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SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, D.C. 20549





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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 April 30, 2002





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





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CREDENCE SYSTEMS CORPORATION


(Exact name of registrant as specified in its charter)





Delaware

94-2878499(State or other jurisdiction of
incorporation or organization)

(IRS Employer 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.





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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 June 3, 2002, there were approximately 60,633,965 shares of the Registrants common stock, $0.001 par value per share, outstanding.





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CREDENCE SYSTEMS CORPORATION





INDEX





Page No.PART I.

FINANCIAL INFORMATIONItem 1.

Financial Statements

3Condensed Consolidated Balance Sheets

3Condensed Consolidated Statements of Operations

4Condensed Consolidated Statements of Cash Flows

5Notes to Condensed Consolidated Financial Statements

6Item 2.

Managements Discussion and Analysis of Financial Condition and Results of Operations

11Item 3.

Quantitative and Qualitative Disclosures about Market Risk

28PART II.

OTHER INFORMATIONItem 1.

Legal Proceedings

29Item 2.

Changes in Securities

29Item 3.

Defaults Upon Senior Securities

29Item 4.

Submission of Matters to a Vote of Security holders

29Item 5.

Other Information

30Item 6.

Exhibits and Reports on Form 8-K

30






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PART IFINANCIAL INFORMATION





Item I
Financial Statements





CREDENCE SYSTEMS CORPORATION





CONDENSED CONSOLIDATED BALANCE SHEETS


(in thousands)





April 30, 2002

October 31, 2001a(unaudited)ASSETSCurrent assets:Cash and cash equivalents

$
86,342

$
44,309Short-term investments


107,193


96,497Accounts receivable, net


32,945


39,831Inventories


126,898


123,219Income tax receivable


8,798


41,031Deferred income taxes and other current assets


48,432


49,457Total current assets


410,608


394,344Long-term investments


114,568


161,889Property and equipment, net


99,480


109,528Goodwill from acquisitions, net


42,478


47,124Other intangible assets, net


29,952


34,450Other assets


13,593


10,084Total assets

$
710,679

$
757,419LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
18,319

$
17,510Accrued expenses and other liabilities


38,628


41,181Deferred profit


2,867


11,707Total current liabilities


59,814


70,398Other liabilities


4,007


5,761Minority interest


79


320Stockholders equity


646,779


680,940Total liabilities and stockholders equity

$
710,679

$
757,419


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|a) |  | Derived from the audited consolidated balance sheet included in our Form 10-K for the year ended October 31, 2001.
|-- |  | ------------------------------------------------------------------------------------------------------------------




See accompanying notes.




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CREDENCE SYSTEMS CORPORATION





CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS


(in thousands, except per share amounts)


(unaudited)





Three Months Ended April
30,


Six Months Ended April
30,2002


2001


2002


2001Net sales

$
38,675


$
75,639


$
73,302


$
211,950Cost of goods soldon net sales


23,795



34,078



45,261



93,272Cost of goods soldspecial charges






45,020







45,020Gross margin


14,880



(3,459
)


28,041



73,658Operating expenses:Research and development


20,038



21,104



40,530



43,618Selling, general and administrative


22,448



28,089



44,097



60,648Amortization of purchased intangibles


5,146



6,114



10,292



11,293Special charges






3,343







3,343Total operating expenses


47,632



58,650



94,919



118,902Operating income (loss)


(32,752
)


(62,109
)


(66,878
)


(45,244
)Interest and other income, net


2,361



5,152



5,732



9,724Income (loss) before income tax provision


(30,391
)


(56,957
)


(61,146
)


(35,520
)Income tax (benefit)


(10,638
)


(20,437
)


(21,402
)


(12,461
)Minority interest (benefit)


(332
)


(26
)


(222
)


(160
)Net income (loss)

$
(19,421
)

$
(36,494
)

$
(39,522
)

$
(22,899
)Net income (loss) per shareBasic

$
(0.32
)

$
(0.61
)

$
(0.65
)

$
(0.38
)Diluted

$
(0.32
)

$
(0.61
)

$
(0.65
)

$
(0.38
)Number of shares used in computing per share amountBasic


60,528



59,608



60,378



59,979Diluted


60,528



59,608



60,378



59,979








See accompanying notes.




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CREDENCE SYSTEMS CORPORATION





CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


Increase (decrease) in cash and cash equivalents


(in thousands)


(unaudited)





Six Months Ended April
30,2002


2001Cash flows from operating activities:Net income (loss)

$
(39,522
)

$
(22,899
)Adjustments to reconcile net income to net cash used in operating activity activities:Depreciation and amortization


25,262



29,600(Gain) loss on disposal of property and equipment


2,292



475Non cash special charges






45,670Minority interest


(243
)


(158
)Changes in operating assets and liabilities:Accounts receivable, inventories and other current assets


34,698



50,825Accounts payable, accrued liabilities and income taxes payable


(10,126
)


(87,290
)Net cash provided by operating activities


12,361



16,223Cash flows from investing activities:Purchases of available-for-sale securities


(51,205
)


(171,279
)Maturities of available-for-sale short-term securities


10,163



11,137Sales of available-for-sale securities


75,768



128,963Acquisition of property and equipment


(6,705
)


(30,444
)Acquisition of other assets


(3,206
)


(21,986
)Proceeds from the sale of assets






80Net cash provided by (used in) investing activities


24,815



(83,529
)Cash flows from financing activities:Issuance of common & treasury stock


4,851



3,632Repurchase of common stock






(5,808
)Other


6



550Net cash provided by (used in) financing activities


4,857



(1,626
)Net increase (decrease) in cash and cash equivalents


42,033



(68,932
)Cash and cash equivalents at beginning of period


44,309



137,401Cash and cash equivalents at end of period

$
86,342


$
68,469Supplemental disclosures of cash flow information:Income taxes paid (received)

$
(52,938
)

$
21,581Non cash investing activities:Net transfers of inventory to property and equipment


326



2,409Non cash financing activities:Income tax benefit from stock option exercises


769



1,236





See accompanying notes.




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CREDENCE SYSTEMS CORPORATION





NOTES TO CONDENSED CONSOLIDATED FINANICIAL STATEMENTS







1.    Quarterly Financial Statements





The condensed consolidated financial statements and related notes for the six months ended April 30, 2002 and 2001 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 Credence Systems Corporation (Credence or
the Company) for the interim periods. The results of operations for the six months ended April 30, 2002 and 2001 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, 2001 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 importance of timely product introduction, 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, 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 receiving 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.





