<PAGE>


                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549

                                    FORM 10-K

            [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998

                                       OR

          [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

                         COMMISSION FILE NUMBER 0-26274

                      INTEGRATED MEASUREMENT SYSTEMS, INC.
             (Exact name of registrant as specified in its charter)

                     OREGON                                    93-0840631
         (State or other jurisdiction of                      (IRS Employer
         incorporation or organization)                    Identification No.)

     9525 SW GEMINI DRIVE, BEAVERTON, OREGON                      97008
    (Address of principal executive offices)                   (Zip Code)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:         (503) 626-7117

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

                                 TITLE OF CLASS
                     Common Stock, $.01 par value per share

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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ____________

The aggregate market value of the voting stock held by non-affiliates of the
Registrant was $58,752,351 on March 12, 1999, based upon the last sales price of
the Common Stock on that date reported in the NASDAQ National Market System. On
March 12, 1999, there were 7,460,616 shares of the Registrant's Common Stock
outstanding, including 2,856,147 held by affiliates.

                       DOCUMENTS INCORPORATED BY REFERENCE

     Document                          Part of Form 10-K into which incorporated
     --------                          -----------------------------------------
Portions of Proxy Statement                            Part III
dated April 2, 1999                 

                                       1
<PAGE>

                      INTEGRATED MEASUREMENT SYSTEMS, INC.
                          1998 FORM 10-K ANNUAL REPORT

                                TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                      PAGE
                                                                      ----
                              PART I

<S>                                                                    <C>
Item 1.    Business                                                      3

Item 2.    Properties                                                    8

Item 3.    Legal Proceedings                                             8

Item 4.    Submission of Matters to a Vote of Security Holders           8

                              PART II

Item 5.    Market for Registrants Common Equity and Related              9
           Stockholder Matters

Item 6.    Selected Financial Data                                      10

Item 7.    Management's Discussion and Analysis of Results of           11
           Operations and Financial Condition

Item 8.    Financial Statements and Supplementary Data                  18

Item 9.    Changes in and Disagreements with Accountants on             18
           Accounting and Financial Disclosure

                              PART III

Item 10.   Directors and Executive Officers of Registrant               18

Item 11.   Executive Compensation                                       18

Item 12.   Security Ownership of Certain Beneficial Owners and          18
           Management

Item 13.   Certain Relationships and Related Transactions               18

                              PART IV

Item 14.   Exhibits, Financial Statements Schedules, and Reports        19
           on Form 8-K
</TABLE>

                                 2
<PAGE>



                                     PART I

ITEM 1.  BUSINESS

                                     GENERAL

Integrated Measurement Systems, Inc. (the Company) was incorporated in Oregon in
1983. The Company operated as an independent entity until it was acquired by
Valid Logic, Inc. ("Valid Logic") in 1989. In 1991, the Company became a
wholly-owned subsidiary of Cadence Design Systems, Inc. ("Cadence") as a result
of the merger of Valid Logic with Cadence. Both Cadence and Valid Logic operated
the Company as a separate subsidiary. On July 21, 1995, the Company successfully
completed an initial public offering of common stock, with 375,000 shares sold
by the Company, and 2,615,000 shares sold by Cadence. In February 1997, the
Company completed a secondary public offering of common stock, in which 700,000
shares were sold by the Company and 950,000 shares were sold by Cadence. As of
December 31, 1998, Cadence owned approximately 37% of the outstanding common
stock of the Company. On September 3, 1998, the Company acquired all of the
assets of PerformIC, a Germany-based designer and manufacturer of memory
engineering Test Stations, and subsequently established its European Design
Center in Dresden, Germany. The Company's European Design Center will
concentrate on the development of technologies aimed at addressing the
engineering test needs of memory manufacturers. The Company's common stock is
traded on the NASDAQ National Market System under the symbol IMSC.

                              PRODUCTS AND SERVICES

The Company designs, manufactures, markets and services a family of versatile,
high performance engineering Test Stations. Customers use the Company's Test
Stations to test, at the prototype stage, complex digital, mixed-signal and
memory devices such as microprocessors, application specific integrated circuits
(ASICS's), multi-chip modules (MCM's), static random access memory (SRAM) and
dynamic random access memory (DRAM) devices. In addition, the Company develops,
markets and supports a line of Virtual Test Software that permits design and
test engineers to automate test program development and to conduct simulated
tests of electronic device designs prior to the fabrication of the prototype of
the actual device. The Company's products enable its customers to shorten
time-to-market, enhance accuracy of design, reduce both the time required to
test and the cost of testing devices and provide reliable and prompt feedback to
both design and test engineers.

IMS TEST STATION PRODUCTS
The Company's Test Stations play a variety of roles in bridging the gap between
electronic design automation (EDA) to automated test equipment (ATE). At the
beginning of the process, design engineering data, including EDA simulation
data, is converted into data compatible with the Company's Test Station, thus
bridging the gap between design software and verification. The IMS Test Stations
enable data conversion from popular simulation products including Verilog, VHDL,
Quicksim and others.

The IMS Test Stations stimulate the device under test by sending defined signals
to it and then measure the actual output and compare it with the expected
output. The IMS Test Stations perform these functions at real-time device
operating speeds. Using the Company's products, design and test engineers can
identify failures, assess areas of concern, run short diagnostic sequences to
pinpoint the cause(s) of failure, and identify changes needed to correct or
enhance designs. IMS Test Stations are designed to work with industry standard
computers to receive and execute test commands and report the results of test
procedures. IMS Test Stations can also be linked to widely used EDA software
tools, including those offered by Cadence, Mentor Graphics, Synopsys and others.
The result is a reduction of the overall time required for verification and
characterization, more timely feedback to design engineers and hence lower cost
of design, reduced time-to-market and increased competitiveness for the
companies designing today's increasingly complex integrated circuits.

The Company complies with industry standard conventions which facilitate
compatibility with ATE equipment. Compatible design between the Company's Test
Stations and ATE systems enables rapid movement of devices from the engineering
test environment to production test.

                                    3
<PAGE>

The Company's Test Stations are designed and configured to match varying
customer requirements. Generally, they differ from one another as to the maximum
clock speed and data rates (from 40 MHz to 500 MHz), size of the device to be
tested (from 16 to 896 or more total pins), device type (digital, mixed-signal,
MCM, memory), flexibility in the number and variety of applications
(verification, characterization, failure analysis, etc.), and price. Test
Stations typically range in price from $500,000 to $1.5 million, though
high-speed, high-pin-count systems can sell for over $2.0 million (depending on
configuration and intended application).

The Company currently offers three families of Test Stations. The digital
family, which accounted for 48% of total revenues in 1998, is the oldest and
largest of the three families. Customers typically use the Company's digital
Test Stations to verify the designs of complex microprocessors, application
specific IC's (ASIC's) and Multichip Modules (MCM's). Included in this family
are the ATS and XTS products, the Company's flagship products for the past
several years, which can test devices at up to 200MHz. These systems sell for
between $250,000 and $1,800,000, depending on the configuration, and accounted
for the majority of digital family revenues in 1998. In October, 1998 the
Company introduced its newest generation of digital Test Station, the Vanguard.
This product, which can test devices up to 500 MHz, sells for between $900,000
and $2,300,000 and is expected to account for the majority of the digital family
revenues in future years.

The mixed signal family of Test Stations includes the older generation MSTS, and
the Electra, which was introduced in 1998. Mixed signal Test Stations are used
by customers to verify the designs of complex devices used in such applications
as Digital Subscriber Loop (DSL) modems, 100 megabit ethernet and 3D graphics.
Depending on the configuration, the mixed signal Test Stations can test devices
at up to 200 MHz and sell for between $300,000 and $2,100,000. Mixed signal Test
Stations accounted for 11% of total revenues in 1998.

With the acquisition of Perform IC in September, 1998, the Company added its
newest Test Station family, the Orion Memory Test Stations. The Orion will be
used by customers to verify the designs of complex SRAM's and DRAM's at speeds
up to 200MHz. Depending on the configuration, these Test Stations sell for
between $400,000 and $600,000. The Company expects to begin shipping Orion Test
Stations to customers during 1999. (Please refer to "Research and Development"
discussion below, and to "Management's Discussion and Analysis of Results of
Operations and Financial Condition" for cautionary statements that may bear on
this forward looking statement.)

TEST STATION SOFTWARE PRODUCTS
The Company has developed Test Station software products that are either
embedded in the Company's Test Stations or sold as separate add-on software
products. These software packages provide optimal operation in various
applications, including interactive device verification, automated device
characterization, and EDA and ATE system linkages.

The Company's Test Stations can be interfaced to a network, allowing the Test
Station access to other resources on the network, and allowing multiple
workstations on the network to have access to the Test Station. Using various
software tools available from the Company or from third-party vendors, users can
import and export test data to and from the EDA environment. In addition, test
information can be exported for use on traditional ATE systems.

VIRTUAL TEST SOFTWARE
While EDA tools have helped improve designer productivity, little has been done
to provide test development engineers with software productivity tools. As a
result, test development times have increased while design time has been
reduced. To address this trend, the Company has made a major commitment to
providing a set of software tools for test engineers. These tools, called
Virtual Test Software, allow the test engineer to accelerate the generation of a
test program, simulate the test environment, develop the test fixture and
document the entire test process. These tools are run on a workstation rather
than on an expensive ATE system. This software can be used to simulate the ATE
environment and eliminate the need to use ATE machines for debugging test
programs, and allows test engineers to develop test programs in parallel with
the design, prototype manufacturing and engineering test processes.

The Company's TestDirect Virtual Test Software, introduced in the first half of
1997, is a productivity tool for digital test engineers. TestDirect is a test
pattern generation program that provides test engineers with an automatic 

                                        4
<PAGE>

tool for generating ATE test patterns from the designer's original test bench 
simulation environment. This process shortens the overall product development 
cycle, increasing a customer's revenue potential and improves their 
time-to-market competitiveness. The IMS Digital VirtualTester is the first 
automated test productivity software tool to provide a high-quality, 
cost-effective way to verify and debug IC test patterns and timing on 
engineering workstations without having to wait until first silicon and 
without using valuable ATE time. Harnessing the power of EDA simulation and 
proprietary ATE data, the Digital VirtualTester can reduce time-to-market 
costs by allowing engineers to perform IC test development prior to silicon 
fabrication in a fault-free, virtual test environment.

Although the market for Virtual Test Software is relatively difficult to
quantify, the Company believes that its TestDirect, and Digital VirtualTester
software products and services provide a significant advantage to semiconductor
designers to reduce time to market and save development cost. The Virtual Test
software products currently operate in conjunction with Cadence EDA software and
certain ATE machines manufactured by Advantest, Credence, Hewlett-Packard, LTX,
and Teradyne. In 1998, revenues from the sale of Virtual Test Software and
related services comprised approximately 11% of the Company's net sales.

                            RESEARCH AND DEVELOPMENT

The electronic design and test equipment market is subject to rapid
technological change and new product introductions. The Company's ability to
remain competitive in this market will depend in significant part upon its
ability to continue to successfully develop and introduce new products and
enhancements to existing products on a timely and cost-effective basis. There
can be no assurance that the Company will be successful in developing and
marketing new products and product enhancements that respond to technological
change, evolving industry standards and changing customer requirements; that the
Company will not experience difficulties that could delay or prevent the
successful development, introduction and marketing of these products; or that
its new products and product enhancements will adequately meet the requirements
of the marketplace and achieve market acceptance.

The Company has historically devoted the great majority of its research and
development efforts to the design and development of engineering Test Stations
and related hardware and software technologies. Certain of the Company's Virtual
Test Software technologies were originally developed by Cadence employees and
purchased by the Company. The Company is currently developing additional
software products for its Virtual Test product line and expects to continue
considerable internal research and development efforts for this product line in
the future.

The Company also from time to time evaluates opportunities to acquire technology
and assets. In 1998, the Company acquired PerformIC a developer of technologies
aimed at addressing the engineering test needs of memory manufacturers. The
Company has established its new European Design Center in Perform IC's
facilities in Dresden, Germany to principally concentrate on developing Test
Station technologies to address the memory market. The Company currently
believes that the research and development efforts will result in commercially
feasible products in the next 12 months. (Please refer to "Management's
Discussion and Analysis of Results of Operations and Financial Condition" for
cautionary statements that may bear on this forward looking statement.)

The Company's research and development efforts are performed by approximately 78
employees at locations at Company headquarters in Beaverton, Oregon and the
Company's European Design Center in Dresden, Germany.

                            MANUFACTURING OPERATIONS

The Company's test systems are complex and are used by the Company's customers
in critical projects that demand a high level of quality and reliability. The
Company invests significant resources to assure the high quality and reliability
of its test systems and is committed to providing a high level of service to its
customers in the event of malfunction to minimize downtime. The Company's
manufacturing operations primarily consist of order administration, materials
planning, procurement, final assembly, quality control of materials, components
and subassemblies, final systems integration and extensive calibration and
testing. The Company uses a manufacturing control computer system to monitor
orders, purchasing, inventory, production and manufacturing costs.

                                     5
<PAGE>

The components used in the Company's products consist of standard parts
available from numerous vendors, along with a number of proprietary items
available only from sole or single source suppliers. The Company currently uses
several independent third-party vendors to manufacture its subassemblies and
semiconductor components, including circuit boards, integrated circuits and
integrated circuit packaging, cable assembly and mechanical parts. External
manufacturing is performed to the Company's specifications with technical
support from the Company. In the event that any of the Company's third-party
vendors, particularly its sole and single source vendors, were to experience
financial, operational, production or quality assurance difficulties, or a
catastrophic event that resulted in a reduction or interruption in supply to the
Company, the Company's operating results could be materially adversely affected
until the Company was able to establish sufficient manufacturing supply from
alternative sources. The Company has partially mitigated this risk by securing
$12 million of insurance coverage against potential losses resulting from an
insurable peril experienced by any of the Company's critical suppliers. While to
date suitable third party manufacturing capacity has been available, there can
be no assurance that such manufacturers will be able to meet the Company's
future requirements or that such services will continue to be available to the
Company at favorable prices.

The Company manufactures its digital and mixed signal test stations at its 
headquarters facility in Beaverton, Oregon. It is currently manufacturing 
prototype Orion Test Stations at the Perform IC facilities in Dresden, 
Germany, but plans to move the memory Test Station manufacturing operations 
to its European Headquarters in Sargans, Switzerland as soon as such a move 
is practical.

