<PAGE>

________________________________________________________________________________

                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-Q

(Mark One)

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

For the quarterly period ended July 31, 2001
                                       OR

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

For the transition period from     to

                         Commission file number 0-22366

                          CREDENCE SYSTEMS CORPORATION
             (Exact name of registrant as specified in its charter)

                  Delaware                                    94-2878499
        (State or other jurisdiction)                       (IRS  Employer
      of incorporation or organization)                   Identification No.)


    215 Fourier Ave., Fremont, California                        94539
   (Address of principal executive offices)                    (Zip Code)

        Registrant's telephone number, including area code (510) 657-7400

________________________________________________________________________________
    Former name, former address and former fiscal year, if changed since last
                                    report.

     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 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 [_]

                      APPLICABLE ONLY TO CORPORATE ISSUERS:

     At September 7, 2001, there were approximately 60,114,383 shares of the
Registrant's common stock, $0.001 par value per share, outstanding.


________________________________________________________________________________

                                        1

<PAGE>

CREDENCE SYSTEMS CORPORATION

<TABLE>
<CAPTION>
                                 INDEX                                                          PAGE NO.
                                 -----

<S>                                                                                             <C>
PART I.    FINANCIAL INFORMATION

Item 1.    Financial Statements ............................................................        3
           Condensed Consolidated Balance Sheets ...........................................        3
           Condensed Consolidated Statements of Operations .................................        4
           Condensed Consolidated Statements of Cash Flows .................................        5
           Notes to Condensed Consolidated Financial Statements ............................        6
Item 2.    Management's Discussion and Analysis of Financial Condition and Results of
           Operations ......................................................................        9
Item 3.    Quantitative and Qualitative Disclosures about Market Risk ......................       24


PART II.   OTHER INFORMATION

Item 1.    Legal Proceedings ...............................................................       25
Item 2.    Changes in Securities ...........................................................       25
Item 3.    Defaults Upon Senior Securities .................................................       25
Item 4.    Submission of Matters to a Vote of  Securityholders .............................       25
Item 5.    Other Information ...............................................................       25
Item 6.    Exhibits and Reports on Form 8-K ................................................       25
</TABLE>

                                        2

<PAGE>

PART I  - FINANCIAL INFORMATION

Item I  - Financial Statements

                          CREDENCE SYSTEMS CORPORATION
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                                 (in thousands)

<TABLE>
<CAPTION>
                                                           July 31,          October 31,
                                                             2001              2000/a/
                                                        --------------     ---------------
                                                         (unaudited)
<S>                                                     <C>                <C>
ASSETS
Current assets:
  Cash and cash equivalents .........................      $  40,416         $  119,089
  Short-term investments ............................         57,559            124,545
  Accounts receivable, net ..........................         45,138            175,794
  Inventories .......................................        144,431            102,034
  Other current assets ..............................         53,442             29,420
                                                           ---------         ----------
    Total current assets ............................        340,986            550,882
Long-term investments ...............................        202,211            133,804
Property and equipment, net .........................        104,501             94,853
Goodwill from acquisitions, net .....................         54,487             55,133
Other intangible assets, net ........................         41,316             42,161
Other assets ........................................          8,675              2,404
                                                           ---------         ----------
    Total assets ....................................      $ 752,176         $  879,237
                                                           =========         ==========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable ..................................      $  22,527         $   53,287
  Accrued liabilities ...............................         41,008             71,202
  Income taxes payable ..............................             --             23,866
                                                           ---------         ----------
    Total current liabilities .......................         63,535            148,355
Other liabilities ...................................          9,874              8,332
Minority interest ...................................            231                323
Stockholders' equity ................................        678,536            722,227
                                                           ---------         ----------
    Total liabilities and stockholders' equity ......      $ 752,176         $  879,237
                                                           =========         ==========
</TABLE>


                             See accompanying notes.

 a)  Derived from the audited consolidated balance sheet included in the
     Company's Form 10-K for the year ended October 31, 2000.

                                        3

<PAGE>

                          CREDENCE SYSTEMS CORPORATION
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                    (in thousands, except per share amounts)
                                   (unaudited)

<TABLE>
<CAPTION>
                                                                        Three Months Ended               Nine Months Ended
                                                                             July 31,                         July 31,
                                                                  -------------------------------  -------------------------------
                                                                      2001              2000           2001              2000
                                                                  -------------     -------------  -------------     -------------
<S>                                                               <C>               <C>            <C>               <C>
Net sales ..................................................       $   18,762         $ 204,000     $  185,232         $ 459,522
Cost of goods sold - on net sales ..........................           14,659            80,765         89,653           186,584
Cost of goods sold - special charges .......................               --                --         45,020                --
                                                                   ----------         ---------     ----------         ---------
Gross margin ...............................................            4,103           123,235         50,559           272,938
Operating expenses:
   Research and development ................................           19,330            19,490         57,763            48,176
   Selling, general and administrative .....................           17,076            29,885         65,536            74,120
   Amortization of purchased intangibles ...................            5,987             3,360         17,280             5,491
   Acquired in-process research and development ............               --             8,282             --             8,282
   Special charges .........................................            2,705                --          4,673                --
                                                                   ----------         ---------     ----------         ---------
       Total operating expenses ............................           45,098            61,017        145,252           136,069
                                                                   ----------         ---------     ----------         ---------
Operating income (loss) ....................................          (40,995)           62,218        (94,693)          136,869
Interest and other income, net .............................            4,061             5,874         12,933             9,366
                                                                   ----------         ---------     ----------         ---------
Income (loss) before income tax provision (benefit) ........          (36,934)           68,092        (81,760)          146,235
Income tax provision (benefit) .............................          (14,562)           27,113        (30,251)           54,853
Minority interest (benefit) ................................               67               (18)           (93)               29
                                                                   ----------         ---------     ----------         ---------
Net income (loss) ..........................................         ($22,439)        $  40,997       ($51,416)        $  91,353
                                                                   ==========         =========     ==========         =========
Net income (loss) per share
   Basic ...................................................           ($0.43)        $    0.82         ($0.98)        $    1.94
                                                                   ==========         =========     ==========         =========
   Diluted .................................................           ($0.43)        $    0.74         ($0.98)        $    1.75
                                                                   ==========         =========     ==========         =========
Number of shares used in computing per share amount
   Basic ...................................................           52,723            49,802         52,542            47,200
                                                                   ==========         =========     ==========         =========
   Diluted .................................................           52,723            55,101         52,542            52,079
                                                                   ==========         =========     ==========         =========
</TABLE>


                             See accompanying notes.

                                        4

<PAGE>

                          CREDENCE SYSTEMS CORPORATION
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                Increase (decrease) in cash and cash equivalents
                            (unaudited, in thousands)

<TABLE>
<CAPTION>
                                                                                             Nine Months Ended
                                                                                                 July 31,
                                                                                         ----------------------
                                                                                            2001         2000
                                                                                         ---------    ---------
<S>                                                                                      <C>          <C>
Cash flows from operating activities:
   Net income (loss) ..............................................................      ($ 51,416)   $  91,353
   Adjustments to reconcile net income (loss) to net cash used in operating
activity
      Depreciation and amortization ...............................................         39,231       22,972
      Non cash special charges ....................................................         47,407           --
      (Gain) loss on disposal of property and equipment ...........................          1,410       (1,156)
      Minority interest ...........................................................            (92)          29
      Changes in operating assets and liabilities:
         Accounts receivable, inventories and other current assets ................         17,278     (128,480)
         Accounts payable, accrued liabilities and income taxes payable ...........        (82,365)      51,887
                                                                                         ---------    ---------
            Net cash provided by (used in) operating activities ...................        (28,547)      36,605
Cash flows from investing activities:
   Purchases of available-for-sale securities .....................................       (194,841)    (241,081)
   Maturities of available-for-sale short-term securities .........................         39,150       33,792
   Sales of available-for-sale securities .........................................        156,555       17,612
   Acquisition of property and equipment ..........................................        (30,665)     (20,664)
   Purchases of intangible assets and other assets ................................        (22,061)     (47,398)
   Proceeds from sale of property and equipment ...................................            315        2,188
                                                                                         ---------    ---------
         Net cash used in investing activities ....................................        (51,547)    (255,551)
Cash flows from financing activities:
   Issuance of common & treasury stock ............................................          7,906      300,340
   Repurchase of common stock .....................................................         (6,485)          --
                                                                                         ---------    ---------
         Net cash provided by financing activities ................................          1,421      300,340
                                                                                         ---------    ---------
Net increase (decrease) in cash and cash equivalents ..............................        (78,673)      81,394
Cash and cash equivalents at beginning of period ..................................        119,089       52,104
                                                                                         ---------    ---------
Cash and cash equivalents at end of period ........................................      $  40,416    $ 133,498
                                                                                         =========    =========
Supplemental disclosures of cash flow information:
   Interest paid ..................................................................      $     541    $   2,536
   Income taxes paid ..............................................................      $  17,459    $  38,447
Noncash activities:
   Net transfers of inventory to property and equipment ...........................      $   2,765    $   5,501
   Income tax benefit from employee stock activity ................................      $   1,738    $   7,964
   Issuance of common or treasury stock for convertible subordinated notes ........      $      --    $     589
   Exchange of convertible sub. notes for common stock plus issuance costs ........      $      --    $    (589)
</TABLE>

                             See accompanying notes.

