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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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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 September 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
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 October 31, 2004, the registrant had outstanding 31,292,684
shares of common stock.
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TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Item 1 Condensed Consolidated Financial Statements (unaudited):
Condensed Consolidated Statements of Operations for the three months and six months
ended September 30, 2004 and 2003................................................................................ 3
Condensed Consolidated Balance Sheets as of September 30, 2004 and March 31, 2004................................ 4
Condensed Consolidated Statements of Cash Flow for the six months ended September 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....................................................... 27
Item 4 Controls and Procedures.......................................................................................... 29
PART II - OTHER INFORMATION
Item 1 Legal Proceedings................................................................................................ 31
Item 2 Unregistered Sales of Equity and Use of Proceeds................................................................. 31
Item 6 Exhibits and Reports on Form 8-K................................................................................. 31
2
PART I - FINANCIAL INFORMATION
ITEM 1 - CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
HPL Technologies, Inc.
Consolidated Statements of Operations
(In thousands, except per share amounts)
(Unaudited)
Three months ended Six months ended
September 30, September 30,
---------------------------- ----------------------------
2004 2003 2004 2003
------------- ------------- ------------- -------------
Revenues:
Software licenses $ 294 $ 1,876 $ 1,652 $ 2,017
Consulting services, maintenance and other 1,496 1,408 3,299 3,339
------------- ------------- ------------- -------------
Total revenues 1,790 3,284 4,951 5,356
------------- ------------- ------------- -------------
Cost of revenues:
Software licenses 3 - 64 3
Consulting services, maintenance and other 758 947 1,477 1,766
------------- ------------- ------------- -------------
Total cost of revenues 761 947 1,541 1,769
------------- ------------- ------------- -------------
Gross profit 1,029 2,337 3,410 3,587
------------- ------------- ------------- -------------
Operating expenses:
Research and development (1) 1,727 1,546 3,317 3,382
Sales, general and administrative (1) 2,250 3,917 4,326 8,301
Legal settlement charges - - 1,200 -
Stock-based compensation 12 22 23 128
Amortization of intangible assets 332 332 664 664
------------- ------------- ------------- -------------
Total operating expenses 4,321 5,817 9,530 12,475
------------- ------------- ------------- -------------
Loss from operations (3,292) (3,480) (6,120) (8,888)
Interest income (expense) and other, net 34 47 92 96
------------- ------------- ------------- -------------
Net loss before income taxes (3,258) (3,433) (6,028) (8,792)
Provision for income taxes 4 5 (145) 12
------------- ------------- ------------- -------------
Net loss $ (3,262) $ (3,438) $ (5,883) $ (8,804)
============= ============= ============= =============
Net loss per share-basic and diluted $ (0.10) $ (0.11) $ (0.19) $ (0.28)
============= ============= ============= =============
Shares used in per share calculations-basic and diluted 31,275 31,222 31,275 31,017
============= ============= ============= =============
(1) Excludes the following stock-based compensation charges:
Research and development $ 4 $ (24) $ 6 $ 22
Sales, general and administrative 8 46 17 106
------------- ------------- ------------- -------------
$ 12 $ 22 $ 23 $ 128
============= ============= ============= =============
The accompanying notes are an integral part of these condensed consolidated financial statements.
3
HPL Technologies, Inc.
