**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-K**

 

**FOR ANNUAL AND TRANSITIONAL REPORTS**

**PURSUANT TO SECTIONS 13 OR 15(d)**

**OF THE SECURITIES EXCHANGE ACT OF1934**

 

**(Mark One)**

 

**ý****  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIESEXCHANGE ACT OF 1934**

 

**FOR THEFISCAL YEAR ENDED DECEMBER 31, 2002**

 

**OR**

 

**o****  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

 

**FOR THETRANSITION PERIOD FROM                           TO                            **

 

**Commission file number 0-27755**

 

| **JNI  Corporation**                                              |
|-------------------------------------------------------------------|
| (Name of  Registrant as Specified in its Charter)                 |
|                                                              |   |   |
| **Delaware**                                                      |   | **33-0740004** |
| (State or Other Jurisdiction of  Incorporation or Organization)   |   | (I.R.S. Employer  Identification No.) |
|                                                              |   |   |
| **10945 Vista Sorrento Parkway  San Diego, California**           |   | **92130** |
| (Address of Principal Executive Offices)                          |   | (Zip Code) |
|                                                              |   |   |
| **(858) 523-7000**                                                |
| (Registrant’s  Telephone Number, Including Area Code)        |
|                                                              |   |   |
| Securities  registered pursuant to Section 12(b) of the Act: |
| **None.**                                                         |
|                                                              |
| Securities registered  pursuant to Section 12(g) of the Act: |
| Common Stock,  $0.001 par value                                   |
| Preferred Stock  Purchase Rights                                  |
| (Title of Class)                                                  |

 

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

 

Indicateby check mark if disclosure of delinquent filer pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to thebest of registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K.  o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inExchange Act Rule 12b-2). YES  ý   NO  o

 

Asof June 28, 2002, the aggregate market value of the registrant’s voting stockheld by non-affiliates of the registrant was approximately $92,779,855 based onthe closing price of the Company’s Common Stock on the Nasdaq National Marketon June 28, 2002 of $3.50 per share.

 

Asof February 28, 2003, 26,590,864 shares of registrant’s Common Stock, $0.001par value, were outstanding.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

None.

 

 

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**PART I**

 

**Item 1.****           *Business***

 

**Overview**

 

We are a leading designer and supplier of FibreChannel enterprise storage connectivity products that connect servers and datastorage devices. We currently design, market and sell a broad range of FibreChannel host bus adapters that connect servers to storage subsystems tofacilitate the integration and management of devices used in storage areanetworks, or SANs. Our Fibre Channel products operate with most major serveroperating systems and network configurations used in SANs. Our Fibre Channelhost bus adapters incorporate our proprietary ASIC technology and can be usedboth with Unix-based and PC-based server platforms and their associatedinterfaces. Our software drivers enable the integration of our host busadapters into heterogeneous environments and ensure interoperability betweendifferent sets of platforms and servers. We also offer a line of InfiniBandproducts for server-to-server connectivity that are designed to operate withWindows 2000, Linux and Solaris.

 

We have leveraged our success in the market for SANconnectivity products in high-end Sun Solaris operating environments to build areputation for quality that has enabled us to obtain certifications fromleading storage and server original equipment manufacturers, or OEMs, includingEMC, Hewlett-Packard, Hitachi Data Systems, IBM, Network Appliance, StorageTekand Sun Microsystems.  We also maintainstrategic relationships with industry leaders, including Brocade, LSIStorage-Metastor, McData, Mellanox Technologies, Oracle, TopSpin and VERITASSoftware.  Additionally, we havedistributor agreements in place with key distributors of our products, includingAcal Electronics, Bell Micro, GE Access and Tidal Wire.

 

Investors wishing to obtain more information mayaccess our annual, quarterly and other reports and information with theSEC.  Investors can read and copy anyinformation we have filed with the SEC at the SEC’s Public Reference Room at450 Fifth Street, NW, Washington, DC 20549. You can obtain additional information about the operation of the PublicReference Room by calling the SEC at 1-800-SEC-0330.  In addition, the SEC maintains an Internet site (www.sec.gov)that contains reports, proxy and information statements, and other informationregarding issuers that file electronically with the SEC, including us.  We also maintain an Internet site(www.jni.com) that contains documents as soon as reasonably practicable aftersuch material is electronically filed with or furnished to the SEC.

 

***Background***

 

*Server to Storage Connectivity*

 

The volume of business-critical data generated,processed, stored and manipulated has grown dramatically over the last decade,and managing the increase in data is one of the most important challenges fororganizations.  Traditionally,enterprises accessed stored networked data using a server-centric architectureknown as direct attached storage. In this architecture, a single servercontrols access to each storage device, and stored data is only available toapplications running on the server directly connected to the storage device.For enterprises that rely on large networks, this creates a bottleneck that candegrade network performance, drain server processing power, complicate networkmanagement and increase costs.  Toaddress these issues, large enterprises in recent years have deployed emergingnetworked storage architectures, including storage area networks, or SANs, toaccess, share and manage data storage. The rapid adoption of SANs was madepossible by the emergence of the Fibre Channel interconnect protocol.

 

Fibre Channel is a computer communications protocoldesigned to meet the many requirements related to the increasing demand forhigh performance information transfer. As a result of its broad range of features, many industry analystsconsider Fibre Channel to be the most reliable and scalable communicationstechnology available today for high speed transmissions of blocks of data.Because Fibre Channel technology is so effective in handling data blocktransmissions, it can be implemented in a wide variety of applications,including enterprise resource planning, digital video transmission and editingand data warehousing.  To date, FibreChannel technology has been most widely accepted and deployed in SANs, but anumber of next generation technologies are currently under 

 

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development, including iSCSI, that are expect to provide newalternatives for server to storage connectivity that have the potential toexpand the adoption  and flexibility ofSANs.

 

A SAN is a dedicated network of interconnected serversand data storage devices enabling data sharing at gigabit speeds.  The overall Fibre Channel SAN componentsmarket is expected to grow from $1.87 billion in 2002 to $6.7 billion by 2006,a 37.6% CAGR, according to a Gartner, Inc. study published in June 2002. Theworldwide Fibre Channel HBA revenue is expected to grow from $613 million in2002 to $1.2 billion in 2006, a 18.6% CAGR, according to an International DataCorporation study published in May 2002. SANs provide an open, scalableplatform for storage access in data intensive environments.  The SAN environment complements the ongoingadvancements in local area network technologies by extending the benefits ofimproved performance and capabilities from the client local area network toservers and storage.

 

*Serverto Server Connectivity*

 

Today, enterprises deploying large networks andmanaging dramatically increasing volumes of networked stored data are beginningto face costly bottlenecks created by the limitations of the standard serverbus architecture, peripheral component interconnect, or PCI.  The bus serves as the interface between thecentral processing unit and the connected peripheral devices.  The PCI bus was introduced in 1992 and hasseen only one major upgrade since introduction.  In the same time, processing speeds and network bandwidths haveincreased dramatically.  As a result,the PCI bus limits a processor’s ability to push and retrieve data to externaldevices quickly.  Similarly, the PCI buslimits the ability of the processor to connect to multiple remote devicesbecause all peripherals must be plugged into the same bus and share a singlecommunication path to memory and the processor.  Thus, only one device can communicate at a time, which limitsaccess to the processor.

 

To address these issues, many leading computer andtechnology companies are collaborating to form an open standards approach toconnect servers with remote storage, networking devices and other servers, aswell as for use inside servers for interprocessor communications.  The first result of this collaboration isthe InfiniBand Architecture that was released in 2000.  InfiniBand is an open, serial technologycapable of being implemented across either optical fiber or coppercabling.  It offers bandwidthssubstantially greater than the standard PCI bus as well as improved flexibilityand scalability.  InfiniBand is apoint-to-point architecture in which each communication link extends betweenonly two devices which have full and exclusive access to the communicationpath.  In addition, it is a switchedfabric architecture in which a communication path can be extended through thenetwork using switches that increase bandwidth and reliability by creatingmultiple paths between devices.

 

In the same way that Fibre Channel enabled the removalof storage from the server and the creation of storage area networks,InfiniBand has the potential to separate the server’s central processing unitfrom the PCI bus to create server area networks.  InfiniBand connectivity devices can currently allow processors tocommunicate at speeds of up to 10 Gb with other processors, remote storage andnetwork devices without using the PCI bus. InfiniBand provides for the scalable expansion of processing independentof storage connectivity through a lower cost processing unit with improveddensity and reduced latency.

 

**Products**

 

Our current significant products include a suite ofFibre Channel host bus adapters and a line of InfiniBand connectivity modules.We are one of only two major independent manufacturers that derive the majorityof revenue from Fibre Channel host bus adapters.

 

***Fibre Channel Host Bus Adapters***

 

We design, manufacture and sell a suite of FibreChannel host bus adapters**,**managementsoftware and related device driver software. A host bus adapter is anelectronic circuit card that fits standard sockets on motherboards for servers,workstations, disk arrays and other SAN devices and enables high-speed datatransfer within the SAN.  Communicationbetween the host bus adapter and the operating system is regulated by devicedriver software that is included with the host bus adapter. The device driversoftware also provides a high-reliability data path from a user’s applicationto a storage device across a SAN. Working in conjunction with our device driversoftware, our host bus adapters work with all SAN topologies, interoperate withall major operating systems and can

 

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be used with the PCI, PCI-X, cPCI and SBus interfaces. Our host busadapters are widely deployed in demanding SAN environments by Global 1000enterprises.

 

We offer Fibre Channel host bus adapters at a varietyof price, performance and feature sets. Our FibreStar products incorporate ourproprietary Emerald ASICs. Our Emerald ASICs were the first Fibre Channelcontrollers to operate at a 2 Gb rate. They incorporate an efficient, proprietary data flow architecture and ahigh performance embedded processor that enables a highly integrated FibreChannel subsystem design that delivers full Fibre Channel bandwidth.  We also sell the Emerald ASICs separately toOEMs for products such as SAN controllers for disk arrays, tape libraries,switches and other SAN devices.

 

The FibreStar line of products is designed with highperformance, cut-through architecture, low CPU utilization, a highly efficientphysical layer design and a modular software structure.  Our PC Server DriverSuite is a single,integrated software driver platform that enables our FibreStar host busadapters to operate under all major PC server operating systems, including MicrosoftWindows 2003 and Windows 2000. The Unix DriverSuite complements the PC ServerDriverSuite and is designed to allow FibreStar host bus adapters to operateunder nearly all Unix server operating systems, including Solaris, Linux,Hewlett-Packard HP-UX and IBM AIX.   Wealso offer our EZ Fibre management software with our host bus adapters tosimplify the installation and configuration of host bus adapters in SANs and toprovide diagnostic and monitoring information to SAN administrators.

 

***InfiniBand Products***

 

*HCAModules.*  A hostchannel adapter (HCA) is an interface that resides within a server andcommunicates directly with the server’s memory and processor as well as withthe InfiniBand network fabric.  Whenplaced on a printed circuit board card similar to a host bus adapter, it isreferred to as an HCA module under the naming guidelines set forth by theInfiniBand Architecture specification. An HCA module guarantees delivery of data, performs advance memory accessand can recover from transmission errors. Our HCA products combine Mellanox Technologies’ InfiniBridge 10 Gb ASICwith our driver software technology. The dual-port IBX-4x02 achieves 10 Gb data link speeds in each directionfor each 4x port. In full duplex mode, the result is a total of 40 Gb speed perHCA module. Our HCA IBX-4x02 was the first high performance 10 Gb InfiniBandHCA module to be delivered to market.

 

**StrategicRelationships**

 

We intend to continue working closely with leaders inthe storage, networking and computing industries to develop new and enhancedconnectivity products. We believe that establishing strategic relationshipswith technology partners is essential to ensure that we continue to developcompetitive products that integrate well with solutions from other leadingparticipants in the SAN and InfiniBand markets.  We have created the JNI SAN partners program, helping us formstrategic relationships and industry alliances with leading technologycompanies. In addition to many of our OEMs, members of our partners programinclude Brocade, LSI Storage-Metastor, McData, Mellanox Technologies, Oracle,TopSpin and VERITAS Software.

 

**Researchand Development**

 

Our success will depend to a substantial degree uponour ability to develop and introduce in a timely fashion new products andenhancements to our existing products that meet changing customer requirementsand emerging industry standards. We have made and plan to continue to makesubstantial investments in research and development and to participate in thedevelopment of industry standards. Our research and development expenses in theyear ended December 31, 2002 were $21.1 million compared to $24.6 million inthe year ended December 31, 2001.

 

We intend to focus our development efforts on FibreChannel ASICs, host bus adapters and related software drivers and tools and onserver-to-server connectivity technologies and products. Before a new productis developed, our research and development engineers work with marketingmanagers and customers to develop a comprehensive requirements specification.After the product is designed and commercially released, our engineers continueto work with customers on early design-in efforts to understand requirementsfor future generations and upgrades.

 

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At our principal offices in San Diego, we haveestablished the JNI system integration lab, or SIL, to provide comprehensivefunctional and system level integration/interoperability testing between ourconnectivity products and various computer platforms and network environments.To facilitate expanded market penetration of our products and technology, ourintegration test methodologies and software are continually evolving as westrive to deliver best in class testing capabilities that we can offer to majorSAN suppliers and OEMs. We conduct functionality testing at our SIL in formal,repeatable processes using documented product specifications and features toverify the operation of both our hardware and our software. The overall goal isto ensure enterprise class performance and interoperability in real worlddeployments.

 

**Sellingand Marketing**

 

We sell principally to OEMs and distributors whomarket and sell our products to system integrators, value-added resellers andend-users. We principally target OEMs and distributors in the United States,Europe and Asia who resell our products as a part of complete SAN solutions toend-users. Our selling and marketing strategy will continue to focus on thedevelopment of the SAN connectivity market. We have continued expandinginternationally by partnering with additional OEMs and distributors who have astrong international presence and are capable of selling and installing complexSAN solutions. Our outbound marketing efforts are focused on increasingawareness of our products and our JNI brand, promoting SAN-based solutions, andadvocating industry-wide standards and interoperability.  Our marketing personnel also focus onidentifying product features that meet the evolving needs of customers. Our sellingand marketing organization includes field sales representatives, applicationsengineers, customer service personnel, product marketing, product management,marketing communications and inside sales personnel.

 

**CustomerService and Support**

 

We offer a wide range of standard support programsthat includes telephone support 24 hours a day, seven days a week. Our customerservice and support organization provides technical support to our OEM andsystems integrator customers, enabling them to provide technical support totheir end-users. We prepare our OEMs, systems integrator, and distributionchannel customers for product launch and on-going support through comprehensivetraining programs. In addition, we employ field applications engineers forfield support.

 

**Manufacturing,Test and Assembly**

 

We outsource the majority of our manufacturing.  We maintain quality assurance, supply chainmanagement, manufacturing/test engineering, and finish assembly operationsorganizations at our headquarters facility in San Diego, California. Thisapproach enables us to reduce fixed costs, provide flexibility in orderfulfillment, and necessary support for our customers. Our contractmanufacturers are ISO 9002 certified. We are planning to achieve 9000-2000certification in 2003.

 

Taiwan Semiconductor Manufacturing Company fabricatesour Emerald ASIC wafers in Asia. Sanmina-SCI Corporation in Rapid City, SouthDakota, and Corlund Electronics in Tustin, California perform substantially allassembly operations for our adapter products. Our contract manufacturers purchase the components of our products, andassemble them to our specifications. The contract manufacturers deliver theassembled products to us where we perform the final assembly, testing andpackaging in our San Diego facility.  Wewill be introducing a new automated test system in 2003 that will allow thecontract manufacturers to fully test and package the products.

 

We believe most component parts used in our FibreChannel host bus adapters are standard off-the-shelf items, which are, or canbe, purchased from two or more sources. Similarly, most of the components inour host channel adapter modules, other than our proprietary ASICs and theintegrated circuits supplied by Mellanox Technologies, are readily availablefrom multiple sources.  We selectsuppliers on the basis of functionality, manufacturing capacity, quality andcost. Whenever possible and practicable, we strive to have at least twomanufacturing locations for each product.

 

Nevertheless, our reliance on third-partymanufacturers involves risks, including possible limitations on availability ofproducts due to market abnormalities, unavailability of, or delays in obtainingaccess to, certain

 

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product technologies and the absence of complete control over deliveryschedules, manufacturing yields, and total production costs. The inability ofour suppliers to deliver products of acceptable quality and in a timely manneror our inability to procure adequate supplies of our products could have amaterial adverse effect on our business, financial condition or operatingresults.

 

**Competition**

 

The markets in which we compete are intenselycompetitive and characterized by frequent new product introductions, changingcustomer preferences and evolving technology and industry standards. Ourcompetitors continue to introduce products with improved functionality, qualityand performance characteristics, and we will have to do the same to remaincompetitive. Increased competition could result in significant pricecompetition, reduced revenues, lower profit margins or loss of market share,any of which would have a material adverse effect on our business, operatingresults and financial condition.

 

Our principal competitors in the Fibre Channel hostbus adapter market are Emulex, QLogic and Agilent.  Our products may also compete at the end-user level with othertechnology alternatives that are available from companies such as Adaptec, LSILogic and QLogic as well as a number of smaller companies. Some of our OEMcustomers could develop products internally that would replace our products.The resulting reduction in sales of our products to any such OEM customers, inaddition to the increased competition presented by these customers, could havea material adverse effect on our business.

 

We believe that the principal bases of competition inour target markets presently include reliability, interoperability,performance, time-to-market, customer service and price. We believe that we arecompetitive with respect to each of these factors. We also believe that we havea competitive strength in our relationship with Sun Microsystems and ourreputation as the leading provider of host bus adapters for the Solarisenvironment. Some of our other competitive advantages include our early entryinto Fibre Channel and InfiniBand technology, our workforce of highlyexperienced researchers and designers and our intellectual property.

 

**IntellectualProperty and Licenses**

 

The intellectual property rights we have in ourtechnology, which generally consist of ASIC designs, product designs, softwareand know-how associated with our product portfolio, principally arise fromexclusive licenses and our own internal development efforts. We attempt to protectour technology through a combination of copyrights, patents, trade secret laws,trademarks and contractual obligations. There can be no assurance that ourintellectual property protection measures will be sufficient to preventmisappropriation of our technology or that our competitors will notindependently develop technologies that are substantially equivalent orsuperior to our technology. In addition, the laws of many foreign countries donot protect our intellectual property rights to the same extent as the laws ofthe United States. Our failure to protect our proprietary information couldhave a material adverse effect on our business, financial condition oroperating results. We have recently initiated the process for obtaining patentprotection on some of our intellectual property rights, but we may not be ableto obtain such protection. The lack of patent protection may make it moredifficult for us to prevent other parties from developing or using technologysubstantially similar to ours. Our software products are protected by copyrightlaws, and we have several common law trademarks.

 

We may need to initiate litigation in the future toenforce our intellectual property rights, to protect our trade secrets or todetermine the validity and scope of the proprietary rights of others.Litigation could result in substantial costs and diversion of our resources andcould materially harm our business. We may receive in the future notice ofinfringement claims of other parties’ proprietary rights. Infringement or otherclaims could be asserted or prosecuted against us in the future, and it ispossible that such assertions or prosecutions could harm our business. Any suchclaims, with or without merit, could be time-consuming, result in costlylitigation and diversion of technical and management personnel, cause delays inthe development and release of our products, or require us to developnon-infringing technology or enter into royalty or licensing arrangements. Suchroyalty or licensing arrangements, if required, may not be available on termsacceptable to us, or at all. For these reasons, infringement claims couldmaterially harm our business.

 

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**Backlog**

 

At December 31, 2002, backlog for our products was approximately $1.9million, substantially all of which is scheduled for delivery to customersduring the quarter ending March 31, 2003, compared to backlog of approximately$3.3 million at December 31, 2001, substantially all of which was scheduled fordelivery to customers during the quarter ended March 31, 2002.  Typically, our OEM customers forecastexpected purchases on a three to six month rolling basis, as compared todistributor customers which order as required with minimal order fulfillmenttime. All orders are subject to cancellation or delay by the customers withlimited or no penalty. Therefore, our backlog is not necessarily indicative ofactual sales for any succeeding period.

 

**Employees**

 

As of December 31, 2002, we had 163 employees, including21 in administration, 31 in sales and marketing, 83 in engineering and 28 inoperations. None of our employees are represented by a labor union. We have notexperienced any work stoppages and consider our relations with our employees tobe good.

 

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**Factors That May Affect Future Performance**

 

**Risksrelating to our business**

 

**We may not be able to achieve and maintain profitability on aconsistent basis.**

 

We have experienced net losses for several consecutivequarters, and we are likely to continue to experience net losses during2003.  If we are not able to penetratenew market segments, we will likely not realize sufficient revenues in futureperiods to achieve and maintain profitability. In addition, because of thecompetition in and the evolving nature of the enterprise data connectivitymarkets, achieving and sustaining profitability may be extremely challenging.

 

**We intend to make changes to our business to respond toadverse market developments, and those changes may not positively affect ourrevenues or operating results.**

 

We are in a process ofcontinuing business transition necessitated by changes in our markets.  The market for Fibre Channel products hasreached a relatively mature state in which the rate of adoption of newtechnologies has slowed.  As a result,we believe there will be fewer opportunities for us to increase market sharethrough introduction of new generations of Fibre Channel products.  To respond to this transition in ourmarkets, we are evaluating various approaches to improving our operatingresults and market position.  As part ofthis evaluation, we are investigating our options to maximize the strategicvalue of our assets, personnel and intellectual property in our ASICs operations.  This evaluation may result in a materialchange in the operation of our ASICs business, and we cannot assure you thatsuch a change will have a positive effect on our business.  Actions related to our ASICs operations orotherwise that management undertakes to reverse our declining market share andto improve our operations could cause disruption in our business or result incharges or expenses that could have adverse effects on our operating results orfinancial condition.

 

**Because we depend on a small number of OEM and distributionchannel customers for a significant portion of our revenues in each period, theloss of any of these customers, the failure to obtain certifications or anycancellation or delay of a large purchase by any of these customers couldsignificantly reduce our net revenues.**

 

Historically, a limited number of OEMs anddistribution channel customers has accounted for a significant majority of ourtotal net revenues. The loss of any of our key customers, or a significantreduction in sales to those customers, could significantly reduce our netrevenues.  For the year ended December31, 2002, Hitachi Data Systems accounted for 22% of our net revenues, AcalElectronics accounted for 10% of our net revenues and Info X, Inc. accounted for10% of our net revenues.  A significantportion of the products sold to the distributors was utilized by our OEMcustomers.  We anticipate that ouroperating results in any given period will continue to depend to a significantextent upon revenues from a small number of customers.

 

Before we can sell our products to an OEM, eitherdirectly or through its associated distribution channel, that OEM must certifyour products. The certification process can take up to 12 months. This processrequires the commitment of OEM personnel and test equipment, and we competewith other suppliers for these resources. Any delays in obtaining thesecertifications or any failure to obtain these certifications would adverselyaffect our ability to sell our products. In addition, because none of ourcustomers is contractually obligated to purchase any fixed amount of productsfrom us in the future, they may stop placing orders with us at any time,regardless of any forecast they may have previously provided. If any of our largecustomers stops or delays purchases, our revenues and operating results wouldbe adversely affected. We cannot be certain that we will retain our current OEMor distribution channel customers or that we will be able to recruit additionalor replacement customers. As is common in the technology industry, ouragreements with OEMs and distribution channel customers typically arenon-exclusive, contain no minimum purchase requirements and often may beterminated by either party with limited or no notice and without cause.Moreover, many of our OEM and distribution channel customers utilize or carrycompeting product lines. If we were to suddenly lose one or more important OEMor distribution channel customers to a competitor, our business, operatingresults or financial condition could suffer. Furthermore, some of our OEMcustomers could develop products internally that would replace our products.The resulting reduction in sales of our products to any such OEM customers, inaddition to the increased competition presented by these customers, could havea material adverse effect on our business.

 

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**If we do not develop, market and sell host bus adapters thatinteroperate with operating systems other than the Sun Solaris operatingsystem, we may not be able to achieve profitability.**

 

We have derived a substantial majority of ourhistorical revenues from sales of host bus adapters that include softwaredesigned to work with the Sun Microsystems Solaris operating system. Toincrease our revenues and grow our business we must maintain our leadingposition in Solaris environments and build market share with our newer productsthat interoperate with other operating systems. These products have notobtained market penetration comparable to what we have achieved in the Solarisenvironment, and our ability to increase market share is subject to the risksinherent in the commercialization of new products. In particular, competitionin the market for non-Solaris Fibre Channel host bus adapters is fierce, and itwill be challenging to displace incumbent suppliers such as Emulex and Qlogicto expand our market share.  We may notbe successful in marketing and selling the new products we develop, and wecannot assure you that our intended customers will purchase our productsinstead of competing products. Our failure to obtain a significant share of themarket for host bus adapters compatible with operating systems other than theSolaris operating system would impair our growth and harm our operatingresults.

 

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

 

Our host bus adaptershave achieved their greatest market acceptance in computing environments builtwith high-end servers from Sun Microsystems due to our products’interoperability with the Sun Solaris operating system. If the demand for Sun’sservers, and particularly its high-end servers, does not expand, our revenuesand operating results may suffer.

 

**Becausea significant portion of our host bus adapters is integrated with storagedevices manufactured by a limited number of storage companies, our futurerevenue growth depends on our ability to obtain OEM certifications for the newand existing products of these manufacturers and on the increased demand forsuch products.**

 

We believe that themajority of our products are used to form connections to storage arraysmanufactured by EMC,****HitachiData Systems, Network Appliance, Storagetek or Sun Microsystems.  To a material extent, our future revenuegrowth depends upon the continued acceptance of and increased demand for thestorage products offered by these vendors. To maintain and expand our position with these vendors, we must continueto provide high quality, early-to-market, high performance host bus adapters atcompetitive prices.  Even if we are ableto meet the demands of these vendors, it is possible that they will develop oracquire products or technologies that make our products uncompetitive.  Further, these vendors may form allianceswith other industry participants or competitive suppliers of host bus adaptersthat could adversely impact the demand for our products.  In addition, if we are unable to timelyobtain OEM certifications for new storage products offered by these vendors,they could make arrangements with competing host bus adapter manufacturers thatwould make our products less competitive for both existing and new storagearrays.  If  we are unable to maintain or expand our relationships with EMC,Hitachi Data Systems, Network Appliance, Storagetek or Sun Microsystems, ourrevenues may suffer.

 

**The long lasting downturn in information technology spendinghas negatively affected our revenues and operating results.**

 

Since late 2000, largeenterprises throughout the global economy have significantly reduced theirspending on information technology products, which has had a continuingnegative effect on our revenues and operating results. We cannot predict thedepth or duration of this downturn in spending, and if it grows more severe orcontinues for a long period of time, our ability to increase or maintain ourrevenues and operating results may be impaired. In addition, because we intendto continue to make significant investments in research and development and tomaintain our customer service and support capabilities, any resulting declinein our revenues will have a significant adverse impact on our operatingresults.

 

**Our operating results may suffer because of increasingcompetition.**

 

The markets in which we compete are intenselycompetitive.  As a result, we will facea variety of significant challenges, including rapid technological advances,price erosion, changing customer preferences and

 

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evolving industry standards. Our competitors continue to introduce products with improvedprice/performance characteristics, and we will have to do the same to remaincompetitive. Increased competition could result in significant pricecompetition, reduced revenues, lower profit margins or loss of market share,any of which would have a material adverse effect on our business.  We cannot be certain that we will be able tocompete successfully in the future.

