##### Table of Contents



U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-Q

|                                                 |  |                                                                     
|------------------------------------------------ |  | --------------------------------------------------------------------
|[X]                                              |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  
|                                                 |  | EXCHANGE ACT OF 1934                                                
|                                                 |  |                                                                     
|For the Quarterly Period Ended December 31, 2002
|                                                 |  |                                                                     
|[   ]                                            |  | 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
(State or other jurisdiction of
Incorporation or Organization) |  | 33-0732700
(IRS Employer
Identification Number)

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

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

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

Yes [X]         No [   ]

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

Yes [   ]         No [X]

The number of shares outstanding of the Registrants Common Stock, par value
$.001 per share, was 10,591,038 at January 27, 2003.

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TABLE OF CONTENTS



|                               |                                                                                               |                                                      |  |  |  |  |  | 
|------------------------------ | --------------------------------------------------------------------------------------------- | ---------------------------------------------------- |  |  |  |  |  | 
|PART 1  FINANCIAL INFORMATION
|                               | Item 1. Financial Statements                                                                 
|                               |                                                                                               | CONDENSED CONSOLIDATED BALANCE SHEETS               
|                               |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS     
|                               |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS     
|                               |                                                                                               | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
|                               | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                               | Item 3. Quantitative and Qualitative Disclosures About Market Risk                           
|                               | Item 4. Controls and Procedures                                                              
|PART II  OTHER INFORMATION   
|                               | Item 1. Legal Proceedings                                                                    
|                               | Item 2. Changes in Securities                                                                
|                               | Item 3. Defaults Upon Senior Securities                                                      
|                               | Item 4. Submission of Matters to a Vote of Security Holders                                  
|SIGNATURES                    
|INDEX TO EXHIBITS             
|EXHIBIT 99.1                  
|EXHIBIT 99.2                  



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##### Table of Contents



HIFN, INC.

INDEX TO FORM 10-Q

|                  |    |                                                                                       |  |                                                                                                       |       |  |      | 
|----------------- | -- | ------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------- | ----- |  | ---- | 
|PART I.           |    | FINANCIAL INFORMATION                                                                 |  |                                                                                                       |       | 
|Item 1.           |    | Financial Statements                                                                  |  |                                                                                                       |       | 
|                  |    |                                                                                       |  | Condensed
Consolidated Balance Sheets
as of December 31, 2002 and September 30, 2002                  |       |  | 3    | 
|                  |    |                                                                                       |  | Condensed Consolidated Statements of Operations
for the three months ended December 31, 2002 and 2001 |       |  | 4    | 
|                  |    |                                                                                       |  | Condensed Consolidated Statements of Cash Flows
for the three months ended December 31, 2002 and 2001 |       |  | 5    | 
|                  |    |                                                                                       |  | Notes to Condensed Consolidated Financial Statements                                                  |       |  | 6-10 | 
|Item 2.           |    | Managements Discussion and Analysis of Financial Condition and Results of Operations |  |                                                                                                       | 11-27 | 
|Item 3.           |    | Quantitative and Qualitative Disclosure About Market Risks                            |  |                                                                                                       | 27    | 
|Item 4.           |    | Controls and Procedures                                                               |  |                                                                                                       | 27    | 
|PART II.          |    | OTHER INFORMATION                                                                     |  |                                                                                                       |       | 
|Item 1.           |    | Legal Proceedings                                                                     |  |                                                                                                       | 28    | 
|Item 6.           |    | Exhibits and Reports on Form 8-K                                                      |  |                                                                                                       | 29    | 
|Signatures        |    |                                                                                       |  |                                                                                                       | 30    | 
|Certifications    |    |                                                                                       |  |                                                                                                       | 31-32 | 
|Index to Exhibits | 33 |                                                                                      
|                  |    |                                                                                       |  | Exhibit 99.1                                                                                          |       |  | 34   | 
|                  |    |                                                                                       |  | Exhibit 99.2                                                                                          |       |  | 35   | 

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##### Table of Contents






PART 1  FINANCIAL INFORMATION




Item 1. Financial Statements




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

|                                     |                                                |                           |        |                            |        |              |        |               |        |  |        | 
|------------------------------------ | ---------------------------------------------- | ------------------------- | ------ | -------------------------- | ------ | ------------ | ------ | ------------- | ------ |  | ------ | 
|                                     |                                                |                           |        |                            |        | December 31, |        | September 30,
|                                     |                                                |                           |        |                            |        | 2002         |        | 2002         
|                                     |                                                |                           |        |                            |        |              |        |              
|                                     |                                                |                           |        |                            |        | (unaudited)  |        |               |        | 
|ASSETS                              
|CURRENT ASSETS:                      |                                                |                           |        |                            |        |              |        |              
|                                     | Cash and cash equivalents                      |                           | $      | 50,032                     |        |              | $      | 53,060        |       
|                                     | Short-term investments                         |                           |        |                           |        |              |        | 1,606         |       
|                                     | Accounts receivable, net                       |                           |        | 1,934                      |        |              |        | 2,263         |       
|                                     | Inventories                                    |                           |        | 740                        |        |              |        | 704           |       
|                                     | Prepaid expenses and other current assets      |                           |        | 3,872                      |        |              |        | 2,788         |       
|                                     |                                                |                           |        |                            |        |              |        |              
|                                     |                                                | Total current assets      |        |                            | 56,578 |              |        |               | 60,421 | 
|Property and equipment, net          |                                                |                           | 2,276  |                            |        |              | 2,580  |              
|Intangibles and other assets, net    |                                                |                           | 8,488  |                            |        |              | 9,278  |              
|                                     |                                                |                           |        |                            |        |              |        |              
|                                     |                                                | $                         | 67,342 |                            |        | $            | 72,279 |              
|                                     |                                                |                           |        |                            |        |              |        |              
|LIABILITIES AND STOCKHOLDERS EQUITY
|CURRENT LIABILITIES:                 |                                                |                           |        |                            |        |              |        |              
|                                     | Accounts payable                               |                           | $      | 3,685                      |        |              | $      | 3,686         |       
|                                     | Accrued expenses and other current liabilities |                           |        | 11,519                     |        |              |        | 11,937        |       
|                                     |                                                |                           |        |                            |        |              |        |              
|                                     |                                                | Total current liabilities |        |                            | 15,204 |              |        |               | 15,623 | 
|                                     |                                                |                           |        |                            |        |              |        |              
|STOCKHOLDERS EQUITY:                |                                                |                           |        |                            |        |              |        |              
|                                     | Common stock                                   |                           |        | 11                         |        |              |        | 10            |       
|                                     | Additional paid-in capital                     |                           |        | 123,276                    |        |              |        | 122,672       |       
|                                     | Accumulated deficit                            |                           |        | (71,149                    | )      |              |        | (66,026       | )     
|                                     |                                                |                           |        |                            |        |              |        |              
|                                     |                                                |                           |        | Total stockholders equity |        |              | 52,138 |               |        |  | 56,656 | 
|                                     |                                                |                           |        |                            |        |              |        |              
|                                     |                                                | $                         | 67,342 |                            |        | $            | 72,279 |              
|                                     |                                                |                           |        |                            |        |              |        |              

See accompanying notes to condensed consolidated financial statements.

