================================================================================


                                  UNITED STATES

                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-Q

     |X|  QUARTERLY  REPORT  PURSUANT  TO SECTION 13 OR 15(d) OF THE  SECURITIES
          EXCHANGE ACT OF 1934

                  For the quarterly period ended June 30, 2004

                                       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 of Incorporation)     (I.R.S. Employer Identification No.)

         2033 Gateway Place, Suite 400
           San Jose, California 95110               (408) 437-1466
   (Address of Principal  Executive Offices) (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

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

         Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 under the Securities Exchange Act of 1934)
Yes |_| No |X|

         As of July 31, 2004, the registrant had outstanding 31,273,472 shares
of common stock.




================================================================================



<PAGE>


                                TABLE OF CONTENTS



                         PART I - FINANCIAL INFORMATION
<TABLE>
<CAPTION>
<S>                     <C>
Item 1        Condensed Consolidated Financial Statements (unaudited):

              Condensed Consolidated Statements of Operations for the three months ended June 30, 2004 and 2003................    3

              Condensed Consolidated Balance Sheets as of June 30, 2004 and March 31, 2004.....................................    4

              Condensed Consolidated Statements of Cash Flow for the three months ended June 30, 2004 and 2003.................    5

              Notes to Condensed Consolidated Financial Statements.............................................................    6

Item 2        Management's Discussion and Analysis of Financial Condition and Results of Operations............................   14

Item 3        Quantitative and Qualitative Disclosures about Market Risk.......................................................   29

Item 4        Controls and Procedures..........................................................................................   31

                          PART II - OTHER INFORMATION

Item 1        Legal Proceedings................................................................................................   33

Item 2        Changes in Securities and Use of Proceeds........................................................................   33

Item 6        Exhibits and Reports on Form 8-K.................................................................................   33
</TABLE>




                                       2

<PAGE>



PART I - FINANCIAL INFORMATION

ITEM 1 - CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

                             HPL Technologies, Inc.
                      Consolidated Statements of Operations
                    (In thousands, except per share amounts)
                                   (Unaudited)
<TABLE>
<CAPTION>
                                                                                     Three months ended June 30,
                                                                               ----------------------------------------
                                                                                       2004                2003
                                                                               ------------------- --------------------
<S>                                                                           <C>                 <C>
Revenues:
   Software licenses                                                            $            1,358 $                141
   Consulting services, maintenance and other                                                1,803                1,931
                                                                               ------------------- --------------------
Total revenues                                                                               3,161                2,072
                                                                               ------------------- --------------------
Cost of revenues:
   Software licenses                                                                            61                    3
   Consulting services, maintenance and other                                                  719                  819
                                                                               ------------------- --------------------
Total cost of revenues                                                                         780                  822
                                                                               ------------------- --------------------
Gross profit                                                                                 2,381                1,250
                                                                               ------------------- --------------------
Operating expenses:
   Research and development (1)                                                              1,590                1,836
   Sales, general and administrative (1)                                                     2,076                4,384
   Legal settlement expense(Note 2)                                                          1,200                    -
   Stock-based compensation                                                                     11                  106
   Amortization of intangible assets                                                           332                  332
                                                                               ------------------- --------------------
        Total operating expenses                                                             5,209                6,658
                                                                               ------------------- --------------------
Loss from operations                                                            $           (2,828)$             (5,408)
Interest income (expense) and other, net                                                        58                   49
                                                                               ------------------- --------------------
Net loss before income taxes                                                    $           (2,770)$             (5,359)
Provision (benefit from) for income taxes                                                     (149)                   7
                                                                               ------------------- --------------------
Net loss                                                                        $           (2,621)$             (5,366)
                                                                               =================== ====================

Net loss per share-basic and diluted:                                           $            (0.08)$              (0.17)
                                                                               =================== ====================

Shares used in per share calculations-basic and diluted:                                    31,275               30,810
                                                                               =================== ====================
___________
(1)  Excludes the following stock-based compensation charges:

Research and development                                                        $                2 $                 46
Sales, general and administrative                                                                9                   60
                                                                               ------------------- --------------------
                                                                                $               11 $                106
                                                                               =================== ====================
<FN>
The accompanying notes are an integral part of these condensed consolidated financial statements.
</FN>
</TABLE>


                                       3

<PAGE>


                             HPL Technologies, Inc.
                           Consolidated Balance Sheets
                      (In thousands, except per share data)
<TABLE>
<CAPTION>
                                                                                               June 30,          March 31,
                                                                                                 2004              2004
                                                                                          -----------------  -----------------
                                                                                            (unaudited)
<S>                                                                                      <C>                <C>
ASSETS
Current assets:
    Cash and cash equivalents                                                             $           2,219  $           4,708
    Short-term investments                                                                            6,040              5,502
    Accounts receivable, net of allowances of $100 and $100, respectively                             2,911              2,888
    Unbilled accounts receivable                                                                        146                  4
    Prepaid expenses and other current assets                                                           747                940
                                                                                          -----------------  -----------------
Total current assets                                                                                 12,063             14,042
Property and equipment, net                                                                           1,275              1,308
Goodwill                                                                                             27,754             27,754
Other intangible assets, net                                                                            849              1,181
Other assets                                                                                            573                580
                                                                                          -----------------  -----------------
Total assets                                                                              $          42,514   $         44,865
                                                                                          =================  =================

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
    Accounts payable                                                                      $           1,370   $          2,085
    Accrued liabilities                                                                               6,544              6,579
    Deferred revenue                                                                                  1,855              1,894
    Capital lease obligations-current portion                                                            64                 91
                                                                                          -----------------  -----------------
Total current liabilities                                                                             9,833             10,649
Capital lease obligations-net of current portion                                                         27                 39
Legal settlement liability (Note 2)                                                                   9,100              7,900
Other liabilities                                                                                       170                235
                                                                                          -----------------  -----------------
Total liabilities                                                                                    19,130             18,823
                                                                                          -----------------  -----------------

Contingencies and Commitments (Note 2)
Stockholders' equity :
    Preferred stock, $0.001 par value, 10,000 shares authorized, no shares
    issued and outstanding at June 30, 2004 and March 31, 2004                                            -                  -

    Common stock, $0.001 par value; 75,000 shares authorized; 31,275 shares
    issued and outstanding at June 30, 2004 and March 31, 2004                                           32                 32
    Additional paid-in capital                                                                      124,173            124,205
    Deferred stock-based compensation                                                                   (86)              (129)
    Accumulated deficit                                                                            (100,668)           (98,047)
    Accumulated other comprehensive loss                                                                (67)               (19)
                                                                                          -----------------  -----------------
         Total stockholders' equity                                                                  23,384             26,042
                                                                                          -----------------  -----------------
Total liabilities and stockholders' equity                                                $          42,514  $          44,865
                                                                                          =================  =================
<FN>
The accompanying notes are an integral part of these condensed consolidated financial statements.
</FN>
</TABLE>


                                       4

<PAGE>


                             HPL Technologies, Inc.
                      Consolidated Statements of Cash Flows
                                 (In thousands)
                                   (Unaudited)
<TABLE>
<CAPTION>
                                                                                           Three months ended June 30,
                                                                                      ------------------- -----------------
                                                                                              2004              2003
                                                                                      ------------------- -----------------
<S>                                                                                  <C>                 <C>
Cash flows from operation activities:
 Net loss                                                                              $           (2,621)$          (5,366)
   Adjustments to reconcile net loss to net cash used in
   operating activities:
    Depreciation and amortization                                                                     596               661
    Legal settlement expense                                                                        1,200                 -
    Stock-based compensation                                                                           11               106
   Changes in assets and liabilities, net of effects from acquisitions:
    Accounts receivable                                                                               (23)               49
    Unbilled accounts receivable                                                                     (142)              146
    Prepaid expenses and other current assets                                                         187               341
    Other assets                                                                                        7                42
    Accounts payable                                                                                 (715)                4
    Accrued liabilities                                                                               (35)              569
    Other liabilities                                                                                 (65)              (79)
    Deferred revenue                                                                                  (38)               97
                                                                                      ------------------- -----------------
     Net cash used in operating activities                                                         (1,638)           (3,430)
                                                                                      ------------------- -----------------

Cash flows from investing activities:
  Acquisition of property and equipment                                                              (226)             (163)
  Purchase of short-term investments                                                                 (538)           (7,137)
                                                                                      ------------------- -----------------
     Net cash used in investing activities                                                           (764)           (7,300)
                                                                                      ------------------- -----------------

Cash flows from financing activities:
  Repayment of Convetible Debenture                                                                    -             (1,500)
  Principal payments on capital lease obligations                                                     (39)             (121)
                                                                                      ------------------- -----------------
     Net cash used in financing activities                                                            (39)           (1,621)
                                                                                      ------------------- -----------------
  Effect of exchange rate changes on cash and cash equivalents                                        (48)               (8)
                                                                                      ------------------- -----------------

  Net decrease in cash and cash equivalents                                                        (2,489)          (12,359)
  Cash and cash equivalents at beginning of period                                                  4,708            17,350
                                                                                      ------------------- -----------------
  Cash and cash equivalents at end of period                                          $             2,219 $           4,991
                                                                                      =================== =================

Supplemental disclosures of cash flow information:
 Interest paid                                                                        $                 2 $             173
 Income taxes paid                                                                    $                11 $               -

<FN>
     The accompany notes are an integral part of these condensed consolidated
     financial statements.
</FN>
</TABLE>




                                       5

<PAGE>

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

NOTE 1.  GENERAL

         HPL Technologies, Inc. ("HPL" or the "Company") is engaged in the sale,
support and providing of services related to the yield optimization software it
designs for companies involved in the design, fabrication and testing of
semiconductors and flat panel displays.

         The accompanying financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the satisfaction
of liabilities in the normal course of business; and, accordingly, the financial
statements do not include any adjustments relating to the recoverability and
classification of recorded asset amounts or the amount and classification of
liabilities that might be necessary should the Company be unable to continue as
a going concern. The Company has experienced net losses and negative cash flows
since going public in July 2001 and, as of June 30, 2004, had an accumulated
deficit of $100.7 million. The Company expects to have a net operating loss in
the year ending March 31, 2005. For the year ending March 31, 2004, cash used in
operations and to fund capital expenditures was $9.7 million. Management's plans
for the Company to continue as a going concern include increases in revenues or
raising additional capital. At June 30, 2004, the Company had approximately $8.3
million in cash and cash equivalents and short-term investments. The Company's
current operating plan for the year ending March 31, 2005 projects that cash
available from planned revenue combined with the $8.3 million on hand at June
30, 2004 will be adequate to fund operations through March 31, 2005. Future
capital requirements will be affected by slow or diminished revenue growth,
additional research and development and sales and marketing costs, and higher
general and administrative costs, including costs related to the litigation
matters described in Note 2. There can be no assurances that the current cash on
hand combined with the projected revenues will be adequate to sustain operations
through March 31, 2005. If additional capital is required, there is no assurance
that funds would be available to the Company or, if available, under terms that
would be acceptable to the Company, and management is not certain that it will
be able to raise additional capital until the litigation and other uncertainties
described in Note 2 are resolved.