 

As the Fibre Channel market continues to mature, thecommoditization of the Fibre Channel market favors larger organizations such asour current and potential competitors in the Fibre Channel market, includingEmulex Corporation, QLogic Corporation, Agilent Technologies, Inc.,Hewlett-Packard and LSI Logic.  Thesecompanies all have substantially greater financial, marketing and distributionresources than we have. Our primary competitors, Emulex and QLogic, haveentered the Sun Solaris segment of the Fibre Channel market, which is theprimary market for our Fibre Channel products. We may also face competition from new entrants to the Fibre Channelmarket, including larger technology companies that may develop or acquiredifferentiating technology and then apply their resources to our detriment. OurFibre Channel products may also compete at the end-user level with othercurrent or future technology alternatives. Further, businesses that implementSANs may select fully-integrated SAN systems that are offered by large productsolution companies. Because such systems typically do not interoperate with ourproducts, customers that invest in these systems will be less likely topurchase our products. Because most of our current products are based on FibreChannel, unless we are able to develop products based on other emergingconnectivity technologies, our business could suffer if the market for FibreChannel products grows more slowly than we anticipate as a result ofcompetition from such technologies.   Tothe extent that we develop products based on other standards, such as ourInfiniBand products, we will face competition in the markets for such productsthat may come from larger technology companies such as Emulex, IBM, Qlogic andSun.   If we are not successful, forcompetitive or other reasons, in achieving market penetration with ourInfiniBand or other potential products, we may not be able to recover ourinvestment in pursuing new markets.

 

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

 

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

 

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

 

**Delays in product development could adversely affect ourmarket position or customer relationships.**

 

We have experienced delays in product development inthe past and may experience similar delays in the future. Given the shortproduct life cycles in the markets for our products, any delay or unanticipateddifficulty associated with new product introductions or product enhancementscould cause us to lose customers and damage our competitive position.  Delays may result from numerous factors,such as:

 

•                                          changingOEM product specifications;

•                                          evolvingstandards;

•                                          undetectederrors or failures in software or hardware;

•                                          changingmarket requirements;

•                                          competitiveproduct introductions;

•                                          difficultiesin hiring and retaining necessary personnel;

•                                          difficultiesin allocating engineering resources and other resource limitations;

•                                          difficultieswith independent contractors;

•                                          unanticipatedengineering complexity; and

•                                          delaysin the acceptance or shipment of products by OEM customers.

 

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

 

The market for our products is characterized byrapidly changing technology, evolving industry standards and the frequent introductionof new products and enhancements. Our future success depends in large part onour ability to enhance our existing products and to introduce new products andtechnologies on a timely basis to meet changes in customer preferences andevolving industry standards. Additionally, changes in technology and customerpreferences could potentially render our current products uncompetitive orobsolete. We cannot be certain that we will be successful in designing,supplying and marketing new products or product enhancements that respond tosuch changes in a timely manner and achieve market acceptance. We also cannotbe certain that we will be able to develop the underlying core technologiesnecessary to create new products and enhancements, or that we will be able tolicense the core technologies from third parties. In addition, because ourproducts are designed to work with software produced by third parties, ouroperating results could be adversely affected if such third parties delayintroduction of new versions of their software for which we have designed newproducts or if they make unanticipated modifications to such software. If weare unable, for technological or other reasons, to develop new products orenhance existing products in a timely manner in response to technological andmarket changes, our business, operating results and financial condition wouldbe materially adversely affected.

 

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

 

The growth of the market for our current Fibre Channelproducts depends upon the continued deployment of Fibre Channel technology inSANs. Accordingly, increasing rates of deployment of Fibre Channel-based SANsis crucial to our future revenue growth. If this market does not expand at therate we anticipate, our revenues and operating results will suffer.

 

**Ourfuture success will depend to a certain extent upon our ability to develop newproducts as well as receive a return on investments in new products based uponnew technologies.**

 

In addition to our Fibre Channel-based products, weoffer host channel adapter modules based on the InfiniBand Architecturestandard.  The InfiniBand standard, likeall new standards, is subject to market and research and development transitionswith major OEM customers.  To date, wehave announced one OEM design win for InfiniBand with Network Appliance, andthe success or failure of this relationship and Network Appliance’s successwith its Infiniband product will have a material effect on our ability toexpand our InfiniBand business.  Wecurrently intend to continue to make research and development investments todeveloping InfiniBand products.  Inrecent periods, several key industry participants have withdrawn support forInfiniBand or terminated their efforts to support InfiniBand, which increasesthe risks associated with our investment in InfiniBand technology.  In addition, Mellanox is currently the onlysignificant supplier of integrated circuits that implement InfiniBand technology,and we cannot assure you that they will continue to supply such integratedcircuits to us on reasonable terms or at all. The absence of multiple integrated circuit suppliers for the InfiniBandmarket may deter customers from deploying InfiniBand technology due to concernsover the long term viability of the market. Although 10 Gigabit Ethernet for server to server connectivity willlikely not be commercially deployed until at least 2005, InfiniBand will eventuallycompete with 10 Gigabit Ethernet, which is a standard that has considerablymore industry support than InfiniBand. There is no assurance that InifinBandwill ever achieve greater acceptance in the market, and if the market forInfiniBand does not materialize as anticipated, our investment in InfiniBandmay not result in any material benefits to our business.

 

**Our quarterly operating results are volatile and may causeour stock price to fluctuate.**

 

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

 

•                                          thesize, timing, terms and fluctuations of customer orders, particularly largeorders from our significant OEM or reseller customers;

•                                          changesin customer buying patterns;

 

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•                                          decliningaverage selling prices of our products;

•                                          fluctuationsin sales levels of Sun servers;

•                                          thetiming of the introduction or enhancement of products by us, our significantOEM or reseller customers or our competitors;

•                                          delays inobtaining OEM certifications for our products;

•                                          ourability to obtain sufficient supplies of single- or limited-source componentsof our products;

•                                          fluctuationsin costs of goods sold and potential write-offs of obsolete inventory as wetransition to new products;

•                                          changesin accounting standards or principles;

•                                          operatingexpenses, particularly in connection with our strategies to increase brandawareness or to invest in accelerated research and development;

•                                          chargesand expenses associated with restructuring our operations;

•                                          thecosts and other effects of potential acquisitions or strategic investments; and

•                                          generaleconomic conditions.

 

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

 

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

 

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

 

**The failure of our OEM customers to keep pace with rapidtechnological change and to successfully develop and introduce new productscould adversely affect our revenues.**

 

Our ability to generate increased revenues dependssignificantly upon the ability and willingness of our OEM customers to developand promote products on a timely basis that incorporate our technology. OEMsmust commit significant resources each time they develop a product thatincorporates one of our new products. If our OEM customers do not invest in thedevelopment and marketing of solutions that incorporate our products andsuccessfully market these solutions, then sales of our products to the OEMcustomers will be adversely affected. The ability and willingness of OEMcustomers to develop and promote such products is based upon a number offactors beyond our control.

 

**We expect that the average selling prices of each of ourproducts will decrease over time, which may reduce our gross margins orrevenues.**

 

We expect that we will continue to experience downwardpricing pressure on our products. We anticipate that the average selling pricesof each of our products will decrease over time in response to competitivepricing pressures, increased sales discounts, new product introductions by usor our competitors, introductions of competing technological solutions or otherfactors. Therefore, to maintain our gross margins, we must develop andintroduce on a timely basis new products and product enhancements andcontinually reduce our product costs. Our failure to do so would cause ourrevenue and gross margins to decline, which could materially adversely affectour operating results and cause the price of our common stock to decline.

 

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

 

In the rapidly changing technology environment inwhich we operate, product cycles tend to be short. However, we must havesufficient quantities of our products available to satisfy our customers’demands. Accordingly, we order significant quantities of our products from ourmanufacturers prior to receiving customer orders. Although we expect to sellthe inventory within a short period of time, products may remain in inventoryfor extended periods and may become obsolete because of the passage of time andthe introduction of new products. For example, as we introduce successivegenerations of ASICs, we may experience excess inventory of host bus adaptersthat incorporate the prior generation of ASICs. In these situations, we wouldbe required to write off obsolete inventory, which could have a materialadverse effect on our results of operations.

 

**We may engage in future acquisitions of complementarybusinesses, products or technologies that dilute our stockholders’ equity or causeus to incur debt or assume contingent liabilities.**

 

We may pursue acquisitions that could provide newtechnologies or products. Future acquisitions may involve the use ofsignificant amounts of cash, potentially dilutive issuances of equity orequity-linked securities, the incurrence of debt, or amortization expensesrelated to intangible assets.  We maynot realize the expected benefits of any acquisition we complete, which couldresult in impairment or other charges similar to those we incurred as a resultof our acquisition of products and technology from Troika Networks in January2002.

 

In addition, acquisitions involve numerous risks,including:

 

•                                          difficultiesin the assimilation of the operations, technologies, products and personnel ofthe acquired company;

•                                          thediversion of management’s attention from other business concerns;

•                                          risksof entering markets in which we have no or limited prior experience; and

•                                          thepotential loss of key employees of the acquired company.

 

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

 

**Because we depend on sole source and limited source suppliersfor key components, we are susceptible to supply shortages and quality problemsthat could adversely affect our operating results.**

 

We rely on third-party suppliers for components thatare used in our products, and we have experienced delays and difficulty insecuring components in the past.  Intimes of shortage, we have been required to pay, and may in the future berequired to pay, substantial premiums for components, which could adverselyaffect our gross margins. Key components that we use in our products may, fromtime to time, only be available from single sources.  Any interruption in our supply of key components, whether due toshortage or financial difficulties faced by our suppliers, could render usunable to sell and deliver our products due to a lack of components andpotentially require us to redesign products to incorporate alternativecomponents, which could materially adversely affect our business.  The components we use for our products arebased on advanced technology and may not be available with the performancecharacteristics or in the quantities that we require.  For each version of our host channel adapter product, we have asole supplier that provides us with the ASIC, and we do not believe that acomparable ASIC is available. In addition, because the third party componentswe use for our products are complex, they may contain errors or defects thatare not discovered until after our products are installed in end-userSANs.  Any such errors or defectsdiscovered by our customers could harm our reputation and cause us to losecustomers.

 

**Because we rely on third parties, and in some cases, a solemanufacturer, for substantially all of our manufacturing and assembly, failuresby these third parties to provide products of sufficient quality and quantitycould cause us to delay product shipments, which could result in delayed orlost revenues or customer dissatisfaction.**

 

Taiwan Semiconductor Manufacturing Company, or TSMC,is currently our sole manufacturer for all of our ASIC wafers. Sanmina-SCICorporation in Rapid City, South Dakota, and Corlund Electronics in Tustin,California

 

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perform substantially all assembly operations for our host bus adaptersand host channel adapter modules.  Thecontract electronics manufacturing industry, which includes Sanmina-SCI andCorlund, has experienced substantial disruption as a result of the currenteconomic downturn, which increases the risks associated with our reliance onthese manufacturers. We have no firm long-term commitments from any of thesecompanies to supply products to us for any specific period, or in any specificquantity, except as may be provided in a particular purchase order.

 

Our reliance on TSMC for fabrication of our ASICwafers involves particular risks. The semiconductor industry is highly cyclicaland, in the past, foundry capacity has been very limited at times and maybecome limited in the future. Our dependence on TSMC increases our exposure tothis cyclicality and to possible shortages of key components, productperformance shortfalls and reduced controls over delivery schedules,manufacturing capability, quality assurance, quantity and costs. If TSMC or anyof our other third-party manufacturers experiences delays, disruptions,earthquakes, capacity constraints or quality control problems in itsmanufacturing operations, then product shipments to our customers could bedelayed, which would negatively impact our net revenues, competitive positionand reputation.

 

Further, our business would be harmed if we fail toeffectively manage the assembly of our products. Because we place orders withour manufacturers based on our forecasts of expected demand for our products,if we inaccurately forecast demand, we may be unable to obtain adequatemanufacturing capacity or adequate quantities of components to meet ourcustomers’ delivery requirements, or we may accumulate excess inventories.

 

We may in the future need to find new contractmanufacturers to address either our changing needs or the changingcircumstances of our current contract manufacturers. We may not be able to findcontract manufacturers that meet our needs, and even if we do, qualifying a newcontract manufacturer and commencing volume production is expensive and hasinherent risks. If we are required or elect to change contract manufacturers,we may lose revenues, quality may be negatively impacted and our customerrelationships may suffer.

 

**Our reliance on manufacturers outside the U.S. subjects us torisks inherent in doing business on an international level that could harm ouroperating results.**

 

Currently, our ASIC products are manufactured by TSMCwhich is located in Asia, and we may expand our manufacturing, assembly andtesting activities abroad. Accordingly, we are subject to risks inherent ininternational operations, which include:

 

•                                          political,social and economic conditions, particularly those associated with currentworldwide conflicts and events;

•                                          traderestrictions and tariffs;

•                                          theimposition of governmental controls;

•                                          exposureto different legal standards, particularly with respect to intellectualproperty;

•                                          importand export license requirements;

•                                          unexpectedchanges in regulatory requirements; and

•                                          potentiallyadverse tax consequences.

 

In particular, many Asian countries have in recentyears experienced significant economic difficulties, including currencydevaluation and instability, business failures and a generally depressedbusiness climate, particularly in the semiconductor industry. In view of ourreliance on Asian manufacturers, and our expanded international operations, anyfuture economic downturns in the Asian economy may seriously harm our business.

 

**Because our intellectual property is critical to the successof our business, our operating results would suffer if we were unable toadequately protect our intellectual property.**

 

Our proprietary technologies are crucial to oursuccess and ability to compete. We rely primarily on a combination ofcopyrights, trademarks, trade secret laws and contractual provisions toestablish and protect our intellectual property rights in our proprietarytechnologies, including the source code for our software and the referencedesigns for our ASICs. We presently have no patents. We generally enter intoconfidentiality or license agreements with employees, consultants and customersand seek to control access to and distribution of our source code,documentation and other proprietary information. Despite our efforts to protectour proprietary rights, unauthorized parties may attempt to copy aspects of ourproducts or to obtain and use information that we regard as proprietary.Policing unauthorized use of our proprietary information is difficult. Otherparties also may 

 

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independently develop or otherwise acquire equivalent or superiortechnology. In addition, the laws of some of the countries in which ourproducts are or may be developed, manufactured or sold may not protect ourintellectual property rights to the same extent as the laws of the UnitedStates, or at all. Our failure to protect our intellectual property rightscould have a material adverse effect on our business.

 

**We may become involved in costly and lengthy patentinfringement or intellectual property litigation which could seriously harm ourbusiness.**

 

In recent years, there has been significant litigationin the United States and in foreign countries involving patents and otherintellectual property rights.  We maybecome party to litigation in the future as a result of an alleged infringementof others’ intellectual property.  Fromtime to time, we receive inquiries from other companies concerning whether weused their proprietary information.  Anyclaims that we improperly use another party’s proprietary information or thatwe infringe another party’s intellectual property, with or without merit, couldadversely affect or delay sales of our products that use the technology inquestion, result in costly and time-consuming litigation, divert our technicaland management personnel, or require us to develop non-infringing technology orenter into royalty or licensing arrangements, any of which would adverselyaffect our business.  It also ispossible that patent holders will assert patent rights which apply broadly toour industry, and that such patent rights, if valid, may apply to our productsor technology.  These or other claims mayrequire us to stop using the challenged intellectual property or to enter intoroyalty or licensing agreements.  Wecannot be certain that the necessary licenses will be available or that theycan be obtained on commercially reasonable terms.  If we were to fail to obtain such royalty or licensing agreementsin a timely manner or on reasonable terms, our business could be materiallyadversely affected.

 

**Our export sales subject us to risks that could adverselyaffect our business.**

 

Export sales accounted for 24% of our net revenues in2002, 30% of our net revenues in 2001 and 23% of our net revenues in 2000.Accordingly, we encounter risks inherent in international operations. Becauseall of our sales are currently denominated in U.S. dollars, if the value of theU.S. dollar increases relative to foreign currencies, our products could becomeless competitive in international markets. Our export sales could also belimited or disrupted by any of the following factors:

 

•                                          restrictionson the export of technology;

•                                          longeraccounts receivable payment cycles;

•                                          reducedand limited protections of intellectual property rights;

•                                          traderestrictions; and

•                                          changesin tariffs.

 

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

 

Our products are subject to U.S. Department ofCommerce and Federal Communications Commission regulations as well as variousstandards established by authorities in other countries. Failure to comply withexisting or evolving U.S. or foreign governmental regulation or to obtaintimely domestic or foreign regulatory approvals or certificates couldmaterially harm our business by reducing our sales or requiring designmodifications to our products or the products of our OEM customers. Neither wenor our customers may export such products without obtaining an export license.United States export laws also prohibit the export of our products to a numberof countries deemed by the U.S. to be hostile. These restrictions may makeforeign competitors facing less stringent controls on their products morecompetitive in the global market than we or our customers are. The U.S.government may not approve any pending or future export license requests. Inaddition, the list of products and countries for which export approval isrequired, and the regulatory policies with respect thereto, could be revised.

 

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

 

Products as complex as ours frequently containundetected software or hardware errors when first introduced or as new versionsare released. We have from time to time found errors in existing products, andwe may from time to time find errors in our existing, new or enhanced products.The occurrence of hardware or software errors could adversely affect sales ofour products, cause us to incur significant warranty and repair costs, divertthe

 

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attention of our engineering personnel from our product developmentefforts and cause us to lose credibility with current or prospective customers.

 

**Ourstock price is volatile, which has and may result in lawsuits against us andour officers and directors.**

 

The stock market ingeneral, and the stock prices of technology-based companies in particular, haveexperienced extreme volatility that often has been unrelated to the operatingperformance of any specific public company. The market price of our commonstock has fluctuated in the past and is likely to fluctuate in the future aswell. Factors which could have a significant impact on the market price of ourcommon stock include, but are not limited to, the following:

•                                          quarterlyvariations in operating results and cash flows;

•                                          announcementsof new products by us or our competitors;

•                                          changesin management;

•                                          thegain or loss of significant customers;

•                                          changesin analysts’ earnings estimates;

•                                          rumorsor dissemination of false information;

•                                          unauthorizeddisclosure of confidential information;

•                                          pricingpressures;

•                                          shortselling of our common stock;

•                                          generalconditions in the computer, storage or communications markets;

•                                          politicaland military events associated with current worldwide conflicts; or

•                                          eventsaffecting other companies that investors deem to be comparable to us.

 

In the past, companies that have experiencedvolatility in the market price of their stock have been the object ofsecurities class action litigation. In this regard, we and certain of ourofficers and directors have been named as defendants in securities class actionlawsuits filed in the United States District Court for the Southern District ofCalifornia and the United States District Court for the Southern District ofNew York. Such lawsuits allege that we and certain of our officers anddirectors made misrepresentations and omissions in violation of sections 10(b)and 20(a) of the Securities Exchange Act of 1934 and sections 11, 12(a)(2) and15 of the Securities Act of 1933. As a result of the Southern District ofCalifornia lawsuits, a derivative case has been filed in California allegingthat certain of our officers and directors breached their fiduciary duties tothe Company in connection with the events alleged in the class action lawsuits.The complaints generally seek compensatory damages, costs and attorney’s feesin an unspecified amount. Such litigation could result in substantial costs tous and a diversion of our management’s attention and resources. While webelieve that the lawsuits are without legal merit and intend to defend themvigorously, because the lawsuits are at an early stage, it is not possible topredict whether we will incur any material liability in connection with such lawsuits.

 

**Futurechanges in financial accounting standards may cause adverse unexpected revenuefluctuations and affect our reported results of operations.**

 

A change in accounting standards can have asignificant effect on our reported results and may even affect our reporting oftransactions completed before a change is announced.  New pronouncements and varying interpretations of pronouncementshave occurred with frequency and are likely to occur in the future as a resultof recent congressional action.  Changesto existing rules or the questioning of current practices may adversely affectour reported financial results or the way we conduct our business.

 

**Ourstockholder rights plan could adversely affect the performance of our stock.**

 

We have distributed a dividend of one right for eachoutstanding share of our common stock pursuant to the terms of our preferredshare purchase rights plan. These rights will cause substantial dilution to theownership of a person or group that attempts to acquire us on terms notapproved by our board of directors and may have the effect of deterring hostiletakeover attempts. In addition, our board of directors has the authority to fixthe rights and preferences of and issue shares of preferred stock. This rightmay have the effect of delaying or preventing a change in our control.

 

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**Item 2.  Properties**

 

We lease approximately85,329 square feet in San Diego, California as our corporate headquarters, forproduct development and test laboratories, for manufacturing operations, andfor administrative, engineering, marketing and sales offices. The term of thelease expires March 31, 2011.  We leaseapproximately 19,727 square feet in Fremont, California primarily for our ASICsteam under a lease that expires in May 2005. We believe that our current facilities will be adequate to meet ourneeds until at least the end of 2003.

 

As of December 31, 2002, we were committed to a fiveyear lease for a building adjacent to our current corporate headquarters.    In February 2003, we entered into variousagreements with our landlord and a third party who agreed to lease the buildingadjacent to our current corporate headquarters whereby we terminated our leasefor this building and are completely absolved of any further liability.  See Note 10, “Loss on Lease Commitments” inthe Notes to Financial Statements for further discussion.

 

**Item 3.  LegalProceedings**

 

**Legal Proceedings**

 

In April 2001, an allegedstockholder of the Company filed an alleged class action complaint against theCompany and certain of its officers and directors in the United States DistrictCourt for the Southern District of California on behalf of purchasers of theCompany’s common stock during the period between October 16, 2000 and January24, 2001.  Thereafter, five additionaland virtually identical lawsuits have been filed.  The most recent of these lawsuits allege claims on behalf of purchasersof the Company’s common stock during the period between October 16, 2000 andMarch 28, 2001 (the “Class Period”). The cases allege that during the ClassPeriod, the Company made false statements about its business and resultscausing its stock to trade at artificially inflated levels.  Based on these allegations, the cases allegethat the Company and the others named in the cases violated the SecuritiesExchange Act of 1934.  The Company hasretained counsel to defend these cases. On February 8, 2002, the Court appointed a lead plaintiff and leadcounsel and ordered the consolidation of the cases.  The court gave the plaintiffs until March 25, 2002 to file aconsolidated amended complaint. On March 25, 2002, plaintiffs filed a firstconsolidated and amended complaint.  Thefirst consolidated and amended complaint alleges a new class period of July 13,2000 through March 28, 2001 and adds alleged claims under Securities Act of1933 arising from the Company’s secondary public offering in October 2000.  On April 29, 2002, the Company filed amotion to dismiss  and a motion to strikethe first consolidated and amended complaint. Since July 1, 2002, the motions have been under submission with theCourt for decision.  The Companybelieves that these cases are without merit and intends to defend the casesvigorously.

 

In October 2001, analleged stockholder of the Company, Richard Grosset, filed an allegedstockholder derivative lawsuit against the Company and certain present andformer members of the Company’s board of directors in the San Diego CountySuperior Court.  The lawsuit allegesthat during the Class Period, the present and former members of the Company’sboard failed to adequately oversee the activities of management and, as aresult, the Company allegedly made false statements about its business andresults causing its stock to trade at artificially inflated levels.  Based on these allegations, the plaintiffalleges that the present and former members of the Company’s board breachedtheir fiduciary duties to the Company. The alleged stockholder filed the lawsuit without first making a demandupon the board of directors.  TheCompany has retained counsel to defend this case.  On February 1, 2002, the Court sustained the Company’s demurrerto the plaintiff’s complaint with leave to amend.  On March 8, 2002, the plaintiff filed a first amendedcomplaint.  On March 22, 2002, theCompany filed a demurrer to the first amended complaint and the hearing on thedemurrer was set for April 12, 2002.  OnApril 12, 2002, the Court entered an order sustaining the demurrer and givingthe plaintiff leave to file another amended complaint.  On April 29, 2002, the plaintiff filed asecond amended complaint.  On May 31,2002, the Company filed a demurrer to the second amended complaint.  On the same day, Sik-Lin Huang, an allegedstockholder of the Company, filed a motion to intervene in the case as aplaintiff.  On June 21, 2002, theCourt sustained the Company’s demurrer and dismissed Grosset as a plaintiffbecause he is no longer a stockholder of the Company.  The Court, however, granted Huang’s motion to intervene andordered Huang to file a complaint in intervention.

 

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Huang filed a complaint in intervention on July 5, 2002.  On September 16, 2002, the Board ofDirectors of the Company appointed a special litigation committee toinvestigate the allegations in this case and to determine whether it is in thebest interest of the Company to allow this case to proceed.  On February 11, 2003, the special litigationcommittee issued a report of its investigation which concluded that it is notin the best interests of JNI to pursue the Grosset action, and that the bestinterests of JNI require that this action be dismissed in its entirety.  On February 19, 2003, counsel for thespecial litigation committee filed a motion to dismiss this action, which iscurrently scheduled for hearing on May 9, 2003.

 

On May 30, 2002, analleged stockholder of the Company, Ali Bemanian, filed a purported stockholderderivative suit against the Company and certain present and former members ofthe Company’s board of directors in the San Diego County Superior Court.  The lawsuit repeats the allegations of thederivative lawsuit filed by Grosset. The lawsuit also adds allegations that the defendants caused or allowed theCompany to falsely report its results for the fourth quarter of fiscal2001.  These additional allegationsrelate to the Company’s May 20, 2002 announcement that it would restate itsfinancial statements and file an amended report on Form 10-K.  On September 16, 2002, the Board ofDirectors of the Company appointed a special litigation committee toinvestigate the allegations in this case and to determine whether it is in thebest interest of the Company to allow this case to proceed.  On February 11, 2003, the special litigationcommittee issued a report of its investigation which concluded that it is notin the best interests of JNI to pursue the Bemanian action, and that the bestinterests of JNI require that this action be dismissed in its entirety.  On February 19, 2003, counsel for the speciallitigation committee filed a motion to dismiss this action, which is currentlyscheduled for hearing on May 9, 2003.

 

On November 29, 2001, analleged stockholder of the Company filed a class action lawsuit in the UnitedStates District Court for the Southern District of New York.  The lawsuit also names as defendants theunderwriters on the Company’s initial public offering and secondary offering.  The plaintiff alleges that defendantsviolated Securities Act of 1933 and the Securities Exchange Act of 1934 inconnection with the Company’s public offerings.  This case is among the over 300 class action lawsuits pending inthe United States District Court for the Southern District of New York thathave come to be known as the IPO laddering cases.  The complaint in this case was served on the Company on June 20,2002.  On November 1, 2002, the courtheard argument on motions to dismiss all of the IPO laddering cases.  On February 19, 2003, the court issued anorder on the motion to dismiss the IPO laddering cases.  As to the Company, the motion was denied andas to its present and former officers and directors who were also named asdefendants, the motion was denied in part and granted in part with two formerofficers being dismissed from the case. The Company believes that this case lacks merit and intends to defendthe case vigorously.

 

In addition to the above matters, the Company isinvolved in certain other legal proceedings, including various employee relatedlawsuits, which are generally incidental to its normal businessactivities.  The Company cannot make anestimate of the potential loss from these legal proceedings.  However, the Company believes that thesecases lack merit and intends to defend the cases vigorously.

 

**Item 4.  Submission ofMatters to a Vote of Security Holders**

 

No matters were submitted to a vote of securityholders during the quarter ended December 31, 2002.

