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SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

FORM 10-Q

(MARK ONE)

|/x/ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
|--- | ----------------------------------------------------------------------------------------
|    | For the quarterly period ended December 31, 2001                                        
|OR 
|/ / | 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 or other jurisdiction
of incorporation or organization)

(I.R.S. Employer
Identification Number)


2033 Gateway Place
San Jose, California 95110(Address of Principal Executive Offices)

(408) 437-1466(Registrant's Telephone Number, Including Area Code)

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

As
of January 31, 2002, there were 27,536,991 shares of Common Stock outstanding.

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HPL Technologies, Inc.  Table of Contents

|                              |  |                                                                                                                |  | Page
|----------------------------- |  | -------------------------------------------------------------------------------------------------------------- |  | ----
|PART I. FINANCIAL INFORMATION |  |                                                                                                               
|Item 1.                       |  | Condensed Consolidated Financial Statements:                                                                   |  |     
|                              |  | Condensed Consolidated Balance Sheets as of December 31, 2001 and March 31, 2001                               |  | 2   
|                              |  | Condensed Consolidated Statements of Operations for the three and nine months ended December 31, 2001 and 2000 |  | 3   
|                              |  | Condensed Consolidated Statements of Cash Flows for the nine months ended December 31, 2001 and 2000           |  | 4   
|                              |  | Notes to Condensed Consolidated Financial Statements                                                           |  | 5   
|Item 2.                       |  | Management's Discussion and Analysis of Financial Condition and Results of Operations                          |  | 11  
|Item 3.                       |  | Quantitative and Qualitative Disclosures About Market Risk                                                     |  | 16  
|PART II. OTHER INFORMATION    |  |                                                                                                               
|Item 1.                       |  | Legal Proceedings                                                                                              |  | 17  
|Item 2.                       |  | Changes in Securities and Use of Proceeds                                                                      |  | 17  
|Item 3.                       |  | Defaults Upon Senior Securities                                                                                |  | 17  
|Item 6.                       |  | Exhibits and Reports on Form 8-K                                                                               |  | 17  
|                              |  | Signatures                                                                                                     |  | 18  

1

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HPL TECHNOLOGIES, INC.  CONDENSED CONSOLIDATED BALANCE SHEETS  (In thousands)  (unaudited)

Item 1.Condensed Consolidated Financial Statements

|                                                  |                                           | December 31,
2001 |        | March 31,
2001 |  
|------------------------------------------------- | ----------------------------------------- | ----------------- | ------ | -------------- | -
|Assets                                            |                                           |                   |        |                |  
|Current assets:                                   |                                           |                   |        |                |  
|                                                  | Cash and cash equivalents                 |                   | $      | 63,621         |  
|                                                  | Accounts receivable, net                  |                   |        | 15,565         |  
|                                                  | Prepaid expenses and other current assets |                   |        | 1,220          |  
|                                                  |                                           |                   |        |                |  
|Total current assets                              |                                           |                   | 80,406 |                |  
|Property and equipment, net                       |                                           |                   | 1,510  |                |  
|Other assets                                      |                                           |                   | 4,220  |                |  
|Goodwill and other intangible assets, net         |                                           |                   | 11,707 |                |  
|                                                  |                                           |                   |        |                |  
|Total assets                                      |                                           | $                 | 97,843 |                | $
|                                                  |                                           |                   |        |                |  
|Liabilities and stockholders' equity              |                                           |                   |        |                |  
|Current liabilities:                              |                                           |                   |        |                |  
|                                                  | Accounts payable                          |                   | $      | 1,682          |  
|                                                  | Accrued liabilities and other             |                   |        | 5,220          |  
|                                                  | Deferred revenue                          |                   |        | 2,061          |  
|                                                  | Convertible debenture                     |                   |        | 1,500          |  
|                                                  |                                           |                   |        |                |  
|Total current liabilities                         |                                           |                   | 10,463 |                |  
|Capital lease obligations, net of current portion |                                           |                   | 96     |                |  
|Notes payable, net of current portion             |                                           |                   |       |                |  
|                                                  |                                           |                   |        |                |  
|Total liabilities                                 |                                           |                   | 10,559 |                |  
|                                                  |                                           |                   |        |                |  
|Stockholders' equity:                             |                                           |                   |        |                |  
|                                                  | Common stock                              |                   |        | 27             |  
|                                                  | Additional paid-in capital                |                   |        | 90,883         |  
|                                                  | Deferred stock-based compensation         |                   |        | (3,007         | )
|                                                  | Accumulated other comprehensive loss      |                   |        | (517           | )
|                                                  | Accumulated deficit                       |                   |        | (102           | )
|                                                  |                                           |                   |        |                |  
|Total stockholders' equity                        |                                           |                   | 87,284 |                |  
|                                                  |                                           |                   |        |                |  
|Total liabilities and stockholders' equity        |                                           | $                 | 97,843 |                | $
|                                                  |                                           |                   |        |                |  

The
accompanying notes are an integral part of these condensed consolidated financial statements.

