001 and 2000,
respectively. In connection with the acquisition of Apptitude in August 2000, we
acquired additional engineering headcount to develop new products which combine
data compression, data encryption and flow classification for the network
security markets and to develop additional products for the storage market. As a
result of the additional personnel, we incurred increased salary, labor and
facility rental costs offset by a decrease in outside engineering consulting
costs. In addition, amortization of deferred stock compensation of $472,000 and
$937,000 related to the acquisition of Apptitude also contributed to the
increase in research and development expense in the three and six months ended
March 31, 2001, respectively, as compared to the same periods ended March 31,
2000.


                                       10
<PAGE>   11
      Sales and Marketing. Sales and marketing expenses consist primarily of the
salaries, commissions and benefits of sales, marketing and support personnel,
and consulting, advertising, promotion and overhead expenses. Such expenses were
approximately $2.6 million and $1.9 million for the three months ended March 31,
2001 and 2000, respectively. Sales and marketing expense for the six months
ended March 31, 2001 and 2000 were approximately $5.4 million and $3.6 million,
respectively. The increase primarily reflects additional personnel costs as well
as increased commission costs associated with the increase in revenues. In
addition, amortization of deferred stock compensation of $75,000 and $161,000
related to the acquisition of Apptitude also contributed to the increase in
sales and marketing expense in the three and six months ended March 31, 2001,
respectively, as compared to the same periods ended March 31, 2000.

      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 $2.3 million
and $1.1 million for the three months ended March 31, 2001 and 2000,
respectively. General and administrative expenses for the six months ended March
31, 2001 and 2000 were $4.3 million and $1.9 million, respectively. The increase
is a result of the amortization of deferred stock compensation related to the
acquisition of Apptitude of $524,000 and $1.5 million for the three and six
months ended March 31, 2001, respectively, a charge of $388,000 related to
facility sublease and an increase in salaries and benefit costs related to
increased headcount.

      Amortization of Intangibles and Goodwill. Amortization of intangibles and
goodwill for the three and six months ended March 31, 2001 of $2.8 million and
$5.6 million, respectively, were a result of the acquisition of Apptitude and
other intellectual property in August 2000 as well as other acquired technology
in April 1998.

      Interest and Other Income, Net. Net interest and other income was $791,000
and $1.0 million for the three months ended March 31, 2001 and 2000,
respectively, and $1.6 million and $2.0 million for the six months ended March
31, 2001 and 2000, respectively. The decrease in interest and other income for
the periods presented was mainly due to a shift in the investment mix from stock
instruments to commercial paper and municipal bonds.

      Income Taxes. The effective income tax rate for three and six months ended
March 31, 2001 was (63)% and 1407%, respectively, as compared to approximately
40% for the same periods in 2000. The increase in the effective rate reflects
the non-deductibility of certain acquisition related charges.

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

<TABLE>
<S>                                                                      <C>
      Property and equipment                                             $   205
      Current and other assets                                             1,081
      Deferred tax asset                                                   3,905
      Liabilities assumed                                                (2,404)
      Goodwill                                                            47,121
      Purchased in-process research and development                        4,085
      Acquired developed and core technology, workforce and patents        4,462
                                                                         -------
                                                                         $58,455
                                                                         =======
</TABLE>

      The goodwill, acquired developed and core technology, workforce and
patents are recorded on the balance sheet as intangibles and other assets and
are amortized on a straight-line basis over periods ranging from two to five
years. The purchased in-process research and development was expensed at the
time of the acquisition as a one-time charge.


                                       11
<PAGE>   12
LIQUIDITY AND CAPITAL RESOURCES

      Net cash provided by operating activities was $6.4 million and $3.0
million for the six months ended March 31, 2001 and 2000, respectively. During
the six months ended March 31, 2001, net cash provided by operating activities
was attributed to net loss as adjusted for non-cash items including amortization
of intangibles and deferred stock compensation of $8.3 million, tax benefit from
employee stock plans of $3.9 million, depreciation and amortization costs of
$711,000 as well as a decrease in accounts receivable of $1.7 million and
increases in accounts payable and accrued expenses and other current liabilities
of $1.7 million and income taxes payable of $1.8 million. These adjustments were
offset by increases in inventory and prepaid expenses and other assets of $4.2
million and $5.4 million, respectively. During the six months ended March 31,
2000, the net cash provided by operating activities was attributed to net income
from operations adjusted for depreciation and amortization costs of $1.2
million, a decrease in accounts receivable of $2.3 million as well as a net
decrease in prepaid expenses and other assets of $1.3 million offset by an
increase in inventory of $878,000 and decreases in accounts payable of $359,000,
income taxes payable of $1.3 million and accrued expenses and other current
liabilities of $1.2 million.