NOTE 2.  LEGAL PROCEEDINGS

         Between July 31, 2002 and November 15, 2002, several class-action
lawsuits were filed against the Company, certain current and former officers and
directors of the Company, and the Company's independent auditors in the United
States District Court for the Northern District of California. The lawsuits were
consolidated into a single action (the "Securities Class Action"), which alleges
that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange
Act of 1934, Rule 10b-5 promulgated thereunder, and Sections 11, 12(a)(2) and 15
of the Securities Act of 1933 by making a series of material misrepresentations
as to the financial condition of the Company during the class period of July 31,
2001 to July 19, 2002. The plaintiffs are generally seeking to recover
compensatory damages, costs and expenses incurred, interest and such other
relief as the court may deem appropriate. The parties have stipulated to extend
the time to respond to the consolidated complaint. A status conference with the
Court is scheduled for August 31, 2004.

         The Company has signed a memorandum of understanding (the "MOU") with
the lead plaintiffs that resolves the Securities Class Action. Under the MOU,
the Company would issue shares of common stock to the class. Final settlement is
contingent on several conditions, including execution of a formal settlement
agreement and court approval.



                                       6

<PAGE>

         Former shareholders of Covalar Technologies Group, Inc., which was
acquired by the Company in February 2002, brought suit in the District Court of
Dallas County, Texas, against the Company's independent auditors and the
managing underwriter in the Company's initial public offering, in connection
with claims relating to the acquisition (the "Covalar Action"). On April 26,
2004, the Company and the Company's former President and Chief Executive Officer
were named as defendants in this action. The Company's response to the amended
petition is currently due September 1, 2004. Subject to a reservation of rights,
the Company has accepted the underwriter's request to indemnify the underwriter
in connection with the Company's initial public offering and to advance expenses
in this matter. While the Company had obtained insurance to cover its obligation
to indemnify and advance expenses to the underwriter, its insurers have raised
certain defenses to coverage. Even if coverage is afforded, however, coverage
for these indemnification obligations is subject to a sub-limit of $1,000,000
and may be exhausted by payments of defense costs and settlements in the
Securities Class Action. On June 3, 2004, an associate judge granted the
auditors' and underwriter's motions for summary judgment. The plaintiffs have
appealed this ruling and a hearing is currently scheduled for August 20, 2004.
On June 9, 2004, the Company's independent auditors filed a responsible third
party petition against the Company and Company's former President and Chief
Executive Officer. The third party petition does not seek affirmative relief but
instead was filed for purposes of apportioning fault in jury findings. The
Company has accepted service of the third party petition. On July 14, 2004,
defendant UBS Securities LLC ("UBS") filed a similar third party petition
against the Company and Company's former President and Chief Executive Officer.
The Company has also agreed to accept service of UBS' third party petition. The
Company's responses to the third party petitions have been extended until thirty
days after the hearing on plaintiffs' notice of appeal of the associate judge's
decision on the summary judgment motions.

         On July 13, 2004 the Company signed a settlement and release agreement
with the plaintiffs in the Covalar Action pursuant to which the Company has
agreed to issue the plaintiffs additional shares of common stock, which will be
placed in escrow pending the final approval of the settlement in the Securities
Class Action.

         Based on the terms of the above settlements, the Company determined
that a liability related to the Securities Class Action and the Covalar Action
was probable and that the value was reasonably estimable. Accordingly, the
Company recorded a non-cash long term liability of approximately $7.9 million in
its consolidated financial statements as of March 31, 2004, representing
management's estimate of the value of the 7 million shares of common stock that
the Company has agreed to issue under the MOU and the Covalar Action settlement.
This liability was calculated by utilizing a valuation based on both the income
and market approaches as of March 31, 2004, consistent with the Company's
assessment of goodwill impairment. This liability will be revalued quarterly
until the actual effective date of the settlements. There was no change in the
revalued amount from March 31, 2004.

         On May 22, 2003, five former shareholders of FabCentric, Inc., which
was acquired by the Company in December 2001, sued the Company, the Company's
former President and Chief Executive Officer and former Chief Financial Officer,
and the Company's independent auditors in a lawsuit pending in Superior Court in
the County of Santa Clara, California (the "FabCentric Action"). This lawsuit
alleges claims for fraud, negligent misrepresentation, breach of warranties and
covenants, breach of contract, and negligence, and seeks rescission or,
alternatively, damages, costs and expenses. On October 31, 2003, the plaintiffs
filed an amended complaint adding the managing underwriter in the Company's
initial public offering and the Company's current Chief Financial Officer as
defendants. The underwriter and auditors have filed demurrers, which are
scheduled to be heard on September 28, 2004. The parties have stipulated to
extend the time for the other defendants to respond to the amended complaint
until September 7, 2004. The plaintiffs served inspection demands on the
defendants on June 25, 2004. The Company's responses to the demands were served
on August 6, 2004.


                                        7
<PAGE>


         The Company is also a nominal defendant in consolidated stockholder
derivative lawsuits pending in Superior Court in the County of Santa Clara,
California. These lawsuits, which were filed between July 31, 2002 and December
31, 2002, assert derivative claims on behalf of the Company against certain
current and former officers and directors of the Company and the Company's
independent auditors. The consolidated complaint asserts claims for insider
trading, breach of fiduciary duties, breach of contract, professional negligence
and unjust enrichment, and seek damages suffered by the Company, treble damages
for the sale of shares, costs and expenses of these actions and such other
relief as the court may deem appropriate. The parties have stipulated to extend
the time to respond to the consolidated derivative complaint until August 27,
2004, and are continuing to negotiate a potential resolution of this action.

         Additionally, in April 2003, UBS PaineWebber, Inc. filed suit against
the Company in the Supreme Court of the State of New York, County of New York
(the "New York Action") alleging tortious interference of contract and a
violation of the Uniform Commercial Code. This action relates to the transfer of
shares of HPL common stock putatively pledged to UBS PaineWebber, Inc. by Y.
David Lepejian, the Company's former President and Chief Executive Officer, and
his spouse and sought, among other things, mandatory injunctive relief requiring
HPL to affect the transfer of the subject stock. The Company moved to dismiss
the New York Action. In May 2003, the Company filed an interpleader action in
United States District Court for the Northern District of California relating to
the stock in question in the New York Action (the "California Action"). Mr.
Lepejian and UBS PaineWebber have been engaged in an NASD arbitration proceeding
regarding the pledge of the shares. The interpleader action and the New York
action were voluntarily dismissed without prejudice by the Company and UBS
PaineWebber, respectively. On or about October 1, 2003, UBS PaineWebber filed
suit in Delaware Chancery Court which essentially re-stated the claims
originally asserted in the New York action (the "Delaware Action"). On June 22,
2004, the Company and UBS PaineWebber signed a settlement agreement and mutual
release whereby the parties dismissed the New York Action, the California Action
and the Delaware Action with prejudice at no cost to the Company.

         Additionally, Twin City Fire Insurance Company (the Company's
first-layer excess "D&O" insurance carrier) filed a declaratory relief action on
October 6, 2003, in Superior Court in the County of Santa Clara, California,
against the Company, its former President and Chief Executive Officer, its
former Chief Financial Officer, and other former and current officers and
directors of the Company seeking a determination that no coverage is afforded
the defendants under Twin City's policy, which follows form to the Company's
primary D&O policy issued by Executive Risk Indemnity Inc. Executive Risk has
already agreed to pay its policy limits for the Securities Class Actions,
exhausting the limits of the Company's primary D&O policy. The Company filed an
amended cross-complaint on June 14, 2004 in the Twin City action, seeking a
declaration that Twin City and the Company's other excess D&O insurance
carriers, National Union and St. Paul, are obligated to indemnify the Company
for losses in connection with the Securities Class Actions and related
litigation and that Twin City has breached its insurance contract by not paying
the defendants' defense expenses on a current basis. On June 21, 2004, the
Superior Court granted Twin City's unopposed motion to file a Third Amended
Complaint alleging two additional declaratory-relief causes of actions based on
two policy exclusions.

         On June 29, 2004, the Company demurred to and moved to strike Twin
City's Third Amended Complaint. On July 20, 2004, the Santa Clara Superior Court
denied the Company's motions, effectively holding that it was premature to
address the merits of Twin City's insurance coverage allegations. The Company
intends to continue to oppose the claims made in the Third Amended Complaint and
to seek coverage under Twin City's policy.

         As of June 30, 2004, the company has accrued $9.1 million, including
$1.2 million in the quarter ended June 30, 2004, for the above matters. Except
as noted above, these matters are in the early stages of litigation and


                                       8
<PAGE>

accordingly they may ultimately be resolved on a basis different than currently
estimated. Because many factors that enter into the ultimate resolution of these
matters are not within the Company's control, the Company is not able to
estimate the maximum potential financial exposure related to these matters. Any
adverse resolution of the aforementioned litigation could have a material effect
on the Company's financial condition, results of operations or cash flows.


NOTE 3.  LOSS PER SHARE

         Basic net loss per share is computed by dividing the net loss for the
period by the weighted average number of shares of common stock outstanding
during the period, less shares outstanding that are subject to repurchase.
Diluted net loss per share is computed by dividing the net loss for the period
by the weighted average number of shares and potential shares of common stock
outstanding during the period. The calculation of diluted net loss per share
excludes shares of potential common stock if their effect is anti-dilutive.
Potential common stock consists of shares of common stock that are incremental
common shares issuable upon the exercise of stock options and warrants, computed
using the treasury stock method, and shares issuable upon conversion of the
convertible debenture, computed using the if-converted method.

