<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 January 31, 1998
                                                  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 February 2, 1998, there were 21,614,279 shares of the Registrant's
common stock, $0.001 par value per share outstanding.

________________________________________________________________________________
<PAGE>
 
CREDENCE SYSTEMS CORPORATION

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

PART I.     FINANCIAL INFORMATION
<S>         <C>                                                                         <C>
Item 1.     Financial Statements......................................................      3
            Condensed Consolidated Balance Sheets.....................................      3
            Condensed Consolidated Income Statements..................................      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................................................................      7
 
PART II.    OTHER INFORMATION
Item 1.     Legal Proceedings.........................................................     20
Item 2.     Changes in Securities.....................................................     20
Item 3.     Defaults Upon Senior Securities...........................................     20
Item 4.     Submission of Matters to a Vote of Securityholders........................     20
Item 5.     Other Information.........................................................     20
Item 6.     Exhibits and Reports on Form 8-K..........................................     20
</TABLE>

                                       2
<PAGE>
 
PART I  - FINANCIAL INFORMATION

ITEM I  - FINANCIAL STATEMENTS


                         CREDENCE SYSTEMS CORPORATION
                     CONDENSED CONSOLIDATED BALANCE SHEETS
                                (IN THOUSANDS)


<TABLE>
<CAPTION>
                                                     JANUARY 31,            OCTOBER 31,
                                                         1998                 1997/A/
                                                  ---------------        ---------------
ASSETS                                               (UNAUDITED)
<S>                                               <C>                    <C>
Current assets:
  Cash and cash equivalents.........................     $ 88,667               $132,761
  Restricted cash...................................        7,206                 10,002
  Short-term investments............................       62,608                 35,013
  Accounts receivable, net..........................       62,103                 55,246
  Inventories.......................................       48,761                 42,125
  Other current assets..............................       14,552                 13,001
                                                      -----------             ----------
    Total current assets............................      283,897                288,148
Long-term investments...............................       17,396                  8,561
Property and equipment, net.........................       44,497                 43,050
Other assets........................................       17,442                 18,382
                                                      -----------             ----------
    Total assets....................................     $363,232               $358,141
                                                      ===========             ==========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable..................................     $ 14,386               $ 13,182
  Accrued liabilities...............................       23,454                 20,346
  Income taxes payable..............................        6,476                  4,284
                                                      -----------             ----------
    Total current liabilities.......................       44,316                 37,812
Convertible subordinated notes......................      115,000                115,000
Minority interest...................................          366                    418
Stockholders' equity................................      203,550                204,911
                                                      -----------             ----------
    Total liabilities and stockholders' equity......     $363,232               $358,141
                                                      ===========             ==========
</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, 1997.

                                       3
<PAGE>
 
                         CREDENCE SYSTEMS CORPORATION
                   CONDENSED CONSOLIDATED INCOME STATEMENTS
                   (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
                                  (UNAUDITED)

<TABLE>
<CAPTION>
                                                           THREE MONTHS ENDED JANUARY 31,
                                                        -----------------------------------
                                                            1998                  1997
                                                        --------------       --------------
<S>                                                     <C>                  <C>
Net sales............................................          $82,375              $40,261
Cost of goods sold...................................           35,438               19,439
                                                        --------------       --------------
Gross margin.........................................           46,937               20,822
Operating expenses:
   Research and development..........................           13,491                8,806
   Selling, general and administrative...............           20,308               11,431
                                                        --------------       --------------
       Total operating expenses......................           33,799               20,237
                                                        --------------       --------------
Operating income.....................................           13,138                  585
Interest income and other expenses, net..............              958                1,027
                                                        --------------       --------------

Income before income taxes...........................           14,096                1,612
Income taxes.........................................            4,934                  558
Minority interest....................................              (29)                   -
                                                        --------------       --------------
Net income...........................................          $ 9,191              $ 1,054
                                                        ==============       ==============
Net income per share
    Basic............................................            $0.42                $0.05
                                                        ==============       ==============
    Diluted..........................................            $0.41                $0.05
                                                        ==============       ==============
Number of shares used in computing per share amount
    Basic............................................           21,864               21,733
                                                        ==============       ==============
    Diluted..........................................           22,415               22,215
                                                        ==============       ==============
</TABLE>

                            See accompanying notes.

                                       4
<PAGE>
 
                         CREDENCE SYSTEMS CORPORATION
                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
               INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
                                (IN THOUSANDS)
                                  (UNAUDITED)

<TABLE>
<CAPTION>
                                                                                              THREE MONTHS ENDED
                                                                                                 JANUARY 31,
                                                                                    -----------------------------------
                                                                                           1998                1997
                                                                                    ---------------     ---------------
<S>                                                                                 <C>                 <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
   Net income......................................................................        $  9,191            $  1,054
   Adjustments to reconcile net income to net cash provided by operating activities:
      Depreciation and amortization................................................           4,326               2,821
      (Gain) loss on disposal of property and equipment............................               -                 (26)
      Minority interest                                                                          29                   -
      Changes in operating assets and liabilities:
        Restricted cash, accounts receivable, inventories and other current assets.         (13,581)             (5,196)
        Accounts payable, accrued liabilities and income taxes payable.............           7,072              (6,768)
                                                                                     --------------     ---------------
          Net cash provided (used) by operating activities.........................           7,037              (8,115)
CASH FLOWS FROM INVESTING ACTIVITIES:
   Purchases of available-for-sale securities......................................         (58,420)            (13,360)
   Maturities of available-for-sale short-term investments.........................          20,990              19,135
   Sales of available-for-sale securities..........................................           1,000               7,397
   Acquisition of property and equipment...........................................          (3,431)             (3,355)
   Other assets....................................................................             (69)             (1,738)
   Proceeds from sale of property and equipment....................................               -                 243
                                                                                     --------------     ---------------
          Net cash (used) provided in investing activities.........................         (39,930)              8,322
CASH FLOWS FROM FINANCING ACTIVITIES:
   Issuance of common stock........................................................           1,594                 816
   Repurchase of common stock......................................................         (12,795)                  -
                                                                                     --------------     ---------------
          Net cash (used for) provided by financing activities.....................         (11,201)                816
                                                                                     --------------     ---------------
Net increase (decrease) in cash and cash equivalents...............................         (44,094)              1,023
Cash and cash equivalents at beginning of period...................................         132,761              48,649
                                                                                    ---------------     ---------------
Cash and cash equivalents at end of period.........................................        $ 88,667            $ 49,672
                                                                                    ===============     ===============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
   Interest paid...................................................................        $     --            $     --
   Income taxes paid...............................................................        $  2,063            $    648
NONCASH INVESTING ACTIVITIES:
   Net transfers of inventory to property and equipment............................        $  1,333            $  4,198
NONCASH FINANCING ACTIVITIES:
   Income tax benefit from stock option exercises..................................        $    649            $    149
</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 months ended January 31, 1998 and 1997 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 months ended January 31, 1998 and 1997 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, 1997 included in the Annual
Report on Form 10-K and the additional risk factors, including, without
limitation, risks relating to fluctuations in operating results, rapid
technological change, importance of timely product introduction, risks of
delays, limited system sales, backlog, cyclicality of semiconductor industry,
expansion of operations, management of growth, sole or limited sources of
supply, reliance on subcontractors, highly competitive industry, dependence on
key customers, lengthy sales cycle, dependence on key personnel, management
changes, international sales, proprietary rights, acquisitions, future capital
needs and volatility of stock price, as set forth in this Report. Any party
interested in reviewing these publicly available documents should write to the
Chief Financial Officer of the Company.