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

|                                                       |                                          |                                    |        |                    |       |      |        |       |        | 
|------------------------------------------------------ | ---------------------------------------- | ---------------------------------- | ------ | ------------------ | ----- | ---- | ------ | ----- | ------ | 
|                                                       |                                          |                                    |        | Three Months Ended
|                                                       |                                          |                                    |        | December 31,      
|                                                       |                                          |                                    |        |                   
|                                                       |                                          |                                    |        | 2002               |       | 2001
|                                                       |                                          |                                    |        |                    |       |     
|                                                       |                                          |                                    |        | (unaudited)       
|Net revenues                                           |                                          | $                                  | 4,415  |                    |       | $    | 6,404  |      
|                                                       |                                          |                                    |        |                    |       |      |        |      
|Costs and operating expenses:                          |                                          |                                    |        |                    |       |      |        |      
|                                                       | Cost of revenues                         |                                    |        | 1,434              |       |      |        | 1,657 |       
|                                                       | Research and development                 |                                    |        | 5,214              |       |      |        | 5,111 |       
|                                                       | Sales and marketing                      |                                    |        | 1,775              |       |      |        | 2,190 |       
|                                                       | General and administrative               |                                    |        | 987                |       |      |        | 1,576 |       
|                                                       | Amortization of intangibles and goodwill |                                    |        | 358                |       |      |        | 2,778 |       
|                                                       |                                          |                                    |        |                    |       |      |        |      
|                                                       |                                          | Total costs and operating expenses |        |                    | 9,768 |      |        |       | 13,312 | 
|                                                       |                                          |                                    |        |                    |       |      |        |      
|Loss from operations                                   |                                          |                                    | (5,353 | )                  |       |      | (6,908 | )    
|Interest and other income, net                         |                                          |                                    | 230    |                    |       |      | 364    |      
|                                                       |                                          |                                    |        |                    |       |      |        |      
|Loss before income taxes                               |                                          |                                    | (5,123 | )                  |       |      | (6,544 | )    
|Benefit from income taxes                              |                                          |                                    |       |                    |       |      | (1,531 | )    
|                                                       |                                          |                                    |        |                    |       |      |        |      
|Net loss                                               |                                          | $                                  | (5,123 | )                  |       | $    | (5,013 | )    
|                                                       |                                          |                                    |        |                    |       |      |        |      
|Net loss per share, basic and diluted                  |                                          | $                                  | (0.48  | )                  |       | $    | (0.49  | )    
|                                                       |                                          |                                    |        |                    |       |      |        |      
|Weighted average shares outstanding, basic and diluted |                                          |                                    | 10,584 |                    |       |      | 10,262 |      
|                                                       |                                          |                                    |        |                    |       |      |        |      

See accompanying notes to condensed consolidated financial statements.

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

|                                                 |                                                                             |                                                                    |                                           |        |                    |        |        |        |        |        |  
|------------------------------------------------ | --------------------------------------------------------------------------- | ------------------------------------------------------------------ | ----------------------------------------- | ------ | ------------------ | ------ | ------ | ------ | ------ | ------ | -
|                                                 |                                                                             |                                                                    |                                           |        | Three Months Ended
|                                                 |                                                                             |                                                                    |                                           |        | December 31,      
|                                                 |                                                                             |                                                                    |                                           |        |                   
|                                                 |                                                                             |                                                                    |                                           |        | 2002               |        | 2001  
|                                                 |                                                                             |                                                                    |                                           |        |                    |        |       
|                                                 |                                                                             |                                                                    |                                           |        | (unaudited)       
|Cash flows from operating activities:            |                                                                             |                                                                    |                                           |        |                    |        |        |       
|                                                 | Net loss                                                                    |                                                                    | $                                         | (5,123 | )                  |        | $      | (5,013 | )     
|                                                 | Adjustments to reconcile net loss to
net cash used in operating activities: |                                                                    |                                           |        |                    |        |        |        |       
|                                                 |                                                                             | Depreciation and amortization                                      |                                           |        | 398                |        |        |        | 488    |       
|                                                 |                                                                             | Amortization of intangibles and goodwill                           |                                           |        | 607                |        |        |        | 2,778  |       
|                                                 |                                                                             | Amortization of deferred stock compensation                        |                                           |        | 129                |        |        |        | 410    |       
|                                                 |                                                                             | Reversal of deferred stock compensation for canceled stock options |                                           |        |                   |        |        |        | 1,691  |       
|                                                 |                                                                             | Deferred tax asset                                                 |                                           |        |                   |        |        |        | 281    |       
|                                                 | Changes in assets and liabilities:                                          |                                                                    |                                           |        |                    |        |        |        |       
|                                                 |                                                                             | Accounts receivable                                                |                                           |        | 329                |        |        |        | (1,136 | )     
|                                                 |                                                                             | Inventories                                                        |                                           |        | (36                | )      |        |        | 358    |       
|                                                 |                                                                             | Prepaid expenses and other current assets                          |                                           |        | (1,084             | )      |        |        | (2,054 | )     
|                                                 |                                                                             | Intangibles and other assets                                       |                                           |        | 183                |        |        |        | (2,659 | )     
|                                                 |                                                                             | Accounts payable                                                   |                                           |        | (1                 | )      |        |        | 2,065  |       
|                                                 |                                                                             | Accrued expenses and other current liabilities                     |                                           |        | (418               | )      |        |        | (333   | )     
|                                                 |                                                                             |                                                                    |                                           |        |                    |        |        |       
|                                                 |                                                                             |                                                                    | Net cash used in operating activities     |        |                    | (5,016 | )      |        |        | (3,124 | )
|                                                 |                                                                             |                                                                    |                                           |        |                    |        |        |       
|Cash flows from investing activities:            |                                                                             |                                                                    |                                           |        |                    |        |        |       
|                                                 | Sale of short-term investments                                              |                                                                    |                                           | 1,606  |                    |        |        | 424    |       
|                                                 | Purchases of property and equipment                                         |                                                                    |                                           | (94    | )                  |        |        | (18    | )     
|                                                 |                                                                             |                                                                    |                                           |        |                    |        |        |       
|                                                 |                                                                             |                                                                    | Net cash provided by investing activities |        |                    | 1,512  |        |        |        | 406    |  
|                                                 |                                                                             |                                                                    |                                           |        |                    |        |        |       
|Cash flows from financing activities:            |                                                                             |                                                                    |                                           |        |                    |        |        |       
|                                                 | Proceeds from issuance of common stock, net                                 |                                                                    |                                           | 476    |                    |        |        | 431    |       
|                                                 | Payment on capital lease obligations                                        |                                                                    |                                           |       |                    |        |        | (26    | )     
|                                                 |                                                                             |                                                                    |                                           |        |                    |        |        |       
|                                                 |                                                                             |                                                                    | Net cash provided by financing activities |        |                    | 476    |        |        |        | 405    |  
|                                                 |                                                                             |                                                                    |                                           |        |                    |        |        |       
|Net decrease in cash and cash equivalents        |                                                                             |                                                                    | (3,028                                    | )      |                    |        | (2,313 | )     
|Cash and cash equivalents at beginning of period |                                                                             |                                                                    | 53,060                                    |        |                    |        | 54,600 |       
|                                                 |                                                                             |                                                                    |                                           |        |                    |        |        |       
|Cash and cash equivalents at end of period       |                                                                             | $                                                                  | 50,032                                    |        |                    | $      | 52,287 |       
|                                                 |                                                                             |                                                                    |                                           |        |                    |        |        |       

See accompanying notes to condensed consolidated financial statements.

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

Note 1  Basis of Presentation

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

The accompanying condensed consolidated financial statements have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission regarding interim financial reporting. Accordingly, they do not
include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements and should be read in
conjunction with the Financial Statements and notes thereto included in the
Companys Form 10-K for period ending September 30, 2002. In the opinion of
management, the accompanying condensed consolidated financial statements
contain all adjustments, consisting only of normal recurring items, which the
Company believes is necessary for a fair statement of the Companys financial
position as of December 31, 2002 and its results of operations for the three
months ended December 31, 2002 and 2001, respectively. These condensed
consolidated financial statements are not necessarily indicative of the results
to be expected for the entire year.

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

Note 2  Net Loss Per Share

Basic earnings per share is computed using the weighted average number of
common shares outstanding for the period, without consideration for the
dilutive impact of potential common shares that were outstanding during the
period. Diluted earnings per share is computed using the weighted average
number of common and common equivalent shares outstanding for the period.
Common equivalent shares consist of incremental common shares issuable upon the
exercise of stock options, using the treasury method, and are excluded from the
calculation of diluted net loss per share if anti-dilutive. Outstanding options
to purchase 4,177,740 shares of common stock, or 224,698 weighted average
shares, for the period ended December 31, 2002 were not included in the
computation of diluted earnings per share because their impact would be
anti-dilutive. Outstanding options to purchase 3,658,088 shares of common
stock, or 367,126 weighted average shares, for the period ended December 31,
2001 were not included in the computation of diluted earnings per share because
their impact would be anti-dilutive.