                                       5

<PAGE>

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.   Quarterly Financial Statements

       The condensed consolidated financial statements and related notes for the
three and nine months ended July 31, 2001 and 2000 are unaudited but include all
adjustments (consisting solely of normal recurring adjustments) which are, in
the opinion of management, necessary for a fair presentation of the financial
position and results of operations of the Company for the interim periods. The
results of operations for the three and nine months ended July 31, 2001 and 2000
were not necessarily indicative of the operating results to be expected for the
full fiscal year. The information included in this report should be read in
conjunction with the Company's audited consolidated financial statements and
notes thereto for the fiscal year ended October 31, 2000 included in the
Company's most recent Annual Report on Form 10-K and the additional risk factors
contained herein and therein, including, without limitation, risks relating to
successful integration of acquisitions, fluctuations in our quarterly net sales
and operating results, limited systems sales, backlog, cyclicality of
semiconductor industry, management of fluctuations in our operating results,
expansion of our product lines, limited sources of supply, reliance on our
subcontractors, highly competitive industry, rapid technological change,
importance of timely product introduction, customer concentration, lengthy sales
cycle, changes in financial accounting standards and accounting estimates,
dependence on key personnel, international sales, proprietary rights, future
capital needs, leverage, volatility of our stock price and effects of certain
anti-takeover provisions, as set forth in this Report. Any party interested in
reviewing a free copy of the Form 10-K or the Company's other publicly available
documents should write to the Chief Financial Officer of the Company.

       USE OF ESTIMATES - The preparation of the accompanying unaudited
condensed consolidated financial statements requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements. Actual results could differ from those estimates.

       BASIS OF PRESENTATION - Certain prior year amounts in the Condensed
Consolidated Financial Statements and related notes have been reclassified to
conform to the current year's presentation.

2.   Inventories

       Inventories are stated at the lower of standard cost (which approximates
first-in, first-out cost) or market. Inventories consist of the following (in
thousands):

                                             July 31,  October 31,
                                               2001       2000
                                             --------   --------
                                            (unaudited)

           Raw materials .................   $ 77,971   $ 39,736
           Work-in-process ...............     25,365     44,704
           Finished goods ................     41,095     17,594
                                             --------   --------
                                             $144,431   $102,034
                                             ========   ========

3.   Net Income (Loss) Per Share

       Basic net income (loss) per share is based upon the weighted average
number of common shares outstanding during the period. Diluted net income (loss)
per share is based upon the weighted average number of common shares and
dilutive-potential common shares outstanding during the period. Options to
purchase approximately 10,606,541 shares at an average price of $19.98 per share
were outstanding at July 31, 2001, but were not included in the computation of
diluted net loss per share because options are anti-dilutive in periods when the
Company incurs a net loss.

       The following table sets forth the computation of basic and dilutive net
income (loss) per share (in thousands, except per share amounts):

                                       6

<PAGE>

<TABLE>
<CAPTION>
                                                                       Three Months Ended      Nine Months Ended
                                                                             July 31,               July 31,
                                                                      --------    --------   --------------------
                                                                        2001        2000       2001        2000
                                                                      --------    --------   --------    --------
<S>                                                                   <C>         <C>        <C>         <C>
 Numerator:
   Numerator for basic and diluted net income (loss) per share-
   net income (loss) .............................................    ($22,439)   $ 40,997   ($51,416)   $ 91,353
                                                                      --------    --------   --------    --------

Denominator:
   Denominator for basic net income (loss) per share-
   weighted-average shares .......................................      52,723      49,802     52,542      47,200
   Effect of dilutive securities-employee stock options ..........          --       3,648         --       3,650
   Effect of dilutive securities-subordinated convertible notes ..          --       1,651         --       1,230
                                                                      --------    --------   --------    --------

Denominator for diluted earnings per share-adjusted
weighted-average shares and assumed conversions ..................      52,723      55,101     52,542      52,079
                                                                      --------    --------   --------    --------

  Basic net income (loss) per share ..............................      ($0.43)   $   0.82     ($0.98)   $   1.94
                                                                      ========    ========   ========    ========

  Diluted net income (loss) per share ............................      ($0.43)   $   0.74     ($0.98)   $   1.75
                                                                      ========    ========   ========    ========
</TABLE>

4.   Recent Accounting Pronouncements

       In November 2000, the Company adopted SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," (SFAS 133). SFAS 133 requires
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 earnings.
If the derivative is a hedge, depending on the nature of the hedge, changes in
the fair value of derivatives will either be offset against the change in the
fair value of the hedged assets, liabilities or firm commitments through
earnings, or recognized in other comprehensive income (loss) until the hedged
item is recognized in earnings. The ineffective portion of a derivative's change
in fair value will be immediately recognized in earnings. Adoption of SFAS 133
did not have a material impact on the Company's financial condition or results
of operations.

       In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin 101 ("SAB 101") "Revenue Recognition in Financial
Statements". SAB 101 provides guidance on the recognition, presentation, and
disclosure of revenue in financial statements. All registrants are expected to
apply the accounting principles and disclosure described in SAB 101. Because the
Company has complied with generally accepted accounting principles for its
historical revenue recognition, the change in its revenue policy resulting from
SAB 101 will be reported as a cumulative effect adjustment resulting from a
change in accounting principle effective November 1, 2000, in the fourth quarter
of fiscal 2001. Adoption of SAB 101 will also require the Company to re-state
the quarterly results for the three fiscal quarters ended July 31, 2001. The
Company is currently in the process of assessing SAB 101 and how it will impact
its reported revenues and income and is therefore unable to determine the impact
of SAB 101 on its financial statements.

5.   Contingencies

       The Company is involved in various claims arising in the ordinary course
of business, none of which, in the opinion of management, if determined
adversely against the Company, would have a material adverse effect on the
Company's business, financial condition or results of operations.

       We have at times been notified that we may be infringing intellectual
property rights of third parties and we have litigated patent infringement
claims in the past. We expect to continue to receive notice of such claims in
the future. In July 1998, inTEST IP Corporation, or inTEST, alleged in writing
that certain of our products are infringing a patent held by inTEST. We have
since then engaged in sporadic discussions with inTEST concerning this matter.
On December 15, 2000, inTEST filed a complaint in the U.S. District Court for
the District of Delaware against us, alleging infringement of inTEST U.S. patent
number 4,589,815 and seeking damages and injunctive relief. On April 10, 2001,
the Company was served with the complaint. We may also be obligated to other
third parties relating to

                                        7

<PAGE>

this allegation. We believe we have meritorious defenses to the claims. However,
we cannot be certain of success in defending this patent infringement claim or
claims for indemnification resulting from infringement claims and that it will
not have a material impact.

6.   Special Charges

     Operations for the three month period ended July 31, 2001 included a
pre-tax charge of approximately $1.7 million related to fees and expenses
associated with the recent acquisition of Integrated Measurement Systems, Inc.
("IMS") as well as a pre-tax charge of approximately $1.0 million for severance
payments and asset disposals associated with the Company's continuing headcount
reductions.

     Operations for the nine month period ended July 31, 2001 included the above
items as well as a pre-tax charge of approximately $45.0 million related to a
provision for excess inventory and a pre-tax charge of approximately $2.0
million for severance payments and asset disposals associated with the Company's
continuing headcount reductions.

7.   Accumulated Other Comprehensive Income (Loss)

     Accumulated other comprehensive income (loss) and changes thereto consist
of:

                                                             Fiscal Years
                                            Nine Months          Ended
                                           Ended July 31,     October 31,
                                           --------------   ---------------
                                                2001              2000
                                           --------------   ---------------
Beginning balance gain (loss)                     $ 2,217         $   (661)
Unrealized gain on available-
for-sale securities                                   446            3,158
Currency translation adjustment                     1,839             (280)
                                           --------------    -------------
Total                                             $ 4,502         $  2,217
                                           ==============    =============

8.   Acquisition, Subsequent Events

     On August 1, 2001, Credence completed the previously announced acquisition
of Oregon-based IMS for approximately $155 million in a stock-for-stock
transaction. Each share of IMS common stock was converted into 0.90 shares of
Credence common stock. Approximately 7.2 million shares of Credence common stock
were issued in the acquisition. The acquisition will be accounted for as a
pooling of interests transaction. IMS, located in Beaverton, Oregon, specializes
in the design, manufacture, and marketing of high performance integrated circuit
validation systems used to test, at the prototype stage, complex digital,
mixed-signal and memory devices. IMS was founded in 1983 and currently has
approximately 300 employees. The Company expects to record a special charge of
approximately $12 to $17 million in the fourth fiscal quarter for this
transaction. Approximately $7 million of that amount will consist of cash
transaction expenses and the remaining portion will be related to facility
closures, asset disposals and conforming accounting policies.

     On August 14, 2001 the board of directors, in accordance with the pooling
of interests accounting on the IMS transaction, suspended the treasury stock
purchase program previously announced in September 2000.

