<PAGE>
________________________________________________________________________________

                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-Q

(Mark One)

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

For the quarterly period ended January 31, 2002
                                       OR

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

For the transition period from          to

                         Commission file number 0-22366

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

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

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

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

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

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

                      APPLICABLE ONLY TO CORPORATE ISSUERS:

     At March 1, 2002, there were approximately 60,496,263 shares of the
Registrant's common stock, $0.001 par value per share, outstanding.

--------------------------------------------------------------------------------

                                       1

<PAGE>

CREDENCE SYSTEMS CORPORATION

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

PART I.    FINANCIAL INFORMATION

<S>                                                                                       <C>
Item 1.    Financial Statements ................................................             3
           Condensed Consolidated Balance Sheets ...............................             3
           Condensed Consolidated Statements of Operations .....................             4
           Condensed Consolidated Statements of Cash Flows .....................             5
           Notes to Condensed Consolidated Financial Statements ................             6
Item 2.    Management's Discussion and Analysis of Financial Condition and
           Results of Operations ...............................................            11
Item 3.    Quantitative and Qualitative Disclosures about Market Risk ..........            28

PART II.   OTHER INFORMATION

Item 1.    Legal Proceedings ...................................................            29
Item 2.    Changes in Securities ...............................................            29
Item 3.    Defaults Upon Senior Securities .....................................            29
Item 4.    Submission of Matters to a Vote of Securityholders ..................            29
Item 5.    Other Information ...................................................            29
Item 6.    Exhibits and Reports on Form 8-K ....................................            29
</TABLE>

                                       2

<PAGE>

PART I  - FINANCIAL INFORMATION

ITEM I  - FINANCIAL STATEMENTS

                          CREDENCE SYSTEMS CORPORATION
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                                 (in thousands)
<TABLE>
<CAPTION>
                                                                                 January 31,    October 31,
                                                                                    2002          2001 /A/
                                                                                  --------       --------
                                                                                 (unaudited)
<S>                                                                                <C>           <C>
ASSETS
Current assets:
 Cash and cash equivalents .....................................................  $ 40,543      $ 44,309
 Short-term investments ........................................................    82,932        96,497
 Accounts receivable, net ......................................................    31,633        39,831
 Inventories ...................................................................   128,763       123,219
 Income tax receivable .........................................................    41,468        41,031
 Deferred income taxes and other current assets ................................    48,666        49,457
                                                                                 --------      --------
  Total current assets .........................................................   374,005       394,344
Long-term investments ..........................................................   157,018       161,889
Property and equipment, net ....................................................   103,482       109,528
Goodwill from acquisitions, net ................................................    45,030        47,124
Other intangible assets, net ...................................................    31,836        34,450
Other assets ...................................................................    13,770        10,084
                                                                                  --------      --------
  Total assets .................................................................  $725,141      $757,419
                                                                                  ========      ========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
 Accounts payable ..............................................................  $ 13,768      $ 17,510
 Accrued expenses and other liabilities ........................................    38,801        41,181
 Deferred profit ...............................................................     5,708        11,707
                                                                                  --------      --------
  Total current liabilities ....................................................    58,277        70,398
Other liabilities ..............................................................     4,283         5,761
Minority interest ..............................................................       428           320
Stockholders' equity ...........................................................   662,153       680,940
                                                                                  --------      --------
  Total liabilities and stockholders' equity ...................................  $725,141      $757,419
                                                                                  ========      ========
</TABLE>

                             See accompanying notes.

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

                                       3

<PAGE>

                          CREDENCE SYSTEMS CORPORATION
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                    (in thousands, except per share amounts)
                                   (unaudited)
<TABLE>
<CAPTION>
                                                                                          Three Months Ended
                                                                                              January 31,
                                                                                   -------------------------------
                                                                                       2002              2001
                                                                                   -------------     -------------

<S>                                                                                    <C>              <C>
Net sales ......................................................................      $ 34,627         $  136,311
Cost of goods sold .............................................................        21,466             59,194
                                                                                   ------------      -------------
Gross margin ...................................................................        13,161             77,117
Operating expenses:
   Research and development ....................................................        20,492             22,514
   Selling, general and administrative .........................................        21,649             32,559
   Amortization of goodwill and purchased intangibles ..........................         5,146              5,179
                                                                                   ------------      -------------
       Total operating expenses ................................................        47,287             60,252
                                                                                   ------------      -------------
Operating income (loss) ........................................................       (34,126)            16,865
Interest and other income, net .................................................         3,371              4,572
                                                                                   -----------       -------------
Income (loss) before income tax provision ......................................       (30,755)            21,437
Income tax provision (benefit) .................................................       (10,764)             7,976
Minority interest (benefit) ....................................................           110               (134)
                                                                                   ------------      -------------
Net income (loss) ..............................................................     ($ 20,101)         $  13,595
                                                                                   ============      =============
Net income per share
    Basic ......................................................................        ($0.33)         $    0.23
                                                                                   ============      =============
    Diluted ....................................................................        ($0.33)         $    0.22
                                                                                   ============      =============
Number of shares used in computing per share amount
    Basic ......................................................................        60,233             59,523
                                                                                   ============      =============
    Diluted ....................................................................        60,233             61,941
                                                                                   ============      =============
</TABLE>

                             See accompanying notes.