      Net cash used in investing activities was $5.6 million for the six months
ended March 31, 2001 and related to the purchase of $4.2 million in short-term
investments and $1.4 million in property and equipment. Net cash used in
investing activities for the six months ended March 31, 2000 of $923,000 related
to the purchase of property and equipment.

      Net cash provided by financing activities was $592,000 and $867,000 for
the six month periods ended March 31, 2001 and 2000, respectively. Net cash
provided by financing activities for both periods was attributable to proceeds
from issuance of common stock slightly offset, for the period ended March 31,
2001, by payments on capital lease obligations.

       We use a number of independent suppliers to manufacture substantially all
of its products. As a result, we rely on these suppliers to allocate to us a
sufficient portion of foundry capacity to meet our needs and deliver sufficient
quantities of our products on a timely basis. These arrangements allow us to
avoid utilizing our capital resources for manufacturing facilities and
work-in-process inventory and to focus substantially all of our resources on the
design, development and marketing of our products. Additionally, orders with our
suppliers require substantial lead times and require, from time to time,
adjustments in our ordering patterns based on anticipated customer demand. As of
March 31, 2001, our inventory balance increased to $5.5 million as compared to
$1.4 million as of fiscal year ended September 30, 2000 resulting mainly from
receipt of orders placed in late 2000 coupled with a reduction in customer
demand and increased inventory at customer locations. We have adjusted, and will
continue to evaluate, our order levels accordingly.

      We require substantial working capital to fund our business, particularly
to finance accounts receivable and inventory, and for investments in property
and equipment. Our need to raise capital in the future will depend on many
factors including the rate of sales growth, market acceptance of our existing
and new products, the amount and timing of research and development
expenditures, the timing and size of acquisitions of businesses or technologies,
the timing of the introduction of new products and the expansion of sales and
marketing efforts.

RECENT ACCOUNTING PRONOUNCEMENTS

      In June 1998, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 133, "Accounting for Derivatives and Hedging Activities." SFAS No. 133
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. In July 1999, the FASB issued SFAS No. 137, "Accounting for
Derivative Instruments and Hedging Activities--Deferral of the Effective Date of
FASB Statement No. 133." SFAS No. 137 deferred the effective date of SFAS No.
133 until fiscal years beginning after June 15, 2000. We have adopted SFAS 133
and have not engaged in derivative or hedging activities to date.

      In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") 101, "Revenue Recognition in Financial Statements."
SAB 101 summarizes certain of the Staff's views in applying


                                       12
<PAGE>   13
generally accepted accounting principles to revenue recognition in financial
statements. We have adopted SAB 101 and such adoption did not have a material
effect on our results of operations.

TRENDS AND UNCERTAINTIES

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

WE HAVE A LIMITED OPERATING HISTORY AS AN INDEPENDENT COMPANY.

      On August 14, 1996, we were incorporated by Stac, Inc. ("Stac") which
transferred its semiconductor business to us in exchange for shares of our
Preferred Stock and Common Stock. Because we are a relatively new company with a
limited operating history, we may experience financial and other difficulties as
we attempt to grow our business. For example, to expand our business we are
increasing our research and development and other operating expenses. This
increase in expenses will negatively affect our financial performance unless we
are able to sustain and grow revenues. If we are not able to evolve and expand
our business, we may not become profitable and therefore may not be able to
sustain a viable business.

OUR OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY.

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

      -  General business conditions in our markets as well as global economic
         uncertainty;

      -  Increases or reductions in demand for our customers' products;

      -  The timing and volume of orders we receive from our customers;

      -  Cancellations or delays of customer product orders;

      -  Any new product introductions by us or our competitors;

      -  Our suppliers increasing costs or changing the delivery of products to
         us;

      -  Increased competition or reductions in the prices that we are able to
         charge;

      -  The variety of the products that we sell as well as seasonal demand for
         our products; and

      -  The availability of manufacturing capacity necessary to make our
         products.

WE DEPEND UPON A SMALL NUMBER OF CUSTOMERS.