Note 3  Detailed Balance Sheet:

|                     |                                       |              |             |               |   |   |       |       |  
|-------------------- | ------------------------------------- | ------------ | ----------- | ------------- | - | - | ----- | ----- | -
|                     |                                       | December 31, |             | September 30,
|(in thousands)       |                                       | 2002         |             | 2002         
|                     |                                       |              |             |              
|                     |                                       |              | (unaudited) |               |   |   |      
|Accounts receivable: |                                       |              |             |               |   |   |       |      
|                     | Trade receivables                     |              | $           | 2,117         |   |   | $     | 2,427 |  
|                     | Less: allowance for doubtful accounts |              |             | (183          | ) |   |       | (164  | )
|                     |                                       |              |             |               |   |   |       |      
|                     |                                       | $            | 1,934       |               |   | $ | 2,263 |      
|                     |                                       |              |             |               |   |   |       |      

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Note 3  Detailed Balance Sheet (continued):

|                                                |                                    |                 |        |               |       |   |        |        |       | 
|----------------------------------------------- | ---------------------------------- | --------------- | ------ | ------------- | ----- | - | ------ | ------ | ----- | 
|                                                |                                    | December 31,    |        | September 30,
|(in thousands)                                  |                                    | 2002            |        | 2002         
|                                                |                                    |                 |        |              
|                                                |                                    |                 |        | (unaudited)   |       |   |        |       
|Prepaid expenses and other current assets:      |                                    |                 |        |               |       |   |        |       
|                                                | Prepaid income taxes               |                 | $      | 948           |       |   | $      | 948    |      
|                                                | Prepaid licenses                   |                 |        | 910           |       |   |        | 727    |      
|                                                | Prepaid insurance                  |                 |        | 760           |       |   |        | 119    |      
|                                                | Prepaid maintenance                |                 |        | 579           |       |   |        | 323    |      
|                                                | Prepaid rent                       |                 |        | 270           |       |   |        | 259    |      
|                                                | Other                              |                 |        | 405           |       |   |        | 412    |      
|                                                |                                    |                 |        |               |       |   |        |       
|                                                |                                    | $               | 3,872  |               |       | $ | 2,788  |       
|                                                |                                    |                 |        |               |       |   |        |       
|Property and equipment:                         |                                    |                 |        |               |       |   |        |       
|                                                | Computer equipment                 |                 | $      | 5,178         |       |   | $      | 5,084  |      
|                                                | Furniture and fixtures             |                 |        | 1,191         |       |   |        | 1,191  |      
|                                                | Leasehold improvements             |                 |        | 1,205         |       |   |        | 1,205  |      
|                                                | Office equipment                   |                 |        | 615           |       |   |        | 615    |      
|                                                |                                    |                 |        |               |       |   |        |       
|                                                |                                    |                 | 8,189  |               |       |   | 8,095  |       
|                                                | Less: accumulated depreciation     |                 |        | (5,913        | )     |   |        | (5,515 | )    
|                                                |                                    |                 |        |               |       |   |        |       
|                                                |                                    | $               | 2,276  |               |       | $ | 2,580  |       
|                                                |                                    |                 |        |               |       |   |        |       
|Intangibles and other assets:                   |                                    |                 |        |               |       |   |        |       
|                                                | Developed and core technology      |                 | $      | 8,871         |       |   | $      | 8,871  |      
|                                                | Workforce                          |                 |        | 255           |       |   |        | 255    |      
|                                                | Patents                            |                 |        | 600           |       |   |        | 600    |      
|                                                | Goodwill                           |                 |        | 1,029         |       |   |        | 1,029  |      
|                                                |                                    |                 |        |               |       |   |        |       
|                                                |                                    |                 | 10,755 |               |       |   | 10,755 |       
|                                                | Less: accumulated amortization     |                 |        | (3,795        | )     |   |        | (3,188 | )    
|                                                |                                    |                 |        |               |       |   |        |       
|                                                |                                    | Net intangibles |        |               | 6,960 |   |        |        | 7,567 | 
|                                                | Other assets                       |                 |        | 1,528         |       |   |        | 1,711  |      
|                                                |                                    |                 |        |               |       |   |        |       
|                                                |                                    | $               | 8,488  |               |       | $ | 9,278  |       
|                                                |                                    |                 |        |               |       |   |        |       
|Accrued expenses and other current liabilities: |                                    |                 |        |               |       |   |        |       
|                                                | Deferred revenue                   |                 | $      | 2,744         |       |   | $      | 2,788  |      
|                                                | Compensation and employee benefits |                 |        | 1,232         |       |   |        | 1,367  |      
|                                                | Accrued vacant facility lease cost |                 |        | 4,109         |       |   |        | 4,329  |      
|                                                | Accrued litigation settlement      |                 |        | 2,700         |       |   |        | 2,700  |      
|                                                | Other                              |                 |        | 734           |       |   |        | 753    |      
|                                                |                                    |                 |        |               |       |   |        |       
|                                                |                                    | $               | 11,519 |               |       | $ | 11,937 |       
|                                                |                                    |                 |        |               |       |   |        |       

Note 4  Intangible Assets and Goodwill

In August 2001, the FASB issued Statement of Financial Accounting
Standards No. 144 (SFAS 144), Accounting for the Impairment or Disposal of
Long-Lived Assets. SFAS 144 supersedes Statement of Financial Accounting
Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of, and provides further guidance regarding
the accounting and disclosure of long-lived assets. Our adoption of SFAS 144 on
October 1, 2002 did not have a material effect on our financial condition and
results of operations.

In June 2001, the FASB issued Statement of Financial Accounting Standards
No. 141 (SFAS 141), Business Combinations and Statement of Financial
Accounting Standards No. 142 (SFAS 142), Goodwill and Other Intangible
Assets. SFAS 141 applies to business combinations and eliminates the
pooling-of-interests method of accounting. Goodwill and intangible assets
deemed to have indefinite lives are no longer amortized and are subject to
annual impairment tests, the first of which was conducted as of October 1,
2002, in accordance with the Statements. Other intangible assets will be
amortized over their useful lives. Under the new Statements, certain
intangibles such as workforce acquired in a business combination are
reclassified as goodwill and certain intangibles

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are reclassified as previously
reported goodwill. As a result of our adoption of these Statements for
accounting for goodwill and other intangible assets on October 1, 2002, we have
ceased amortization of goodwill. As of December 31, 2002, the Company has
goodwill of $1.0 million.

If amortization expenses related to goodwill that is no longer amortized
with the adoption of SFAS 142 had been excluded from operating expenses for the
three months ended December 31, 2001, earnings per share would have been as
follows:

|                                      |                                     |  |                    |        |  
|------------------------------------- | ----------------------------------- |  | ------------------ | ------ | -
|                                      |                                     |  | Three Months Ended
|                                      |                                     |  | December 30, 2001 
|                                      |                                     |  |                   
|Net loss:                             |                                     |  |                    |       
|                                      | Reported net loss                   |  | $                  | (5,013 | )
|                                      | Goodwill and workforce amortization |  |                    | 2,431  |  
|                                      |                                     |  |                    |       
|                                      | Adjusted net loss                   |  | $                  | (2,582 | )
|                                      |                                     |  |                    |       
|Basic and diluted net loss per share: |                                     |  |                    |       
|                                      | Reported net loss                   |  | $                  | (0.49  | )
|                                      | Goodwill and workforce amortization |  |                    | .24    |  
|                                      |                                     |  |                    |       
|                                      | Adjusted net loss                   |  | $                  | (0.25  | )
|                                      |                                     |  |                    |       

Note 5  Severance Costs

In September 2002, the Company announced a plan to align its costs and
expenses through a reduction in workforce which involved the elimination of 27
positions consisting of one operations employee, 17 research and development
employees, seven sales and marketing employees and two general and
administrative employees. The Company recorded an accrual for severance and
employment related costs of $423,000. The remaining accrual balance as of
December 31, 2002 of $121,000 is included in accrued liabilities.