 

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**PART II**

 

**Item 5.  *Market for Registrant’s Common Equity and RelatedStockholder Matters***

 

**Market Information**

 

The Company’s Common Stock, $0.001 par value pershare, has traded on The Nasdaq National Market under the symbol “JNIC” sinceOctober 27, 1999. The following table sets forth the high and low sale pricesfor the Common Stock as reported by the Nasdaq National Market for the periodsindicated:

 
|                             |   | **High** |       | **Low**    |       |
|----------------------------------|--------|----------|------------|------------|------------|
|                             |   |     |       |       |       |
| **Year ended December 31, 2001** |   |     | ** ** |       | ** ** |
|                             |   |     |       |       |       |
| **First  Quarter**               |   | **$**    | **31.41**  | ** ** | **$**      | **7.19** | ** ** |
|                             |   |     |       |       |       |
| **Second  Quarter**              |   | **$**    | **18.48**  | ** ** | **$**      | **5.75** | ** ** |
|                             |   |     |       |       |       |
| **Third  Quarter**               |   | **$**    | **14.50**  | ** ** | **$**      | **5.08** | ** ** |
|                             |   |     |       |       |       |
| **Fourth  Quarter**              |   | **$**    | **11.40**  | ** ** | **$**      | **5.66** | ** ** |
|                             |   |     | ** ** |       | ** ** |
| **Year ended December 31, 2002** |   |     | ** ** |       | ** ** |
|                             |   |     |       |       |       |
| **First  Quarter**               |   | **$**    | **9.74**   | ** ** | **$**      | **6.41** | ** ** |
|                             |   |     |       |       |       |
| **Second  Quarter**              |   | **$**    | **7.20**   | ** ** | **$**      | **2.75** | ** ** |
|                             |   |     |       |       |       |
| **Third  Quarter**               |   | **$**    | **3.64**   | ** ** | **$**      | **2.20** | ** ** |
|                             |   |     |       |       |       |
| **Fourth  Quarter**              |   | **$**    | **3.41**   | ** ** | **$**      | **2.05** | ** ** |

 

As of February 28, 2003, there were 26,590,864 sharesof common stock outstanding held by approximately 157 holders of record.  The Company has never declared or paid cashdividends on its common stock.  TheCompany currently anticipates that it will retain all future earnings for usein its business and does not anticipate paying any cash dividends in theforeseeable future.

 

Disclosure on securities authorized for issuance under equitycompensation plans is set forth in Item 12 of this report. 

 

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**Item 6.  SelectedFinancial Data**

 

The selected financial data as of December 31, 2002and 2001 and for each of the three years in the period ended December 31, 2002have been derived from the Company’s audited financial statements includedelsewhere in this report.  The selectedfinancial data as of December 31, 2000, 1999 and 1998 and for the years endedDecember 31, 1999 and 1998 have been derived from audited financial statementsfor the Company not included herein. The selected financial data set forth below is qualified in its entiretyby reference to, and should be read in conjunction with, “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andthe Financial Statements and related notes thereto included elsewhere in thisreport.

 
|                                              |                                       | **Year Ended  December 31,** |       |
|---------------------------------------------------|--------------------------------------------|------------------------------|------------|
|                                              |                                       | **2002**                     |       | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                                              | **(In thousands, except per share data )** | ** **                   |
| **Statement  of Operations Data:**                |                                       |                         |       |   |   |   |   |   |   |   |   |
| Net  revenues                                     |                                       | $                            | 38,362     |   | $ | 75,263 |   | $ | 103,181 |   | $ | 40,171 |   | $ | 12,189 |   |
| Cost  of revenues                                 |                                       | 25,399                       |       | 39,321 |   | 42,050 |   | 15,402 |   | 5,361 |   |
| Gross  margin                                     |                                       | 12,963                       |       | 35,942 |   | 61,131 |   | 24,769 |   | 6,828 |   |
| Operating  expenses:                              |                                       |                         |       |   |   |   |   |   |   |   |   |
| Research  and development                         |                                       | 21,125                       |       | 24,564 |   | 18,918 |   | 11,951 |   | 2,919 |   |
| Selling  and marketing                            |                                       | 11,832                       |       | 15,993 |   | 12,323 |   | 4,806 |   | 1,526 |   |
| General  and administrative                       |                                       | 8,731                        |       | 9,063 |   | 7,938 |   | 3,476 |   | 1,698 |   |
| Loss  on lease commitment                         |                                       | 6,991                        |       | — |   | — |   | — |   | — |   |
| Amortization  of intangible assets                |                                       | —                       |       | 4,688 |   | 5,359 |   | 1,506 |   | 47 |   |
| Amortization  of stock-based compensation         |                                       | 166                          |       | 433 |   | 623 |   | 842 |   | 35 |   |
| Total  operating expenses                         |                                       | 48,845                       |       | 54,741 |   | 45,161 |   | 22,581 |   | 6,225 |   |
| Operating  income (loss)                          |                                       | (35,882                      | )          | (18,799 | ) | 15,970 |   | 2,188 |   | 603 |   |
| Interest  income                                  |                                       | 2,822                        |       | 5,056 |   | 2,953 |   | 352 |   | — |   |
| Interest  expense                                 |                                       | —                       |       | — |   | — |   | (455 | ) | (265 | ) |
| Other  income (expense), net                      |                                       | (1,584                       | )          | (5 | ) | (45 | ) | — |   | — |   |
| Income  (loss) before income taxes                |                                       | (34,644                      | )          | (13,748 | ) | 18,878 |   | 2,085 |   | 338 |   |
| Income  tax provision (benefit)                   |                                       | —                       |       | — |   | 4,622 |   | (673 | ) | 27 |   |
| Net  income (loss)                                |                                       | $                            | (34,644    | ) | $ | (13,748 | ) | $ | 14,256 |   | $ | 2,758 |   | $ | 311 |   |
| Earnings  (loss) per common share:                |                                       |                         |       |   |   |   |   |   |   |   |   |
| Basic                                             |                                       | $                            | (1.30      | ) | $ | (0.51 | ) | $ | 0.61 |   | $ | 0.64 |   | $ | 0.74 |   |
| Diluted                                           |                                       | $                            | (1.30      | ) | $ | (0.51 | ) | $ | 0.53 |   | $ | 0.12 |   | $ | 0.02 |   |
| Number  of shares used in per share computations: |                                       |                         |       |   |   |   |   |   |   |   |   |
| Basic                                             |                                       | 26,563                       |       | 26,938 |   | 23,541 |   | 4,285 |   | 420 |   |
| Diluted                                           |                                       | 26,563                       |       | 26,938 |   | 27,009 |   | 23,789 |   | 17,977 |   |
| **Balance  Sheet Data:**                          |                                       |                         | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Cash,  cash equivalents and marketable securities |                                       | $                            | 102,680    |   | $ | 118,022 |   | $ | 116,445 |   | $ | 44,829 |   | $ | — |   |
| Working  capital                                  |                                       | 80,617                       |       | 96,970 |   | 142,446 |   | 49,346 |   | (1,830 | ) |
| Total  assets                                     |                                       | 122,081                      |       | 152,147 |   | 178,094 |   | 72,825 |   | 7,814 |   |
| Long-term  obligations                            |                                       | 368                          |       | 531 |   | — |   | 119 |   | — |   |
| Due  to affiliate                                 |                                       | —                       |       | — |   | — |   | — |   | 3,061 |   |
| Stockholders’  equity                        |                                       | 106,119                      |       | 141,004 |   | 156,689 |   | 65,222 |   | 1,173 |   |

 

**Item 7.  *Management’s Discussion and Analysis of FinancialCondition and Results of Operations***

 

**Forward Looking Statements**

 

Except for the historicalinformation contained herein, the discussions in this Report on Form 10-K ingeneral may contain certain forward-looking statements. In addition, when usedin this Form 10-K, the words “anticipates,” “in the opinion,” “believes,”“intends,” “expects” and similar expressions are intended to identifyforward-looking statements. Actual future results could differ materially fromthose described in the

 

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forward-looking statements as a result of factors discussed inManagement’s Discussion and Analysis of Financial Condition and Results ofOperations set forth below, as well as in “Risk Factors” set forth herein. TheCompany expressly disclaims any obligation or undertaking to release publiclyany updates or changes to these forward-looking statements that may be made toreflect any future events or circumstances. References contained herein to“JNI,” the “Company,” “we,” “our” and “us” refer to JNI Corporation.

 

**Overview**

 

We are a leading designer and supplier of FibreChannel enterprise storage connectivity products that connect servers and datastorage devices. We currently design, market and sell a broad range of FibreChannel host bus adapters that connect servers to storage subsystems tofacilitate the integration and management of devices used in storage areanetworks, or SANs. Our Fibre Channel products operate with most major serveroperating systems and network configurations used in SANs. Our Fibre Channelhost bus adapters incorporate our proprietary ASIC technology and can be usedboth with Unix-based and PC-based server platforms and their associatedinterfaces. Our software drivers enable the integration of our host busadapters into heterogeneous environments and ensure interoperability betweendifferent sets of platforms and servers. We also offer a line of InfiniBandproducts for server-to-server connectivity that are designed to operate withWindows 2000, Linux and Solaris.  As ofDecember 31, 2002, we had a total of 163 employees compared to 219 employees asof December 31, 2001.

 

Revenues are comprised principally of sales of ourhost bus adapter products and host channel adapter module products.  To a lesser extent, revenues also includesales of our ASICs and fees received from our ASIC development agreements.

 

Cost of revenues is comprisedprincipally of payments to our contract manufacturers, costs ofcomponents,  final assembly costs,manufacturing and quality-related costs, inventory management costs, warrantyand support costs and material expediting charges. Also included in cost ofrevenues in 2002 are amortization and impairment charges for licensedtechnology acquired in connection with the purchase of the exclusive license toTroika Networks’ Fibre Channel software and hardware products.  We expect our gross margin to be affected bymany factors, including changes in average unit selling price, fluctuations indemand for our products, the mix of products sold, the mix of sales channels throughwhich our products are sold, the timing and size of customer orders,fluctuations in manufacturing volumes, changes in costs of components, and newproduct introductions both by us and our competitors.  We reserve for warranty claims at the time of sale based onhistorical experience.

 

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

 

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

 

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

 

Amortizationof intangible assets is attributed to the amortization of intangible assetsacquired in connection with the purchase of products and technology fromAdaptec in November 1998. As a result of the consideration paid to Adaptec, werecorded $11.6 million in intangible assets related to the core technologyacquired, which was amortized over an estimated useful life of three years.  Amortization of this amount was completedduring the year ended December 31, 2001.

 

Amortization of stock-basedcompensation relates to deferred compensation recorded in connection with thegrant of stock options to employees in all operating expense categories wherethe option exercise price

 

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was less than the fair value of the underlying shares of common stockas determined for financial reporting purposes.  The amortization of stock-based compensation was completed duringthe year ended December 31, 2002.

 

**Application of Critical AccountingPolicies**

 

Our discussion and analysis of our financial conditionand results of operations are based upon our financial statements, which havebeen prepared in accordance with accounting principles generally accepted inthe United States of America. The preparation of these financial statementsrequires us to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues and expenses, and related disclosure ofcontingent assets and liabilities. On an on-going basis, we evaluate theseestimates, including those related to customer programs and incentives, productreturns, bad debts, inventories, investments, intangible assets, income taxes,warranty obligations, commitments, contingencies and litigation. We base ourestimates on historical experience and on various other assumptions that arebelieved to be reasonable under the circumstances, the results of which formthe basis for making judgments about the carrying values of assets andliabilities that are not readily apparent from other sources. Actual resultsmay differ from these estimates under different assumptions or conditions.

 

We consider the followingaccounting policies to be both those most important to the portrayal of ourfinancial condition and those that require the most subjective judgment:

 

•                  Revenuerecognition;

•                  inventoryvaluation and related reserves;

•                  valuationof licensed technology;

•                  accountingfor the estimated loss on our lease commitments;

•                  valuationof investment;

•                  allowancefor doubtful accounts;

•                  litigation;and

•                  accountingfor income taxes.

 

*Revenuerecognition.*We sell our products domestically andinternationally primarily to OEM customers and distributors who resell ourproducts to system integrators, value added resellers and  end-users. Our significant customers includeleading storage solution providers, server OEMs and storage OEMs.

 

We recognize revenue fromproduct sales upon shipment except for sales to distributor customers that havecontractual rights of return. Revenue from sales to distributors that havecontractual rights of return is recognized when these distributors ship ourproducts to their end-user customers based on reports that we receive from suchdistributors. Allowances for estimated sales returns are provided at the timerevenue is recognized. We reserve for uncollectible accounts and productreturns based on our historical experience and expected future returns relatedto products shipped. Revenue from our long-term ASIC development agreements isgenerally recognized as the services are performed using the percentage ofcompletion method based on costs incurred to date compared to total estimatedcosts at completion.

 

For all sales, we useeither a binding purchase order or signed agreement as evidence of anarrangement. Sales through our distributors and major OEMs are evidenced by amaster agreement governing the relationship together with binding purchaseorders on a transaction by transaction basis.

 

Our products sold aregenerally covered by a warranty of one to five years for our adapter productsand a one year warranty for our ASICs. We accrue a warranty reserve for theestimated costs to provide warranty services. Our estimate of costs to service our warranty obligations is based onhistorical experience and expectation of future conditions.  To the extent we experience increasedwarranty claim activity or increased costs associated with servicing thoseclaims, our warranty accrual will increase resulting in decreased gross margin.

 

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*Inventoryvaluation and related reserves.*Inventories are valued at thelower of cost or market on a first-in, first-out basis. We use a standard costsystem for purposes of determining cost; the standards are adjusted asnecessary to ensure they approximate actual costs. We write down or reserve forestimated obsolete or excess inventory based upon assumptions about futuredemand and market conditions. We compare current inventory levels on a productbasis to our current sales forecast in order to assess our inventory reservebalance. Our sales forecasts are based on economic conditions and trends (bothcurrent and projected), anticipated customer demand and acceptance of ourproducts, current products, expected future products, expected future sellingprices and various other assumptions. If actual market conditions are less favorable than those projected bymanagement, additional write-downs may be required.

 

During the second quarterof 2001, we recorded an excess inventory charge of $7.7 million based on theanticipated demand for our 1 gigabit products. We increased our 1 gigabitproducts and associated component inventory levels during the fourth quarter of2000 in anticipation of continued strong sales momentum for these productswhich did not materialize. Additionally, information technology spendingcontinued to slow down also contributing to the excess inventory charge.   Notwithstanding our judgment in 2001regarding lack of future demand for our 1 gigabit products, the migration fromone gigabit to two gigabit products was much slower than we initiallyanticipated, and demand for our 1 gigabit products continued in 2002. Wedetermined in the first quarter of 2002 that simple modifications to the hostbus adapters previously considered excess inventory would make them saleableproduct.  In the year ended December 31,2002, the value of the converted boards sold with a zero cost basis totaled$1.4 million, favorably impacting margins. Any future judgments regarding the demand for products in inventorycould result in similar unanticipated subsequent effects due to changes intechnology or customer demands.

 

*Valuationof licensed technology.* Acquisitions of intangible assetsrequire us to make determinations about the value and recoverability of thoseassets that involve estimates and judgments. In connection with our purchase of an exclusive license from Troika, werecorded a long-term intangible asset of $7.3 million for the licensedtechnology we acquired.  We based ourdetermination of valuation on a report provided by an independent third-partyvaluation firm.  We concluded that thetiming of the projected revenue stream associated with the licensed technologyis uncertain, and therefore in the second quarter of 2002 we began recordingthe amortization on a straight-line basis over the asset’s estimated remaininguseful life.

 

Additionally, we assessthe impairment of our long-lived assets when events or changes in circumstancesindicate that an asset’s carrying value may not be recoverable.  An impairment charge is recognized when thesum of the expected future undiscounted net cash flows is less than thecarrying value of the asset.  Animpairment charge would be measured by comparing the amount by which thecarrying value exceeds the fair value of the asset being evaluated forimpairment.  Any resulting impairmentcharge could have an adverse impact on our results of operations.

 

During the fourth quarterof 2002, we noted indicators that the carrying value of our licensed technologymay not be recoverable and performed an impairment review.  The impairment review was performed pursuantto Statement of Financial Accounting Standard (“SFAS”) No. 144, “Accounting forthe Impairment or Disposal of Long-Lived Assets,” because of factors such aslower sales of products incorporating the licensed technology in 2002 comparedto the original projections, revisions in future revenue forecasts and changingmarket conditions, including products provided by our competitors.  As a result of these factors, the projectedfuture revenue and cash flows for these products were revised downward.  Therefore, we evaluated the recoverabilityof our licensed technology and recorded an impairment charge of $5.5 million tocost of revenues during the quarter ended December 31, 2002 based on the amountby which the carrying value of the asset exceeded its fair value.  Subsequent to the impairment charge, theremaining net book value of our licensed technology totaled $600,000 as ofDecember 31, 2002 and is being amortized to cost of revenues on a straight-linebasis over an estimated remaining useful life of four years.

 

In assessing therecoverability of our licensed technology, we must make assumptions regardingestimated future cash flows, estimated future revenues and other factors,including future selling prices, total available market and our estimatedmarket share.  If these estimates ortheir related assumptions change

 

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in the future, we may be required to record additional impairmentcharges for our licensed technology not previously recorded.

 

*Accountingfor the estimated loss on our lease commitments.* As ofDecember 31, 2002, we were committed to a lease for a building adjacent to ourcurrent corporate headquarters that ran through June 2007 with aggregate leasepayments due from us of $8.8 million.  We never occupied the building. In February 2003, we entered into various agreements with our landlordand a third party who agreed to lease the building adjacent to our currentcorporate headquarters whereby we terminated our lease for this building andare completely absolved of any further liability.  During the year ended December 31, 2002, we accrued total chargesof $5.0 million for terminating this lease based on the contractual terms ofthe agreements.

 

Additionally, we arecommitted to a lease for our current corporate headquarters in San Diego, Californiathat runs through March 2011 and includes 85,329 square feet on fourfloors.  During the fourth quarter of2002, we consolidated our entire operations at our corporate headquarters tothree floors and vacated the fourth floor. We do not intend to re-occupy this fourth floor space and are activelyseeking a tenant to sub-lease this space. As of December 31, 2002, we have been unable to secure a tenant tosub-lease this space.  We recorded anestimated loss on our lease commitment totaling $2.0 million for vacating thisspace in the fourth quarter of 2002.  Indetermining this estimated loss for our lease commitment, we made variousassumptions, including occupancy dates for new tenants, sub-lease rental rates,tenant improvement allowances, abandoned leasehold improvements and commissionpayments, that involve estimates and judgments.  In formulating our assumptions, we took into account current andprojected real estate market conditions. Additionally, we did not use a discount rate for purposes of calculatingour estimated loss.  If our estimatesand related assumptions change in the future, we may be required to revise ourestimated loss on our lease commitment. If any revisions to our estimated loss are necessary, then an additionalloss or a benefit will be recorded.

 

*Valuationof investment. *Wehold a minority preferred stock investment in a privately held InfiniBandsemiconductor developer whose value is difficult to determine.  As a result, we are required to record animpairment charge when we believe our investment has experienced a decline thatis other than temporary.  Thedetermination that a decline is other than temporary is subjective andinfluenced by many factors.  Whenassessing an investment in a private company for an other than temporarydecline in value, we consider such factors as the share price from theinvestee’s latest financing round, the performance of the investee in relationto its own operating targets and its business plan, the investee’s revenue andcost trends, the liquidity and cash position, including its cash burnrate.  We also consider quoted marketprices of public companies in the industry in which the investee operates aswell as overall market conditions.  Weevaluated these factors, and we recorded a $1.4 million impairment charge inour preferred stock investment during the fourth quarter of 2002.  As of December 31, 2002, the carrying valueof our preferred stock investment totaled $600,000 which represents our estimatedfair value.  This impairment charge isincluded in other expenses in ourstatement of operations.  Futureadverse changes in market conditions or poor operating results of an investeecould result in losses or an inability to recover the carrying value of aninvestment, thereby possibly requiring additional impairment charges.

 

*Allowancefor doubtful accounts. *Weregularly analyze our customer accounts, and when we become aware of a specificcustomer’s inability to meet its financial obligations to us, such as in thecase of bankruptcy filings or deterioration in a customer’s overall financialcondition, we record a specific provision for uncollectible accounts to reducethe related receivable to the amount that is estimated to be collectible. Wealso record and maintain a provision for doubtful accounts for customers basedon a variety of factors including our historical experience, the length of timethe receivable has been outstanding and the financial condition of thecustomer. If there were a deterioration in the financial condition of ourcustomers, or actual defaults were higher than our historical experience, ourestimates of the recoverability of amounts due to us could be overstated, whichcould have an adverse impact on our results from operations.

 

*Litigation.*We are currently involved in certain legal proceedings. Weestimate the range of liability related to pending litigation where the amountand range of loss can be estimated. We record our estimate of a loss when theloss is considered probable. Where a liability is probable and there is a rangeof estimated loss, we record the minimum estimated liability related to theclaim. As additional information becomes available, we

 

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assess the potential liability related to our pending litigation andrevise our estimates. Revisions in our estimates of the potential liabilitycould materially impact our results of operations.

 

*Accountingfor income taxes.*Judgment is required in determining ourprovision for income taxes, our deferred tax assets and liabilities and anyvaluation allowance recorded against our net deferred tax assets. Our incometax provision is based on calculations and assumptions that may be subject toexamination by the Internal Revenue Service and other tax authorities. Weregularly assess the potential outcomes of these examinations in determiningthe adequacy of our provision for income taxes. Should the actual resultsdiffer from our estimates, we would have to adjust the income tax provision inthe period in which the facts that give rise to the revision become known. Taxlaw and rate changes are reflected in the income tax provision in the period inwhich such changes are enacted. We have recorded a full valuation allowance onour net deferred tax assets as of December 31, 2002, due to uncertaintiesrelated to our ability to utilize our deferred tax assets, primarily consistingof certain net operating losses carried forward and research and developmenttax credits, before they expire.

 

**Results of Operations**

 

The following discussionshould be read in conjunction with the financial statements and the relatednotes contained elsewhere in this report.

 

**Comparison of Years Ended December 31, 2002 and 2001**

 

*Net revenues.*Netrevenues decreased $36.9 million, or 49.0%, to $38.4 million in the year endedDecember 31, 2002 from $75.3 million in the year ended December 31, 2001.  The decrease was due to a decline in salesof our SBus host bus adapter products and a decrease in sales of our ASICs andfees received under ASIC development agreements partially offset by an increasein sales of our PCI host bus adapter products and our InfiniBand host channeladapter products.  The overall decreasein net revenues for the year ended December 31, 2002 is primarily the result ofa decrease in overall unit sales of our SBus products.  Additionally, the shift in demand from ourSBus products to our PCI products which have lower average selling prices thanSBus products also contributed to the decrease in net revenues. The demand forour SBus products has continued to decline as Sun Microsystems has released newmidrange and high-end server products that do not include the SBus interface.

 

As our customers migratefrom one-gigabit to two-gigabit Fibre Channel host bus adapter products, we haveexperienced a significant increase in revenues from our two-gigabit productsfor the year ended December 31, 2002 compared to the same period in the prioryear that has partially offset the significant decline in revenues from ourone-gigabit products.  Sales of ourtwo-gigabit products increased by $11.4 million for the year ended December 31,2002 compared to the year ended December 31, 2001.  Revenues from the sale of our two-gigabit products represented33.8% and 2.1% of total net revenues for the years ended December 31, 2002 and2001, respectively.  Sales to customersoutside of the United States accounted for 24% and 30% of net revenues for theyears ended December 31, 2002 and 2001, respectively.

 

*Gross margin.*Grossmargin decreased $22.9 million, or 63.9%, to $13.0 million in the year endedDecember 31, 2002 from $35.9 million in the year ended December 31, 2001. Grossmargin as a percentage of net revenues decreased to 33.8% during the year endedDecember 31, 2002 from 47.8% during the year ended December 31, 2001. Grossmargin for 2002 includes a  $5.5 millionimpairment charge recorded in the fourth quarter on our licensed technology,and gross margin for 2001 includes a $7.7 million charge recorded for excessinventory in the second quarter. Excluding the $5.5 million impairment charge in 2002 and the $7.7million excess inventory charge in 2001, gross margin as a percentage of netrevenues decreased to 48.0% during the year ended December 31, 2002 from 58.0%during the year ended December 31, 2001.

 

Excluding the $5.5million impairment charge in 2002 and the $7.7 million excess inventory chargein 2001, the decrease in gross margin percentage is primarily due to increasedsales of our PCI host bus adapter products which have lower gross margins thanour SBus host bus adapter products coupled with a decrease in the averageselling price for our SBus host bus adapter products and the allocation offixed manufacturing costs over a lower revenue base.  Gross margins for the year ended December 31, 2002 were

 

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also affected unfavorably by amortization costs associated with ourlicensed technology and additional costs incurred on an ASIC developmentagreement partially offset by the favorable impact from the sale of boards forwhich we previously recorded a charge for excess inventory.  Total amortization costs related to ourlicensed technology recorded to cost of sales in the year ended December 31,2002 totaled $1.2 million.  Due to theimpairment charge taken with respect to the licensed technology, totalamortization costs in future periods related to this technology will bematerially lower than in 2002.  Duringthe second quarter of 2002, we revised our estimated costs at completion for anASIC development agreement which will result in reduced margins on theproject.  The change in estimate wasrecorded as a cumulative catch-up adjustment in the second quarter of 2002amounting to a $277,000 charge to cost of sales.

 

*Research and development.*Research and development expenses decreased $3.5 million, or 14.0%, to $21.1million for the year ended December 31, 2002 from $24.6 million for the yearended December 31, 2001. The decrease in research and development expenses wasdue primarily to lower personnel costs, resulting from headcount reductions inthe first and third quarters of 2002, decreased consulting expenses, lower labequipment and supply costs, and a decline in non-recurring engineering expensespartially offset by increased depreciation expense. Additionally, the decreasewas due to lower recruiting costs and travel expenses partially offset byincreased equipment leasing costs. Research and development expenses as a percentage of net revenues increasedsignificantly for the year ended December 31, 2002 from the comparable periodin 2001 primarily due to the decrease in revenues.

 

*Selling and marketing*.  Selling and marketing expenses decreased$4.2 million, or 26.0%, to $11.8 million for the year ended December 31, 2002from $16.0 million for the year ended December 31, 2001. The decrease inselling and marketing expense was due primarily to lower personnel costs,resulting from headcount reductions in the first and third quarters of 2002 anda decrease in travel expenses. Additionally, the decrease was due to a lowerallocation of corporate facility costs, lower recruiting costs, reducedpromotional costs, decreased consulting expenses and decreased public relationsexpenses, as we continued to manage various discretionary costs.  To a lesser extent, a decrease inadvertising and expenses associated with sales and marketing incentives alsocontributed to the decrease in selling and marketing expenses. Selling andmarketing expenses as a percentage of net revenues increased significantly forthe year ended December 31, 2002 from the comparable period in 2001 primarilydue to the decrease in revenues.

 

*General and administrative*. General andadministrative expenses decreased $332,000, or 3.7%, to $8.7 million for theyear ended December 31, 2002 from $9.1 million for the year ended December 31,2001. The decrease was primarily due to lower personnel costs due to headcountreductions in the first and third quarters of 2002 partially offset by anincrease in consulting costs. Additionally, an insurance refund and a decreasein investor relations costs also contributed to the decrease in general andadministrative expenses.  General andadministrative expenses as a percentage of net revenues increased significantlyfor the year ended December 31, 2002 from the comparable period in 2001primarily due to the decrease in revenues.

 

*Interest income.*Interest income decreased $2.3 million, or 44.2%, to $2.8 million for the yearended December 31, 2002 from $5.1 million for the year ended December 31, 2001.The decrease in interest income is primarily due to the decrease in interestrates over the past year and to a lesser extent due to a decrease in theaverage cash and marketable securities balance during the year ended December31, 2002 compared to the same period in 2001.