2

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

|                                                |                                                              | Three Months Ended                            |        | Nine Months Ended |       
|----------------------------------------------- | ------------------------------------------------------------ | --------------------------------------------- | ------ | ----------------- | ------
|
|Revenues:                                       |                                                              |                                               |        |                   |       
|                                                |                                                              | Software licenses                             |        | $                 | 8,713 
|                                                |                                                              | Consulting services, maintenance and other    |        |                   | 2,190 
|                                                |                                                              |                                               |        |                   |       
|Total revenues                                  |                                                              |                                               | 10,903 |                   |       
|                                                |                                                              |                                               |        |                   |       
|Cost of revenues:                               |                                                              |                                               |        |                   |       
|                                                |                                                              | Software licenses                             |        |                   | 260   
|                                                |                                                              | Consulting services, maintenance and other(1) |        |                   | 824   
|                                                |                                                              |                                               |        |                   |       
|Total cost of revenues                          |                                                              |                                               | 1,084  |                   |       
|                                                |                                                              |                                               |        |                   |       
|Gross profit                                    |                                                              |                                               | 9,819  |                   |       
|                                                |                                                              |                                               |        |                   |       
|Operating expenses:                             |                                                              |                                               |        |                   |       
|                                                |                                                              | Research and development(1)                   |        |                   | 1,431 
|                                                |                                                              | Selling, general and administrative(1)        |        |                   | 2,846 
|                                                |                                                              | Stock-based compensation                      |        |                   | 828   
|                                                |                                                              |                                               |        |                   |       
|Total operating expenses                        |                                                              |                                               | 5,105  |                   |       
|                                                |                                                              |                                               |        |                   |       
|Income from operations                          |                                                              |                                               | 4,714  |                   |       
|Interest income (expense) and other income, net |                                                              |                                               | 383    |                   |       
|                                                |                                                              |                                               |        |                   |       
|Income (loss) before income taxes               |                                                              |                                               | 5,097  |                   |       
|Provision for (benefit from) income taxes       |                                                              |                                               | 2,753  |                   |       
|                                                |                                                              |                                               |        |                   |       
|Net income (loss)                               |                                                              | $                                             | 2,344  |                   | $     
|                                                |                                                              |                                               |        |                   |       
|Net income (loss) per share:                    |                                                              |                                               |        |                   |       
|                                                |                                                              | Basic                                         |        | $                 | 0.09  
|                                                |                                                              |                                               |        |                   |       
|                                                |                                                              | Diluted                                       |        | $                 | 0.07  
|                                                |                                                              |                                               |        |                   |       
|Shares used in computing per share amounts:     |                                                              |                                               |        |                   |       
|                                                |                                                              | Basic                                         |        |                   | 27,015
|                                                |                                                              |                                               |        |                   |       
|                                                |                                                              | Diluted                                       |        |                   | 35,073
|                                                |                                                              |                                               |        |                   |       
|                                                | (1) Excludes the following stock-based compensation charges: |                                               |        |                   |       
|                                                |                                                              | Cost of revenues                              |        | $                 | 9     
|                                                |                                                              | Research and development                      |        |                   | 131   
|                                                |                                                              | Selling, general and administrative           |        |                   | 688   
|                                                |                                                              |                                               |        |                   |       
|                                                |                                                              | $                                             | 828    |                   | $     
|                                                |                                                              |                                               |        |                   |       

The
accompanying notes are an integral part of these condensed consolidated financial statements.

3

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HPL TECHNOLOGIES, INC.  CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS  (In thousands)  (unaudited)

|                                                             |                                                                                                    | Nine Months Ended
December 31,            |                                                    
|------------------------------------------------------------ | -------------------------------------------------------------------------------------------------- | ----------------------------------------- | ---------------------------------------------------
|
|Cash flows from operating activities:                        |                                                                                                    |                                           |                                                    
|                                                             | Net income (loss)                                                                                  |                                           | $                                                  
|                                                             | Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities: |                                           |                                                    
|                                                             | Depreciation and amortization                                                                      |                                           |                                                    
|                                                             | Accreted interest expense                                                                          |                                           |                                                    
|                                                             | Stock-based compensation                                                                           |                                           |                                                    
|                                                             | Tax benefit from exercise of non-qualified stock options                                           |                                           |                                                    
|                                                             | Loss on disposal of property and equipment                                                         |                                           |                                                    
|                                                             | Changes in operating assets and liabilities, net of effects from acquisitions:                     |                                           |                                                    
|                                                             |                                                                                                    | Accounts receivable                       |                                                    
|                                                             |                                                                                                    | Prepaid expenses and other current assets |                                                    
|                                                             |                                                                                                    | Accounts payable                          |                                                    
|                                                             |                                                                                                    | Accrued liabilities and other             |                                                    
|                                                             |                                                                                                    | Deferred revenue                          |                                                    
|                                                             |                                                                                                    |                                           |                                                    
|                                                             |                                                                                                    |                                           | Net cash provided by (used in) operating activities
|                                                             |                                                                                                    |                                           |                                                    
|Cash flows from investing activities:                        |                                                                                                    |                                           |                                                    
|                                                             | Purchase of property and equipment                                                                 |                                           |                                                    
|                                                             | Acquisitions, net of cash acquired                                                                 |                                           |                                                    
|                                                             | Issuance of notes receivable                                                                       |                                           |                                                    
|                                                             |                                                                                                    |                                           |                                                    
|                                                             | Net cash used in investing activities                                                              |                                           |                                                    
|                                                             |                                                                                                    |                                           |                                                    
|Cash flows from financing activities:                        |                                                                                                    |                                           |                                                    
|                                                             | Repayment of notes payable                                                                         |                                           |                                                    
|                                                             | Proceeds from issuance of common stock, net                                                        |                                           |                                                    
|                                                             | Proceeds from line of credit                                                                       |                                           |                                                    
|                                                             | Principal payments on capital lease obligations                                                    |                                           |                                                    
|                                                             |                                                                                                    |                                           |                                                    
|                                                             | Net cash provided by (used in) financing activities                                                |                                           |                                                    
|                                                             |                                                                                                    |                                           |                                                    
|Net increase in cash and cash equivalents                    |                                                                                                    |                                           | 63,149                                             
|Effect of exchange rate changes on cash and cash equivalents |                                                                                                    |                                           | (517                                               
|Cash and cash equivalents, beginning of period               |                                                                                                    |                                           | 989                                                
|                                                             |                                                                                                    |                                           |                                                    
|Cash and cash equivalents, end of period                     |                                                                                                    | $                                         | 63,621                                             
|Non-cash investing activities:                               |                                                                                                    |                                           |                                                    
|                                                             | Acquisition of property and equipment under capital lease obligations                              |                                           | $                                                  
|                                                             | Issuance of common stock and assumption of options related to acquisition                          |                                           | $                                                  

The
accompanying notes are an integral part of these condensed consolidated financial statements.