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 (the District Court) against the Company and certain of its
officers and directors. On March 17, 2000, these complaints were consolidated
into In re Hi/fn, Inc. Securities Litigation No. 99-04531 SI. The consolidated
complaint was filed on behalf of persons who purchased the Companys stock
between July 26, 1999 and October 7, 1999 (the class period). The complaint
sought unspecified money damages and alleged that the Company and certain of
its officers and directors violated federal securities laws in connection with
various public statements made during the class period. In August 2000, the
District Court dismissed the complaint as to all defendants, other than Raymond
J. Farnham and the Company. In February 2001, the District Court certified the
purported class. On May 15, 2002, the parties entered into a Memorandum of
Understanding to settle all claims in the consolidated securities class action.
Under the terms of the settlement, all claims will be dismissed without any
admission of liability or wrongdoing by any defendant, and the shareholder
class will receive $9.5 million, comprised of $6.8 million in cash, which was
contributed by our insurance carriers, and the balance in the Companys stock
with a minimum of 270,000 shares to be issued. On June 10, 2002, the District
Court entered an order preliminarily approving the Stipulation of Settlement
and providing for notice and an opportunity to object to the shareholder class.
The District Court approved the settlement and entered a Final Judgment and
Order of Dismissal with Prejudice on September 4, 2002. In accordance with the
settlement, we will issue at least 270,000 shares of the Companys common
stock, supplementing the allotment with cash or additional shares of common
stock to compensate for shortfall in fair value below $2.7 million. To the
extent that the trading price of the common stock exceeds $10.00 at the time of
distribution, the Company would recognize an additional litigation settlement
charge equal to the aggregate fair market value of the 270,000 shares of common
stock less the $2.7 million already recognized and any such additional charge
may negatively affect our financial condition and results of operations.

In March 2002, two purported shareholder derivative actions were filed,
one in the United States District Court for the Northern District of California
and one in the Superior Court of California for the County of Santa Clara (the
federal derivative action and the state derivative action, respectively).
These complaints were filed against the Company and certain of its current and
former officers and directors. The derivative complaints alleged violations of

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California Corporations Code Section 25402, breach of fiduciary duty and waste
of corporate assets, based on the same facts and events alleged in the class
action. On June 7, 2002, the federal court entered an order granting
plaintiffs motion to voluntarily dismiss the federal derivative action without
prejudice. On June 26, 2002, the state court sustained the Companys demurrer,
with leave to amend, on the ground that plaintiff had failed to plead facts
showing that he was excused from making demand on the Companys board of
directors. The court also ordered limited discovery relating solely to the
issue whether demand is excused. The court did not rule upon the demurrer to
the derivative complaint filed by the individual director defendants. The
plaintiff filed an amended complaint and the defendants filed another demurrer,
which is scheduled for hearing on March 10, 2003. The Company and the
individual director defendants believe the allegations contained in the
complaint are without merit and intend to defend the action vigorously.

Note 7  Recent Accounting Pronouncements

In June 2002, the FASB issued Statement of Financial Accounting Standards
No. 146 (SFAS 146), Accounting for Costs Associated with Exit or Disposal
Activities. SFAS 146 addresses significant issues regarding the recognition,
measurement, and reporting of costs that are associated with exit and disposal
activities, including restructuring activities that are currently accounted for
under EITF No. 94-3, Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring). The scope of SFAS 146 also includes costs related to
terminating a contract that is not a capital lease and termination benefits
that employees who are involuntarily terminated receive under the terms of a
one-time benefit arrangement that is not an ongoing benefit arrangement or an
individual deferred-compensation contract. SFAS 146 will be effective for exit
or disposal activities that are initiated after December 31, 2002 and early
application is encouraged. The Company will adopt SFAS 146 during the second
fiscal quarter ending March 31, 2003. The provisions of EITF No. 94-3 shall
continue to apply for an exit activity initiated under an exit plan that met
the criteria of EITF No. 94-3 prior to the adoption of SFAS 146. The effect on
adoption of SFAS 146 will change on a prospective basis the timing of when
restructuring charges are recorded from a commitment date approach to when the
liability is incurred.

In November 2002, the EITF reached a consensus on Issue 00-21 (EITF
00-21), Multiple-Deliverable Revenue Arrangements. EITF 00-21 addresses how
to account for arrangements that may involve the delivery or performance of
multiple products, services, and/or rights to use assets. The consensus
mandates how to identify whether goods or services or both that are to be
delivered separately in a bundled sales arrangement should be accounted for
separately because they are separate units of accounting. The guidance can
affect the timing of revenue recognition for such arrangements, even though it
does not change rules governing the timing or pattern of revenue recognition of
individual items accounted for separately. The final consensus will be
applicable to agreements entered into in fiscal years beginning after June 15,
2003 with early adoption permitted. Additionally, companies will be permitted
to apply the consensus guidance to all existing arrangements as the cumulative
effect of a change in accounting principle in accordance with APB Opinion No.
20, Accounting Changes. The Company is assessing, but at this point does not
believe the adoption of EITF 00-21 will have a material impact on its financial
position, cash flows or results of operations.

In
November 2002, the FASB issued Interpretation No. 45 (FIN 45),
Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. This interpretation elaborates
on the disclosures to be made by a guarantor in its interim and annual
financial statements about its obligations under certain guarantees that it has
issued. It also clarifies that a guarantor is required to recognize, at the
inception of a guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee. The disclosure requirements of FIN 45 are
effective for interim and annual periods after December 15, 2002. The initial
recognition and initial measurement requirements of FIN 45 are effective
prospectively for guarantees issued or modified after December 31, 2002. The
Company is assessing, but at this point does not believe the adoption of the
recognition and initial measurement requirements of FIN 45 will have a material
impact on its financial position, cash flows or results of operations.

In December 2002, the FASB issued Statement of Financial Accounting
Standards No. 148 (SFAS 148), Accounting for Stock-Based Compensation -
Transition and Disclosure. SFAS 148 amends Statement of Financial Accounting
Standards No. 123 (SFAS 123), Accounting for Stock-Based Compensation, and
provides

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alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. SFAS
148 also amends the disclosure requirements of SFAS 123 to require more
prominent and frequent disclosures in financial statements about the effects of
stock-based compensation. The transition guidance and annual disclosure
provisions of SFAS 148 are effective for financial statements issued for fiscal
years ending after December 15, 2002. The interim disclosure provisions are
effective for financial reports containing financial statements for interim
periods beginning after December 15, 2002. Adoption of SFAS 148 is not expected
to have a material impact on the Companys financial position, cash flows or
results of operations.

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

Cautionary Statement Regarding Forward-Looking Statements

The section entitled Managements Discussion and Analysis of Financial
Condition and Results of Operations set forth below contains forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended
(the Exchange Act). Words such as believes, anticipates, estimates,
expects, and words of similar expressions are intended to identify
forward-looking statements that involve risks and uncertainties. Such
statements are expectations based on information currently available and are
subject to risk, uncertainties and changes in condition, significance, value
and effect, including those discussed under the heading Trends, Risks and
Uncertainties below and reports filed by Hifn with the Securities and Exchange
Commission, specifically Forms 10-K, 8-K, 10-Q and S-8. Such risks,
uncertainties and changes in condition, significance, value and effect could
cause our actual results to differ materially from those anticipated events.
Although we believe that the assumptions underlying the forward-looking
statements are reasonable, any of the assumptions could prove inaccurate,
including, but not limited to, statements as to our future operating results
and business plans. We disclaim any intention or obligation to update or revise
any forward-looking statements, whether as a result of new information, future
events or otherwise.

Overview

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

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

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

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Critical Accounting Policies

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

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

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

We receive software license revenue from OEMs that sublicense our software
shipped with their products. The OEM sublicense agreements are generally valid
for a term of one year and include rights to unspecified future upgrades and
maintenance during the term of the agreement. License fees under these
agreements are recognized ratably over the term of the agreement. Revenues from
sublicenses sold in excess of the specified volume in the original license
agreement are recognized when they are reported as sold to end customers by the
OEM. Our deferred revenue balance as of December 31, 2002 was $2.7 million and
included approximately $252,000 in exchange rights for unsold licenses.