         The total number of shares excluded from the calculation of diluted net
loss per share is detailed in the table below (in thousands):

<TABLE>
<CAPTION>
                                                                      Three months ended June 30,
                                                                ---------------------------------------
                                                                         2004               2003
                                                                ------------------- -------------------
<S>                                                            <C>                 <C>

    Outstanding stock options                                                 7,152               1,402
    Shares issuable under warrants                                              138                 138
                                                                ------------------- -------------------
    Total                                                                     7,290               1,540
                                                                =================== ===================
</TABLE>



NOTE 4.  CONCENTRATION OF CREDIT RISK

         Financial instruments that potentially subject the Company to
significant concentrations of credit risk consist principally of cash, cash
equivalents, short-term investments, unbilled receivables, 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 June 30, 2004, the Company's top
five customers accounted for 17%, 13%, 12 %, 12%, and 12% of the Company's
accounts receivable and unbilled receivables combined. At June 30, 2003, the
Company's top three customers accounted for 31%, 19% and 14% of the Company's
accounts receivable and unbilled receivables combined.


NOTE 5.  COMPREHENSIVE LOSS

         Other comprehensive 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 months ended June 30, 2004 and 2003, total
comprehensive loss was $2.7 million and $5.3 million, respectively.

                                       9

<PAGE>

     The difference between net loss and comprehensive loss for the three months
ended June 30, 2004, is the result of foreign currency translation gains and
losses and the net unrealized gains and losses on available for sale securities
in the aggregate amount of net loss of $34,000 and net loss of $14,000,
respectively. The difference between net loss and comprehensive loss for the
three months ended June 30, 2003, was the result of the foreign currency
translation gains and the net unrealized gains and losses on available for sale
securities in the aggregate amount of net loss of $8,000 and net loss of
$15,000, respectively.


NOTE 6.  ACCRUED LIABILITIES

         Accrued liabilities consist of the following (in thousands):
<TABLE>
<CAPTION>
                                                                                  June 30, 2004      March 31, 2004
                                                                              ----------------------------------------
<S>                                                                           <C>                  <C>
Payroll and related expenses                                                  $               902  $               888
Professional fees                                                                             572                  528
Other accrued expenses                                                                        735                  828
Amounts received from HPL's former Chief Executive Officer                                  4,335                4,335
                                                                              -------------------- -------------------
                                                                              $             6,544  $             6,579
                                                                              ==================== ===================
</TABLE>

       Although the amounts received from HPL's former Chief Executive Officer
are included in accrued liabilities, the Company does not expect it will be
required to repay this sum because the Company believes it has offsetting claims
against this individual.

NOTE 7.  INTANGIBLE ASSETS

         Intangible assets consist of the following (in thousands):
<TABLE>
<CAPTION>
                                                                                         June 30, 2004
                                                               ----------------------------------------------------------------
                                              Amortization         Gross Carrying         Accumulated          Net Carrying
                                                 Period                Amount             Amortization            Amount
                                           ------------------  --------------------- -------------------- ---------------------
<S>                                       <C>                 <C>                   <C>                  <C>
Existing technology                             3 years        $               2,760 $            (2,165) $                 595
Modular library                                 3 years                        1,220                (966)                   254
                                                               --------------------- -------------------- ---------------------
                                                               $               3,980 $            (3,131) $                 849
                                                               ===================== ==================== =====================

                                                                                         March 31, 2004
                                                               ----------------------------------------------------------------
                                              Amortization          Gross Carrying          Accumulated        Net Carrying
                                                 Period                 Amount              Amortization          Amount
                                           ------------------  --------------------- -------------------- ---------------------
Existing technology                             3 years        $               2,760 $            (1,935)  $                825
Modular library                                 3 years                        1,220                (864)                   356
                                                              ---------------------- -------------------- ---------------------
                                                               $               3,980 $            (2,799)  $              1,181
                                                              ====================== ==================== =====================
</TABLE>

             The amortization of intangible assets for the three months ended
June 30, 2004 and 2003 was $332,000 and $332,000, respectively.

         The estimated future amortization of intangible assets for the
remaining nine months ending March 31, 2005 is $849,000.

NOTE 8.  STOCK-BASED COMPENSATION

     The Company accounts for stock-based compensation in accordance with the
provisions of Accounting Principles Board Opinion No. 25 ("APB No. 25"),
Accounting for Stock Issued to Employees, and complies with the disclosure
provisions of SFAS No. 123 as amended by SFAS No.148, Accounting for Stock-Based
Compensation -- Transition and Disclosures. Deferred compensation recognized

                                       10

<PAGE>

under APB No. 25 is amortized to expense using the graded vesting method.
The Company accounts for stock options and warrants issued to non-employees in
accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force
No. 96-18 under the fair value based method.

         The Company adopted the disclosure-only provisions of SFAS No. 123, and
accordingly, no expense has been recognized for options granted to employees
under the Company's various stock plans. The Company amortizes deferred
stock-based compensation on the graded vesting method over the vesting periods
of the applicable stock purchase rights and stock options, generally four years.
The graded vesting method provides for vesting of portions of the overall awards
at interim dates and results in greater vesting in earlier years than the
straight-line method. Had compensation expense been determined based on the fair
value at the grant date for the award, consistent with the provisions of SFAS
No. 123, the Company's pro forma net loss and net loss per share for the
following periods would be (in thousands, except per share data):
<TABLE>
<CAPTION>
                                                                                       Three months ended
                                                                                            June 30
                                                                                  June 2004             June 2003
                                                                             -------------------   -------------------
<S>                                                                          <C>                   <C>
Net loss as reported:                                                        $           (2,621)   $           (5,366)
Add: stock-based employee compensation expense included in
 reported net loss under APB No. 25                                                          11                   106
Deduct:  total employee stock-based compensation
 determined under fair value based method for all
 awards, net of related tax effects                                                        (181)                 (121)
                                                                             -------------------   -------------------
Pro forma net loss                                                           $           (2,791)   $           (5,381)
                                                                             ===================   ===================
Basic and diluted net loss per share:
 As reported                                                                 $            (0.08)   $            (0.17)
 Pro forma                                                                   $            (0.09)   $            (0.17)
</TABLE>


NOTE 9.  SEGMENT AND GEOGRAPHIC INFORMATION

         The Company has determined that it has one reportable business segment:
the sale of yield optimization software and services used in the design,
fabrication and testing of semiconductors and flat panel displays.

         The following is a geographic breakdown of the Company's revenues by
destination for the following periods (in thousands):
<TABLE>
<CAPTION>
                               June 30, 2004       June 30, 2003
                            -----------------   -----------------
<S>                        <C>                 <C>
United States               $           1,155   $           1,155
Japan                                     416                 284
Rest of Asia                            1,552                 593
Rest of the world                          38                  40
                            -----------------   -----------------
Total                       $           3,161   $           2,072
                            =================   =================
</TABLE>

         For the three months ended June 30, 2004, the Company derived revenue
from five customers which comprised 18%, 18%, 14%, 14% and 11% of the Company's
total revenues, respectively.

                                       11
<PAGE>


         For the three months ended June 30, 2003, the Company derived revenue
from two customers which comprised 34% and 18% of the Company's total revenues,
respectively.

NOTE 10.  GUARANTEES AND INDEMNIFICATIONS

         FASB issued Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." The Company adopted the recognition and measurement
provisions prospectively to guarantees issued or modified after December 31,
2002. The following is a summary of the agreements that the Company has
determined are within the scope of FIN 45:

         The Company's Amended and Restated Certificate of Incorporation (the
"Certificate") provides that, except to the extent prohibited by the Delaware
General Corporation Law (the "DGCL"), the Company's directors and officers shall
not be personally liable to the Company or its stockholders for monetary damages
for any breach of fiduciary duty as a director or officer. The Certificate
eliminates the personal liability of directors and officers to the fullest
extent permitted by the DGCL and, together with the Company's Bylaws (the
"Bylaws"), provides that the Company shall fully indemnify any person who was or
is a party or is threatened to be made a party to any threatened, pending or
completed action, suit or proceeding (whether civil, criminal, administrative or
investigative) by reason of the fact that such person is or was a director or
officer of the Company, or is or was serving at the request of the Company as a
director or officer of another corporation, partnership, joint venture, trust,
employee benefit plan or other enterprise, against expenses (including
attorneys' fees), judgments, fines and amounts paid in settlement actually and
reasonably incurred by such person in connection with such action, suit or
proceeding ("Expenses"). Additionally, the Company has entered into
indemnification agreements with its directors and officers pursuant to which the
Company is required to indemnify its officers and directors and advance any and
all Expenses. These agreements have no term and the maximum potential amount of
future payments HPL could be required to make under these indemnification
agreements is unlimited. Except as noted below, no claims for indemnification
have been made against the Company.

         To limit the Company's exposure to indemnification claims by directors
and officers, the Company obtained in July 2001 four directors and officers
liability insurance policies with aggregate limits of $20 million. The validity
of these policies is being contested with respect to coverage for the Company,
Mr. Lepejian (the Company's former President and Chief Executive Officer), and
other of the Company's current and former directors and officers. In February
2003, the Company obtained two new directors and officers' liability insurance
policies with aggregate policy limits of $10 million which were renewed in
February 2004. These two new policies exclude claims relating to prior acts,
including the acts giving rise to the previous restatement of the Company's
financial statements.

         Certain of the Company's current and former directors and officers have
been named as defendants in the litigation described in Note 2. Furthermore, one
or more of the Company's former officers have given testimony in connection with
investigations being conducted by the SEC and the Department of Justice. Except
for our former Chief Financial Officer, who has requested advancement of
expenses in connection with her deposition before the SEC, no other directors or
former officers have requested indemnification from the Company. However, if the
Company is unable to settle its litigation, it expects all of the defendant
directors and officers will demand indemnification and advancement of expenses
under their respective indemnification agreements. Because management is not
currently able to evaluate the likelihood of an unfavorable outcome or an
estimate of the amount or range of potential loss, management cannot determine
the estimated fair value of these obligations and, accordingly, the Company has
recorded no liability for these obligations at March 31, 2004 or June 30, 2004.

                                      12

<PAGE>

         The Company is also obligated to provide indemnification to the
underwriters in its initial public offering pursuant to an Underwriting
Agreement, dated July 30, 2001, by and among the Company, UBS Warburg LLC, Dain
Rauscher Wessels, Wit SoundView Corporation and Adams Harkness & Hill, Inc., as
representatives of the several underwriters (the "Underwriting Agreement"). In
October 2002, UBS Warburg was named as a defendant in a lawsuit relating to the
Company's issuance of stock in the acquisition of Covalar Technologies Group,
Inc. Pursuant to the Underwriting Agreement, UBS Warburg demanded that the
Company indemnify it in connection with this matter and advance its litigation
expenses. While the Company had obtained insurance to cover its obligation to
indemnify and advance UBS Warburg's expenses, its insurers have raised certain
defenses to coverage. Even if coverage is afforded, however, coverage for these
indemnification obligations is subject to a sub-limit of $1,000,000. Because
management is not currently able to evaluate the likelihood of an unfavorable
outcome or an estimate of the amount or range of potential loss, management
cannot determine the estimated fair value of these obligations and, according,
the Company has recorded no liability for these obligations at March 31, 2004 or
June 30, 2004.

