<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, 1999

                                       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 $100,836,959 on March 15, 2000, based upon the last sales price
of the Common Stock on that date reported in the NASDAQ National Market System.
On March 15, 2000, there were 7,798,055 shares of the Registrant's Common Stock
outstanding, including 2,659,866 held by affiliates.

                       DOCUMENTS INCORPORATED BY REFERENCE

            Document                   Part of Form 10-K into which incorporated
            --------                   -----------------------------------------
Portions of Proxy Statement to be                     Part III
used in connection with the
Company's 2000 annual meeting of
shareholders to be
held on or about May 16.


                                        1
<PAGE>

                      INTEGRATED MEASUREMENT SYSTEMS, INC.
                          1999 FORM 10-K ANNUAL REPORT
                                TABLE OF CONTENTS

                                                                            Page
                                                                            ----
                                     PART I

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 7A.    Quantitative and Qualitative Disclosures About                    18
            Market Risk

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                    19

Item 11.    Executive Compensation                                            19

Item 12.    Security Ownership of Certain Beneficial Owners and               19
            Management

Item 13.    Certain Relationships and Related Transactions                    19

                                     PART IV

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


                                       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, 1999, Cadence owned approximately 36% of the outstanding shares of
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 IC validation systems. Customers use the Company's
IC validation systems 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 IC Validation Systems Products

The Company's IC validation systems 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, the Company's software converts design engineering
data, including EDA simulation data, into data compatible with the Company's IC
validation systems, thus bridging the gap between design software and
verification. The IMS IC validation systems enable data conversion from popular
simulation products including Verilog, VHDL, Quicksim and others.

The IMS IC validation systems stimulate the device under test by sending defined
signals to the device, measuring the actual output and comparing it with the
expected output. The IMS IC validation systems 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 IC validation systems are designed to work with
industry standard computers to receive and execute test commands and report the
results of test procedures. IMS IC validation systems 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.


                                       3
<PAGE>

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

The Company's IC validation systems 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. IC
validation systems 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 IC validation systems. The logic
family, which accounted for 65% of total revenues in 1999, is the oldest and
largest of the three families. Customers typically use the Company's logic IC
validation systems to verify the designs of complex microprocessors, application
specific IC's (ASIC's) and Multichip Modules (MCM's). Included in this family is
the Vanguard, the Company's flagship product during 1999, which can test devices
at up to 500MHz. The Vanguard systems sell for between $700,000 and $2,300,000,
depending on the configuration, and accounted for the majority of logic family
revenues in 1999. The logic IC validation system family also includes the ATS
and XTS products, the Company's leading logic IC validation system products
prior to 1999, which can test devices at up to 400MHz. These systems sell for
between $250,000 and $1,800,000, depending on the configuration.

The mixed-signal family of IC validation systems includes the Electra and the
Electra MX, which was introduced in 1999. Mixed-signal IC validation systems are
used by customers to verify the designs of complex devices used in such
applications as telecommunications, system-on-chip (SOC) and video electronics.
Depending on the configuration, the mixed-signal IC validation systems can test
devices at up to 400 MHz and sell for between $300,000 and $2,100,000.
Mixed-signal Test Stations accounted for 10% of total revenues in 1999.

With the acquisition of Perform IC in September, 1998, the Company added its
newest IC validation system family, the Orion Memory IC validation systems. The
Orion is used by customers to verify the designs of complex SRAM's and DRAM's at
speeds up to 200MHz. Depending on the configuration, these IC validation systems
sell for between $350,000 and $500,000. The Company began shipping Orion IC
validation systems to customers during the second quarter of 1999. Sales of the
Orion Memory systems contributed 4% of total 1999 revenues.

IC Validation Systems Software Products

The Company has developed IC validation systems software products that are
either embedded in the Company's IC validation systems 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 IC validation systems can be interfaced to a network, allowing the
IC validation systems access to other resources on the network, and allowing
multiple workstations on the network to have access to the IC validation system.
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


                                       4
<PAGE>

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 1997, is a
productivity tool for digital test engineers. TestDirect is a test pattern
generation program that provides test engineers with an automatic tool for
generating ATE test patterns from the designer's original test bench simulation
environment. This process shortens the test development time and the overall
product development cycle, increasing a customer's revenue potential and
improves their time-to-market competitiveness. The IMS Digital VirtualTester,
introduced in 1998, 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 difficult to quantify, the
Company believes that its TestDirect, and Digital VirtualTester software
products and services provide a significant advantage to semiconductor designers
and test engineers . The Virtual Test software products currently operate in
conjunction with Cadence, Synopsys and Mentor Graphics EDA software and certain
ATE machines manufactured by Advantest, Agilent, Schlumberger, Teradyne and
Credence later this year. In 1999, revenues from the sale of Virtual Test
Software comprised approximately 5% 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 IC validation
systems and related hardware and software technologies. Certain of the Company's
Virtual Test Software technologies were 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 additional
technology and assets. In 1998, the Company acquired PerformIC a developer of
technologies aimed at addressing the engineering test needs of memory
manufacturers. As a result, the Company has established its new European Design
Center in Perform IC's facilities in Dresden, Germany to principally concentrate
on developing IC validation system technologies to address the memory market.

The Company's research and development efforts are performed by approximately 82
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


                                       5
<PAGE>

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 manufacturing control software to monitor orders, purchasing, inventory,
production and manufacturing costs.

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. 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 IC validation systems at
its headquarters facility in Beaverton, Oregon. The Company's Orion IC
validation systems are manufactured at its European Headquarters in Sargans,
Switzerland.

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 IC validation
systems. 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 IC validation systems 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 in the United States 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


                                       6
<PAGE>

the sophisticated needs of prospective customers' engineering staffs as part of
the customer support process. The U.S. 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.

The Company markets its products in the European region through a direct sales
force in France and the United Kingdom, and independent distributors in Germany,
Scandinavia, Italy, Turkey and Israel Kingdom. In Asia the Company sells through
through a direct sales force in Japan and through distributors in Taiwan, the
People's Republic of China, Hong Kong, Malaysia/Singapore, Philippines 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 Notes 12 and 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, 1999, 1998, and 1997, sales to one customer
represented approximately 50%, 25% and 27% of the Company's net sales,
respectively. No other customer accounted for more than 10% of the Company's net
sales in 1999, 1998 or 1997.

                                   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 ease of use, product performance and
reliability, price, 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 ease of use, product performance, low
cost and service and support.

The Company currently competes with a number of other verification and
characterization equipment manufacturers. Competitors for the Company's digital
and mixed-signal IC verification systems include companies such as Agilent,
Teradyne, Credence and Schlumberger. The primary competitor for the Company's
Orion memory IC validation systems is Mosaid. Most of these companies 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


                                       7
<PAGE>

To be competitive, the Company believes it must provide a high level of support
and service. Support and service accounted for 16% of the Company's net sales
for the fiscal year ended December 31, 1999. 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 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 1998,
1997, 1996, 1995, 1994 and 1993 in customer satisfaction and quality for
suppliers of test and material handling equipment according to VLSI Research,
Inc. The Company generally warrants its IC validation systems for twelve months,
and in certain instances for 24 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, 1999, the Company had 268 employees, including 68 in marketing
and sales, 83 in manufacturing and service, 82 in research, development and
engineering and 35 in administration and finance. The Company also has 3
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 80,000 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 11,000 square feet of office space
in which certain of its regional sales offices are located.