4

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HPL Technologies, Inc.        Notes to the unaudited Condensed Consolidated Financial Statements

NOTE 1General

The
unaudited condensed consolidated financial statements have been prepared by HPL Technologies, Inc., a Delaware company (the "Company"), pursuant to the rules and regulations of the
Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and regulations. These unaudited condensed consolidated financial statements should be read in conjunction with the audited
consolidated financial statements and the notes thereto for the year ended March 31, 2001 included in the Company's Registration Statement on Form S-1, as amended (File
No. 333-61810). In the opinion of management, all adjustments (consisting only of normal recurring adjustments) necessary to present a fair statement of financial position as of
December 31, 2001, and results of operations for the three and nine months ended December 31, 2001 and 2000, and cash flows for the nine-month period ended
December 31, 2001 and 2000, have been made. The results of operations for the three and nine months ended December 31, 2001 are not necessarily indicative of the operating results for
the full fiscal year or any future periods. Certain amounts for prior periods have been reclassified to conform to the current period presentation.

The
balance sheet as of March 31, 2001 has been derived from audited financial statements but does not include all disclosures required by generally accepted accounting principles. Such
disclosures are contained in our Registration Statement on Form S-1, as amended.

The
preparation of condensed consolidated financial statements in conformity with generally accepted accounting principles in the United Stated States of America requires management to make estimates
and assumptions that affect the results reported in the financial statements. These estimates may affect the amounts of assets and liabilities reported in the balance sheet, the disclosure of
contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting periods presented. Actual results may differ from those
estimates.

In
July 2001, Heuristic Physics Laboratories, Inc. was effectively reincorporated in the state of Delaware. This was accomplished through a merger of a wholly-owned subsidiary of the
Company, into Heuristic Physics Laboratories, Inc. and the conversion of all outstanding shares of common stock of Heuristic Physics Laboratories, Inc. into 1.7 shares of common stock of
the Company. Heuristic Physics Laboratories, Inc. continues to do business as a wholly-owned subsidiary of the Company. The merger was accounted for in a manner similar to a pooling of
interests. The financial statements for all periods presented have been retroactively adjusted to reflect the merger and stock conversion.

On
July 31, 2001, the Company completed its initial public offering of 6,000,000 shares of common stock at $11 per share and commenced trading on the Nasdaq National Market. On
August 22, 2001, the Company's underwriters exercised their over-allotment option and purchased 900,000 additional shares of common stock at $11 per share. Cash proceeds from the
offering, net of commissions, discounts and offering expenses, totaled approximately $68.7 million.

NOTE
2Income (loss) per share

Basic
and diluted net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted average number of shares of common stock outstanding during the period. The
calculation of diluted net income (loss) per share excludes shares of common stock that may be issued if the effect of their issuance is antidilutive. Potential common stock consists of shares of
common stock that are incremental common shares issuable upon the exercise of stock options and warrants,

5

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computed using the treasury stock method, and shares issuable upon conversion of the Company's convertible debenture, computed using the if-converted method.

The
following table presents the calculation of net income (loss) per common sharebasic and diluted (in thousands, except per share information):

|                                                   |                                                                                               | Three Months Ended
December 31, |        | Nine Months Ended
December 31, |  
|-------------------------------------------------- | --------------------------------------------------------------------------------------------- | ------------------------------- | ------ | ------------------------------ | -
|
|
|Numerator:                                         |                                                                                               |                                 |        |                                |  
|Net income (loss)  basic                          |                                                                                               | $                               | 2,344  |                                | $
|                                                   | Adjustment for elimination of interest expense on assumed conversion of convertible debenture |                                 |        | 19                             |  
|                                                   |                                                                                               |                                 |        |                                |  
|Net income (loss)  diluted                        |                                                                                               | $                               | 2,363  |                                | $
|                                                   |                                                                                               |                                 |        |                                |  
|Denominator:                                       |                                                                                               |                                 |        |                                |  
|Weighted average common shares outstanding  Basic |                                                                                               |                                 | 27,015 |                                |  
|                                                   | Adjustment for dilutive stock options                                                         |                                 |        | 6,906                          |  
|                                                   | Adjustment for warrants                                                                       |                                 |        | 120                            |  
|                                                   | Adjustment for assumed conversion of convertible debentures                                   |                                 |        | 1,032                          |  
|                                                   |                                                                                               |                                 |        |                                |  
|Weighted average common shares outstanding-diluted |                                                                                               |                                 | 35,073 |                                |  
|                                                   |                                                                                               |                                 |        |                                |  
|Net income (loss) per common share-basic           |                                                                                               | $                               | 0.09   |                                | $
|                                                   |                                                                                               |                                 |        |                                |  
|Net income (loss) per common share-diluted         |                                                                                               | $                               | 0.07   |                                | $
|                                                   |                                                                                               |                                 |        |                                |  

NOTE
3Concentration of credit risk

Financial
instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash, cash equivalents, accounts receivable and a note receivable. Cash
and cash equivalents are deposited with financial institutions that management believes are credit worthy. The Company performs ongoing credit evaluations of its customers' financial condition and
generally requires no collateral from its customers. At December 31, 2001, two customers accounted for 80% and 18% of the Company's accounts receivable, respectively. At March 31, 2001,
two customers accounted for 80% and 12% of the Company's accounts receivable, respectively.

The
Company is holding approximately 1.3 million shares of its common stock with a market value of approximately $23 million at December 31, 2001 as collateral for a note
receivable from an employee totaling approximately $2.7 million which is included in other assets on the condensed consolidated balance sheet. The note receivable bears interest at 5% per annum
and is due on September 21, 2003.

For
the three months ended December 31, 2001, the Company derived 84% of its revenue from six end-user customers that individually represented 17%, 16%, 15%, 15%, 11% and 10% of the
Company's total revenues, respectively. Sales to four of these end-user customers, representing in aggregate 63% of the Company's total revenues for that period, were made through the
Company's distributor in Japan. For the nine months ended December 31, 2001, the Company derived 55% of its revenue from four end-user customers that individually represented 16%,
15%, 12% and 12% of the Company's total revenues, respectively. Sales to three of these end-user customers, representing in aggregate 43% of the Company's total revenues for that period,
were made through the Company's distributor in Japan.