                                       4

<PAGE>

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

<TABLE>
<CAPTION>
                                                                                             Three Months Ended
                                                                                                January 31,
                                                                                        --------------------------
                                                                                          2002             2001
                                                                                        ---------        ---------
<S>                                                                                     <C>              <C>
Cash flows from operating activities:

   Net income (loss) ...............................................................    $ (20,101)       $  13,595
   Adjustments to reconcile net income to net cash used in operating activity
      Depreciation and amortization ................................................       12,425           13,753
      Loss on disposal of property and equipment ...................................        1,326              198
          Minority interest ........................................................          108             (134)
      Changes in operating assets and liabilities:
         Accounts receivable, inventories and other current assets .................        1,776              331
         Accounts payable, accrued liabilities and income taxes payable ............      (11,598)         (26,884)
                                                                                        ---------        ---------
            Net cash provided by (used in) operating activities ....................      (16,064)             859

Cash flows from investing activities:

   Purchases of available-for-sale securities ......................................      (10,209)         (74,634)
   Sales of available-for-sale securities ..........................................       26,204           96,131
   Acquisition of property and equipment ...........................................       (2,472)         (17,968)
   Acquisition of other assets .....................................................       (3,382)          (8,308)
                                                                                        ---------        ---------
         Net cash provided by (used in) investing activities .......................       10,141           (4,779)

Cash flows from financing activities:

   Issuance of common & treasury stock .............................................        2,153            2,006
   Repurchase of common stock ......................................................           --           (7,567)
   Other ...........................................................................            4             (162)
                                                                                        ---------        ---------
         Net cash provided by (used in) financing activities .......................        2,157           (5,723)
                                                                                        ---------        ---------
Net (decrease) in cash and cash equivalents ........................................       (3,766)          (9,643)
Cash and cash equivalents at beginning of period ...................................       44,309          137,401
                                                                                        ---------        ---------
Cash and cash equivalents at end of period .........................................    $  40,543        $ 127,758
                                                                                        =========        =========

Supplemental disclosures of cash flow information:

   Income taxes paid (received) ....................................................    $  (9,539)       $  12,250
Noncash investing activities:

   Net transfers of inventory to property and equipment ............................    $      --        $   1,612
Noncash financing activities:

   Income tax benefit from stock option exercises ..................................    $     769        $     427
</TABLE>

                             See accompanying notes.

                                        5

<PAGE>

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Quarterly Financial Statements

     The condensed consolidated financial statements and related notes for the
three months ended January 31, 2002 and 2001 are unaudited but include all
adjustments (consisting solely of normal recurring adjustments) which are, in
the opinion of management, necessary for a fair presentation of the financial
position and results of operations of Credence Systems Corporation (Credence or
"the Company") for the interim periods. The results of operations for the three
months ended January 31, 2002 and 2001 were not necessarily indicative of the
operating results to be expected for the full fiscal year. The information
included in this report should be read in conjunction with the Company's audited
consolidated financial statements and notes thereto for the fiscal year ended
October 31, 2001 included in the Company's most recent Annual Report on Form
10-K and the additional risk factors contained herein and therein, including,
without limitation, risks relating to importance of timely product introduction,
successful integration of acquisitions, fluctuations in our quarterly net sales
and operating results, limited systems sales, backlog, cyclicality of
semiconductor industry, management of fluctuations in our operating results,
expansion of our product lines, limited sources of supply, reliance on our
subcontractors, highly competitive industry, rapid technological change,
customer concentration, lengthy sales cycle, changes in financial accounting
standards and accounting estimates, dependence on key personnel, international
sales, proprietary rights, future capital needs, leverage, volatility of our
stock price and effects of certain anti-takeover provisions, as set forth in
this Report. Any party interested in reviewing a free copy of the Form 10-K or
the Company's other publicly available documents should write to the Chief
Financial Officer of the Company.

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

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

2. Revenue Recognition

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

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

                                        6

<PAGE>

3. Inventories

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

                                                January 31,         October 31,
                                                   2002                2001
                                              --------------      --------------
                                                (unaudited)
          Raw materials ....................     $ 68,503             $ 65,553
          Work-in-process ..................       22,890               21,905
          Finished goods ...................       37,370               35,761
                                                 --------             --------
                                                 $128,763             $123,219
                                                 ========             ========

4. Net Income 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 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 1,756,600 shares of common stock from the diluted income per share
calculation for the fiscal quarter ended January 31, 2002 because options are
anti-dilutive in periods when the Company incurs a net loss. The following table
sets forth the computation of basic and diluted net income (loss) per share (in
thousands, except per share amounts):

<TABLE>
<CAPTION>
                                                                             Three Months Ended
                                                                                 January 31,
                                                                        -----------------------------
                                                                            2002             2001
                                                                        ------------     ------------
<S>                                                                     <C>              <C>
Numerator:
   Numerator for basic and diluted net income per share-
   net income (loss)                                                       ($ 20,101)         $13,595
                                                                            ========          =======

 Denominator:
   Denominator for basic net income per share-
   weighted-average shares                                                    60,233           59,523
 Effect of dilutive securities-employee stock options                             --            2,418
                                                                           ---------          -------
 Denominator for diluted earnings per share-adjusted
 weighted-average shares and assumed conversions                              60,233           61,941
                                                                           ---------          -------

   Basic net income (loss) per share                                       $   (0.33)         $  0.23
                                                                           =========          =======

   Diluted net income (loss) per share                                     $   (0.33)         $  0.22
                                                                           =========          =======
</TABLE>

5. Recent Accounting Pronouncements

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

                                        7

<PAGE>

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

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

6. Contingencies

     In July 1998, the Company received a written allegation from inTEST IP
Corp., with its patent licensee inTEST Corporation, inTEST, that Credence was
infringing on a patent held by inTEST. The Company has since then engaged in
sporadic discussions with inTEST concerning this matter. On December 15, 2000,
inTEST filed a complaint in the U.S. District Court for the District of
Delaware, alleging infringement of inTEST U.S. patent number 4,589,815 and
seeking damages and injunctive relief. In April 2001 the Company was served with
the complaint. In addition to direct costs and diversion of resources which may
result, the Company may be obligated to indemnify third parties for costs
related to this allegation. We currently intend to vigorously defend ourselves
against this claim and we believe we have meritorious defenses to the claims.
However, we cannot be certain of success in defending this patent infringement
claim.