In August 2001, the Company completed a merger with Integrated Measurement
Systems, Inc. (IMS). IMS designs, manufactures, markets and services integrated circuit validation systems and virtual test software. This acquisition was accounted for as a pooling of interests in accordance with Accounting Principles
Board 16 (APB 16) and therefore, the consolidated financial statements, including the related notes, have been restated as of the earliest period presented to include the results of operations, financial position and cash flows of IMS.





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.





2.    Revenue Recognition





The Company
recognizes revenue on the sale of semiconductor manufacturing equipment when title and risk of loss has passed to the customer, there is persuasive evidence of an arrangement, delivery has occurred or services have been rendered, the sales price is
fixed or determinable, collectibility is reasonably assured and customer acceptance criteria have been successfully demonstrated. Product revenue is recognized upon shipment when the product is classified as mature and the customer acceptance
criteria can be demonstrated prior to shipment. Revenue related to the fair value of the installation obligation is recognized upon completion of the installation. Products are classified as mature after several different customers have accepted
similar systems. For sales of new products or when the customer acceptance criteria cannot be demonstrated prior to shipment, revenue and the related cost of goods sold are deferred until customer acceptance. Revenue related to maintenance and
service contracts is recognized ratably over the duration of the contracts.





Deferred revenue on the balance sheet
includes deferred revenue related to maintenance contracts (and other undelivered services) and deferred profit related to equipment that was shipped to certain customers, but the revenue and cost of goods sold were not recognized because either the
customer specified acceptance criteria has not been met as of the fiscal period end or the product is not classified as mature as of the fiscal period end and has not been accepted by the customer.





3.    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):




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CREDENCE SYSTEMS CORPORATION





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







April 30, 2002

October 31, 2001(unaudited)Raw materials

$
66,142

$
65,553Work-in-process


24,942


21,905Finished goods


35,814


35,761$
126,898

$
123,219





4.    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. The Company excluded options to purchase 2,037,745 shares of common stock from the diluted
income (loss) per share calculation for the fiscal quarter ended April 30, 2002 because options are anti-dilutive in periods when the Company incurs a net loss. The following table sets forth the computation of basic and diluted net income (loss)
per share (in thousands, except per share amounts):





Three Months Ended April
30,


Six Months Ended April
302002


2001


2002


2001Numerator:Numerator for basic and diluted net income per share-net income (loss)

$
(19,421
)

$
(36,494
)

$
(39,522
)

$
(22,899
)Denominator:Denominator for basic net income per share-weighted-average shares


60,528



59,608



60,378



59,979Effect of dilutive securities-employee stock optionsDenominator for diluted earnings per share-adjusted weighted-average shares and assumed conversions


60,528



59,608



60,378



59,979Basic net income (loss) per share


(0.32
)

$
(0.61
)

$
(0.65
)

$
(0.38
)Diluted net income (loss) per share

$
(0.32
)

$
(0.61
)

$
(0.65
)

$
(0.38
)





5.    Recent Accounting Pronouncements





In July 2001, the Financial Accounting Standards Board (FASB) issued Statements of Financial Accounting Standards No. 141
(SFAS 141), Business Combinations. SFAS 141 eliminates the pooling-of-interests method of accounting for business combinations except for qualifying business combinations that were initiated prior to July 1, 2001. In
addition, SFAS 141 further clarifies the criteria to recognize intangible assets separately from goodwill. Specifically, SFAS 141 requires that an intangible asset may be separately recognized only if such an asset meets the contractual-legal
criterion or the separability criterion. The requirements of Statement 141 are effective for any business combination accounted for by the purchase method that is completed after June 30, 2001 (i.e., the acquisition date is July 1, 2001 or after).
The Company is currently evaluating the impact of SFAS 141 and has not yet determined the impact that adopting SFAS 141 will have on its financial statements. On adoption, the Company will be required to reassess the goodwill and intangible assets
previously recorded in acquisitions prior to July 1, 2001 to determine if the new recognition criteria for an intangible asset to be recognized apart from goodwill are met.





In July 2001, the FASB issued Statements of Financial Accounting Standards No. 142 (SFAS 142), Goodwill and Other Intangible
Assets. Under SFAS 142, goodwill and indefinite lived intangible assets are no longer amortized but are reviewed annually (or more frequently if impairment indicators arise) for impairment. For intangible assets with indefinite useful lives,
the impairment review will involve a comparison of fair value to carrying value, with any excess of carrying value over fair value being recorded as an impairment loss. For goodwill, the impairment test shall be a two-step process, consisting of a
comparison of the fair value of a reporting unit with its carrying amount, including the goodwill allocated to each reporting unit. If the carrying amount is in excess of the




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CREDENCE SYSTEMS CORPORATION





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







fair value, the implied fair value of the reporting unit goodwill is compared to the
carrying amount of the reporting unit goodwill. Any excess of the carrying value of the reporting unit goodwill over the implied fair value of the reporting unit goodwill will be recorded as an impairment loss. Separable intangible assets that are
deemed to have a finite life will continue to be amortized over their useful lives (but with no maximum life). Intangible assets with finite useful lives will continue to be reviewed for impairment in accordance with Statements of Financial
Accounting Standards No. 121 (SFAS 121), Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. The amortization provisions of SFAS 142 apply to goodwill and intangible assets acquired
after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2001, the Company will apply the new accounting rules beginning November 1, 2002 and will reassess the useful lives of its separately recognized intangible
assets in the first quarter of fiscal 2003. The Company will review for impairment previously recognized intangible assets that are deemed to have indefinite lives upon the completion of this analysis in the first quarter of fiscal 2003.
Additionally, upon the adoption of SFAS 142, the Company will perform a transitional impairment review related to the carrying value of goodwill as of November 1, 2002 by the end of the second quarter of fiscal 2003. Because of the different
transition dates for goodwill and intangible assets acquired on or before June 30, 2001 and those acquired after that date, pre-existing goodwill and intangibles will be amortized during this transition period until adoption whereas new goodwill and
indefinite lived intangible assets acquired after June 30, 2001 will not. The Company is currently in the process of determining its reporting units for the purpose of applying the impairment test, analyzing how fair value will be determined for
purposes of applying SFAS 142 and quantifying the anticipated impact of adopting the provisions of SFAS 142.