     USE OF ESTIMATES - The preparation of the accompanying unaudited
consolidated condensed 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.


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):


<TABLE>
<CAPTION>
                                                                                 JANUARY 31,            OCTOBER 31,
                                                                                    1998                   1997
                                                                              --------------         --------------
          <S>                                                                 <C>                    <C>
          Raw materials.................................................             $26,269                $24,862
          Work-in-process...............................................              17,407                 14,173
          Finished goods................................................               5,085                  3,090
                                                                              --------------         --------------
                                                                                     $48,761                $42,125
                                                                              ==============         ==============
</TABLE>

3.   NET INCOME PER SHARE

     The Company has adopted Statement of Financial Accounting Standards No.128
"Earnings Per Share" (SFAS 128) beginning in the first quarter of fiscal 1998.
Accordingly, net income per share (basic) is based upon the weighted average
number of common shares outstanding during the period. Net income per share
(diluted) is based upon the weighted average number of common and dilutive
potential common shares  outstanding during the period. The Company's
convertible subordinated notes are not dilutive potential common shares and,
accordingly, were excluded from the calculation of net income per share
(diluted). Options to purchase 926,127 shares at an average price of $29.84 per
share were outstanding at January 31, 1998 but were not included in the
computation of diluted earnings per share because the options' exercise price
was greater than the average market price of the common shares and, therefore,
the effect would be antidilutive. All earnings per share amounts for all periods
have been presented and where necessary, restated to conform to SFAS 128 
requirements. The following table sets forth the computation of basic and
dilutive earnings per share (in thousands):

                                       6
<PAGE>
 
<TABLE>
<CAPTION>
                                                                             THREE MONTHS ENDED
                                                                                JANUARY 31,
                                                                    ----------------------------------
                                                                          1998                1997
                                                                    --------------      --------------
<S>                                                                 <C>                 <C>
Numerator:
Numerator for basic and diluted earnings per share-
 net income                                                                $ 9,191             $ 1,054
                                                                    --------------      --------------
 
Denominator:
 Denominator for basic earnings per share-
 weighted-average shares                                                    21,864              21,733
 
Effect of dilutive securities-employee stock options                           551                 482
                                                                    --------------      --------------
 
Denominator for diluted earnings per share-adjusted
 weighted-average shares and assumed conversions                            22,415              22,215
                                                                    --------------      --------------
 
Basic earnings per share                                                   $  0.42             $  0.05
                                                                    ==============      ==============
 
Diluted earnings per share                                                 $  0.41             $  0.05
                                                                    ==============      ==============
</TABLE>

4.    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, will have a material adverse effect on the Company's
business, financial condition or results of operations.

5.    COMMITMENTS
 
     The Company currently has an agreement with Summit Design, Inc. to purchase
product licenses through 1999. The remaining commitment under this agreement as
of January 31, 1998 is approximately $7 million. Restricted cash represents cash
in escrow related to the remaining purchase commitments under this agreement.


ITEM 2  - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

     The following discussion may contain predictions, estimates and other
forward-looking statements that involve a number of risks and uncertainties.
While this discussion represents the Company's current judgment on the future
direction of the business, such risks and uncertainties could cause actual
results to differ materially from any future performance suggested herein.
Factors that could cause actual results to differ are identified throughout the
discussion below, as well as the section entitled "Risk Factors" below, and
elsewhere in this report. The Company undertakes no obligation to publicly
release the result of any revisions to these forward-looking statements which
may be made to reflect events or circumstances after the date hereof or to
reflect the occurrence of unanticipated events.

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

                                       7
<PAGE>
 
<TABLE>
<CAPTION>
                                                                       THREE MONTHS ENDED JANUARY 31,
                                                                   ------------------------------------
                                                                         1998                  1997
                                                                   --------------        --------------
     <S>                                                           <C>                   <C>
     Net sales.................................................          100.0%                100.0%     
     Cost of goods sold........................................           43.0                  48.3      
                                                                         -----                 -----      
     Gross margin..............................................           57.0                  51.7      
     Operating expenses                                                                                   
       Research and development................................           16.4                  21.9      
       Selling, general, and administrative....................           24.7                  28.4      
                                                                         -----                 -----      
     Operating expenses........................................           41.1                  50.3      
                                                                         -----                 -----      
     Operating income..........................................           15.9                   1.4      
     Interest income and other expenses, net...................            1.2                   2.6      
                                                                         -----                 -----      
     Income before income taxes................................           17.1                   4.0      
     Income taxes..............................................            5.9                   1.4      
                                                                         -----                 -----      
     Net income................................................           11.2%                  2.6%     
                                                                         =====                  =====     
</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 $82.4 million for the
first quarter of fiscal 1998, representing an increase of 104.6% over the
comparable period of fiscal 1997. This increase was due primarily to increased
worldwide demand for semiconductor automatic test equipment, particularly in the
Asia Pacific region.  International net sales accounted for approximately 67.1%
of the total net sales for the first quarter of fiscal 1998, compared to
approximately 75.3% for the comparable period a year ago. The decrease in
international sales as a percentage of sales resulted primarily from decreased
demand in Europe, partially offset by increases in the Asia Pacific region. The
Company's international sales of its products and spare parts and its service
revenues are denominated primarily in United States dollars.

GROSS MARGIN

     The Company's 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. Gross margin was 57.0% for the first quarter of
fiscal 1998, compared with 51.7% for the first quarter of fiscal 1997.  The
increase in gross margin as a percent of sales was due to increases in the
efficiency of the production process, as well as higher manufacturing and
shipping volumes which spread fixed production costs over a greater number of
systems. Gross margin in the first quarter of fiscal 1997 was negatively
impacted by reserves taken for slow moving inventory resulting from accelerated
new product introductions.