Consolidated Balance Sheets
(In thousands, except per share data)
September 30, March 31,
2004 2004
---------------- -----------------
(unaudited)
Current assets:
Cash and cash equivalents $ 2,570 $ 4,708
Short-term investments 4,465 5,502
Accounts receivable, net of allowances of $100 and $100, respectively 1,063 2,888
Unbilled accounts receivable 64 4
Prepaid expenses and other current assets 653 940
---------------- -----------------
Total current assets 8,815 14,042
Property and equipment, net 1,166 1,308
Goodwill 27,754 27,754
Other intangible assets, net 517 1,181
Other assets 434 580
---------------- -----------------
Total assets $ 38,686 $ 44,865
================ =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,508 $ 2,085
Accrued liabilities 6,344 6,579
Deferred revenue 1,409 1,894
Capital lease obligations--current portion 43 91
---------------- -----------------
Total current liabilities 9,304 10,649
Capital lease obligations--net of current portion 23 39
Legal settlement liability (Note 2) 9,100 7,900
Other liabilities 106 235
---------------- -----------------
Total liabilities 18,533 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 September 30, 2004 and March 31, 2004 - -
Common stock, $0.001 par value; 75,000 shares authorized; 31,275 shares issued
and outstanding at September 30, 2004 and March 31, 2004 32 32
Additional paid-in capital 124,155 124,205
Deferred stock-based compensation (56) (129)
Accumulated deficit (103,931) (98,047)
Accumulated other comprehensive loss (47) (19)
---------------- -----------------
Total stockholders' equity 20,153 26,042
---------------- -----------------
Total liabilities and stockholders' equity $ 38,686 $ 44,865
================ =================
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
HPL Technologies, Inc.
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
Six months ended September 30,
----------------------------------
2004 2003
--------------- ----------------
Cash flows from operation activities:
Net loss $ (5,883) $ (8,804)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 1,178 1,314
Loss on disposal of property and equipment 7 -
Legal settlement expense 1,200 -
Stock-based compensation 23 128
Changes in assets and liabilities, net of effects from acquisitions:
Accounts receivable 1,825 (533)
Unbilled accounts receivable (60) 177
Prepaid expenses and other current assets 281 772
Other assets 146 48
Accounts payable (578) 594
Accrued liabilities (98) 523
Other liabilities (265) (147)
Deferred revenue (485) (1,089)
--------------- ----------------
Net cash used in operating activities (2,709) (7,017)
--------------- ----------------
Cash flows from investing activities:
Acquisition of property and equipment (373) (241)
Sales (purchase) of short-term investments, net 1,037 (4,959)
--------------- ----------------
Net cash provided by (used in) investing activities 664 (5,200)
--------------- ----------------
Cash flows from financing activities:
Repayment of Convetible Debenture - (1,500)
Issuance of Common Stock - 9
Principal payments on capital lease obligations (65) (221)
--------------- ----------------
Net cash used in financing activities (65) (1,712)
--------------- ----------------
Effect of exchange rate changes on cash and cash equivalents (28) (31)
--------------- ----------------
Net decrease in cash and cash equivalents (2,138) (13,960)
Cash and cash equivalents at beginning of period 4,708 17,350
--------------- ----------------
Cash and cash equivalents at end of period $ 2,570 $ 3,390
=============== ================
Supplemental disclosures of cash flow information:
Interest paid $ 4 $ 179
Income taxes paid $ 15 $ 2
The accompany notes are an integral part of these condensed consolidated financial statements.
5
HPL Technologies, Inc.
Notes to unaudited Condensed Consolidated Financial Statements
NOTE 1. GENERAL
HPL Technologies, Inc. ("HPL" or the "Company") provides comprehensive
yield-optimization solutions to the semiconductor industry and flat-panel
display manufacturers.
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 September 30, 2004, had an
accumulated deficit of $103.9 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 September 30, 2004, the
Company had approximately $7.0 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 $7.0 million on hand at September 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.
The Company has entered into a Stipulation of Settlement with the lead
plaintiffs that resolves the Securities Class Action. Under the Stipulation, the
Company would issue shares of common stock to the class. Final settlement is
contingent on several conditions, including court approval. The motion for
preliminary approval of the settlement was heard on November 4, 2004, and
granted in an order issued on November 5, 2004. The court will consider the
final approval of the settlement at a hearing on February 24, 2005.
6
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. 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. Plaintiffs' appeal of
this ruling was heard on August 20, 2004 and is pending. 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.
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
issued the plaintiffs additional shares of common stock, which have been placed
in escrow pending the final approval of the settlement in the Securities Class
Action. Plaintiffs filed a motion to dismiss the Company without prejudice on
October 29, 2004.