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, 1999.


                                       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 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.

                                                               High       Low
                                                               ----       ---
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
Fiscal 1999
      First Quarter.........................................        11         7
      Second Quarter........................................    14 3/8     6 3/4
      Third Quarter.........................................   15 1/16     9 3/4
      Fourth Quarter........................................    14 1/2   10 7/16

As of March 15, 2000, there were approximately 1,525 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, 1999, the Company made no sales of
securities that were not registered under the Securities Act of 1933.


                                       9
<PAGE>

Item 6. Selected Financial Data

                    (In thousands, except per share amounts)

<TABLE>
<CAPTION>
                                                            Year ended December 31,
                                            --------------------------------------------------------
                                              1999        1998         1997        1996        1995
                                            -------     -------      -------     -------     -------
<S>                                         <C>         <C>          <C>         <C>         <C>
Consolidated Statements of Operations Data:
   Net sales ...........................    $56,070     $36,697      $46,850     $50,837     $41,093
   Gross margin % ......................       62.2%       59.6%        65.5%       64.3%       61.6%
   Operating income (loss) .............     $7,374     $(4,587)      $7,073      $9,495      $5,469
   Operating income (loss) % ...........       13.2%      (12.5)%       15.1%       18.7%       13.3%
   Net income (loss) (a) ...............     $5,581     $(3,331)      $5,205      $6,166      $3,535
   Basic earnings (loss) per share (a) .      $0.74      $(0.44)       $0.70       $0.92       $0.54
   Diluted earnings (loss) per share (a)      $0.70      $(0.44)       $0.67       $0.88       $0.53

<CAPTION>
                                                                   December 31,
                                            --------------------------------------------------------
                                              1999        1998         1997        1996        1995
                                            -------     -------      -------     -------     -------
<S>                                         <C>         <C>          <C>         <C>         <C>
Consolidated Balance sheet data:
   Cash and cash equivalents ...........     $7,507      $3,379      $17,464      $9,545      $8,930
   Short-term investments ..............    $15,117      $7,630       $8,371          --          --
   Total assets ........................    $74,424     $63,414      $65,523     $44,314     $35,184
   Long-term obligations, net of
     current portion ...................       $213        $363         $152        $278         $54
   Shareholders' equity ................    $61,820     $53,542      $57,433     $34,859     $26,484
</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.

COMPANY BACKGROUND

The Company was founded in 1983 to design and develop engineering IC validation
systems 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. 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 shares sold by Cadence, yielding net proceeds to the
Company and Cadence of $13.4 million and $18.6 million, respectively. As of
December 31, 1999, Cadence continues to own approximately 36% of the Company's
common stock.

RESULTS OF OPERATIONS

Net Sales

Net sales is comprised of engineering IC validation systems sales, software
sales (including IC validation systems software and Virtual Test Software) and
service sales, which consists primarily of revenue derived from maintenance and
consulting contracts.

Net sales rose sharply in 1999 after two consecutive years of sales declines. In
general, two factors contributed to the increase:

      1)    The product line is broader than it was two years ago. Towards the
            end of 1998, the Company released the 500Mhz Vanguard logic IC
            validation system, Electra and Electra MX mixed-signal IC validation
            systems, all of which contributed to the increase in net sales .
            Additionally, in mid-1999, the Company began customer shipments of
            the Orion Memory IC validation system . Systems and software sales
            for the last three years are as follows:


                                       11
<PAGE>

<TABLE>
<CAPTION>
                                          Year ended December 31,
                             ---------------------------------------------------
                                       Increase              Increase
                               1999   (Decrease)     1998   (Decrease)     1997
                             -------   -------     -------   -------     -------
<S>                          <C>       <C>         <C>       <C>         <C>
Systems
  Vanguard ...............   $19,032       444%     $3,500       n/a          $0
  Other Logic ............    14,553        (8)     15,766       (44%)    28,373
  Mixed Signal ...........     5,329        75       3,052       (17)      3,686
  Memory .................     2,211       n/a           0       n/a           0
                             -------   -------     -------   -------     -------
     Total Systems .......   $41,125        84%    $22,318       (30%)   $32,059
                             =======   =======     =======   =======     =======

Software
  Systems ................    $2,958        43%     $2,066        52%     $1,358
  Virtual Test ...........     2,882        12       2,566         9       2,360
                             -------   -------     -------   -------     -------
     Total Software ......    $5,840        26%     $4,632        25%     $3,718
                             =======   =======     =======   =======     =======
</TABLE>

2)    Capital spending within the Semiconductor Industry increased in 1999 for
      the first time in several years. Although our revenues do not necessarily
      correlate directly with industry capital spending, the increase in
      expenditures indicates a healthier selling environment for our products.
      Semiconductor capital spending over the past three years is as follows:

<TABLE>
<CAPTION>
                                                     Year ended December 31,
                                 --------------------------------------------------------------------
                                                Increase                    Increase
                                    1999       (Decrease)       1998       (Decrease)        1997
                                 -----------   ----------    -----------   ----------     -----------
<S>                              <C>           <C>           <C>           <C>            <C>
Semiconductor Capital Spending
(Per VLSI Research, Dec. 1999)   $32,518,000           10%   $29,463,700          (35%)   $45,562,000
</TABLE>

Systems Sales

Systems sales in 1999 increased $18.8 million or 84% over 1998, after decreasing
$9.7 million or 30% in 1998 from 1997. Sales of the 500 MHz Vanguard logic IC
validation system, almost entirely to the Company's largest customer, accounted
for 46% of net system sales in 1999, up from 16% in 1998. The Vanguard is the
Company's flagship product and eventually will be the platform for our
mixed-signal and system-on-chip (SOC) solutions in addition to the current logic
solutions. Sales of other logic systems declined by $1.2 million or 8% from 1998
as a result of the Vanguard ramp, but still accounted for 35% of net system
sales. The Company expects these products to continue to contribute to revenues
over the next several years. Mixed-signal systems sales increased $2.3 million
or % over 1998, with most of the volume occurring in the latter part of 1999.
Nearly all mixed-signal sales in 1999 were for the Electra family, while all
mixed-signal sales in 1998 were for older generation products. The Company began
shipping Orion memory IC validation systems in the second quarter of 1999. There
were no revenues from memory systems in 1998.

System sales in 1998 declined $9.7 million or 30% from 1997. This decline
resulted in part from the generally depressed state of the semiconductor
industry, and in part because of a strategy shift made by the Company's largest
customer. That customer was in the process of segmenting its markets over 1997
and 1998 and, as a result, spent substantially less money on the Company's
systems as it developed and implemented its segmentation strategy. A number of
the design starts resulting from this strategy shift are now getting to the
prototype validation stage, driving the current demand for Vanguard systems.