In
August, 2001, the FASB issued Statements of Financial Accounting Standards ( SFAS 144), Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS 144 supercedes SFAS 121, Accounting for the Impairment of
Long-Lived Assets and Long-Lived Assets to be Disposed Of and the accounting and reporting provisions of Accounting Principles Board Opinion No. 30, Reporting the Results of OperationsReporting the Effects of Disposal of a Segment
of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business. SFAS 144 establishes a single accounting model for assets to be disposed of by sale whether previously
held and used or newly acquired. SFAS No. 144 retains the provisions of APB No. 30 for presentation of discontinued operations in the income statement, but broadens the presentation to include a component of an entity. SFAS 144 is effective for
fiscal years beginning after December 15, 2001 and the interim periods within. The Company is currently in the process of determining the anticipated impact of adopting the provisions of SFAS 144.





6.    Commitments and Contingencies





The Company has an agreement with a captive leasing company whereby the Company issued a guaranty in favor of a bank with respect to certain obligations of the leasing company to the bank. Under this
agreement, the leasing company agreed to grant the Company a security interest to secure the obligations of the leasing company as a result of any payments by the Company pursuant to the guaranty. At April 30, 2002, the maximum allowable debt of the
leasing company subject to this guaranty of $8.8 million was outstanding.





In July 1998, the Company received a
written allegation from inTEST IP Corp., with its patent licensee inTEST Corporation, inTEST that Credence was infringing on a patent held by inTEST. The Company has 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, alleging infringement of inTEST U.S. patent number 4,589,815 and seeking damages and injunctive relief. In April 2001 the Company was served with
the complaint and since that date discovery has commenced. In March 2002, the court set the trial for this action for May 19, 2003. In addition to direct costs and diversion of resources that may result, the Company may be obligated to indemnify
third parties for costs related to this allegation





In April 2002, Reptron Electronics, Inc. a supplier of certain
electronic components to the Company, filed a complaint in the U.S. District Court for the District of Oregon, alleging that the Company had breached a contract to purchase certain components ordered by Reptron during 2000. The complaint seeks
damages of approximately $3.9 million.





The Company is involved in other 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 its business, financial condition or results of operations.




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CREDENCE SYSTEMS CORPORATION





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







7.    Accumulated Other Comprehensive Income (Loss)





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





Six Months Ended April 30, 2002


Fiscal Year Ended October 31, 2001Beginning balance, net of tax

$
4,854


$
2,097Unrealized gain (loss) on available-for-salesecurities, net of tax


(1,306
)


373Currency translation adjustment, net of tax


(592
)


2,384Ending balance, net of tax

$
2,956


$
4,854





8.    Acquisitions





In August 2001, the Company completed a merger with IMS, issuing approximately 7.2 million shares of common stock in exchange for all of
the outstanding common stock of IMS. In addition, outstanding options to purchase IMS common stock were converted into options to purchase approximately 2.1 million shares of Credence common stock. This transaction was accounted for as a pooling of
interests and, therefore, all prior period consolidated financial statements presented, and the consolidated financial statements as of October 31, 2001 and for the year then ended, were restated as if the merger took place at the beginning of such
periods.





In January 2001 and February 2001, Credence acquired Dimensions Consulting, Inc. (DCI), and
the principal assets of Rich Rabkin & Associates, Inc. (Rabkin), respectively. DCI specializes in providing interface solutions for the semiconductor test and development market through ATE board design and test socket systems.
Rabkin specializes in providing interface solutions and test head positioning devices for the semiconductor test market through its patented solution for high parallel memory testing. DCI and Rabkin were integrated into the Memory Products Division
to offer test solutions, which we believe increase manufacturing efficiencies and provide faster time to market for our customers. These transactions were accounted for as purchases and accordingly, the accompanying financial statements include the
results of operations of DCI and Rabkin subsequent to the acquisition date. The total purchase price of $13.5 million consisted of $13.3 million paid in cash at the closing and the cancellation of $0.2 million in existing receivables. Credence also
created a $1.5 million deferred tax liability through the accounting for the acquisition. Additionally, the Company agreed to make payments to the employees of DCI and Rabkin based on the attainment of performance criteria for their business and the
business of the Memory Products Division for a period of two years following the acquisition. These payments have been recorded as compensation expense as they have been incurred. The net tangible assets purchased were approximately $0.8 million.





The total purchase cost of the DCI and Rabkin acquisitions were as follows (in thousands):





Cash paid

$
13,286Deferred tax liability


1,491Cancelled receivable


214Total purchase cost

$
14,991





The purchase price allocation is as follows (in thousands):





Amount

Annual Amortization

Useful LivesPurchase Price Allocation:Tangible net assets

$
806

$


Intangible assets acquired:Assembled workforce


545


182

3Developed technology


2,236


559

4Customer lists


3,347


669

5Goodwill


8,057


1,612

5Total purchase price allocation

$
14,991

$
3,022





A valuation of the purchased assets was undertaken to assist the
Company in determining the fair value of each identifiable intangible asset and in allocating the purchase price among the acquired assets. The intangible assets, consisting primarily of developed technology, assembled workforce, customer lists and
goodwill, were




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CREDENCE SYSTEMS CORPORATION





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







assigned a value of $14.2 million and are being amortized over their estimated useful lives,
ranging from three to five years.





9.    Special Charges





For the six-month period ended April 30, 2001 the Company recorded a special charge for costs of goods sold of approximately $45 million related to the write down of
excess inventories. In addition, the Company recorded a special operating charge for the same period of approximately $3.3 million for severance payments and asset disposals.





10.     Subsequent Events





On March 25,
2002, the Company entered into a Real Estate Purchase and Sale Agreement, which Agreement was amended on May 8, 2002, to acquire two office and manufacturing buildings in Milpitas, California, for approximately $21.8 million. The Company anticipates
that this transaction will close during August 2002. The Company intends to relocate it corporate headquarters to this facility in 2003.