RESEARCH AND DEVELOPMENT

     Research and development expenses were $13.5 million in the first quarter
of fiscal 1998, an increase of $4.7 million or 53.2% over the same period of
fiscal 1997. This increase, in absolute dollars, reflected the Company's
continued development work on new products and product enhancements. As a
percentage of net sales, research and development expenses were 16.4% for the
first quarter of fiscal 1998, down from 21.9% in the first quarter of fiscal
1997.  The decrease in these expenses as a percentage of net sales is
attributable primarily to the significant increase in net sales in the first
quarter of fiscal 1998 as compared with the comparable period of fiscal 1997.
The Company currently intends to continue to invest significant resources in the
development of new products and enhancements for the foreseeable future.
Accordingly, the Company expects these expenses to remain relatively flat in
absolute dollars for the remainder of fiscal 1998.

                                       8
<PAGE>
 
SELLING, GENERAL AND ADMINISTRATIVE

     Selling, general and administrative expenses were $20.3 million in the
first quarter of fiscal 1998, representing an $8.9 million or 77.7% increase
from the comparable period of fiscal 1997. The increase from the prior period is
primarily due to increased commissions payable on higher sales and  higher
marketing, sales, and administrative overhead expenses to support the Company's
increased business levels. As a percentage of net sales, selling, general and
administrative expenses were 24.7% for the first quarter of fiscal 1998,
compared with 28.4% for the corresponding period in fiscal 1997. This decrease
as a percentage of net sales is attributable primarily to the significant
increase in net sales in the first quarter of fiscal 1998 as compared with the
comparable period of fiscal 1997. The Company expects selling, general and
administrative expenses for the remainder of fiscal 1998 to remain flat in
absolute dollars.

INTEREST INCOME AND OTHER EXPENSES, NET

     The Company generated net interest income and other expenses of $1.0
million for the first quarter of fiscal 1998, as compared to $1.0 million for
the first quarter of fiscal 1997.

INCOME TAXES

     The Company's provision for income taxes for the first quarter of fiscal
1998 and fiscal 1997 is computed based on the projected annualized effective tax
rate of 35.0% and 34.5% respectfully, applied to fiscal year-to-date book
income. The projected effective tax rate for both fiscal 1998 and fiscal 1997 is
expected to be less than the combined federal and state statutory rate due
primarily to the projected benefit of the Company's foreign sales corporation.

LIQUIDITY AND CAPITAL RESOURCES

     Net cash provided (used) by operating activities was $7.0 million and
($8.1) million for the three months ended January 31, 1998 and 1997,
respectively. Net cash flows provided by operating activities for the first
quarter of 1998 resulted primarily from net income of $9.2 million,
depreciation and amortization of $4.3 million and increases in accounts payable,
accrued liabilities and income taxes payable of $7.1 million, partially offset
by increases in restricted cash, accounts receivable, inventories and other
current liabilities of $13.6 million. Net cash flows used by operating
activities in the first quarter of 1997 were primarily attributable to an
increase in inventory, some of which was transferred to property and equipment
($4.2 million), and reductions in accounts payable, accrued liabilities and
income taxes payable. Investing activities (used) provided net cash of ($39.9
million) and $8.3 million for the three months ended January 31, 1998 and 1997,
respectively. In the first three months of fiscal 1998, the Company used cash to
purchase a net increase of $27.6 million in short-term investments and $8.8
million in long-term investments while also purchasing $3.4 million of property
and equipment. Net cash (used for) provided by financing activities was ($11.2
million) and $0.8 million for the three months ended January 31, 1998 and 1997,
respectively. The use of cash in the first quarter of fiscal 1998 was primarily
due to the Company repurchasing 500,000 of its shares of common stock at a cost
of approximately $12.8 million. The purpose of the repurchase was to offset
potential future dilution resulting from increases in the Company's stock option
plan and employee stock purchase plan.

     As of January 31, 1998, the Company had working capital of approximately
$239.6 million, including cash and short-term investments of $151.3 million,
$62.1 million of accounts receivable and $48.8 million of inventories. The
Company expects accounts receivable to continue to represent a significant
portion of working capital. The Company believes that because of the relatively
long manufacturing cycles of many of its testers and the new products it has and
plans 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 the Company to increased risks
which could materially adversely affect the Company's business, financial
condition and results of operations. Total current liabilities of $37.8 million
as of October 31, 1997 increased to $44.3 million as of January 31, 1998. The
$6.5 million increase was due primarily to increases in accounts payable by $1.2
million, accrued liabilities by $3.1 million, and income taxes payable by $2.2
million.

                                       9
<PAGE>
 
     The Company's principal sources of liquidity as of January 31, 1998
consisted of approximately $88.7 million of cash and cash equivalents, short-
term investments of $62.6 million and $20.0 million available under the
Company's unsecured working capital line of credit expiring on July 24, 1998. In
addition, the Company has $17.4 million of long-term investments. As of January
31, 1998, no amounts were outstanding under the unsecured line of credit.
Additionally, as of January 31, 1998, the Company has operating leases for 
facilities and test and other equipment totaling approximately $19.2 million
through 2006.

     The Company is currently in the process of assessing and testing the
software components of its products for year 2000 compliance. The Company does
not believe that its products contain undetected errors or defects associated
with year 2000 date functions that may result in material costs to the Company,
including repair costs and costs incurred in litigation due to any such defects,
however there can be no assurance that such errors or defects do not exist. Many
commentators have stated that a significant amount of litigation will arise out
of year 2000 compliance issues. Because of the unprecedented nature of such
litigation, there can be no assurance that the Company will not be materially
adversely affected by claims related to year 2000 compliance.

     Although the Company is not aware of any material operational issues or
costs associated with preparing its internal systems for the year 2000, there
can be no assurance that the Company will not experience serious unanticipated
negative consequences and/or material costs caused by undetected errors or
defects in the technology used in its internal operating systems, which are
composed predominately of third party software and hardware technology.