6

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For
the three months ended December 31, 2000, the Company derived 72% of its revenues from two end-user customers that individually represented 48% and 24% of the Company's total
revenues, respectively. Sales to one of these end-user customers, representing 48% of the Company's total revenues for that period, were made through the Company's distributor in Japan. In
aggregate, sales through the Company's distributor in Japan represented 59% of total revenues for the three months ended December 31, 2000. For the nine months ended December 31, 2000,
the Company derived 77% of
its revenues from three end-user customers that individually represented 31%, 30% and 16% of the Company's total revenues, respectively. Sales to these two end-user customers,
representing 47% of the Company's total revenues for that period, were made through the Company's distributor in Japan.

NOTE
4Foreign currency translation

The
Company's Japanese subsidiary, established in October 2001, uses the Japanese Yen as its functional currency. The Company translates assets and liabilities to U.S. dollars at the current
exchange rate as of the applicable balance sheet date. Revenue and expenses are translated at the average exchange rates prevailing during the period. Adjustments resulting from the translation of the
Japanese subsidiary financial statements are recorded as accumulated other comprehensive income (loss) in stockholders' equity.

NOTE
5Comprehensive income (loss)

Comprehensive
income (loss) consists of gains and losses that are not recorded in the statements of operations but instead are recorded directly to stockholders' equity. For the three and nine months
ended December 31, 2001, comprehensive income was $1,827,000 and $3,374,000 respectively. Accumulated other compensation loss, as presented in the accompanying consolidated balance sheets,
consists of the net unrealized loss on the cumulative translation adjustment.

NOTE
6Accrued liabilities and other

Accrued
liabilities and other consist of the following (in thousands):

|                                            |  | December 31,
2001 |       | March 31,
2001
|------------------------------------------- |  | ----------------- | ----- | --------------
|
|Payroll and related expenses                |  | $                 | 624   |               
|Professional service expenses               |  |                   | 867   |               
|Capital lease obligations  current portion |  |                   | 79    |               
|Income taxes payable                        |  |                   | 2,123 |               
|Other accrued expenses                      |  |                   | 1,527 |               
|                                            |  |                   |       |               
|                                            |  | $                 | 5,220 |               
|                                            |  |                   |       |               

NOTE
7Convertible debenture

In
February 2000, Heuristic Physics Laboratories, Inc. ("HPLI"), a wholly-owned subsidiary of the Company, issued a $1.5 million convertible debenture and pledged all of its
assets to secure the debenture. The debenture bears interest at the rate of 8% per annum. This debenture may be converted at any time at the option of the holder to HPLI common stock, at a conversion
price of $2.47 per share after March 31, 2000. The debenture, if not converted, is due on February 15, 2005. With the completion of the Company's initial public offering in
July 2001, the holder of the debenture has the right to demand repayment of the debenture.

7

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At
December 31, 2001, the Company was not in compliance with certain non-financial covenants of the debenture. As a result, the debenture holder may declare all outstanding
obligations under the debenture immediately due and payable and as such the debenture is classified as a current liability. To date, the holder of the debenture has not demanded repayment of the
debenture. If the Company repays the debenture, the debenture holder will forfeit its right to convert the debenture into shares of common stock.

In
connection with the reincorporation of HPLI and in the event the holder of the debenture elects to convert the debenture into common stock of the Company, the Company may issue up to 1,032,388
shares of its common stock. If, notwithstanding such right to convert the debenture into shares of common stock of the Company, the holder elects to convert the debenture into HPLI stock in accordance
with the express terms of the debenture, the holder could receive up to 607,287 shares of common stock of Heuristic Physics Laboratories, Inc., representing approximately 5.5% of the
outstanding stock of that subsidiary.

NOTE
8Stock-based compensation

In
connection with the granting of stock options to employees, the Company recorded deferred stock-based charges, totaling approximately $3,870,000 and $1,023,000 during the nine months ended
December 31, 2001 and 2000, respectively. These amounts represent the difference between the exercise price at which the stock options were granted and the deemed fair value of the Company's
common stock for accounting purposes on the date of grant, and are included as components of stockholders' equity. In addition, for the nine months ended December 31, 2001 the Company recorded
$106,000 of deferred stock-based compensation related to its acquisition of FabCentric, Inc. These stock-based compensation amounts are being amortized on an accelerated basis by charges to
operations over the vesting period of the options, which is generally four years.

NOTE
9Segment and geographic information

The
Company has determined that it has one reportable business segment: the sale of yield optimization software used in the semiconductor production process.

For
the three months ended December 31, 2001, sales to end-user customers located in the United States, Japan and the rest of the world accounted for 11%, 84%, and 5% of the
Company's total revenues, respectively. For the nine months ended December 31, 2001, sales to end-user customers located in the United States, Japan, Singapore and the rest of the
world accounted for 8%, 74%, 10% and 8% of the Company's total revenues, respectively.

For
the three months ended December 31, 2000, sales to end-user customers located in the United States, Japan and the rest of the world accounted for 38%, 57% and 5% of the
Company's total revenues, respectively. For the nine months ended December 31, 2000, sales to end-user customers located in the United States, Japan and the rest of the world
accounted for 46%, 47% and 7% of the Company's total revenues, respectively.

NOTE
10Acquisitions

On
October 4, 2001, the Company's Japanese subsidiary, HPL Japan KK, acquired all outstanding shares of Tyecin-Innotech Corporation, a corporation organized under the laws of Japan ("Tyecin"),
for approximately $789,000 in cash. The results of Tyecin have been included in the consolidated financial statements since the October 4, 2001 acquisition date. The transaction was accounted
for using the purchase method of accounting. The purchase price was allocated to tangible net assets acquired of approximately $509,000 and goodwill of approximately $280,000.

