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

                       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 July 31, 1998

                                       OR

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

For the transition period from          to

                         Commission file number 0-22366

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


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


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

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


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

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

                      APPLICABLE ONLY TO CORPORATE ISSUERS:

     At August 25, 1998, there were 21,721,264 shares of the Registrant's common
stock, $0.001 par value per share outstanding.


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


                                       1
<PAGE>




CREDENCE SYSTEMS CORPORATION

                                       INDEX                            PAGE NO.



PART I.    FINANCIAL INFORMATION
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....................................    8

PART II.   OTHER INFORMATION
Item 1.    Legal Proceedings............................................   23
Item 2.    Changes in Securities........................................   23
Item 3.    Defaults Upon Senior Securities..............................   23
Item 4.    Submission of Matters to a Vote of Securityholders...........   23
Item 5.    Other Information............................................   23
Item 6.    Exhibits and Reports on Form 8-K.............................   23









                                       2
<PAGE>


PART I  - FINANCIAL INFORMATION

Item I  - Financial Statements

                          CREDENCE SYSTEMS CORPORATION
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                                 (in thousands)

<TABLE>
<CAPTION>

                                                 July 31, 1998      October 31,
                                                                       1997
                                                 -------------      -----------
                                                  (unaudited)
<S>                                                 <C>               <C>
ASSETS                                            
Current assets:
  Cash and cash equivalents ......................  $ 55,621          $132,761
  Restricted cash ................................     4,600            10,002
  Short-term investments .........................    75,826            35,013
  Accounts receivable, net .......................    53,059            55,246
  Inventories ....................................    36,311            42,125
  Deferred income taxes ..........................    17,365             5,853
  Prepaid and other current assets ...............    12,490             7,148
                                                    --------          --------
    Total current assets .........................   255,272           288,148
Long-term investments ............................    27,207             8,561
Property and equipment, net ......................    40,428            43,050
Other assets .....................................    17,066            18,382
                                                    ========          ========
    Total assets .................................  $339,973          $358,141
                                                    ========          ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities: 
  Accounts payable ...............................  $ 13,225          $ 13,182
  Accrued liabilities ............................    28,613            20,346
  Income taxes payable ...........................     2,317             4,284
    Total current liabilities ....................    44,155            37,812
Convertible subordinated notes ...................   115,000           115,000
Minority interest ................................       231               418
Stockholders' equity .............................   180,587           204,911
                                                    ========          ========
    Total liabilities and stockholders' equity ...  $339,973          $358,141
                                                    ========          ========

</TABLE>

                             See accompanying notes.


                                       3
<PAGE>




                          CREDENCE SYSTEMS CORPORATION
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                    (in thousands, except per share amounts)
                                   (unaudited)
<TABLE>
<CAPTION>

                                                       Three Months Ended     Nine Months Ended
                                                             July 31,               July 31,
                                                       -------------------    -------------------
                                                         1998       1997        1998       1997
                                                       --------   --------    --------   --------

