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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q



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(Mark One)

|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------

For the quarterly period ended August 4, 2007

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)



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

1421 California Circle, Milpitas, California

95035

(Address of principal
executive offices)

(Zip Code)

(408) 635-4300

(Registrants telephone number, including area code)

N/A

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 ̈

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of
accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.

Large accelerated
filer ̈Accelerated filer  x    Non-accelerated filer ̈

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes ̈No  x

At August 31, 2007, there were 101,651,255 shares of the Registrants common stock, $0.001 par value per share, outstanding.



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##### Table of Contents

CREDENCE SYSTEMS CORPORATION

INDEX



|                              |  |                                                                                       |  |   
|----------------------------- |  | ------------------------------------------------------------------------------------- |  | --
|                              |  | PAGE NO.                                                                             
|PART I. FINANCIAL INFORMATION
|                              |  |                                                                                      
|Item 1.                       |  | Financial Statements (unaudited):                                                     |  | 3 
|                              |  |                                                                                      
|                              |  | Condensed Consolidated Balance Sheets                                                 |  | 3 
|                              |  |                                                                                      
|                              |  | Condensed Consolidated Statements of Operations                                       |  | 4 
|                              |  |                                                                                      
|                              |  | Condensed Consolidated Statements of Cash Flows                                       |  | 5 
|                              |  |                                                                                      
|                              |  | Notes to Condensed Consolidated Financial Statements                                  |  | 6 
|                              |  |                                                                                      
|Item 2.                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 19
|                              |  |                                                                                      
|Item 3.                       |  | Quantitative and Qualitative Disclosures about Market Risk                            |  | 33
|                              |  |                                                                                      
|Item 4.                       |  | Controls and Procedures                                                               |  | 34
|                             
|PART II. OTHER INFORMATION   
|                              |  |                                                                                      
|Item 1.                       |  | Legal Proceedings                                                                     |  | 34
|                              |  |                                                                                      
|Item 1A.                      |  | Risk Factors                                                                          |  | 34
|                              |  |                                                                                      
|Item 2.                       |  | Unregistered Sales of Equity Securities and Use of Proceeds                           |  | 47
|                              |  |                                                                                      
|Item 3.                       |  | Defaults Upon Senior Securities                                                       |  | 47
|                              |  |                                                                                      
|Item 4.                       |  | Submission of Matters to a Vote of Security Holders                                   |  | 47
|                              |  |                                                                                      
|Item 5.                       |  | Other Information                                                                     |  | 47
|                              |  |                                                                                      
|Item 6.                       |  | Exhibits                                                                              |  | 47
|                              | 
|SIGNATURES                    |  | 48                                                                                   



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##### Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

CREDENCE SYSTEMS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

(unaudited)



|                                           |  |               |         |                 |   |        
|------------------------------------------ |  | ------------- | ------- | --------------- | - | -------
|                                           |  | August 4,2007 |         | October 31,2006
|ASSETS                                     |  |               |         |                 |   |        
|Current assets:                            |  |               |         |                 |   |        
|Cash and cash equivalents                  |  | $             | 118,056 |                 | $ | 95,635 
|Short-term investments                     |  |               | 72,816  |                 |   | 7,177  
|Accounts receivable, net                   |  |               | 108,269 |                 |   | 114,796
|Inventories                                |  |               | 67,461  |                 |   | 55,200 
|Income tax receivable                      |  |               | 657     |                 |   | 275    
|Deferred income taxes                      |  |               | 9,891   |                 |   | 9,875  
|Prepaid expenses and other current assets  |  |               | 16,184  |                 |   | 14,511 
|                                           |  |               |         |                 |   |        
|Total current assets                       |  |               | 393,334 |                 |   | 297,469
|Property and equipment, net                |  |               | 78,369  |                 |   | 87,175 
|Goodwill                                   |  |               | 2,665   |                 |   |       
|Other intangible assets, net               |  |               | 70,417  |                 |   | 83,878 
|Other assets                               |  |               | 51,223  |                 |   | 49,072 
|                                           |  |               |         |                 |   |        
|Total assets                               |  | $             | 596,008 |                 | $ | 517,594
|                                           |  |               |         |                 |   |        
|                                           |  |              
|LIABILITIES AND STOCKHOLDERS EQUITY       |  |               |         |                 |   |        
|Current liabilities:                       |  |               |         |                 |   |        
|Accounts payable                           |  | $             | 25,320  |                 | $ | 32,477 
|Accrued expenses and other liabilities     |  |               | 31,747  |                 |   | 37,251 
|Accrued payroll and related liabilities    |  |               | 16,896  |                 |   | 17,496 
|Convertible subordinated notes             |  |               | 72,500  |                 |   |       
|Deferred revenue                           |  |               | 26,656  |                 |   | 21,935 
|Income taxes payable                       |  |               | 12,261  |                 |   | 14,893 
|Accrued warranty                           |  |               | 12,953  |                 |   | 13,514 
|Deferred profit                            |  |               | 6,295   |                 |   | 6,143  
|                                           |  |               |         |                 |   |        
|Total current liabilities                  |  |               | 204,628 |                 |   | 143,709
|Convertible subordinated notes             |  |               | 119,278 |                 |   | 145,000
|Long-term restructuring liabilities        |  |               | 1,229   |                 |   | 2,545  
|Long-term deferred income taxes            |  |               | 9,473   |                 |   | 9,473  
|Other liabilities                          |  |               | 34,152  |                 |   | 4,141  
|Stockholders equity                       |  |               | 227,248 |                 |   | 212,726
|                                           |  |               |         |                 |   |        
|Total liabilities and stockholders equity |  | $             | 596,008 |                 | $ | 517,594
|                                           |  |               |         |                 |   |        

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 |         |   | Nine Months Ended |  
|                                                                                                                                |  | August 4,2007      |         |   | July 312006       |   |          | August 4,2007 |  |   | July 31,2006 |  
|Net sales                                                                                                                       |  |                    |         |   |                   |   |          |               |  |   |              |   |  |   |          |  
|Systems and upgrades                                                                                                            |  | $                  | 99,388  |   |                   | $ | 80,619   |               |  | $ | 284,826      |   |  | $ | 266,086  |  
|Services and spare parts                                                                                                        |  |                    | 24,144  |   |                   |   | 33,857   |               |  |   | 78,644       |   |  |   | 100,140  |  
|                                                                                                                                |  |                    |         |   |                   |   |          |               |  |   |              |   |  |   |          |  
|Total net sales                                                                                                                 |  |                    | 123,532 |   |                   |   | 114,476  |               |  |   | 363,470      |   |  |   | 366,226  |  
|Cost of goods sold                                                                                                              |  |                    |         |   |                   |   |          |               |  |   |              |   |  |   |          |  
|Systems and upgrades (including stock-based compensation expense of $62, $313, $248 and $492, respectively)                     |  |                    | 44,308  |   |                   |   | 68,125   |               |  |   | 136,144      |   |  |   | 177,058  |  
|Services and spare parts                                                                                                        |  |                    | 15,920  |   |                   |   | 20,743   |               |  |   | 57,304       |   |  |   | 61,545   |  
|                                                                                                                                |  |                    |         |   |                   |   |          |               |  |   |              |   |  |   |          |  
|Total cost of goods sold                                                                                                        |  |                    | 60,228  |   |                   |   | 88,868   |               |  |   | 193,448      |   |  |   | 238,603  |  
|Gross margin                                                                                                                    |  |                    | 63,304  |   |                   |   | 25,608   |               |  |   | 170,022      |   |  |   | 127,623  |  
|Operating expenses:                                                                                                             |  |                    |         |   |                   |   |          |               |  |   |              |   |  |   |          |  
|Research and development (including stock-based compensation expense of $513, $615, $1,259 and $1,545, respectively)            |  |                    | 18,696  |   |                   |   | 22,576   |               |  |   | 60,236       |   |  |   | 70,847   |  
|Selling, general and administrative (including stock-based compensation expense of $579, $822, $2,637 and $2,357,
respectively) |  |                    | 27,042  |   |                   |   | 30,782   |               |  |   | 81,995       |   |  |   | 89,852   |  
|Amortization of purchased intangibles                                                                                           |  |                    | 4,451   |   |                   |   | 4,338    |               |  |   | 13,360       |   |  |   | 12,709   |  
|Reduction of goodwill                                                                                                           |  |                    |        |   |                   |   | 423,875  |               |  |   |             |   |  |   | 423,875  |  
|Restructuring charges                                                                                                           |  |                    | (9      | ) |                   |   | 1,792    |               |  |   | 1,009        |   |  |   | 3,166    |  
|                                                                                                                                |  |                    |         |   |                   |   |          |               |  |   |              |   |  |   |          |  
|Total operating expenses                                                                                                        |  |                    | 50,180  |   |                   |   | 483,363  |               |  |   | 156,600      |   |  |   | 600,449  |  
|                                                                                                                                |  |                    |         |   |                   |   |          |               |  |   |              |   |  |   |          |  
|Operating income (loss)                                                                                                         |  |                    | 13,124  |   |                   |   | (457,755 | )             |  |   | 13,422       |   |  |   | (472,826 | )
|Interest income                                                                                                                 |  |                    | 2,138   |   |                   |   | 979      |               |  |   | 5,234        |   |  |   | 2,758    |  
|Interest expense                                                                                                                |  |                    | (2,546  | ) |                   |   | (677     | )             |  |   | (6,036       | ) |  |   | (2,056   | )
|Other expense                                                                                                                   |  |                    | (755    | ) |                   |   | (1,803   | )             |  |   | (181         | ) |  |   | (2,675   | )
|                                                                                                                                |  |                    |         |   |                   |   |          |               |  |   |              |   |  |   |          |  
|Net income (loss) before income tax provision                                                                                   |  |                    | 11,961  |   |                   |   | (459,256 | )             |  |   | 12,439       |   |  |   | (474,799 | )
|Income tax provision                                                                                                            |  |                    | 1,623   |   |                   |   | 2,110    |               |  |   | 5,566        |   |  |   | 4,844    |  
|                                                                                                                                |  |                    |         |   |                   |   |          |               |  |   |              |   |  |   |          |  
|Net income (loss)                                                                                                               |  | $                  | 10,338  |   |                   | $ | (461,366 | )             |  | $ | 6,873        |   |  | $ | (479,643 | )
|                                                                                                                                |  |                    |         |   |                   |   |          |               |  |   |              |   |  |   |          |  
|Net income (loss) per share                                                                                                     |  |                    |         |   |                   |   |          |               |  |   |              |   |  |   |          |  
|Basic                                                                                                                           |  | $                  | 0.10    |   |                   | $ | (4.61    | )             |  | $ | 0.07         |   |  | $ | (4.81    | )
|                                                                                                                                |  |                    |         |   |                   |   |          |               |  |   |              |   |  |   |          |  
|Diluted                                                                                                                         |  | $                  | 0.10    |   |                   | $ | (4.61    | )             |  | $ | 0.07         |   |  | $ | (4.81    | )
|                                                                                                                                |  |                    |         |   |                   |   |          |               |  |   |              |   |  |   |          |  
|Number of shares used in computing per share amount                                                                             |  |                    |         |   |                   |   |          |               |  |   |              |   |  |   |          |  
|Basic                                                                                                                           |  |                    | 101,194 |   |                   |   | 100,017  |               |  |   | 100,940      |   |  |   | 99,798   |  
|                                                                                                                                |  |                    |         |   |                   |   |          |               |  |   |              |   |  |   |          |  
|Diluted                                                                                                                         |  |                    | 107,726 |   |                   |   | 100,017  |               |  |   | 101,067      |   |  |   | 99,798   |  
|                                                                                                                                |  |                    |         |   |                   |   |          |               |  |   |              |   |  |   |          |  

See accompanying notes.



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CREDENCE SYSTEMS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)



|                                                                            |  |                   |         |   |              |   |          |  
|--------------------------------------------------------------------------- |  | ----------------- | ------- | - | ------------ | - | -------- | -
|                                                                            |  | Nine Months Ended |        
|                                                                            |  | August 4,2007     |         |   | July 31,2006 |  
|Cash flows from operating activities:                                       |  |                   |         |   |              |   |          |  
|Net income (loss)                                                           |  | $                 | 6,873   |   |              | $ | (479,643 | )
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                   |         |   |              |   |          |  
|Depreciation and amortization                                               |  |                   | 37,738  |   |              |   | 39,729   |  
|Stock-based compensation charges                                            |  |                   | 4,144   |   |              |   | 4,523    |  
|Provision for inventory write-downs                                         |  |                   | 768     |   |              |   | 37,485   |  
|Reduction of goodwill                                                       |  |                   |        |   |              |   | 423,875  |  
|(Recovery) provision for allowance for doubtful accounts                    |  |                   | (350    | ) |              |   | 561      |  
|Loss on disposal of long-term intellectual property asset                   |  |                   | 679     |   |              |   |         |  
|Loss on disposal of property and equipment                                  |  |                   | 1,876   |   |              |   | 1,076    |  
|Impairment of investment in a privately held company                        |  |                   |        |   |              |   | 945      |  
|Realized loss on available-for-sale securities                              |  |                   |        |   |              |   | (302     | )
|Gain on exchanged convertible notes                                         |  |                   | (2,955  | ) |              |   |         |  
|Changes in operating assets and liabilities:                                |  |                   |         |   |              |   |          |  
|Accounts receivable                                                         |  |                   | 10,379  |   |              |   | 7,892    |  
|Inventories                                                                 |  |                   | (12,894 | ) |              |   | (13,970  | )
|Income tax receivable and payable                                           |  |                   | (5,160  | ) |              |   | (3,994   | )
|Prepaid expenses and other current assets                                   |  |                   | (1,145  | ) |              |   | 5,214    |  
|Other assets                                                                |  |                   | (12,744 | ) |              |   | (11,356  | )
|Accounts payable                                                            |  |                   | (7,335  | ) |              |   | (17,595  | )
|Accrued expenses and other current liabilities                              |  |                   | (994    | ) |              |   | (4,631   | )
|Deferred profit                                                             |  |                   | (381    | ) |              |   | (1,135   | )
|                                                                            |  |                   |         |   |              |   |          |  
|Net cash provided by (used in) operating activities                         |  |                   | 18,499  |   |              |   | (11,326  | )
|Cash flows from investing activities:                                       |  |                   |         |   |              |   |          |  
|Purchases of available-for-sale securities                                  |  |                   | (72,104 | ) |              |   | (28,581  | )
|Maturities of available-for-sale securities                                 |  |                   | 6,644   |   |              |   | 20,770   |  
|Acquisition of property and equipment                                       |  |                   | (5,546  | ) |              |   | (7,368   | )
|Acquisition of business, net of cash and cash equivalents                   |  |                   |        |   |              |   | (4,643   | )
|Proceeds from sale of property and equipment                                |  |                   | 2,691   |   |              |   | 2,364    |  
|                                                                            |  |                   |         |   |              |   |          |  
|Net cash used in investing activities                                       |  |                   | (68,315 | ) |              |   | (17,458  | )
|Cash flows from financing activities:                                       |  |                   |         |   |              |   |          |  
|Issuance of common stock                                                    |  |                   | 882     |   |              |   | 3,942    |  
|Proceeds from issuance of convertible notes, net of issue costs             |  |                   | 44,129  |   |              |   |         |  
|Proceeds from sale-leaseback                                                |  |                   | 30,000  |   |              |   |         |  
|Payments of note payable                                                    |  |                   | (1,313  | ) |              |   |         |  
|Payments of bank loans                                                      |  |                   |        |   |              |   | (5,000   | )
|                                                                            |  |                   |         |   |              |   |          |  
|Net cash provided by (used by) financing activities                         |  |                   | 73,698  |   |              |   | (1,058   | )
|                                                                            |  |                   |         |   |              |   |          |  
|Effects of exchange rate on cash and cash equivalents                       |  |                   | (1,461  | ) |              |   | 1,268    |  
|                                                                            |  |                   |         |   |              |   |          |  
|Net increase (decrease) in cash and cash equivalents                        |  |                   | 22,421  |   |              |   | (28,574  | )
|Cash and cash equivalents at beginning of period                            |  |                   | 95,635  |   |              |   | 142,180  |  
|                                                                            |  |                   |         |   |              |   |          |  
|Cash and cash equivalents at end of period                                  |  | $                 | 118,056 |   |              | $ | 113,606  |  
|                                                                            |  |                   |         |   |              |   |          |  
|Supplemental disclosures of cash flow information:                          |  |                   |         |   |              |   |          |  
|Interest paid                                                               |  | $                 | 4,312   |   |              | $ | 2,732    |  
|Income taxes paid                                                           |  | $                 | 10,263  |   |              | $ | 9,111    |  
|Noncash investing activities:                                               |  |                   |         |   |              |   |          |  
|Net transfers of inventory to property and equipment                        |  | $                 | 1,162   |   |              | $ | 1,679    |  
|Unrealized loss on available-for-sale investments                           |  | $                 | 22      |   |              | $ | 230      |  

See accompanying notes.



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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



|1. | Quarterly Financial Statements
|-- | ------------------------------

The unaudited
condensed consolidated financial statements and related notes for the three and nine month periods ended August 4, 2007 and July 31, 2006 are unaudited, but include all 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, in accordance with U.S. generally accepted accounting principles. The results of operations for
the three and nine month periods ended August 4, 2007 and July 31, 2006 are 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, 2006 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 the importance of timely product introduction, fluctuations in the Companys quarterly net sales and operating results, limited systems sales, backlog, cyclicality of the
semiconductor industry, management of fluctuations in our operating results, expansion of our product lines, limited sources of supply, reliance on the Companys subcontractors, the Companys highly competitive industry, customization of
products, rapid technological change, customer concentration, lengthy sales cycles, changes in financial accounting standards and accounting estimates, dependence on key personnel, international sales, proprietary rights, legal proceedings,
volatility of the Companys stock price, terrorist attacks and other geopolitical instability, effects of the Sarbanes-Oxley Act of 2002, 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.

Description of Business  Credence was incorporated in California in March 1982 and was reincorporated in Delaware in October 1993. The principal business activity of the Company is the design,
development, manufacture, sale and service of integrated test solutions throughout the design, validation and production processes for semiconductors.

Fiscal Year Starting with fiscal 2007, the Company changed its fiscal year end from October 31 to a 52 or 53 week year ending on the Saturday closest to October 31. Fiscal year 2007 will be a
52 week fiscal year ending November 3, 2007 in which each fiscal quarter will be a 13-week quarter. This change has no impact on the Companys results of operations, financial position, or cash flows.

Basis of Presentation The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and its
wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated. Effective in the first quarter of fiscal 2007, the Company reclassified engineering consulting and customized services as net sales instead of as
an offset to selling, general, and administrative expenses. The labor and material associated with the delivery of these services which had previously been reported as selling, general, and administrative expenses are classified as cost of goods
sold. For the three and nine month periods ended August 4, 2007, the total amount of engineering consulting and customized services classified as net sales is $2.6 million and $11.4 million respectively. For the three and nine month periods
ended August 4, 2007, the total amount of cost of goods sold is $1.6 million and $8.2 million, respectively. For comparative purposes, for the three and nine month periods ended July 31, 2006, $4.9 million and $13.7 million, respectively
has been reclassified as net sales. The related cost of goods sold of $3.1 million and $8.3 million for the three and nine month periods ended July 31, 2006, respectively has been reclassified to cost of goods sold from selling, general, and
administrative expenses. These reclassifications had no effect on the financial position, results of operations, or cash flows for any of the periods presented.

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
unaudited condensed consolidated financial statements. Actual results could differ from those estimates.



|2. | Revenue Recognition
|-- | -------------------

Under Securities and Exchange
Commissions Staff Accounting Bulletin No. 104, Revenue Recognition, (SAB 104), the Company recognizes 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 and collectibility is reasonably assured. Revenue recognition policies are applied consistently among the
Companys semiconductor manufacturing equipment product lines. Systems and upgrades revenue are recognized upon shipment only when achieving the customer acceptance criteria can be demonstrated prior to shipment, which generally occurs with
mature products. Systems and upgrades are classified as mature after several different customers have accepted similar systems or one customer accepted three of the same system. When the customer acceptance criteria



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cannot be demonstrated prior to shipment, revenue and the related cost of goods sold are deferred until customer acceptance. Revenue related to the fair
value of the installation obligation is recognized upon completion of the installation. Service revenues are generally recognized upon performance of the activities requested by the customers. For some customers in certain countries where
collections may be an issue, the Company may require a letter of credit to be established or cash receipt in advance before revenue can be recognized. Lease revenue is recorded in accordance with Statement of Financial Accounting Standard
No. 13, Accounting for Leases, (SFAS No. 13), which requires that a lessor account for each lease by either the sales-type or operating method. Revenue from sales-type leases is recognized at the net present value of future
lease payments. Revenue from operating leases is recognized over the lease period.

During fiscal year 2006, the Company introduced several
new enhancements, systems and products. Certain revenue from sales of these new systems and products during fiscal year 2006 were deferred until the revenue recognition requirements of the Companys revenue recognition policy have been
satisfied. This practice will continue in the future. In the past, the Company experienced significant delays in the introduction and acceptance of new testers as well as certain enhancements to the Companys existing testers. Delays in
introducing a product or delays in the Companys ability to obtain customer acceptance, if they occur in the future, will delay the recognition of revenue and gross profit by the Company.

With respect to arrangements with multiple deliverables, the Company follows the guidance in Emerging Issue Task Force No. 00-21, Revenue
Arrangements with Multiple Deliverables (EITF 00-21), to determine whether there is more than one unit of accounting. To the extent that the deliverables are separable into multiple units of accounting, the Company then allocates the total fee
on such arrangements to the individual units of accounting using the residual method. The Company then recognizes revenue for each unit of accounting depending on the nature of the deliverable(s) comprising the unit of accounting (principally
following SAB 104).