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

7. Accumulated Other Comprehensive Income (Loss)

                                        8

<PAGE>

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

                                                                  Fiscal Years
                                                Three Months          Ended
                                                Ended Jan. 31,     October 31,
                                                -------------     ------------
                                                    2002             2001
                                                -------------     ------------
Beginning balance, net of tax                        $ 4,854          $ 2,097
Unrealized gain  (loss) on available-for-sale
  securities, net of tax                              (1,909)             373
Currency translation adjustment, net of tax             (531)           2,384
                                                -------------     ------------
Ending balance, net of tax                           $ 2,414          $ 4,854
                                                =============     ============

8.  Acquisitions

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

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

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

Cash paid .................................................     $13,286
Deferred tax liability ....................................       1,491
Cancelled receivable ......................................         214
                                                                -------
       Total purchase cost ................................     $14,991
                                                                -------

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

<TABLE>
<CAPTION>
                                                                                      Annual      Useful
                                                                           Amount   Amortization  Lives
                                                                           ------   ------------  -----
<S>                                                                       <C>       <C>           <C>
Purchase Price Allocation:
     Tangible net assets ............................................     $   806     $    --      --
     Intangible assets acquired:

            Assembled workforce .....................................         545         182       3
            Developed technology ....................................       2,236         559       4
            Customer lists ..........................................       3,347         669       5
            Goodwill ................................................       8,057       1,612       5
                                                                          -------     -------
                  Total purchase price allocation ...................     $14,991     $ 3,022
                                                                          =======     =======
</TABLE>

                                       9

<PAGE>

         A valuation of the purchased assets was undertaken to assist the
Company in determining the fair value of each identifiable intangible asset and
in allocating the purchase price among the acquired assets. The intangible
assets, consisting primarily of developed technology, assembled workforce,
customer lists and goodwill, were assigned a value of $14.2 million and are
being amortized over their estimated useful lives, ranging from three to five
years.

                                       10

<PAGE>

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

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

         Revenue declined throughout fiscal 2001 and has remained at low levels
in the first fiscal quarter of 2002 in the test and assembly sector of the
semiconductor equipment industry during what we believe is a severe cyclical
downturn in the industry. There is uncertainty as to if and when the next
cyclical growth phase will occur. Until such time as we return to a growth
period, we expect a continuing low order rate and therefore expect that the
April 30, 2002 fiscal quarter's revenue will be approximately flat with those
recorded in the first fiscal quarter of 2002 and may continue to remain
depressed throughout fiscal 2002.

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

Critical Accounting Policies and Estimates

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

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

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

                                       11

<PAGE>

         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. We
currently anticipate introducing several new systems in fiscal 2002. In the
past, we experienced significant delays in the introduction of new testers as
well as certain enhancements to our existing testers. As a result, some
customers have experienced significant delays in receiving and accepting our
testers in production. Delays in introducing a product or delays in our ability
to obtain customer acceptance, if they occur in the future, will delay the
recognition of revenue and gross profit by us.

         With the dramatic decline in revenue since early in fiscal 2001, we
continue to monitor our inventory levels in light of product development changes
and expectations of an eventual market upturn. We recorded a charge of $45.0
million in the second fiscal quarter of 2001 and a charge of $38.0 million in
the fourth fiscal quarter of 2001 for the write-down of excess inventories. We
may be required to take additional charges for excess and obsolete inventory if
the industry downturn causes further reductions to our current inventory
valuations or changes our current product development plans. We evaluate our
inventory levels and valuations based on our estimates and forecasts of the next
cyclical industry upturn. These forecasts require us to estimate our ability to
sell current and future products in the next industry upturn and compare those
estimates with our current inventory levels. If these forecasts or estimates
change, or our product roadmaps change, then we would need to adjust our
assessment of the inventory valuations. At January 31, 2002, approximately 42%
and 22% of the inventory balances are for the Quartet mixed signal and Kalos
memory product families, respectively.


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

         Realization of the net deferred tax assets is dependent on our ability
to generate approximately $105,000,000 of future taxable income. Management
believes that it is more likely than not that the assets will be realized, based
on forecasted income. However, there can be no assurance that we will meet our
expectations of future income. Management will evaluate the realizability of the
deferred tax assets on a quarterly basis and assess the need for additional
valuation allowances.

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:

                                       12

<PAGE>

                                                             Three Months Ended
                                                                 January 31,
                                                            --------------------
                                                              2002        2001
                                                            -------     --------
                                                                   Unaudited

   Net sales .............................................    100.0 %     100.0%
   Cost of goods sold ....................................     62.0        43.4
                                                            -------    --------
   Gross margin ..........................................     38.0        56.6
   Operating expenses
      Research and development ...........................     59.2        16.5
      Selling, general, and administrative ...............     62.5        23.9
      Amortization of purchased intangible assets ........     14.9         3.8
                                                            -------     -------
         Operating expenses ..............................    136.6        44.2
                                                            -------     -------
   Operating income (loss) ...............................    (98.6)       12.4
   Interest and other income, net ........................      9.7         3.4
                                                            -------     -------
   Income (loss) before income tax provision .............    (88.9)       15.8
   Income tax provision (benefit) ........................     30.9         5.8
                                                            -------     -------
   Net income ............................................    (58.0)%      10.0%
                                                            =======     =======

NET SALES

         Net sales consist of revenues from systems sales, spare parts sales,
maintenance contracts and software sales. Net sales were $34.6 million for the
first quarter of fiscal 2002, representing an decrease of 74.6% from the net
sales of $136.3 million in the comparable period of fiscal 2001. Net sales
declined 6.4% from the fourth quarter of fiscal 2001, when we recorded $37.0
million in revenue. During fiscal 2001, our net sales declined sequentially in
each quarter due to what we believe is a severe cyclical downturn in the
semiconductor industry. There is uncertainty as to if and when the next cyclical
growth phase will occur. Until such time as we return to a growth period, we
expect a continuing low order rate.

         International net sales accounted for approximately 45%, 61% and 74% of
total net sales in the fiscal first quarter of 2002 and fiscal years 2001 and
2000, respectively. Our net sales to the Asia Pacific region accounted for
approximately 37%, 38% and 66% of total net sales in the fiscal first quarter of
2002 and fiscal years 2001 and 2000, respectively, and thus are subject to the
risk of economic instability in that region that materially adversely affected
the demand for our products in 1998 and early 1999. Capital markets in Korea and
other areas of Asia have been highly volatile, resulting in economic
instabilities. These instabilities may reoccur which could materially adversely
affect demand for our products.