         The Company includes standard intellectual property indemnification
clauses in its software license agreements. Pursuant to these provisions, HPL
holds harmless and agrees to defend the indemnified party, generally HPL's
business partners and customers, in connection with certain patent, copyright or
trade secret infringement claims by third parties with respect to HPL's
products. The term of the indemnification provisions is generally for the term
of the license agreement and the applicable statute of limitations. The Company
believes the estimated fair value of these obligations is minimal. HPL has
recorded no liabilities for these obligations as of March 31, 2004 or June 30,
2004 and has never had to make a payment under such indemnification provisions.

         The Company generally warrants that its software products will perform
in all material respects in accordance with its standard published
specifications in effect at the time of delivery of the licensed products to the
customer for a period of 90 days following delivery. If necessary, HPL would
provide for the estimated cost of product warranties based on specific warranty
claims and claim history. The Company has incurred no significant expense under
its product warranties to date and, as a result, the Company believes the
estimated fair value of these warranties is minimal. The Company has recorded no
liabilities for these warranties as of March 31, 2004 or June 30, 2004.

NOTE 11.  RECENT ACCOUNTING PRONOUNCEMENTS

         In March 2004 the Emerging Issues Task Force ("EITF") reached a final
consensus on Issue 03-06. Issue 03-06 addressed a number of questions regarding
the computation of earnings per shares ("EPS") by companies that have issued
securities other than common stock that contractually entitle the holder to
participate in dividends and earnings of the Company when, and if, it declares
dividends on its common stock. The issue also provides further guidance in
applying the two-class method of calculating EPS. It clarifies what constitutes
a participating security and how to apply the two-class method of computing EPS
once it is determined that a security is participating, including how to
allocate undistributed earnings to such a security. Issue 03-06 is effective for
the first fiscal period beginning after its issuance. During the quarter ended
June 30, 2004, we adopted Issue 03-06 and the adoption did not have any material
effect on our financial position or results of operations.

         On March 31, 2004, the FASB issued a proposed Statement, "Share-Based
Payment, an amendment of FASB Statements Nos. 123 and 95," that addresses the
accounting for share-based payment transactions in which an enterprise receives
employee services in exchange for either equity instruments of the enterprise
or, liabilities that are based on the fair value of the enterprise's equity
instruments or that may be settled by the issuance of such equity instruments.
The proposed statement would eliminate the ability to account for share-based
compensation transactions using Accounting Principles Board, or APB, Opinion No.

                                       13

<PAGE>
25, "Accounting for Stock Issued to Employees," and generally would require that
such transactions be accounted for using a fair-value-based method and
recognized as expenses in our consolidated statement of income. The proposed
standard would require the modified prospective method be used, which would
require that the fair value of new awards granted from the beginning of the year
of adoption plus unvested awards at the date of adoption be expensed over the
vesting period. In addition, the proposed statement encourages companies to use
the "binomial" approach to value stock options, which differs from the
Black-Scholes option pricing model, that we currently use to determine the fair
value of our options. The proposed standard is recommending that the effective
date for public companies be fiscal years beginning after December 15, 2004. The
changes under this proposed standard will not have a material impact upon our
financial position or cash flows, but may have a material impact on our results
of operations, depending on the amount of stock options we grant in future
periods.

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, any resolution of pending litigation matters, 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 the information under
the caption "Risk Factors" in this Quarterly Report concerning certain factors
that could cause our actual results to differ materially from the results
anticipated in such forward-looking statements and in our most recent Annual
Report on Form 10-K filed with the Securities and Exchange Commission.

OVERVIEW

         We provide comprehensive yield-optimization solutions to the
semiconductor industry and flat-panel display manufacturers. We license our
software products and sell related services through our direct sales force,
distributors and sales agents.

         From July 2002 until today, as a result of our investigation into
financial and accounting irregularities which ultimately lead to a restatement
of our financial statements for the years ended March 31, 2001 and 2002, and the
litigation discussed above in Note 2 to the Condensed Consolidated Financial
Statements, we experienced a significant period of transition. In our year
ending March 31, 2003, senior management was focused on determining the impact
of the financial restatement on our business going forward, integrating
previously acquired businesses and cutting costs to reflect the level of sales
activities we were experiencing. In our year ended March 31, 2004, we began to
hire a new management team, filling five senior positions with the hiring of a
new Chief Executive Officer, Senior Vice President of Sales, Vice President of
Software Development, Vice President of Marketing and Vice President of Business
Development. With the new management team in place, we have shifted our focus
and resources to better integrate our yield analysis software capabilities with
our TestChip solutions to more effectively compete in the DFM market segment.
This has resulted in a decrease in our revenue in the year ended March 31, 2004
from the year ended March 31, 2003. Since going public in 2001, we have not
achieved profitability on a quarterly or annual basis. At June 30, 2004 we had
$8.3 million in cash, cash equivalents and short term investments and an
accumulated deficit of $100.7 million. As we continue to strive to build our
customer base and further develop new products, we expect to continue to incur
net operating losses at least through our year ending March 31, 2005. We will
need to generate significantly higher revenues in order to support research and

                                       14

<PAGE>

development, sales and marketing and general and administrative expenses, and to
achieve and maintain profitability. Our ability to generate higher revenues may
continue to be impacted by our litigation, the capital spending trends of our
potential and current customers in the semiconductor industry, the lead time to
get our new products to market and our ability to compete in our market segment.
See "Liquidity and Capital Resources" below.

         In the three months ended June 30, 2004 and 2003, a relatively small
number of customers accounted for a large portion of our revenue, and the
composition of these customers' changes from period to period. This is because
our products have a lengthy sales cycle and are characterized by large license
fees or engagement contracts. During the three months ended June 30, 2004 and
2003, five and two customers accounted for 75% and 52% of our revenues,
respectively.

CRITICAL ACCOUNTING POLICIES

         The discussion and analysis of our financial condition and results of
operations are based upon our condensed consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these financial statements requires us
to make estimates and judgments that affect our reported assets, liabilities,
revenues and expenses, and our related disclosure of contingent assets and
liabilities. On an on-going basis, we evaluate our estimates, including those
related to revenue recognition, goodwill and identifiable, separately recorded
intangible assets, litigation, contingent liabilities and income taxes. We base
our estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances. Our estimates then form the
basis of judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.

         We believe the following critical accounting policies and the related
judgments and estimates significantly affect the preparation of our consolidated
financial statements:

Revenue Recognition

         Revenue recognition rules are very complex, and certain judgments
affect the application of our revenue policy. The amount and timing of our
revenue is difficult to predict, and any shortfall in revenue or delay in
recognizing revenue could cause our operating results to vary significantly from
quarter to quarter. In addition to determining our results of operations for a
given period, our revenue recognition determines the timing of certain expenses,
such as commissions, royalties and other variable expenses.

         We derive revenues principally from the sale of software licenses,
software maintenance contracts and consulting services. We offer two types of
licenses: perpetual and time-based. Perpetual licenses have no expiration date,
while time-based licenses require renewal. Our software product licenses provide
a narrowly defined subset of features for a given customer. The customer may
acquire additional licenses to extend the functionality of our products as its
technologies and facilities change or if it wishes to use additional features of
our software for its production process. Our licenses usually limit the number
of people who can use the software at a given time.

         Revenues from software licenses are generally recognized upon the
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 reasonably assured; and the agreement does not
contain customer acceptance clauses. If customer acceptance clauses exist,
revenues are recognized upon customer acceptance and all other revenue
recognition criteria are met.

                                       15

<PAGE>

         If consulting or other services sold in connection with the software
license are essential to the functionality of the software or involve
significant production, customization or modification of software, we recognize
revenue on either a percentage-of-completion or completed contract basis. For
the percentage-of-completion method, we recognize revenues using labor hours
incurred as the measure of progress against the total labor hours estimated for
completion of the project. We consider a project completed after all contractual
obligations are met. At times, an unbilled accounts receivable balance can exist
which comprises revenue recognized in advance of contractual billings. We make
provisions for estimated contract losses in the period in which the loss becomes
probable and can be reasonably estimated. Estimates of total labor hours or
expected losses on contracts are subject to judgment and actual amounts may
differ significantly from those estimates.

         For contracts 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
generally recognized ratably over the period of the licenses. Determining
whether objective evidence of fair value exists is subject to judgment and
resulting fair values used in determining the value of the undelivered elements
is also subject to judgment and estimates.

         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. Revenues derived from software development
projects are recognized on a completed contract basis.

         We also derive revenues from the sale of software licenses, maintenance
and post-contract support services through our distributors. Revenues from sales
made through our distributors for which the distributors have return rights are
recognized when the distributors have sold the software licenses or service to
their customers and the criteria for revenue recognition under SOP 97-2, as
amended, are met. Revenues from maintenance and post-contract support services
sold through our distributors 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.

Goodwill and Intangible Assets

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

         We assess the impairment of identifiable intangibles and long-lived
assets whenever events or changes in circumstances indicate that the carrying

                                       16

<PAGE>

value may not be recoverable. Furthermore, we assess the impairment of goodwill
at least annually. Factors we consider important which could trigger an
impairment review include the following:

     o significant underperformance relative to historical or projected future
       operating results;
     o significant changes in the manner of our use of the
       acquired assets or the strategy for our overall business;
     o significant negative industry or economic trends;
     o significant decline in our stock price for a sustained period;
     o market capitalization relative to net book value; and
     o a current expectation that, more likely than not, a long-lived
       asset will be sold or otherwise disposed of significantly
       before the end of its previously estimated useful life.

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

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

Step 1 - We compare the fair value of our reporting units to the carrying value,
including goodwill. For each reporting unit where the carrying value, including
goodwill, exceeds the unit's fair value, we proceed on to Step 2. If a unit's
fair value exceeds the carrying value, no further analysis is performed and no
impairment charge is necessary. We measure fair value by weighing equally our
projected five year discounted cash flows with a terminal value discounted to
the measurement date (the "Income Approach") and looking at comparable public
companies and the multiples at which they trade, based on their trailing twelve
months revenue and forward looking twelve months revenue compared to our
comparable revenue to determine our market value (the "Market Approach").