      Quantum Corporation ("Quantum"), through its manufacturing subcontractor,
accounted for approximately 26%, 34% and 36% of our revenues in the three months
ended March 31, 2001 and December 31, 2000 and in fiscal year 2000,
respectively. Lucent, through its manufacturing subcontractors, accounted for
approximately 22%, 25% and 35% of our revenues during the three months ended
March 31, 2001 and December 31, 2000 and fiscal year 2000, respectively. Neither
Quantum nor Lucent are under any binding obligation to order from us. If our
sales to Quantum or Lucent decline, our business, financial condition and
results of operations could suffer. We expect that our most significant
customers in the future could be different from our largest customers today for
a number of reasons, including customers' deployment schedules and budget
considerations. As a result, we believe we may experience significant
fluctuations in our results of operations on a quarterly and an annual basis.


                                       13
<PAGE>   14
      Limited numbers of network and storage equipment vendors account for a
majority of packet processor purchases in their respective markets. In
particular, the market for network equipment that would include packet
processors, such as routers, remote access concentrators and firewalls, is
dominated by a few large vendors, including Cisco Systems, Inc., Lucent
Technologies Inc., Nortel Networks, Inc. and 3Com Corporation. As a result, our
future success will depend upon our ability to establish and maintain
relationships with these companies. If these network equipment vendors do not
incorporate our packet processors into their products, our business, financial
condition and results of operations could suffer.

OUR BUSINESS DEPENDS UPON THE DEVELOPMENT OF THE PACKET PROCESSOR MARKET.

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

OUR BUSINESS DEPENDS UPON THE CONTINUED GROWTH AND OUR PENETRATION OF THE
VIRTUAL PRIVATE NETWORK MARKET.

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

      -  Our ability to demonstrate the benefits of our technology to
         distributors, original equipment manufacturers and end users; and

      -  The increased use of the Internet by businesses as replacements for, or
         enhancements to, their private networks.

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

WE FACE RISKS ASSOCIATED WITH EVOLVING INDUSTRY STANDARDS AND RAPID
TECHNOLOGICAL CHANGE.

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

      -  Properly identify emerging target markets and related technological
         trends;

      -  Develop and maintain competitive products;

      -  Enhance our products by adding innovative features that differentiate
         our products from those of competitors;

      -  Bring products to market on a timely basis at competitive prices; and


                                       14
<PAGE>   15
      -  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 more competitive as current competitors expand their product offerings
and new competitors enter the market. The markets that we compete in are subject
to frequent product introductions with improved price-performance
characteristics, rapid technological change, and the continued emergence of new
industry standards. Our products compete with offerings from companies such as
Analog Devices, Inc., Safenet, Inc., International Business Machines Corporation
("IBM"), Broadcom Corporation, Motorola, Inc. and Philips Corporation. In 1994,
Stac entered into two license agreements with IBM in which Stac granted IBM the
right to use, but not sublicense, our patented compression technology in IBM
hardware and software products. Stac also entered into a license agreement with
Microsoft Corporation ("Microsoft") in 1994 whereby Stac granted Microsoft the
right to use, but not sublicense, our compression technology in their software
products. We expect significant future competition from major domestic and
international semiconductor suppliers. Several established electronics and
semiconductor suppliers have recently entered, or expressed an interest to
enter, the network equipment market. We also may face competition from suppliers
of products based on new or emerging technologies. Furthermore, many of our
existing and potential customers internally develop solutions which attempt to
perform all or a portion of the functions performed by our products.

      A key element of our packet processor architecture is our encryption
technology. Until recently, in order to export our encryption-related products,
the U.S. Department of Commerce required us to obtain a license. Foreign
competitors that were not subject to similar requirements have an advantage over
us in their ability to establish existing markets for their products and rapidly
respond to the requests of customers in the global market. Although the export
restriction has been liberalized, we may not be successful in entering or
competing the foreign encryption markets. See "Our Products Are Subject To
Export Restrictions."

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


                                       15
<PAGE>   16
would significantly and negatively impact our ability to compete and obtain or
maintain market share. If we are unable to successfully compete against our
competitors, our business, results of operations and financial condition will
suffer.

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

      -  Performance;

      -  Price;

      -  The time that is required to develop a new product or enhancements to
         existing products;

      -  The ability to achieve product acceptance with major network and
         storage equipment vendors;

      -  The support that exists for new network and storage standards;

      -  Features and functionality;

      -  Adaptability of products to specific applications;

      -  Reliability; and

      -  Technical service and support as well as effective intellectual
         property protection.

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

OUR BUSINESS DEPENDS UPON THE GROWTH OF THE NETWORK EQUIPMENT AND STORAGE
EQUIPMENT MARKETS.