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 new shares of common stock
that the Company has agreed to issue under the Securities Class Action and
Covalar Action settlements. 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. On October 12, 2004, the Court heard the demurrers of the Company,
the underwriters, the auditors, the Company's former CEO and the Company's
former CFO. The Court sustained in part with leave to amend and overruled in
part the Company's demurrer, overruled the auditors' demurrer, and sustained the
other defendants' demurrers with leave to amend. Plaintiffs filed an amended
complaint on November 1, 2004. A case management conference has been scheduled
for January 11, 2005.
7
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 reached an agreement
in principle to settle these derivative actions and are preparing a stipulation
of settlement. The parties have stipulated to extend the time to respond to the
consolidated derivative complaint until December 29, 2004.
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 a
Second Amended Cross-Complaint on September 29, 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. HPL answered the Third Amended Complaint
on August 20, 2004 and asserted several affirmative defenses against Twin City.
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 September 30, 2004, the company has accrued $9.1 million for the
above matters. Except as noted above, these matters are in the early stages of
litigation and 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.
8
The total number of shares excluded from the calculation of diluted net
loss per share is detailed in the table below (in thousands):
Three months ended Six months ended,
September 30, September 30
-------------------------------------------------------
2004 2003 2004 2003
------------- ------------- ------------ ------------
Outstanding stock options 7,168 7,876 7,168 7,876
Shares issuable under warrants - 138 - 138
------------- ------------- ------------ ------------
Total 7,168 8,014 7,168 8,014
============= ============= ============ ============
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 September 30, 2004, the Company's
top four customers accounted for 23%, 23%, 11 %, and 10% of the Company's
accounts receivable and unbilled receivables combined. At September 30, 2003,
the Company's top four customers accounted for 17%, 13%, 11% and 10% 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 and six months ended September 30, 2004,
comprehensive loss was $ 3.2 million and $ 5.9 million, respectively. The
difference between net loss and comprehensive loss for the three and six months
ended September 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 gain of $20,000 and net loss of
$28,000, respectively.
For the three months and six months ended September 30, 2003,
comprehensive loss was $3.5 million and $8.8 million, respectively. The
difference between net loss and comprehensive loss for the three months and six
months ended September 30, 2003, 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 $22,000 and $45,000,
respectively.
9
NOTE 6. ACCRUED LIABILITIES
Accrued liabilities consist of the following (in thousands):
September 30, 2004 March 31, 2004
------------------------------------------------
Payroll and related expenses $ 664 $ 888
Professional fees 615 528
Other accrued expenses 730 828
Amounts received from HPL's former Chief Executive Officer 4,335 4,335
------------------------ ----------------------
$ 6,344 $ 6,579
======================== ======================
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):
September 30, 2004
-----------------------------------------------------------
Amortization Gross Carrying Accumulated Net Carrying
Period Amount Amortization Amount
--------------------- ---------------- ------------------ -----------------
Existing technology 3 years $ 2,760 $ (2,395) $ 365
Modular library 3 years 1,220 (1,068) 152
----------------- ------------------ -----------------
$ 3,980 $ (3,463) $ 517
================= ================== =================
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
================= ================== =================
The amortization of intangible assets for the six months ended
September 30, 2004 and 2003 was $664,000 and $664,000, respectively.
The estimated future amortization of intangible assets for the
remaining six months ending March 31, 2005 is $517,000.
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
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.