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

Inventories.We value our inventory at the lower of cost (determined on a
first-in, first-out cost method) or market. Inventories are comprised solely of
finished goods, which are manufactured by third party foundries for resale by
us. We provide for obsolete, slow moving or excess inventories, based on
forecasts prepared by management, in the period when obsolescence or inventory
in excess of expected demand is first identified. Reserves are established to
reduce the cost basis of inventory for excess and obsolete inventory. As of
December 31, 2002, inventories of $3.3 million that were previously written
down were still on hand. Subsequent increases in projected demand will not
result in a reversal of these reserves until the sale of the related inventory.

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

Valuation of long-lived and intangible assets and goodwill.We evaluate
the recovery of goodwill, other intangible assets and other long-lived assets
whenever events or changes in circumstances indicate that their carrying value
may not be recoverable through the estimated undiscounted future cash flows
resulting from the use of the assets. If we determine that the carrying value
of goodwill, other intangible assets and other long-lived assets may not be
recoverable, we measure impairment by using the projected discounted cash flow
method. Our judgments regarding the existence of impairment indicators are
based on market conditions and operational performance of our

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business. During
the fourth quarter of fiscal 2002, we concluded that impairment indicators
existed and that goodwill was impaired and as a result, we recorded an
impairment charge of $27.4 million. The impairment charge was based on the
present value of management estimates of future cash flows. Changes in these
estimates could have a material impact on the impairment charge and any
resulting impairment loss could have a material adverse impact on our financial
condition and results of operations.

In accordance with SFAS 142, Goodwill and Other Intangible Assets,
goodwill and intangible assets deemed to have indefinite lives will no longer
be amortized but instead will be subject to annual impairment tests. We adopted
SFAS 142 during the first quarter of fiscal 2003. Other intangible assets will
continue to be amortized over their useful lives. Goodwill amortization expense
aggregated $8.6 million and $2.4 million during fiscal 2002 and the three
months ended December 31, 2001, respectively. The net book value of goodwill
was approximately $1.0 million at December 31, 2002. Asset impairment charges
could have a material effect on our consolidated financial position and results
of operations.

Accounting for income taxes.As part of the process of preparing our
consolidated financial statements we are required to estimate our income taxes,
which involves estimating our actual current tax exposure together with
assessing temporary differences resulting from differing treatment of items for
tax and accounting purposes. These differences result in deferred tax assets
and liabilities. Significant management judgment is required to assess the
likelihood that our deferred tax assets will be recovered from future taxable
income. During fiscal 2002, we recorded a net tax expense of $6.0 million to
establish a valuation allowance against deferred tax assets. Continuing losses
in recent reporting periods increase the uncertainties regarding realizability
of deferred tax assets. We have provided a full valuation allowance against
deferred tax assets. While we have considered future taxable income and ongoing
prudent and feasible tax planning strategies in assessing the need for the
valuation allowance, in the event we were to determine that we would be able to
realize our deferred tax assets in the future in excess of its net recorded
amount, an adjustment to the deferred tax asset would increase income in the
period such determination is made.

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

As of December 31, 2002, in relation to the class action suit against us,
the court approved a settlement of all claims and we recognized approximately
$2.7 million in accrued litigation settlement charges, which represent the
uninsured portion of the settlement amount. In accordance with the settlement,
we will issue at least 270,000 shares of our common stock, supplementing the
allotment with cash or additional shares of common stock to compensate for any
shortfall in fair value below $2.7 million. To the extent that the trading
price of the common stock exceeds $10.00 at the time of distribution, we would
recognize an additional litigation settlement charge equal to the aggregate
fair market value of the 270,000 shares of common stock less the $2.7 million
already recognized. Such an adjustment may materially affect our results of
operations, financial condition and future cash flows.

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Results of Operations

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

|                                          |                                          |                                    |      |                    |     |      |      |    |     | 
|----------------------------------------- | ---------------------------------------- | ---------------------------------- | ---- | ------------------ | --- | ---- | ---- | -- | --- | 
|                                          |                                          |                                    |      | Three Months Ended
|                                          |                                          |                                    |      | December 31,      
|                                          |                                          |                                    |      |                   
|                                          |                                          |                                    |      | 2002               |     | 2001
|                                          |                                          |                                    |      |                    |     |     
|Net revenues                              |                                          |                                    | 100  | %                  |     |      | 100  | % 
|                                          |                                          |                                    |      |                    |     |      |      |   
|Costs and operating expenses:             |                                          |                                    |      |                    |     |      |      |   
|                                          | Cost of revenues                         |                                    |      | 33                 |     |      |      | 26 |    
|                                          | Research and development                 |                                    |      | 118                |     |      |      | 80 |    
|                                          | Sales and marketing                      |                                    |      | 40                 |     |      |      | 34 |    
|                                          | General and administrative               |                                    |      | 22                 |     |      |      | 25 |    
|                                          | Amortization of intangibles and goodwill |                                    |      | 8                  |     |      |      | 43 |    
|                                          |                                          |                                    |      |                    |     |      |      |   
|                                          |                                          | Total costs and operating expenses |      |                    | 221 |      |      |    | 208 | 
|                                          |                                          |                                    |      |                    |     |      |      |   
|Income (loss) from operations             |                                          |                                    | (121 | )                  |     |      | (108 | ) 
|Interest and other income, net            |                                          |                                    | 5    |                    |     |      | 6    |   
|                                          |                                          |                                    |      |                    |     |      |      |   
|Income (loss) before income taxes         |                                          |                                    | (116 | )                  |     |      | (102 | ) 
|Provision for (benefit from) income taxes |                                          |                                    |     |                    |     |      | (24  | ) 
|                                          |                                          |                                    |      |                    |     |      |      |   
|Net loss                                  |                                          |                                    | (116 | )%                 |     |      | (78  | )%
|                                          |                                          |                                    |      |                    |     |      |      |   

Net Revenues.Net revenues decreased 31.1% to $4.4 million for the
quarter ended December 31, 2002 from $6.4 million for the quarter ended
December 31, 2001. The decrease in revenues was primarily due to decreased
sales of Hifns data compression and encryption processors to network equipment
manufacturers as well as decreased revenues and royalties related to
classification and other software. Semiconductor sales to Quantum Corporation,
an original equipment manufacturer of high-performance tape storage devices,
through its manufacturing subcontractor, comprised 33% and 45% of net revenues
for the quarter ended December 31, 2002 and 2001, respectively.

Cost of Revenues.Cost of revenues consists primarily of semiconductors
which were manufactured to our specifications by third parties for resale by
us. Cost of revenues as a percentage of net revenues increased to 32.5% for the
three months ended December 31, 2002 from 25.9% for the same period in fiscal
2002. The increase in cost of revenues as a percentage of net revenues in
fiscal 2003 is primarily a result of a shift in the revenue mix with software
revenues comprising 14.6% and 29.4% of total revenues for the three months
ended December 31, 2002 and 2001, respectively. Additionally, cost of revenues
during the quarter ended December 31, 2002 includes the benefit from the
recovery of $272,000 in prior excess inventory charge as a result of the sale
of previously identified excess inventories.

Research and Development.The cost of product development consists
primarily of salaries, employee benefits, overhead, outside contractors and
non-recurring engineering fees. Such research and development expenses remained
flat at approximately $5.2 million and $5.1 million for the quarters ended
December 31, 2002 and 2001, respectively. Amortization of deferred stock
compensation decreased by $1.4 million, inclusive of $1.3 million for options
canceled during December 2001 in relation to the voluntary stock
option exchange program, while
salaries and benefits increased by $615,000 and nonrecurring engineering costs
relating to new product development increased by $668,000.

Sales and Marketing.Sales and marketing expenses consist primarily of
salaries, commissions and benefits of sales, marketing and support personnel as
well as consulting, advertising, promotion and overhead expenses. Such expenses
were approximately $1.8 million and $2.2 million for the three months ended
December 31, 2002 and 2001, respectively. The decrease reflects a decrease in
amortization of deferred stock compensation of $359,000 and a decrease in
professional services and tradeshow costs of $110,000 offset by an increase in
commission costs of $62,000 as a result of the mix of revenues subject to sales
commissions.