8

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On
December 5, 2001, the Company acquired FabCentric, Inc. ("FabCentric"), a design yield optimization and productivity improvement software company. The results of FabCentric have been
included in the consolidated financial statements since the December 5, 2001 acquisition date. In connection with the merger, each share of FabCentric common, preferred A and preferred B stock
outstanding immediately prior to the consummation of the merger was converted into the right to receive 0.0129946, 0.0600401 and 0.141136, respectively, shares of the Company's common stock and the
Company assumed FabCentric's outstanding stock options. As a result, the Company issued 703,355 shares of its common stock and assumed options to acquire 23,321 shares of the Company's common stock.
The transaction was accounted for using the purchase method of accounting. The acquisition of FabCentric will increase the suite of products that the Company will offer to its customers.

The
estimated purchase price was approximately $8.5 million, measured as the average fair market value of the Company's outstanding common stock from December 3 to December 4,
2001, two trading days before the merger agreement was announced plus the Black-Scholes calculated value of the options of FabCentric assumed by the Company in the merger, and other costs directly
related to the merger as follows (in thousands):

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

The
preliminary allocation of the purchase price to assets acquired and liabilities assumed is as follows (in thousands):

|Tangible assets acquired   |  | $ | 253    |  
|-------------------------- |  | - | ------ | -
|Net deferred tax asset     |  |   | 1,182  |  
|Deferred compensation      |  |   | 106    |  
|Liabilities assumed        |  |   | (4,493 | )
|Intangible assets acquired |  |   | 906    |  
|Goodwill                   |  |   | 10,551 |  
|                           |  |   |       
|Net assets acquired        |  | $ | 8,505  |  
|                           |  |   |       

Deferred
compensation acquired in connection with the merger will be amortized over a four-year period. Acquired intangible assets will be amortized over their estimated useful life of six
months to three years. Amounts allocated to goodwill will not be amortized.

The
following unaudited pro forma revenues, net income (loss) and net income (loss) per share data for the three and nine months ended December 31, 2001 and 2000 are based on the respective
historical financial statements of the Company and FabCentric. The pro forma data reflects the consolidated results of operations as if the merger with FabCentric occurred at the beginning of each of
the periods indicated and includes the amortization of intangible assets and deferred compensation. The pro forma financial data presented are not necessarily indicative of the Company's results of
operations that might have occurred had the transaction been completed at the beginning of the

9

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periods specified, and do not purport to represent what the Company's consolidated results of operations might be for any future period.

Three Months Ended
December 30,

Nine Months Ended
December 30,2001

2000

2001

2000(Unaudited Pro forma)Net revenues

$
10,929

$
3,757

$
23,713

$
8,981Net income (loss)

$
1,412

$
(670
)
$
1,169

$
(1,584
)Net income (loss) per share:Basic

$
0.05

$
(0.04
)
$
0.05

$
(0.09
)Diluted

$
0.04

$
(0.04
)
$
0.04

$
(0.09
)Shares used in computing per share amounts:Basic


27,520


18,519


23,200


18,099Diluted


35,588


18,519


31,973


18,099


NOTE
11Recent accounting pronouncements

In
July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141 "Business Combinations." SFAS No. 141 requires
the purchase
method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of-interests method. The adoption of SFAS No. 141 has not
had a significant impact on the Company's consolidated financial statements.

In
July 2001, the FASB issued SFAS 142, "Goodwill and Other Intangible Assets", which is required to be applied starting with fiscal years beginning after December 15, 2001. SFAS
No. 142 requires, among other things, the discontinuance of goodwill amortization. In addition, SFAS No. 142 includes provisions upon adoption for the classification of certain existing
recognized intangibles as goodwill, assessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the testing for
impairment of existing goodwill and other intangibles. SFAS No. 142 will be fully adopted by the Company no later than the first quarter of fiscal 2003 and is not expected to have a material
impact on its consolidated financial statements. The Company is applying provisions of SFAS No.142 for any business combination consummated on or after July 1, 2001.

In
October 2001, the FASB issued Statement of Financial Accounting Standards No.144, "Accounting for the Impairment or Disposal of Long-Lived Assets"("SFAS 144"), which is
required to be applied starting with fiscal years beginning after December 15, 2001. SFAS 144 requires, amongst other things, the application of one accounting model for
long-lived assets that are impaired or to be disposed of by sale. The adoption of SFAS 144 is not expected to have a significant impact on the Company's financial statements.

NOTE
12Subsequent Event

On
January 29, 2002, the Company entered into a definitive agreement to acquire all outstanding shares and options of Covalar Technology Group Inc. and its wholly-owned subsidiary,
TestChip Technologies, Inc. ("TestChip"), for $10 million in cash and up to 1.9 million shares of the Company's common stock, for an estimated purchase price of approximately
$35 million. In addition, the Company may issue up to 600,000 additional shares of common stock if TestChip exceeds certain revenue levels

10

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during the 12 months following the closing of the transaction. Such additional shares, if any, would be accounted for as additional purchase price. This acquisition will be accounted for as a
purchase. TestChip provides proprietary software and a library of parameterized soft intellectual property which enables the acceleration of the time-to-production for new
semiconductor processes.

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

Certain parts of this Quarterly Report on Form 10-Q, including the "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Legal Proceedings," may contain forward-looking statements that involve risks and uncertainties. Statements that are not historical fact are forward-looking
statements within the meaning of the Federal securities laws. These statements are based on current expectations, estimates and projections about the industries in which we operate and management's
beliefs, and assumptions. Specifically, the amount and timing of future sales, research and development expenses and results, industry demand, and competitive pressures could vary greatly and affect
the results of operations. Readers should refer to a discussion under "Risk Factors" contained in HPL Technologies, Inc.'s Prospectus dated July 31, 2001, concerning certain factors that
could cause our actual results to differ materially from the results anticipated in such forward-looking statements. These Risk Factors are incorporated by reference into this Quarterly
Report.