 

*Otherincome (expense).* Other income (expense) was an expense of$1.6 million for the year ended December 31, 2002.  The expense was primarily due to a $1.4 million write down in ourpreferred stock investment and a $336,000 loss on the settlement of a loanpartially offset by $206,000 in net realized gains on investments.  In the fourth quarter of 2002, we concludedthat our preferred stock investment had experienced a decline that is otherthan temporary and recorded a $1.4 million impairment charge to write down ourinvestment to its estimated fair value. In the second quarter of 2002, we incurred a $336,000 loss related tothe settlement of an outstanding loan with a former executive of theCompany.  Pursuant to the settlement, wereceived 200,000 common shares of Company stock previously pledged by theformer executive as security for an outstanding loan and accrued interest inthe amount of $1.26 million.  Werecorded the 200,000 common shares into treasury stock at their fair marketvalue of $924,000 and the loan was deemed repaid.

 

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*Income tax provision**.*** We recognized an income tax provision of $0during the years ended December 31, 2002 and 2001 as a result of the taxable lossduring the fiscal years 2002 and 2001.  Thedifference between our effective tax rate of 0% and the statutory tax rate isprimarily a result of the net change in the deferred tax asset valuationallowance.  We recorded a valuationallowance on our net deferred tax assets as of December 31, 2002 and 2001because of uncertainty regarding their realizability.

 

**Comparison of Years Ended December 31, 2001 and 2000**

 

*Net Revenues.*  Net revenues decreased $27.9 million,or 27.1%, to $75.3 million in the year ended December 31, 2001 from$103.2 million in the year ended December 31, 2000.  The decrease was due to a  $28.9 million decrease in sales of our SBushost bus adapter products and a $0.7 million decrease in sales of our PCI hostbus adapter products partially offset by a $1.6 million increase in sales ofour ASICs and revenue received under ASIC development agreements. The totalrevenue recognized under research and development agreements for the year endedDecember 31, 2001 was $1.1 million as compared to no revenues in 2000. Theoverall decrease in revenues for the year ended December 31, 2001 is primarilya result of the slowdown in information technology spending in 2001 coupledwith weakness in the Solaris market, which is the principal market for our products.Additionally, the decrease in SBus sales resulted from the transition of ourSolaris based products from the SBus to the PCI interface. The decline in netrevenues is also attributable to a decrease in the average selling price forour host bus adapters primarily as a result of continued pricing pressure anddiscounts provided to our major OEM partners as well as the transition to PCIproducts which have lower average selling prices than SBus products. Sales tocustomers outside of the United States accounted for 30% of net revenues in2001 compared to 23% of net revenues in 2000.

 

*Gross Margin.*  Gross margin decreased $25.2 million,or 41.2%, to $35.9 million in the year ended December 31, 2001 from$61.1 million in the year ended December 31, 2000. Gross margin as apercentage of net revenues decreased to 47.8% during the year ended December31, 2001 from 59.2% during the year ended December 31, 2000.  The decrease is primarily attributed to a$7.7 million charge recorded for excess inventory.  Excluding the $7.7 million excess inventory charge, gross marginas a percentage of net revenues decreased to 58.0% during the year endedDecember 31, 2001 from 59.2% during the year ended December 31, 2000.  The allocation of fixed manufacturing costsover a lower revenue base also contributed to the decrease in grossmargins.  Additionally, the decrease inthe average selling price for our host bus adapters contributed to the declinein gross margins.

 

*Research and Development.*  Research and development expenses increased$5.7 million, or 29.8%, to $24.6 million for the year ended December31, 2001 from $18.9 million for the year ended December 31, 2000.  The increase was due primarily to higherpersonnel costs, resulting from an increase in the number of personnel neededin order to staff a higher level of research and development, and higherdepreciation expense, resulting from an increase in capital expendituresnecessary to expand our research and development efforts and continuedinvestments in our system integration lab. The increase in office and lab space for our research and developmentteam resulted in higher rent and occupancy related expenses.  Additionally, we opened up an office for aresearch and development team in Singapore in January of 2001 to assist in thedesign and development of our ASICs which also contributed to the increase inresearch and development expenses.  As apercentage of net revenues, research and development expenses increased to 32.6%for the year ended December 31, 2001 from 18.3% for the year ended December 31,2000.  This increase was primarilyattributable to the decrease in revenues.

 

*Selling and Marketing.*  Selling and marketing expenses increased$3.7 million, or 29.8%, to $16.0 million for the year ended December31, 2001 from $12.3 million for the year ended December 31, 2000.  The increase in selling and marketingexpenses was due primarily to an increase in personnel costs, an increase inbusiness development and marketing programs, an increase in travel expenses byour sales people, an increase in public relations expenses and reproduction andprinting costs as we continued our efforts to increase our brand awareness andincreased costs associated with opening new sales offices in the United Statesand Europe, partially offset by a decrease in sales commissions due to thedecrease in net revenues.  Selling andmarketing expenses as a percentage of net revenues increased to 21.2% for theyear

 

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ended December 31, 2001 from 11.9% for the year ended December 31,2000. This increase was primarily attributable to the decrease in revenues.

 

*General and Administrative.*  General and administrative expensesincreased $1.2 million, or 14.2%, to $9.1 million for the year endedDecember 31, 2001 from $7.9 million for the year ended December 31,2000.  The increase was primarily due tohigher personnel costs arising from costs associated with changes in seniormanagement, an increase in legal fees mainly as a result of the class actionlawsuit filed in April 2001 and an increase in insurance and consultingexpenses. General and administrative expenses as a percentage of net revenuesincreased to 12.0% for the year ended December 31, 2001 from 7.7% for the yearended December 31, 2000. This increase was primarily attributable to thedecrease in revenues.

 

*Amortizationof Intangible Assets.* We amortized $4.7 million of intangible assets during the yearended December 31, 2001 compared to $5.4 million during the year ended December31, 2000.  The decrease relates to thebalance being fully amortized during the year ended December 31, 2001.  The intangible assets related to additionalconsideration we issued to Adaptec in the third quarter of 1999 for FibreChannel technology we acquired from Adaptec in November 1998.

 

*Interest Income.*  Interest income increased $2.2 million, or73.7%, to $5.1 million for the year ended December 31, 2001 from $2.9 millionfor the year ended December 31, 2000. Interest income for the year ended December 31, 2001 primarilyrepresents interest earned on our investments in marketable securitiesresulting from the proceeds from our public offering completed in October2000.  Interest income for the yearended December 31, 2000, primarily represents interest earned on ourinvestments in marketable securities resulting from the proceeds from ourinitial public offering completed in October 1999.

 

*Income Tax Provision (Benefit).*  Werecognized an income tax provision of $0 during the year ended December 31, 2001as a result of the taxable loss during the fiscal year 2001.  The difference between our effectivetax rate of 0% and the statutory tax rate is primarily a result of the netchange in the deferred tax asset valuation allowance. We recognized an incometax provision of $4.6 million, with an effective tax rate of 24.5%, duringthe year ended December 31, 2000 as a result of the taxable income generated inthe year ended December 31, 2000. The difference between our effective tax rateof 24.5% and the statutory tax rate is primarily a result of research anddevelopment tax credits generated.  Werecorded a valuation allowance on our net deferred tax assets as of December31, 2001 because of uncertainty regarding their realizability.

 

**Comparison of Years Ended December 31, 2000 and 1999**

 

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

 

*Gross Margin.*  Gross margin increased $36.4 million,or 147%, to $61.1 million in the year ended December 31, 2000 from$24.8 million in the year ended December 31, 1999. Gross margin as apercentage of net revenues decreased to 59.2% during the year ended December31, 2000 from 61.7% during the year ended December 31, 1999.  The decrease was due to increased sales ofour PCI host bus adapter products which generally have lower gross margins thanour SBus host bus adapter products. Gross margins for the year ended December 31, 2000 also decreased as aresult of inventory reserves recorded for slow moving and obsolete inventoryand higher prices on certain components due to industry-wide shortages.

 

*Research and Development.*  Research and development expenses increased$7.0 million, or 58%, to $18.9 million for the year ended December31, 2000 from $12.0 million for the year ended December 31, 1999.  The increase was due primarily to higherpersonnel costs and contracted services, resulting from an increase in thenumber of personnel needed in order to staff a higher level of research anddevelopment, and higher depreciation expense, resulting from an increase incapital expenditures necessary to expand our 

 

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research and development efforts. As a percentage of net revenues, research and development expensesdecreased to 18.3% for the year ended December 31, 2000 from 29.8% for the yearended December 31, 1999.  This decreasewas primarily attributable to the increase in revenues.

 

*Selling and Marketing.*  Selling and marketing expenses increased$7.5 million, or 156%, to $12.3 million for the year ended December31, 2000 from $4.8 million for the year ended December 31, 1999.  The increase in selling and marketingexpenses was due primarily to an increase in personnel costs resulting from theexpansion of our sales and marketing staff, increased trade show participationand continued spending on an advertising and marketing program which welaunched in the first quarter to focus on our premium branding and channelexpansion.  Selling and marketingexpenses as a percentage of net revenues decreased to 11.9% for the year endedDecember 31, 2000 from 12.0% for the year ended December 31, 1999.

 

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

 

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

 

                                              *InterestIncome.*  Interest income of$2.9 million primarily represents interest earned on our investments inmarketable securities during the year ended December 31, 2000, resulting primarilyfrom the proceeds from the initial public offering completed in October1999.  Interest income of $352,000 in1999 primarily represents interest earned in November and December 1999 on ourinvestments in marketable securities, resulting from the proceeds from ourinitial public offering completed at the end of October 1999.

 

*Interest Expense.*  Interest expense for the year ended December31, 1999 represents interest associated with our intercompany revolverborrowings from Jaycor.  Subsequent toour initial public offering, we repaid the outstanding balance to Jaycor infull.  Accordingly, we had no interestexpense in the year ended December 31, 2000.

 

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

 

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

 

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**Liquidity and Capital Resources**

 

During the year endedDecember 31, 2002, cash used in operating activities was $4.9 million, comparedto $12.7 million and $4.8 million of cash provided by operating activitiesduring the years ended December 31, 2001 and 2000, respectively.  The cash used in operations during the yearended December 31, 2002 reflects a net loss before depreciation, amortization,impairment and other non-cash charges of approximately $20.0 million and a $1.2million decrease in deferred revenue, other liabilities and other assetspartially offset by a $4.9 million decrease in accounts receivable, a $5.7million decrease in inventories, and a $5.8 million increase in accruedliabilities and accounts payable.

 

Net cash provided byinvesting activities was $3.7 million in the year ended December 31, 2002 andconsisted of proceeds from the sale of marketable securities of $17.5 millionwhich was used for the purchase of licensed technology and services from Troikafor $7.5 million, $2.0 million for the purchase of a preferred stock investmentin a privately held InfiniBand semiconductor developer and $8.0 million for thefunding of our current operations offset by capital expenditures of $1.3million and purchases of marketable securities available for sale of $3.0million.  Net cash used in investingactivities was $9.5 million in the year ended December 31, 2001 and consistedof capital expenditures of $8.7 million and purchases of marketable securitiesavailable for sale of $9.9 million partially offset by the proceeds from thesale of marketable securities of $9.1 million. Net cash used in investing activities was $79.2 million in the yearended December 31, 2000 and consisted of capital expenditures and purchases ofmarketable securities available for sale. The capital expenditures primarily reflect our investment in computerand lab equipment to build out our system integration lab as well as investmentin software development tools and equipment for our engineering operations andthe development of testing stations. Capital expenditures decreased $7.4 million, or 85.1%, to $1.3 millionfor the year ended December 31, 2002 from $8.7 million for the year endedDecember 31, 2001. This decrease is primarily due to costs associated with ourcorporate headquarters and completion of our engineering and systemsintegration labs in 2001.

 

Net cash provided by financing activities was $561,000in the year ended December 31, 2002, which consisted of net proceeds of$694,000 from the issuance of common stock, consisting of proceeds from theexercise of stock options and purchases of shares under our employee stockpurchase plan offset by $133,000 in principle payments made on our capitalleases.  Net cash used in financingactivities was $2.8 million in the year ended December 31, 2001, whichconsisted of a treasury stock repurchase of $5.1 million or 900,000 shares ofour common shares offset by the net proceeds of $2.3 million from the issuanceof common stock consisting of proceeds from the exercise of stock options andpurchases of shares under our employee stock purchase plan.  Net cash provided by financing activitieswas $73.3 million in the year ended December 31, 2000, which resulted primarilyfrom the net proceeds from our second public offering in October 2000.  In addition, the proceeds from the exerciseof stock options and purchases of shares under our employee stock purchase planalso provided cash from financing activities in 2000.

 

We had $102.7 million ofcash and cash equivalents and investments and $80.6 million of working capitalat December 31, 2002.  We believe thatour cash and investments position will be sufficient to meet our workingcapital needs at least through the next 12 months.

 

At December 31, 2002, ouroutstanding commitments included (in thousands):

 
|                                   |   |      | **Payments due by period** |                     |   |                   |
|----------------------------------------|--------|-----------|----------------------------|--------------------------|--------|------------------------|
| **Contractual  Obligations**           |   | **Total** |                       | **Less   than 1   year** |   | **1 – 3   years** |   | **3 – 5   years** |   | **More   than 5  years** |   |
| Operating  leases(a)                   |   | $         | 32,193                     |                     | $      | 5,022                  |   | $ | 9,673 |   | $ | 7,987 |   | $ | 9,511 |   |
| Capital  leases(a)                     |   | 664       |                       | 280                      |   | 384                    |   | — |   | — |   |
| Purchase  commitments for inventory(a) |   | 2,747     |                       | 2,747                    |   | —                 |   | — |   | — |   |
| Total                                  |   | $         | 35,604                     |                     | $      | 8,049                  |   | $ | 10,057 |   | $ | 7,987 |   | $ | 9,511 |   |

 

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(a)          For informationregarding commitments, including operating and capital leases and inventorypurchase commitments, at December 31, 2002, reference Note 8, “Commitments” inthe Notes to Financial Statements.

 

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

 

In January 2003, we announced that we areinvestigating strategic options to optimize the value and market responsivenessof our ASIC assets.  As of February 28,2003, we have not concluded our investigation.

 

On March 20, 2003, the Board of Directors authorizedthe Company to repurchase up to $10 million of its outstanding common stock inopen market and private transactions over a twelve-month period ending March20, 2004.  The timing and price of stockpurchases will be made at the discretion of management.

 

Our intent is to move ourcorporate headquarters by the end of 2003. We would like to secure office space that is less expensive than ourcurrent office space and which would also allow us to expand our job applicantpool to Orange County, California in addition to San Diego County,California.  Before such a move, wewould need to find a tenant to lease our current corporate headquarters.  If we find a new tenant for this space andare able to eliminate our current lease obligation for our corporateheadquarters, we may incur an additional loss on our lease commitment and mayneed to expend some of our cash and investments which could have an adverseimpact on our financial condition and results of operations.  We have made no commitments to date withrespect to the possible relocation of our corporate headquarters.

 

**Recent Accounting Pronouncements**

 

In July 2002, the Financial Accounting Standards Board(“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 146 —Accounting for Costs Associated with Exit or Disposal Activities.  SFAS No. 146 provides guidance on therecognition and measurement of liabilities associated with exit and disposalactivities. Under SFAS No. 146, liabilities for costs associated with exit ordisposal activities should be recognized when the liabilities are incurred andmeasured at fair value. This statement is effective prospectively for exit ordisposal activities initiated after December 31, 2002. The adoption is notexpected to have a material effect on the Company’s results of operations orfinancial condition.

 

In November 2002, the FASB issued FASB InterpretationNo. 45 (“FIN 45”), — “Guarantor’s Accounting and Disclosure Requirements forGuarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45requires that a liability be recorded in the guarantor’s balance sheet uponissuance of a guarantee. In addition, FIN 45 requires disclosures about theguarantees that an entity has issued, including a rollforward of the entity’sproduct warranty liabilities. The Company will apply the recognition provisionsof FIN 45 prospectively to guarantees issued after December 31, 2002. Thedisclosure provisions of FIN 45 are effective for, and are reflected in, the2002 financial statements. The adoption of FIN 45 is not expected to have amaterial effect on the Company’s results of operations or financial condition.

 

In November 2002, the Emerging Issues Task Force(EITF) issued Issue No. 00-21, “Accounting for Revenue Arrangements withMultiple Deliverables.” This issue addresses determination of whether anarrangement involving more than one deliverable contains more than one unit ofaccounting and how arrangement consideration should be measured and allocated tothe separate units of accounting. EITF Issue No. 00-21 will be effective forrevenue arrangements entered into in fiscal periods beginning after June 15,2003 or the Company may elect to report the change in accounting as acumulative-effect adjustment. The Company is reviewing EITF Issue No. 00-21 andhas not yet determined the impact this issue will have on its operating resultsand financial position.

 

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**Item 7A.  *Quantitative and Qualitative Disclosures About MarketRisk***

 

Our exposure to marketrisk for changes in interest rates relates primarily to changes in the fairmarket value of our investments and the amount of interest income earned on ourinvestment portfolio. In the normal course of business, we employ establishedpolicies and procedures to manage our exposure to changes in the fair marketvalue of our investments. However, the fair market value of our investments inmarketable securities may be adversely affected due to a rise in interest rates,and we may suffer losses in principal if forced to sell securities that havedeclined in market value due to changes in interest rates.

 

Under our current policies, we do not use interestrate derivative instruments to manage exposure to interest rate changes. Weensure the safety and preservation of our invested principal funds by limitingdefault risks, market risk and reinvestment risk. We mitigate default risk byinvesting in investment grade securities. A hypothetical 100 basis pointadverse move in interest rates along the entire interest rate yield curve wouldnot materially affect the fair value of our interest sensitive financialinstruments at December 31, 2002.

**Item 8.  *Financial Statements and Supplementary Data***

 

See the Index to Financial Statements on page F-1.

 

**Item 9.  *Changes in and Disagreements with Accountants onAccounting and Financial Disclosure***

 

None.

**PART III**

 

**Item 10.  *Directors and Executive Officers of the Registrant***

 

**Directors**

 

*Directors*.  The following sets forth, for the currentdirectors, information concerning their age and background.

 
| **Name**                |   | **Position With JNI**                            |   | **Age** |   | **Director   Since** |   |
|-------------------------|--------|--------------------------------------------------|--------|---------|--------|----------------------|--------|
|                    |   |                                             |   |    |   |                 |   |
| John Bolger             |   | Director                                         |   | 56      |   | 1999                 |   |
|                    |   |                                             |   |    |   |                 |   |
| Leon (Bud) Edney        |   | Director                                         |   | 68      |   | 2002                 |   |
|                    |   |                                             |   |    |   |                 |   |
| Tom St. Dennis          |   | Director                                         |   | 49      |   | 2001                 |   |
|                    |   |                                             |   |    |   |                 |   |
| Russell Stern           |   | President, Chief  Executive Officer and Director |   | 47      |   | 2002                 |   |
|                    |   |                                             |   |    |   |                 |   |
| John C. Stiska          |   | Chairman of the  Board of Directors              |   | 61      |   | 2000                 |   |
|                    |   |                                             |   |    |   |                 |   |
| Sylvia Summers Dubrevil |   | Director                                         |   | 50      |   | 2001                 |   |
|                    |   |                                             |   |    |   |                 |   |
| Peter van Cuylenburg    |   | Director                                         |   | 55      |   | 2002                 |   |
|                    |   |                                             |   |    |   |                 |   |
| Howard Wiener           |   | Director                                         |   | 72      |   | 2002                 |   |

 

***John Bolger*** has served as a directorof JNI since October 1999. Mr. Bolger is a retired Vice President of Financeand Administration of Cisco Systems, Inc., a manufacturer of computer networkingsystems which is publicly held. Mr. Bolger is currently a private investor andserves as a director of Integrated Device Technology, Inc., Wind River Systems,Inc., Mission West Properties, Inc. and Sanmina-

 

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SCI Corporation, all public companies. Mr. Bolger earned a B.A. from the University of Massachusetts and anM.B.A. from Harvard University, and he is a certified public accountant.

 

***Leon (Bud) Edney*** has served as adirector of JNI since September 2002. He is a retired admiral from the UnitedStates Navy and currently serves as an independent consultant in the defenseindustry and as a director for several privately held companies and non profitassociations.  Since retirement, heserved as Vice President of Naval Systems for Loral Corporation and was thefirst occupant of the Distinguised Leadership Chair at the United States NavalAcademy from 1997 to 1999.  AdmiralEdney was a 1970-1971 White House Fellow, former Vice Chief of Naval Operationsand retired from the United States Navy as Commander in Chief United StatesAtlantic Command in 1992.  He received adegree in engineering from the United States Naval Academy and a Master’sDegree in Public Administration from Harvard University.

 

***Tom St. Dennis***has served as adirector of JNI since June 2001. Since September 1999, Mr. St. Dennis hasserved as President and Chief Executive Officer of Wind River Systems, Inc., apublic software company. Before joining Wind River, from September 1992 toSeptember 1999, he served in a variety of senior management positions atApplied Materials, Inc., a public semiconductor equipment manufacturer, mostrecently as Group Vice President and President of one of the product businessgroups. Mr. St. Dennis received an M.S. and B.S. in physics at the Universityof California, Los Angeles.

 

***Russell Stern*** joined JNI as Presidentand Chief Executive Officer in September 2002. From July 2001 to September 2002, Mr. Stern served as Chief OperatingOfficer of Quantum/ATL, a subsidiary of Quantum Corporation, a public disk,tape and tape automation company.  FromJuly 2000 to June 2001, Mr. Stern was President and Chief Executive Officer ofEscrow.com, a privately held software and financial services company.  From December 1994 to October 1999, Mr.Stern served in senior management positions at Western Digital, a public diskdrive manufacturer, most recently as the Co-Chief Operating Officer.  Mr. Stern earned a B.S. in electricalengineering technology from the Rochester Institute of Technology.

 

***John C. Stiska*** has served Chairman ofthe Board of Directors of JNI since September 2002.  He has served as a director of JNI since May 2000.  From May 2002 to September 2002, Mr. Stiskaserved as JNI’s Interim Chief Executive Officer.  Mr. Stiska is Chairman of Commercial Bridge Capital, LLC, asecured bridge loan fund, and served as Of Counsel to the law firm of Latham& Watkins from July 1998 through June 2000.  From February 1996 to February 1998, Mr. Stiska served as corporateSenior Vice President of QUALCOMM Incorporated, and as General Manager ofQUALCOMM’s Technology Applications Group. Prior to joining QUALCOMM, Mr. Stiska was Chairman and Chief ExecutiveOfficer of Triton Group from 1993 to 1996. Mr. Stiska currently serves on the Board of Directors for VentureHoldings, LLC as well as several privately held companies.  Mr. Stiska earned a B.A. in accounting and aJ.D. from the University of Wisconsin.

 

***Sylvia Summers Dubrevil***has served asa director of JNI since July 2001.  InMarch 2003, Ms. Summers Dubrevil joined Advanced Micro Devices, a publicsemiconductor manufacturer, as Vice President and General Manager of theEmbedded Business Unit.  From September2001 to February 2002, she served as President and Chief Executive Officer ofSilvan Networks, a private telecom company. From January 2000 to August 2001, she was a Group Vice President atCisco Systems, Inc., a manufacturer of computer networking systems which ispublicly held.  From May 1997 to June1999, she served as Vice President and General Manager of a division atStorageTek, a public storage products company. She currently serves on the Board of Directors for Riverstone Networks,a publicly traded provider of metropolitan area networking solutions.  Ms. Summers Dubrevil received an M.B.A. fromThomson CSF in France, an M.S.E.E. from the University of California, Berkeley,and a B.S.E.E. from Ecole Polytecnique Feminine in France.

 

***Peter van Cuylenburg*** has served as a director of JNI since May2002.  Dr. van Cuylenburg is currentlyan independent consultant and serves as a director for QAD, Inc., a publiclytraded enterprise resource planning software company as well as for severalprivately held companies.  He served asChief Operating Office of InterTrust Technologies Corporation and advisor toits Chairman from October 1999 to December 2000.  From September 1996 to October 1999, he served as President ofQuantum DSSG, a publicly traded data storage manufacturer.  Dr. van Cuylenburg received a Diploma in ElectricalEngineering from Bristol Polytechnic, England and was awarded an honoraryDoctorate of Technology by Bristol Polytechnic in 1992.

 

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***Howard Wiener*** has served as a directorof JNI since September 2002.  He is aretired Justice of the California Court of Appeal and has served as a mediator,arbitrator and private judge for dispute resolution since 1994.  Justice Wiener earned an A.B. in philosophyfrom Brown University, an L.L.B. from Harvard Law School and received a Mastersof Law degree in the judicial process from the University of Virginia LawSchool.

 

**Executive Officers and Key Employees**

 

The executive officersand key employees of JNI and their ages as of March 24, 2003 are as follows:

 
| **Name**              |   | **Age** |   | **Position**                                     |   |
|-----------------------|--------|---------|--------|--------------------------------------------------|--------|
| *Executive  Officers* |   |    |   |                                             |   |
| Russell  Stern        |   | 47      |   | President, Chief  Executive Officer and Director |   |
| Paul  Kim             |   | 35      |   | Chief Financial Officer                          |   |
|                  |   |    |   |                                             |   |
| *Key  Employees*      |   |    |   |                                             |   |
| Philip  Brotherton    |   | 42      |   | Vice President,  Marketing                       |   |
| Russell  Krapf        |   | 55      |   | Vice President,  Business Development            |   |
| Gordon  Liechti       |   | 46      |   | Vice President, Sales                            |   |
| Bradley  Masters      |   | 44      |   | Vice President,  Engineering                     |   |
| Pradeep  Patel        |   | 47      |   | Vice President, ASIC  Operations                 |   |
| Rick  Sander          |   | 44      |   | Vice President,  Operations                      |   |
| Sassan  Teymouri      |   | 45      |   | Vice President, ASICs                            |   |

 

 

***Russell Stern***joined JNI as Presidentand Chief Executive Officer in September 2002. Information regarding Mr. Stern's background is set forth above.

 

***Paul Kim***has served as Chief FinancialOfficer of JNI since September 2002. From October 1999 to August 2002, he was Vice President, Finance andCorporate Controller of JNI.  Prior tojoining JNI, he served as Vice President of Finance and Administration forDatafusion Inc., a privately held software development company, from January1998 until October 1999.  From April1996 to January 1998, he was the Corporate Controller for Interlink ComputerSciences, Inc., a public enterprise software company.  From January 1990 to April 1996, he worked for Coopers andLybrand L.L.P., leaving as an audit manager. Mr. Kim received a B.A. in economics from the University of Californiaat Berkeley and is a Certified Public Accountant.

 

**KeyEmployees**

* *

***Philip Brotherton***joined JNI as Vice President ofMarketing in March 2003.  From January2002 to March 2003, Mr. Brotherton served as a marketing consultant for varioushigh technology companies.  FromDecember 1999 to December 2001, he served as Vice President of Marketing forActa Technology, a private enterprise software company.  From October 1990 to November 1999, heserved in a variety of marketing and engineering positions, most recently asSenior Director of Marketing for the Communications Infrastructure Operation atHewlett Packard, a publicly traded company. Mr. Brotherton received a BSME from the University of California, SantaBarbara and an M.B.A. from the University of California, Berkeley.

 

***Russell Krapf*** joined JNI as VicePresident of Business Development in November 2002. Prior to joining JNI, fromJanuary 2000 through October 2002, Mr. Krapf was President and Chief ExecutiveOfficer for Keen Personal Media, a privately held developer of personal videorecorder hardware and software

 

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products which was spun off from Western Digital.  From September 1997 through January 2000,Mr. Krapf served in senior management positions, most recently as VicePresident of Business Development, for Western Digital, a public disk drivemanufacturer.  Mr. Krapf earned a B.S.in Engineering Sciences from Florida State University and an M.B.A. from BostonUniversity.

