**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

----

 

**FORM 10-K**

 

| **(Mark  One)**                                                                                                                                                                                                                                                                                         |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                                    |
| ý                                                                                                                                                                                                                                                                                                  | **ANNUAL REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                                                                                                                    |   |
| **For  the fiscal year ended March 31, 2003**                                                                                                                                                                                                                                                      |
|                                                                                                                                                                                                                                                                                                    |   |
| **OR**                                                                                                                                                                                                                                                                                                  |
|                                                                                                                                                                                                                                                                                                    |   |
| o                                                                                                                                                                                                                                                                                                       | **TRANSITION REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                                                                                                                    |   |
| **For  the transition period from                         to                       ** |
|                                                                                                                                                                                                                                                                                                    |   |
| **Commission  file number: 000-32967**                                                                                                                                                                                                                                                                  |
|                                                                                                                                                                                                                                                                                                         |  |  |

 

----

 

| **HPL TECHNOLOGIES, INC.**                             |
|-------------------------------------------------------------|
| (Exact Name of  Registrant as Specified in Its Charter)     |
|                                                        |   |   |
| **Delaware**                                                |   | **77-0550714** |
| (State of  Incorporation)                                   |   | (I.R.S. Employer  Identification No.) |
|                                                        |   |   |
| **2033  Gateway Place, Suite 400,****San Jose, California** |   | **95110** |
| (Address of  Principal Executive Offices)                   |   | (Zip Code) |
|                                                        |   |   |
| **(408) 437-1466**                                     |
| (Registrant’s  telephone number, including area code)  |
|                                                        |   |   |
| Securities  registered under Section 12(b) of the Act: |
|                                                        |   |   |
| **None**                                                    |
| Securities  registered under Section 12(g) of the Act: |
|                                                        |   |   |
| **Common  Stock, $0.001 Par Value**                         |
| (Title of Class)                                            |

 

----

 

Indicate by check markwhether the registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes  ý    No  o

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K isnot contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to thisForm 10-K.  ý

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 under the Securities Exchange Act of 1934) Yes  o    No  ý

 

Asof September 30, 2002, the issuer had outstanding 30,784,296 shares ofcommon stock.  The aggregate marketvalue of the shares of the registrant’s common stock, $0.001 par value pershare, held by non-affiliates of the registrant (all stockholders other thanofficers, directors and 5% or greater stockholders) as of that date was$793,721(based upon an average of the closing bid and asked price of $0.05 pershare as of such date, as reported the over-the-counter “pink sheets” publishedby Pink Sheets LLC).

 

Asof March 31, 2003, the registrant had outstanding 30,809,667 shares ofcommon stock.

 

 

----

 

**TABLE OFCONTENTS**

 
| **PART I**   |
|--------------|
|         |   |
| Item 1       | Business |
|         |   |
| Item 2       | Properties |
|         |   |
| Item 3       | Legal Proceedings |
|         |   |
| Item  4      | Submission  of Matters to a Vote of Security Holders |
|         |   |
| **PART II**  |
|         |   |
| Item  5      | Market  for Registrant’s Common Stock and Related Stockholder Matters |
|         |   |
| Item 6       | Selected  Financial Data |
|         |   |
| Item  7      | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
|         |   |
| Item 7A | Quantitative  and Qualitative Disclosures about Market Risk |
|         |   |
| Item  8      | Financial  Statements and Supplementary Data |
|         |   |
| Item  9      | Changes  in and Disagreements with Accountants on Accounting and Financial Disclosure |
|         |   |
| **PART III** |
|         |   |
| Item  10     | Directors  and Executive Officers of the Registrant |
|         |   |
| Item 11      | Executive  Compensation |
|         |   |
| Item  12     | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters |
|         |   |
| Item  13     | Certain Relationships  and Related Transactions |
|         |   |
| Item 14      | Controls  and Procedures |
|         |   |
| Item  15     | Principal Accountant  Fees and Services |
|         |   |
| **PART IV**  |
|         |   |
| Item  16     | Exhibits,  Financial Statement Schedules, and Reports on Form 8-K |

 

2

----

 

**PART I**

 

**GENERAL**

 

**FORWARD-LOOKINGSTATEMENTS**

 

This report containsforward-looking statements that involve substantial risks anduncertainties.  In some cases you canidentify these statements by forward-looking words such as “anticipate,”“believe,” “could,” “estimate,” “expect,” “intend,” “may,” “should,” “will,”and “would” or similar words.  Youshould read statements that contain these words carefully because they maydiscuss our future expectations, contain projections of our future results ofoperations or of our financial position or state other “forward-looking”information.  However, there may beevents in the future that we are not able to accurately predict orcontrol.  The factors listed in Item 7 underthe caption “Risk Factors,” as well as any cautionary language in this report,provide examples of risks, uncertainties and events that may cause our actualresults to differ materially from the expectations we describe in ourforward-looking statements.  You shouldbe aware that the occurrence of any of the events described in these riskfactors and elsewhere in this report could have a material adverse effect onour business, financial condition and results of operations.

 

**ITEM1.  BUSINESS**

 

**OVERVIEW**

 

Weprovide yield optimization solutions for manufacturers of semiconductors andflat panel displays.  We offer scalableyield optimization solutions that permit companies to accelerate the process bywhich they develop technology as well as identify, measure, and correct sourcesof failure in the production process.  Our customizable software products and proprietary TestChipTechnology Development Intellectual Property (“TestChip IP”)  enable our customers to quickly identify andcorrect yield-limiting factors in their design, technology development andmanufacturing processes.  Our integratedtools analyze parametric, bin/sort, bitmap, MES, defect and design layout data,as well as monitor the changes made to process “recipes.”  This analysis and monitoring results infaster improvements in yield or “yield learning.”

 

Wehave principally conducted business as Heuristic PhysicsLaboratories, Inc. (“HPLI”), a California corporation, since 1989.  HPLI merged on July 30, 2001 with awholly-owned subsidiary of HPL Technologies, Inc., a newly organized Delawarecorporation (sometimes referred to in this report as “HPL”, the “Company”,“we”, “our” or “us”), and each outstanding share of HPLI common stock wasconverted into 1.7 shares of HPL common stock. As a result of the merger, HPLI effectively reincorporated into Delawareand we adopted a holding company structure. Unless we specify otherwise, all references to the Company and HPL inthis report refer to HPL and its subsidiaries. Our principal executive offices are located at 2033 Gateway Place, Suite400, San Jose, California 95110 and our telephone number is(408) 437-1466.

 

InJuly 2002, our Audit Committee initiated an investigation into financialand accounting irregularities involving revenue reported during prior periods.Based on the investigation, we discovered that a material amount of revenue wasimproperly recognized during 2001 and 2002, primarily in connection withfictitious sales to an international distributor. Accordingly, we restated ourpreviously issued financial statements as of and for the years ended March 31,2002 and 2001. During the investigation, Y. David Lepejian, the Company’sformer President and Chief Executive Officer, was removed from all positionswith the Company. In addition, the Vice President of Administration and theChief Financial Officer of the Company were replaced.  None of these former officers participated in the preparation oroversight of the restatement of our financial statements or any other financialinformation or reports since the date of their respective departures.  Subsequent to his termination, Mr. Lepejianentered into a consent decree with the SEC and has pleaded guilty to one countof wire fraud.  The Company is a partyto numerous lawsuits relating to these events. See, Item 3 — Legal Proceedings.

 

**INDUSTRY BACKGROUND**

 

Thesemiconductor product development process can be grouped into three broadstages: 1) process technology development, 2) design, and3) manufacturing.  These stages aredescribed below:

 

1)                                      **ProcessTechnology Development.**  Semiconductor production begins with thedevelopment of “process technology,” during which a semiconductor fabricatordetermines device characteristics and assess the yield impact of manufacturingmargins.  Based on the results of theassessment, “design rules” are created to assure that products can be reliablyproduced in a given fabrication facility. These design rules guide the product design process in the second stageof

 

3

----

 

productdevelopment, described below.

 

2)                                      **Design. **The second stage of semiconductor production is productdesign.  Design involves using complexsoftware to place and connect individual electrical components (transistors) toconstruct the functionality of a product. A leading-edge design can call for millions of transistors andinterconnections on a square centimeter of silicon.  For a semiconductor product to be manufactured and work properly,it must be designed with exact precision and expressly for a givensemiconductor process technology, described above.

 

3)                                      **Manufacturing. **The third step in the semiconductor development process ismanufacturing.  Manufacturing requireshundreds of individual processing steps to form patterned layers of material ona wafer to create transistors and connect them to form the desired electroniccircuitry or function.  Additionally,the manufacturing process includes packaging and testing of the individualchips themselves.  In the case of newtechnology, interaction between the various wafer fabrication processes and/orthe design frequently cause new types of defects and new sources offailure.  Constant and accuratemeasurement and inspection are required to find defects and eliminate defectsources during wafer manufacturing as well as assembly and test processes.  The early detection and subsequentresolution of yield problems can result in significant cost savings to themanufacturer.

 

**Importance of Yield**

 

Yieldis a measurement of the efficiency of a product development process.  Specifically, yield is the percentage ofproperly functioning devices produced at each stage in the manufacturingprocess.  Improvement of yield or “yieldlearning” is often challenging and involves the continual identification andresolution of the root causes of failure in the design and manufacturing process.    New products built with newer, less maturesemiconductor manufacturing processes often start with very low yields becausefabrication procedures and device technologies are not yet fully optimized.  During the transition from early fabricationto volume production, yield improvements are often difficult as productionequipment and processes are stressed to maximize throughput.  Even as production volumes increase, yieldoften falls as new production equipment is brought on-line and test programs areenhanced to reduce test escapes.

 

Yieldimprovement is a multi-faceted challenge as thousands of factors in thesemiconductor production process may affect yield.  These factors contribute to yield loss based on the sensitivityand margin of the design and manufacturing. By definition, failures are random or systematic in nature.  Random failures are typically caused byarbitrary particles introduced into the fabrication process causing circuitfaults such as a bridge between two adjacent metal lines.  Systematic failures emanate from non-randomsources such as equipment or environmental changes, and design sensitivity ormaterial property variations.  Due toyield learning, each successive generation of semiconductors become somewhatless sensitive to existing failure modes but remain susceptible to new failuremodes.  This creates a need to captureand analyze more data to improve yields. The sheer volume of data and the amount of complex analysis required hasbecome an impediment to improving the yield learning curve.  To identify factors that affect yield in anew process, semiconductor companies must collect and analyze an immense (andgrowing) amount of data that is generated throughout the semiconductor productdevelopment lifecycle, often from several worldwide locations and,increasingly, from supply chain partners. In any semiconductor fabrication facility, there are likely to be asmany as 50 different sets and formats of data produced, each with thousands ofindividual parameters that need to be tracked. While this data provides important clues to yield enhancement, theefficient collection, correlation and analysis across the various data setspresents a substantial challenge for the semiconductor industry.

 

Highyield is an essential requirement for a profitable semiconductor business,especially during the introduction of new products.  Selling prices and profit margins are typically higher in theearly stages of a new semiconductor product lifecycle.  A small acceleration along the yield learningcurve can create disproportionately greater revenue and profitability.  Another benefit of fast yield ramp is theincreased revenue that is associated with the measured speed ofmicroprocessors, application specific integrated circuits (“ASICs”) and telecomdevices.  High parametric yield enablesparts to operate at higher frequencies and subsequently command higher sellingprices.  As the product lifecyclesadvance, high yield can accelerate cost reductions and maximize efficiencygains.  These factors make it essentialthat semiconductor companies monitor and maintain yield on an ongoing basisthroughout the entire product lifecycle. In today’s volatile markets where capacity utilization rates fluctuate,yield improvement remains fundamental to business success.  Given the immense costs of a semiconductorfabrication facility and the economics of production efficiency, the rate ofyield learning is a critical component in the profitability of a given semiconductorcompany.

 

**Flat Panel Industry**

 

The flat paneldisplay (“FPD”) industry is entering the product phase where the price pointsfor liquid crystal display televisions (“LCD-TVs”) and liquid crystaldisplay-computer monitors make them preferable to cathode ray tube (“CRT”)technology.  The latest estimatespredict the global FPD market will grow 143% to $65.1 billion by 2006.  The projected demand for LCD-TVs, forecastto be 76.5% compound annual growth rate, is expected to drive the majority ofthe FPD market.  Manufacturing cost

 

4

----

 

reductions and new processesthat shorten cycle time and improve performance are expected to acceleratedemand from the manufacturing side.

 

Thecurrent move to new FPD substrate sizes (i.e. generations 5, 6 and 7) areexpected to reduce manufacturing costs. Additionally,new materials such as low-temperature poly-silicon are expected to improveproduct performance.  However, thesechanges present significant manufacturing and yield challenges.  As in the semiconductor industry, FPDyield optimization solutions help users quickly solve these problems byaggregating all yield-relevant data and providing high-powered analysistechniques to FPD engineers.  Usingthese systems, engineers spend less time gathering and preparing data and moretime correcting yield problems.

 

Currently, most FPD yield enhancementtools are internally developed. However, software development is not a core competency of the LCDmanufacturer so their internal solutions tend to lack scalability andapplication integration.  HPL’scommercial FPD software yield solutions leverage our experience in thesemiconductor industry.  HPL providesFPD engineers with fully integrated packages that encapsulate the collectivebest practices of the semiconductor industry. In addition, HPL’s visualization and analysis modules meet the specificrequirements of the display industry so that FPD manufacturers benefit from thefull power and flexibility of the HPL Enterprise Yield Optimization Platform.

 

**HPL PRODUCTS AND TECHNOLOGY**

 

HPL provides an integrated suite of yield enhancementsoftware solutions that enables customers to optimize yields in all threestages of semiconductor development: process technology development, design and manufacturing.  Derived from years of experience workingwith leading semiconductor manufacturing companies, HPL has embedded much ofthe industry’s best practices directly into our yield optimizationproducts.  HPL’s yield optimizationsoftware delivers high-impact business results by reducing the time to highyield through enhanced collaboration among process technology development,design and manufacturing, and streamlined data analysis.

 

***YIELDirectorTM-Workflows***

 

YIELDirector Workflows provide a developmentenvironment for rapid implementation of both interactive applications and/orsophisticated reporting for virtually any data from a wafer fabrication,packaging, or test step of the manufacturing process.  Applications are developed using a development environment whereapplication development is 3 to 15 times faster than traditionaltechniques.  This allows customers toreact to yield problems and deploy solutions very rapidly.  YIELDirector-Workflow can be used with HPL,customer developed, and third party systems.

 

***YIELDirector-FPD***

 

YIELDirector-FPD is a yield optimization solutionbuilt specifically for the flat panel display manufacturers.  YIELDirector-FPD leverages the best-in-classand highly scalable YIELDirector platform. This enables FPD customers to integrate relevant manufacturing data intoa seamless and powerful yield optimization environment.  YIELDirector-FPD is a premier commercialyield optimization solution targeted at the unique challenges of FPDmanufacturing.

 

***Recipe Managementand Editing (“RME”)***

 

RMEis a universal enterprise solution that facilitates the management and controlof process recipes directly from a central repository.  Process recipes are used to control theprogram process and metrology tools at every step in a semiconductormanufacturing process.  RME manages allproduction recipes from a single environment, which dramatically reducesproduct scrap, improves yield and increases productivity of semiconductorfabs.  A patented off-line editingmodule allows engineers to edit process recipes at their desk or anywhere onthe corporate intranet without sacrificing security or increasing tooldowntime.

 

***Memory YIELDirector***

 

MemoryYIELDirector accelerates yield learning and problem resolution for DRAM, SRAMand Flash memory arrays on semiconductor devices.  Memory YIELDirector automates analysis of fab and test data forall memory types including embedded memory. Using powerful analysis algorithms, Memory YIELDirector automaticallydescrambles and classifies failing bitmaps into unique signatures, and correlatesthem to in-line defect inspection data to determine the defect killratios.  Memory YIELDirector haspowerful visualization algorithms that help correlate bitmap failures withfatal defects (defects that will cause a failure in the device) to enable rapidisolation of the root cause failures in memories.

 

5

----

 

***OdysseyTM Defect***

 

OdysseyDefect is a production-proven defect data management solution that is in use atover seventy manufacturing sites worldwide. Odyssey Defect delivers results efficiently and reliably, leveragingerror-correcting processes to assure users of maximum up-time.  It has an open and equipment vendor-neutralarchitecture that supports most inspection, review and classification toolswith a full range of charting, wafer mapping and statistic analysis.  Odyssey Defect is easy to use and provideshigh productivity with its all-in-one graphical user interface (“GUI”).  Odyssey Defect simplifies and automatesin-line defect analysis to reduce cycle times, enabling engineers to addressother critical yield-limiting issues.

 

***OdysseyTM YMS***

 

Odyssey YMS is afab-wide data management tool for improving yields and productivity byefficiently correlating different data types to quickly deduce the root causeof manufacturing problems.  AdvancedData Mining algorithms uncover hidden correlations and easy-to-use templatesautomate daily and repetitive analyses at preset intervals.  Odyssey YMS includes Odyssey Defect andseveral additional powerful analysis modules including:

 

Metrology,which collectsand analyzes data from inline production equipment, such as resistivity,critical dimension, wafer flatness, and oxide and etch rate monitors;

 

Parametric,which analyzes data collected from inline Wafer Electrical Test and end ofline Wafer Acceptance Test automatic test equipment.  Standard support is included for systems such as Agilent andKeithley testers;

 

BIN, whichutilizes final wafer sort (chip probe) data, collected with Automated TestEquipment from companies such as Teradyne, Advantest, Credence, LTX andAgilent;

 

BIT, which analyzesfailing bit signatures, failing patterns per die and per wafer and graphicallyoverlays failure data with defect data; and

 

WIP, which encompassesprocess flow, tool, and route information collected by Manufacturing ExecutionSystems, such as PROMISTM, FACTORYworksTM, WorkStreamTM and SiViewTM.  A key feature of this module is that itpermits drill down from problems found in other data domains to the tool ortool group which may be the source of the problem, thereby saving significantfab engineering time in diagnosing yield problems.

 

***YieldProjector***

 

YieldProjectorenables design engineers to improve their design’s projected yield before itreaches the manufacturing process. YieldProjector simulates the yield impact ofa wide-range of random defects on a design’s layout based on statisticalinformation from the manufacturing process. YieldProjector reports the number of fatal defects on each layer of thedesign along with the projected yield of that layer.  YieldProjector graphically highlights yield-limiters in thedesign layout so design engineers can compare various layout options andcritical feature usage to improve a design’s immunity to random and systematicmanufacturing defects.  Thissignificantly increases yield and speeds time to volume production.

 

***TestChipTechnologies Products and Services***

 

OurTestChip products address the needs of semiconductor companies in many aspectsof process technology development, design and manufacturing.  Developing process technology is typically alengthy process that frequently takes 18-24 months and requires a number ofexpert resources to design and validate each process step followed by processqualification.  The complexity ofsmaller chip features, such as 90 nm and 65 nm (known as “nodes”), requires alarge number of devices and circuits to measure not only each process step butalso the integrated process behavior and performance.  This increasing complexity, coupled with smaller chip sizes, iscausing semiconductor producers to turn to yield solutions such as thoseoffered by our TestChip products.

 

HPL’sTestChip products provide capabilities to accelerate semiconductor processtechnology development to the 65nm node and beyond.  Additionally, for advanced technology nodes, TestChip productsprovide new and innovative methods for semiconductor manufacturing processcharacterization and monitoring.  Wehave deployed advanced semiconductor process technologies using our TestChipsolutions at leading Integrated Device Manufacturers.  Semiconductor manufacturers have used TestChip solutions for morethan 8 years, at 7 technology nodes and across multiple process technologies,such as CMOS, BiCMOS, Radio Frequency (“RF”), Analog and others.

 

6

----

 

TheTestChip product line consists of a library of proprietary intellectualproperty (“IP”), supplemented by software products, and services, each of whichare described more fully below.  HPLwill also customize the TestChip Technology IP and services to better enableproject success.

 

**TestChip Technology Development IP**

 

Our proprietary TestChipIP contains over 1,500 elements to address the full breadth of 90nm CMOStechnology development concerns, including 193nm lithography, copper and low-kinterconnect integration, and advanced transistor development.  Our TestChip IP also contains elements forimproving yield in test structures, non-volatile memory, Silicon-on-Insulator(“SOI”), high-power devices, Silicon-Germanium, and RF devices.  From this IP, we can produce GDSII, HTMLdocumentation and test programs, all generated from a common database resultingin consistent and error-free results.

 

**TestChipTechXpress Array Product Family**

 

Our TestChip TechXpressarray products alleviate many issues involved in sub-130nm technologydevelopment and monitoring. Traditional methods allow a limited number ofdevices and circuits to be used for identifying and resolving process and yieldissues.  Our TechXpress array productsdramatically increase the number of devices and circuits that can be used,thereby resulting in more effective identification, diagnosis and resolution ofprocess and yield issues.

 

The TechXpress ArrayFamily comprises of three powerful products: TDSRAMTM, TDROMTMand TDAnalogTM.

 

**TDSRAM**:The TechXpress TDSRAM can be used for bitcell development and processqualification. The TDSRAM bit is designed intentionally to measure key processparameters and is more sensitive to variations and yield issues than aconventional SRAM design. The TDSRAM can also be used to measure defectdensities during volume manufacturing.

 

**TDROM**:The TechXpress TDROM measures process excursion and design rule skews making itideally suited for process characterization and monitoring. The higher numberof circuits built within a specific TDROM provide a dramatically better spatialresolution than possible with traditional test structures.

 

**TDAnalog**:The TechXpress TDAnalog is unique in its ability to measure the intrinsicelectrical properties of the process. It outputs a parametric responseproviding a finer resolution of the measurement. Examples of TDAnalog usage arevia resistance measurements and FET matching effects measurements among others.

 

Some of the specific usecases for the array family products are bitcell development, process qualification,systematic yield loss diagnosis, process characterization and processmonitoring. Customers use results derived from the arrays to correlate yield,and analyze failures electrically and physically.

 

**TestChip Design & Verification Platform**

 

# **The TestChip Design & Verification Platform is used toaccelerate the specification, design, test and debug of test structures andlarge technology development testchips. The platform consists of a web-basedapplication for specifications capture, revision control and projectmanagement, a layout compiler, an HTML documentation & test programgenerator and a secure layout viewer integrated with the compiler anddocumentation.**

 

**SALES AND MARKETING**

 

We rely on our directsales force, distributors and sales agents to penetrate the semiconductor andflat panel display manufacturing markets. Our direct sales efforts have focused primarily on licensing oursoftware products and TestChip technologies to IDMs, foundries and fablesssemiconductor design companies and flat panel display manufacturers.  Our direct sales force operates out of ourheadquarters in San Jose, California and our facilities in Boston,Massachusetts; Austin, Texas; Plano, Texas; Yokohama, Japan; Hsin Chu, Taiwan;Aix-en-Provence, France; and Singapore.

 

Our sales and marketingpersonnel also focus on developing our relationships with industry partners,which include semiconductor original equipment manufacturers (“OEMs”) whobundle our products in their hardware.  Thesejoint-marketing relationships provide us with access to the customer bases ofthese OEMs.  We intend to continue toexpand our industry partnerships in the future.

 

7

----

 

**RESEARCHAND DEVELOPMENT**

 

The market for yieldoptimization is characterized by rapid technological development and productinnovation.  We believe that timelydevelopment of new products and enhancements to existing products are necessaryto maintain our competitive position. Accordingly, we devote a significant portion of our human and financialresources to research and development programs and seek to maintain closerelationships with customers to remain responsive to their needs.

 

The complexity of yieldoptimization requires expertise in physical integrated circuit (“IC”) designand fabrication as well as software development.  Today, we employ a staff of software development engineersfocused on the development of yield-optimization software products.  Our team also encompasses a core group ofengineers and technicians with extensive education, experience and expertise inthe semiconductor domain.  Virtuallyevery discipline associated with the lifecycle of an IC is represented at ourcompany, including device physics, product design, product engineering, yieldengineering, failure analysis engineering, fab management, process engineeringand testing.

 

**COMPETITION**

 

The worldwide market forproductivity-enhancement tools and systems for semiconductor companies ishighly competitive and characterized by rapidly changing technologies.  We face direct competition fromsemiconductor companies that have developed or have the ability to developtheir own proprietary yield-optimization tools and systems, as well asthird-party providers of yield-management software and services.

 

We have found that thetools and systems against which our products and services most commonly competeare those that semiconductor companies have created in-house as part of aspecific fabrication process or through a dedicated development group.  We must overcome a tendency that someproducers may have to resist outside solutions.

 

The third-party providersthat compete in the market for yield-optimization tools are, generally,divisions of larger semiconductor equipment OEMs, such as KLA-Tencor orrelatively small private companies. Additionally, PDF Solutions provides service-based solutions where HPLproducts can also be used.  The successof our business or other businesses like ours might prompt increasedcompetition.  As a result, we must continueto improve existing products, develop new products and protect our innovationsthrough intellectual property laws in order to continue to differentiate ourproduct offering.

 

Significant factors inour target market’s choice of productivity-enhancement software include itsperformance, ease of use, reliability, price, compatibility with existingsystems, installed base, and technical service and support.  While price is an important competitivefactor, we believe that customers will choose the most effective productivitysoftware, even if it is more expensive, because of the added profitability frombetter production yield.

 

**INTELLECTUALPROPERTY**

 

Our future success andcompetitive position depends heavily upon our continued ability to develop newproprietary technology while protecting our existing intellectualproperty.  To protect our products andthe underlying technology, and to prevent competitors from using our technologyin their products, we use a combination of patents, trade secrets and copyrights.  As of March 31, 2003, we held four U.S.patents, expiring at different times between 2013 and 2019, and had twenty U.S.patent applications and ten foreign patent applications pending.  We expect that if granted, the duration ofthese patents will be 20 years from the date of filing theapplication.  We continue to vigilantlypursue U.S. and foreign patent filings. We have additional patent applications that we are developing internallyand may file in the future.

 

There is no assurancethat any of our current or future patent applications will result in patents,and our existing or future patents may be circumvented, declared invalid orchallenged as to scope or ownership. For these and other reasons, we may not realize any competitiveadvantage from our existing patents and any patents that we may be granted inthe future.  Furthermore, others maydevelop technologies that are similar or superior to our proprietarytechnologies or design around any patents that we may hold.  To the extent that others are able to obtainpatents that overlap with our technologies or processes, we may be required tolicense these patents.  If we are unableto license these patents or obtain licenses on acceptable terms, we may need toalter our products or discontinue selling them altogether.  In addition, we have not secured patentprotection in foreign countries and we cannot be certain that the steps we taketo prevent misappropriation of our intellectual property abroad will beeffective, or that the application of foreign laws to technology developedabroad will not adversely effect the validity or enforceability of our U.S.patents.

 

Much of our intellectualproperty has not been patented or is not patentable.  Accordingly, we have historically protected our non-patentedintellectual property as a trade secret. Trade secret protection is in many ways inferior to patentprotection.  Others may

 

8

----

 

reverse-engineer ournon-patented technologies and lawfully use any underlying technology that isdiscovered in this process.  Wetypically enter into confidentiality agreements with prospective customers,distributors and business partners prior to disclosing material proprietary information.  These agreements prohibit unauthorized useand disclosure of our trade secrets and other proprietary information.  We currently require all of our employees toenter into similar agreements.  While webelieve that these agreements provide a measure of protection of ourintellectual property, they may be declared invalid or unenforceable, or we maynot have the resources to seek enforcement in the event of a breach.  Additionally, courts only protect tradesecrets from misappropriation to the extent that we have taken reasonable stepsto protect the confidentiality of these trade secrets.  It is possible that a court would find ourtrade-secret protection practices inadequate and therefore declare portions ofour trade secrets unprotected from misappropriation.

 

Much of our source codeis written by programmers and engineers in the Republic of Armenia.  We generally rely on U.S. and Armeniancopyright law and international treaties for protection of our software sourcecode, software object code, training materials and user manuals created by ouremployees.  As of March 31, 2003,we have registered 14 copyrights with the U.S. Copyright Office.  While U.S. copyright law protects theexpression of an idea, it does not protect the idea itself from copying.  As a result, others may be able to gleanvaluable concepts and methods from our copyrighted material and lawfully usethese ideas and methods in a competing venture by simply changing the manner ofexpression.  In an effort to protect oursoftware from misappropriation, we do not typically divulge our source code tocustomers or vendors, although we have placed our source code in escrow inconnection with certain transactions.

 

**EMPLOYEES**

 

As of March 31,2003, we employed approximately 267 employees worldwide with 99 in the UnitedStates, 142 in Armenia and 26 in five other locations around the world.  None of our employees are represented by alabor union or are subject to a collective bargaining agreement.  We believe that our relationship with ouremployees is good.

 

**DIRECTORSAND OFFICERS**

 

The following table setsforth the directors and officers of the Company, their ages and positions as ofMay 31, 2003:

 
| **Name**             |   | **Age** |   | **Position**                                                                                         |
|----------------------|--------|---------|--------|------------------------------------------------------------------------------------------------------|
|                 |   |    |   |                                                                                                 |
| Cary D. Vandenberg   |   | 47      |   | President and Chief  Executive Officer                                                               |
| Michael P. Scarpelli |   | 36      |   | Chief Financial Officer,  Treasurer, Senior Vice President of Administration and Assistant Secretary |
| Gene Mullinnix       |   | 51      |   | Senior Vice President  of Operations                                                                 |
| Elias Antoun         |   | 46      |   | Director, Chairman of  the Board                                                                     |
| Lawrence Kraus       |   | 40      |   | Director                                                                                             |
| Dr. Yervant Zorian   |   | 47      |   | Director                                                                                             |
| Michael J. Field     |   | 54      |   | Vice President, General  Counsel and Secretary                                                       |
| Robert B. Baden      |   | 60      |   | Vice President of  Global Sales                                                                      |
| James Chalmers       |   | 43      |   | Vice President of  Marketing                                                                         |

 

*CARY D.VANDENBERG.*  Mr.Vandenberg joined the Company in May 2003 as President and Chief ExecutiveOfficer.  Prior to joining HPL, Mr. Vandenberg was Vice President ofStrategic Business Development at Communicant Semiconductor Technologies AG, aEuropean based semiconductor foundry. He worked at Communicant from July 2001 to May 2003 and duringthis period he was responsible for the design kit and modeling group, corporatepartnerships, and the e-business strategy. Mr. Vandenberg has over 20 years of management experience in softwareand semiconductor companies including positions at Sequencia, Inc. (President& CEO), JENOPTIK INFAB Intrack, Inc. (President), and PROMIS SystemsCorporation Ltd. (Vice President).  Mr.Vandenberg holds a Bachelor of Science degree in commerce from Santa Clara University.

 

*MICHAELP. SCARPELLI.* Mr. Scarpelli has been our Chief Financial Officer, Treasurer,Senior Vice President of Administration and Assistant Secretary sinceJuly 2002.  In these roles, he isprincipally responsible for the Company’s worldwide finance function includingaccounting, financial systems and facilities. Mr. Scarpelli joined the Company in January 2002 as VicePresident of Corporate Development, responsible for the oversight of theCompany’s mergers and acquisitions function. Prior to joining HPL, Mr. Scarpelli was an auditor withPricewaterhouseCoopers LLP since 1989 and an audit partner since 1998.  Mr. Scarpelli received his Bachelor ofArts degree in economics from the University of Western Ontario and is aCertified Public Accountant and a Chartered Accountant.