         Our net sales by product line in the first fiscal quarter of 2002 and
fiscal years 2001 and 2000 consisted of:

                           Fiscal Quarter          Fiscal Years Ended
                           Ended January              October 31,
                                               ---------------------------
                              31, 2002            2001            2000
                         -------------------   ------------    ------------
  Mixed-Signal                  65%                    61%             74%
  Logic                         --                      4              11
  Memory                         5                     19               8
  Service and                   30                     16               7
  software
                         -------------------   ------------    ------------
  Total                        100%                   100%            100%
                         ===================   ============    ============

         Revenues from software were not material to our operations in the first
fiscal quarter of 2002 and fiscal years 2001 and 2000, representing less than 5%
of our net sales in each period. The only remaining logic-only system is the SC
series product family.

                                       13

<PAGE>

GROSS MARGIN

     Our gross margin has been and will continue to be affected by a variety of
factors, including manufacturing efficiencies, pricing by competitors or
suppliers, new product introductions, product sales mix, production volume,
customization and reconfiguration of systems, international and domestic sales
mix and field service margins. Our gross margin was 38.0% for the first quarter
of fiscal 2002, compared with 57.3% for the first quarter of fiscal 2001. We
currently expect gross margins to remain depressed due to lower average selling
prices as well as higher costs caused by under-absorption of manufacturing
expenses.

RESEARCH AND DEVELOPMENT

     Research and development ("or R&D") expenses were $20.5 million in the
first quarter of fiscal 2002, a decrease of $2.0 million or 9% from the same
period of fiscal 2001. The lower level of spending in 2002 reflects company wide
shutdown periods, salary reductions, and small headcount reductions in 2002 when
compared to 2001. As a percentage of net sales, R&D expenses were 59.2% for the
first quarter of fiscal 2002, an increase from 16.5% in the first quarter of
fiscal 2001. We currently intend to continue to invest significant resources in
the development of new products and enhancements for the foreseeable future.
Accordingly, we expect these expenses to be flat to up slightly in absolute
dollars in fiscal 2002 when compared to fiscal 2001.

SELLING, GENERAL AND ADMINISTRATIVE

     Selling, general and administrative expenses ("or SG&A") were $21.6 million
in the first quarter of fiscal 2002, representing a $10.9 million, or 33.5%,
decrease from the comparable period of fiscal 2001. The lower spending in 2002
was primarily due to lower sales commissions on lower sales volumes and
decreases in payroll related expenses due to lower headcounts, salary
reductions, and company wide shutdown periods in fiscal 2002. As a percentage of
net sales, SG&A expenses were 62.5% for the first quarter of fiscal 2002,
compared with 23.90% for the corresponding period in fiscal 2001. This increase
as a percentage of net sales is primarily due to the much lower sales levels in
fiscal 2002. We expect SG&A expenses for the remainder of fiscal 2002 to
increase slightly in absolute dollars because we currently have not scheduled
shutdown periods and, subject to business conditions, we presently intend to
restore salary levels prior to the end of the fiscal year.

AMORTIZATION OF GOODWILL AND PURCHASED INTANGIBLE ASSETS

       Amortization of goodwill and purchased intangible expenses was $5.1
million in the first quarter of fiscal 2002, down slightly from $5.2 million in
the comparable period of fiscal 2001. In the fourth quarter of fiscal 2001 we
wrote down the value of goodwill and purchased intangible assets by $8.9
million. This action resulted in a decrease in the quarterly amortization charge
by about $0.7 million per quarter which was offset in fiscal 2002 by the added
amortization of the DCI and Rabkin acquisitions, when compared to fiscal 2001
(see Note 2 of the Consolidated Financial Statements in the 2001 Form 10-K for
further discussion).

INTEREST AND OTHER INCOME EXPENSES, NET

     We generated net interest and other income of $3.4 million for the first
quarter of fiscal 2002, as compared to $4.6 million for the first quarter of
fiscal 2001. The decrease in fiscal 2002 was due to lower average cash and
investment balances as well as lower short-term interest rates in fiscal 2002 as
compared to fiscal 2001.

INCOME TAXES

     Our estimated effective tax benefit rate for the first three months of
fiscal 2002 was 35.0% compared to an effective tax rate of 37.7% in the first
three months of 2001. The estimated tax benefit rate and tax rate for fiscal
2002 and 2001, respectively are less than the combined federal and state
statutory rate primarily due to the impact of non-deductible goodwill
amortization. The estimated tax benefit rate for fiscal 2002 is lower than the
estimated tax rate in fiscal 2001 due to the increased relative impact of
non-deductible goodwill amortization in the fiscal 2002

                                       14

<PAGE>

forecast. The tax rate applied to pre-tax book income for the first three months
is computed based on a projected effective tax benefit rate for the year.

     Realization of the net deferred tax assets at January 31, 2002 is dependent
on our ability to generate approximately $105,000,000 of future taxable income.
Management believes that it is more likely than not that the assets will be
realized, based on forecasted income. However, there can be no assurance that we
will meet our expectations of future income. Management will evaluate the
realizability of the deferred tax assets on a quarterly basis and assess the
need for additional valuation allowances.

 LIQUIDITY AND CAPITAL RESOURCES

     Operating activities used net cash flows of $16.1 million for the three
months ended January 31, 2002. The net cash flows used in operating activities
for the first quarter of fiscal 2002 were primarily due to the loss before
depreciation and amortization of $7.7 million plus the increase in net operating
assets and liabilities of $9.8 million.

     Investing activities provided net cash flows of approximately $10.1 million
in the three months ended January 31, 2002. For the first quarter of fiscal
2002, approximately $16.0 million was generated from net sales of
available-for-sale securities offset by $5.9 million for purchases of property
and equipment and other assets to support our business.

     Financing activities provided net cash flows of $2.2 million for the three
months ended January 31, 2002. This cash was provided from the issuance of
common stock through our employee equity plans.