 

***Gordon Liechti***has served as VicePresident, Sales since October 2001. Prior to joining JNI, from August 2000 to August 2001, he served asDirector of OEM sales at TROIKA Networks, a privately held company specializingin clustering and high availability software. From January 1999 to April 2000,he was the Vice President of Worldwide Sales at Storm Systems, a privately heldenterprise software company. From August 1997 to December 1998, he was the VicePresident of Sales and Business Development at Creative Design Solutions, aprivately held network attached storage company.  From February 1996 to August 1997, he was an OEM Sales Manager atVeritas Software Corporation, a public enterprise software company. Mr. Liechtiholds a B.A. in business administration and finance from Spring Arbor College,Michigan.

 

***Bradley Masters*** joined JNI as VicePresident of Engineering in December 2002. Prior to joining JNI, from June 2000through November 2002, Mr. Masters was Senior Vice President of Engineering andOperations for Keen Personal Media, a privately held developer of personalvideo recorder hardware and software products which was spun off from WesternDigital.  From October 1983 through June2000, Mr. Masters served in a variety of engineering positions, most recentlyas Vice President of Audio and Video Product Development, for Western Digital,a public disk drive manufacturer.  Mr.Masters earned a B.S. in Electronics Engineering from Cal Poly Pomona.

 

***Pradeep Patel***has served as VicePresident, ASIC Operations since October 2001. From January 1999 to September2001, Mr. Patel was the Director of ASIC Operations at JNI.  From March 1997 to December 1998, he servedas Director of Operations of Initio Corporation, a privately held developer andmarketer of commercial input/output products based on proprietary ASICs.  From 1984 to 1996, Mr. Patel served in avariety of management positions at Advanced Micro Devices, a publicsemiconductor company, most recently as a Senior Manager of Corporate Qualityand Reliability. Mr. Patel received a BSEE degree from SP University in India.

 

***Richard Sander***has served as VicePresident of Operations since September 2001. From January 2000 to September of 2001, Mr. Sander served as VicePresident of Operations for a division of Maxwell Technology, a publicmanufacturer of electronic components and power and computing systems. FromApril 1997 until January 2000, Mr. Sander served as Director of Operations forCymer, a publicly traded supplier of lasers used in the manufacture ofsemiconductors. Mr. Sander earned a B.S. in Engineering from Oregon StateUniversity and an M.B.A. from San Diego State University.

 

***Sassan Teymouri***has served as VicePresident, ASICs since September 2002. From July 2001 to September 2002, Mr. Teymouri was Vice President,Engineering of JNI.  From January 1999to June 2001, Mr. Teymouri was Vice President, ASIC Engineering at JNI.   From September 1996 to October 1998, Mr.Teymouri was President and Chief Executive Officer of Initio Corporation, aprivately held developer and marketer of commercial input/output products basedon proprietary ASICs.  From May 1992through September 1996, Mr. Teymouri was the General Manager for the RAID groupof Adaptec, Inc., a public corporation. Also, during his employment at Adaptec, Mr. Teymouri served as anEngineering Director of Enterprise Computing Networks. Mr. Teymouri receivedBSEE and MSEE degrees from the University of Michigan.

 

**Section 16(a)Beneficial Ownership Reporting Compliance**

 

Section 16(a) of the Securities Exchange Act of1934 requires JNI’s executive officers, directors and persons who beneficiallyown more than 10% of JNI’s common stock to file initial reports of ownershipand reports of changes in ownership with the Securities and Exchange Commission(“SEC”).  Such persons are required bySEC regulations to furnish JNI with copies of all Section 16(a) formsfiled by such person.

 

34

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Based solely on JNI’s review of such forms furnishedto JNI and written representations from certain reporting persons, JNI believesthat all filing requirements applicable to JNI’s executive officers, directorsand more than 10% stockholders were complied with.

 

35

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**Item 11.  *ExecutiveCompensation***

 

The following table sets forth information concerningthe compensation of each person who served as Chief Executive Officer during2002, the one other most highly compensated executive officer and the otherexecutive officer who would have been included among the four other most highlycompensated executive officers had she continued to serve as an executiveofficer through 2002, during the fiscal years ended December 31, 2000,2001 and 2002.

 

***Summary Compensation Table***

*** ***
|                                         |   | **Annual Compensation** |   |
|----------------------------------------------|--------|-------------------------|--------|
| **Name and Principal Position**              |   | **Year**                |   | **Salary** |   |   |   | **Other Annual**

**Compensation** | ** ** |
| Russell Stern                                |   | 2002                    | (1)    | $ | 94,231 |   | $ | 125,000 | (2) | $ | 8,853 | (3) |
| President and Chief Executive Officer        |   |                    |   |   |   |   |   |   |   |
|                                         |   |                    |   |   |   |   |   |   |   |
| Paul Kim                                     |   | 2002                    | (4)    | 174,231 |   | — |   | 11,532 | (5) |
| Chief Financial Officer                      |   | 2001                    |   | — |   | — |   | — |   |
|                                         |   | 2000                    |   | — |   | — |   | — |   |
| *Former  Officers:*                          |   |                    |   |   |   |   |   |   |   |
|                                         |   |                    |   |   |   |   |   |   |   |
| John Stiska                                  |   | 2002                    | (6)    | $ | 127,885 |   | $ | — |   | $ | 1,386 | (7) |
| Former Interim Chief Executive Officer       |   |                    |   |   |   |   |   |   |   |
|                                         |   |                    |   |   |   |   |   |   |   |
| Neal Waddington                              |   | 2002          | (8)    | 164,206  |   | —  |   | 98,495  | (9) |
| Former President and Chief Executive Officer |   | 2001                    |   | 350,000 |   | 157,000 |   | 278,354 | (10) |
|                                         |   | 2000                    | (11)   | 20,192 |   | 118,813 | (12) | 138 | (13) |
|                                         |   |                    |   |   |   |   |   |   |   |
| Gloria Purdy                                 |   | 2002               | (14)   | 215,770  |   | —  |   | $ | 39,279  | (15) |
| Former Chief Financial Officer               |   | 2001                    |   | 224,199 |   | 58,000 |   | 5,192 | (16) |
|                                         |   | 2000                    |   | 193,061 |   | 87,790 |   | 82,411 | (17) |

 

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(1)                                  Mr.Stern joined JNI Corporation in September 2002, and the amounts shown abovereflect only compensation actually earned in 2002.

 

(2)                                  Includes$125,000 paid to Mr. Stern as a hiring bonus.

 

(3)                                  Includes$4,038 paid as a matching contribution to Mr. Stern’s 401(k) account, $315 paidfor group term life insurance and $4,500 paid as an auto allowance.

 

(4)                                  Mr.Kim was appointed as JNI’s Chief Financial Officer on September 6, 2002.  He was not an executive officer prior to2002, therefore, there are no amounts shown above for 2000 and 2001.

 

(5)                                  Includes$8,712 paid as a matching contribution to Mr. Kim’s 401(k) account, $417 paidfor group term life insurance and $2,403 paid for executive benefits.

 

(6)                                  Mr.Stiska served as JNI’s Interim Chief Executive Officer from May 20, 2002 toSeptember 27, 2002, and the amounts shown above reflect only compensation actuallyearned in 2002.

 

(7)                                  Includes$1,386 paid on behalf of Mr. Stiska for group term life insurance.

 

36

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(8)                                  Mr.Waddington resigned from his position on May 17, 2002, and the amounts shownabove reflect only compensation actually earned in 2002.

 

(9)                                  Includes$96,000 received pursuant to a loan agreement between JNI and Mr. Waddington(for more information regarding this loan agreement, see “Certain Relationshipsand Related Transactions”), $1,419 paid for group term life insurance and$1,076 paid for executive benefits.

 

(10)                            Includes$250,000 of principal and $25,000 in accrued interest forgiven by JNI onJanuary 9, 2002 pursuant to a loan agreement between JNI and Mr. Waddington(for more information regarding this loan agreement, see “Certain Relationshipsand Related Transactions”) and $3,354 paid for group term life insurance.

 

(11)                            Mr.Waddington joined JNI in November 2000, and the amounts shown above reflectonly compensation actually earned in 2000.

 

(12)                            Includes$100,000 paid to Mr. Waddington as a hiring bonus.

 

(13)                            Includes$138 paid on behalf of Mr. Waddington for group term life insurance.

 

(14)                            Ms.Purdy resigned from her position on September 6, 2002, and the amounts shownabove reflect only compensation actually earned in 2002.

 

(15)                            Includes$10,000 paid as a matching contribution to Ms. Purdy’s 401(k) account, $2,526paid for group term life insurance and $26,753 paid for executive benefits.

 

(16)                            Includes$3,769 paid as a matching contribution to Ms. Purdy’s 401(k) account and $1,423paid for group term life insurance.

 

(17)                            Includes$77,391 paid to Ms. Purdy for relocation expenses, $3,825 paid as a matchingcontribution to Ms. Purdy’s 401(k) account and $1,195 paid for group term lifeinsurance.

 

37

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**StockOptions Granted in Fiscal 2002**

 

The following table provides the specified informationconcerning grants of options to purchase JNI’s common stock made during thefiscal year ended December 31, 2002, to the persons named in the SummaryCompensation Table. 

 

**OPTION GRANTS IN LASTFISCAL YEAR**

 
|            |   | **Individual Grants**                                           |   | **Potential Realized Value**

**at Assumed Annual  Rates of Stock Price  Appreciation for Option  Term****(1)** |   |
|-----------------|--------|-----------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------|--------|
| **Name**        |   | **Number of  Shares**

**Underlying  Options**

**Granted (2)** |   | **% of Total  Options  Granted to  Employees  in Fiscal  Year**                                                 |   | **Exercise  Price Per Share (3)** |   | **Expiration  Date** |   | **5%** |   | **10%** |   |
|            |   |                                                            |   |                                                                                                            |   |   |   |   |   |   |   |   |   |
| Russell Stern   |   | 350,000                                                         |   | 13.2                                                                                                            | %      | $ | 2.59 |   | 9/6/2012 |   | $ | 570,093 |   | $ | 1,444,728 |   |
| Paul Kim        |   | 27,800                                                          |   | 1.1                                                                                                             | %      | 7.32 |   | 1/31/2012 |   | 127,978 |   | 324,320 |   |
| Neal Waddington |   | 155,000                                                         |   | 5.9                                                                                                             | %      | 7.32 |   | 1/31/2012 |   | 713,544 |   | 1,808,260 |   |
| John Stiska     |   | 50,000                                                          |   | 1.9                                                                                                             | %      | 5.37 |   | 5/20/2012 |   | 168,858 |   | 427,920 |   |
| John Stiska     |   | 10,000                                                          |   | 0.4                                                                                                             | %      | 5.08 |   | 5/22/2012 |   | 31,948 |   | 80,962 |   |
| Gloria Purdy    |   | 57,600                                                          |   | 2.2                                                                                                             | %      | 7.32 |   | 1/31/2012 |   | 265,162 |   | 671,973 |   |
| Gloria Purdy    |   | 50,000                                                          |   | 1.9                                                                                                             | %      | 5.37 |   | 5/20/2012 |   | 168,858 |   | 427,920 |   |
|                 |        |                                                                 |        |                                                                                                                 |        |  |  |  |  |  |  |  |  |  |  |  |

 

----

 

(1)                                  Potentialgains are net of exercise price, but before taxes associated withexercise.  These amounts representcertain assumed rates of appreciation only, based on the Securities andExchange Commission rules.  Actualgains, if any, on stock option exercises are dependent on the futureperformance of the common stock, overall market conditions and the option holders’continued employment through the vesting period.  The amounts reflected in this table may not necessarily beachieved.

 

(2)                                  InSeptember 2002, JNI’s Board of Directors enacted a voluntary stock optionexchange program for its employees. Under the program, JNI employees were given the opportunity to cancelstock options granted to them between March 10, 1999 and September  27, 2002 in exchange for new options to begranted in the future, on a date more than six months after the date ofcancellation of the original options. Mr. Kim was not an executive officer at the time of the program, and heelected to participate in the program. On September 30, 2002, Mr. Kim voluntarily cancelled 125,800 options hehad previously been granted, which included the 27,800 options granted in2002.  On March 31, 2003, he will begranted 131,400 options which represent options to replace the cancelledoptions.  The exercise price of the newoptions will be at the fair market value of JNI’s common stock on thatdate.  A portion of the new options willbe partially vested when granted based upon his length of service with theCompany with the unvested portion vesting over three years.

 

As of December 31, 2002, the 155,000 options grantedto Mr. Waddington were no longer outstanding as they were canceled effective onhis date of resignation of May 17, 2002.

 

(3)                                  Alloptions were granted at fair market value on the date of grant.

 

38

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**Option Exercises and Fiscal 2002Year-End Values**

 

The following table provides the specified informationconcerning exercises of options to purchase JNI’s common stock in the fiscalyear ended December 31, 2002, and unexercised options held as of that date, bythe persons named in the Summary Compensation Table.

 

 

**Aggregated Option Exercises In LastFiscal Year And Fiscal Year-End Values**

** **
|                |   |                               |   |                |   | **Number of Shares  Underlying Unexercised  Options at Fiscal Year End** |   | **Value of Unexercised  In-the-Money Options  at Fiscal Year End****(1)** |   |
|---------------------|--------|------------------------------------|--------|---------------------|--------|--------------------------------------------------------------------------|--------|---------------------------------------------------------------------------|--------|
| **Name**            |   | **Shares  Acquired  on  Exercise** |   | **Value  Realized** |   | **Exercisable**                                                          |   | **Unexercisable**                                                         |   | **Exercisable** |   | **Unexercisable** |   |
|                |   |                               |   |                |   |                                                                     |   |                                                                      |   |   |   |   |   |
| Russell Stern       |   | 0                                  |   | 0                   |   | 0                                                                        |   | 350,000                                                                   |   | $ | 0 |   | $ | 63,000 |   |
| Paul Kim            |   | 0                                  |   | 0                   |   | 0                                                                        |   | 0                                                                         |   | 0 |   | 0 |   |
| *Former  Officers:* |   |                               |   |                |   |                                                                     |   |                                                                      |   |   |   |   |   |
| Neal Waddington     |   | 0                                  |   | 0                   |   | 0                                                                        |   | 0                                                                         |   | 0 |   | 0 |   |
| John Stiska         |   | 0                                  |   | 0                   |   | 66,895                                                                   |   | 24,105                                                                    |   | 0 |   | 0 |   |
| Gloria Purdy        |   | 0                                  |   | 0                   |   | 233,333                                                                  |   | 139,267                                                                   |   | 0 |   | 0 |   |
|                     |        |                                    |        |                     |        |                                                                          |        |                                                                           |        |  |  |  |  |  |  |

 

----

 

(1)                                  Basedon a fair market value of $2.77, the closing price of JNI’s common stock onDecember 31, 2002, as reported by the Nasdaq National Market.

** **

** **

**39**

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** **

**EmploymentContracts and Termination of Employment and Change-in-Control Arrangements**

 

JNI has entered into a Severance and Change of ControlAgreement with Russell Stern.  In theevent that Mr. Stern is terminated without cause or he resigns within one yearof a change in control of JNI, he will receive as a severance payment eighteen(18) months of his then current total compensation, and all of his unvested,outstanding options to purchase shares of stock in JNI will immediatelyvest.  JNI has entered into a Severanceand Change of Control Agreement with Paul Kim. In the event that Mr. Kim is terminated without cause or he resignswithin one year of a change in control of JNI, he will receive as a severancepayment twelve (12) months of his then current total compensation, and all ofhis unvested, outstanding options to purchase shares of stock in JNI willimmediately vest.  Additionally, JNI hasentered into a Twelve-Month Retention Agreement with Mr. Kim.  In the event that Mr. Kim is terminatedwithout cause during the severance period from September 1, 2002 to August 31,2003 and he is not eligible to receive the severance benefits described in hisSeverance and Change of Control Agreement, he will receive as a severancepayment six (6) months of his then current total compensation.

 

**Compensationof Directors**

** **

Members of the Board of Directors are compensated$20,000 annually for their services as directors of JNI.   In addition, JNI reimburses directors forother out-of-pocket expenses incurred in the performance of their duties asdirectors.  From time to time, directorswho are not employees of JNI may receive options under the Company’s stockoption plans as compensation for their services as directors.  Since fiscal 2001, JNI’s existingnon-employee directors received an initial stock option grant of 30,000 sharesof JNI common stock at an exercise price equaling the fair market value of suchcommon stock on the date of grant and which fully vest four years from the dateof grant.

 

JNI’s existing non-employee directors will alsoreceive an annual stock option grant of 10,000 shares of JNI common stock at anexercise price equaling the fair market value of such common stock on the dateof grant and which shall fully vest one year from the date of grant.

 

Beginning in October 2002, non-employee directorsreceived cash compensation of $1,500 for attendance of each board meeting.  Additionally, non-employee directorsreceived the following cash compensation for attendance of audit committeemeetings, compensation committee meetings and corporate governance committeemeetings:

 

| Attendance  of meeting in person (chairperson)      |   | $ | 1,500 |   |
|-----------------------------------------------------|--------|---|-------|--------|
| Attendance  of meeting in person (committee member) |   | $ | 1,000 |   |
| Attendance  of meeting via telephone                |   | $ | 500   |   |

 

In fiscal 2002, JNIestablished a Special Litigation Committee (SLC) comprised of two non-employeedirectors to investigate the allegations in certain stockholder derivativelawsuits and to determine whether it is in the best interest of the Company toallow the cases to proceed.  The membersof the SLC did not receive compensation similar to the other non-employeedirectors as discussed above.  Membersof the SLC received an initial stock option grant of 10,000 shares of JNIcommon stock at an exercise price equaling the fair market value of such commonstock on the date of grant and which vested 50% on the date of grant and anadditional 50% at the time of the annual meeting of stockholders to be held in2003.  Additionally, each member of theSLC received compensation at an hourly rate of $350 per hour for their serviceson the SLC during 2002.  Amounts paid tothe two directors on the SLC totaled $8,575 and $12,425 for 2002.

 

**CompensationCommittee Interlocks and Insider Participation in Compensation Decisions**

 

The members of theCompensation Committee during fiscal 2002 were Mr. Stiska, Ms. SummersDubrevil, Dr. van Cuylenburg and Dr. Wenaas. Mr. Stiska was a member of the committee from January 1, 2002 until hisappointment as Interim CEO in May 2002 and was then reappointed to thecommittee following his resignation as Interim CEO in October 2002, Ms. SummersDubrevil was a member of the committee for the entire year, Dr. Wenaas was amember of the committee from January 1, 2002 until his resignation in September2002, and Dr. van Cuylenburg was appointed in October 2002.  Except for Mr. Stiska, who served as JNI’sInterim Chief Executive Officer from May 2002 to September 2002, none of thecurrent or past members of the Compensation Committee is currently, or has everbeen at any time since JNI’s formation, one of JNI’s officers or employees.

 

**Item 12.  *SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters***

 

Information about theCompany’s equity compensation plans at December 31, 2002 was as follows:

 

40

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| **Plan  Category**                                         |   | **Number of  Shares to be  Issued Upon  Exercise of  Outstanding  Options** |   | **Weighted  Average  Exercise Price  of Outstanding  Options** |   | **Number of  Shares  Remaining  Available for  Future  Issuance** |        |
|------------------------------------------------------------|--------|-----------------------------------------------------------------------------|--------|----------------------------------------------------------------|--------|-------------------------------------------------------------------|-------------|
| Equity  compensation plans approved by stockholders(a)     |   | 1,341,194                                                                   |   | $                                                              | 6.44   |                                                              | 2,512,606(c | ) |
| Equity  compensation plans not approved by stockholders(b) |   | 542,564                                                                     |   | 3.48                                                           |   | 1,954,906                                                         |        |
| Total                                                      |   | 1,883,758                                                                   |   | $                                                              | 5.59   |                                                              | 4,467,512   |   |

 

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(a)          Consists of the 1997Stock Option Plan, the 1999 Stock Option Plan and the 1999 Employee StockPurchase Plan.

(b)         Consists of the 2000Stock Option Plan (see Note 5, “Benefit Plans” in the Notes to FinancialStatements for a description of the plan).

(c)          Includes 139,642remaining shares reserved for issuance under the 1999 Employee Stock PurchasePlan.

 

41

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**StockOwnership of Certain Beneficial Owners and Management**

 

The following table sets forth, as of March 24, 2003,certain information with respect to the beneficial ownership of JNI’s commonstock by (i) each stockholder known by JNI to be the beneficial owner ofmore than 5% of JNI’s common stock, (ii) each director anddirector-nominee of JNI, (iii) each executive officer named in the SummaryCompensation Table, and (iv) all directors and executive officers of JNIas a group.

 
| **Name of Beneficial Owner****(1)**                                               |   | **Number of Shares**

**Beneficially  Owned**** ****(2)** |   | **Percent of  Common Stock  Outstanding****(3)** |   |
|-----------------------------------------------------------------------------------|--------|----------------------------------------------------------------|--------|--------------------------------------------------|--------|
| **5% or  greater stockholders**                                                   |   |                                                           |   |                                             |   |
| Wellington Management Co  LLP(4)75 State Street  Boston, MA 02109                 |   | 2,677,000                                                      |   | 10.1                                             | %      |
| Lloyd I. Miller III(5)  4550 Gordon Drive  Naples, FL 34102                       |   | 2,473,826                                                      |   | 9.3                                              | %      |
| SACC Partners LP(6)****11150 Santa Monica  Blvd, Suite 750  Los Angeles, CA 90025 |   | 1,438,423                                                      |   | 5.4                                              | %      |
| **Directors**                                                                     |   |                                                           |   |                                             |   |
| John Bolger(7)                                                                    |   | 37,791                                                         |   | *                                                |   |
| Leon Edney(8)                                                                     |   | 5,000                                                          |   | *                                                |   |
| Tom St. Dennis(9)                                                                 |   | 13,125                                                         |   | *                                                |   |
| Russell Stern                                                                     |   | 0                                                              |   | *                                                |   |
| John C. Stiska(10)                                                                |   | 122,759                                                        |   | *                                                |   |
| Sylvia Summers Dubrevil(11)                                                       |   | 13,125                                                         |   | *                                                |   |
| Peter van Cuylenburg(12)                                                          |   | 17,500                                                         |   | *                                                |   |
| Howard Wiener(13)                                                                 |   | 5,000                                                          |   | *                                                |   |
|                                                                              |   |                                                           |   |                                             |   |
| **Executive  Officers**                                                           |   |                                                           |   |                                             |   |
| Paul Kim(14)                                                                      |   | 71,900                                                         |   | *                                                |   |
|                                                                              |   |                                                           |   |                                             |   |
| **Former  Executive Officers**                                                    |   |                                                           |   |                                             |   |
| Neal Waddington                                                                   |   | 0                                                              |   | *                                                |   |
| John Stiska                                                                       |   | 122,759                                                        |   | *                                                |   |
| Gloria Purdy                                                                      |   | 291,904                                                        |   | 1.1                                              | %      |
| Directors and executive officers as a group  (9 persons)****(15)             |   | 286,200                                                        |   | 1.1                                              | %      |

 

42

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*                                         Lessthan 1%.

 

(1)                                  Exceptas otherwise indicated, the persons named in this table have sole voting andinvestment power with respect to all shares of common stock shown asbeneficially owned by them, subject to community property laws where applicableand to the information contained in the footnotes to this table.

 

(2)                                  Underthe rules of the Securities and Exchange Commission, a person is deemed to bethe beneficial owner of shares that can be acquired by such person within 60days upon the exercise of options.

 

(3)                                  Calculatedon the basis of 26,590,864 shares of common stock outstanding as of February28, 2003, except that shares of common stock underlying options exercisablewithin 60 days of February 28, 2003 are deemed outstanding for purposes ofcalculating that stockholder’s percentage beneficial ownership.

 

(4)                                  Basedon Schedule 13G filed on January 10, 2003.

 

(5)                                  Basedon Schedule 13D/A filed on March 21, 2003.

 

(6)                                  Basedon Schedule 13G/A filed on February 7, 2003.

 

(7)                                  Includes33,791 shares issuable upon exercise of options exercisable within 60 days ofFebruary 28, 2003.

 

(8)                                  Includes5,000 shares issuable upon exercise of options exercisable within 60 days ofFebruary 28, 2003.

 

(9)                                  Includes13,125 shares issuable upon exercise of options exercisable within 60 days ofFebruary 28, 2003.

 

(10)                            Includes69,478 shares issuable upon exercise of options exercisable within 60 days ofFebruary 28, 2003.

 

(11)                            Includes13,125 shares issuable upon exercise of options exercisable within 60 days ofFebruary 28, 2003.

 

(12)                            Includes17,500 shares issuable upon exercise of options exercisable within 60 days ofFebruary 28, 2003.

 

(13)                            Includes5,000 shares issuable upon exercise of options exercisable within 60 days ofFebruary 28, 2003.

 

(14)                            Includes68,900 shares issuable upon exercise of options exercisable within 60 days ofFebruary 28, 2003.

 

(15)                            SeeNotes 4 through 12.  Includes 225,919shares issuable upon exercise of options exercisable within 60 days of February28, 2003.

 

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**Item 13.**  ***CertainRelationships and Related Transactions***

* *

*Consulting Agreement with Non-Employee Director*

 

Peter van Cuylenburg, anon-employee director of JNI, performed services for the Company over athree-month period pursuant to a consulting agreement.  As payment for his services, Dr. van Cuylenburgreceived cash compensation of $32,500. Additionally, he received a stock option grant of 17,500 sharesof JNI common stock at an exercise price equaling the fair market value of suchcommon stock on the date of grant and which vested ratably over a three monthperiod from the date of grant.  Theseoptions were valued at approximately $32,000 using the Black-Scholes optionpricing model.

 

*Loan to Former Chief Executive Officer*

 

In connection with Mr.Waddington’s initial employment arrangement with JNI, on January 9, 2001, JNIentered into a loan agreement with him in the amount of $500,000 which bore interest at rate of 5%. OnJanuary 9, 2002 (the first anniversary date), the Company forgave $250,000 ofprincipal and $25,000 in accrued interest in accordance with the terms of theloan agreement.  The total amountforgiven was recorded as compensation expense during the year ended December31, 2001.  In the first quarter of 2002,Mr. Waddington executed a promissory note for $99,000 for payroll taxes whichthe Company paid on his behalf on January 9, 2002.  This promissory note was due by April 15, 2003 and bore interestat a 5% rate.

 

At thetime of the his resignation on May 19, 2002, Mr. Waddington’s loan outstandingtotaled $349,000 which consisted of $99,000 in payroll taxes due and $250,000for the remaining portion of the loan which was entered into upon his hiring,plus accrued interest.  Upon hisresignation from the Company, the outstanding loan became due and payable.  In September 2002, Mr. Waddington paid infull the $99,000 in payroll taxes due and $154,000 toward the remaining portionof the loan.  The $96,000 loan balancewas deemed earned under California law based on the services provided by Mr.Waddington through his date of termination and recorded as compensationexpense.  As of December 31, 2002, noamounts remain outstanding from Mr. Waddington.

 

## **Item 14.  *Controls and Procedures***

 

(a) Under the supervisionand with the participation of our management, including our principal executiveofficer and principal financial officer, we evaluated the effectiveness of thedesign and operation of our disclosure controls and procedures, as such term isdefined under Rule 13a-14(c) promulgated under the Securities Exchange Act of1934, as amended (the “Exchange Act”), within the 90 day period prior to thefiling date of this report. Based on their evaluation, our principal executiveofficer and principal financial officer concluded that our disclosure controlsand procedures were effective as of that date.