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

OUR SUCCESS DEPENDS UPON PROTECTING OUR INTELLECTUAL PROPERTY.

      Our proprietary technology is critical to our future success. We rely in
part on patent, trade, trademark, maskwork and copyright law to protect our
intellectual property. We own 12 United States patents and four foreign patents.
We also have 2 pending patent applications in Japan. Our issued patents and
patent applications primarily cover various aspects of our compression
technology and have expiration dates ranging from 2006 to 2013. In addition to
compression, we have six pending patent applications in the United States, four
in Europe and Asia (Japan) covering our flow classification technology. There
are 2 pending patent applications in the United States covering our bandwidth
management and rate shaping technology. Patents may not be issued under our
current or future patent applications, and the patents issued under such patent
applications could be invalidated, circumvented or challenged. In addition,
third parties could make infringement claims against us in the future. Such
infringement claims could result in costly litigation. We may not prevail in any
such litigation or be able to license any valid and


                                       16
<PAGE>   17
infringed patents from third parties on commercially reasonable terms, if at
all. Regardless of the outcome, an infringement claim would likely result in
substantial cost and diversion of our resources. Any infringement claim or other
litigation against us or by us could harm our business, financial condition and
results of operations. The patents issued to us may not be adequate to protect
our proprietary rights, to deter misappropriation or to prevent an unauthorized
third party from copying our technology, designing around the patents we own or
otherwise obtaining and using our products, designs or other information. In
addition, others could develop technologies that are similar or superior to our
technology.

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

THE LENGTH OF TIME IT TAKES TO DEVELOP OUR PRODUCTS AND MAKE A SALE TO OUR
CUSTOMERS MAY IMPAIR OUR OPERATING RESULTS.

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

WE DEPEND UPON INDEPENDENT MANUFACTURERS AND LIMITED SOURCES OF SUPPLY.

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

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

      -  Adapting our product design, if necessary, to the new manufacturer's
         process;

      -  Creating a new mask set to manufacture the product;

      -  Having the new manufacturer prepare sample products so we can verify
         the product specification; and

      -  Providing sample products to customers for qualification.


                                       17
<PAGE>   18
      In general, it takes from 3 to 6 months for a new manufacturer to begin
full-scale production of one of our products. We could have similar or more
protracted problems in the future with existing or new suppliers.

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

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

NETWORK AND STORAGE EQUIPMENT PRICES TYPICALLY DECREASE.

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

      -  Rapidly changing technologies;

      -  Price-performance enhancements; and

      -  Product obsolescence.

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

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


                                       18
<PAGE>   19
current and prospective customers. Any such event would harm our business,
financial condition and results of operations.

WE FACE ORDER AND SHIPMENT UNCERTAINTIES.

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

BUSINESS INTERRUPTIONS COULD ADVERSELY AFFECT OUR BUSINESS.

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

WE DEPEND UPON KEY PERSONNEL.

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

OUR RAPID GROWTH MAY STRAIN OUR OPERATIONS.

      We have experienced a period of rapid growth and expansion which has
placed, and continues to place, a significant strain on our resources. To
accommodate this growth, in fiscal 2000, we implemented a variety of new and
upgraded operational and financial systems, procedures and controls, including
the improvement of the retained accounting and other internal management systems
which were provided by Stac. This required and may continue to require
substantial management effort, and our efforts to do so may not continue to be
successful. In addition, we have had to hire additional employees to accommodate
this growth and our product development activities. This has resulted in
increased responsibilities for our management. Our systems, procedures and
controls may not be adequate to support our operations. If we fail to improve
our operational, financial and management information systems, or to hire,
train, motivate or manage our employees, our business, financial condition and
results of operations could suffer.

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


                                       19
<PAGE>   20
customers may only export products incorporating encryption technology if they
obtain a one-time technical review. These U.S. export laws also prohibit the
export of encryption products to a number of countries deemed by the U.S. to be
hostile. Many foreign countries also restrict exports to many of these countries
deemed to be "terrorist-supporting" states by the U.S. government. Because the
restrictions on exports of encryption products have been liberalized, we, along
with our network equipment customers, have an opportunity to effectively compete
with our foreign competitors. The existence of these restrictions until recently
may have enabled foreign competitors facing less stringent controls on their
products to become more established and, therefore, more competitive in the
global market than our network equipment customers. In addition, the list of
products and countries for which export approval is required, and the regulatory
policies with respect thereto, could be revised, and laws limiting the domestic
use of encryption could be enacted. While the U.S. government now allows U.S.
companies to assume that exports to non-government end-users will be approved
within 30 days of official registration with the Department of Commerce, the
sale of our packet processors could be harmed by the failure of our network
equipment customers to obtain the required approvals or by the costs of
compliance.