 

*GENEMULLINNIX.* Mr. Mullinnix has been Senior Vice President of Operations sinceJuly 2002.  In this role, he isresponsible

 

9

----

 

for all aspects ofproduct development and customer deployment and support.  Mr. Mullinnix has over 29 years ofsemiconductor industry experience including 9 years with Texas Instrumentsand 18 years with Motorola.  InFebruary 2001, Mr. Mullinnix joined TestChip Technologies, Inc.(“TestChip”), as Vice President of Engineering.  Mr. Mullinnix joined HPL in February 2002 in connectionwith the Company’s acquisition of Covalar Technologies Group, Inc., theparent of TestChip, and was promoted to the position of President and GeneralManager, TestChip.  Prior to joiningTestChip, Mr. Mullinnix worked for eighteen years in various positions atMotorola including Operations and Program Manager for the Non-Volatile MemoriesTechnology Center, Site and Wafer Fab Operations Manager, and Global TechnologyManager.  Mr. Mullinnix managedwafer fabs for Motorola in California and North Carolina with responsibilitiesin wafer fab operations, site management, technology development and a designcenter.  Mr. Mullinnix organizedand developed the Microcontroller Technology Group’s External ManufacturingOperations establishing and managing foundry relationships in Asia, Japan,Europe and Israel.  Mr. Mullinnixholds a Bachelor of Science degree in Engineering from Texas A&MUniversity.

 

*ELIASANTOUN.* Mr. Antoun has served as President and Chief Executive Officer ofMediaQ, Incorporated, a semiconductor manufacturer, sinceFebruary 2000.  FromMarch 1998 to January 2000, Mr. Antoun served as Executive VicePresident, Consumer Products Division at LSI Logic.  Mr. Antoun served as President of LSI Logic K.K., a Japanesesubsidiary of LSI Logic, from January 1996 to March 1998.  Mr. Antoun was elected to our board ofdirectors in August 2000 and has served as the Chairman of the board sinceJuly 2002.  Mr. Antoun’s termexpires at the next election of directors.

 

*LAWRENCEKRAUS.*  Mr. Krausis a co-founder of the Company and has served as a member of the board ofdirectors of the Company’s principal operating subsidiary, HPLI, since itsformation in 1989.  FromFebruary 2001 to September 2002, Mr. Kraus served as HPLI’s VicePresident of Strategic Marketing. Mr. Kraus previously served as HPLI’s Director of HardwareDevelopment from May 1989 to January 1995 and as the Vice Presidentand General Manager of HPLI’s hardware divisions until their sale to CredenceSystems Corporation in June 1998. With the sale of the hardware divisions to Credence, Mr. Krausjoined Credence as a Director of Operations and served in that capacity untilFebruary 2001.  Mr. Kraus iscurrently a manager of hardware development at Advantest America, Inc.  Mr. Kraus was elected to our board ofdirectors in August 2000 and his term expires at the next election ofdirectors.

 

*DR.YERVANT ZORIAN.* Dr. Zorian has served as Vice President and Chief Scientist atVirage Logic Corporation since June 2000 and as Chief Technology Advisorat LogicVision from November 1996 until June 2000.  Dr. Zorian was a Distinguished Memberof the Technical Staff at Bell Laboratories, Lucent Technologies from November 1987until November 1996. Dr. Zorian has chaired several Institute of Electrical andElectronic Engineering (“IEEE”) symposiums and workshops.  He currently serves as the editor and chiefemeritus of IEEE Design & Test of Computers.  He has authored three books, received several best paper awardsand holds twelve U.S. patents in the area of test technology.  Dr. Zorian is an honorary doctor of theNational Academy of Science, Armenia, and is a Fellow of IEEE.  Mr. Zorian was elected to our board ofdirectors in August 2000 and his term expires at the next election ofdirectors.

 

*MICHAELJ. FIELD*.  Mr. Fieldjoined the company in September 2002 as a consultant and inMarch 2003 became our Vice President and General Counsel.  Prior to joining the company, Mr. Field wasexecutive vice president and one of the founders of domainLogix Corporation, asemiconductor software company.  From1990 to 1999, Mr. Field has held various senior executive management positionsover a 10 year period with Consilium, Inc., First Pacific Networks, Inc.,SyQuest Technologies, Inc., and other Silicon Valley technology ventures.  Prior to these executive managementpositions, Mr. Field was a partner for approximately 16 years in severalboutique law firms specializing in business and technology transactions.  Mr. Field holds a Bachelor of Arts degree inpsychology from San Jose State University and a Juris Doctorate degree fromSanta Clara University, School of Law.

 

*ROBERT B. BADEN.*  Mr. Baden has been our Vice President ofGlobal Sales since January 2003. In this role he is principally responsible for the deployment andmanagement of the Company’s worldwide sales organization.  Mr. Baden joined the Company inJanuary of 2002 as Manager of Business Development, Design for Yield,responsible for establishing the Company’s yield enhancement products in theintegrated circuit design industry.  Hewas appointed as Director of Sales in July 2002.  Prior to that, Mr. Baden was employed by Synopsys as Senior Manager,Strategic Business Development from July 2000 to November 2001,Program Director, Technology Partnerships from October 1998 toMarch 1999 and Manager, New Business Development from February 1995to September 1998.  FromApril 1999 to June 2000, Mr. Baden was employed by DataMain as VicePresident of Sales.  Mr. Baden has morethan 30 years of worldwide technology marketing and sales experience inmanagement positions with IBM, Xerox and Synopsys.  Mr. Baden received his Master of Science degree in OperationsResearch from New York University and his Bachelor of Science degree in Mathematicsfrom Case Institute of Technology.

 

*JAMES CHALMERS.*  Mr. Chalmers has been our Vice President ofMarketing since January 2003.  Inthis role he is principally responsible for the planning, positioning, andpromotion of the companies’ product portfolio. Mr. Chalmers joined the Company in November of 2001 as Director ofBusiness Development, responsible for expanding the Company’s yield enhancementproduct footprint in the integrated circuit industry.  Prior to that, Mr. Chalmers was employed with KLA-Tencor asSenior Director Information Technology from May 2000 toNovember 2001, Director of Technical marketing from May 1999 toMay 2000 and Director of Software Sales from May 1998 toMay 1999.  Mr. Chalmers has morethan 20 years of software marketing, sales, engineering, and

 

10

----

 

informationtechnology experience in management positions with KLA-Tencor andMotorola.  Mr. Chalmers received hisBachelor of Science degree in Chemical Engineering from The Georgia Instituteof Technology.

 

**ITEM2.  PROPERTIES**

 

The following table setsforth the Company’s principal properties as of May 31, 2003.  We believe that our existing facilities areadequate for our current needs.

 
| **Location**           |   | **Square  Footage** |   | **Expiration  of  Lease Term** |   | **Uses**                           |
|------------------------|--------|---------------------|--------|--------------------------------|--------|------------------------------------|
|                   |   |                |   |                           |   |                               |
| Austin, Texas          |   | 25,140              |   | February 2006             |   | Offices                            |
| Bedford, Massachusetts |   | 12,050              |   | October 2005              |   | Offices                            |
| Chennai, India         |   | 2,097               |   | March 2007                |   | Offices                            |
| HsinChu, Taiwan        |   | 3,007               |   | May 2005                  |   | Offices                            |
| Yokohama, Japan        |   | 3,020               |   | February 2004             |   | Offices                            |
| San Jose, California   |   | 12,500              |   | December 2005             |   | Executive offices                  |
| Plano, Texas           |   | 18,302              |   | March 2006                |   | Offices                            |
| Yerevan, Armenia       |   | 18,772              |   | May 2004                  |   | Offices; research and  development |

 

**ITEM3.  LEGALPROCEEDINGS**

 

BetweenJuly 31, 2002 and November 15, 2002, fourteen class-action lawsuitshave been filed and are pending against the Company, certain current and formerofficers and/or directors of the Company, and the Company’s independentauditors (collectively, the “Defendants”) in the United States District Courtfor the Northern District of California. The lawsuits allege that the Defendants violated Sections 10(b) and20(a) of the Securities Exchange Act of 1934, and Rule 10b-5 promulgatedthereunder by the SEC, by making a series of material misrepresentations as tothe financial condition of the Company during the class period of July 31,2001 to July 19, 2002.  Several ofthe lawsuits further allege violations of Sections 11, 12(a)(2) and 15 of the SecuritiesAct of 1933 (the “Act”).  The plaintiffsare generally seeking to recover compensatory damages, costs and expensesincurred, interest and such other relief as the court may deemappropriate.  We expect that theselawsuits will be consolidated into a single action in the United StatesDistrict Court for the Northern District of California.  Motions for appointment of a lead plaintiffare pending before the Court.

 

Weare also a nominal defendant in five stockholder derivative lawsuits pending inSuperior Court in the County of Santa Clara, California.  These lawsuits, which were filed betweenJuly 31, 2002 and September 30, 2002, assert derivative claims onbehalf of the Company against current and/or former officers and directors ofthe Company and the Company’s independent auditors.  The claims asserted in these lawsuits include insider trading,breach of fiduciary duties, aiding and abetting breaches of fiduciary duties,negligence and professional malpractice, negligent misrepresentation andomission, contribution and indemnification, abuse of control, grossmismanagement, unjust enrichment and breach of contract.  These lawsuits seek damages suffered by theCompany, treble damages for the sale of shares, costs and expenses of theseactions and such other relief as the court may deem appropriate.  In an order dated December 3, 2002, theCourt consolidated these actions and appointed lead plaintiff’s counsel.  The date for filing a consolidated complainthas been continued to July 14, 2003.

 

Fiveshareholders of the Company have sued in state court of the District Court ofDallas County, Texas, the Company’s independent auditors and the managingunderwriter in the Company’s initial public offering, in connection with claimsrelating to the Company’s acquisition of Covalar Technologies Group, Inc. in February 2002.  The Company has been named as a responsiblethird party in this action for purposes of apportioning fault in jury findings;to date, no claims have been brought against the Company.  Subject to a reservation of rights, we haveaccepted the underwriter’s request to indemnify the underwriter in connectionwith the Company’s initial public offering and to advance expenses in the eventthe underwriter becomes a party to any lawsuit arising out of the publicoffering.  While the Company had obtainedinsurance to cover our obligation to indemnify and advance expenses to the underwriter, the insurer has not yettaken a position as to whether such obligations are covered under thepolicy.  If it does not contest coverage, however, coverage for these indemnificationobligations is subject to a sub-limit of $1,000,000.  This lawsuit is only in the preliminary stage and the Company’spotential liability cannot be determined at this time.

 

 Five former shareholders of FabCentric, Inc.,which was acquired by the Company in December 2001, have sued the Company,the Company’s former President and CEO and CFO, and the Company’s independentauditors in a lawsuit pending in Superior Court in the County of Santa Clara,California.  This lawsuit was filed onor about May 22, 2003.** **Thislawsuit alleges claims for fraud, negligent misrepresentation, breach ofwarranties and covenants, breach of contract and negligence, and seeksrescission or, alternatively, damages, costs and expenses.  Because this lawsuit was only recentlyfiled, we have not evaluated the merits of these

 

11

----

 

allegations.

 

Additionally,in April 2003, UBS PaineWebber, Inc. filed suit against the Company in theSupreme Court of the State of New York, County of New York (the “New YorkAction”) alleging tortius interference of contract and a violation of theUniform Commercial Code.  This actionrelates to the transfer of shares of HPL common stock putatively pledged to UBSPaineWebber, Inc. by Y. David Lepejian, our former President and CEO, and hisspouse and seeks, among other things, mandatory injunctive relief requiring HPLto effect the transfer of the subject stock. In May 2003, we filed an interpleader action in United StatesDistrict Court for the Northern District relating to the New York action.  Mr. Lepejian and UBS PaineWebber arecurrently engaged in an NASD arbitration proceeding regarding the pledge of theshares.

 

Theaforementioned litigation matters are in the early stages.  As a result, we believe that no amountshould be accrued for these matters under SFAS No. 5, “Accounting forContingencies,” because we are currently unable to evaluate the likelihood ofan unfavorable outcome or an estimate of the amount or range of potential loss,if any.

 

Anyresolution of the aforementioned litigation could have a material effect on ourfinancial position, results of operations or cash flows.  We are investigating informal or formalrestructuring alternatives which potentially may dilute shareholder equity butcould mitigate any material adverse affect on our financial position or resultsof operations which might otherwise result from an unfavorable resolution ofthese lawsuits.  Any such dilution couldbe significant and could greatly affect the value of our common stock.  See, Risk Factors.

 

**ITEM4.  SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

 

None.

 

12

----

 

**PART II**

 

**ITEM5.  MARKET FOR REGISTRANT’S COMMON STOCKAND RELATED STOCKHOLDER MATTERS**

 

OnSeptember 30, 2002, our common stock was delisted from the Nasdaq NationalMarket.  Since that time, no establishedpublic trading market has existed for our common stock and shares of our commonstock are neither listed on any national securities exchange, nor presentlytraded on any public stock exchange or in any other public market.  Although quotations for shares of our commonstock may be obtained through the over-the-counter “pink sheets” maintained byPink Sheets LLC (a centralized quotation service that collects and publishesmarket maker quotes for over-the-counter securities), because secondary marketactivity for shares of our common stock has been limited and sporadic, suchquotations may not accurately reflect the price or prices at which purchasersor sellers would currently be willing to purchase or sell such shares. Thefollowing table shows the range of high and low closing bid prices for ourcommon stock for the periods indicated, as reported on the Nasdaq NationalMarket under the symbol “HPLA” for the period July 30, 2001, the date ofour initial public offering, to September 30, 2002, and in the Pink Sheetsunder the symbol “OTC:HPLA” for the period October 1, 2002 throughMarch 31, 2003.  The quotations on the Pink Sheets reflect inter-dealerprices, without retail mark-up, mark-down or commission and may not necessarilyrepresent actual transactions.

 

| **Fiscal  2002** |   | **High** | ** ** | **Low** | ** ** |
|------------------|--------|----------|------------|---------|------------|
|             |   |     |       |    |       |
| First  Quarter   |   | N/A      |       | N/A     |       |
| Second  Quarter  |   | $        | 15.74      |    | $          | 3.45 |   |
| Third  Quarter   |   | $        | 18.55      |    | $          | 4.25 |   |
| Fourth  Quarter  |   | $        | 18.65      |    | $          | 11.19 |   |

 

| **Fiscal  2003** |   | **High** | ** ** | **Low** | ** ** |
|------------------|--------|----------|------------|---------|------------|
|             |   |     |       |    |       |
| First  Quarter   |   | $        | 16.26      |    | $          | 9.59 |   |
| Second  Quarter  |   | $        | 15.80      |    | $          | 13.10 |   |
| Third  Quarter   |   | $        | 0.11       |    | $          | 0.02 |   |
| Fourth  Quarter  |   | $        | 0.20       |    | $          | 0.02 |   |

 

As of March 31,2003, there were approximately 124 holders of record of our common stock and30,809,667 shares of common stock outstanding. No dividends have been paid on our common stock since inception, and wedo not anticipate paying any dividends in the foreseeable future.

 

RECENT SALES OFUNREGISTERED SECURITIES

 

On April 10, 2002,we acquired Defect & Yield Management, Inc., a Delawarecorporation (“DYM”).  In connection withthis acquisition, we issued a total of 967,260 shares of common stock to theDYM shareholders and assumed options to purchase up to 82,740 shares of commonstock that may be issued upon exercise of outstanding DYM stock options.  We will also issue 396,826 additional shareswith a value of $50,000 in the aggregate pursuant to an earn-out provision inthe purchase agreement.  This offeringwas exempt from registration under Rule 506, promulgated under the Act.

 

USE OF PROCEEDS FROMSALES OF REGISTERED SECURITIES.

 

Our RegistrationStatement on Form S-1 (Commission File No. 333-61810) for our initialpublic offering of common stock was declared effective on July 30,2001.  We sold a total of 6,900,000shares of common stock to an underwriting syndicate for aggregate grossoffering proceeds of $75.9 million. In connection with this offering, we incurred total expenses ofapproximately $7.2 million, consisting of $5.3 million forunderwriting discounts and commissions, and approximately $1.9 million ofother expenses.  None of these expenseswere paid directly or indirectly to any of our directors, officers, or theirassociates, persons owning 10% or more of any class of our securities, oraffiliates of HPL.  Offering proceeds,net of expenses were approximately $68.7 million.  We have applied the proceeds to temporaryinvestments in a money market investment account, the purchase of short-terminvestments and have spent a portion of the proceeds on research anddevelopment, sales and marketing and the acquisitions of Tyecin-InnotechCorporation, FabCentric, Covalar, and DYM.

 

13

----

 

**ITEM6.  SELECTEDFINANCIAL DATA**

 

The selected consolidatedfinancial data set forth below should be read in conjunction with “Management’sDiscussion and Analysis of Financial Condition and Results of Operations,” andthe consolidated financial statements of HPL and the notes to the consolidatedfinancial statements included elsewhere in this annual report onForm 10-K.  The consolidatedstatement of operations data for the years ending March 31, 2003, 2002 and2001 and the consolidated balance sheet data at March 31, 2003 and 2002are derived from the audited financial statements included in this annualreport on Form 10-K.   The consolidatedstatement of operations data for the years ending March 31, 2000 and 1999and the consolidated balance sheet data at March 31, 2001, 2000 and 1999are derived from the audited financial statements not included in this annualreport on Form 10-K.   Our historicalresults are not necessarily indicative of results to be expected for futureperiods.

 

14

----

 

**Statement ofOperations Data:**

 
|                                                                     |   | **Years Ended March 31,**                 | ** ** |
|--------------------------------------------------------------------------|--------|-------------------------------------------|------------|
|                                                                     |   | **2003**                                  | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** | **1999** | ** ** |
|                                                                     |   | **(in thousands, except per share data)** | ** ** |
|                                                                     |   |                                      |       |   |   |   |   |   |   |   |   |
| Revenues:                                                                |   |                                      |       |   |   |   |   |   |   |   |   |
| Software  licenses                                                       |   | $                                         | 5,281      |   | $ | 1,614 |   | $ | 3,159 |   | $ | 3,039 |   | $ | 45 |   |
| Consulting  services, maintenance and other                              |   | 10,311                                    |       | 2,899 |   | 1,156 |   | 665 |   | 103 |   |
| Total  revenues                                                          |   | 15,592                                    |       | 4,513 |   | 4,315 |   | 3,704 |   | 148 |   |
| Cost  of revenues:                                                       |   |                                      |       |   |   |   |   |   |   |   |   |
| Software  licenses                                                       |   | 656                                       |       | 587 |   | 133 |   | 9 |   | 1 |   |
| Consulting  services, maintenance and other (1)                          |   | 3,808                                     |       | 507 |   | 243 |   | 259 |   | 61 |   |
| Total  cost of revenues                                                  |   | 4,464                                     |       | 1,094 |   | 376 |   | 268 |   | 62 |   |
| Gross  profit                                                            |   | 11,128                                    |       | 3,419 |   | 3,939 |   | 3,436 |   | 86 |   |
| Operating  expenses:                                                     |   |                                      |       |   |   |   |   |   |   |   |   |
| Research  and development (1)                                            |   | 10,515                                    |       | 6,118 |   | 3,349 |   | 2,851 |   | 2,503 |   |
| Sales,  general and administrative (1)                                   |   | 19,788                                    |       | 9,285 |   | 4,329 |   | 3,155 |   | 2,613 |   |
| Goodwill  impairment                                                     |   | 30,570                                    |       | — |   | — |   | — |   | — |   |
| Stock-based  compensation                                                |   | 1,047                                     |       | 3,547 |   | 2,369 |   | 580 |   | 64 |   |
| Amortization  of intangible assets                                       |   | 1,494                                     |       | 294 |   | 137 |   | 148 |   | 11 |   |
| Total  operating expenses                                                |   | 63,414                                    |       | 19,244 |   | 10,184 |   | 6,734 |   | 5,191 |   |
| Loss  from operations                                                    |   | (52,286                                   | )          | (15,825 | ) | (6,245 | ) | (3,298 | ) | (5,105 | ) |
| Interest  income (expense) and other, net                                |   | 468                                       |       | 908 |   | (190 | ) | (248 | ) | 48 |   |
| Loss  before income taxes and discontinued operations                    |   | (51,818                                   | )          | (14,917 | ) | (6,435 | ) | (3,546 | ) | (5,057 | ) |
| Benefit  from income taxes                                               |   | —                                    |       | — |   | — |   | — |   | (1,982 | ) |
| Loss  from continuing operations                                         |   | (51,818                                   | )          | (14,917 | ) | (6,435 | ) | (3,546 | ) | (3,075 | ) |
| Discontinued  operations:                                                |   |                                      |       |   |   |   |   |   |   |   |   |
| Income  from discontinued operations (net of income tax of $17 in 1999)  |   | —                                    |       | — |   | — |   | — |   | 25 |   |
| Gain  on sale of discontinued operations (net of income tax of $1,965)   |   | —                                    |       | — |   | — |   | — |   | 2,916 |   |
| Net  loss                                                                |   | $                                         | (51,818    | ) | $ | (14,917 | ) | $ | (6,435 | ) | $ | (3,546 | ) | $ | (134 | ) |
|                                                                     |   |                                      |       |   |   |   |   |   |   |   |   |
| Loss  per common share from continuing operations—basic and diluted |   | $                                         | (1.69      | ) | $ | (0.62 | ) | $ | (0.37 | ) | $ | (0.21 | ) | $ | (0.19 | ) |
| Net  loss per share—basic and diluted                               |   | $                                         | (1.69      | ) | $ | (0.62 | ) | $ | (0.37 | ) | $ | (0.21 | ) | $ | (0.01 | ) |
| Shares  used in per share computations:                                  |   |                                      |       |   |   |   |   |   |   |   |   |
| Basic                                                                    |   | 30,645                                    |       | 24,038 |   | 17,496 |   | 17,068 |   | 16,422 |   |
| Diluted                                                                  |   | 30,645                                    |       | 24,038 |   | 17,496 |   | 17,068 |   | 16,422 |   |

 

----

(1)          Excludesthe following stock-based compensation charges:

 
| Cost  of revenues              |   | $   | 18     |   | $      | 39    |   | $   | 60     |   | $      | 2   |   | $ | — |   |
|--------------------------------|--------|-----|--------|--------|--------|-------|--------|-----|--------|--------|--------|-----|--------|---|--------|--------|
| Research  and development      |   | 414 |   | 692    |   | 296   |   | 96  |   | 23     |   |
| Sales,  general administrative |   | 615 |   | 2,816  |   | 2,013 |   | 482 |   | 41     |   |
|                           |   | $   | 1,047  |   | $      | 3,547 |   | $   | 2,369  |   | $      | 580 |   | $ | 64     |   |

 

**Consolidated Balance Sheet Data:**

 
|                                               |   | **March 31,**      | ** ** |
|----------------------------------------------------|--------|--------------------|------------|
|                                               |   | **2003**           | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** | **1999** | ** ** |
|                                               |   | **(in thousands)** | ** ** |
|                                               |   |               |       |   |   |   |   |   |   |   |   |
| Cash,  cash equivalents and short-term investments |   | $                  | 21,741     |   | $ | 47,109 |   | $ | 989 |   | $ | 178 |   | $ | 332 |   |
| Working  capital (deficit)                         |   | 13,525             |       | 35,062 |   | (7,169 | ) | (2,090 | ) | (957 | ) |
| Total  assets                                      |   | 60,385             |       | 101,308 |   | 5,455 |   | 5,031 |   | 1,895 |   |
| Long-term  debt, less current portion              |   | 130                |       | 280 |   | 295 |   | 1,857 |   | 78 |   |
| Total  stockholders’ equity (deficit)         |   | $                  | 46,032     |   | $ | 82,316 |   | $ | (6,748 | ) | $ | (2,727 | ) | $ | 193 |   |

 

15

----

 

**ITEM7.  MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

*Thefollowing discussion should be read in conjunction with Item 1: Business; Item6: Selected Financial Data; and Item 8: Financial Statements and SupplementaryData.  This discussion and analysiscontains forward-looking statements that involve risks, uncertainties andassumptions.  Our actual results maydiffer materially from those anticipated in these forward-looking statements asa result of certain factors, including, but not limited to, those set forthunder “Risk Factors” and elsewhere in this report.  HPL undertakes no obligation to update any forward-lookingstatement to reflect events after the date of this report.*

 

**OVERVIEW**

 

We provide comprehensiveyield-optimization solutions to the semiconductor industry and flat-paneldisplay manufacturers.  We license oursoftware products and sell related services through our direct sales force,distributors, sales agents and semiconductor equipment manufacturers (“OEMs”)that bundle our software with their hardware.

 

Our sales cycle for thelicense of our software products has historically been very long.  Our products are new and our customers spenda significant amount of time evaluating our products.  Customer purchase orders typically include integration andinstallation services, rights of return and acceptance criteria.  As such, we defer a significant amount ofour license revenue until integration and installation services are complete,rights of return lapse and final acceptance occurs.  The amount of our license revenue is currently at levels thathave resulted in no meaningful trend from period to period.  Our ability to sell our products in thefuture may also be affected by the current decline in capital spending by potentialcustomers in the semiconductor industry.

 

In July 2001, wesold 6,900,000 shares of our common stock in our initial public offering,raising aggregate gross offering proceeds of $75.9 million.  In connection with this offering, weincurred total expenses of approximately $7.2 million, consisting of$5.3 million for underwriting discounts and commissions and approximately$1.9 million in other expenses.  Aportion of the net proceeds have been used to expand our operations, includingpayments related to the following acquisitions:

 

On October 4, 2001,we acquired all of the outstanding shares of Tyecin-Innotech Corporation(“Tyecin”), a corporation organized under the laws of Japan, for approximately$789,000 in cash.  The transaction wasaccounted for using the purchase method of accounting.  The purchase price was allocated to tangiblenet assets acquired of approximately $708,000 and goodwill of approximately$81,000.  Tyecin provides softwaresupport and services to manufacturing companies.  The acquisition provided us with an experienced workforce inJapan and helps support existing and future customers in Japan.

 

On December 5, 2001,we acquired FabCentric, Inc. (“FabCentric”), for a purchase price ofapproximately $8.5 million.  Inconnection with the acquisition, all of the shares of FabCentric’s common,Series A preferred and Series B preferred stock outstandingimmediately prior to the consummation of the acquisition were converted into703,355 shares of our common stock.  Wealso assumed FabCentric’s outstanding stock options, which converted intooptions to purchase 23,231 shares of our common stock.  The transaction was accounted for using thepurchase method of accounting. FabCentric is engaged in the business of software development and salesto semiconductor companies.  Theacquisition gave us access to FabCentric’s customer base, complementarytechnology and a highly skilled workforce.

 

On February 15,2002, we acquired all of the outstanding common shares of Covalar TechnologiesGroup, Inc. (“Covalar”), a design yield optimization and productivityimprovement software company which offers solutions to semiconductor companiesthat include testing, analysis and advanced circuit design.  In connection with the acquisition, weissued 1,481,566 shares of our common stock, paid $10.0 million in cashand assumed options to purchase 418,434 shares of our common stock.  The aggregate purchase price wasapproximately $36.0 million.  Thetransaction was accounted for using the purchase method of accounting.  The acquisition of Covalar has allowed us tooffer our customers a complete end-to-end software and related servicessolution from design through manufacturing, gain a broader customer base andrelationships, and provide us with a highly skilled workforce.

 

On April 10, 2002,we acquired all of the outstanding capital stock of Defect & YieldManagement, Inc., a Delaware corporation (“DYM”).  DYM is engaged in the sale and support ofmanufacturing floor defect data management software.  In connection with the acquisition, we paid the shareholders$2.0 million in cash, issued 967,260 shares of HPL common stock and agreedto assume stock options to purchase up to 82,740 shares of HPL’s commonstock.  The total value of thetransaction was $17.1 million.  Wewill issue an additional 396,826 shares of common stock with a value of $50,000in the aggregate to the former DYM stockholders to satisfy the earn-outprovisions in the merger agreement.  Theacquisition provided the Company access to an installed customer base in over70 facilities worldwide.

 

16

----

 

Our standard paymentterms for our customers provide for payment in 30 days.  It is frequently the case that ourreceivables are outstanding for more than 30 days.  Our accounts receivable from internationalcustomers have been outstanding longer than our domestic receivables and weexpect this to continue.

 

In each of the last threefiscal years, a relatively small number of customers have accounted for a largeportion of our revenues, and the composition of our major customers has changedfrom year to year.  This is because wecurrently have a limited sales force, our products have a lengthy sales cycleand we recognize relatively large license revenues upon entering into perpetuallicensing agreements.  We had three,four and four end customers that individually accounted for at least 10% of ourrevenues in the years ended March 31, 2003, 2002 and 2001, respectively.  In the aggregate, these end customers accountedfor 61%, 66% and 61% of our revenues in the years ended March 31, 2003,2002 and 2001, respectively.

 

**CRITICAL ACCOUNTING POLICIES**

 

The discussion andanalysis of our financial condition and results of operations are based uponour consolidated financial statements, which have been prepared in accordancewith accounting principles generally accepted in the United States.  The preparation of these financialstatements requires us to make estimates and judgments that affect our reportedassets, liabilities, revenues and expenses, and our related disclosure ofcontingent assets and liabilities.  Onan on-going basis, we evaluate our estimates, including those related torevenue recognition, goodwill and identifiable, separately recorded intangibleassets, litigation, contingent liabilities and income taxes.  We base our estimates on historicalexperience and on various other assumptions that are believed to be reasonableunder the circumstances.  Our estimatesthen form the basis of judgments about the carrying values of assets andliabilities that are not readily apparent from other sources.  Actual results may differ from theseestimates under different assumptions or conditions.

 

We believe the followingcritical accounting policies and the related judgments and estimatessignificantly affect the preparation of our consolidated financial statements:

 

**RevenueRecognition**

 

Revenue recognition rulesare very complex, and certain judgments affect the application of our revenuepolicy.  The amount and timing of ourrevenue is difficult to predict, and any shortfall in revenue or delay inrecognizing revenue could cause our operating results to vary significantlyfrom quarter to quarter.  In addition todetermining our results of operations for a given period, our revenuerecognition determines the timing of certain expenses, such as commissions,royalties and other variable expenses.

 

We derive revenuesprincipally from the sale of software licenses, software maintenance contractsand consulting services.  We offer twotypes of licenses: perpetual and time-based. Perpetual licenses have no expiration date, while time-based licensesrequire renewal.  Our software productlicenses provide a narrowly defined subset of features for a givencustomer.  The customer may acquireadditional licenses to extend the functionality of our products as itstechnologies and facilities change or if it wishes to use additional featuresof our software for its production process. Our licenses usually limit the number of people who can use the softwareat a given time.

 

Revenues from softwarelicenses are generally recognized upon the execution of a binding agreement anddelivery of the software, provided that: the fee is fixed or determinable;vendor-specific objective evidence exists to allocate a portion of the totallicense fee to any undelivered elements of the arrangement; collection isreasonably assured; and the agreement does not contain customer acceptanceclauses.  If customer acceptance clausesexist, revenues are recognized upon customer acceptance and all other revenuerecognition criteria are met.

 

If the consulting orother services sold in connection with the software license are essential tothe functionality of the software or involve significant production, customizationor modification of software, we recognize revenue on either apercentage-of-completion or completed contract basis.  For the percentage-of-completion method, we recognize revenuesusing labor hours incurred as the measure of progress against the total laborhours estimated for completion of the project. We consider a project completed after all contractual obligations aremet.  At times, an unbilled accountsreceivable balance can exist which comprises revenue recognized in advance ofcontractual billings.  We makeprovisions for estimated contract losses in the period in which the lossbecomes probable and can be reasonably estimated.  Estimates of total labor hours or expected losses on contractsare subject to judgment and actual amounts may differ significantly from thoseestimates.