 

(b) There have been no significant changes (includingcorrective actions with regard to significant deficiencies or materialweaknesses) in our internal controls or in other factors that couldsignificantly affect these controls subsequent to the date of the evaluationreferenced in paragraph (a) above.

 

# **PART IV**

## ** **

## **Item 15.  *Exhibits,Financial Statement Schedules, and Reports on Form 8-K***

 

(a)                                  The following documents are filed as part of thisreport:

 

1.                                       **Financial Statements**:

 

Reportof Independent Accountants

 

BalanceSheets as of December 31, 2002 and 2001

 

44

----

 

Statementsof Operations for the Years Ended December 31, 2002, 2001 and 2000

 

Statementsof Stockholders’ Equity and Comprehensive Income (Loss) for the Years EndedDecember 31, 2002, 2001 and 2000

 

Statementsof Cash Flows for the Years Ended December 31, 2002, 2001 and 2000

 

Notesto Financial Statements

 

2.                                       **Financial Statement Schedules:**

 

Schedule II– Valuation & Qualifying Accounts

 

Allother schedules are omitted because they are not applicable or the requiredinformation is shown in the financial statements or notes thereto.

 

(b)                                 **Reports on Form 8-K**

The Company didnot file any Current Reports on Form 8-K during the quarter ended December 31,2002.

 

(c)                                  **Exhibits:**

 
|   | **Exhibit  Number** |   | **Description**                                                                                                                        |
|--------|---------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------|
|   |                |   |                                                                                                                                   |
|   | 3.1(2)              |   | Fourth Amended and  Restated Certificate of Incorporation of the Company                                                               |
|   | 3.2(1)              |   | By-laws of the Company  as amended on March 20, 2003                                                                                   |
|   | 4.1(2)              |   | Specimen Common Stock  Certificate                                                                                                     |
|   | 10.1(2)             |   | Form of Indemnity  Agreement for directors and executive officers                                                                      |
|   | 10.2(2)             |   | 1997 Stock Option Plan,  as amended, and forms of Incentive Stock Option Agreement and Nonstatutory  Stock Option Agreement thereunder |
|   | 10.3(4)             |   | Amended and Restated  1999 Stock Option Plan, terms of Stock Option Agreement and form of Stock  Option Grant Agreement thereunder     |
|   | 10.4(2)             |   | 1999 Employee Stock  Purchase Plan and form of subscription agreement thereunder                                                       |
|   | 10.5(5)             |   | 2000 Non-Qualified  Stock Option Plan, terms of Stock Option Agreement and form of Stock Option  Grant Agreement thereunder            |
|   | 10.16(3)            |   | Lease dated, July 11,  2000 between Pacific Plaza Carmel Valley LLC and JNI Corporation (Building A)                                   |
|   | 10.17(3)            |   | Lease dated, July 11,  2000 between Pacific Plaza Carmel Valley LLC and JNI Corporation (Building B)                                   |
|   | 10.21(6)            |   | Loan Agreement and  Promissory Note between JNI and Neal Waddington, dated January 9, 2001                                             |
|   | 10.26(7)            |   | Addendum to Loan  Agreement between JNI and Neal Waddington dated February 13, 2002                                                    |
|   | 10.27(7)(8)         |   | Asset Acquisition  Agreement between JNI Corporation and Troika Networks, Inc. dated January 22,  2002                                 |
|   | 10.28(7)            |   | Development and License  Agreement between JNI Corporation and Troika Networks, Inc. dated January 22,  2002                           |
|   | 10.29(9)            |   | Offer letter between  Russell Stern and JNI Corporation dated September 6, 2002                                                        |
|   | 10.30(9)            |   | Severance and Change of  Control Agreement between Russell Stern and JNI Corporation dated September  8, 2002                          |
|   | 10.31(1)            |   | Severance and Change of  Control Agreement between Paul Kim and JNI Corporation dated June 21, 2002                                    |

 

45

----

 
|   | 10.32(1) |   | Twelve-Month Retention  Agreement between Paul Kim and JNI Corporation dated September 1, 2002 |
|--------|----------|--------|------------------------------------------------------------------------------------------------|
|   | 23.1(1)  |   | Consent of  PricewaterhouseCoopers LLP                                                         |
|   | 99.1     |   | Certification of Chief  Executive Officer                                                      |
|   | 99.2     |   | Certification of Chief  Financial Officer                                                      |

 

----

(1) Filed herewith.

 

(2)Incorporated by reference to the Registration Statement on Form S-1 filed byJNI Corporation (File No.333-86501).

 

(3) Incorporated byreference to the Quarterly Report on Form 10-Q filed by JNI for the quarterended June 30, 2000.

 

(4) Incorporated byreference to the Registration Statement on Form S-1 filed by JNI Corporation(File No.333-45934).

 

(5) Incorporated byreference to the Registration Statement on Form S-8 filed by JNI on September14, 2000 (File No. 333-45752).

 

(6) Incorporated byreference to the Report on Form 10-K filed by JNI for the year ended December31, 2001.

 

(7) Incorporated byreference to the Quarterly Report on Form 10-Q filed by JNI for the quarterended March 31, 2002.

 

(8) Confidentialtreatment has been granted with respect to certain portions of thisexhibit.  Omitted portions have beenfiled separately with the Securities and Exchange Commission.

 

(9) Incorporated by referenceto the Quarterly Report on Form 10-Q filed by JNI for the quarter endedSeptember 30, 2002.

 

46

----

 

**SIGNATURES**

 

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

 
|   | JNI CORPORATION |
|--------|-----------------|
|   |            |
|   | March 28, 2003  |
|   |            |
|   | By:             | /s/ RUSSELL STERN |   |
|   |            | Russell Stern |
|   |            | *President,  Chief Executive Officer and* |
|   |            | *Director* |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant in thecapacities and on the dates indicated.

 
| **Signature**                  |   | **Title**                                                            |   | **Date**       |
|--------------------------------|--------|----------------------------------------------------------------------|--------|----------------|
| /s/ RUSSELL STERN              |   | President, Chief Executive Officer and Director                      |   | March 28, 2003 |
| Russell Stern                  |   | (Principal Executive Officer)                                        |   |
|                           |   |                                                                 |   |           |
| /s/ PAUL KIM                   |   | Chief Financial Officer(Principal  Financial and Accounting Officer) |   | March 28, 2003 |
| Paul Kim                       |   |                                                                 |
|                           |   |                                                                 |   |           |
| /s/ JOHN STISKA                |   | Chairman of the Board of Directors                                   |   | March 28, 2003 |
| John Stiska                    |   |                                                                 |
|                           |   |                                                                 |   |           |
| /s/ JOHN BOLGER                |   | Director                                                             |   | March 28, 2003 |
| John Bolger                    |   |                                                                 |
|                           |   |                                                                 |   |           |
| /s/ TOM ST. DENNIS             |   | Director                                                             |   | March 28, 2003 |
| Tom St. Dennis                 |   |                                                                 |
|                           |   |                                                                 |   |           |
| /s/ SYLVIA SUMMERS-DUBREVIL    |   | Director                                                             |   | March 28, 2003 |
| Sylvia Summers-Dubrevil        |   |                                                                 |
|                           |   |                                                                 |   |           |
| /s/  PETER VAN CUYLENBURG |   | Director                                                             |   | March 28, 2003 |
| Peter Van Cuylenburg           |   |                                                                 |

 

47

----

 

**CERTIFICATIONS**

 

I, Russell Stern, certifythat:

 

1. I have reviewed thisannual report on Form 10-K of JNI Corporation;

2. Based on my knowledge,this annual report does not contain any untrue statement of a material fact oromit to state a material fact necessary to make the statements made, in lightof the circumstances under which such statements were made, not misleading withrespect to the period covered by this annual report;

3. Based on my knowledge,the financial statements, and other financial information included in thisannual report, fairly present in all material respects the financial condition,results of operations and cash flows of the registrant as of, and for, theperiods presented in this annual report;

4. The registrant’s othercertifying officer and I are responsible for establishing and maintainingdisclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and15d-14) for the registrant and have:

a)              designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant is made known to us by others within those entities,particularly during the period in which this annual report is being prepared;

b)             evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this annual report (the “EvaluationDate”); and

c)              presented in thisannual report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s othercertifying officer and I have disclosed, based on our most recent evaluation,to the registrant’s auditors and the audit committee of registrant’s board ofdirectors (or persons performing the equivalent functions):

a)              all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

b)             any fraud, whether ornot material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

6. The registrant’s othercertifying officer and I have indicated in this annual report whether therewere significant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 
| Dated:  March 28, 2003              |
|------------------------------------------|
|                                     |
| /s/ RUSSELL STERN                        |   |
| Russell Stern,                           |
| *Chief  Executive Officer and President* |

 

 

48

----

 

I, Paul Kim, certifythat:

 

1. I have reviewed thisannual report on Form 10-K of JNI Corporation;

2. Based on my knowledge,this annual report does not contain any untrue statement of a material fact oromit to state a material fact necessary to make the statements made, in lightof the circumstances under which such statements were made, not misleading withrespect to the period covered by this annual report;

3. Based on my knowledge,the financial statements, and other financial information included in thisannual report, fairly present in all material respects the financial condition,results of operations and cash flows of the registrant as of, and for, theperiods presented in this annual report;

4. The registrant’s othercertifying officer and I are responsible for establishing and maintainingdisclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and15d-14) for the registrant and have:

a)              designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant is made known to us by others within those entities,particularly during the period in which this annual report is being prepared;

b)             evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this annual report (the“Evaluation Date”); and

c)              presented in thisannual report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s othercertifying officer and I have disclosed, based on our most recent evaluation,to the registrant’s auditors and the audit committee of registrant’s board ofdirectors (or persons performing the equivalent functions):

a)              all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

b)             any fraud, whether ornot material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

6. The registrant’s othercertifying officer and I have indicated in this annual report whether therewere significant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 
| Dated:  March 28, 2003 |
|-----------------------------|
|                        |
|  /s/ PAUL KIM          |   |
| Paul Kim,                   |
| *Chief  Financial Officer*  |

 

 

49

----

 

**JNI Corporation**

** **

**INDEX TOFINANCIAL STATEMENTS**

 
| Report of Independent  Accountants                                                                                             |
|--------------------------------------------------------------------------------------------------------------------------------|
| Balance Sheets as of December 31, 2002  and 2001                                                                               |
| Statements  of Operations for the Years Ended December 31, 2002, 2001 and 2000                                                 |
| Statements  of Stockholders’ Equity and Comprehensive Income (Loss) for the Years Ended  December 31, 2002, 2001 and 2000 |
| Statements  of Cash Flows for the Years Ended December 31, 2002, 2001 and 2000                                                 |
| Notes to Financial  Statements                                                                                                 |

 

F-1

----

 

**JNICorporation**

 

**Report of Independent Accountants**

 

To the Board of Directorsand Stockholders of JNI Corporation:

 

In our opinion, thefinancial statements listed in the index appearing under Item 15(a)(1) on page44 present fairly, in all material respects, the financial position of JNICorporation at December 31, 2002 and 2001, and the results of its operationsand its cash flows for each of the three years in the period ended December 31,2002 in conformity with accounting principles generally accepted in the UnitedStates of America.  In addition, in ouropinion, the financial statement schedule listed in the index appearing underItem 15(a)(2) on page 44 presents fairly, in all material respects, theinformation set forth therein when read in conjunction with the relatedfinancial statements.  These financialstatements and financial statement schedule are the responsibility of theCompany’s management; our responsibility is to express an opinion on thesefinancial statements and financial statement schedule based on our audits.  We conducted our audits of these statementsin accordance with auditing standards generally accepted in the United Statesof America, which require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement.  An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements, assessing the accounting principlesused and significant estimates made by management, and evaluating the overallfinancial statement presentation.  Webelieve that our audits provide a reasonable basis for our opinion.

 
| PricewaterhouseCoopers  LLP |
|-----------------------------|
|                        |
| San Diego, California       |
| March 18, 2003              |

 

F-2

----

 

**JNICorporation**

** **

**BALANCESHEETS**

**(In thousands, except share and pershare data)**

 
|                                                                                                                                    |   | **December  31,** |    |
|-----------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|---------|
|                                                                                                                                    |   | **2002**          |    | **2001** |   |
| ASSETS                                                                                                                                  |   |              |    |   |   |
| Current  assets:                                                                                                                        |   |              |    |   |   |
| Cash  and cash equivalents                                                                                                              |   | $                 | 3,809   |   | $ | 4,490 |   |
| Marketable  securities available for sale                                                                                               |   | 83,558            |    | 82,974 |   |
| Accounts  receivable, net                                                                                                               |   | 3,715             |    | 8,605 |   |
| Inventories                                                                                                                             |   | 3,874             |    | 9,545 |   |
| Other  current assets                                                                                                                   |   | 1,255             |    | 1,968 |   |
| Total current assets                                                                                                                    |   | 96,211            |    | 107,582 |   |
| Marketable  securities available for sale                                                                                               |   | 15,313            |    | 30,558 |   |
| Property  and equipment, net                                                                                                            |   | 8,980             |    | 13,371 |   |
| Licensed technology, net                                                                                                                |   | 600               |    | — |   |
| Preferred  stock investment                                                                                                             |   | 600               |    | — |   |
| Other  assets                                                                                                                           |   | 377               |    | 636 |   |
|                                                                                                                                    |   | $                 | 122,081 |   | $ | 152,147 |   |
|                                                                                                                                    |   |              |    |   |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                               |   |              |    |   |   |
|                                                                                                                                    |   |              |    |   |   |
| Current  liabilities:                                                                                                                   |   |              |    |   |   |
| Accounts  payable                                                                                                                       |   | $                 | 3,188   |   | $ | 2,769 |   |
| Accrued  liabilities                                                                                                                    |   | 10,697            |    | 5,446 |   |
| Deferred  revenue                                                                                                                       |   | 1,709             |    | 2,397 |   |
| Total  current liabilities                                                                                                              |   | 15,594            |    | 10,612 |   |
| Other  liabilities                                                                                                                      |   | 368               |    | 531 |   |
| Total  liabilities                                                                                                                      |   | 15,962            |    | 11,143 |   |
|                                                                                                                                    |   |              |    |   |   |
| Commitments  and Contingencies (Notes 8 and 9)                                                                                          |   |              |    |   |   |
|                                                                                                                                    |   |              |    |   |   |
| Stockholders’  equity:                                                                                                             |   |              |    |   |   |
| Preferred  stock, undesignated series, 5,000,000 shares authorized; none issued                                                         |   | —            |    | — |   |
| Common  stock, par value $.001 per share; 100,000,000 shares authorized;  26,590,864 and 26,574,873 shares issued  and outstanding |   | 27                |    | 27 |   |
| Additional  paid-in capital                                                                                                             |   | 146,580           |    | 145,854 |   |
| Unearned  stock-based compensation                                                                                                      |   | —            |    | (166 | ) |
| Accumulated  other comprehensive income                                                                                                 |   | 246               |    | 455 |   |
| Retained  deficit                                                                                                                       |   | (34,680           | )       | (36 | ) |
| Common  stock in treasury, at cost – 1,100,000 and 900,000 shares                                                                  |   | (6,054            | )       | (5,130 | ) |
| Total  stockholders’ equity                                                                                                        |   | 106,119           |    | 141,004 |   |
|                                                                                                                                    |   | $                 | 122,081 |   | $ | 152,147 |   |

 

See accompanyingnotes to financial statements.

 

F-3

----

 

**JNICorporation**

 

**STATEMENTS OF OPERATIONS**

**(In thousands, except share and pershare data)**

 
|                                              |   | **Year Ended  December 31,** |    |
|---------------------------------------------------|--------|------------------------------|---------|
|                                              |   | **2002**                     |    | **2001** |   | **2000** |   |
|                                              |   |                         |    |   |   |   |   |
| Net  revenues                                     |   | $                            | 38,362  |   | $ | 75,263 |   | $ | 103,181 |   |
| Cost  of revenues                                 |   | 25,399                       |    | 39,321 |   | 42,050 |   |
| Gross  margin                                     |   | 12,963                       |    | 35,942 |   | 61,131 |   |
|                                              |   |                         |    |   |   |   |   |
| Operating  expenses:                              |   |                         |    |   |   |   |   |
| Research  and development                         |   | 21,125                       |    | 24,564 |   | 18,918 |   |
| Selling  and marketing                            |   | 11,832                       |    | 15,993 |   | 12,323 |   |
| General  and administrative                       |   | 8,731                        |    | 9,063 |   | 7,938 |   |
| Loss  on lease commitment                         |   | 6,991                        |    | — |   | — |   |
| Amortization  of intangible assets                |   | —                       |    | 4,688 |   | 5,359 |   |
| Amortization  of stock-based compensation         |   | 166                          |    | 433 |   | 623 |   |
| Total  operating expenses                         |   | 48,845                       |    | 54,741 |   | 45,161 |   |
| Operating  income (loss)                          |   | (35,882                      | )       | (18,799 | ) | 15,970 |   |
| Interest  income                                  |   | 2,822                        |    | 5,056 |   | 2,953 |   |
| Other  income (expense), net                      |   | (1,584                       | )       | (5 | ) | (45 | ) |
| Income  (loss) before income taxes                |   | (34,644                      | )       | (13,748 | ) | 18,878 |   |
| Income  tax provision                             |   | —                       |    | — |   | 4,622 |   |
|                                              |   |                         |    |   |   |   |   |
| Net  income (loss)                                |   | $                            | (34,644 | ) | $ | (13,748 | ) | $ | 14,256 |   |
|                                              |   |                         |    |   |   |   |   |
| Earnings  (loss) per share:                       |   |                         |    |   |   |   |   |
| Basic                                             |   | $                            | (1.30   | ) | $ | (0.51 | ) | $ | 0.61 |   |
| Diluted                                           |   | $                            | (1.30   | ) | $ | (0.51 | ) | $ | 0.53 |   |
|                                              |   |                         |    |   |   |   |   |
| Number  of shares used in per share computations: |   |                         |    |   |   |   |   |
| Basic                                             |   | 26,563,000                   |    | 26,938,000 |   | 23,541,000 |   |
| Diluted                                           |   | 26,563,000                   |    | 26,938,000 |   | 27,009,000 |   |

 

**Seeaccompanying notes to financial statements.**

** **

**F-4**

----

**JNICorporation**

** **

**STATEMENTS OFSTOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)**

**(In thousands, except share data)**

** **
|                                                                                      |   | **Common  Stock** |   | **Additional    Paid-In  Capital** |   | **Unearned  Stock-Based   Compensation** |       | **Accumulated  Other  Comprehensive  Income (Loss)** |       | **Retained  Earnings  (Deficit)** |       | **Treasury  Stock** |   | **Total  Stockholders’  Equity** |   | **Comprehensive  Income  (Loss)** |    |
|-------------------------------------------------------------------------------------------|--------|-------------------|--------|------------------------------------|--------|------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------|------------|---------------------|--------|---------------------------------------|--------|-----------------------------------|---------|
|                                                                                      |   | **Shares**        |   | **Amount**                         |   |                                     | ** ** | ** **                                           | ** ** | ** **                        | ** ** |
| **Balance  – December 31, 1999**                                                     |   | 21,838,679        |   | $                                  | 22     |                                     | $          | 67,078                                               |       | $                                 | (1,311     | )                   | $      | (23                                   | )      | $                                 | (544    | ) | $ | — |   | $ | 65,222 |   |   |   |
| Exercise  of warrants by Adaptec                                                          |   | 839,998           |   | 1                                  |   |                                     |       |                                                 |       |                              |       |                |   |                                  |   | 1                                 |    |   |   |
| Stock-based  compensation                                                                 |   |              |   |                               |   |                                     |       | 646                                                  |       |                              |       |                |   |                                  |   | 646                               |    |   |   |
| Common  stock options exercised                                                           |   | 1,789,409         |   | 2                                  |   | 3,047                                    |       |                                                 |       |                              |       |                |   |                                  |   | 3,049                             |    |   |   |
| Common  stock issued under Employee Stock Purchase Plan                                   |   | 83,663            |   |                               |   | 1,381                                    |       |                                                 |       |                              |       |                |   |                                  |   | 1,381                             |    |   |   |
| Unrealized  gain on marketable Securities                                                 |   |              |   |                               |   |                                     |       |                                                 |       | 29                                |       |                |   |                                  |   | 29                                |    | 29 |   |
| Tax  benefit from stock option transactions                                               |   |              |   |                               |   | 3,187                                    |       |                                                 |       |                              |       |                |   |                                  |   | 3,187                             |    |   |   |
| Issuance  of common stock in public offering, net of issuance costs                       |   | 1,000,000         |   | 1                                  |   | 68,917                                   |       |                                                 |       |                              |       |                |   |                                  |   | 68,918                            |    |   |   |
| Net  income                                                                               |   |              |   |                               |   |                                     |       |                                                 |       |                              |       | 14,256              |   |                                  |   | 14,256                            |    | 14,256 |   |
| **Balance  – December 31, 2000**                                                     |   | 25,551,749        |   | 26                                 |   | 143,610                                  |       | (665                                                 | )          | 6                                 |       | 13,712              |   | —                                |   | 156,689                           |    | 14,285 |   |
| Stock-based  compensation                                                                 |   |              |   |                               |   | (66                                      | )          | 499                                                  |       |                              |       |                |   |                                  |   | 433                               |    |   |   |
| Common  stock options exercised                                                           |   | 1,760,222         |   | 1                                  |   | 1,111                                    |       |                                                 |       |                              |       |                |   |                                  |   | 1,112                             |    |   |   |
| Common  stock issued under Employee Stock Purchase Plan                                   |   | 162,902           |   |                               |   | 1,199                                    |       |                                                 |       |                              |       |                |   |                                  |   | 1,199                             |    |   |   |
| Unrealized  gain on marketable Securities                                                 |   |              |   |                               |   |                                     |       |                                                 |       | 449                               |       |                |   |                                  |   | 449                               |    | 449 |   |
| Repurchase  of common stock                                                               |   | (900,000          | )      |                               |   |                                     |       |                                                 |       |                              |       |                |   | (5,130                                | )      | (5,130                            | )       |   |   |
| Net  loss                                                                            |   |              |   |                               |   |                                     |       |                                                 |       |                              |       | (13,748             | )      |                                  |   | (13,748                           | )       | (13,748 | ) |
| **Balance – December 31, 2001**                                                      |   | 26,574,873        |   | 27                                 |   | 145,854                                  |       | (166                                                 | )          | 455                               |       | (36                 | )      | (5,130                                | )      | 141,004                           |    | (13,299 | ) |
| Stock-based

        compensation                      |   |              |   |                               |   | 166                                      |       |                                                 |       |                              |       |                |   | 166                                   |   |                              |    |
| Common  stock options exercised                                                           |   | 52,198            |   |                               |   | 51                                       |       |                                                 |       |                              |       |                |   |                                  |   | 51                                |    |   |   |
| Common  stock issued under Employee Stock Purchase Plan                                   |   | 163,793           |   |                               |   | 643                                      |       |                                                 |       |                              |       |                |   |                                  |   | 643                               |    |   |   |
| Stock  options granted to consultant                                                      |   |              |   |                               |   | 32                                       |       |                                                 |       |                              |       |                |   |                                  |   | 32                                |    |   |   |
| Unrealized  loss on marketable Securities                                                 |   |              |   |                               |   |                                     |       |                                                 |       | (209                              | )          |                |   |                                  |   | (209                              | )       | (209 | ) |
| Settlement  of a note receivable in the form of common stock received into treasury stock |   | (200,000          | )      |                               |   |                                     |       |                                                 |       |                              |       |                |   | (924                                  | )      | (924                              | )       |   |   |
| Net  loss                                                                            |   |              |   |                               |   |                                     |       |                                                 |       |                              |       | (34,644             | )      |                                  |   | (34,644                           | )       | (34,644 | ) |
| **Balance – December 31, 2002**                                                      |   | 26,590,864        |   | $                                  | 27     |                                     | $          | 146,580                                              |       | $                                 | —     |                | $      | 246                                   |   | $                                 | (34,680 | ) | $ | (6,054 | ) | $ | 106,119 |   | $ | (34,853 | ) |
|                                                                                           |        |                   |        |                                    |        |                                          |            |                                                      |            |                                   |            |                     |        |                                       |        |                                   |         |  |  |  |  |  |  |  |  |  |  |  |

 

 

See accompanyingnotes to financial statements.

** **

**F-5**

----

**JNICorporation**

** **

**STATEMENTS OF CASH FLOWS**

**(In thousands)**

** **
|                                                                                                 |   | **Year Ended  December 31,** |    |
|------------------------------------------------------------------------------------------------------|--------|------------------------------|---------|
|                                                                                                 |   | **2002**                     |    | **2001** |   | **2000** |   |
| **Cash  flows from operating activities:**                                                           |   |                         |    |   |   |   |   |
| Net  income (loss)                                                                                   |   | $                            | (34,644 | ) | $ | (13,748 | ) | $ | 14,256 |   |
| Adjustments  to reconcile net income (loss) to net cash (used in) provided by operating  activities: |   |                         |    |   |   |   |   |
| Deferred  income taxes                                                                               |   | —                       |    | — |   | (3,850 | ) |
| Tax  benefit from stock option transactions                                                          |   | —                       |    | — |   | 3,187 |   |
| Depreciation  and amortization                                                                       |   | 5,766                        |    | 5,049 |   | 2,238 |   |
| Amortization  of intangible assets and licensed technology                                           |   | 1,204                        |    | 4,688 |   | 5,359 |   |
| Impairment  of licensed technology                                                                   |   | 5,452                        |    | — |   | — |   |
| Amortization  of stock-based compensation                                                            |   | 166                          |    | 433 |   | 646 |   |
| Impairment  of preferred stock investment                                                            |   | 1,400                        |    | — |   | — |   |
| Non-cash  expenses and charges                                                                       |   | 612                          |    | — |   | — |   |
| Changes  in assets and liabilities:                                                                  |   |                         |    |   |   |   |   |
| Accounts  receivable, net                                                                            |   | 4,890                        |    | 13,030 |   | (15,330 | ) |
| Inventories                                                                                          |   | 5,671                        |    | 9,717 |   | (15,216 | ) |
| Other  assets                                                                                        |   | (288                         | )       | 4,465 |   | (6,358 | ) |
| Deferred  income taxes                                                                               |   | —                       |    | — |   | 6,105 |   |
| Accounts  payable                                                                                    |   | 419                          |    | (6,357 | ) | 5,002 |   |
| Accrued  liabilities                                                                                 |   | 5,355                        |    | (2,276 | ) | 4,208 |   |
| Deferred  revenue                                                                                    |   | (688                         | )       | (2,307 | ) | 4,704 |   |
| Other  liabilities                                                                                   |   | (207                         | )       | — |   | (112 | ) |
| Net  cash (used in) provided by operating activities                                                 |   | (4,892                       | )       | 12,694 |   | 4,839 |   |
|                                                                                                 |   |                         |    |   |   |   |   |
| **Cash  flows from investing activities:**                                                           |   |                         |    |   |   |   |   |
| Purchases  of marketable securities available for sale                                               |   | (3,048                       | )       | (9,863 | ) | (72,554 | ) |
| Proceeds  from sale of marketable securities available for sale                                      |   | 17,500                       |    | 9,130 |   | — |   |
| Purchase  of licensed technology and services                                                        |   | (7,500                       | )       | — |   | — |   |
| Purchase  of preferred stock investment                                                              |   | (2,000                       | )       | — |   | — |   |
| Capital  expenditures                                                                                |   | (1,302                       | )       | (8,747 | ) | (6,601 | ) |
| Net  cash provided by (used in) investing activities                                                 |   | 3,650                        |    | (9,480 | ) | (79,155 | ) |
|                                                                                                 |   |                         |    |   |   |   |   |
| **Cash  flows from financing activities:**                                                           |   |                         |    |   |   |   |   |
| Net  proceeds from issuance of common stock                                                          |   | 694                          |    | 2,311 |   | 73,349 |   |
| Purchase  of treasury stock                                                                          |   | —                       |    | (5,130 | ) | — |   |
| Payment  of capital leases                                                                           |   | (133                         | )       | — |   | — |   |
| Net  cash provided by (used in) financing activities                                                 |   | 561                          |    | (2,819 | ) | 73,349 |   |
| Net  change in cash                                                                                  |   | (681                         | )       | 395 |   | (967 | ) |
| Cash,  beginning of period                                                                           |   | 4,490                        |    | 4,095 |   | 5,062 |   |
| Cash,  end of period                                                                                 |   | $                            | 3,809   |   | $ | 4,490 |   | $ | 4,095 |   |
|                                                                                                 |   |                         |    |   |   |   |   |
| **Supplemental  non-cash activities:**                                                               |   |                         |    |   |   |   |   |
| Acquisition  of property and equipment under capital leases                                          |   | $                            | 73      |   | $ | 678 |   | $ | — |   |
| Settlement  of a note receivable in the form of common stock received into treasury stock            |   | $                            | 1,260   |   | $ | — |   | $ | — |   |

 

See accompanyingnotes to financial statements.