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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 the 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 for the first six months of fiscal 2002 remains significantly lower compared to the same period in fiscal 2001. The test and assembly sector of the semiconductor equipment industry continues to
be impacted by what we believe is a severe 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 period of sustainable growth, we anticipate a
continuing low order rate and expect only modest sales growth in the third fiscal quarter of 2002 ending July 31, 2002. We maintain a cautious outlook for future orders and expect sales levels to remain relatively depressed for the balance of fiscal
2002, compared to fiscal 2001.





Our sales, gross margins and operating results have in the past fluctuated
significantly and will, in the future, fluctuate significantly depending upon a variety of factors. The factors that have caused and will continue to cause our results to fluctuate include cyclicality or downturns in the semiconductor market and the
markets served by our customers, the timing of new product announcements and releases by us or our competitors, market acceptance of new products and enhanced versions of our products, manufacturing inefficiencies associated with the start up of new
products, changes in pricing by us, our competitors, customers or suppliers, the ability to volume produce systems and meet customer requirements, excess and obsolete inventory, patterns of capital spending by customers, delays, cancellations or
rescheduling of orders due to customer financial difficulties or otherwise, expenses associated with acquisitions and alliances, product discounts, 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, natural disasters, political and economic instability, regulatory changes and outbreaks of hostilities. Due to these and
additional factors, historical results and percentage relationships discussed in this Report on Form 10-Q will not necessarily be indicative of the results of operations for any future period. For a further discussion of our business, and risk
factors affecting our results of operations, please refer to the section entitled Risk Factors included elsewhere herein.





CRITICAL ACCOUNTING POLICIES AND ESTIMATES





Our discussion and analysis of our financial
condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements
requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those
related to bad debts, inventories, investments, intangible assets, income taxes, warranty obligations, restructuring, and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed
to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates
under different assumptions or conditions.





We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated financial statements.





Revenue Recognition





We historically recognized revenue on the sale of semiconductor manufacturing equipment upon shipment.
Effective November 1, 1999 we changed our revenue recognition policy based on guidance provided in SEC Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements (SAB 101).





Under SAB 101, we recognize revenue on the sale of semiconductor manufacturing equipment when title and risk of loss have passed to the
customer, there is persuasive evidence of an arrangement, delivery has occurred or services have been rendered, the sales price is fixed or determinable, collectibility is reasonably assured and customer acceptance criteria have been successfully
demonstrated. Product revenue is recognized upon shipment when the product is classified as mature and the customer acceptance criteria can be demonstrated prior to shipment.




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Revenue related to the fair value of the installation obligation is recognized
upon completion of the installation. Products are classified as mature after several different customers have accepted similar systems. For sales of new products or when the customer acceptance criteria cannot be demonstrated prior to shipment,
revenue and the related cost of goods sold are deferred until customer acceptance.





Under the SAB 101 revenue
recognition policy, we defer revenue for transactions that involve newly introduced products or when customers specify acceptance criteria that cannot be demonstrated prior to the shipment. We currently anticipate introducing several new systems in
fiscal 2002. In the past, we experienced significant delays in the introduction of new testers as well as certain enhancements to our existing testers. As a result, some customers have experienced significant delays in receiving and accepting our
testers in production. Delays in introducing a product or delays in our ability to obtain customer acceptance, if they occur in the future, will delay the recognition of revenue and gross profit by us.





Inventory Valuation





Due to the dramatic decline in the semiconductor business cycle and impact on revenue since early in fiscal 2001, and continued uncertainty over the next cycle of the semiconductor equipment industry, we continue to monitor our
inventory levels in light of product development changes and expectations of an eventual market upturn. We recorded a charge of $45.0 million in the second fiscal quarter of 2001 and a charge of $38.0 million in the fourth fiscal quarter of 2001 for
the write-down of excess inventories. We may be required to take additional charges for excess and obsolete inventory if the industry downturn causes further reductions to our current inventory valuations or changes our current product development
plans. We evaluate our inventory levels and valuations based on our estimates and forecasts of the next cyclical industry upturn. These forecasts require us to estimate our ability to sell current and future products in the next industry upturn and
compare those estimates with our current inventory levels. If these forecasts or estimates change, or our product roadmaps change, then we would need to adjust our assessment of the inventory valuations. Once inventories are written down, we carry
that inventory at its reduced value until it is sold or otherwise disposed of. At April 30 2002, approximately 37% and 20% of the inventory balances are for the Quartet and Octet mixed signal and Kalos memory product families, respectively.





Allowance for Doubtful Accounts





During industry downturns, certain of our customers have difficulty with their cash flows. For certain customers, typically those with whom we have long-term relationships, we have granted and may
continue to grant extended payment terms. We review, with assistance from our sales distribution partners, the ability of our customers to pay the indebtedness they incur with us. Certain of our receivables have due dates in excess of 90 days and we
have a history of successfully collecting these extended payment term receivables. We provide an allowance for doubtful accounts for all specific receivables that we judge to be unlikely for collection. In addition, we record a reserve based on the
age of receivable balances. These estimated allowances are periodically reviewed, analyzing the customers payment history and information regarding customers credit worthiness known to us.





Deferred Taxes





Realization of the net deferred tax assets is dependent on our ability to generate approximately $93 million of future taxable income. Management believes that it is more likely than not that the assets will be realized, based on
forecasted income. However, there can be no assurance that we will meet our expectations of future income. Management will evaluate the realizability of the deferred tax assets on a quarterly basis and assess the need for additional valuation
allowances.




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RESULTS OF OPERATIONS





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





Three Months Ended April
30,


Six Months Ended April 30,2002


2001


2002


2001Net sales

100.0
%

100.0
%

100.0
%

100.0
%Cost of goods soldon net sales

61.5


45.1


61.7


44.0Cost of goods soldspecial charges




59.5





21.2Gross margin

38.5


(4.6
)

38.3


34.8Operating expensesResearch and development

51.8


27.9


55.3


20.6Selling, general and administrative

58.0


37.1


60.2


28.6Amortization of purchased intangible assets

13.3


8.1


14.0


5.3Special charges




4.4





1.6Operating expenses

123.2


77.5


129.5


56.1Operating income (loss)

(84.7
)

(82.1
)

(91.2
)

(21.3
)Interest and other income

6.1


6.8


7.8


4.6Income (loss) before income tax provision (benefit)

(78.6
)

(75.3
)

(83.4
)

(16.8
)Income tax provision (benefit)

(27.5
)

(27.0
)

(29.2
)

(5.9
)Net income (loss)

(50.2
)

(48.2
)

(53.9
)

(10.8
)





Net Sales





Net sales consist of revenues from systems sales, spare parts sales, maintenance contracts and software sales. Net sales were $38.7 million for the second quarter of fiscal
2002, representing a decrease of 49% from the net sales of $75.6 million in the comparable period of fiscal 2001. Net sales increased 12% from $34.6 million in the first quarter of fiscal 2002. Although our net sales increased sequentially in the
first two quarters compared to sequential decreases each quarter in fiscal 2001, there is uncertainty as to if and when the next growth phase will occur. We maintain a cautious outlook for future orders and expect sales levels to remain relatively
depressed for the balance of fiscal 2002, compared to fiscal 2001.