 

For contracts withmultiple obligations (e.g., deliverable and undeliverable products,post-contract support and other services), we allocate revenues to theundelivered element of the contract based on objective evidence of its fairvalue.  This objective evidence is thesales price of the element when sold separately or the renewal rate specifiedin the agreement for licensing arrangements with terms of one year or greaterthat include post-contract customer support and software updates.  We recognize revenues allocated toundelivered products

 

17

----

 

when the criteria forsoftware license revenues set forth above are met.  Revenues from time-based software licenses are generallyrecognized ratably over the period of the licenses.  Determining whether objective evidence of fair value exists issubject to judgment and resulting fair values used in determining the value ofthe undelivered elements is also subject to judgment and estimates.

 

Software maintenancerevenues are recognized ratably over the term of the maintenance period, whichis generally one year.  Our softwaremaintenance includes product maintenance updates, Internet-based technical supportand telephone support.  Revenues derivedfrom our consulting services are recognized as the services are performed.  Revenues derived from software developmentprojects are recognized on a completed contract basis.

 

We also derive revenuesfrom the sale of software licenses, maintenance and post-contract supportservices through our distributors. Revenues from sales made through our distributors for which thedistributors have return rights are recognized when the distributors have soldthe software licenses or service to their customers and the criteria forrevenue recognition under SOP 97-2, as amended, are met.  Revenues from maintenance and post-contractsupport services sold through our distributors are recognized ratably over thecontract period.

 

Amounts invoiced to ourcustomers in excess of recognized revenues are recorded as deferredrevenues.  The timing and amountsinvoiced to customers can vary significantly depending on specific contractterms and can therefore have a significant impact on deferred revenues in anygiven period.

 

**Goodwilland Intangible Assets**

 

Consideration paid inconnection with acquisitions is required to be allocated to the acquiredassets, including certain identifiable intangible assets, goodwill, andliabilities acquired.  Acquired assetsand liabilities are recorded based on our estimate of fair value, whichrequires significant judgments, including those with respect to futureestimated cash flows and discount rates. For identifiable intangible assets that we separately record, we arerequired to estimate the useful life of the assets and recognize their cost asan expense over the useful lives.  Weuse the straight-line method to amortize long-lived assets, except goodwill,which results in an equal amount of expense in each period.

 

We assess theimpairment of identifiable intangibles and long-lived assets whenever events orchanges in circumstances indicate that the carrying value may not berecoverable.  Furthermore, we assess theimpairment of goodwill at least annually. Factors we consider important which could trigger an impairment reviewinclude the following:

 

•                  significant underperformancerelative to expected historical or projected future operating results;

•                  significant changes in themanner of our use of the acquired assets or the strategy for our overallbusiness;

•                  significant negative industry oreconomic trends;

•                  significant decline in our stockprice for a sustained period;

•                  market capitalization relativeto net book value; and

•                  a current expectation that, morelikely than not, a long-lived asset will be sold or otherwise disposed ofsignificantly before the end of its previously estimated useful life.

 

When one ormore of the above indicators of impairment occurs we estimate the value oflong-lived assets and intangible assets to determine whether there is animpairment.  We measure any impairmentbased on projected discounted cash flow method, which requires us to makeseveral estimates including the estimated cash flows associated with the asset,the period over which these cash flows will be generated and a discount ratecommensurate with the risk inherent in our current business model.  These estimates are subjective and if wemade different estimates, it could materially impact the estimated fair valueof these assets and the conclusions we reached regarding an impairment.  We identified triggering events in thesecond, third and fourth quarter of our year ended March 31, 2003 whichrequired us to perform the first step of the analysis.

 

The first andsecond steps of the two-step process are as follows:

 

Step 1 - We compare the fairvalue of our reporting units to the carrying value, including goodwill.  For each reporting unit where the carryingvalue, including goodwill, exceeds the unit’s fair value, we proceed on to Step2.  If a unit’s fair value exceeds thecarrying value, no further analysis is performed and no impairment charge isnecessary.

 

Step 2 - We perform anallocation of the fair value of the reporting unit to our identifiable tangibleand non-goodwill intangible assets and liabilities.  This derives an implied fair value for the reporting unit’sgoodwill.  We then compare the impliedfair value of the reporting unit’s goodwill with the carrying amount of thereporting unit’s goodwill.  If thecarrying amount of the reporting unit’s goodwill is greater than the impliedfair value of its goodwill, an impairment charge would be recognized for theexcess.

 

18

----

 

We determinedthat we have one reporting unit.  We performedStep 1 of the goodwill impairment analysis required by SFAS 142 as ofApril 1, 2002, June 30, 2002, September 30, 2002 andDecember 31, 2002 and concluded that goodwill was not impaired.  Accordingly, Step 2 was not performed.  We performed Step 1 as of March 31,2003 and determined that goodwill was impaired.  We then performed Step 2 and determined that a $30.6 millionimpairment charge was required in the three months ended March 31, 2003.  We will continue to test for impairment onan annual basis and on an interim basis if an event occurs or circumstanceschange that would potentially reduce the fair value of our reporting unitsbelow their carrying amount.

 

**Litigation**

 

Management’s estimatedrange of liability related to some of the pending litigation is based on claimsfor which our management can estimate the amount and range of loss.  Because of the uncertainties related to ourinsurance coverage and indemnification obligations we have provided to variousparties who are defendants and the amount and range of potential losses, ifany, related to litigation, management is currently unable to make a reasonableestimate of the liability that could result from an unfavorable outcome.  As additional information becomes available,we will assess the potential liability related to our pending litigation andcreate and/or revise our estimates. Such revisions in estimates of the potential liability could materiallyimpact our results of operation and financial position.  Any resolution of the litigation couldmaterially affect our financial resources and liquidity.

 

**IncomeTaxes**

 

We are required toestimate our income taxes in each of the jurisdictions in which we operate aspart of the process of preparing our consolidated financial statements.  This process involves estimating our actualcurrent tax exposure, together with assessing temporary differences resultingfrom differing treatment of items, such as deferred revenue, for tax andaccounting purposes.  These differencesresult in deferred tax assets and liabilities. We then assess the likelihood that our net deferred tax assets will berecovered from future taxable income and, to the extent we believe thatrecovery is not likely, we must establish a valuation allowance.  We currently have a full valuation allowanceon our gross deferred tax assets.  Inthe event our future taxable income is expected to be sufficient to utilize ourdeferred tax assets, an adjustment to the valuation allowance will be made, increasingincome in the period in which such determination is made.

 

**Stock-basedcompensation**

 

We account for ouremployee stock option plans using the intrinsic value method described inAccounting Principles Board (“APB”) Opinion No. 25, “Accounting for StockIssued to Employees” and related interpretations.  Under APB Opinion No. 25, deferred stock compensation isrecorded for the difference, if any, between an option’s exercise price and thefair value of the underlying common stock on the grant date of the option.  As permitted by SFAS No. 123,“Accounting for Stock-Based Compensation,” we adopted the “disclosure only”alternative described in SFAS No. 123 for its employee stock plans.

 

We account for stockissued to non-employees in accordance with the provisions of SFAS No. 123and Emerging Issues Task Force Consensus (“EITF”) No. 96-18 “Accountingfor Equity Instruments that Are Issued to Other than Employees For Acquiring,or in Conjunction with Selling, Goods or Services.”  Under SFAS No. 123 and EITF No. 96-18, stock optionsand warrants issued to non-employees are accounted for at their fair valuecalculated using the Black-Scholes option pricing model.

 

Compensation expenseresulting from employee and non-employee stock options are amortized to expenseusing an accelerated approach over the term of the options in accordance withFinancial Accounting Standards Board Interpretation (“FIN”) No. 28,“Accounting for Stock Appreciation Rights and Other Variable Stock Option orAward Plans.”

 

**RECENT ACCOUNTING PRONOUNCEMENTS**

 

InNovember 2002, the Financial Accounting Standards Board (“FASB”) issuedFIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees,Including Indirect Guarantees of Indebtedness of Others.”  FIN 45 requiresa guarantor to recognize a liability for obligations it has undertaken inrelation to the issuance of a guarantee. It requires that the liability be recorded at fair value on the datethat the guarantee is issued.  It also requiresa guarantor to provide additional disclosures regarding guarantees, includingthe nature of the guarantee, the maximum potential amount of future paymentsunder the guarantee, the carrying amount of the liability, if any, for theguarantor’s obligations under the guarantee, and the nature and extent of anyrecourse provisions or available collateral that would enable the guarantor torecover the amounts paid under the guarantee. The disclosure requirements under FIN 45 are effective for the interimand annual periods ending after December 15, 2002.  The recognition and measurement provisionsunder FIN 45 are effective for guarantees issued or modified afterDecember 31, 2002.  The adoption ofFIN 45 did not have a material impact upon our financial position, cash flowsor results of operations.

 

19

----

 

InJanuary 2003, the FASB issued FIN No. 46, “Consolidation of VariableInterest Entities, an Interpretation of ARB No. 51”(“FIN 46”).  FIN 46 requires certain variable interestentities to be consolidated by the primary beneficiary of the entity if theequity investors in the entity do not have the characteristics of a controllingfinancial interest or do not have sufficient equity at risk for the entity tofinance its activities without additional subordinated financial support from otherparties.  FIN 46 is effectiveimmediately for all new variable interest entities created or acquired afterJanuary 31, 2003.  For variableinterest entities created or acquired prior to February 1, 2003, theprovisions of FIN 46 must be applied for the first interim or annual periodbeginning after June 15, 2003.  Wedo not believe that the adoption of this standard will have a material effecton our financial position or results of operations.

 

InApril 2003, the FASB issued SFAS 149, “Amendment of Statement 133 onDerivative Instruments and Hedging Activities,” which amends SFAS 133 forcertain decisions made by the FASB Derivatives Implementation Group.  Inparticular, SFAS 149 (1) clarifies under what circumstances a contract with aninitial net investment meets the characteristic of a derivative, (2) clarifieswhen a derivative contains a financing component, (3) amends the definition ofan underlying to conform it to language used in FIN 45, and (4) amends certainother existing pronouncements.  This Statement is effective for contractsentered into or modified after June 30, 2003, and for hedgingrelationships designated after June 30, 2003.  In addition, most provisions of SFAS 149 are to be appliedprospectively.  We do not expect theadoption of SFAS 149 to have a material impact upon our financial position,cash flows or results of operations.

 

InMay 2003, the FASB issued SFAS 150, “Accounting for Certain FinancialInstruments with Characteristics of both Liabilities and Equity.”  SFAS150 establishes standards for how an issuer classifies and measures certainfinancial instruments with characteristics of both liabilities and equity.  It requires that an issuer classify afinancial instrument that is within its scope as a liability (or an asset insome circumstances).  SFAS 150 is effective for financial instrumentsentered into or modified after May 31, 2003, and otherwise is effective atthe beginning of the first interim period beginning after June 15, 2003.  It is to be implemented by reporting thecumulative effect of a change in an accounting principle for financialinstruments created before the issuance date of the Statement and stillexisting at the beginning of the interim period of adoption.  Restatement is not permitted.  We do not expect the adoption of SFAS 150 tohave a material impact upon our financial position, cash flows or results ofoperations.

 

**RESULTS OF OPERATIONS**

 

The following table setsforth statement of operations data for the periods indicated as a percentage oftotal revenues.

 
|                                       |   | **Year ended  March 31,** | ** ** |
|--------------------------------------------|--------|--------------------------------|------------|
|                                       |   | **2003**                       |       | **2002** | ** ** | **2001** | ** ** |
|                                       |   |                           |       |   |   |   |   |
| Revenues:                                  |   |                           |       |   |   |   |   |
| Software licenses                          |   | 34                             | %          | 36 | % | 73 | % |
| Consulting services, maintenance and other |   | 66                             | %          | 64 | % | 27 | % |
| Total revenues                             |   | **100**                        | **%**      | **100** | **%** | **100** | **%** |
|                                       |   |                           |       |   |   |   |   |
| Cost of revenues:                          |   |                           |       |   |   |   |   |
| Software licenses                          |   | 4                              | %          | 13 | % | 3 | % |
| Consulting services, maintenance and other |   | 24                             | %          | 11 | % | 6 | % |
| Total cost of revenues                     |   | **28**                         | **%**      | **24** | **%** | **9** | **%** |
| Gross profit                               |   | **72**                         | **%**      | **76** | **%** | **91** | **%** |
| Operating expenses:                        |   |                           |       |   |   |   |   |
| Research and development                   |   | 67                             | %          | 136 | % | 78 | % |
| Sales, general and administrative          |   | 127                            | %          | 206 | % | 100 | % |
| Goodwill impairment                        |   | 196                            | %          | — | % | — | % |
| Stock based compensation                   |   | 7                              | %          | 79 | % | 55 | % |
| Amortization of intangible assets          |   | 10                             | %          | 7 | % | 3 | % |
| Total operating expenses                   |   | **407**                        | **%**      | **428** | **%** | **236** | **%** |
|                                       |   |                           | ** ** |   | ** ** |   | ** ** |
| Loss from operations                       |   | **(335**                       | **)%**     | **(352** | **)%** | **(145** | **)%** |

 

20

----

 

**Comparisonof years ended March 31, 2003 and 2002**

 

*Revenues.*  Total revenues increased to$15.6 million in the year ended March 31, 2003 from $4.5 millionin the year ended March 31, 2002, or an increase of 245%.  Our sales cycle for the license of oursoftware products has historically been very long.  Our products are new and our customers spend a significant amountof time evaluating our products. Customer purchase orders typically include integration and installationservices, rights of return and acceptance criteria.  As such, we defer a significant amount of our license revenueuntil integration and installation services are complete, rights of returnlapse and final acceptance occurs. Approximately 75% of this increase is attributable to increasedconsulting revenue from our acquisitionof Covalar.  The amount of ourlicense revenue is currently at levels that have resulted in no meaningfultrend from period to period.  Ourability to sell our products in the future may also be affected by the currentdecline in capital spending by potential customers in the semiconductorindustry.

 

Product sales were highlyconcentrated, with 61% of total revenues in the year ended March 31, 2003coming from three customers and 66% of total revenues in the year endedMarch 31, 2002 coming from four customers.

 

Software license revenueincreased to $5.3 million in the year ended March 31, 2003, from$1.6 million in the year ended March 31, 2002, or an increase of227%.  This increase was due to greatercustomer acceptance of the Company’s product during the year endedMarch 31, 2003.  Software license revenue in theyear ended March 31, 2003 relates primarily to previously deferred revenuefor which the revenue was recognized in the current year as final customeracceptances were received on previously delivered software.  Approximately $380,000 of softwarelicense revenue in the year ended March 31, 2002 relates to an arbitrationsettlement of royalties due from a customer.

 

Consulting services, maintenance and other revenuesincreased to $10.3 million in the year ended March 31, 2003, up from$2.9 million in the year ended March 31, 2002, or an increase of256%.  These increases were due to anincrease in consulting services related to our acquisition of Covalar and anincrease in maintenance fees from a greater number of customers, both existingcustomers and those from our acquisitions.

 

*Grossprofit.*  As apercentage of revenues, gross profit decreased from 76% for the year endedMarch 31, 2002 to 72% for the year ended March 31, 2003 as servicerevenue as a percentage of total revenue increased in the year.  Gross profit has been and will continue tobe affected by a variety of factors, the most important of which is therelative mix of revenues among software licenses, maintenance fees andconsulting services. 

 

*Researchand development.* Research and development expenses represented 67% of revenues in theyear ended March 31, 2003 compared to 136% of revenues in the year endedMarch 31, 2002.  Actual costsincreased to $10.5 million for the year ended March 31, 2003, up from$6.1 million for the year ended March 31, 2002.  This increase in absolute terms is primarilyattributable to the increase of software engineers related toacquisitions.  Salaries and relatedbenefits of research and development engineers represent the single largestcomponent of our research and development expenses.

 

*Sales,general and administrative.* Sales, general and administrative expenses for the year endedMarch 31, 2003 were $19.8 million, or 127% of revenues, compared to$9.3 million, or 206% of revenues in the year ended March 31,2002.  The increase in costs wasprimarily due to increases in staff, professional fees and the headcountincreases related to acquisitions, and legal and professional fees associatedwith litigation and the restatement of our financial statements.

 

*Goodwillimpairment. *The Company operates within onereporting unit as defined by SFAS 142. Therefore, goodwill is not allocated within the Company, as it isconsidered enterprise goodwill.  Duringthe fourth quarter of the year ended March 31, 2003, the Companydetermined that there were indicators of impairment to the carrying value ofgoodwill, principally as a result of reducing its revenue forecast given thecurrent economic environment in the semiconductor industry.  The Company performed its annual impairmentreview for goodwill and other intangible assets on March 31, 2003 andrecorded a charge of $30.6 million relating to goodwill impairment, which isrecorded as a component of operating income in the accompanying consolidatedstatement of operations.  The amount ofgoodwill impairment was based on the fair value of the Company, representingits only reporting unit utilizing a valuation based on both the discounted cashflow and market approach.  Futuregoodwill impairment tests may result in charges to earnings if the Companydetermines that goodwill has been further impaired.

 

*Stock-basedcompensation.* Stock-based compensation expense for the year ended March 31, 2003decreased to $1.0 million, compared with $3.5 million for the yearended March 31, 2002.  Stock-basedcompensation expense in the year ended March 31, 2003 decreased from the previousyear primarily as a result of our reduction in workforce on September 30,2002, which resulted in the reversal of previously expensed stock-basedcompensation which was not earned by the terminated employees.

 

*Amortizationof intangible assets.* Amortization of intangible assets was $1.5 million in the year endedMarch 31, 2003,

 

21

----

 

compared to $294,000 inthe year ended March 31, 2002. This increase in amortization resulted from the acquisitions of Defect& Yield Management in the first quarter of fiscal 2003 and a full yearamortization of the intangible assets related to the acquisitions of FabCentricand Covalar, which were completed in the year ended March 31, 2002.

 

*Interestincome (expense) and other, net.*  Interest income, net of interest and other expenses for the yearended March 31, 2003, was $468,000, compared with net expense of $908,000,for the year ended March 31, 2002**. **This decrease was due to lessinterest income from lower average balances of cash, cash equivalents andshort-term investments and low interest rates on cash balances during the yearended March 31, 2003.

 

*Provisionfor income taxes.*  Inthe years ended March 31, 2003 and 2002, we incurred operating losses forwhich we have recorded valuation allowances for the full amount of our netdeferred tax assets, because the future realization of the deferred tax assetswas not likely as of March 31, 2003 and 2002.

 

**Comparisonof years ended March 31, 2002 and 2001**

 

*Revenues.*  Total revenues increased to$4.5 million in the year ended March 31, 2002 from $4.3 millionin the year ended March 31, 2001, or an increase of 5%.  Product sales were highly concentrated, with66% of total revenues in the year ended March 31, 2002 coming from fourcustomers and 61% of total revenues in the year ended March 31, 2001coming from four customers.

 

Software license revenuedecreased to $1.6 million in the year ended March 31, 2002, from$3.2 million in the year ended March 31, 2001, or a decrease of50%.  The decrease in software licenserevenue was due, in part, to a $950,000 payment to our Japanese distributorwhich has been recorded as a reduction to our revenue.  Approximately $380,000 of software licenserevenue in the year ended March 31, 2002 relates to an arbitrationsettlement of royalties due from a customer.

 

Consulting services,maintenance and other revenues increased to $2.9 million in the year endedMarch 31, 2002, up from $1.2 million in the year ended March 31,2001, or an increase of 142%.  Thisincrease was due to an increase in maintenance fees from a greater number ofcustomers and an increase in consulting services related to acquired companies.

 

*Grossprofit.*  As apercentage of revenues, gross profit decreased from 91% for the year endedMarch 31, 2001 to 76% for the year ended March 31, 2002.  Gross profit has been and will continue tobe affected by a variety of factors, the most important of which is therelative mix of revenues among software licenses, maintenance fees andconsulting services.  The decrease wasthe result of a higher percentage of revenues generated from consultingservices in the year ended March 31, 2002 compared to the year endedMarch 31, 2001.

 

*Researchand development.* Research and development expenses represented 136% of revenues in theyear ended March 31, 2002 compared to 78% of revenues in the year endedMarch 31, 2001.  Actual costsincreased to $6.1 million for the year ended March 31, 2002, up from$3.3 million for the year ended March 31, 2001.  This increase is primarily attributable tothe hiring of additional software engineers and technical staff and increasesof headcount related to acquisitions completed during the year.  Salaries and related benefits of researchand development engineers represent the single largest component of ourresearch and development expenses.

 

*Sales,general and administrative.* Sales, general and administrative expenses for the year endedMarch 31, 2002 were $9.3 million, or 206% of revenues, compared to$4.3 million, or 100% of revenues in the year ended March 31,2001.  The increase in costs wasprimarily due to increases in staff and professional fees and the headcountincreases related to acquisitions we completed during the year endedMarch 31, 2002.

 

*Stock-basedcompensation.* Stock-based compensation expense for the year ended March 31, 2002increased to $3.5 million, compared with $2.4 million for the yearended March 31, 2001.  Stock-basedcompensation expense in the year ended March 31, 2002 increased from theprevious year primarily as a result of recording deferred compensation early infiscal 2002 related to the issuance of stock options at less than their deemedfair market value.  The cost of theseoptions are being amortized on an accelerated basis to expense over the term ofthe options.  Additionally, as a resultof our acquisitions where we have recorded deferred compensation related tostock options assumed, we expect stock-based compensation expense in the nearterm to increase and then decrease in the future.

 

*Amortizationof intangible assets.* Amortization of intangible assets was $294,000 in the year endedMarch 31, 2002, compared to $137,000 in the year ended March 31,2001.  This increase in amortizationresulted from the acquisitions of FabCentric and Covalar in the currentyear.  We expect this amount to increasein the year ending March 31, 2003 as there will be a full year’samortization of the intangible assets acquired as well as amortization of theintangible assets acquired in connection with the acquisition of DYM in thefirst quarter of fiscal 2003.

 

22

----

 

*Interestincome (expense) and other, net.*  Interest income, net of interest and other expenses for the yearended March 31, 2002 was $908,000, compared with net expense of $190,000,for the year ended March 31, 2001. This increase was due to greater interest income from higher averagebalances of cash, cash equivalents and short-term investments generated fromour initial public offering.

 

*Provisionfor income taxes.*  Inthe years ended March 31, 2002 and 2001, we incurred operating losses forwhich we have recorded valuation allowances for the full amount of our netdeferred tax assets, because the future realization of the deferred tax assetswas not likely as of March 31, 2002 and 2001.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

At March 31, 2003,we had approximately $21.7 million in cash and cash equivalents andshort-term investments.  Subsequent toyear-end, we repaid our $1.5 million secured convertible debenture plus accruedinterest of $164,000.

 

Net cash used inoperating activities for the year ended March 31, 2003 was approximately$23.8 million, compared to $12.4 million used in operating activitiesfor the year ended March 31, 2002 and $2.0 million provided byoperating activities in the year ended March 31, 2001.  Our cash used in operations for the yearsended March 31, 2003 and 2002 was primarily due to our net loss, adjustedfor certain non-cash items including depreciation and amortization, goodwillimpairment, stock-based compensation and deferred revenue.  Our cash provided by operations for the yearended March 31, 2001 was primarily attributed to our net loss, adjustedfor certain non-cash items including the depreciation and amortization, andstock-based compensation.

 

Net cash provided byinvesting activities was $7.1 million for the year ended March 31,2003 compared to $27.4 million used in investing activities for the year endedMarch 31, 2002 and $870,000 for the year ended March 31, 2001.  The cash inflows from investing activitiesfor the year ended March 31, 2003 consisted primarily of proceeds fromsales of marketable securities.  Ourinvesting activities for the year ended March 31, 2002 consisted primarilyof the acquisitions of Tyecin, FabCentric and Covalar, purchases of marketablesecurities, and equipment purchases. The investing activities for the year ended March 31, 2001consisted primarily of a loan of $750,000 to FabCentric.

 

Net cash provided byfinancing activities was $1.1 million for the year ended March 31, 2003,mainly due to the additional amount received from our former Chief ExecutiveOfficer in connection with fictitious sales transactions.  Net cash provided by financing activitieswas  $71.7 million for the yearended March 31, 2002, primarily from our initial public offering completedin August 2001, amounts received from our former Chief Executive Officer,and proceeds from exercise of stock options, partially offset by the repaymentof notes payable and capital lease obligations.  Net cash used in financing activities was $272,000 for the yearended March 31, 2001, primarily from repayments of notes payable andcapital lease obligations.

 

Future paymentsdue under debt and lease obligations as of March 31, 2003 are as follows(in thousands):

 
| **Year  Ending March 31,** |   | **Convertible  Debenture (1)** |   | **Capital  Lease  Obligations (2)** |   | **Operating  Leases** |   | **Total** |   |
|---------------------------------|--------|--------------------------------|--------|-------------------------------------|--------|-----------------------|--------|-----------|--------|
|                            |   |                           |   |                                |   |                  |   |      |   |
| 2004                            |   | $                              | 1,500  |                                | $      | 360                   |   | $         | 1,366  |   | $ | 3,226 |   |
| 2005                            |   | —                         |   | 98                                  |   | 1,266                 |   | 1,364     |   |
| 2006                            |   | —                         |   | 27                                  |   | 937                   |   | 964       |   |
| 2007                            |   | —                         |   | 13                                  |   | 11                    |   | 24        |   |
|                            |   | $                              | 1,500  |                                | $      | 498                   |   | $         | 3,580  |   | $ | 5,578 |   |

 

----

(1)                                  Thisdebenture was repaid in May 2003.

 

(2)                                  From2003 to 2007, we are required to make interest payments totaling $30,000 forcapital leases obligations; this interest component is included in thecommitment schedule above.

 

We believe our currentcash and cash equivalents, our short-term investments, and our cash flows fromoperations will be sufficient to meet our cash requirements for at least thenext twelve months.  Our future cashposition will be adversely affected by slow or diminished revenue growth,research and development expenses, additional sales and marketing costs andhigher general and administrative expenses, such as professional feesassociated with the litigation.  TheCompany does not believe that it will be able to raise additional capital untilthe litigation described below is resolved.

 

23

----

 

BetweenJuly 31, 2002 and November 15, 2002, fourteen class-action lawsuitshave been filed and are pending against the Company, certain current and formerofficers and/or directors of the Company, and the Company’s independentauditors (collectively, the “Defendants”) in the United States District Courtfor the Northern District of California. The lawsuits allege that the Defendants violated Sections 10(b) and20(a) of the Securities Exchange Act of 1934, and Rule 10b-5 promulgatedthereunder by the SEC, by making a series of material misrepresentations as tothe financial condition of the Company during the class period of July 31,2001 to July 19, 2002.  Several ofthe lawsuits further allege violations of Sections 11, 12(a)(2) and 15 of theSecurities Act of 1933.  The plaintiffsare generally seeking to recover compensatory damages, costs and expensesincurred, interest and such other relief as the court may deemappropriate.  We expect that theselawsuits will be consolidated into a single action in the United StatesDistrict Court for the Northern District of California.  Motions for appointment of a lead plaintiffare pending before the Court.

 

Weare also a nominal defendant in five stockholder derivative lawsuits pending inSuperior Court in the County of Santa Clara, California.  These lawsuits, which were filed betweenJuly 31, 2002 and September 30, 2002, assert derivative claims onbehalf of the Company against current and/or former officers and directors ofthe Company and the Company’s independent auditors.  The claims asserted in these lawsuits include insider trading,breach of fiduciary duties, aiding and abetting breaches of fiduciary duties,negligence and professional malpractice, negligent misrepresentation andomission, contribution and indemnification, abuse of control, gross mismanagement,unjust enrichment and breach of contract. These lawsuits seek damages suffered by the Company, treble damages forthe sale of shares, costs and expenses of these actions and such other relief,as the court may deem appropriate.  Inan order dated December 3, 2002, the Court consolidated these actions andappointed lead plaintiff’s counsel.  Thedate for filing a consolidated complaint has been continued to July 14,2003.

 

Fiveshareholders of the Company have sued in the state court of the District Courtof Dallas County, Texas, the Company’s independent auditors and the managingunderwriter in the Company’s initial public offering, in connection with claimsrelating to the Company’s acquisition of Covalar Technologies Group, Inc. inFebruary 2002.  The Company hasbeen named as a responsible third party in this action for purposes ofapportioning fault in jury findings; to date, no claims have been broughtagainst the Company.  Subject to areservation of rights, we have accepted the underwriter’s request to indemnifythe underwriter in connection with the our initial public offering and toadvance expenses in the event the underwriter becomes a party to any lawsuitarising out of the public offering. While we have obtained insurance to cover our obligation to indemnify and advance expenses to theunderwriter, the insurer has not yet taken a position as to whether suchobligations are covered under the policy.  If it does not contestcoverage, however, coverage for these indemnification obligations is subject toa sub-limit of $1,000,000.  This lawsuitis only in the preliminary stage and our potential liability cannot bedetermined at this time.

 

Five formershareholders of FabCentric, Inc., which was acquired by the Company inDecember 2001, have sued the Company, the Company’s former President andCEO and CFO, and the Company’s independent auditors in a lawsuit pending inSuperior Court in the County of Santa Clara, California.  This lawsuit was filed on or about May 22,2003.** **This lawsuit allegesclaims for fraud, negligent misrepresentation, breach of warranties andcovenants, breach of contract and negligence, and seeks rescission or,alternatively, damages, costs and expenses. Because this lawsuit was only recently filed, we have not evaluated themerits of these allegations.

 

Additionally,in April 2003, UBS PaineWebber, Inc. filed suit against the Company in theSupreme Court of the State of New York, County of New York (the “New YorkAction”) alleging tortius interference of contract and a violation of theUniform Commercial Code.  The actionrelates to the transfer of shares of HPL common stock putatively pledged to UBSPaineWebber, Inc. by Y. David Lepejian, our former President and CEO, and hisspouse and seeks, among other things, mandatory injunctive relief requiring HPLto effect the transfer of subject stock. In May 2003, we filed an interpleader action in United StatesDistrict Court for the Northern District relating to the New York Action.  Mr. Lepejian and UBS PaineWebber arecurrently engaged in an NASD arbitration proceeding regarding the pledge of theshares.

 

Theaforementioned litigation matters are in the early stages.  As a result, we believe that no amountshould be accrued for these matters under SFAS No. 5, “Accounting for Contingencies,”because we are currently unable to evaluate the likelihood of an unfavorableoutcome or an estimate of the amount or range of potential loss, if any.

 

Anyresolution of the aforementioned litigation could have a material effect on ourfinancial position, results of operations or cash flows.  We are investigating informal or formalrestructuring alternatives which potentially may dilute shareholder equity butcould mitigate any material adverse affect on our financial position or resultsof operations which might otherwise result from an unfavorable resolution ofthese lawsuits.  Any such dilution couldbe significant and could greatly affect the value of our common stock.  See, Risk Factors.