                                       8

<PAGE>

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


     In addition to the historical information contained in this document, the
discussion in this Report on Form 10-Q contains forward-looking statements,
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, that involve
risks and uncertainties, such as statements of our plans, objectives,
expectations and intentions. The cautionary statements made in this Report on
Form 10-Q should be read as being applicable to all related forward-looking
statements whenever they appear in this Report on Form 10-Q. Our actual results
could differ materially from those discussed herein. Factors that could cause or
contribute to such differences include those discussed below as well as those
cautionary statements and other factors set forth in "Risk Factors" and
elsewhere herein.

     Revenue growth has slowed in the first nine months of fiscal 2001 in the
test and assembly sector of the semiconductor equipment industry during what we
believe is a cyclical downturn in the industry. There is uncertainty as to if
and when the next cyclical growth phase will occur. Until such time as we return
to a growth period, we expect a continuing decline in orders and therefore
expect that the October 31, 2001 fiscal quarter's revenue will be flat or
decline from the levels experienced by us during the third quarter of fiscal
2001.

     The following table sets forth items from the Condensed Consolidated
Statements of Operations as a percentage of net sales for the periods indicated:

<TABLE>
<CAPTION>
                                                                 Three Months Ended                 Nine Months Ended
                                                                      July 31,                           July 31,
                                                             ---------------------------------------------------------------
                                                                2001            2000              2001            2000
                                                             ------------   -------------      ------------    ------------
<S>                                                          <C>            <C>                <C>             <C>
Net sales                                                          100.0%          100.0%            100.0%          100.0%
Cost of goods sold - on net sales                                   78.1            39.6              48.4            40.6
Cost of goods sold - special charges                                  --                              24.3
                                                             -----------    ------------       -----------     -----------
Gross margin                                                        21.9            60.4              27.3            59.4
Operating expenses
  Research and development                                         103.0             9.6              31.2            10.5
  Selling, general and administrative                               91.0            14.6              35.4            16.1
  Amortization of purchased intangible assets                       31.9             1.6               9.3             1.2
  Acquired in-process research and development                        --             4.1                --             1.8
  Special charges                                                   14.4              --               2.5              --
                                                             -----------    ------------       -----------     -----------
    Operating expenses                                             240.4            29.9              78.4            29.6
                                                             -----------    ------------       -----------     -----------
Operating income (loss)                                           (218.5)           30.5             (51.1)           29.8
Interest and other income                                           21.6             2.9               7.0             2.0
                                                             -----------    ------------       -----------     -----------
Income (loss) before income tax provision (benefit)                196.9)           33.4             (44.1)           31.8
Income tax provision (benefit)                                     (77.3)           13.3             (16.3)           11.9
                                                             -----------    ------------       -----------     -----------
Net income (loss)                                                 (119.6)           20.1             (27.8)           19.9
                                                             ===========    ============       ===========     ===========
</TABLE>

RESULTS OF OPERATIONS

NET SALES

     Net sales consist of revenues from systems sales, spare parts sales,
maintenance contracts and software sales. Net sales were $18.8 million for the
third quarter of fiscal 2001, representing a decrease of 90.8% from the net
sales of $204.0 million in the comparable third quarter of fiscal 2000. Net
sales declined 56.7% from the second quarter of fiscal 2001, when the Company
recorded $43.3 million in revenue.

     During fiscal years 1999 and 2000, our net sales improved each sequential
quarter because of four principal factors:

                                        9

<PAGE>

     .    a significant increase in the worldwide demand for semiconductor ATE;

     .    improved business and economic conditions in Asia, particularly in
          Taiwan;

     .    the increased sales of two major products: the Quartet
          high-performance mixed signal tester and the Kalos memory tester; and

     .    the acquisition of the TMT, Inc. ("TMT") product lines in May 2000.

     Since October 2000, revenue has declined in each fiscal quarter of 2001 in
the test and assembly sector of the semiconductor equipment industry during what
is now believed to be a cyclical downturn in the industry. This belief is based
on weakening order activity, order cancellations, and customer-requested
shipment delays from our existing backlog. This business weakness is being
experienced throughout the industry with particularly strong declines in Asia.

     International net sales accounted for approximately 73%, 80%, and 64% of
total net sales in the first nine months of fiscal 2001 and fiscal years 2000
and 1999, respectively. Our net sales to the Asia-Pacific region accounted for
approximately 46%, 69% and 55% of total net sales in the first nine months of
fiscal 2001 and fiscal years 2000 and 1999, respectively, and thus are subject
to the risk of economic instability in that region that materially adversely
affected the demand for our products in 1998. Capital markets in Korea and other
areas of Asia have been highly volatile, resulting in economic instabilities.
These instabilities may reoccur, which could materially adversely affect demand
for our products.

     Our net sales by product line in the first nine months of fiscal 2001 and
fiscal years 2000 and 1999 consisted of:

<TABLE>
<CAPTION>
                                             Nine Months       Fiscal Years Ended
                                            Ended July 31,         October 31,
                                          -----------------  ----------------------
                                               2001             2000        1999
                                          -----------------  ----------  ----------
             <S>                          <C>                <C>         <C>
             Mixed-Signal                               64%         72%         65%
             Logic                                       5          12          16
             Memory                                     16          11           7
             Service and software                       15           5          12
                                          ----------------   ---------   ---------
             Total                                     100%        100%        100%
                                          ================   =========   =========
</TABLE>

     The increase in the memory percentage and the high percentage of net sales
attributable to mixed-signal products are principally derived from the sales of
the Kalos and Quartet products, respectively. Revenues from software were not
material to our operations in the first nine months of 2001 and fiscal years
2000 and 1999, representing less than 4% of our net sales in each period.

GROSS MARGIN

     Our gross margin has been and will continue to be affected by a variety of
factors, including manufacturing efficiencies, pricing by competitors or
suppliers, new product introductions, product sales mix, production volume,
customization and reconfiguration of systems, international and domestic sales
mix and field service margins. Our gross margins for the third quarter and the
first nine months of fiscal 2001 were impacted by declining manufacturing
volumes and charges for excess inventories made in the second fiscal quarter.
During the second quarter of fiscal 2001, we recorded approximately $45.0
million of special charges related to the write down of excess inventory and
purchase commitment liabilities, of which approximately $19 million was related
to the logic product lines with the rest largely earmarked for the mixed signal
product lines. Our gross margin (excluding these charges), was 21.9% and 51.6%
for the three and nine month periods ended July 31, 2001, respectively, compared
with 60.4% and 59.4% for the comparable periods in fiscal 2000. The falling
gross margins are the results of higher costs caused by under-absorption of
largely fixed manufacturing expenses as well as lower average selling prices in
fiscal 2001.

                                       10

<PAGE>

RESEARCH AND DEVELOPMENT

     Research and development ("R&D") expenses were $57.7 million in the first
nine months of fiscal 2001, an increase of $9.6 million or 19.9% over the same
period of fiscal 2000. The higher level of spending in fiscal 2001 reflects the
acquisitions of TMT and Modulation Instruments, Inc. ("MI") in fiscal 2000 as
well as increases in internal R&D project expenses. As a percentage of net
sales, R&D expenses were 31.2% for the first nine months of fiscal 2001, an
increase from 10.5% in the first nine months of fiscal 2000. We currently intend
to continue to invest significant resources in the development of new products
and enhancements of existing products for the foreseeable future. Accordingly,
we expect these expenses to be relatively stable in absolute dollars for the
remainder of fiscal 2001.

SELLING, GENERAL AND ADMINISTRATIVE

     Selling, general and administrative expenses ("SG&A") were $65.5 million in
the first nine months of fiscal 2001, representing an $8.6 million, or 11.6%,
decrease from the comparable period of fiscal 2000. The lower spending in 2001
was primarily due to decreased payroll and commission related expenses due to a
lower headcount and lower sales levels in fiscal 2001. As a percentage of net
sales, SG&A expenses were 35.4% for the first nine months of fiscal 2001,
compared with 16.1% for the corresponding period in fiscal 2000. We expect SG&A
expenses for the remainder of fiscal 2001 to decline slightly in absolute
dollars because of the headcount reductions effected in February, May and August
2001, as well as other cost saving measures.

AMORTIZATION OF PURCHASED INTANGIBLES

     Amortization of purchased intangible expenses increased to $17.3 million in
the first nine months of fiscal 2001 from $5.5 million in the comparable period
of fiscal 2000, an increase of 215%. In May 2000, we purchased TMT for
approximately $80.0 million, in August 2000 we purchased MI for approximately
$20.5 million and Credence Europa for approximately $8.4 million, in October
2000 we purchased NewMillennia Solutions, Inc. for approximately $11.3 million,
and earlier this calendar year we purchased Dimensions Consulting, Inc. ("DCI")
and certain assets of Rich Rabkin & Associates, Inc ("Rabkin") for approximately
$13.9 million. These acquisitions have resulted in approximately $5.9 million in
quarterly charges for amortization of purchased intangibles assets.