The Company believes it has developed a strong vendor base, purchasing
components and subassemblies both from national distributors and directly from
vendors' factories. Some of the subassembly vendors are small, local companies
to which IMS represents substantial volume.

Currently, the Company purchases a number of critical parts from sole source
suppliers for which alternative sources are not available. The Company's
reliance on a sole or a limited group of suppliers, some of which are small
independent companies, and on outside subcontractors involves several risks,
including a potential inability to obtain an adequate supply of required
components and reduced control over pricing and timely delivery of components.
The Company has generally been able to obtain adequate supplies of components in
a timely manner from current vendors, or, when necessary to meet production
needs, from alternate vendors. The Company has thus far been able to avoid any
material adverse impact on timing of customer deliveries for its Test Stations.
However, no assurance can be given that supply problems will not occur or, if
such problems do occur, that the Company's solutions to these problems will be
effective in every case. Any prolonged inability to obtain adequate supplies of
quality components or any other circumstances that would require the Company to
seek alternative sources of supply could have a material adverse effect on the
Company's business, financial condition and results of operations and could
damage the Company's relationships with it customers.

The Company's Test Stations have a history of staying in the market for many
years. Over time suppliers of critical components may discontinue manufacturing
such components. In such cases, when designing that component out of the product
is deemed to not be feasible, the Company will place a last time buy order for
the component. Although the Company uses the best information available at the
time to determine the last time buy quantities, no assurance can be given that
such quantities will be adequate to meet the requirements over the remainder of
the product's remaining life. There also can be no assurance given that such
life time buy quantities are not in excess of requirements over the product's
remaining life.

                               MARKETING AND SALES

The Company markets its products domestically through a direct sales force which
has primary responsibility for developing orders, coordinating distribution,
providing demonstrations and providing applications support. The Company employs
skilled applications and service engineers and technically proficient sales
people capable of serving the sophisticated needs of prospective customers'
engineering staffs as part of the customer support process. The domestic sales
force is managed from the Company's headquarters in Beaverton, Oregon and its
regional offices in Irvine and Santa Clara, California; Boston, Massachusetts;
Phoenix, Arizona; and Columbia, Maryland.

                                       6
<PAGE>

The Company markets its products in the European region through a direct sales
force in France, independent distributors in Germany, Scandinavia, Italy, Turkey
and Israel, and through dedicated agents employed by Cadence in The United
Kingdom. In Asia the Company sells through dedicated agents employed by Cadence
in Taiwan, through a dedicated sales force in Japan and through distributors in
the People's Republic of China, Hong Kong, Malaysia/Singapore and Korea. The
Company's foreign sales and service operations are subject to risks inherent in
foreign operations, including unexpected changes in regulatory requirements,
exchange rates, tariffs or other barriers and potentially negative tax
consequences. In addition, in certain jurisdictions, there is a risk of reduced
protection for the Company's copyrights, trademarks and trade secrets.
Additional information regarding foreign sales is contained in Note 13 to the
Financial Statements contained in this Annual Report.

The Company uses advertising in trade journals, technical articles, exhibits at
trade shows, direct mail and telephone solicitations to build interest in the
Company and its products. The Company provides extensive training for its sales
representatives and distributors and supports its representatives and
distributors with marketing tools, including sales brochures, demonstration test
equipment and promotional product literature.

For the years ended December 31, 1998, 1997, and 1996, sales to Intel
represented approximately 25%, 27% and 36% of the Company's net sales,
respectively. No other customer accounted for more than 10% of the Company's net
sales in 1998, 1997 or 1996.


                                   COMPETITION

The design and test equipment market is highly competitive. Although the Company
believes that it has a competitive advantage in the verification market due to
the high performance and cost effectiveness of its products, the Company
anticipates that technical advancement in the industry generally could lead to
increased competition in the future.

The Company believes that the principal competitive factors in the 
verification and characterization markets are product performance and 
reliability, price, ease of use, marketing and distribution capability, 
service and support and the supplier's reputation and financial stability. 
The Company believes that it competes favorably with respect to all principal 
competitive factors and that it is particularly strong in the areas of 
product performance, ease of use, low cost and service and support.

The Company currently competes with a number of other verification and
characterization equipment manufacturers. Some of these manufacturers, such as
Hewlett-Packard, Teradyne, and Schlumberger have significantly greater
financial, marketing, manufacturing and technological resources than the
Company. New product introductions or product announcements by the Company's
competitors could cause a decline in sales or loss of market acceptance of the
Company's existing products. Moreover, increased competitive pressure could lead
to intensified price-based competition, which could have a material adverse
effect on the Company's business, financial condition and results of operations.
The Company believes that its long-term success will depend largely on its
ability to identify design and test needs ahead of its competitors and develop
products which respond to those needs in a timely manner. In addition, no
assurance can be given that other companies, including EDA companies, will not
develop methodologies and products that are competitive with the Company's
Virtual Test Software business. The Company also believes that to remain
competitive, it will require significant financial resources in order to invest
in new product development and to maintain a worldwide customer service and
support network. There can be no assurance that the Company will continue to
compete successfully in the future.

                          CUSTOMER SUPPORT AND SERVICE

To be competitive, the Company believes it must provide a high level of support
and service. Support and service accounted for 30% of the Company's net sales
for the fiscal year ended December 31, 1998. The Company maintains and supports
products sold directly in the United States, Europe and Japan with the Company's
service and support personnel. The Company's international distributors and
dedicated international sales agents generally 

                                      7
<PAGE>

provide maintenance and support to their customers. The Company offers a 
toll-free technical support hotline to customers and distributors. Support 
engineers answer the technical support calls and generally provide same-day 
responses to questions that cannot be resolved during the initial call.
When necessary, however, support engineers are dispatched to the customer's
facility.

The Company maintains a rapid response program, which is designed to quickly 
respond to customer support issues. Many of the Company's customers currently 
have support agreements with the Company. The Company ranked first in 1997, 
1996, 1995, 1994 and 1993 in customer satisfaction and quality for pure test 
equipment manufacturers according to VLSI Research, Inc. The Company 
generally warrants its Test Systems for twelve months. During the warranty 
period, the Company will repair or replace failed components, will 
investigate all reported software problems and will endeavor to provide a 
solution. No assurances can be given that warranty costs will not increase in 
the future or that any such increase would not have a material adverse effect 
on the Company's financial condition and results of operations.

                                    EMPLOYEES

At December 31, 1998, the Company had 289 employees, including 76 in marketing
and sales, 89 in manufacturing and service, 78 in research, development and
engineering and 39 in administration and finance. The Company also has 7
dedicated employees on the payroll of affiliated companies, which are
international subsidiaries of Cadence. The Company reimburses Cadence the full
cost of the employees' expense to Cadence under the terms of a Corporate
Services Agreement between the Company and Cadence. These employees work full
time on the Company's business and report to and are directly managed by the
Company. See "Item 13. Certain Relationships and Related Transactions." The
Company believes that its future success will depend on its continued ability to
attract and retain highly qualified technical, management and marketing
personnel. The Company's employees are not represented by a collective
bargaining unit and the Company believes that its employee relations are very
good.

ITEM 2.  PROPERTIES

The Company's executive offices, as well as its principal manufacturing,
engineering and marketing operations, are located in a leased building of
approximately 89,000 square feet in Beaverton, Oregon. The lease expires on
February 29, 2004. The Company believes the space will be adequate through that
period and, if required, suitable additional space is available nearby. The
Company also leases a total of approximately 7,300 square feet of office space
in which certain of its regional sales offices are located. Under a Corporate
Services Agreement between Cadence and the Company, Cadence has agreed to
provide office space and associated office support for certain Company personnel
located in the United States and a number of foreign countries.

ITEM 3.  LEGAL PROCEEDINGS

The Company is not a party to any material legal proceedings.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of the security holders of the Company
during the fourth quarter of the fiscal year ended December 31, 1997.

                                     8
<PAGE>

                                     PART II

ITEM 5.  MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

The Company's common stock is traded publicly on the Nasdaq National Market
under the symbol "IMSC." The Company completed its initial public offering of
common stock on July 21, 1995, at a price of $11 per share. The following table
sets forth, for the periods indicated, the high and low prices for the Company's
common stock as reported by the Nasdaq National Market.

<TABLE>
<CAPTION>
                                                           HIGH        LOW
                                                           ----        ---
<S>                                                       <C>         <C>
FISCAL 1997
    First Quarter...................................      23 1/2      14 3/4
    Second Quarter..................................      17 3/4      12
    Third Quarter...................................      18 1/16     10 3/4
    Fourth Quarter..................................      20          15 1/4
FISCAL 1998
    First Quarter...................................      17 3/8      11
    Second Quarter..................................      12 1/2       7 5/8
    Third Quarter...................................      10 5/8       5 3/8
    Fourth Quarter..................................      13 1/4       5 1/4
</TABLE>

As of March 12, 1999, there were approximately 1,347 shareholders that held
beneficial interests in shares of common stock. The Company has not paid any
cash dividends on its common stock, and it does not anticipate paying any cash
dividends in the foreseeable future.

During the quarter ended December 31, 1998, the Company made no sales of
securities that were not registered under the Securities Act of 1933.

                                       9
<PAGE>



ITEM 6.  SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>
                                                        (In thousands, except per share amounts)

                                                                           Year ended December 31,
                                                 --------------------------------------------------------------------------------
                                                  1998               1997              1996              1995              1994
                                                 -------            -------           -------           -------           -------
<S>                                              <C>                <C>               <C>               <C>               <C>
Statement of income data:
  Net sales ...........................          $36,697            $46,850           $50,837           $41,093           $30,052
  Gross margin % ......................             59.6%              65.5%             64.3%             61.6%             58.6%
  Operating income (loss) .............          $(4,587)           $ 7,073           $ 9,495           $ 5,469           $ 2,981
  Operating income (loss) % ...........            (12.5)%             15.1%             18.7%             13.3%              9.9%
  Net income (loss) (a) ...............          $(3,331)           $ 5,205           $ 6,166           $ 3,535           $ 1,910
  Basic earnings (loss) per share (a) .          $ (0.44)           $  0.70           $  0.92           $  0.54           $  0.30
  Diluted earnings (loss) per share (a)          $ (0.44)           $  0.67           $  0.88           $  0.53           $  0.30

                                                                                  December 31,
                                                 --------------------------------------------------------------------------------
                                                  1998               1997              1996              1995              1994
                                                 -------            -------           -------           -------           -------
Balance sheet data:
  Cash and cash equivalents ...........          $ 3,379            $17,464           $ 9,545           $ 8,930           $ 4,384
  Short-term investments ..............          $ 7,630            $ 8,371                --                --                --
  Total assets ........................          $63,414            $65,523           $44,314           $35,184           $22,662
  Long-term obligations, net of
    current portion....................          $   363            $   152           $   278           $    54           $    83
  Shareholders' equity ................          $53,542            $57,433           $34,859           $26,484           $18,269
</TABLE>

   (a)   Net income, basic earnings per share and diluted earnings per share for
         1998, before nonrecurring acquisition and restructuring charges, were
         $129, $0.02 per share, and $0.02 per share, respectively.

                                            10
<PAGE>

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

Unless otherwise indicated, all numerical references are in thousands, except 
percentages and share data.

     The following discussion and analysis should be read in conjunction with 
Selected Financial Data and the Company's Consolidated Financial Statements 
and the Notes thereto included elsewhere in this Annual Report. This Annual 
Report, including the following discussion and analysis of financial 
condition and results of operations, contains certain statements, trend 
analysis and other information that constitute "forward-looking statements" 
within the meaning of the Private Securities Litigation Reform Act of 1995, 
as amended, which may involve risks and uncertainties. Such forward looking 
statements include, but are not limited to, statements including the words 
"anticipate," "believe," "plan," "estimate," "expect," "intend" and other 
similar expressions. The Company's actual results could differ materially 
from those discussed herein due to numerous factors including, but not 
limited to, those discussed in the following discussion and analysis of 
financial condition and results of operations, as well as those discussed 
elsewhere herein.

OVERVIEW

     The Company was founded in 1983 to design and develop engineering Test 
Stations to test and measure complex electronic devices at the prototype 
stage. The Company was acquired by Valid Logic in 1989 and then by Cadence in 
1991 as a result of the merger of Valid Logic into Cadence. Cadence operated 
the Company as a separate subsidiary.

     In July 1995, the Company successfully completed an initial public 
offering of common stock, yielding net proceeds to the Company and Cadence of 
$3.3 million and $26.6 million, respectively. At December 31, 1996, Cadence 
owned approximately 55% of the outstanding common stock of the Company, with 
the remaining 45% publicly owned. In February 1997, the Company completed a 
secondary public offering of its common stock, including 700,000 shares 
issued by the Company, and 950,000 sold by Cadence, yielding net proceeds to 
the Company and Cadence of $13.4 million and $18.6 million, respectively. 
Following the secondary public offering, Cadence continues to own 
approximately 37% of the Company's common stock.

     Prior to 1998, the Company had been profitable for each of the previous 
ten years and had financed its business activities during that period 
principally through cash generated from its own operations. The Company's net 
sales increased from 1994 to 1996 at an annually compounded rate of 30%, 
reflecting the Company's successful introduction of Test Station and Virtual 
Test Software products during these periods. During 1997, net sales declined 
8% from 1996, as a result of a slowdown in orders from certain customers for 
the Company's Test Station products. This slowdown continued and was more 
pronounced during 1998, driven primarily by an overall downturn in the 
economic cycle for companies in the semiconductor industry, many of which are 
long-term customers of the Company. This resulted in a decrease in net sales 
of 22% from 1997 to 1998.

     In September, 1998, the Company acquired all of the assets of PerformIC 
for a cash price of $1.3 million. PerformIC, located in Dresden, Germany, is 
a developer of technologies aimed at addressing the engineering test needs of 
memory manufacturers. A charge for acquired in-process research & development 
of $861 is included in Acquisition and Restructuring costs in the 
accompanying Statements of Operations. With this acquisition, the Company 
opened its new European Design Center in Dresden.

     During the second half of 1998, the Company implemented a restructuring 
plan, including a reduction in the Company's worldwide employee headcount by 
approximately 14%, the termination of certain international distributor 
agreements, and the establishment of direct sales operations in Europe and 
Asia. The primary objectives of the restructuring plan were to strengthen the 
Company's international distribution channel, and to maintain acceptable 
operating expense levels as the Company moves into 1999.