10
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):
Three months ended Six months ended
September 30, September 30,
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net loss as reported: $ (3,262) $ (3,438) $ (5,883) $ (8,804)
Add: stock-based employee compensation expense included in
reported net loss under APB No. 25 12 22 23 128
Deduct: total employee stock-based compensation
determined under fair value based method for all
awards, net of related tax effects (165) 11 (347) (110)
------------ ------------ ------------ ------------
Pro forma net loss $ (3,415) $ (3,405) $ (6,207) $ (8,786)
============ ============ ============ ============
Basic and diluted net loss per share:
As reported $ (0.10) $ (0.11) $ (0.19) $ (0.28)
Pro forma $ (0.11) $ (0.11) $ (0.20) $ (0.28)
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):
Three months ended Six months ended
September 30, September 30,
------------------------- ----------------------------
2004 2003 2004 2003
------------ ------------ -------------- ------------
United States $ 527 $ 683 $ 1,708 $ 1,838
Japan 487 1,963 903 2,247
Rest of Asia 703 304 2,230 897
Rest of the world 73 334 110 374
------------ ------------ -------------- ------------
Total $ 1,790 $ 3,284 $ 4,951 $ 5,356
============ ============ ============== ============
For the three months and six months ended September 30, 2004,
the Company derived revenue from two and four customers, which comprised 26%
and 55% of the Company's total revenues, respectively.
For the three and six months ended September 30, 2003, the Company
derived revenue from its Japanese distributor and two end-user customers, which
comprised 45% and 45% of the Company's total revenues, respectively.
11
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 September 30,
2004.
12
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. Furthermore, even if coverage is afforded, 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,
accordingly, the Company has recorded no liability for these obligations at
March 31, 2004 or September 30, 2004.
The Company includes standard intellectual property indemnification
clauses in its software license agreements. Pursuant to these provisions, HPL
agrees to hold harmless and 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 September
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 September 30, 2004.
NOTE 11. RECENT ACCOUNTING PRONOUNCEMENTS
In March 2004 the Emerging Issues Task Force ("EITF") reached a final
consensus on Issue No. 03-06, "Participating Securities and the Two-Class Method
Under FASB Statement No. 128 Earnings Per Share" . Issue No. 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 No. 03-06 is effective for the first fiscal period beginning
after its issuance. During the quarter ended June 30, 2004, we adopted Issue No.
03-06 and the adoption did not have any material effect on our financial
position or results of operations.
In March 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
13
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. On October 13, 2004, the FASB delayed the effective
date of its proposed standard for public companies for interim or annual periods
beginning after June 15, 2005, rather than December 15, 2004 as originally
proposed. The propsed standard's effective date would be applicable for awards
that are granted, modified, or settled in cash in interim or annual periods
beginning after June 15, 2005. The FASB recently decided to include in the
proposed statement two transition methods: one that provides for prospective
application and one that provides for retrospective application. The proposed
effective date and the two transition alternatives will present specific issues
that public companies will need to address as part of their implementation
strategy. 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.
In July 2004, the EITF issued a draft abstract for EITF Issue No.
04-08, "The Effect of Contingently Convertible Debt on Diluted Earnings per
Share" ("EITF 04-08"). EITF 04-08 reflects the Task Force's tentative conclusion
that contingently convertible debt should be included in diluted earnings per
share computations regardless of whether the market price trigger has been met.
If adopted, the consensus reached by the Task Force in this Issue will be
effective for reporting periods ending after December 15, 2004. Prior period
earnings per share amounts presented for comparative purposes would be required
to be restated to conform to this consensus and the Company would be required to
include the shares issuable upon the conversion of the Notes in the diluted
earnings per share computation for all periods during which the Notes are
outstanding. The Company is currently evaluating the effect of this proposed
statement on its financial position and results of operations.
In September 2004, the EITF delayed the effective date for the
recognition and measurement guidance previously discussed under EITF Issue No.
03-01, "The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments" ("EITF 03-01") as included in paragraphs 10-20 of the
proposed statement. The proposed statement will clarify the meaning of
other-than-temporary impairment and its application to investments in debt and
equity securities, in particular investments within the scope of FASB Statement
No. 115, "Accounting for Certain Investments in Debt and Equity Securities," and
investments accounted for under the cost method. The Company is currently
evaluating the effect of this proposed statement on its financial position and
results of operations.
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.
14
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.