<S>                                                    <C>        <C>         <C>        <C>     
Net sales .............................................$ 37,322   $ 51,082    $194,357   $134,698
Cost of goods sold - on net sales .....................  16,901     21,638      84,003     59,451
Cost of goods sold - restructure and other ............  20,952         --      20,952         --
                                                       --------   --------    --------   --------
Gross margin ..........................................    (531)    29,444      89,402     75,247
Operating expenses:
   Research and development ...........................  11,569      9,257      37,293     27,016
   Selling, general and administrative ................  13,987     14,529      52,226     37,949
   In-process research and development ................   4,838      6,022       4,838      6,022
   Restructure and other ..............................  18,386         --      18,386         --
                                                       --------   --------    --------   --------
    Total operating expenses ..........................  48,780     29,808     112,743     70,987
                                                       --------   --------    --------   --------
Operating income (loss) ............................... (49,311)      (364)    (23,341)     4,260
Interest income and (other expenses), net .............      (7)     1,011       1,151      2,912
                                                       --------   --------    --------   --------
Income (loss) before income tax provision (benefit) ... (49,318)       647     (22,190)     7,172
Income tax provision (benefit) ........................ (15,682)     1,542      (6,458)     3,727
Minority interest .....................................     (50)         2        (124)         2
                                                       ========   ========    ========   ========
Net income (loss) .....................................$(33,586)  $   (897)   $(15,608)  $  3,443
                                                       ========   ========    ========   ========
Net income (loss) per share
    Basic .............................................$  (1.55)  $  (0.04)   $  (0.72)  $   0.16
                                                       ========   ========    ========   ========
    Diluted ...........................................$  (1.55)  $  (0.04)   $  (0.72)  $   0.15
                                                       ========   ========    ========   ========
Number of shares used in computing per share amount
    Basic .............................................  21,674     21,873      21,726     21,813
                                                       ========   ========    ========   ========
    Diluted ...........................................  21,674     21,873      21,726     22,323
                                                       ========   ========    ========   ========
</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>
                                                                                  Nine Months Ended
                                                                                        July 31,
                                                                               ----------------------
                                                                                 1998          1997
                                                                               --------      --------
<S>                                                                           <C>           <C>
Cash flows from operating activities:
   Net income (loss) .......................................................  $ (15,608)    $   3,443
   Adjustments to reconcile net income (loss) to net cash provided by
   (used in) operating activities:
      Depreciation and amortization ........................................     12,838         8,760
      Acquired in-process research and development .........................      4,838            --
      Loss related to restructure and other
            Accounts receivable ............................................      1,390            --
            Inventory ......................................................     19,791            --
            Prepaids and other current assets ..............................      2,956            --
            Impairment of fixed assets .....................................      7,928            --
            Impairment of purchased technology & investments ...............      4,118            --
            Excess facility cost ...........................................      2,656            --
            Other accruals .................................................        500            --
      Loss (gain) on disposal of property and equipment ....................        149           (26)
      Deferred income taxes ................................................    (11,512)           --
      Minority interest ....................................................        124            --
      Changes in operating assets and liabilities:
         Restricted cash, accounts receivable, inventories
         and other current assets ..........................................    (23,503)      (12,336)
         Accounts payable, accrued liabilities and
         income taxes payable ..............................................      4,157        (3,272)
                                                                               --------      --------
            Net cash provided by (used in) operating activities ............     10,822        (3,431)
Cash flows from investing activities:
   Purchases of short-term investments                                         (135,080)      (29,398)
   Maturities of available-for-sale short-term investments .................     63,644        44,722
   Sales of short-term investments .........................................     11,977         3,112
   Acquisition of property and equipment ...................................     (8,319)       (7,823)
   Other assets ............................................................    (10,498)       (3,639)
   Proceeds from sale of property and equipment ............................         --         1,736
                                                                               --------      --------
         Net cash (used in) provided by investing activities ...............    (78,276)        8,710
Cash flows from financing activities:
   Issuance of common stock ................................................      3,109         1,998
   Repurchase of common stock ..............................................    (12,795)           --
                                                                               --------      --------
         Net cash (used in) provided by financing activities ...............     (9,686)        1,998
                                                                               --------      --------
Net increase (decrease) in cash and cash equivalents .......................    (77,140)        7,277
Cash and cash equivalents at beginning of period ...........................    132,761        48,649
                                                                               ========      ========
Cash and cash equivalents at end of period .................................  $  55,621     $  55,926
                                                                               ========      ========
Supplemental disclosures of cash flow information:
   Interest paid ...........................................................  $   3,103     $       1
   Income taxes paid .......................................................  $  12,492     $   2,533
Noncash investing activities:
   Net transfers of inventory to property and equipment ....................  $   7,427     $  11,684
Noncash financing activities:
   Income tax benefit from stock option exercises ..........................  $     970     $     149

                             See accompanying notes.
</TABLE>

                                       5
<PAGE>




              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.   Quarterly Financial Statements