Sales in the United States are principally made through the Companys direct sales organization consisting of
direct sales employees and representatives. Sales outside the United States utilize both direct sales employees and distributors. There are no significant differences in revenue recognition policies based on the sales channel due to the business
practices that have been adopted with the Companys distributor relationships. Because of these business circumstances, the Company does not use price protection, stock rotation or similar programs with its distributors.
In general, the Company sells products to the distributor on the basis of a purchase order received from an end customer. The Company evaluates any revenue recognition issues, in such cases, based on the characteristics of the end customer.

The Company has embedded software in its semiconductor manufacturing equipment. The Company believes this embedded software is incidental
to its products and therefore it is excluded from the scope of Statement of Position 97-2, Software Revenue Recognition (SOP 97-2), since the embedded software in the Companys products is not sold separately, cannot be used on
another vendors products, and the Company cannot fundamentally enhance or expand the capability of the equipment with new or revised embedded software. In addition, the equipments principal performance characteristics are governed by
digital speed and pin count, which are primarily a function of the hardware.

Deferred revenue includes deferred revenue related to
maintenance contracts (and other undelivered services). Deferred profit is related to equipment that was shipped to certain customers, but for which the revenue and cost of goods sold are not recognized because the customer-specified acceptance
criteria has not been met as of the fiscal period end or because the customer is deemed to be a high credit risk and payment has not been received as of the fiscal period end.

The Company warrants its products to its customers generally for one year from the date of shipment. In addition to the provision of standard warranties,
the Company may offer customers extended warranty services with a fixed fee. The fixed fees are recognized as revenue on a straight-line basis over the applicable term of the contract. Costs related to extended warranty services are recorded as
incurred.

For certain customers, typically those with whom the Company has long-term relationships, the Company may grant extended payment
terms. Certain of the Companys receivables have due dates in excess of 90 days, and the Company has a history of successfully collecting these extended payment term accounts receivable.





|3. | Investments
|-- | -----------

Investments consist of an equity
investment in a privately-held company that develops products that are strategic to the Company. During the first quarter of fiscal 2007, the Company entered into an agreement to terminate the equity investment relationship with the privately-held
company. As part of the agreement, the Company was entitled to the intellectual property developed which it intended to further develop and incorporate into future products. Based on the expected future use of the technology, the remaining carrying
value of the investment of $0.7 million was reclassified to intangible assets, and was being amortized over a five year period using the straight-line method. Subsequently, during the second quarter, the Company completed a review of planned
development projects as a part of an expense rationalization process and determined that technology would not be commercialized into a product and consequently had no future use. Therefore, the Company wrote off the remaining intellectual property
value in the second quarter of fiscal year 2007.



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|4. | Guarantees
|-- | ----------

The Company accounts for guarantees in
accordance with FASB Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees to Others, an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of
FASB Interpretation No. 34 (FIN 45). Accordingly, the Company evaluates its guarantees to determine whether (a) the guarantee is specifically excluded from the scope of FIN 45, (b) the guarantee is subject to FIN 45 disclosure
requirements only, but not subject to the initial recognition and measurement provisions, or (c) the guarantee is required to be recorded in the financial statements at fair value. The Company has evaluated its guarantees and has concluded that
they are either not within the scope of FIN 45 or do not require recognition in the financial statements.

The Companys corporate
by-laws require that the Company indemnify its officers and directors, as well as those who act as directors and officers of other entities at the Companys request, against expenses, judgments, fines, settlements and other amounts actually and
reasonably incurred in connection with any proceedings arising out of their services to the Company. In addition, the Company has entered into separate indemnification agreements with each director and each executive officer of the Company that
provide for indemnification of these directors and officers under similar circumstances and under additional circumstances. The indemnification obligations are more fully described in the by-laws and the indemnification agreements. The Company
purchases standard directors and officers insurance to cover claims or a portion of the claims made against its directors and officers. Since a maximum obligation is not explicitly stated in the Companys by-laws or in the indemnification
agreements and will depend on the facts and circumstances that arise out of any future claims, the overall maximum amount of the obligations cannot be reasonably estimated. Historically, the Company has not been required to make payments related to
these obligations, and the fair value for these obligations is zero on the unaudited condensed consolidated balance sheet as of August 4, 2007.

As is customary in the Companys industry and as provided for under local law in the U.S. and other jurisdictions, many of the Companys standard contracts provide remedies to customers and others with whom
the Company does business, such as defense, settlement, or payment of judgment for intellectual property claims related to the use of the Companys products. From time to time, the Company indemnifies customers, as well as the Companys
suppliers, contractors, lessors under operating lease agreements for environmental matters, lessees, companies that purchase the Companys businesses or assets and others with whom the Company enters into contracts, against combinations of
loss, expense, or liability arising from various triggering events related to the sale and the use of the Companys products and services such as warranty, the use of their goods and services, the use of facilities and state of the
Companys owned facilities, the state of the assets and businesses that the Company sells and other matters covered by such contracts, usually up to a specified maximum amount. Based on past experience, claims made under such indemnifications
are rare and the associated estimated fair value of the liability is not material.



|5. | Stock-Based Compensation
|-- | ------------------------

Stock Option Plans

The Company has a stock-based compensation program that provides its Board of Directors broad discretion in creating employee equity
incentives. This program includes incentive and non-statutory stock options, restricted stock units and other types of equity granted under various plans, the majority of which are stockholder approved. Stock options are generally time-based,
vesting over a four-year period with 12.5% of the granted shares vesting six months after the grant date, and the remaining shares vesting at the rate of 6.25% each quarter thereafter for the following 14 quarters over four years and expire up to
ten years from the grant date. Additionally, the Company has an Employee Stock Purchase Plan (ESPP) that allows employees to purchase shares of common stock at 85% of the fair market value at the lower of either the date of enrollment or the date of
purchase. Shares issued as a result of stock option exercises and the Companys ESPP are generally from the Companys new shares. As of August 4, 2007, the Company had approximately 3.1 million shares of common stock reserved for
future issuance under the stock option plans and ESPP.

In April and July 2007, the Companys Board of Directors approved inducement
stock option grants to certain officers of the Company which were made outside of any current Company plan. The Company elected to make inducement option grants to induce and attract higher qualified candidates to accept employment with the Company
and to fill open officer positions. As of August 4, 2007, there were 510,000 shares issued under these awards.

On November 1,
2005, the Company adopted the provision of SFAS 123(R), for its share-based compensation plans. Under SFAS 123(R), the Company is required to recognize stock-based compensation costs based on the estimated fair value at the grant date for its
share-based awards. In accordance with this standard, the Company recognizes the compensation cost of all share-based awards on a straight-line basis over the vesting period of the award.



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The following table illustrates the stock-based compensation expense resulting from stock options and
ESPP included in the unaudited condensed consolidated statement of operations for the three and nine months ended August 4, 2007 and July 31, 2006 (in thousands):



|                                                             |  |                    |       |                   |   |                |  |               |       |  |   |      
|------------------------------------------------------------ |  | ------------------ | ----- | ----------------- | - | -------------- |  | ------------- | ----- |  | - | -----
|                                                             |  | Three Months Ended |       | Nine Months Ended
|                                                             |  | August 4, 2007     |       | July 31, 2006     |   | August 4, 2007 |  | July 31, 2006
|Cost of goods sold                                           |  | $                  | 62    |                   | $ | 313            |  | $             | 248   |  | $ | 492  
|Research and development                                     |  |                    | 513   |                   |   | 615            |  |               | 1,259 |  |   | 1,545
|Selling, general and administrative                          |  |                    | 579   |                   |   | 822            |  |               | 2,637 |  |   | 2,357
|                                                             |  |                    |       |                   |   |                |  |               |       |  |   |      
|Stock-based compensation expense before income taxes benefit |  | $                  | 1,154 |                   | $ | 1,750          |  | $             | 4,144 |  | $ | 4,394
|Income tax benefit                                           |  |                    |      |                   |   |               |  |               |      |  |   |     
|                                                             |  |                    |       |                   |   |                |  |               |       |  |   |      
|Stock-based compensation expense after income taxes benefit  |  | $                  | 1,154 |                   | $ | 1,750          |  | $             | 4,144 |  | $ | 4,394
|                                                             |  |                    |       |                   |   |                |  |               |       |  |   |      

As of August 4, 2007 and July 31, 2006, the Company capitalized $0.3 million and $0.1
million of stock-based compensation expense as inventory, respectively.

Summary of activity under stock option plans for the nine months ended
August 4, 2007:



|                                             |  |                             |   |  |                               |   |  |                                          |       |                           |   |                                             |  |     
|-------------------------------------------- |  | --------------------------- | - |  | ----------------------------- | - |  | ---------------------------------------- | ----- | ------------------------- | - | ------------------------------------------- |  | ----
|                                             |  | Options Available for Grant |   |  | Number of Options Outstanding |   |  | Weighted Average Exercise Priceper
share |       | Aggregate Intrinsic Value |   | Weighted Average Remaining Contractual Life
|                                             |  | (In thousands)              |   |  | (In thousands)                |   |  |                                          |       | (In thousands)            |   | (In years)                                 
|Balance at October 31, 2006                  |  | 4,425                       |   |  | 17,092                        |   |  | $                                        | 12.48 |                           |   |                                             |  |     
|Options granted                              |  | (3,085                      | ) |  | 3,463                         |   |  | $                                        | 2.10  |                           |   |                                             |  |     
|Options canceled                             |  | 970                         |   |  | (987                          | ) |  | $                                        | 7.07  |                           |   |                                             |  |     
|Options forfeited/expired                    |  |                            |   |  | (4,173                        | ) |  | $                                        | 11.95 |                           |   |                                             |  |     
|Options exercised                            |  |                            |   |  | (47                           | ) |  | $                                        | 1.94  |                           |   |                                             |  |     
|                                             |  |                             |   |  |                               |   |  |                                          |       |                           |   |                                             |  |     
|Balance at August 4, 2007                    |  | 2,310                       |   |  | 15,348                        |   |  | $                                        | 11.24 |                           | $ | 20,371                                      |  | 4.44
|                                             |  |                             |   |  |                               |   |  |                                          |       |                           |   |                                             |  |     
|Vested or expected to vest at August 4, 2007 |  |                             |   |  | 10,823                        |   |  | $                                        | 13.54 |                           | $ | 5,683                                       |  | 4.44
|                                             |  |                             |   |  |                               |   |  |                                          |       |                           |   |                                             |  |     
|Exercisable at August 4, 2007                |  |                             |   |  | 10,777                        |   |  | $                                        | 13.55 |                           | $ | 5,623                                       |  | 4.44
|                                             |  |                             |   |  |                               |   |  |                                          |       |                           |   |                                             |  |     

Restricted stock is granted from the pool of options available for grant. The Companys plan
requires that for every share of restricted stock issued, the Company will be counted against the plan limit as 1.4 shares in the above table.

The weighted-average grant date fair value per options granted during the three and nine months ended August 4, 2007 was $1.76 and $2.10, respectively. The weighted-average grant date fair value per options granted during the three and
nine months ended July 31, 2006 was $2.01 and $3.50, respectively. The total intrinsic value of options exercised during the three and nine months ended August 4, 2007 was $3,200 and $22,000, respectively. The total intrinsic value of
options exercised during the three and nine months ended July 31, 2006 was approximately $5,200 and $0.5 million, respectively. Cash proceeds from the exercise of stock options were $4,200 and $22,100 for the three and nine months ended
August 4, 2007, respectively. Cash proceeds from the exercise of stock options were $39,000 and $2.0 million for the three and nine months ended July 31, 2006, respectively. No income tax benefit was realized from the stock option
exercises during the three and nine-month periods ended August 4, 2007 and July 31, 2006, respectively. Stock-based compensation expense related to stock options recognized under SFAS 123(R) for the three and nine month periods ended
August 4, 2007 was $0.9 million and $3.3 million, respectively. Stock-based compensation expense related to stock options recognized under SFAS 123(R) for the three and nine months ended July 31, 2006 was $1.3 million and $3.2 million,
respectively. The Company generally settles employee stock option exercises with newly issued common shares. At August 4, 2007, there was $12.5 million of unrecognized stock-based compensation expense related to non-vested options that is
expected to be recognized over a weighted-average period of 3.0 years.

The fair value of option grants was estimated by using the
Black-Scholes-Merton model with the following weighted-average assumptions for the three and nine months ended August 4, 2007 and July 31, 2006, respectively:



|                         |  |                    |   |  |                   |   |  |               |   |  |              |  
|------------------------ |  | ------------------ | - |  | ----------------- | - |  | ------------- | - |  | ------------ | -
|                         |  | Three Months Ended |   |  | Nine Months Ended |  
|                         |  | August 4, 2007     |   |  | July 31,2006      |   |  | August 4,2007 |   |  | July 31,2006 |  
|Expected volatility      |  | 58                 | % |  | 54                | % |  | 58            | % |  | 54           | %
|Dividend yield           |  |                   |   |  |                  |   |  |              |   |  |             |  
|Risk-free interest rate  |  | 4.9                | % |  | 5.0               | % |  | 4.6           | % |  | 4.8          | %
|Expected term (in years) |  | 4.0                |   |  | 4.0               |   |  | 4.0           |   |  | 4.0          |  

Expected Volatility: The Companys computation of expected volatility for the three
and nine month periods ended August 4, 2007 and July 31, 2006 is based on a combination of implied volatilities from traded options on the Companys stock and historical volatility. The selection of a combination of the implied and
historical volatility approach was based upon the availability of actively traded options on the Companys stock and the Companys assessment that this combination is more representative of future stock price trends than historical
volatility alone.

Dividend Yield: The dividend yield assumption is based on the Companys history and expectation of dividend
payouts.

Risk-Free Interest Rate: The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of
grant for the expected term of the option.

Expected Term: The Companys expected term represents the period that the
Companys stock-based awards are expected to be outstanding and was determined for the three and nine month periods ended August 4, 2007 and July 31, 2006 based on historical experience of similar awards, giving consideration to the
contractual terms of the stock-based awards, vesting schedules and expectations of future employee behavior.

Forfeitures Rate:
Compensation expense recognized in the condensed consolidated statement of operations for the three and nine month periods ended August 4, 2007 and July 31, 2006 are based on awards ultimately expected to vest and it reflects estimated
forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Prior to adoption of SFAS 123(R), the Company accounted for
forfeitures as they occurred.



9



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##### Table of Contents

Employee Stock Purchase Plan (ESPP)

In 1994, the Company adopted the 1994 Employee Stock Purchase Plan (the 1994 Plan), which provides direct employees, employed with the Company for at least thirty consecutive days as of the entry date into any
offering period, with the opportunity to acquire shares of the Companys common stock. Employees may contribute up to 10% of their base salary to the plan. The Company has a one-year rolling plan with two six-month purchases within the offering
period. The purchase price is 85% of the fair market value per share of common stock at the beginning of the offering period or the end of the purchase period, whichever is lower. If the fair market value per share is lower on the purchase date than
the beginning of the offering period, the current offering period will terminate and a new one-year offering period will commence. The plan restricts the maximum number of shares that an employee can purchase to 1,500 shares each semi-annual period
and to $25,000 worth of common stock each year. At August 4, 2007, there were 762,000 shares reserved for issuance under the 1994 Plan.

The fair value of issuances under the 1994 Plan is estimated on the issuance date by applying the principles of FASB Technical Bulletin 97-1 (FTB 97-1), Accounting under Statement 123 for Certain Employee Stock Purchase Plan with a
Look Back Option (FTB 97-1) and using the Black-Scholes-Merton options pricing model. During the nine months ended August 4, 2007 and July 31, 2006, the Company issued 541,306 shares and 263,044 shares, respectively, under the 1994
Plan. Total cash received for the issuance of shares under the employee stock purchase plan was approximately $0.9 million and $1.9 million during the nine months ended August 4, 2007 and July 31, 2006, respectively. Stock-based
compensation expense related to the 1994 Plan recognized under SFAS 123(R) for the three and nine month periods ended August 4, 2007 was $0.3 million and $0.8 million, respectively. Stock-based compensation expense related to the 1994 Plan
recognized under SFAS 123(R) in the three and nine months ended July 31, 2006 was $0.5 million and $1.2 million, respectively. At August 4, 2007, there was $0.1 million of unrecognized stock-based compensation expense related to
outstanding ESPP shares and is expected to be recognized over a one-month period.

The fair value of awards granted under the 1994 Plan
stock-based compensation was estimated by using the Black-Scholes-Merton model with the following weighted-average assumptions for the three and nine months ended August 4, 2007 and July 31, 2006, respectively:



|                         |  |                    |   |  |                   |   |  |               |   |  |              |  
|------------------------ |  | ------------------ | - |  | ----------------- | - |  | ------------- | - |  | ------------ | -
|                         |  | Three Months Ended |   |  | Nine Months Ended |  
|                         |  | August 4,2007      |   |  | July 31,2006      |   |  | August 4,2007 |   |  | July 31,2006 |  
|Expected volatility      |  | 61                 | % |  | 50                | % |  | 61            | % |  | 50           | %
|Dividend yield           |  |                   |   |  |                  |   |  |              |   |  |             |  
|Risk-free interest rate  |  | 4.8                | % |  | 4.7               | % |  | 4.8           | % |  | 4.4          | %
|Expected term (in years) |  | 0.5                |   |  | 0.5               |   |  | 0.5           |   |  | 0.5          |  



|6. | 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):



|                |  |               |        |                 |   |       
|--------------- |  | ------------- | ------ | --------------- | - | ------
|                |  | August 4,2007 |        | October 31,2006
|Raw materials   |  | $             | 46,908 |                 | $ | 36,436
|Work-in-process |  |               | 17,110 |                 |   | 14,097
|Finished goods  |  |               | 3,443  |                 |   | 4,667 
|                |  |               |        |                 |   |       
|Total           |  | $             | 67,461 |                 | $ | 55,200
|                |  |               |        |                 |   |       



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|7. | Balance Sheet Components
|-- | ------------------------

Prepaid expenses and
other current assets consist of the following (in thousands):



|                                                  |  |               |        |                 |   |       
|------------------------------------------------- |  | ------------- | ------ | --------------- | - | ------
|                                                  |  | August 4,2007 |        | October 31,2006
|Receivables from contract equipment manufacturers |  | $             | 1,186  |                 | $ | 2,565 
|Value added tax receivable                        |  |               | 6,001  |                 |   | 3,613 
|Other prepaid expenses                            |  |               | 8,997  |                 |   | 8,333 
|                                                  |  |               |        |                 |   |       
|Total                                             |  | $             | 16,184 |                 | $ | 14,511
|                                                  |  |               |        |                 |   |       

Property and equipment, net (in thousands):



|                              |  |               |          |   |                 |   |          |  
|----------------------------- |  | ------------- | -------- | - | --------------- | - | -------- | -
|                              |  | August 4,2007 |          |   | October 31,2006 |  
|Land                          |  | $             | 20,682   |   |                 | $ | 24,381   |  
|Buildings                     |  |               | 36,124   |   |                 |   | 35,876   |  
|Machinery and equipment       |  |               | 109,776  |   |                 |   | 106,824  |  
|Software                      |  |               | 33,960   |   |                 |   | 33,731   |  
|Leasehold improvements        |  |               | 41,863   |   |                 |   | 40,734   |  
|Furniture and fixtures        |  |               | 10,336   |   |                 |   | 10,696   |  
|                              |  |               |          |   |                 |   |          |  
|                              |  |               | 252,741  |   |                 |   | 252,242  |  
|Less accumulated depreciation |  |               | (174,372 | ) |                 |   | (165,067 | )
|                              |  |               |          |   |                 |   |          |  
|Total                         |  | $             | 78,369   |   |                 | $ | 87,175   |  
|                              |  |               |          |   |                 |   |          |  

Other assets consist of the following (in thousands):



|                     |  |                |        |                  |   |       
|-------------------- |  | -------------- | ------ | ---------------- | - | ------
|                     |  | August 4, 2007 |        | October 31, 2006
|Field service spares |  | $              | 32,577 |                  | $ | 33,633
|Product consignment  |  |                | 6,530  |                  |   | 9,811 
|Other assets         |  |                | 12,116 |                  |   | 5,628 
|                     |  |                |        |                  |   |       
|Total                |  | $              | 51,223 |                  | $ | 49,072
|                     |  |                |        |                  |   |       

Field service spares used in the Companys service business are classified as long-term
assets and are amortized using the straight-line method over five years. Amortization expense was approximately $2.9 million and $2.8 million for the third quarter of fiscal 2007 and 2006, respectively. Amortization expense was approximately $8.3
million and $8.3 million for the nine months ended August 4, 2007 and July 31, 2006, respectively.

Product consignments to
internal and external customers are classified as other assets and are depreciated using the straight-line method over 36 months. Amortization expense was approximately $1.1 million and $2.1 million for the third quarter of fiscal 2007 and 2006,
respectively. Amortization expense was approximately $3.6 million and $6.4 million for the nine months ended August 4, 2007 and July 31, 2006, respectively.

Accrued expenses and other liabilities consist of the following (in thousands):



|                               |  |                |        |                  |   |       
|------------------------------ |  | -------------- | ------ | ---------------- | - | ------
|                               |  | August 4, 2007 |        | October 31, 2006
|Accrued bonuses                |  | $              | 2,909  |                  | $ | 5,914 
|Accrued restructuring expenses |  |                | 3,131  |                  |   | 8,305 
|Other accrued liabilities      |  |                | 25,707 |                  |   | 23,032
|                               |  |                |        |                  |   |       
|Total                          |  | $              | 31,747 |                  | $ | 37,251
|                               |  |                |        |                  |   |       



|8. | Convertible Subordinated Notes
|-- | ------------------------------

Convertible
Subordinated Notes due 2008

In June 2003, the Company issued $180 million of 1.5% convertible subordinated notes (the Notes) due
May 2008 in a private placement. The Notes are unsecured obligations of the Company and are subordinated to all present and future senior indebtedness of the Company. Interest is payable semiannually on May 15 and November 15, commenced on
November 15, 2003. The Notes are convertible into common stock of the Company at an initial conversion price of $11.31 per share, subject to adjustment in certain dilution events. The Notes do not include a beneficial conversion feature or
financial



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##### Table of Contents

covenants. Expenses associated with the offering were capitalized upon issuance and are included in prepaid expense and other current assets and in other
assets in the unaudited condensed consolidated balance sheets. Such expenses are being amortized to interest expenses over the term of the Notes. The Company continues to use the net proceeds of the offering for general corporate purposes, including
working capital and potential acquisitions.