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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 $1.0 million
and $1.6 million for the three months ended December 31, 2002 and 2001,
respectively. The decrease was the result of a reduction in amortization of
deferred stock compensation of $186,000 and a decrease in legal costs of
$212,000 and in facility costs of $119,000 as a result of a
previously recorded charge related to vacant facility lease obligations.

Amortization of Intangibles and Goodwill.Amortization of intangibles was
$358,000 for the three months ended December 31, 2002 and $2.8 million for the
three months ended December 31, 2001. The decrease in amortization of
intangibles and goodwill is the result of an impairment of goodwill recorded in
September 2002 and the adoption of SFAS 142 in October 2002, which adoption
requires that goodwill no longer be amortized. Goodwill amortization comprised
$2.0 million of total amortization expense during the three months ended
December 31, 2001.

Interest and Other Income, net.Net interest and other income was $230,000
for the three months ended December 31, 2002 and $364,000 for the three months
ended December 31, 2001. The decrease in interest and other income for the
three months ended December 31, 2002 compared to the same period
in the prior fiscal year was
mainly due to the continuing decrease in the average cash balance coupled with
decreasing overall interest rates.

Income Taxes.As a result of continuing losses over a longer period than
previously expected, we recorded a tax valuation allowance during fiscal 2002
to reduce the carrying value of our deferred tax assets to zero. Accordingly,
we have not recognized tax benefits for the three months ended December 31,
2002. The effective income tax rate for the three months ended December 31,
2001 was 23%. The resulting effective tax rate was mainly due to the
non-deductibility of certain acquisition-related costs consisting primarily of
the amortization of intangibles and goodwill.

Liquidity and Capital Resources

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

Net cash used in operating activities of $3.1 million for the three months
ended December 31, 2001 was the result of net loss of $5.0 million as adjusted
for non-cash items including amortization of intangibles and goodwill of $2.8 million, a
reduction in deferred stock compensation of $2.1 million, depreciation and
amortization costs of $488,000 and deferred tax asset of $281,000 as well as a
decrease in inventory of $358,000 and an increase in accounts payable of $2.1
million. These adjustments were offset by increases in accounts receivable of
$1.1 million and in prepaid expenses and other current assets as well as
intangibles and other assets of $4.7 million and a decrease in accrued expenses
and other current liabilities of $333,000.

Net cash provided by investing activities of $1.5 million for the three
months ended December 31, 2002 primarily reflects a decrease in short-term
investments partially offset by the purchase of property and equipment. Net
cash provided by investing activities of $406,000 for the three months ended
December 31, 2001 primarily reflects a decrease in short-term investments.

Net cash provided by financing activities was $476,000 and $405,000 for
the three months ended December 31, 2002 and 2001, respectively. The net cash
provided by financing activities for both periods was primarily attributable to
proceeds from issuance of common stock.

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

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arrangements allow the Company to avoid
utilizing its capital resources for manufacturing facilities and
work-in-process inventory and to focus substantially all of its resources on
the design, development and marketing of its products.

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

Recent Accounting Pronouncements

In June 2002, the FASB issued Statement of Financial Accounting Standards
No. 146 (SFAS 146), Accounting for Costs Associated with Exit or Disposal
Activities. SFAS 146 addresses significant issues regarding the recognition,
measurement, and reporting of costs that are associated with exit and disposal
activities, including restructuring activities that are currently accounted for
under EITF No. 94-3, Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring). The scope of SFAS 146 also includes costs related to
terminating a contract that is not a capital lease and termination benefits
that employees who are involuntarily terminated receive under the terms of a
one-time benefit arrangement that is not an ongoing benefit arrangement or an
individual deferred-compensation contract. SFAS 146 will be effective for exit
or disposal activities that are initiated after December 31, 2002 and early
application is encouraged. We will adopt SFAS 146 during the second fiscal
quarter ending March 31, 2003. The provisions of EITF No. 94-3 shall continue
to apply for an exit activity initiated under an exit plan that met the
criteria of EITF No. 94-3 prior to the adoption of SFAS 146. The effect on
adoption of SFAS 146 will change on a prospective basis the timing of when
restructuring charges are recorded from a commitment date approach to when the
liability is incurred.

In November 2002, the EITF reached a consensus on Issue 00-21 (EITF
00-21), Multiple-Deliverable Revenue Arrangements. EITF 00-21 addresses how
to account for arrangements that may involve the delivery or performance of
multiple products, services, and/or rights to use assets. The consensus
mandates how to identify whether goods or services or both that are to be
delivered separately in a bundled sales arrangement should be accounted for
separately because they are separate units of accounting. The guidance can
affect the timing of revenue recognition for such arrangements, even though it
does not change rules governing the timing or pattern of revenue recognition of
individual items accounted for separately. The final consensus will be
applicable to agreements entered into in fiscal years beginning after June 15,
2003 with early adoption permitted. Additionally, companies will be permitted
to apply the consensus guidance to all existing arrangements as the cumulative
effect of a change in accounting principle in accordance with APB Opinion No.
20, Accounting Changes. We are assessing, but at this point do not believe
the adoption of EITF 00-21 will have a material impact on our financial
position, cash flows or results of operations.

In November 2002, the FASB issued Interpretation No. 45 (FIN 45),
Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. This interpretation elaborates
on the disclosures to be made by a guarantor in its interim and annual
financial statements about its obligations under certain guarantees that it has
issued. It also clarifies that a guarantor is required to recognize, at the
inception of a guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee. The disclosure requirements of FIN 45 are
effective for interim and annual periods after December 15, 2002. The initial
recognition and initial measurement requirements of FIN 45 are effective
prospectively for guarantees issued or modified after December 31, 2002. We are
assessing, but at this point do not believe the

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adoption of the recognition and
initial measurement requirements of FIN 45 will have a material impact on our
financial position, cash flows or results of operations.

In December 2002, the FASB issued Statement of Financial Accounting
Standards No. 148 (SFAS 148), Accounting for Stock-Based Compensation -
Transition and Disclosure. SFAS 148 amends Statement of Financial Accounting
Standards No. 123 (SFAS 123), Accounting for Stock-Based Compensation, and
provides alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. SFAS
148 also amends the disclosure requirements of SFAS 123 to require more
prominent and frequent disclosures in financial statements about the effects of
stock-based compensation. The transition guidance and annual disclosure
provisions of SFAS 148 are effective for financial statements issued for fiscal
years ending after December 15, 2002. The interim disclosure provisions are
effective for financial reports containing financial statements for interim
periods beginning after December 15, 2002. Adoption of SFAS 148 is not expected
to materially impact our financial position, cash flows and results of
operations.

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Trends, Risks and Uncertainties

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

Our Operating Results May Fluctuate Significantly.

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



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

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

During fiscal 2002, we performed an impairment analysis of goodwill and
long-lived assets and determined that impairment had been realized on goodwill
and certain developed technology, resulting in recognition of an impairment
charge of $27.4 million. Pursuant to SFAS 142, Goodwill and Other Intangible
Assets, we will continue to perform an annual impairment test and, if as a
result of this analysis, we determine that there has been an impairment of our
goodwill and other long-lived assets, asset impairment charges will be
recognized. Approximately $1.0 million of goodwill remains as of December 31,
2002.

We Depend Upon A Small Number Of Customers.

Quantum Corporation (Quantum), through its manufacturing subcontractor,
accounted for approximately 33%, 46% and 36%, respectively, of our net revenues
during the three months ended December 31, 2002 and in fiscal 2002 and 2001.
Quantum is not under any binding obligation to order from us. If our sales to
Quantum decline, our business, financial condition and results of operations
could suffer. We expect that our most significant customers in the future could
be different from our largest customers today for a number of reasons,
including customers deployment schedules and budget considerations. As a
result, we believe we may experience significant fluctuations in our results of
operations on a quarterly and annual basis.

Limited numbers of network and storage equipment vendors account for a
majority of packet processor purchases in their respective markets. In
particular, the market for network equipment that would include packet

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



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

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

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

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



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

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

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

Our Markets Are Highly Competitive.