         The condensed  consolidated  financial statements and related notes for
the nine  months  ended July 31,  1998 and 1997 are  unaudited  but  include all
adjustments  (consisting  solely of normal recurring  adjustments) which are, in
the opinion of management,  necessary for a fair  presentation  of the financial
position and results of operations of the Company for the interim  periods.  The
results of operations  for the three and nine months ended July 31, 1998 are not
necessarily  indicative  of the  operating  results to be expected  for the full
fiscal  year.  The  information  included  in  this  report  should  be  read in
conjunction with the Company's  audited  consolidated  financial  statements and
notes  thereto for the fiscal year ended  October 31, 1997  included in its most
recent Annual Report on Form 10-K and the  additional  risk factors,  including,
without limitation,  risks relating to fluctuations in operating results,  rapid
technological change, importance of timely product introduction,  limited system
sales, backlog,  cyclicality of semiconductor industry, expansion of operations,
management of  fluctuations  in operating  results,  sole or limited  sources of
supply, reliance on subcontractors,  highly competitive industry,  dependence on
key customers,  lengthy sales cycle, dependence on key personnel,  international
sales,  proprietary  rights,  acquisitions,  importance of Japanese market, Year
2000 compliance,  ability to reduce operating expenses, leverage, future capital
needs and  volatility  of stock price,  as set forth in this  Report.  Any party
interested in reviewing these publicly  available  documents should write to the
Chief Financial Officer of the Company.

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

2.   Restructure and Other

         In the third quarter of fiscal 1998, the Company  recorded  restructure
and other  costs  totaling  $39,338,000.  These  charges  are the  result of the
Company's  reaction to a major downturn in the current and  forecasted  business
outlook for the Automatic Test Equipment  ("ATE") and related  semiconductor and
semiconductor  equipment  industries  which took place  during the period.  As a
result of this industry  downturn,  the company has downsized its own operations
including reducing headcount, reducing the volume of products being produced and
the cancellation or delay of various projects,  including facilities expansions,
certain research and development projects and various infrastructure enhancement
projects. The impact of this downsizing and these decisions, is that significant
amounts  of  the  Company's  inventories,  receivables,  fixed  assets,  prepaid
expenses,  investments and purchased technologies have been impaired and certain
liabilities  have been incurred.  As a result,  and in accordance with Financial
Accounting Standards No. 121, the Company has written down the related assets to
their net realizable values and made provision for the estimated liabilities.

         Of the $39.3  million  total  charge,  approximately  $21.0 million was
charged as cost of goods sold, of which  approximately $19.8 million was related
to write  down of excess or  obsolete  inventories.  The  elements  of the total
charge as of July 31, 1998 are as follows (in thousands):

<TABLE>
    <S>                                                                <C>
    Write down of inventories to net realizable value
    (including expected losses on supplier commitments)                $ 19,791
    Write down of excess fixed assets to fair value                       7,928
    Write down purchased technology and investments to fair value         4,118
    Write-off of prepaid and other current assets                         2,956
    Excess facility costs                                                 2,656
    Write down of receivables to net realizable value                     1,390
    Employee termination benefits and accrued liabilities                   500
                                                                        -------
                                                                       $ 39,339
                                                                       ========
</TABLE>


                                       6
<PAGE>




         Cash  expenditures   associated  with  the   restructuring   plan  were
approximately  $170,000 in the third quarter of fiscal 1998. It is expected that
approximately  $1.8  million and $1.5  million of cash  expenditures,  primarily
related  to  losses  on  supplier  commitments  and  lease  payments  on  excess
facilities,  will occur  during the fourth  quarter of fiscal 1998 and the first
quarter of fiscal 1999,  respectively.  Subsequent  cash  expenditures,  related
primarily to lease payments on excess  facilities,  will be  approximately  $1.5
million over an 18 month period.