WE FACE RISKS ASSOCIATED WITH OUR INTERNATIONAL BUSINESS ACTIVITIES.

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

      -  The imposition of governmental controls;

      -  Export license/technical review requirements;

      -  Restrictions on the export of technology;

      -  Currency exchange fluctuations;

      -  Political instability;

      -  Financial and stock market dislocations;

      -  Trade restrictions; and

      -  Changes in tariffs.

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

WE FACE RISKS ASSOCIATED WITH ACQUISITIONS.

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


                                       20
<PAGE>   21
      -  Difficulties in assimilating acquired operations, technologies and
         products, in particular, if we fail to successfully integrate the
         acquisition of Apptitude, the anticipated benefits of this transaction
         will not occur;

      -  Diversion of management's attention from other business concerns;

      -  Risks of entering markets in which we have little or no prior
         experience; and

      -  Loss of key employees of acquired organizations.

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

      In addition, if we are a party to a transaction or series of transactions
that result in 50% or more of our outstanding stock being transferred to one or
more persons, the IRS may claim that our spin-off from Stac was a taxable event
to Stac and its stockholders. Under the Tax Allocation and Indemnity Agreement
that we entered into with Stac, we may be obligated to pay the taxes of Stac if
we caused the spin-off to be a taxable event. Our cash flows, business,
financial condition and results of operations would suffer if we became liable
for any such tax liability. See "We Face Certain Risks as a Result of our
Spin-Off from Stac."

THE CYCLICALITY 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.

WE FACE CERTAIN RISKS AS A RESULT OF OUR SPIN-OFF FROM STAC.

      On December 8, 1998, Stac received a private letter ruling from the
Internal Revenue Service ("IRS") stating, among other things, that the
distribution of our Common Stock held by Stac on December 16, 1998 to Stac
stockholders would not result in recognition of taxable income or gain to Stac
or its stockholders under Section 355 of the Internal Revenue Code of 1986, as
amended ("Code") (except to the extent of cash received in lieu of fractional
shares). A tax ruling, while generally binding upon the IRS, is subject to
certain factual representations and assumptions. If the factual representations
and assumptions made by Stac were incorrect in a material respect, the rights of
taxpayers to rely on a tax ruling or Stac's ability to rely on the tax opinion
would be jeopardized.

      If the distribution were not to constitute a tax-free spin-off, then Stac
would be treated as recognizing a taxable gain equal to the difference between
(i) the fair market value of our Common Stock that was distributed to Stac
stockholders on December 16, 1998 and (ii) Stac's adjusted basis of such Common
Stock. In addition, under the consolidated tax return rules of the Code, each
member of Stac's consolidated group (including Hifn) would be severally liable
for such tax liability. Furthermore, in connection with the spin-off we entered
into a Tax Allocation and Indemnity Agreement with Stac whereby each of us
agreed that if either party took actions after the spin-off that caused Section
355(e) of the Code to apply to the Company's Common Stock, then whichever party
first caused Section 355(e) of the Code to apply to the Company's Common Stock
would be obligated to bear all taxes of Stac resulting from such action. Under
recently enacted Section 355(e) of the Code, if the spin-off was considered to
be part of a plan or series of related transactions (a "Plan") in which, after
the spin-off, a 50% or greater interest in the Company or Stac were acquired by
one or more persons, the IRS would claim that the spin-off was taxable at the
corporate level. Although neither we nor Stac believes the spin-off is part of a
Plan to effect a 50% change in ownership of either the Company or Stac, the IRS
has issued no guidance on the definition of a Plan and for the first two years
following the spin-off, any cumulative 50% change of ownership within the
two-year period will be rebuttably presumed to be the result of a Plan. Our cash
flows, business, financial condition and results of operations would suffer if
we became liable for any such tax liability.


                                       21
<PAGE>   22
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.

WE ARE CURRENTLY ENGAGED IN SEVERAL SECURITIES CLASS-ACTION LAWSUITS.

