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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q



(Mark One)

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



For the quarterly period ended January 31, 2003



OR



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



For the transition period from
 to



Commission
file number 0-22366



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CREDENCE SYSTEMS CORPORATION

(Exact name of registrant as specified in its charter)



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



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





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



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



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Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x  No ̈



APPLICABLE ONLY TO CORPORATE ISSUERS:



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



APPLICABLE ONLY TO CORPORATE ISSUERS:



At March 3, 2003, there were approximately 63,095,530 shares
of the Registrants common stock, $0.001 par value per share, outstanding.



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CREDENCE SYSTEMS CORPORATION



INDEX





|                             
|-----------------------------
|PART I. FINANCIAL INFORMATION
|                             
|Item 1.                      
|                             
|                             
|                             
|                             
|                             
|                             
|                             
|                             
|                             
|Item 2.                      
|                             
|Item 3.                      
|                             
|Item 4.                      
|                             
|PART II. OTHER INFORMATION   
|                             
|Item 1.                      
|                             
|Item 2.                      
|                             
|Item 3.                      
|                             
|Item 4.                      
|                             
|Item 5.                      
|                             
|Item 6.                      



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##### Table of Contents



PART I - FINANCIAL
INFORMATION



Item 1. -
FINANCIAL STATEMENTS



CREDENCE SYSTEMS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)



|                                               |  | January 31, 2003 |         | October 31, 2002a
|---------------------------------------------- |  | ---------------- | ------- | -----------------
|                                               |  | (unaudited)     
|ASSETS                                         |  |                  |         |                  
|Current assets:                                |  |                  |         |                  
|Cash and cash equivalents                      |  | $                | 24,874  |                  
|Short-term investments                         |  |                  | 76,527  |                  
|Accounts receivable, net                       |  |                  | 32,579  |                  
|Inventories                                    |  |                  | 107,394 |                  
|Income tax receivable                          |  |                  | 20,481  |                  
|Deferred income taxes and other current assets |  |                  | 9,580   |                  
|                                               |  |                  |         |                  
|Total current assets                           |  |                  | 271,435 |                  
|Long-term investments                          |  |                  | 107,105 |                  
|Property and equipment, net                    |  |                  | 108,840 |                  
|Goodwill, net                                  |  |                  | 34,740  |                  
|Other intangible assets, net                   |  |                  | 41,139  |                  
|Other assets                                   |  |                  | 7,062   |                  
|                                               |  |                  |         |                  
|Total assets                                   |  | $                | 570,321 |                  
|                                               |  |                  |         |                  
|LIABILITIES AND STOCKHOLDERS
EQUITY           |  |                  |         |                  
|Current liabilities:                           |  |                  |         |                  
|Accounts payable                               |  | $                | 17,641  |                  
|Accrued expenses and other liabilities         |  |                  | 42,417  |                  
|Deferred profit                                |  |                  | 2,062   |                  
|                                               |  |                  |         |                  
|Total current liabilities                      |  |                  | 62,120  |                  
|Other liabilities                              |  |                  | 820     |                  
|Stockholders equity                           |  |                  | 507,381 |                  
|                                               |  |                  |         |                  
|Total liabilities and stockholders equity     |  | $                | 570,321 |                  
|                                               |  |                  |         |                  



|a) |  | Derived from the audited consolidated balance sheet included in our Form 10-K for the year ended October 31, 2002.
|-- |  | ------------------------------------------------------------------------------------------------------------------



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 January 31, |        
|--------------------------------------------------- |  | ------------------------------ | -------
|                                                    |  | 2003                           |        
|Net sales                                           |  | $                              | 36,672 
|Cost of goods sold                                  |  |                                | 24,208 
|                                                    |  |                                |        
|Gross margin                                        |  |                                | 12,464 
|Operating expenses:                                 |  |                                |        
|Research and development                            |  |                                | 19,496 
|Selling, general and administrative                 |  |                                | 20,566 
|Amortization of purchased intangibles               |  |                                | 1,590  
|In-Process research and development                 |  |                                | 1,510  
|Special charges                                     |  |                                | 1,392  
|                                                    |  |                                |        
|Total operating expenses                            |  |                                | 44,554 
|                                                    |  |                                |        
|Operating income (loss)                             |  |                                | (32,090
|Interest and other income, net                      |  |                                | 1,927  
|                                                    |  |                                |        
|Income (loss) before income tax provision           |  |                                | (30,163
|Income tax (benefit)                                |  |                                | 82     
|Minority interest (benefit)                         |  |                                | (81    
|                                                    |  |                                |        
|Net income (loss)                                   |  | ($                             | 30,164 
|                                                    |  |                                |        
|Net income (loss) per share                         |  |                                |        
|Basic                                               |  | ($                             | 0.49   
|                                                    |  |                                |        
|Diluted                                             |  | ($                             | 0.49   
|                                                    |  |                                |        
|Number of shares used in computing per share amount |  |                                |        
|Basic                                               |  |                                | 61,145 
|                                                    |  |                                |        
|Diluted                                             |  |                                | 61,145 
|                                                    |  |                                |        



See
accompanying notes.



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CREDENCE
SYSTEMS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Increase (decrease) in cash and cash equivalents

(in thousands)

(unaudited)



|                                                                              |  | Three Months Ended January 31, |        
|----------------------------------------------------------------------------- |  | ------------------------------ | -------
|                                                                              |  | 2003                           |        
|Cash flows from operating activities:                                         |  |                                |        
|Net income (loss)                                                             |  | $                              | (30,164
|Adjustments to reconcile net income to net cash used in operating
activities: |  |                                |        
|Depreciation and amortization                                                 |  |                                | 7,496  
|Special non-cash IPR&D charge                                                 |  |                                | 1,510  
|Loss on disposal of property and equipment                                    |  |                                | 227    
|Unrealized gain/loss on investment, translation adjustment                    |  |                                | 899    
|Minority interest                                                             |  |                                | (81    
|Changes in operating assets and liabilities:                                  |  |                                |        
|Accounts receivable, inventories and other current assets                     |  |                                | (3,389 
|Accounts payable, accrued liabilities and income taxes payable                |  |                                | (2,319 
|                                                                              |  |                                |        
|Net cash provided by (used in) operating activities                           |  |                                | (25,821
|Cash flows from investing activities:                                         |  |                                |        
|Purchases of available-for-sale securities                                    |  |                                | (45,398
|Sales of available-for-sale securities                                        |  |                                | 53,236 
|Acquisition of property and equipment                                         |  |                                | (1,697 
|Acquisition of other assets                                                   |  |                                | (5,880 
|                                                                              |  |                                |        
|Net cash provided by (used in) investing activities                           |  |                                | 261    
|Cash flows from financing activities:                                         |  |                                |        
|Issuance of common & treasury stock                                           |  |                                | 242    
|Other                                                                         |  |                                |       
|                                                                              |  |                                |        
|Net cash provided by (used in) financing activities                           |  |                                | 242    
|                                                                              |  |                                |        
|Net (decrease) in cash and cash equivalents                                   |  |                                | (25,318
|Cash and cash equivalents at beginning of period                              |  |                                | 50,192 
|                                                                              |  |                                |        
|Cash and cash equivalents at end of period                                    |  | $                              | 24,874 
|                                                                              |  |                                |        
|Supplemental disclosures of cash flow information:                            |  |                                |        
|Income taxes paid (received)                                                  |  | $                              | 2,912  
|Noncash investing activities:                                                 |  |                                |        
|Net transfers of inventory to property and equipment                          |  |                                |       
|Acquisition of Optonics using Credence common stock                           |  | $                              | (17,139
|Noncash financing activities:                                                 |  |                                |        
|Income tax benefit from stock option exercises                                |  |                                |       
|Acquisition of Optonics using Credence common stock                           |  | $                              | 17,139 



See
accompanying notes.



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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



1. Quarterly Financial Statements



The condensed consolidated financial statements and related notes for the three month periods ended January 31, 2003 and 2002 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. The results of operations for the three-month periods ended January 31, 2003
and 2002 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, 2002 included in the Companys most recent Annual Report on Form 10-K and the additional risk factors contained herein and therein, including, without limitation, risks relating to importance
of timely product introduction, successful integration of acquisitions, fluctuations in our quarterly net sales and operating results, limited systems sales, backlog, cyclicality of semiconductor industry, management of fluctuations in our operating
results, expansion of our product lines, limited sources of supply, reliance on our subcontractors, highly competitive industry, rapid technological change, customer concentration, lengthy sales cycle, changes in financial accounting standards and
accounting estimates, dependence on key personnel, international sales, proprietary rights, future capital needs, leverage, volatility of our stock price and effects of certain anti-takeover provisions, as set forth in this Report. Any party
interested in receiving a free copy of the Form 10-K or the Companys other publicly available documents should write to the Chief Financial Officer of the Company.



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



2. Revenue Recognition



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





Deferred revenue, which is included in accrued expenses and other liabilities on the balance sheet, 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 either the customer specified acceptance criteria has not been met as of the fiscal period end or the product is not classified as mature as of
the fiscal period end and has not been accepted by the customer.



3. Stock-Based Compensation



In October 2002, the FASB issued Statement No. 148 Accounting for Stock-Based Compensation-Transition and Disclosure, or SFAS 148, providing alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. SFAS 148 also amends the disclosure requirements of SFAS No. 123, Accounting for Stock-Based Compensation, or SFAS 123 to include prominent disclosures in annual and interim
financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company adopted the provisions of SFAS 148 on November 1, 2002.