 

24

----

 

**RISKFACTORS**

 

**RISKS ASSOCIATED WITH OUR BUSINESS**

 

**An investment in our securities is highly speculative**.

 

We havesustained a substantial decline in the value of our securities since announcingthe accounting and financial inaccuracies in our previously filed financialstatements and our securities have been delisted from the Nasdaq NationalMarket System.  We have also been namedin a number of lawsuits and been the subject of an SEC investigation.  The ultimate cost and effect of thesematters on the financial condition, results of operations, customer relationsand management of the Company is unknown at this time.  If the Company is unsuccessful in defendingitself in these actions, we may face significant damage awards that couldmaterially impair our liquidity and results of operations.  In addition, the Company is investigatinginformal and formal restructuring alternatives which potentially may diluteshareholder equity.  Accordingly, aninvestment in our securities is highly speculative and should not be madeunless you are prepared to lose your entire investment.

 

**The restatement of our financial statements and pending securitieslitigation may raise concerns among our customers regarding our long-termstability.  These concerns may adverselyaffect future sales.**

 

Customers whopurchase our software products make a significant long-term investment in ourtechnology.  Our products often becomean integral part of each installed fabrication facility and our customers lookto us to provide continuing support, enhancements and new versions of ourproducts.  Because of the long-termnature of an investment in yield optimization software, customers are oftenconcerned about the stability of their suppliers.  Our restatement and the pending securities litigation may causecurrent and potential customers concern over our stability and these concernsmay cause us to lose sales.  Any loss insales could adversely affect our results of operations, further deepeningconcern among current and potential customers.

 

**Our restatement and pending securities litigation will make it difficult,if not impossible, to raise additional capital.**

 

Our pendingsecurities litigation raises uncertainty regarding the financial condition andlong term viability of the Company. Until this litigation is resolved, it is unlikely that the Company willbe able to raise additional capital.

 

**Although we have an obligation to indemnify our officers and directorsand underwriters, we may not have insurance coverage available for this purposeand may be forced to pay these indemnification costs directly.**

 

Our charter andbylaws require that we indemnify our directors and officers to the fullestextent provided by applicable law.  Inaddition, the Underwriting Agreement with our underwriters for our initialpublic offering requires us to indemnify the underwriters in certaininstances.  Although we have purchaseddirectors and officers liability insurance to fund such obligations, ourinsurance carriers have notified us that coverage may not be available.  If our insurance carriers are able to denycoverage, we would be forced to bear these indemnification costs directly,which could be substantial and may have an adverse effect on our results ofoperations and liquidity.

 

**Our stock has been delisted from the Nasdaq National Market and asubsequent public market for our stock may never develop**.

 

InJuly 2002, we received a Staff Determination Notice from the NasdaqNational Market informing us that our stock may be delisted due to a failure tocomply with Nasdaq’s continued listing standards.  We appealed the Nasdaq staff determination in August 2002and were subsequently notified by Nasdaq that on September 30, 2002, ourstock would no longer be listed on the Nasdaq National Market.  Our stock is currently traded in the overthe counter market or “pink sheets.” Stocks trading in this market typically suffer significantly lowervolume (liquidity) and lower share prices.

 

**We currently have only three directors and believe we will havedifficulty attracting qualified candidates to serve on our board.  Our failure to add additional directorscould adversely impact the management of our company, our compliance withsecurities laws and our future exchange listing eligibility.**

 

SinceJuly 2003, two of our directors resigned from the board of directors ofthe Company, leaving only three directors. We have begun searching for candidates to fill these vacancies.  However, in light of the restatement of ourfinancial statements and the pending securities litigation, we believe we willhave difficulty attracting qualified individuals to serve on our board.  Our inability to attract and retainqualified independent directors may adversely affect the quality of ourmanagement and may make it more difficult

 

25

----

 

for us to comply with corporategovernance requirements of the securities exchanges, such as Nasdaq and thoseimposed by the Securities and Exchange Commission pursuant to theSarbanes-Oxley Act of 2002.

 

**There are significant barriers to widespread adoption of our yieldoptimization products by the semiconductor industry.**

 

In order forour business to grow, we must overcome certain barriers to the adoption of ouryield optimization products by the semiconductor industry.  Many semiconductor designers andmanufacturers have in-house yield management systems and may be reluctant toimplement our software because they may believe that third party tools will notincorporate their existing know-how and methodology.  If participants in this industry reject using third partysoftware to optimize their yield, our growth would be impaired, which wouldnegatively affect our results of operations and cause our business tofail.  In addition, because our yieldoptimization solutions are relatively new to the semiconductor industry and canbe difficult to explain, intensive marketing and sales efforts will benecessary to educate prospective industry partners and customers regarding theuses and benefits of our technologies and software products.  Accordingly, we cannot assure you that oursoftware products will gain acceptance at the level or in the time frame weanticipate.  Such a failure to gain acceptancewould have a material adverse effect on our business.

 

**The semiconductor industry is currently experiencing a downturn and hasexperienced downturns in the past and any future downturns or prolonged currentdownturn could adversely affect our revenues and operating results.**

 

Our businessdepends in part on the economic health of our customers: IDMs, or integrateddevice manufacturers, fabless semiconductor companies, and semiconductorequipment OEMs, or original equipment manufacturers.  The semiconductor industry is prone to periods of oversupplyresulting in significantly reduced capital expenditures, and it is currentlyexperiencing such a downturn.  As aresult of the slowdown, some semiconductor manufacturers have postponed orcanceled capital expenditures for previously planned expansions or newfabrication facility construction projects, resulting in a substantial declinein worldwide semiconductor capital expenditures.

 

Currentconditions and future downturns could affect the willingness of semiconductorcompanies to purchase our yield-optimization products and services or topurchase equipment from semiconductor equipment OEMs that have embedded oursoftware in their products.  Significantdownturns could materially and adversely affect our business and operatingresults.  In addition, we expect tocontinue increasing our investment in engineering, research and development,and marketing, which limits our ability to reduce expenses during suchdownturns.

 

**In any particular period, we derive a substantial portion of our revenuesfrom a small number of customers, and our revenues may decline significantly ifany major customer cancels or delays a purchase of our products.**

 

In each of theyears ended March 31, 2003, 2002, and 2001, customers that individuallyaccounted for at least 10% of our revenues together represented 61%, 66% and61% of our revenues, respectively, and in each of these years, there wassubstantial change among the companies that represented our largestcustomers.  In the year endedMarch 31, 2003, sales to three customers accounted for 29%, 17% and 15%,respectively, of our revenues.  Becausewe derive most of our revenues from a few customers and because our existingcustomers’ needs for additional products are based on intermittent events, suchas the introduction of new technologies or processes, building of newfacilities or the need to increase capacity of existing facilities, our largestcustomers change from period to period. Delays or failures in selling new licenses to existing or new customerswould cause significant period-to-period changes in our operating results,which may result in our failure to meet market expectations.  We may also incur significant expense anddevote management attention to the pursuit of potentially significant licenserevenues, but ultimately fail to secure these revenues.

 

**We must continually replace the revenues generated from the sale oflicenses and one-time orders to maintain and grow our business.**

 

Over the pastyear, we have generated the bulk of our revenues from sales of one-timecustomer orders.  These licenses andorders produce large amounts of revenues in the periods in which the licensefees are recognized and are not necessarily indicative of a commensurate levelof revenues from the same customers in future periods.  Achieving period-to-period growth will dependsignificantly on our ability to expand the number of users of our productswithin our customers’ organizations, license additional software to ourcustomers and attract new customers.  Wemay not be successful in these sales efforts and, consequently, revenues in anyfuture period may not match that of prior periods.

 

**We have a long and variable sales cycle, which can result in uncertaintyand delays in generating additional revenues.**

 

Because ouryield optimization software and services are often unfamiliar to ourprospective customers, it can take a significant amount of time and effort toexplain the benefits of our products. For example, it generally takes at least six months after

 

26

----

 

our first contact with aprospective customer before we start licensing our products to thatcustomer.  In addition, due to thenature of fabrication facility deployment and the extended time required tobring a fabrication facility to full capacity, capital expenditures varygreatly during this time.  Accordingly,we may be unable to predict accurately the timing of any significant futuresales of software licenses.  We may alsospend substantial time and management attention on potential licenses that arenot consummated, thereby foregoing other opportunities.

 

**Our operating results may fluctuate significantly and any failure to meetfinancial expectations may disappoint investors and could cause our stock priceto decline.**

 

Historically, our quarterly operating results havefluctuated and we expect them to continue to fluctuate in the future due to avariety of factors, many of which are outside of our control.  Because of our current limited sales force,the lengthy sales cycle of our products and the intermittent needs ofcustomers, we derive our revenues primarily from a relatively small number oflarge transactions in any given operating period.  Accordingly, the timing of large orders has significantlyaffected, and will continue to significantly affect, quarterly operatingresults.  In addition to the previouslydiscussed risk resulting from our restatement of previously issued financialstatements, factors that could cause our revenues and operating results to varyfrom period to period include:

 

•                  large sales unevenlyspaced over time;

•                  timing of newproducts and product enhancements by us and our competitors;

•                  the cyclicalnature of the semiconductor industry;

•                  changes in ourcustomers’ development schedules, expenditure levels and product supportrequirements; and

•                  incurrenceof sales and marketing and research and development expenses that may notgenerate revenues until subsequent quarters.

 

As a result, we believe thatperiod-to-period comparisons of our results of operations are not necessarilymeaningful and may not be accurate indicators of future performance.  These factors may cause our operatingresults to be below market expectations in some future quarters, which couldcause the market price of our stock to decline.

 

**We may not succeed in developing new products and our operating resultsmay decline as a result.**

 

Our customers and competitors operate in rapidly evolvingmarkets that are characterized by introduction of new technologies and morecomplex designs, shorter product life cycles and disaggregation of the industryinto new subsectors.  For example, eversmaller geometries are being used in semiconductors and new materials are beingemployed to enhance performance.  Wemust continually create new software and add features and functionality to ourexisting software products to keep pace with these changes in the semiconductorindustry.  Specifically, we need tofocus our research and development to:

 

•                  interfacewith new semiconductor producing hardware and systems that others develop;

•                  remaincompetitive with companies marketing third party yield management software andconsulting services;

•                  continuedeveloping new software modules that are attractive to existing customers, manyof which have purchased perpetual licenses and are under no ongoing obligationto make future purchases from us; and

•                  attract new customers to our software.

 

Maintaining and capitalizing on our current competitivestrengths will require us to invest heavily in research and development,marketing, and customer service and support. Although we intend to devote substantial expenditures to productdevelopment, we may not be able to create new products in a timely manner thatadequately meet the needs of our existing and potential customers.  A failure to do so would adversely affectour competitive position and would result in lower sales and a decline in ourprofitability.

 

**We may not be able to effectively compete against other companies, whichcould impair our growth and profitability.**

 

We target IDMs,fabless semiconductor companies, foundries and semiconductor equipmentOEMS.  The tools and systems againstwhich our products and services most commonly compete are those thatsemiconductor companies have created in house. In order to grow our business, we must convince these producers of thebenefit of an outside solution.  Thethird party providers against whom we compete are, generally, divisions oflarger semiconductor equipment OEMs, such as KLA-Tencor.  These companies can compete on the basis oftheir greater financial, engineering and manufacturing resources, and theirlong-standing relationships with the same companies we are targeting.  If we cannot compete successfully againstthese forms of competition, the growth of our business will be impaired.

 

27

----

 

**Errors in our products or the failure of our products to conform tospecifications could hurt our reputation and result in our customers demandingrefunds or asserting claims against us for damages.**

 

Because our software products are complex, they couldcontain errors or “bugs” that can be detected at any point in a product’slifecycle.  We have a team dedicated todetecting errors in our products prior to their release in order to enable oursoftware developers to remedy any such errors. In the past we have discovered errors in some of our products and haveexperienced delays in the delivery of our products because of theseerrors.  In addition, we have softwareengineers and developers who participate in the maintenance and support of ourproducts and assist in detecting and remedying errors after our products aresold.  On some occasions in the past, wehave had to replace defective products that were already delivered.  These delays and replacements have principallyrelated to new product releases. Detection of any significant errors may result in:

 

•                  theloss of, or delay in, market acceptance and sales of our products;

•                  thedelay or loss of revenues;

•                  diversionof development resources;

•                  injuryto our reputation; or

•                  increasedmaintenance and warranty costs.

 

Any of these problems could harm our business and operatingresults.  If our products fail toconform to specifications, customers could demand a refund for the purchaseprice or assert claims for damages. Liability claims could require us to spend significant time and money inlitigation or to pay significant damages. Any such claims, whether or not successful, could seriously damage ourreputation and our business.

 

**We may continue to experience losses in the future.**

 

We will need to continue to generate new sales whilecontrolling our costs and we may not be able to successfully generate enoughrevenues to cover our expenses.  Weanticipate that our expenses may increase in the next twelve months as we:

 

•                  increaseour direct sales and marketing personnel and activities;

•                  developour technology, expand our existing product lines and create additionalsoftware modules for our products;

•                  developadditional strategic alliances with third party providers of semiconductordesign, fabrication and test solutions;

•                  implementadditional internal systems, develop additional infrastructure and hireadditional management; and

•                  payprofessional fees and other costs related to litigation matters.

 

Any failure to increase our revenues and control costs as weimplement our product and distribution strategies would harm our profitabilityand would likely negatively affect the market price of our common stock.

 

**Our limited operating history selling our software products makes ourbusiness difficult to evaluate.**

 

Because we arein the early stages of our development as a provider of yield optimizingsoftware, it may be difficult to evaluate our business operations andprospects.  Past revenues and salesfigures may be a poor indicator of future performance.  In addition, we have only sold our currentproduct line for approximately three years. This makes it more difficult for us to plan for the further developmentof our business than if we had a more mature business line.

 

**We may incur non cash charges resulting from acquisitions and equityissuances, which could harm our operating results.**

 

We incurred a$30.6 million goodwill impairment charge in the fourth quarter of our yearended March 31, 2003.  We willcontinue to incur charges to reflect amortization and any future impairment ofidentified intangible assets acquired in connection with our acquisitions ofFabCentric, Covalar and DYM, and we may make other acquisitions or issueadditional stock or other securities in the future that could result in furtheraccounting charges.  In the future, wemay incur additional impairment charges related to the goodwill alreadyrecorded, as well as goodwill arising out of any future acquisitions.  Current and future accounting charges likethese could result in significant losses and delay our achievement of netincome.

 

**Our cost reduction initiatives may adversely affect the morale andperformance of our personnel and our ability to hire new personnel.**

 

In connectionwith our effort to streamline operations, reduce costs and bring our staffingand structure in line with industry standards, we restructured our organizationon September 27, 2002, with substantial reductions in our workforce.  There have been and may continue to be substantialcosts associated with the workforce reductions, including severance and otheremployee related costs,

 

28

----

 

and our restructuring plan mayyield unanticipated consequences, such as attrition beyond our plannedreduction in workforce.  As a result ofthese reductions, our ability to respond to unexpected challenges may beimpaired and we may be unable to take advantage of new opportunities.

 

In addition,many of the employees who were terminated possessed specific knowledge orexpertise that may prove to have been important to our operations.  In that case, their absence may createsignificant difficulties.  This personnelreduction may also subject us to the risk of litigation, which may adversely impactour ability to conduct our operations and may cause us to incur significantexpense.

 

**Key employees**

 

Our employeesare vital to our success, and our key management, engineering and otheremployees are difficult to replace.  Wegenerally do not have employment contracts with our key employees.  Further, we do not maintain key person lifeinsurance on any of our employees.  Theexpansion of high technology companies worldwide has increased the demand andcompetition for qualified personnel.  Ifwe are unable to retain key personnel, or if we are not able to attract,assimilate or retain additional highly qualified employees to meet our needs inthe future, our business and operations could be harmed.  These factors could seriously harm ourbusiness.

 

**Terrorist activities and resulting military and other actionscould adversely affect our business**

 

Terrorist attacks in New York,Pennsylvania and Washington, D.C. in September 2001 disruptedcommerce throughout the United States and other parts of the world. Thecontinued threat of terrorism within the United States and abroad, and thepotential for military action and heightened security measures in response tosuch threats, may cause significant disruption to commerce throughout theworld. To the extent that such disruptions result in delays or cancellations ofcustomer orders, a general decrease in corporate spending, or our inability toeffectively market, sell or operate our services and software, our business andresults of operations could be materially and adversely affected.

 

**RISKS RELATED TO OUR INTERNATIONAL OPERATIONS**

 

**Our business could be harmed by political or economic instability in theRepublic of Armenia.**

 

Our softwareproducts are largely developed, produced, delivered and supported from our facilitiesin the Republic of Armenia.  Armenianemployees participate in our direct sales and marketing efforts.  Changes in the political or economicconditions in Armenia and the surrounding region, such as fluctuations inexchange rates, the imposition of currency transfer restrictions orlimitations, or the adoption of burdensome trade or tax policies, procedures,rules, regulations or tariffs, could adversely affect our ability to developnew products and take advantage of Armenia’s low labor and production costs,and to otherwise conduct business effectively in Armenia.

 

Armenia votedfor independence in 1991 and adopted its current constitution in 1995.  Laws protecting property (includingintellectual property) are not well established and may be difficult toenforce.  In recent years, Armenia hassuffered significant political and economic instability.  Any future political and economicinstability could interfere with our ability to retain or recruit employees,significantly increase the cost of our operations, or result in regulatoryrestrictions on our business, making it difficult for us to maintain ourbusiness in Armenia or disrupting our Armenian operations.  Any significant increase in the costs of ourArmenian operations (whether due to inflation, imposition of additional taxesor other causes) would diminish, and could eliminate their currentcost-advantages.  Furthermore, we cannotassure you that restrictive foreign relations laws or policies on the part ofArmenia or the United States will not constrain our ability to operateeffectively in both countries.  If welose or choose to terminate any part of our Armenian operation, replacementscould be costly and we could experience delays in our product development,thereby harming our competitive position and adversely affecting our results ofoperations.

 

**Our expansion into international markets may result in higher costs andcould reduce our operating margins due to the higher costs of internationalsales.**

 

Our currentstrategy for growth includes further expansion in Asia, Europe, and otherinternational markets.  To effectivelyfurther this strategy, we must find additional partners to sell our products ininternational markets and expand our direct international sales presence.  We would likely incur higher sales costs byexpanding our direct sales staff abroad, but we might not realize correspondingincreases in revenues or profitability. Furthermore, we may be forced to share sales revenues with distributorsor other sales partners abroad in order to successfully penetrate foreignmarkets.  Even if we successfully expandour direct and indirect

 

29

----

 

international sales efforts, wecannot be certain that we will be able to create or increase internationalmarket penetration or demand for our products.

 

**Problems with international business operations could adversely affectour sales.**

 

Sales to customers located outside the United Statesaccounted for approximately 36%, 30% and 31% of our revenues in the years endedMarch 31, 2003, 2002 and 2001, respectively.  We anticipate that sales to customers located outside the UnitedStates will represent a significant portion of our total revenues in future periods.  In addition, many of our customers rely onthird party foundries operating outside of the United States.  Accordingly, our operations and revenues aresubject to a number of risks associated with foreign commerce, including thefollowing:

 

•                  managing foreign distributors;

•                  maintaining relationships withforeign distributors;

•                  staffing and managing foreignbranch offices;

•                  political and economicinstability abroad;

•                  foreign currency exchangefluctuations;

•                  changes in taxlaws and tariffs;

•                  timing and availability ofexport licenses;

•                  inadequate protection ofintellectual property rights in some countries; and

•                  obtaining governmental approvalsfor certain technologies.

 

Any of these factors could result in decreased sales tointernational customers and domestic customers that use foreign fabricationfacilities.

 

Our accountsreceivable from international customers are generally outstanding longer thanour domestic receivables and, as a result, we may need a proportionatelygreater amount of working capital to support our international sales.

 

# **INTELLECTUAL PROPERTY RELATED RISKS**

# ** **

**Our success depends in part on our ability to protect our intellectualproperty, and any inability to do so could cause our business material harm.**

 

Our success depends in significant part on our intellectualproperty.  While we have attempted toprotect our intellectual property through patents, copyrights, or themaintenance of trade secrets, there can be no assurance that these measureswill successfully protect our technology or that competitors will not be ableto develop similar technology independently. It is possible, for example, that the claims we are allowed on any ofour patents will not be sufficiently broad to protect our technology.  In addition, patents issued to us could bechallenged, invalidated or circumvented and the rights granted under thosepatents might not provide us with any significant competitive advantage.  The laws of some foreign countries do notprotect our intellectual property as effectively as the laws of the UnitedStates.  Also, our source code developedin Armenia may not receive the same copyright protection that it would receiveif it was developed in the United States. As we increase our international presence, we expect that it will becomemore difficult to monitor the development of competing products that mayinfringe on our rights as well as unauthorized use of our products.

 

**Our operating results would suffer if we were subject to a protractedintellectual property infringement claim or one with a significant damages award.**

 

Litigation regarding intellectual property rights frequentlyoccurs in the software industry.  Weexpect we will be subject to infringement claims as the number of competitorsin our industry segment grows.  While weare unaware of any claims that our products infringe on the intellectualproperty rights of others, such claims may arise in the future.  Regardless whether these claims have merit,they could:

 

•                  becostly to defend;

•                  divertsenior management’s time, attention and resources;

•                  causeproduct shipment delays; and

•                  require us to enter into costlylicensing or royalty arrangements.

 

Any of these potential results of intellectual propertyinfringement claims could limit our ability to maintain our business andnegatively affect our operating results.

 

30

----

 

**ITEM7A.  QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

In the normalcourse of business, our financial position is subject to a variety of risks,including market risk associated with interest rate and foreign currencyexchange movements.  We regularly assessthese risks and have established policies and business practices to protectagainst these and other exposures.  As aresult, we do not anticipate material potential losses in these areas.

 

**InterestRate Risk**

 

We invest excess cash indebt instruments of the U.S. Government and its agencies, and in high qualitycorporate issuers and, limit the amount of credit exposure to any oneissuer.  Our investments in fixed ratesecurities may have their fair market value adversely impacted due to a rise ininterest rates.  We believe that achange in long-term interest rates would not have a material effect on ourbusiness, financial condition results of operations or cash flow.  Our cash and cash equivalents consist ofcash and highly liquid money market instruments with original or remainingmaturities of 90 days or less. Because of the short maturities of these instruments, a sudden change inmarket interest rates would not have a material impact on the fair value of theportfolio, but it may cause the amount of income we derive to varysignificantly from period to period.  Ahypothetical 10% increase in interest rates would result in an approximate$2,000 decrease in the fair value of our available-for-sale securities as ofMarch 31, 2003.

 

**ForeignExchange Risk**

 

Our sales are primarilydenominated in U.S. dollars and, as a result, we have relatively littleexposure to foreign currency exchange risk with respect to revenues.  Our sales through our Japanese subsidiary,which represented approximately 6.9% of total revenues for the year endedMarch 31, 2003, are denominated in yen. A 10% adverse change in yen exchange rates would not have had materialimpact on revenues for the year ended March 31, 2003.  Additionally, our exposure to foreignexchange rate fluctuations arises in part from inter-company accounts which canbe denominated in the functional currency of the foreign subsidiary.  As exchange rates vary when the accounts aretranslated, results may vary from expectations and adversely impactearnings.  The effect of foreignexchange rate fluctuations for the fiscal 2003 was not material.

 

While our sales aregenerally denominated in U.S. dollars, our international subsidiaries’ booksand records are maintained in the local currency.  As a result, our financial statements are remeasured in U.S.dollars using a combination of current and historical exchange rates.  The functional currencies of our foreignsubsidiaries are their local currencies. We translate certain assets and liabilities to U.S. dollars at thecurrent exchange rate as of the applicable balance sheet date.  Revenues and expenses are translated at theaverage exchange rates prevailing during the period.  Adjustments resulting from the translation of the foreignsubsidiaries’ financial statements are recorded in accumulated othercomprehensive income (loss) in stockholders’ equity.

 

31

----

 

**ITEM8.  FINANCIAL STATEMENTS AND SUPPLEMENTARYDATA**

 

Index toConsolidated Financial Statements

 
| Consolidated Financial  Statements:                                                                                                                          |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                         |
| Report of Independent  Auditors                                                                                                                              |
|                                                                                                                                                         |
| Consolidated  Statements of Operations for each of the three years in the period ended  March 31, 2003                                                  |
|                                                                                                                                                         |
| Consolidated  Balance Sheets at March 31, 2003 and 2002                                                                                                 |
|                                                                                                                                                         |
| Consolidated Statements of  Cash Flows for each of the three years in the period ended March 31,  2003                                                  |
|                                                                                                                                                         |
| Consolidated  Statements of Stockholders’ Equity (Deficit) for each of the three years in  the period ended March 31, 2003                         |
|                                                                                                                                                         |
| Notes to  Consolidated Financial Statements                                                                                                                  |
|                                                                                                                                                         |
| Financial Statement  Schedules:                                                                                                                              |
|                                                                                                                                                         |
| All  schedules are omitted because they are not applicable or the required  Information is shown in the Consolidated Financial Statements or Notes  thereto. |
|                                                                                                                                                         |
| Supplementary Financial  Data:                                                                                                                               |
|                                                                                                                                                         |
| Quarterly Financial Data (unaudited) for  the two years ended March 31, 2003                                                                            |

 

32

----

 

**Report of Independent Auditors**

 

To the Board of DirectorsandStockholders of HPL Technologies, Inc.:

 

In our opinion, theconsolidated financial statements listed in the accompanying index presentfairly, in all material respects, the financial position of HPLTechnologies, Inc. and its subsidiaries at March 31, 2003 and 2002,and the results of their operations and their cash flows for each of the threeyears in the period ended March 31, 2003 in conformity with accountingprinciples generally accepted in the United States of America.  These financial statements are the responsibilityof the Company’s management; our responsibility is to express an opinion onthese financial statements based on our audits.  We conducted our audits of these statements in accordance withauditing standards generally accepted in the United States of America, whichrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement.  An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, and evaluating the overall financial statementpresentation.  We believe that ouraudits provide a reasonable basis for our opinion.

 

 

PricewaterhouseCoopersLLP

 

San Jose, California

May 22, 2003

 

33

----

 

**HPLTechnologies, Inc.**

**ConsolidatedStatements****ofOperations**

*(Inthousands, except per share amounts)*

 
|                                                           |   | **Year ended March 31,** | ** ** |
|----------------------------------------------------------------|--------|--------------------------|------------|
|                                                           |   | **2003**                 |       | **2002** | ** ** | **2001** | ** ** |
| Revenues:                                                      |   |                     |       |   |   |   |   |
| Software licenses                                              |   | $                        | 5,281      |   | $ | 1,614 |   | $ | 3,159 |   |
| Consulting services,  maintenance and other                    |   | 10,311                   |       | 2,899 |   | 1,156 |   |
| Total revenues                                                 |   | 15,592                   |       | 4,513 |   | 4,315 |   |
|                                                           |   |                     |       |   |   |   |   |
| Cost of revenues:                                              |   |                     |       |   |   |   |   |
| Software licenses                                              |   | 656                      |       | 587 |   | 133 |   |
| Consulting services, maintenance  and other (1)                |   | 3,808                    |       | 507 |   | 243 |   |
| Total cost of revenues                                         |   | 4,464                    |       | 1,094 |   | 376 |   |
| Gross profit                                                   |   | 11,128                   |       | 3,419 |   | 3,939 |   |
| Operating expenses:                                            |   |                     |       |   |   |   |   |
| Research and development (1)                                   |   | 10,515                   |       | 6,118 |   | 3,349 |   |
| Sales, general and  administrative (1)                         |   | 19,788                   |       | 9,285 |   | 4,329 |   |
| Goodwill impairment                                            |   | 30,570                   |       | — |   | — |   |
| Stock-based compensation                                       |   | 1,047                    |       | 3,547 |   | 2,369 |   |
| Amortization of intangible  assets                             |   | 1,494                    |       | 294 |   | 137 |   |
| Total operating expenses                                       |   | 63,414                   |       | 19,244 |   | 10,184 |   |
| Loss from operations                                           |   | $                        | (52,286    | ) | $ | (15,825 | ) | $ | (6,245 | ) |
| Interest income (expense) and  other, net                      |   | 468                      |       | 908 |   | (190 | ) |
| Net loss                                                       |   | $                        | (51,818    | ) | $ | (14,917 | ) | $ | (6,435 | ) |
|                                                           |   |                     |       |   |   |   |   |
| Net loss per share—basic and  diluted:                    |   | $                        | (1.69      | ) | $ | (0.62 | ) | $ | (0.37 | ) |
|                                                           |   |                     |       |   |   |   |   |
| Shares used in per share  calculations—basic and diluted: |   | 30,645                   |       | 24,038 |   | 17,496 |   |

 

----

(1)          Excludes the following stock-based compensation charges:

 
| Cost of revenues                   |   | $   | 18     |   | $      | 39    |   | $ | 60    |   |
|------------------------------------|--------|-----|--------|--------|--------|-------|--------|---|-------|--------|
| Research and development           |   | 414 |   | 692    |   | 296   |   |
| Sales, general and  administrative |   | 615 |   | 2,816  |   | 2,013 |   |
|                               |   | $   | 1,047  |   | $      | 3,547 |   | $ | 2,369 |   |

 

The accompanying notes are an integral part of theseconsolidated financial statements.

 

34

----

 

**HPLTechnologies, Inc.**

**ConsolidatedBalanc****e Sheets**

*(Inthousands, except per share data)*

 
|                                                                                                                                   |   | **March 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|--------|---------------|------------|
|                                                                                                                                   |   | **2003**      |       | **2002** | ** ** |
| **ASSETS**                                                                                                                             |   |          |       |   |   |
| ***Current assets:***                                                                                                                  |   |          |       |   |   |
| Cash and cash equivalents                                                                                                              |   | $             | 17,350     |   | $ | 32,798 |   |
| Short-term investments                                                                                                                 |   | 4,391         |       | 14,311 |   |
| Accounts receivable, net of  allowances of $100 and $100, respectively                                                                 |   | 1,560         |       | 1,212 |   |
| Unbilled accounts receivable                                                                                                           |   | 619           |       | 783 |   |
| Prepaid expenses and other  current assets                                                                                             |   | 3,206         |       | 3,870 |   |
| Total current assets                                                                                                                   |   | 27,126        |       | 52,974 |   |
| Property and equipment, net                                                                                                            |   | 2,316         |       | 3,147 |   |
| Goodwill                                                                                                                               |   | 27,704        |       | 42,040 |   |
| Other intangible assets, net                                                                                                           |   | 2,508         |       | 2,701 |   |
| Other assets                                                                                                                           |   | 731           |       | 446 |   |
| **Total assets**                                                                                                                       |   | $             | 60,385     |   | $ | 101,308 |   |
|                                                                                                                                   |   |          |       |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                         |   |          |       |   |   |
| ***Current liabilities:***                                                                                                             |   |          |       |   |   |
| Accounts payable                                                                                                                       |   | $             | 1,342      |   | $ | 2,570 |   |
| Accrued liabilities                                                                                                                    |   | 6,754         |       | 5,755 |   |
| Deferred revenue                                                                                                                       |   | 3,667         |       | 7,893 |   |
| Capital lease  obligations—current portion                                                                                        |   | 338           |       | 194 |   |
| Convertible debenture                                                                                                                  |   | 1,500         |       | 1,500 |   |
| Total current liabilities                                                                                                              |   | 13,601        |       | 17,912 |   |
| Capital lease obligations—net  of current portion                                                                                 |   | 130           |       | 280 |   |
| Deferred revenue                                                                                                                       |   | 108           |       | — |   |
| Other liabilities                                                                                                                      |   | 514           |       | 800 |   |
| Total liabilities                                                                                                                      |   | 14,353        |       | 18,992 |   |
|                                                                                                                                   |   |          |       |   |   |
| Contingencies and Commitments  (Notes 7, 8 and 16)                                                                                     |   |          |       |   |   |
| ***Stockholders’ equity :***                                                                                                      |   |          |       |   |   |
| Preferred stock, $0.001 par  value, 10,000 shares authorized, no shares issued and outstanding at March  31, 2003 and 2002             |   | —        |       | — |   |
| Common stock, $0.001 par  value; 75,000 shares authorized; 30,810 and 29,400 shares issued and  outstanding at March 31, 2003 and 2002 |   | 31            |       | 29 |   |
| Additional paid-in capital                                                                                                             |   | 124,590       |       | 112,369 |   |
| Deferred stock-based  compensation                                                                                                     |   | (887          | )          | (4,017 | ) |
| Accumulated deficit                                                                                                                    |   | (77,704       | )          | (25,886 | ) |
| Accumulated other  comprehensive gain (loss)                                                                                           |   | 2             |       | (179 | ) |
| Total stockholders’ equity                                                                                                        |   | 46,032        |       | 82,316 |   |
| **Total  liabilities and stockholders’ equity**                                                                                   |   | $             | 60,385     |   | $ | 101,308 |   |

 

The accompanying notes are an integral part of theseconsolidated financial statements.