Since July 2002, we experienced a significant period of transition as a
result of our investigation into financial and accounting irregularities which
ultimately led 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. In our year ended 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 senior positions with the hiring of a new Chief
Executive Officer, 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 September 30, 2004, we had $7.0 million in cash,
cash equivalents and short term investments and an accumulated deficit of $103.9
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 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 and six months ended September 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
September 30, 2004 two customers accounted for 26% of our revenues and during
the three months ended September 30, 2004 our Japanese distributor accounted for
45% of our revenues. During the six months ended September 30, 2004 four
customers accounted for 55% of our revenues and during the six months ended
September 30, 2003 one customer and our Japanese distributor accounted for 45%
of our revenues.
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
15
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 there have been no significant changes in our critical
accounting estimates during the six months ended September 30, 2004 as compared
to what was previously disclosed in Management's Discussion and Analysis of
Financial Condition and Results of Operations included in our Annual Report on
Form 10-K for the year ended March 31, 2004.
RECENT ACCOUNTING PRONOUNCEMENTS
In March 2004 the Emerging Issues Task Force ("EITF") reached a final
consensus on Issue No. 03-06 " Participating Securities and Two-Class Method
under FASB Statement No. 128 Earnings Per Share". Issue No. 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 No. 03-06 is effective for the first fiscal period beginning
after its issuance. During the quarter ended June 30, 2004, we adopted Issue No.
03-06 and the adoption did not have any material effect on our financial
position or results of operations.
In March 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. On October 13, 2004, the FASB delayed the effective
date of its proposed standard for public companies for interim or annual periods
beginning after June 15, 2005, rather than December 15, 2004 as originally
proposed. The proposed standard's effective date would be applicable for awards
that are granted, modified, or settled in cash in interim or annual periods
beginning after June 15, 2005. The FASB recently decided to include in the
proposed statement two transition methods: one that provides for prospective
application and one that provides for retrospective application. The proposed
effective date and the two transition alternatives will present specific issues
that public companies will need to address as part of their implementation
strategy. 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.
In July 2004, the EITF issued a draft abstract for EITF Issue No.
04-08, "The Effect of Contingently Convertible Debt on Diluted Earnings per
Share" ("EITF 04-08"). EITF 04-08 reflects the Task Force's tentative conclusion
that contingently convertible debt should be included in diluted earnings per
share computations regardless of whether the market price trigger has been met.
If adopted, the consensus reached by the Task Force in this Issue will be
effective for reporting periods ending after December 15, 2004.
Prior period earnings per share amounts presented for comparative purposes would
be required to be restated to conform to this consensus and the Company would be
required to include the shares issuable upon the conversion of the Notes in the
diluted earnings per share computation for all periods during which the Notes
are outstanding. The Company is currently evaluating the effect of this proposed
statement on its financial position and results of operations.
16
In September 2004, the EITF delayed the effective date for the
recognition and measurement guidance previously discussed under EITF Issue No.
03-01, "The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments" ("EITF 03-01") as included in paragraphs 10-20 of the
proposed statement. The proposed statement will clarify the meaning of
other-than-temporary impairment and its application to investments in debt and
equity securities, in particular investments within the scope of FASB Statement
No. 115, "Accounting for Certain Investments in Debt and Equity Securities," and
investments accounted for under the cost method. The Company is currently
evaluating the effect of this proposed statement on its financial position and
results of operations.
RESULTS OF OPERATIONS
Comparison of the three and six months ended September 30, 2004 and 2003
Revenues. Total revenues decreased to $1.8 million in the three months
ended September 30, 2004 from $3.3 million in the three months ended September
30, 2003, or a decrease of 45%. Total revenues decreased to $5.0 million in the
six months ended September 30, 2004 from $5.4 million in the six months ended
September 30, 2003, or a decrease of 8%. 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 decrease in revenue is
primarily due to the delay of integration and installation of our products in
addition to a decline in customer orders during the three months ended September
30, 2004. 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 were highly concentrated, and, during the three months
ended September 30, 2004 and 2003, two customers and one customer accounted for
26% and 45% of our revenues, respectively. During the six months ended September
30, 2004 and 2003, four and two customers accounted for 55% and 45% of our
revenues, respectively.