Had the Company determined stock-based compensation costs
based on the estimated fair value at the grant date for its stock options, the Companys net loss and net loss per share for the three months ended January 31, 2003 and 2002 respectively would have been as follows (in thousands, except per
share data):



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|                                                                                                                                                                                      |  | Three Months Ended January 31, |        
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------ | -------
|                                                                                                                                                                                      |  | 2003                           |        
|Net (loss) as reported                                                                                                                                                                |  | $                              | (30,164
|Stock-based employee compensation expense determined under fair value based methods for
all awards net of tax effects (0% and 36% effective tax rate for FY03 and FY02, respectively) |  | $                              | 6,972  
|                                                                                                                                                                                      |  |                                |        
|Pro forma net loss                                                                                                                                                                    |  | $                              | (37,136
|                                                                                                                                                                                      |  |                                |        
|Basic loss per share as reported                                                                                                                                                      |  | $                              | (0.49  
|Basic loss per share pro forma                                                                                                                                                        |  | $                              | (0.61  
|Diluted loss per share as reported                                                                                                                                                    |  | $                              | (0.49  
|Diluted loss per share pro forma                                                                                                                                                      |  | $                              | (0.61  



The fair
value for these options was estimated at the grant date using a Black-Scholes option-pricing model with the following weighted average assumptions for the three months ended January 31, 2003 and January 31, 2002.



|                                               |  | January 31, 2003 |   |  | January 31, 2002 |  
|---------------------------------------------- |  | ---------------- | - |  | ---------------- | -
|Expected stock volatility                      |  | 0.7725           |   |  | 0.7725           |  
|Risk free interest rate                        |  | 3.575            | % |  | 3.599            | %
|Expected life of options after vesting (years) |  | 6.7              |   |  | 6.8              |  



4. 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):



|                |  | January 31, 2003 |         | October 31, 2002
|--------------- |  | ---------------- | ------- | ----------------
|                |  | (unaudited)     
|Raw materials   |  | $                | 54,771  |                 
|Work-in-process |  |                  | 24,701  |                 
|Finished goods  |  |                  | 27,922  |                 
|                |  |                  |         |                 
|                |  | $                | 107,394 |                 
|                |  |                  |         |                 



5. Goodwill and Other
Intangibles



Effective November 1, 2002, the
Company adopted Statement of Financial Accounting Standard No. 142,  Goodwill and Other Intangible Assets, or SFAS 142, which was issued by the FASB in July 2001. Under this standard, the Company ceased amortizing goodwill effective
November 1, 2002. In addition, on adoption, the Company reclassified certain intangibles with a net book value of $0.4 million, consisting of acquired workforce, which is no longer defined as an acquired intangible under SFAS 142 to goodwill.
Accordingly, there was no amortization of acquired workforce in acquisition costs recognized during the three months ended January 31, 2003.



The following table presents a reconciliation of previously reported net loss per share to the amounts adjusted to exclude goodwill and
acquired workforce amortization (in thousands, except per share data):



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|                                                         |  | January 31, 2003 |         |   | January 31, 2002 |  
|-------------------------------------------------------- |  | ---------------- | ------- | - | ---------------- | -
|Net loss as reported                                     |  | $                | (30,164 | ) |                  | $
|Goodwill amortization (net of 35% tax benefit)           |  |                  |        |   |                  |  
|Acquired workforce amortization (net of 35% tax benefit) |  |                  |        |   |                  |  
|                                                         |  |                  |         |   |                  |  
|Proforma net loss                                        |  | $                | (30,164 | ) |                  | $
|                                                         |  |                  |         |   |                  |  
|Basic and diluted net loss per share as reported:        |  | $                | (0.49   | ) |                  | $
|Goodwill amortization                                    |  |                  |        |   |                  |  
|Acquired workforce amortization                          |  |                  |        |   |                  |  
|                                                         |  |                  |         |   |                  |  
|Proforma net loss per share                              |  | $                | (0.49   | ) |                  | $
|                                                         |  |                  |         |   |                  |  



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



|January 31, 2003               |  | Cost |        | Accumulated Amortization |   |         | Net
|------------------------------ |  | ---- | ------ | ------------------------ | - | ------- | ---
|Optonics purchased intangibles |  | $    | 17,979 |                          | $ |        |    
|Purchased technology           |  |      | 32,153 |                          |   | (12,024 | )  
|Customer relations             |  |      | 6,052  |                          |   | (4,068  | )  
|Trademarks                     |  |      | 2,053  |                          |   | (1,380  | )  
|Patents                        |  |      | 862    |                          |   | (488    | )  
|                               |  |      |        |                          |   |         |    
|Total                          |  | $    | 59,099 |                          | $ | (17,960 | )  
|                               |  |      |        |                          |   |         |    



|October 31, 2002     |  | Cost |        | Accumulated Amortization |   |         | Net
|-------------------- |  | ---- | ------ | ------------------------ | - | ------- | ---
|Purchased technology |  | $    | 32,153 |                          | $ | (10,970 | )  
|Customer relations   |  |      | 6,052  |                          |   | (3,677  | )  
|Trademarks           |  |      | 2,053  |                          |   | (1,247  | )  
|Patents              |  |      | 862    |                          |   | (445    | )  
|Assembled workforce  |  |      | 1,954  |                          |   | (1,527  | )  
|                     |  |      |        |                          |   |         |    
|Total                |  | $    | 43,074 |                          | $ | (17,866 | )  
|                     |  |      |        |                          |   |         |    



Amortization expense for the other intangible assets was $1.6 million for the three months ended January 31, 2003, as compared to $2.6 million for the three months ended January 31, 2002. Excluding future amortization expense for the
Optonics purchased intangibles, estimated annual amortization expense for the other intangible assets is $4.8 million for the remaining three quarters of fiscal 2003, $6.4 million for the fiscal year ending October 31, 2004, $6.4 million for the
fiscal year ending October 31, 2005, and $4.1 million for the fiscal year ending October 31, 2006.



The Company expects to record identified purchased technology, customer relationships, and non-compete agreements as the principal
intangible assets when the Optonics purchase price allocation is finalized. Once completed, useful lives will be assigned to the individual intangible categories allowing the Company to provide future estimates of amortization expense. The final
purchase price and its allocation are expected to be finalized during the second quarter of fiscal 2003.



The Company will test goodwill for impairment using the two-step process prescribed in SFAS 142.



6. Net Income (Loss) Per Share



Basic net income (loss) per share is based upon the weighted
average number of common shares outstanding during the period. Diluted net income (loss) per share is based upon the weighted average number of common shares and dilutive-potential common shares outstanding during the period. The Company excluded
options to purchase 470,903 shares of common stock from the diluted income (loss) per share calculation for the fiscal quarter ended January 31, 2003 because options are anti-dilutive in periods when the Company incurs a net loss.



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



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|                                                                                                    |  | Three Months Ended January 31, |        
|--------------------------------------------------------------------------------------------------- |  | ------------------------------ | -------
|                                                                                                    |  | 2003                           |        
|Numerator:                                                                                          |  |                                |        
|Numerator for basic and diluted net income per share-net income (loss)                              |  | $                              | (30,164
|                                                                                                    |  |                                |        
|Denominator:                                                                                        |  |                                |        
|Denominator for basic net income per share-weighted-average sharesweighted-average
shares           |  |                                | 61,145 
|Effect of dilutive securities-employee stock options                                                |  |                                |       
|                                                                                                    |  |                                |        
|Denominator for diluted earnings per share-adjusted weighted-average shares and assumed conversions |  |                                | 61,145 
|                                                                                                    |  |                                |        
|Basic net income (loss) per share                                                                   |  | $                              | (0.49  
|                                                                                                    |  |                                |        
|Diluted net income (loss) per share                                                                 |  | $                              | (0.49  
|                                                                                                    |  |                                |        



7. Recent Accounting
Pronouncements



In June 2001, the Financial
Accounting Standards Board issued Statement of Financial Accounting Standard No. 141, Business Combinations, or SFAS 141 and Statement of Financial Accounting Standard No. 142, Goodwill and Other Intangible Assets, or SFAS
142.



SFAS 141 supercedes APB Opinion No. 16,
Business Combinations, and eliminates the pooling-of-interests method of accounting for business combinations, thus requiring that all business combinations be accounted for using the purchase method. In addition, in applying the
purchase method, SFAS 141 changes the criteria for recognizing intangible assets other than goodwill and states that the following criteria should be considered in determining the classification of intangible assets: (1) whether the intangible asset
arises from contractual or other legal rights, or (2) whether the intangible asset is separable or dividable from the acquired entity and capable of being sold, transferred, licensed, rented, or exchanged. If neither criteria is met, the intangible
assets are classified as goodwill and are not amortized. The Company will apply the requirements of SFAS 141 to all business combinations initiated after June 30, 2001. The Companys purchase of Optonics during the quarter ended January 31,
2003, is subject to these requirements.