RISK FACTORS

     The Company's results of operations are affected by a variety of factors,
including the following:

FLUCTUATIONS IN OPERATING RESULTS

     The Company's operating results have in the past fluctuated significantly
and will in the future fluctuate significantly, due to a variety of factors. The
Company's operating performance from the first quarter of fiscal 1993 through
the third quarter of fiscal 1996 produced sequential quarter-to-quarter growth
in both net sales and net income. In the fourth quarter of fiscal 1996, however,
net sales decreased 34% from the third quarter of fiscal 1996 and 17% from the
fourth quarter of fiscal 1995. Net income for the fourth quarter of fiscal 1996
decreased 63% from the third quarter of fiscal 1996 and 55% from the fourth
quarter of fiscal 1995. In the first quarter of fiscal 1997, net sales decreased
9% from the fourth quarter of fiscal 1996 and decreased 34% from the first
quarter of fiscal 1996. Net income for the first quarter of fiscal 1997
decreased 75% from the fourth quarter of fiscal 1996 and decreased 90% from the
first quarter of fiscal 1996. In the second quarter of fiscal 1997, net sales
increased 8% from the first quarter of fiscal 1997 and decreased 35% from the
second quarter of fiscal 1996. Net income for the second quarter of fiscal 1997
increased 212% from the first quarter of fiscal 1997 and decreased 71% from the
second quarter of fiscal 1996. The Company's third quarter fiscal 1997 net sales
increased 18% from the second quarter of fiscal 1997 and decreased 24% from the
third quarter of fiscal 1996. The third quarter of fiscal 1997 reflected a net
loss due to a pre-tax charge for in process research and development related to
an acquisition. Without the charge, third quarter net income would have been up
35% from the second quarter of fiscal 1997 and down 62% from the third quarter
of fiscal 1996. In the fourth quarter of fiscal 1997, net sales were up 36% over
the third quarter of fiscal 1997 and 57% over the fourth quarter of fiscal 1996.
Net income for the fourth quarter of fiscal 1997 increased 69% from the fourth
quarter of fiscal 1996 and represented a significant increase over the third
quarter of 1997 in which the Company incurred a loss of $0.9 million, which
included a charge of $6.0 million for acquisition related in-process research
and development. In the first quarter of fiscal 1998, net sales increased 19%
over the fourth quarter of fiscal 1997 and 105% over the first quarter of fiscal
1997. Net income for the first quarter of fiscal 1998 increased 27% from the
fourth quarter of fiscal 1997 and 772% from the first quarter of fiscal 1997.
The decreases were due primarily to a significant weakness in the ATE market
which materially adversely affected the Company's business, financial condition
and results of operations and several other companies in the semiconductor
equipment industry. Although the ATE industry returned to a capacity expansion
mode in fiscal 1997, resulting in sequential increases in revenues during the
second, third, and fourth quarters of fiscal 1997 and the first quarter of
fiscal 1998, there can be no assurance that it will continue to expand in
subsequent quarters. The factors that have caused and will continue to cause the
Company's results to fluctuate include the timing of new product announcements
and releases by the Company or its competitors, market acceptance of new
products and enhanced 

                                       10
<PAGE>
 
versions of the Company's products, manufacturing inefficiencies associated with
the start up of new products, changes in pricing and payment terms and cycles by
the Company, its competitors, customers or suppliers, manufacturing capacity,
the ability to volume produce systems and meet customer requirements, inventory
obsolescence and writeoffs (which the Company has experienced), patterns of
capital spending by customers, delays, cancellations or reschedulings of 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, subassemblies and
services, expenses associated with acquisitions and alliances, product
discounts, customization and reconfiguration of systems, product reliability,
the proportion of direct sales and sales through third parties, including
distributors and original equipment manufacturers, the mix of products sold, the
length of manufacturing and sales cycles, cyclicality or downturns in the
semiconductor market and the markets served by the Company's customers, natural
disasters, political and economic instability, regulatory changes and outbreaks
of hostilities. The Company presently intends to introduce many new products and
product enhancements in the future, which will affect its operating results,
financial condition and business. The Company's gross margins on system sales
have varied significantly, and will continue to vary significantly based on a
variety of factors, including manufacturing efficiencies, pricing by competitors
or suppliers, product sales mix, reserves, production volume, new product
introductions, product reliability, the rate of capacity utilization,
customization and reconfiguration of systems, international and domestic sales
mix and field service margins. In addition, new and enhanced products typically
have lower gross margins in the early stages of commercial introduction and
production. While the Company has recorded and continues to record allowances
for estimated sales returns and uncollectible accounts, there can be no
assurance that such estimates regarding allowances will be adequate.

LIMITED SYSTEMS SALES; BACKLOG

     The Company derives a substantial portion of its net sales from the sale of
a relatively small number of systems that typically range in price from $350,000
to $3.6 million, excluding the EPRO memory products, for which the price range
is typically below $50,000. As a result, the timing of recognition of revenue
from a single transaction could have a significant impact on the Company's net
sales and operating results for a particular period. The Company's net sales and
operating results for a particular period could be materially adversely affected
if an anticipated order for even one system is not received in time to permit
shipment during that period. The Company's backlog at the beginning of a quarter
typically does not include all orders necessary to achieve the Company's sales
objectives for that quarter. In addition, orders in backlog are subject to
cancellation, delay, deferral or rescheduling by a customer with limited or no
penalties. Consequently, the Company's net sales and operating results for a
quarter have in the past and will in the future depend upon the Company
obtaining orders for systems to be shipped in the same quarter that the order is
received. Furthermore, products generating most of the Company's net sales
continue to be shipped near the end of each quarter. Accordingly, the failure to
receive an anticipated order or a delay or rescheduling in a shipment near the
end of a particular period due, for example, to an order cancellation, a delay
by a customer, manufacturing, technical, reliability or other difficulties,
including difficulties relating to customization and reconfiguration of systems,
a delay in the supply of components, subassemblies or services or a delay due to
competitive or economic factors, may cause net sales in a particular period to
fall significantly below the Company's expectations, which could have a material
adverse effect upon the Company's business, financial condition or results of
operations. The relatively long manufacturing cycle of many of its testers has
caused and could continue to cause future shipments of such products to be
delayed from one quarter to the next, which could materially adversely affect
the Company's business, financial condition or results of operations.
Furthermore, announcements by the Company or its competitors of new products and
technologies could cause customers to defer or cancel purchases of the Company's
existing systems, which could also have a material adverse effect on the
Company's business, financial condition or results of operations. The impact of
these and other factors on the Company's sales and operating results in any
future period cannot be forecasted with certainty. In addition, the 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, among other factors, will make it
difficult for the Company to reduce its significant fixed expenses in a
particular period if the Company's net sales goals for such period are not met.
Accordingly, there can be no assurance that the Company will be profitable or
that it will not again sustain losses in future periods. Due to all of the
foregoing factors, it is likely that in some future quarter the Company's
operating results will be below the expectations of public market analysts and
investors, as they were in fiscal 1997. In such event, the price of the
Company's Common Stock may be materially adversely affected.