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):
<TABLE>
<CAPTION>
                                                   July 31,       October 31,
                                                     1998            1997
                                                   --------       -----------
               <S>                                 <C>              <C>     
               Raw materials ..................... $  9,969         $ 24,862
               Work-in-process ...................   22,791           14,173
               Finished goods ....................    3,551            3,090
                                                   --------         --------
                                                   $ 36,311         $ 42,125
                                                   ========         ========
</TABLE>
4.   Net Income (Loss) Per Share

         The Company has adopted  Statement  of Financial  Accounting  Standards
No.128  "Earnings Per Share" (SFAS 128) beginning in the first quarter of fiscal
1998.  Accordingly,  net  income  (loss)  per share  (basic)  is based  upon the
weighted  average  number of common shares  outstanding  during the period.  Net
income (loss) per share  (diluted) is based upon the weighted  average number of
common  shares and  dilutive  potential  common  shares  outstanding  during the
period. The Company's convertible  subordinated notes are not dilutive potential
common shares and, accordingly, were excluded from the calculation of net income
(loss) per share (diluted).  Options to purchase  1,023,195 shares at an average
price of  $28.26  per  share  were  outstanding  at July  31,  1998 but were not
included in the  computation  of diluted  earnings  (loss) per share because the
options'  exercise price was greater than the average market price of the common
shares and the Company incurred a net loss.  Therefore,  the effect of including
the options would be antidilutive. All earnings (loss) per share amounts for all
periods have been presented to conform to SFAS 128  requirements.  The following
table sets forth the  computation  of basic and dilutive  net income  (loss) per
share (in thousands):
<TABLE>
<CAPTION>
                                                         Three Months Ended      Nine Months Ended
                                                              July 31,                July 31,
                                                        --------------------    --------------------
                                                          1998        1997        1998        1997
                                                        --------    --------    --------    --------
  <S>                                                  <C>         <C>         <C>         <C>
  Numerator:
    Numerator for basic and diluted 
    earnings per share - net income (loss) ........... $(33,586)   $   (897)   $(15,608)   $  3,443
                                                        --------    --------    --------    --------
  Denominator:
    Denominator for basic earnings per 
     share-weighted-average shares ...................   21,674      21,873      21,726      21,813

  Effect of dilutive securities-
     employee stock options ..........................       --          --          --         510
                                                        --------    --------    --------    --------
  Denominator for diluted earnings per
     share-adjusted weighted-average shares
     and assumed conversions .........................   21,674      21,873      21,726      22,323
                                                        --------    --------    --------    --------
  Basic earnings (loss) per share .................... $  (1.55)   $  (0.04)   $  (0.72)   $   0.16
                                                        ========    ========    ========    ========
  Diluted earnings (loss) per share .................. $  (1.55)   $  (0.04)   $  (0.72)   $   0.15
                                                        ========    ========    ========    ========
</TABLE>
                                       7
<PAGE>



5.   Contingencies

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

         On July 21,  1998,  the  Company  received  a  letter  from  inTEST  IP
Corporation  alleging that the Company is infringing its U.S. Pat. No 4,589,815.
The Company is investigating  the allegation,  and has nothing to report at this
time with respect to the merits of the allegation or its financial impact on the
Company, if any.

6.   Commitments

         The Company  currently  has an agreement  with Summit  Design,  Inc. to
purchase  product  licenses  through 1999. The remaining  commitment  under this
agreement as of July 31, 1998 is  approximately  $4.6 million.  Restricted  cash
represents cash in escrow related to the remaining  purchase  commitments  under
this agreement.

7.   Acquired In-Process Technology

         On  June  1,  1998,  the  Company   purchased  from  Heuristic  Physics
Laboratories,  Inc.  ("HPL")  certain  assets and  assumed  certain  liabilities
relating to their memory test business for  approximately  $8.0 million in cash.
The assumed  liabilities  amounted to approximately $0.2 million.  In connection
with this  transaction,  the Company  recognized  approximately  $4.8 million of
acquired in-process research and development expense. The remaining $3.2 million
has been capitalized,  of which $2.6 million is purchased  technology which will
be amortized  ratably over five years. As of July 31, 1998, the Company had paid
$6.0 million of the purchase  price.  The remaining  purchase price will be paid
when all the closing conditions have been met, which is anticipated to be in the
fourth quarter of fiscal 1998.