Step 2 - We perform an allocation of the fair value of the reporting unit to our
identifiable tangible and non-goodwill intangible assets and liabilities. This
derives an implied fair value for the reporting unit's goodwill. We then compare
the implied fair value of the reporting unit's goodwill with the carrying amount
of the reporting unit's goodwill. If the carrying amount of the reporting unit's
goodwill is greater than the implied fair value of its goodwill, an impairment
charge would be recognized for the excess.

         At March 31, 2003, 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 million impairment charge was required in the three months ended
March 31, 2003. We continued to test for impairment on an annual basis and
determined that there was no impairment in goodwill at March 31, 2004 or June
30, 2004.

Litigation

         Management's estimated range of liability related to some of the
pending litigation is based on claims for which our management can estimate the
amount and range of loss. Because of the uncertainties related to our insurance
coverage and indemnification obligations we have provided to various parties who
are defendants and the amount and range of potential losses, if any, related to
litigation, management is currently unable to make a reasonable estimate of the
total liability that could result from an unfavorable outcome of all of the

                                       17

<PAGE>

litigation. As of March 31, 2004, we had tentatively settled the Securities
Class Action and the Covalar Action. These settlements require the Company to
issue 7 million shares of HPL common stock which have been valued in a manner
consistent with our calculation for the impairment of goodwill at $7.9 million.
As of June 30, 2004, we determined that it was probable and reasonably estimable
that we would incur an additional $1.2 million charge for other settlement
expenses. This additional liability was calculated by utilizing a valuation
based on both the income and market approaches as of June 30, 2004, consistent
with the Company's assessment of goodwill impairment. Accordingly, we have
accrued these costs in our financial statements as of March 31, 2004 and June
30, 2004. This liability will be revalued quarterly until the effective date of
the settlements. As additional information becomes available on our other
pending litigation, we will assess the potential liability related to these
matters and create and/or revise our estimates. Such revisions in estimates of
the potential liability could materially impact our results of operation and
financial condition. Any resolution of the litigation could materially affect
our financial resources and liquidity. See "Liquidity and Capital Resources"
below.

Income Taxes

         We are required to estimate our income taxes in each of the
jurisdictions in which we operate as part of the process of preparing our
consolidated financial statements. This process involves estimating our actual
current tax exposure, together with assessing temporary differences resulting
from differing treatment of items, such as deferred revenue, for tax and
accounting purposes. These differences result in deferred tax assets and
liabilities. We then assess the likelihood that our net deferred tax assets will
be recovered from future taxable income and, to the extent we believe that
recovery is not likely, we must establish a valuation allowance. We currently
have a full valuation allowance on our gross deferred tax assets. In the event
our future taxable income is expected to be sufficient to utilize our deferred
tax assets, an adjustment to the valuation allowance will be made, increasing
income in the period in which such determination is made.

Stock-based compensation

         We account for our employee stock option plans using the intrinsic
value method described in Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees" and related interpretations. Under
APB Opinion No. 25, deferred stock compensation is recorded for the difference,
if any, between an option's exercise price and the fair 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 stock issued to non-employees in accordance with the
provisions of SFAS No. 123 and Emerging Issues Task Force Consensus ("EITF") No.
96-18 "Accounting for 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 options and warrants issued to non-employees
are accounted for at their fair value calculated using the Black-Scholes option
pricing model.

         Compensation expense resulting from employee and non-employee stock
options are amortized to expense using an accelerated approach over the term of
the options in accordance with Financial Accounting Standards Board
Interpretation ("FIN") No. 28, "Accounting for Stock Appreciation Rights and
Other Variable Stock Option or Award Plans."

RECENT ACCOUNTING PRONOUNCEMENTS

         In March 2004 the Emerging Issues Task Force ("EITF") reached a final
consensus on Issue 03-06. Issue 03-06 addressed a number of questions regarding

                                       18

<PAGE>

the computation of earnings per shares ("EPS") by companies that have issued
securities other than common stock that contractually entitle the holder to
participate in dividends and earnings of the Company when, and if, it declares
dividends on its common stock. The issue also provides further guidance in
applying the two-class method of calculating EPS. It clarifies what constitutes
a participating security and how to apply the two-class method of computing EPS
once it is determined that a security is participating, including how to
allocate undistributed earnings to such a security. Issue 03-06 is effective for
the first fiscal period beginning after its issuance. During the quarter ended
June 30, 2004, we adopted Issue 03-06 and the adoption did not have any material
effect on our financial position or results of operations.

         On March 31, 2004, the FASB issued a proposed Statement, "Share-Based
Payment, an amendment of FASB Statements Nos. 123 and 95," that addresses the
accounting for share-based payment transactions in which an enterprise receives
employee services in exchange for either equity instruments of the enterprise
or, liabilities that are based on the fair value of the enterprise's equity
instruments or that may be settled by the issuance of such equity instruments.
The proposed statement would eliminate the ability to account for share-based
compensation transactions using Accounting Principles Board, or APB, Opinion No.
25, "Accounting for Stock Issued to Employees," and generally would require that
such transactions be accounted for using a fair-value-based method and
recognized as expenses in our consolidated statement of income. The proposed
standard would require the modified prospective method be used, which would
require that the fair value of new awards granted from the beginning of the year
of adoption plus unvested awards at the date of adoption be expensed over the
vesting period. In addition, the proposed statement encourages companies to use
the "binomial" approach to value stock options, which differs from the
Black-Scholes option pricing model that we currently use to determine the fair
value of our options. The proposed standard is recommending that the effective
date for public companies be fiscal years beginning after December 15, 2004. The
changes under this proposed standard will not have a material impact upon our
financial position or cash flows, but may have a material impact on our results
of operations, depending on the amount of stock options we grant in future
periods.

RESULTS OF OPERATIONS

Comparison of the three months ended June 30, 2004 and 2003

         Revenues. Total revenues increased to $3.2 million in the three months
ended June 30, 2004 from $2.1 million in the three months ended June 30, 2003,
or an increase of 53%. Our sales cycle for the license of our software products
has historically been very long as our customers spend a significant amount of
time evaluating our products. The increase in revenue is primarily due to the
completion of integration and installation of our products. Customer purchase
orders typically include integration and installation services and acceptance
criteria. As such, we defer a significant amount of our 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 that have resulted in no meaningful trend from period to period, and our
ability to sell our products in the future may be adversely affected by our
pending lawsuits.

         Our revenues in all periods were highly concentrated, with 75% of total
revenues in the three months ended June 30, 2004 coming from five customers, and
52% of total revenues in the three months ended June 30, 2003 coming from two
customers.

         Software license revenue increased to $1.4 million in the three months
ended June 30, 2004 from $141,000 in the three months ended June 30, 2003. The
increase in our license revenue during the three months ended June 30, 2004 is
primarily due to the completion of integration and installation of our products
at three customer sites.

                                       19

<PAGE>

         Consulting services, maintenance and other revenues decreased slightly
to $1.8 million in the three months ended June 30, 2004, down from $1.9 million
in the three months ended June 30, 2003, or a decrease of 7%. The decrease was
due to customer delays in providing layout design specifications necessary for
certain consulting services and due to our shifting from low-margin,
higher-volume consulting services to high-margin, lower-volume consulting
services.

         Gross profit. As a percentage of revenues, gross profit increased to
75% for the three months ended June 30, 2004 from 60%, for the three months
ended June 30, 2003. The increase in gross profit percentage is a result of
higher margin license sales in the three months ended June 30, 2004 versus the
three months ended June 30, 2003. Gross profit has been and will continue to be
affected by a variety of factors, the most important of which is the relative
mix of revenues among software licenses, maintenance fees and consulting
services.

         Research and development. Research and development expenses represented
50% of revenues in the three months ended June 30, 2004, compared to 89% of
revenues in the three months ended June 30, 2003. Actual costs decreased to $1.6
million for the three months ended June 30, 2004 down from $1.8 million for the
three months ended June 30, 2003 primary due to headcount decrease in the
research and development group. Salaries and related benefits of research and
development engineers represent the single largest component of our research and
development expenses. We expect our research and development expenses to remain
relatively stable for the foreseeable future.

         Sales, general and administrative. Sales, general and administrative
expenses for the three months ended June 30, 2004 were $2.1 million, or 66% of
revenues, compared to $4.4 million, or 212% of revenues in the three months
ended June 30, 2003. The decrease in costs was primarily due to decreases in
staff as a result of our cost cutting measures in the amount of approximately
$720,000 and lower professional fees associated with our pending litigation in
the amount of approximately $1.2 million.

         Stock-based compensation. Stock-based compensation expense for the
three months ended June 30, 2004 decreased to $11,000, compared with $106,000
for the three months ended June 30, 2003. The decrease was primary a result of
reversing previously expensed stock-based compensation that was being amortized
on an accelerated basis but that was not earned by certain terminated employees
during the three months ended June 30, 2004.

         Amortization of intangible assets. Amortization of intangible assets
was $332,000 in the three months ended June 30, 2004 and June 30, 2003. The
estimated quarterly amortization of intangible assets will be $332,000 for the
next two quarters and $185,000 in the quarter ending March 31, 2005.

         Interest income (expense) and other, net. Interest income, net of
interest and other expenses for the three months ended June 30, 2004, was
$58,000, compared to $49,000 for the three months ended June 30, 2003. This
increase was due to lower interest payments under the capital leases offset by
less interest income from lower average balances of cash, cash equivalents and
short-term investments during the three months ended June 30, 2004.

         Provision for income taxes. In the three months ended June 30, 2004 and
2003, we incurred operating losses for which we have recorded valuation
allowances for the full amount of our net deferred tax assets, because the
future realization of the deferred tax assets was not likely as of June 30, 2004
and 2003. Our income tax benefit of $149,000 in the three months ended June 30,
2004 was primarily due to a tax refund resulting from filing an amended income
tax return for the prior year. Part of the tax refund was recorded as an income
tax benefit in the amount of $156,000.