Overview

We provide comprehensive yield-optimization software and services to the semiconductor industry. We license our software products and sell related services
through our direct sales force, our Japanese distributor, Canon, and semiconductor equipment manufacturers ("OEMs") that bundle our software with their hardware.

On
October 4, 2001, our Japanese subsidiary, HPL Japan KK, acquired all outstanding shares of Tyecin-Innotech Corporation, a corporation organized under the laws of Japan
("Tyecin"), for approximately $789,000 in cash. The transaction was accounted for using the purchase method of accounting. The purchase price was allocated to tangible net assets acquired of
approximately $509,000 and goodwill of approximately $280,000.

On
December 5, 2001, we acquired FabCentric, Inc. ("FabCentric"), a design yield optimization and productivity improvement software company for an estimated purchase price
of approximately $8.5 million. In connection with the merger, all of the shares of FabCentric's common, preferred A and preferred B stock outstanding immediately prior to the consummation of
the merger were converted into 703,355 shares of our common stock. We also assumed FabCentric's outstanding stock options, which converted into options to purchase 23,321 shares of our common stock.
The transaction was accounted for using the purchase method of accounting.

On
January 29, 2002, we entered into a definitive agreement to acquire all outstanding shares and options of Covalar Technology Group Inc. and its wholly-owned subsidiary,
TestChip Technologies, Inc. ("TestChip"), for $10 million in cash and up to 1.9 million shares of our common stock, for an estimated purchase price of approximately
$35 million. In addition, we may issue up to 600,000 additional shares of common stock if TestChip exceeds certain revenue levels during the 12 months following the closing of the
transaction. This acquisition will be accounted for as a purchase. TestChip provides proprietary software and a library of parameterized soft intellectual property which enables the acceleration of
the time-to-production for new semiconductor processes.

We
derive revenues principally from software license sales, software maintenance fees and consulting services. We offer two types of licenses: perpetual and time-based.
Perpetual licenses have no

11

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expiration date, while time-based licenses require renewal. Our software product licenses provide a narrowly defined subset of features for a given customer. Customers may acquire
additional licenses to extend the functionality of our products as their technologies and facilities change, or if they wish to use additional features of our software for their production process.
Our licenses usually limit the number of people who can use the software at a given time. Historically, most of our revenues have come from the sale of perpetual licenses, although we expect to derive
more revenues from time-based licenses in the future.

Revenues
from software licenses are recognized upon execution of a binding agreement and delivery of the software, provided that: the fee is fixed or determinable; vendor-specific
objective evidence exists to allocate a portion of the total license fee to any undelivered elements of the arrangement; collection is probable; there are no remaining obligations by us; and the
agreement does not contain customer acceptance clauses. If customer acceptance clauses exist, revenues are recognized upon customer acceptance.

For
perpetual licenses with multiple obligations (e.g., deliverable and undeliverable products, post-contract support and other services), we allocate revenues to the
undelivered element of the contract based on objective evidence of its fair value. This objective evidence is the sales price of the element when sold separately or the renewal rate specified in the
agreement for licensing arrangements with terms of one year or greater that include post-contract customer support and software updates. We recognize revenues allocated to undelivered
products when the criteria for software license revenues set forth above are met. Revenues from time-based software licenses are recognized ratably over the period of the licenses.

Software
maintenance revenues are recognized ratably over the term of the maintenance period, which is generally one year. Our software maintenance includes product maintenance updates,
Internet-based technical support and telephone support. Revenues derived from our consulting services are recognized as the services are performed.

We
also derive revenues from the sale of software licenses, maintenance and post-contract support services through our Japanese distributor, Canon. Revenues from sales made
through this distributor are recognized when the distributor has sold software licenses or service to its customers. Revenues from maintenance and post-contract support services sold
through the distributor are recognized ratably over the contract period.

Amounts
invoiced to our customers in excess of recognized revenues are recorded as deferred revenues. The timing and amounts invoiced to customers can vary significantly depending on
specific contract terms and can therefore have a significant impact on deferred revenues in any given period. Historically, we have had no material order backlog.

Our
standard payment terms for our customers provide for payment in 30 days. To date, we have not made concessions to secure payment of our receivables. However, it is frequently
the case that our receivables are outstanding for a longer period than 30 days. Our accounts receivable from international customers have been outstanding longer than our domestic receivables
and we expect this to continue to be the case. In each of the past three fiscal years, a relatively small number of customers have accounted for a large portion of our revenues, and the composition of
our major customers has changed from year to year. This is because we currently have a limited sales force, our products have a lengthy sales cycle and we recognize relatively large license revenues
upon entering into perpetual licensing agreements. For the three months ended December 31, 2001, six end-user customers accounted for 82% of our revenue compared to two
end-user customers that accounted for 72% of our revenues for the three months ended December 31, 2000. As we expand our sales and marketing

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activities and increase our sales force, we expect to gain a larger number of customers and experience less significant customer concentration.

Results of Operations

Three and nine months ended December 31, 2001 compared to three and nine months ended December 31, 2000

Revenues

Total revenues increased 191% to $10.9 million for the three months ended December 31, 2001, up from $3.8 million for the three months ended
December 31, 2000. Revenues from the three months ended December 31, 2001 includes revenue of approximately $400,000 from a favorable arbitration ruling.

Total
revenues for the nine months ended December 31, 2001 were $23.4 million, compared with $9.0 million for the nine months ended December 31, 2000, an
increase of 161%.

The
growth in revenues during the three months ended December 31, 2001, was primarily due to increased license sales of the Company's YIELDirector platform and related software
modules, increased software maintenance revenues from an expanded customer base, increased consulting activities and the acquisitions of Tyecin and FabCentric.

Gross profit

As a percentage of revenues, gross profit for the three months ended December 31, 2001 was 90% compared to gross profit of 86% for the three months ended
December 31, 2000. Gross profit for the nine months ended December 31, 2001 was 92% compared to gross profit of 90% for the nine months ended December 31, 2000. Gross profit will
continue to be affected by a variety of factors, particularly by the relative mix of revenue among software licenses, maintenance fees, consulting services and any potential acquisitions.