     The total nonrecurring acquisition and restructuring charges recorded in 
the latter part of 1998 amounted to $3.9 million. In addition to the acquired 
in-process research and development expenses, the charges included $2.0 
million for inventories rendered obsolete by the PerformIC acquisition, $623 
associated with the termination of certain international distributors, and 
$424 for severance costs.

     The sales trends and events discussed above, combined with moderate 
growth in operating expenses, resulted in net income of $5.2 million and $6.2 
million for 1997 and 1996, respectively, and a net loss of $3.3 million for 
1998. Future operating results will depend on many factors, including demand 
for the Company's products, the introduction of new products by the Company 
and its competitors, the level and timing of shippable orders and 
                                       


                                      11

<PAGE>
                                       
backlog, the duration and severity of the economic downturn in Asia, and the 
other business risks discussed herein. There can be no assurance that the 
Company's net sales will grow or that such growth will be sustained in future 
periods or that the Company will return to profitability in the near future.

RESULTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 1998 AND 1997

     NET SALES. Net sales is comprised of systems sales (including sales of 
engineering Test Stations), software sales (including Test Station software 
and Virtual Test Software) and service sales, which consists primarily of 
revenue derived from maintenance and consulting contracts. Net sales of $36.7 
million for 1998 were $10.2 million or 22% lower than net sales of $46.9 
million for 1997.

     There is a close correlation between the Company's sales and 
semiconductor industry capital spending. The decline in net sales reflects 
the slowdown in capital spending for the Company's Test Station systems by 
the Company's customers during 1998, as compared to 1997. Many of the 
Company's semiconductor manufacturing customers reduced, delayed or froze 
capital spending beginning in the second half of 1997, due to a broad decline 
in business activity in the semiconductor industry.

     Systems sales decreased $9.7 million or 30% in 1998, as compared to 
1997, primarily due to the slowdown in customer capital spending cited above. 
Software sales increased $913 or 25% in 1998 over 1997, due primarily to an 
increased sales volume for Virtual Test Software products. Sales of services 
declined $1.3 million or 12% during 1998 from 1997, due primarily to the 
completion of certain Virtual Test consulting services contracts in late 
1997, which more than offset growth in the sale of systems maintenance 
contracts. The Company is not currently pursuing consulting services for its 
Virtual Test business.

     International sales, as a percentage of the Company's net sales, 
decreased from 34% for the year ended December 31, 1997 to 26% for the year 
ended December 31, 1998, due primarily to much lower sales to customers in 
Asia-Pacific, partially offset by a moderate improvement in net sales in 
Europe.

     COST OF SALES. Cost of sales consists of material, labor, manufacturing 
and service overhead as well as amortization of capitalized software 
development costs. Total cost of sales decreased 8% from $16.2 million in the 
year ended December 31, 1997 to $14.8 million in the year ended December 31, 
1998.

     Systems cost of sales decreased 18% from $12.2 million for the year 1997 
to $10.0 million for 1998, primarily due to lower sales volume and reductions 
in certain material costs. Partially offsetting these lower costs was a 
charge of $2.0 million to write-off certain inventories made obsolete as a 
result of the PerformIC acquisition during 1998 as discussed above. Software 
cost of sales increased to $707 during 1998 from $211 for 1997, reflecting 
costs for customization of certain Virtual Test Software products sold during 
the first half of 1998. Service and other cost of sales increased 12% from 
$3.7 million in 1997 to $4.1 million in 1998, due primarily to increased 
costs associated with providing maintenance services to a growing installed 
base of the Company's Test Station products.

     GROSS MARGIN. The Company's gross margin of $21.9 million in 1998 
decreased 29% from $30.7 million in 1997, as a direct result of lower net 
sales and the $2.0 million inventory adjustment related to the PerformIC 
acquisition discussed above. Without this inventory adjustment, the Company's 
gross margin would have decreased 22% during 1998 from 1997. Excluding the 
nonrecurring inventory adjustment related to the PerformIC acquisition, gross 
margin decreased to 65% of net sales for 1998, from 66% of net sales for 
1997, reflecting reduced gross margin from sales of services, partially 
offset by higher gross margin from sales of Test Stations.

     The gross margin from sales of the Company's Test Station systems, 
excluding the nonrecurring inventory adjustment related to the PerformIC 
acquisition, was 64% for 1998, compared to 62% for 1997, reflecting 
reductions of certain material costs in 1998. Software gross margin of 85% 
for 1998 was down from 94% in 1997 due primarily to the impact of costs of 
customization of certain software products sold during the first half of 
1998. Sales of services yielded gross margin of 58% during 1998, down from 
67% during 1997 due primarily to the completion of certain higher margin 
Virtual Test consulting contracts in 1997.

     RESEARCH, DEVELOPMENT AND ENGINEERING. Research, development and 
engineering (R&D) expenses consist primarily of employee costs, cost of 
material consumed, depreciation of equipment and engineering related costs. 
R&D expenses decreased 8% from $7.4 million for the year ended December 31, 
1997 to $6.8 million for the year 
                                       


                                      12

<PAGE>
                                       
ended December 31, 1998. As a percentage of net sales, R&D expenses increased 
from 16% in the year ended December 31, 1997 to 18% in the year ended 
December 31, 1998. The decrease in reported R&D expense was principally 
attributable to increased capitalization of software development costs 
associated with development of the Company's new Vanguard Test Station and 
Virtual Test Software products during 1998.

     Gross R&D spending, before capitalization of software development costs, 
increased from $8.5 million during 1997 to $9.2 million during 1998, 
reflecting the cost associated with completing development of the Vanguard 
Test Station product. The first customer shipment of the Vanguard occurred 
during the fourth quarter of 1998. Capitalization of software development 
costs amounted to $2.4 million and $1.1 million in 1998 and 1997, 
respectively.

     Capitalization of software development costs was offset by amortization 
of previously capitalized costs to cost of sales in the amount of $748 and 
$753 during 1998 and 1997, respectively. Amortization is expected to increase 
during 1999, as amounts capitalized related to the Vanguard and certain 
Virtual Test products are now being amortized.

     The Company plans to increase the dollar amount of R&D expense in the 
future, as investments in the development of the Company's Orion memory Test 
Station more than offset reductions in other areas resulting from 
implementation of the restructuring plan discussed above.

     SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative 
(SG&A) expenses include salaries and commissions of sales, marketing and 
administrative personnel, and other marketing and general administrative 
expenses. SG&A expenses increased 10% from $16.2 million for the year ended 
December 31, 1997 to $17.8 million for the year ended December 31, 1998. The 
increase was principally attributable to increased investment in the 
Company's direct distribution channels, most notably in Europe and Japan, as 
well as increased distributor commissions for sales in regions not served by 
the Company's direct sales organization.

     As a percentage of net sales, SG&A expenses increased from 35% in the 
year ended December 31, 1997 to 48% in the year ended December 31, 1998 due 
partially to the increase in SG&A, but primarily to the impact of much lower 
net sales discussed above.

     OTHER INCOME, NET. Other income, net includes interest income, interest 
expense and gain and loss on sale of assets. Other income, net decreased from 
$932 in the year ended December 31, 1997 to $760 in the year ended December 
31, 1998. The decrease was due to the impact of lower average cash and 
investment balances on interest income.

     INCOME TAXES. The Company's benefit from income taxes for 1998 reflects 
recognition of a portion of the benefit from net operating loss 
carryforwards. At December 31, 1998, the Company has recorded deferred tax 
assets from net operating loss carryforwards of $3,538, against which it has 
recorded a valuation allowance of $2,388. As the probability of realizing 
these deferred tax assets in the future increases, the valuation allowance 
will be reduced appropriately. Any such reduction will have a positive impact 
on the Company's effective tax. The valuation allowance includes 
approximately $1.5 million which, if reversed, would be recorded directly to 
Shareholders' Equity in recognition of the tax benefits from deduction of 
employee gains on stock option exercises for tax return purposes.

     The Company's income tax position combines the effects of available tax 
benefits in certain countries where the Company does business, benefits for 
available net operating loss carryforwards, and tax expense for subsidiaries 
with pre-tax income.

YEARS ENDED DECEMBER 31, 1997 AND 1996

     NET SALES. Net sales decreased 8% from $50.8 million in the year ended 
December 31, 1996 to $46.9 million in the year ended December 31, 1997. The 
decrease in net sales was primarily due to the delay of orders anticipated 
from certain customers for the Company's Test Station products into future 
periods.

     Systems sales decreased 14% from $37.5 million in the year ended 
December 31, 1996 to $32.1 million in the year ended December 31, 1997, 
reflecting the shortfall in Test Station system sales. Software sales 
increased 35% from $2.8 million in 1996 to $3.7 million in 1997, due 
primarily to a 76% increase in sales of Virtual Test Software products, which 
was partially offset by a decline in sales of Test Station related software 
products. Service sales 
                                       


                                      13

<PAGE>
                                       
increased 5% from $10.6 million for the year ended December 31, 1996 to $11.1 
million for the year ended December 31, 1997, due principally to growth in 
sales of Virtual Test related services.

     International sales, as a percentage of the Company's net sales, 
increased from 26% for the year ended December 31, 1996 to 34% for the year 
ended December 31, 1997, due primarily to increased sales in Europe and Asia, 
and relatively weaker performance in North America.

     COST OF SALES. Total cost of sales decreased 11% from $18.1 million in 
the year ended December 31, 1996 to $16.2 million in the year ended December 
31, 1997.

     System cost of sales decreased 12% from $13.9 million for the year 1996 
to $12.2 million for 1997, primarily due to lower systems sales volume and 
certain reductions in material costs. Software cost of sales decreased to 
$211 for 1997 from $283 for 1996 reflecting an increase in the mix of 
standard software products and a corresponding decrease in sales of higher 
cost custom-developed software. Service cost of sales decreased 6% from $3.9 
million in the year 1996 to $3.7 million in 1997. This decrease was due 
primarily to a $327 charge in the first quarter of 1996 for the Company's 
change in accounting for spare parts, partially offset by increased labor 
costs associated with Virtual Test Software related services.

     GROSS MARGIN. The Company's gross margin decreased 6% from $32.7 million 
in the year ended December 31, 1996 to $30.7 million in the year ended 
December 31, 1997. As a percentage of net sales, gross margin increased from 
64% for the year ended December 31, 1996 to 66% for the year ended December 
31, 1997.

     Systems gross margin, as a percent of related sales, decreased from 63% 
for 1996 to 62% for 1997, reflecting a slight decline in gross margin 
realized on sales of the Company's Test Station products. Software gross 
margin, as a percent of related sales, exceeded 90% in both 1997 and 1996. 
Service gross margin, as a percent of related sales, increased from 63% for 
1996 to 67% for 1997, due primarily to the charge to cost of service sales in 
1996 related to the change in accounting method for spare parts.

     RESEARCH, DEVELOPMENT AND ENGINEERING. R&D expenses decreased 5% from 
$7.8 million for the year ended December 31, 1996 to $7.4 million for the 
year ended December 31, 1997. As a percentage of net sales, R&D expenses 
increased from 15% in the year ended December 31, 1996 to 16% in the year 
ended December 31, 1997. The decrease in reported R&D expense was principally 
attributable to greater capitalization of software development costs 
associated with development of the Company's new products during 1997 while 
gross R&D spending remained approximately flat from 1996 to 1997.

     The Company capitalized certain software development costs relating to 
these activities in the amounts of $1.1 million and $715 in 1997 and 1996, 
respectively. Capitalization of software development costs was offset by 
amortization of previously capitalized costs to product cost of sales in the 
amount of $753 and $842 during 1997 and 1996, respectively.

     SELLING, GENERAL AND ADMINISTRATIVE. SG&A expenses increased 5% from 
$15.4 million for the year ended December 31, 1996 to $16.2 million for the 
year ended December 31, 1997. The increase was principally attributable to 
higher commissions and increased investment in the Company's selling 
function. As a percentage of net sales, SG&A expenses increased from 30% in 
the year ended December 31, 1996 to 35% in the year ended December 31, 1997 
due to the increase in SG&A expenses combined with the impact of lower net 
sales discussed above.

     Following the Company's secondary stock offering in February 1997, 
Cadence's ownership of the Company's common stock dropped below 50%. This 
event required the Company to recognize additional compensation expense of 
approximately $313 during 1997, as a result of payments made by Cadence to 
certain Company employees in respect of Cadence stock options held by such 
employees.

     OTHER INCOME, NET. Other income, net increased from $217 in the year 
ended December 31, 1996 to $932 in the year ended December 31, 1997. The 
increase was due to interest income on higher average cash and investment 
balances, combined with the impact of a one-time write-off of expenses 
associated with the Company's withdrawn secondary public stock offering in 
June 1996, due to unfavorable capital market conditions at that time. Costs 
of the Company's successful stock offering in February 1997 were charged as 
an offset to the offering proceeds in Shareholders' Equity.
                                       


                                      14

<PAGE>
                                       
     INCOME TAXES. The Company's effective rate for Federal and state taxes 
was 35.0% for the year ended December 31, 1997 and 36.5% for the year ended 
December 31, 1996. The change in effective tax rates from 1996 to 1997 was 
primarily due to increased research and development tax credits earned during 
1997.

FUTURE OPERATING RESULTS

     Results of operations for the periods discussed above should not be 
considered indicative of the results to be expected in any future period, and 
fluctuations in operating results may also result in fluctuations in the 
market price of the Company's common stock. Like most high technology and 
high growth companies, the Company faces certain business risks that could 
have adverse effects on the Company's results of operations.

     For the years ended December 31, 1998, 1997 and 1996, sales to Intel 
Corporation represented approximately 25%, 27%, and 36% of the Company's net 
sales, respectively. No other customer accounted for more than 10% of the 
Company's net sales in 1998, 1997, or 1996. Sales of the Company's products 
to Intel and a limited number of other customers are expected to continue to 
account for a high percentage of net sales over the foreseeable future. Any 
sudden reduction or loss of orders from Intel or any other major customer 
would have a material adverse effect on the Company's financial condition and 
results of operations.

     Like most high technology and high growth companies, the Company faces 
certain business risks that could have adverse effects on the Company's 
results of operations, including, but not limited to the following. The 
Company is dependent on high-dollar customer orders, deriving a substantial 
portion of its net sales from the sale of Test Stations which typically range 
in price from $0.5 million to $1.5 million per unit and may be priced as high 
as $2.0 million or more for a single unit.