                                       11
<PAGE>
 
CYCLICALITY OF SEMICONDUCTOR INDUSTRY

     The Company's business and results of operations depend in significant part
upon the capital expenditures of manufacturers of semiconductors and companies
which specialize in contract packaging and/or testing of semiconductors,
including 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. Historically and recently, the
semiconductor industry has been highly cyclical with recurring periods of
oversupply, which often have had a severe effect on the semiconductor industry's
demand for test equipment, including the systems manufactured and marketed by
the Company. The Company believes that the markets for newer generations of
semiconductors will also be subject to similar fluctuations. The Company has in
the past experienced shipment delays, delays in commitments and purchase order
restructurings by several of its customers and anticipates that this may
continue to occur in the future. Accordingly, the Company can give no assurance
that it will be able to achieve or maintain its current or prior level of sales
or rate of growth. Through the first three quarters of 1997, the Company's net
sales, gross margins and net income were significantly below the net sales,
gross margins and net income, respectively, of the comparable prior year's
quarterly results. In the fourth quarter of 1997 and the first quarter of 1998,
the Company's net sales and net income were significantly above the net sales
and net income of the fourth quarter of 1996 and the first quarter of 1997,
respectively; however there can be no assurance that they will continue to
exceed prior year amounts in future quarters. The Company anticipates 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, any factor adversely affecting the
semiconductor industry or particular segments within the semiconductor industry
may adversely affect the Company's business, financial condition or results of
operations. Therefore, there can be no assurance that the Company's operating
results will not continue to be materially adversely affected if downturns or
slowdowns in the semiconductor industry continue or occur again in the future.
Company net sales to the Asia Pacific region accounted for approximately 63%,
66%, 58%, and 45% of total net sales in the first quarter of fiscal 1998, and
fiscal years 1997, 1996, and 1995, and thus are subject to the risk of economic
instability in that region that might materially adversely affect the demand for
the Company's products. Although the current economic instability in the Asia
Pacific region has not materially adversely affected the Company's order
backlog, balance sheet, or results of operations, there can be no assurance that
it will not in the future.

MANAGEMENT OF FLUCTUATIONS IN OPERATING RESULTS

     The Company has over the last several years experienced significant
fluctuations in its operating results. Since 1993, the Company has overall
significantly increased the scale of its operations to support increased sales
levels and has expanded its operations to address critical infrastructure and
other requirements, including the hiring of additional personnel, significant
investments in research and development to support product development, the
March 1995 acquisition of EPRO, the Company's establishment of a joint venture
with Innotech, Inc., the Company's acquisition in July 1997 of the assets and
certain liabilities of Test Systems Strategies, Inc. ("TSSI") and the Company's
acquisition in August 1997 of a software product line from Zycad Corporation
("Zycad").  However, the Company has during certain historical periods,
particularly in the last fiscal year, experienced revenue declines and
reductions in its operations.

     Fluctuations in the Company's sales and operations have placed a
considerable strain on its management, financial, manufacturing and other
resources. In order to effectively deal with the changes brought on by the
cyclical nature of the industry, the Company has 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 the
Company's business. There can be no assurance that any existing or new systems,
procedures or controls will be adequate to support fluctuations in the Company's
operations or that its systems, procedures and controls will be designed,
implemented or improved in a cost effective and timely manner. Any failure to
implement, improve and expand or contract such systems, procedures and controls
in an efficient manner at a pace consistent with the Company's business could
have a material adverse effect on the Company's business, financial condition or
results of operations.

                                       12
<PAGE>
 
EXPANSION OF OPERATIONS

     Currently, the Company is devoting and will continue to devote significant
resources to the development of new products and technologies. During 1998, the
Company is conducting evaluations of these new products and will continue to
invest significant additional resources in plant and equipment, leased
facilities, inventory, personnel and other costs, to begin or prepare to begin
production of these products and to provide the marketing, administration and
after-sales service and support, if any, required to service and support these
new products. Accordingly, there can be no assurance that gross profit margin
and inventory levels will not be adversely impacted in the future by start-up
costs associated with the initial production and installation of these new
product lines. These start-up costs include, but are not limited to, additional
manufacturing overhead, additional inventory and warranty reserve requirements
and the creation of after-sales service and support organizations. Additionally,
there can be no assurance that operating expenses will not increase, relative to
sales, as a result of adding additional marketing and administrative personnel,
among other costs, to support the Company's additional products. If the Company
is unable to achieve significantly increased net sales or its sales fall below
expectations, the Company's operating results will be materially adversely
affected. There can be no assurance that net sales will increase or remain at
recent levels or that  any new products will be successfully commercialized.

LIMITED SOURCES OF SUPPLY; RELIANCE ON SUBCONTRACTORS

     Certain components, subassemblies and services necessary for the
manufacture of the Company's testers are obtained from a limited group of
suppliers. The Company does not maintain long-term supply agreements with most
of its vendors and purchases most of its components and subassemblies through
individual purchase orders. The manufacture of certain of the Company's
components and subassemblies is an extremely complex process. The Company also
relies on outside vendors to manufacture certain components and subassemblies
and to provide certain services. The Company has recently experienced and
continues to experience significant reliability, quality and timeliness problems
with several critical components. In addition, the Company and certain of its
subcontractors periodically experience significant shortages and delays in
delivery of various components and subassemblies. There can be no assurance that
these or other problems will not continue to occur in the future with these or
the Company's other suppliers or outside subcontractors. The Company's reliance
on a limited group of suppliers and the Company's reliance on outside
subcontractors involve several risks, including a potential 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 has delayed
and could continue to delay shipments of the Company's systems and could have a
material adverse effect on the Company's business, financial condition or
results of operations. Any continuing inability to obtain adequate yields or
timely deliveries or any other circumstance that would require the Company to
seek alternative sources of supply or to manufacture such components internally
could have a material adverse effect on the Company's business, financial
condition or results of operations. Such delays, shortages and disruptions would
also damage relationships with current and prospective customers and could allow
competitors to penetrate such customer accounts. There can be no assurance that
the Company's internal manufacturing capacity and that of its suppliers and
subcontractors will be sufficient to meet customer requirements.

HIGHLY COMPETITIVE INDUSTRY

     The automatic test equipment ("ATE") industry is intensely competitive.
Because of the substantial investment required to develop test application
software and interfaces, the Company believes that once a semiconductor
manufacturer has selected a particular ATE vendor's tester, the semiconductor
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. The inability of the Company to penetrate any large
ATE customer or achieve significant sales to any ATE customer could have a
material adverse effect on the Company's business, financial condition or
results of operations.