Research and development expenses

Research and development expenses for the three months ended December 31, 2001 increased to $1.4 million, up from $831,000 for the three months
ended December 31, 2000. Research and development expenses for the nine months ended December 31, 2001 were $4.0 million, compared with $2.5 million for the nine months
ended December 31, 2000. The absolute dollar increases in both the three- and nine-month periods ended December 31, 2001 were primarily due to increased personnel costs and
from our acquisitions. As a percentage of total revenue, research and development expenses were 13% for the three months ended December 31, 2001, compared to 22% for the three months ended
December 31, 2000. Research and development expenses as a percentage of total revenue were 17% for the nine months ended December 31, 2001, compared to 28% for the nine months ended
December 31, 2000. Research and development spending decreased as a percentage of total revenue due to the faster pace at which revenues grew during this period. With the planned ongoing
expansion of our research and development activities and acquisitions, we expect research and development costs to continue increasing in absolute terms in future periods, though not necessarily
increasing as a percentage of revenues.

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Selling, general and administrative expenses

Selling, general and administrative expenses for the three months ended December 31, 2001 were $2.8 million, compared with $1.5 million for
the three months ended December 31, 2000. Selling, general and administrative expenses for the nine months ended December 31, 2001 were $7.0 million, compared with
$3.4 million for the nine months ended December 31, 2000. This change for the three and nine month periods was due to increased costs related to personnel, legal and other professional
services incurred in connection with the expansion of our sales and marketing department, the cost of operating as an public company and acquisitions. As a percentage of total revenues, selling,
general and administrative expenses were 26% and 39% for the three-month periods ended December 31, 2001 and 2000, respectively, and were 30% and 38% for the nine-month periods
ended December 31, 2001 and 2000, respectively. We expect selling, general and administrative expenses to increase in absolute dollars
in future periods as a result of growth, increased sales and marketing efforts and as we continue to expand our operations both internally and through acquisitions.

Stock-based compensation

Stock-based compensation expense for the three months ended December 31, 2001 increased to $828,000, compared with $276,000 for the three months ended
December 31, 2000. Stock-based compensation expense for the nine months ended December 31, 2001 was $2.7 million, compared with $2.1 million for the nine months ended
December 31, 2000. As a result of acquisitions, we expect stock-based compensation charges in the near term to increase. This may change and will be subject to any stock-based compensation
charges we may incur a result of future acquisitions.

Provision for (benefit from) income taxes

Our effective tax rate for the three months ended December 31, 2001 was 54.0%, compared to 72.4% for the three months ended December 31, 2000. The
provision for income taxes for the three months ended December 31, 2001 and 2000 reflect the non-deductibility for income tax purposes of stock-based compensation. The effective
rates are based on statutory Federal and state tax rates, net of the estimated realization of deferred tax assets.

Liquidity and Capital Resources

As of December 31, 2001, the Company had cash and cash equivalents of $63.6 million, compared to $1.0 million as of March 31, 2001.
Our working capital as of December 31, 2001 was $69.9 million.

Net
cash used in operating activities for the nine months ended December 31, 2001 was approximately $900,000 compared to net cash provided by operating activities of approximately
$311,000 for the nine months ended December 31, 2000. Net cash used in operating activities resulted from an increase in accounts receivable, offset partially by an increase in accounts
payable, accrued liabilities and an increase in profitability. Our standard payment terms for our customers provide for payment in 30 days. Although our payment terms are stated in our customer
agreements, our experience with certain customers is that they take longer to pay and that some payments from international customers are not received for up to 180 days.

Net
cash used in investing activities was $4.3 million and $71,000 for the nine months ended December 31, 2001 and 2000, respectively. Our investing activities for the nine
months ended December 31, 2001 consisted primarily of the acquisition of Tyecin, a loan made to an employee and
equipment purchases. The loan to the employee was an advance to pay withholding taxes due upon exercise of a stock option to purchase 1,632,000 shares of common stock. The loan, which bears

14

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interest at a rate of 5% per annum and is due on September 21, 2003, is collateralized by 1.3 million shares of Company's common stock held by the employee with a market value of
approximately $23 million at December 31, 2001.

Net
cash provided by financing activities was $68.4 million for the nine months ended December 31, 2001, primarily from our initial public offering completed in
August 2001, and proceeds from exercise of stock options, partially offset by the repayment of notes payable. Net cash used in financing activities was $237,000 for the nine months ended
December 31, 2000, primarily from repayments of notes payable and capital lease obligations.

We
are currently not in compliance with certain non-financial covenants of the $1.5 million secured convertible debenture issued by our subsidiary to Applied
Materials, and as a result Applied Materials may declare all outstanding obligations under the debenture immediately due and payable. To date, the holder of the debenture has not demanded repayment of
the debenture. If the Company repays the debenture, the debenture holder will forfeit its right to convert the debenture into shares of common stock.

We
believe that the proceeds from our initial public offering, combined with cash we expect to generate from operations, will be sufficient to meet our capital requirements for at least
the next twelve months. Our future capital requirements will depend on many factors, including the rate of revenue growth, profitability, spending on research and development programs, expansion of
sales and marketing and administrative activities, introductions of new products and product enhancements, market acceptance of our products and acquisitions of other companies or technologies.

On
January 29, 2002, we signed a definitive agreement to acquire all outstanding shares and options of Covalar Technology Group Inc. and its wholly-owned subsidiary,
TestChip Technologies, Inc. ("TestChip"), for $10 million in cash and 1.9 million shares and options to acquire shares, in the aggregate of our common stock for estimated purchase
price of approximately $35 million. In addition, we may issue up to 600,000 additional shares of common stock if TestChip exceeds certain revenue levels during the 12 months following
the closing of the transaction. This acquisition will be accounted for as a purchase and is expected to be accretive after any potential one-time charges. TestChip provides proprietary
software and a library of parameterized soft intellectual property which enables the acceleration of the time-to-production for new semiconductor processes.