     A substantial amount of the Company's net sales are typically realized 
in the last few days of each quarter. During 1997 and 1998, the Company's 
quarterly net sales were negatively impacted by customer decisions to delay 
or cancel plans to place orders for the Company's Test Station products in 
the last few days of the quarter. The timing and sales price of a single 
order can have a significant impact on the Company's net sales and results of 
operations for a particular period. The Company's net sales and results of 
operations may be negatively impacted if an order is received too late in a 
given period to permit product shipment and the recognition of revenue during 
that period.

     A significant portion of the Company's operating expenses are relatively 
fixed and planned expenditures are based, in part, on anticipated orders. In 
addition, the need for continued expenditures for research, development and 
engineering makes it difficult to reduce expenses in a particular quarter if 
the Company's sales goals for that quarter are not met. The inability to 
reduce the Company's expenses quickly enough to compensate for any revenue 
shortfall would magnify the adverse impact of any revenue shortfall on the 
Company's results of operations.

     The Company purchases some key components from sole or single source 
vendors, for which alternative sources are not readily available. A few of 
these suppliers are small independent companies and could expose the Company 
to increased risk of temporary shortages for certain key components. The 
Company's future operating results and financial condition are also subject 
to influences driven by rapid technological changes, a highly competitive 
industry, a lengthy sales cycle, and the cyclical nature of general economic 
conditions.

     During 1998, approximately 11% the Company's net sales were to customers 
in the Asia-Pacific region, compared to 23% for 1997. These sales were 
predominantly to Asian locations of U.S. based multinational companies, but 
also included sales to companies headquartered in Japan, Korea, Taiwan, and 
Singapore. The decline in sales to Asian customers from 1997 to 1998 reflects 
the impact of the current financial crisis in the Asia-Pacific region. There 
can be no assurance that the Asia-Pacific financial crisis will not have a 
further negative impact on the Company's net sales.

     Future operating results will depend on many factors, including demand 
for the Company's products, the introduction of new products by the Company 
and by its competitors, industry acceptance of Virtual Test software, the 
level and timing of available shippable orders and backlog, and the business 
risks discussed above. There can be no assurance that the Company's net sales 
will grow or that such growth will be sustained in future periods or that the 
Company will remain profitable in any future period.

YEAR 2000

     The company has developed its Year 2000 Readiness Plan which includes 
steps to review, test and implement corrective measures for the Company's 
products and information systems. In addition, the Company has identified its 
                                       


                                      15

<PAGE>
                                       
most critical vendors and suppliers, and is collecting sufficient information 
from each of them to monitor their Year 2000 readiness.

     To-date, the Company has completed testing of it's currently offered 
products. Based on these tests, the Company believes them to be free of any 
problems associated with the Year 2000. The Company has tested selected 
earlier-version products for Year 2000 readiness, and believes them to be 
free of any problems associated with the Year 2000. The Company will continue 
to selectively perform Year 2000 readiness testing on specific customer 
configurations as requested during the next several quarters. Based upon 
testing to-date, the Company does not believe additional product testing will 
result in the discovery of any materially adverse Year 2000 readiness issues.

     The Company has completed review of its Year 2000 readiness with respect 
to its information systems. The review has not identified any significant 
information systems Year 2000 issues beyond those that will be corrected 
through implementation of previously planned systems upgrades. Vendors for 
the Company's information systems have represented those systems, with the 
planned upgrades, to be Year 2000 compliant. The Company plans to test those 
systems for Year 2000 Readiness as the upgrades are implemented and expects 
to complete such testing by June 30, 1999.

     The Company estimates the costs in 1998, including payments to third 
parties and estimates of internal costs, for developing and implementing its 
Year 2000 readiness plan were less than $200,000. The Company expects 
additional implementation costs in 1999 to be less than $300,000.

     The Company has not developed a most reasonably likely worst case 
scenario. However, it is developing contingency plans in the event 
mission-critical third-party vendors or other significant third parties fail 
to adequately address Year 2000 issues. Such plans principally involve 
identifying alternative vendors or, in the extreme, adding inventory safety 
stocks. There can be no assurance that any such plans will fully mitigate any 
such failures or problems. In addition, there are mission-critical third 
parties, such as utilities, transportation and telecommunication companies 
where alternative arrangements or sources are limited or unavailable.

LIQUIDITY AND CAPITAL RESOURCES

     As of December 31, 1998, the Company's principal sources of liquidity 
consisted of cash, cash equivalents and short-term investments of 
approximately $11.0 million, and funds available under an existing bank line 
of credit of $10.0 million. Since 1988, the Company has relied on cash 
generated from operations and cash raised through public stock offerings as 
its principal source of liquidity.

     OPERATING ACTIVITIES. The Company's net cash flows from operating 
activities includes cash received from customers, payments to suppliers, 
payments to employees and interest received and paid. During 1998, net cash 
used in operating activities amounted to $3.3 million. Net cash provided by 
operating activities amounted to $8.8 million and $5.7 million for 1997 and 
1996, respectively.

     A significant decline in revenues during a year where the Company 
continued to invest heavily in both its research and development efforts and 
in its distribution capabilities led to a decline in cash flow from 
operations in 1998. Other factors negatively impacting cash flow from 
operating activities during 1998 were increases in trade receivables and 
inventories. The Company's trade receivables, inventories and accounts 
payable have fluctuated from period to period as a result of the timing of 
shipments, cash collections and inventory receipts near period end. The size 
and timing of a single customer shipment or collection can have a significant 
impact on trade receivables and inventories.

     Trade receivables increased from $10.6 million at December 31, 1997 to 
$14.0 million at December 31, 1998, reflecting the impact of extended payment 
terms taken by certain customers and distributors during 1998. The very sharp 
decline in industry capital spending is the primary cause of the extended 
payment terms. Inventories increased from $11.3 million at December 31, 1997 
to $14.9 million at December 31, 1998. This increase was primarily due to 
additional parts inventories associated with the Company's new Vanguard and 
Orion products, last time purchases of key components being discontinued by 
vendors, and the impact of the uncertainty in forecasting of systems sales 
volume and mix during 1998.

     INVESTING ACTIVITIES. Capital equipment expenditures of $6.2 million, 
$4.1 million, and $3.3 million in 1998, 1997, and 1996, respectively, were 
primarily for computers, software, demo equipment and engineering equipment 
used in the Company's operations. The increase in capital spending during 
1998 was largely driven by investments in 
                                       


                                      16

<PAGE>
                                       
production equipment and tooling necessary to begin shipments of the 
Company's Vanguard Test Stations late in 1998.

     Expenditures to increase the Company's service spare parts pool were 
$1.0 million, $1.5 million and $1.1 million for 1998, 1997 and 1996, 
respectively. The continuing investment in service spare parts reflects the 
stocking of parts for servicing the Company's new Test Station products as 
they are introduced.

     In addition, the Company capitalized certain expenses associated with 
software development costs of $2.4 million, $1.1 million and $715 for 1998, 
1997 and 1996, respectively. The increase in 1998 reflects the investment in 
software technology associated with the Company's new Vanguard Test Stations 
and its Virtual Test software.

     FINANCING ACTIVITIES. In 1998 and 1996, net cash used in financing 
activities was $757 and $12, respectively. In 1997, net cash provided by 
financing activities was $14.2 million.

     In May 1998, the Company announced a plan to repurchase up to 500,000 
shares of its currently outstanding common stock over 12 months in open 
market and negotiated transactions. This repurchase program authorizes the 
repurchase of shares in increments in accordance with SEC regulations and 
Board of Directors' guidance. As of December 31, 1998, this program had 
resulted in the repurchase of 150,500 shares at a total cost of $1.2 million.

This program may continue in future periods, subject to authorization by the 
Board of Directors.

     Cash used for payments of certain capital leases obtained by the Company 
for computers and equipment used in operations was $197, $251 and $300 for 
1998, 1997 and 1996, respectively. The Company received $595, $1.0 million 
and $288, in 1998, 1997 and 1996, respectively, from the issuance of stock 
under employee stock option and stock purchase plans. Cash provided by 
financing activities during 1997 was attributable to proceeds of $13.4 
million from the Company's secondary public offering of common stock.

     During 1997 and 1996, the Company realized reductions in current income 
tax liabilities of $2.7 million and $1.9 million, respectively, resulting 
from the benefit of tax deductions of employee gains upon exercise of Cadence 
stock options, and to a lesser extent from the exercise of the Company's 
employee stock options. During 1998, no such benefits were recorded as a 
result of the Company's pre-tax loss before deduction of such benefits. Had 
the Company generated sufficient pre-tax income during 1998, the tax benefits 
which would have been realized as a result of deduction of employee stock 
option gains would have amounted to approximately $1.5 million. For 1998, 
these deductions increased the Company's net operating loss carryforward for 
tax return purposes. If and when the Company generates sufficient pre-tax 
income in the future, the benefit of the carryforward deduction of these 
option exercises will reduce the amount of cash otherwise required for income 
tax payments.

     The compensation for tax purposes associated with stock option exercises 
and with disqualifying dispositions are typically not treated as expenses of 
the Company for financial reporting purposes, and the exercise of Cadence 
stock options does not increase the number of shares of Company common stock 
outstanding. The tax benefits available from the stock option deduction will 
decrease in the future as employee holdings of Cadence stock options decline 
due to option exercises and cancellations. The timing and magnitude of this 
decrease in tax benefits is uncertain as the number of employee stock options 
which are exercised, and the amount of gains realized upon exercise, will be 
determined by, among other factors, fluctuations in the market value of 
Cadence common stock.

     At the end of 1995, the Company secured a $10.0 million revolving line 
of credit with U.S. National Bank of Oregon, which is available for general 
corporate purposes as needed. Under the agreement, the Company can borrow, 
with interest at the bank's prime lending rate, or if lower, at certain 
margins above banker's acceptance or interbank offering rates. There have 
been no borrowings against the line of credit to date. The term of the 
current credit line agreement ends April 30, 1999. Management intends to 
renew the agreement at that time.

     The Company believes that existing funds, funds expected to be generated 
by operating activities, and the available line of credit, will satisfy the 
Company's anticipated working capital and other general corporate purposes 
through at least the next twelve months. The Company currently has no 
significant capital commitments other than commitments under facility 
operating leases and vendor contracts for development services, consulting 
services and parts. From time to time, the Company may consider the 
acquisition of complementary businesses, products or technologies. The 
Company presently has no significant understandings, commitments or 
agreements with respect to any such acquisitions. Any such transactions, if 
consummated, may require additional financing. No assurance can be given that 
additional financing will be available or that, if available, such financing 
will be obtainable on terms favorable to the Company.
                                       


                                      17

<PAGE>
                                       
ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements and schedule listed in Item 14(a)(1) and (2) are 
included in this Report beginning on Page F-1.

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE

None.


                                       
                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT

The information required by Item 401 of Regulation S-K is included under the 
captions "Election of Directors" and "Management" in the Company's Proxy 
Statement dated April 2, 1999 and is incorporated herein by reference. The 
information required by Item 405 of Regulation S-K is included under the 
captions "Section 16(a) Beneficial Ownership Reporting Compliance" in the 
Company's Proxy Statement dated April 2, 1999 and is incorporated herein by 
reference.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this item is included under the caption 
"Executive Compensation" in the Company's Proxy Statement dated April 2, 1999 
and is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this item is included under the caption "Stock 
Owned by Management and Principal Shareholders" in the Company's Proxy 
Statement dated April 2, 1999 and is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this item is included under the caption "Certain 
Transactions and Relationships" in the Company's Proxy Statement dated April 
2, 1999 and is incorporated herein by reference.
                                       


                                      18

<PAGE>
                                       
                                    PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 8-K

(a)  Documents filed as part of this report:

     (1)  Financial Statements and Supplementary Data

          The documents and schedule listed below are filed as part of this 
report on the pages indicated:

<TABLE>
<CAPTION>
                                                                     Page
                                                                     ----
              <S>                                                    <C>
              Independent Auditors' Report                           F-1
              Statements of Income                                   F-2
              Balance Sheets                                         F-3
              Statements of Shareholders' Equity                     F-4
              Statements of Cash Flows                               F-5
              Notes to Consolidated Financial Statements             F-7
              Selected Quarterly Financial Data                      F-17
</TABLE>

     (2)  Financial Statement Schedules

          The documents and schedule listed below are filed as part of this 
report on the pages indicated:

<TABLE>
<CAPTION>
                                                                     Page
                                                                     ----
              <S>                                                    <C>
              Schedule II -- Valuation and Qualifying Accounts       F-18
              Independent Auditors' Report on Financial 
                Statements Schedule                                  F-19
</TABLE>

          All other financial statement schedules have been omitted since they
          are not required, not applicable or the information is included in
          the consolidated financial statements or notes.

     (3)  Exhibits

<TABLE>
<CAPTION>
                                                                                     Sequential
                                                                                     Page Number
                                                                                     -----------
     <S>      <C>                                                                    <C>
      3.1.    Restated Articles of Incorporation of Integrated Measurement
              Systems, Inc. Incorporated by reference to Exhibit 3.1 of the
              Company's Registration Statement on Form S-1 (Registration No.
              33-92408)

      3.2.    Second Restated Bylaws of Integrated Measurement Systems, Inc.
              Incorporated by reference to Exhibit 3(ii) of the Company's Report
              on Form 8-K filed March 26, 1998.

      10.1.   Form of Indemnity Agreement between Integrated Measurement
              Systems, Inc. and each of its executive officers and directors.
              Incorporated by reference to Exhibit 10.1 of the Company's
              Registration Statement on Form S-1 (Registration No. 33-92408)

      10.2.   1995 Stock Incentive Plan. Incorporated by reference to Exhibit
              10.2 of the Company's Registration Statement on Form S-1
              (Registration No. 33-92408)

      10.3.   1995 Stock Option Plan for Nonemployee Directors. Incorporated by
              reference to Exhibit 10.3 of the Company's Registration Statement
              on Form S-1 (Registration No. 33-92408)

      10.4.   Form of Employment Agreement between Integrated Measurement
              Systems, Inc. and each of its executive officers. Incorporated by
              reference to Exhibit 10.4 of the Company's Registration Statement
              on Form S-1 (Registration No. 33-92408)
                                             


                                             19

<PAGE>

      10.5.   Asset Transfer Agreement between Integrated Measurement Systems,
              Inc. and Cadence Design Systems, Inc. Incorporated by reference to
              Exhibit 10.7 of the Company's Registration Statement on Form S-1
              (Registration No. 33-92408)

      10.6.   Tax Sharing Agreement between Integrated Measurement Systems, Inc.
              and Cadence Design Systems, Inc. Incorporated by reference to
              Exhibit 10.9 of the Company's Registration Statement on Form S-1
              (Registration No. 33-92408)

      10.7.   Line of Credit agreement with US Bank. Incorporated by reference
              to Exhibit 10.11 of the Company's Annual Report on Form 10-K for
              the year ended December 31, 1995.