     The Company faces substantial competition throughout the world, primarily
from ATE manufacturers located in the United States, Europe and Japan, as well
as several of the Company's customers. Many of the Company's competitors have
substantially greater financial and other resources with which to pursue
engineering, manufacturing, 

                                       13
<PAGE>
 
marketing and distribution of their products. Certain of the Company's
competitors have recently introduced or announced new products with certain
performance or price characteristics equal or superior to certain products
currently offered by the Company. The Company believes that if the ATE industry
continues to consolidate through strategic alliances or acquisitions, the
Company will continue to face significant additional competition from larger
competitors that may offer more complete product lines and services than the
Company. The Company's 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 the Company's competitors could
continue to cause a decline in sales or loss of market acceptance of the
Company's existing products. Moreover, increased competitive pressure could
continue to lead to intensified price-based competition, which could materially
adversely affect the Company's business, financial condition or results of
operations. The Company has experienced and continues to experience significant
price competition in the sale of all of its testers. In addition, at the end of
a product life cycle and as competitors introduce more technologically advanced
products, pricing pressures typically become more intense as the Company has
experienced with sales of its older products. The Company believes that to be
competitive, it must continue to expend significant financial resources in order
to, among other items, invest in new product development and enhancements and to
maintain customer service and support centers worldwide. There can be no
assurance that the Company will be able to compete successfully in the future.

RAPID TECHNOLOGICAL CHANGE; IMPORTANCE OF TIMELY PRODUCT INTRODUCTION

     The ATE market is subject to rapid technological change and new product
introductions and enhancements and related software tools. The Company's ability
to be competitive in this market will depend in significant part upon its
ability to successfully develop and introduce new products and enhancements and
related software tools with greater features on a timely and cost-effective
basis, including the products under development acquired in the EPRO merger and
the TSSI and Zycad product line acquisitions. The Company's customers require
testers with additional features and higher performance and other capabilities.
The Company is therefore required to enhance the performance and other
capabilities of its existing systems and related software tools. Any success by
the Company in developing new and enhanced systems and related software tools
and new features to its existing systems depends upon a variety of factors,
including product selection, timely and efficient completion of product design,
timely and efficient implementation of manufacturing and assembly processes,
product performance and reliability in the field and effective sales and
marketing. Because new product development commitments must be made well in
advance of sales, new product decisions must anticipate both future demand and
the availability of technology to satisfy that demand. There can be no assurance
that the Company will be successful in selecting, developing, manufacturing and
marketing new products or enhancements and related software tools. The inability
of the Company 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 the Company's business, financial condition or
results of operations. New product or technology introductions by the Company's
competitors could cause a decline in sales or loss of market acceptance of the
Company's existing products. In addition, new product introductions by the
Company may cause the Company's customers to curtail purchases of the older
products and delay new products purchases.

     Significant delays can occur between a system's introduction and the
commencement by the Company of volume production of such system. The Company has
in the past experienced and continues to experience significant delays in the
introduction, volume production and sales of its systems and related feature
enhancements, including new models within the digital, mixed-signal and non-
volatile memory product lines, due to technical, manufacturing, parts shortages,
component reliability and other difficulties and may continue to experience
similar delays in the future. As a result, certain of the Company's significant
customers have experienced significant delays in receiving and using certain of
the Company's testers in production. There can be no assurance that these or
additional difficulties will not continue to arise in the future with respect to
the Company's systems or that such delays will not materially adversely affect
customer relationships and future sales. Moreover, there can be no assurance
that the Company will not encounter these or other difficulties that could delay
future introductions or volume production or sales of its systems or
enhancements and related software tools. The Company has incurred and may
continue to incur substantial unanticipated costs to ensure the functionality
and reliability of its testers and to increase feature sets. If the Company's
systems continue to have reliability, quality or other problems, or the market
perceives certain of the Company's products to be feature deficient, reduced
orders, higher manufacturing costs, delays in collecting accounts receivable and
higher service, support and warranty expenses, or inventory write-offs, among
other items, could result. The Company's failure to have 

                                       14
<PAGE>
 
a competitive tester and related software tools available when required by a
semiconductor manufacturer could make it substantially more difficult for the
Company to sell testers to that manufacturer for a number of years. The Company
believes that the continued acceptance, volume production, timely delivery and
customer satisfaction of its newer digital, mixed signal and non-volatile memory
testers are of critical importance to its future financial results. As a result,
an inability to correct any technical, reliability, parts shortages or other
difficulties associated with the Company's systems or to manufacture and ship
the Company's systems on a timely basis to meet customer requirements could
damage relationships with current and prospective customers and would materially
adversely affect the Company's business, financial condition or results of
operations.

CUSTOMER CONCENTRATION; LENGTHY SALES CYCLE

     One customer (a distributor) accounted for 27%, 30%, 25% and 17% of the
Company's net sales in the first quarter of fiscal 1998, and fiscal years 1997,
1996 and 1995, respectively. Another customer accounted for 14% of net sales in
the first quarter of fiscal 1998. Another customer accounted for 11% of net
sales in fiscal 1995. The loss of or any reduction in orders by this or any
other significant customer, including losses or reductions due to continuing or
other technical, manufacturing or reliability problems with the Company's
products, continued slowdowns in the semiconductor industry or in other
industries that manufacture products utilizing semiconductors could materially
adversely affect the Company's business, financial condition or results of
operations. The Company's ability to maintain or increase its sales levels in
the future will depend in significant part upon its ability to obtain orders
from existing and new customers and to manufacture systems on a timely and cost-
effective basis, the financial condition and success of its customers, general
economic conditions, and the Company's ability to meet increasingly stringent
customer performance and other requirements and shipment delivery dates. There
can be no assurance that the Company will be able to maintain or increase the
level of its net sales in the future or that the Company will be able to retain
existing customers or attract new ones.

     Sales of the Company's systems depend in significant part upon the decision
of a semiconductor manufacturer to develop and manufacture new semiconductor
devices or to increase manufacturing capacity. As a result, sales of the
Company's testers are subject to a variety of factors outside of the Company's
control. In addition, the decision to purchase a tester generally involves a
significant commitment of capital, with the attendant delays frequently
associated with significant capital expenditures. For these and other reasons,
the Company's systems have lengthy sales cycles during which the Company may
expend substantial funds and management effort to secure a sale and subject the
Company to a number of significant risks.

ACQUISITIONS

     The Company has developed in significant part through mergers and
acquisitions of other companies and businesses. Prior to its initial public
offering in 1993, the Company acquired two companies and the semiconductor test
division of Tektronix, Inc. In 1995, the Company acquired EPRO, a memory tester
company. In July 1997, the Company acquired the assets and assumed certain
liabilities of TSSI and, in August 1997, acquired the fault simulation and test
program development products from Zycad. The Company intends in the future to
pursue additional acquisitions of complementary product lines, technologies and
businesses. Any future acquisitions by the Company could result in potentially
dilutive issuances of equity securities, the incurrence of debt and contingent
liabilities, expenditures and reserves, and amortization expenses related to
goodwill and other intangible assets (which may exceed the benefits actually
derived from the acquisitions), which could materially adversely affect the
Company's business, financial condition or results of operations. The Company's
charge for in-process research and development for the TSSI asset acquisition
accounted for the Company's net loss for the third quarter of 1997. In addition,
acquisitions involve numerous other risks, including difficulties in the
assimilation of the operations, personnel, technologies and products of the
acquired companies, the diversion of management's attention from other business
concerns, risks of entering markets in which the Company has no or limited
direct prior experience, and the potential loss of key employees of the acquired
company. From time to time, the Company has engaged in and will continue to
engage in discussions with third parties concerning potential acquisitions of
product lines, technologies and businesses. In the event that such an
acquisition does occur, however, there can be no assurance as to the effect
thereof on the Company's business, financial condition or results of operations.