 

35

----

 

**HPLTechnologies, Inc.**

**ConsolidatedStatements of****CashFlows**

*(Inthousands)*

 
|                                                                                       |   | **Year ended  March 31,** | ** ** |
|--------------------------------------------------------------------------------------------|--------|---------------------------|------------|
|                                                                                       |   | **2003**                  |       | **2002** | ** ** | **2001** | ** ** |
| ***Cash flows from operating activities:***                                                |   |                      |       |   |   |   |   |
| Net  loss                                                                                  |   | $                         | (51,818    | ) | $ | (14,917 | ) | $ | (6,435 | ) |
| Adjustments  to reconcile net loss to net cash provided by (used in) operating activities: |   |                      |       |   |   |   |   |
| Depreciation  and amortization                                                             |   | 3,218                     |       | 779 |   | 463 |   |
| Goodwill  impairment                                                                       |   | 30,570                    |       | — |   | — |   |
| Forgiveness  of note                                                                       |   | 150                       |       | — |   | — |   |
| Allowance  for doubtful accounts                                                           |   | —                    |       | (63 | ) | 163 |   |
| Accreted  interest expense                                                                 |   | —                    |       | 25 |   | 70 |   |
| Stock-based  compensation                                                                  |   | 1,047                     |       | 3,547 |   | 2,369 |   |
| Loss  on disposal of property and equipment                                                |   | —                    |       | — |   | 92 |   |
| Changes  in assets and liabilities, net of effects from acquisitions:                      |   |                      |       |   |   |   |   |
| Accounts  receivable                                                                       |   | (47                       | )          | 1,806 |   | 740 |   |
| Unbilled  accounts receivable                                                              |   | 164                       |       | (393 | ) | — |   |
| Prepaid  expenses and other current assets                                                 |   | 687                       |       | (2,472 | ) | (270 | ) |
| Other  assets                                                                              |   | 15                        |       | (64 | ) | — |   |
| Accounts  payable                                                                          |   | (1,398                    | )          | (261 | ) | 152 |   |
| Accrued  liabilities                                                                       |   | (1,068                    | )          | 607 |   | (29 | ) |
| Other  liabilities                                                                         |   | (225                      | )          | (344 | ) | — |   |
| Deferred  revenue                                                                          |   | (5,054                    | )          | (662 | ) | 4,638 |   |
| Net  cash provided by (used in) operating activities                                       |   | (23,759                   | )          | (12,412 | ) | 1,953 |   |
|                                                                                       |   |                      |       |   |   |   |   |
| ***Cash flows from investing activities:***                                                |   |                      |       |   |   |   |   |
| Acquisition  of property and equipment                                                     |   | (397                      | )          | (633 | ) | (120 | ) |
| Issuance  of notes receivable                                                              |   | (450                      | )          | (3,045 | ) | (750 | ) |
| Repayment  of notes receivable                                                             |   | —                    |       | 2,745 |   | — |   |
| Acquisitions,  net of cash acquired                                                        |   | (2,012                    | )          | (12,095 | ) | — |   |
| Sales  (purchases) of marketable securities                                                |   | 9,941                     |       | (14,360 | ) | — |   |
| Net  cash provided by (used in) investing activities                                       |   | 7,082                     |       | (27,388 | ) | (870 | ) |
|                                                                                       |   |                      |       |   |   |   |   |
| ***Cash flows from financing activities:***                                                |   |                      |       |   |   |   |   |
| Proceeds  from issuance of notes payable and line of credit                                |   | —                    |       | 84 |   | — |   |
| Repayments  of notes payable and line of credit                                            |   | —                    |       | (284 | ) | (220 | ) |
| Issuance  of common stock                                                                  |   | 166                       |       | 69,048 |   | 45 |   |
| Principal  payments on capital lease obligations                                           |   | (397                      | )          | (144 | ) | (97 | ) |
| Amounts  received from HPL’s former Chief Executive Officer                           |   | 1,300                     |       | 3,035 |   | — |   |
| Net  cash provided by (used in) financing activities                                       |   | 1,069                     |       | 71,739 |   | (272 | ) |
| Effect  of exchange rate changes on cash and cash equivalents                              |   | 160                       |       | (130 | ) | — |   |
| Net  increase (decrease) in cash and cash equivalents                                      |   | (15,448                   | )          | 31,809 |   | 811 |   |
| Cash  and cash equivalents at beginning of period                                          |   | 32,798                    |       | 989 |   | 178 |   |
| Cash  and cash equivalents at end of period                                                |   | $                         | 17,350     |   | $ | 32,798 |   | $ | 989 |   |
|                                                                                       |   |                      |       |   |   |   |   |
| **Supplemental disclosures of cash flow information:**                                     |   |                      |       |   |   |   |   |
| Interest  paid                                                                             |   | $                         | 22         |   | $ | 202 |   | $ | 147 |   |
| Income  taxes paid                                                                         |   | $                         | 1,749      |   | $ | 793 |   | $ | — |   |
| **Supplemental disclosure of non-cash investing and financing  activities:**               |   |                      |       |   |   |   |   |
| Acquisition  of property and equipment under capital lease obligations                     |   | $                         | 391        |   | $ | 461 |   | $ | — |   |
| Issuance  of common stock and options assumed in connection with acquisitions              |   | $                         | 14,178     |   | $ | 33,592 |   | $ | — |   |
| Forgiveness  of note                                                                       |   | $                         | 150        |   | $ | — |   | $ | — |   |

 

The accompanying notes are anintegral part of these consolidated financial statements

 

36

----

 

**HPLTechnologies, Inc.**

**ConsolidatedStatements of Stockholders’****Equity (Deficit)**

*(Inthousands)*

 

 
|                                                                          |   | **Common  Stock** | ** ** | **Additional  paid-in  capital** |       | **Deferred  stock-based  compensation** |   | **Accumulated  deficit** |   | **Accumulated  other  comprehensive  gain(loss)** | ** ** | **Total  stockholders’  equity  (deficit)** | ** ** |
|-------------------------------------------------------------------------------|--------|-------------------|------------|----------------------------------|------------|-----------------------------------------|--------|--------------------------|--------|---------------------------------------------------|------------|--------------------------------------------------|------------|
|                                                                          |   | **Shares**        |       | **Amount**                       | ** ** |                                    |   |                     |   |                                              |
|                                                                          |   |              |       |                             |       |                                    |   |                     |   |                                              |       |                                             |       |   |   |
| Balances as of March 31, 2000                                            |   | 17,243            |       | $                                | 17         |                                    | $      | 2,716                    |   | $                                                 | (926       | )                                                | $          | (4,534 | ) | $ | — |   | $ | (2,727 | ) |
| Issuance of common stock upon exercise of stock  options                      |   | 585               |       | 1                                |       | 44                                      |   | —                   |   | —                                            |       | —                                           |       | 45 |   |
| Issuance of stock options to employees                                        |   | —            |       | —                           |       | 1,683                                   |   | (1,683                   | )      | —                                            |       | —                                           |       | — |   |
| Escrow release of stock-based compensation shares                             |   | —            |       | —                           |       | 1,272                                   |   | (1,272                   | )      | —                                            |       | —                                           |       | — |   |
| Stock-based compensation                                                      |   | —            |       | —                           |       | —                                  |   | 2,369                    |   | —                                            |       | —                                           |       | 2,369 |   |
| Net loss                                                                      |   | —            |       | —                           |       | —                                  |   | —                   |   | (6,435                                            | )          |                                             |       | (6,435 | ) |
| Balances as of March 31, 2001                                            |   | 17,828            |       | 18                               |       | 5,715                                   |   | (1,512                   | )      | (10,969                                           | )          | —                                           |       | (6,748 | ) |
| Components of comprehensive loss:                                             |   |              |       |                             |       |                                    |   |                     |   |                                              |       |                                             |       |   |   |
| Net loss                                                                      |   | —            |       | —                           |       | —                                  |   | —                   |   | (14,917                                           | )          | —                                           |       | (14,917 | ) |
| Unrealized loss on available for sale securities                              |   | —            |       | —                           |       | —                                  |   | —                   |   | —                                            |       | (49                                              | )          | (49 | ) |
| Foreign currency translation adjustment                                       |   | —            |       | —                           |       | —                                  |   | —                   |   | —                                            |       | (130                                             | )          | (130 | ) |
| Total comprehensive loss                                                      |   |              |       |                             |       |                                    |   |                     |   |                                              |       |                                             |       | (15,096 | ) |
| Issuance of stock options to employees                                        |   | —            |       | —                           |       | 3,863                                   |   | (3,863                   | )      | —                                            |       | —                                           |       | — |   |
| Issuance of stock options to non-employees                                    |   | —            |       | —                           |       | 162                                     |   | —                   |   | —                                            |       | —                                           |       | 162 |   |
| Stock-based compensation                                                      |   | —            |       | —                           |       | —                                  |   | 3,385                    |   | —                                            |       | —                                           |       | 3,385 |   |
| Issuance of common stock in public offering and  exercise of options          |   | 9,387             |       | 9                                |       | 69,039                                  |   | —                   |   | —                                            |       | —                                           |       | 69,048 |   |
| Issuance of common stock and options assumed in  connection with acquisitions |   | 2,185             |       | 2                                |       | 33,590                                  |   | (2,027                   | )      | —                                            |       | —                                           |       | 31,565 |   |
| Balances as of March 31, 2002                                            |   | 29,400            |       | 29                               |       | 112,369                                 |   | (4,017                   | )      | (25,886                                           | )          | (179                                             | )          | 82,316 |   |
|                                                                          |   |              |       |                             |       |                                    |   |                     |   |                                              |       |                                             |       |   |   |
| Components of comprehensive loss:                                             |   |              |       |                             |       |                                    |   |                     |   |                                              |       |                                             |       |   |   |
| Net loss                                                                      |   | —            |       | —                           |       | —                                  |   | —                   |   | (51,818                                           | )          | —                                           |       | (51,818 | ) |
| Unrealized gain on available for sale securities                              |   | —            |       | —                           |       | —                                  |   | —                   |   | —                                            |       | 69                                               |       | 69 |   |
| Foreign currency translation adjustment                                       |   | —            |       | —                           |       | —                                  |   | —                   |   | —                                            |       | 112                                              |       | 112 |   |
| Total comprehensive loss                                                      |   |              |       |                             |       |                                    |   |                     |   |                                              |       |                                             |       | (51,637 | ) |
| Exercise of stock options for cash                                            |   | 443               |       | 1                                |       | 165                                     |   | —                   |   | —                                            |       | —                                           |       | 166 |   |
| Issuance of common stock and options assumed in  connection with acquisitions |   | 967               |       | 1                                |       | 14,177                                  |   | (38                      | )      | —                                            |       | —                                           |       | 14,140 |   |
| Stock-based compensation                                                      |   |              |       |                             |       | (2,121                                  | )      | 3,168                    |   | —                                            |       | —                                           |       | 1,047 |   |
| Balances as of March 31, 2003                                            |   | 30,810            |       | $                                | 31         |                                    | $      | 124,590                  |   | $                                                 | (887       | )                                                | $          | (77,704 | ) | $ | 2 |   | $ | 46,032 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

37

----

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMEN****TS**

 

**NOTE1.  NATURE OF OPERATIONS**

 

HPLTechnologies, Inc. (“HPL” or the “Company”) is engaged in the sale,support and providing of services related to the yield optimization software itdesigns for companies involved in the design, fabrication and testing ofsemiconductors and flat panel displays.

 

Prior to thereincorporation in July 2001, the Company, a Delaware corporation,principally conducted business as Heuristic Physics Laboratories, Inc.(“HPLI”).  Through the merger of awholly-owned subsidiary of HPL with HPLI, a California corporation formed inJune 1989, HPLI became a wholly-owned subsidiary of the Company.  HPL issued 1.7 shares for each outstandingshare of common stock of HPLI exchanged in the merger.  HPLI continues to do business as awholly-owned subsidiary of the Company. This merger has been accounted for in a manner similar to a pooling ofinterests.

 

The consolidatedfinancial statements for prior years have been retroactively adjusted toreflect the merger and stock conversion.

 

The Company has fundedits losses from operations principally through its July 2001 initialpublic offering and debt financing. Management believes the Company has sufficient cash, cash equivalentsand short-term investments to fund its operations through at leastMarch 31, 2004.  Future capitalrequirements will be affected by slow or diminished revenue growth, additionalresearch and development and sales and marketing costs, and higher general andadministrative costs, including costs related to the litigation mattersdescribed in Note 16.  In the eventthe Company needs to raise capital, there is no assurance that funds would beavailable to the Company or, if available, under terms that would be acceptableto the Company.  The Company does notbelieve it will be able to raise additional capital until the litigation andother uncertainties described in Note 16 are resolved.

 

**NOTE2.  SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES**

 

**Principlesof consolidation**

 

The accompanyingconsolidated financial statements include the accounts of the Company and itswholly-owned subsidiaries after the elimination of intercompany balances andtransactions.

 

**Use ofestimates**

 

The preparation offinancial statements in conformity with generally accepted accountingprinciples in the United States of America requires management to makeestimates and assumptions that affect the amounts reported in the financialstatements.  These estimates may affectthe amounts of assets and liabilities reported in the balance sheet, thedisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenue and expense during the periodspresented.  Actual amounts may differfrom those estimates.

 

**Revenuerecognition**

 

The Company recognizesrevenue in accordance with the provisions of Statement of Position (“SOP”)97-2, “Software Revenue Recognition,” as amended by SOP 98-4, SOP 98-9 andStaff Accounting Bulletin No. 101, “Revenue Recognition in FinancialStatements” issued by the Securities and Exchange Commission.  The Company’s revenues are primarily derivedfrom three sources: (i) software license revenue, derived primarily fromsales to end users; (ii) maintenance revenue, derived primarily fromproviding post-contract customer support and software updates to end users; and(iii) consulting services revenues derived from providing design and test services,training and consulting services to end users.

 

If the consulting orother services sold in connection with a software license are essential to thefunctionality of the software, the Company recognizes revenue on either apercentage-of-completion or completed contract basis.  For the percentage-of-completion method, the Company recognizesrevenues using labor hours incurred as the measure of progress against thetotal labor hours estimated for completion. The Company considers a project completed after all contractualobligations are met.  Unbilled accountsreceivable comprises revenue recognized in advance of contractual billings.

 

Provisions for estimatedcontract losses are recognized in the period in which the loss becomes probableand can be reasonably estimated.  Whenthe services sold are not essential to the functionality of the software, theCompany recognizes revenues from software licenses upon delivery of thesoftware and execution of a binding agreement with the customer, provided thatthe fee is fixed or determinable, collection is reasonably assured and thereare no customer acceptance clauses. When customer acceptance clauses exist, revenues are recognized uponcustomer acceptance.

 

38

----

 

For contracts withmultiple obligations (e.g., deliverable and undeliverable products,post-contract support and other services), the Company allocates revenues tothe undelivered element of the contract based on objective evidence of its fairvalue.  This objective evidence is thesales price of the element when sold separately or the renewal rate specifiedin the agreement for licensing arrangements with terms of one year or more thatinclude post-contract customer support and software updates.  The Company recognizes revenues allocated toundelivered products when all of the other criteria for revenue recognitionhave been met.

 

Revenues for time-basedsoftware licenses for periods of one year or less are recognized ratably overthe term of the contract.  When thecontract term is greater than one year and there is a stated renewal rate,which is substantive, in the arrangement for maintenance and post-contractsupport services, the Company recognizes the license fee upon delivery of thesoftware assuming all other revenue recognition criteria have been met.

 

Revenues from maintenanceand post-contract support services are recognized ratably over the contractualperiod.  Payments for maintenance andsupport services are generally made in advance and are non-refundable.  Revenues from training and consultingservices are recognized as the related services are performed.  Customer advances and billed amounts duefrom customers in excess of revenue recognized are recorded as deferredrevenue.

 

The Company also derivesrevenues from the sale of its software licenses, maintenance and post-contractsupport services through distributors. Revenues from sales made through distributors which have return rightsare recognized when the distributors have sold the software licenses or serviceto their customers and the criteria for revenue recognition underSOP 97-2, as amended, are met. Revenues from maintenance and post-contract support services soldthrough distributors are recognized ratably over the contractual period.  Revenues derived from software developmentprojects are recognized on a completed contract basis.

 

Deferred revenue includesadvance payments received for maintenance and support services and licenserevenues received or due under the terms of the contracts for which customeracceptance has not been received.

 

**Cost ofrevenues**

 

Cost of revenues consistsprimarily of expenses directly related to the cost of media on which a productis delivered, third party software royalties, product fulfillment costs, anddirect customer service, consulting and support costs such as salaries andrelated expenses.

 

**Softwaredevelopment costs**

 

Costs related to theresearch, design and development of software products are generally expensed asincurred.  Software development costs arecapitalized beginning when a product’s technological feasibility has beenestablished through the time of general release of the product.  Based on the Company’s product developmentprocess, technological feasibility is established upon the completion of aworking model.  Costs eligible forcapitalization, incurred after achieving technological feasibility and beforegeneral release of its product, were not material in the years endedMarch 31, 2003, 2002 and 2001. Accordingly, all software development costs have been charged toresearch and development expense in the accompanying consolidated statements ofoperations.

 

**Cash,cash equivalents and short-term investments**

 

The Company invests itsexcess cash in debt instruments of the US Government and its agencies, andhigh-quality corporate issuers.  TheCompany considers all highly liquid investments with an original or remainingmaturity of three months or less at the date of purchase to be cashequivalents.  Short-term investments areclassified as securities available-for-sale and are reported at fair valuebased on quoted market prices as of the balance sheet date.  Realized gains or losses and declines invalue judged to be other than temporary, if any, are determined on the specificidentification method and are reflected in other income or loss.  Net unrealized gains or losses, net of tax,are recorded directly in stockholders’ equity (deficit) as other comprehensiveincome.

 

**Propertyand equipment**

 

Property and equipmentare stated at cost less accumulated depreciation.  Depreciation is computed using the straight-line method over theestimated useful lives of the assets, as follows:

 
| Computers and equipment        |   | 3 years      |
|--------------------------------|--------|--------------|
| Furniture, fixtures and  other |   | 3 to 7 years |

 

39

----

 

Computers and equipmentacquired under capital leases are amortized over the shorter of the lease termor the useful life of the asset. Leasehold improvements are amortized using the straight-line method overthe shorter of the remaining lease term or the estimated useful life of theimprovement.  Repair and maintenancecosts are expensed as incurred.  Whenproperty and equipment are retired or otherwise disposed of, the cost andaccumulated depreciation are relieved from the accounts and the net gain orloss is included in the determination of income or loss.

 

Depreciation expensetotaled $1.7 million, $485,000 and $326,000 for the years ended March 31, 2003, 2002 and 2001,respectively.

 

# **Goodwilland intangible assets**

# ** **

Goodwill is stated atfair value and intangible assets are stated at cost less accumulatedamortization.  Intangible assets areamortized on a straight line basis over the estimated useful life.  Goodwill is not amortized, but rather issubject to at least an annual assessment for impairment.

 

Intangible assetsacquired in business combinations consist primarily of purchased technology andcustomer backlog and are being amortized on a straight-line basis over theirestimated useful life which ranges from six months to three years.  Amortization expense totaled $1.5 million,$294,000 and $137,000 for the years ended March 31, 2003, 2002 and 2001,respectively.

 

TheCompany periodically reviews the carrying value of acquired intangible assets,including goodwill, to determine whether impairment may exist.  Statement of Financial Accounting StandardsNo. 142 (“SFAS 142”), “Goodwill and Other Intangible Assets,” requires thatgoodwill and certain intangible assets be assessed for impairment using fairvalue measurement techniques. Specifically, goodwill impairment is determined using a two-stepprocess.  The first step of the goodwillimpairment test is used to identify potential impairment by comparing the fairvalue of a reporting unit with its carrying amount, including goodwill.  If the fair value of a reporting unitexceeds its carrying amount, goodwill of the reporting unit is considered notimpaired and the second step of the impairment test is unnecessary.  If the carrying amount of a reporting unitexceeds its fair value, the second step of the goodwill impairment test isperformed to measure the amount of impairment loss, if any.  The second step of the goodwill impairmenttest compares the implied fair value of the reporting unit’s goodwill with thecarrying amount of that goodwill.  Ifthe carrying amount of the reporting unit’s goodwill exceeds the implied fairvalue of that goodwill, an impairment loss is recognized in an amount equal tothat excess.  The implied fair value ofgoodwill is determined in the same manner as the amount of goodwill recognizedin a business combination.  That is, thefair value of the reporting unit is allocated to all of the assets andliabilities of that unit (including any unrecognized intangible assets) as ifthe reporting unit had been acquired in a business combination and the fairvalue of the reporting unit was the purchase price paid to acquire thereporting unit.  The impairment test forother intangible assets not subject to amortization consists of a comparison ofthe fair value of the intangible asset with its carrying value.  If the carrying value of the intangibleasset exceeds its fair value, an impairment loss is recognized in an amountequal to that excess.  For intangibleassets subject to amortization, to the extent the fair value of the intangibleasset, determined based upon the estimated future cash inflows on a discountedbasis attributable to the asset, less estimated future cash outflows on adiscounted basis, are less than the carrying amount, an impairment loss is recognized.  The determination of impairment of goodwilland other intangible assets requires significant judgment and managementestimates.

 

**Long-lived assets**

 

The Company monitorsevents and changes in circumstances that could indicate the carrying amounts oflong-lived assets may not be recoverable. When such events or changes in circumstances are present, the Companyassesses the recoverability of long-lived assets by determining whether thecarrying value of the assets will be recovered through non-discounted expectedfuture cash flows.  If the assets areconsidered to be impaired, the impairment to be recognized is measured by theamount by which the carrying amount of the assets exceeds the fair value of theassets.

 

**Foreigncurrency translation**

 

The functional currencyfor the Company’s international subsidiaries are the local currencies.  These international subsidiaries’ financialstatements are translated to United States dollars using period-end rates ofexchange for assets and liabilities, and the average rates of exchange for theyear for revenues and expenses. Translation gains (losses) are recorded in accumulated othercomprehensive income (loss) in stockholders’ equity (deficit).  Net gains and losses resulting from foreignexchange transactions are included in other income (loss), net and were notsignificant in any of the periods presented.

 

40

----

 

**Incometaxes**

 

Deferred tax assets andliabilities are recognized for the expected future tax consequences of eventsthat have been included in the financial statements or tax returns.  Under this method, deferred tax assets andliabilities are determined based on temporary differences between the financialstatement and tax bases of assets and liabilities using enacted tax rates ineffect for the year in which the differences are expected to reverse.  A valuation allowance is recorded to reducedeferred tax assets to an amount whose realization is more likely than not.

 

**Advertisingexpense**

 

Advertising costs areincluded in sales, general and administrative expenses and are expensed asincurred.  Advertising expense totaled$18,000,  $105,000 and $61,000 for theyears ended March 31, 2003, 2002 and 2001, respectively.

 

**Stock-basedcompensation**

 

The Company accounts forits employee stock option plans using the intrinsic value method described inAccounting Principles Board (“APB”) Opinion No. 25, “Accounting for StockIssued to Employees” and related interpretations.  Under APB Opinion No. 25, deferred stock compensation isrecorded for the difference, if any, between an option’s exercise price and thefair value of the underlying common stock on the grant date of the option.  As permitted by SFAS No. 123, “Accountingfor Stock-Based Compensation,” the Company has adopted the “disclosure only”alternative described in SFAS No. 123 for its employee stock plans.

 

The Company accounts forstock issued to non-employees in accordance with the provisions of SFASNo. 123 and Emerging Issues Task Force Consensus (“EITF”) No. 96-18,“Accounting for Equity Instruments that Are Issued to Other than Employees ForAcquiring, or in Conjunction with Selling, Goods or Services.”  Under SFAS No. 123 and EITFNo. 96-18, stock options and warrants issued to non-employees are accountedfor at their fair value calculated using the Black-Scholes option pricingmodel.

 

Compensation expenseresulting from employee and non-employee stock options is amortized to expenseusing an accelerated approach over the term of the options in accordance withFinancial Accounting Standards Board Interpretation (“FIN”) No. 28,“Accounting for Stock Appreciation Rights and Other Variable Stock Option orAward Plans.”

 

InDecember 2002, the FASB issued SFAS 148, “Accounting for Stock BasedCompensation - Transition and Disclosure” which provides for two additionaltransition methods for entities that voluntarily adopt the fair value method ofrecording expenses when accounting for stock based compensation.  We have chosen not to voluntarily adopt thefair value method of accounting for employee stock option grants at this time.

 

If compensation cost hadbeen determined in accordance with SFAS No.123, net loss and net loss per sharewould have been changed to the pro forma amounts indicated below:

 
|                                                                                            |   | **March 31,** | ** ** |
|-------------------------------------------------------------------------------------------------|--------|--------------------|------------|
|                                                                                            |   | **2003**           |       | **2002** | ** ** | **2001** | ** ** |
| Net loss, as reported                                                                           |   | $                  | (51,818    | ) | $ | (14,917 | ) | $ | (6,435 | ) |
| Add: Stock-based employee  compensation expense included in reported net loss                   |   | 1,047              |       | 3,547 |   | 2,369 |   |
| Deduct: total stock-based  compensation determined under fair value based method for all awards |   | (1,045             | )          | (4,944 | ) | (3,533 | ) |
| Pro forma net loss, fair value  method for all stock-based awards                               |   | $                  | (51,816    | ) | $ | (16,314 | ) | $ | (7,599 | ) |
| Basic and diluted net loss per  share:                                                          |   |               |       |   |   |   |   |
| As reported                                                                                     |   | $                  | (1.69      | ) | $ | (0.62 | ) | $ | (0.37 | ) |
| Pro forma net loss, fair value  method for all stock-based awards                               |   | $                  | (1.69      | ) | $ | (0.68 | ) | $ | (0.43 | ) |

 

**Concentrationof credit risk**

 

Financial instrumentsthat potentially subject the Company to significant concentrations of creditrisk consist principally of cash, cash equivalents and short-term investments,accounts receivable and unbilled receivables. Cash, cash equivalents and short-term investments are managed by  financial institutions that managementbelieves are credit worthy.

 

The Company performsongoing credit evaluations of its customers’ financial condition, generallyrequires no collateral from its customers and maintains allowances forpotential credit losses.

 

41

----

 

At March 31, 2003,receivables from two of the Company’s domestic customers accounted for 45% and12% of accounts receivable and unbilled receivables combined.  At March 31, 2002, receivables from theCompany’s Japanese distributor, two domestic customers and an internationalcustomer accounted for 12%, 38% and 27% of accounts receivable and unbilledreceivables combined, respectively.

 

**Accumulatedother comprehensive income (loss)**

 

Accumulated othercomprehensive income (loss) consists of gains and losses that are not recordedin the statements of operations but instead are recorded directly tostockholders’ equity.  The Company’scomponents of accumulated other comprehensive income (loss) include netunrealized gain (loss) on available-for-sale securities and the cumulativeforeign currency translation adjustment.

 

**Net lossper share**

 

Basic net loss per shareis computed by dividing the net loss for the period by the weighted averagenumber of shares of common stock outstanding during the period, less sharesoutstanding that are subject to repurchase. Diluted net loss per share is computed by dividing the net loss for theperiod by the weighted average number of shares and potential shares of commonstock outstanding during the period. The calculation of diluted net loss per share excludes shares ofpotential common stock if their effect is anti-dilutive.  Potential common stock consists of shares ofcommon stock that are incremental common shares issuable upon the exercise ofstock options and warrants, computed using the treasury stock method, andshares issuable upon conversion of the convertible debenture, computed usingthe if-converted method.  The followingtable presents the calculation of net loss per common share—basic and diluted(in thousands, except for per share data):

 
|                                                               |   | **Years  ended March 31,** | ** ** |
|--------------------------------------------------------------------|--------|---------------------------------|------------|
|                                                               |   | **2003**                        |       | **2002** | ** ** | **2001** | ** ** |
| Numerator:                                                         |   |                            |       |   |   |   |   |
| Net  loss                                                          |   | $                               | (51,818    | ) | $ | (14,917 | ) | $ | (6,435 | ) |
| Denominator:                                                       |   |                            |       |   |   |   |   |
| Weighted  average common shares outstanding—basic and diluted |   | 30,645                          |       | 24,038 |   | 17,496 |   |
| Net  loss per common share—basic and diluted                  |   | $                               | (1.69      | ) | $ | (0.62 | ) | $ | (0.37 | ) |

 

The total number ofshares excluded from the calculation of diluted net loss per share are detailedin the table below (in thousands):

 
|                                                       |   | **March 31,** | ** ** |
|------------------------------------------------------------|--------|--------------------|------------|
|                                                       |   | **2003**           |       | **2002** | ** ** | **2001** | ** ** |
| Outstanding  stock options                                 |   | 1,136              |       | 7,782 |   | 9,128 |   |
| Convertible  debenture (Note 7)                            |   | 1,032              |       | 1,032 |   | 1,032 |   |
| Shares  issuable under warrants                            |   | 138                |       | 138 |   | 175 |   |
| Contingent  shares issuable to former Covalar stockholders |   | —             |       | 600 |   | — |   |
| Total                                                      |   | 2,306              |       | 9,552 |   | 10,335 |   |

 

**RECENTACCOUNTING PRONOUNCEMENTS**

 

InNovember 2002, the Financial Accounting Standards Board (“FASB”) issuedFIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees,Including Indirect Guarantees of Indebtedness of Others.”  FIN 45 requiresa guarantor to recognize a liability for obligations it has undertaken inrelation to the issuance of a guarantee. It requires that the liability be recorded at fair value on the datethat the guarantee is issued.  It alsorequires a guarantor to provide additional disclosures regarding guarantees,including the nature of the guarantee, the maximum potential amount of futurepayments under the guarantee, the carrying amount of the liability, if any, forthe guarantor’s obligations under the guarantee, and the nature and extent ofany recourse provisions or available collateral that would enable the guarantorto recover the amounts paid under the guarantee.  The disclosure requirements under FIN 45 are effective for theinterim and annual periods ending after December 15, 2002.  The recognition and measurement provisionsunder FIN 45 are effective for guarantees issued or modified afterDecember 31, 2002.  The adoption ofFIN 45 did not

 

42

----

 

have a material impact upon the Company’s financial position, cashflows or results of operations.