Software Sales

System software sales increased $892 or 43% in 1999 from 1998. The increase is
directly attributable to the increase in system sales, and particularly Vanguard
system sales, which carry a higher dollar volume of software revenue. Virtual
Test software revenues increased by $316 or 12% in 1999 from 1998, as increased
sales of standardized Virtual Test software licenses more than offset reduced
sales of custom software. The Company no longer pursues non-standard custom
software sales, and now focuses on developing standard products that can be sold
multiple times to multiple customers.


                                       12
<PAGE>

System software sales in 1998 increased $708 or 52% from 1997 largely due to the
introduction of the Vanguard IC validation system in late 1998. Virtual Test
software sales increased by $206 or 9% in 1998 compared to 1997, as the Company
began shifting from non-standard custom software sales to standard software
product sales as discussed above.

Service Sales

Service revenues declined in 1999 by $642 or 7% from 1998. In 1998, service
revenues decreased $1.3 million or 12% from 1997. The principle reason for these
declines was the Company's decision to exit the consulting business for Virtual
Test and focus on sales of standard Virtual Test software products.

International sales amounted to 25% of net sales for the year ended December 31,
1999 compared to 26% and 34% of net sales for 1998 and 1997, respectively. The
decrease in international sales since 1997 has been due primarily to much lower
sales to customers in the Asia-Pacific region, partially offset by moderate
improvement in net sales in Europe. Sales to one customer amounted to 50%, 25%
and 27% of net sales in 1999, 1998, and 1997, respectively. No other customer
accounted for more than 10% of the Company's net sales in 1999, 1998 or 1997.

Gross Margin

For the year ended December 31, 1999 gross margin was $34.9 million or 62% of
net sales compared to $21.9 million or 65% of net sales, excluding non-recurring
charges, for 1998, and $30.7 million or 66% of net sales for 1997. During 1999,
slower growth for higher-margin software sales relative to growth in systems
sales, increased provisions for warranty costs (due to an increase in standard
warranty terms from 90 days to one year, and to two years for the Company's
largest customer), and sales of certain lower-margin older generation systems
resulted in gross margins below the prior years levels, excluding non-recurring
charges. Overall gross margin percent in 2000 is expected to remain at similar
levels to those realized in 1999.

The gross margin from sales of the Company's IC validation systems was 61% for
1999, compared to 64% for 1998, excluding non-recurring charges, and 62% for
1997. Software gross margin of 86% for 1999 was slightly higher than the 1998
gross margin of 85%. Software gross margin in 1998 and 1999 declined from 94% in
1997 due primarily to the impact of costs of customization of certain software
products sold during the first half of 1998, and increased amortization of
capitalized software development costs. Sales of services yielded gross margin
of 50% for 1999, down from 58% in 1998 and 67% in 1997. Service gross margin
declined from 1997 through 1999 due primarily to a decrease in higher-margin
Virtual Test consulting contracts during these periods.

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. In connection with this acquisition, a charge of $2.0
million was recorded in Systems Cost of Sales for inventories rendered obsolete
by the PerformIC acquisition. With this acquisition, the Company opened its new
European Design Center in Dresden.

Operating Expenses

For the year ended December 31, 1999, research, development and engineering
(R&D) expenses increased by $1.6 million or 24% to $8.4 million from $6.8
million for the same period in 1998. R&D expenses were $7.4 million in 1997.
The increase in 1999 was due primarily to the Company's investment in the
development of the Orion memory IC validation system products, combined with
lower capitalization of software development costs. As a percentage of net
sales, R&D expenses were 15% for the year ended December 31, 1999 and 18% and
16% for 1998 and 1997, respectively. The decrease in R&D expenses as a
percentage of net sales in 1999 was attributable to the increase in net sales
discussed above. Capitalized software development costs and amortization were
$1.9 million and $1.4 million, respectively, for the year ended December 31,
1999, compared with $2.4 million and $748, respectively, in 1998, and $1.1
million and $753, respectively, in 1997. Amortization of capitalized software

                                       13
<PAGE>

development costs increased in 1999 because capitalized amounts related to the
Vanguard IC validation system and certain Virtual Test products began amortizing
when the products were released to customers beginning in late 1998.

For the year ended December 31, 1999, selling, general and administrative (SG&A)
expenses increased by $1.3 million or 8% to $19.1 million from $17.8 million in
1998. In 1998, SG&A expenses increased 10% or $1.6 million from $16.2 million in
1997. The increase in operating expenses in 1999 primarily reflects payment of
sales commissions on higher sales volumes, and payment of employee performance
bonuses attributable to Company achievement of specified operating income
targets. The increase in SG&A expenses in 1998 over 1997 was principally the
result of 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 decreased to 34% for the year ended
December 31, 1999 compared to 48% for the same period in 1998 and 35% in 1997.
The 1999 decrease in SG&A expenses as a percent of net sales resulted directly
from the increase in net sales discussed above.

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 moved forward.

The total non-recurring acquisition and restructuring charges recorded in 1998
operating expenses amounted to $1.9 million. These charges included acquired
in-process research & development of $861 associated with the acquisition of
PerformIC, $623 associated with the termination of certain international
distributors, and $424 for severance costs.

Other Income, net

Other income, net was $834 for 1999, $760 for 1998 and $932 for 1997. The
increase in other income, net for 1999 from 1998 was due primarily to foreign
exchange transaction gains. The decrease in other income, net from 1997 to 1998
was due to the impact of lower average cash and investment balances on interest
income.

Income Taxes

The Company's effective tax rate was 32% for the year ended December 31, 1999.
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 had recorded deferred tax assets from net operating loss
carryforwards of $3.5 million, against which it recorded a valuation allowance
of $2.4 million. As the Company returned to profitability during 1999, this
valuation allowance was reduced appropriately by approximately $2.1 million. Of
this reduction in the valuation allowance, approximately $1.5 million was
credited 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 effective tax rate for the year ended December 31, 1997
was 35%.

The Company's income tax position includes 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. While management anticipates the Company's effective tax rate to remain
at levels similar to 1999, this rate is very sensitive to the geographic and
product mix of the Company's net sales, and therefore could be higher or lower
in the future depending upon actual net sales realized.

Net Income


                                       14
<PAGE>

As a result of the various factors discussed above, net income for the year
ended December 31, 1999 increased to $5.6 million or $0.70 per diluted share
compared to a loss of $3.3 million or $0.44 per share for the corresponding
period in 1998. Net income for the year ended December 31, 1997 was $5.2 million
or $0.67 per diluted share.

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. These risks include, but are not limited to,
the following:

Sales of the Company's products to a limited number of major 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 any major
customer would have a material adverse effect on the Company's financial
condition and results of operations.

The Company is dependent on high-dollar customer orders, deriving a substantial
portion of its net sales from the sale of engineering IC validation systems
which typically range in price from $0.3 million to over $2.0 million per unit.
A substantial amount of the Company's net sales are typically realized in the
last few days of each quarter. During 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 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 during
that period.