Software license revenue decreased to $294,000 in the three months
ended September 30, 2004 from $1.9 million in the three months ended September
30, 2003. Software license revenue decreased to $1.7 million in the six months
ended September 30, 2004 from $2.0 million in the six months ended September 30,
2003.The decrease in our license revenue during the three and six months ended
September 30, 2004 is primarily due to the delay of integration and installation
of our products in addition to a decline in new licenses during the three months
ended September 30, 2004.
Consulting services, maintenance and other revenues increased slightly
to $1.5 million in the three months ended September 30, 2004, up from $1.4
million in the three months ended September 30, 2003. Consulting services,
maintenance and other revenues remained flat in the six months ended September
30, 2004 and September 30, 2003.
Gross profit. As a percentage of revenues, gross profit decreased to
57% for the three months ended September 30, 2004 from 71%, for the three months
ended September 30, 2003. As a percentage of revenues, gross profit increased to
69% for the six months ended September 30, 2004 from 67%, for the six months
ended September 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 in this period among software licenses, maintenance fees and consulting
services.
17
Research and development. Research and development expenses represented
96% of revenues in the three months ended September 30, 2004, compared to 47% of
revenues in the three months ended September 30, 2003 due to the revenue decline
during the three months ended September 30, 2004. Research and development
expenses represented 67% of revenues in the six months ended September 30, 2004,
compared to 63% of revenues in the three months ended September 30, 2003. Actual
costs increased to $1.7 million for the three months ended September 30, 2004,
up from $1.5 million for the three months ended September 30, 2003. Actual costs
decreased to $3.3 million for the six months ended September 30, 2004 down from
$3.4 million for the six months ended September 30, 2003. 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 September 30, 2004 were $2.3 million, or
126% of revenues, compared to $3.9 million, or 119% of revenues in the three
months ended September 30, 2003. The decrease in costs was primarily due to
decreases in staff in the amount of approximately $ 600,000 and lower
professional fees associated with our pending litigation in the amount of
approximately $700,000. Sales, general and administrative expenses for the six
months ended September 30, 2004 were $4.3 million, or 87% of revenues, compared
to $8.3 million, or 155% of revenues in the six months ended September 30, 2003.
The decrease in costs was primarily due to decreases in staff in the amount of
approximately $1.4 million and lower professional fees associated with our
pending litigation in the amount of approximately $1.9 million.
Stock-based compensation. Stock-based compensation expense for the
three months ended September 30, 2004 decreased to $12,000, compared with
$22,000 for the three months ended September 30, 2003. Stock-based compensation
expense for the six months ended September 30, 2004 decreased to $23,000,
compared with $128,000 for the six months ended September 30, 2003. The decrease
was primary a result of reversing previously expensed stock-based compensation
that was being amortized on an accelerated basis that was not earned by certain
terminated employees during the three and six months ended September 30, 2004.
Amortization of intangible assets. Amortization of intangible assets
was $332,000 in the three months ended September 30, 2004 and September 30,
2003. Amortization of intangible assets was $664,000 in the six months ended
September 30, 2004 and September 30, 2003. The estimated quarterly amortization
of intangible assets will be $332,000 in the quarter ending December 31, 2004
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 September 30, 2004, was
$34,000, compared to $47,000 for the three months ended September 30, 2003. This
decrease was due to lower interest income from lower average balances of cash,
cash equivalents and short-term investments during the three months ended
September 30, 2004.
Provision for income taxes. In the three and six months ended September
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 September
30, 2004 and 2003. Our income tax provision of $4,000 in the three months ended
September 30, 2004 was primarily from the Company's international subsidiaries
payable to the local jurisdictions. Our income tax benefit of $145,000 in the
six months ended September 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.
18
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 September 30, 2004, we had an accumulated deficit of $103.9 million.