 

InJanuary 2003, the FASB issued FIN No. 46, “Consolidation of VariableInterest Entities, an Interpretation of ARB No. 51”(“FIN 46”).  FIN 46 requires certain variable interestentities to be consolidated by the primary beneficiary of the entity if theequity investors in the entity do not have the characteristics of a controllingfinancial interest or do not have sufficient equity at risk for the entity tofinance its activities without additional subordinated financial support fromother parties.  FIN 46 is effectiveimmediately for all new variable interest entities created or acquired afterJanuary 31, 2003.  For variableinterest entities created or acquired prior to February 1, 2003, the provisionsof FIN 46 must be applied for the first interim or annual period beginningafter June 15, 2003.  The Companydoes not believe that the adoption of this standard will have a material effecton its financial position or results of operations.

 

In April 2003,the FASB issued SFAS 149, “Amendment of Statement 133 on Derivative Instrumentsand Hedging Activities,” which amends SFAS 133 for certain decisions made bythe FASB Derivatives Implementation Group.  In particular, SFAS 149 (1)clarifies under what circumstances a contract with an initial net investmentmeets the characteristic of a derivative, (2) clarifies when a derivativecontains a financing component, (3) amends the definition of an underlying toconform it to language used in FIN 45, and (4) amends certain other existingpronouncements.  This Statement is effective for contracts entered into ormodified after June 30, 2003, and for hedging relationships designatedafter June 30, 2003.  In addition,most provisions of SFAS 149 are to be applied prospectively.  The Company does not expect the adoption ofSFAS 149 to have a material impact upon its financial position, cash flows orresults of operations.

 

InMay 2003, the FASB issued SFAS 150, “Accounting for Certain FinancialInstruments with Characteristics of both Liabilities and Equity.”  SFAS150 establishes standards for how an issuer classifies and measures certainfinancial instruments with characteristics of both liabilities and equity.  It requires that an issuer classify afinancial instrument that is within its scope as a liability (or an asset insome circumstances).  SFAS 150 is effective for financial instrumentsentered into or modified after May 31, 2003, and otherwise is effective atthe beginning of the first interim period beginning after June 15,2003.  It is to be implemented byreporting the cumulative effect of a change in an accounting principle forfinancial instruments created before the issuance date of the Statement andstill existing at the beginning of the interim period of adoption.  Restatement is not permitted.  The Company does not expect the adoption ofSFAS 150 to have a material impact upon its financial position, cash flows orresults of operations.

 

**NOTE3.  BUSINESS COMBINATIONS**

 

**Tyecin-InnotechCorporation**

 

On October 4, 2001,the Company acquired all of the outstanding shares of Tyecin-InnotechCorporation (“Tyecin”), a corporation organized under the laws of Japan, thatwas engaged in the business of providing software support and services tomanufacturing companies for approximately $789,000 in cash.  The transaction was accounted for using thepurchase method of accounting.  Thepurchase price was allocated to tangible net assets acquired of approximately$708,000 and goodwill of approximately $81,000.  The acquisition provides the Company with an experiencedworkforce in Japan and will help support existing and future customers inJapan.

 

**FabCentric,Inc.**

 

In January andMarch 2001, in conjunction with the potential acquisition ofFabCentric Inc. (“FabCentric”), the Company loaned $750,000 to FabCentricin exchange for unsecured notes receivable bearing interest at the rate of 8%per annum.

 

The Company resumeddiscussions and on December 5, 2001, the Company acquired FabCentric, acompany engaged in the business of software development and sales tosemiconductor companies.  In connectionwith the acquisition, the Company issued 703,355 shares of common stock andassumed options to acquire 23,231 shares of its common stock.  The transaction was accounted for using thepurchase method of accounting.  Theacquisition will give the Company access to FabCentric’s customer base,complementary technology and a highly skilled workforce.

 

The purchase price issummarized as follows (in thousands):

 
| Fair  market value of common stock    |   | $   | 8,032  |   |
|---------------------------------------|--------|-----|--------|--------|
| Fair  market value of options assumed |   | 223 |   |
| Acquisition  related costs            |   | 250 |   |
| Total  consideration                  |   | $   | 8,505  |   |

 

43

----

 

The purchase priceallocation is as follows (in thousands):

 
| Tangible  assets acquired   |   | $      | 685    |   |
|-----------------------------|--------|--------|--------|--------|
| Intangible  assets acquired |   | 660    |   |
| Deferred  compensation      |   | 106    |   |
| Goodwill                    |   | 10,750 |   |
| Liabilities  assumed        |   | (3,696 | )      |
| Total                       |   | $      | 8,505  |   |

 

Deferred compensationrecorded in connection with the acquisition will be amortized over theremaining term of the options assumed, generally less than four years.  Intangible assets acquired will be amortizedover their estimated useful life of six months to three years (weighted-averageuseful life of 2.36 years).

 

**CovalarTechnologies Group, Inc.**

 

On February 15,2002, the Company acquired Covalar Technologies Group, Inc. (“Covalar”), adesign yield optimization and productivity improvement software company whichoffers solutions to semiconductor companies which include testing, analysis andadvanced circuit design.  In connectionwith the acquisition, the Company issued 1,481,566 shares of its common stock,paid $10.0 million in cash and assumed options to purchase 418,434 sharesof the Company’s common stock.  TheCompany had reserved 600,000 shares of its common stock to be issued to Covalarshareholders if certain revenue targets were achieved in the twelve monthsfollowing the closing of the acquisition on February 15, 2002.  The revenue targets were not met during theearn-out period and accordingly the reserved shares were unreserved.  The transaction was accounted for using thepurchase method of accounting.  Theacquisition of Covalar will allow the Company to offer its customers a completeend-to-end software and related services solution from design throughmanufacturing, gain a broader customer base and relationships, and provide theCompany with a highly skilled workforce.

 

The purchase price issummarized as follows (in thousands):

 
| Cash                                  |   | $      | 10,000 |   |
|---------------------------------------|--------|--------|--------|--------|
| Fair  market value of common stock    |   | 20,531 |   |
| Fair  market value of options assumed |   | 4,806  |   |
| Acquisition  related costs            |   | 675    |   |
| Total                                 |   | $      | 36,012 |   |

 

The allocation of thepurchase price to assets acquired and liabilities assumed is as follows (inthousands):

 
| Tangible  assets acquired   |   | $      | 3,882  |   |
|-----------------------------|--------|--------|--------|--------|
| Intangible  assets acquired |   | 2,330  |   |
| Deferred  compensation      |   | 1,921  |   |
| Goodwill                    |   | 31,209 |   |
| Liabilities  assumed        |   | (2,187 | )      |
| Unfavorable  leases assumed |   | (1,143 | )      |
| Total                       |   | $      | 36,012 |   |

 

Deferred compensationrecorded in connection with the merger will be amortized over the remainingterm of the options assumed generally less than four years.  Acquired intangible assets will be amortizedover their estimated useful life of six months to three years (weighted-averageuseful life of 2.85 years).

 

**Defect& Yield Management, Inc.**

 

On April 10, 2002,the Company acquired all of the outstanding common and preferred shares ofDefect & Yield Management, Inc. (“DYM”), a defect analysis and yieldoptimization software company offering software solutions to semiconductor companies.  The results of DYM have been included in theconsolidated financial statements from April 10, 2002, the acquisitiondate.  In connection with theacquisition, the Company issued 967,260 shares of its common stock, paid $2.0million in cash and assumed options to purchase up to 82,740 shares of theCompany’s common stock.  The Company mayalso be required to issue up to $5.0 million of common stock to the former DYMshareholders if a certain number of customer maintenance contracts with thecurrent DYM installed base of customers are

 

44

----

 

achieved in the one-yearperiod ending April 9, 2003.  Fiveof these contracts were entered into during the earn-out period entitling theformer DYM shareholders to an additional 396,826 shares in the aggregate,valued at $50,000, which will be issued subsequent to March 31, 2003.  The transaction has been accounted for usingthe purchase method of accounting.  Theacquisition of DYM provides the Company access to an installed customer base inover 70 facilities worldwide.

 

The aggregate purchaseprice was approximately $17.1 million, is summarized as follows (in thousands):

 
| Cash                                  |   | $      | 2,000  |   |
|---------------------------------------|--------|--------|--------|--------|
| Fair  market value of common stock    |   | 13,474 |   |
| Fair  market value of options assumed |   | 704    |   |
| Acquisition  related costs            |   | 943    |   |
| Total                                 |   | $      | 17,121 |   |

 

The allocation of thepurchase price to assets acquired and liabilities assumed is as follows (inthousands):

 
| Tangible  assets acquired   |   | $      | 665    |   |
|-----------------------------|--------|--------|--------|--------|
| Intangible  assets acquired |   | 1,300  |   |
| Deferred  compensation      |   | 38     |   |
| Goodwill                    |   | 16,545 |   |
| Liabilities  assumed        |   | (1,427 | )      |
| Total                       |   | $      | 17,121 |   |

 

The Company has includedthe results of operations of the acquired entities beginning as of therespective acquisition dates.

 

The following unauditedpro forma revenues, net loss and net loss per share data for the years endedMarch 31, 2003 and 2002 are based on the respective historical financialstatements of the Company, Tyecin, FabCentric, Covalar and DYM.  The pro forma data reflects the consolidatedresults of operations as if the mergers with Tyecin, FabCentric, Covalar andDYM occurred at the beginning of each of the years indicated and includes theamortization of intangible assets and deferred compensation.  The pro forma financial data presented are notnecessarily indicative of the Company’s results of operations that might haveoccurred had the transactions been completed at the beginning of the yearsspecified, and do not purport to represent what the Company’s consolidatedresults of operations might be for any future period.

 

**(UnauditedPro Forma)**

**(inthousands except for per share data)**

 
|                                                               |   | **Years  Ended March 31,** | ** ** |
|--------------------------------------------------------------------|--------|---------------------------------|------------|
|                                                               |   | **2003**                        |       | **2002** | ** ** |
|                                                               |   |                            | ** ** |   | ** ** |
| Revenues                                                           |   | $                               | 15,711     |   | $ | 12,105 |   |
| Net  loss                                                          |   | $                               | (51,824    | ) | $ | (23,372 | ) |
| Net  loss per share—basic and diluted                         |   | $                               | (1.69      | ) | $ | (0.87 | ) |
| Shares  used in computing per share amounts—basic and diluted |   | 30,671                          |       | 26,788 |   |

 

**NOTE4.  GOODWILL IMPAIRMENT**

 

The Companyoperates within one reporting unit as defined by SFAS 142.  Therefore, goodwill is not allocated withinthe Company as it is considered enterprise goodwill.  During the fourth quarter of the year ended March 31, 2003,the Company determined that there were indicators of impairment to the carryingvalue of goodwill, principally as a result of reducing its revenue forecastgiven the current economic environment in the semiconductor industry.  The Company performed its annual impairmentreview for goodwill and other intangible assets and recorded a charge of $30.6million relating to goodwill, which is recorded as a component of operatingincome in the accompanying consolidated statement of operations.  The amount of goodwill impairment was basedon the fair value of the Company, representing its only reporting unitutilizing a valuation based on both the income and market approach.  Future goodwill impairment tests may resultin charges to earnings if the Company determines that goodwill has beenimpaired.

 

45

----

 

**NOTE 5.  PROPERTY AND EQUIPMENT**

 

Property and equipmentconsists of the following (in thousands):

 
|                            |   | **March 31,** | ** ** |
|---------------------------------|--------|--------------------|------------|
|                            |   | **2003**           |       | **2002** | ** ** |
|                            |   |               | ** ** |   | ** ** |
| Computers,  equipment and other |   | $                  | 3,213      |   | $ | 2,221 |   |
| Furniture  and fixtures         |   | 530                |       | 782 |   |
| Leasehold  improvements         |   | 622                |       | 603 |   |
| Leased  equipment and furniture |   | 905                |       | 770 |   |
|                            |   | 5,270              |       | 4,376 |   |
| Less:  Accumulated depreciation |   | (2,954             | )          | (1,229 | ) |
|                            |   | $                  | 2,316      |   | $ | 3,147 |   |

 

At March 31, 2003and 2002, accumulated depreciation on the leased property and equipment was$504,000 and $292,000, respectively.

 

**NOTE6.  ACCRUED LIABILITIES**

 

Accrued liabilitiesconsist of the following (in thousands):

 
|                                                                           |   | **March 31,** | ** ** |
|--------------------------------------------------------------------------------|--------|--------------------|------------|
|                                                                           |   | **2003**           |       | **2002** | ** ** |
|                                                                           |   |               | ** ** |   | ** ** |
| Payroll  and related expenses                                                  |   | $                  | 819        |   | $ | 588 |   |
| Professional  fees                                                             |   | 563                |       | 638 |   |
| Other  accrued expenses                                                        |   | 1,037              |       | 1,494 |   |
| Amounts  received from HPL’s former Chief Executive Officer (see Note 10) |   | 4,335              |       | 3,035 |   |
|                                                                           |   | $                  | 6,754      |   | $ | 5,755 |   |

 

**NOTE7.  CONVERTIBLE DEBENTURE**

 

In February 2000,the Company issued a $1.5 million convertible debenture against which allof HPLI’s assets have been pledged as security.  The debenture bore interest at the rate of 8% per annum.  This debenture was convertible at any timeat the option of the holder to common stock of the Company, at a conversionprice of $1.45 per share.  Thedebenture, if not converted, was due on February 15, 2005.  The note provided that if the Companycompletes its initial public offering, the holder had the right to demandrepayment.

 

At March 31, 2003,the Company was not in compliance with certain non-financial covenants of thedebenture.  As a result, the debentureholder could have declared all outstanding obligations under the debentureimmediately due and payable.  Thedebenture was repaid in full on May 13, 2003, along with accrued interestof $164,000.

 

**NOTE8.  COMMITMENTS**

 

The Company leases itsfacilities under operating lease agreements that expire at various datesthrough March 15, 2007.  Rentexpense for all operating leases for the years ended March 31, 2003, 2002and 2001 was $1.5 million, $652,000 and $609,000, respectively.

 

Minimum future leasepayments under non-cancelable operating leases and future minimum paymentsunder capital lease agreements at March 31, 2003 are included in the tablebelow (in thousands):

 

46

----

 
| **Year  ending March 31,**                     |   | **Capital  leases** | ** ** | **Operating  leases** | ** ** |
|-----------------------------------------------------|--------|---------------------|------------|-----------------------|------------|
|                                                |   |                |       |                  |       |
| 2004                                                |   | $                   | 360        |                  | $          | 1,366 |   |
| 2005                                                |   | 98                  |       | 1,266                 |       |
| 2006                                                |   | 27                  |       | 937                   |       |
| 2007                                                |   | 13                  |       | 11                    |       |
|                                                |   | 498                 |       | $                     | 3,580      |   |
| Less:  Amount representing interest (2.9% to 22.1%) |   | 30                  |       |                  |       |
| Present  value of capital lease obligations         |   | 468                 |       |                  |       |
| Less:  Current portion                              |   | 338                 |       |                  |       |
| Non-current  portion                                |   | $                   | 130        |                  |       |   |

 

Guarantees and Indemnifications

 

In November 2002, the FASB issued Interpretation No. 45(“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees,Including Indirect Guarantees of Indebtedness of Others.”  FIN 45 requires that a guarantor recognize,at the inception of a guarantee, a liability for the fair value of theobligation undertaken in issuing the guarantee or indemnification.  FIN 45 also requires additional disclosureby a guarantor in its interim and annual financial statements about itsobligations under certain guarantees and indemnifications.  The initial recognition and measurementprovisions of FIN 45 are applicable for guarantees issued or modified afterDecember 31, 2002.  The disclosurerequirements of FIN 45 are effective for financial statements of interim orannual periods ending after December 15, 2002.  The Company adopted the recognition and measurement provisions ofFIN 45 prospectively to guarantees issued or modified after December 31,2002, and the adoption did not have a material impact on its financial positionor results of operations.  The followingis a summary of the agreements that the Company has determined are within thescope of FIN 45:

 

The Company’s amended and restated Certificate ofIncorporation (the “Certificate”) provides that, except to the extentprohibited by the Delaware General Corporation Law (the “DGCL”), the Company’sdirectors and officers shall not be personally liable to the Company or itsstockholders for monetary damages for any breach of fiduciary duty as adirector or officer.  The Certificateeliminates the personal liability of directors and officers to the fullestextent permitted by the DGCL and, together with the Company’s Bylaws (the“Bylaws”), provides that the Company shall fully indemnify any person who wasor is a party or is threatened to be made a party to any threatened, pending orcompleted action, suit or proceeding (whether civil, criminal, administrativeor investigative) by reason of the fact that such person is or was a directoror officer of the Company, or is or was serving at the request of the Companyas a director or officer of another corporation, partnership, joint venture,trust, employee benefit plan or other enterprise, against expenses (includingattorneys’ fees), judgments, fines and amounts paid in settlement actually andreasonably incurred by such person in connection with such action, suit orproceeding (“Expenses”). Additionally, the Company has entered intoindemnification agreements with its directors and officers pursuant to whichthe Company is required to indemnify its officers and directors and advance anyand all Expenses.  These agreements haveno term and the maximum potential amount of future payments HPL could berequired to make under these indemnification agreements is unlimited.  Except as noted below, no claims forindemnification have been made against the Company.

 

To limit the Company’s exposure to indemnificationclaims by directors and officers, the Company obtained in July 2001 fourdirectors and officers liability insurance policies with aggregate limits of$20 million.  The validity of thesepolicies is being contested with respect to coverage for the Company and Mr.Lepejian, the Company’s former President and Chief Executive Officer.  In February 2003, the Company obtainedtwo new directors and officers’ liability insurance policies with aggregatepolicy limits of $10 million.  These twonew policies exclude claims relating to prior acts, including the acts givingrise to the previous restatement of the Company’s financial statements.

 

The Company’s directors and officers have been namedas defendants in the class action and derivative litigation described in Note16.  Furthermore, one or more of theCompany’s former officers have given testimony in connection withinvestigations being conducted by the SEC and the Department of Justice.  Except for our former Chief FinancialOfficer, who has requested advancement of expenses in connection with herdeposition before the SEC, no other directors or former officers have requestedindemnification from the Company. However, once a lead plaintiffs’ lawyer is designated in the classaction litigation and a consolidated amended complaint is filed, we expect allof our directors, officers and former officers will demand indemnification andadvancement of expenses under their respective indemnification agreements.  Because we are not currently able toevaluate the likelihood of an

 

47

----

 

unfavorable outcome or an estimate of the amount or range of potentialloss, we cannot determine the estimated fair value of these obligations and,accordingly, the Company has recorded no liability for these obligations atMarch 31, 2003.

 

The Company is also obligated to provideindemnification to the underwriters in its initial public offering pursuant toan Underwriting Agreement, dated July 30, 2001, by and among the Company,UBS Warburg LLC, Dain Rauscher Wessels, Wit SoundView Corporation and AdamsHarkness & Hill, Inc., as representatives of the several underwriters (the“Underwriting Agreement”).  InOctober 2002, UBS Warburg was named as a defendant in a lawsuit relatingto the Company’s issuance of stock in the acquisition of Covalar TechnologiesGroup, Inc.  Pursuant to theUnderwriting Agreement, UBS Warburg demanded that the Company indemnify it inconnection with this matter and advance its litigation expenses.  While the Company had obtained insurance tocover its obligation to indemnify andadvance UBS Warburg’s expenses, the insurer has not yet taken a positionas to whether such obligations are covered under the policy.  If it doesnot contest coverage, however, coverage for these indemnification obligationsis subject to a sub-limit of $1,000,000. Because we are not currently able to evaluate the likelihood of anunfavorable outcome or an estimate of the amount or range of potential loss, wecannot determine the estimated fair value of these obligations and, according,the Company has recorded no liability for these obligations at March 31,2003.

 

The Companyincludes standard intellectual property indemnification clauses in its softwarelicense agreements.  Pursuant to theseprovisions, HPL holds harmless and agrees to defend the indemnified party,generally HPL’s business partners and customers, in connection with certainpatent, copyright or trade secret infringement claims by third parties withrespect to HPL’s products.  The term ofthe indemnification provisions is generally for the term of the licenseagreement and the applicable statute of limitations.  The Company believes the estimated fair value of theseobligations is minimal.  HPL hasrecorded no liabilities for these obligations as of March 31, 2003.

 

The Companygenerally warrants that its software products will perform in all materialrespects in accordance with its standard published specifications in effect atthe time of delivery of the licensed products to the customer for a period ofninety days following delivery.  Ifnecessary, HPL would provide for the estimated cost of product warranties basedon specific warranty claims and claim history. The Company has incurred no significant expense under its productwarranties to date and, as a result, the Company believes the estimated fairvalue of these warranties is minimal. The Company has recorded no liabilities for these warranties as ofMarch 31, 2003.

 

**NOTE9.  CAPITAL STOCK**

 

**Commonstock**

 

The Company has reservedthe following shares of authorized but unissued common stock for futureissuance (in thousands):

 
|                                                      |   | **March 31,** | ** ** |
|-----------------------------------------------------------|--------|--------------------|------------|
|                                                      |   | **2003**           |       | **2002** | ** ** |
| Conversion  of outstanding convertible debenture (Note 7) |   | 1,032              |       | 1,032 |   |
| Exercise  of warrants                                     |   | 138                |       | 138 |   |
| Stock  option plans                                       |   | 10,971             |       | 11,847 |   |
| Employee  stock purchase plans                            |   | 797                |       | 647 |   |
|                                                      |   | 12,938             |       | 13,664 |   |

 

**Warrants**

 

The Company hasoutstanding at March 31, 2003 and 2002 warrants to acquire 137,652 sharesof HPL common stock at an exercise price of $1.45 per share.  These warrants expire in August 2004.

 

**Stockoption plans**

 

In May 2001, theCompany adopted its 2001 Equity Incentive Plan (the “Plan”) and reserved atotal of 12,750,000 shares of its common stock for issuance to directors,employees and consultants under the Plan. Options granted under the Plan expire 10 years from the date ofgrant and generally vest over a four-year period.  Under the Plan, eligible employees and consultants who own lessthan ten percent of voting power of all classes of stock, can receive optionsto purchase shares of the Company’s common stock at a price no less than 100%and 85% of the fair value on the grant date for incentive stock options andnon-statutory stock options, respectively. Those eligible employees and consultants who own more than ten percentof voting power of all classes of stock can receive options to purchase sharesof the Company’s common stock at a price no less than 110% of the fair value onthe grant date for incentive stock options and nonqualified stock options.

 

48

----

 

Prior to the adoption ofthe Plan, the Company’s subsidiary, HPLI adopted the 1998 Stock Option Plan(the “1998 Plan”).  All optionsoutstanding under the 1998 Plan were exchanged for substitute options grantedunder the Plan in connection with HPLI’s merger with the Company.  No new options have been granted under the1998 Plan since that time.  HPLI hasalso granted a stock option to an employee to purchase up to 1,632,000 sharesof HPLI common stock at an exercise price of $0.02 per share and were fullyvested.  This option was exercised inthe year ended March 31, 2002.

 

In connection with theacquisitions of FabCentric and Covalar in the year ended March 31, 2002,the Company assumed the options granted under the FabCentric and Covalar optionplans totaling 441,665 HPL options. These options have similar terms as the Company’s Plan.

 

In connectionwith the acquisition of DYM in the year ended March 31, 2003, the Companyassumed the options granted under the DYM option plan totaling 82,740 HPLoptions.  These options have similarterms as the Company’s Plan.

 

The following tablesummarizes information with respect to stock option activity:

 
|                                   |   | **2003**                 | ** ** | **2002**                               | ** ** | **2001**                 | ** ** |
|----------------------------------------|--------|--------------------------|------------|----------------------------------------|------------|--------------------------|------------|
| **Years  ended March 31,**        |   | **Shares  (000’s)** |       | **Weighted  Average  Exercise  Price** | ** ** | **Shares  (000’s)** |       | **Weighted  Average  Exercise  Price** | ** ** | **Shares  (000’s)** |   | **Weighted  Average  Exercise  Price** | ** ** |
|                                   |   |                     |       |                                   |       |                     |       |   |   |   |   |   |   |
| Outstanding  at beginning of year      |   | 8,650                    |       | $                                      | 2.18       |                     | 7,431      |   | $ | 0.22 |   | 8,029 |   | $ | 0.11 |   |
| Granted  and assumed upon acquisitions |   | 238                      |       | 10.40                                  |       | 2,222                    |       | 7.81 |   | 558 |   | 1.56 |   |
| Exercised                              |   | (443                     | )          | 0.38                                   |       | (759                     | )          | 0.15 |   | (586 | ) | 0.08 |   |
| Forfeited                              |   | (6,955                   | )          | 2.10                                   |       | (244                     | )          | 0.10 |   | (570 | ) | 0.09 |   |
| Outstanding  at end of year            |   | 1,490                    |       | 4.40                                   |       | 8,650                    |       | 2.18 |   | 7,431 |   | 0.22 |   |
| Options  exercisable at end of year    |   | 873                      |       |                                   |       | 3,195                    |       |   |   | 3,110 |   |   |   |
| Shares available for grant             |   | 9,997                    |       |                                   |       |                     |       |   |   |   |   |   |   |
|                                        |        |                          |            |                                        |            |                          |            |  |  |  |  |  |  |  |  |  |

 

The following tablesummarizes information regarding options outstanding and exercisable as ofMarch 31, 2003:

 
|                          |   | **Options  Outstanding**              | ** ** | **Options  Exercisable**                                    | ** ** |
|-------------------------------|--------|---------------------------------------|------------|-------------------------------------------------------------|------------|
| **Range  of Exercise Prices** |   | **Number  Outstanding  (000’s)** |       | **Weighted  Average  Remaining  Contractual Life  (Years)** |       | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable  (000’s)** |   | **Weighted  Average  Exercise  Price** | ** ** |
|                          |   |                                  |       |                                                        |       |   |   |   |   |   |   |
| $0.04  — $0.04           |   | 3                                     |       | 6.67                                                        |       | $ | 0.04 |   | 3 |   | $ | 0.04 |   |
| $0.07  — $0.07           |   | 283                                   |       | 5.30                                                        |       | 0.07 |   | 283 |   | 0.07 |   |
| $0.09  — $0.29           |   | 252                                   |       | 6.55                                                        |       | 0.23 |   | 185 |   | 0.22 |   |
| $0.97  — $3.30           |   | 287                                   |       | 7.48                                                        |       | 2.73 |   | 213 |   | 2.54 |   |
| $3.45  — $6.50           |   | 279                                   |       | 8.32                                                        |       | 4.50 |   | 100 |   | 4.42 |   |
| $9.59  — $14.33          |   | 386                                   |       | 8.63                                                        |       | 11.50 |   | 89 |   | 11.97 |   |
|                          |   | 1,490                                 |       | 7.36                                                        |       | $ | 4.40 |   | 873 |   | $ | 2.42 |   |
|                               |        |                                       |            |                                                             |            |  |  |  |  |  |  |  |  |  |

 

Pro forma informationregarding net loss per share is required by SFAS No. 123, as if theCompany had accounted for its employee stock options under the fair valuemethod of SFAS No. 123.  Theweighted average fair value of options granted for the years endedMarch 31, 2003, 2002 and 2001 was $6.05, $6.73 and $3.30, respectively. The fair value of each option grant was estimated on the date of grantusing the Black-Scholes option pricing model and the following weighted averageassumptions:

 

49

----

 
|                                      |   | **Stock  Options** |       | **Employee  Stock  Purchase Plan** |       |
|-------------------------------------------|--------|--------------------|------------|------------------------------------|------------|
| **Years  ended March 31,**           |   | **2003**           | ** ** | **2002**                           | ** ** | **2001** | ** ** | **2002** | ** ** |
|                                      |   |               |       |                               |       |   |   |   |   |
| Expected  volatility                      |   | 85                 | %          | 85                                 | %          | 85 | % | 85 | % |
| Weighted  average risk free interest rate |   | 3.90               | %          | 3.96                               | %          | 6.00 | % | 3.50 | % |
| Expected  life                            |   | 5 years            |       | 5 years                            |       | 5 years |   | 0.5 years |   |
| Expected  dividend yield                  |   | —             |       | —                             |       | — |   | — |   |
|                                      |   |               |       |                               |       |   |   |   |   |

 

**Employeestock purchase plans**

 

The 2001 Employee StockOption Purchase Plan and 2001 Foreign Employee Stock Purchase Plan (the “ESPP”)were adopted by the Company’s Board of Directors on May 22, 2001.  A total of 660,000 shares of common stockmay be purchased under the ESPP. Subject to the terms of the ESPP, the number of shares of common stockreserved and available for issuance pursuant to the ESPP will automaticallyincrease on March 1 of each year until and including March 1, 2011 bya number of shares equal to the lesser of (i) 150,000, (ii) onepercent of the number of shares of all classes of common stock outstanding onthat date of, or (iii) a lesser number determined by the Board ofDirectors or a committee appointed by the Board of Directors.  Qualified employees can elect to have up to15 percent (30 percent for the Company’s employees in the Republic ofArmenia) of their annual earnings withheld, up to $25,000 in any calendar year,or portion of a calendar year, included in an offering period.  No more than 1,500 shares can be purchasedon any purchase date by an individual employee.

 

The purchase price of thestock is 85% of the lower of the fair market value at the beginning of thetwenty-four month offering period or at the end of each six-month purchaseperiod.  For the year ended March 31,2002, 12,845 shares were issued under the ESPP.  No shares were issued in the year ended March 31, 2003 asthe Company suspended the plans on July 19, 2002.

 

**Deferredstock-based compensation**

 

In connection with thegranting of stock options to employees, the Company recorded deferredstock-based charges, net of cancellations, totaling approximately $0,$3,863,000 and $1,683,000 for the years ended March 31, 2003, 2002 and2001, respectively.  This amountrepresents the difference between the exercise price at which the stock optionswere granted and the deemed fair value of the Company’s common stock foraccounting purposes on the date of grant. In connection with the acquisitions of FabCentric and Covalar in theyear ended March 31, 2002, the Company recorded deferred compensationtotaling $2,027,000.  In connection withthe acquisitions of DYM in the year ended March 31, 2003, the Companyrecorded deferred compensation totaling $38,000.  These amounts are included as a component of stockholders’ equityand, in accordance with the method described in FIN No. 28, are beingamortized on an accelerated basis by charging to operations over the vestingperiod of the options, which is generally four years.  Accordingly, this resulted in an expense of $1,047,000,$3,547,000 and $2,369,000 for the years ended March 31, 2003, 2002 and2001, respectively.

 

**NOTE10.  RELATED PARTY**

 

During fiscal 2001, theCompany sold certain software and maintenance to a company that is affiliatedwith a director of HPL for approximately $300,000.  The Company recognized no revenue in this transaction in the 2001financial statements.  In fiscal 2002,the Company purchased certain unrelated software products from this affiliatedcompany for approximately $700,000.  TheCompany has not deployed the software purchased and therefore expensed theamount paid for such software in the period purchased in its financialstatements.  The Company recognizedapproximately  $40,000 and $8,000 inrevenue related to this affiliate in the years ended March 31, 2003 and2002, respectively, on unrelated transactions.

 

In October 2001, theCompany acquired all of the outstanding capital stock of Tyecin forapproximately $789,000 in cash.  At thetime of the acquisition, Tyecin was a 90% owned subsidiary of InnotechCorporation.  A former director of HPLwas the president of Innoquest Corporation and served on the board of directorsof Innotech Corporation, the parent corporation to Innoquest Corporation.