      10.8.   Integrated Measurement Systems, Inc. 1995 Employee Stock Purchase
              Plan. Incorporated by reference to Exhibit 10.12 of the Company's
              Annual Report on Form 10-K for the year ended December 31, 1995.

      10.9.   Employment Agreement dated March 16, 1996 between Integrated
              Measurement Systems, Inc. and Keith L. Barnes. Incorporated by
              reference to Exhibit 10.a of the Company's Quarterly Report on
              Form 10-Q for the quarter ended March 31, 1996.

      10.10.  Amended Stockholder Agreement between Integrated Measurement
              Systems, Inc. and Cadence Design Systems, Inc. Incorporated by
              reference to Exhibit 10.15 of the Company's Registration Statement
              on Form S-1 (Registration No. 333-20495)

      10.11.  Amended Corporate Services Agreement between Integrated
              Measurement Systems, Inc. and Cadence Design Systems, Inc.
              Incorporated by reference to Exhibit 10.16 of the Company's
              Registration Statement on Form S-1 (Registration No. 333-20495)

      10.12.  Second Amendment to Joint Sales Agency Agreement between
              Integrated Measurement Systems, Inc. and Cadence Design Systems,
              Inc. Incorporated by reference to Exhibit 10.17 of the Company's
              Registration Statement on Form S-1 (Registration No. 333-20495)

      10.13.  Integrated Measurement Systems, Inc. Executive Deferred
              Compensation Plan. Incorporated by reference to Exhibit 10 of the
              Company's Quarterly Report on Form 10-Q for the quarter ended
              September 30, 1996.

      10.14.  Lease Agreement, dated September 22, 1997, between Integrated
              Measurement Systems, Inc. and Spieker Partners, LP, a limited
              partnership. Incorporated by reference to Exhibit 10.21 of the
              Company's Annual Report on Form 10-K for the year ended December
              31, 1997.

      10.15.  Rights Agreement, dated as of March 25, 1998, between Integrated
              Measurement Systems, Inc. and ChaseMellon Shareholder Services,
              L.L.C. including the Articles of Amendment creating the Series A
              Participating Preferred Stock of Integrated Measurement Systems,
              Inc., the form of Rights Certificate and the Summary of Rights
              attached thereto as Exhibits A, B and C, respectively.
              Incorporated by reference to Exhibit 4.1 of the Company's Report
              on Form 8-K filed March 26, 1998.

      10.16.  Amended and Restated Shareholder Agreement, dated as of March 25,
              1998, between Integrated Measurement Systems, Inc. and Cadence
              Design Systems, Inc. Incorporated by reference to Exhibit 4.2 of
              the Company's Report on Form 8-K filed March 26, 1998.

      16.1.   Letter of Arthur Andersen LLP regarding change in accounting
              principles. Incorporated by reference to Exhibit 10.a of the
              Company's Quarterly Report on Form 10-Q for the quarter ended
              March 31, 1996.

      21.     List of Subsidiaries of the Company*

      23.1.   Consent of Arthur Andersen LLP*

      27.1.   Financial Data Schedule*
</TABLE>
----------------------
    * File Herewith
                                             


                                             20

<PAGE>

(b)   Reports on Form 8-K

      No report on Form 8-K was filed during the quarter ended 
December 31, 1998.
                                             









                                             21

<PAGE>
                                       
                                   SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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, on the 30th day 
of March, 1999.

INTEGRATED MEASUREMENT SYSTEMS, INC.

By  /s/ FRED HALL
   -----------------------

   Fred Hall
   Chief Financial Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this 
report has been signed below by the following persons on behalf of the 
registrant and in the capacities indicated, on the 30th day of March, 1999.

<TABLE>
<CAPTION>

         Signature                                     Title
         ---------                                     -----
<S>                               <C>


/s/ KEITH L. BARNES               President, Chief Executive Officer, and Director
----------------------            (Principal Executive Officer)
Keith L. Barnes                   


/s/ FRED HALL                     Chief Financial Officer (Principal Financial
----------------------            and Accounting Officer)
Fred Hall                         


/s/ H. RAYMOND BINGHAM            Chairman of the Board
----------------------            
H. Raymond Bingham


/s/ PAUL GARY                     Director
----------------------            
Paul Gary


/s/ C. SCOTT GIBSON               Director
----------------------            
C. Scott Gibson


/s/ JAMES E. SOLOMON              Director
----------------------            
James E. Solomon


/s/ MILTON R. SMITH               Director
----------------------            
Milton R. Smith
</TABLE>


                                      22

<PAGE>

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF INTEGRATED MEASUREMENT SYSTEMS, 
INC.:

      We have audited the accompanying consolidated balance sheets of 
Integrated Measurement Systems, Inc. (an Oregon corporation) and subsidiaries 
as of December 31, 1998 and 1997, and the related consolidated statements of 
income, shareholders' equity, and cash flows for each of the years in the 
three-year period ended December 31, 1998. These financial statements are the 
responsibility of the Company's management. Our responsibility is to express 
an opinion on these financial statements based upon our audits.

      We conducted our audits in accordance with generally accepted auditing 
standards. Those standards require that we plan and perform the audit to 
obtain reasonable assurance about whether the financial statements are free 
of material misstatement. An audit includes examining, on a test basis, 
evidence supporting the amounts and disclosures in the financial statements. 
An audit also includes assessing the accounting principles used and 
significant estimates made by management, as well as evaluating the overall 
financial statement presentation. We believe that our audits provide a 
reasonable basis for our opinion.

      In our opinion, the consolidated financial statements referred to above 
present fairly, in all material respects, the financial position of 
Integrated Measurement Systems, Inc. and subsidiaries as of December 31, 1998 
and 1997, and the results of its operations and its cash flows for each of 
the years in the three-year period ended December 31, 1998 in conformity with 
generally accepted accounting principles.

                                       ARTHUR ANDERSEN LLP

Portland, Oregon
January 21, 1999

<PAGE>

<TABLE>
                                                        
                                      CONSOLIDATED STATEMENTS OF OPERATIONS
                                    (In thousands, except per share amounts)
<CAPTION>
                                                                                Year ended December 31,
                                                                   -----------------------------------------------
                                                                     1998                1997               1996
                                                                   --------            --------           --------
<S>                                                                <C>                 <C>                <C>
Sales:
    Systems ............................................           $ 22,318            $ 32,059           $ 37,494
    Software ...........................................              4,632               3,718              2,750
    Service ............................................              9,747              11,073             10,593
                                                                   --------            --------           --------
        Net sales ......................................             36,697              46,850             50,837

Cost of sales:
    Systems ............................................              9,993              12,241             13,920
    Software ...........................................                707                 211                283
    Service ............................................              4,132               3,702              3,935
                                                                   --------            --------           --------
        Total cost of sales ............................             14,832              16,154             18,138
                                                                   --------            --------           --------
        Gross margin ...................................             21,865              30,696             32,699

Operating expenses:
    Research, development and engineering ..............              6,763               7,385              7,796
    Selling, general and administrative ................             17,781              16,238             15,408
    Acquisition and restructuring ......................              1,908                --                 --
                                                                   --------            --------           --------
        Total operating expenses .......................             26,452              23,623             23,204
                                                                   --------            --------           --------
        Operating income (loss) ........................             (4,587)              7,073              9,495

Other income, net ......................................                760                 932                217
                                                                   --------            --------           --------
Income (loss) before income taxes ......................             (3,827)              8,005              9,712
Provision (benefit) for income taxes ...................               (496)              2,800              3,546
                                                                   --------            --------           --------
        Net income (loss) ..............................           $ (3,331)           $  5,205           $  6,166
                                                                   ========            ========           ========

Basic earnings (loss) per share ........................           $  (0.44)           $   0.70           $   0.92
                                                                   ========            ========           ========
Diluted earnings (loss) per share ......................           $  (0.44)           $   0.67           $   0.88
                                                                   ========            ========           ========

Weighted average number of common shares outstanding for
  basic earnings (loss) per share ......................              7,496               7,388              6,710
Incremental shares from assumed conversion of employee
  stock options ........................................               --                   360                293
                                                                   --------            --------           --------
Adjusted weighted average shares for diluted earnings
  (loss)per share ......................................              7,496               7,748              7,003
                                                                   --------            --------           --------
                                                                   --------            --------           --------


                                                        
                       The accompanying notes are an integral part of these financial statements.
</TABLE>


                                                       F-2

<PAGE>
                                                       
                                           CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

<TABLE>
<CAPTION>
                                                                                              December 31,
                                                                                       -------------------------
                                                                                         1997              1997
                                                                                       -------           -------
<S>                                                                                    <C>               <C>
ASSETS
Current assets:
    Cash and cash equivalents ..............................................           $ 3,379           $17,464
    Short-term investments .................................................             7,630             8,371
    Trade receivables, less allowance for doubtful accounts of 
      $413 and $577 ........................................................            13,977            10,582
    Receivable from Cadence, net ...........................................                --               219
    Inventories ............................................................            14,943            11,311
    Income taxes receivable ................................................                --               336
    Deferred income taxes ..................................................             1,453             1,637
    Prepaid expenses and other current assets ..............................             2,381             2,428
                                                                                       -------           -------
        Total current assets ...............................................            43,763            52,348
Property, plant and equipment, net .........................................            11,063             7,418
Service spare parts, net ...................................................             3,692             3,395
Software development costs, net ............................................             3,457             1,763
Deferred income taxes ......................................................               219                --
Other assets, net ..........................................................             1,220               599
                                                                                       -------           -------
        Total assets .......................................................           $63,414           $65,523
                                                                                       =======           =======

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
    Accounts payable .......................................................           $ 1,828           $ 2,321
    Payable to Cadence, net ................................................               506                --
    Accrued compensation ...................................................             1,718             1,354
    Deferred revenue .......................................................             2,304             2,294
    Income taxes payable ...................................................               197                --
    Other current liabilities ..............................................             1,408               475
    Capital lease obligations - current ....................................               394               181
                                                                                       -------           -------
        Total current liabilities ..........................................             8,355             6,625
Deferred income taxes ......................................................                --               483
Capital lease obligations, net of current portion ..........................               363               152
Deferred compensation ......................................................             1,154               830

Commitments

Shareholders' equity:
    Preferred stock, $.01 par value, authorized 10,000,000 shares;
        none issued and outstanding ........................................                --                --
    Common stock, $.01 par value, authorized 15,000,000 shares;
        7,425,951 and 7,521,393 issued and outstanding .....................                74                75
    Additional paid-in capital .............................................            39,478            40,037
    Retained earnings ......................................................            13,990            17,321
                                                                                       -------           -------
        Total shareholders' equity .........................................            53,542            57,433
                                                                                       -------           -------
        Total liabilities and shareholders' equity .........................           $63,414           $65,523
                                                                                       =======           =======


                                                       
                   The accompanying notes are an integral part of these financial statements.
</TABLE>


                                                      F-3

<PAGE>



                 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
                                 (In thousands)
<TABLE>
<CAPTION>
                                                                                    Additional                          Total
                                                          Common Stock               Paid-in          Retained       Shareholders'
                                                    Shares           Amount          Capital          Earnings          Equity
                                                   --------         --------         -------          --------         --------
<S>                                                <C>              <C>              <C>              <C>              <C>
Balance, December 31, 1995 ................           6,700         $     67         $ 20,467         $  5,950         $ 26,484
    Stock issued under employee 
      stock plans..........................              26             --                288             --                288
    Tax benefit from Cadence and IMS stock
      options .............................            --               --              1,921             --              1,921
    Net income ............................            --               --               --              6,166            6,166
                                                   --------         --------         --------         --------         --------
Balance, December 31, 1996 ................           6,726               67           22,676           12,116           34,859
    Contributed capital ...................            --               --                313             --                313
    Net proceeds from secondary public
      offering ............................             700                7           13,360             --             13,367
    Stock issued under employee stock 
      plans................................              95                1            1,036             --              1,037
    Tax benefit from Cadence and IMS stock
      options .............................            --               --              2,652             --              2,652
    Net income ............................            --               --               --              5,205            5,205
                                                   --------         --------         --------         --------         --------
Balance, December 31, 1997 ................           7,521               75           40,037           17,321           57,433
    Repurchases of common stock............            (151)              (2)          (1,153)            --             (1,155)
    Stock issued under employee stock 
      plans................................              56                1              594             --                595
    Net loss ..............................            --               --               --             (3,331)          (3,331)
                                                   --------         --------         --------         --------         --------
Balance, December 31, 1998 ................           7,426         $     74         $ 39,478         $ 13,990         $ 53,542
                                                   ========         ========         ========         ========         ========
</TABLE>