 

F-6

----

 

**JNICorporation**

** **

**NOTES TOFINANCIAL STATEMENTS**

**(Inthousands, except share and per share data)**

** **

**Note 1 —The Company and its Significant Accounting Policies**

 

# ***The Company***

 

JNI Corporation (“JNI” orthe “Company”) is a leading designer and supplier of enterprise storageconnectivity products that connect servers and data storage devices. TheCompany currently designs, markets and sells a broad range of Fibre Channelhost bus adapters that connect servers to storage subsystems to facilitate theintegration and management of devices used in storage area networks, or SANs.The Company’s Fibre Channel host bus adapters incorporate its proprietary ASICtechnology. The Company also offers a line of InfiniBand products forserver-to-server connectivity.  TheCompany operates in one business segment.

 

# ***Use of Estimates***

 

The preparation offinancial statements in conformity with generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period.  Actual results could differ from thoseestimates.

 

# ***Cash and Cash Equivalents***

 

The Company considers cashequivalents to be only those investments which are highly liquid, readilyconvertible to cash and which mature within three months from the date ofpurchase.  The carrying value of cashand cash equivalents approximates fair value due to the nature of theirshort-term maturities.

 

# ***Marketable Securities***

 

The Company’s marketable securities consist of moneymarkets, certificates of deposit, commercial paper, and fixed and variable A orhigher graded U.S. government, state and local, and corporate debt obligationswith maturities ranging from one to twenty-four months, all of which aremanaged by three domestic financial institutions. The Company has classifiedits marketable securities as “available for sale” and carries them at fairvalue with net unrealized holding gains and losses reported in accumulatedother comprehensive income (loss).

 

# ***Inventories***

 

Inventories are stated atthe lower of cost (on a first-in, first-out method) or market.  Provisions, when necessary, are made toreduce excess and obsolete inventories to their estimated net realizablevalues.

 

# ***Property and Equipment***

 

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

 

F-7

----

 

# ***Capital Leases***

 

Property under capital leases is amortized over thelives of the respective leases or the estimated useful lives of theassets.  Amortization expense forproperty acquired under capital leases is included in depreciationexpense.  The Company’s property undercapital leases totaled $751 and $678 at December 31, 2002 and 2001,respectively.  The total accumulated amortizationas of December 31, 2002 and 2001 totaled $251 and $19, respectively.

 

# ***Long-lived Assets***

 

The Company evaluates thecarrying value of its long-lived assets when events or changes in circumstancesindicate that an asset’s carrying value may not be recoverable.  An impairment loss is recognized when thesum of the expected future undiscounted net cash flows is less than thecarrying value of the asset.  Animpairment loss would be measured by comparing the amount by which the carryingvalue exceeds the fair value of the asset being evaluated for impairment.  The Company recorded an impairment charge tocost of revenues for licensed technology during the year ended December 31,2002 (Note 11).

 

# ***Intangible Assets***

 

Amortization of intangible assets is attributed to theamortization of intangible assets acquired in connection with the purchase ofproducts and technology from Adaptec, Inc. (“Adaptec”). As a result of theconsideration paid to Adaptec, the Company recorded $11,582 in intangibleassets related to the core technology acquired, which was amortized over anestimated useful life of three years. Amortization of this amount was completed during the year ended December31, 2001.

 

# ***Fair Value of Investments***

# ** **

TheCompany periodically reviews its investments for impairment.  In the event the carrying value of aninvestment exceeds its fair value and the decline is determined to beother-than-temporary, the Company writes down the value of the investment toits fair value.  The Companyrecorded an impairment charge to other expense for its preferred stockinvestment during the year ended December 31, 2002 (Note 12).

 

# ***Revenue Recognition***

 

Revenue from productsales is recognized upon shipment except for sales to distributor customersthat have contractual rights of return. Revenue from sales to distributors that have contractual rights ofreturn is recognized when these distributors ship the Company’s products totheir end-user customers.  Allowancesfor estimated sales returns are provided at the time revenue isrecognized.  The Company reserves foruncollectible accounts and warranty claims based on historical experience.

 

Revenue from ourlong-term ASIC development agreements is generally recognized as the servicesare performed using the percentage of completion method based on costs incurredto date compared to total estimated costs at completion.

 

# ***Product Warranty***

 

The Company’s currentpractice is generally to warranty its adapter products against defects inmaterials and workmanship for a one to five-year period from the date ofshipment and its Application Specific Integrated Circuits (“ASICs”) productsfor a one-year period from the date of shipment.  The estimated cost of warranty obligations is accrued at the timerevenue is recognized.  In estimatingits warranty obligations the Company considers various relevant factors,including the Company’s stated warranty policies and practices, historicalproduct returns and failure rates and the estimated cost to replace or repairits

 

F-8

----

 

products under warranty.  Thefollowing table reflects the change in the Company’s warranty accrual duringthe year ended December 31, 2002.

 

|                                              |   | **For the  year ended  December 31, 2002** |   |
|---------------------------------------------------|--------|--------------------------------------------|--------|
| Balance,  beginning of period                     |   | $                                          | 100    |   |
| Accruals  for warranties issued during the period |   | 203                                        |   |
| Settlements  made during the period               |   | (97                                        | )      |
| Balance,  December 31, 2002                       |   | $                                          | 206    |   |

 

# ***Research and Development Costs***

 

The Company is involvedin a large and continuing research and development effort that includes thecontinual development of new products and the improvement of existingproducts.  All research and developmentcosts are expensed as incurred.

 

The Company capitalizeseligible computer software development costs upon the establishment of technologicalfeasibility, which is defined as completion of designing, coding and testingactivities.  The amount of costseligible for capitalization, after consideration of factors such as netrealizable value, have not historically been material and, accordingly, allsoftware development costs have been charged to research and developmentexpense as incurred in the accompanying statements of operations.

 

# ***Income Taxes***

 

Current income taxexpense is the amount of income taxes expected to be payable for the currentyear. A deferred tax asset and/or liability is computed for both the expectedfuture impact of differences between the financial statement and tax bases ofassets and liabilities and for the expected future tax benefit to be derivedfrom tax loss and tax credit carryforwards. Valuation allowances are established when necessary to reduce deferredtax assets to the amount expected to be “more likely than not” realized infuture tax returns.  Tax rate changesare reflected in income in the period such changes are enacted.

 

# ***Stock-based Compensation***

 

The Company measurescompensation costs related to stock option plans using the intrinsic valuemethod and provides pro forma disclosures of net income (loss) and earnings(loss) per common share as if the fair value based method had been applied inmeasuring compensation costs. Accordingly, compensation cost for stock options is measured as theexcess, if any, of the deemed fair value of the Company’s common stock at thedate of grant over the amount an employee must pay to acquire the stock and isamortized over the vesting period, generally four years.  As of December 31, 2002, all stock-basedcompensation was fully amortized.

 

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

 

F-9

----

 

 

|                                                                     |   | **Year Ended  December 31,** |    |
|--------------------------------------------------------------------------|--------|------------------------------|---------|
|                                                                     |   | **2002**                     |    | **2001** |   | **2000** |   |
| Net  income (loss):                                                      |   |                         |    |   |   |   |   |
| As  reported                                                             |   | $                            | (34,644 | ) | $ | (13,748 | ) | $ | 14,256 |   |
| Stock  based compensation included in net income (loss)                  |   | 166                          |    | 433 |   | 623 |   |
| Stock  based employee compensation expense under fair value based method |   | 1,580                        |    | (5,419 | ) | (15,090 | ) |
| Pro  forma net income (loss)                                             |   | (32,898                      | )       | (18,734 | ) | (211 | ) |
| Basic  earnings (loss) per common share:                                 |   |                         |    |   |   |   |   |
| As  reported                                                             |   | $                            | (1.30   | ) | $ | (0.51 | ) | $ | 0.61 |   |
| Pro  forma                                                               |   | (1.24                        | )       | (0.70 | ) | (0.01 | ) |
| Diluted  earnings (loss) per common share:                               |   |                         |    |   |   |   |   |
| As  reported                                                             |   | $                            | (1.30   | ) | $ | (0.51 | ) | $ | 0.53 |   |
| Pro  forma                                                               |   | (1.24                        | )       | (0.70 | ) | (0.01 | ) |

 

As a result of the stockoptions cancelled under the Company’s voluntary stock option exchange programcompleted in August 2002, the Company received a net benefit of $1,580 duringthe year ended December 31, 2002 due to the cancellation of unvested optionsfor which an expense had been previously recorded (Note 5).  Stock-based compensation is amortized overthe related vesting periods using an accelerated method in accordance withFinancial Accounting Standards Board Interpretation ("FIN") No. 28,"Accounting for Stock Appreciation Rights and Other Variable Stock Optionsor Award Plans."  The amount ofstock-based compensation expense to be recorded in future periods coulddecrease if awards for which accrued but unamortized compensation expense hasbeen recorded are forfeited.

 

|                                                                           |   | **Year Ended  December 31,** |   |
|--------------------------------------------------------------------------------|--------|------------------------------|--------|
|                                                                           |   | **2002**                     |   | **2001** |   | **2000** |   |
| Weighted  average grant-date fair value of options granted:                    |   |                         |   |   |   |   |   |
| Exercise  price equal to estimated fair value of stock on the grant date:      |   |                         |   |   |   |   |   |
| Aggregate  value                                                               |   | $                            | 15,107 |   | $ | 19,995 |   | $ | 72,141 |   |
| Per  share value                                                               |   | 5.72                         |   | 5.89 |   | 38.81 |   |
| Exercise  price less than the estimated fair value of stock on the grant date: |   |                         |   |   |   |   |   |
| Aggregate  value                                                               |   | $                            | — |   | $ | — |   | $ | — |   |
| Per  share value                                                               |   | —                       |   | — |   | — |   |

 

The fair value of eachoption grant was estimated as of the date of grant using the Black-Scholesoption pricing model with the following weighted-average assumptions used forgrants during the years ended December 31, 2002, 2001 and 2000: no dividendyield; risk-free interest rate of 3.18%, 4.09% and 6.03% and expected terms of3.1 years, 3.0 years and 3.3 years, respectively.  The volatility of the Company’s common stock underlying the optionswas 87%, 107% and 115% during the years ended December 31, 2002, 2001 and 2000,respectively.  The fair value of theemployees’ purchase rights pursuant to the Purchase Plan was estimated usingthe Black-Scholes model with the following assumptions for the years endedDecember 31, 2002, 2001 and 2000: no dividend yield; risk-free interest rate of2.46%, 3.19% and 5.36%; expected term of 1.3 years, 1.4 years and 1.3 years andexpected volatility of 104%, 104% and 97%, respectively.  The weighted average fair value of thosepurchase rights granted in 2002, 2001 and 2000 was $5.45, $7.64 and $13.80,respectively.

 

# ***Earnings (Loss) Per Share***

 

Earnings (loss) per shareis computed using the weighted average number of shares of common stockoutstanding and is presented for basic and diluted earnings (loss) pershare.  Basic earnings (loss) per shareis computed by dividing income (loss) available to common stockholders by theweighted average number of common shares outstanding for the period.  Diluted earnings (loss) per share iscomputed by dividing income (loss) available to common stockholders by theweighted average number of common shares outstanding during the periodincreased to include, if dilutive, the number of additional common shares thatwould have been outstanding if the potential common shares had beenissued.  The dilutive effect ofoutstanding stock options is reflected in diluted earnings (loss) per share byapplication of the treasury stock method. The

 

F-10

----

 

Company has excluded all outstanding stock options from the calculationof diluted loss per share for the years ended December 31, 2002 and 2001because such securities are antidilutive for this period.  The total number of potential common sharesexcluded from the calculations of diluted loss per common share for the yearsended December 31, 2002 and 2001 was 242,000 and 477,000, respectively.

 

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

  
|                                                                                        |   | **Year Ended  December 31,** |    |
|---------------------------------------------------------------------------------------------|--------|------------------------------|---------|
|                                                                                        |   | **2002**                     |    | **2001** |   | **2000** |   |
| Numerator:                                                                                  |   |                         |    |   |   |   |   |
| Net  income (loss)                                                                          |   | $                            | (34,644 | ) | $ | (13,748 | ) | $ | 14,256 |   |
| Denominator:                                                                                |   |                         |    |   |   |   |   |
| Denominator  for basic earnings (loss) per share – weighted average shares Outstanding |   | 26,563,000                   |    | 26,938,000 |   | 23,541,000 |   |
| Effect  of dilutive securities:                                                             |   |                         |    |   |   |   |   |
| Dilutive  warrants outstanding                                                              |   | —                       |    | — |   | 69,000 |   |
| Dilutive  options outstanding                                                               |   | —                       |    | — |   | 3,378,000 |   |
| Employee  stock purchase plan shares                                                        |   | —                       |    | — |   | 21,000 |   |
| Denominator  for diluted earnings (loss) per share – adjusted weighted average shares  |   | 26,563,000                   |    | 26,938,000 |   | 27,009,000 |   |
| Basic  earnings (loss) per share                                                            |   | $                            | (1.30   | ) | $ | (0.51 | ) | $ | 0.61 |   |
| Diluted  earnings (loss) per share                                                          |   | $                            | (1.30   | ) | $ | (0.51 | ) | $ | 0.53 |   |

* *

# ***Recent Accounting Pronouncements***

 

In July 2002, theFinancial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standard (“SFAS”) No. 146 — *Accountingfor Costs Associated with Exit or Disposal Activities*. SFASNo. 146 provides guidance on the recognition and measurement ofliabilities associated with exit and disposal activities. Under SFASNo. 146, liabilities for costs associated with exit or disposal activitiesshould be recognized when the liabilities are incurred and measured at fairvalue. This statement is effective prospectively for exit or disposalactivities initiated after December 31, 2002. The adoption is not expectedto have a material effect on the Company’s results of operations or financialcondition.

 

In November 2002, theFASB issued FASB Interpretation No. 45 (“FIN 45”), *— “Guarantor’s Accounting and Disclosure Requirementsfor Guarantees, Including Indirect Guarantees of Indebtedness of Others.”*FIN45 requires that a liability be recorded in the guarantor’s balance sheet uponissuance of a guarantee. In addition, FIN 45 requires disclosures about theguarantees that an entity has issued, including a rollforward of the entity’sproduct warranty liabilities. The Company will apply the recognition provisionsof FIN 45 prospectively to guarantees issued after December 31, 2002. Thedisclosure provisions of FIN 45 are effective for, and are reflected in, the2002 financial statements. The adoption of FIN 45 is not expected to have amaterial effect on the Company’s results of operations or financial condition.

 

In November 2002, theEmerging Issues Task Force (EITF) issued Issue No. 00-21, “Accountingfor Revenue Arrangements with Multiple Deliverables.” This issue addressesdetermination of whether an arrangement involving more than one deliverable containsmore than one unit of accounting and how arrangement consideration should bemeasured and allocated to the separate units of accounting. EITF IssueNo. 00-21 will be effective for revenue arrangements entered into infiscal periods beginning after June 15, 2003 or the Company may elect toreport the change in accounting as a cumulative-effect adjustment. The Companyis reviewing EITF Issue No. 00-21 and has not yet determined the impactthis issue will have on its operating results and financial position.

 

F-11

----

 

*Reclassifications*

 

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

 

 **Note 2 — Composition of Certain Financial StatementCaptions**

** **

|                                  |   | **As of  December 31,** |   |
|---------------------------------------|--------|-------------------------|--------|
|                                  |   | **2002**                |   | **2001** |   |
| Accounts  receivable:                 |   |                    |   |   |   |
| Accounts  receivable                  |   | $                       | 4,288  |   | $ | 9,431 |   |
| Less  allowance for doubtful accounts |   | (573                    | )      | (826 | ) |
| Total                                 |   | $                       | 3,715  |   | $ | 8,605 |   |

 

|             |   | **As of  December 31,** | ** ** |
|------------------|--------|-------------------------|------------|
|             |   | **2002**                |       | **2001** | ** ** |
| Inventories:     |   |                    |       |   |   |
| Raw  materials   |   | $                       | 1,615      |   | $ | 6,566 |   |
| Work  in process |   | 204                     |       | 1,299 |   |
| Finished  goods  |   | 2,055                   |       | 1,680 |   |
| Total            |   | $                       | 3,874      |   | $ | 9,545 |   |

 

|                                            |   | **As of  December 31,** | ** ** |
|-------------------------------------------------|--------|-------------------------|------------|
|                                            |   | **2002**                |       | **2001** | ** ** |
| Property  and equipment, net:                   |   |                    |       |   |   |
| Computer  and test equipment                    |   | $                       | 18,722     |   | $ | 17,893 |   |
| Leasehold  improvements                         |   | 698                     |       | 831 |   |
| Office  furniture and other equipment           |   | 3,319                   |       | 3,416 |   |
|                                            |   | 22,739                  |       | 22,140 |   |
| Less  accumulated depreciation and amortization |   | (13,759                 | )          | (8,769 | ) |
| Total                                           |   | $                       | 8,980      |   | $ | 13,371 |   |

 

|                               |   | **As of  December 31,** | ** ** |
|------------------------------------|--------|-------------------------|------------|
|                               |   | **2002**                |       | **2001** | ** ** |
| Accrued  liabilities:              |   |                    |       |   |   |
| Payroll  and payroll related costs |   | $                       | 1,664      |   | $ | 3,126 |   |
| Loss  on lease commitment          |   | 6,124                   |       | — |   |
| Other                              |   | 2,909                   |       | 2,320 |   |
| Total                              |   | $                       | 10,697     |   | $ | 5,446 |   |

##### *** ***

##### ***Note 3 —***Marketable Securities

 

At December 31, 2002 and2001, the amortized cost and estimated fair value of marketable securitiesavailable for sale were as follows:

 
|                             |   | **December 31, 2002** |   |
|----------------------------------|--------|-----------------------|--------|
|                             |   | **Amortized  Cost**   |   | **Unrealized  Gains** |   | **Unrealized  Losses** |   | **Fair  Value** |   |
| U.S.  government and agency debt |   | $                     | 9,867  |   | $ | 146 |   | $ | (46 | ) | $ | 9,967 |   |
| Corporate  debt                  |   | 80,692                |   | 219 |   | (74 | ) | 80,837 |   |
| Short-term  instruments          |   | 8,066                 |   | 1 |   | — |   | 8,067 |   |
|                             |   | $                     | 98,625 |   | $ | 366 |   | $ | (120 | ) | $ | 98,871 |   |

 
|                             |   | **December  31, 2001** |    |
|----------------------------------|--------|------------------------|---------|
|                             |   | **Amortized  Cost**    |    | **Unrealized  Gains** |   | **Unrealized  Losses** |   | **Fair  Value** |   |
| U.S.  government and agency debt |   | $                      | 16,497  |   | $ | 175 |   | $ | (102 | ) | $ | 16,570 |   |
| Corporate  debt                  |   | 81,215                 |    | 376 |   | — |   | 81,591 |   |
| Short-term  instruments          |   | 15,371                 |    | — |   | — |   | 15,371 |   |
|                             |   | $                      | 113,083 |   | $ | 551 |   | $ | (102 | ) | $ | 113,532 |   |

 

F-12

----

 

The cost of securitiessold is based on the specific identification method.  Realized gains were $209 and realized losses were $3 on the saleof available for sale securities during the year ended December 31, 2002.  Realized gains were $88 on the sale ofavailable for sale securities during the year ended December 31, 2001.  Realized losses were $41 on the sale ofavailable for sale securities during the year ended December 31, 2000.  The Company’s short-term instruments consistprimarily of money markets, certificates of deposit, and commercial paper.

 

**Note 4 — Stockholders’ Equity**

 

# ***Common Stock***

 

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

 

# **Preferred Stock**

 

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

 

# ***Treasury Stock***

 

The Company’s Board ofDirectors authorized the Company to repurchase up to $15,000 of its outstandingcommon stock in open market and private transactions over a twelve-month periodwhich ended on September 18, 2002.  Thetiming and price of stock purchases were made at the discretion ofmanagement.  In 2002 and 2001, theCompany repurchased an aggregate of 200,000 and 900,000 shares at a cost of$924 and $5,130, respectively.  The200,000 treasury shares received by the Company in 2002 resulted from asettlement agreement with a former executive of the Company (Note 7).

 

# ***Exercise of Warrants***

Duringthe first quarter of 2000, Adaptec exercised its warrant to purchase 840,000shares of the Company’s common stock.  Adaptec performed a net exercise ofthe warrant, pursuant to which the Company issued a total of 839,998 commonshares to Adaptec after taking into consideration the one hundred dollarexercise price.

 

# ***Stockholder Rights Plan***

 

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

 

F-13

----

 

If a person or groupaccumulates 15% or more of the common stock, each Right (other than Rights heldby a 15% acquiror) allows the stockholder to purchase common stock having amarket value of twice the exercise price of the Right. In addition, in the eventof certain business combinations, the Rights allow the holders to purchasecommon stock of an acquiror at a 50% discount. The Board of Directors isentitled to redeem the Rights at $.001 per Right at any time prior to thepublic announcement of the existence of a 15% holder.

 

**Note 5 — Benefit Plans**

 

The Company has a savingsplan under Section 401(k) of the Internal Revenue Code under which allemployees are eligible to participate on the first day of the month followingtheir hire date.  The plan allows for aCompany matching contribution (the “Match”) in which employees vest one-thirdper year on the first through third anniversaries of their hire date. The Matchis 100% of the employee’s first five percentage points of salary contributed.  During the years ended December 31, 2002,2001 and 2000, the charge to operations for the Match was $574, $703 and $621,respectively.

 

During February 1997, theCompany adopted an option plan (the “1997 Plan”) which provides for theissuance of 4,396,441 shares of the Company’s common stock. The 1997 Planprovides for the grant to employees and directors of the Company of incentivestock options and non-qualified stock options to purchase shares of theCompany’s common stock.  Options grantedunder the 1997 Plan became exercisable upon the Company’s initial publicoffering and have a ten year term from the date of grant.  The exercise price of all options grantedunder the 1997 Plan are not less than the fair market value of the Company’scommon stock as determined by the Board on the date of grant. Options grantedunder the 1997 Plan generally vest over a three-year period. At December 31,2002, there were 200,362 shares of the Company’s common stock available forfuture grant under the 1997 Plan.

 

In April 1999, the Companyadopted a second option plan (the “1999 Plan”), as amended, which provides forthe issuance of up to 3,812,800 shares of the Company’s common stock.  The 1999 Plan provides for the grant toemployees, consultants and directors of the Company of incentive stock optionsand non-qualified stock options to purchase shares of the Company’s commonstock. Options granted under the 1999 Plan shall be exercisable at such time orupon such event and subject to the terms, conditions and restrictions asdetermined by the Board; provided, however, that no option shall be exercisableafter ten years from the date of grant. The exercise price of all incentivestock options granted under the 1999 Plan are not less than the fair marketvalue of the Company’s common stock on the date of grant. Options granted underthe 1999 Plan generally vest over a four-year period. At December 31, 2002,there were 2,172,602 shares of the Company’s common stock available for futuregrant under the 1999 Plan.

 

In August 2000, theCompany adopted a third option plan (the “2000 Plan”), which provides for theissuance of up to 2,500,000 shares of the Company’s common stock.  The 2000 Plan provides for the grant toemployees and consultants of the Company of non-qualified stock options to purchaseshares of the Company’s common stock. Options granted under the 2000 Plan shallbe exercisable at such time or upon such event and subject to the terms,conditions and restrictions as determined by the Board; provided, however, thatno option shall be exercisable after ten years from the date of grant. Optionsgranted under the 2000 Plan generally vest over a four-year period. At December31, 2002, there were 1,954,906 shares of the Company’s common stock availablefor future grant under the 2000 Plan.

 

In February 2001, theCompany’s compensation committee of its Board of Directors approved a voluntarystock option exchange program for the Company’s employees, officers anddirectors.  Under the program, theCompany’s employees, officers and directors were given the opportunity tocancel stock options granted to them between January 2000 and December 2000 inexchange for an equal number of new options

 

F-14

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to be granted in the future, on a date more than six months after thedate of cancellation of the original options. The new options were granted on August 21, 2001 with an exercise priceof $6.50, which was the fair market value of the Company’s common stock on thatdate.  Cancelled options total 1,145,450shares with an average exercise price of $57 per share.

 

In August 2002, theCompany’s compensation committee of its Board of Directors approved a voluntarystock option exchange program for the Company’s employees, excluding executiveofficers and directors.  Under theprogram, the Company’s employees, excluding executive officers and directors,were given the opportunity to cancel stock options granted to them betweenMarch 10, 1999 and August 29, 2002 in exchange for a number of new optionsbased on each individual option holder’s position and performance at theCompany to be granted in the future, on a date more than six months after thedate of cancellation of the original options. The exercise price of the new options will be the fair market value ofthe Company’s common stock on that date. Cancelled options total 2,984,352 withan average exercise price of $13.48 per share. As of February 28, 2003, the Company expects to grant a total of2,391,837 options to purchase its common stock in exchange for the optionscancelled.