International net sales accounted for
approximately 44%, 61% and 74% of total net sales in the fiscal six months of 2002 and fiscal years 2001 and 2000, respectively. Our net sales to the Asia Pacific region accounted for approximately 30%, 38%, and 66% of total net sales in the first
six months of 2002 and fiscal years 2001 and 2000, 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 and early 1999. Capital markets in Korea
and other areas of Asia have been historically 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 six months of 2002 and fiscal years 2001 and 2000 consisted of:





Six Months Ended April 30, 2002


Fiscal Years Ended October 31,2001


2000Mixed-Signal

57
%

61
%

74
%Logic

4


4


11Memory

11


19


8Service and software

28


16


7Total

100
%

100
%

100
%




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##### Table of Contents




Revenues from software were not material to our operations in the first six
months of 2002 and fiscal years 2001 and 2000, representing less than 5% 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, excess and obsolete inventory write downs, sell through of previously written down inventory, 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 margin was 38.5% and 38.3% for the three and six month periods ending April 30, 2002. For the comparable periods ending April 30, 2001 the gross margins excluding
special charges were 54.9% and 56.0% respectively. The drop in gross margins from fiscal 2001 levels reflects the competitive pricing environment as a result of the cyclical downturn in the semiconductor equipment industry and higher costs caused by
under-absorption of manufacturing expenses. We expect gross margins to remain low for the balance of fiscal 2002 due to the ongoing competitive pressure on average selling prices, and manufacturing inefficiencies resulting from the current business
cycle.





Research and Development





Research and development (or R&D) expenses were $40.5 million in the first six months of fiscal 2002, a decrease of 7.1%, or $3.1 million from the same period of fiscal 2001. The
decrease in spending reflects company wide shutdown periods, salary reductions, and small headcount reductions in 2002 when compared to 2001. As a percentage of net sales, R&D expenses were 55.3% for the first six months of 2002, compared to
20.6% for the same period in fiscal 2001. We currently intend to continue to invest significant resources in the development of new products and product enhancements for the foreseeable future. Accordingly, we expect R&D expenses to increase in
absolute dollar terms for the remainder of fiscal 2002.





Selling, General and Administrative





Selling, general and administrative expenses (or SG&A) were $44.1 million in the first six month of fiscal 2002,
representing a $16.6 million or 27.3% decrease from the comparable period of fiscal 2001. The lower spending in 2002 was primarily due to lower sales commissions on lower sales volumes and decreases in payroll related expenses due to lower
headcounts, salary reductions, and company wide shutdown periods in fiscal 2002. As a percentage of net sales, SG&A expenses were 60.2% for the first six months of fiscal 2002, compared with 28.6% for the corresponding period in fiscal 2001.
This increase as a percentage of net sales is primarily due to the significantly lower sales levels in fiscal 2002 compared to fiscal 2001. We expect SG&A expenses for the remainder of fiscal 2002 to increase slightly in absolute dollars due to
planned salary restorations, some integration projects with IMS and no further planned shutdown periods through the end of the fiscal year.





Amortization of Goodwill and Purchased Intangibles





Amortization of goodwill and purchased
intangible expenses was $10.3 million in the first six months of fiscal 2002, compared to $11.3 million for the same period in fiscal 2001. The decrease in year over year amortization expense is due to a write down in the value of goodwill and
purchased intangible assets of $8.9 million in the fourth quarter of fiscal 2001. This action resulted in a decrease in the quarterly amortization charge by about $0.7 million per quarter which was offset in fiscal 2002 by the added amortization of
the DCI and Rabkin acquisitions, when compared to fiscal 2001 (see Note 2 of the Consolidated Financial Statements in the 2001 Form 10-K for further discussion).





Interest and Other Income Expenses, Net





We generated net interest and other
income of $5.7 million for the first six months of fiscal 2002, as compared to $9.7 million for the same period of fiscal 2001. The decrease in fiscal 2002 was due to lower average cash and investment balances and decreasing returns on our cash
investments as longer-term investments mature and are re-invested at current short-term interest rates. In addition, in the second quarter of fiscal 2002 we recorded losses of approximately $1.2 million on the disposal of property and equipment.




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Income Taxes





Our estimated effective tax benefit rate for the first six months of fiscal 2002 and 2001 was 35.0%. The estimated tax benefit rates for fiscal 2002 and 2001 are less than
the combined federal and state statutory rate primarily due to the impact of non-deductible goodwill amortization. The tax rate applied to pre-tax book income (loss) for the first six months is computed based on a projected effective tax benefit
rate for the year.





Realization of the net deferred tax assets at April 30, 2002 is dependent on our ability to
generate approximately $93 million of future taxable income. Management believes that it is more likely than not that the assets will be realized, based on forecasted income. However, there can be no assurance that we will meet our expectations of
future income. Management will evaluate the realizability of the deferred tax assets on a quarterly basis and assess the need for additional valuation allowances.





LIQUIDITY AND CAPITAL RESOURCES





Operating activities
generated net cash flows of $12.4 million for the six months ended April 30, 2002. The net cash flow generated by operating activities for the first six months of fiscal 2002 was primarily due to the significant decrease in operating assets
resulting from fiscal year to date income tax refunds of $52.9 million.





Investing activities provided net cash
flows of approximately $24.8 million in the six months ended April 30, 2002 resulting from the net sales of available-for-sale securities of $34.7 million offset by approximately $9.9 million for purchases of property and equipment and other assets
to support our business.