In September 2006, the Company purchased $35 million of the Notes for approximately $32
million in cash. This purchase generated a net gain of approximately $2.8 million which was recorded as other income (expenses), net on the unaudited condensed consolidated statement of operations.

On December 20, 2006, the Company completed the exchange of an aggregate principal amount of $72.5 million of its Notes for a new series of 3.5%
Convertible Senior Subordinated Notes due in May 2010. See below under Convertible Subordinated Notes due 2010, for further discussion of the exchange.

Unamortized debt issuance costs associated with the Notes were $0.4 million and $1.5 million at August 4, 2007 and October 31, 2006, respectively. Amortization of prepaid loan costs are classified
as other income (expense), net on the unaudited condensed consolidated statements of operations. Amortization of prepaid loan costs were $0.1 million and $0.3 for the three months ended August 4, 2007 and July 31, 2006, respectively.
Amortization of prepaid loan costs were $0.4 million and $0.9 million for the nine months ended August 4, 2007 and July 31, 2006, respectively.

Convertible Subordinated Notes due 2010

On December 20, 2006, the Company completed the
exchange of an aggregate principal amount of $72.5 million of 1.5% Convertible Subordinated Notes due in May 2008 for a new series of 3.5% Convertible Senior Subordinated Notes (the New Notes) due in May 2010, as well as the issuance of additional
New Notes with an aggregate principal amount of $50.0 million in a private placement. The New Notes are unsecured obligations of the Company and are subordinated to all present and future senior indebtedness of the Company. Interest is payable
semiannually on May 15 and November 15. The New Notes were issued at an implied initial conversion price of $8.25 per share (subject to adjustment) upon occurrence of certain events specified in the indenture. The New Notes contain a
provision known as net share settlement which requires that, upon conversion of the New Notes, the Company will pay holders in cash for the principal amount of the New Notes which are converted. Any amount in excess of converted principal will be
settled in shares of the Companys common stock, or at its option, in cash. The New Notes do not have financial covenants.

The New
Notes can be converted under certain circumstances, including among others, (a) during any calendar quarter when the volume weighted average price per share of the Companys common stock has been more than 150% of the conversion price for
a specified period ending on the last trading day of the preceding calendar quarter, (b) during the five business days when the trading price per $1,000 principal amount of the New Notes for each day within a specified period was less than 98%
of the product of the volume weighted average price of the common stock for each day in that period and the applicable conversion rate per $1,000 principal amount of the New Note, (c) if the Company distributes to its stockholders, rights or
warrants entitling them to purchase common stock within a specified period at a price less than the closing price of the common stock on the date of issuance, (d) if the Company distributes to its stockholders, assets or securities of the
Company, which distribution has a per share value exceeding 7.5% of the volume weighted average price of the common stock on the business day preceding the declaration date for such distribution, (e) in the event a change in control or
cessation of trading of the Companys stock occurs or is anticipated to occur or (f) at any time during the 60 day period prior to the maturity date. In addition, the Company has the ability to terminate the conversion feature of the New
Notes in the event that the volume weighted average price per share of the Companys common stock has been more than 150% of the conversion price for a specified period. If the Company exercises its right to terminate conversion, the holders of
the New Notes may convert their notes within a specified period. The foregoing description of these conversion events is not necessarily complete and reference is made to the Indenture filed as an exhibit to the Companys Current Report on Form
8-K filed with the SEC on December 21, 2006.

The Company recorded a discount of $6.1 million related to the New Notes since they
were issued at a discount. This amount is being amortized to interest expense over the life of the New Notes, or sooner upon conversion. During the three and nine month periods ended August 4, 2007, the Company recorded related amortization of
$0.4 million and $1.1 million, respectively.

Expenses of $3.4 million associated with the New Notes offering were capitalized upon
issuance and are included in prepaid expenses and other current assets and in other assets in the unaudited condensed consolidated balance sheets. Such expenses are being amortized to interest expenses over the term of the New Notes. Unamortized
debt issuance costs associated with the New Notes were $2.8 million at August 4, 2007. Amortization of prepaid loan costs are classified as other income (expense), net on the unaudited condensed consolidated statements of operations.
Amortization of prepaid loan costs was $0.2 million and $0.6 million for the three and nine month periods ended August 4, 2007, respectively.



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|9. | Goodwill and Other Intangible Assets
|-- | ------------------------------------

Goodwill

During the third quarter of fiscal 2007, the Company recorded goodwill related to pre-acquisition tax contingencies associated with Hypervision, Inc.
in the amount of $2.7 million.

Other Intangible Assets

Other intangible assets subject to amortization were as follows (in thousands):



|                       |  |      |         |                         |   |          |     |  |   |       
|---------------------- |  | ---- | ------- | ----------------------- | - | -------- | --- |  | - | ------
|August 4, 2007         |  | Cost |         | AccumulatedAmortization |   |          | Net
|Purchased technology   |  | $    | 128,441 |                         | $ | (70,900  | )   |  | $ | 57,541
|Customer relations     |  |      | 21,202  |                         |   | (13,386  | )   |  |   | 7,816 
|Maintenance contracts  |  |      | 13,800  |                         |   | (8,740   | )   |  |   | 5,060 
|Product backlog        |  |      | 4,900   |                         |   | (4,900   | )   |  |   |      
|Trademarks             |  |      | 2,053   |                         |   | (2,053   | )   |  |   |      
|Patents                |  |      | 862     |                         |   | (862     | )   |  |   |      
|Non-compete agreements |  |      | 750     |                         |   | (750     | )   |  |   |      
|                       |  |      |         |                         |   |          |     |  |   |       
|Total                  |  | $    | 172,008 |                         | $ | (101,591 | )   |  | $ | 70,417
|                       |  |      |         |                         |   |          |     |  |   |       



|                       |  |      |         |                          |   |         |     |  |   |       
|---------------------- |  | ---- | ------- | ------------------------ | - | ------- | --- |  | - | ------
|October 31, 2006       |  | Cost |         | Accumulated Amortization |   |         | Net
|Purchased technology   |  | $    | 128,481 |                          | $ | (60,977 | )   |  | $ | 67,504
|Customer relations     |  |      | 21,202  |                          |   | (11,958 | )   |  |   | 9,244 
|Maintenance contracts  |  |      | 13,800  |                          |   | (6,670  | )   |  |   | 7,130 
|Product backlog        |  |      | 4,900   |                          |   | (4,900  | )   |  |   |      
|Trademarks             |  |      | 2,053   |                          |   | (2,053  | )   |  |   |      
|Patents                |  |      | 862     |                          |   | (862    | )   |  |   |      
|Non-compete agreements |  |      | 750     |                          |   | (750    | )   |  |   |      
|                       |  |      |         |                          |   |         |     |  |   |       
|Total                  |  | $    | 172,048 |                          | $ | (88,170 | )   |  | $ | 83,878
|                       |  |      |         |                          |   |         |     |  |   |       

Amortization expenses for the other intangible assets were $4.5 million and $4.3 million for the
third quarter of fiscal 2007 and 2006, respectively. Amortization expenses for the other intangible assets were $13.4 million and $12.7 million for the nine months ended August 4, 2007 and July 31, 2006, respectively.

The estimated future amortization expense of purchased intangible assets with definite lives for the next five years is as follows (in thousands):



|                         |  |        |       
|------------------------ |  | ------ | ------
|Fiscal Year Ending       |  | Amount
|Remainder of fiscal 2007 |  | $      | 4,451 
|2008                     |  |        | 15,856
|2009                     |  |        | 13,503
|2010                     |  |        | 10,038
|2011                     |  |        | 8,143 
|Thereafter               |  |        | 18,426
|                         |  |        |       
|Total                    |  | $      | 70,417
|                         |  |        |       



|10. | Net Income (Loss) Per Share
|--- | ---------------------------

Basic and diluted net
income (loss) per share is based upon the weighted average number of common shares outstanding during the period. Diluted net income per share would be based upon the weighted average number of common shares and dilutive-potential common shares
outstanding during the period.

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



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|                                                                                               |  |                    |         |               |                   |          |                |  |               |         |  |   |          |  
|---------------------------------------------------------------------------------------------- |  | ------------------ | ------- | ------------- | ----------------- | -------- | -------------- |  | ------------- | ------- |  | - | -------- | -
|                                                                                               |  | Three Months Ended |         |               | Nine Months Ended |         
|                                                                                               |  | August 4, 2007     |         | July 31, 2006 |                   |          | August 4, 2007 |  | July 31, 2006 |        
|Numerator:                                                                                     |  |                    |         |               |                   |          |                |  |               |         |  |   |          |  
|Numerator for basic net income (loss) per share  net income (loss)                            |  | $                  | 10,338  |               | $                 | (461,366 | )              |  | $             | 6,873   |  | $ | (479,643 | )
|Effect of convertible subordinated notes interest expense and amortization of origination fees |  |                    | 290     |               |                   |         |                |  |               |        |  |   |         |  
|                                                                                               |  |                    |         |               |                   |          |                |  |               |         |  |   |          |  
|Numerator for diluted net income (loss) per share  net income (loss)                          |  | $                  | 10,628  |               | $                 | (461,366 | )              |  | $             | 6,873   |  | $ | (479,643 | )
|                                                                                               |  |                    |         |               |                   |          |                |  |               |         |  |   |          |  
|Denominator:                                                                                   |  |                    |         |               |                   |          |                |  |               |         |  |   |          |  
|Basic average shares outstanding                                                               |  |                    | 101,194 |               |                   | 100,017  |                |  |               | 100,940 |  |   | 99,798   |  
|Effect of convertible subordinated notes                                                       |  |                    | 6,411   |               |                   |         |                |  |               |        |  |   |         |  
|Effect of dilutive options                                                                     |  |                    | 121     |               |                   |         |                |  |               | 127     |  |   |         |  
|                                                                                               |  |                    |         |               |                   |          |                |  |               |         |  |   |          |  
|Denominator for diluted earnings per share                                                     |  |                    | 107,726 |               |                   | 100,017  |                |  |               | 101,067 |  |   | 99,798   |  
|                                                                                               |  |                    |         |               |                   |          |                |  |               |         |  |   |          |  
|Basic net income (loss) per share                                                              |  | $                  | 0.10    |               | $                 | (4.61    | )              |  | $             | 0.07    |  | $ | (4.81    | )
|                                                                                               |  |                    |         |               |                   |          |                |  |               |         |  |   |          |  
|Diluted earnings (loss) per share                                                              |  | $                  | 0.10    |               | $                 | (4.61    | )              |  | $             | 0.07    |  | $ | (4.81    | )
|                                                                                               |  |                    |         |               |                   |          |                |  |               |         |  |   |          |  

At August 4, 2007 and July 31, 2006, there were options to purchase 15,348,293 and
17,991,486 shares of common stock outstanding at a weighted average exercise price of $11.24 and $13.56, respectively, which were excluded from the diluted net loss per share calculation for the three and nine months ended August 4, 2007 and
July 31, 2006 as their effect would be anti-dilutive in each respective period. There were 400,300 shares of restricted stock options which were excluded from the diluted earnings per share calculation for the three and nine month periods ended
August 4, 2007, respectively, as their effect was anti-dilutive in each respective period.

With respect to the convertible
subordinated notes issued in June 2003, there were 6,410,256 shares which were included in the three month period ended August 4, 2007 as their impact on earnings per share was dilutive but were excluded from the diluted earnings per share
calculation for the nine month period ended August 4, 2007, as their effect was anti-dilutive. There were also 15,915,119 shares which were excluded from the diluted earnings per share calculation for the three and nine month periods ended July 31,
2007, as their effect was anti-dilutive in each respective period.

With respect to the convertible subordinated notes issued in December
2006, in accordance with EITF 90-19 Convertible Bonds with Issuer Option to Settle for Cash Upon Conversion and Statement of Financial Accounting Standard No. 128 Earnings per Share, there were no shares included in the
diluted earnings per share calculation for the three and nine month periods ended August 4, 2007, respectively. The principal portion of the notes were excluded from the per share calculation as this portion of the obligation can only be settled in
cash. There were no incremental shares under the as converted method as the initial conversion per share price of $8.25 exceeded the Companys share price for the three and nine month periods ended August 4, 2007.



|11. | Recent Accounting Pronouncements
|--- | --------------------------------

In June 2006, the
FASB issued FIN No. 48, Accounting for Uncertainty in Income Taxes, (FIN 48), which clarifies the accounting for uncertainty in income taxes recognized in an enterprises financial statements in accordance with Statement of
Financial Accounting Standard No. 109, Accounting for Income Taxes. This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. This interpretation also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning
after December 15, 2006. The Company is currently evaluating the impact of adopting this interpretation on its financial position, results of operations and cash flows.

In September 2006, FASB issued Statement of Financial Accounting Standard No. 157, Fair Value Measurements (SFAS 157). SFAS 157
defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions of SFAS 157 are effective for the fiscal year
beginning November 2, 2008. The Company is currently evaluating the impact of the provisions of SFAS 157 on its financial position, results of operations and cash flows.

In February 2007, the FASB issued Statement of Financial Accounting Standard No. 159, The Fair Value Option for Financial
Assets and Financial LiabilitiesIncluding an amendment of FASB Statement No. 115 (SFAS 159). Under SFAS 159, a company may choose, at specified election dates, to measure eligible financial instrument and certain other items at fair
value that are not otherwise required to be so measured. If a company elects the fair value option for an eligible item, changes in that items fair value in subsequent reporting periods must be recognized in current earnings. SFAS 159 is
effective for fiscal year beginning after November 15, 2007. The Company is currently evaluating the impact of SFAS 159 on its financial position, results of operations and cash flows.



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|12. | Sale-Leaseback
|--- | --------------

On February 28, 2007, the Company completed a sale-leaseback transaction involving our corporate headquarters located in Milpitas, California. The properties were sold to NRFC Milpitas Holdings, LLC (purchaser),
an unrelated third party, for a total price of $30.0 million. Simultaneously, the Company agreed to lease the properties back from the purchaser for a period of 10 years, along with four, five-year renewal options upon expiration of the initial
lease term. The initial lease commenced on February 28, 2007, and will expire on February 28, 2017. The annual rent for the first year of the lease is approximately $2.5 million and will increase 2% for each of the following nine years
until the expiration of the initial lease term. As part of the lease agreement, the Company issued a letter of credit in the amount of $5,090,400, which is used as security on the lease. The letter of credit will expire no sooner than
December 31, 2010 unless, including among other conditions, the Company retires the 11/2% convertible
subordinated notes (the Notes) due May 2008 and does not within six months thereafter issue any new debt or equity. Under the terms of the letter of credit, the purchaser will have the right to draw down the amount of the rental obligations in the
event the Company defaults on the terms of the lease including making the monthly payments. The letter of credit is collateralized by restricted cash which is reflected in the other assets section of the unaudited condensed consolidated balance
sheets.

Due to the letter of credit being collateralized by restricted cash, the Company is accounting for this transaction as a
sale/leaseback transaction using the financing method under SFAS 98. Accordingly, the Company recorded the proceeds on its books as long-term liabilities, and the Company is expensing periodic lease payments as interest expense. The sale will not be
recorded until the letter of credit expires or is otherwise terminated.



|13. | Contingencies and Guarantees
|--- | ----------------------------

The Company leases
some of its facilities and equipment under operating leases that expire periodically through 2017.

The future minimum lease payments at
August 4, 2007, are as follows (in thousands):



|                         |  |                                |        |                                          |   |                                  |  |   |       
|------------------------ |  | ------------------------------ | ------ | ---------------------------------------- | - | -------------------------------- |  | - | ------
|                         |  | Committed Gross Lease Payments |        | Leases WrittenOff inRestructuringCharges |   | Net EstimatedFuture LeaseExpense
|Remainder of fiscal 2007 |  | $                              | 1,508  |                                          | $ | 22                               |  | $ | 1,486 
|2008                     |  |                                | 5,198  |                                          |   | 54                               |  |   | 5,144 
|2009                     |  |                                | 4,345  |                                          |   |                                 |  |   | 4,345 
|2010                     |  |                                | 3,482  |                                          |   |                                 |  |   | 3,482 
|2011                     |  |                                | 3,174  |                                          |   |                                 |  |   | 3,174 
|Thereafter               |  |                                | 15,382 |                                          |   |                                 |  |   | 15,382
|                         |  |                                |        |                                          |   |                                  |  |   |       
|                         |  | $                              | 33,089 |                                          | $ | 76                               |  | $ | 33,013
|                         |  |                                |        |                                          |   |                                  |  |   |       

Some of the components that the Company purchases are unique to the Company and must be purchased
in relatively high minimum quantities with long (in excess of three months) lead times. These business circumstances can lead to the Company holding relatively high inventory levels and associated risks. In addition, purchase commitments for unique
components are relatively inflexible in terms of deferral or cancellation. At August 4, 2007, the Company had open and committed purchase orders totaling approximately $52.8 million.

The following summarizes the Companys minimum contractual cash obligations and other commitments at August 4, 2007, and the effect of such
obligations in future periods (in thousands):



|                                                   |  |       |         |                        |   |            |  |            |         |            |   |            |  |            |         |  |   |       |  |   |       
|-------------------------------------------------- |  | ----- | ------- | ---------------------- | - | ---------- |  | ---------- | ------- | ---------- | - | ---------- |  | ---------- | ------- |  | - | ----- |  | - | ------
|                                                   |  | Total |         | Remainderof Fiscal2007 |   | Fiscal2008 |  | Fiscal2009 |         | Fiscal2010 |   | Fiscal2011 |  | Thereafter
|Contractual Obligations:                           |  |       |         |                        |   |            |  |            |         |            |   |            |  |            |         |  |   |       |  |   |       
|Facilities and equipment operating leases (1)      |  | $     | 33,013  |                        | $ | 1,486      |  | $          | 5,144   |            | $ | 4,345      |  | $          | 3,482   |  | $ | 3,174 |  | $ | 15,382
|Convertible subordinated notes (2)                 |  |       | 195,000 |                        |   |           |  |            | 72,500  |            |   |           |  |            | 122,500 |  |   |      |  |   |      
|Interest on convertible subordinated notes         |  |       | 12,823  |                        |   | 1,344      |  |            | 4,875   |            |   | 4,287      |  |            | 2,317   |  |   |      |  |   |      
|Open and non-cancelable purchase order commitments |  |       | 52,830  |                        |   | 23,959     |  |            | 27,995  |            |   | 699        |  |            | 163     |  |   | 14    |  |   |      
|                                                   |  |       |         |                        |   |            |  |            |         |            |   |            |  |            |         |  |   |       |  |   |       
|Total contractual cash obligations                 |  |       | 293,666 |                        |   | 26,789     |  |            | 110,514 |            |   | 9,331      |  |            | 128,462 |  |   | 3,188 |  |   | 15,382
|                                                   |  |       |         |                        |   |            |  |            |         |            |   |            |  |            |         |  |   |       |  |   |       

---

|(1) | Approximately $0.1 million of this total has been accrued for as restructuring
charges in the unaudited condensed consolidated balance sheets as accrued expenses and other liabilities.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | This amount is recorded in the unaudited condensed consolidated balance sheets as
convertible subordinated notes.
|--- | -----------------------------------------------------------------------------------------------------------------



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The Company provides reserves for the estimated costs of product warranties at the time revenue is
recognized. The Company estimates the costs of warranty obligations based on historical experience of known product failure rates, use of materials to repair or replace defective products, and service delivery costs incurred in correcting product
failures.

The following table represents the activity in the warranty accrual for the nine months ended August 4, 2007 and
July 31, 2006 (in thousands):



|                                                 |  |                   |         |   |               |   |         |  
|------------------------------------------------ |  | ----------------- | ------- | - | ------------- | - | ------- | -
|                                                 |  | Nine Months Ended |        
|                                                 |  | August 4,2007     |         |   | July 31, 2006 |  
|Beginning balance                                |  | $                 | 13,514  |   |               | $ | 13,419  |  
|Accruals for warranties issued during the period |  |                   | 17,424  |   |               |   | 13,291  |  
|Adjustments of prior period accrual estimates    |  |                   | (117    | ) |               |   | (150    | )
|Warranty claims made during the period           |  |                   | (17,868 | ) |               |   | (13,388 | )
|                                                 |  |                   |         |   |               |   |         |  
|Ending balance                                   |  | $                 | 12,953  |   |               | $ | 13,172  |  
|                                                 |  |                   |         |   |               |   |         |  

The Company occasionally offers warranties in excess of one year. Revenues associated with
warranties beyond one year are deferred and recognized over the relevant period. Costs that are directly related to services performed for warranties in excess of one year are charged to expense as incurred.

Legal Proceedings

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



|14. | Comprehensive Income (Loss)
|--- | ---------------------------

The Companys
accumulated other comprehensive income consists of the accumulated net unrealized gains or losses on available-for-sale investments and foreign currency translation adjustments. At August 4, 2007 and July 31, 2006, the Company had a
balance of net unrealized gains (losses) of $22,000 and $(0.2) million, respectively, on available-for-sale investments. Additionally, at August 4, 2007 and July 31, 2006, the Company had a balance of $2.3 million and $2.1 million,
respectively, of net foreign currency translation gains.