A significant portion of the Company's operating expenses is 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.

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, the duration and severity of the
economic downturn in Asia, 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

During 1999 and 1998, the Company developed and executed its Year 2000 Readiness
Plan which included steps to monitor, test and implement corrective measures for
the Company's critical vendors and suppliers, products and information systems .
The Company estimates the costs incurred during 1999 and 1998, including
payments to third parties and estimates of internal costs, for developing and
implementing its Year 2000 readiness plan were less than $300 and $200,
respectively. To date, the Company has not been impacted by any material Year
2000 issues.


                                       15
<PAGE>

LIQUIDITY AND CAPITAL RESOURCES

As of December 31, 1999, the Company's principal sources of liquidity consisted
of cash, cash equivalents and short-term investments of approximately $22.6
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 1999 and 1997, net cash provided by operating
activities amounted to $16.0 million and $8.8 million, respectively. During
1998, net cash used in operating activities amounted to $3.3 million.

For 1999, the Company realized a significant improvement in cash flow from
operating activities, driven by the increase in net sales discussed above,
combined with improvement in the days sales outstanding in trade receivables,
and reductions in inventory levels. During 1998, 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 operating activities. Other factors which negatively
impacted 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 amounted to $14.0 million at December 31, 1999 and December
31, 1998. Because a more significant portion of the Company's quarterly net
sales were realized earlier in each quarter during 1999 than the Company had
experienced in 1998, days sales outstanding declined from 122 days at December
31, 1998 to 75 days at December 31, 1999. Inventories decreased from $14.9
million at December 31, 1998 to $13.2 million at December 31, 1999. This
decrease was primarily due to the combination of increased sales volume and
focused inventory reduction programs.

Investing Activities

Capital equipment expenditures of $3.1 million, $7.1 million, and $5.6 million
in 1999, 1998, and 1997, respectively, were primarily for computers, software,
demo equipment, engineering equipment and service spare parts used in the
Company's operations. The higher level of capital spending during 1998 was
largely driven by investments in production equipment and tooling necessary to
begin shipments of the Company's Vanguard IC validation systems late in 1998.
Following these significant investments, there was less need for additional
capital expenditures during 1999.

In addition, the Company capitalized certain costs associated with software
development of $1.9 million, $2.4 million and $1.1 million for 1999, 1998 and
1997, respectively. The higher amount in 1998 reflects the investment in
software technology associated with the Company's new Vanguard IC validation
systems which were introduced in late 1998.

Financing Activities

In 1999 and 1997, net cash provided by financing activities was $622 and $14.2
million, respectively. In 1998, net cash used in financing activities was $757.

In May 1998, the Company initiated a plan to repurchase up to 500,000 shares of
its currently outstanding common stock over twelve months in open market and
negotiated transactions. This repurchase program authorized the repurchase of
shares in increments in accordance with SEC regulations and Board of Directors'
guidance. During


                                       16
<PAGE>

1998, this program resulted in the repurchase of 150,500 shares at a total cost
of $1.2 million. The Company did not repurchase any of its common stock during
1999.

Cash used for payments of certain capital leases obtained by the Company for
computers and equipment used in operations was $395, $197 and $251 during 1999,
1998 and 1997, respectively. The Company received $1.0 million, $595, and $1.0
million in 1999, 1998 and 1997, 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 1999 and 1997, the Company realized reductions in current income tax
liabilities of $1.7 million and $2.7 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.
During 1999, the Company generated sufficient pre-tax income to realize the
benefit of the carryforward deduction of these option exercises. This benefit is
included above in the realized reduction in income tax liabilities for 1999.

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 may
decrease in the future as employee holdings of Cadence stock options decline due
to option exercises and cancellations. The timing and magnitude of such decrease
in tax benefits, if realized, 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, 2000. 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 7A. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk

The Company's exposure to market risk for changes in interest rates relate
primarily to its investment portfolio. The Company mitigates its risk by
diversifying its investments among high credit quality securities in accordance
with the Company's investment policy. As of December 31, 1999, the Company's
investment portfolio includes marketable debt securities of $16.3 million. These
securities are subject to interest rate risk, and will decline in value if the
interest rates increase. Due to the short duration of the Company's investment
portfolio, an immediate 10 percent increase in interest rates would not have a
material effect on the Company's financial condition or the results of its
operations.

Foreign Currency Exchange Rate Risk

The Euro is the functional currency of the Company's subsidiaries in France,
Germany and Switzerland. The Yen is the functional currency of the Company's
subsidiary in Japan. The Company does maintain cash balances denominated in
currencies other than the U.S. Dollar in order to meet minimum operating
requirements of its foreign subsidiaries.

The Company has limited involvement with derivative financial instruments and
does not use them for trading purposes. Derivatives are used to manage
well-defined foreign currency risks. The Company enters into forward exchange
contracts to hedge the value of recorded short-term receivables and payables
denominated in a foreign currency. Accordingly, the impact of exchange rates on
the forward contracts will be substantially offset by the impact of such changes
on the underlying transactions. The effect of an immediate 10 percent change in
exchange rates on the forward exchange contracts and the underlying hedged
positions denominated in foreign currencies would not be material to the
Company's financial position or the results of its operations.

Item 8. Financial Statements and Supplementary Data

The financial statements and schedule listed in Item 15(a)(1) and (2) are
included in this Report beginning on Page F-2.

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

None.


                                       18
<PAGE>

                                    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 to be used in connection with the Company's 2000 annual meeting of
shareholders to be held on or about May 16, 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 to be used in connection with the Company's 2000
annual meeting of shareholders to be held on or about May 16, 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 to be used in connection with the
Company's 2000 annual meeting of shareholders to be held on or about May 16, 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 to be
used in connection with the Company's 2000 annual meeting of shareholders to be
held on or about May 16, 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 to be used in
connection with the Company's 2000 annual meeting of shareholders to be held on
or about May 16, and is incorporated herein by reference.

                                     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:

                                                                            Page
                                                                            ----
            Report of Independent Public Accountants                        F-1
            Consolidated Statements of Operations                           F-2
            Consolidated Balance Sheets                                     F-3
            Consolidated Statements of Shareholders' Equity                 F-4


                                       19
<PAGE>

            Consolidated Statements of Cash Flows                           F-5
            Notes to Consolidated Financial Statements                      F-7
            Selected Quarterly Financial Data                               F-21

      (2)   Financial Statement Schedules

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

                                                                            Page
                                                                            ----
            Schedule II -- Valuation and Qualifying Accounts                F-22
            Report of Independent Public Accountants on Financial
            Statements Schedule                                             F-23

            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

                                                                      Sequential
                                                                     Page Number

            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)

            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


                                       20
<PAGE>

                      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.

            21.       List of Subsidiaries of the Company*

            23.1.     Consent of Arthur Andersen LLP*

            27.1.     Financial Data Schedule*

            --------

            * File Herewith

      (b)   Reports on Form 8-K

            No report on Form 8-K was filed during the quarter ended December
            31, 1999.