     As of January 31, 2002, we had working capital of approximately $315.7
million, including cash and short-term investments of $123.5 million, and
accounts receivable and inventories representing $160.4 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.

     We have an agreement with a captive leasing company whereby we issued a
guaranty in favor of a bank with respect to certain obligations of the leasing
company to the bank. Under this agreement, the leasing company agreed to grant
to us a security interest to secure the obligations of the leasing company as a
result of any payments by us pursuant to the guaranty. At January 31, 2002, the
maximum allowable debt of the leasing company subject to this guaranty of
$8,750,000 was outstanding.

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

                                                              Lease Payments
                                                              --------------

2002 .....................................................         $   3,615
2003 .....................................................             5,128
2004 .....................................................             3,517
2005 .....................................................             1,461
2006 .....................................................               163
Thereafter ...............................................                 0
                                                             ----------------
                                                                   $  13,884
                                                             ================

                                       15

<PAGE>

RECENT ACCOUNTING PRONOUNCEMENTS

     In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statements of Financial Accounting Standards No. 141 ("SFAS 141"), "Business
Combinations." SFAS 141 eliminates the pooling-of-interests method of accounting
for business combinations except for qualifying business combinations that were
initiated prior to July 1, 2001. In addition, SFAS 141 further clarifies the
criteria to recognize intangible assets separately from goodwill. Specifically,
SFAS 141 requires that an intangible asset may be separately recognized only if
such an asset meets the contractual-legal criterion or the separability
criterion. The requirements of Statement 141 are effective for any business
combination accounted for by the purchase method that is completed after June
30, 2001 (i.e., the acquisition date is July 1, 2001 or after). We are currently
evaluating the impact of SFAS 141 and has not yet determined the impact that
adopting SFAS 141 will have on its financial statements. On adoption, we will be
required to reassess the goodwill and intangible assets previously recorded in
acquisitions prior to July 1, 2001 to determine if the new recognition criteria
for an intangible asset to be recognized apart from goodwill are met.
     In July 2001, the FASB issued Statements of Financial Accounting Standards
No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets." Under SFAS 142,
goodwill and indefinite lived intangible assets are no longer amortized but are
reviewed annually (or more frequently if impairment indicators arise) for
impairment. For intangible assets with indefinite useful lives, the impairment
review will involve a comparison of fair value to carrying value, with any
excess of carrying value over fair value being recorded as an impairment loss.
For goodwill, the impairment test shall be a two-step process, consisting of a
comparison of the fair value of a reporting unit with its carrying amount,
including the goodwill allocated to each reporting unit. If the carrying amount
is in excess of the fair value, the implied fair value of the reporting unit
goodwill is compared to the carrying amount of the reporting unit goodwill. Any
excess of the carrying value of the reporting unit goodwill over the implied
fair value of the reporting unit goodwill will be recorded as an impairment
loss. Separable intangible assets that are deemed to have a finite life will
continue to be amortized over their useful lives (but with no maximum life).
Intangible assets with finite useful lives will continue to be reviewed for
impairment in accordance with Statements of Financial Accounting Standards No.
121 ("SFAS 121"), "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of." The amortization provisions of SFAS 142
apply to goodwill and intangible assets acquired after June 30, 2001. With
respect to goodwill and intangible assets acquired prior to July 1, 2001, the
Company will apply the new accounting rules beginning November 1, 2002 and will
reassess the useful lives of its separately recognized intangible assets in the
first quarter of fiscal 2003. We will review for impairment previously
recognized intangible assets that are deemed to have indefinite lives upon the
completion of this analysis in the first quarter of fiscal 2003. Additionally,
upon the adoption of SFAS 142, we will perform a transitional impairment review
related to the carrying value of goodwill as of November 1, 2002 by the end of
the second quarter of fiscal 2003. Because of the different transition dates for
goodwill and intangible assets acquired on or before June 30, 2001 and those
acquired after that date, pre-existing goodwill and intangibles will be
amortized during this transition period until adoption whereas new goodwill and
indefinite lived intangible assets acquired after June 30, 2001 will not. We are
currently in the process of determining our reporting units for the purpose of
applying the impairment test, analyzing how fair value will be determined for
purposes of applying SFAS 142 and quantifying the anticipated impact of adopting
the provisions of SFAS 142.

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

                                       16

<PAGE>

     RISK FACTORS

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

                                    [GRAPH]

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

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

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

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

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

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

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

     .    supply constraints;

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

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

     .    expenses associated with acquisitions and alliances;

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

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

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

                                       17

<PAGE>

          hostilities; and

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

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


     .    manufacturing inefficiencies;

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

     .    hardware and software product sales mix;

     .    inventory write-downs;

     .    manufacturing volumes;

     .    new product introductions;

     .    product reliability;

     .    absorption levels and the rate of capacity utilization;

     .    customization and reconfiguration of systems; o international and
          domestic sales mix and field service margins; and

     .    facility relocations and closures.

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

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

     .    research and development;

     .    support costs for the distribution channels;

     .    marketing and other expenses for new products;

     .    capital equipment purchases and world-wide training; and

     .    customer support and service.

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

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

     We have in the past experienced significant delays in the introduction,
volume production and sales of our new systems and related feature enhancements.
In the past, we experienced significant delays in the introduction of our
ValStar 2000 and Kalos series testers as well as certain enhancements to our
existing testers. These delays have been primarily related to our inability to
successfully complete product hardware and software engineering within the