The components of comprehensive income (loss), net of tax, are as follows for the
periods indicated (in thousands):



|                                                           |  |                    |        |   |                   |   |          |               |  |              |       |  |   |          |  
|---------------------------------------------------------- |  | ------------------ | ------ | - | ----------------- | - | -------- | ------------- |  | ------------ | ----- |  | - | -------- | -
|                                                           |  | Three Months Ended |        |   | Nine Months Ended |  
|                                                           |  | August 4,2006      |        |   | July 31,2006      |   |          | August 4,2007 |  | July 31,2006 |      
|Net income (loss)                                          |  | $                  | 10,338 |   |                   | $ | (461,366 | )             |  | $            | 6,873 |  | $ | (479,643 | )
|                                                           |  |                    |        |   |                   |   |          |               |  |              |       |  |   |          |  
|Unrealized gains (losses) on available-for sale securities |  |                    | 3      |   |                   |   | (6       | )             |  |              | 22    |  |   | (230     | )
|Currency translation adjustment                            |  |                    | (54    | ) |                   |   | 763      |               |  |              | 2,258 |  |   | 2,073    |  
|                                                           |  |                    |        |   |                   |   |          |               |  |              |       |  |   |          |  
|Other comprehensive (loss) income                          |  |                    | (51    | ) |                   |   | 757      |               |  |              | 2,280 |  |   | 1,843    |  
|                                                           |  |                    |        |   |                   |   |          |               |  |              |       |  |   |          |  
|Total comprehensive income (loss)                          |  | $                  | 10,287 |   |                   | $ | (460,609 | )             |  | $            | 9,153 |  | $ | (477,800 | )
|                                                           |  |                    |        |   |                   |   |          |               |  |              |       |  |   |          |  



|15. | Restructuring Charges
|--- | ---------------------

During previous years, the
Company has recorded restructuring charges as it rationalized operations in light of customer demand declines and the economic downturn. The measures, which included reducing the workforce, consolidating facilities and changing the strategic focus
of a number of sites, were largely intended to align the Companys capacity and infrastructure to anticipated customer demand and transition its operations for higher utilization of facility space. The restructuring charges include employee
severance and benefit costs, and costs related to leased facilities vacated, net of



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##### Table of Contents

estimated sublease income. Severance and benefit costs and other costs associated with restructuring activities were recorded in compliance with Statement of
Financial Accounting Standard No. 146, Accounting for Costs Associated with Exit or Disposal Activities, (SFAS 146). During October 2004, the Company also adopted Statement of Financial Accounting Standard No. 112,
Employers Accounting for Post Employment Benefits, (SFAS 112), for severance and benefit costs as the Company concluded that (a) the Company has a substantive post employment benefit obligation that is attributed to prior
services rendered, (b) rights to those benefits have vested, and (c) payment is probable and the amount can be reasonably estimated. This accounting for restructuring costs requires the Company to record provisions and charges when it has
a formal and committed restructuring plan.

The following table illustrates the activity for the nine-month period ended August 4,
2007 and the estimated timing of future payouts for major restructuring categories (in thousands):



|                                    |  |                             |         |   |         |   |          |  |             |       |  |                           |        |   |  |   |        |  
|----------------------------------- |  | --------------------------- | ------- | - | ------- | - | -------- |  | ----------- | ----- |  | ------------------------- | ------ | - |  | - | ------ | -
|                                    |  | Balance at October 31, 2006 |         |   | Charges |   | Utilized |  | Adjustments |       |  | Balance at August 4, 2007 |       
|Severance                           |  | $                           | (5,029  | ) |         | $ |         |  | $           | 4,158 |  | $                         | (1,039 | ) |  | $ | (1,910 | )
|Operating leases                    |  |                             | (5,554  | ) |         |   |         |  |             | 3,146 |  |                           | 30     |   |  |   | (2,378 | )
|                                    |  |                             |         |   |         |   |          |  |             |       |  |                           |        |   |  |   |        |  
|Total                               |  | $                           | (10,583 | ) |         | $ |         |  | $           | 7,304 |  | $                         | (1,009 | ) |  | $ | (4,288 | )
|                                    |  |                             |         |   |         |   |          |  |             |       |  |                           |        |   |  |   |        |  
|Estimated timing of future payouts: |  |                             |         |   |         |   |          |  |             |       |  |                           |        |   |  |   |        |  
|Remainder of fiscal 2007            |  |                             |         |   |         |   |          |  |             |       |  |                           |        |   |  |   | 1,870  |  
|Fiscal 2008                         |  |                             |         |   |         |   |          |  |             |       |  |                           |        |   |  |   | 1,169  |  
|Fiscal 2009                         |  |                             |         |   |         |   |          |  |             |       |  |                           |        |   |  |   | 1,249  |  
|                                    |  |                             |         |   |         |   |          |  |             |       |  |                           |        |   |  |   |        |  
|Total                               |  |                             |         |   |         |   |          |  |             |       |  |                           |        |   |  | $ | 4,288  |  
|                                    |  |                             |         |   |         |   |          |  |             |       |  |                           |        |   |  |   |        |  

For the three and nine months ended August 4, 2007, the Company recorded restructuring
charges of approximately $0.0 million and $1.0 million, respectively, as restructuring charges in operating expenses related to headcount reductions and facilities. For the three and nine months ended July 31, 2006, the Company recorded
restructuring charges of approximately $1.8 million and $3.2 million, respectively, as operating expenses related to headcount reductions, facilities, fixed assets write-off and other liabilities related to the discontinuation of the memory
products.



|16. | Employee Benefit Plans
|--- | ----------------------

The Company maintains a
401(k) retirement savings plan for its full-time domestic employees, which allows them to contribute up to 20% of their pre-tax wages subject to IRS limits. The Companys contribution to this plan for the three and nine months ended
August 4, 2007 was approximately $0.4 million and $1.4 million, respectively. The Companys contribution to this plan for the three and nine months ended July 31, 2006 was approximately $0.4 million and $1.6 million, respectively.

Outside of the United States, the Company also assumed several defined benefit and defined contribution plans that cover substantially all
employees as part of its acquisition of NPTest in May 2004. Where applicable, employees are covered by statutory plans. For defined benefit plans, charges to expense are based upon costs computed by independent actuaries. These plans are
substantially fully funded with trustees in respect to past and current service. At August 4, 2007, the pension liability was $0.6 million. The expenses associated with these plans were not material for the nine months ended August 4, 2007
and July 31, 2006.

The Company has a deferred compensation plan for certain employees (a Rabbi Trust or
trust). The assets in the Rabbi Trust, consisting of cash equivalents and debt and equity securities, are recorded at current market prices. The trust assets are available to satisfy claims of the Companys general creditors in the
event of its bankruptcy. The trusts assets of approximately $1.8 million at August 4, 2007 are included in other assets, and the corresponding deferred compensation liability is included in the other liabilities in the accompanying
unaudited condensed consolidated balance sheets.



|17. | Industry Segment
|--- | ----------------

Operating segments are business
units that have separate financial information and are separately reviewed by the Companys chief decision makers. The Companys chief decision makers are the Chief Executive Officer and Chief Financial Officer. The Company and its
subsidiaries currently operate in a single industry segment: the design, development, manufacture, sale and service of advanced semiconductor test and diagnostic systems used in the production of semiconductors. The Company has a single reporting
unit for purposes of Statement of Financial Accounting Standard No. 131, Disclosure About Segments of an Enterprise and Related Information, (SFAS 131), advanced semiconductor test and diagnostic systems, primarily because all of
the components of the Companys advanced semiconductor test and diagnostic systems segment are subject to similar economic characteristics, have similar production processes, have common customers, and are distributed using the same channels.



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The Companys net sales by product line consisted of:



|                                 |  |                    |   |  |                   |   |  |               |   |  |              |  
|-------------------------------- |  | ------------------ | - |  | ----------------- | - |  | ------------- | - |  | ------------ | -
|                                 |  | Three Months Ended |   |  | Nine Months Ended |  
|                                 |  | August 4,2007      |   |  | July 31,2006      |   |  | August 4,2007 |   |  | July 31,2006 |  
|SoC                              |  | 48                 | % |  | 30                | % |  | 46            | % |  | 33           | %
|Analog Mixed Signal              |  | 23                 |   |  | 36                |   |  | 24            |   |  | 32           |  
|Memory                           |  |                   |   |  | 3                 |   |  | 1             |   |  | 2            |  
|Diagnostics and Characterization |  | 9                  |   |  | 5                 |   |  | 7             |   |  | 8            |  
|Service and Other                |  | 20                 |   |  | 26                |   |  | 22            |   |  | 25           |  
|                                 |  |                    |   |  |                   |   |  |               |   |  |              |  
|Total                            |  | 100                | % |  | 100               | % |  | 100           | % |  | 100          | %
|                                 |  |                    |   |  |                   |   |  |               |   |  |              |  

Most of the Companys products are manufactured in the United States. Export sales from the
United States are primarily denominated in United States dollars, but are occasionally denominated in Japanese Yen or Euros. The automotive products are manufactured in Germany and these sales are denominated in United States dollars, Japanese Yen
or Euros. All of the Companys products are shipped to the Companys customers throughout North America, Asia Pacific, Europe, and the Middle East. Sales by the Company to customers in different geographic areas, expressed as a percentage
of net sales, for the periods ended were:



|                             |  |                    |   |  |                   |   |  |               |   |  |              |  
|---------------------------- |  | ------------------ | - |  | ----------------- | - |  | ------------- | - |  | ------------ | -
|                             |  | Three Months Ended |   |  | Nine Months Ended |  
|                             |  | August 4,2007      |   |  | July 31,2006      |   |  | August 4,2007 |   |  | July 31,2006 |  
|North America                |  | 38                 | % |  | 26                | % |  | 28            | % |  | 32           | %
|Singapore                    |  | 9                  |   |  | 16                |   |  | 20            |   |  | 19           |  
|Taiwan                       |  | 19                 |   |  | 15                |   |  | 14            |   |  | 12           |  
|Southeast Asia               |  | 7                  |   |  | 13                |   |  | 8             |   |  | 10           |  
|Japan & rest of Asia Pacific |  | 8                  |   |  | 11                |   |  | 9             |   |  | 11           |  
|Germany                      |  | 12                 |   |  | 10                |   |  | 14            |   |  | 6            |  
|Europe & Middle East         |  | 7                  |   |  | 9                 |   |  | 7             |   |  | 10           |  
|                             |  |                    |   |  |                   |   |  |               |   |  |              |  
|Total                        |  | 100                | % |  | 100               | % |  | 100           | % |  | 100          | %
|                             |  |                    |   |  |                   |   |  |               |   |  |              |  

For the three months ended August 4, 2007, two customers accounted for 26% and 17% of the
Companys net sales. For the nine months ended August 4, 2007, two customers accounted for 32% and 15% of the Companys net sales. For the three months ended July 31, 2006, three customers accounted for 17%, 13% and 11% of the
Companys net sales. For the nine months ended July 31, 2006, two customers accounted for 20% and 14% of the Companys net sales.

As of August 4, 2007, three customers accounted for 28%, 21%, and 18% of the Companys gross accounts receivable. As of October 31, 2006, two customers accounted for 36% and 10% of the Companys gross receivables,
respectively.

As of August 4, 2007 and October 31, 2006, the majority of the Companys long-lived assets were attributable
to its United States operations.



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ITEM 2.MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This quarterly 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, including
statements using terminology such as may, will, expects, plans, anticipates, goals, estimates, potential, or continue, or the negative
thereof or other comparable terminology regarding beliefs, plans, expectations or intentions regarding the future. Forward-looking statements include statements regarding our revenue recognition practices regarding new enhancements, systems and
products; the impact of the adoption of certain accounting pronouncements on the Companys financial position, results of operations and cash flow; our belief that our sales, gross margins and operating results will fluctuate significantly in
the future; our belief that our embedded software is incidental to our products; our belief that our tax positions are consistent with the tax positions in the jurisdictions in which we conduct business; estimated future restructuring payments; our
anticipation that net sales will be approximately $101.0 million to $105.0 million for the fourth quarter of fiscal year 2007; our belief that our gross margin percentage will be approximately 49% in the fourth quarter of fiscal year 2007; our
anticipation that R&D expenses will be slightly lower in the fourth quarter of fiscal year 2007 as compared to the third quarter of fiscal year 2007; our expectation that SG&A expenses will be slightly lower in the fourth quarter of fiscal
year 2007 as compared to the third quarter of fiscal year 2007; our expectation that we will maintain a full valuation allowance on United States deferred assets until we can sustain an appropriate level of profitability; our expectation that we
will not recognize any significant tax benefits in our results of operations; domestic tax benefits; our belief that investments in inventory will continue to represent a significant portion of our working capital; the highly cyclical semiconductor
industry may experience downturns; our belief that our current cash and investment positions combined with our ability to borrow funds will be sufficient to meet our anticipated business requirements for the next 12 months; that we will continue to
assess the need to use derivatives in the future; our expectation that a 10% change in interest rate will not have any material effect on our interest expense; our belief that our net sales and operating results will continue to fluctuate; our
intention to introduce new products and product enhancements; our belief that our gross margins on systems sales will continue to vary significantly; our expectation that 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 results of operations in the future; our expectation that our top ten customers in the
aggregate will continue to account for a large portion of our net sales for the foreseeable future; our intent to outsource in the future and our expectation that we will achieve operational flexibility and costs savings as a result of outsourcing;
our belief that significant portions of our new orders are dependent upon demand from semiconductor device manufacturers building or expanding fabrication facilities and new device testing requirements; our belief that stock options and other
long-term equity incentives directly motivate our employees to maximize long-term stockholder value and, through the use of vesting, encourage employees to remain with us; our belief that order cancellations and customer-requested shipment delays
will occur in the future; our belief that in the future some of our customers may 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; our belief that we
may continue to incur substantial unanticipated costs to increase feature sets in our systems; our belief that we may continue to suffer reduced orders, higher manufacturing costs, delay in collecting accounts receivable and higher service, support
and warranty expenses, and/or inventory write-offs, among other effects; our belief that the continued acceptance, volume production, timely delivery and customer satisfaction of our newer digital, mixed signal and non-volatile memory testers is of
critical importance to our future financial results; our success in developing new and enhanced systems and new features to our existing systems being dependent upon a variety of factors; our intent to continue to devote significant resources to the
development, enhancement, production and commercialization of new products and technologies; our intent to continue to invest significant resources in property, plant and equipment, purchased and leased facilities, inventory, personnel and other
costs to begin or prepare to increase production; our belief 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 subsequent generations of products; our belief that the ATE industry in total has not been profitable for the last three years; our belief that we will continue to face significant additional competition from
larger competitors that may offer product lines and services more complete than ours; our belief that to be competitive, we must expend significant financial resources to invest in new product development and enhancements and to maintain customer
service and support centers worldwide; the repatriation of our cash from our foreign subsidiaries to the United States and the incurrence of additional income taxes from repatriation; our anticipation that international sales will continue to
account for a significant portion of our total net sales in the foreseeable future and will be subject to certain risks; our intent to continue to address the need to develop new products and enhance existing products through acquisitions of other
companies, product lines, technologies and personnel; our expectation to continue to receive notice of patent infringement claims in the future; our expectation that we will incur additional administrative expense as we implement Section 404 of
the Sarbanes-Oxley Act; our expectation that the law, rules and regulations relating to corporate governance will continue to increase the scope, complexity and cost of our corporate governance, reporting and disclosure practices and make it more
difficult and more expensive for us to obtain director and officer liability insurance; our belief that our ability to compete in the Automatic Test Equipment market depends upon our ability to successfully develop and introduce new products and



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enhancements with enhanced features on a timely and cost-effective basis, including products under development internally as well as products obtained in
acquisition; sales levels in Taiwan; future minimum lease payments; minimum contractual cash obligations and the effect of such obligations in future periods; the highly competitive nature of the ATE industry which is subject to rapid technological
change; our expectation regarding the recognition of stock-based compensation expense; our belief that collectibility is reasonably assured in connection with certain advance shipments of systems; our expectation that the sale of our corporate
headquarters will not be recorded until the letter of credit expires or is otherwise terminated; that in the opinion of management, none of the claims arising in the ordinary course of business will have a material adverse effect on our business,
financial condition or results of operations; that we continue to evaluate the impact of SFAS 123(R) on our operating results and financial condition; that we do not anticipate paying any cash dividends in the foreseeable future; that the risks
detailed will likely be present in all periods reported; certain beliefs regarding the effect of management on our future operating results; that our business, financial condition or results of operations will continue to be materially adversely
affected by continuing competitive pressure and continued intense price-based competition.

These forward-looking statements involve
important factors that could cause our actual results to differ materially from those in the forward-looking statements. Such important factors involve risks and uncertainties including, but not limited to difficulties in utilizing different
technologies; delays in bringing products to market due to development problems; difficulties in developing new engineering validation test systems; the possibility that our existing systems will become obsolete; excessively high costs in the future
related to enhancing our existing systems; significant changes in customer preferences; difficulties in integrating acquired technology with our product lines; the possibility that competitors will introduce products faster than us; unanticipated
difficulties in building close working relationships with vendors; difficulties in developing the Sapphire platform; less sales of the Sapphire platform products than anticipated; product defects sustained during the manufacturing process; the risk
that we may not be successful in obtaining new orders from major customers; unanticipated decreases in demand for our products in foreign countries; difficulties in providing extensive support to major customers; unanticipated difficulties in
manufacturing and delivering new products; unanticipated difficulties in integrating our products with customers operations; unanticipated difficulties in integrating developed technology; substantial technological changes in the semiconductor
industry; a lack of the required resources to invest in the development of new products; uncertainties as to the current products provided by our competitors; unanticipated difficulties in locating and evaluating potential product lines,
technologies and business to acquire; the viability of legal claims brought against us; our failure to accurately predict the effect of the ultimate outcome of claims on our business, financial condition or results of operations; lower than expected
revenues; the risk that we may be required to expend more cash in the future than anticipated; difficulties in obtaining orders from manufacturers of semiconductors and companies that specialize in contract packaging and/or testing of
semiconductors; the timing of orders; an unanticipated lack of resources to invest in property, plant and equipment, purchased and leased facilities, inventory, personnel and other costs; changing market conditions in Taiwan; inaccuracies in our
assumptions regarding our tax positions; uncertainties as to the nature and extent of any potential cyclical downturn in the semiconductor industry; uncertainties as to the prospect of future orders and sales levels; changes in laws applicable to us
regarding revenue recognition practices relating to our new products; uncertainties as to the future level of sales and revenues; unanticipated budgetary constraints; uncertainties as to the assumptions underlying our calculations regarding
estimated annual amortization expenses for purchased intangible assets; uncertainties as to the effects of the adoption by us of certain accounting policies; the risk that our future working capital will not be sufficient to invest significant
portions of such working capital in inventories; uncertainties as to the effect of the adoption of certain accounting pronouncements; unanticipated difficulties in the remediation of internal control deficiencies; increased fragmentation in the ATE
industry; cost overruns, delayed deliveries, shortages, quality issues or other problems resulting from outsourcing; our inability to collect upon certain advance shipments of systems and other factors set forth in Risk Factors and
elsewhere herein. Reference is made to the discussion of risk factors detailed in our filings with the Securities and Exchange Commission, including our reports on Form 10-K and 10-Q. All projections in this Quarterly Report on Form 10-Q are based
on limited information currently available to us, which is subject to change. Although any such projections and the factors influencing them will likely change, we will not necessarily update the information, since we are only to provide guidance at
certain points during the year. Actual events or results could differ materially and no reader of this Form 10-Q should assume that the information provided today would still be valid in the future. Such information speaks only as of the date of
this Form 10-Q.

OVERVIEW

We serve a
broad spectrum of the semiconductor industrys testing needs through a wide range of products that test digital logic, mixed-signal, system-on-a-chip, radio frequency and non-volatile memory semiconductors. We utilize our proprietary
technologies to design products which are intended to provide a lower total cost of ownership than many competing products currently available while meeting the increasingly demanding performance requirements of todays engineering validation
test, diagnostics and failure analysis and ATE markets. Our hardware products are designed to test semiconductors at two stages of their lifecycle; first, at the prototype stage, and, second, as they are produced in high volume. Collectively, our
customers include major semiconductor manufacturers, fabless design houses, foundries and assembly and test services companies.



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We design, manufacture, sell and service engineering validation test equipment, diagnostics and failure
analysis products and automatic test equipment, or ATE, used for testing semiconductor integrated circuits, or ICs. We utilize our proprietary technologies to design products that enable the flexibility needed by our customers to meet their
challenging time to market needs, at a lower total cost of ownership and improved yield learning cycles. Our products help bridge the communication gap between design teams, the foundries used to manufacture their products, and the test and
diagnostics groups involved in characterization and debug for their products. This improves their ability to bring products from concept to yield in todays challenging nano-chip environment. By applying leading-edge technology to
create flexibility and lower the overall cost-of-test, we are committed to deliver innovative technology at a competitive cost and performance advantages to integrated device manufacturers, or IDMs, wafer foundries, outsource assembly and test
suppliers, or OSATs, and fabless chip companies worldwide.

Major business developments during the nine months ended August 4, 2007
and through the date of this Form 10-Q included:



| |  |  | On December 20, 2006, we completed the exchange of an aggregate principal amount of $72.5 million of our 1.5% Convertible Subordinated Notes due in May 2008
for a new series of 3.5% Convertible Senior Subordinated Notes due in May 2010, as well as the issuance of new 3.5% Convertible Senior Subordinated Notes with an aggregate principal amount of $50.0 million.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | On February 28, 2007, we completed the sale of our facilities located at 1355 and 1421 California Circle, Milpitas. The sales price for the property was
$30,000,000. As part of the agreement, we entered into an agreement to lease back the property for a ten-year period, with renewal options.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | During the third quarter of fiscal 2007, we launched the industrys most cost-effective, highest-performing solution for testing microprocessor, gaming, and
graphics devices used in emerging high-speed computing and consumer applications. The Sapphire D-6432DFT instrument is the first integrated test solution for high-speed serial buses to combine at-speed loopback testing with jitter measurement and
injection  along with scan/functional tests and DC parametrics  all in a single insertion. The D-6432DFT delivers four times greater density than comparative offerings, presenting manufacturers with a breakthrough design-for-test (DFT)
methodology that dramatically lowers overall cost and time-to-market of high-speed semiconductor devices.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In the third quarter of fiscal 2007, we achieved our revenue plan for the quarter of $123.5 million and significantly exceeded our gross margin by improving it to
51% and achieved profitability of $10.3 million.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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, our ability to effectively integrate acquisitions, 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,
new accounting pronouncements, regulatory changes and outbreaks of hostilities. Due to these and additional factors, historical results and percentage relationships discussed in this Quarterly 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 unaudited condensed consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The
preparation of these financial statements requires us to make estimates and judgments that affect



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the reported amounts of assets, liabilities, revenues and expenses, as well as the disclosure of contingent assets and liabilities. On an on-going basis, we
evaluate our estimates, including those related to revenue recognition, allowance for doubtful accounts, inventory valuation and residual values related to leased products, long-lived assets valuation, warranty accrual, deferred taxes, restructuring
charges and stock-based compensation. 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 discuss the development and selection of the critical accounting
estimates with the audit committee of our board of directors on a quarterly basis, and the audit committee has reviewed our disclosure relating to them in this Quarterly Report on Form 10-Q.