                                       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,
2000.

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, 2000.

       Signature                            Title
       ---------                            -----


/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/ THOMAS R. FRANZ             Director
-----------------------
Thomas R. Franz


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


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


/s/ MILTON R. SMITH             Director
-----------------------
Milton R. Smith


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


                                       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, 1999 and 1998, and the related consolidated statements of
operations, shareholders' equity, and cash flows for each of the three years in
the period ended December 31, 1999. 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, 1999 and 1998, and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 1999 in conformity with generally accepted
accounting principles.


                                                /s/ ARTHUR ANDERSEN LLP

Portland, Oregon
January 21, 2000


                                      F-1
<PAGE>

                      CONSOLIDATED STATEMENTS OF OPERATIONS
                    (In thousands, except per share amounts)

<TABLE>
<CAPTION>
                                                                   Year ended December 31,
                                                               -------------------------------
                                                                 1999       1998        1997
                                                               --------   --------    --------
<S>                                                            <C>        <C>         <C>
Sales:
  Systems ..................................................   $ 41,125   $ 22,318    $ 32,059
  Software .................................................      5,840      4,632       3,718
  Service ..................................................      9,105      9,747      11,073
                                                               --------   --------    --------

    Net sales ..............................................     56,070     36,697      46,850

Cost of sales:
  Systems ..................................................     15,863      9,993      12,241
  Software .................................................        823        707         211
  Service ..................................................      4,510      4,132       3,702
                                                               --------   --------    --------

    Total cost of sales ....................................     21,196     14,832      16,154
                                                               --------   --------    --------

    Gross margin ...........................................     34,874     21,865      30,696

Operating expenses:
  Research, development and engineering ....................      8,362      6,763       7,385
  Selling, general and administrative ......................     19,138     17,781      16,238
  Acquisition and restructuring ............................         --      1,908          --
                                                               --------   --------    --------

    Total operating expenses ...............................     27,500     26,452      23,623
                                                               --------   --------    --------

    Operating income (loss) ................................      7,374     (4,587)      7,073

Other income, net ..........................................        834        760         932
                                                               --------   --------    --------

Income (loss) before income taxes ..........................      8,208     (3,827)      8,005

Provision (benefit) for income taxes .......................      2,627       (496)      2,800
                                                               --------   --------    --------

    Net income (loss) ......................................   $  5,581   $ (3,331)   $  5,205
                                                               ========   ========    ========

Basic earnings (loss) per share ............................   $   0.74   $  (0.44)   $   0.70
                                                               ========   ========    ========
Diluted earnings (loss) per share ..........................   $   0.70   $  (0.44)   $   0.67
                                                               ========   ========    ========

Weighted average number of common shares outstanding for
  basic earnings (loss) per share ..........................      7,492      7,496       7,388
Incremental shares from assumed conversion of employee
  stock options ............................................        488         --         360
                                                               --------   --------    --------
Adjusted weighted average shares for diluted earnings (loss)
  per share ................................................      7,980      7,496       7,748
                                                               ========   ========    ========
</TABLE>

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


                                      F-2
<PAGE>

                           CONSOLIDATED BALANCE SHEETS
                      (In thousands, except share amounts)

<TABLE>
<CAPTION>
                                                                                December 31,
                                                                             -----------------
                                                                               1999      1998
                                                                             -------   -------
<S>                                                                          <C>       <C>
ASSETS

Current assets:
  Cash and cash equivalents ..............................................   $ 7,507   $ 3,379
  Short-term investments .................................................    15,117     7,630
  Trade receivables, less allowance for doubtful accounts of $257 and $413    13,956    13,977
  Inventories ............................................................    13,176    14,943
  Deferred income taxes ..................................................     2,662     1,453
  Prepaid expenses and other current assets ..............................     3,453     2,381
                                                                             -------   -------

    Total current assets .................................................    55,871    43,763

Property, plant and equipment, net .......................................    10,737    11,063

Service spare parts, net .................................................     2,986     3,692

Software development costs, net ..........................................     3,915     3,457

Deferred income taxes ....................................................        --       219

Other assets, net ........................................................       915     1,220
                                                                             -------   -------

    Total assets .........................................................   $74,424   $63,414
                                                                             =======   =======

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
  Accounts payable .......................................................   $ 1,512   $ 1,828
  Payable to Cadence, net ................................................        27       506
  Accrued compensation ...................................................     2,608     1,718
  Accrued warranty .......................................................     1,182       296
  Deferred revenue .......................................................     2,193     2,008
  Income taxes payable ...................................................       818       197
  Other current liabilities ..............................................       947     1,408
  Capital lease obligations -- current ...................................       149       394
                                                                             -------   -------

    Total current liabilities ............................................     9,436     8,355

Deferred income taxes ....................................................     1,390        --

Capital lease obligations, net of current portion ........................       213       363

Deferred compensation ....................................................     1,565     1,154

Commitments (note 5)

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;
    7,588,600 and 7,425,951 issued and outstanding .......................        76        74

  Additional paid-in capital .............................................    42,173    39,478

  Retained earnings ......................................................    19,571    13,990
                                                                             -------   -------

       Total shareholders' equity ........................................    61,820    53,542
                                                                             -------   -------

       Total liabilities and shareholders' equity ........................   $74,424   $63,414
                                                                             =======   =======
</TABLE>

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


                                      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, 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
  Stock issued under employee stock plans ......        163           2       1,015          --       1,017
  Tax benefit from Cadence and IMS stock options         --          --       1,680          --       1,680
  Net income ...................................         --          --          --       5,581       5,581
                                                   --------    --------    --------    --------    --------
Balance, December 31, 1999 .....................      7,589    $     76    $ 42,173    $ 19,571    $ 61,820
                                                   ========    ========    ========    ========    ========
</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,
                                                                     --------------------------------
                                                                       1999        1998        1997
                                                                     --------    --------    --------
<S>                                                                  <C>         <C>         <C>
Cash flows from operating activities:
  Net income (loss) ..............................................   $  5,581    $ (3,331)   $  5,205
  Adjustments to reconcile net income (loss) to cash provided
    by (used in) operating activities:
    Acquired in-process research & development ...................         --         861          --
    Depreciation and amortization ................................      5,881       4,247       4,001
    Contributed capital ..........................................         --          --         313
    Provision (benefit) for deferred income taxes ................        400        (518)        119
    Deferred compensation ........................................        411         324         372
  Net change in receivable from / payable to Cadence .............       (479)        725       1,906
  Decrease (increase) in trade receivables .......................         21      (3,395)        770
  Decrease (increase) in inventories .............................      1,767      (3,505)     (3,371)
  (Increase) decrease in prepaid expenses and other current assets
                                                                       (1,072)         47        (851)
  Net change in income taxes payable or receivable ...............      2,301         533       1,337
  Increase (decrease) in accounts payable and accrued expenses
                                                                          999         679      (1,032)
  Increase in deferred revenue ...................................        185          10          67
                                                                     --------    --------    --------