In
August 2001, the FASB issued Statements of Financial Accounting Standards No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets, or SFAS 144. SFAS 144 supercedes SFAS 121, Accounting for the Impairment of
Long-Lived Assets and Long-Lived Assets to be Disposed Of and the accounting and reporting provisions of Accounting Principles Board Opinion No. 30, Reporting the Results of OperationsReporting the Effects of Disposal of a Segment
of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business. SFAS 144 establishes a single accounting model for assets to be disposed of by sale whether previously
held and used or newly acquired. SFAS No. 144 retains the provisions of APB No. 30 for presentation of discontinued operations in the income stateent, but broadens the presentation to include a component of an entity. The Company has adopted SFAS
144 effective November 1, 2002, and the adoption did not have a material impact on the Companys financial position or results of operations.



In July 2002, the FASB approved Statement of Financial Accounting Standards No. 146 Accounting for Costs Associated with Exit or
Disposal Activities, or SFAS 146. SFAS 146 addresses the financial accounting and reporting for obligations associated with an exit activity, including restructuring, or with a disposal of long-lived assets. Exit activities include, but are
not limited to, eliminating or reducing product lines, terminating employees and contracts and relocating manufacturing facilities or personnel. SFAS 146 specifies that a company will record a liability for a cost associated with an exit or disposal
activity only when that liability is incurred and can be measured at fair value. Therefore, commitment to an exit plan or a plan of disposal expresses only managements intended future actions and, therefore, does not meet the requirement for
recognizing a liability and the related expense. SFAS 146 is effective prospectively for exit or disposal activities initiated after December 31, 2002. The effect of adoption of SFAS 146 is dependent on the Companys related activities
subsequent to the date of adoption.



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In November
2002, the EITF reached a consensus on Issue No. 00-21, Revenue Arrangements with Multiple Deliverables. EITF Issue No. 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple
products, services and/or rights to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The Company is currently evaluating the effect that the adoption
of EITF Issue No. 00-21 will have on its results of operations and financial condition.



8. Accrued Warranty



In November 2002, the FASB issued Interpretation No. 45  Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, or FIN 45. It requires that a
liability be recorded in the guarantors balance sheet upon issuance of a guarantee. In addition, FIN 45 requires disclosures about the guarantee that an entity has issued, including a reconciliation of changes in the entities product warranty
liabilities. The initial recognition and initial measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 2002. The Company believes that the adoption of this standard will have no
material impact on its financial statements.



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 three months ended January 31, 2003 (in thousands):



|Balance at October 31, 2002                |  | $ | 4,316  |  
|------------------------------------------ |  | - | ------ | -
|Add: Warranty accrual                      |  |   | 1,640  |  
|Acquired pre-existing warranty obligations |  |   | 408    |  
|Less: Warranty spending                    |  |   | (1,160 | )
|                                           |  |   |        |  
|Balance at January 31,2003                 |  | $ | 5,204  |  
|                                           |  |   |        |  



9. Contingencies and
Guarantees



The Company from time to time
enters into certain types of contracts that contingently require the Company to indemnify parties against third party claims. These contracts primarily relate to: (i) certain real estate leases, under which the Company may be required to indemnify
property owners for environmental and other liabilities, and other claims arising from the Companys use of the applicable premises; and (ii) certain agreements with the Companys officers and directors and employees, under which the
Company may be required to indemnify such persons for liabilities arising out of their employment relationship.



The terms of such obligations vary. Generally, a maximum obligation is not explicitly stated. Because the obligated amounts of these types
of agreements often are not explicitly stated, the overall maximum amount of the obligations cannot be reasonably estimated. Historically, the Company has not been obligated to make significant payments for these obligations, and no liabilities,
have been recorded for these obligations on its balance sheet as of January 31, 2003.



The Company has an agreement with a non-related leasing company, Credence Capital Corporation, or CCC, whereby the Company issued a guaranty in favor of a bank with respect to certain obligations of
CCC to the bank. Under this agreement, CCC agreed to grant the Company a security interest to secure the obligations of the leasing company as a result of any payments by the Company pursuant to the guaranty. At January 31, 2003, the amount of debt
of CCC subject to this guaranty was $5.0 million. In February 2003, the Company acquired CCC, and the underlying liability will be shown as a direct obligation of the Company. See Note 13 for further discussion.



In July 1998, the Company received a written allegation from
inTEST IP Corp., together with its patent licensee inTEST Corporation, (inTEST), that the Company was infringing a patent held by inTEST. On December 15, 2000, inTEST filed a complaint in the U.S. District Court for the District of
Delaware, alleging infringement of inTEST U.S. patent number 4,589,815 and seeking damages and injunctive relief. In March 2003, the Company entered into an agreement with inTEST settling this litigation. Under the terms of the settlement agreement
the Company will pay to inTEST a non-material amount, the parties will cross-license on a non-exclusive and fully-paid basis certain patents and the Company will source certain equipment from inTEST in connection with sales of its ASL3000 product
family.



In April 2002, Reptron Electronics, Inc.
a supplier of certain electronic components to the Company, filed a complaint in the U.S. District Court for the District of Oregon, alleging that the Company had breached a contract to purchase certain components ordered by Reptron during 2000. The
complaint seeks damages of approximately $3.9 million. In November 2002, the court set trial for this action for July 15, 2003.



The Company is involved in other various claims arising in the ordinary course of business. The Company currently believes that the
ultimate amount of liability, if any, for any pending claims of any type (either alone or combined) will not materially affect its financial position, results of operations or liquidity.



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10. Accumulated Other
Comprehensive Income (Loss)



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



|                                                                    |  | Three Months Ended January 31, 2003 |       |   | Fiscal Year Ended October 31, 2002 |  
|------------------------------------------------------------------- |  | ----------------------------------- | ----- | - | ---------------------------------- | -
|Beginning balance, net of tax                                       |  | $                                   | 3,843 |   |                                    | $
|Unrealized gain (loss) on available-for-sale securities, net of tax |  |                                     | (255  | ) |                                    |  
|Currency translation adjustment, net of tax                         |  |                                     | 1,154 |   |                                    |  
|                                                                    |  |                                     |       |   |                                    |  
|Ending balance, net of tax                                          |  | $                                   | 4,742 |   |                                    | $
|                                                                    |  |                                     |       |   |                                    |  



11. Acquisitions



In December 2002, the Company completed the
acquisition of certain assets of SZ Testsysteme AG and SZ Testsysteme GmbH (SZ). The Credence-SZ division will operate with approximately 135 contracted employees from a facility located in Amerang, Germany and focus on the advanced analog, power
automotive, and communications markets. The purchase price for the assets was approximately $4.7 million in cash and the purchase price will be allocated to tangible assets, primarily inventory and fixed assets.



In January 2003, the Company acquired Optonics, Inc.
headquartered in Mountain View, California. Optonics has approximately 35 employees and is a leading supplier of integrated solutions for emission-based optical diagnostics and failure analysis. The acquisition was completed on January 22, 2003 in
an all-stock transaction pursuant to which the Company issued approximately 1.9 million shares of its common stock for all of the outstanding shares of Optonics as well as options to purchase an additional 100,000 shares of the Companys common
stock. A preliminary purchase price allocation analysis was performed with the assistance of a third party advisor and is expected to be finalized in the current second fiscal quarter.



The preliminary purchase price allocation has been completed based on an estimated purchase price valuation
of approximately $17.1 million for the 1.9 million Credence common shares issued. The preliminary purchase cost of the acquisition was recorded as follows in the three-month period ended January 31, 2003 (in thousands):



|In process research and development |  | $ | 1,510  |  
|----------------------------------- |  | - | ------ | -
|Intangible assets                   |  |   | 17,979 |  
|Tangible net assets                 |  |   | (2,350 | )
|                                    |  |   |        |  
|Total                               |  | $ | 17,139 |  
|                                    |  |   |        |  



The
Company expects to record identified purchased technology, customer relationships, and non-compete agreements as the principle intangible assets when the purchase price allocation is finalized. The Company is in the process of determining the value
of stock awards assumed in the acquisition. The final purchase price and its allocation are expected to be finalized during the second quarter of fiscal 2003.



12. Special Charges



For the period ended January 31, 2003 the Company recorded special charges of $1.4 million as operating expenses related to headcount
reductions and facility consolidations which the Company implemented in the quarter. During this period the Company reduced headcount by approximately 70 persons. The bulk of the affected employees were in SG&A and a smaller number were in
R&D. Also, during the quarter the Company completed its plans to exit the IMS facility in Beaverton, Oregon and consolidated the remaining employees into its Hillsboro, Oregon facility



The following table illustrates the activity for the three-month period ended January 31, 2003 and the
estimated timing of future payouts for major restructuring categories (in thousands):



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|                                    |  | Severance |        |   | Operating Leases |   |        | Other |  |   | Total |  
|----------------------------------- |  | --------- | ------ | - | ---------------- | - | ------ | ----- |  | - | ----- | -
|Balance at October 31, 2002         |  | $         | (716   | ) |                  | $ | (5,177 | )     |  | $ |      |  
|Headcount reduction                 |  |           | (1,186 | ) |                  |   |        |       |  |   | (5    | )
|Operating leases written off        |  |           |        |   |                  |   | (202   | )     |  |   |       |  
|Cash Payments                       |  |           | 790    |   |                  |   | 607    |       |  |   | 5     |  
|                                    |  |           |        |   |                  |   |        |       |  |   |       |  
|Balance at January 31, 2003         |  | $         | (1,112 | ) |                  | $ | (4,772 | )     |  | $ |      |  
|                                    |  |           |        |   |                  |   |        |       |  |   |       |  
|Estimated timing of future payouts: |  |           |        |   |                  |   |        |       |  |   |       |  
|Balance of fiscal 2003              |  |           | 871    |   |                  |   | 2,157  |       |  |   |      |  
|Fiscal 2004                         |  |           | 241    |   |                  |   | 1,497  |       |  |   |      |  
|Fiscal 2005 and beyond              |  |           |        |   |                  |   | 1,118  |       |  |   |      |  
|                                    |  |           |        |   |                  |   |        |       |  |   |       |  
|Total                               |  | $         | 1,112  |   |                  | $ | 4,772  |       |  | $ |      |  
|                                    |  |           |        |   |                  |   |        |       |  |   |       |  



The
opening balances at October 31, 2002 in the above table are associated with headcount reductions and facility consolidations the Company implemented in the fourth quarter of fiscal 2002.