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

Revenue Recognition:

Under Securities and Exchange Commissions Staff Accounting Bulletin No. 104, Revenue Recognition, (SAB 104), 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. Revenue recognition policies are applied consistently among our semiconductor manufacturing equipment product lines. Systems and
upgrades revenue are recognized upon shipment only when achieving the customer acceptance criteria can be demonstrated prior to shipment, which generally occurs with mature products. Systems and upgrades are classified as mature after several
different customers have accepted similar systems or one customer accepted three of the same system. 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 the fair value of the installation obligation is recognized upon completion of the installation. Service revenues are generally recognized upon performance of the activities requested by the customers. For
some customers in certain countries where collection may be an issue, we may require a letter of credit to be established or cash receipt in advance before revenue can be recognized. Lease revenue is recorded in accordance with Statement of
Financial Accounting Standard No. 13, Accounting for Leases, (SFAS No. 13), which requires that a lessor accounts for each lease by either the direct financing, sales-type or operating method. Revenue from sales-type leases is
recognized at the net present value of future lease payments. Revenue from operating leases is recognized over the lease period.

During
fiscal years 2006 and 2005, we introduced several new enhancements, systems and products. Certain revenues from sales of these new enhancements, systems and products during these years were deferred until the revenue recognition requirements of our
revenue recognition policy are satisfied. This practice will continue in the future. In the past, we experienced significant delays in the introduction and acceptance of new testers as well as certain enhancements to our existing testers. 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.

With respect to arrangements with multiple deliverables, we follow the guidance in EITF 00-21, Revenue Arrangements with Multiple Deliverables, to determine whether there is more than one unit of
accounting. To the extent that the deliverables are separable into multiple units of accounting, we then allocate the total fee on such arrangements to the individual units of accounting using the residual method. We then recognize revenue for each
unit of accounting depending on the nature of the deliverable(s) comprising the unit of accounting (principally following SAB 104).

Sales
in the United States are principally through our direct sales organization consisting of direct sales employees and representatives. Sales outside the United States utilize both direct sales employees and distributors. There are no significant
differences in revenue recognition policies based on the sales channel, due to the business practices that have been adopted with our distributor relationships. Because of these business practices, we do not use price protection,
stock rotation or similar programs with our distributors. In general, we sell product to the distributor on the basis of a purchase order received from an end customer. We evaluate any revenue recognition issues, in such cases, based on
the characterization of the end customer in light of our revenue recognition policy. In order to better respond to customer requirements, we have shipped a limited number of systems to a select number of distributors in advance of receipt of end
customer orders. These orders do not have a right of return and we have concluded that collectibility is reasonably assured on the basis of the payment history we have with those distributors.

Our semiconductor manufacturing equipment includes embedded software. We believe this embedded software is incidental to our products and therefore it is
excluded from the scope of Statement of Position 97-2, Software Revenue Recognition, (SOP 97-2). Also, the embedded software in our products is not sold separately, cannot be used on another



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vendors products, and we cannot fundamentally enhance or expand the capability of the equipment with new or revised embedded software. In addition, the
equipments principal performance characteristics are governed by digital speed and pin count which are primarily a function of the hardware.

Deferred revenue includes deferred revenue related to maintenance contracts (and other undelivered services). Deferred profit is related to equipment that was shipped to certain customers, but the revenue and cost of goods sold were not
recognized because the customer-specified acceptance criteria has not been met as of the fiscal period end or because the customer is deemed to be a high credit risk and payment has not been received as of the fiscal period end.

We warrant our products to our customers generally for one year from the date of shipment. In addition to the provision of standard warranties, we may
offer customer paid extended warranty services with a fixed fee. The fixed fees are recognized as revenue on a straight-line basis over the applicable term of the contract. Related costs are recorded either as incurred or when related liabilities
are determined to be probable and estimable.

For certain customers, typically those with whom we have long-term relationships, we may
grant extended payment terms. Certain of our receivables have due dates in excess of 90 days, and we have a history of successfully collecting these extended payment term accounts receivable.

Allowance for Doubtful Accounts:

We,
along with our sales and distribution partners, perform ongoing credit evaluations of our customers financial condition. We maintain allowances for doubtful accounts for estimated losses resulting from the inability or unwillingness of our
customers to make required payments. We record our bad debt expenses as selling, general and administrative expenses. When we become aware that a specific customer is unable to meet its financial obligations to us, generally because of bankruptcy or
deterioration in the customers operating results or financial position, we record a specific allowance to reflect the level of credit risk in the customers outstanding receivable balance. In addition, we record additional allowances
based on certain percentages of our aged receivable balances. These percentages are determined by a variety of factors including, but not limited to, current economic trends, historical payment and bad debt write-off experience. We are not able to
predict changes in the financial condition of our customers or changes in general economic conditions, and if circumstances related to our customers deteriorate, our estimates of the recoverability of our trade receivables could be materially
affected and we may be required to record additional allowances. Alternatively, if we provide more allowances than we need, we may reverse a portion of such provisions in future periods based on our actual collection experience.

Inventory Valuation and Residual Values Related to Leased Products:

We evaluate our inventory levels and valuations based on our estimates and forecasts of the next cyclical period in our industry. These forecasts require us to estimate our ability to sell current and future products
in the next cyclical industry period and compare those estimates with our current inventory levels. If these forecasts or estimates change, or our product initiatives 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 scrapped or otherwise disposed of.

We monitor
our inventory levels in light of product development changes and expectations of the cyclical period ahead. For the four year period ended October 31, 2006 and nine month period ended August 4, 2007, we recorded a total of $145.6 million
in write down of excess and obsolete inventories. We do not as a matter of course scrap all inventory that is identified as excess or obsolete. Our products are capital goods with potentially long economic lives and, historically, the opportunity to
sell these products has both arisen and fallen unexpectedly. We have occasionally encountered unexpected demand for old products as well as the inability to transition customers to newer products. We closely monitor the inventories that have been
written down but not scrapped, so that if any sales of these items occur and affect our reported gross margins, the effect, if material, is disclosed. We may be required to take additional charges for excess and obsolete inventory if a downturn
causes further reductions to our current inventory valuations or if our current product development plans change.

We consign a portion of
our finished goods to both external and internal customers primarily for the purpose of customer demonstration or applications development. This inventory is categorized as other long-term assets on our unaudited condensed consolidated balance
sheets. We depreciate all consigned inventories during the period that they are held on consignment over periods ranging from 18 months to 36 months. The depreciation expense for consigned inventory is charged to selling, general and administrative
expense.

Residual values assigned to our products that are leased to customers are based on their remaining economic life at the end of
the lease terms. The amounts assigned to the residual values are evaluated periodically based on technological change and the forecasted business cycle.



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Long-Lived Asset Valuation:

Our long-lived assets consist of property and equipment, goodwill and identified intangible assets.

We evaluate the carrying value of our long-lived assets, consisting primarily of purchased intangible assets, and property and equipment, whenever
certain events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable, or at least annually, in accordance with Statement of Financial Accounting Standard No. 144, Accounting for the
Impairment or Disposal of Long-lived Assets, (SFAS 144). Such events or circumstances include, but are not limited to, a prolonged industry downturn, a significant decline in our market value, changes in the planned use of our long-lived
assets, changes in our business model, or significant reductions in projected future cash flows. In assessing the recoverability of our long-lived assets, we compare the carrying value to the undiscounted future cash flows the assets are expected to
generate. If the total of the undiscounted future cash flows is less than the carrying amount of the assets, we write down such assets based on the excess of the carrying amount over the fair value of the assets. Fair value is generally determined
by calculating the discounted future cash flows using a discount rate based upon our weighted average cost of capital. Significant judgments and assumptions are required in the forecast of future operating results used in the preparation of the
estimated future cash flows, including profit margins, long-term forecasts of the amounts and timing of overall market growth and our percentage of that market, groupings of assets, discount rates and terminal growth rates. In addition, significant
estimates and assumptions are required in the determination of the fair value of our tangible long-lived assets, including replacement cost, economic obsolescence, and the value that could be realized in liquidation. Changes in these estimates could
have a material adverse effect on the assessment of our long-lived assets, thereby requiring us to write down the assets. We make certain assessments with respect to the determination of all identifiable assets to be used in the business as well as
research and development activities as of an acquisition date. Each of these activities was evaluated by both interviews and data analysis to determine our state of development and related fair value. The purchased intangibles consist of purchased
technology, customer relations, trademarks, patents and non-compete agreements, and they typically have estimated useful lives of one to ten years.

Warranty Accrual:

We provide reserves for the estimated costs of product warranties at the time revenue is recognized. We
estimate the costs of our warranty obligations based on our historical experience of known product failure rates, use of materials to repair or replace defective products and service delivery costs incurred in correcting product failures. In
addition, from time to time, specific warranty accruals may be made if unforeseen technical problems arise. Should our actual experience relative to these factors differ from our estimates, we may be required to record additional warranty reserves.
Alternatively, if we provide more reserves than we need, we may reverse a portion of such provisions in future periods.

Deferred Taxes:

When we prepare our unaudited condensed consolidated financial statements, we calculate our income taxes based on the various
jurisdictions where we conduct business. This requires us to calculate our actual current tax exposure and to assess temporary differences that result from different treatment of certain items for tax and accounting purposes. These differences
result in deferred tax assets and liabilities, which we show on our unaudited condensed consolidated balance sheets. The net deferred tax assets are reduced by a valuation allowance if, based upon weighted available evidence, it is more likely than
not that some or all of the deferred tax assets will not be realized.

Our net deferred tax asset balance as of August 4, 2007 was
$0.4 million which relates to our foreign subsidiaries that are currently generating taxable income. Our domestic tax assets reflect a full valuation allowance due to uncertainties surrounding our ability to generate future taxable income and our
corresponding ability to utilize our deferred tax assets.

We are a U.S.-based multinational company subject to tax in multiple U.S. and
foreign tax jurisdictions. Our effective tax rate is based on expected income, statutory rates and enacted tax rules, including transfer pricing. Significant judgment is required in determining our effective tax rate and in evaluating our tax
positions on a worldwide basis. We believe our tax positions, including intercompany transfer pricing policies are consistent with the tax laws in the jurisdictions in which we conduct our business. It is possible that these positions may be
challenged which may have an impact on our effective tax rate.

Restructuring Charges:

During previous years, we have recorded restructuring charges as we rationalized operations in light of customer demand declines and the economic
downturn. These measures, which included major changes in senior management, workforce reduction, facilities consolidation and changes to the strategic focus of a number of sites, were largely intended to



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align our capacity and infrastructure to anticipate customer demand and to transition our operations to lower cost regions. The restructuring charges include
employee severance and benefit costs, write-offs of property and equipment and costs related to leased facilities vacated and subleased. Severance and benefit costs and other costs associated with restructuring activities were recorded in accordance
with Statement of Financial Accounting Standard No. 146, Accounting for Costs Associated with Exit or Disposal Activities, (SFAS 146). We also record severance and benefit costs in accordance with Statement of Financial Accounting
Standard No. 112, Employers Accounting for Post Employment Benefits, (SFAS 112), as we conclude that (a) we have a substantive post employment benefit obligation that is attributed to prior services rendered,
(b) rights to those benefits have vested, and (c) payment is probable and the amount can be reasonably estimated. The current accounting for restructuring costs requires us to record provisions and charges when we have a formal and
committed restructuring plan.

Given the significance of, and the timing of the execution of such activities, this process is complex and
involves periodic reassessments of original estimates. We continually evaluate the adequacy of the remaining liabilities under our restructuring initiatives. Although we believe that these estimates accurately reflect the costs of our restructuring
and other plans, actual results may differ, thereby requiring us to record additional provisions or reverse a portion of such provisions.

Stock-Based Compensation:

In December 2004, the FASB issued Statement of Financial Accounting
Standard No. 123(R), Share Based Payment, (SFAS 123(R)). This statement requires that the cost resulting from all share-based payment transactions be recognized in the unaudited condensed consolidated financial statements. In
March 2005, the Securities and Exchange Commission (SEC) released SEC Staff Accounting Bulletin No. 107, Share-Based Payment (SAB No. 107). SAB No. 107 provides the SECs staffs position regarding
the application of SFAS No. 123(R) and certain SEC rules and regulations, and also provides the staffs views regarding the valuation of share-based payment arrangements for public companies. We adopted SFAS 123(R) utilizing the
modified prospective method and will continue to evaluate the impact of SFAS 123(R) on our operating results and financial condition. Our assessment of the estimated compensation charges is affected by our stock price as well as assumptions
regarding a number of complex and subjective variables and the related tax impacts. These variables include, but are not limited to, our stock price volatility and employee stock option exercise behaviors. See Note 5 Stock-Based
Compensation of the Notes to the unaudited condensed consolidated financial statements for further discussion.

We estimate the fair
value of options granted using the Black-Scholes-Merton option valuation model and the assumptions discussed in Note 5, Stock-Based Compensation, of the Notes to the unaudited condensed consolidated financial statements. We estimate the
expected term of options granted based on historical experience of similar awards, giving consideration to the contractual terms of the stock-based awards, vesting schedules and expectations of future employee behavior. We estimate the volatility of
our common stock at the date of grant based on a combination of historical and implied volatilities, consistent with SFAS 123(R) and SEC SAB No. 107. Prior to the adoption of SFAS 123(R), we relied exclusively on the historical prices of our
common stock in the calculation of expected volatility. We base the risk-free interest rate that we use in the Black-Scholes-Merton option valuation model on the implied yield in effect at the time of option grant. We have never paid any cash
dividends on our common stock and we do not anticipate paying any cash dividends in the foreseeable future. Consequently, we use an expected dividend yield of zero in the Black-Scholes-Merton option valuation model. We use historical data to
estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest. For options granted before November 1, 2005, we estimated the fair value using the multiple option approach and
we are amortizing the fair value on a graded vesting basis. For options granted on or after November 1, 2005, we estimate the fair value using a single option approach and amortize the fair value on a straight-line basis. All options are
amortized over the requisite service periods of the awards, which are generally the vesting periods. We may elect to use different assumptions under the Black-Scholes-Merton option valuation model in the future if our current experience indicates
that a different measure is preferable, which could materially affect our net income or loss and net income or loss per share.

On
November 10, 2005, the FASB issued FASB Staff Position No. FAS 123(R)-3 Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards (FSP 123(R)-3). We adopted the alternative transition method provided in
the FASB Staff Position for calculating the tax effects of stock-based compensation pursuant to SFAS 123(R) in fiscal year 2006. The alternative transition method includes simplified methods to establish the beginning balance of the additional
paid-in capital pool (APIC pool) related to the tax effects of employee stock-based compensation, and to determine the subsequent impact on the APIC pool and consolidated statements of cash flows of the tax effects of employee stock-based
compensation awards that are outstanding upon adoption of SFAS 123(R). The adoption did not have a material impact on our results of operations and financial condition.



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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 (unaudited):



|                                      |  |                    |   |  |                   |    |  |               |   |  |               |   
|------------------------------------- |  | ------------------ | - |  | ----------------- | -- |  | ------------- | - |  | ------------- | --
|                                      |  | Three Months Ended |   |  | Nine Months Ended |   
|                                      |  | August 4,2007      |   |  | July 31, 2006     |    |  | August 4,2007 |   |  | July 31, 2006 |   
|Net sales                             |  | 100.0              | % |  | 100.0             | %  |  | 100.0         | % |  | 100.0         | % 
|Cost of goods sold  on net sales     |  | 48.7               |   |  | 77.6              |    |  | 53.2          |   |  | 65.2          |   
|                                      |  |                    |   |  |                   |    |  |               |   |  |               |   
|Gross margin                          |  | 51.3               |   |  | 22.4              |    |  | 46.8          |   |  | 34.8          |   
|Operating expenses                    |  |                    |   |  |                   |    |  |               |   |  |               |   
|Research and development              |  | 15.1               |   |  | 19.7              |    |  | 16.6          |   |  | 19.4          |   
|Selling, general and administrative   |  | 21.9               |   |  | 26.8              |    |  | 22.5          |   |  | 24.5          |   
|Restructuring charges                 |  |                   |   |  | 1.6               |    |  | 0.3           |   |  | 0.9           |   
|Reduction of goodwill                 |  |                   |   |  | 370.3             |    |  |              |   |  | 115.7         |   
|Amortization of purchased intangibles |  | 3.6                |   |  | 3.8               |    |  | 3.7           |   |  | 3.5           |   
|                                      |  |                    |   |  |                   |    |  |               |   |  |               |   
|Total operating expenses              |  | 40.6               |   |  | 422.2             |    |  | 43.1          |   |  | 164.0         |   
|                                      |  |                    |   |  |                   |    |  |               |   |  |               |   
|Operating income (loss)               |  | 10.7               |   |  | (399.9            | )  |  | 3.7           |   |  | (129.2        | ) 
|                                      |  |                    |   |  |                   |    |  |               |   |  |               |   
|Net income (loss)                     |  | 8.4                | % |  | (403.0            | )% |  | 1.9           | % |  | (131.0        | )%
|                                      |  |                    |   |  |                   |    |  |               |   |  |               |   

Net sales consist of revenues from systems sales, upgrades, spare parts sales, maintenance
contracts, engineering consulting, customized services and lease income. Net sales were $123.5 million for the three months ended August 4, 2007 representing an increase of 8% from net sales of $114.5 million during the three months ended
July 31, 2006. Net sales decreased $2.8 million, or 1%, to $363.5 million for the nine months ended August 4, 2007 from $366.2 million for the nine months ended July 31, 2006. The increase in net sales for the three months ended
August 4, 2007 as compared to July 31, 2006 was due primarily to increased demand of our SoC products. The decrease in net sales for the nine months of fiscal 2007 as compared to fiscal 2006 was due to declines in our analog mixed signal
product and our service business.

Our net sales by product line for the three and nine months ended August 4, 2007 and July 31,
2006:



|                                 |  |                    |   |  |                   |   |  |               |   |  |              |  
|-------------------------------- |  | ------------------ | - |  | ----------------- | - |  | ------------- | - |  | ------------ | -
|                                 |  | Three Months Ended |   |  | Nine Months Ended |  
|                                 |  | August 4,2007      |   |  | July 31,2006      |   |  | August 4,2007 |   |  | July 31,2006 |  
|SoC                              |  | 48                 | % |  | 30                | % |  | 46            | % |  | 33           | %
|Analog Mixed Signal              |  | 23                 |   |  | 36                |   |  | 24            |   |  | 32           |  
|Memory                           |  |                   |   |  | 3                 |   |  | 1             |   |  | 2            |  
|Diagnostics and Characterization |  | 9                  |   |  | 5                 |   |  | 7             |   |  | 8            |  
|Service and Other                |  | 20                 |   |  | 26                |   |  | 22            |   |  | 25           |  
|                                 |  |                    |   |  |                   |   |  |               |   |  |              |  
|Total                            |  | 100                | % |  | 100               | % |  | 100           | % |  | 100          | %
|                                 |  |                    |   |  |                   |   |  |               |   |  |              |  

For the three months ended August 4, 2007, net sales of our SoC and diagnostics and
characterization products increased 85% to $71.1 million from $38.5 million during the three months ended July 31, 2006. Our analog mixed signal, memory and service and other net sales for the three months ended August 4, 2007 decreased
31% to $52.5 million from $76.0 million during the three months ended July 31, 2006.

For the nine months ended August 4, 2007,
net sales from our SoC increased to $169.1 million representing an increase of 44% from $117.4 million from the same period of fiscal 2006. The increase in net sales was offset by a 22% decrease in net sales of analog mixed signal, diagnostics and
characterization, memory and service and other from $248.8 million during the nine months ended July 31, 2006 to $194.3 million during the same period of fiscal 2007.

We anticipate net sales in the fourth quarter of fiscal year 2007 will be in the range of $101.0 million to $105.0 million. Net sales levels will be
affected by the economic climate as well as other risks and factors described under the section titled Risk Factors herein.



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Our net sales by region for the three and nine months ended August 4, 2007 and July 31, 2006:



|                             |  |                    |   |  |                   |   |  |               |   |  |              |  
|---------------------------- |  | ------------------ | - |  | ----------------- | - |  | ------------- | - |  | ------------ | -
|                             |  | Three Months Ended |   |  | Nine Months Ended |  
|                             |  | August 4,2007      |   |  | July 31,2006      |   |  | August 4,2007 |   |  | July 31,2006 |  
|North America                |  | 38                 | % |  | 26                | % |  | 28            | % |  | 32           | %
|Singapore                    |  | 9                  |   |  | 16                |   |  | 20            |   |  | 19           |  
|Taiwan                       |  | 19                 |   |  | 15                |   |  | 14            |   |  | 12           |  
|Southeast Asia               |  | 7                  |   |  | 13                |   |  | 8             |   |  | 10           |  
|Japan & rest of Asia Pacific |  | 8                  |   |  | 11                |   |  | 9             |   |  | 11           |  
|Germany                      |  | 12                 |   |  | 10                |   |  | 14            |   |  | 6            |  
|Europe & Middle East         |  | 7                  |   |  | 9                 |   |  | 7             |   |  | 10           |  
|                             |  |                    |   |  |                   |   |  |               |   |  |              |  
|Total                        |  | 100                | % |  | 100               | % |  | 100           | % |  | 100          | %
|                             |  |                    |   |  |                   |   |  |               |   |  |              |  

International net sales accounted for approximately 62% and 74% of total net sales in the three
months ended August 4, 2007 and July 31, 2006, respectively. International net sales accounted for approximately 72% and 68% of total net sales for the nine months ended August 4, 2007 and July 31, 2006, respectively. Our net
sales to the Asia Pacific region accounted for approximately 43% and 55% of total net sales in the three months ended August 4, 2007 and July 31, 2006, respectively, as well as 51% and 52% for the nine months ended August 4, 2007 and
July 31, 2006, respectively. The demand for automated test and engineering capital equipment in Asian markets historically has been highly volatile and, in some Asian regions, there has been geopolitical unrest, both of which have resulted in
economic instabilities. These potential economic instabilities could materially adversely affect future demand for our products.