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

                                        F-4
<PAGE>

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (In thousands)
<TABLE>
<CAPTION>
                                                                                              Year ended December 31,
                                                                                    --------------------------------------------
                                                                                      1998              1997              1996
                                                                                    ---------         --------          --------
<S>                                                                                 <C>               <C>               <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
   Net income (loss) ......................................................         $ (3,331)         $  5,205          $  6,166
   Adjustments to reconcile net income (loss) to cash (used in) provided by
        operating activities:
        Acquired in-process research & development ........................              861              --                --
        Depreciation and amortization .....................................            4,247             4,001             3,492
        Contributed capital ...............................................             --                 313              --
        (Benefit) provision for deferred income taxes .....................             (518)              119              (144)
        Deferred compensation .............................................              324               372               270
   Net change in receivable from / payable to Cadence .....................              725             1,906            (1,031)
   (Increase) decrease in trade receivables ...............................           (3,395)              770            (3,235)
   Increase in inventories ................................................           (3,505)           (3,371)           (2,110)
   Increase (decrease) in prepaid expenses and other current assets .......               47              (851)             (653)
   Net change in income taxes payable or receivable .......................              533             1,337             2,900
   Increase (decrease) in accounts payable and accrued expenses............              679            (1,032)              908
   Increase (decrease) in deferred revenue ................................               10                67              (865)
                                                                                    --------          --------          --------
Net cash (used in) provided by operating activities .......................           (3,323)            8,836             5,698
                                                                                    --------          --------          --------
CASH FLOWS FROM INVESTING ACTIVITIES:
   Acquisition of PerformIC ...............................................           (1,194)             --                --
   Purchases of short-term investments ....................................           (5,840)          (11,392)             --
   Sale of short-term investments .........................................            6,581             3,021              --
   Purchases of equipment and software ....................................           (6,151)           (4,128)           (3,299)
   Purchases of service spare parts .......................................             (959)           (1,501)           (1,057)
   Software development costs .............................................           (2,442)           (1,070)             (715)
                                                                                    --------          --------          --------
        Net cash used in investing activities .............................          (10,005)          (15,070)           (5,071)
                                                                                    --------          --------          --------
CASH FLOWS FROM FINANCING ACTIVITIES:
   Principal payments under capital leases ................................             (197)             (251)             (300)
   Net proceeds from public stock offerings ...............................             --              13,367              --
   Repurchase of common stock .............................................           (1,155)             --                --
   Proceeds from employee stock plans .....................................              595             1,037               288
                                                                                    --------          --------          --------
        Net cash (used in) provided by financing activities ...............             (757)           14,153               (12)
                                                                                    --------          --------          --------
        Net (decrease) increase in cash and cash equivalents ..............          (14,085)            7,919               615
Cash and cash equivalents at beginning of year ............................           17,464             9,545             8,930
                                                                                    --------          --------          --------
Cash and cash equivalents at end of year ..................................         $  3,379          $ 17,464          $  9,545
                                                                                    ========          ========          ========
</TABLE>
                                   F-5
<PAGE>

<TABLE>
<CAPTION>
                                                                    Year ended December 31,
                                                           -----------------------------------------
                                                             1998            1997             1996
                                                           --------         -------          -------
<S>                                                        <C>              <C>              <C>
Supplemental schedule of noncash financing activities:
    Purchases of assets through capital leases ........    $   621          $    59          $   607
    Tax benefit from Cadence and IMS stock options ....    $  --            $ 2,652          $ 1,921
    Acquisition of PerformIC ..........................    $   125          $  --            $  --

Other supplemental cash flow disclosures:
    Income taxes refunded (paid) ......................    $   512          $(1,307)         $  (629)
    Interest paid .....................................    $   (35)         $   (41)         $   (33)
</TABLE>

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

                                       F-6
<PAGE>

                          NOTES TO FINANCIAL STATEMENTS
   (All numerical references in thousands, except percentages and share data)


1.     COMPANY BACKGROUND AND INITIAL PUBLIC OFFERING:

       Integrated Measurement Systems, Inc. (the Company or IMS) commenced 
operations in August 1983. The Company was independent until acquired by 
Valid Logic in 1989. In 1991, Valid Logic merged with Cadence Design Systems, 
Inc. (Cadence) in a transaction accounted for as a pooling. From that time 
until July 21, 1995, the Company was a wholly owned subsidiary of Cadence.

       In July 1995, the Company successfully completed an initial public 
offering of common stock at a price of $11 per share. A total of 2,990,000 
shares were sold, consisting of 375,000 shares issued by the Company and 
2,615,000 shares sold by Cadence. The net proceeds to the Company from this 
offering, after deduction of directly related expenses, were $3.3 million, 
while net proceeds to Cadence amounted to approximately $26.6 million. In 
February 1997, the Company issued 700,000 additional shares of common stock, 
and Cadence sold 950,000 shares of the Company's common stock in a registered 
public stock offering. Net proceeds to the Company amounted to $13.4 million. 
At December 31, 1998, Cadence owned 37% of the outstanding common stock of 
the Company, with the remaining 63% publicly owned.

       The Company is engaged in designing, developing, manufacturing, 
marketing and servicing high-performance engineering Test Stations and test 
software to test and measure the performance of complex electronic devices. 
In addition, the Company develops, markets and supports a line of Virtual 
Test Software that permits design and test engineers to automate test program 
development and to conduct simulated tests of electronic device designs prior 
to the fabrication of a prototype of the actual device.

       The Company markets and supports its products worldwide through a 
network of direct sales force personnel, independent distributors and 
dedicated agents employed by Cadence in certain international locations.

2.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

PRINCIPLES OF CONSOLIDATION
       The consolidated financial statements include the financial statements 
of Integrated Measurement Systems, Inc. and its wholly owned subsidiaries. 
All significant intercompany accounts and transactions are eliminated in 
consolidation.

FOREIGN CURRENCY TRANSLATION
       Assets and liabilities of foreign subsidiaries, where the functional 
currency is the local currency, are translated using exchange rates in effect 
at the end of the period and revenues and costs are translated using average 
exchange rates for the period. Gains and losses on the translation into U.S. 
dollars of amounts denominated in foreign currencies are included in net 
income (loss) for those operations whose functional currency is the U.S. 
dollar. Gains and losses on translation into U.S. dollars of amounts 
denominated in foreign currencies for those operations where the functional 
currency is the local currency are not material, and are included in 
Additional Paid-in Capital in the accompanying consolidated financial 
statements.

USE OF ESTIMATES
       The preparation of financial statements in conformance with generally 
accepted accounting principles requires management to make estimates and 
assumptions that affect the reported amounts of assets and liabilities and 
disclosure of contingent assets and liabilities at the date of the financial 
statements and the reported amounts of revenues and expenses during the 
reporting period. Actual results could differ from those estimates.

RECLASSIFICATIONS
       Certain reclassifications have been made in the accompanying financial 
statements for 1997 and 1996 to conform with the 1998 presentation.

                                     F-7
<PAGE>



REVENUE RECOGNITION
      Revenue from systems sales and software licenses is generally recognized
as the product ships and when no significant obligations remain. Contract
service and support revenues billed in advance are recorded as deferred revenue
and recognized ratably over the contractual period as the services and support
are performed. Revenue from other services, such as consulting and training, is
recognized as the related services are performed or when certain milestones are
achieved.

CASH AND CASH EQUIVALENTS
      The Company classifies all highly liquid investments with a maturity of
three months or less at purchase as cash equivalents. The carrying amount
approximates fair value because of the short maturity of these instruments. The
Company investments are placed with high credit-quality financial institutions
and bear minimal credit risk.

INVESTMENTS
      The Company accounts for its investments in accordance with the Financial
Accounting Standards Board Statement No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" (SFAS 115). Under the provisions of
SFAS 115, the Company is required to classify and account for its security
investments as trading securities, securities available for sale or securities
held to maturity depending on the Company's intent to hold or trade the
securities at the time of purchase. The Company's short-term investments are
placed with high credit-quality financial institutions or in short-duration,
high quality debt securities. The Company limits the amount of credit exposure
in any one institution or type of investment instrument. As of December 31,
1998, the Company's short-term investments consisted of debt securities issued
by the Federal government and agencies of the United States, and high-quality
corporate and financial institution obligations. Debt securities available for
sale are carried on the balance sheet at fair market value, with the change in
unrealized gain or loss included in Shareholders' Equity. The unrealized gain on
the Company's investments in debt securities at December 31, 1998 and 1997 was
not material and therefore is combined with Additional Paid-in Capital in the
accompanying Consolidated Balance Sheets and Statements of Shareholders' Equity.

INVENTORIES
      Inventories, consisting principally of computer hardware, electronic
sub-assemblies and test equipment, are valued at the lower of cost (first-in,
first-out) or market. Costs used for inventory valuation purposes include
material, labor and manufacturing overhead.

<TABLE>
<CAPTION>
      DECEMBER 31,                               1998         1997
                                              ---------     --------
<S>                                           <C>           <C>

      Raw materials.........................  $   9,775     $  5,780
      Work-in-progress......................      2,608        4,037
      Finished goods........................      2,560        1,494
                                              ---------     --------

      Total inventories.....................  $  14,943     $ 11,311
                                              =========     ========
</TABLE>

                                     F-8
<PAGE>

PROPERTY, PLANT AND EQUIPMENT
      Property, plant and equipment is stated at cost and consists principally
of equipment, furniture and leasehold improvements. Depreciation of equipment
and furniture is computed principally on a straight-line basis over the
estimated useful lives of the assets, generally three to five years. Leasehold
improvements are amortized on a straight-line basis over the lesser of the term
of the lease, or the estimated useful lives of the improvements.

<TABLE>
<CAPTION>
     DECEMBER 31,                              1998             1997
                                             --------         --------
<S>                                          <C>              <C>
     Leasehold improvements................  $    324         $    285
     Computer equipment and software.......     6,521            5,307
     Manufacturing and test equipment......     5,081            4,293
     Demonstration equipment...............    10,661            6,615
     Office furniture and equipment........       840              822
                                             --------          -------
                                               23,427           17,322
     Less accumulated depreciation.........   (12,364)          (9,904)
                                             --------          -------
     Net property, plant and equipment.....  $ 11,063          $ 7,418
                                             ========          =======
</TABLE>

SERVICE SPARE PARTS
      Service spare parts consist of electronic components used to service Test
Stations for which the Company has entered into equipment maintenance agreements
with customers. Subsequent to December 31, 1995, the Company reclassified its
service spare parts from inventory to non-current assets to more accurately
reflect the use of such parts in the Company's service business. These assets
are not held for sale, diminish in value in a reasonably predictable manner, and
therefore are subject to depreciation. Beginning January 1, 1996, depreciation
of the Company's service spare parts is computed on a straight-line basis over
the estimated useful lives of the assets, generally eight years, and charged to
Cost of Service Sales. Prior to 1996, the Company charged normally recurring
adjustments necessary to present inventory at its estimated net realizable value
to Cost of Service Sales. In order to reflect this change, the Company recorded
a charge to Cost of Service Sales of $327 during the first quarter of 1996,
representing the cumulative difference in financial statement carrying value
between the depreciated cost under the new accounting method at January 1, 1996
and the net inventory carrying value of the service spare parts assets at
December 31, 1995. Cost and accumulated depreciation of service spare parts are
as follows:

<TABLE>
<CAPTION>
     DECEMBER 31,                             1998              1997
                                             -------          -------
<S>                                          <C>              <C>
     Service spare parts, at cost..........  $ 5,905          $ 5,233
     Less accumulated depreciation.........
                                              (2,213)          (1,838)
                                             -------          -------
     Net service spare parts...............  $ 3,692          $ 3,395
                                             =======          =======
</TABLE>

RESEARCH, DEVELOPMENT AND ENGINEERING COSTS
      Research, development and engineering costs are expensed as incurred.

                                      F-9
<PAGE>


SOFTWARE DEVELOPMENT COSTS
      The Company capitalizes certain software development costs incurred once
technological and economic feasibility of the product has been demonstrated.
These capitalized costs are amortized over the estimated economic life of the
related product, generally three years, computed principally on a straight-line
basis. Amortization is included in Cost of Systems Sales in the accompanying
Consolidated Statements of Operations. The Company capitalized software
development costs amounting to $2,442, $1,070 and $715 in 1998, 1997 and 1996,
respectively. Related amortization expense of $748, $753 and $842 was recorded
in 1998, 1997 and 1996, respectively.

<TABLE>
<CAPTION>
     DECEMBER 31,                              1998             1997
                                              -------          -------
<S>                                           <C>              <C>

     Software development costs............   $ 8,743          $ 6,301
     Less accumulated amortization.........    (5,286)          (4,538)
                                              -------          -------
     Net software development costs........   $ 3,457          $ 1,763
                                              =======          =======
</TABLE>

INCOME TAXES
      The Company accounts for income taxes under the asset and liability method
as defined by the provisions of Statement of Financial Accounting Standards
(SFAS) No. 109, "Accounting for Income Taxes". Under this method, deferred
income taxes are recognized for the future tax consequences attributable to
temporary differences between the financial statement and tax balances of
existing assets and liabilities. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. Under SFAS 109, the effect on deferred taxes of a change in tax rates
is recognized in income in the period that includes the enactment date.

STOCK-BASED COMPENSATION PLANS
      The Company accounts for its stock-based plans under Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25). The
Company has adopted the disclosure provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS
123).

EARNINGS PER SHARE
      The Company calculates earnings per share in accordance with Statement of
Financial Accounting Standards No. 128, "Earnings per Share" (SFAS 128). Basic
earnings (loss) per share are computed using the weighted average number of
common shares actually outstanding during the period. Diluted earnings (loss)
per share are computed by dividing net income (loss) by the weighted average
number of shares of common stock and common stock equivalents outstanding during
the period, calculated using the treasury stock method as defined in SFAS 128.
The Company's common stock equivalents consist of dilutive shares issuable upon
the exercise of outstanding common stock options. There are no differences in
net income (loss) used for basic and diluted earnings (loss) per share.
Following is a summary of common stock options outstanding but not included in
the computation of diluted earnings (loss) per share because their effect would
have been anti-dilutive.

<TABLE>
<CAPTION>
     YEAR ENDED
     DECEMBER 31,                      1998              1997          1996
                                       ----              ----          ----
<S>                                 <C>                <C>           <C>
    Number of anti-
     dilutive options .........      1,706,617          32,500        25,921
    Weighted average
     exercise price ...........     $     7.35         $ 18.99       $ 19.18
</TABLE>

COMPREHENSIVE INCOME
In July 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income." The statement is effective for the Company's
fiscal year ending December 31, 1998. SFAS 130 sets standards for reporting and
display of comprehensive income and its components in a full set of general
purpose financial statements. Comprehensive income is the total of net income
and all other non-owner changes in equity. The only non-owner changes in equity
recorded by the Company have been unrealized holding gains/losses on short-term
investment securities classified as available-for-sale under SFAS 115,
"Accounting for Certain Investments in Debt 

                                      F-10
<PAGE>

and Equity Securities," and foreign currency translation adjustment resulting 
from translation of subsidiary financial statements into US dollars from the 
local currencies in which the subsidiary financial statements are maintained. 
These non-owner changes in equity were not material, and therefore are not 
reported separately in the accompanying consolidated financial statements. 
The accumulated unrealized gains/losses on short-term investments and foreign 
currency translation adjustment are included in Additional Paid-in Capital in 
the accompanying Consolidated Balance Sheets.