SPECIAL CHARGES

     In the second quarter of fiscal 2001, we recorded approximately $47 million
of special charges as a result of a major downturn in the semiconductor
equipment industry. In the third quarter we recorded $2.7 million of special
charges. The recent headcount reductions have reduced our worldwide headcount
from approximately 1,450 at October 31, 2000 to 1,080 today. In addition we have
instituted a reduced work schedule and implemented pay cuts for our remaining
employees.

     We recorded a special charge in the second fiscal quarter for costs of
goods sold of approximately $45 million related to the write down of excess
inventories. Approximately $19 million of this charge is for our logic product
lines and is principally for raw materials and work in process. The remaining
$26 million is primarily for the mixed signal product lines and is principally
for raw materials, work in process and purchase commitment liabilities. With the
dramatic decline in revenue during this downturn, the Company continues to
monitor its inventory levels in light of product development changes and
expectations of an eventual upturn. The Company may be required to take
additional charges for excess and obsolete inventories as we better understand
the impact of these events on our current inventory levels.

     We recorded a special operating charge of approximately $2 million in the
second fiscal quarter and $1 million in the third fiscal quarter for severance
payments and asset disposals associated with our recent headcount reductions.
Approximately $2.1 million was for severance payments and the rest of the charge
was for asset disposals. The cash expenditures associated with these charges
largely occurred in the first nine months of this fiscal year with the remaining
amounts expected to be paid in the fourth fiscal quarter of 2001.

     We recorded a special operating charge of approximately $1.7 million for
transaction related expenses for the IMS acquisition in the third fiscal quarter
of 2001. The Company expects to record a special charge of approximately $12 to
$17 million in the fourth fiscal quarter related to the closing of this
transaction. Approximately $7 million of

                                       11

<PAGE>

that amount will consist of cash transaction expenses and the remaining portion
will be related to facility closures, asset disposals and conforming accounting
policies.

INTEREST AND OTHER INCOME (EXPENSES), NET

     We generated net interest and other income of $12.9 million for the first
nine months of fiscal 2001, as compared to $9.4 million for the first nine
months of fiscal 2000. The increase in fiscal 2001 was due to higher average
cash and investment balances in fiscal 2001 as compared to fiscal 2000. These
higher average balances were the result of the cash received in our secondary
public offering in February 2000 offset by cash outlays for acquisitions and the
purchase of our Hillsboro, Oregon facility. In addition, in September 2000, we
called for redemption of our remaining outstanding Convertible Subordinated
Notes.

INCOME TAXES

     Our estimated effective tax benefit rate for the first nine months of
fiscal 2001 was 37.0%, compared to an effective tax rate of 35.5% in the first
nine months of fiscal 2000. The estimated tax benefit rate for fiscal 2001 is
less than the combined federal and state statutory rate primarily due to the
impact of non-deductible goodwill amortization. The effective tax rate in fiscal
2000 was less than the combined federal and state statutory rate primarily due
to the benefits of our foreign sales corporation. The tax rate applied to
pre-tax book income for the first nine months is computed based on a projected
effective tax rate for the year.

LIQUIDITY AND CAPITAL RESOURCES

     Operating activities used a net cash flow of $28.5 million and provided a
net cash flow of $36.6 million for the nine months ended July 31, 2001 and 2000,
respectively. Net cash flows used by operating activities for the first nine
months of fiscal 2001 were primarily due to net income before special non-cash
charges and depreciation and amortization of $35.2 million offset by an increase
in working capital of $65.1 million.

     Investing activities used net cash flows of approximately $51.5 million and
$255.6 million in the nine months ended July 31, 2001 and 2000, respectively.
For fiscal 2001, approximately $0.9 million was used for net purchases of
available-for-sale securities, $30.7 million for purchases of property and
equipment to support our business, and we disbursed approximately $13 million
for the acquisition of DCI and the assets of Rabkin. We also provided a $5
million dollar loan in the form of a note receivable to our independent leasing
associate during the first half of fiscal 2001.

     Financing activities provided net cash flows of $1.4 million and $300.3
million for the nine months ended July 31, 2001 and 2000, respectively. The net
cash flows provided for the first nine months of fiscal 2001 were primarily from
the issuance of common stock through our employee equity plans offset by the
repurchase of 325,000 shares of our common stock for $6.5 million.

     As of July 31, 2001, we had working capital of approximately $277.5
million, including cash and short-term investments of $98.0 million, and
accounts receivable and inventories representing $189.6 million. We expect our
receivables to continue to represent a significant portion of working capital.
We believe that because of the relatively long manufacturing cycles of many of
our testers and the new products we have and plan to continue to introduce,
investments in inventories will also continue to represent a significant portion
of working capital. Significant investments in accounts receivable and
inventories may subject us to increased risks which could materially adversely
affect our business, financial condition and results of operations. Total
current liabilities of $63.5 million as of July 31, 2001 decreased from $148.4
million as of October 31, 2000.

     Our principal sources of liquidity as of July 31, 2001 consisted of
approximately $40.4 million of cash and cash equivalents, and short-term
investments of $57.6 million. In addition, we had $202.2 million of
available-for-sale securities, classified as long-term investments at July 31,
2001.

                                       12

<PAGE>

RECENT ACCOUNTING PRONOUNCEMENTS

       In November 2000, we adopted SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," (SFAS 133). SFAS 133 requires us to
recognize all derivatives on the balance sheet at fair value. Derivatives that
are not hedges must be adjusted to fair value through earnings. If the
derivative is a hedge, depending on the nature of the hedge, changes in the fair
value of derivatives will either be offset against the change in the fair value
of the hedged assets, liabilities or firm commitments through earnings, or
recognized in other comprehensive income (loss) until the hedged item is
recognized in earnings. The ineffective portion of a derivative's change in fair
value will be immediately recognized in earnings. Adoption of SFAS 133 did not
have a material impact on our financial condition or results of operations.

       In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin 101 ("SAB 101") "Revenue Recognition in Financial
Statements". SAB 101 provides guidance on the recognition, presentation, and
disclosure of revenue in financial statements. All registrants are expected to
apply the accounting principles and disclosure described in SAB 101. Because we
have complied with generally accepted accounting principles for our historical
revenue recognition, the change in our revenue policy resulting from SAB 101
will be reported as a cumulative effect adjustment resulting from a change in
accounting principle effective November 1, 2000, in the fourth quarter of fiscal
2001. Adoption of SAB 101 will also require us to restate our quarterly results
for the three fiscal quarters ended July 31, 2001. We are currently in the
process of assessing SAB 101 and how it will impact our reported revenues and
income and we are, therefore, unable to determine the impact of SAB 101 on our
financial statements.

       In June 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 141, Business Combinations, and No. 142,
Goodwill and Other Intangible Assets, effective for fiscal years beginning after
December 15, 2001. Under the new rules, goodwill will no longer be amortized but
will be subject to annual impairment tests in accordance with the Statements.
Other intangible assets will continue to be amortized over their useful lives.
The Company will apply the new rules on accounting for goodwill and other
intangible assets beginning in the first quarter of fiscal 2003. Application of
the nonamortization provisions of the Statement is expected to result in an
increase in net income of approximately $10 million per year. During fiscal
2003, the Company will perform the first of the required impairment tests of
goodwill and indefinite lived intangible assets as of November 1, 2002 and has
not yet determined what the effect of these tests will be on the earnings and
financial position of the Company.

                                       13

<PAGE>

       RISK FACTORS

Our operating results may fluctuate significantly which may adversely affect our
stock price

                                    [GRAPH]

     A variety of factors affect our results of operations. The above graph
illustrates that our quarterly net sales and operating results have fluctuated
significantly. We believe they will continue to fluctuate for several reasons,
including:

     .    economic conditions in the semiconductor industry in general and
          capital equipment industry specifically;

     .    manufacturing capacity and ability to volume produce systems,
          including our newest systems, and meet customer requirements;

     .    timing of new product announcements and new product releases by us or
          our competitors;

     .    market acceptance of our new products and enhanced versions of
          existing products;

     .    manufacturing inefficiencies associated with the start-up of our new
          products, changes in our pricing or payment terms and cycles, and
          those of our competitors, customers and suppliers;

     .    write-offs of excess and obsolete inventories and accounts receivable
          that are not collectible;

     .    supply constraints;

     .    patterns of capital spending by our customers, delays, cancellations
          or reschedulings of customer orders due to customer financial
          difficulties or otherwise;

     .    changes in overhead absorption levels due to changes in the number of
          systems manufactured, the timing and shipment of orders, availability
          of components including custom ICs, subassemblies and services,
          customization and reconfiguration of our systems and product
          reliability;

     .    expenses associated with acquisitions and alliances;

     .    operating expense reductions associated with cyclical industry
          downturns, including costs relating to facilities consolidations and
          related expenses;

     .    the proportion of our direct sales and sales through third parties,
          including distributors and OEMS, the mix of products sold, the length
          of manufacturing and sales cycles, and product discounts;

                                       14

<PAGE>

     .    natural disasters, political and economic instability, currency
          fluctuations, regulatory changes and outbreaks of hostilities; and

     .    our ability to attract and retain qualified employees in a competitive
          market.