Gross Margin

Our gross margin as a percentage of net sales was 51% and 22% during the three months ended August 4, 2007 and July 31, 2006,
respectively. The increase in gross margins was primarily due to a more favorable product mix, improved manufacturing efficiencies and overall lower costs along with no significant inventory write-downs as experienced in the three months ended
July 31, 2006. Gross margin for the three months ended August 4, 2007 and July 31, 2006 included $0.1 million and $0.3 million of stock-based compensation expense on our costs of sales related to employee stock options and employee
stock purchases under SFAS 123(R), respectively. In addition, our gross margin benefited by approximately $0.8 million or 1.2% and $0.5 million or 2.2% from the sale of fully reserved inventory during the three months ended August 4, 2007 and
July 31, 2006, respectively.

For nine months ended August 4, 2007 and July 31, 2006, our gross margin was 47% and 35%,
respectively. The increase in gross margins was primarily due to a more favorable product mix, improved manufacturing efficiencies and overall lower costs along with no significant inventory write-downs as experienced in the nine months ended
July 31, 2006. Gross margin for the nine months ended August 4, 2007 and July 31, 2006 included $0.3 million and $0.5 million of stock-based compensation expense on our costs of sales related to employee stock options and employee
stock purchases under SFAS 123(R), respectively. In addition, our gross margin benefited by approximately $2.2 million or 1.3% and $1.0 million or 0.9% from the sale of fully reserved inventory during the nine months ended August 4, 2007 and
July 31, 2006, respectively. We believe our gross margin percentage in the fourth quarter of fiscal year 2007 will be approximately 49%.

Research
and Development

Research and development, or R&D, expenses were $18.7 million during the three months ended August 4, 2007,
representing a decrease of 17% from $22.6 million during the three months ended July 31, 2006. The decrease in expenses during the three months ended August 4, 2007 resulted primarily from reduced salary and fringe benefits of
approximately $2.6 million, decreased consulting expenses of approximately $1.0 million and a decrease in depreciation expenses of $0.2 million.

R&D expenses were $60.2 million and $70.8 million for the nine months ended August 4, 2007 and July 31, 2006, respectively. The decrease in expenses in the three months ended August 4, 2007 resulted primarily from reduced
salary and fringe benefits of approximately $7.0 million, a decrease in temporary labor expenses of approximately $0.9 million, a decrease in maintenance contracts of approximately $0.9 million and a decrease in consulting and outside service
expenses of approximately $1.7 million.

As a percentage of net sales, R&D expenses were 15.1% and 19.7% in the three months ended
August 4, 2007 and July 31, 2006, respectively; as well as 16.6% and 19.3% in the nine months ended August 4, 2007 and July 31, 2006, respectively. We anticipate that R&D expenses will be slightly lower in the fourth quarter
of fiscal year 2007 as compared to third quarter of fiscal 2007.



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Selling, General and Administrative

Selling, general, and administrative, or SG&A, expenses were $27.0 million and $30.8 million in the three months ended August 4, 2007 and July 31, 2006, respectively. The decrease was primarily due to
decreased salary and fringe benefits of approximately $0.9 million, a decrease in recruiting and relocation expenses of approximately $0.4 million, a decrease in temporary labor expenses of approximately $0.6 million, a decrease in travel and
entertainment expenses of approximately $0.7 million, a decrease in depreciation expenses of approximately $0.3 million, a decrease in consignment expenses of approximately $1.1 million, a decrease in facilities and postage expenses of approximately
$0.3 million, a decrease in telecommunication expenses of approximately $0.2 million and a decrease in stock-based compensation of approximately of $0.3 million. The decreases were offset by an increase in commission expenses of approximately $1.1
million, an increase in legal and audit fees of approximately of $0.4 million and an increase in marketing expenses of approximately $0.4 million.

SG&A expenses were $82.0 and $89.9 million in the nine months ended August 4, 2007 and July 31, 2006, respectively. The decrease was primarily due to a decrease in consignment expenses of approximately $2.9 million, a decrease
in travel and entertainment expenses of approximately $1.4 million, a decrease in depreciation expenses of approximately $1.5 million, a decrease in outside services expenses of approximately $1.2 million, a decrease in salary and fringe benefits
expenses of approximately $1.0 million, a decrease in telecommunication expenses of approximately $0.7 million, a decrease in temporary labor expenses of approximately $0.4 million, a decrease in office supplies and postage expenses of approximately
$0.4 million and a decrease in trade and turnkey accounts receivable bad debt expenses of approximately $0.4 million. These decreases were partially offset by an increase in consulting expenses of approximately $2.1 million, an increase in
recruiting and relocation expenses of approximately $0.9 million, an increase in legal fees of approximately of $0.8 million and an increase in stock-based compensation expenses of approximately $0.3 million.

As a percentage of net sales, SG&A expenses were 21.9% and 26.8% in the three months ended August 4, 2007 and July 31, 2006, respectively;
as well as 22.6% and 24.5% in the nine months ended August 4, 2007 and July 31, 2006, respectively. We anticipate that SG&A expenses will be slightly lower in the fourth quarter of fiscal year 2007 compared to third quarter of fiscal
2007.

Amortization of Purchased Intangibles

Amortization of purchased intangible assets expenses was $4.5 million and $4.3 million in the three months ended August 4, 2007 and July 31, 2006, respectively. For the nine months ended August 4, 2007 and July 31, 2006,
amortization of purchased intangible assets expenses were $13.4 million and $12.7 million, respectively. The increase in amortization of purchased intangible assets in the three and nine month periods ended August 4, 2007 was due primarily to
purchased intangible assets resulting from our Hypervision, Inc. acquisition in the third quarter of fiscal year 2006.

Reduction of Goodwill

Effective November 1, 2002, the Company adopted Statement of Financial Accounting Standard No. 142, Goodwill and Other
Intangible Assets (SFAS 142), which was issued by the FASB in July 2001. Under this standard, the Company ceased amortizing goodwill effective November 1, 2002.

It is required that we test goodwill for possible impairment on an annual basis and at any other time if events occur or circumstances indicate that the
carrying amount of goodwill may not be recoverable. Circumstances that could trigger an impairment test include but are not limited to: a significant adverse change in the business climate or legal factors; unanticipated competition; loss of key
personnel; a significant change in direction with respect to investment in a product or market segment; the likelihood that a significant portion of the business will be sold or disposed of; or the results of testing for recoverability of a
significant asset group within a reporting unit determined in accordance with SFAS 142.

The impairment test for goodwill involves a
two-step process: step one consists 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, step two requires the
comparison of the implied fair value of the reporting unit goodwill with the carrying amount of the reporting unit goodwill. Any excess in 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.

The determination as to whether a write-down of goodwill is necessary involves significant
judgment based on short-term and long-term projections of our operations. The assumptions supporting the estimated future cash flows of the reporting unit, including profit margins, long-term forecasts of the amounts and timing of overall market
growth and our percentage of that market, discount rates and terminal growth rates, reflect our best estimates.



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Based on a combination of factors identified during the third quarter of fiscal 2006, particularly
(1) our changed current and projected operating results reflecting lower demand from major customers and (2) our then current market capitalization which was less than our book value for the preceding 10 weeks, we concluded there were
sufficient indicators to require us to assess whether any portion of our recorded goodwill balance was impaired. We concluded based on our estimated forecasted discounted cash flows as well as our market capitalization that our goodwill was impaired
at July 31, 2006. Further analysis indicated that goodwill impairment charges of $423.9 million were necessary in the third quarter of fiscal 2006. Other long-lived assets were assessed for impairment prior to the performance of the SFAS 142
analysis and were determined not to be impaired.

We have performed the first step of the interim SFAS 142 analysis, consisting of a
comparison of the fair value of the reporting unit with our carrying amount, including the goodwill. The fair value of the reporting units was determined based on a combination of the Income Approach, which estimates the fair value based on the
future discounted cash flows, and Market Approach, which estimates the fair value based on market prices of comparable companies. Under the Income Approach, we assumed a forecasted cash flow period of 5 years, long-term annual growth rates of
9% to 17%, a discount rate of 20% and terminal value growth rates of 5%. We also considered our total market capitalization as of July 31, 2006, and our average market capitalization for the quarter in order to assess volatility of our market
capitalization on that day. Based on the first step of the analysis, we determined that the carrying amount of the reporting unit was in excess of its fair value. As such, we were required to perform the second step of the analysis on the reporting
unit that has failed the first step test to determine the amount of the impairment loss. The second step of the analysis consisted of comparing the implied fair value of the goodwill with the carrying amount of the goodwill, with an impairment
charge resulting from any excess of the carrying value of the goodwill over the implied fair value of the goodwill based on a hypothetical allocation of the estimated fair value of the Company to the Companys tangible and intangible assets
(other than goodwill). Based on the second step of the analysis, we concluded that all of our recorded goodwill ($423.9 million) was impaired and as such recorded a noncash charge to continuing operations during the third quarter of fiscal
2006.

Restructuring Charges

During
the three months ended August 4, 2007 and July 31, 2006, we recorded restructuring charges of approximately ($9,000) and $1.8 million, respectively. Restructuring charges were $1.0 million and $3.2 million during the nine months ended
August 4, 2007 and July 31, 2006, respectively. The restructuring charges for the three and nine months ended August 4, 2007 were from changes to the original estimates. The restructuring charges for the three and nine months ended
July 31, 2006 were for severance expenses related to headcount reduction, facilities, fixed assets write-off and other liabilities related to the discontinuance of the memory product.

Interest Income

We generated interest income of $2.1
million and $1.0 million in the three months ended August 4, 2007 and July 31, 2006, respectively. For the nine months ended August 4, 2007 and July 31, 2006, interest income was $5.2 million and $2.8 million, respectively. The
increase in the three and nine months ended August 4, 2007, was primarily due to higher average cash balances and higher interest rates compared to the same period of prior year.

Interest Expense

Interest expenses were $2.5 million and $0.7 million for the three months ended
August 4, 2007 and July 31, 2006, respectively. For the nine months ended August 4, 2007 and July 31, 2006, interest expenses were $6.0 million and $2.1 million, respectively. The increase in interest expense was primarily due to
interest on our 3.5% New Notes with a principal aggregate amount of $122.5 million as well as interest on the note payable that resulted from the lease buyout in July of fiscal year 2006. In addition, the increase is related to rent paid on the
Milpitas facilities which was accounted for using the financing method under Statement of Financial Accounting Standard No. 98 Accounting for Leases.

Other Expense

Other expenses were $0.8 million and $1.8 million for the three months ended
August 4, 2007 and July 31, 2006, respectively. Other expenses were $0.2 million and $2.7 million for the nine months ended August 4, 2007 and July 31, 2006, respectively. The change to other expenses for the three months ended
August 4, 2007 from other net expenses for the three months ended July 31, 2006 was primarily due to the write off of impaired equity investment of $0.9 million in the three months ended July 31, 2006 and higher loss on disposal of
fixed assets of $0.3 million in the three months ended August 4, 2007 offset with a favorable foreign exchange rate of $0.3 million. The net change to other expense for the nine months ended August 4, 2007 from other net expenses for the
nine months ended July 31, 2006 was primarily due to $3.0 million gain in the convertible notes exchange, offset by a loss on the sale of our Oregon real property of $1.0 million and the loss on a fixed assets disposal of $0.7 million.



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Income Taxes

We recorded an income tax provision of $1.6 million and $2.1 million for the three months ended August 4, 2007 and July 31, 2006, respectively. The income tax provision was $5.6 million and $4.8 million for the nine months ended
August 4, 2007 and July 31, 2006, respectively. The income tax expense for the periods consists primarily of foreign tax on earnings generated in foreign jurisdictions. In addition, for the three and nine months ended August 4, 2007,
the income tax provision included $0.8 million pre-acquisition tax contingencies associated with Hypervision, Inc.

We expect to maintain a
full valuation allowance on United States deferred tax assets until we can sustain an appropriate level of profitability to insure utilization of existing assets. Until such time, we would not expect to recognize any significant tax benefits in our
results of operations.

Stock Options and Incentive Plan

We have a stock-based compensation program that provides our board of directors broad discretion in creating employee equity incentives. This program includes incentive and non-statutory stock options granted under
various plans, the majority of which are stockholder approved. Stock options are generally time-based, vesting over a four-year period with 12.5% of the granted shares vesting six months after the grant date, and the remaining shares vesting at the
rate of 6.25% each quarter thereafter for the following 14 quarters and expiring ten years from the grant date. Additionally, we have an Employee Stock Purchase Plan (ESPP) that allows employees to purchase shares of common stock at 85% of the fair
market value at the lower of either the date of enrollment or the date of purchase. Shares issued as a result of stock option exercises and our ESPP are generally from our new and treasury shares. As of August 4, 2007, we had approximately
3.1 million shares of common stock reserved for future issuance under the stock option plans and ESPP.

On November 1, 2005, we
adopted the provision of SFAS 123(R) for our share-based compensation plans. We elected to use the modified prospective transition method as permitted by SFAS 123(R), and therefore, have not restated our financial results for prior periods. In
conjunction with the adoption of SFAS 123(R), we changed our method of attributing the value of stock-based compensation to expense from the accelerated multiple-option approach to the straight-line single option method. Compensation expense for all
share-based payment awards granted prior to November 1, 2005 will continue to be recognized using the accelerated multiple-option approach while compensation expense for all share-based payment awards granted on or subsequent to
November 1, 2005 is recognized using the straight-line single-option approach.

At August 4, 2007, there was $12.5 million of
unrecognized stock-based compensation expense related to non-vested options that is expected to be recognized over a weighted-average period of 3.0 years. At August 4, 2007, there was $0.1 million of unrecognized stock-based compensation
expense related to outstanding ESPP shares that is expected to be recognized over a one month period.

See Note 5 Stock-Based
Compensation of the Notes to the unaudited condensed consolidated financial statements for further discussion.

LIQUIDITY AND CAPITAL RESOURCES

In the nine months ended August 4, 2007, net cash provided by operating activities was $18.5 million. The increase in net cash
provided by operating activities for the nine months ended August 4, 2007 reflected a net income of $6.9 million, depreciation and amortization of $37.7 million, non-cash charges related to provision for inventory write-downs of $0.8 million,
stock-based compensation expense related to employee stock options and employee stock purchases under SFAS 123(R) of $4.1 million, the write-off of a long-term intellectual property asset of $0.7 million, and the loss on the sale of the Oregon real
property and loss on disposal of fixed assets of $1.9 million. The increase in operating activities was offset by a decrease in working capital of $30.3 million and a gain on convertible notes exchanged of $3.0 million.

Investing activities used net cash of $68.3 million for the nine months ended August 4, 2007, primarily attributable to net cash used of $72.1
million to purchase available-for-sale securities and $5.5 million to purchase property and equipment to support our business, partially offset by maturities of available-for-sale securities of $6.6 million and attributable to proceeds from the sale
of the Oregon real property of $2.7 million.

Financing activities provided net cash of $73.7 million in the nine months ended
August 4, 2007. Net cash provided by financing activities primarily reflected $0.9 million received for the issuance of common stock relating to our employee equity plans, $44.1 million of proceeds resulting from the issuance of convertible
notes and $30.0 million of proceeds resulting from the sale-leaseback transaction.



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On February 28, 2007, we completed a
sale-leaseback transaction involving our corporate headquarters located in Milpitas, California. The properties were sold to NRFC Milpitas Holdings, LLC (purchaser) for a total price of $30.0 million. Simultaneously, we agreed to lease the
properties back from the purchaser for a period of 10 years, along with four, five-year renewal options upon expiration of the initial lease term. The lease was to commence on February 28, 2007 and will expire on February 28,
2017. The annual rent for the first year of the lease is approximately $2.5 million and will increase 2% for each of the following nine years until the expiration of the lease term. As part of the lease agreement, we issued a letter of
credit in the amount of $5,090,400, which is used as security on the lease. The letter of credit will expire no sooner than December 31, 2010 unless, including among other conditions, the Company retires the 11/2% convertible subordinated notes (the Notes) due May 2008 and does not within six months thereafter issue any new debt or equity . Under the terms of the letter of credit, the
purchaser will have the right to draw down the amount of the rental obligations in the event we default on making the monthly payments. The letter of credit is collateralized by restricted cash.

In August 2006, we implemented a plan to repatriate cash from certain of our foreign subsidiaries. In the first quarter of fiscal 2007, we repatriated
approximately $7.1 million in unremitted foreign earnings.

On December 20, 2006, we completed the exchange of an aggregate principal
amount of $72.5 million of our 1.5% Convertible Subordinated Notes due in May 2008 for a new series of 3.5% Convertible Senior Subordinated Notes (the New Notes) due in May 2010, as well as the issuance of additional New Notes with an aggregate
principal amount of $50.0 million in a private placement. The New Notes are unsecured obligations and are subordinated to all our present and future senior indebtedness. Interest is payable semiannually on May 15 and November 15,
commencing May 15, 2007. The New Notes contain net share settlement provisions that require us, upon conversion of the New Notes, to pay holders in cash up to the principal amount of the converted New Notes. Any amount in excess of the
converted principal will be settled in shares of our common stock, or at our option, cash. See Note 8 Convertible Subordinated Notes of the Notes to the unaudited condensed consolidated financial statements for further discussion.

As of August 4, 2007, we had working capital of $188.7 million, including cash and short-term investments of $190.9 million, and
accounts receivable and inventories totaling $175.7 million. We believe that because of the relatively long manufacturing cycles of many of our testers and the new products we presently offer and plan to introduce, investments in inventories will
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 we manufacture and market. In addition, the automatic test equipment industry is highly competitive and subject to rapid technological change. It is reasonably possible that events related to these
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.

We believe our current cash and investment positions combined with the ability to borrow funds will be sufficient to meet our anticipated business
requirements for the next 12 months.

We lease some of our facilities and equipment under operating leases that expire through 2017. The
approximate future minimum lease payments at August 4, 2007 are as follows (in thousands):



|                         |  |                                |        |                                             |   |                                    |  |   |       
|------------------------ |  | ------------------------------ | ------ | ------------------------------------------- | - | ---------------------------------- |  | - | ------
|                         |  | Committed Gross Lease Payments |        | Leases Written Off in Restructuring Charges |   | Net Estimated Future Lease Expense
|Remainder of fiscal 2007 |  | $                              | 1,508  |                                             | $ | 22                                 |  | $ | 1,486 
|2008                     |  |                                | 5,198  |                                             |   | 54                                 |  |   | 5,144 
|2009                     |  |                                | 4,345  |                                             |   |                                   |  |   | 4,345 
|2010                     |  |                                | 3,482  |                                             |   |                                   |  |   | 3,482 
|2011                     |  |                                | 3,174  |                                             |   |                                   |  |   | 3,174 
|Thereafter               |  |                                | 15,382 |                                             |   |                                   |  |   | 15,382
|                         |  |                                |        |                                             |   |                                    |  |   |       
|                         |  | $                              | 33,089 |                                             | $ | 76                                 |  | $ | 33,013
|                         |  |                                |        |                                             |   |                                    |  |   |       



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The following summarizes our minimum contractual cash obligations and other commitments at August 4,
2007, and the effect of such obligations in future periods (in thousands):



|                                                   |  |       |         |                        |   |            |  |            |         |            |   |            |  |            |         |  |   |       |  |   |       
|-------------------------------------------------- |  | ----- | ------- | ---------------------- | - | ---------- |  | ---------- | ------- | ---------- | - | ---------- |  | ---------- | ------- |  | - | ----- |  | - | ------
|                                                   |  | Total |         | Remainderof Fiscal2007 |   | Fiscal2008 |  | Fiscal2009 |         | Fiscal2010 |   | Fiscal2011 |  | Thereafter
|Contractual Obligations:                           |  |       |         |                        |   |            |  |            |         |            |   |            |  |            |         |  |   |       |  |   |       
|Facilities and equipment operating leases (1)      |  | $     | 33,013  |                        | $ | 1,486      |  | $          | 5,144   |            | $ | 4,345      |  | $          | 3,482   |  | $ | 3,174 |  | $ | 15,382
|Convertible subordinated notes (2)                 |  |       | 195,000 |                        |   |           |  |            | 72,500  |            |   |           |  |            | 122,500 |  |   |      |  |   |      
|Interest on convertible subordinated notes         |  |       | 12,823  |                        |   | 1,344      |  |            | 4,875   |            |   | 4,287      |  |            | 2,317   |  |   |      |  |   |      
|Open and non-cancelable purchase order commitments |  |       | 52,830  |                        |   | 23,959     |  |            | 27,995  |            |   | 699        |  |            | 163     |  |   | 14    |  |   |      
|                                                   |  |       |         |                        |   |            |  |            |         |            |   |            |  |            |         |  |   |       |  |   |       
|Total contractual cash obligations                 |  |       | 293,666 |                        |   | 26,789     |  |            | 110,514 |            |   | 9,331      |  |            | 128,462 |  |   | 3,188 |  |   | 15,382
|                                                   |  |       |         |                        |   |            |  |            |         |            |   |            |  |            |         |  |   |       |  |   |       

---

|(1) | Approximately $0.1 million of this total has been accrued for as restructuring
charges in the condensed consolidated balance sheets as accrued expenses and other liabilities.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | This amount is recorded in the condensed consolidated balance sheets as
convertible subordinated notes.
|--- | -------------------------------------------------------------------------------------------------------

Some of the components that we purchase are unique to us and must be purchased in
relatively high minimum quantities with long (four and five month) lead times. These business circumstances can lead to us holding relatively high inventory levels and associated risks. In addition, purchase commitments for unique components are
relatively inflexible in terms of deferral or cancellation. At August 4, 2007, we had open and committed non-cancelable purchase orders totaling approximately $52.8 million. The contractual cash obligations and commitments table presented above
contains our minimum obligations at August 4, 2007 under these arrangements and others. Actual expenditures will vary based on the volume of transactions and length of contractual service provided. In addition to minimum spending commitments,
certain of these arrangements provide for potential cancellation charges.