Net cash provided by (used in) operating activities ..............     15,995      (3,323)      8,836
                                                                     --------    --------    --------

Cash flows from investing activities:
  Acquisition of PerformIC .......................................         --      (1,194)         --
  Purchases of short-term investments ............................     (9,609)     (5,840)    (11,392)
  Sale of short-term investments .................................      2,122       6,581       3,021
  Purchases of equipment and service spare parts .................     (3,129)     (7,110)     (5,629)
  Software development costs .....................................     (1,873)     (2,442)     (1,070)
                                                                     --------    --------    --------

    Net cash used in investing activities ........................    (12,489)    (10,005)    (15,070)
                                                                     --------    --------    --------

Cash flows from financing activities:
  Principal payments under capital leases ........................       (395)       (197)       (251)
  Net proceeds from public stock offerings .......................         --          --      13,367
  Repurchase of common stock .....................................         --      (1,155)         --
  Proceeds from employee stock plans .............................      1,017         595       1,037
                                                                     --------    --------    --------

    Net cash provided by (used in) financing activities ..........        622        (757)     14,153
                                                                     --------    --------    --------

    Net increase (decrease) in cash and cash equivalents .........      4,128     (14,085)      7,919
Cash and cash equivalents at beginning of year ...................      3,379      17,464       9,545
                                                                     --------    --------    --------

Cash and cash equivalents at end of year .........................   $  7,507    $  3,379    $ 17,464
                                                                     ========    ========    ========
</TABLE>


                                      F-5
<PAGE>

<TABLE>
<CAPTION>
                                                            Year ended December 31,
                                                         -----------------------------
                                                           1999       1998       1997
                                                         -------    -------    -------
<S>                                                      <C>        <C>        <C>
Supplemental schedule of noncash financing activities:
  Purchases of assets through capital leases .........   $    --    $   621    $    59
  Tax benefit from Cadence and IMS stock options .....   $ 1,680    $    --    $ 2,652
  Acquisition of PerformIC ...........................   $    --    $   125    $    --

Other supplemental cash flow disclosures:
  Income taxes refunded (paid) .......................   $   100    $   512    $(1,307)
  Interest paid ......................................   $   (45)   $   (35)   $   (41)
</TABLE>

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


                                      F-6
<PAGE>

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

1. COMPANY BACKGROUND:

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. 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. 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 $13,400. At December 31, 1999,
Cadence owned 36% of the outstanding common stock of the Company, with the
remaining 64% publicly owned.

The Company is engaged in designing, developing, manufacturing, marketing and
servicing high-performance engineering IC validation systems and 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 the United Kingdom.

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 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. Transaction gains and losses
are included in net income (loss) in the accompanying Consolidated Statements of
Operations.

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 1998 and 1997 to conform with the 1999 presentation.

Revenue Recognition


                                      F-7
<PAGE>

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.

In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial
Statements." SAB 101 summarizes certain of the SEC's views in applying generally
accepted accounting principles (GAAP) to revenue recognition in financial
statements. The Company is required to adopt SAB 101 in the first quarter
beginning after December 15, 1999. Although the Company believes its revenue
recognition policies are in accordance with GAAP, the Company is currently
studying SAB 101 and has not determined its impact on the Company's financial
statements.

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's
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,
1999, 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, 1999 and 1998 was
not material .

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.

                     December 31,         1999      1998
                                         -------   -------

                     Raw materials ...   $ 7,443   $ 9,265
                     Work-in-progress      2,184     2,608
                     Finished goods ..     3,549     3,070
                                         -------   -------

                     Total inventories   $13,176   $14,943
                                         =======   =======


                                      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.

           December 31, ....................     1999        1998
                                               --------    --------

           Leasehold improvements ..........   $    395    $    324
           Computer equipment and software .      6,185       6,521
           Manufacturing and test equipment       4,918       5,081
           Demonstration equipment .........     12,697      10,661
           Office furniture and equipment ..      1,167         840
                                               --------    --------
                                                 25,362      23,427
           Less accumulated depreciation ...    (14,625)    (12,364)
                                               --------    --------
           Net property, plant and equipment   $ 10,737    $ 11,063
                                               ========    ========

Service Spare Parts

Service spare parts consist of electronic components used to service IC
validation systems for which the Company has entered into equipment maintenance
agreements with customers. The Company classifies its service spare parts as
non-current assets to reflect the long-term 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.
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. Cost and accumulated depreciation of service
spare parts are as follows:

              December 31, ................     1999       1998
                                              -------    -------

              Service spare parts, at cost    $ 5,736    $ 5,905
              Less accumulated depreciation    (2,750)    (2,213)
                                              -------    -------
              Net service spare parts .....   $ 2,986    $ 3,692
                                              =======    =======

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 $1,873, $2,442 and $1,070 in 1999, 1998 and 1997,
respectively. Related amortization expense of $1,415, $748 and $753 was recorded
in 1999, 1998 and 1997, respectively.

             December 31, .................     1999        1998
                                              --------    --------
             Software development costs ...   $ 10,616    $  8,743
             Less accumulated amortization      (6,701)     (5,286)
                                              --------    --------
             Net software development costs   $  3,915    $  3,457
                                              ========    ========

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.

Year ended
December 31, ............................     1999        1998        1997
                                            ---------   ---------   ---------
Number of shares of anti-dilutive options      82,920   1,706,617      32,500
Weighted average exercise price per share   $   13.22   $    7.35   $   18.99

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


                                      F-10
<PAGE>

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
and Equity Securities," and foreign currency translation adjustment resulting
from translation of subsidiary financial statements into US dollars from the
functional 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.

Derivative Instruments and Hedging Activities

In June 1998, the Financial Accounting Standards Board issued "Accounting for
Derivative Instruments and Hedging Activities" (SFAS 133), which was
subsequently amended by "Accounting for Derivative Instruments and Hedging
Activities" (SFAS 137) in June 1999. SFAS 133 and SFAS 137 require the Company
to recognize all derivatives on the balance sheet at fair value. Derivatives
that are not hedges must be adjusted to fair value through income. If the
derivative is a hedge, depending on the nature of the hedge, changes in the fair
value of the derivatives will either be offset against the change in fair value
of the hedged assets, liabilities, or firm commitments through earnings, or
recognized in other comprehensive income until the hedged item is recognized in
earnings. The change in the derivative's fair value related to the ineffective
portion of a hedge, if any, will be immediately recognized in earnings. The
Company expects to adopt this Standard for fiscal 2001. The effect of adopting
this standard is not expected to have a material effect on the Company's
financial position or its results of operations.

The Company enters into foreign currency forward contracts (forward contracts)
to manage exposure related to certain foreign currency transactions. All
outstanding forward contracts at the end of the period are marked-to-market,
with unrealized gains and losses included in net income as a component of other
income, net. The Company may, from time to time, adjust its foreign currency
hedging positions by taking out additional contracts or by terminating or
offsetting existing forward contracts. These adjustments typically result from
changes in the underlying foreign currency exposures. Realized gains and losses
on terminated forward contracts, or on contracts that are offset, are recognized
in income in the period of contract termination or offset. At December 31, 1999,
the Company had outstanding forward contracts with notional amounts totaling
approximately $1,478. These contracts, which mature within 45 days of year-end,
are hedges of certain foreign currency transaction exposures in the British
pound sterling, Euro, and Japanese yen. The estimate fair value of the contracts
was negligible.