We expect to have a net operating loss in our year ending March 31, 2005. For
the six months ended September 30, 2004 cash used in operations and to fund
capital expenditures was $3.1 million. Such conditions raise doubt about our
ability to continue as a going concern unless we increase our revenues or raise
additional capital. At September 30, 2004, we had approximately $7.0 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 $7.0 million in cash and cash equivalents and
short-term investments on hand at September 30, 2004 will be adequate to fund
operations only 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. Although we intend to seek additional funds
to support our future operations, 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. If we are unable to raise
adequate capital to fund our future operations, we may need to curtail our
operations and seek other strategic alternatives.
Net cash used in operating activities was $2.7 million for the six
months ended September 30, 2004, compared to $7.0 million used in operating
activities for the six months ended September 30, 2003, mainly due to a lower
operating loss and a higher accounts receivable collection during the six months
ended September 30, 2004.
Net cash provided by investing activities was $664,000 for the six
months ended September 30, 2004, compared to $5.2 million used in operating
activities for the six months ended September 30, 2003. The cash used in
investing activities for the six months ended September 30, 2003 consisted
primarily of the purchase of marketable securities in the amount of $5.0
million.
Net cash used in financing activities was $65,000 for the six months
ended September 30, 2004. Net cash used in financing activities was $1.7 million
for the six months ended September 30, 2003, mainly due to the repayment of our
$1.5 million convertible debenture and $221,000 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 September 30, 2004, a summary of our
contractual commitments is as follows:
19
Payment Due by Year Ending March 31,
Total 2005 2006 2007 2008 2009
----------------------------------------------------------------------------------
Capital Lease Obligation $ 96 $ 56 $ 27 $ 13 $ - $ -
Rent Obligation 1,752 683 1,048 20
----------------------------------------------------------------------------------
Total $ 1,848 $ 739 $ 1,075 $ 33 $ - $ -
==================================================================================
Overall, we used $1.2 million of cash, cash equivalents, and short-term
investments during the three months ended September 30, 2004. We estimate that
we will continue to use cash through our year ending March 31, 2005 to fund
operating losses.
RISK FACTORS
RISKS ASSOCIATED WITH OUR BUSINESS
We need to increase revenues, reduce costs or raise additional capital to fund
our operating activities.
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 only
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
settlements in the Securities Class Action and the Covalar Action whereby we
have agreed to issue approximately 7 million new 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
and results of operations. In addition, the Company is investigating informal
20
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, the pending securities litigation and our limited cash reserves 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 affected 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.
21
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. 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
of any significant future sales of software licenses, which has significantly
22
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 flat
panel display manufacturers. 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.
23
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 new 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.
24
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.
We rely on our employees for their scientific, technical and management
experience in connection with our business operations.
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.
25
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.
26
The laws of some foreign countries do not protect our intellectual property as
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 $4,000 decrease in the fair value of our available-for-sale
securities as of September 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 16% and 9% of total revenues for the three months and
six months ended September 30, 2004, are denominated in Yen. A 10% adverse
27
change in Yen exchange rates would not have had a material impact on revenues
for the three months ended September 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 September 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.
28
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,
weaknesses in the control system or acts of fraud and to confirm that
appropriate corrective action, including process improvements, if any, were
29
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.
30
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. UNREGISTERED SALES OF EQUITY 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 August 13, 2004,
reporting the financial results for the first quarter of fiscal year 2005.
31
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: November 12, 2004 By: /s/ CARY D. VANDENBERG
-------------------------------------
Cary D. Vandenberg
President and Chief Executive Officer
32
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
33
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 officer(s) 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: November 12, 2004
/s/ Cary D. Vandenberg
- ----------------------
Cary D. Vandenberg
President and Chief Executive Officer
34
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 officer(s) 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: November 12, 2004
/s/ Michael P. Scarpelli
- ------------------------
Michael P. Scarpelli
Chief Financial Officer
35
Exhibit 32.1
CERTIFICATION PURSUANT TO
SECTIONS 906 OF THE SARBANES-OXLEY ACT OF 2002
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: November 12, 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.
36
Exhibit 32.2
CERTIFICATION PURSUANT TO
SECTIONS 906 OF THE SARBANES-OXLEY ACT OF 2002
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: November 12, 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.
37