 

A summary of theCompany’s stock option plans as of December 31, 2002, 2001 and 2000 and changesduring the periods is as follows:

 
|                                                                         |   | **Year Ended  December 31,** |   |
|------------------------------------------------------------------------------|--------|------------------------------|--------|
|                                                                         |   | **2002**                     |   | **2001** |   | **2000** |   |
|                                                                         |   | **Options**                  |   | **Weighted  average  exercise price** |   | **Options** |   | **Weighted  average  exercise price** |   | **Options** |   | **Weighted  average exercise price** |   |
| Outstanding  at beginning of period                                          |   | 4,112,095                    |   | $ | 13.08 |   | 4,397,992 |   | $ | 23.93 |   | 4,568,107 |   | $ | 3.15 |   |
| Granted                                                                      |   | 2,643,007                    |   | 5.72 |   | 3,397,300 |   | 8.91 |   | 1,858,850 |   | 54.18 |   |
| Exercised                                                                    |   | (52,198                      | )      | 0.98 |   | (1,760,222 | ) | 0.63 |   | (1,789,409 | ) | 1.70 |   |
| Cancelled                                                                    |   | (4,819,146                   | )      | 12.10 |   | (1,922,975 | ) | 41.91 |   | (239,556 | ) | 28.40 |   |
| Outstanding  at end of period                                                |   | 1,883,758                    |   | $ | 5.59 |   | 4,112,095 |   | $ | 13.08 |   | 4,397,992 |   | $ | 23.93 |   |
| Vested  and exercisable at end of period                                     |   | 576,274                      |   | $ | 7.73 |   | 784,572 |   | $ | 16.07 |   | 1,614,511 |   | $ | 1.04 |   |
| Weighted  average fair value per option of options granted during the period |   |                         |   | $ |   3.13 |   |   |   | $ |   5.89 |   |   |   | $ |   38.81 |   |
|                                                                              |        |                              |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The following table summarizes information regardingemployee stock options outstanding at December 31, 2002:

 
|                  |   |                    |       | **OPTIONS OUTSTANDING**                                     |   | **OPTIONS EXERCISABLE**                |       |
|-----------------------|--------|-------------------------|------------|-------------------------------------------------------------|--------|----------------------------------------|------------|
| **Exercise prices**   |   | **Number  Outstanding** | ** ** | **Weighted  average  remaining  contractual  life (years)** |   | **Weighted  average  exercise  price** | ** ** | **Number****Exercisable** | ** ** | **Weighted  Average****Exercise****price** | ** ** |
| December  31, 2002:   |   |                    |       |                                                        |   |                                   |       |   |   |   |   |
| $  0.17 – $2.54  |   | 112,875                 |       | 7.22                                                        |   | $                                      | 0.95       |   | 85,475 |   | $ | 0.47 |   |
| $  2.59               |   | 350,000                 |       | 9.68                                                        |   | 2.59                                   |       | — |   | — |   |
| $  2.60 – $3.10  |   | 376,100                 |       | 9.82                                                        |   | 2.89                                   |       | — |   | — |   |
| $  3.16 – $5.85  |   | 320,400                 |       | 9.19                                                        |   | 5.30                                   |       | 150,416 |   | 5.44 |   |
| $  6.50 – $7.32  |   | 413,734                 |       | 7.71                                                        |   | 6.77                                   |       | 126,121 |   | 6.52 |   |
| $  9.80 – $62.56 |   | 310,649                 |       | 7.18                                                        |   | 12.66                                  |       | 214,262 |   | 12.95 |   |
| $  0.17 – $62.56 |   | 1,883,758               |       | 8.63                                                        |   | $                                      | 5.59       |   | 576,274 |   | $ | 7.73 |   |

 

During October 1999, the Company adopted the 1999 EmployeeStock Purchase Plan (the “Purchase Plan”). A total of 550,000 shares of theCompany’s common stock have been reserved for issuance under the PurchasePlan.  As of December 31, 2002, 410,358shares of common stock have been issued under the Purchase Plan.  The number of shares reserved for issuanceunder the Purchase Plan is subject to an annual

 

F-15

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increase on January 1 of each year beginning in 2001 equal to thelesser of (a) 87,500 shares, (b) 1.0% of the outstanding shares on such date or(c) a lesser amount as determined by the Board. The Purchase Plan permitseligible employees to purchase shares of common stock at a fifteen percent(15%) discount through payroll deductions during sequential 24-month offeringperiods. Each such offering period is divided into four consecutive six-monthpurchase periods.  Unless the Boardestablishes a higher price, the price at which shares are purchased under thePurchase Plan for such offering period is equal to 85% of the lesser of thefair market value of the common stock on the first day of such offering periodor the last day of the applicable purchase period within such offering period.

 

**Note 6 — Income Taxes**

 

The components of theincome tax provision (benefit) are as follows:

 

|                           |   | **Year Ended  December 31,** |   |
|--------------------------------|--------|------------------------------|--------|
|                           |   | **2002**                     |   | **2001** |   | **2000** |   |
| **Current:**                   |   |                         |   |   |   |   |   |
| Federal                        |   | $                            | — |   | $ | — |   | $ | 7,618 |   |
| State                          |   | —                       |   | — |   | 854 |   |
|                           |   | —                       |   | — |   | 8,472 |   |
|                           |   |                         |   |   |   |   |   |
| **Deferred:**                  |   |                         |   |   |   |   |   |
| Federal                        |   | (11,315                      | )      | (4,357 | ) | (3,170 | ) |
| State                          |   | (2,331                       | )      | (2,350 | ) | (680 | ) |
|                           |   | (13,646                      | )      | (6,707 | ) | (3,850 | ) |
| Change  in valuation allowance |   | 13,646                       |   | 6,707 |   | — |   |
|                           |   | $                            | — |   | $ | — |   | $ | 4,622 |   |

 

The following is a reconciliation of the statutoryfederal income tax rate to the Company’s effective tax rate:

 

|                                             |   | **Year Ended  December 31,** | ** ** |
|--------------------------------------------------|--------|------------------------------|------------|
|                                             |   | **2002**                     |       | **2001** |   | **2000** |   |
| Tax  provision (benefit) at statutory rate       |   | (34                          | )%         | (34 | )% | 34 | % |
| State  tax (benefit), net of federal tax benefit |   | (4                           | )          | (12 | ) | 7 |   |
| Research  and development credits                |   | (1                           | )          | (4 | ) | (14 | ) |
| Stock-based  compensation                        |   | —                       |       | 1 |   | 1 |   |
| Utilization  of net operating loss carryforwards |   | —                       |       | — |   | — |   |
| Net  change in valuation allowance               |   | 39                           |       | 49 |   | — |   |
| Other                                            |   | —                       |       | — |   | (4 | ) |
|                                             |   | —                       | %          | — | % | 24 | % |

 

The components of the Company’s net deferred taxassets (liabilities) are as follows:

 

|                                           |   | **December  31,** |   |
|------------------------------------------------|--------|-------------------|--------|
|                                           |   | **2002**          |   | **2001** |   |
| Deferred  tax assets:                          |   |              |   |   |   |
| Net  operating loss carryforwards              |   | $                 | 25,227 |   | $ | 13,250 |   |
| Research  and development credit carryforwards |   | 4,112             |   | 3,390 |   |
| Allowances  and reserves                       |   | 2,138             |   | 4,387 |   |
| Accrued  payroll and payroll related costs     |   | 248               |   | 334 |   |
| Intangible  assets                             |   | 6,439             |   | 4,379 |   |
| Loss  on lease commitments                     |   | 829               |   | — |   |
| Deferred  revenue                              |   | 671               |   | 745 |   |
| Depreciation                                   |   | 74                |   | 315 |   |
| Other                                          |   | 1,302             |   | 723 |   |
| Total  deferred tax assets                     |   | $                 | 41,040 |   | $ | 27,523 |   |
| Deferred  tax liabilities:                     |   |              |   |   |   |
| Deferred  costs                                |   | $                 | (288   | ) | $ | (353 | ) |
| Depreciation                                   |   | $                 | — |   | $ | — |   |
| Net  deferred tax asset                        |   | 40,752            |   | 27,170 |   |
| Less  valuation allowance                      |   | (40,752           | )      | (27,170 | ) |
|                                           |   | $                 | — |   | $ | — |   |

 

F-16

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At December 31, 2002, theCompany provided a valuation allowance for its net deferred tax assets becauseof uncertainty regarding their realizability. At December 31, 2002, thedeferred tax asset includes $20,483 related to the tax benefit for the exerciseof stock options. If or when recognized, the tax benefit of the deferred taxassets related to stock option exercises will result in a benefit to additionalpaid in capital and a reduction to the valuation allowance.

 

As of December 31, 2002,the Company had federal and state net operating loss carryforwards ofapproximately $67,504 and $41,159 expiring from 2007 to 2022, which may besubject to certain limitations under Section 382 of the Internal RevenueCode.  The net operating loss includesthe tax benefit related to the exercise of stock options, which benefit wasrecorded to additional paid-in capital. The Company also had federal and state research and development taxcredit carryforwards of approximately $2,559 and $2,353, expiring from 2019 to2022.

 

**Note 7 — Related Party Transactions**

 

# ***Related Party Loans***

 

On January 9, 2001, theCompany entered into a loan agreement with its former chief executive officerin the amount of $500 which bore interest at a rate of 5% and was recorded asan other asset.  On January 9, 2002 (thefirst anniversary date), the Company forgave $250 of principal and $25 inaccrued interest in accordance with the terms of the loan agreement.  The total amount forgiven was recorded ascompensation expense during the year ended December 31, 2001.  In the first quarter of 2002, the Company’sformer chief executive officer executed a promissory note for $99 for payrolltaxes which the Company paid on his behalf on January 9, 2002.  This promissory note was due by April 15,2003 and bore interest at a 5% rate.

 

Atthe time of the former chief executive officer’s resignation on May 19, 2002,his loan outstanding totaled $349 which consisted of $99 in payroll taxes dueand $250 for the remaining portion of the loan which was entered into upon hishiring, plus accrued interest.  Upon hisresignation from the Company, the outstanding loan became due and payable.  In September 2002, the former chiefexecutive officer paid in full the $99 in payroll taxes due and $154 toward theremaining portion of the loan.  The $96loan balance was deemed earned under California law based on the servicesprovided by the former chief executive officer through his date of terminationand recorded as compensation expense. As of December 31, 2002, no amounts remain outstanding from the formerchief executive officer.

 

In April 2001, two of theCompany’s former executives received loans from the Company in the amount of$1,200 and $400, respectively, payable in full on or before April 5, 2002, atan interest rate of 5%.  In the fourthquarter of 2001, the former executive with the $400 loan paid his loan and allaccrued interest in full.

 

In the second quarter of2002, the Company entered into a settlement agreement with the other formerexecutive to resolve his outstanding loan and accrued interest totaling $1,260.Pursuant to the settlement, the Company received 200,000 common shares ofCompany stock previously pledged by the former executive as security for theoutstanding loan and accrued interest. The Company recorded the 200,000 common shares into treasury stock attheir fair market value of $924 and the loan was deemed 

 

F-17

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repaid.  The Company incurred a loss of $336 as aresult of the settlement which is included in other expenses in the statementof operations.

 

**Note 8 — Commitments**

 

TheCompany leases its operating facilities and certain office equipment undernoncancelable operating leases.  Thefacility leases require the payment of taxes, maintenance, utilities andinsurance.

 

Future annual minimum leasepayments due under noncancelable capital and operating leases consists of thefollowing at December 31, 2002:

 
| **Years Ending December 31,**               |   | **Capital  Leases** |   | **Operating  Leases** |   |
|---------------------------------------------|--------|---------------------|--------|-----------------------|--------|
| 2003                                        |   | $                   | 280    |                  | $      | 5,022 |   |
| 2004                                        |   | 280                 |   | 5,040                 |   |
| 2005                                        |   | 104                 |   | 4,633                 |   |
| 2006                                        |   | —              |   | 4,478                 |   |
| 2007                                        |   | —              |   | 3,509                 |   |
| Thereafter                                  |   | —              |   |  9,511           |   |
| Total  minimum lease payments               |   | $                   | 664    |                  | $      | 32,193 |   |
| Amount  representing interest               |   | (46                 | )      |                  |   |
| Obligations  under capital leases           |   | 618                 |   |                  |   |
| Obligations  due within one year            |   | (250                | )      |                  |   |
| Long-term  obligations under capital leases |   | $                   | 368    |                  |   |   |

 

Rent expense under alloperating leases for the years ended December 31, 2002, 2001 and 2000 was$3,184, $3,172 and $1,560, respectively.

 

The lease commitmentschedule above includes $7,787 related to the Company’s remaining leasecommitment as of December 31, 2002 for a building adjacent to its currentcorporate headquarters.  Subsequent toDecember 31, 2002, the Company entered into various agreements with itslandlord and a new tenant whereby the Company terminated its lease for thisbuilding and is completely absolved of any further liability (Note 10).

 

As of December 31, 2002,the Company had purchase commitments totaling $2,747 for inventory which areexpected to be completed within one year.

 

##### ***Note 9 — Contingencies***

 

In April 2001, an allegedstockholder of the Company filed an alleged class action complaint against theCompany and certain of its officers and directors in the United States DistrictCourt for the Southern District of California on behalf of purchasers of theCompany’s common stock during the period between October 16, 2000 and January24, 2001.  Thereafter, five additionaland virtually identical lawsuits have been filed.  The most recent of these lawsuits allege claims on behalf ofpurchasers of the Company’s common stock during the period between October 16,2000 and March 28, 2001 (the “Class Period”). The cases allege that during theClass Period, the Company made false statements about its business and resultscausing its stock to trade at artificially inflated levels.  Based on these allegations, the cases allegethat the Company and the others named in the cases violated the SecuritiesExchange Act of 1934.  The Company hasretained counsel to defend these cases. On February 8, 2002, the Court appointed a lead plaintiff and leadcounsel and ordered the consolidation of the cases.  The court gave the plaintiffs until March 25, 2002 to file aconsolidated amended complaint. On March 25, 2002, plaintiffs filed a firstconsolidated and amended complaint.  Thefirst consolidated and amended complaint alleges a new class period of July 13,2000 through March 28, 2001 and adds alleged claims under Securities Act of1933 arising from the Company’s secondary 

 

F-18

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public offering inOctober 2000.  On April 29, 2002, theCompany filed a motion to dismiss  and amotion to strike the first consolidated and amended complaint.  Since July 1, 2002, the motions have beenunder submission with the Court for decision. The Company believes that these cases are without merit and intends todefend the cases vigorously.

 

In October 2001, analleged stockholder of the Company, Richard Grosset, filed an allegedstockholder derivative lawsuit against the Company and certain present andformer members of the Company’s board of directors in the San Diego CountySuperior Court.  The lawsuit allegesthat during the Class Period, the present and former members of the Company’sboard failed to adequately oversee the activities of management and, as aresult, the Company allegedly made false statements about its business andresults causing its stock to trade at artificially inflated levels.  Based on these allegations, the plaintiffalleges that the present and former members of the Company’s board breachedtheir fiduciary duties to the Company. The alleged stockholder filed the lawsuit without first making a demandupon the board of directors.  TheCompany has retained counsel to defend this case.  On February 1, 2002, the Court sustained the Company’s demurrerto the plaintiff’s complaint with leave to amend.  On March 8, 2002, the plaintiff filed a first amendedcomplaint.  On March 22, 2002, theCompany filed a demurrer to the first amended complaint and the hearing on thedemurrer was set for April 12, 2002.  OnApril 12, 2002, the Court entered an order sustaining the demurrer and givingthe plaintiff leave to file another amended complaint.  On April 29, 2002, the plaintiff filed asecond amended complaint.  On May 31,2002, the Company filed a demurrer to the second amended complaint.  On the same day, Sik-Lin Huang, an allegedstockholder of the Company, filed a motion to intervene in the case as aplaintiff.  On June 21, 2002, the Courtsustained the Company’s demurrer and dismissed Grosset as a plaintiff becausehe is no longer a stockholder of the Company. The Court, however, granted Huang’s motion to intervene and orderedHuang to file a complaint in intervention. Huang filed a complaint in intervention on July 5, 2002.  On September 16, 2002, the Board ofDirectors of the Company appointed a special litigation committee toinvestigate the allegations in this case and to determine whether it is in thebest interest of the Company to allow this case to proceed.  On February 11, 2003, the special litigationcommittee issued a report of its investigation which concluded that it is notin the best interests of JNI to pursue the Grosset action, and that the bestinterests of JNI require that this action be dismissed in its entirety.  On February 19, 2003, counsel for thespecial litigation committee filed a motion to dismiss this action, which iscurrently scheduled for hearing on May 9, 2003.

 

On May 30, 2002, analleged stockholder of the Company, Ali Bemanian, filed a purported stockholderderivative suit against the Company and certain present and former members ofthe Company’s board of directors in the San Diego County Superior Court.  The lawsuit repeats the allegations of thederivative lawsuit filed by Grosset. The lawsuit also adds allegations that the defendants caused or allowedthe Company to falsely report its results for the fourth quarter of fiscal2001.  These additional allegationsrelate to the Company’s May 20, 2002 announcement that it would restate itsfinancial statements and file an amended report on Form 10-K.  On September 16, 2002, the Board ofDirectors of the Company appointed a special litigation committee toinvestigate the allegations in this case and to determine whether it is in thebest interest of the Company to allow this case to proceed.  On February 11, 2003, the special litigationcommittee issued a report of its investigation which concluded that it is notin the best interests of JNI to pursue the Bemanian action, and that the bestinterests of JNI require that this action be dismissed in its entirety.  On February 19, 2003, counsel for thespecial litigation committee filed a motion to dismiss this action, which iscurrently scheduled for hearing on May 9, 2003.

 

On November 29, 2001, analleged stockholder of the Company filed a class action lawsuit in the UnitedStates District Court for the Southern District of New York.  The lawsuit also names as defendants theunderwriters on the Company’s initial public offering and secondaryoffering.  The plaintiff alleges thatdefendants violated Securities Act of 1933 and the Securities Exchange Act of1934 in connection with the Company’s public offerings.  This case is among the over 300 class actionlawsuits pending in the United 

 

F-19

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States District Court forthe Southern District of New York that have come to be known as the IPOladdering cases.  The complaint in thiscase was served on the Company on June 20, 2002.  On November 1, 2002, the court heard argument on motions todismiss all of the IPO laddering cases. On February 19, 2003, the court issued an order on the motion to dismissthe IPO laddering cases.  As to theCompany, the motion was denied and as to its present and former officers and directorswho were also named as defendants, the motion was denied in part and granted inpart with two former officers being dismissed from the case.  The Company believes that this case lacksmerit and intends to defend the case vigorously.

 

In addition to the abovematters, the Company is involved in certain other legal proceedings, includingvarious employee related lawsuits, which are generally incidental to its normalbusiness activities.  The Company cannotmake an estimate of the potential loss from these legal proceedings. However,the Company believes that these cases lack merit and intends to defend thecases vigorously.

 

##### ***Note 10 — Loss on Lease Commitments***

As ofDecember 31, 2002, the Company was committed to a lease for a building adjacentto its current corporate headquarters that ran through June 2007 with aggregatelease payments due totaling $8,770.  TheCompany never occupied the building.  InFebruary 2003, the Company entered into various agreements with its landlordand a third party who agreed to lease the building adjacent to our currentcorporate headquarters whereby the Company terminated its lease for thisbuilding and is completely absolved of any further liability.  During the year ended December 31, 2002, theCompany accrued total charges of $4,996 for terminating this lease based on thecontractual terms of the agreements which was paid in February 2003.

TheCompany is committed to a ten year lease for its current corporate headquartersin San Diego, California which is for 85,329 square feet and includes fourfloors.  During the fourth quarter of2002, the Company consolidated its entire operations at its corporateheadquarters to three floors and vacated the fourth floor.  The Company does not intend to occupy thisfourth floor space and is actively seeking a tenant to sub-lease thisspace.  As of December 31, 2002, theCompany has been unable to secure a tenant to sub-lease this space.  During the quarter ended December 31, 2002,the Company recorded an estimated loss on its lease commitment totaling $1,995for vacating the fourth floor of its corporate headquarters.  In determining this estimated loss for itslease commitment, the Company has been required to make various assumptions,including occupancy dates for new tenants, sub-lease rental rates, tenantimprovement allowances, abandoned leasehold improvements and commissionpayments, that involve estimates and judgments.  In formulating its assumptions, the Company took into accountcurrent and projected real estate market conditions.  If the Company’s estimates and related assumptions change in thefuture, the Company may be required to revise this estimated loss on its leasecommitment.  If any revisions to itsestimated loss are necessary, then an additional loss or a benefit will berecorded.

As of December 31, 2002,the total accrued loss for the Company’s lease commitments totals $6,124 and isincluded in current accrued liabilities on the balance sheet.

 

##### ***Note 11 — Licensed Technology and Services***

In January 2002, the Companyacquired an exclusive license to Troika Networks’ Fibre Channel software andhardware products that provide high-availability storage area network solutionsfor enterprise class servers running under Windows NT, Windows 2000 and Solarisoperating systems.  The purchase priceincluded an initial payment of $7,500 and contingent consideration of $3,000.The $7,500 consideration includes payment for the licensed software technology,research and development services, transition services and a covenant not tocompete. The $3,000 contingent payment may be due if the Company reachescertain 

 

F-20

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revenue or unit sales levels andupon completion of certain OEM certification requirements. Additionally, if theCompany attains certain revenue or unit sales levels of the related products,the Company will be obligated to make royalty payments based on revenue for oneyear from the royalty payment start date or until June 30, 2004, whicheveroccurs earlier. To the extent that the Company does not achieve certain revenueor unit levels by January 1, 2004, Troika is obligated to reimburse the Companyfor a portion of the initial purchase price, up to $3,500.

 

An independent valuation of thistransaction was completed for accounting purposes.  As a result of the valuation, the $7,500 initial payment wasallocated as follows: $7,256 was attributed to the licensed technology , $210was attributed to research and development services, and $34 was attributed totransition services.  During 2002, theCompany commenced amortization of the licensed technology to cost of revenuesover a five year period on a straight-line basis.  If the $3,000 contingent payment is made, this amount will berecorded as licensed technology and amortized to cost of revenues over theremaining portion of the five year period. However, at this time, the Company does not believe it is probable thatsuch payment will ever be required.  Thecosts attributed to research and development and transition services have beenexpensed as incurred.  For the yearended December 31, 2002, the Company amortized licensed technology of $1,204and incurred expenses for research and development and transition services of$210 and $34, respectively.

 

During the fourth quarter of 2002,the Company noted indicators that the carrying value of its licensed technologymay not be recoverable and performed an impairment review.  The impairment review was performed pursuantto SFAS No. 144, “Accounting for the Impairment or Disposal of Long-LivedAssets,” because of factors such as lower sales of products incorporating thelicensed technology in 2002 compared to the original projections, revisions infuture revenue forecasts and changing market conditions, including productsprovided by the Company’s competitors. As a result of these factors, the Company’s projected future revenue andcash flows for these products were revised downward.  Therefore, the Company evaluated the recoverability of itslicensed technology and recorded an impairment charge of $5,452 to cost ofrevenues during the year ended December 31, 2002 based on the amount by whichthe carrying amount of the asset exceeded its fair value.  Subsequent to the impairment charge, theremaining net book value of the Company’s licensed technology totaled $600 asof December 31, 2002 and is being amortized to cost of revenues over aremaining useful life of four years.

 

##### ***Note 12 — Preferred Stock Investment***

 

InJanuary 2002, the Company invested $2,000 in a privately held InfiniBandsemiconductor developer.  Thisinvestment is being accounted for under the cost method of accounting.  The Company’s ownership in this entity isinsignificant relative to the total ownership. During the fourth quarter of 2002, the Company recorded a $1,400impairment charge in its preferred stock investment, representing another-than-temporary decline in the value of its investment.  This impairment charge is included in otherexpenses in the statement of operations.

 

##### ***Note 13 — Concentrations of Risk***

 

TheCompany’s products are concentrated in the storage area network industry whichis highly competitive and subject to rapid technological change.  The Company’s revenues are concentrated withseveral major customers and certain vital components of the Company’s productsare manufactured by a small number of key suppliers. The loss of a majorcustomer, the interruption of product supply from a contract manufacturer, achange of suppliers or a significant technological change in the industry couldaffect operating results adversely.

 

F-21

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The Company primarilysells its products to original equipment manufacturers and distribution channelcustomers and extends credit based on an evaluation of the customer’s financialcondition, generally without requiring collateral. Exposure to losses onreceivables is principally dependent on each customer’s financial condition.The Company monitors its exposure for credit losses and maintains allowancesfor anticipated losses.

 

Sales to customersoutside of the United States accounted for 24%, 30% and 23% of the Company’snet revenues for the years ended December 31, 2002, 2001 and 2000,respectively. In relation to the Company’s net revenues, 6%, 9% and 7% were tocustomers located in the Asia-Pacific region and 18%, 21% and 16% were tocustomers located in the Europe region.

 

The percentage of salesto significant customers was as follows:

 

|        |   | **Year Ended  December 31,** |   |
|-------------|--------|------------------------------|--------|
|        |   | **2002**                     |   | **2001** |   | **2000** |   |
| Customer  A |   | 6                            | %      | 6 | % | 16 | % |
| Customer  B |   | 22                           |   | 8 |   | 1 |   |
| Customer  C |   | 10                           |   | 20 |   | 21 |   |
| Customer  D |   | 10                           |   | 14 |   | 13 |   |

 

##### ***Note 14 — Subsequent Event (unaudited)***

 

On March 20, 2003, theBoard of Directors authorized the Company to repurchase up to $10,000 of itsoutstanding common stock in open market and private transactions over atwelve-month period ending March 20, 2004. The timing and price of stock purchases will be made at the discretionof management.

 

**Note 15— Quarterly Financial Data** (unaudited)

** **
|                         |   | **Quarter ended** |   |
|------------------------------|--------|-------------------|--------|
|                         |   | **March 31**      |   | **June 30** |   | **September 30** |   | **December 31** |   |
| **2001**                     |   |              |   |   |   |   |   |   |   |
| Net revenues                 |   | $                 | 21,142 |   | $ | 23,057 |   | $ | 18,080 |   | $ | 12,984 |   |
|                         |   |              |   |   |   |   |   |   |   |
| Gross  margin                |   | 12,554            |   | 5,986 |   | 10,499 |   | 6,903 |   |
|                         |   |              |   |   |   |   |   |   |   |
| Operating  loss              |   | (973              | )      | (9,336 | ) | (3,259 | ) | (5,231 | ) |
|                         |   |              |   |   |   |   |   |   |   |
| Net  income (loss)           |   | $                 | 301    |   | $ | (7,854 | ) | $ | (1,989 | ) | $ | (4,206 | ) |
|                         |   |              |   |   |   |   |   |   |   |
| Net  income (loss) per share |   | $                 | 0.01   |   | $ | (0.29 | ) | $ | (0.07 | ) | $ | (0.16 | ) |

 
| **2002**            |   |   |   |   |   |   |   |    |   |
|---------------------|--------|--------|--------|--------|--------|--------|--------|---------|--------|
| Net revenues        |   | $      | 11,914 |   | $      | 10,923 |   | $       | 7,107  |   | $ | 8,418 |   |
|                |   |   |   |   |   |   |   |    |   |
| Gross  margin       |   | 5,908  |   | 5,076  |   | 3,156  |   | (1,177  | )      |
|                |   |   |   |   |   |   |   |    |   |
| Operating  loss     |   | (5,007 | )      | (9,206 | )      | (6,694 | )      | (14,975 | )      |
|                |   |   |   |   |   |   |   |    |   |
| Net  loss           |   | $      | (4,133 | )      | $      | (8,718 | )      | $       | (5,962 | ) | $ | (15,831 | ) |
|                |   |   |   |   |   |   |   |    |   |
| Net  loss per share |   | $      | (0.16  | )      | $      | (0.33  | )      | $       | (0.22  | ) | $ | (0.60 | ) |

** **

**F-22**

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**Schedule II – Valuation &Qualifying Accounts**

**(In thousands)**

 

** **
|                                 |   | **Balance at  Beginning  of Period** |   | **Charged to  Costs and  Expenses** |   | **Deductions  Taken Against  Allowance** |   | **Balance at  End of  Period** |   |
|--------------------------------------|--------|--------------------------------------|--------|-------------------------------------|--------|------------------------------------------|--------|--------------------------------|--------|
| **Allowance For Doubtful Accounts:** |   |                                 |   |                                |   |                                     |   |                           |   |
| Year Ended December 31, 2000         |   | 495                                  |   | 677                                 |   | 346                                      |   | 826                            |   |
| Year Ended December 31, 2001         |   | 826                                  |   | —                              |   | —                                   |   | 826                            |   |
| Year Ended December 31, 2002         |   | 826                                  |   | —                              |   | 253                                      |   | 573                            |   |

 

S-1

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