In addition, to the above special charges, the Company also recorded a charge of $1.5 million in the first
quarter of fiscal 2003 for in-process research development resulting from the purchase of Optonics in January 2003.



13. Subsequent Events



In February 2003, the Company acquired the outstanding stock of Credence Capital Corporation (CCC), a non-related leasing company that
provides leasing and other financing solutions to customers seeking alternative options to acquire the Companys equipment, for $ 5.5 million. Contemporaneous with the transaction, CCCs sole shareholder and an affiliate repaid
indebtedness to CCC in the approximate amount of $5.2 million. The assets of CCC consist primarily of a portfolio of leases of Credence equipment and its liabilities include indebtedness of approximately $17 million associated with the lease
portfolio. The Company presently intends to continue to operate CCC as a wholly-owned subsidiary to provide leasing and other financing solutions to Credence customers.



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 the recording of intangible assets, allocation of purchase price, application
and adoption of certain accounting requirements, impact of various claims on the Company, continuation of CCC as a wholly-owned subsidiary, fluctuation of sales, gross margins and operating results, expectations of an eventual market upturn, charges
for excess and obsolete inventory, recordation of additional allowances or reversal of such recordations, reoccurrence of economic instabilities, effect on future orders as a result of geopolitical instabilities, expectations that gross margins will
remain at current or lower levels, intent to invest significant resources in the development and completion of new products and product enhancements and in the increase of production of current products, acquisition and R&D expenses accounting
for significant percentage of sales, SG&A expenses remaining consistent, recordation of full valuation allowance on domestic tax benefits, recognition of any significant tax benefits, introduction of new products and product enhancements,
investments in inventories representing a significant portion of working capital, change in estimate of net realizable value of receivables, inventories or other assets and adequacy of accrued liabilities, effect of downturn on revenue levels,
markets for newer generations of semiconductors subject to fluctuations, continuation of shipment and commitment delays, restructured purchase orders and cancellation of orders, dependence of new orders on demand from semiconductor device building
or expanding fabrication facilities and new device testing requirements, delays in customer acceptance, incurring of substantial unanticipated costs to ensure functionality and reliability, importance of continued acceptance, volume production,
timely delivery and customer satisfaction to financial results, weakness in IC demand causing reduction of demand for products, product introduction delays, continuing to pursue additional acquisitions, international sales accounting for significant
portion of total net sales, effect of slow down on product backlog, balance sheet and results of operations, experiencing of significant reliability, quality and timeliness problems with critical components, effects of Sarbanes-Oxley on legal
compliance and insurance costs. These forward-looking statements involve risks and uncertainties and actual results could differ materially from those discussed in the forward-looking statements. These risks and uncertainties include, but are not
limited to, those described under the heading Risk Factors as well as risks described immediately prior to or following some forward-looking statements. All forward-looking statements and risk factors included in this document are made
as of the date hereof, based on information available to us as of the date thereof, and we assume no obligation to update any forward-looking statement or risk factors.



Revenue for the first three months of fiscal 2003 was approximately 6% higher compared to the same period in
fiscal 2002, but was 15% lower compared to the fourth fiscal quarter of fiscal 2002. The test and assembly sector of the semiconductor equipment industry continues to be impacted by an extraordinarily long and severe downturn. There is uncertainty
as to if and when the next cyclical growth phase will occur. Until such time as we return to a period of sustainable growth and due to continued low visibility, we maintain a cautious outlook for future orders and sales levels.



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,



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cancellations or rescheduling
of orders due to customer financial difficulties or otherwise, expenses associated with acquisitions and alliances, product discounts, product reliability, the proportion of direct sales and sales through third parties, including distributors and
original equipment manufacturers, the mix of products sold, the length of manufacturing and sales cycles, natural disasters, political and economic instability, regulatory changes and outbreaks of hostilities. Due to these and additional factors,
historical results and percentage relationships discussed in this Report on Form 10-Q will not necessarily be indicative of the results of operations for any future period. For a further discussion of our business, and risk factors affecting our
results of operations, please refer to the section entitled Risk Factors included elsewhere herein.



CRITICAL ACCOUNTING POLICIES AND ESTIMATES



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



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



Revenue Recognition



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



Under SAB 101, we recognize revenue on the sale of semiconductor manufacturing equipment when title and risk of loss have passed to the
customer, there is persuasive evidence of an arrangement, delivery has occurred or services have been rendered, the sales price is fixed or determinable, collectibility is reasonably assured and customer acceptance criteria have been successfully
demonstrated. Product revenue is recognized upon shipment when the product is classified as mature and the customer acceptance criteria can be demonstrated prior to shipment. Revenue related to the fair value of the installation obligation is
recognized upon completion of the installation. Products are classified as mature after several different customers have accepted similar systems. For sales of new products or when the customer acceptance criteria cannot be demonstrated prior to
shipment, revenue and the related cost of goods sold are deferred until customer acceptance.



Under the SAB 101 revenue recognition policy, we defer revenue for transactions that involve newly introduced products or when customers specify acceptance criteria that cannot be demonstrated prior to
the shipment. During fiscal 2002, we introduced several new systems and products. Revenues from sales of these new systems and products during fiscal 2003 may be deferred until the revenue recognition requirements of our revenue recognition policy
are satisfied. In the past, we experienced significant delays in the introduction and acceptance of new testers as well as certain enhancements to our existing testers. As a result, some customers have experienced significant delays in receiving and
accepting our testers in production. Delays in introducing a product or delays in our ability to obtain customer acceptance, if they occur in the future, will delay the recognition of revenue and gross profit by us.



Inventory Valuation



Due to the dramatic decline in the semiconductor business
cycle and corresponding impact on revenue since early in fiscal 2001, and continued uncertainty over any turn around of the semiconductor equipment industry, we continue to monitor our inventory levels in light of product development changes and
expectations of an eventual market upturn. We recorded a charge of $9.4 million in the fourth quarter of fiscal 2002, and charges of $45.0 million and $38.0 million in the second and fourth quarters of fiscal 2001, respectively, for the write-down
of excess inventories. We may be required to take additional charges for excess and obsolete inventory if the industry downturn causes further reductions to our current inventory valuations or changes our current product development plans. We
evaluate our inventory levels and valuations based on our estimates and forecasts of the next cyclical industry upturn.



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These forecasts require us to
estimate our ability to sell current and future products in the next industry upturn and compare those estimates with our current inventory levels. If these forecasts or estimates change, or our product roadmaps change, then we would need to adjust
our assessment of the inventory valuations. Once inventories are written down, we carry that inventory at its reduced value until it is sold or otherwise disposed of. At January 31, 2003, approximately 29% and 16% of the inventory balances are for
our older Quartet mixed signal and Kalos non-volatile memory product families, respectively.



Allowance for Doubtful Accounts



Our sales and distribution partners and we 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, such as bankruptcy or deteriorations 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.



Deferred Taxes



When we prepare our consolidated financial statements, we
estimate our income taxes based on the various jurisdictions where we conduct business. This requires us to estimate our actual current tax exposure and to assess temporary differences that result from differing treatment of certain items for tax
and accounting purposes. These differences result in deferred tax assets and liabilities, which we show on our consolidated balance sheet. The net deferred tax assets are reduced by a valuation allowance if, based upon the weight of 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 January 31, 2003 was zero reflecting 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.



Special Charges



The current accounting for restructuring costs requires us to record provisions and charges when we have a formal and committed plan. In connection with these plans, we have recorded estimated expenses for severance and
benefit costs, lease cancellations, asset write-offs and other restructuring costs. 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 plans, actual results may differ, thereby requiring us to
record additional provisions or reverse a portion of such provisions.



Long-Lived Assets



We
evaluate the carrying value of our long-lived assets, consisting primarily of goodwill and identifiable intangible assets, and property, plant and equipment, whenever certain events or changes in circumstances indicate that the carrying amount of
these assets may not be recoverable. Such events or circumstances include, but not limited to, a prolonged industry downturn, a significant decline in our market value, 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 orderly 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.