 

In the fourth quarter offiscal 2002 and the first quarter of fiscal 2003, the Company provided a loanto an officer of the Company for an aggregate sum of $750,000 pursuant to hisemployment arrangement.  The loan iscollateralized by a second deed of trust on the officer’s home and bears interestat a rate equal to the higher of: (i) 6%, or (ii) the short-term“applicable federal rate” (assuming semi-annual compounding) as periodicallypublished by the Internal Revenue Service. The employment arrangement provides that 20% of the principal sum andaccrued interest will be forgiven annually over a period of five years,commencing on the first anniversary of the officer’s employment, provided thathe remains continuously employed by the Company during that time.

 

50

----

 

In the third quarter offiscal 2002, the Company advanced to an employee $2,745,000 to pay withholdingtaxes due upon exercise of a stock option to purchase 1,632,000 shares of theCompany’s common stock.  The loan, whichbears interest at a rate of 5% per annum and is due on September 21, 2003,was collateralized by 1.3 million shares of Company’s common stock held bythe employee.  The principal balance of$2,745,000 and accrued interest were repaid in total during the quarter endedMarch 31, 2002.

 

During fiscal 2002, theformer Chief Executive Officer of the Company had deposited approximately$3,035,000 into the Company’s bank accounts which were purported to haverepresented proceeds from the payment of accounts receivable related tofictitious sales transactions.  An additional$1,300,000 was deposited by this individual for this purpose inJune 2002.  Although these amountsare included in accrued liabilities, the Company does not expect it will berequired to repay this sum because the Company believes it has offsettingclaims against its former Chief Executive Officer.

 

During fiscal 2002, theCompany entered into several transactions with Selastar Corporation(“Selastar”), a Japanese company owned by former employees of the Company’sJapanese subsidiary and a former member of the Company’s board ofdirectors.  These transactions includeda $5.0 million payment to Selastar. Approximately $1.2 million was returned to the Company prior to March 31,2002.  Selastar retained approximately$600,000 as reimbursement of expenses and payment for fixed assetpurchases.  In addition, the Companypaid Selastar approximately $300,000 as reimbursement of expenses in fiscal2002.  The Company also paid Selastar$600,000 of which $545,000 was paid back to the Company in fiscal 2002.

 

**NOTE11.  FAIR VALUE OF FINANCIAL INSTRUMENTS**

 

The estimated fair valueof financial instruments has been determined using available market informationand appropriate valuation methodologies. However, considerable judgment is necessarily required in interpretingmarket data to develop estimates of fair value.  Accordingly, the estimates presented herein are not necessarilyindicative of the amounts that the Company would realize in a current marketexchange.

 

Cash, cash equivalents,accounts receivable, notes receivable and accounts payable are carried at cost,which approximates their fair value because of the short maturities of theseinstruments.  The Company’s short-terminvestments are reported at fair value.

 

The following is asummary of cash, cash equivalents and short-term investments (in thousands):

 
|                       |   | **March 31,  2003** | ** ** |
|----------------------------|--------|--------------------------|------------|
|                       |   | **Amortized  Cost**      |       | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  (Losses)** |   | **Estimated  Fair Value** | ** ** |
|                       |   |                     | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Checking  and savings      |   | $                        | 567        |   | $ | — |   | $ | — |   | $ | 567 |   |
| Money  market funds        |   | 10,914                   |       | — |   | — |   | 10,914 |   |
| Commercial  paper          |   | 5,870                    |       | — |   | (1 | ) | 5,869 |   |
| Municipal  bonds - taxable |   | 1,145                    |       | — |   | — |   | 1,145 |   |
| Corporate  debt securities |   | 1,713                    |       | 1 |   | 9 |   | 1,723 |   |
| US  Government agencies    |   | 1,512                    |       | 11 |   | — |   | 1,523 |   |
|                       |   | $                        | 21,721     |   | $ | 12 |   | $ | 8 |   | $ | 21,741 |   |
|                       |   |                     |       |   |   |   |   |   |   |
| Included  in:              |   |                     |       |   |   |   |   |   |   |
| Cash  and cash equivalents |   |                     |       |   |   |   |   | $ | 17,350 |   |
| Short-term  investments    |   |                     |       |   |   |   |   | 4,391 |   |
|                       |   |                     |       |   |   |   |   | $ | 21,741 |   |

 

51

----

 
|                       |   | **March 31,  2002** | ** ** |
|----------------------------|--------|--------------------------|------------|
|                       |   | **Amortized  Cost**      |       | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  (Losses)** |   | **Estimated  Fair Value** | ** ** |
|                       |   |                     | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Checking  and savings      |   | $                        | 4,563      |   | $ | — |   | $ | — |   | $ | 4,563 |   |
| Money  market funds        |   | 14,719                   |       | — |   | — |   | 14,719 |   |
| Commercial  paper          |   | 4,260                    |       | 1 |   | — |   | 4,261 |   |
| Corporate  debt securities |   | 5,549                    |       | 1 |   | (6 | ) | 5,544 |   |
| US  Government agencies    |   | 18,067                   |       | — |   | (45 | ) | 18,022 |   |
|                       |   | $                        | 47,158     |   | $ | 2 |   | $ | (51 | ) | $ | 47,109 |   |
|                       |   |                     |       |   |   |   |   |   |   |
| Included  in:              |   |                     |       |   |   |   |   |   |   |
| Cash  and cash equivalents |   |                     |       |   |   |   |   | $ | 32,798 |   |
| Short-term  investments    |   |                     |       |   |   |   |   | 14,311 |   |
|                       |   |                     |       |   |   |   |   | $ | 47,109 |   |

 

The estimated fair valueof the convertible debenture is as follows (in thousands) :

 
|                            |   | **March 31,  2003** | ** ** | **March 31,  2002**  | ** ** |
|---------------------------------|--------|--------------------------|------------|---------------------------|------------|
|                            |   | **Carrying  amount**     |       | **Estimated  fair value** | ** ** | **Carrying  amount** | ** ** | **Estimated  fair value** | ** ** |
| Convertible  debenture (Note 7) |   | $                        | 1,500      |                      | $          | 1,500 |   | $ | 1,500 |   | $ | 15,562 |   |
|                                 |        |                          |            |                           |            |  |  |  |  |  |  |  |  |

 

**NOTE12.  EMPLOYEE BENEFIT PLAN**

 

The Company has a 401(k)Profit Sharing Plan (the “Profit Sharing Plan”) qualified underSection 401(k) of the Internal Revenue Code of 1986.  Each eligible employee may elect tocontribute up to the maximum IRS annual deferral amount.  The Company, at the discretion of its boardof directors, may match employee contributions to the Profit Sharing Plan ormake contributions to the Profit Sharing Plan for all eligible employees.  The Company has elected not to make matchingor other contributions to the Profit Sharing Plan for the years endedMarch 31, 2003, 2002, and 2001.

 

**NOTE 13.  INCOME TAXES**

 

The Company’s deferredtax assets (liabilities) consist of the following (in thousands):

 
|                                          |   | **March 31,** | ** ** |
|-----------------------------------------------|--------|--------------------|------------|
|                                          |   | **2003**           |       | **2002** | ** ** |
| Deferred  tax assets:                         |   |               |       |   |   |
| Net  operating loss and credit carry forwards |   | $                  | 22,321     |   | $ | 10,114 |   |
| Other  accruals                               |   | 4,466              |       | 2,714 |   |
| Gross  deferred tax assets                    |   | 26,787             |       | 12,828 |   |
| Valuation  allowance                          |   | (25,811            | )          | (11,832 | ) |
| Net  deferred tax assets                      |   | $                  | 976        |   | $ | 996 |   |
|                                          |   |               |       |   |   |
| Deferred  tax liabilities:                    |   |               |       |   |   |
| Intangible  assets                            |   | (948               | )          | (996 | ) |
| Change  of accounting methods                 |   | (28                | )          | — |   |
| Net  deferred tax liabilities                 |   | $                  | (976       | ) | $ | (996 | ) |

 

Based on the availableobjective evidence, management believes it is more likely than not that the netdeferred tax assets at March 31, 2003 and 2002 will not be fullyrealizable.  Accordingly, the Companyhas applied a full valuation allowance against its net

 

52

----

 

deferred tax assets as ofMarch 31, 2003 and 2002.

 

Reconciliation of thestatutory federal income tax to the Company’s effective tax is as follows:

 
|                           |   | **Years  Ended March 31,** | ** ** |
|--------------------------------|--------|---------------------------------|------------|
|                           |   | **2003**                        |       | **2002** | ** ** | **2001** | ** ** |
|                           |   |                            | ** ** |   | ** ** |   | ** ** |
| Tax  at federal statutory rate |   | (34.0                           | )%         | (34.0 | )% | (34.0 | )% |
| State,  net of federal benefit |   | (3.8                            | )          | (5.8 | ) | (7.3 | ) |
| Other                          |   | (0.2                            | )          | (4.6 | ) | (6.1 | ) |
| Option  compensation           |   | 0.8                             |       | 9.5 |   | 12.5 |   |
| Valuation  allowance           |   | 37.2                            |       | 34.9 |   | 34.9 |   |
| Provision  for income taxes    |   | 0.0                             | %          | 0.0 | % | 0.0 | % |

 

At March 31, 2003,the Company had approximately $63.0 million of Federal and $15.0 million ofState net operating loss carryforwards available to reduce future taxableincome which will begin to expire in 2013 for Federal and 2005 for state taxpurposes, respectively.  The State ofCalifornia has suspended the utilization of tax loss carryforwards through2005.

 

The Company has researchcredit carryforwards of approximately $2.0 million and $1.4 million for Federaland state income tax purposes, respectively. If not utilized, the Federal carryforward will expire in various amountsbeginning in 2009.  The Californiacredit can be carried forward indefinitely.

 

The Internal Revenue Codelimits the use of net operating loss and tax credit carryforwards in certainsituations where changes occur in the stock ownership of a company.  In the event the Company has had a change inownership, utilization of the carryforwards could be restricted.

 

**NOTE15.  SEGMENT AND GEOGRAPHIC INFORMATION**

 

The Company hasdetermined that it has one reportable business segment: the sale of yieldoptimization software used in the design, fabrication and testing ofsemiconductors and flat panel displays. The Company has a facility in the Republic of Armenia, which has fixedassets with a net book value of $169,000 as of March 31, 2003, and$152,000 as of March 31, 2002.

 

The following is ageographic breakdown of the Company’s revenues by destination for the followingperiods (in thousands):

 
|               |   | **Years  ended March 31,** | ** ** |
|--------------------|--------|---------------------------------|------------|
|               |   | **2003**                        |       | **2002** | ** ** | **2001** | ** ** |
|               |   |                            |       |   |   |   |   |
| United  States     |   | $                               | 9,948      |   | $ | 3,181 |   | $ | 2,965 |   |
| Japan              |   | 2,820                           |       | 666 |   | 797 |   |
| France             |   | 365                             |       | 643 |   | 553 |   |
| Rest  of the world |   | 2,459                           |       | 23 |   | — |   |
|               |   | $                               | 15,592     |   | $ | 4,513 |   | $ | 4,315 |   |

 

For the year endedMarch 31, 2003, the Company derived revenue from three customers whichcomprised 29%, 17% and 15% of the Company’s total revenues, respectively.

 

For the year endedMarch 31, 2002, the Company derived revenue from four customers whichcomprised 24%, 18%, 14% and 10% of the Company’s total revenues, respectively.

 

For the year endedMarch 31, 2001, the Company derived revenue from four customers whichcomprised 19%, 18%, 12% and 12% of the Company’s total revenues, respectively.

 

**NOTE16.  CONTINGENCIES**

 

BetweenJuly 31, 2002 and November 15, 2002, fourteen class-action lawsuitshave been filed and are pending against the Company, certain current and formerofficers and/or directors of the Company, and the Company’s independentauditors (collectively, the “Defendants”) in the United States District Courtfor the Northern District of California. The lawsuits allege that the Defendants

 

53

----

 

violatedSections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5promulgated thereunder by the SEC, by making a series of materialmisrepresentations as to the financial condition of the Company during theclass period of July 31, 2001 to July 19, 2002.  Several of the lawsuits further allegeviolations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933.  The plaintiffs are generally seeking torecover compensatory damages, costs and expenses incurred, interest and suchother relief as the court may deem appropriate.  The Company expects that these lawsuits will be consolidated intoa single action in the United States District Court for the Northern Districtof California.  Motions for appointmentof a lead plaintiff are pending before the Court.

 

TheCompany is also a nominal defendant in five stockholder derivative lawsuitspending in Superior Court in the County of Santa Clara, California.  These lawsuits, which were filed betweenJuly 31, 2002 and September 30, 2002, assert derivative claims onbehalf of the Company against current and/or former officers and directors ofthe Company and the Company’s independent auditors.   The claims asserted in these lawsuits include insider trading,breach of fiduciary duties, aiding and abetting breaches of fiduciary duties,negligence and professional malpractice, negligent misrepresentation andomission, contribution and indemnification, abuse of control, grossmismanagement, unjust enrichment and breach of contract.  These lawsuits seek damages suffered by theCompany, treble damages for the sale of shares, costs and expenses of theseactions and such other relief as the court may deem appropriate.  In an order dated December 3, 2002, theCourt consolidated these actions and appointed lead plaintiff’s counsel.  The date for filing a consolidated complainthas been continued to July 14, 2003.

 

Fiveshareholders of the Company have sued in state court of the District Court ofDallas County, Texas, the Company’s independent auditors and the managingunderwriter in the Company’s initial public offering, in connection with claimsrelating to the Company’s acquisition of Covalar Technologies Group, Inc. inFebruary 2002.  The Company hasbeen named as a responsible third party in this action for purposes ofapportioning fault in jury findings; to date, no claims have been broughtagainst the Company.  Subject to a reservationof rights, the Company has accepted the underwriter’s request to indemnify theunderwriter in connection with the Company’s initial public offering and toadvance expenses in the event the underwriter becomes a party to any lawsuitarising out of the public offering. While the Company had obtained insurance to cover its obligation toindemnify and advance expenses to theunderwriter, the insurer has not yet taken a position as to whether suchobligations are covered under the policy.  If it does not contestcoverage, however, coverage for these indemnification obligations is subject toa sub-limit of $1,000,000.  This lawsuitis only in the preliminary stage and the Company’s potential liability cannotbe determined at this time.

 

Five formershareholders of FabCentric, Inc., which was acquired by the Company inDecember 2001, have sued the Company, the Company’s former President andCEO and CFO, and the Company’s independent auditors in a lawsuit pending inSuperior Court in the County of Santa Clara, California.  This lawsuit was filed on or aboutMay 22, 2003.** **Thislawsuit alleges claims for fraud, negligent misrepresentation, breach ofwarranties and covenants, breach of contract and negligence, and seeksrescission or, alternatively, damages, costs and expenses.  Because this lawsuit was only recentlyfiled, the Company has not evaluated the merits of these allegations.

 

Additionally,in April 2003, UBS PaineWebber, Inc. filed suit against the Company in theSupreme Court of the State of New York, County of New York (the “New YorkAction”) alleging tortius interference of contract and a violation of theUniform Commercial Code.  This actionrelates to the transfer of shares of HPL common stock putatively pledged to UBSPaineWebber, Inc. by Y. David Lepejian, our former President and CEO, and hisspouse and seeks, among other things, mandatory injunctive relief requiring HPLto effect the transfer of the subject stock. In May 2003, the Company filed an interpleader action in UnitedStates District Court for the Northern District relating to the New YorkAction.  Mr. Lepejian and UBSPaineWebber are currently engaged in an NASD arbitration proceeding regardingthe pledge of the shares.

 

Theaforementioned litigation matters are in the early stages.  As a result, the Company believes that noamount should be accrued for these matters under SFAS No. 5, “Accounting forContingencies,” because we are currently unable to evaluate the likelihood ofan unfavorable outcome or an estimate of the amount or range of potential loss,if any.

 

Anyresolution of the aforementioned litigation could have a material effect on theCompany’s financial position, results of operations or cash flows.  The Company is investigating informal orformal restructuring alternatives which potentially may dilute shareholderequity but could mitigate any material adverse affect on our financial positionor results of operations which might otherwise result from an unfavorableresolution of these lawsuits.

 

54

----

 

**SupplementaryFinancial Data**

**QuarterlyDat****a (Unaudited)**

 
|                                                                       |   | **For  the Quarters Ended** | ** ** |
|----------------------------------------------------------------------------|--------|-----------------------------|------------|
| **(in thousands, except per share amounts)Year ended March 31, 2002** |   | **March 31,  2002**    | ** ** | **December 31,  2001** | ** ** | **September 30  2001** | ** ** | **June 30,  2001** | ** ** |
|                                                                       |   |                        | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Revenues                                                                   |   | $                           | 2,106      |   | $ | 2,534 |   | $ | (718 | ) | $ | 591 |   |
| Gross  profit (loss)                                                       |   | 1,558                       |       | 2,359 |   | (893 | ) | 395 |   |
| Net  loss                                                                  |   | (4,401                      | )          | (2,166 | ) | (4,439 | ) | (3,911 | ) |
| Net  loss per share—basic and diluted:                                |   | $                           | (0.16      | ) | $ | (0.08 | ) | $ | (0.20 | ) | $ | (0.22 | ) |
| Shares  used in computing per share amounts—basic and diluted:        |   | 28,437                      |       | 27,015 |   | 22,674 |   | 17,836 |   |

 
|                                                                       |   | **For  the Quarters Ended** | ** ** |
|----------------------------------------------------------------------------|--------|-----------------------------|------------|
| **(in thousands, except per share amounts)Year ended March 31, 2003** |   | **March 31,  2003**    | ** ** | **December 31,    2002** | ** ** | **September 30,  2002** | ** ** | **June 30,  2002** | ** ** |
|                                                                       |   |                        | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Revenues                                                                   |   | $                           | 3,582      |   | $ | 5,248 |   | $ | 4,483 |   | $ | 2,279 |   |
| Gross  profit                                                              |   | 2,018                       |       | 3,806 |   | 3,635 |   | 1,669 |   |
| Net  loss                                                                  |   | (34,526                     | )          | (2,756 | ) | (6,886 | ) | (7,650 | ) |
| Net  loss per share—basic and diluted:                                |   | $                           | (1.12      | ) | $ | (0.09 | ) | $ | (0.22 | ) | $ | (0.25 | ) |
| Shares  used in computing per share amounts—basic and diluted:        |   | 30,796                      |       | 30,784 |   | 30,777 |   | 30,410 |   |

 

Included in the net lossfor the quarter ended March 31, 2003 is a non-cash charge of $30.6 millionrelated to the impairment of goodwill in the quarter.

 

55

----

 

**ITEM9.  CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

None.

 

56

----

 

**PARTIII****.**

 

**ITEM10.  DIRECTORS AND EXECUTIVE OFFICERS OFTHE REGISTRANT**

 

The informationconcerning our directors and executive officers required by this Item isincorporated by reference to the section in Item 1 of this Report entitled“Directors and Officers.”

 

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

 

Section 16(a)of the Securities Exchange Act of 1934 requires the Company’s officers anddirectors and persons who own more than 10% of the Company’s CommonStock (collectively, “***ReportingPersons***”) to file reports of ownership and changes in ownershipwith the SEC on a periodic basis. Reporting Persons are required by SEC regulations to furnish the Companywith copies of all Section 16(a) forms they file.  Based solely on a review of the copies of such forms provided tothe Company, we believe that with respect to the fiscal year endedMarch 31, 2003, all of the Reporting Persons complied with the applicablefiling requirements.

 

**Code of Ethics**

 

Wehave adopted a code of ethics that applies to its directors, officers andemployees.  A copy of the code of ethicsis available on our website at www.hpl.com. Any waiver to or amendments of our code of ethics will be posted to ourwebsite.

 

# **ITEM 11.  EXECUTIVE COMPENSATION**

# ** **

**Summary Compensation Table**

 

The following table sets forth certain summaryinformation concerning the compensation paid by the Company to its ChiefExecutive Officers and each executive officer of the Company for the year endedMarch 31, 2003  (hereinafterreferred to as the “***namedexecutive officers***”) for the three most recent fiscal years.

 
|                                                                                               |   |      | ** ** |    | ** ** | **Long-term  Compensation** | ** ** |                                    | ** ** |
|----------------------------------------------------------------------------------------------------|--------|-----------|------------|---------|------------|-----------------------------|------------|-----------------------------------------|------------|
| **Name and  Principal Position(s)**                                                                |   | **Year**  | ** ** |    |       |                        | ** ** | **Securities  Underlying  Options (#)** | ** ** | **All Other  Compensation** | ** ** |
| **Annual  Compensation**                                                                           |
| **Salary**                                                                                         |   | **Bonus** |
|                                                                                               |   |      |       |    |       |                        |       |                                    |       |   |   |
| Y. David Lepejian (1)                                                                              |   | 2003      |       | $       | 70,037     |                        | $          | —                                  |       | — |   | $ | 8,025 | ** ** |
| President and                                                                                      |   | 2002      |       | 174,980 |       | —                      |       | —                                  |       | 9,066 |   |
| Chief Executive Officer                                                                            |   | 2001      |       | 174,980 |       | —                      |       | —                                  |       | 7,276 |   |
|                                                                                               |   |      |       |    |       |                        |       |                                    |       |   |   |
| Thomas A. Tomasetti (2)                                                                            |   | 2003      |       | —  |       | —                      |       | —                                  |       | 229,000 |   |
| President and  Chief Executive Officer                                                             |   |      |       |    |       |                        |       |                                    |       |   |   |
|                                                                                               |   |      |       |    |       |                        |       |                                    |       |   |   |
| Michael P. Scarpelli (3)                                                                           |   | 2003      |       | 242,466 |       | 50,000                      |       | —                                  |       | 187,225 |   |
| Chief Financial  Officer,  Senior Vice President-Administration, Treasurer and Assistant Secretary |   | 2002      |       | 56,250  |       | —                      |       | 325,000                                 |       | — |   |
|                                                                                               |   |      |       |    |       |                        |       |                                    |       |   |   |
| Gene Mullinnix (4)                                                                                 |   | 2003      |       | 203,333 |       | 50,000                      |       | 29,645                                  |       | — |   |
| Senior Vice  President -  Operations                                                               |   | 2002      |       | 18,750  |       | —                      |       | 179,645                                 |       | — |   |
|                                                                                               |   |      |       |    |       |                        |       |                                    |       |   |   |
| Michael J. Field (5)                                                                               |   | 2003      |       | 15,833  |       | —                      |       | —                                  |       | 108,854 |   |
| Vice President,  General  Counsel and Secretary                                                    |   |      |       |    |       |                        |       |                                    |       |   |   |
|                                                                                                    |        |           |            |         |            |                             |            |                                         |            |  |  |  |  |  |

 

57

----

 

----

(1)          “All Other Compensation”for Mr. Lepejian consists of premiums paid by the Company for his term lifeinsurance policy.  Mr. Lepejian wasterminated as an employee and officer of the Company on July 19, 2002.

 

(2)          Mr. Tomasetti served asour interim President and Chief Executive Officer from August 2002 throughMarch 2003 pursuant to a consulting agreement between the Company and TheBrenner Group, his employer.  “All OtherCompensation” represents the consulting fees we paid to The Brenner Group.

 

(3)          Mr. Scarpelli joined theCompany in January 2002 as our Vice President of CorporateDevelopment.  In July 2002, Mr.Scarpelli was appointed Chief Financial Officer of the Company.  Mr. Scarpelli was awarded the bonus as partof an executive retention bonus arrangement. The $187,225 in “All Other Compensation” relates to the forgiveness of$150,000 in principal and $37,225 in interest on a $750,000 loan Mr. Scarpellireceived as part of his original employment agreement with the Company.  All of Mr. Scarpelli’s options granted infiscal 2002 were cancelled in fiscal 2003.

 

(4)          Mr. Mullinnix joined theCompany in February 2002 through the acquisition of Covalar.  He was promoted to an executive officer inAugust 2002.  Mr. Mullinnix wasawarded the bonus as part of an executive retention bonus arrangement.  150,000 of Mr. Mullinnix’s stock optionswere cancelled in fiscal 2003.

 

(5)          Mr. Field joined theCompany as a consultant in September 2002 and became an employee andexecutive officer in March 2003. “All Other Compensation” represents the consulting fees paid to Mr.Field prior to becoming an employee.

 

**Fiscal 2003 Stock Option Grants**

 

The Company granted nostock options in fiscal 2003 to the named executive officers.

 

**Aggregated Option Exercises in LastFiscal Year**

 

The following table sets forth certain informationwith respect to the exercise of options during the last fiscal year and thevalue of options held by the named executive officers as of the end of fiscal2003.

 

 
| **Name**                                                                      |       | **Shares  Acquired on  Exercise (#)**                                       |       | **Value  Realized ($)** |       |              |   |   |   |   |   |   | ** ** |
|-------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|-------------------------|------------|-------------------|--------|--------|--------|--------|--------|--------|------------|
| **Number of  Shares Underlying  Unexercised Options  at Fiscal Year-End (#)** |       | **Value of  Unexercised  in-the-money Options  at Fiscal Year-End (1) ($)** |
| **Exercisable**                                                               | ** ** | **Unexercisable**                                                           | ** ** | **Exercisable**         | ** ** | **Unexercisable** |
| Y. David  Lepejian                                                            |       | 50,000                                                                      |       | $                       | —     |              | — |   | — |   | $      | — |       | $ | — |   |
| Thomas A.  Tomasetti                                                          |       | —                                                                      |       | —                  |       | —            |   | — |   | — |   | — |       |
| Michael P.  Scarpelli                                                         |       | —                                                                      |       | —                  |       | —            |   | — |   | — |   | — |       |
| Gene Mullinnix                                                                |       | —                                                                      |       | —                  |       | 11,038            |   | 18,607 |   | — |   | — |       |
| Michael J. Field                                                              |       | —                                                                      |       | —                  |       | —            |   | — |   | — |   | — |       |
|                                                                               |            |                                                                             |            |                         |            |                   |        |        |        |        |        |        |            |  |  |  |

 

----

(1)                                  Thevalue of the in-the-money options represents the difference between (A) $0.15,our closing stock price on March 31, 2003 (the last trading day of fiscal2003), and (B) the respective exercise price for each option, multiplied by thenumber of shares of Common Stock underlying each respective option.

 

**Employment Arrangements**

 

In December 2001, weentered into an employment agreement, which is terminable at-will, with MichaelScarpelli, our Chief Financial Officer. This agreement provided Mr. Scarpelli with an annual base salary of$225,000, an annual bonus payable at the discretion of the board and a loanof  $750,000.  The loan bears interest at a rate equal to the higher of:(i) 6%, or (ii) the short-term

 

58

----

 

“applicable federal rate”as periodically published by the Internal Revenue Service.  The employment arrangement provides that 20%of the principal sum and accrued interest will be forgiven annually over aperiod of five years, commencing on the first anniversary of the officer’semployment, provided that he remains continuously employed by the Companyduring that time.  The agreement furtherprovides that if Mr. Scarpelli is terminated without “cause” (as defined), orthere is a “corporate transaction” (as defined), all outstanding principal andinterest on the loan will be immediately forgiven.  This agreement was subsequently amended in August 2002 toprovide Mr. Scarpelli with: 1) an increase in annual base salary to $250,000;2) a retention bonus of $100,000, payable 50% on January 18, 2003 and 50%on July 18, 2003, so long as Mr. Scarpelli remains an employee of theCompany on each respective payment date: and 3) a severance arrangement inwhich he will be entitled to a severance payment of 50% of his base annualsalary in the event he is terminated or not offered a comparable position inthe event of a “corporate transaction,” as defined.

 

In February 2002, weentered into an employment agreement, which is terminable at-will, with Gene Mullinnix,our Senior Vice President of Operations. This agreement was subsequently amended in August 2002 to provideMr. Mullinnix with: 1) an increase in annual base salary to $230,000; 2) aretention bonus of $100,000, payable 50% on January 18, 2003 and 50% onJuly 18, 2003, so long as Mr. Mullinnix remains an employee of the Companyon each respective payment date: and 3) a severance arrangement in which hewill be entitled to a severance payment of 50% of his base annual salary in theevent he is terminated or not offered a comparable position in the event of a“corporate transaction,” as defined.

 

The Company has entered into employment agreement withMr. Field.  This agreement, which isterminable at-will, provides an annual base salary of $190,000 and an annualbonus to be awarded at the discretion of the board of directors.

 

**Compensation Committee Interlocks andInsider Participation**

 

The CompensationCommittee currently consists of Messrs. Antoun and Zorian.  No member of the Compensation Committee orexecutive officer of the Company has a relationship that would constitute aninterlocking relationship with any executive officers or directors of anotherentity.

 

### **DIRECTOR COMPENSATION**

### ** **

Each non-employee director of the Company receives$10,000 annually and $500 for each meeting of the board of directors, or anycommittee of the board of directors, he attends.  In addition, each non-employee director is eligible to receive anannual option grant to purchase up to 7,500 shares of Common Stock, at an exerciseprice equal to the fair market value of the stock on the date of grant.  No stock options were granted to ourdirectors in fiscal 2003.

 

**ITEM 12.  SECURITY OWNERSHIPOF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**

 

The following table sets forth certain information, asof May 31, 2003 (unless otherwise indicated below), with respect to thebeneficial ownership of the outstanding Common Stock by: (i) each stockholderknown by the Company to be the beneficial owner of more than 5% of theoutstanding Common Stock; (ii) each director or nominee; (iii) each of thenamed executive officers; and (iv) all current executive officers and directorsas a group.  Unless otherwise indicatedbelow, each stockholder has sole voting and sole investment power with respectto all shares beneficially owned, subject to community property laws, ifapplicable.

 

59

----

 
| **Name and Address  of Beneficial Owner**†                                                               |   |                      |   |           |   |       |   |   |   |
|---------------------------------------------------------------------------------------------------------------|--------|---------------------------|--------|----------------|--------|------------|--------|--------|--------|
| **Shares  Beneficially Owned and Shares Underlying  Options Exercisable Within 60 days of May 31, 2003** |   | **Percent  of Class (1)** |
| **Shares (#)**                                                                                                |   | **Options  (#)**          |   | **Total (#)**  |   |
|                                                                                                          |   |                      |   |           |   |       |   |   |   |
| Y. David  Lepejian(2)                                                                                         |   | 10,203,128                |   | —

  |   | 10,203,128 |   | 33.1   | %      |
| 1357 Lakeshore Circle –  Bldg. #12  San Jose, CA 95131                                                   |   |                      |   |           |   |       |   |   |   |
| Lawrence Kraus                                                                                                |   | 3,924,250                 |   | —         |   | 3,924,250  |   | 12.7   | %      |
| Dr. Yervant  Zorian                                                                                           |   | 782,500                   |   | —         |   | 782,500    |   | 2.5    | %      |
| Elias Antoun                                                                                                  |   | —                    |   | 85,170         |   | 85,170     |   |   | *      |
| Michael P.  Scarpelli                                                                                         |   | —                    |   | —         |   | —     |   | — |   |
| Gene Mullinnix                                                                                                |   | —                    |   | 18,607         |   | 18,607     |   |   | *      |
| Michael J. Field                                                                                              |   | —                    |   | —         |   | —     |   | — |   |
|                                                                                                          |   |                      |   |           |   |       |   |   |   |
| All directors  and executive officers as a group (6 persons)                                                  |   | 4,706,750                 |   | 103,777        |   | 4,810,527  |   | 15.6   | %      |

 

----

†                                          Unlessindicated otherwise, the address of each beneficial owner is HPL Technologies,2033 Gateway Place, Suite 400, San Jose, California 95110.

 

*                                         Lessthan 1% of the outstanding Common Stock.