                                       18

<PAGE>

time frame originally anticipated, including design errors and redesigns of ICs.
As a result, some customers have experienced significant delays in receiving and
using our testers in production. In addition, under the new revenue recognition
policy that is in accordance with SAB 101, we will be deferring revenue for
transactions that involve newly introduced products or when customers specify
acceptance criteria that cannot be demonstrated prior to the shipment. This will
result in a delay in the recognition of revenue as compared to the historic norm
of generally recognizing revenue upon shipment. We currently anticipate
introducing several new systems in fiscal 2002. Delays in introducing a product
or delays in our ability to obtain customer acceptance, if they occur in the
future, will delay the recognition of revenue and gross profit by us. We cannot
be certain that these or additional difficulties will not continue to arise or
that delays will not continue to materially adversely affect customer
relationships and future sales. Moreover, we cannot be certain that we will not
encounter these or other difficulties that could delay future introductions or
volume production or sales of our systems or enhancements and related software
tools. In the past, we have incurred and we may continue to incur substantial
unanticipated costs to ensure the functionality and reliability of our testers
and to increase feature sets. If our systems have reliability, quality or other
problems, or the market perceives our products to be feature deficient, we may
suffer reduced orders, higher manufacturing costs, delays in collecting accounts
receivable and higher service, support and warranty expenses, and/or inventory
write-offs, among other effects. Our failure to have a competitive tester and
related software tools available when required by a customer could make it
substantially more difficult for us to sell testers to that customer for a
number of years. We believe that the continued acceptance, volume production,
timely delivery and customer satisfaction of our newer digital, mixed signal and
non-volatile memory testers are of critical importance to our future financial
results. As a result, our inability to correct any technical, reliability, parts
shortages or other difficulties associated with our systems or to manufacture
and ship the systems on a timely basis to meet customer requirements could
damage our relationships with current and prospective customers and would
continue to materially adversely affect our business, financial condition and
results of operations.

The ATE market is subject to rapid technological change.

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

     .    product selection;

     .    timely and efficient completion of product design;

     .    implementation of manufacturing and assembly processes;

     .    successful coding and debugging of software;

     .    product performance;

     .    reliability in the field; and o effective sales and marketing.

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

                                       19

<PAGE>

purchases. In addition, weakness in demand may have caused integrated device
manufacturers, or IDM's, to pull testing back in-house versus using outsource
test houses. Because less of our market share is from the IDMs, this trend may
reduce the demand for our products. Any decline in demand for our hardware or
software products could have a materially adverse effect on our business,
financial condition or results of operations.

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

     Other than certain memory products and software products, for which the
price range is typically below $50,000, we obtain most of our net sales from the
sale of a relatively few number of systems that typically range in price from
$200,000 to $2.0 million. This has resulted and could continue to result in our
net sales and operating results for a particular period being significantly
impacted by the timing of recognition of revenue from a single transaction. Our
net sales and operating results for a particular period could also be materially
adversely affected if an anticipated order from just one customer is not
received in time to permit shipment during that period. Backlog at the beginning
of a quarter typically does not include all orders necessary to achieve our
sales objectives for that quarter. Orders in backlog are subject to
cancellation, delay, deferral or rescheduling by customers with limited or no
penalties. In fiscal 2001 and 2002, we have experienced customer-requested
shipment delays and order cancellations, and we believe it is probable that
orders will be canceled in the future. Consequently, our quarterly net sales and
operating results have in the past and will in the future, depend upon our
obtaining orders for systems to be shipped in the same quarter in which the
order is received.

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

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

The semiconductor industry has been cyclical.

     Revenue growth has slowed in the test and assembly sector of the
semiconductor equipment industry during what we believe is a cyclical downturn
in the industry. There is uncertainty as to if and when the next cyclical growth
phase will occur. 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 weakness in order activity and therefore expect
that the April 30, 2002 fiscal quarter's revenue will be flat with the levels we
experienced during the first quarter of fiscal 2002 and revenues may decline
throughout fiscal 2002. We reduced our worldwide workforce during fiscal 2001 by
approximately 23%, or about 400 people. We took a charge related to this
reduction in force of approximately $2.0 million in our second fiscal quarter,
$1.0 million in our third fiscal quarter and another $0.2 million in the fourth
fiscal quarter of 2001. Additionally, remaining employees were required to take
time off in the second, third and fourth quarters of fiscal 2001, as well as the
first quarter of fiscal 2002. Other initiatives, including a domestic pay cut, a
four day work week for most manufacturing and some operating employees, the
consolidation and reorganization of certain functions and operations, and the
curtailment of discretionary expenses, were also implemented. If we continue to
reduce our workforce, it may adversely impact our ability to respond rapidly to
any renewed growth opportunities in the future.

     With the dramatic decline in revenue during this downturn, we continue to
monitor our inventory levels in light of product development changes and a
possible eventual upturn. We recorded a charge of $45.0 million in the

                                       20

<PAGE>

second fiscal quarter of 2001 and a charge of $38.0 million in the fourth fiscal
quarter of 2001 for the write-down of excess inventories. We may be required to
take additional charges for excess and obsolete inventory if the industry
downturn causes further reductions to our current inventory valuations or
changes our current product development plans.

     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. In addition, sales are
expected to be sequentially flat or down in the next fiscal quarter and possibly
in the upcoming quarters. We anticipate that a significant portion of new orders
may depend upon demand from semiconductor device manufacturers building or
expanding fabrication facilities and new device testing requirements that are
not addressable by currently installed test equipment, and there can be no
assurance that such demand will develop to a significant degree, or at all. In
addition, our business, financial condition or results of operations may be
adversely affected by any factor adversely affecting the semiconductor industry
in general or particular segments within the semiconductor industry. For
example, 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 which we
sell. This industry slowdown had, and similar slowdowns may in the future have,
a material adverse effect on our product backlog, balance sheet, financial
condition and results of operations. Therefore, there can be no assurance that
our operating results will not be materially adversely affected if downturns or
slowdowns in the semiconductor industry occur again in the future.