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



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 July 31, |   
|----------------------------------------------- |  | --------------------------- | --
|                                                |  | 2003                        |   
|Net sales                                       |  | 100.0                       | % 
|Cost of goods sold  on net sales               |  | 66.0                        |   
|                                                |  |                             |   
|Gross margin                                    |  | 34.0                        |   
|Operating expenses                              |  |                             |   
|Research and development                        |  | 53.2                        |   
|Selling, general and administrative             |  | 56.1                        |   
|Amortization of purchased and intangible assets |  | 4.3                         |   
|Special charges including IPR&D                 |  | 7.9                         |   
|                                                |  |                             |   
|Total operating expenses                        |  | 121.5                       |   
|                                                |  |                             |   
|Operating income (loss)                         |  | (87.5                       | ) 
|Interest and other income, net                  |  | 5.3                         |   
|                                                |  |                             |   
|Income (loss) before income tax provision       |  | (82.2                       | ) 
|Income tax provision (benefit)                  |  |                            |   
|                                                |  |                             |   
|Net income (loss)                               |  | (82.2                       | )%
|                                                |  |                             |   



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Net Sales



Net sales consist of revenues from systems sales, spare parts
sales, maintenance contracts and software sales. Net sales were $36.7 million for the first quarter of fiscal 2003, representing an increase of approximately 6% from the net sales of $34.6 million in the comparable period for fiscal 2002. Net sales
decreased approximately 15% from $43.2 million in the fourth quarter of fiscal 2002. Although our net sales were higher compared to the same period in fiscal 2002, there is uncertainty as to if and when the next growth phase will occur. As is stated
in previous interim reports and our most recent form 10-K, we maintain a cautious outlook for future orders and sales levels.



International net sales accounted for approximately 56%, 55% and 61% of total net sales in the first quarter of fiscal 2003 and fiscal
years 2002 and 2001, respectively. Our net sales to the Asia Pacific region accounted for approximately 39%, 42%, and 38% of total net sales in the first three months of 2003 and fiscal years 2002 and 2001, respectively, and thus are subject to the
risk of economic instability in that region that materially adversely affected the demand for our products in 1998 and early 1999. Capital markets in Korea and other areas of Asia have been historically highly volatile, resulting in economic
instabilities. These instabilities may reoccur which could materially adversely affect demand for our products. In addition, current geopolitical instabilities on the Korean peninsula may affect future orders to this region and the timing of or
payment for shipment made to this region.



Our
net sales by product line in the first three months of 2003 and fiscal years 2002 and 2001 consisted of:



|                         |  | Fiscal Quarter Ended January 31, 2003 |      | Fiscal Years Ended October 31, |  
|------------------------ |  | ------------------------------------- | ---- | ------------------------------ | -
|                         |  |                                       | 2002 |                                |  
|Mixed-Signal             |  | 55%                                   |      | 51                             | %
|Logic                    |  | 3                                     |      | 5                              |  
|Memory                   |  | 15                                    |      | 18                             |  
|Service, software, other |  | 27                                    |      | 26                             |  
|                         |  |                                       |      |                                |  
|Total                    |  | 100%                                  |      | 100                            | %
|                         |  |                                       |      |                                |  



Revenues
from software were not material to our operations in the first three months of 2003 and fiscal years 2002 and 2001, representing less than 4% of our net sales in each period.



Gross Margin



Our gross margin has been and will continue to be affected by a variety of factors, including manufacturing efficiencies, excess and
obsolete inventory write downs, pricing by competitors or suppliers, new product introductions, product sales mix, production volume, customization and reconfiguration of systems, international and domestic sales mix and field service margins. Our
gross margin was 34% for the three-month period ending January 31, 2003. For the comparable period ended January 31, 2002 the gross margin was 38%. The drop in gross margin from the first quarter of fiscal 2002 levels reflects the competitive
pricing environment as a result of the cyclical downturn in the semiconductor equipment industry and higher costs caused by under-absorption of manufacturing expenses. We expect gross margins to remain at or below current levels for the foreseeable
future due to ongoing competitive pricing pressure caused by the severe and prolonged downturn in the semiconductor industry, and manufacturing inefficiencies resulting from the current low business levels.



Research and Development



Research and development, (or R&D) expenses
were $19.5 million in the first three months of fiscal 2003, a decrease of 4.9%, or $1.0 million from the same period of fiscal 2002. The decrease in spending reflects restructuring actions affecting R&D taken during the fourth quarter of fiscal
2002 and first quarter of fiscal 2003 when compared to the first fiscal quarter of fiscal 2002. These savings are partially offset by the ongoing investment in new products. As a percentage of net sales, R&D expenses were 53.2% for the first
three months of 2003, compared to 59.2% for the same period in fiscal 2002. We currently intend to continue to invest significant resources in the development and completion of new products and product enhancements for the foreseeable future.
Accordingly, along with recent acquisitions, we anticipate that R&D expenses will remain significant in absolute dollar terms and as a percentage of net sales for the rest of the fiscal year.



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Selling, General and
Administrative



Selling, general and
administrative expenses (or SG&A) were $20.6 million in the first three months of fiscal 2003, representing a decrease of $1.1 million, or 5.0% from the comparable period of fiscal 2002. The lower spending in SG&A in the first
quarter of fiscal 2003 was primarily due to decreases in payroll related expenses resulting from a lower headcount, a company wide shutdown during the first quarter and ongoing operating expense management. As a percentage of net sales, SG&A
expenses were 56.1% for the first three months of fiscal 2003, compared with 62.5% for the same period in fiscal 2002. We expect SG&A expenses for the rest of the fiscal year to remain consistent with the first quarter of fiscal 2003. Added
expenses from recent acquisitions will partially offset cost savings achieved due to headcount reductions made in the fourth and first quarters of fiscal 2002 and 2003 respectively.



Amortization of Goodwill and Purchased Intangibles



Amortization of goodwill and purchased intangible expenses was $1.6 million in the first three months of
fiscal 2003, compared to $5.1 million for the same period in fiscal 2002. As of November 1, 2002 we adopted Statements of Financial Accounting Standards Goodwill and Other Intangible Assets No. 142, or SFAS 142. Under SFAS 142, goodwill
and indefinite lived intangible assets are no longer amortized, but are reviewed annually (or more frequently if impairment indicators arise) for impairment.



Special Charges and In-process Research and Development



In the first quarter of fiscal 2003, we recorded a charges of approximately $1.4 million for severance charges, and a lease write-off that
was included in operating expenses. These charges were associated with headcount reductions and the completion of the consolidation of our IMS facility in Beaverton, Oregon into our Hillsboro, Oregon site. During the first quarter of fiscal 2003, we
reduced our headcount by approximately 70 persons. The bulk of the affected employees were in SG&A and a smaller number were in R&D. See Note 12 to the Consolidated Financial Statements.



In addition, we also recorded a charge of $1.5 million in the
first quarter of fiscal 2003 for the write-off of in-process research and development resulting from the purchase of Optonics. The charge was recorded as an operating expense.



Interest and Other Income Expenses, Net



We generated net interest and other income of $1.9 million for the first three months of fiscal 2003, as
compared to $3.4 million for the same period of fiscal 2002. The decrease in the first quarter of fiscal 2003 was primarily due to lower average cash and investment balances and decreasing returns on our cash investments as longer-term investments
mature and are re-invested at currently lower short-term interest rates.



Income Taxes



The Company
recorded an income tax provision of $0.1M for the three months ended January 31, 2003. The income tax expense for the period consists of foreign tax on earnings and foreign withholding taxes generated from our foreign operations. During the first
three months of fiscal 2002, the Companys estimated effective tax benefit rate was 35.0%. The estimated tax benefit rate in fiscal 2002 was less than the combined federal and state statutory rate primarily due to the impact of non-deductible
goodwill amortization.



We expect to record a
full valuation allowance on domestic tax benefits until we can sustain an appropriate level of profitability. Until such time, we would not expect to recognize any significant tax benefits in our results of operations.



LIQUIDITY AND CAPITAL RESOURCES



The net cash outflows from operating activities during the
three months ended January 31, 2003 was $25.8 million. The net cash flows used by operating activities for the first three months of fiscal 2003 was primarily attributable to a net loss before depreciation and amortization of $22.7 million plus the
use of cash for net working capital.



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Investing
activities provided net cash of approximately $0.3 million in the three months ended January 31, 2003 resulting from the net sales of available-for-sale securities of $7.8 million offset by approximately $7.6 million for the acquisition of the SZ
assets and property and equipment to support our business.



As of January 31, 2003 we had working capital of approximately $209.3 million, including cash and short-term investments of $101.4 million, and accounts receivable and inventories totaling $140.0 million. We believe that because of
the relatively long manufacturing cycles of many of our testers and the new products we have and plan to continue to introduce, investments in inventories will also continue to represent a significant portion of our working capital. The
semiconductor industry has historically been highly cyclical and has experienced downturns, which have had a material adverse effect on the semiconductor industrys demand for automatic test equipment, including equipment manufactured and
marketed by us. In addition, the automatic test equipment industry is highly competitive and subject to rapid technological change. It is reasonably possible that events related to the above factors may occur in the near term which would cause a
change to our estimate of the net realizable value of receivables, inventories or other assets, and the adequacy of accrued liabilities. See discussion of Critical Accounting Policies and Estimates above.



Our principal sources of liquidity as of January 31, 2003
consisted of approximately $24.9 million of cash and cash equivalents, and short-term investments of $76.5 million. In addition, we had $107.1 million of available-for-sale securities, classified as long-term investments at January 31, 2003.