We compete in markets that are intensely competitive and are expected to
become increasingly competitive as current competitors expand their product
offerings and new competitors enter the market. The markets that we compete in
are subject to frequent product introductions with improved price-performance
characteristics, rapid technological change, and the continued emergence of new
industry standards. Our products compete with offerings from companies such as
Analog Devices, Inc., SafeNet, Inc., IBM, Broadcom Corporation, Motorola, Inc.
and Royal Philips Electronics. 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 in the foreign encryption markets. See Our Products Are
Subject To Export Restrictions.

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

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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 17 United States patents and seven foreign
patents. We also have two pending patent applications in Japan. Our issued
patents and patent applications primarily cover various aspects of our
compression, bandwidth management and rate shaping technologies and have
expiration dates ranging from 2006 to 2017. In addition to compression, we have
six pending patent applications in the United States, four in Europe and Asia
(Japan) covering our flow classification technology. Patents may not be issued
under our current or future patent applications, and the patents issued under
such patent applications could be invalidated, circumvented or challenged. In
addition, third parties could make infringement claims against us in the
future. Such infringement claims could result in costly litigation. We may not
prevail in any such litigation or be able to license any valid and infringed
patents from third parties on commercially reasonable terms, if at all.
Regardless of the outcome, an infringement claim would likely result in
substantial cost and diversion of our resources. Any infringement claim or
other litigation against us or by us could harm our business, financial
condition and results of operations. The patents issued to us may not be
adequate to protect our proprietary rights, to deter misappropriation

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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 OKI Semiconductor. Since we depend upon
independent manufacturers, we do not directly control product delivery
schedules or product quality. None of our products are manufactured by more
than one supplier. Since the semiconductor industry is highly cyclical, foundry
capacity has been very limited at times in the past and may become limited in
the future.

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



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

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

Both Toshiba Corporation and OKI Semiconductor manufacture products for us
in plants located in Asia. To date, the financial and stock market dislocations
that have occurred in the Asian financial markets in the past have

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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 current and prospective customers. Any such
event would harm our business, financial condition and results of operations.

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We Face Order And Shipment Uncertainties.

We generally make our sales under individual purchase orders that may be
canceled or deferred by customers on short notice without significant penalty,
if any. Cancellation or deferral of product orders could cause us to hold
excess inventory, which could harm our profit margins and restrict our ability
to fund our operations. During fiscal 2002, we recorded an excess inventory
reserve of $3.4 million as a result of a significant decrease in forecasted
demand for our products. We recognize revenue upon shipment of products to our
customers, net of an allowance for estimated returns. An unanticipated level of
returns could harm our business, financial condition and results of operations.

We Depend Upon Key Personnel.

Our success greatly depends on the continued contributions of our key
management and other personnel, many of whom would be difficult to replace. We
do not have employment contracts with any of our key personnel, nor do we
maintain any key man life insurance on any of our personnel. Several members of
our management team have joined us in the last 24 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 has, in the past, been
intense in the geographic areas and market segments in which we compete, and we
may not be successful in hiring and retaining such people. If we lose the
services of any key personnel, or cannot attract or retain qualified personnel,
particularly engineers, our business, financial condition and results of
operations could suffer. In addition, companies in technology industries whose
employees accept positions with competitors have in the past claimed that their
competitors have engaged in unfair competition or hiring practices. We could
receive such claims in the future as we seek to hire qualified personnel. These
claims could result in material litigation. We could incur substantial costs in
defending against any such claims, regardless of their merits.

Our Products Are Subject To Export Restrictions.

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

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

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

We Face Risks Associated With Acquisitions.

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 intangible assets, any of which could
harm our operating results and/or the price of our Common Stock. Acquisitions
entail numerous risks, including:



| |  |  | Difficulties in assimilating acquired operations, technologies
and products, in particular, if we fail to successfully integrate
the acquisition of Apptitude and certain other assets and
intellectual property acquired in September 2002, the anticipated
benefits of these transaction will not occur;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Diversion of managements attention from other business concerns;                                                                                                                                                                                                                                         
|
| |  |  | Risks of entering markets in which we have little or no prior experience; and                                                                                                                                                                                                                             
|
| |  |  | Loss of key employees of acquired organizations.                                                                                                                                                                                                                                                          

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

The 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.

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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 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 (the District Court) against Hifn and certain of its officers and
directors. On March 17, 2000, these complaints were consolidated into In re
Hi/fn, Inc. Securities Litigation No. 99-04531 SI. The consolidated complaint
was filed on behalf of persons who purchased Hifns stock between July 26, 1999
and October 7, 1999 (the class period). The complaint sought unspecified
money damages and alleged that the Hifn and certain of its officers and
directors violated federal securities laws in connection with various public
statements made during the class period. In August 2000, the District Court
dismissed the complaint as to all defendants, other than Raymond J. Farnham and
Hifn. In February 2001, the District Court certified the purported class. On
May 15, 2002, the parties entered into a Memorandum of Understanding to settle
all claims in the consolidated securities class action. Under the terms of the
settlement, all claims will be dismissed without any admission of liability or
wrongdoing by any defendant, and the shareholder class will receive $9.5
million, comprised of $6.8 million in cash, which was contributed by our
insurance carriers, and the balance in Hifn stock with a minimum of 270,000
shares to be issued. On June 10, 2002, the District Court entered an order
preliminarily approving the Stipulation of Settlement and providing for notice
and an opportunity to object to the shareholder class. The District Court
approved the settlement and entered a Final Judgment and Order of Dismissal
with Prejudice on September 4, 2002. In accordance with the settlement, we will
issue at least 270,000 shares of Hifn common stock, supplementing the allotment
with cash or additional shares of common stock to compensate for shortfall in
fair value below $2.7 million. To the extent that the trading price of the
common stock exceeds $10.00 at the time of distribution, Hifn would recognize
an additional litigation settlement charge equal to the aggregate fair market
value of the 270,000 shares of common stock less the $2.7 million already
recognized and any such additional charge may negatively affect our financial
condition and results of operations.

In March 2002, two purported shareholder derivative actions were filed,
one in the United States District Court for the Northern District of California
and one in the Superior Court of California for the County of Santa Clara (the
federal derivative action and the state derivative action, respectively).
These complaints were filed against Hifn and certain of its current and former
officers and directors. The derivative complaints alleged violations of
California Corporations Code Section 25402, breach of fiduciary duty and waste
of corporate assets, based on the same facts and events alleged in the class
action. On June 7, 2002, the federal court entered an order granting
plaintiffs motion to voluntarily dismiss the federal derivative action without
prejudice. On June 26, 2002, the state court sustained Hifns demurrer, with
leave to amend, on the ground that plaintiff had failed to plead facts showing
that he was excused from making demand on Hifns board of directors. The court
also ordered limited discovery relating solely to the issue whether demand is
excused. The court did not rule upon the demurrer to the derivative complaint
filed by the individual director defendants. The plaintiff filed an amended
complaint and the defendants filed another

26



---



##### Table of Contents



demurrer, which is scheduled for
hearing on March 10, 2003. Hifn and the individual director defendants believe
the allegations contained in the complaint are without merit and intend to
defend the action vigorously.




Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk  The Company does not use derivative financial
instruments in its investment portfolio. The Companys investment portfolio is
generally comprised of commercial paper. The Company places investments in
instruments that meet high credit quality standards. These securities are
subject to interest rate risk, and could decline in value if interest rates
fluctuate. Due to the short duration and conservative nature of the Companys
investment portfolio, the Company does not expect any material loss with
respect to its investment portfolio. A 10% move in interest rates at December
31, 2002 would not have a material effect on the Companys pre-tax earnings and
the carrying value of its investments over the next fiscal year.

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




Item 4. Controls and Procedures

(a)  Evaluation of disclosure controls and procedures. Based on their
evaluation as of a date within 90 days of the filing date of this Quarterly
Report on Form 10-Q, the Companys principal executive officer and principal
financial officer have concluded that the Companys disclosure controls and
procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities
Exchange Act of 1934 (the Exchange Act) are effective to ensure that
information required to be disclosed by the Company in reports that it files or
submits under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in Securities and Exchange Commission rules
and forms.