Financing activities provided net cash flows of $4.9 million for the six months ended
April 30, 2002. The cash for the first six months of fiscal 2002 was provided from the issuance of common stock through our employee equity plans.





As of April 30, 2002 we had working capital of approximately $350.8 million, including cash and short-term investments of $193.5 million, and accounts receivable and inventories representing $159.8
million. 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
our working capital. The semiconductor industry has historically been highly cyclical and has experienced downturns, which have had a material adverse effect on the semiconductor industrys demand for automatic test equipment, including
equipment manufactured and marketed by us. In addition, the automatic test equipment industry is highly competitive and subject to rapid technological change. It is reasonably possible that events related to the above factors may occur in the near
term which would cause a change to our estimate of the net realizable value of receivables, inventories or other assets, and the adequacy of accrued liabilities. See discussion of Critical Accounting Policies and Estimates above.





Our principal sources of liquidity as of April 30, 2002 consisted of approximately $86.3 million of cash and cash
equivalents, and short-term investments of $107.2 million. In addition, we had $114.6 million of available-for-sale securities, classified as long-term investments at April 30, 2002.





We have an agreement with a captive leasing company whereby we issued a guaranty in favor of a bank with respect to certain obligations of the leasing company to the bank.
Under this agreement, the leasing company agreed to grant to us a security interest to secure the obligations of the leasing company as a result of any payments by us pursuant to the guaranty. At April 30, 2002, the maximum allowable debt of the
leasing company subject to this guaranty of $8.8 million was outstanding.





The Company leases its facilities and
equipment under operating leases that expire periodically through 2006. The approximate future minimum lease payments under operating leases for facilities and equipment at April 30, 2002 are as follows (in thousands):




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##### Table of Contents




Lease Payments2002

$
2,3002003


5,1282004


3,5172005


1,4612006


163Thereafter


$
12,569





RECENT ACCOUNTING PRONOUNCEMENTS





In July 2001, the Financial Accounting Standards Board (FASB) issued Statements of Financial Accounting Standards No. 141
(SFAS 141), Business Combinations. SFAS 141 eliminates the pooling-of-interests method of accounting for business combinations except for qualifying business combinations that were initiated prior to July 1, 2001. In
addition, SFAS 141 further clarifies the criteria to recognize intangible assets separately from goodwill. Specifically, SFAS 141 requires that an intangible asset may be separately recognized only if such an asset meets the contractual-legal
criterion or the separability criterion. The requirements of Statement 141 are effective for any business combination accounted for by the purchase method that is completed after June 30, 2001 (i.e., the acquisition date is July 1, 2001 or after).
We are currently evaluating the impact of SFAS 141 and has not yet determined the impact that adopting SFAS 141 will have on its financial statements. On adoption, we will be required to reassess the goodwill and intangible assets previously
recorded in acquisitions prior to July 1, 2001 to determine if the new recognition criteria for an intangible asset to be recognized apart from goodwill are met.





In July 2001, the FASB issued Statements of Financial Accounting Standards No. 142 (SFAS 142), Goodwill and Other Intangible Assets. Under SFAS 142, goodwill and indefinite
lived intangible assets are no longer amortized but are reviewed annually (or more frequently if impairment indicators arise) for impairment.





For intangible assets with indefinite useful lives, the impairment review will involve a comparison of fair value to carrying value, with any excess of carrying value over fair value being recorded as
an impairment loss. For goodwill, the impairment test shall be a two-step process, consisting of a comparison of the fair value of a reporting unit with its carrying amount, including the goodwill allocated to each reporting unit. If the carrying
amount is in excess of the fair value, the implied fair value of the reporting unit goodwill is compared to the carrying amount of the reporting unit goodwill. Any excess of the carrying value of the reporting unit goodwill over the implied fair
value of the reporting unit goodwill will be recorded as an impairment loss. Separable intangible assets that are deemed to have a finite life will continue to be amortized over their useful lives (but with no maximum life). Intangible assets with
finite useful lives will continue to be reviewed for impairment in accordance with Statements of Financial Accounting Standards No. 121 (SFAS 121), Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be
Disposed Of. The amortization provisions of SFAS 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2001, the Company will apply the new accounting
rules beginning November 1, 2002 and will reassess the useful lives of its separately recognized intangible assets in the first quarter of fiscal 2003. We will review for impairment previously recognized intangible assets that are deemed to have
indefinite lives upon the completion of this analysis in the first quarter of fiscal 2003. Additionally, upon the adoption of SFAS 142, we will perform a transitional impairment review related to the carrying value of goodwill as of November 1, 2002
by the end of the second quarter of fiscal 2003. Because of the different transition dates for goodwill and intangible assets acquired on or before June 30, 2001 and those acquired after that date, pre-existing goodwill and intangibles will be
amortized during this transition period until adoption whereas new goodwill and indefinite lived intangible assets acquired after June 30, 2001 will not. We are currently in the process of determining our reporting units for the purpose of applying
the impairment test, analyzing how fair value will be determined for purposes of applying SFAS 142 and quantifying the anticipated impact of adopting the provisions of SFAS 142.





In August, 2001, the FASB issued Statements of Financial Accounting Standards (SFAS 144), Accounting for the Impairment or Disposal of Long-Lived
Assets. SFAS 144 supercedes SFAS 121, Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of and the accounting and reporting provisions of Accounting Principles Board Opinion No. 30,
Reporting the Results of OperationsReporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business. SFAS 144
establishes a single accounting model for assets to be disposed of by sale whether previously held and used or newly acquired. SFAS No. 144 retains the provisions




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##### Table of Contents

of APB No. 30 for presentation of discontinued operations in the income statement, but broadens the presentation to include a component of an
entity. SFAS 144 is effective for fiscal years beginning after December 15, 2001 and the interim periods within. We are currently in the process of determining the anticipated impact of adopting the provisions of SFAS 144.




17




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##### Table of Contents




RISK FACTORS





Our operating results have fluctuated significantly which has and may continue to adversely affect our stock price.








LOGO





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:





| |  |  | worldwide 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;
| | - |  | -----------------------------------------------------------------------------------------------




| |  |  | labor and materials 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;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | 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.
| | - |  | ------------------------------------------------------------------------------



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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;
| | - |  | -----------------------------




| |  |  | long-term 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 accounts receivable
allowances, product warranty costs, and deferred revenue, 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.