At January 31, 2003 we had an agreement with a
non-related leasing company, Credence Capital Corporation, or CCC, whereby we issued a guaranty in favor of a bank with respect to certain obligations of CCC to the bank. Under this agreement, CCC agreed to grant to us a security interest to secure
the obligations of CCC as a result of any payments by us pursuant to the guaranty. At January 31, 2003, the debt of CCC subject to this guaranty was $5.0 million. In February 2003, we purchased CCC. See Note 13 to the Consolidated Financial
Statements for further discussion



The Company
leases its facilities and equipment under operating leases that expire periodically through 2006. The approximate future minimum lease payments under operating leases for facilities and equipment at January 31, 2002 are as follows (in thousands):



|           |  | Minimum Lease Payments
|---------- |  | ----------------------
|2003       |  | $                     
|2004       |  |                       
|2005       |  |                       
|2006       |  |                       
|2007       |  |                       
|Thereafter |  |                       
|           |  |                       
|           |  | $                     
|           |  |                       



Approximately $4.8 million of the above lease commitments have been written-off to special operating charges. See Note 12 to the Consolidated Financial Statements. In addition to the lease commitments above, at January 31, 2003, we
have open and committed purchase orders totaling approximately $19.4 million.



In December 2002, we took steps to reduce headcount by approximately 70 employees or approximately 6% of the workforce, in response to the ongoing downturn in the semiconductor equipment industry and
uncertainty as to when the beginning of a sustainable recovery may occur. In addition, we are currently evaluating other reorganization and restructuring steps. These actions resulted in special charges of approximately $1.4 million of which the
majority was paid out in cash during the quarter.



In December 2002, the Company completed the acquisition of certain assets of SZ Testsysteme AG and SZ Testsysteme GmbH (SZ) located in Amerang, Germany for approximately $4.7 million in cash.



RECENT ACCOUNTING PRONOUNCEMENTS



In June 2001, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard No. 141, Business Combinations, or SFAS 141 and Statement of Financial Accounting Standard No. 142, Goodwill and Other Intangible Assets, or SFAS 142.



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SFAS 141
supercedes APB Opinion No. 16, Business Combinations, and eliminates the pooling-of-interests method of accounting for business combinations, thus requiring that all business combinations be accounted for using the purchase method. In
addition, in applying the purchase method, SFAS 141 changes the criteria for recognizing intangible assets other than goodwill and states that the following criteria should be considered in determining the classification of intangible assets: (1)
whether the intangible asset arises from contractual or other legal rights, or (2) whether the intangible asset is separable or dividable from the acquired entity and capable of being sold, transferred, licensed, rented, or exchanged. If neither
criteria is met, the intangible assets are classified as goodwill and are not amortized. We have applied the requirements of SFAS 141 to all business combinations initiated after June 30, 2001. Through October 31, 2002, there were no business
combinations subject to these requirements. Our purchase of Optonics, Inc. during the quarter ended January 31,2003 is accounted for under FAS 141.



In August 2001, the FASB issued Statements of Financial Accounting Standards No. 144 Accounting for the Impairment or Disposal of
Long-Lived Assets, or SFAS 144. SFAS 144 supercedes SFAS 121, Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of and the accounting and reporting provisions of Accounting Principles Board
Opinion No. 30, Reporting the Results of OperationsReporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a
business. SFAS 144 establishes a single accounting model for assets to be disposed of by sale whether previously held and used or newly acquired. SFAS No. 144 retains the provisions of APB No. 30 for presentation of discontinued operations in the
income statement, but broadens the presentation to include a component of an entity. We have adopted SFAS 144 effective November 1, 2002. The adoption did not have a material impact on the Companys financial position or results of operations.



In July 2002, the FASB approved Statement of
Financial Accounting Standards No. 146 Accounting for Costs Associated with Exit or Disposal Activities, or SFAS 146. SFAS 146 addresses the financial accounting and reporting for obligations associated with an exit activity, including
restructuring, or with a disposal of long-lived assets. Exit activities include, but are not limited to, eliminating or reducing product lines, terminating employees and contracts and relocating manufacturing facilities or personnel. SFAS 146
specifies that a company will record a liability for a cost associated with an exit or disposal activity only when that liability is incurred and can be measured at fair value. Therefore, commitment to an exit plan or a plan of disposal expresses
only managements intended future actions and, therefore, does not meet the requirement for recognizing a liability and the related expense. SFAS 146 is effective prospectively for exit or disposal activities initiated after December 31, 2002.
The effect of adoption of SFAS 146 is dependent on our related activities subsequent to the date of adoption.



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RISK
FACTORS



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







LOGO



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



| |  |  | worldwide economic conditions in the semiconductor industry in general and the capital equipment industry specifically;
| | - |  | -----------------------------------------------------------------------------------------------------------------------



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



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



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



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



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



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



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



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



| |  |  | expenses associated with acquisitions and alliances;
| | - |  | ----------------------------------------------------

|
|



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



| |  |  | natural disasters, political and economic instability, currency fluctuations, regulatory changes and outbreaks of hostilities; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------



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



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



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



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



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



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



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



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



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



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



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



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



| |  |  | facility relocations and closures.
| | - |  | ----------------------------------



New and enhanced products typically have lower gross margins in the early stages of commercial introduction and production. Although we
have recorded and continue to record accounts receivable allowances, product warranty costs, and deferred revenue, we cannot be certain that our estimates will be adequate.



We cannot forecast with any certainty the impact of these and other factors on our sales and operating
results in any future period. Results of operations in any period, therefore, should not be considered indicative of the results to be expected for any future period. Because of this difficulty in predicting future performance, our operating results
have fallen and may continue to fall below the expectations of securities analysts or investors in some future quarter or quarters. Our failure 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. These other expenditures
include:



| |  |  | research and development;
| | - |  | -------------------------



| |  |  | support costs for the distribution channels;
| | - |  | --------------------------------------------



| |  |  | marketing and other expenses for new products;
| | - |  | ----------------------------------------------



| |  |  | capital equipment purchases and world-wide training; and
| | - |  | --------------------------------------------------------





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| |  |  | customer support and service.
| | - |  | -----------------------------



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



The semiconductor industry has been cyclical.



Our revenue growth has been materially adversely affected by the cyclical downturn in the semiconductor
industry and its resulting impact upon the semiconductor equipment sector. There is uncertainty as to if and when the next cyclical growth phase will occur. Our belief regarding the downturn is based on weakened order activity, order cancellation
activity, and customer-requested shipment delays from our existing backlog. This business weakness is worldwide, but we see it in particular with customers in Asia. Until such time as we return to a growth period, we expect a continuing volatility
in order activity. We anticipate revenue levels to continue to remain under pressure throughout fiscal 2003 due to the prolonged cyclical downturn and uncertainty over the start of the next cyclical growth phase. Revenues may decline thereafter due
to the uncertainty of a sustainable recovery in the semiconductor and related capital equipment industry. As a result of the cyclical downturn, in fiscal 2001 we reduced our worldwide workforce by approximately 23%, or more than 400 people. In
fiscal 2002, we reduced our worldwide workforce by 21%, or about 245 people. In the first quarter of fiscal 2003 we reduced our worldwide workforce by approximately 70 people excluding the effect of the acquisitions. We took charges related to these
reductions in force of approximately $1.2 million in the first quarter of fiscal 2003, approximately $5.7 million in the fourth quarter of fiscal 2002, and approximately $3.2 million throughout fiscal 2001. Additionally, remaining employees were
required to take time off in the second, third and fourth quarters of fiscal 2001, as well as the first quarter of fiscal 2002 and fiscal 2003. Other initiatives, including a temporary domestic and European pay cut, a four-day workweek for most
manufacturing and some operating employees, the consolidation and reorganization of certain functions and operations, and the curtailment of discretionary expenses, were also implemented. If we continue to reduce our workforce or adopt additional
cost-saving measures, it may adversely impact our ability to respond rapidly to any renewed growth opportunities in the future should they occur.



As a result of the rapid and steep decline in revenue during this latest downturn, we continue to monitor our inventory levels in light of
product development changes and a possible eventual upturn. We recorded a charge of $9.4 million in the fourth fiscal quarter of 2002 for the write down of excess inventories. We may be required to take additional charges for excess and obsolete
inventory if this prolonged industry downturn causes further reductions to our current inventory valuations, or changes our current product development plans.



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



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



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



Other than certain memory products and software products, for which the price range is typically below $50,000, we obtain most of our net
sales from the sale of a relatively few number of systems that typically range in selling price from $0.2 million to $2.0 million. This has resulted and could continue to result in our net sales and operating results for a particular period being
significantly impacted by the timing of recognition of revenue from a single transaction. Our net sales and operating results for a particular period could also be materially adversely affected if an anticipated order from just one customer is not
received in time to permit shipment during that period. Backlog at the beginning of a quarter typically does not include all orders necessary to achieve our sales objectives for that quarter. Orders in backlog are subject to cancellation, delay,
deferral or rescheduling by customers with limited or no penalties. Throughout fiscal 2001 to the present, we have experienced customer-requested shipment delays and order cancellations, and we believe it is probable that orders will be canceled in
the future. Consequently, our quarterly net sales and operating results have in the past, and will in the future, depend upon our obtaining orders for systems to be shipped in the same quarter in which the order is received.



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



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 and we announce new products and technologies, customers may defer or cancel purchases of our existing systems. We cannot forecast the impact of these and other factors on our sales and
operating results.