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

     In the fourth fiscal quarter of fiscal 2001, our net sales fell 73% from
those recorded in the first quarter of fiscal 2001. In the first fiscal quarter
of 2002 net sales declined a further 6% from those recorded in the fourth
quarter of 2001. In fiscal 2000, we generated revenue of $136.3 million in the
first quarter and $221.7 million in the fourth quarter, an increase of 63%. In
fiscal 1999, we generated revenue of $37.7 million in the first quarter and
$97.0 million in the fourth quarter, an increase of 157%. Since 1993, except for
the current cost-cutting efforts and those during fiscal 1998 and the first half
of fiscal 1999, we have overall significantly increased the scale of our
operations in general to support periods of generally increased sales levels and
expanded product offerings and have expanded operations to address critical
infrastructure and other requirements, including the hiring of additional
personnel, significant investments in research and development to support
product development, acquisition of the new facilities in Oregon, further
investments in our ERP system and numerous acquisitions. These fluctuations in
our sales and operations have placed and are continuing to place a considerable
strain on our management, financial, manufacturing and other resources. In order
to effectively deal with the changes brought on by the cyclical nature of the
industry, we have been required to implement and improve a variety of highly
flexible operating, financial and other systems, procedures and controls capable
of expanding, or contracting consistent with our business. However, we cannot be
certain that any existing or new systems, procedures or controls, including our
ERP system, will be adequate to support fluctuations in our operations or that
our systems, procedures and controls will be cost-effective or timely. Any
failure to implement, improve and expand or contract such systems, procedures
and controls efficiently and at a pace consistent with our business could have a
material adverse effect on our business, financial condition or results of
operations.

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

                                       21

<PAGE>

     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. Under the new revenue
recognition policy that is in accordance with SAB 101, we will be deferring
revenue for transactions that involve newly introduced products or when
customers specify acceptance criteria that cannot be demonstrated prior to the
shipment. This will result in a delay in the recognition of revenue as compared
to the historic norm of recognizing revenue upon shipment. Product introduction
delays, if they occur in the future, will delay the recognition of revenue and
gross profit by us. During the remainder of fiscal 2002, we anticipate
introducing new products as well as evolutions and derivatives of current
products. In late fiscal 1999 and into 2000, we shipped three major new
products. We invested and continue to invest significant resources in plant and
equipment, leased facilities, inventory, personnel and other costs to begin or
prepare to increase production of these products. A significant portion of these
investments will provide the marketing, administration and after-sales service
and support required for these new hardware and software products. Accordingly,
we cannot be certain that gross profit margin and inventory levels will not be
adversely impacted by delays in new product introductions or start-up costs
associated with the initial production and installation of these new product
lines. We also cannot be certain that we can manufacture these systems per the
time and quantity required by our customers. The start-up costs include
additional manufacturing overhead, additional inventory and warranty reserve
requirements and the enhancement of after-sales service and support
organizations. In addition, the increases in inventory on hand for new product
development and customer support requirements have increased and will continue
to increase the risk of inventory write-offs. We cannot be certain that our net
sales will increase or remain at historical levels or that any new products will
be successfully commercialized or contribute to revenue growth or that any of
our additional costs will be covered.

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

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

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

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

     We face substantial competition from ATE manufacturers throughout the
world, as well as several of our customers. We do not currently compete in the
testing of high-end microprocessors, linear ICs or DRAMs.

                                       22

<PAGE>

Moreover, a substantial portion of our net sales is derived from sales of
mixed-signal testers. Many competitors have substantially greater financial and
other resources with which to pursue engineering, manufacturing, marketing and
distribution of their products. Certain competitors have introduced or announced
new products with certain performance or price characteristics equal or superior
to products we currently offer. These competitors have introduced products that
compete directly against our products. We believe that if the ATE industry
continues to consolidate through strategic alliances or acquisitions, we will
continue to face significant additional competition from larger competitors that
may offer product lines and services more complete than ours. Our competitors
are continuing to improve the performance of their current products and to
introduce new products, enhancements and new technologies that provide improved
cost of ownership and performance characteristics. New product introductions by
our competitors could cause a decline in our sales or loss of market acceptance
of our existing products.

     Moreover, our business, financial condition or results of operations could
continue to be materially adversely affected by increased competitive pressure
and continued intense price-based competition. We have experienced and continue
to experience significant price competition in the sale of our products. In
addition, pricing pressures typically become more intense at the end of a
product's life cycle and as competitors introduce more technologically advanced
products. We believe that, to be competitive, we must continue to expend
significant financial resources in order to, among other things, invest in new
product development and enhancements and to maintain customer service and
support centers worldwide. We cannot be certain that we will be able to compete
successfully in the future.

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

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

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 5%, 13% and 42% of
our net sales in the first three months of fiscal 2002 and the fiscal years 2001
and 2000, respectively. Our agreement with Spirox can be terminated for any
reason on 90 days prior written notice. The semiconductor industry is highly
concentrated, and a small number of semiconductor device manufacturers and
contract assemblers account for a substantial portion of the purchases of
semiconductor test equipment generally, including our test equipment. Our top
ten end user customers have recently accounted for a substantial portion of our
net sales. Consequently, our business, financial condition and results of
operations could be materially adversely affected by the loss of or any
reduction in orders by Spirox, any termination of the Spirox relationship, or
any other significant customer, including the potential for reductions in orders
by assembly and tester service companies which that customer may utilize or
reductions due to continuing or other technical, manufacturing or reliability
problems with our products or continued slow-downs in the semiconductor industry
or in other industries that manufacture products utilizing semiconductors. Our
ability to maintain or increase sales levels will depend upon:

                                       23

<PAGE>

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

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

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

     .    our customers' financial condition and success;

     .    general economic conditions; and

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

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

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

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

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

     In addition, acquisitions involve numerous other risks, including:

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

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

     .    increased complexity and costs associated with internal management
          structures;

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

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

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

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

     We prepare our financial statements to conform with generally accepted
accounting principles, or GAAP. GAAP are subject to interpretation by the
American Institute of Certified Public Accountants, the SEC and various bodies
formed to interpret and create appropriate accounting policies. A change in
those policies can have a significant effect on our reported results and may
even affect our reporting of transactions completed before a change is
announced. Accounting rules affecting many aspects of our business, including
rules relating to purchase and pooling-of-interests accounting for business
combinations, in-process research and development charges, 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

                                       24

<PAGE>

quarter of fiscal 2001, we implemented SAB 101. Adoption of SAB 101 required us
to restate our quarterly results for the seven fiscal quarters ended July 31,
2001 (see Notes 1 and 13 of the Notes to the Consolidated Financial Statements
in the Form 10-K for further discussion). In addition, the preparation of our
financial statements in accordance with GAAP requires that we make estimates and
assumptions that affect the recorded amounts of assets and liabilities,
disclosure of those assets and liabilities at the date of the financial
statements and the recorded amounts of expenses during the reporting period. A
change in the facts and circumstances surrounding those estimates could result
in a change to our estimates and could impact our future operating results.