8.   Line of Credit

         During the third quarter of fiscal 1998, the Company  re-negotiated its
unsecured  working  capital line of credit to increase the amount  available for
borrowings from $20.0 million to $40.0 million.

9.   Common Stock Repurchase

         During the nine months ended July 31, 1998, the Company has repurchased
a total of 500,000 shares of its common stock at a cost of $12.8 million.

10.  Subsequent Events

     In August , 1998, the Board of Directors authorized the repurchase of up to
$20.0 million in value of the Company's common stock.


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

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

                                       8
<PAGE>

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

<TABLE>
<CAPTION>

                                                            Three Months Ended      Nine Months Ended
                                                                  July 31,               July 31,
                                                            -------------------    -------------------
                                                              1998       1997        1998       1997
                                                            --------   --------    --------   --------
      <S>                                                    <C>         <C>         <C>        <C>   
      Net sales                                               100.0%     100.0%      100.0%     100.0%
      Cost of goods sold - on net sales                        45.3       42.4        43.2       44.1
      Cost of goods sold - restructure and other               56.1         --        10.8         --
                                                              -----      -----       -----      -----
      Gross margin                                             (1.4)      57.6        46.0       55.9
      Operating expenses:
         Research and development                              31.0       18.1        19.2       20.0
         Selling, general and administrative                   37.5       28.4        26.9       28.2
         In process research & development                     13.0       11.8         2.5        4.5
         Restructure and other                                 49.3         --         9.4         --
                                                              -----      -----       -----      -----
             Operating expenses                               130.8       58.3        58.0       52.7
                                                              -----      -----       -----      -----
      Operating income (loss)                                (132.2)      (0.7)      (12.0)       3.2
      Interest income and (other expenses), net                 0.0        2.0         0.6        2.2
                                                              -----      -----       -----      -----
      Income (loss) before income tax provision (benefit)    (132.2)       1.3       (11.4)       5.4
      Income tax provision (benefit)                          (42.2)       3.1        (3.4)       2.8
                                                              -----      -----       -----      -----
      Net income (loss)                                       (90.0)%    ( 1.8)%     ( 8.0)%      2.6%
                                                              =====      =====       =====      =====
</TABLE>


RESULTS OF OPERATIONS

NET SALES

         Net sales  consist of revenues  from the sale of systems,  spare parts,
maintenance  contracts and software.  Net sales were $37.3 million for the third
quarter  and  $194.4   million  for  the  first  nine  months  of  fiscal  1998,
representing a decrease of 27.0% and an increase of 44.3% respectively, over the
comparable  periods of fiscal 1997. The decrease in third quarter net sales over
the comparable  period in fiscal 1997 was primarily due to significant  weakness
in the Automatic  Test  Equipment  ("ATE") market in the third quarter of fiscal
1998 which  materially  adversely  affected the  company's  business,  financial
condition  and  results  of  operations  and  several  other  companies  in  the
semiconductor capital equipment market. The increase in the first nine months of
fiscal  1998 over the  comparable  period of fiscal  1997 was due  primarily  to
higher demands for ATE in the first and second  quarters of fiscal 1998 over the
comparable  periods  in  fiscal  1997.  International  net sales  accounted  for
approximately  61.0%  and  72.0%,  respectively,  of the total net sales for the
third quarter and nine months of fiscal 1998,  compared to  approximately  71.3%
and 70.0%,  respectively,  for the comparable  periods a year ago. The Company's
international  sales are  denominated  primarily in United States  dollars.  The
decrease in international net sales in the third quarter of fiscal 1998 over the
comparable period of fiscal 1997 was due to lower demand primarily in Asia.