                                       15
<PAGE>
 
DEPENDENCE ON KEY PERSONNEL

     The Company's future operating results depend in significant part upon the
continued service of its key personnel, none of whom are bound by an employment
or non-competition agreement. The Company's future operating results also depend
in significant part upon its ability to attract and retain qualified management,
manufacturing, technical, engineering and marketing and sales and support
personnel. Competition for such personnel is intense, and there can be no
assurance that the Company will be successful in attracting or retaining such
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 the
Company to hire such personnel over time. The loss of any key employee, the
failure of any key employee to perform in his or her current position, or the
Company's inability to attract and retain skilled employees, as needed, could
materially adversely affect the Company's business, financial condition or
results of operations.

INTERNATIONAL SALES

     International sales accounted for approximately 67%, 70%, 67% and 55% of
total net sales for the first quarter of fiscal 1998 and fiscal years 1997, 1996
and 1995, respectively. As a result, the Company anticipates that international
sales will continue to account for a significant portion of 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 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. The Company is also subject to the
risks associated with the imposition of legislation and regulations relating to
the import or export of semiconductor equipment. The Company cannot predict
whether quotas, duties, taxes or other charges or restrictions will be
implemented by the United States or any other country upon the importation or
exportation of the Company's products in the future. Any of these factors or the
adoption of restrictive policies could have a material adverse effect on the
Company's business, financial condition or results of operations. Company net
sales to the Asia Pacific region accounted for approximately 62%, 66%, 58%, and
45% of total net sales in the first quarter of fiscal 1998 and fiscal years
1997, 1996, and 1995, and thus are subject to the risk of economic instability
in that region that might materially adversely affect the demand for the
Company's products. Countries in the Asia Pacific region, including Japan, have
recently experienced weaknesses in their currency, banking and equity markets.
These weaknesses could adversely affect demand for the Company's products, the
availability and supply of product components to the Company, and ultimately the
Company's consolidated results of operations. Although the current economic
instability in the Asia Pacific region has not materially adversely affected the
Company's order backlog, balance sheet, or results of operations, there can be
no assurance that it will not in the future.

IMPORTANCE OF JAPANESE MARKET

     To date, the Company has made limited sales of its systems to Japanese
semiconductor manufacturers. The Japanese semiconductor market is large,
represents a substantial percentage of the worldwide semiconductor manufacturing
capacity, and is difficult for foreign companies to penetrate. The Company may
be at a competitive disadvantage with respect to Japanese semiconductor capital
equipment suppliers that have been engaged for some time in collaborative
efforts with Japanese semiconductor manufacturers. The Company believes that the
Japanese companies with which it competes have a competitive advantage because
of their dominance of the Japanese market segment. The Company believes that
increased penetration of the Japanese market is important to its financial
results and intends to continue to invest significant resources in Japan in
order to meet this objective. As part of its strategy to penetrate the Japanese
market, the Company entered into a joint venture agreement with Innotech
Corporation, a local distributor of products, and set up a local subsidiary in
Japan. The Company believes that Innotech is an important element of its
strategy to increase its presence in Japan. If Innotech is not successful in
selling such systems or such agreement is terminated, the Company's strategy to
increase product sales into the Japanese market would be adversely affected. In
addition, in recent years, Japanese semiconductor manufacturers substantially
reduced their level of capital spending on new fabrication facilities and
equipment, thereby increasing competitive pressures in the Japanese market
segment. There can be no assurance, however, that the Company will be able to
achieve significant sales to, or will be able to compete successfully in, the
Japanese semiconductor market segment.

                                       16
<PAGE>
 
PROPRIETARY RIGHTS

     The Company attempts to protect its intellectual property rights through
patents, copyrights, trademarks, trade secrets and other measures, including
confidentiality agreements. There can be no assurance that others will not
independently develop substantially equivalent proprietary information and
techniques or otherwise gain access to the Company's trade secrets and other
intellectual property rights or disclose such technology or that the Company can
meaningfully protect its trade secrets or other intellectual property rights.
There can be no assurance that patents owned by the Company will not be
invalidated, deemed unenforceable, circumvented or challenged, or that the
rights granted thereunder will provide competitive advantages to the Company or
that any of the Company's pending or future patent applications will be issued
with claims of the scope sought by the Company, if at all. Furthermore, there
can be no assurance that others will not develop similar products, duplicate the
Company's products or design around the patents owned by the Company. In
addition, there can be no assurance that foreign intellectual property laws or
the Company's agreements will protect the Company's intellectual property
rights. Failure to protect the Company's intellectual property rights could have
a material adverse effect upon the Company's business, financial condition or
results of operations. The Company has been involved in extensive, expensive and
time-consuming reviews of, and litigation concerning, patent infringement
claims. In addition, the Company has at times been notified of other claims that
it may be infringing intellectual property rights possessed by third parties and
expects to continue to receive notice of such claims in the future.

     The European patent application relating to one of the proprietary CMOS
stabilization methods owned by the Company was abandoned by the prior owner
after the European patent examiner cited prior art. This prior art was not
referenced in the corresponding United States patent application. Based upon its
review to date of the cited prior art and the European examiner's objections,
and in part upon the advice of  outside patent counsel to the Company, the
Company believes that such prior art is unlikely to affect the validity or scope
of the claims of the United States issued patent.

     This prior art may, however, render invalid or significantly narrow the
scope of certain claims set forth in the United States patent covering another
of the Company's  proprietary CMOS stabilization methods. The European examiner
referred to this prior art in the corresponding European patent application. The
European application was approved, but with narrower claims than the United
States patent. This prior art was not referenced in the corresponding United
States patent. Based in part upon the advice of outside patent counsel, and on
the Company's review of its current products, the Company believes that this
patent will continue to be valuable to the Company in preventing imitation of
the Company's products covered by this patent. Additionally, in mid-1992, a
third party suggested that certain claims set forth in this patent might be
invalid as a result of other alleged prior art. The Company believes, based in
part upon the advice of outside patent counsel, that the prior art alleged by
the third party is less relevant than the prior art referenced by the European
examiner. However, there can be no assurance that any of the aforementioned
prior art or other prior art will not be successfully asserted and used to
invalidate or narrow the scope of any claim of the United States patents or any
other patents or other patent applications of the Company.