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



We have in the past experienced significant delays in the introduction, volume production and sales of our new systems and related feature enhancements. In the past, we experienced significant delays
in the introduction of our Octet, ValStar 2000 and Kalos series testers as well as certain enhancements to our other testers. The Octet tester was first shipped in October 2002 and at this time there are a small number of systems in the field
undergoing evaluation by customers. No revenue has been recognized on the Octet product. These delays have been primarily related to our inability to successfully complete product hardware and software engineering within the time frame originally
anticipated, including design errors and redesigns of ICs. As a result, some customers have experienced significant delays in receiving and using our testers in production. In addition, under our revenue recognition policy that is in accordance with
SAB 101, we defer revenue for transactions that involve newly introduced products or when 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 generally recognizing revenue upon shipment. We have introduced several new systems and products during fiscal 2002. Revenues from sales of those new systems and products may be deferred until the revenue recognition
requirements of our revenue recognition policy are satisfied. 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 and related software tools. In the past, we have incurred and we may continue to incur substantial unanticipated costs to
ensure the functionality and reliability of our testers and to increase feature sets. If our systems continue to have 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, delays in collecting accounts receivable and higher service, support and warranty expenses, and/or inventory write-offs, among other effects. Our failure to have a competitive tester and related software
tools available when required by a customer could make it substantially more difficult for us to sell testers to that customer for a number of years. We believe that the continued acceptance, volume production, timely delivery and customer
satisfaction of our newer digital, mixed signal and non-volatile memory testers are of critical importance to our future financial results. As a result, our inability to correct any technical, reliability, parts





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shortages or other
difficulties associated with our systems or to manufacture and ship the systems on a timely basis to meet customer requirements could damage our relationships with current and prospective customers and would continue to materially adversely affect
our business, financial condition and results of operations.



The ATE market is subject to rapid technological change.



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



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



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



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



| |  |  | successful coding and debugging of software;
| | - |  | --------------------------------------------



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



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



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



Because we must make new product development commitments well in advance of sales, new product decisions must anticipate both future
demand and the availability of technology to satisfy that demand. We cannot be certain that we will be successful in selecting, developing, manufacturing and marketing new hardware and software products or enhancements and related software tools.
Our inability to introduce new products and related software tools that contribute significantly to net sales, gross margins and net income would have a material adverse effect on our business, financial condition and results of operations. New
product or technology introductions by our competitors could cause a decline in sales or loss of market acceptance of our existing products. If we introduce new products, existing customers may curtail purchases of the older products and delay new
product purchases. In addition, weakness in IC demand may cause integrated device manufacturers, or IDMs, to curtail or discontinue the outsourcing of testing to test house, relying instead on in-house testing. Because less of our market share is
from the IDMs, this trend may reduce the demand for our products. Any decline in demand for our hardware or software products could have a materially adverse effect on our business, financial condition or results of operations.



Over the last several years we have experienced significant fluctuations in
our operating results due in part to the semiconductor business cycles and an increased scale of operations.



In the first three months of fiscal 2003 our net sales increased by 6% from those recorded in the first three months of fiscal 2002;
however, in fiscal 2002, our net sales fell 45.6% from those recorded in fiscal 2001 as the semiconductor industry continued in a steep cyclical downturn. In fiscal 2002, we generated revenue of $34.6 million in the first quarter and $43.2 million
in the fourth quarter an increase of 24.7%. In fiscal 2001, we generated revenue of $136.3 million in the first quarter and $37.0 million in the fourth quarter, a decrease of 72.9%. In fiscal 2000, we generated revenue of $136.3 million in the first
quarter and $221.7 million in the fourth quarter, an increase of 62.7%. Since 1993, except for the current cost-cutting efforts and those during fiscal 1998 and the first half of fiscal 1999, we have overall significantly increased the scale of our
operations to support periods of generally increased sales levels and expanded product offerings and have expanded operations to address critical infrastructure and other requirements, including the hiring of additional personnel, significant
investments in research and development to support product development, acquisition of the new facilities in Oregon and California, further investments in our ERP system and numerous acquisitions. These fluctuations in our sales and operations have
placed and are continuing to place a considerable strain on our management, financial, manufacturing and other resources. In order to effectively deal with the changes brought on by the cyclical nature of the industry, we have been required to





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implement and improve a
variety of highly flexible operating, financial and other systems, procedures and controls capable of expanding, or contracting consistent with our business. However, we cannot be certain that any existing or new systems, procedures or controls,
including our ERP system, will be adequate to support fluctuations in our operations or that our systems, procedures and controls will be cost-effective or timely. Any failure to implement, improve and expand or contract such systems, procedures and
controls efficiently and at a pace consistent with our business could have a material adverse effect on our business, financial condition or results of operations.



We are continuing to invest significant resources in the expansion of our product lines.



We are currently devoting and intend to continue to devote
significant resources to the development, production and commercialization of new products and technologies. During fiscal 2001, we primarily introduced products that are either evolutions or derivatives of existing products. During fiscal 2002, we
introduced several products that are evolutions or derivatives of existing products as well as products that are largely new. Under our revenue recognition policy adopted in accordance with SAB 101, we defer revenue for transactions that involve
newly introduced products or when 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 by us. We invested and continue to invest significant resources in 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 hardware and
software 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 revenue growth.



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



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



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



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



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



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



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 19%, 20% and 13% of our net sales in the first quarter of fiscal 2003 and fiscal years 2002 and 2001 respectively. Our agreement with Spirox 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 any other significant customer, including the
potential for reductions in orders by assembly and tester service companies which that customer may utilize or reductions due to continuing or other technical, manufacturing or reliability problems with our products or continued slow-downs in the
semiconductor industry or in other industries that manufacture products utilizing semiconductors. Our ability to maintain or increase sales levels will depend upon:



| |  |  | our ability to obtain orders from existing and new customers;
| | - |  | -------------------------------------------------------------



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



| |  |  | our ability to timely complete the development of our new hardware and software products;
| | - |  | -----------------------------------------------------------------------------------------



| |  |  | our customers financial condition and success;
| | - |  | -----------------------------------------------



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



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



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



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



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





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



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connection with acquisitions, which have and could continue to materially adversely affect our business,
financial condition and results of operations.



In addition, acquisitions involve numerous other risks, including:



| |  |  | difficulties assimilating the domestic and international operations, personnel, technologies, sales channels and products of the acquired companies;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | diversion of our managements attention from other business concerns;
| | - |  | ---------------------------------------------------------------------



| |  |  | increased complexity and costs associated with international and domestic internal management structures;
| | - |  | ---------------------------------------------------------------------------------------------------------



| |  |  | risks of entering markets in which we have no or limited experience; and
| | - |  | ------------------------------------------------------------------------



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



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



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



We prepare our financial statements to conform to generally accepted accounting principles, or GAAP. GAAP are subject to interpretation by the American Institute of Certified Public Accountants, the SEC and various bodies
formed to interpret and create appropriate accounting policies. A change in those policies can have a significant effect on our reported results and may even affect our reporting of transactions completed before a change is announced. Accounting
rules affecting many aspects of our business, including rules relating to purchase and pooling-of-interests accounting for business combinations, asset impairment, revenue recognition, employee stock purchase plans and stock option grants have
recently been revised or are currently under review. Changes to those rules or current interpretation of those rules may have a material adverse effect on our reported financial results or on the way we conduct our business. For example, in the
fourth quarter of fiscal 2001, we implemented SAB 101. Adoption of SAB 101 required us to restate our quarterly results for the seven fiscal quarters ended July 31, 2001 (see Notes 1 and 13 of the Notes to the Consolidated Financial Statements in
the Annual Report on Form 10-K for further discussion). In addition, the preparation of our financial statements in accordance with GAAP requires that we make estimates and assumptions that affect the recorded amounts of assets and liabilities,
disclosure of those assets and liabilities at the date of the financial statements and the recorded amounts of expenses during the reporting period. A change in the facts and circumstances surrounding those estimates could result in a change to our
estimates and could impact our future operating results.



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



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



Our international business exposes
us to additional risks.



International sales
accounted for approximately 56%, 55%, and 61% of our total net sales for the first three months of fiscal 2003 and fiscal 2002, 2001 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;
| | - |  | -----------------------------------



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| |  |  | tariffs and other barriers;
| | - |  | ---------------------------



| |  |  | political and economic instability;
| | - |  | -----------------------------------



| |  |  | an 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, joint venture partners, original equipment manufacturers, foreign subsidiaries and branch operations;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------



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



| |  |  | the possibility of difficulty in accounts receivable collection.
| | - |  | ----------------------------------------------------------------



We are also subject to the risks associated with the imposition of domestic and foreign legislation and
regulations relating to the import or export of semiconductor equipment and software products. We cannot predict whether the import and export of our products will be subject to quotas, duties, taxes or other charges or restrictions imposed by the
United States or any other country in the future. Any of these factors or the adoption of restrictive policies could have a material adverse effect on our business, financial condition or results of operations. Net sales to the Asia-Pacific region
accounted for approximately 39%, 42% and 38% of our total net sales in the first three months of fiscal 2003 and fiscal years 2002 and 2001, respectively, and thus demand for our products is subject to the risk of economic instability in that region
and could continue to be materially adversely affected. Countries in the Asia-Pacific region, including Korea and Japan, have experienced weaknesses in their currency, banking and equity markets in the recent past. These weaknesses could continue to
adversely affect demand for our products, the availability and supply of our product components and our consolidated results of operations. The 1997/1998 Asian financial crisis contributed to widespread uncertainty and a slowdown in the
semiconductor industry. This slowdown resulted in reduced spending on semiconductor capital equipment, including ATE, and has had, and may in the future have, a material adverse effect on our product backlog, balance sheet and results of operations.
Further, many of our customers in the Asia-Pacific region built up capacity in ATE during fiscal 2000 in anticipation of a steep ramp up in wafer fabrication. However, this steep ramp up in output has not fully materialized leaving some customers
with excess capacity.