(b)  Changes in internal controls. There were no significant changes in the
Companys internal controls or in other factors that could significantly affect
these controls subsequent to the date of their evaluation. There were no
significant deficiencies or material weaknesses, and therefore there were no
corrective actions taken.

27



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##### Table of Contents






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 (the District Court) against Hifn and certain of its
officers and directors. On March 17, 2000, these complaints were
consolidated into In re Hi/fn, Inc. Securities Litigation No. 99-04531
SI. The consolidated complaint was filed on behalf of persons who
purchased Hifns stock between July 26, 1999 and October 7, 1999 (the
class period). The complaint sought unspecified money damages and
alleged that the Hifn and certain of its officers and directors violated
federal securities laws in connection with various public statements
made during the class period. In August 2000, the District Court
dismissed the complaint as to all defendants, other than Raymond J.
Farnham and Hifn. In February 2001, the District Court certified the
purported class. On May 15, 2002, the parties entered into a Memorandum
of Understanding to settle all claims in the consolidated securities
class action. Under the terms of the settlement, all claims will be
dismissed without any admission of liability or wrongdoing by any
defendant, and the shareholder class will receive $9.5 million,
comprised of $6.8 million in cash, which was contributed by our
insurance carriers, and the balance in Hifn stock with a minimum of
270,000 shares to be issued. On June 10, 2002, the District Court
entered an order preliminarily approving the Stipulation of Settlement
and providing for notice and an opportunity to object to the shareholder
class. The District Court approved the settlement and entered a Final
Judgment and Order of Dismissal with Prejudice on September 4, 2002. In
accordance with the settlement, we will issue at least 270,000 shares of
Hifn common stock, supplementing the allotment with cash or additional
shares of common stock to compensate for shortfall in fair value below
$2.7 million. To the extent that the trading price of the common stock
exceeds $10.00 at the time of distribution, Hifn would recognize an
additional litigation settlement charge equal to the aggregate fair
market value of the 270,000 shares of common stock less the $2.7 million
already recognized and any such additional charge may negatively affect
our financial condition and results of operations.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | In March 2002, two purported shareholder derivative actions were
filed, one in the United States District Court for the Northern District
of California and one in the Superior Court of California for the County
of Santa Clara (the federal derivative action and the state
derivative action, respectively). These complaints were filed against
Hifn and certain of its current and former officers and directors. The
derivative complaints alleged violations of California Corporations Code
Section 25402, breach of fiduciary duty and waste of corporate assets,
based on the same facts and events alleged in the class action. On June
7, 2002, the federal court entered an order granting plaintiffs motion
to voluntarily dismiss the federal derivative action without prejudice.
On June 26, 2002, the state court sustained Hifns demurrer, with leave
to amend, on the ground that plaintiff had failed to plead facts showing
that he was excused from making demand on Hifns board of directors. The
court also ordered limited discovery relating solely to the issue
whether demand is excused. The court did not rule upon the demurrer to
the derivative complaint filed by the individual director defendants.
The plaintiff filed an amended complaint and the defendants filed
another demurrer, which is scheduled for hearing on March 10, 2003. Hifn
and the individual director defendants believe the allegations contained
in the complaint are without merit and intend to defend the action
vigorously.




Item 2. Changes in Securities



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




Item 3. Defaults Upon Senior Securities



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




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



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

28



---



##### Table of Contents



Item 5. Other Information



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

Item 6. Exhibits and Reports on Form 8-K



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

|               |  |                                                                                                                                                       
|-------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description                                                                                                                                           
|               |  |                                                                                                                                                       
|3.1*           |  | Form of Third Amended and Restated
Certificate of Incorporation of hi/fn, inc.                                                                        
|               |  |                                                                                                                                                       
|3.2*           |  | Amended and Restated Bylaws of hi/fn, inc.                                                                                                            
|               |  |                                                                                                                                                       
|99.1           |  | Certification of the Chief Executive
Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|               |  |                                                                                                                                                       
|99.2           |  | Certification of the Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.



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



---

|* |  | Incoporated by reference from Registrants Registration Statement on Form
10 (File No. 0-24765) filed with the SEC on August 7, 1998 as amended.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------

29



---



##### Table of Contents






SIGNATURES

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

|                       |  |                                                                                                             |  |                      
|---------------------- |  | ----------------------------------------------------------------------------------------------------------- |  | ---------------------
|                       |  | hi/fn, inc.                                                                                                
|                       |  | (Registrant)                                                                                               
|                       |  |                                                                                                             |  |                      
|Date: February 4, 2003 |  | By:                                                                                                         |  | /s/ WILLIAM R. WALKER
|                       |  |                                                                                                             |  |                      
|                       |  | William R. Walker                                                                                          
|                       |  | Vice President, Finance, Chief Financial
Officer and Secretary (principal financial and accounting officer)

30



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##### Table of Contents



CERTIFICATION PURSUANT TO
SECTION 302 (a)
THE SARBANES-OXLEY ACT OF 2002

I, Christopher G. Kenber, certify that:



|1. |  | I have reviewed this quarterly report on Form 10-Q of Hifn, Inc.;                                                                                                                                                                                                                                                             
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|2. |  | Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
|  
|3. |  | Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;                   
|  
|4. |  | The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:                                                                                                     



| | a) |  | designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | evaluated the effectiveness of the registrants disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the Evaluation Date); and                                                                                                  
|
| | c) |  | presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;                                                                                                                        



|5. |  | The registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent functions):
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrants
ability to record, process, summarize and report financial data and
have identified for the registrants auditors any material weaknesses
in internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrants
internal controls; and                                                                                                                                        



|6. |  | The registrants other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                       |  |                                              
|---------------------- |  | ---------------------------------------------
|Date: February 4, 2003 |  |                                              
|                       |  |                                              
|                       |  | /s/ CHRISTOPHER G. KENBER                    
|                       |  |                                              
|                       |  | Christopher G. Kenber                        
|                       |  | Chairman, President & Chief Executive Officer

31



---



##### Table of Contents



CERTIFICATION PURSUANT TO
SECTION 302 (a)
THE SARBANES-OXLEY ACT OF 2002

I, William R. Walker, certify that:



|1. |  | I have reviewed this quarterly report on Form 10-Q of Hifn, Inc.;                                                                                                                                                                                                                                                             
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|2. |  | Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
|  
|3. |  | Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;                   
|  
|4. |  | The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:                                                                                                     



| | a) |  | designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | evaluated the effectiveness of the registrants disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the Evaluation Date); and                                                                                                  
|
| | c) |  | presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;                                                                                                                        



|5. |  | The registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent functions):
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrants ability to
record, process, summarize and report financial data and have
identified for the registrants auditors any material weaknesses in
internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrants
internal controls; and                                                                                                                                        



|6. |  | The registrants other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                       |  |                                                  
|---------------------- |  | -------------------------------------------------
|Date: February 4, 2003 |  |                                                  
|                       |  |                                                  
|                       |  | /s/ WILLIAM R. WALKER                            
|                       |  |                                                  
|                       |  | William R. Walker                                
|                       |  | Vice President, Finance & Chief Financial Officer

32



---



##### Table of Contents






INDEX TO EXHIBITS

|        |  |                                                                                                                                                        |  |  |  | 
|------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------ |  |  |  | 
|Exhibit |  |                                                                                                                                                        |  |  |  | 
|Number  |  | Exhibit                                                                                                                                                |  |  |  | 
|        |  |                                                                                                                                                        |  |  |  | 
|3.1*    |  | Form of Third Amended and Restated Certificate of Incorporation of hi/fn, inc.                                                                        
|        |  |                                                                                                                                                       
|3.2*    |  | Amended and Restated Bylaws of hi/fn, inc.                                                                                                            
|        |  |                                                                                                                                                       
|99.1    |  | Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|        |  |                                                                                                                                                       
|99.2    |  | Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.



---

|* |  | Incoporated by reference from Registrants Registration Statement on Form
10 (File No. 0-24765) filed with the SEC on August 7, 1998 as amended.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------

33