Recent accounting pronouncements

In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 141, "Business Combinations".
SFAS No. 141 requires the purchase method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of-interests method.
The adoption of SFAS No. 141 has not had a significant impact on the Company's consolidated financial statements.

In
July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets", which is required to be applied starting with fiscal years beginning after
December 15, 2001. SFAS No. 142 requires, among other things, the discontinuance of goodwill amortization. In addition, SFAS No. 142 includes provisions upon adoption for the
classification of certain existing recognized intangibles as goodwill, assessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously
reported goodwill and the testing for impairment of existing goodwill and other intangibles. SFAS No. 142 will be fully adopted by the Company in the first quarter of fiscal 2003 and is not
expected to have a material impact on its consolidated financial statements. The Company is

15

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applying the non-amortization provisions of SFAS No. 142 for any business combination consummated on or after July 1, 2001.

In
October 2001, the FASB issued Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets"("SFAS 144"), which is required to be applied starting with fiscal years beginning after December 15, 2001. SFAS 144 requires, amongst other things, the application of one
accounting model for long-lived assets that are impaired or to be disposed of by sale. The adoption of SFAS 144 is not expected to have a significant impact on the Company's
financial statements.

Item 3.Quantitative and Qualitative Disclosures About Market Risk

The Company's sales are primarily denominated in US dollars and, as a result, the Company has relatively little exposure to foreign currency exchange risk with
respect to revenues. However, our international subsidiaries' books and records are maintained in the local currency. As a result, the Company's financial statements are remeasured into US dollars
using a combination of current and historical exchange rates. The functional currencies of the Company's foreign subsidiaries are their local currencies. The Company translates assets and liabilities
to US dollars at the current exchange rate as of the applicable balance sheet date. Revenues and expenses are translated at the average exchange rates prevailing during the period. Adjustments
resulting from the translation of the foreign subsidiaries' financial statements are recorded in accumulated other comprehensive income (loss) in stockholders' equity.

The
Company is exposed to interest rate risk on its $1.5 million convertible debenture at December 31, 2001. Changes in the fixed rate interest market would change the
estimated value of our debenture. We believe that a change in long term interest rates would not have a material effect on our business, financial condition results of operations or cash flow. Our
cash and cash equivalents consist of cash and highly liquid money market instruments with original or remaining maturities of 90 days or less. Because of the short maturities of these
instruments, a sudden change in market interest rates would not have a material impact on the fair value of the portfolio, but it may cause the amount of income we derive to vary significantly from
period to period.

16

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PART II

Item 1.Legal Proceedings

In February 2001, the Company filed an arbitration claim against Teradyne, Inc. alleging that Teradyne failed to pay the Company approximately
$1.5 million under a software license agreement. In October 2001, the arbitration tribunal awarded HPL $540,000 plus interest and ordered Teradyne to pay future royalties. Additionally,
because the arbitration tribunal determined that HPL was the prevailing party in the dispute, HPL was awarded its costs and attorneys' fees incurred in connection with the arbitration.

Item 2.Changes in Securities and Use of Proceeds

USE OF PROCEEDS FROM REGISTERED SECURITIES.

The
Company's Registration Statement on Form S-1 (Commission File No. 333-61810) for its initial public offering of common stock was declared
effective on July 30, 2001. The Company sold a total of 6,900,000 shares of common stock to an underwriting syndicate for aggregate gross offering proceeds of $75.9 million. In
connection with this offering, the Company incurred total expenses of approximately $7.2 million, consisting of $5.3 million for underwriting discounts and commissions, and approximately
$1.9 million of other expenses. None of these expenses were paid directly or indirectly to any of the Company's directors, officers, or their associates, persons owning 10% or more of any class
of the our securities, or affiliates of the corporation. Offering proceeds, net of expenses were approximately $68.7 million. The Company has applied the proceeds to temporary investments in a
commercial money market investment account and has spent a portion of the proceeds on the acquisition of Tyecin and FabCentric.

Item 3.Defaults Upon Senior Securities

Please refer to the discussion of our secured convertible debenture contained in Note 7 to the Condensed Consolidated Financial Statements contained
herein.

Item 6.Exhibits and Reports on Forms 8-K

(a)

|Exhibit |  | Description                                                                                                                                                                
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.1    |  | Agreement and Plan of Merger, dated as of December 5, 2001, by and among HPL Technologies, Inc., HPL Acquisition Corp., FabCentric, Inc., John Kulusich and Lucian Wagner.*
|10.2    |  | Amendment, dated October 16, 2001, to that certain Employment Offer Letter from Heuristic Physics Laboratories, Inc. to Ita Geva, dated April 3, 2000.                     
|10.3    |  | Employment Offer Letter from HPL Technologies, Inc. to Michael Scarpelli, dated December 4, 2001.                                                                          
|10.4    |  | Employment Offer Letter from HPL Technologies, Inc. to Mark Milligan, dated September 26, 2001.                                                                            

---

17

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SIGNATURES

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

February 14,
2002

| |  | HPL TECHNOLOGIES, INC.
| |  | ----------------------
| |  | By:                   
| |  | By:                   

18

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Exhibit index

|Exhibit |  | Description                                                                                                                                                                
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.1    |  | Agreement and Plan of Merger, dated as of December 5, 2001, by and among HPL Technologies, Inc., HPL Acquisition Corp., FabCentric, Inc., John Kulusich and Lucian Wagner.*
|10.2    |  | Amendment, dated October 16, 2001, to that certain Employment Offer Letter from Heuristic Physics Laboratories, Inc. to Ita Geva, dated April 3, 2000.                     
|10.3    |  | Employment Offer Letter from HPL Technologies, Inc. to Michael Scarpelli, dated December 4, 2001.                                                                          
|10.4    |  | Employment Offer Letter from HPL Technologies, Inc. to Mark Milligan, dated September 26, 2001.                                                                            

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