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

      In December 2000, a former employee of the Company filed suit against the
Company and one of its former employees alleging wrongful termination, invasion
of privacy, violation of Fair Employment and Housing Act, based on sexual
harassment, sexual discrimination and retaliation, defamation, breach of the
covenant of good faith and fair dealing, negligence and conversion. On April 16,
2001, the Company filed an answer to the complaint, generally denying its
allegations and asserting various affirmative defenses. The parties have
voluntarily agreed to participate in a mediation session in an effort to
amicably resolve the matter. In the event the matter is not amicably resolved,
the Company intends to defend the matter vigorously. The ultimate outcome of
this matter cannot be determined at this time, however, management does not
believe that this matter will have a material adverse effect on the financial
position of the Company.


                                       22
<PAGE>   23
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

      Interest Rate Risk -- We do not use derivative financial instruments in
our investment portfolio. Our investment portfolio is generally comprised of
commercial paper and municipal bonds and we place investments in instruments
that meet high credit quality standards. These securities are subject to
interest rate risk, and could decline in value if interest rates fluctuate. Due
to the short duration and conservative nature of our investment portfolio, we do
not expect any material loss with respect to our investment portfolio. A 10%
move in interest rates at March 31, 2001 would have an immaterial effect on our
pre-tax earnings and the carrying value of our investments over the next fiscal
year.

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


                                       23
<PAGE>   24
PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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

      In December 2000, a former employee of the Company filed suit against the
Company and one of its former employees alleging wrongful termination, invasion
of privacy, violation of Fair Employment and Housing Act, based on sexual
harassment, sexual discrimination and retaliation, defamation, breach of the
covenant of good faith and fair dealing, negligence and conversion. On April 16,
2001, the Company filed an answer to the complaint, generally denying its
allegations and asserting various affirmative defenses. The parties have
voluntarily agreed to participate in a mediation session in an effort to
amicably resolve the matter. In the event the matter is not amicably resolved,
the Company intends to defend the matter vigorously. The ultimate outcome of
this matter cannot be determined at this time, however, management does not
believe that this matter will have a material adverse effect on the financial
position of the Company.

ITEM 2. CHANGES IN SECURITIES

      None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

      None.

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

      The Company held its Annual Meeting of Stockholders on February 23, 2001.
At the meeting, the following proposals received the votes listed below:

Proposal I. Election of Class II Director for three-year terms expiring 2004.

<TABLE>
<CAPTION>
                                       Votes for:             Votes against:
                                       ----------             --------------
<S>                                    <C>                    <C>
              Taher Elgamal             8,798,146                 79,541
              Robert Johnson            8,798,146                 79,541
</TABLE>

      The Company's Board of Directors is currently comprised of six members who
are divided into three classes with overlapping three-year terms. The term for
Class III directors (Douglas L. Whiting and Albert E. Sisto) will expire at the
meeting of stockholders to be held in 2002. The term for Class I directors
(Christopher G. Kenber and Raymond J. Farnham) will expire at the meeting of
stockholders to be held in 2003.

Proposal II: Approval of an amendment to the Company's 1996 Stock Option Plan to
provide for an increase in the number of shares of common stock available for
issuance thereunder by 475,000 shares to 3,949,900 shares.


                                       24
<PAGE>   25

<TABLE>
<S>                                       <C>
              Votes for:                  7,004,022
              Votes against:              1,866,046
              Abstentions:                    7,619
</TABLE>

Proposal III: Approval of ratification of the appointment of
Pricewaterhousecoopers LLP as independent auditors of the Company for the fiscal
year ending September 30, 2001.

<TABLE>
<S>                                       <C>
              Votes for:                  8,850,629
              Votes against:                 11,498
              Abstentions:                   15,560
</TABLE>

ITEM 5. OTHER INFORMATION

           None.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

           (a)  Exhibits

<TABLE>
<CAPTION>
<S>                     <C>
                  10.1  2001 NonStatutory Stock Option Plan

                  10.2  Agreement dated April 6, 2001 by and between Driving
                        Media, Inc, and hi/fn, Inc.
</TABLE>

           (b)    Reports on Form 8-K

                  None


                                       25
<PAGE>   26
                                   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: May 1, 2001                 By: /s/ WILLIAM R. WALKER
                                       --------------------------------------
                                   William R. Walker
                                   Vice President, Finance,
                                   Chief Financial Officer and Secretary
                                   (principal financial and accounting officer)


                                       26
<PAGE>   27
<TABLE>
<CAPTION>
                                 EXHIBIT INDEX

Exhibit
 Number         Description
<S>             <C>

      10.1      2001 Non Statutory Stock Option Plan

      10.2      Agreement dated April 6, 2001 by and between Driving Media,
                Inc. and hi/fn, Inc.
</TABLE>