GROSS MARGIN

         The Company's gross margin has been and will continue to be affected by
a  variety  of  factors,  including  manufacturing   efficiencies,   pricing  by
competitors  or  suppliers,  new  product  introductions,   product  sales  mix,
production volume,  customization and reconfiguration of systems,  international
and domestic sales mix and field service margins.  Gross margin  percentages for
the third  quarter  and the first nine  months of fiscal  1998 were  impacted by
restructure  and other  charges.  During the third  quarter of fiscal 1998,  the
Company recognized approximately $21.0 million of restructure and other charges,
of which  $19.8  million  was  related to write down of  inventory  due to lower
demands (See Note 2). Gross margin  (excluding  restructure and other) was 54.7%


                                       9
<PAGE>

for the  third  quarter  and 56.8% for the  first  nine  months of fiscal  1998,
compared with 57.6% for the third quarter and 55.9% for the first nine months of
fiscal 1997. The gross margin decline  (excluding  restructure and other) in the
third  quarter  of fiscal  1998 is  primarily  due to  declining  ASP's on older
products and product mix change to newer products with higher cost due primarily
to lower volume.

RESEARCH AND DEVELOPMENT

         Research  and  development  expenses  were  $11.6  million in the third
quarter  of fiscal  1998,  an  increase  of $2.3  million or 25.0% over the same
period of fiscal 1997.  Research and development  expenses were $37.3 million in
the first nine months of fiscal 1998, an increase of $10.3 million or 38.0% over
the same period in fiscal 1997. This increase, in absolute dollars, in the third
quarter and the first nine months of fiscal 1998 over the comparable  periods in
fiscal 1997, reflected primarily the Company's continued development work on new
products and product  enhancements.  As a percentage of net sales,  research and
development  expenses  were 31.0% for the third  quarter and 19.2% for the first
nine months of fiscal 1998, compared to 18.1% in the third quarter and 20.0% for
the  first  nine  months of fiscal  1997.  The  increase  in R&D  expenses  as a
percentage of net sales in the third quarter of fiscal 1998 over the  comparable
period of fiscal 1997 is attributable  primarily to the significant  decrease in
net sales. The Company  currently intends to continue to invest resources in the
development  of new  products  and  enhancements  of existing  products  for the
foreseeable  future.  Currently the Company  expects these  expenses to decrease
from current levels in absolute dollars for the remainder of fiscal 1998.

IN-PROCESS RESEARCH AND DEVELOPMENT

         On  June  1,  1998,  the  Company   purchased  from  Heuristic  Physics
Laboratories,  Inc.  ("HPL")  certain  assets and  assumed  certain  liabilities
relating to their memory test business for  approximately  $8.0 million in cash.
In connection with this transaction,  the Company recognized  approximately $4.8
million of acquired in-process research and development  expense.  The remaining
$3.2 million has been capitalized, of which $2.6 million is purchased technology
which will be amortized ratably over five years.

SELLING, GENERAL AND ADMINISTRATIVE

         Selling,  general and administrative expenses were $14.0 million in the
third quarter of fiscal 1998,  representing a $0.5 million or 3.7% decrease from
the  comparable  period of fiscal  1997.  Selling,  general  and  administrative
expenses were $52.2 million in the first nine months of fiscal 1998, an increase
of $14.3  million or 37.6% over the same period in fiscal 1997.  As a percentage
of net sales,  selling,  general and administrative  expenses were 37.5% for the
third quarter and 26.9% for the first nine months of fiscal 1998,  compared with
28.4% and 28.2%, respectively, for the corresponding periods in fiscal 1997. The
increase in SG&A  expenses as a percentage  of net sales in the third quarter of
fiscal  1998,  over the  comparable  period  of  fiscal  1997,  is  attributable
primarily  to the  significant  decrease  in net sales.  Currently  the  Company
expects selling, general and administrative expenses for the remainder of fiscal
1998 to decrease from current levels in absolute dollars.

RESTRUCTURE AND OTHER CHARGE

         In the third quarter of fiscal 1998, the Company  recorded  restructure
and other  costs  totaling  $39,338,000.  These  charges  are the  result of the
Company's  reaction to a major downturn in the current and  forecasted  business
outlook for the Automatic Test Equipment  ("ATE") and related  semiconductor and
semiconductor  equipment  industries  which took place  during the period.  As a
result of this industry  downturn,  the company has downsized its own operations
including reducing headcount, reducing the volume of products being produced and
the cancellation or delay of various projects,  including facilities expansions,
certain research and development projects and various infrastructure enhancement
projects. The impact of this downsizing and these decisions, is that significant
amounts  of  the  Company's  inventories,  receivables,  fixed  assets,  prepaid
expenses,  investments and purchased technologies have been impaired and certain
liabilities  have been incurred.  As a result,  and in accordance with Financial
Accounting Standards No. 121, the Company has written down the related assets to
their net realizable values and made provision for the estimated liabilities.