     We intend to introduce new products and product enhancements in the future,
the timing and success of which will affect our business, financial condition
and results of operations. Our gross margins on system sales have varied
significantly and will continue to vary significantly based on a variety of
factors including:

     .    manufacturing inefficiencies;

     .    pricing concessions by us and our competitors and pricing by our
          suppliers;

     .    hardware and software product sales mix;

     .    inventory write-downs;

     .    manufacturing volumes;

     .    new product introductions;

     .    product reliability;

     .    absorption levels and the rate of capacity utilization;

     .    customization and reconfiguration of systems;

     .    international and domestic sales mix and field service margins; and

     .    facility relocations and closures.

     New and enhanced products typically have lower gross margins in the early
stages of commercial introduction and production. Although we have recorded and
continue to record provisions for estimated sales allowances and price
adjustments, accounts receivable that might not be collectible, and product
warranty costs, we cannot be certain that our estimates will be adequate.

     We cannot forecast with any certainty the impact of these and other factors
on our sales and operating results in any future period. Results of operations
in any period, therefore, should not be considered indicative of the results to
be expected for any future period. Because of this difficulty in predicting
future performance, our operating results may fall below the expectations of
securities analysts or investors in some future quarter or quarters. Our failure
to meet these expectations would likely adversely affect the market price of our
common stock. In addition, our need for continued significant expenditures for
research and development, marketing and other expenses for new products, capital
equipment purchases and worldwide training and customer service and support will
impact our sales and operations results in the future. Other significant
expenditures may make it difficult for us to reduce our significant fixed
expenses in a particular period if we do not meet our net sales goals for that
period. These other expenditures include:

     .    research and development;

     .    support costs for the distribution channels;

     .    marketing and other expenses for new products;

     .    capital equipment purchases and world-wide training; and

     .    customer support and service.

     As a result, we cannot be certain that we will be profitable in the future.

                                       15

<PAGE>

We have a limited backlog and obtain most of our net sales from a relatively few
number of system sales transactions, which can result in fluctuations of
quarterly results.

         Other than some memory products and software products, for which the
price range is typically below $50,000, we obtain most of our net sales from the
sale of a relatively few number of systems that typically range in price from
$200,000 to $2.0 million. This has resulted and could continue to result in our
net sales and operating results for a particular period being significantly
impacted by the timing of recognition of revenue from a single transaction. Our
net sales and operating results for a particular period could also be materially
adversely affected if an anticipated order from just one customer is not
received in time to permit shipment during that period. Backlog at the beginning
of a quarter typically does not include all orders necessary to achieve our
sales objectives for that quarter. Orders in backlog are subject to
cancellation, delay, deferral or rescheduling by customers with limited or no
penalties. In the first nine months of fiscal 2001, we experienced
customer-requested shipment delays and order cancellations, and we believe it is
probable that orders will be canceled in the future. Consequently, our quarterly
net sales and operating results have in the past and will in the future, depend
upon our obtaining orders for systems to be shipped in the same quarter in which
the order is received.

         We believe that some of our customers may, from time to time, place
orders with us for more systems than they will ultimately require, or they will
order a more rapid delivery than they will ultimately require. For this reason,
our backlog may include customer orders in excess of those actually delivered to
them or other customers.

         Furthermore, we generally ship products generating most of our net
sales near the end of each quarter. Accordingly, our failure to receive an
anticipated order or a delay or rescheduling in a shipment near the end of a
particular period may cause net sales in a particular period to fall
significantly below expectations, which could have a material adverse effect on
our business, financial condition or results of operations. The relatively long
manufacturing cycle of many of our testers has caused and could continue to
cause future shipments of testers to be delayed from one quarter to the next.
Furthermore, as we and our competitors announce new products and technologies,
customers may defer or cancel purchases of our existing systems. We cannot
forecast the impact of these and other factors on our sales and operating
results.

The semiconductor industry has been cyclical

         Revenue growth has slowed in the test and assembly sector of the
semiconductor equipment industry during what we now believe is a cyclical
downturn in the industry. There is uncertainty as to if and when the next
cyclical growth phase will occur. This belief is based on weakening order
activity, order cancellation activity, and customer-requested shipment delays
from our existing backlog. This business weakness is worldwide but we see it in
particular with customers in Asia. Until such time as we return to a growth
period, we expect a continuing weakness in order activity and therefore expect
that the October 31, 2001 fiscal quarter's revenue will be flat or declining
from the levels we experienced during the third quarter of fiscal 2001. In light
of that belief, we have reduced our worldwide workforce by approximately 25%, or
370 people. We took a charge related to this reduction in force of approximately
$2 million in our second fiscal quarter and another $1 million in our third
fiscal quarter of 2001. Additionally, all remaining employees will be required
to take five days of time off per quarter through October 31, 2001. Other
initiatives, including a domestic pay cut, the consolidation and reorganization
of certain functions and operations, and the curtailment of discretionary
expenses, are also being implemented. If we continue to reduce our workforce, it
may adversely impact our ability to respond rapidly to any renewed growth
opportunities in the future.

         With the dramatic decline in revenue during this downturn, the Company
continues to monitor its inventory levels in light of product development
changes and expectations of an eventual upturn. The Company maybe required to
take additional charges for excess and obsolete inventories as we better
understand the impact of these events on our current inventory levels.

         Our business and results of operations depend largely upon the capital
expenditures of manufacturers of semiconductors and companies that specialize in
contract packaging and/or testing of semiconductors. This includes manufacturers
and contractors that are opening new or expanding existing fabrication
facilities or upgrading existing equipment, which in turn depend upon the
current and anticipated market demand for semiconductors and products
incorporating semiconductors. The semiconductor industry has been highly
cyclical with recurring periods of oversupply, which often has had a severe
effect on the semiconductor industry's demand for test equipment, including the
systems we manufacture and market. We believe that the markets for newer
generations of semiconductors will also be subject to similar fluctuations.

                                       16

<PAGE>

         We have experienced shipment delays, delays in commitments and
restructured purchase orders by customers and we expect this activity to
continue. Accordingly, we cannot be certain that we will be able to achieve or
maintain our current or prior level of sales or rate of growth. In addition,
sales are expected to be sequentially down in the next fiscal quarter and
possibly in the following fiscal year. We anticipate that a significant portion
of new orders may depend upon demand from semiconductor device manufacturers
building or expanding fabrication facilities and new device testing requirements
that are not addressable by currently installed test equipment, and there can be
no assurance that such demand will develop to a significant degree, or at all.
In addition, our business, financial condition or results of operations may be
adversely affected by any factor adversely affecting the semiconductor industry
in general or particular segments within the semiconductor industry. For
example, the 1997/1998 Asian financial crisis contributed to widespread
uncertainty and, in part, a slowdown in the semiconductor industry. This
slowdown in the semiconductor industry resulted in reduced spending for
semiconductor capital equipment, including ATE which we sell. This industry
slowdown had, and similar slowdowns may in the future have, a material adverse
effect on our product backlog, balance sheet, financial condition and results of
operations. Therefore, there can be no assurance that our operating results will
not be materially adversely affected if downturns or slowdowns in the
semiconductor industry occur again in the future.

Over the last several years we have experienced significant fluctuations in our
operating results and an increased scale of operations.

         In the third fiscal quarter ended July 31, 2001 our net sales fell 85%
from those recorded in the first quarter of fiscal 2001 as the industry began a
cyclical downturn. In fiscal 2000, we generated revenue of $101.8 million in the
first quarter and $220.2 million in the fourth quarter, an increase of 116%. In
fiscal 1999, we generated revenue of $26.5 million in the first quarter and
$80.2 million in the fourth quarter, an increase of 203%. Since 1993, except for
the current cost-cutting efforts and those during fiscal 1998 and most of fiscal
1999, we have overall significantly increased the scale of our operations in
general to support periods of generally increased sales levels and expanded
product offerings and have expanded operations to address critical
infrastructure and other requirements, including the hiring of additional
personnel, significant investments in research and development to support
product development, acquisition of the new facilities in Oregon, further
investments in our ERP system and numerous acquisitions. These fluctuations in
our sales and operations have placed and are placing a considerable strain on
our management, financial, manufacturing and other resources. In order to
effectively deal with the changes brought on by the cyclical nature of the
industry, we have been required to implement and improve a variety of highly
flexible operating, financial and other systems, procedures and controls capable
of expanding, or contracting consistent with our business. However, we cannot be
certain that any existing or new systems, procedures or controls, including our
ERP system, will be adequate to support fluctuations in our operations or that
our systems, procedures and controls will be cost-effective or timely. Any
failure to implement, improve and expand or contract such systems, procedures
and controls efficiently and at a pace consistent with our business could have a
material adverse effect on our business, financial condition or results of
operations.

We are expanding and intend to continue the expansion of our product lines.