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. In the past, we
experienced significant delays in the introduction of our ValStar 2000 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. In
addition, under the new revenue recognition policy that is in accordance with SAB 101, we will be deferring revenue for transactions that involve newly introduced products or when customers specify acceptance criteria that cannot be demonstrated
prior to the shipment. This will result in a delay in the recognition of revenue as compared to the historic norm of generally recognizing revenue upon shipment. We currently anticipate introducing several new systems in fiscal 2002. Delays in
introducing a product or delays in our ability to obtain customer acceptance, if they occur in the future, will delay the recognition of revenue and gross profit by us. We cannot be certain that these or additional difficulties will not




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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. In the past, we have incurred and we may continue to
incur substantial unanticipated costs to ensure the functionality and reliability of our testers and to increase feature sets. If our systems 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, and/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 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.





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. Therefore, it is necessary for us to enhance the performance and other capabilities of our existing systems and software products and
related software tools, or develop new systems and software products and related software tools, to adequately address these requirements. 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 worldwide 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. In addition, weakness in demand may have
caused integrated device manufacturers, or IDMs, to pull testing back in-house versus using outsource test houses. Because less of our market share is from the IDMs, this trend may reduce the demand for our products. Any decline in demand for
our hardware or software products could have a materially adverse effect on our business, financial condition or results of operations.





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 certain 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




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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 fiscal 2001 and 2002, we have 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.





In the past, some of our customers have placed orders with us for more systems than they ultimately
required. We believe that in the future 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 that will actually be 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 or a delay in receiving customer acceptance from a customer 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 been adversely affected by the cyclical downturn in the semiconductor industry. There is uncertainty as to if and when the next cyclical growth phase will occur. Our belief regarding the downturn is based on weakened 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
volatility in order activity. Although, we anticipate modest revenue growth over the second quarter for the third quarter ending July 31, 2002, revenues may decline thereafter due to the uncertainty of a sustainable recovery in the semiconductor and
related capital equipment industry. As a result of the cyclical downturn, in fiscal 2001 we reduced our worldwide workforce by approximately 23%, or about 400 people. We took a charge related to this reduction in force of approximately $2.0 million
in our second quarter of fiscal 2001, $1.0 million in our third fiscal quarter and another $0.2 million in the fourth fiscal quarter of 2001. Additionally, remaining employees were required to take time off in the second, third and fourth quarters
of fiscal 2001, as well as the first quarter of fiscal 2002. Other initiatives, including a domestic pay cut, a four-day workweek for most manufacturing and some operating employees, the consolidation and reorganization of certain functions and
operations, and the curtailment of discretionary expenses, were also 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.





As a result of the rapid and steep decline in revenue during this latest downturn, we continue to monitor our inventory levels
in light of product development changes and a possible eventual upturn. We recorded a charge of $45.0 million in the second fiscal quarter of 2001 and a charge of $38.0 million in the fourth fiscal quarter of 2001 for the write-down of excess
inventories. We may be required to take additional charges for excess and obsolete inventory if the current industry downturn causes further reductions to our current inventory valuations, or changes our current product development plans.





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.





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. 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




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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, both the 1997/1998 Asian financial crisis and the current economic downturn have contributed to widespread uncertainty and a slowdown in the semiconductor industry. This slowdown in
the semiconductor industry resulted in reduced spending for semiconductor capital equipment, including ATE that 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 due to the semiconductor
business cycles and an increased scale of operations.





In the fist six months of fiscal 2002, our net sales
fell 65% from those recorded in the first six months of fiscal 2001 as the semiconductor industry continued in a steep cyclical downturn. In fiscal 2000, we generated revenue of $136.3 million in the first quarter and $221.7 million in the fourth
quarter, an increase of 63%. In fiscal 1999, we generated revenue of $37.7 million in the first quarter and $97.0 million in the fourth quarter, an increase of 157%. Since 1993, except for the current cost-cutting efforts and those during fiscal
1998 and the first half of fiscal 1999, we have overall significantly increased the scale of our operations 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 continuing to place 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 primarily introduced products that are either evolutions or derivatives of existing products. During fiscal 2002 we expect to introduce products that are evolutions or derivatives of existing
products as well as products that are largely new. Under the new revenue recognition policy that is in accordance with SAB 101, we will be deferring revenue for transactions that involve newly introduced products or when customers specify acceptance
criteria that cannot be demonstrated prior to the shipment. This will result in a delay in the recognition of revenue as compared to the historic norm of recognizing revenue upon shipment. Product introduction delays, if they occur in the future,
will delay the recognition of revenue and gross profit by us. During the remainder of fiscal 2002, we anticipate introducing new products as well as evolutions and derivatives of current 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 certain that our net sales will increase or remain at historical 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




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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 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 production testing of
high-end microprocessors, or DRAMs. Moreover, a substantial portion of our net sales is 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 introduced or announced new products with certain performance or price characteristics equal or superior to products we currently offer. These competitors have
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 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.





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.




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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 8%, 13% and 42% of our net sales in the first six months of fiscal 2002 and the entire fiscal years 2001 and 2000, 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 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.




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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 rules affecting many aspects of our business, including rules relating to purchase and pooling-of-interests accounting for business
combinations, asset impairment, revenue recognition, employee stock purchase plans and stock option grants have recently been revised or are currently under review. Changes to those rules or current interpretation of those rules 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 implemented SAB 101. Adoption of SAB 101 required us to restate our quarterly results for the seven fiscal
quarters ended July 31, 2001 (see Notes 1 and 13 of the Notes to the Consolidated Financial Statements in the Form 10-K for further discussion). In addition, the preparation of our 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 our inability to attract and retain skilled employees.





Our international business exposes us to additional risks.





International sales accounted for approximately 45%, 61% and 74% of our total net sales for the first six months of fiscal 2002 and for the fiscal years 2001 and 2000, 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 30%, 38% and 66% of our total net
sales in the first six months of fiscal 2002 and fiscal years 2001 and 2000, 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




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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.





In the first six months of fiscal 2002 we have one U.S. based customer that represents more than 10% of our business. Two end-user customers headquartered in Europe
accounted for approximately 13% and 11% respectively, of our net sales in fiscal 2001 and one end-user customer headquartered in Taiwan accounted for 17% of our net sales in fiscal 2000.