3.    RECENT EVENTS:
      On September 3, 1998, the Company acquired all of the assets of PerformIC
for a cash price of $1,319 of which $1,194 has been paid. The remaining $125
will be paid in accordance with the terms of the acquisition agreement between
now and September 3, 1999. PerformIC, located in Dresden, Germany, is a
developer of technologies aimed at addressing the engineering test needs of
memory manufacturers. The transaction was accounted for as a purchase. In
connection with the purchase price allocation, the Company allocated a portion
of the purchase price to acquired in-process research and development. At that
time, the development of these products had not reached technological
feasibility and the technology was believed to have no alternative future use.
In accordance with generally accepted accounting principals, a charge for
in-process research and development of $861 has been reflected in the
accompanying Consolidated Statements of Operations as part of acquisition and
restructuring costs. In addition, royalties will be payable on future revenues
derived from the acquired technology for up to five years from the date of
acquisition.

      The nature of efforts required to develop the purchased in-process
technology into commercially viable products principally relate to the
completion of all planning, designing, prototyping, verification and testing
activities that are necessary to establish that the products can be produced to
meet its design specifications, including functions, features and technical
performance requirements. The Company currently believes that the research and
development efforts will result in commercially feasible products in the next 12
months at an estimated cost of approximately $2.5 million.

       Pro forma combined statement of operations data for the years ended
December 31, 1998, 1997 and 1996 was not materially different from results
presented in the accompanying Consolidated Statements of Operations.

      During the second half of 1998, the Company implemented a restructuring
plan, including a reduction in the Company's worldwide employee headcount by
approximately 14%, the termination of certain international distributor
agreements, and the establishment of direct sales operations in Europe and Asia.
The restructuring charge of $3,088 consisted of payments in connection with the
termination of distributors, costs to set up direct international operations as
a result of the pending expiration of a support agreement with Cadence, employee
severance, writedowns of inventory made obsolete by the acquisition of
PerformIC, and associated legal and consulting costs. Charges affecting
inventories of $2,041 have been classified in Systems Cost of Sales in the
accompanying Consolidated Statements of Operations. The remainder of the
restructuring expenses were recorded as acquisition and restructuring expense in
operating expenses.

      The following is an analysis of the restructuring charge and reserves at
December 31, 1998:

<TABLE>
<S>                                                           <C>
      Inventory write-downs.................................  $2,041
      Employee severance....................................     424
      Distributor termination costs & other.................     623
                                                              ------
      Total.................................................  $3,088
                                                              ======
</TABLE>

      Approximately $539 of the restructuring costs have not been paid and are
included in other current liabilities in the accompanying Consolidated Balance
Sheets as of December 31, 1998.

                                      F-11
<PAGE>


4.    CAPITAL LEASE OBLIGATIONS:

      The Company leases certain equipment under capital lease agreements, which
are secured by the related assets. A schedule of future minimum lease payments
under capital lease agreements as of December 31, 1998 is as follows:

<TABLE>
<S>                                                           <C>
      1999..................................................  $  439
      2000..................................................     173
      2001..................................................     222
                                                              ------
      Total minimum payments................................     834
      Amount representing interest..........................     (77)
                                                              ------
      Present value of future minimum lease payments........     757
          Less current portion..............................    (394)
                                                              ------

      Long-term capital lease obligation....................  $  363
                                                              ======
</TABLE>

5.    COMMITMENTS:

      The Company leases its facilities and certain equipment under operating
leases that expire from 1999 to 2006. The approximate future minimum lease
payments under these operating leases at December 31, 1998 are as follows:

<TABLE>
<S>                                                           <C>
      1999..................................................  $1,317
      2000..................................................   1,289
      2001..................................................   1,220
      2002..................................................   1,244
      2003..................................................   1,244
      Thereafter............................................     228

</TABLE>

      Rent expense was approximately $1,385, $1,164 and $1,189 for the years
ended December 31, 1998, 1997 and 1996, respectively.

6.    LINE OF CREDIT:

      In December 1995, the Company secured a revolving line of credit with a
bank allowing maximum borrowings of $10,000. The Company can borrow, with
interest at the bank's prime lending rate, or if lower, at certain margins above
bankers' acceptance on inter-bank offering rates. There have been no borrowings
against the line of credit to date. Certain financial covenants are included in
this agreement, which the Company was in compliance with at December 31, 1998.
The line of credit is renewable April 30, 1999.

7.    EMPLOYEE SAVINGS PLANS:

The Company has a profit sharing plan and trust that qualifies as a deferred
salary arrangement under Section 401(k) of the Internal Revenue Code. Under the
terms of the plan, the employees of the Company may make voluntary contributions
to the plan as a percentage of compensation, but not in excess of the maximum
allowed under the Code. Employees become eligible to participate in the plan on
the first day of the calendar quarter following date of hire. The Company
currently does not match employee contributions. 

On July 1, 1996, the Company implemented an Executive Deferred Compensation 
Plan (the "Plan") for the purpose of providing eligible employees with a 
program for deferring compensation earned during employment. The Plan is 
intended to constitute an unfunded deferred compensation arrangement for the 
benefit of certain highly compensated 

                                    F-12
<PAGE>

employees of the Company. Under the terms of the Plan, eligible employees of 
the Company may make voluntary contributions to the Plan as a percentage of 
compensation, but not in excess of limitations stated in the Plan. The 
Company has invested these voluntary contributions in a variety of investment 
funds for the intended use of paying plan benefits when participating 
employees become eligible to receive such benefits under the terms of the 
Plan. These investments have been included in Prepaid expenses and other 
current assets in the accompanying Balance Sheets. The Company currently does 
not match employee contributions and does not intend to do so in the near 
future.

8.    EMPLOYEE AND DIRECTOR STOCK PLANS:

      In May, 1995, the Company adopted the 1995 Stock Incentive Plan (the 1995
Plan) pursuant to which 1,995,000 shares of the Company's common stock have been
reserved for issuance. Options under the 1995 Plan generally vest ratably over a
four-year period from the date of grant, expire ten years from the date of
grant, and are exercisable at prices generally not less than the fair market
value at the grant date. During 1998 and 1997, the Company cancelled and
reissued, with modified vesting provisions, certain incentive stock options
granted to employees. The reissued options were granted at fair market value on
the date of reissuance and have been reflected in the table below as
cancellations and new grants. These options generally vest ratably over four
years from the date of the reissuance.

      On May 10, 1995, the Board of Directors approved the adoption of the 
1995 Stock Option Plan for Nonemployee Directors (the "Nonemployee Director 
Plan") pursuant to which 250,000 shares of the Company's common stock have 
been reserved for issuance. The Nonemployee Director Plan covers directors 
who are not employees of the Company. The Nonemployee Director Plan allows 
for the automatic grant of 10,000 options upon becoming a director and 3,000 
options annually thereafter. To-date, grants have been made at fair market 
value on the date of grant. These options vest ratably over three years from 
the date of grant. Since consummation of the Company's initial public 
offering, 75,000 stock options were awarded under the Nonemployee Director 
Plan. No stock options were awarded under the Nonemployee Director Plan 
during 1998.

      On May 6, 1996, the shareholders approved the adoption of the 1995
Employee Stock Purchase Plan (the "ESPP") pursuant to which 250,000 shares of
the Company's common stock have been reserved for issuance to participating
employees, of which 111,199 shares have been issued as of December 31, 1998.
Eligible employees may elect to contribute up to 10 percent of their cash
compensation during each pay period. The ESPP provides for two semiannual
offering periods, beginning February 1 and August 1 of each year. During the
offering periods, participants accumulate funds in an account via payroll
deduction. At the end of each six-month offering period, the purchase price is
determined and the accumulated funds are used to automatically purchase shares
of the Company's common stock. The purchase price per share is equal to 85
percent of the lower of the fair market value of the common stock (a) on the
Enrollment Date of the offering period or (b) on the date of the purchase.

      During 1995, the Financial Accounting Standards Board issued SFAS 123
which defines a fair value based method of accounting for an employee stock
option or similar equity instrument and encourages all entities to adopt that
method of accounting for all of their employee stock compensation plans.
However, it also allows an entity to continue to measure compensation cost for
those plans using the method of accounting prescribed in APB 25. Entities
electing to remain with the accounting in APB 25 must make pro forma disclosures
of net income and, if presented, earnings per share, as if the fair value based
method of accounting defined in SFAS 123 had been applied.

      The Company has elected to account for its stock-based compensation plans
under APB 25. However, the Company has computed, for pro forma disclosure
purposes, the value of all options granted and shares issued pursuant to the
ESPP during 1998, 1997 and 1996 using the Black-Scholes option-pricing model as
prescribed by SFAS 123, using the following weighted average assumptions:

<TABLE>
<CAPTION>
      YEAR ENDED DECEMBER 31,          1998        1997        1996
                                      -------     -------     -------
<S>                                   <C>         <C>         <C>
      Risk-free interest .........         5%          6%          6%
      Expected dividend yield ....         0%          0%          0%
      Expected life ..............    4 years     4 years     4 years
      Expected volatility ........        77%         56%         61%
</TABLE>

                                     F-13
<PAGE>

      The total value of options granted during 1998, 1997 and 1996 would be
amortized on a pro forma basis over the vesting period of the options. Options
generally vest equally over four years. If the Company had accounted for these
plans in accordance with SFAS 123, the Company's net income (loss) and net
income (loss) per share would have changed as reflected in the following pro
forma amounts:

<TABLE>
<CAPTION>
      YEAR ENDED DECEMBER 31,                      1998            1997       1996
                                                  -------         ------     ------
<S>                                               <C>             <C>        <C>
      Net income (loss):
          As reported..........................   $(3,331)        $5,205     $6,166
          Pro forma............................   $(5,588)        $3,463     $5,092
      Basic earnings (loss) per share:
          As reported..........................   $ (0.44)        $ 0.70     $ 0.92
          Pro forma............................   $ (0.75)        $ 0.47     $ 0.76
      Diluted earnings (loss) per share:
          As reported..........................   $ (0.44)        $ 0.67     $ 0.88
          Pro forma............................   $ (0.75)        $ 0.46     $ 0.74
</TABLE>

      The Company has not and does not currently contemplate any plans to issue
equity instruments other than options to purchase common stock of the Company.
Options are generally issued with an exercise price equal to the price of the
closing trade on the Nasdaq National Market on the date of issuance.

      A summary of the status of the Company's stock option plans and changes
are presented in the following table:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,                         1998                              1997                              1996
                                      ---------------------------      ---------------------------       ------------------------
                                                        WTD. AVG.                        WTD. AVG.                      WTD. AVG.
                                      SHARES            EX. PRICE      SHARES            EX. PRICE       SHARES         EX. PRICE
                                      ------            ---------      ------            ---------       ------         ---------
<S>                                  <C>                  <C>           <C>                <C>           <C>             <C>
Options outstanding at beginning 
 of year .........................   1,308,118            $11.43        861,608            $10.97        534,264         $ 9.36
Granted ..........................   2,655,742              8.01        682,823             13.37        442,200          14.57
Exercised ........................      (3,293)             9.40        (54,343)             9.64         (7,813)          9.38
Cancelled ........................  (2,253,950)            10.54       (181,970)            16.87       (107,043)         17.91
                                    ----------            ------      ---------            ------       --------         ------
Options outstanding at end of 
 year.............................   1,706,617            $ 7.35      1,308,118            $11.43        861,608         $10.97
                                    ==========            ======      =========            ======       ========         ======
Exercisable at end of year .......     209,284            $ 9.55        430,107            $10.47        241,698         $ 9.81
                                    ==========            ======      =========            ======       ========         ======
Shares issued under the ESPP .....      51,765            $ 8.49         40,793            $11.86         18,641         $11.26
                                    ==========            ======      =========            ======       ========         ======
Weighted average fair value of 
 options granted..................                        $ 4.81             --            $ 6.42             --         $ 6.85
Weighted average fair value of 
 shares issued under the ESPP.....                        $ 3.40             --            $ 5.37             --         $ 3.87
</TABLE>

                                       F-14
<PAGE>

      The following table sets forth the exercise price range, number of shares
outstanding at December 31, 1998, weighted average remaining contractual life,
weighted average exercise price, number of exercisable shares and weighted
average exercise price of exercisable options by groups of similar price and
grant date:
<TABLE>
<CAPTION>
                                           OPTIONS OUTSTANDING                              OPTIONS EXERCISABLE
                      -----------------------------------------------------------   ------------------------------------
                                               WEIGHTED
                                                AVERAGE                 WEIGHTED                              WEIGHTED
       EXERCISE          OUTSTANDING           REMAINING                AVERAGE                               AVERAGE
         PRICE              SHARES            CONTRACTUAL               EXERCISE        EXERCISABLE           EXERCISE
         RANGE           AT 12/31/98          LIFE (YEARS)               PRICE            OPTIONS               PRICE
 ------------------   ----------------    --------------------    ---------------   ------------------  ----------------
<S>                   <C>                 <C>                     <C>               <C>                 <C>
     $ 5.75-$ 6.25            341,250               9.69              $     6.21               25,718      $      6.25
     $ 7.00-$ 7.00          1,072,981               9.52              $     7.00                2,500      $      7.00
     $ 7.25-$ 9.00            186,875               7.81              $     8.71              105,310      $      8.58
     $10.00-$24.00            105,511               7.59              $    12.14               75,756      $     12.09
</TABLE>

      As of December 31, 1998, employees of the Company also held 
approximately 119,049 Cadence stock options, under the original terms of 
their issuance. These options were granted to IMS employees by Cadence prior 
to 1995 (see Note 1). Upon exercise of Cadence options, proceeds equal to the 
option exercise price pass to Cadence, and there is no impact on the number 
of shares of Company stock outstanding.

9.    SHAREHOLDER RIGHTS PLAN:

      In March 1998, the Company adopted a Shareholder Rights Plan (the 
"Rights Plan"). Under the Rights Plan, a dividend of one Share Purchase Right 
(a "Right") was declared for each share of Company Common Stock outstanding 
at the close of business on April 17, 1998. In the event that a person or 
group acquires 20% or more of the Company's Common Stock (other than 
stockholders currently owning 20% or more of Company Common Stock) without 
advance approval by the Board of Directors, each Right will entitle the 
holder, other than the acquirer, to buy Common Stock with a market value of 
twice the Right's then current exercise price (initially $70.00, subject to 
adjustment). In addition, if the new Rights are triggered by such a 
non-approved acquisition and the Company is thereafter acquired in a merger 
or other transaction in which the shareholders of the Company are not treated 
equally, shareholders with unexercised Rights will be entitled to purchase 
common stock of the acquirer with a value of twice the exercise price of the 
Rights.