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

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

Our international business exposes us to additional risks.

     International sales accounted for approximately 45%, 61% and 74% of our
total net sales for the first three months of fiscal 2002 and for the fiscal
years 2001 and 2000, respectively. As a result, we anticipate that international
sales will continue to account for a significant portion of our total net sales
in the foreseeable future. These international sales will continue to be subject
to certain risks, including:


     .    changes in regulatory requirements;

     .    tariffs and other barriers;

     .    political and economic instability;

     .    an outbreak of hostilities;

     .    integration and management of foreign operations of acquired
          businesses;

     .    foreign currency exchange rate fluctuations;

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

     .    potentially adverse tax consequences; and

     .    the possibility of difficulty in accounts receivable collection.

     We are also subject to the risks associated with the imposition of domestic
and foreign legislation and regulations relating to the import or export of
semiconductor equipment and software products. We cannot predict whether the
import and export of our products will be subject to quotas, duties, taxes or
other charges or restrictions imposed by the United States or any other country
in the future. Any of these factors or the adoption of restrictive policies
could have a material adverse effect on our business, financial condition or
results of operations. Net sales to the Asia-Pacific region accounted for
approximately 37%, 38% and 66% of our total net sales in the first three months
of fiscal 2002 and fiscal years 2001 and 2000, respectively, and thus demand for
our products is subject to the risk of economic instability in that region and
could continue to be materially adversely affected. Countries in the
Asia-Pacific region, including Korea and Japan, have experienced weaknesses in
their currency, banking and equity 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

                                       25

<PAGE>

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. We have been involved
in extensive, expensive and time-consuming reviews of, and litigation
concerning, patent infringement claims.

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

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

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

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

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

                                       26

<PAGE>

     In recent years, the stock market in general, and the market for shares of
high-tech companies in particular, including ours, have experienced extreme
price fluctuations, which have often been unrelated to the operating performance
of affected companies. For example, in fiscal 2000, the price of our common
stock has ranged from a closing high of $74.59 to a closing low of $16.13. In
fiscal 2001 and through February 2002, the price of our common stock has ranged
from a closing high of $29.50 to a closing low of $11.26. The market price of
our common stock is likely to continue to fluctuate significantly in the future,
including fluctuations unrelated to our performance. We believe that
fluctuations of our stock price may be caused by a variety of factors,
including:

     .    announcements of developments related to our business;

     .    fluctuations in our financial results;

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

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

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

     .    developments in patents or other intellectual property rights;

     .    developments in our relationships with customers and suppliers;

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

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

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

     The recent terrorist attacks in the United States, the U.S. retaliation for
these attacks and the related decline in consumer confidence and continued
economic weakness have had a substantial adverse impact on the economy. If
consumer confidence does not recover, our revenues and profitability may be
adversely impacted in fiscal 2002 and beyond.

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

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

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

                                       27

<PAGE>

ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

       Our exposure to market risk for changes in interest rates relates
primarily to our investment portfolio. We maintain a strict investment policy
which ensures the safety and preservation of 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):

<TABLE>
<CAPTION>
                                     Balance at    Future maturities of investments held at January 31, 2002
                                      10/31/01        2002       2003       2004       2005     2006    Thereafter
                                    ------------   ---------  ----------  --------  --------- --------  ----------
<S>                                 <C>            <C>        <C>         <C>       <C>       <C>       <C>
Cash equivalents
   Fixed rate .....................   $ 44,309      $ 40,543          --        --         --       --         --
   Average rate ...................       2.65%         4.35%         --        --         --       --         --
Short term investments
   Fixed rate .....................   $ 96,497      $ 61,168    $ 21,764        --         --       --         --
   Average rate ...................       6.70%         5.95%       6.11%       --         --       --         --
Long term investments
   Fixed rate .....................   $160,607            --    $116,387   $22,645   $  6,369       --    $11,617
   Average rate ...................       5.60%           --        5.54%     5.06%      5.78%      --       5.34%
                                    ------------   ---------  ----------  --------  --------- --------  ---------
     Total investment securities ..   $301,413      $101,711    $138,151   $22,645   $  6,369       --    $11,617
   Average rate ...................       5.52%         5.31%       5.63%     5.06%      5.78%      --       5.34%

Equity investments ................   $  1,282            --          --        --         --       --         --
</TABLE>

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

                                       28

<PAGE>

PART II. - OTHER INFORMATION

Item 1.  Legal Proceedings

         See our Form 10-K for the year ended October 31, 2001.

Item 2.  Changes in Securities

         None

Item 3.  Defaults upon Senior Securities

         None

Item 4.  Submission of Matters to a Vote of Securityholders

         None

Item 5.  Other Information

         None

Item 6.  Exhibits and Reports on Form 8-K

         (a)      See Exhibit Index on page 31

         (b)      Reports of Form 8-K

         None


                                       29

<PAGE>

                                   SIGNATURES

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

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



            March 15, 2002                  /S/ JOHN R. DETWILER
         --------------------     ----------------------------------------------
                Date                            John R. Detwiler
                                  John R. Detwiler, Senior Vice President, Chief
                                         Financial Officer and Secretary

                                       30

<PAGE>


EXHIBIT INDEX

  Exhibit
   Number
  -------
    3.2         Amended and Restated Bylaws of the Company, as currently in
                effect.
  10.34/(1)/    Employment Agreement, dated January 15, 2002, by and between the
                Company and David A. Ranhoff.
  10.37/(1)/    Letter Agreement, dated January 15, 2002, by and between the
                Company and Keith L.
                Barnes.
  10.39/(1)/    Letter Agreement, dated January 15, 2002, by and between the
                Company and Fred
                Hall.
  (1)         Incorporated by reference to an exhibit to the Company's Annual
              Report on Form 10-K for the year ended October 31, 2001.

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