                                       20

<PAGE>

LIQUIDITY AND CAPITAL RESOURCES

         Our financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and the satisfaction of liabilities
in the normal course of business. Accordingly, the financial statements do not
include any adjustments relating to the recoverability and classification of
recorded asset amounts or the amount and classification of liabilities that
might be necessary if we are unable to continue as a going concern. We have
experienced net losses and negative cash flows since going public in July 2001
and, as of June 30, 2004, we had an accumulated deficit of $100.7 million. We
expect to have a net operating loss in our year ending March 31, 2005. For the
three months ended June 30, 2004 cash used in operations and to fund capital
expenditures was $1.9 million. Such conditions raise doubt about our ability to
continue as a going concern unless we increase our revenues or raise additional
capital. At June 30, 2004, we had approximately $8.3 million in cash and cash
equivalents and short-term investments. Our current operating plan for the year
ending March 31, 2005 projects that cash available from planned revenue combined
with the $8.3 million in cash and cash equivalents and short-term investments on
hand at June 30, 2004 will be adequate to fund operations through March 31,
2005. There can be no assurance that the current cash and short-term investments
on hand combined with the projected revenues will be adequate to sustain
operations through March 31, 2005. Our future cash position will be adversely
affected by slow or diminished revenue growth, research and development
expenses, additional sales and marketing costs and higher general and
administrative expenses, such as professional fees associated with the
litigation. If additional funds are required, there is no assurance that the
Company will be able to raise such funds on term acceptable to the Company, or
at all, until all of our pending litigation discussed in Note 2 to our Condensed
Consolidated Financial Statements is resolved.

         Net cash used in operating activities was $1.6 million for the three
months ended June 30, 2004, compared to $3.4 million used in operating
activities for the three months ended June 30, 2003, mainly due to a lower
operating loss during the three months ended June 30, 2004

         Net cash used in investing activities was $764,000 for the three months
ended June 30, 2004, compared to $7.3 million used in operating activities for
the three months ended June 30, 2003. The cash used in investing activities for
the three months ended June 30, 2003 consisted primarily of the purchase of
marketable securities in the amount of $7.1 million.

         Net cash used in financing activities was $39,000 for the three months
ended June 30, 2004. Net cash used in financing activities was $1.6 million for
the three months ended June 30, 2003, mainly due to the repayment of our $1.5
million convertible debenture and $121,000 in payments of capital lease
obligations.

         We have commitments that will expire at various times through 2007. We
lease offices and certain property and equipment under non-cancelable operating
leases that will expire in 2007 with certain renewal options. Otherwise, we have
no other significant contractual obligations or commitments that were not
recorded in our financial statements. At June 30, 2004, a summary of our
contractual commitments is as follows:

<TABLE>
<CAPTION>
                                                                 Payment Due by Fiscal Year
                                         Total         2005          2006          2007        2008         2009
                                       -----------------------------------------------------------------------------
<S>                                    <C>           <C>           <C>           <C>          <C>         <C>
Capital Lease Obligation               $      96     $      56     $      27     $      13    $     -     $       -
Rent Obligation                            2,098         1,030         1,048            20
                                       -----------------------------------------------------------------------------
Total                                  $   2,194     $   1,086     $   1,075     $      33    $     -     $       -
                                       =============================================================================
</TABLE>

                                       21

<PAGE>


         Overall, we used $2.0 million of cash, cash equivalents, and short-term
investments during the three months ended June 30, 2004. Although we are
targeting operating cash flow breakeven by the end of our year ending March 31,
2005, we estimate that we will continue to use cash through our year ending
March 31, 2005 to fund operating losses.

         We believe our current cash and cash equivalents, our short-term
investments, and our cash flows from operations will be sufficient to meet our
cash requirements and fund our current operations through at least March 31,
2005. Our future cash position will be adversely affected by slow or diminishing
sales, research and development expenses, sales and marketing costs and higher
general and administrative expenses, such as professional fees associated with
our pending litigation. If additional funds are required, there is no assurance
that the Company will be able to raise such funds on terms acceptable to the
Company, or at all, until all of our pending litigation discussed in Note 2 to
our Condensed Consolidated Financial Statements is resolved.

RISK FACTORS

RISKS ASSOCIATED WITH OUR BUSINESS

We need to increase revenues, reduce costs or raise additional capital to fund
our operating activities for the next twelve months.

         We currently are able to pay our debts and meet our obligations as they
become due, and we believe that our existing capital resources will be
sufficient to satisfy our current and projected funding requirements through
March 31, 2005. Although these estimates reflect our current expectations, it is
possible that our actual expenditures could exceed these estimates, or that our
revenues could fall short of expectations, which, in either case, would shorten
the time during which we could fund our operations. We intend to seek additional
funding to support our future operations through public or private sales of our
equity or debt securities. However, our pending securities litigation raises
uncertainty regarding the financial condition and long term viability of the
Company. Until these matters are resolved, it is unlikely that the Company will
be able to raise additional capital on terms acceptable to the Company, or at
all. If we are unable to obtain additional funds to support our operations, we
may need to reduce or curtail our operations, and you may lose your investment
in our company.

We expect to issue shares of common stock in settlement of our pending
litigation matters and any such issuances could be highly dilutive to our
existing investors.

         We are currently attempting to settle our pending litigation matters
and, in an effort to preserve operating capital, we expect to issue shares of
common stock to the plaintiffs in these actions. We recently entered into
tentative settlements in the Securities Class Action and the Covalar Action
whereby we have agreed to issue approximately 7 million shares of common stock
to the plaintiffs. Any settlement of our other pending litigation matters will
likely result in additional stock issuances, which could be dilutive to our
existing stockholders and could depress our stock price.

An investment in our securities is highly speculative.

         We have sustained a substantial decline in the value of our securities
since announcing the accounting and financial inaccuracies in our previously
filed financial statements and our securities have been delisted from the Nasdaq
National Market System. We have also been named in a number of lawsuits. The
ultimate cost and effect of these matters on the financial condition, results of
operations, customer relations and management of the Company is unknown at this
time. If the Company is unsuccessful in defending itself in these actions, we
may face significant damage awards that could materially impair our liquidity

                                       22

<PAGE>

and results of operations. In addition, the Company is investigating informal
and formal restructuring alternatives which potentially may dilute shareholder
equity. Accordingly, an investment in our securities is highly speculative and
should not be made unless you are prepared to lose your entire investment.

The restatement of our financial statements and pending securities litigation
may raise concerns among our customers regarding our long-term stability. These
concerns may adversely affect future sales.

         Customers who purchase our software products make a significant
long-term investment in our technology. Our products often become an integral
part of each installed fabrication facility and our customers look to us to
provide continuing support, enhancements and new versions of our products.
Because of the long-term nature of an investment in yield optimization software,
customers are often concerned about the stability of their suppliers. Our
restatement and the pending securities litigation may cause current and
potential customers concern over our stability and these concerns may cause us
to lose sales. Any loss in sales could adversely affect our results of
operations, further deepening concern among current and potential customers.

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

         Our charter and bylaws require that we indemnify our directors and
officers to the fullest extent provided by applicable law. In addition, the
Underwriting Agreement with our underwriters for our initial public offering
requires us to indemnify the underwriters in certain instances. Although we have
purchased directors and officers liability insurance to fund such obligations,
our insurance carriers have notified us that coverage may not be available. If
our insurance carriers are able to deny coverage, we would be forced to bear
these indemnification costs directly, which could be substantial and may have an
adverse effect on our results of operations and liquidity.

Our stock is currently only traded in the over the counter market.

         Our stock is currently traded in the over the counter market or "pink
sheets." Stocks trading in this market typically suffer significantly lower
volume (liquidity) and lower share prices. As a result, you may have difficulty
selling shares of our stock and larger sales effected over the pink sheets could
significantly depress our stock price.

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

         Since July 2002, two of our directors resigned from the board of
directors of the Company, leaving only three directors. We have begun searching
for candidates to fill these vacancies. However, in light of the restatement of
our financial statements and the pending securities litigation, we believe we
will have difficulty attracting qualified individuals to serve on our board. Our
inability to attract and retain qualified independent directors may adversely
affect the quality of our management and may make it more difficult for us to
comply with corporate governance requirements of the securities exchanges, such
as Nasdaq and those imposed by the Securities and Exchange Commission pursuant
to the Sarbanes-Oxley Act of 2002.

The semiconductor industry has experienced downturns in the past and any future
downturns could adversely affect our revenues and operating results.

                                       23

<PAGE>

         Our business depends in part on the economic health of our customers:
IDMs, or integrated device manufacturers, fabless semiconductor companies, and
semiconductor equipment OEMs, or original equipment manufacturers. The
semiconductor industry is prone to periods of oversupply resulting in
significantly reduced capital expenditures. As a result of slowdowns, some
semiconductor manufacturers have postponed or canceled capital expenditures for
previously planned expansions or new fabrication facility construction projects,
resulting in a substantial decline in worldwide semiconductor capital
expenditures.

         Current conditions and future downturns could affect the willingness of
semiconductor companies to purchase our yield-optimization products and services
or to purchase equipment from semiconductor equipment OEMs that have embedded
our software in their products. Significant downturns could materially and
adversely affect our business and operating results. In addition, we expect to
continue increasing our investment in engineering, research and development, and
marketing, which limits our ability to reduce expenses during such downturns.

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

         In each of the years ended March 31, 2004, 2003, and 2002, customers
that individually accounted for at least 10% of our revenues together
represented 42%, 61% and 66% of our revenues, respectively, and in each of these
years, there was substantial change among the companies that represented our
largest customers. In the year ended March 31, 2004, sales to three customers
accounted for 18%, 12% and 12%, respectively, of our revenues. Because we derive
most of our revenues from a few customers and because our existing customers'
needs for additional products are based on intermittent events, such as the
introduction of new technologies or processes, building of new facilities or the
need to increase capacity of existing facilities, our largest customers change
from period to period. Delays or failures in selling new licenses to existing or
new customers would 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 and devote management attention to the pursuit of
potentially significant license revenues, but ultimately fail to secure these
revenues.

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

         Over the past year, we have generated the bulk of our revenues from
sales of one-time customer orders. These licenses and orders produce large
amounts of revenues in the periods in which the license fees are recognized and
are not necessarily indicative of a commensurate level of revenues from the same
customers in future periods. Achieving period-to-period growth will depend
significantly on our ability to expand the number of users of our products
within our customers' organizations, license additional software to our
customers and attract new customers. We may not be successful in these sales
efforts and, consequently, revenues in any future period may not match that of
prior periods.

We have a long and variable sales cycle, which can result in uncertainty and
delays in generating additional revenues and results in potentially significant
fluctuations in revenues from period to period.