         We are currently devoting and intend to continue to devote significant
resources to the development, production and commercialization of new products
and technologies. During fiscal 2001 we have primarily introduced products that
are either evolutions of current platforms or derivative products. In the
future, we expect to introduce several new products. In late fiscal 1999 and
into 2000, we shipped three major new products. We invested and continue to
invest significant resources in plant and equipment, leased facilities,
inventory, personnel and other costs to begin or prepare to increase production
of these products. A significant portion of these investments will provide the
marketing, administration and after-sales service and support required for these
new hardware and software products. Accordingly, we cannot be certain that gross
profit margin and inventory levels will not be adversely impacted by delays in
new product introductions or start-up costs associated with the initial
production and installation of these new product lines. We also cannot be
certain that we can manufacture these systems per the time and quantity required
by our customers. The start-up costs include additional manufacturing overhead,
additional inventory and warranty reserve requirements and the enhancement of
after-sales service and support organizations. In addition, the increases in
inventory on hand for new product development and customer support requirements
have increased and will continue to increase the risk of inventory write-offs.
We cannot be

                                       17

<PAGE>

certain that our net sales will increase or remain at recent levels or that any
new products will be successfully commercialized or contribute to revenue growth
or that any of our additional costs will be covered.

There are limitations on our ability to find the supplies and services necessary
to run our business.

         We obtain certain components, subassemblies and services necessary for
the manufacture of our testers from a limited group of suppliers. We do not
maintain long-term supply agreements with most of our vendors and we purchase
most of our components and subassemblies through individual purchase orders. The
manufacture of certain of our components and subassemblies is an extremely
complex process. We also rely on outside vendors to manufacture certain
components and subassemblies and to provide certain services. We have recently
experienced and continue to experience significant reliability, quality and
timeliness problems with several critical components including certain custom
integrated circuits. We cannot be certain that these or other problems will not
continue to occur in the future with our suppliers or outside subcontractors.
Our reliance on a limited group of suppliers and on outside subcontractors
involves several risks, including an inability to obtain an adequate supply of
required components, subassemblies and services and reduced control over the
price, timely delivery, reliability and quality of components, subassemblies and
services. Shortages, delays, disruptions or terminations of the sources for
these components and subassemblies have delayed and could continue to delay
shipments of our systems and new products and could continue to have a material
adverse effect on our business. Our continuing inability to obtain adequate
yields or timely deliveries or any other circumstance that would require us to
seek alternative sources of supply or to manufacture such components internally
could also have a material adverse effect on our business, financial condition
or results of operations. Such delays, shortages and disruptions would also
damage relationships with current and prospective customers and have and could
continue to allow competitors to penetrate our customer accounts. We cannot be
certain that our internal manufacturing capacity or that of our suppliers and
subcontractors will be sufficient to meet customer requirements.

The ATE industry is intensely competitive which can adversely affect our revenue
growth.

         With the substantial investment required to develop test application
software and interfaces, we believe that once a semiconductor manufacturer has
selected a particular ATE vendor's tester, the manufacturer is likely to use
that tester for a majority of its testing requirements for the market life of
that semiconductor and, to the extent possible, subsequent generations of
similar products. As a result, once an ATE customer chooses a system for the
testing of a particular device, it is difficult for competing vendors to achieve
significant ATE sales to such customer for similar use. Our inability to
penetrate any large ATE customer or achieve significant sales to any ATE
customer could have a material adverse effect on our business, financial
condition or results of operations.

         We face substantial competition from ATE manufacturers throughout the
world, as well as several of our customers. We do not currently compete in the
testing of high-end microprocessors, linear ICs or DRAMs. Moreover, a
substantial portion of our net sales are derived from sales of mixed-signal
testers. Many competitors have substantially greater financial and other
resources with which to pursue engineering, manufacturing, marketing and
distribution of their products. Certain competitors have recently introduced or
announced new products with certain performance or price characteristics equal
or superior to products we currently offer. These competitors have recently
introduced products that compete directly against our products. We believe that
if the ATE industry continues to consolidate through strategic alliances or
acquisitions, we will continue to face significant additional competition from
larger competitors that may offer product lines and services more complete than
ours. Our competitors are continuing to improve the performance of their current
products and to introduce new products, enhancements and new technologies that
provide improved cost of ownership and performance characteristics. New product
introductions by our competitors could cause a decline in our sales or loss of
market acceptance of our existing products.

         Moreover, our business, financial condition or results of operations
could continue to be materially adversely affected by increased competitive
pressure and continued intense price-based competition. We have experienced and
continue to experience significant price competition in the sale of our
products. In addition, pricing pressures typically become more intense at the
end of a product's life cycle and as competitors introduce more technologically
advanced products. We believe that, to be competitive, we must continue to
expend significant

                                       18

<PAGE>
financial resources in order to, among other things, invest in new product
development and enhancements and to maintain customer service and support
centers worldwide. We cannot be certain that we will be able to compete
successfully in the future.

The ATE market is subject to rapid technological change

         Our ability to compete in the ATE market depends upon our ability to
successfully develop and introduce new hardware and software products and
enhancements and related software tools with greater features on a timely and
cost-effective basis, including products under development internally as well as
products obtained in acquisitions. Our customers require testers and software
products with additional features and higher performance and other capabilities.
We are therefore required to enhance the performance and other capabilities of
our existing systems and software products and related software tools. Any
success we may have in developing new and enhanced systems and software products
and new features to our existing systems and software products will depend upon
a variety of factors, including:

            .   product selection;

            .   timely and efficient completion of product design;

            .   implementation of manufacturing and assembly processes;

            .   successful coding and debugging of software;

            .   product performance;

            .   reliability in the field; and

            .   effective sales and marketing,

         Because we must make new product development commitments well in
advance of sales, new product decisions must anticipate both future demand and
the availability of technology to satisfy that demand. We cannot be certain that
we will be successful in selecting, developing, manufacturing and marketing new
hardware and software products or enhancements and related software tools. Our
inability to introduce new products and related software tools that contribute
significantly to net sales, gross margins and net income would have a material
adverse effect on our business, financial condition and results of operations.
New product or technology introductions by our competitors could cause a decline
in sales or loss of market acceptance of our existing products. In addition, if
we introduce new products, existing customers may curtail purchases of the older
products and delay new product purchases. Any unanticipated decline in demand
for our hardware or software products could have a materially adverse effect on
our business, financial condition or results of operations.

Significant delays can occur between the time we introduce a system and the time
we are able to produce that system in volume.

         We have in the past experienced significant delays in the introduction,
volume production and sales of our new systems and related feature enhancements.
For example, we have experienced significant delays in the introduction of our
VS2000 and Kalos series testers as well as certain enhancements to our existing
testers. These delays have been primarily related to our inability to
successfully complete product hardware and software engineering within the time
frame originally anticipated, including design errors and redesigns of ICs. As a
result, some customers have experienced significant delays in receiving and
using our testers in production. We cannot be certain that these or additional
difficulties will not continue to arise or that delays will not continue to
materially adversely affect customer relationships and future sales. Moreover,
we cannot be certain that we will not encounter these or other difficulties that
could delay future introductions or volume production or sales of our systems or
enhancements and related software tools. We have incurred and may continue to
incur substantial unanticipated costs to ensure the functionality and
reliability of our testers and to increase feature sets. If our systems continue
to have reliability, quality or other problems, or the market perceives our
products to be feature deficient, we may suffer reduced orders, higher
manufacturing costs, delays in collecting accounts receivable and higher
service, support and warranty expenses, or inventory write-offs, among other
effects. Our failure to have a competitive tester and related software tools
available when required by a customer could make it substantially more difficult
for us to sell testers

                                       19

<PAGE>

to that customer for a number of years. We believe that the continued
acceptance, volume production, timely delivery and customer satisfaction of our
newer digital, mixed signal and non-volatile memory testers are of critical
importance to our future financial results. As a result, our inability to
correct any technical, reliability, parts shortages or other difficulties
associated with our systems or to manufacture and ship the systems on a timely
basis to meet customer requirements could damage our relationships with current
and prospective customers and would continue to materially adversely affect our
business, financial condition and results of operations.

We may not be able to deliver custom hardware options and software applications
to satisfy specific customer needs in a timely manner.

         We must develop and deliver customized hardware and software to meet
our customers' specific test requirements. The market requires us to manufacture
these systems on a timely basis. Our test equipment may fail to meet our
customers' technical or cost requirements and may be replaced by competitive
equipment or an alternative technology solution. Our inability to meet such
hardware and software requirements could impact our ability to recognize revenue
on the related equipment. Our inability to provide a test system that meets
requested performance criteria when required by a device manufacturer would
severely damage our reputation with that customer. This loss of reputation may
make it substantially more difficult for us to sell test systems to that
manufacturer for a number of years.

We rely on Spirox Corporation and customers in Taiwan for a significant portion
of our revenues and the termination of this distribution relationship would
materially adversely affect our business.