As of August 4, 2007, our principal sources of liquidity
consisted of approximately $118.1 million of cash and cash equivalents and short-term investments of $72.8 million.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 2006, the FASB issued FIN No. 48, Accounting for Uncertainty in Income Taxes, (FIN 48) which clarifies the
accounting for uncertainty in income taxes recognized in an enterprises financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. This interpretation prescribes a recognition threshold and measurement
attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on de-recognition, classification, interest and penalties, accounting in
interim periods, disclosure, and transition. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. We are currently evaluating the impact of adopting this interpretation on our financial position, results of
operations and cash flows.

In September 2006, FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157). SFAS 157
defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions of SFAS 157 are effective for the fiscal year
beginning November 2, 2008. We are currently evaluating the impact of the provisions of SFAS 157 on our financial position, results of operations and cash flows.

In September 2006, the SEC issued Staff Accounting Bulletin No. 108 (SAB 108), Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.
SAB 108 provides interpretative guidance on the process of quantifying financial statement misstatements and is effective for fiscal years ending after November 15, 2006. We applied the provisions of SAB 108 beginning in the first quarter of
fiscal 2007 and there was no impact on our unaudited condensed consolidated financial statements.

In February 2007, the FASB
issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial LiabilitiesIncluding an amendment of FASB Statement No. 115 (SFAS 159). Under SFAS 159, a company may choose, at specified election dates,
to measure eligible financial instrument and certain other items at fair value that are not otherwise required to be so measured. If a company elects the fair value option for an eligible item, changes in that items fair value in subsequent
reporting periods must be recognized in current earnings. SFAS 159 is effective as of the beginning of the fiscal year beginning after November 15, 2007. We are currently evaluating the impact of SFAS 159 on our financial position, results of
operations and cash flows.



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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to market risk from
changes in interest rates relates primarily to our cash equivalents and investment portfolio. We maintain a strict investment policy, which ensures the safety and preservation of our invested funds by limiting default risk, market risk, and
reinvestment risk. Our investments consist primarily of commercial paper, medium term notes, asset backed securities, United States Treasury notes and obligations of United States 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).



|                          |  |                          |         |   |                        |   |         |      |  |   |         |   |  |      |        |   |  |   |       |  
|------------------------- |  | ------------------------ | ------- | - | ---------------------- | - | ------- | ---- |  | - | ------- | - |  | ---- | ------ | - |  | - | ----- | -
|                          |  | Balance October 31, 2006 |         |   | Balance August 4, 2007 |   |         | 2007 |  |   | 2008    |   |  | 2009 |       
|Cash and cash equivalents |  |                          |         |   |                        |   |         |      |  |   |         |   |  |      |        |   |  |   |       |  
|Amounts                   |  | $                        | 95,635  |   |                        | $ | 118,056 |      |  | $ | 118,056 |   |  |      |       |   |  |   |      |  
|Average rate              |  |                          | 3.62    | % |                        |   | 4.24    | %    |  |   | 4.24    | % |  |      |       |   |  |   |      |  
|Short term investments    |  |                          |         |   |                        |   |         |      |  |   |         |   |  |      |        |   |  |   |       |  
|Amounts                   |  | $                        | 7,177   |   |                        | $ | 72,816  |      |  | $ | 25,006  |   |  | $    | 45,810 |   |  | $ | 2,000 |  
|Average rate              |  |                          | 5.04    | % |                        |   | 5.35    | %    |  |   | 5.00    | % |  |      | 4.88   | % |  |   | 5.38  | %
|                          |  |                          |         |   |                        |   |         |      |  |   |         |   |  |      |        |   |  |   |       |  
|Total investment          |  | $                        | 102,812 |   |                        | $ | 190,872 |      |  | $ | 143,063 |   |  | $    | 45,810 |   |  | $ | 2,000 |  
|Average rate              |  |                          | 3.72    | % |                        |   | 4.66    | %    |  |   | 4.37    | % |  |      | 4.88   | % |  |   | 5.38  | %
|Equity instruments        |  | $                        | 391     |   |                        |   |        |      |  |   |        |   |  |      |       |   |  |   |      |  

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.

The sensitivity analysis model used by us for interest rate
exposure compares interest income on current investment interest rates versus current investment levels at current interest rates with a 10% increase. Based on this model, a 10% increase or decrease in interest rate would result in an increase or a
decrease in interest income of approximately $0.3 million. There can be no assurances that the above projected interest rate increase will materialize. Fluctuations of interest rates are beyond our control.

Foreign Exchange

We generate a
significant portion of our sales from customers located outside the United States, principally in Asia and, to a lesser extent, Europe. International sales are made mostly to foreign distributors and some foreign subsidiaries and are typically
denominated in United States dollars, but occasionally are denominated in the local currency for European and Japanese customers. The subsidiaries also incur most of their expenses in the local currency. Our SZ product line is developed and
manufactured in Germany and, thus, those expenses are Euro based. Accordingly, some of our foreign subsidiaries use the local currency as their functional currency. For the three months ended August 4, 2007 and July 31, 2006, foreign
currency losses were approximately $0.1 million and $0.1 million, respectively. Foreign currency losses were approximately $1.0 million loss and $0.6 million for the nine months ended August 4, 2007 and July 31, 2006, respectively. They
are included in other income (expense), net on the condensed consolidated statements of operations.

Our international business is subject
to risks typical of an international business including, but not limited to: differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange rate volatility.
Accordingly, our future results could be materially adversely impacted by changes in these or other factors. We do not currently use derivatives, but will continue to assess the need for these instruments in the future.

Interest Rate Risk

The Convertible
Subordinated Notes bear interest at a fixed rate of 1.5% and 3.5%, and therefore changes in interest rates do not impact our interest expense on this debt. From time to time, we have outstanding short-term borrowings with variable interest rates.
The total average amount of these borrowings outstanding annually has been insignificant. Therefore, we expect that a 10% change in interest rate will not have any material effect on our interest expense.



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ITEM 4.  CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures.Based on
our managements evaluation (with the participation of our chief executive officer and chief financial officer), as of the end of the period covered by this report, our chief executive officer and chief financial officer have concluded that,
subject to limitations described below, our disclosure controls and procedures (as defined in Securities Exchange Act Rules 13a-15(e) and 15d-15(e)) are effective to provide reasonable assurance that the information required to be disclosed by us in
reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

Changes in Internal Control over Financial Reporting. There was no change in our internal control over financial reporting during the periods
covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II.  OTHER INFORMATION

Item 1. Legal Proceedings.

We are involved in 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 1A. Risk Factors.

Set forth below and elsewhere in this Quarterly Report on Form 10-Q and in other documents we file
with the SEC, are risks and uncertainties that could cause actual results to differ materially from the results expressed or implied by the forward-looking statements contained in this Quarterly Report. The fact that some of the risk factors may be
the same or similar to our past filings means only that the risks are present in multiple periods. We believe that many of the risks detailed here and in our other SEC filings are part of doing business in the semiconductor industry and will likely
be present in all periods reported. The fact that certain risks are endemic to the industry does not lessen the significance of the risk. There are no material changes to risk factors described under the title Risk Factors in our Annual
Report on Form 10-K for the fiscal year ended October 31, 2006 filed with the SEC.



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Our operating results have fluctuated significantly which has adversely affected 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;
| | - |  | -------------------------------------------------------------------------------------------------------------------



| |  |  | loss of certain key customers who account for large portions of our revenue;
| | - |  | ----------------------------------------------------------------------------



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



| |  |  | market acceptance of our new products and enhanced versions of existing products;
| | - |  | ---------------------------------------------------------------------------------



| |  |  | 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 integrated circuits, or ICs, subassemblies and services, customization and reconfiguration of our systems and product reliability;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



| |  |  | our ability to attract and retain qualified employees in a competitive market;
| | - |  | ------------------------------------------------------------------------------



| |  |  | timing of new product announcements and new product releases by us or our competitors;
| | - |  | --------------------------------------------------------------------------------------



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



| |  |  | labor and materials supply constraints;
| | - |  | ---------------------------------------



| |  |  | expenses associated with acquisitions and alliances, including expenses charged for any impaired acquired intangible assets and goodwill;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | 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; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | natural disasters, political and economic instability, currency fluctuations, regulatory changes and outbreaks of hostilities, especially in Asia.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------

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 systems sales have varied significantly and will continue to vary significantly based on a variety of factors including:



| |  |  | long-term pricing decreases by us and our competitors and pricing by our suppliers;
| | - |  | -----------------------------------------------------------------------------------



| |  |  | manufacturing volumes;
| | - |  | ----------------------



| |  |  | manufacturing inefficiencies;
| | - |  | -----------------------------



| |  |  | hardware product sales mix;
| | - |  | ---------------------------



| |  |  | absorption levels and the rate of capacity utilization;
| | - |  | -------------------------------------------------------



| |  |  | inventory write-downs;
| | - |  | ----------------------



| |  |  | new product introductions;
| | - |  | --------------------------



| |  |  | product reliability;
| | - |  | --------------------



| |  |  | customization and reconfiguration of systems;
| | - |  | ---------------------------------------------



| |  |  | possible sale of inventory previously written-off;
| | - |  | --------------------------------------------------



| |  |  | international and domestic sales mix and field service margins; and
| | - |  | -------------------------------------------------------------------



| |  |  | ceasing investment in underperforming or redundant product lines.
| | - |  | -----------------------------------------------------------------

New and enhanced products typically have lower gross margins in their early stages of commercial introduction and production, and we may build substantial finished goods inventories of such new products. If delays in
or cancellations of orders for those products occur, it may require future inventory write-offs, which would negatively affect our future financial performance. Although we have recorded and continue to record inventory write-offs, 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 in the past to meet these expectations has adversely affected the market price
of our common stock and may continue to do so. 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. Many of these expenses are fixed and will be difficult to reduce in a particular period if our net sales goal for that period is not met. As a result, we cannot be certain that we will be profitable in the future.

Some of our net sales are generated from a small number of key customers and the loss of a key customer or material reductions in capital spending by a key customer
could substantially reduce our revenues and be perceived as a loss of momentum in our business.

Over time, we have expanded our base of
customers; however, a large portion of our net sales are generated from a small number of key customers. In particular, two customers, Advanced Micro Devices, Inc. and Intel Corporation accounted for 32% and 15% of our net sales for nine months
ended August 4, 2007. Our top ten customers accounted for 75%, 65% and 66% of our net sales for nine months ended August 4, 2007, fiscal years 2006 and 2005, respectively. We



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expect that our top ten customers in the aggregate will continue to account for a large portion of our net sales for the foreseeable future, and the loss of
one or more of these customers or collaborative partners or material reductions in capital spending by one or more of these customers or collaborative partners would harm our business and operating results. The loss of a significant customer could
also be perceived as a loss of momentum in our business and an adverse impact on our financial results, and this may cause the market price of our common stock to fall. In addition, as a result of the concentration of our business with a small
number of key customers, delays in spending by one or more of those customers also may harm our business and operating results.

Increased reliance on
outsourced manufacturing and logistics may affect our business.

We are increasingly outsourcing manufacturing and logistics activities
to third-party service providers, which decreases our control over the performance of these functions.

We have already outsourced certain
manufacturing and spare parts logistics functions to third-party service providers, and we may outsource more of those functions in the future. While we expect to achieve operational flexibility and cost savings as a result of this outsourcing,
outsourcing has a number of risks and reduces our control over the performance of the outsourced functions. Significant performance problems by these third-party service providers could result in cost overruns, delayed deliveries, shortages, quality
issues or other problems that could result in significant customer dissatisfaction and could materially and adversely affect our business, financial condition and results of operations.

If for any reason one or more of these third-party service providers becomes unable or unwilling to continue to provide services of acceptable quality,
at acceptable costs and in a timely manner, our ability to deliver our products or spare parts to our customers could be severely impaired. We would quickly need to identify and qualify substitute service providers or increase our internal capacity,
which could be expensive, time-consuming and difficult, and could result in unforeseen operations problems. Substitute service providers might not be available or, if available, might be unwilling or unable to offer services on acceptable terms.

Compliance with current and future environmental regulations may be costly which could impact our future earnings.

We may be subject to environmental and other regulations due to our production and marketing of products in certain states and countries. We also face
increasing complexity in our product design and procurement operations as we adjust to new and upcoming requirements relating to the materials composition of our products, including the restrictions on lead and certain other substances in
electronics that apply to specified electronics products put on the market in the European Union as of July 1, 2006 (Restriction of Hazardous Substances in Electrical and Electronic Equipment Directive (EU RoHS). The European Union has also
finalized the Waste Electrical and Electronic Equipment Directive (WEEE), which makes producers of electrical goods financially responsible for specified collection, recycling, treatment and disposal of past and future covered products. The deadline
for enacting and implementing this directive by individual European Union governments was August 13, 2004 (WEEE Legislation), although extensions were granted in some countries. Producers became financially responsible under the WEEE
Legislation beginning in August 2005. Other countries, such as the United States, China and Japan, have enacted or may enact laws or regulations similar to the EU RoHS or WEEE Legislation. These and other environmental regulations may require us to
reengineer certain of our existing products and develop new strategies for the design of new products to utilize components which are more environmentally compatible. Such reengineering and component substitution may result in delays in product
design and manufacture and could cause us to incur additional costs. Although we currently do not anticipate any material adverse effects based on the nature of our operations and the effect of such laws, there is no assurance that such existing
laws or future laws will not have a material adverse effect on our business.

We are subject to the internal control evaluation and attestation
requirements of Section 404 of the Sarbanes-Oxley Act of 2002.

Section 404 of the Sarbanes-Oxley Act of 2002 requires that we
include in our annual report our assessment of the effectiveness of our internal control over financial reporting and our audited financial statements as of the end of each fiscal year. Furthermore, our independent registered public accounting firm,
or Firm, is required to attest to whether our internal control over financial reporting is fairly stated in all material respects and separately report on whether it believes we maintained, in all material respects, effective internal control over
financial reporting as of the end of each fiscal year. We successfully completed our assessment and obtained our Firms attestation as to the effectiveness of our internal control over financial reporting as of October 31, 2006 and 2005.
In future years, if we fail to timely complete this assessment, or if our Firm cannot timely attest to the effectiveness of our internal control over financial reporting, we could be subject to regulatory sanctions and a loss of public confidence in
our internal control. In addition, any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to timely meet our regulatory reporting
obligations.

We have experienced turnover in various areas of the business, including our finance and operations groups. As a result,
during the prior periods quarter-end financial statement close process, we identified certain sub-processes that due to



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certain deficiencies required us to record the adjustments necessary for the fair presentation of our financial statements as well as develop and document
more robust processes to reduce the possibility of error. Those sub-processes included the review of income tax provision calculations, distributor commission computation and the thoroughness of accrual documentation for certain liabilities.
Although we have implemented a review of these sub-processes and are implementing changes to remediate the identified deficiencies, and although we have implemented various processes to review, assess and maintain the effectiveness of our internal
controls, there can be no assurance that similar or additional deficiencies will not be identified in the future. Any failure to achieve and maintain an effective internal control environment could have a material adverse effect on our stock price.

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. Our chief executive officer,
Lavi A. Lev, and chief financial officer, Joy Leo, recently joined us and have limited experience in our business. 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.

We have substantial indebtedness and if we need additional financing, it could be difficult to obtain.

As of August 4,
2007, we had $72.5 million principal amount of 1.5% Convertible Subordinated Notes, or 1.5% Notes, due in May 2008 and $122.5 million principal amount of 3.50% Convertible Senior Subordinated Notes, due 2010 (the New Notes). The New Notes contain
net share settlement provisions which require that, upon conversion of the New Notes, we will pay holders in cash up to the principal amount of the converted New Notes. Any amounts in excess of this converted amount will be settled in shares of our
common stock or, at our option, cash. The initial conversion price is $8.25.

The level of indebtedness, among other things, could:



| |  |  | make it difficult for us to make payments on our debt and other obligations, particularly upon maturity of the 1.5% Notes in May 2008 and the maturity or conversion
of the New Notes, due 2010 if we were unable to cause the conversion of this debt into equity;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | make it difficult for us to obtain any necessary future financing for working capital, capital expenditures, debt service requirements or other purposes;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | require the dedication of a substantial portion of any cash flow from operations to service the indebtedness, thereby reducing the amount of cash flow available for
other purposes, including capital expenditures;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | limit our flexibility in planning for, or reacting to changes in our business and the industries in which we compete;
| | - |  | ---------------------------------------------------------------------------------------------------------------------



| |  |  | place us at a possible competitive disadvantage with respect to less leveraged competitors and competitors that have better access to capital resources; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | make us more vulnerable in the event of a further downturn in our business.
| | - |  | ---------------------------------------------------------------------------

There can be no assurance that we will be able to meet our debt service obligations, including our obligations under the 1.5% Notes or the New Notes.

We expect that our existing cash and short-term investments will be sufficient to meet our cash requirements to fund operations and
expected capital expenditures for the next 12 months. In the event we may need to raise additional funds, we cannot be certain that we will be able to obtain such additional financing on favorable terms if at all. Further, if we issue additional
equity securities, stockholders may experience additional dilution or the new equity securities may have rights, preferences or privileges senior to those of existing holders of common stock. Future financings may place restrictions on how we
operate our business. If we cannot raise funds on acceptable terms, if and when needed, we may not be able to develop or enhance our products and services, take advantage of future business opportunities, grow our business or respond to competitive
pressures, which could seriously harm our business.

The semiconductor industry is cyclical.

The semiconductor equipment industry is highly cyclical. 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



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testing of semiconductors. This includes manufacturers and contractors that are opening new or expanding existing fabrication facilities or upgrading
existing equipment, which in turn depends upon the current and anticipated market demand for semiconductors and products incorporating semiconductors. The timing, length and severity of the up-and-down cycles in the semiconductor equipment industry
are difficult to predict. This cyclical nature of the industry in which we operate affects our ability to accurately predict future revenue and, thus, future expense levels. When cyclical fluctuations result in lower than expected revenue
levels, operating results may be adversely affected and cost reduction measures may be necessary in order for us to remain competitive and financially sound. During a down cycle, we must be in a position to adjust our cost and expense structure
to prevailing market conditions and to continue to motivate and retain our key employees. In addition, during periods of rapid growth, we must be able to increase manufacturing capacity and personnel to meet customer demand. We can provide no
assurance that these objectives can be met in a timely manner in response to industry cycles. If we fail to respond to industry cycles, our business could be seriously harmed.

As a result of the cyclical nature of the semiconductor industry, 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 condition or results of operations may continue to be materially adversely affected by any factor materially adversely affecting the semiconductor industry
in general or particular segments within the semiconductor industry.

Implementation or changes to our enterprise resource planning system and other
related systems may affect our business.

We may experience difficulties in implementing, making changes or enhancements to our
enterprise resource planning, or ERP, system and other related systems that could disrupt our ability to timely and accurately process and report key components of the results of our consolidated operations, our financial position and cash flows.
Any disruptions or difficulties that may occur in connection with implementing, making changes or enhancements to our ERP system or any future systems could also adversely affect our ability to complete the evaluation of our internal controls and
attestation activities pursuant to Section 404 of the Sarbanes-Oxley Act of 2002. System failure or malfunctioning may result in disruption of operations and the inability to process transactions and could adversely affect our financial
results.

We operate in a volatile industryindicators of other long-lived assets impairment under Statement of Financial Accounting Standard
No. 142 and 144 may be present from time-to-time.

Effective November 1, 2002, we adopted SFAS 142, which was issued by the
FASB in July 2001. Under this standard, we ceased amortizing goodwill and acquired workforce costs effective November 1, 2002.

As
mandated by SFAS 142, we test goodwill for possible impairment on an annual basis and at any other time if events occur or circumstances indicate that the carrying amount of goodwill may not be recoverable. Circumstances that could trigger an
impairment test include but are not limited to: our market value falling below our net book value for a significant period of time, a significant adverse change in the business climate or legal factors; unanticipated competition; loss of key
personnel; a significant change in direction with respect to investment in a product or market segment; the likelihood that a significant portion of the business will be sold or disposed of; or the results of testing for recoverability of a
significant asset group within a reporting unit determined in accordance with SFAS 142.

Based on a combination of factors that came into
existence and were identified during the third quarter of fiscal year 2006, particularly (1) our changed current and projected operating results reflecting lower demand from major customers and (2) our current market capitalization which
was significantly less than our book value for the preceding 10 weeks prior to the end of the third quarter, we concluded there were sufficient indicators to require us to assess whether any portion of our recorded goodwill balance was impaired. We
determined, based on our estimates of forecasted discounted cash flows and our market capitalization, that our goodwill was impaired at July 31, 2006. Further analysis indicated that goodwill impaired and charges of $423.9 million were recorded
in the third quarter of fiscal year 2006. Other long-lived assets were assessed for impairment prior to the performance of the SFAS 142 analysis and were determined not to be impaired.