Two end-user customers
headquartered in Europe accounted for approximately 13% and 11% respectively, of our net sales in fiscal 2001 and one end-user customer headquartered in Taiwan accounted for 17% of our net sales in fiscal 2000.



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



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



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



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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.



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



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



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 integrated circuits. We cannot be certain that these or other problems will not continue to occur in the future with our
suppliers or outside subcontractors. Our reliance on a limited group of suppliers and on outside subcontractors involves several risks, including an inability to obtain an adequate supply of required components, subassemblies and services and
reduced control over the price, timely delivery, reliability and quality of components, subassemblies and services. Shortages, delays, disruptions or terminations of the sources for these components and subassemblies have delayed and could continue
to delay shipments of our systems and new products and could continue to have a material adverse effect on our business. Our continuing inability to obtain adequate yields or timely deliveries or any other circumstance that would require us to seek
alternative sources of supply or to manufacture such components internally could also have a material adverse effect on our business, financial condition or results of operations. Such delays, shortages and disruptions would also damage
relationships with current and prospective customers and have and could continue to allow competitors to penetrate our customer accounts. We cannot be certain that our internal manufacturing capacity or that of our suppliers and subcontractors will
be sufficient to meet customer requirements.



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



In recent years, the stock market in general, and the market for shares of high-tech companies in particular, including ours, have experienced extreme price fluctuations, which have often been unrelated to the operating performance
of affected companies. For example, for the period November, 2001 through March 3, 2003 the price of our common stock has ranged from a closing high of $24.64 to a closing low of $6.30. The market price of our common stock is likely to continue to
fluctuate significantly in the future, including fluctuations unrelated to our performance. We believe that fluctuations of our stock price may be caused by a variety of factors, including:





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| |  |  | announcements of developments related to our business;
| | - |  | ------------------------------------------------------



| |  |  | fluctuations in our financial results;
| | - |  | --------------------------------------



| |  |  | general conditions in the stock market or around the world, terrorism, or developments in the semiconductor and capital equipment industry and the general economy;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | sales or purchases of our common stock in the marketplace;
| | - |  | ----------------------------------------------------------



| |  |  | announcements of our technological innovations or new products or enhancements or those of our competitors;
| | - |  | -----------------------------------------------------------------------------------------------------------



| |  |  | developments in patents or other intellectual property rights;
| | - |  | --------------------------------------------------------------



| |  |  | developments in our relationships with customers and suppliers;
| | - |  | ---------------------------------------------------------------



| |  |  | a shortfall or changes in revenue, gross margins or earnings or other financial results from analysts expectations or an outbreak of hostilities or natural
disasters; or
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



Terrorist attacks, 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 the U.S. retaliation for these attacks and the resulting decline in
consumer confidence has had a substantial adverse impact on the economy. If consumer confidence does not recover, our revenues and profitability may be adversely impacted in fiscal 2003 and beyond.



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



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



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



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



The Sarbanes-Oxley Act of 2002 that became law in July 2002
requires changes in some of our corporate governance and securities disclosure or compliance practices. That Act also requires the SEC to promulgate new rules on a variety of subjects, in addition to rule proposals already made, and Nasdaq has
proposed revisions to its requirements for companies that are Nasdaq-listed. We expect these developments to increase our legal compliance costs, and to make some activities more difficult, such as stockholder approval of new option plans. We expect
these developments to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. These developments
could make it more difficult for us to attract and retain qualified members of our board of directors, or qualified executive officers. We are presently evaluating and monitoring regulatory developments and cannot estimate the timing or magnitude of
additional costs we may incur as a result.



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ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



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







|                            |  | Balance at 10/31/02 |         |   | Future maturities of investments held at January 31, 2003
|--------------------------- |  | ------------------- | ------- | - | ---------------------------------------------------------
|                            |  |                     | 2003    |   |                                                          
|Cash equivalents            |  |                     |         |   |                                                          
|Fixed rate                  |  | $                   | 50,192  |   |                                                          
|Average rate                |  |                     | 2.07    | % |                                                          
|Short term investments      |  |                     |         |   |                                                          
|Fixed rate                  |  | $                   | 82,223  |   |                                                          
|Average rate                |  |                     | 4.98    | % |                                                          
|Long term investments       |  |                     |         |   |                                                          
|Fixed rate                  |  | $                   | 108,231 |   |                                                          
|Average rate                |  |                     | 4.56    | % |                                                          
|                            |  |                     |         |   |                                                          
|Total investment securities |  | $                   | 240,646 |   |                                                          
|Average rate                |  |                     | 4.19    | % |                                                          
|Equity instruments          |  | $                   | 1,016   |   |                                                          



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 level of diversification.



ITEM 4.  CONTROLS AND PROCEDURES



Within 90 days prior to the filing date of this report, we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934, as amended. Based upon that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that our disclosure controls and procedures are effective in timely alerting management to material information relating to the Company that is required to be included in our periodic filings with the Securities and Exchange
Commission. There have been no significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to the date we carried out our evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.



PART II.
 OTHER INFORMATION



Item 1. Legal Proceedings



In July 1998, we received a written allegation from inTEST IP Corp., together with its patent licensee inTEST Corporation, inTEST, that we were infringing a patent held by inTEST. On December 15, 2000, inTEST filed a complaint in the
U.S. District Court for the District of Delaware against us, alleging infringement of inTEST U.S. patent number 4,589,815 and seeking damages and injunctive relief. In March 2003, we entered into an agreement with inTEST settling this litigation.
Under the terms of the settlement agreement we will pay to inTEST a non-material amount, the parties will cross-license on a non-exclusive and fully-paid basis certain patents and we will source certain equipment from inTEST in connection with sales
of our ASL3000 product family.



In April 2002,
Reptron Electronics, Inc. a supplier of certain electronic components to us, filed a complaint in the U.S. District Court for the District of Oregon, alleging that we had breached a contract to purchase certain components ordered by Reptron during
2000. The complaint seeks damages of approximately $3.9 million. In November 2002, the court set the trial for this action for July 15, 2003.



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



Item 2. Changes in Securities



None



Item 3. Defaults upon Senior Securities



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None



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



None



Item 5. Other Information



None



Item 6. Exhibits and Reports on Form 8-K



(a) See Exhibit Index on page 35



(b) Reports on Form 8-K



| | 1) |  | The Company filed a report on Form 8-K on November 27, 2002 announcing the execution of the definitive agreement for the registrants acquisition of Optonics,
Inc.
| | -- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 2) |  | The Company filed a report on Form 8-K on January 23, 2003 announcing the closing of the registrants acquisition of Optonics, Inc.
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------





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SIGNATURES



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





| |  |  |  |  |  | CREDENCE SYSTEMS CORPORATION
| |  |  |  |  |  | ----------------------------
| |  |  |  |  |  |                             
| |  |  |  |  |  |                             



| |  | March 17, 2003 |  |  |  |  |  | /S/ JOHN R. DETWILER                                            
| |  | -------------- |  |  |  |  |  | ----------------------------------------------------------------
| |  | Date           |  |  |  |  |  | John R. Detwiler                                                
| |  |                |  |  |  |  |  | John R. Detwiler, Senior Vice President, Chief Financial Officer



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CERTIFICATION



I, Graham J. Siddall
certify that:



|1. |  | I have reviewed this quarterly report on Form 10-Q of Credence Systems Corporation;
|-- |  | -----------------------------------------------------------------------------------



|2. |  | Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|3. |  | Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|4. |  | The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and we have:
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | b) |  | evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report
(the Evaluation Date); and
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | c) |  | presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation
Date;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------



|5. |  | The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee
of registrants board of directors (or persons performing the equivalent functions):
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrants ability to record, process, summarize
and report financial data and have identified for the registrants auditors any material weaknesses in internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | b) |  | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal controls; and
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



|6. |  | The registrants other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Date: March 17, 2003



/s/    GRAHAM J. SIDDALL,Graham J. Siddall, Chairman of the Board and Chief Executive Officer




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CERTIFICATION



I, John R. Detwiler,
certify that:



|1. |  | I have reviewed this quarterly report on Form 10-Q of Credence Systems Corporation;
|-- |  | -----------------------------------------------------------------------------------



|2. |  | Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|3. |  | Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|4. |  | The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and we have:
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | b) |  | evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report
(the Evaluation Date); and
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | c) |  | presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation
Date;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------



|5. |  | The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee
of registrants board of directors (or persons performing the equivalent functions):
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrants ability to record, process, summarize
and report financial data and have identified for the registrants auditors any material weaknesses in internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | b) |  | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal controls; and
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



|6. |  | The registrants other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Date: March 17, 2003



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




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EXHIBIT INDEX



|Exhibit Number |  |                                                                                                                          
|-------------- |  | -------------------------------------------------------------------------------------------------------------------------
|99.1           |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002   
|99.2           |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Action of
2002



35