     Spirox Corporation, a distributor in Taiwan that sells to end-user
customers in Taiwan and China, accounted for approximately 20%, 45%, and 39% of
our net sales in the first nine months of fiscal 2001 and fiscal years 2000 and
1999, respectively. Our agreement with Spirox can be terminated for any reason
on 90 days prior written notice. The semiconductor industry is highly
concentrated, and a small number of semiconductor device manufacturers and
contract assemblers account for a substantial portion of the purchases of
semiconductor test equipment generally, including our test equipment. Our top
ten end user customers have recently accounted for a substantial portion of our
net sales. Consequently, our business, financial condition and results of
operations could be materially adversely affected by the loss of or any
reduction in orders by Spirox, any termination of the Spirox relationship, or
any other significant customer, including the potential for reductions in orders
by assembly and tester service companies which that customer may utilize or
reductions due to continuing or other technical, manufacturing or reliability
problems with our products or continued slow-downs in the semiconductor industry
or in other industries that manufacture products utilizing semiconductors. Our
ability to maintain or increase sales levels will depend upon:

     .   our ability to obtain orders from existing and new customers;

     .   our ability to manufacture systems on a timely and cost-effective
         basis;

     .   our ability to timely complete the development of our new hardware and
         software products;

     .   our customers' financial condition and success;

     .   general economic conditions; and

     .   our ability to meet increasingly stringent customer performance and
         other requirements and shipment delivery dates.

Our long and variable sales cycle depends upon factors outside of our control
and could cause us to expend significant time and resources prior to earning
associated revenues.

         Sales of our systems depend in part upon the decision of semiconductor
manufacturers to develop and manufacture new semiconductor devices or to
increase manufacturing capacity. As a result, sales of our products are subject
to a variety of factors we cannot control. The decision to purchase our products
generally involves a significant commitment of capital, with the attendant
delays frequently associated with significant capital expenditures. For these
and other reasons, our systems have lengthy sales cycles during which we may
expend substantial funds and management effort to secure a sale, subjecting us
to a number of significant risks. We cannot

                                       20

<PAGE>

be certain that we will be able to maintain or increase net sales in the future
or that we will be able to retain existing customers or attract new ones.

If we engage in acquisitions, we will incur a variety of costs, and the
anticipated benefits of the acquisitions may never be realized.

         We have developed in significant part through mergers and acquisitions
of other companies and businesses. We intend in the future to pursue additional
acquisitions of complementary product lines, technologies and businesses. We may
have to issue debt or equity securities to pay for future acquisitions, which
could be dilutive to then current stockholders. We have also incurred and may
continue to incur certain liabilities or other expenses in connection with
acquisitions, which have and could continue to materially adversely affect our
business, financial condition and results of operations.

     In addition, acquisitions involve numerous other risks, including:

     .   difficulties assimilating the operations, personnel, technologies and
         products of the acquired companies;

     .   diversion of our management's attention from other business concerns;

     .   increased complexity and costs associated with internal management
         structures;

     .   risks of entering markets in which we have no or limited experience;
         and

     .   the potential loss of key employees of the acquired companies.

     For these reasons, we cannot be certain what effect future acquisitions may
have on our business, financial condition and results of operations.

Changes to financial accounting standards may affect our reported results of
operations.

         We prepare our financial statements to conform with generally accepted
accounting principles, or GAAP. GAAP are subject to interpretation by the
American Institute of Certified Public Accountants, the SEC and various bodies
formed to interpret and create appropriate accounting policies. A change in
those policies can have a significant effect on our reported results and may
even affect our reporting of transactions completed before a change is
announced. Accounting policies affecting many other aspects of our business,
including rules relating to purchase and pooling-of-interests accounting for
business combinations, in-process research and development charges, revenue
recognition, employee stock purchase plans and stock option grants have recently
been revised or are under review. Changes to those rules or the questioning of
current practices may have a material adverse effect on our reported financial
results or on the way we conduct our business. For example, in the fourth
quarter of fiscal 2001, we will be required to implement SAB 101 (see Note 4 of
the Notes to the Condensed Consolidated Financial Statements). In addition, our
preparation of financial statements in accordance with GAAP requires that we
make estimates and assumptions that affect the recorded amounts of assets and
liabilities, disclosure of those assets and liabilities at the date of the
financial statements and the recorded amounts of expenses during the reporting
period. A change in the facts and circumstances surrounding those estimates
could result in a change to our estimates and could impact our future operating
results.

Our executive officers and certain key personnel are critical to our business.

         Our future operating results depend substantially upon the continued
service of our executive officers and key personnel, none of whom are bound by
an employment or non-competition agreement. Our future operating results also
depend in significant part upon our ability to attract and retain qualified
management, manufacturing, technical, engineering, marketing, sales and support
personnel. Competition for qualified personnel is intense, and we cannot ensure
success in attracting or retaining qualified personnel. There may be only a
limited number of persons with the requisite skills to serve in these positions
and it may be increasingly difficult for us to hire personnel over time. Our
business, financial condition and results of operations could be materially
adversely affected by the loss of any of our key employees, by the failure of
any key employee to perform in his or her current position, or by

                                       21

<PAGE>

our inability to attract and retain skilled employees. In December 2000, our
Chief Financial Officer resigned from his positions with us. In connection with
his resignation, our board of directors promoted John R. Detwiler to the
position of Senior Vice President of Finance, Chief Financial Officer and
Secretary in February 2001.

Our international business exposes us to additional risks.

     International sales accounted for approximately 73%, 80%, and 64% of our
total net sales for the first nine months of fiscal 2001 and fiscal 2000 and
1999, respectively. As a result, we anticipate that international sales will
continue to account for a significant portion of our total net sales in the
foreseeable future. These international sales will continue to be subject to
certain risks, including:

     .    changes in regulatory requirements;

     .    tariffs and other barriers;

     .    political and economic instability;

     .    an outbreak of hostilities;

     .    integration and management of foreign operations of acquired
          businesses;

     .    foreign currency exchange rate fluctuations;

     .    difficulties with distributors, joint venture partners, original
          equipment manufacturers, foreign subsidiaries and branch operations;

     .    potentially adverse tax consequences; and

     .    the possibility of difficulty in accounts receivable collection.

     We are also subject to the risks associated with the imposition of domestic
and foreign legislation and regulations relating to the import or export of
semiconductor equipment and software products. We cannot predict whether the
import and export of our products will be subject to quotas, duties, taxes or
other charges or restrictions imposed by the United States or any other country
in the future. Any of these factors or the adoption of restrictive policies
could have a material adverse effect on our business, financial condition or
results of operations. Net sales to the Asia-Pacific region accounted for
approximately 46%, 69%, and 55% of our total net sales in the first nine months
of fiscal 2001 and fiscal 2000 and 1999, respectively, and thus demand for our
products is subject to the risk of economic instability in that region and could
continue to be materially adversely affected. Countries in the Asia-Pacific
region, including Korea and Japan, have experienced weaknesses in their
currency, banking and equity markets in the recent past. These weaknesses could
continue to adversely affect demand for our products, the availability and
supply of our product components and our consolidated results of operations. The
1997/1998 Asian financial crisis contributed to widespread uncertainty and a
slowdown in the semiconductor industry. This slowdown resulted in reduced
spending on semiconductor capital equipment, including ATE, and has had, and may
in the future have, a material adverse effect on our product backlog, balance
sheet and results of operations. Further, many of our customers in the
Asia-Pacific region built up capacity in ATE during fiscal 2000 in anticipation
of a steep ramp up in wafer fabrication. However, this steep ramp up in output
has not fully materialized leaving some customers with excess capacity.
Therefore, it is now probable that these customers will spend less in the
aggregate this year than they did in fiscal 2000.

     One end-user customer headquartered in Europe accounted for approximately
16% of our net sales in the first nine months of fiscal 2001.

     In addition, one of our major distributors, Spirox Corporation, is a
Taiwan-based company. This subjects a significant portion of our receivables and
future revenues to the risks associated with doing business in a foreign
country, including political and economic instability, currency exchange rate
fluctuations and regulatory changes. Disruption of business in Asia caused by
the previously mentioned factors could continue to have a material impact on our
business, financial condition or results of operations.

                                       22

<PAGE>
If the protection of proprietary rights is inadequate, our business could be
harmed.

     We attempt to protect our intellectual property rights through patents,
copyrights, trademarks, maintenance of trade secrets and other measures,
including entering into confidentiality agreements. However, we cannot be
certain that others will not independently develop substantially equivalent
intellectual property or that we can meaningfully protect our intellectual
property. Nor can we be certain that our patents will not be invalidated, deemed
unenforceable, circumvented or challenged, or that the rights granted thereunder
will provide us with competitive advantages, or that any of our pending or
future patent applications will be issued with claims of the scope we seek, if
at all. Furthermore, we cannot be certain that others will not develop similar
products, duplicate our products or design around our patents, or that foreign
intellectual property laws, or agreements into which we have entered will
protect our intellectual property rights. Inability or failure to protect our
intellectual property rights could have a material adverse effect upon our
business, financial condition and results of operations. We have been involved
in extensive, expensive and time-consuming reviews of, and litigation
concerning, patent infringement claims.

Our business may be harmed if we are found to infringe proprietary rights of
others.