10.   INCOME TAXES:

The provision (benefit) for income taxes consisted of the following 
components:
<TABLE>
<CAPTION>

YEAR ENDED                     1998            1997             1996       
DECEMBER 31,               -------------   --------------   -------------- 
<S>                        <C>             <C>              <C>
 Current:
     Federal.............  $       --      $     2,052      $     3,098
     State...............           10             629              592
     Foreign.............           12             --               --
                           -------------   --------------   --------------
                                    22           2,681            3,690

 Deferred................         (518)            119             (144)
                           -------------   --------------   --------------

     Total...............  $      (496)    $     2,800      $     3,546
                           =============   ==============   ==============
</TABLE>


                                       F-15

<PAGE>

      The effective tax rate differs from the Federal Statutory Tax Rate as
follows:
<TABLE>
<CAPTION>

YEAR ENDED                     1998            1997             1996       
DECEMBER 31,               -------------   --------------   -------------- 
<S>                        <C>             <C>              <C>
 Federal statutory tax                                       
   rate..................       34.0%           34.0%           34.0%
 State taxes, net 
  of Federal tax effect..       (1.7)            4.4             4.1
 Foreign tax rates.......       (2.2)            --               --
 Research and development
   tax credits...........        7.8            (3.1)           (1.9)
 Valuation allowance for
   deferred tax assets...      (24.1)            --               --
 Other, net..............       (0.8)           (0.3)            0.3
                           -------------   --------------   --------------
     Total...............       13.0%           35.0%           36.5%
                           =============   ==============   ==============
</TABLE>

      Net deferred tax assets consist of the following tax effects relating 
to temporary differences:
<TABLE>
<CAPTION>
DECEMBER 31,                                    1998             1997
                                           --------------   --------------
<S>                                        <C>              <C>
 Deferred tax assets:

     Inventory valuation.................  $        844     $        966
     Accrued vacation and other
         compensation....................           654              590
     Book in excess of tax depreciation..           130              110
     Allowance for doubtful accounts.....           150              202
     Deferred revenue....................           110              155
     Research and development credit
         carryforward....................           298              --
     Net operating loss carryforwards....         3,538              --
     Other...............................            31              --
                                           --------------   --------------
     Gross deferred tax assets...........         5,755            2,023
     Less valuation allowance............        (2,388)             --
                                           --------------   --------------
                                                  3,367            2,023
                                           --------------   --------------
 Deferred tax liabilities:
     Service spare parts valuation.......          (440)            (238)
     Software development costs..........        (1,255)            (617)
     Other...............................            --              (14)
                                           --------------   --------------
                                                 (1,695)            (869)
                                           --------------   --------------
     Net deferred tax assets.............  $      1,672     $      1,154
                                           ==============   ==============
</TABLE>


                                       F-16

<PAGE>

      As of December 31, 1998, the Company had net operating loss 
carryforwards for income tax purposes of approximately $10,059. Such 
carryforwards will expire from 2003 to 2018 if not used by the Company to 
reduce income taxes payable in future periods.

      For the years ended December 31, 1997 and 1996, income taxes payable 
have been reduced by $2,652 and $1,921, respectively, for the tax benefit 
from tax deduction of employee gains upon exercise of Cadence and IMS stock 
options. The tax benefit of the stock option deduction for 1996 and 1997 is 
reflected as an increase in Additional Paid-in Capital in the accompanying 
Consolidated Statements of Shareholders' Equity. At such time that the 
Company is able to realize the benefits of its net operating loss 
carryforward, tax benefits from the stock option deduction for the year ended 
December 31, 1998, amounting to approximately $1,464 will be recorded as an 
increase in Additional Paid-in Capital. The employee gains are generally not 
expenses of the Company for financial reporting purposes, and the exercise of 
Cadence stock options does not increase the number of shares of Company 
common stock outstanding.

11.   TRANSACTIONS WITH CADENCE:

      In certain foreign markets, Cadence employees act as sales agents for 
the Company. The Company reimburses Cadence for related costs incurred on the 
Company's behalf, plus an administrative fee. Cadence provides selling, 
service and production support related to the Company's Virtual Test 
Software. The Company has paid Cadence based upon estimated costs to provide 
this support, and related expenses have been reflected in the accompanying 
Consolidated Statements of Operations. Cadence provides facilities for 
certain domestic Company sales personnel. Charges for utilization of these 
facilities have been reflected in the accompanying Consolidated Statements of 
Operations as Selling, General and Administrative expense. For the years 
1998, 1997 and 1996, the costs of the above services provided by Cadence 
totaled $1,746, $2,648 and $2,608, respectively. In 1997 and 1996, the 
Company sold a mixed-signal Test Station and related upgrades and peripherals 
to Cadence, to be used by Cadence's design services group providing 
engineering test services to their customers, for $1,329 and $1,260, 
respectively. In 1998, the Company sold Virtual Test Software to Cadence for 
resale to Cadence customers in the amount of $1,176.

12.      SEGMENT DISCLOSURES:

      The Company adopted SFAS No. 131, Disclosures about Segments of an 
Enterprise and Related Information, during the fourth quarter of 1997. SFAS 
No. 131 established standards for reporting information about operating 
segments in annual financial statements and requires selected information 
about operating segments in interim financial reports issued to stockholders. 
It also established standards for related disclosures about products and 
services, and geographic areas. Operating segments are defined as components 
of an enterprise about which separate financial information is available that 
is evaluated regularly by the chief operating decision maker, or decision 
making group, in deciding how to allocate resources and in assessing 
performance. The Company's chief operating decision making group is the 
Executive Committee, which is comprised of the Chief Executive Officer, Chief 
Financial Officer and the lead executives of each of the Company's operating 
segments. The reported operating segments are managed separately because each 
operating segment represents a strategic business unit that offers different 
products and serves different markets. Certain internal operating groups have 
been aggregated in the Test Systems segment below, due to significant 
similarities in their products & services, production processes, markets & 
customers, and common distribution channels.

      The Company's reportable operating segments include Test Systems and 
Virtual Test. Test Systems designs, develops, manufactures, markets and 
services high-performance engineering Test Stations and software to test and 
measure the performance of complex electronic devices. Virtual Test designs, 
develops, manufactures and markets software tools to help test engineers to 
accelerate the generation of test programs, simulate the test environment, 
develop the test fixture and document the entire test process for complex 
electronic devices.

      The accounting policies of the operating segments are the same as those 
described in the summary of significant accounting policies except that the 
separate financial results for the Company's operating segments have been 
prepared using a management approach, which is consistent with the basis and 
manner in which Company management internally reports financial information 
for the purposes of assisting in making internal operating decisions. The 
Company evaluates performance based on standalone operating income for each 
operating segment. 

                                       F-17

<PAGE>

Revenues are attributed to geographic areas based on the location of the 
customer taking delivery of the related products or services.

OPERATING SEGMENTS
<TABLE>
<CAPTION>
                                                    TEST SYSTEMS         VIRTUAL TEST           OTHER            CONSOLIDATED
                                                ------------------   ------------------  -----------------   ------------------
<S>                                             <C>                  <C>                 <C>                 <C>
1996
Segment net sales                                     $ 46,458            $  4,379                --             $ 50,837
Segment operating income                              $  9,010            $    485                --             $  9,495
Identifiable segment assets                           $ 30,846            $    895            $ 12,573           $ 44,314
Segment depreciation & amortization expense           $  3,359            $    133                --             $  3,492
Expenditure to acquire long-lived property            $  4,596            $    475                --             $  5,071

1997
Segment net sales                                     $ 40,960            $  5,890                --             $ 46,850
Segment operating income                              $  6,533            $    540                --             $  7,073
Identifiable segment assets                           $ 33,283            $  1,897            $ 30,343           $ 65,523
Segment depreciation & amortization expense           $  3,831            $    170                --             $  4,001
Expenditure to acquire long-lived property            $  6,135            $    564                --             $  6,699

1998
Segment net sales                                     $ 32,788            $  3,909                --             $ 36,697
Segment operating (loss) (a)(b)                       $ (2,573)           $   (967)           $ (1,047)          $ (4,587)
Identifiable segment assets                           $ 45,404            $  3,225            $ 14,785           $ 63,414
Segment depreciation & amortization expense           $  3,919            $    328                --             $  4,247
Expenditure to acquire long-lived property            $  8,036            $  1,516                --             $  9,552
</TABLE>

(a)   Test Systems operating loss includes effect of the adjustment t write-off
      certain inventories made obsolete as a result of the acquisition of
      PerformIC.

(b)   Other consists of acquisition and restructuring expenses.

       Exports sales are made to the Company's customers throughout Asia-Pacific
and Europe. Sales by customer geographic region, generally denominated in U.S.
dollars, were:
<TABLE>
<CAPTION>

YEAR ENDED                     1998            1997             1996       
DECEMBER 31,               -------------   --------------   -------------- 
<S>                        <C>             <C>              <C>
 United States...........  $     27,051    $     30,772     $     37,591
 Asia-Pacific............         3,899          10,990            8,999
 Europe..................         5,582           4,842            3,790
 Other...................           165             246              457
                           -------------   --------------   --------------
     Total...............  $     36,697    $     46,850     $     50,837
                           =============   ==============   ==============
</TABLE>

Long-lived assets by geographic region were:
<TABLE>
<CAPTION>

AT DECEMBER 31,                1998            1997
                           -------------   --------------
<S>                        <C>             <C>              
 United States...........  $     18,251    $     13,175
 Asia-Pacific............           839              --
 Europe..................           342              --
                           -------------   --------------
     Total...............  $     19,432    $     13,175
                           =============   ==============
</TABLE>


                                       F-18

<PAGE>

13.      CONCENTRATIONS OF CREDIT RISK AND GEOGRAPHIC INFORMATION:

      The Company sells to customers located throughout the United States, 
Asia-Pacific and Europe. Credit evaluations of its customers' financial 
conditions are performed periodically, and the Company generally does not 
require collateral from its customers. The Company maintains reserves for 
potential credit losses and such losses have been both immaterial and within 
management's expectations.

      In 1998, 1997, and 1996, one customer accounted for 25 percent, 27 
percent and 36 percent of net sales, respectively. The Company is subject to 
credit risk through trade receivables, which is minimized due to the size and 
financial stability of the Company's customers. At December 31, 1998 trade 
receivables by geographic region were:

<TABLE>
<CAPTION>
<S>                                                      <C>
 United States.........................................  $     9,988
 Asia-Pacific..........................................        2,432
 Europe................................................        1,970
                                                         -------------
                                                              14,390

 Less allowance for doubtful accounts..................         (413)
                                                         -------------

 Trade receivables, net................................  $    13,977
                                                         =============
</TABLE>


                                       F-19

<PAGE>

                 SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) 
                     (In thousands, except per share data)     
<TABLE>
<CAPTION>
QUARTER ENDED                                   MARCH 31             JUNE 30            SEPTEMBER 30         DECEMBER 31        
                                               ---------------------------------------------------------------------------------
<S>                                            <C>                  <C>                 <C>                  <C>                
1998
Net sales                                      $  8,492             $  8,407             $  9,473             $ 10,325
Gross margin                                   $  5,647             $  5,589             $  3,926             $  6,703
Operating loss *                               $   (146)            $   (320)            $ (3,704)            $   (417)
Net income (loss) *                            $     48             $    (88)            $ (3,350)            $     59
Basic earnings (loss) per share *              $   0.01             $  (0.01)            $  (0.45)            $   0.01
Diluted earnings (loss) per share *            $   0.01             $  (0.01)            $  (0.45)            $   0.01
--------------------------------------------------------------------------------------------------------------------------------

1997
Net sales                                      $ 13,280             $ 11,026             $ 12,067             $ 10,477
Gross margin                                   $  8,602             $  7,274             $  8,040             $  6,780
Operating income                               $  2,683             $  1,473             $  2,071             $    846
Net income                                     $  1,825             $  1,174             $  1,518             $    688
Basic earnings per share                       $   0.26             $   0.16             $   0.20             $   0.09
Diluted earnings per share                     $   0.25             $   0.15             $   0.20             $   0.09
--------------------------------------------------------------------------------------------------------------------------------
</TABLE>

*     Operating loss, net income (loss), basic earnings (loss) per share, and
      diluted earnings (loss) per share, before nonrecurring acquisition and
      restructuring charges for the quarter ended September 30, 1998, were
      $(155), $39, $0.01 per share, and $0.01 per share, respectively.

      Operating loss, net income (loss), basic earnings (loss) per share, and
      diluted earnings (loss) per share, before nonrecurring acquisition and
      restructuring charges for the quarter ended December 31, 1998, were $(17),
      $130, $0.02 per share, and $0.02 per share, respectively.


                                       F-20

<PAGE>

                      INTEGRATED MEASUREMENT SYSTEMS, INC.

                        VALUATION AND QUALIFYING ACCOUNTS

                                 (In Thousands)
<TABLE>
<CAPTION>
                                                         Additions
                                                         Charged to
                                       Beginning           Cost &                           Ending
       Description                      Balance           Expenses        Deductions        Balance
       -----------                      -------           --------        ----------        -------
<S>                                    <C>               <C>              <C>               <C>    
Year ended December 31, 1996
     Allowance for doubtful accounts      $338              $  151          $  --             $489

Year ended December 31, 1997
     Allowance for doubtful accounts      $489              $  150          $   (62)          $577

Year ended December 31, 1998
     Allowance for doubtful accounts      $577              $  --           $  (164)          $413
     Accrued restructuring expense        $ --              $3,088          $(2,549)          $539
</TABLE>


                                       F-21


<PAGE>

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE

To the Board of Directors and Shareholders of
Integrated Measurement Systems, Inc.:

      We have audited, in accordance with generally accepted auditing 
standards, the consolidated financial statements of Integrated Measurement 
Systems, Inc. included in the 1998 Form 10-K annual report and have issued 
our report thereon dated January 21, 1999. Our audits were made for the 
purpose of forming an opinion on those statements taken as a whole. The 
Valuation and Qualifying accounts schedule is the responsibility of the 
Company's management and is presented for purposes of complying with the 
Securities and Exchange Commission's rules and is not part of the basic 
financial statements. This schedule has been subjected to the auditing 
procedures applied in the audits of the basic financial statements and, in 
our opinion, fairly state in all material respects the financial data 
required to be set forth therein in relation to the basic financial 
statements taken as a whole.


                                       ARTHUR ANDERSEN LLP


Portland, Oregon
January 21, 1999



                                       F-22