 

(1)          Applicable percentage ofownership is based on approximately 30,809,667 shares of Common Stockoutstanding as of May 31, 2003, together with applicable stock options forsuch stockholder.  Beneficial ownershipis determined in accordance with the rules of the Securities and ExchangeCommission.  Shares of common stocksubject to options currently exercisable or exercisable within 60 days ofMay 31, 2003 are deemed outstanding for computing the percentage ofownership of the person holding such stock options, but are not deemedoutstanding for computing the percentage of any other person.

 

(2)          Based on allegationsincluded in a lawsuit filed by UBS PaineWebber, Inc. against the Company, Mr.Lepejian has pledged 6,639,128 shares of common stock to UBS PaineWebber, Inc.to secure the repayment of loans in the amount of approximately $3.5million.  Mr. Lepejian and his spousehave contested the validity of the pledge in an arbitration matter before theNational Association of Securities Dealers. In addition, Mr. Lepejian has served notice of exercise of a stockoption to purchase up to 2,670,000 shares of common stock previously issued byHPLI.  The Company has refused to issuethe shares as the options were cancelled on his termination from employment.

 

**Equity Compensation Plan Information**

 

The Company maintains the2001 Equity Incentive Plan (the “***2001 Plan***”), the 2001 Employee Stock PurchasePlan (the “***ESPP***”)and the 2001 Foreign Employee Stock Purchase Plan (the “***Foreign ESPP***”),pursuant to which it may grant equity awards to eligible persons.  The following table sets forth certaininformation regarding the 2001 Plan, the ESPP and the Foreign ESPP as ofMarch 31, 2003.

 

60

----

 
| **Plan category**                                           |   | **Number of  securities to be  issued upon exercise of  outstanding options,  warrants and rights (1)** |   | **Weighted-average  exercise price of  outstanding options,  warrants and rights (1)** |   | **Number of  securities  remaining available for  future issuance under  equity compensation plans  (excluding securities  reflected in first column) (2)** |       |
|-------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                                        |   |                                                                                                    |   |                                                                                   |   |                                                                                                                                                        |       |
| Equity  compensation plans approved by security holders     |   | 1,136,040                                                                                               |   | $                                                                                      | 4.62   |                                                                                                                                                        | 10,631,857 |   |
|                                                        |   |                                                                                                    |   |                                                                                   |   |                                                                                                                                                        |       |
| Equity compensation  plans not approved by security holders |   | —                                                                                                  |   | —                                                                                 |   | —                                                                                                                                                      |       |
|                                                        |   |                                                                                                    |   |                                                                                   |   |                                                                                                                                                        |       |
| Total                                                       |   | 1,136,040                                                                                               |   | $                                                                                      | 4.62   |                                                                                                                                                        | 10,631,857 |   |

 

----

(1)                                  TheCompany has assumed certain stock option awards in connection with threeacquisitions completed through the end of fiscal 2003.  A total of 524,405 shares of Company commonstock underly the assumed options, with a weighted-average exercise price ofapproximately $4.28 per share.  Nofurther awards will be made under the plans governing the assumed awards.  Statistics regarding the assumed options arenot included in the above table.

 

(2)                                  AtMarch 31, 2003, 9,834,702 and 797,155 shares of Common Stock wereavailable for future issuance under the 2001 Plan and the ESPPs,respectively.  The ESPPs contain anevergreen provision that provides for an annual share increase on March 1of each year, until and including March 1, 2011, equal to the least of:(i) 150,000, (ii) 1% of the number of shares of Common Stock outstanding onthat date, or (iii) a lesser number determined by the administrator.

 

**ITEM13.  CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS**

 

During 2001, the Companysold certain software and maintenance to a company that is affiliated withYervant Zorian, a director of HPL, for approximately $300,000.  The Company recognized no revenue in thistransaction in the restated 2001 financial statements.  In 2002, the Company purchased certainunrelated software products from this affiliated company for approximately$700,000.  The Company has not deployedthe software purchased and therefore expensed the amount paid for such softwarein the period purchased in its restated financial statements.  The Company recognized approximately $8,000in revenue related to this affiliate in the year ended March 31, 2002 onunrelated transactions.

 

In October 2001, theCompany acquired all of the outstanding capital stock of Tyecin forapproximately $789,000 in cash.  At thetime of the acquisition, Tyecin was a 90% owned subsidiary of InnotechCorporation.  Osamu Kano, a formerdirector of HPL, was the president of Innoquest Corporation and served on theboard of directors of Innotech Corporation, the parent corporation to InnoquestCorporation.

 

In the fourth quarter offiscal 2002 and the first quarter of fiscal 2003, the Company provided a loanto Michael Scarpelli, an officer of the Company, for an aggregate sum of$750,000 pursuant to his employment arrangement.  The loan bears interest at a rate equal to the higher of:(i) 6%, or (ii) the short-term “applicable federal rate” asperiodically published by the Internal Revenue Service.  The employment arrangement provides that 20%of the principal sum and accrued interest will be forgiven annually over aperiod of five years, commencing on the first anniversary of the officer’semployment, provided that he remains continuously employed by the Companyduring that time.

 

During fiscal 2002, Y.David Lepejian, the former Chief Executive Officer of the Company, haddeposited approximately $3,035,000 into the Company’s bank accounts.  An additional $1,300,000 was deposited bythis individual in June 2002. Although this amount is included in accrued liabilities, the Companydoes not expect that it will be required to repay this sum because the Companybelieves it has offsetting claims against its former Chief Executive Officer.

 

During fiscal 2002, theCompany entered into several transactions with Selastar Corporation(“Selastar”), a Japanese company owned by former employees of the Company’sJapanese subsidiary and a former member of the Company’s board of directors,Osamu Kano.  These transactions includeda $5.0 million payment to Selastar for which approximately$3.2 million was paid to our Japanese

 

61

----

 

distributor.  Approximately $1.2 million was returnedto the Company prior to March 31, 2002. Selastar retained approximately $600,000 as reimbursement of expensesand payment for fixed asset purchases. In addition, the Company paid Selastar approximately $300,000 asreimbursement of expenses in fiscal 2002. The Company also paid Selastar $600,000 of which $545,000 was paid backto the Company.

 

**ITEM****14.  CONTROLS ANDPROCEDURES**

 

**CEO and CFO Certifications**

 

Appearingimmediately following the signature page of this Annual Report on Form 10-Kthere are certifications of the chief executive officer and the chief financialofficer.  The certifications arerequired in accordance with Section 302 of the Sarbanes-Oxley Act of 2002.  This section of the Annual Report on Form10-K contains the information concerning the controls evaluation referred to inthe Section 302 certifications and this information should be read inconjunction with the Section 302 certifications for a more completeunderstanding of the topics presented.

 

**Disclosure Controls and Internal Controls**

 

Disclosurecontrols are procedures that are designed with the objective of ensuring thatinformation required to be disclosed in our reports filed under the SecuritiesExchange Act of 1934, or the Exchange Act, such as this Annual Report on Form10-K, is recorded, processed, summarized and reported within the time periodsspecified in the SEC’s rules and forms. Disclosure controls are also designed with the objective of ensuringthat such information is accumulated and communicated to our management,including the chief executive officer and chief financial officer, asappropriate to allow timely decisions regarding required disclosure.  Internal controls are procedures which aredesigned with the objective of providing reasonable assurance that ourtransactions are properly authorized, our assets are safeguarded againstunauthorized or improper use and our transactions are properly recorded andreported, all to permit the preparation of our financial statements inconformity with generally accepted accounting principles.

 

We maintaindisclosure controls and procedures.  Inresponse to recent legislation and proposed regulations, we reviewed ourinternal control structure and our disclosure controls and procedures.  As disclosed in our Form 10-K/A filed onNovember 8, 2002, the restatement of our March 31, 2002 and 2001financial statements occurred as a result of material weaknesses in our systemof internal controls and its operation. Starting in July 2002, we took measures to strengthen and ensure compliancewith our internal controls to help prevent similar events from occurringagain.  These weaknesses have beendiscussed with our audit committee.  Theinternal controls specifically addressed by us involve our sales orderfulfillment and revenue recognition procedures, cash receipts and disbursementsprocedures and our segregation of duties. In addition, we have reviewed the qualifications and training of ourmanagement and employees and determined that they are sufficient to allow themto fulfill their assigned roles.

 

**Limitations on the Effectiveness ofControls**

 

Our management, including our Chief Executive Officerand Chief Financial Officer, does not expect that our disclosure controls orour internal controls will prevent all error and all fraud.  A control system, no matter how wellconceived and operated, can provide only reasonable, not absolute, assurancethat the objectives of the control system are met.  Further, the design of a control system must reflect the factthat there are resource constraints, and the benefits of controls must beconsidered relative to their costs. Because of the inherent limitations in all control systems, noevaluation of controls can provide absolute assurance that all control issuesand instances of fraud, if any, within HPL have been detected.  These inherent limitations include therealities that judgments in decision-making can be faulty, and that breakdownscan occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts ofsome persons, by collusion of two or more people, or by management override ofthe control.  The design of any systemof controls also is based in part upon certain assumptions about the likelihoodof future events, and there can be no assurance that any design will succeed inachieving its stated goals under all potential future conditions; over time,control may become inadequate because of changes in conditions, or the degreeof compliance with the policies or procedures may deteriorate.  Because of the inherent limitations in acost-effective control system, misstatements due to error or fraud may occurand not be detected.

 

**Scope of the Controls Evaluation**

 

Within 90 daysprior to the date of this report (the “Evaluation Date”), the Company’s ChiefExecutive Officer and Chief Financial Officer, carried out an evaluation of theeffectiveness of the Company’s disclosure controls and procedures.  The evaluation of our disclosurecontrols and our internal controls included a review of controls implemented byHPL and the effect of the controls on the information generated for use in thisAnnual Report on Form 10-K.  In thecourse of the controls evaluation, we sought to identify data errors, controlsproblems or acts of fraud and to confirm that appropriate corrective action,including process improvements, were

 

62

----

 

being undertaken.  This type ofevaluation will be done on a quarterly basis so that the conclusions concerningcontrols effectiveness can be reported in our quarterly reports on Form 10-Qand our Annual Report on Form 10-K. Our internal controls are also evaluated onan ongoing basis by our finance department. The overall goals of these various evaluation activities are to monitorour disclosure controls and our internal controls and to make modifications asnecessary; our intent in this regard is that the disclosure controls and theinternal controls will be maintained as dynamic systems that change (includingwith improvements and corrections) as conditions warrant.

 

Among othermatters, we sought in our evaluation to determine whether there were anysignificant deficiencies or material weaknesses in our internal controls, orwhether we had identified any acts of fraud involving personnel who have asignificant role in our internal controls. This information was important both for the controls evaluationgenerally and because Items 5 and 6 in the Section 302 certifications of thechief executive officer and the chief financial officer require that the chiefexecutive officer and the chief financial officer disclose that information toour board’s audit committee and to our independent auditors and to report onrelated matters in this section of the Annual Report on Form 10-K.  In the professional auditing literature,significant deficiencies are referred to as reportable conditions.  These are control issues that could have asignificant adverse effect on the ability to record, process, summarize andreport financial data in the financial statements.  A material weakness is defined in the auditing literature as aparticularly serious reportable condition where the internal control does notreduce to a relatively low level the risk that misstatements caused by error orfraud may occur in amounts that would be material in relation to the financialstatements and not be detected within a timely period by employees in thenormal course of performing their assigned functions.  We also sought to deal with other controls matters in thecontrols evaluation and, in each case if a problem was identified, weconsidered what revision, improvement, and/or correction to make in accordancewith our ongoing procedures.  Inaccordance with SEC requirements, the chief executive officer and the chieffinancial officer note that, since the date of the controls evaluation to thedate of this Annual Report on Form 10-K, there have been no significant changesin internal controls or in other factors that could significantly affectinternal controls, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

**Conclusions**

 

Based upon the controls evaluation, our ChiefExecutive Officer and our Chief Financial Officer have concluded that, subjectto the limitations noted above, our disclosure controls are effective to ensurethat material information relating to HPL is made known to management,including our Chief Executive Officer and Chief Financial Officer, particularlyduring the period when our periodic reports are being prepared, and that ourinternal controls are effective to provide reasonable assurance that ourfinancial statements are fairly presented in conformity with generally acceptedaccounting principles.  There were no significantchanges in the Company’s internal controls, or to the Company’s knowledge, inother factors that could significantly affect the Company’s disclosure controlsand procedures subsequent to the Evaluation Date.

 

**ITEM****15.  PRINCIPAL ACCOUNTANT FEES ANDSERVICES**

 

The following table presents the fees for audit and otherservices provided by our principal accounting firm, PricewaterhouseCoopers LLP,for the years ended March 31, 2003 and 2002 (in thousands):

 

 
| **Type of Fees**       |   | **2003** | ** ** | **2002** | ** ** |
|------------------------|--------|----------|------------|----------|------------|
|                   |   |     |       |     |       |
| Audit Fees (1)         |   | $        | 1,352      |     | $          | 911 |   |
| Audit-Related Fees (2) |   | 104      |       | 172      |       |
| Tax Fees (3)           |   | 126      |       | 475      |       |
| All Other Fees (4)     |   | —   |       | —   |       |
|                   |   |     |       |     |       |
| Total                  |   | $        | 1,582      |     | $          | 1,558 |   |

 

----

(1)                                  Audit Fees include professionalservices rendered by PricewaterhouseCoopers LLP, the member firms ofPricewaterhouseCoopers, and their respective affiliates (collectively,“PricewaterhouseCoopers”) for the audit of HPL’s annual financial statementsand review of financial statements or services that are normally provided inconnection with statutory and regulatory filings or engagements for that fiscalyear.

 

(2)                                  Audit-Related Fees includeassurance and related services by PricewaterhouseCoopers that are reasonablyrelated to the performance of the audit or review of HPL’s financial statementsand are not reported under paragraph (1) above.  During 2002 and 2003 the fees principally relate to the Form8-K’s filed relating to the various acquisitions. 

 

(3)                                  Tax Fees include professionalservices rendered by PricewaterhouseCoopers for tax compliance, tax advice, andtax planning.

 

63

----

 

(4)                                  All Other Fees include servicesprovided by PricewaterhouseCoopers, other than the services reported inparagraphs (1) through (3) of this section.

 

**Audit Committee’s Pre-Approval Policies and Procedures**

 

OnJune 25, 2003, our Board of Directors adopted a new Audit CommitteeCharter that, among other things, requires the Audit Committee to pre-approvethe rendering by our independent auditor of audit or permitted non-auditservices.  The Chair of the Audit Committeemay pre-approve the rendering of services on behalf of the Committee, providedthe matter is then presented to the full Committee at the next scheduledmeeting.  A copy of our Audit CommitteeCharter is filed as an exhibit to this Annual Report on Form 10-K.

 

OurAudit Committee approved the audit fees for audit of our consolidated financialstatements for the year ended March 31, 2003 prior to the commencement ofthe audit.

 

64

----

 

**PART IV**

 

**ITEM16.  EXHIBITS, FINANCIAL STATEMENTSCHEDULES, AND REPORTS ON FORM 8-K**

 

(a)                                  FinancialStatements:

 

Financial Statements forthe three years ended March 31, 2003 are included in Item 8.  All schedules are omitted because they arenot applicable or the required information is shown in the financial statementsor notes thereto.

 

(b)                                 Reportson Form 8-K:

 

The Registrant filed aCurrent Report on Form 8-K on February 12, 2003.

 

(c)                                  Exhibits:

 

The following exhibitsare incorporated by reference or filed as part of this report.

 
| **Exhibit  Number** |   | **Description**                                                                                                                                                                                                                                     |
|---------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                                                                                                                                                |
| 3.1                 |   | Amended and Restated  Certificate of Incorporation of Registrant.   (1)                                                                                                                                                                        |
|                |   |                                                                                                                                                                                                                                                |
| 3.2                 |   | Bylaws of  Registrant.  (1)                                                                                                                                                                                                                    |
|                |   |                                                                                                                                                                                                                                                |
| 4.1                 |   | Form of Common Stock  Certificate.  (1)                                                                                                                                                                                                        |
|                |   |                                                                                                                                                                                                                                                |
| 10.1                |   | 2001 Amended and  Restated Equity Incentive Plan (1)                                                                                                                                                                                                |
|                |   |                                                                                                                                                                                                                                                |
| 10.2                |   | 2001 Amended and  Restated Employee Stock Purchase Plan (1)                                                                                                                                                                                         |
|                |   |                                                                                                                                                                                                                                                |
| 10.3                |   | HPL Technologies, Inc.  2001 Foreign Subsidiary Employee Stock Purchase Plan, as amended (2)                                                                                                                                                   |
|                |   |                                                                                                                                                                                                                                                |
| 10.4                |   | Form of Officer and  Director Indemnification Agreement (1)                                                                                                                                                                                         |
|                |   |                                                                                                                                                                                                                                                |
| 10.5                |   | Employment Offer Letter  from HPL Technologies, Inc. to Michael Scarpelli, dated December 4,  2001  (3)                                                                                                                                   |
|                |   |                                                                                                                                                                                                                                                |
| 10.6                |   | Employment Amendment  Letter from HPL Technologies, Inc. to Michael Scarpelli, dated August 6,  2002.                                                                                                                                          |
|                |   |                                                                                                                                                                                                                                                |
| 10.7                |   | Employment Amendment Letter  from HPL Technologies, Inc. to Gene Mullinnix, dated August 6, 2002.                                                                                                                                              |
|                |   |                                                                                                                                                                                                                                                |
| 10.8                |   | Employment Offer Letter  from HPL Technologies, Inc. to Michael Field, dated March 1, 2003.                                                                                                                                                    |
|                |   |                                                                                                                                                                                                                                                |
| 10.9                |   | Real property lease  dated August 19, 1998 by and between Heuristic Physics Laboratories,  Inc. and Spieker Properties, L.P., (San Jose, California) (1)                                                                                       |
|                |   |                                                                                                                                                                                                                                                |
| 10.10               |   | Industrial Lease  Agreement, dated as of November 17, 2000, between Research Interchange  One L.P., a Texas Limited Partnership and Testchip Technologies, Inc., a Texas  Corporation(4)                                                       |
|                |   |                                                                                                                                                                                                                                                |
| 10.11               |   | First Amendment, dated  as of March 28, 2001, to Industrial Lease Agreement, dated as of  November 17, 2000, between Research Interchange One L.P., a Texas  Limited Partnership and Testchip Technologies, Inc., a Texas Corporation (4) |
|                |   |                                                                                                                                                                                                                                                |
| 10.12               |   | Second Amendment, dated  June 6, 2001, to Industrial Lease Agreement, dated as of  November 17, 2000, between Research Interchange One L.P., a Texas  Limited Partnership and Testchip Technologies, Inc., a Texas Corporation(4)         |
|                |   |                                                                                                                                                                                                                                                |
| 10.13               |   | Third Amendment, dated  October 1, 2001, to Industrial Lease Agreement, dated as of  November 17, 2000, between Research Interchange One L.P., a Texas  Limited Partnership and Testchip Technologies, Inc., a Texas Corporation (4)      |
|                |   |                                                                                                                                                                                                                                                |
| 10.14               |   | Lease Agreement, dated  June 1, 2000, between Jackson-Shaw Technology Center II, LTD and  Testchip Technologies, Inc (4)                                                                                                                       |
|                |   |                                                                                                                                                                                                                                                |
| 10.18               |   | Modification and  Ratification of Lease, dated October 31, 2001, between Jackson-Shaw  Technology Center II, LTD. and Testchip Technologies (4)                                                                                                |
|                |   |                                                                                                                                                                                                                                                |
| 21.1                |   | Subsidiaries of the  registrant                                                                                                                                                                                                                     |
|                |   |                                                                                                                                                                                                                                                |
| 23.1                |   | Consent of  PricewaterhouseCoopers LLP, Independent Auditors                                                                                                                                                                                        |

 

65

----

 
| **Exhibit  Number** |   | **Description**                                                          |
|---------------------|--------|--------------------------------------------------------------------------|
|                |   |                                                                     |
| 24.1                |   | Powers of  Attorney.  (Contained on Signature  Page)                |
|                |   |                                                                     |
| 99.1                |   | Certification pursuant  to section 906 of the Sarbanes-Oxley act of 2002 |

 

----

*                                         Previouslyfiled

 

(1)                                  Incorporatedby reference from our Registration Statement on Form S-1 filed with theCommission May 29, 2001, as amended (Registration No. 333-61810).

 

(2)                                  Incorporatedby reference from our Quarterly Report on Form 10-Q for the quarter endedSeptember 30, 2001.

 

(3)                                  Incorporatedby reference from our Quarterly Report on Form 10-Q for the quarter endedDecember 31, 2001.

 

(4)                                  Incorporatedby reference from our Annual Report on Form 10-K for the year endedMarch 31, 2002.

 

66

----

 

**SIGNATURE**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 

 
|                       | HPL Technologies, Inc. |
|----------------------------|------------------------|
|                       |                   |   |
|                       |                   |   |
| Dated: June 27,  2003 | By:                    | /s/ Cary D Vandenberg |
|                       |                   | Cary D. Vandenberg |
|                       |                   | President and Chief  Executive Officer |

 

**POWERSOF ATTORNEY AND SIGNATURES**

 

KNOW ALL MEN BY THESEPRESENTS, that each person whose signature appears below constitutes andappoints Cary D. Vandenberg and Michael P. Scarpelli as his true and lawfulattorney-in-fact and agent, with full power of substitution and resubstitution,for him and in his name, place and stead, in any and all capacities, to signany and all amendments to this report, and to file the same, with exhibitsthereto and other documents in connection therewith, with the SecuritiesExchange Commission, granting unto said attorney-in-fact and agent full powerand authority to do and perform each and every act and thing requisite andnecessary to be done, as fully to all intents and purposes as he might or coulddo in person, hereby ratifying and confirming all that said attorney-in-factand agent or his substitute may lawfully do or cause to be done by virtuehereof.

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the Registrant and in thecapacities and on the dates indicated.

 

 
| **Signature**             |   | **Title**                                     |   | **Date**            |
|---------------------------|--------|-----------------------------------------------|--------|---------------------|
|                      |   |                                          |   |                |
| /s/ Cary D.  Vandenberg   |   | President and Chief  Executive Officer        |   | June 27,  2003 |
| Cary D.  Vandenberg       |   | (Principal Executive  Officer)                |   |                |
|                      |   |                                          |   |                |
| /s/ Michael P.  Scarpelli |   | Chief Financial Officer                       |   | June 27,  2003 |
| Michael P.  Scarpelli     |   | (Principal Financial  and Accounting Officer) |   |                |
|                      |   |                                          |   |                |
| /s/ Elias Antoun          |   | Director                                      |   | June 27,  2003 |
| Elias Antoun              |   |                                          |   |                |
|                      |   |                                          |   |                |
| /s/ Lawrence  Kraus       |   | Director                                      |   | June 27,  2003 |
| Lawrence Kraus            |   |                                          |   |                |
|                      |   |                                          |   |                |
| /s/ Dr. Yervant  Zorian   |   | Director                                      |   | June 27,  2003 |
| Dr. Yervant  Zorian       |   |                                          |   |                |

 

67

----

 

**CERTIFICATIONS**

 

I, Cary D. Vandenberg, certifythat:

 

1.               I have reviewed this annualreport on Form 10-K of HPL Technologies, Inc.; 

 

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

 

3.               Based on my knowledge, thefinancial statements, and other financial information included in this annualreport, fairly present in all material respects the financial condition, resultsof operations and cash flows of the registrant as of, and for, the periodspresented 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 we have: 

 

(a)          designed such disclosurecontrols and procedures to ensure that material information relating to theregistrant, including its consolidated subsidiaries, is made known to us byothers within those entities, particularly during the period in which thisannual report is being prepared; 

 

(b)         evaluated the effectiveness ofthe registrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this annual report (the “Evaluation Date”); and 

 

(c)          presented in this annual reportour conclusions about the effectiveness of the disclosure controls andprocedures based on our evaluation as of the Evaluation Date; 

 

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

 

(a)          all significant deficiencies inthe design or operation of internal controls which could adversely affect theregistrant’s ability to record, process, summarize and report financial dataand have identified for the registrant’s auditors any material weaknesses ininternal controls; and 

 

(b)         any fraud, whether or notmaterial, that involves management or other employees who have a significantrole in the registrant’s internal controls; and 

 

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

 

 
| Date:  | June 27, 2003                          |   | By: | /s/  Cary D. Vandenberg |   |
|--------|----------------------------------------|--------|-----|-------------------------|--------|
|   | Cary D. Vandenberg                     |
|   | President and Chief  Executive Officer |

 

68

----

 

I, Michael P. Scarpelli, certifythat:

 

1.               I have reviewed this annual reporton Form 10-K of HPL Technologies, Inc.; 

 

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

 

3.               Based on my knowledge, thefinancial statements, and other financial information included in this annualreport, 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 maintaining disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)for the registrant and we have: 

 

(a)          designed such disclosurecontrols and procedures to ensure that material information relating to theregistrant, including its consolidated subsidiaries, is made known to us byothers within those entities, particularly during the period in which thisannual report is being prepared; 

 

(b)         evaluated the effectiveness ofthe registrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this annual report (the “Evaluation Date”); and 

 

(c)          presented in this annual reportour conclusions about the effectiveness of the disclosure controls andprocedures 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 function): 

 

(a)          all significant deficiencies inthe design or operation of internal controls which could adversely affect theregistrant’s ability to record, process, summarize and report financial dataand have identified for the registrant’s auditors any material weaknesses ininternal controls; and 

 

(b)         any fraud, whether or notmaterial, that involves management or other employees who have a significantrole in the registrant’s internal controls; and 

 

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

 

 
| Date:  | June 27, 2003                  |   | By: | /s/  Michael P. Scarpelli |   |
|--------|--------------------------------|--------|-----|---------------------------|--------|
|   | Michael P. Scarpelli           |
|   | Chief Financial  Officer  |

 

69

----

 

**EXHIBITINDEX**

 
| **Exhibit  Number** |   | **Description**                                                                                                                                                                                                                                     |
|---------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                                                                                                                                                |
| 3.1                 |   | Amended and Restated  Certificate of Incorporation of Registrant (1)                                                                                                                                                                                |
|                |   |                                                                                                                                                                                                                                                |
| 3.2                 |   | Bylaws of  Registrant  (1)                                                                                                                                                                                                                     |
|                |   |                                                                                                                                                                                                                                                |
| 4.1                 |   | Form of Common Stock  Certificate  (1)                                                                                                                                                                                                         |
|                |   |                                                                                                                                                                                                                                                |
| 10.1                |   | 2001 Amended and  Restated Equity Incentive Plan (1)                                                                                                                                                                                                |
|                |   |                                                                                                                                                                                                                                                |
| 10.2                |   | 2001 Amended and  Restated Employee Stock Purchase Plan (1)                                                                                                                                                                                         |
|                |   |                                                                                                                                                                                                                                                |
| 10.3                |   | HPL Technologies, Inc.  2001 Foreign Subsidiary Employee Stock Purchase Plan, as amended (2)                                                                                                                                                   |
|                |   |                                                                                                                                                                                                                                                |
| 10.4                |   | Form of Officer and  Director Indemnification Agreement (1)                                                                                                                                                                                         |
|                |   |                                                                                                                                                                                                                                                |
| 10.5                |   | Employment Offer Letter  from HPL Technologies, Inc. to Michael Scarpelli, dated December 4,  2001.  (3)                                                                                                                                  |
|                |   |                                                                                                                                                                                                                                                |
| 10.6                |   | Employment Amendment  Letter from HPL Technologies, Inc. to Michael Scarpelli, dated August 6,  2002                                                                                                                                           |
|                |   |                                                                                                                                                                                                                                                |
| 10.7                |   | Employment Amendment  Letter from HPL Technologies, Inc. to Gene Mullinnix, dated August 6,  2002                                                                                                                                              |
|                |   |                                                                                                                                                                                                                                                |
| 10.8                |   | Employment Offer Letter  from HPL Technologies, Inc. to Michael Field, dated March 1, 2003                                                                                                                                                     |
|                |   |                                                                                                                                                                                                                                                |
| 10.9                |   | Real property lease  dated August 19, 1998 by and between Heuristic Physics Laboratories,  Inc. and Spieker Properties, L.P., (San Jose, California) (1)                                                                                       |
|                |   |                                                                                                                                                                                                                                                |
| 10.10               |   | Industrial Lease  Agreement, dated as of November 17, 2000, between Research Interchange  One L.P., a Texas Limited Partnership and Testchip Technologies, Inc., a  Texas Corporation.(4)                                                      |
|                |   |                                                                                                                                                                                                                                                |
| 10.11               |   | First Amendment, dated  as of March 28, 2001, to Industrial Lease Agreement, dated as of  November 17, 2000, between Research Interchange One L.P., a Texas  Limited Partnership and Testchip Technologies, Inc., a Texas Corporation.(4) |
|                |   |                                                                                                                                                                                                                                                |
| 10.12               |   | Second Amendment, dated  June 6, 2001, to Industrial Lease Agreement, dated as of  November 17, 2000, between Research Interchange One L.P., a Texas  Limited Partnership and Testchip Technologies, Inc., a Texas Corporation(4)         |
|                |   |                                                                                                                                                                                                                                                |
| 10.13               |   | Third Amendment, dated  October 1, 2001, to Industrial Lease Agreement, dated as of  November 17, 2000, between Research Interchange One L.P., a Texas  Limited Partnership and Testchip Technologies, Inc., a Texas Corporation(4)       |
|                |   |                                                                                                                                                                                                                                                |
| 10.14               |   | Lease Agreement, dated  June 1, 2000, between Jackson-Shaw Technology Center II, LTD and  Testchip Technologies, Inc(4)                                                                                                                        |
|                |   |                                                                                                                                                                                                                                                |
| 10.15               |   | Amendment, dated  August 7, 2000, to Lease Agreement, dated June 1, 2000, between  Jackson-Shaw Technology Center, II, LTD. and Testchip Technologies(4)                                                                                  |
|                |   |                                                                                                                                                                                                                                                |
| 10.16               |   | Modification and  Ratification of Lease, dated October 31, 2001, between Jackson-Shaw  Technology Center II, LTD. and Testchip Technologies.(4)                                                                                                |
|                |   |                                                                                                                                                                                                                                                |
| 21.1                |   | Subsidiaries of the  registrant                                                                                                                                                                                                                     |
|                |   |                                                                                                                                                                                                                                                |
| 23.1                |   | Consent of  PricewaterhouseCoopers LLP, Independent Auditors                                                                                                                                                                                        |
|                |   |                                                                                                                                                                                                                                                |
| 24.1                |   | Powers of  Attorney.  (Contained on Signature  Page)                                                                                                                                                                                           |
|                |   |                                                                                                                                                                                                                                                |
| 99.1                |   | Certification pursuant  to section 906 of the Sarbanes-Oxley act of 2002                                                                                                                                                                            |

 

70

----

 

----

*                                         Previouslyfiled

 

(1)                                  Incorporatedby reference from our Registration Statement on Form S-1 filed with theCommission May 29, 2001, as amended (Registration No. 333-61810).

 

(2)                                  Incorporatedby reference from our Quarterly Report on Form 10-Q for the quarter endedSeptember 30, 2001.

 

(3)                                  Incorporatedby reference from our Quarterly Report on Form 10-Q for the quarter endedDecember 31, 2001.

 

(4)                                  Incorporatedby reference from our Annual Report on Form 10-K for the year endedMarch 31, 2002.

 

71

----