3. ACQUISITION AND RESTRUCTURING:

On September 3, 1998, the Company acquired all of the assets of PerformIC for a
cash price of $1,319. 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 1998.
In addition, royalties are 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. During 1999, the Company invested approximately $1,600 in research
and development efforts necessary to introduce a commercially feasible product
to market.


                                      F-11
<PAGE>

Pro forma combined statement of operations data for the years ended December 31,
1998 and 1997 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 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 recorded for the year
ended December 31, 1998:

                 Inventory write-downs ...............   $2,041
                 Employee severance ..................      424
                 Distributor termination costs & other      623
                                                         ------
                 Total ...............................   $3,088
                                                         ======

Substantially all of the restructuring costs were paid in 1998 and early 1999.


                                      F-12
<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, 1999 is as follows:

                 2000 ................................   $ 172
                 2001 ................................     222
                                                         -----

                 Total minimum payments ..............     394
                 Amount representing interest ........     (32)
                                                         -----

                 Present value of future minimum lease
                   payments ..........................     362
                 Less current portion ................    (149)
                                                         -----

                 Long-term capital lease obligation ..   $ 213
                                                         =====

5. COMMITMENTS:

The Company leases its facilities and certain equipment under operating leases
that expire from 2000 to 2004. The approximate future minimum lease payments
under these operating leases at December 31, 1999 are as follows:

                 2000 ...................  $1,488
                 2001 ...................   1,392
                 2002 ...................   1,357
                 2003 ...................   1,293
                 2004 ...................     216
                 Thereafter .............      --

Rent expense was approximately $1,201, $1,385 and $1,164 for the years ended
December 31, 1999, 1998 and 1997, 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, 1999. The
line of credit is renewable April 30, 2000.

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 has
not matched employee contributions. Effective in 2000, the Company plans to
contribute to the plan an amount equal to 3% of each eligible employee's base
compensation, subject to the Company's achievement of targeted operating income
levels.


                                      F-13
<PAGE>

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 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 Consolidated 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 2,215,000 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. No option grants were cancelled and
reissued during 1999.

In May, 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 or 1999.

In May, 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 176,724 shares have been issued as of December 31, 1999. 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. Effective February 1, 2000,
the Company amended the ESPP to extend the offering period from six months to
twenty-four months. Participants shall continue to accumulate funds into
accounts via payroll deduction. At the end of the offering period the
accumulated funds shall be used to automatically purchase shares of the
Company's common stock. The purchase price per share shall continue to be equal
to 85 percent of the lower of the fair market value of the common stock on (a)
each participant's Enrollment Date or (b) 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.


                                      F-14
<PAGE>

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
1999, 1998 and 1997 using the Black-Scholes option-pricing model as prescribed
by SFAS 123, using the following weighted average assumptions:

Year ended December 31,                1999       1998       1997
                                       ----       ----       ----
Risk-free interest rate .............    5.5%        5%         6%
Expected dividend yield .............      0%        0%         0%
Expected life ......... ............. 4 years   4 years    4 years
Expected volatility ... .............     77%       77%        56%

The total value of options granted during 1999, 1998 and 1997 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:

Year ended December 31,                          1999        1998         1997
                                              ---------   ---------    ---------
Net income (loss):
      As reported .........................   $   5,581   $  (3,331)   $   5,205
      Pro forma ...........................   $   3,411   $  (5,588)   $   3,463
Basic earnings (loss) per share:
      As reported .........................   $    0.74   $   (0.44)   $    0.70
      Pro forma ...........................   $    0.46   $   (0.75)   $    0.47
Diluted earnings (loss) per share:
      As reported .........................   $    0.70   $   (0.44)   $    0.67
      Pro forma ...........................   $    0.43   $   (0.75)   $    0.46

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,                                                1999                  1998                  1997
                                                              --------------------   --------------------   --------------------
                                                                          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 ..................    1,706,617    $ 7.35    1,308,118    $11.43      861,608    $10.97
Granted ...................................................      440,212      9.46    2,655,742      8.01      682,823     13.37
Exercised .................................................      (97,124)     8.00       (3,293)     9.40      (54,343)     9.64
Cancelled .................................................     (180,782)     7.61   (2,253,950)    10.54     (181,970)    16.87
                                                              ----------    ------   ----------    ------   ----------    ------

Options outstanding at end of year ........................    1,868,923    $ 7.77    1,706,617    $ 7.35    1,308,118    $11.43
                                                              ==========    ======   ==========    ======   ==========    ======

Exercisable at end of year ................................      821,621    $ 7.73      209,284    $ 9.55      430,107    $10.47
                                                              ==========    ======   ==========    ======   ==========    ======

Shares issued under the ESPP ..............................       65,525    $ 7.90       51,765    $ 8.49       40,793    $11.86
                                                              ==========    ======   ==========    ======   ==========    ======
</TABLE>


                                      F-15
<PAGE>

<TABLE>
<S>                                                            <C>          <C>      <C>           <C>      <C>           <C>
Weighted average fair value of options granted ............           --    $ 6.08           --    $ 4.81           --    $ 6.42

Weighted average fair value of shares issued under the ESPP           --    $ 3.52           --    $ 3.40           --    $ 5.37
</TABLE>

      The following table sets forth the exercise price range, number of shares
outstanding at December 31, 1999, 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:

                           OPTIONS OUTSTANDING             OPTIONS EXERCISABLE
                ---------------------------------------   ----------------------
                                 Weighted
                                  Average      Weighted                 Weighted
   Exercise      Outstanding     Remaining      Average                 Average
    Price           Shares      Contractual    Exercise   Exercisable   Exercise
    Range        at 12/31/99    Life (Years)     Price      Options       Price
-------------    -----------    ------------   --------   -----------   --------

$ 5.75-$ 6.25      291,519          8.69        $ 6.20      101,157      $ 6.21
$ 7.00-$ 7.00      958,707          8.52        $ 7.00      491,859      $ 7.00
$ 7.25-$ 9.00      364,742          8.21        $ 8.68      136,355      $ 8.68
$ 9.13-$19.00      253,955          8.58        $11.16       92,250      $11.92

As of December 31, 1999, employees of the Company also held approximately 84,728
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:

Year ended December 31,
                                      1999              1998               1997
                                    -------           -------            -------

Current:
  Federal ...............           $ 2,161           $    --            $ 2,052
  State .................                15                10                629


                                      F-16
<PAGE>

  Foreign ...............                51                12                 --
                                    -------           -------            -------
                                      2,227                22              2,681

Deferred ................               400              (518)               119
                                    -------           -------            -------