     We have at times been notified that we may be infringing intellectual
property rights of third parties and we have litigated patent infringement
claims in the past. We expect to continue to receive notice of such claims in
the future. In July 1998, inTEST IP Corporation, or inTEST, alleged in writing
that certain of our products are infringing a patent held by inTEST. We have
since then engaged in sporadic discussions with inTEST concerning this matter.
On December 15, 2000, inTEST filed a complaint in the U.S. District Court for
the District of Delaware against us, alleging infringement of inTEST U.S. patent
number 4,589,815 and seeking damages and injunctive relief. On April 10, 2001 we
were served with the complaint. We may also be obligated to other third parties
relating to this allegation. We believe we have meritorious defenses to the
claims. However, we cannot be certain of success in defending this patent
infringement claim or claims for indemnification resulting from infringement
claims.

     Some of our customers have received notices from Mr. Jerome Lemelson
alleging that the manufacture of semiconductor products and/or the equipment
used to manufacture semiconductor products infringes certain patents issued to
Mr. Lemelson. We have been notified by customers that we may be obligated to
defend or settle claims that our products infringe Mr. Lemelson's patents, and
that if it is determined that the customers infringe Mr. Lemelson's patents,
that customers intend to seek indemnification from us for damages and other
related expenses.

     We cannot be certain of success in defending current or future patent or
other infringement claims or claims for indemnification resulting from
infringement claims. Our business, financial condition and results of operations
could be materially adversely affected if we must pay damages to a third party
or suffer an injunction or if we expend significant amounts in defending any
such action, regardless of the outcome. With respect to any claims, we may seek
to obtain a license under the third party's intellectual property rights. We
cannot be certain, however, that the third party will grant us a license on
reasonable terms or at all. We could decide, in the alternative, to continue
litigating such claims. Litigation has been and could continue to be extremely
expensive and time consuming, and could materially adversely affect our
business, financial condition or results of operations, regardless of the
outcome.

A variety of factors may cause the price of our stock to be volatile.

     In recent years, the stock market in general, and the market for shares of
high-tech companies in particular, including ours, have experienced extreme
price fluctuations, which have often been unrelated to the operating performance
of affected companies. For example, in fiscal 1999, the price of our common
stock ranged from a closing high of $24.94 to a closing low of $7.19. In fiscal
2000 and through September 7, 2001, the price of our common stock has ranged
from a closing high of $74.59 to a closing low of $14.97. The market price of
our common stock is likely to continue to fluctuate significantly in the future,
including fluctuations unrelated to our performance. We believe that
fluctuations of our stock price may be caused by a variety of factors,
including:

     .    announcements of developments related to our business;

     .    fluctuations in our financial results;

                                       23

<PAGE>

         .        general conditions or developments in the semiconductor and
               capital equipment industry and the general economy;

         .        sales or purchases of our common stock in the marketplace;

         .        announcements of our technological innovations or new products
               or enhancements or those of our competitors;

         .        developments in patents or other intellectual property rights;

         .        developments in our relationships with customers and
               suppliers;

         .        a shortfall or changes in revenue, gross margins or earnings
               or other financial results from analysts' expectations or an
               outbreak of hostilities or natural disasters; or

         .        acquisition or merger activity and the success in implementing
               such acquisitions or other business combinations.

We are subject to anti-takeover provisions that could delay or prevent an
acquisition of our company.

         Provisions of our amended and restated certificate of incorporation,
shareholders rights plan, equity incentive plans, bylaws and Delaware law may
discourage transactions involving a change in corporate control. In addition to
the foregoing, our classified board of directors, the stockholdings of our
officers, directors and persons or entities that may be deemed affiliates, our
shareholder rights plan and the ability of our board of directors to issue
preferred stock without further stockholder approval could have the effect of
delaying, deferring or preventing a third party to acquire us and may adversely
affect the voting and other rights of holders of our common stock.

ITEM 3  - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         Our exposure to market risk for changes in interest rates relates
primarily to our investment portfolio. We maintain a strict investment policy
which ensures the safety and preservation of our invested funds by limiting
default risk, market risk, and reinvestment risk. Our investments consist
primarily of commercial paper, medium term notes, asset backed securities, US.
Treasury notes and obligations of U.S. Government agencies, bank certificates of
deposit, auction rate preferred securities, corporate bonds and municipal bonds.
The table below presents notional amounts and related weighted-average interest
rates by year of maturity for our investment portfolio (in thousands, except
percent amounts):

<TABLE>
<CAPTION>
                                        2001        2002         2003        2004        2005       Thereafter
                                      --------    --------     --------    --------    --------     ----------
<S>                                   <C>         <C>          <C>         <C>         <C>          <C>
Cash Equivalents
           Fixed rate ..........      $ 40,416           -            -           -           -             -
           Average rate ........          4.47%          -            -           -           -             -
Short term investments
           Fixed rate ..........      $ 16,645    $ 40,914            -           -           -             -
           Average rate ........          7.24%       6.88%           -           -           -             -
Long term investments
           Fixed rate ..........             -    $ 41,007     $116,607     $28,563           -      $ 16,034
           Average rate ........             -        6.55%        5.82%       5.52%          -          5.68%
                                    -------------------------------------------------------------------------

Total investment securities           $ 57,061    $ 81,921     $116,607     $28,563           -      $ 16,034
Average rate                              5.28%       6.71%        5.82%       5.52%          -          5.68%
</TABLE>


         We mitigate default risk by attempting to invest in high credit quality
securities and by constantly positioning our portfolio to respond appropriately
to a significant reduction in a credit rating of any investment issuer or
guarantor. The portfolio includes only marketable securities with active
secondary or resale markets to ensure portfolio liquidity and maintains a
prudent amount of diversification.

                                       24

<PAGE>

PART II.  - OTHER INFORMATION

Item 1.  Legal Proceedings

         In July 1998, we received a written allegation from inTEST that we were
infringing on a patent held by inTEST. We have since then engaged in sporadic
discussions with inTEST concerning this matter. On December 15, 2000, inTEST
filed a complaint in the U.S. District Court for the District of Delaware
against us, alleging infringement of inTEST U.S. patent number 4,589,815 and
seeking damages and injunctive relief. On April 10, 2001 we were served with the
complaint. In addition to direct costs and diversion of resources which may
result, we may be obligated to indemnify third parties for costs related to this
allegation.

Item 2.  Changes in Securities

         None

Item 3.  Defaults Upon Senior Securities

         None

Item 4.  Submission of Matters to a Vote of Securityholders

         None

Item 5.  Other Information

         None

Item 6. Exhibits and Reports on Form 8-K

(a)  Exhibits

         See Exhibit Index on page 27

(b)  Reports on Form 8-K


     1)  The Company filed a report on Form 8-K on May 17, 2001 announcing the
         execution of the definitive agreement for the registrant's acquisition
         of Integrated Measurement Systems, Inc.

     2)  The Company filed a report on Form 8-K on May 17, 2001 providing the
         definitive agreement for the registrant's acquisition of Integrated
         Measurement Systems, Inc. and a Shareholder Agreement by and among the
         Registrant, Iguana Acquisition Corporation, and Cadence Design Systems,
         Inc.

     3)  The Company filed a report on Form 8-K on June 4, 2001 providing an
         amendment dated June 1, 2001, to the Agreement and Plan of Merger and
         Reorganization, May 16, 2001, by and among the registrant, Iguana
         Acquisition Corporation and Integrated Measurement Systems, Inc. An
         amended and restated Shareholder Agreement, dated June 4, 2001, by and
         among the registrant, Iguana Acquisition Corporation and Cadence Design
         Systems, Inc. was also provided.


SIGNATURES

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

                                       25

<PAGE>

                                                  CREDENCE SYSTEMS CORPORATION
                                                --------------------------------
                                                          (Registrant)



                September 14, 2001                    /S/ JOHN R. DETWILER
           -----------------------------        --------------------------------
                      Date                               John R. Detwiler
                                                  John R. Detwiler, Senior Vice
                                                   President, Chief Financial
                                                     Officer and Secretary

                                       26

<PAGE>

EXHIBIT INDEX

 Exhibit
  Number
  ------
2.15(1)        Agreement and Plan of Merger and Reorganization, dated May 16,
               2001, by and among Credence Systems Corporation, Iguana
               Acquisition Corporation and Integrated Systems, Inc.

2.16(2)        Amendment No. 1 to Agreement and Plan of Merger and
               Reorganization, dated June 1, 2001, by and among Credence Systems
               Corporation, Iguana Acquisition Corporation and Integrated
               Measurement Systems, Inc.

4.7(3)         Registration Rights Agreement, dated May 16, 2001, by and between
               Credence Systems Corporation and Cadence Design Systems, Inc.

10.36(2)       Amended and Restated Shareholder Agreement effective as of May
               16, 2001 and dated June 4, 2001, by and among Credence Systems
               Corporation, Iguana Acquisition Corporation and Cadence Design
               Systems, Inc.

10.37(3)       Employment Agreement, dated March 30, 2001, by and between
               Credence Systems Corporation and John R. Detwiler.

___________________
(1)      Incorporated by reference to an exhibit to the Company's Current Report
         on Form 8-K as filed with the Commission on May 17, 2001.
(2)      Incorporated by reference to an exhibit to the Company's Current Report
         on Form 8-K as filed with the Commission on June 4, 2001.
(3)      Incorporated by reference to an exhibit to the Company's Registration
         Statement on Form S-4 (Registration Statement No. 333-62386), as
         amended.

                                       27