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.





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. In April 2001, we were served with the complaint and since that date discovery has commenced. In March 2002, the court set the trial for this action for May 19, 2003. We may also be obligated to other third parties relating to
this allegation.





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.




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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, for the period November 1, 2001 through April 30, 2002 the price of our common stock has ranged from a closing
high of $24.64 to a closing low of $14.01. In fiscal 2001, the price of our common stock has ranged from a closing high of $29.50 to a closing low of $11.26. 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;
| | - |  | --------------------------------------




| |  |  | general conditions in the stock market or around the world, terrorism, 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.
| | - |  | ----------------------------------------------------------------------------------------------------------------




Terrorist attacks and threats, and government responses thereto, may negatively impact all aspects of our operations, revenues, costs and stock price.





The terrorist attacks last year in the United States and the U.S. retaliation for these attacks and the
resulting decline in consumer confidence has had a substantial adverse impact on the economy. If consumer confidence does not recover, our revenues and profitability may be adversely impacted in fiscal 2002 and beyond.





In addition, any similar future events may disrupt our operations or those of our customers and suppliers. In addition, these events have
had and may continue to have an adverse impact on the U.S. and world economy in general and consumer confidence and spending in particular, which could harm our sales. Any of these events could increase volatility in the U.S. and world financial
markets, which could harm our stock price and may limit the capital resources available to us and our customers or suppliers. This could have a significant impact on our operating results, revenues and costs and may result in increased volatility in
the market price of our common stock.





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.




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##### Table of Contents




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 that ensures the safety and preservation of its 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):





Future maturities of investments held at April 30, 2002Balance at 10/31/01


2002


2003


2004


2005


2006

ThereafterCash equivalentsFixed rate

$
44,309


$
86,342

















Average rate


2.65
%


1.69
%
















Short term investmentsFixed rate

$
96,497


$
40,666


$
66,527













Average rate


6.70
%


6.61
%


5.16
%












Long term investmentsFixed rate

$
160,607






$
63,736


$
26,222


$
9,917




$
10,787Average rate


5.60
%






5.67
%


4.86
%


6.08
%




5.07
%Total investment securities

$
301,413


$
127,008


$
130,263


$
26,222


$
9,917




$
10,787Average rate


5.52
%


3.26
%


5.41
%


4.86
%


6.08
%




5.07
%Equity instruments

$
1,282


$
3,906























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.




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##### Table of Contents




PART II.OTHER INFORMATION





Item 1.Legal Proceedings





In July 1998, we received a written allegation from inTEST
IP Corp., or with its patent licensee inTEST Corporation, inTEST, that we were 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. In April 2001 we were served with the complaint and since that date discovery
has commenced. In March 2002, the court set the trial for this action for May 19, 2003. 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.





In April 2002, Reptron Electronics, Inc. a supplier of certain electronic components to us, filed a complaint in
the U.S. District Court for the District of Oregon, alleging that we had breached a contract to purchase certain components ordered by Reptron during 2000. The complaint seeks damages of approximately $3.9 million.





We are involved in other various claims arising in the ordinary course of business, none of which, in the opinion of management, if
determined adversely against us, will have a material adverse effect on our business, financial condition or results of operations.





Item 2.Changes in Securities





None





Item 3.Defaults upon Senior Securities





None





Item 4.Submission of Matters to a Vote of Security holders





The following
proposals were voted upon by our stockholders at the Annual Meeting of Stockholders held on March 20, 2002.





1.  A proposal to elect two directors to serve for three-year terms ending in 2005 or until their respective successors are elected and qualified, was approved as follows:





Graham J. Siddall

For48,642,072, Withheld6,033,807Jon D. Tompkins

For54,286,310, Withheld389,569





2.  A proposal to approve an amendment to the automatic
option grant in effect for the non-employee members of the Board of Directors under our 1993 Stock Option Plan which would provide the following special benefits for each non-employee board member who ceases board service after completion of three
or more years of such board service: (i) accelerated vesting of all options granted and (ii) a one-year period following cessation of board service in which to exercise those vested options. This proposal was not approved as follows:





Common Shares

For23,605,742, Against30,338,369, Abstain731,768





3.  A proposal to ratify the appointment of Ernst &
Young LLP as our independent auditors was approved as follows:





Common Shares

For53,565,363, Against1,086,150, Abstain24,366




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Item 5.Other Information





Rule 10b5-1 Stock Selling Plans





We have been informed that two of our executive officers, Keith L. Barnes and John R. Detwiler, have adopted stock selling
plans under Rule 10b5-1 of the Securities Exchange Act of 1934, as amended, pursuant to which they intend to sell shares of our common stock from time to time.





The term of Mr. Barnes plan begins on July 1, 2002 and terminates on March 31, 2003. The plan provides for sales of stock on a quarterly basis subject to certain market prices. No more than
20,000 shares may be sold in any single day and no more than 200,000 shares may be sold in any given quarter.





The term of Mr. Detwilers plan begins on July 8, 2002 and terminates on March 31, 2003. The plan provides for sales of stock on a monthly basis subject to certain
market prices. The plan will terminate if and when an aggregate of 110,500 shares have been sold pursuant to the plan.





Real Estate Purchase





On March 25, 2002, we entered into a Real Estate Purchase and Sale
Agreement, which Agreement was amended on May 8, 2002, to acquire two office and manufacturing buildings in Milpitas, California for approximately $21.8 million. We anticipate that this transaction will close during August 2002. We intend to
relocate our corporate headquarters to this facility in 2003.





Item 6.Exhibits and Reports on Form 8-K





(a)  See Exhibit Index on
page 32





(b)  Reports on Form 8-K





None




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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.





CREDENCE SYSTEMS CORPORATION(Registrant)By:

/s/    JOHN R.
DETWILERJohn R. Detwiler Senior Vice
President, Chief Financial Officer and Secretary


Date    June 14, 2002




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EXHIBIT INDEX





Exhibit Number10.40

Real Estate Purchase and Sale Agreement by and between Transwestern Dixon Landings, L.L.C. and the Company dated as
of March 25, 2002.10.41

First Amendment effective May 8, 2002 to Real Estate Purchase and Sale Agreement by and between Transwestern Dixon
Landings, L.L.C. and the Company dated as of March 25, 2002.




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