  Total .................           $ 2,627           $  (496)           $ 2,800
                                    =======           =======            =======

      The effective tax rate differs from the Federal Statutory Tax Rate as
follows:

Year ended December 31,                           1999        1998        1997
                                                  ----        ----        ----

Federal statutory tax rate .................      34.0%       34.0%       34.0%
State taxes, net of Federal tax
      effect ...............................       1.1        (1.7)        4.4
Foreign tax rates ..........................       0.2        (2.2)         --
Research and development tax credits .......      (2.2)        7.8        (3.1)
Valuation allowance for deferred
      tax assets ...........................      (4.6)       (24.1)        --
Other, net .................................       3.5        (0.8)       (0.3)
                                                  ----        ----        ----

      Total ................................      32.0%       13.0%       35.0%
                                                  ====        ====        ====

Net deferred tax assets consist of the following tax effects relating to
temporary differences:

December 31,                                              1999            1998
                                                        -------         -------

Deferred tax assets:
  Inventory valuation ..........................        $   912         $   844
  Accrued vacation and other compensation ......            524             654
  Book in excess of tax depreciation ...........            148             130
  Allowance for doubtful accounts ..............            148             150
  Accrued warranty .............................            396             108
  Tax credit carryforwards .....................            640             298
  Net operating loss carryforwards .............            823           3,538
  Other ........................................             --              33
                                                        -------         -------
  Gross deferred tax assets ....................          3,591           5,755
  Less valuation allowance .....................           (322)         (2,388)
                                                        -------         -------
                                                          3,269           3,367
                                                        -------         -------

Deferred tax liabilities:
  Service spare parts valuation ................           (640)           (440)
  Software development costs ...................         (1,357)         (1,255)
                                                        -------         -------
                                                         (1,997)         (1,695)
                                                        -------         -------


                                      F-17
<PAGE>

  Net deferred tax assets ......................        $ 1,272         $ 1,672
                                                        =======         =======

As of December 31, 1999, the Company had net operating loss carryforwards for
income tax purposes of approximately $1,994. Such carryforwards will expire from
2003 to 2018 if not used by the Company to reduce income taxes payable in future
periods.

As of December 31, 1999, the Company had research & development credit and
alternative minimum tax credit carryforwards for income tax purposes of
approximately $640. Such carryforwards will expire from 2018 to 2019 if not used
by the Company to reduce income taxes payable in future periods.

For the years ended December 31, 1999 and 1997, income taxes payable have been
reduced by $1,680 and $2,652, 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 1999 and 1997 is reflected as an
increase in Additional Paid-in Capital in the accompanying Consolidated
Statements of Shareholders' Equity. 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 1999, 1998 and 1997, the costs of the
above services provided by Cadence totaled $657, $1,746 and $2,648,
respectively. In 1997 the Company sold a mixed-signal IC validation system and
related upgrades and peripherals to Cadence for $1,329, to be used by Cadence's
design services group providing engineering test services to their customers. 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 Systems and Virtual Test.
The Systems segment designs, develops, manufactures, markets and services
high-performance engineering IC validation systems and software to test and
measure the performance of complex electronic devices. Virtual Test designs,
develops, manufactures and


                                      F-18
<PAGE>

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

<TABLE>
<CAPTION>
Operating Segments
                                                 Systems      Virtual Test       Other      Consolidated
                                                 -------      ------------       -----      ------------
<S>                                              <C>            <C>            <C>            <C>
1997
Segment net sales .........................      $ 40,960       $  5,890             --       $ 46,850
Segment operating income ..................      $  6,533       $    540             --       $  7,073
Identifiable segment assets (c) ...........      $ 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 (c) ...........      $ 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

1999
Segment net sales .........................      $ 52,788       $  3,282             --       $ 56,070
Segment operating income (loss) ...........      $  8,788       $ (1,414)            --       $  7,374
Identifiable segment assets (c) ...........      $ 41,944       $  3,741       $ 28,739       $ 74,424
Segment depreciation & amortization expense      $  5,101       $    780             --       $  5,881
Expenditure to acquire long-lived property       $  4,355       $    647             --       $  5,002
</TABLE>

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

(b)   Other consists of acquisition and restructuring expenses.

(c)   Other consists of cash & cash equivalents, short-term investments,
      deferred income taxes, and prepaid expenses and other current assets.

Exports sales are made to the Company's customers throughout Asia-Pacific and
Europe. Sales by customer geographic region were:

Year ended December 31,               1999              1998              1997
                                     -------           -------           -------
United States ............           $41,871           $27,051           $30,772
Asia-Pacific .............             7,671             3,899            10,990
Europe ...................             6,387             5,582             4,842
Other ....................               141               165               246
                                     -------           -------           -------

  Total ..................           $56,070           $36,697           $46,850
                                     =======           =======           =======


                                      F-19
<PAGE>

Long-lived assets by geographic region were:

                    At December 31,      1999      1998
                                        -------   -------

                    United States ....  $17,197   $18,251
                    Asia-Pacific .....      561       839
                    Europe ...........      795       342
                                        -------   -------

                      Total ..........  $18,553   $19,432
                                        =======   =======

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 1999, 1998, and 1997, one customer accounted for 50 percent, 25 percent
and 27 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, 1999 trade receivables by
geographic region were:

                United States ......................   $  9,091
                Asia-Pacific .......................      2,255
                Europe .............................      2,867
                                                       --------
                                                         14,213

                Less allowance for doubtful accounts       (257)
                                                       --------

                Trade receivables, net .............   $ 13,956
                                                       ========


                                      F-20
<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>
1999
Net sales .........................   $ 11,222    $ 13,162    $ 14,895    $ 16,791
Gross margin ......................   $  6,791    $  8,270    $  9,219    $ 10,594
Operating income ..................   $    530    $  1,423    $  2,109    $  3,312
Net income ........................   $    434    $  1,027    $  1,610    $  2,510
Basic earnings per share ..........   $   0.06    $   0.14    $   0.21    $   0.33
Diluted earnings per share ........   $   0.06    $   0.13    $   0.20    $   0.31
----------------------------------------------------------------------------------

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
----------------------------------------------------------------------------------
</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-21
<PAGE>

                      INTEGRATED MEASUREMENT SYSTEMS, INC.

                        VALUATION AND QUALIFYING ACCOUNTS
                                 (In Thousands)

<TABLE>
<CAPTION>
                                                   Adjustments
                                                   Recorded to
                                      Beginning      Cost &                      Ending
  Description                          Balance      Expenses     Deductions     Balance
                                       -------      -------       -------       -------
<S>                                    <C>          <C>           <C>           <C>
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

Year ended December 31, 1999
  Allowance for doubtful accounts      $   413      $   (50)      $  (106)      $   257
  Accrued restructuring expense        $   539      $    --       $  (539)      $    --
</TABLE>


                                      F-22
<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 1999 Form 10-K annual report and have issued our report thereon
dated January 21, 2000. 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.


                                                /s/ ARTHUR ANDERSEN LLP

Portland, Oregon
January 21, 2000


                                      F-23