     On November 13, 1997, the Company requested the United States Patent and
Trademark Office to re-examine the subject United States patent in light of the
two prior art references.  On January 7, 1998,  the United States Patent and
Trademark Office responded by granting the Company's request for re-examination.
The case is presently pending in the United States Patent and Trademark Office.

     Certain of the Company's customers have received notices of infringement
from Jerome Lemelson alleging that the manufacture of semiconductor products
and/or the equipment used to manufacture semiconductor products infringes
certain patents issued to such person. The Company was notified by a customer in
1990 and a different customer in late 1994 that the Company may be obligated to
defend or settle claims that the Company's products infringe such person's
patents, and, in the event it is subsequently determined that the customer
infringes such person's patents, such customer intends to seek reimbursement
from the Company for damages and other related expenses. There can be no
assurance that the Company will be successful in defending current or future
patent infringement claims or claims for indemnification resulting from
infringement claims. An award of damages, 

                                       17
<PAGE>
 
injunctive relief or expenditures by the Company of significant amounts in
defending any such action could materially adversely affect the Company's
business, financial condition or results of operations, regardless of the
outcome of any litigation. With respect to any claims, the Company may seek to
obtain a license under the third party's intellectual property rights. There can
be no assurance, however, that a license will be available on reasonable terms
or at all. The Company could decide, in the alternative, to continue to resort
to litigation to challenge such claims. Such challenges have been and could
continue to be extremely expensive and time consuming, and could materially
adversely affect the Company's business, financial condition or results of
operations, regardless of the outcome of any litigation.


FUTURE CAPITAL NEEDS


     The development and manufacture of new ATE systems and enhancements are
highly capital intensive. In order to be competitive, the Company must make
significant investments in capital equipment, expansion of operations, systems,
procedures and controls, research and development and worldwide training,
customer service and support, among many other items. The Company expects that
cash on hand and cash equivalents, including restricted cash, short-term
investments, funds available under its bank line of credit, anticipated cash
flow from operations and equipment lease arrangements will satisfy its financing
requirements for at least the next 12 months.


YEAR 2000 COMPLIANCE


     Many currently installed computer systems and software products are coded
to accept only two-digit entries in the date code field. Beginning in the year
2000, these date code fields will need to accept four-digit entries to
distinguish 21/st/ century dates from 20/th/ century dates. As a result,
computer systems and/or software used by many companies will need to be upgraded
to comply with such "Year 2000" requirements. Significant uncertainty exists
concerning the potential effects associated with such compliance. The Company is
currently in the process of assessing and testing the software components of its
products for year 2000 compliance. The Company does not believe that its
products contain undetected errors or defects associated with year 2000 date
functions that may result in material costs to the Company, including repair
costs and costs incurred in litigation due to any such defects, however there
can be no assurance that such errors or defects do not exist. Many commentators
have stated that a significant amount of litigation will arise out of year 2000
compliance issues. Because of the unprecedented nature of such litigation, there
can be no assurance that the Company will not be materially adversely affected
by claims related to year 2000 compliance.

     Although the Company is not aware of any material operational issues or
costs associated with preparing its internal systems for the year 2000, there
can be no assurance that the Company will not experience serious unanticipated
negative consequences and/or material costs caused by undetected errors or
defects in the technology used in its internal operating systems, which are
composed predominately of third party software and hardware technology.


VOLATILITY OF STOCK PRICE


     The Company believes that factors such as announcements of developments
related to the Company's business, fluctuations in the Company's financial
results, general conditions or developments in the semiconductor and capital
equipment industry and the general economy, sales of the Company's Common Stock
into the marketplace, announcements of technological innovations or new products
or enhancements by the Company or its competitors, developments in patents or
other intellectual property rights, developments in the Company's relationships
with its customers and suppliers, or 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, could cause the price of the
Company's Common Stock to fluctuate, perhaps substantially. In recent years the
stock market in general, and the market for shares of small capitalization
stocks in particular, including the Company, have experienced extreme price
fluctuations, which have often been unrelated to the operating performance of
affected companies. For example, in fiscal 1997, the price of the Company's
Common Stock has ranged from a high of $55.00 to a low of $13.75. There can be
no assurance that the market price of the Company's Common Stock will not
continue to experience significant fluctuations in the future, including
fluctuations that are unrelated to the Company's performance.

                                       18
<PAGE>
 
LEVERAGE


     In connection with the sale in September 1997 of Convertible Subordinated
Notes due 2002, the Company incurred $115 million of indebtedness which resulted
in a ratio of long-term debt to total capitalization at October 31, 1997 of
approximately 36%. As a result of this indebtedness, the Company's principal and
interest obligations has increased substantially. The degree to which the
Company is leveraged could materially adversely affect the Company's ability to
obtain financing for working capital, acquisitions or other purposes and could
make it more vulnerable to industry downturns and competitive pressures. The
Company's ability to meet its debt service obligations will be dependent upon
the Company's future performance, which will be subject to financial, business
and other factors affecting the operations of the Company, many of which are
beyond its control.


EFFECTS OF CERTAIN ANTI-TAKEOVER PROVISIONS


     Certain provisions of the Company's Certificate of Incorporation, equity
incentive plans, Bylaws and Delaware law may discourage certain transactions
involving a change in control of the Company. In addition to the foregoing, the
Company's classified board of directors, the shareholdings of the Company's
officers, directors and persons or entities that may be deemed affiliates and
the ability of the Board of Directors to issue "blank check" preferred stock
without further stockholder approval could have the effect of delaying,
deferring or preventing a change in control of the Company and may adversely
affect the voting and other rights of holders of Common Stock.

                                       19
<PAGE>
 
PART II.  - OTHER INFORMATION


ITEM 1. LEGAL PROCEEDINGS


     None


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)  See Exhibit Index on page 22.


     (b)  A report on Form 8-K was filed on December 4, 1997, reporting various
          matters in response to Item 5 of Form 8-K.

                                       20
<PAGE>
 
                                   SIGNATURES


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


 

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


          March 17, 1998                          /s/ JERRY BRUCE
     --------------------------          -------------------------------------
             Date                                     Jerry Bruce
                                      Vice President, Controller, Acting Chief
                                         Financial Officer and Secretary

                                       21
<PAGE>
 
EXHIBIT INDEX


<TABLE>
<CAPTION>
EXHIBIT
NUMBER                                                                                       
------                                                                                       
<S>          <C>                                                                             
10.25        Lease Agreement between the Company and  Bedford Property Investors, Inc.       
             dated December 10, 1997                                                         

27.1         EDGAR Financial Data Schedule
</TABLE> 
 
 
 
 
 

                                       22