         Because our yield optimization software and services are often
unfamiliar to our prospective customers, it can take a significant amount of
time and effort to explain the benefits of our products. This means that we may
spend substantial time and management attention on potential licenses that are
not consummated, thereby foregoing other opportunities. In addition, due to the
nature of fabrication facility deployment and the extended time required to
bring a fabrication facility to full capacity, capital expenditures vary greatly
during this time. Accordingly, we may be unable to predict accurately the timing

                                       24

<PAGE>

of any significant future sales of software licenses, which has significantly
affected, and will continue to significantly affect quarterly operating results.
Additional factors that could cause our revenues and operating results to vary
from period to period include:

         o  large sales unevenly spaced over time;
         o  timing of new products and product enhancements by us and our
            competitors;
         o  the cyclical nature of the semiconductor industry;
         o  changes in our customers' development schedules, expenditure levels
            and product support requirements; and
         o  incurrence of sales and marketing and research and development
            expenses that may not generate revenues until subsequent quarters.

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

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

         Our customers and competitors operate in rapidly evolving markets that
are characterized by introduction of new technologies and more complex designs,
shorter product life cycles and disaggregation of the industry into new
subsectors. For example, ever smaller geometries are being used in
semiconductors and new materials are being employed to enhance performance. We
must continually create new software and add features and functionality to our
existing software products to keep pace with these changes in the semiconductor
industry. Specifically, we need to focus our research and development to:

         o  interface with new semiconductor producing hardware and systems that
            others develop;
         o  remain competitive with companies marketing third party yield
            management software and consulting services;
         o  continue developing new software modules that are attractive to
            existing customers, many of which have purchased
            perpetual licenses and are under no ongoing obligation to make
            future purchases from us; and
         o  attract new customers to our software.

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

Our competitors generally have greater resources and our failure to effectively
compete against other companies could impair our growth and profitability.

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

                                       25

<PAGE>

Errors in our products or the failure of our products to conform to
specifications could hurt our reputation and result in our customers demanding
refunds or asserting claims against us for damages.

         Because our software products are complex, they could contain errors or
"bugs" that can be detected at any point in a product's lifecycle. We have a
team dedicated to detecting errors in our products prior to their release in
order to enable our software developers to remedy any such errors. In the past
we have discovered errors in some of our products and have experienced delays in
the delivery of our products because of these errors. In addition, we have
software engineers and developers who participate in the maintenance and support
of our products and assist in detecting and remedying errors after our products
are sold. These delays and replacements have principally related to new product
releases. Detection of any significant errors may result in:

         o  the loss of, or delay in, market acceptance and sales of our
            products;
         o  the delay or loss of revenues;
         o  diversion of development resources;
         o  injury to our reputation; or
         o  increased maintenance and warranty costs.

         Any of these problems could harm our business and operating results. If
our products fail to conform to specifications, customers could demand a refund
for the purchase price or assert claims for damages. Liability claims could
require us to spend significant time and money in litigation or to pay
significant damages. Any such claims, whether or not successful, could seriously
damage our reputation and our business.

We may incur non-cash charges resulting from acquisitions and equity issuances,
which could harm our operating results.

         We incurred $7.9 million in charges related to our estimated cost of
settling the Securities Class Action and Covalar Action based on the estimated
value of the 7 million shares of our stock we have agreed to issue. We may incur
additional charges related to settling these matters as we revalue the accrual
for issuances quarterly until the shares are actually issued.

         We incurred a $30.6 million goodwill impairment charge in the fourth
quarter of our year ended March 31, 2003. We will continue to incur charges to
reflect amortization and any future impairment of identified intangible assets
acquired in connection with our acquisitions of FabCentric, Covalar and DYM, and
we may make other acquisitions or issue additional stock or other securities in
the future that could result in further accounting charges. In the future, we
may incur additional impairment charges related to the goodwill already
recorded, as well as goodwill arising out of any future acquisitions. Current
and future accounting charges like these could result in significant losses and
delay our achievement of net income.

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

         In connection with our effort to streamline operations, reduce costs
and bring our staffing and structure in line with industry standards, we
restructured our organization in September 2002 and September 2003, with
substantial reductions in our workforce. There have been and may continue to be
substantial costs associated with the workforce reductions, including severance
and other employee related costs, and our restructuring plan may yield
unanticipated consequences, such as attrition beyond our planned reduction in
workforce. As a result of these reductions, our ability to respond to unexpected
challenges may be impaired and we may be unable to take advantage of new
opportunities.
                                       26

<PAGE>

         In addition, many of the employees who were terminated possessed
specific knowledge or expertise that may prove to have been important to our
operations. In that case, their absence may create significant difficulties.
This personnel reduction may also subject us to the risk of litigation, which
may adversely impact our ability to conduct our operations and may cause us to
incur significant expense.

Terrorist  activities  and  resulting  military  and  other  actions  could
adversely affect our business

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

Key employees

         Our employees are vital to our success, and our key management,
engineering and other employees are difficult to replace. We generally do not
have employment contracts with our key employees. Further, we do not maintain
key person life insurance on any of our employees. The expansion of high
technology companies worldwide has increased the demand and competition for
qualified personnel. If we 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 in the future, our business and operations could be harmed. These
factors could seriously harm our business.

RISKS RELATED TO OUR INTERNATIONAL OPERATIONS

Our business could be harmed by political or economic instability in the
Republic of Armenia.

         Some of our software products are largely developed, produced,
delivered and supported from our facilities in the Republic of Armenia. Changes
in the political or economic conditions in Armenia and the surrounding region,
such as fluctuations in exchange rates, the imposition of currency transfer
restrictions or limitations, or the adoption of burdensome trade or tax
policies, procedures, rules, regulations or tariffs, could adversely affect our
ability to develop new products and take advantage of Armenia's low labor and
production costs, and to otherwise conduct business effectively in Armenia.

         Armenia voted for independence in 1991 and adopted its current
constitution in 1995. Laws protecting property (including intellectual property)
are not well established and may be difficult to enforce. In recent years,
Armenia has suffered significant political and economic instability. Any future
political and economic instability could interfere with our ability to retain or
recruit employees, significantly increase the cost of our operations, or result
in regulatory restrictions on our business, making it difficult for us to
maintain our business in Armenia or disrupting our Armenian operations. Any
significant increase in the costs of our Armenian operations (whether due to
inflation, imposition of additional taxes or other causes) would diminish, and
could eliminate their current cost-advantages. Furthermore, we cannot assure you
that restrictive foreign relations laws or policies on the part of Armenia or
the United States will not constrain our ability to operate effectively in both
countries. If we lose or choose to terminate any part of our Armenian operation,
replacements could be costly and we could experience delays in our product
development, thereby harming our competitive position and adversely affecting
our results of operations.

                                       27

<PAGE>

Our expansion into international markets may result in higher costs and could
reduce our operating margins due to the higher costs of international sales.

         Our current strategy for growth includes further expansion in Asia,
Europe, and other international markets. To effectively further this strategy,
we must find additional partners to sell our products in international markets
and expand our direct international sales presence. We would likely incur higher
sales costs by expanding our direct sales staff abroad, but we might not realize
corresponding increases in revenues or profitability. Furthermore, we may be
forced to share sales revenues with distributors or other sales partners abroad
in order to successfully penetrate foreign markets. Even if we successfully
expand our direct and indirect international sales efforts, we cannot be certain
that we will be able to create or increase international market penetration or
demand for our products.

Problems with international business operations could adversely affect our
sales.

         Sales to customers located outside the United States accounted for
approximately 53%, 36% and 30% of our revenues in the years ended March 31,
2004, 2003 and 2002, respectively. We anticipate that sales to customers located
outside the United States will represent a significant portion of our total
revenues in future periods. In addition, many of our customers rely on third
party foundries operating outside of the United States. Accordingly, our
operations and revenues are subject to a number of risks associated with foreign
commerce, including the following:

     o  managing foreign distributors;
     o  maintaining relationships with foreign distributors;
     o  staffing and managing foreign branch offices;
     o  political and economic instability abroad;
     o  foreign currency exchange fluctuations;
     o  changes in tax laws and tariffs;
     o  timing and availability of export licenses;
     o  inadequate protection of intellectual property rights in some countries;
        and
     o  obtaining governmental approvals for certain technologies.

         Any of these factors could result in decreased sales to international
customers and domestic customers that use foreign fabrication facilities.

         Our accounts receivable from international customers are generally
outstanding longer than our domestic receivables and, as a result, we may need a
proportionately greater amount of working capital to support our international
sales.

INTELLECTUAL PROPERTY RELATED RISKS

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

         Our success depends in significant part on our intellectual property.
While we have attempted to protect our intellectual property through patents,
copyrights, or the maintenance of trade secrets, there can be no assurance that
these measures will successfully protect our technology or that competitors will
not be able to develop similar technology independently. It is possible, for
example, that the claims we are allowed on any of our patents will not be
sufficiently broad to protect our technology. In addition, patents issued to us
could be challenged, invalidated or circumvented and the rights granted under
those patents might not provide us with any significant competitive advantage.
The laws of some foreign countries do not protect our intellectual property as

                                       28

<PAGE>

effectively as the laws of the United States. Also, our source code developed in
Armenia may not receive the same copyright protection that it would receive if
it was developed in the United States. As we increase our international
presence, we expect that it will become more difficult to monitor the
development of competing products that may infringe on our rights as well as
unauthorized use of our products.

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

         Litigation regarding intellectual property rights frequently occurs in
the software industry. We may be subject to infringement claims as the number of
competitors in our industry segment grows. While we are unaware of any claims
that our products infringe on the intellectual property rights of others, such
claims may arise in the future. Regardless whether these claims have merit, they
could:

     o  be costly to defend;
     o  divert senior management's time, attention and resources;
     o  cause product shipment delays; and
     o  require us to enter into costly licensing or royalty arrangements.

         Any of these potential results of intellectual property infringement
claims could limit our ability to maintain our business and negatively affect
our operating results.



ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         In the normal course of business, our financial position is subject to
a variety of risks, including market risk associated with interest rate and
foreign currency exchange movements. We regularly assess these risks and have
established policies and business practices to protect against these and other
exposures. As a result, we do not anticipate material potential losses in these
areas.

Interest Rate Risk

         We invest excess cash in debt instruments of the U.S. Government and
its agencies, and in high quality corporate issuers and, limit the amount of
credit exposure to any one issuer. Our investments in fixed rate securities may
have their fair market value adversely impacted due to a rise in interest rates.
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. A hypothetical 10% increase in interest rates would result in an
approximate $9,000 decrease in the fair value of our available-for-sale
securities as of June 30, 2004.