If economic conditions in our industry continue to deteriorate and adversely affect our business, we change the planned use of the long-lived assets, or
we make changes to our business model, we could be required to record impairment charges related to our long-lived assets in accordance with SFAS 144, Accounting for Impairment or Disposal for Long-Lived Assets, which could have a
material adverse effect on our results of operations and financial condition.



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

A change in accounting standards or practices can have a significant effect on our reported results and may even affect our reporting of transactions
completed before the change is effective. New accounting pronouncements and varying interpretations of accounting pronouncements have occurred and may occur in the future. Changes to existing standards or the questioning of current practices may
adversely affect our reported financial results or the way we conduct our business.

For example, since our inception, we have used stock
options and other long-term equity incentives as a fundamental component of our employee compensation packages. We believe that stock options and other long-term equity incentives directly motivate our employees to maximize long-term stockholder
value and, through the use of vesting, encourage employees to remain with Credence. The FASB issued changes to U. S. GAAP that requires us to record a charge to earnings for new and unvested employee stock option grants beginning on November 1,
2005. This regulation has made it more expensive to grant stock options to employees and has negatively impacted our reported earnings by $1.2 million and $4.1 million for the three months and nine months ended August 4, 2007, respectively. For
fiscal year 2006, $3.3 million of expenses associated with stock options negatively impacted our reported earnings.

In July 2006, the
Financial Accounting Standards Board, or FASB, issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxesan Interpretation of FASB Statement No. 109, or FIN 48, which clarifies the accounting for
uncertainty in income tax positions. This interpretation requires that we recognize in our financial statements the impact of a tax position if that position is more likely than not of being sustained on audit, based on the technical merits of the
position. The provisions of FIN 48 are effective for us on November 4, 2007, with the cumulative effect of the change in accounting principle, if any, recorded as an adjustment to opening retained earnings. We are currently evaluating the
impact of adopting FIN 48 on our financial position, cash flows, and results of operations. Changes to existing rules, including the adoption of FIN 48, or the questioning of current practices may adversely affect our reported financial results or
the way we conduct our business.

We have a limited backlog and obtain most of our net sales from products that typically range in price from $100,000
to $5.0 million and generally ship products generating most of our net sales near the end of each quarter, which can result in fluctuations of quarterly results.

We obtain most of our net sales from the sale of a relatively few number of systems that typically range in selling price from $100,000 to $5.0 million. This has resulted and could continue to result in our net sales
and operating results for a particular period being significantly impacted by the timing of recognition of revenue from a single transaction. Our net sales and operating results for a particular period could also be materially adversely affected if
an anticipated order from just one customer is not received in time to permit shipment during that period. Backlog at the beginning of a quarter typically does not include all orders necessary to achieve our sales objectives for that quarter. Orders
in backlog are subject to cancellation, delay, deferral or rescheduling by customers with limited or no penalties. Throughout the recent fiscal years, we have experienced customer-requested shipment delays and order cancellations, and we believe it
is probable that orders will be canceled and delayed 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.

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 our competitors announce new products and technologies, and as we complete acquisitions of similar
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.

We may continue to experience delays in development, introduction, production in volume, and recognition of revenue from sales of our products.

We have in the past experienced significant delays in the development, introduction, volume production and sales of our new systems and related feature
enhancements. These delays related to our inability to successfully complete product hardware engineering within the time frame originally anticipated, including design errors and redesigns of ICs. As a result,



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some customers have experienced significant delays in receiving and using 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. We cannot be certain that these or additional difficulties will not continue to arise or that delays will not continue to
materially adversely affect customer relationships and future sales. Moreover, we cannot be certain that we will not encounter these or other difficulties that could delay future introductions or volume production or sales of our systems or
enhancements. In the past, we have incurred and we may continue to incur substantial unanticipated costs to increase feature sets in our systems. If our systems experience reliability, quality or other problems, or the market perceives our products
to be feature deficient, we may continue to suffer reduced orders, higher manufacturing costs, delay 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 test system 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 and mixed signal 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. In addition, the consolidation of our manufacturing operations in a single site exposes us to the increased risk of manufacturing delays or disruption in the event of natural disasters or other
calamities at the site. Any delays or disruptions could materially adversely affect our business, financial condition and results of operations.

Competition in the ATE market requires rapid technological enhancements and new products and services.

Our ability to
compete in the Automatic Test Equipment, or ATE, market depends upon our ability to successfully develop and introduce new products and enhancements with enhanced features on a timely and cost-effective basis, including products under development
internally as well as products obtained in acquisitions. Our customers require test systems with additional features, higher performance and other capabilities. Therefore, it is necessary for us to develop new systems and/or enhance the performance
and other capabilities of our existing systems to adequately address these requirements. Any success we may have in developing new and enhanced systems and new features to our existing systems will depend upon a variety of factors, including:



| |  |  | product selection;
| | - |  | ------------------



| |  |  | timely and efficient completion of product design;
| | - |  | --------------------------------------------------



| |  |  | implementation of manufacturing and assembly processes;
| | - |  | -------------------------------------------------------



| |  |  | product performance;
| | - |  | --------------------



| |  |  | reliability in the field;
| | - |  | -------------------------



| |  |  | effective worldwide sales and marketing; and
| | - |  | --------------------------------------------



| |  |  | labor and supply constraints.
| | - |  | -----------------------------

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 products or enhancements. Our inability to introduce new products 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. If we introduce new products,
existing customers may curtail purchases of the older products resulting in inventory write-offs and they may delay new product purchases. In addition, capacity utilization at outsourced assembly and test houses, while improving, continues at low
levels that are likely to depress our non-integrated device manufacturers, or non-IDM business until such time that demand and supply conditions improve. Any decline in demand for our hardware products could have a material adverse effect on our
business, financial condition or results of operations.

We are continuing to invest significant resources in the expansion of our product lines and
there is no certainty that our net sales will increase or remain at historical levels or that new products will contribute to revenue growth.

We are currently devoting and intend to continue to devote significant resources to the development, enhancement, production and commercialization of new products and technologies. During fiscal years 2006 and 2005, we introduced several
enhancements as well as new products that are evolutions or derivatives of existing products as well as products that were largely new. Under our revenue recognition policy adopted in accordance with Staff Accounting Bulletin No. 104,
Revenue Recognition, (SAB 104) we defer revenue for transactions that involve newly introduced products or when



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customers specify acceptance criteria that cannot be demonstrated prior to the shipment. This results 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 and may result in delayed cash receipts by us that could materially adversely
affect our business, financial condition and results of operations. We invested and continue to invest significant resources in property, plant and equipment, purchased and 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 products. Accordingly, we cannot be certain that gross profit
margin and inventory levels will not continue to be materially adversely affected 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 significant 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.

The ATE industry is intensely competitive which can adversely affect our ability to maintain or increase our net sales and revenues growth.

With the substantial investment required to develop test application 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 particular 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. A substantial portion of our net sales is derived from sales of mixed-signal testers. We face in some cases seven and in other cases nine
competitors in our primary market segments of digital, mixed signal, and RF wireless ATE. We believe that the ATE industry in total has not been profitable for the last three years, indicating a very competitive and volatile marketplace. Several of
these competitors have substantially greater financial and other resources with which to pursue engineering, manufacturing, marketing and distribution of their products. In addition, three of our competitors recently completed initial public
offerings. The success of these companies could make the competitive environment substantially more severe. 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 will continue to be materially adversely affected by continuing 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 have become more intense during cyclical downturns when
competitors seek to maintain or increase market share, 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 to satisfy specific customer needs in a timely manner.

We must develop and deliver customized hardware 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 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, which could have a material adverse effect on our business, financial condition or results of operations.



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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 14%, 13% and 14% of our net sales in the nine months ended August 4, 2007 and fiscal years ended October 31, 2006 and 2005, respectively. Our agreement with Spirox has
no minimum purchase commitment and can be terminated for any reason on 180 days prior written notice. 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 the loss of any significant Spirox customer, including the potential for reductions in orders by assembly and tester service companies due to 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 in Taiwan will depend upon:



| |  |  | our ability with Spirox 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 products;
| | - |  | ----------------------------------------------------------------------------



| |  |  | Spirox and its end-user customers financial condition and success;
| | - |  | -------------------------------------------------------------------



| |  |  | general economic conditions; and
| | - |  | --------------------------------



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

We require a significant amount of cash, and our ability to generate cash may be affected by factors beyond our control.

Our business may not generate cash flow in an amount sufficient to enable us to fund our liquidity needs, including payment of the principal of, or
interest on, our indebtedness, working capital, capital expenditures, product development efforts, strategic acquisitions, investments and alliances and other general corporate requirements. Our ability to generate cash is subject to general
economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. We cannot be assured that our business will generate sufficient cash flow from operations or that future borrowings or other sources of funding
will be available to us, in amounts sufficient to enable us to fund our liquidity needs or with terms that are favorable to us.

We may repatriate cash
from our foreign subsidiaries, which could result in additional income taxes that could negatively impact our results of operations and financial position. In addition, if foreign countries currency policies limit our ability to repatriate the
needed funds, our business and results of operations could be adversely impacted.

One or more of our foreign subsidiaries hold a
portion of our cash and cash equivalents. If we need additional cash to acquire assets or technology, or to support our operations in the United States, and if the currency policies of these foreign countries allow us, we may repatriate some of our
cash from these foreign subsidiaries to the United States. For example, during the first quarter of fiscal 2007 and fourth quarter of fiscal year 2006, we repatriated $7.1 million and $23.0 million from our subsidiaries, respectively. Depending on
our financial results and the financial results of our subsidiaries at the time that the cash is repatriated, we may incur additional income taxes from the repatriation, which could negatively affect our results of operations and financial position.
In addition, if the currency policies of these foreign countries prohibit or limit our ability to repatriate the needed funds, our business and results of operations could be adversely impacted.

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, including a risk that our competitors may compete for the sale, a further downturn in the economy or other economic factors causing our customers to withdraw or delay their orders or a change in technological
requirements of the customer. As a result, our business, financial condition and results of operations may be materially adversely affected by our long and variable sales cycle and the uncertainty associated with expending substantial funds and
effort with no guarantee that a sale will be made.



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

We obtain certain components, subassemblies and services necessary for the manufacture of our testers from a limited group of suppliers. We do not
maintain long-term supply agreements with most of our vendors, and we purchase most of our components and subassemblies through individual purchase orders. The manufacture of certain of our components and subassemblies is an extremely complex
process. We also rely on outside vendors to manufacture certain components and subassemblies and to provide certain services. We have experienced and continue to experience significant reliability, quality and timeliness problems with several
critical components including certain custom ICs. 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 in the future may delay shipments of our systems and new products and could 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.

Our international business exposes us to additional risks.

International sales accounted for
approximately 72%, 69% and 69% of our total net sales in the nine months ended August 4, 2007 and fiscal years ended October 31, 2006 and 2005, respectively. 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;
| | - |  | -----------------------------------



| |  |  | adverse effects of fears surrounding any health risks on our business and sales and that of our customers, especially in Taiwan, Hong Kong and China;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | outbreak of hostilities in markets where we sell our products, including Korea and Israel;
| | - |  | ------------------------------------------------------------------------------------------



| |  |  | integration and management of foreign operations of acquired businesses;
| | - |  | ------------------------------------------------------------------------



| |  |  | foreign currency exchange rate fluctuations;
| | - |  | --------------------------------------------



| |  |  | difficulties with distributors, original equipment manufacturers, foreign subsidiaries and branch operations;
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | potentially adverse tax consequences;
| | - |  | -------------------------------------



| |  |  | possibility of difficulty in accounts receivable collection;
| | - |  | ------------------------------------------------------------



| |  |  | greater difficulty in maintaining United States accounting standards; and
| | - |  | -------------------------------------------------------------------------



| |  |  | greater difficulty in protecting intellectual property rights.
| | - |  | --------------------------------------------------------------

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 products. We cannot predict whether the
import and export of our products will be adversely affected by changes in or new 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 52%, 51% and 47% of our total net sales for the nine months
ended August 4, 2007 and fiscal years ended October 31, 2006 and 2005, respectively, and thus demand for our products is subject to the risk of economic instability in that region and health risks. Countries in the Asia-Pacific region,
including Korea and Japan, have experienced weaknesses in their currency, banking and equity markets in the recent past. These weaknesses could continue to adversely affect demand for our products, the availability and supply of our product
components and our consolidated results of operations.



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No single end-user customer headquartered in Asia accounted for more than 10% of our net sales during the
nine months ended August 4, 2007 and fiscal years ended October 31, 2006 and 2005. No single end-user customer headquartered in Europe accounted for more than 10% of our net sales during the nine months ended August 4, 2007 and fiscal
years ended October 31, 2006 and 2005. Two customers headquartered in the United States, Advanced Micro Devices, Inc. and Intel Corporation accounted for 32% and 15% of our net sales in the nine months ended August 4, 2007, respectively.
Advanced Micro Devices, Inc. and Intel Corporation accounted for 23% and 15% of our net sales fiscal years ended October 31, 2006, respectively. Advanced Micro Devices, Inc. and Intel Corporation accounted for 14% and 25% of our net sales
fiscal year ended October 31, 2005, respectively.

In addition, one of our major distributors, Spirox Corporation, which accounted for
14%, 13% and 14% of our net sales in the nine months ended August 4, 2007 and fiscal years ended October 31, 2006 and 2005, respectively, 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, fears related to health risks 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.

Future
acquisitions may be difficult to integrate, disrupt our business, dilute stockholder value or divert management attention.

Our growth
depends upon market growth, our ability to enhance our existing products, and our ability to introduce new products on a timely basis. We intend to continue to address the need to develop new products and enhance existing products through
acquisitions of other companies, product lines, technologies, and personnel. Acquisitions involve numerous risks, including the following:



| |  |  | Difficulties in integrating the operations, technologies, products, and personnel of the acquired companies;
| | - |  | ------------------------------------------------------------------------------------------------------------



| |  |  | Diversion of managements attention from normal daily operations of the business;
| | - |  | ---------------------------------------------------------------------------------



| |  |  | Potential difficulties in completing projects associated with in-process research and development;
| | - |  | --------------------------------------------------------------------------------------------------



| |  |  | Difficulties in entering markets in which we may have no or limited direct prior experience and where competitors in such markets may have stronger market
positions;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Initial dependence on unfamiliar supply chains or relatively small supply partners;
| | - |  | -----------------------------------------------------------------------------------



| |  |  | Insufficient revenue to offset increased expenses associated with acquisitions; and
| | - |  | -----------------------------------------------------------------------------------



| |  |  | Potential loss of key employees of the acquired companies.
| | - |  | ----------------------------------------------------------

Acquisitions may also cause us to:



| |  |  | Issue common stock that would dilute our current stockholders percentage ownership;
| | - |  | ------------------------------------------------------------------------------------



| |  |  | Assume liabilities;
| | - |  | -------------------



| |  |  | Record goodwill and non-amortizable intangible assets that will be subject to impairment testing on a regular basis and potential periodic impairment charges;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Incur amortization expenses related to certain intangible assets;
| | - |  | -----------------------------------------------------------------



| |  |  | Incur large and immediate write-offs and restructuring and other related expenses; and
| | - |  | --------------------------------------------------------------------------------------



| |  |  | Become subject to intellectual property or other litigation.
| | - |  | ------------------------------------------------------------

Mergers and acquisitions of high-technology companies are inherently risky, and no assurance can be given that our previous or future acquisitions will be successful and will not materially adversely affect our
business, operating results, or financial condition. Failure to manage and successfully integrate acquisitions could materially harm our business and operating results. Prior acquisitions have resulted in a wide range of outcomes, from successful
introduction of new products and technologies to an inability to do so. Even when an acquired company has already developed and marketed products, there can be no assurance that product enhancements will be made in a timely fashion or that
pre-acquisition due diligence will have identified all possible issues that might arise with respect to such products.

From time-to-time,
we have made acquisitions that resulted in in-process research and development expenses being charged in a single quarter. These charges may occur in any quarter, contributing to variability in our quarterly earnings. Risks related to new product
development also apply to acquisitions.



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If the protection of our 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. In addition, from
time to time we encounter disputes over rights and obligations concerning intellectual property, including disputes with parties with whom we have licensed technologies. We cannot assume that we will prevail in any such intellectual property
disputes. 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. We cannot be certain of the success in defending patent
infringement claims or claims for indemnification resulting from infringement claims.

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.

We may be
materially adversely affected by legal proceedings.

We have been and may in the future be subject to various legal proceedings,
including claims that involve possible infringement of patent or other intellectual property rights of third parties. It is inherently difficult to assess the outcome of litigation matters, and there can be no assurance that we will prevail in any
litigation. Any such litigation could result in substantial cost and diversion of our efforts, which by itself could have a material adverse effect on our financial condition and operating results. Further, adverse determinations in such litigation
could result in loss of our property rights, subject us to significant liabilities to third parties, require us to seek licenses from third parties or prevent us from manufacturing or selling our products, any of which could materially adversely
affect our business, financial condition or results of operations.

Recently enacted and proposed changes in securities laws and regulations are likely
to increase our costs.

Recently enacted and proposed changes in the laws and regulations affecting public companies, including the
provisions of the Sarbanes-Oxley Act of 2002, have increased and will continue to increase our expenses as we evaluate the implications of new rules and devote resources to respond to the new requirements. Sarbanes-Oxley Act mandates, among other
things, that companies adopt new corporate governance measures and imposes comprehensive reporting and disclosure requirements, sets stricter independence and financial expertise standards for audit committee members and imposes increased civil and
criminal penalties for companies, their chief executive officers and chief financial officers and directors for securities law violations. In particular, we incurred and expect to incur additional administrative expense as we implement
Section 404 of the Sarbanes-Oxley Act, which requires management to report on, and our independent registered public accounting firm to attest to, our internal control over financial reporting. In addition, The Nasdaq Global Select Market, on
which our common stock is listed, has also adopted comprehensive rules and regulations relating to corporate governance. These laws, rules and regulations have increased and will continue to increase the scope, complexity and cost of our corporate
governance, reporting and disclosure practices, which could harm our results of operations and divert managements attention from business operations. We also expect these developments to continue to make it more difficult and more expensive
for us to obtain director and officer liability insurance in the future, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. Further, our board members, Chief Executive Officer and Chief
Financial Officer could face an increased risk of personal liability in connection with the performance of their duties. As a result, we may have difficultly attracting and retaining qualified board members and executive officers, which would
adversely affect our business.



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

The terrorist attacks in September 2001 in the United States and
ensuing events and the resulting decline in consumer confidence had a material adverse effect on the economy.

Any similar future events
may disrupt our operations or those of our customers and suppliers. Our markets currently include Taiwan, Korea and Israel, which are experiencing political instability. In addition, these events have had and may continue to have an adverse impact
on the United States 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 United States 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, 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 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 from acquiring us and may adversely affect the voting and other rights of holders of our common stock.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

None

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

None

ITEM 5. OTHER INFORMATION.

None

ITEM 6. EXHIBITS.

(a) See Exhibit Index



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SIGNATURES

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



|                        |  |                                                                     
|----------------------- |  | --------------------------------------------------------------------
|                        |  | CREDENCE SYSTEMS CORPORATION                                        
|                        |  | (Registrant)                                                        
|                        | 
|September 18, 2007 Date |  | /s/ JOY E. LEO                                                      
|                        |  | Joy E. Leo                                                          
|                        |  | Chief Financial Officer (Principal Financial and Accounting Officer)



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EXHIBIT INDEX



|              |  |                                                                                                                               
|------------- |  | ------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  |                                                                                                                               
|3.1(1)        |  | Amended and Restated Certificate of Incorporation of the Company, as currently in effect.                                     
|              | 
|3.2(2)        |  | Amended and Restated Bylaws of the Company, as currently in effect.                                                           
|              | 
|10.1(3)       |  | Lease dated February 27, 2007 between NRFC Milpitas Holdings, LLC and the Company.                                            
|              | 
|10.2(4)       |  | Executive Employment Agreement, dated and effective as of March 13, 2007, by and between the Company and Lavi A. Lev.         
|              | 
|10.3(5)       |  | Executive Employment Agreement, dated and effective as of April 13, 2007, by and between the Company and Joy E. Leo.          
|              | 
|10.4(6)       |  | Notice of Stock Option Award and Stock Option Agreement dated April 16, 2007 between the Company and Joy E. Leo.              
|              | 
|10.5(6)       |  | Notice of Stock Option Award and Stock Option Agreement dated April 16, 2007 between the Company and Pat Brady.               
|              | 
|10.6(6)       |  | Amended and Restated Executive Employment Agreement, amended and restated June 5, 2007, between the Company and John C. Batty.
|              | 
|10.7          |  | Executive Employment Agreement, dated and effective as of August 10, 2007, by and between the Company and Amir Aghdaei.       
|              | 
|10.8          |  | 2005 Non-Employee Director Option Program Revised and Restated as of August 28, 2007.                                         
|              | 
|31.1          |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002        
|              | 
|31.2          |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002        
|              | 
|32.1          |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002        
|              | 
|32.2          |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002        

---

|(1) | Incorporated by reference to Exhibit 3.1 to the Companys Quarterly Report on Form 10-Q for the quarterly period ended April 30, 2000.
|--- | --------------------------------------------------------------------------------------------------------------------------------------

|(2) | Incorporated by reference to Exhibit 3.2 to the Companys Quarterly Report on Form 10-Q for the quarterly period ended January 31, 2002.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------

|(3) | Incorporated by reference to Exhibit 10.5 to the Companys Quarterly Report on Form 10-Q for the quarterly period ended February 3, 2007.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------

|(4) | Incorporated by reference to Exhibit 10.6 to the Companys Quarterly Report on Form 10-Q for the quarterly period ended February 3, 2007.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------

|(5) | Incorporated herein by reference to Exhibit 10.1 to the Companys Current Report on Form 8-K (File No. 000-22366) filed on April 17, 2007.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------

|(6) | Incorporated by reference to Exhibit 10.6 to the Companys Quarterly Report on Form 10-Q for the quarterly period ended May 5, 2007.
|--- | ------------------------------------------------------------------------------------------------------------------------------------



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