Foreign Exchange Risk

         Our foreign sales are primarily denominated in U.S. dollars and, as a
result, we have relatively little exposure to foreign currency exchange risk
with respect to revenues. Our sales through our Japanese subsidiary, which
represented approximately 4% of total revenues for the three months ended June
30, 2004, are denominated in Yen. A 10% adverse change in Yen exchange rates

                                       29

<PAGE>

would not have had a material impact on revenues for the three months ended June
30, 2004. Additionally, our exposure to foreign exchange rate fluctuations
arises in part from inter-company accounts which can be denominated in the
functional currency of the foreign subsidiary. As exchange rates vary when the
accounts are translated, results may vary from expectations and adversely impact
earnings. The effect of foreign exchange rate fluctuations for the three months
ended June 30, 2004 was not material.

         While our foreign sales are generally denominated in U.S. dollars, our
international subsidiaries' books and 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 foreign subsidiaries are their local currencies. We translate
certain assets and liabilities to U.S. 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.

                                       30

<PAGE>



ITEM 4.  CONTROLS AND PROCEDURES

CEO and CFO Certifications

         Attached as Exhibits 31.1 and 31.2 to this Quarterly Report on Form
10-Q are certifications of our Chief Executive Officer and Chief Financial
Officer. The certifications are required in accordance with Section 302 of the
Sarbanes-Oxley Act of 2002. This section of the Quarterly Report on Form 10-Q
contains the information concerning the disclosure controls and procedures
evaluation referred to in the Section 302 certifications and this information
should be read in conjunction with the Section 302 certifications for a more
complete understanding of the topics presented.

Disclosure Controls and Internal Controls

         Disclosure controls are procedures that are designed with the objective
of ensuring that information required to be disclosed in our reports filed under
the Securities Exchange Act of 1934, or the Exchange Act, such as this Quarterly
Report on Form 10-Q, is recorded, processed, summarized and reported within the
time periods specified in the SEC's rules and forms. Disclosure controls are
also designed with the objective of ensuring that such information is
accumulated and communicated to our management, including the chief executive
officer and chief financial officer, as appropriate to allow timely decisions
regarding required disclosure. Internal controls are procedures which are
designed with the objective of providing reasonable assurance that our
transactions are properly authorized, our assets are safeguarded against
unauthorized or improper use and our transactions are properly recorded and
reported, all to permit the preparation of our financial statements in
conformity with generally accepted accounting principles.

Limitations on the Effectiveness of Controls

         Our management, including our Chief Executive Officer and Chief
Financial Officer, does not expect that our disclosure controls or our internal
controls will prevent all errors and all fraud. A control system, no matter how
well conceived and operated, can provide only reasonable, not absolute,
assurance that the objectives of the control system are met. Further, the design
of a control system must reflect the fact that there are resource constraints,
and the benefits of controls must be considered relative to their costs. Because
of the inherent limitations in all control systems, no evaluation of controls
can provide absolute assurance that all control issues and instances of fraud,
if any, within HPL have been detected. These inherent limitations include the
realities that judgments in decision-making can be faulty, and that breakdowns
can occur because of a simple error or mistake. Additionally, controls can be
circumvented by the individual acts of some persons, by collusion of two or more
people, or by management override of the control. The design of any system of
controls also is based in part upon certain assumptions about the likelihood of
future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions; over time,
controls may become inadequate because of changes in conditions, or the degree
of compliance with the policies or procedures may deteriorate. Because of the
inherent limitations in a cost-effective control system, misstatements due to
error or fraud may occur and not be detected.

Scope of the Controls Evaluation

         At the end of the period covered by this report (the "Evaluation
Date"), the Company's Chief Executive Officer and Chief Financial Officer,
carried out an evaluation of the effectiveness of the Company's disclosure
controls and procedures. The evaluation of our disclosure controls included a
review of disclosure controls implemented by HPL and the effect of the controls
on the information generated for use in this Quarterly Report on Form 10-Q. In
the course of the controls evaluation, we sought to identify data errors,

                                       31

<PAGE>

weaknesses in the control problem or acts of fraud and to confirm that
appropriate corrective action, including process improvements, if any, were
being undertaken. This type of evaluation will be done on a quarterly basis so
that the conclusions concerning controls effectiveness can be reported in our
quarterly reports on Form 10-Q and our Annual Report on Form 10-K. The overall
goals of these various evaluation activities are to monitor our disclosure
controls and to make modifications as necessary; our intent in this regard is
that the disclosure controls will be maintained as dynamic systems that change
(with improvements and corrections) as conditions warrant.

         Among other matters, we sought in our evaluation to determine whether
there were any significant deficiencies or material weaknesses in our disclosure
controls, or whether we had identified any acts of fraud involving personnel who
have a significant role in our disclosure controls. This information was
important both for the controls evaluation generally and because the Section 302
certifications of the Chief Executive Officer and the Chief Financial Officer
require that the Chief Executive Officer and the Chief Financial Officer
disclose that information to our board's audit committee and to our independent
auditors and to report on related matters in this section of the Quarterly
Report on Form 10-Q. We also sought to deal with other controls matters in the
controls evaluation and, in each case if a problem was identified, we considered
what revision, improvement, and/or correction to make in accordance with our
ongoing procedures. In accordance with SEC requirements, the Chief Executive
Officer and the Chief Financial Officer note that, since the date of the
controls evaluation to the date of this Quarterly Report on Form 10-Q, there
have been no significant changes in disclosure controls or in other factors that
could significantly affect our disclosure controls, including any corrective
actions with regard to significant deficiencies and material weaknesses.

Conclusions

         Based upon the disclosure controls evaluation, our Chief Executive
Officer and our Chief Financial Officer have concluded that, subject to the
limitations noted above, our disclosure controls are effective to ensure that
material information relating to HPL is made known to management, including our
Chief Executive Officer and Chief Financial Officer, particularly during the
period when our periodic reports are being prepared, and that our disclosure
controls are effective to provide reasonable assurance that our financial
statements are fairly presented in conformity with generally accepted accounting
principles. There were no significant changes in the Company's disclosure
controls, or to the Company's knowledge, in other factors that could
significantly affect the Company's disclosure controls and procedures subsequent
to the Evaluation Date.

                                       32

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PART II - OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

         The information set forth in Note 2 to the Condensed Consolidated
Financial Statements appearing in this report is incorporated herein by
reference.

ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS

         None

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K


(a) Exhibits:

Exhibit
Number                             Description
-------  -----------------------------------------------------------------------

31.1  Certification  pursuant to Section 302 of the  Sarbanes-Oxley  Act of 2002
31.2  Certification  pursuant to Section 302 of the  Sarbanes-Oxley  Act of 2002
32.1  Certification  pursuant to Section 906 of the  Sarbanes-Oxley  Act of 2002
32.2  Certification  pursuant to Section 906 of the  Sarbanes-Oxley  Act of 2002

(b) Reports on Form 8-K:

         The Registrant filed a Current Report on Form 8-K on June 24, 2004,
reporting the sale of approximately 6.2 million shares of common stock.

                                       33

<PAGE>


                                    SIGNATURE

         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.


                                          HPL Technologies, Inc.


Date:  August 13, 2004                    By:     /s/ CARY D. VANDENBERG

                                          --------------------------------------
                                          Cary D. Vandenberg
                                          President and Chief Executive Officer

                                       34

<PAGE>


         EXHIBIT INDEX


Exhibit
Number                                   Description
------  -----------------------------------------------------------------------

 31.1   Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 31.2   Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 32.1   Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 32.2   Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

                                       35

<PAGE>



                                                                    Exhibit 31.1


                                  CERTIFICATION

I, Cary D. Vandenberg, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q of HPL Technologies, Inc.;

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

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

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

         a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those entities,
particularly during the period in which this report is being prepared;

         b) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of the
period covered by this report based on such evaluation; and

         c) disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's most
recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an
annual report) that has materially affected, or is reasonably likely to
materially affect, the registrant's internal control over financial reporting;
and

5. The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):

         a) all significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and

         b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal control
over financial reporting.

Date:  August 13, 2004


/s/ Cary D. Vandenberg
------------------------------
Cary D. Vandenberg
President and Chief Executive Officer

                                       36

<PAGE>


                                                                    Exhibit 31.2

                                  CERTIFICATION

I, Michael P. Scarpelli, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q of HPL Technologies, Inc.;

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

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

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

         a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those entities,
particularly during the period in which this report is being prepared;

         b) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of the
period covered by this report based on such evaluation; and

         c) disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's most
recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an
annual report) that has materially affected, or is reasonably likely to
materially affect, the registrant's internal control over financial reporting;
and

5. The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):

         a) all significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and

         b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal control
over financial reporting.

Date:  August 13, 2004


/s/ Michael P. Scarpelli
--------------------------------
Michael P. Scarpelli
Chief Financial Officer

                                       37

<PAGE>


                                                                    Exhibit 32.1


                            CERTIFICATION PURSUANT TO
                 SECTIONS 906 OF THE SARBANES-OXLEY ACT OF 2002

         Each of the undersigned hereby certifies that, in accordance with 18
U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, in his capacity as an officer of HPL Technologies, Inc. that this
quarterly report on Form 10-Q (the "Report") fully complies with the
requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934,
and that the information contained in the Report fairly presents, in all
material respects, the financial condition and result of operations of HPL
Technologies, Inc.


Date:   August 13, 2004
                                         /s/ CARY D. VANDENBERG

                                         -------------------------------------

                                         Cary D. Vandenberg
                                         President and Chief Executive Officer

The foregoing certification (the "Certification") is being furnished solely
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsection (a) and
(b) of Section 1350, Chapter 63 of Title 18, United States Code). A signed
original of the Certification has been provided to the Company and will be
retained by the Company in accordance with Rule 12b-11(d) of the Act and
furnished to the Securities and Exchange Commission or its staff upon request.

                                       38

<PAGE>



                                                                    Exhibit 32.2

                            CERTIFICATION PURSUANT TO
                 SECTIONS 906 OF THE SARBANES-OXLEY ACT OF 2002

         Each of the undersigned hereby certifies that, in accordance with 18
U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, in his capacity as an officer of HPL Technologies, Inc. that this
quarterly report on Form 10-Q (the "Report") fully complies with the
requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934,
and that the information contained in the Report fairly presents, in all
material respects, the financial condition and result of operations of HPL
Technologies, Inc.


Date:   August 13, 2004
                                          /s/ Michael P. Scarpelli

                                          -------------------------------------

                                          Michael P. Scarpelli
                                          Chief Financial Officer

The foregoing certification (the "Certification") is being furnished solely
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsection (a) and
(b) of Section 1350, Chapter 63 of Title 18, United States Code). A signed
original of the Certification has been provided to the Company and will be
retained by the Company in accordance with Rule 12b-11(d) of the Act and
furnished to the Securities and Exchange Commission or its staff upon request.

                                       39

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