                                       10
<PAGE>

         Of the $39.3  million  total  charge,  approximately  $21.0 million was
charged as cost of goods sold, of which  approximately $19.8 million was related
to write  down of excess or  obsolete  inventories.  The  elements  of the total
charge as of July 31, 1998 are as follows (in thousands):

<TABLE>
    <S>                                                                <C>
    Write down of inventories to net realizable value
    (including expected losses on supplier commitments)                $ 19,791
    Write down of excess fixed assets to fair value                       7,928
    Write down purchased technology and investments to fair value         4,118
    Write-off of prepaid and other current assets                         2,956
    Excess facility costs                                                 2,656
    Write down of receivables to net realizable value                     1,390
    Employee termination benefits and accrued liabilities                   500
                                                                        -------
                                                                       $ 39,339
                                                                       ========
</TABLE>

         Cash  expenditures   associated  with  the   restructuring   plan  were
approximately  $170,000 in the third quarter of fiscal 1998. It is expected that
approximately  $1.8  million and $1.5  million of cash  expenditures,  primarily
related  to  losses  on  supplier  commitments  and  lease  payments  on  excess
facilities,  will occur  during the fourth  quarter of fiscal 1998 and the first
quarter of fiscal 1999,  respectively.  Subsequent  cash  expenditures,  related
primarily to lease payments on excess  facilities,  will be  approximately  $1.5
million over an 18 month period.

INTEREST INCOME AND OTHER EXPENSES, NET

         The Company  generated  nominal net interest and other expenses for the
third  quarter  and $1.2  million  for the first  nine  months  of fiscal  1998,
compared to $1.0 million and $2.9 million,  respectively,  for the corresponding
periods of fiscal 1997. The decreases in net interest  income and other expenses
over prior  periods were  primarily  due to lower  interest  rates earned on the
purchases  of  additional  tax  exempt  securities,   lower  average  investment
balances, and losses on disposal of fixed assets.

INCOME TAXES

         Excluding  the  impact of  in-process  research  and  development,  the
Company's  effective tax rate for the third quarter and the first nine months of
fiscal 1998 and 1997 is 34% and 33.5%, respectively. Excluding the impact of the
in-process  research and development,  the effective tax rates are less than the
combined  federal and state  statutory tax rate  primarily due to the benefit of
the Company's foreign sales corporation.

         The tax provision (benefit) for the third quarter and first nine months
of both 1998 and 1997 consist of two items: a tax provision (benefit) on pre-tax
book income (loss) excluding the in-process research and development,  and a tax
benefit on the in-process research and development.

         A valuation  allowance  has been  established  in the third  quarter of
fiscal 1998 and 1997 to offset a portion of the deferred tax assets attributable
to the in-process  research and development.  Due to the period over which these
tax benefits will be recognized,  sufficient  uncertainty  exists  regarding the
realizability of a portion of these assets to warrant a valuation allowance.

LIQUIDITY AND CAPITAL RESOURCES

     Net cash from operating activities provided was $10.8 million and used $3.4
million for the nine months ended July 31, 1998 and 1997, respectively. Net cash
flows  provided by operating  activities for the nine months ended July 31, 1998
were primarily from  depreciation  and  amortization of $12.8 million,  acquired
in-process  research and  development  expense of $4.8 million,  restructure and
other charge of $39.3 million,  and a net increase in accounts payable,  accrued
liabilities,  and income taxes  payable of $4.2 million,  partially  offset by a
loss of  $15.6  million,  deferred  income  taxes of  $11.5  million,  and a net
decrease in restricted cash, accounts receivable,  inventories and other current
assets of $23.5 million.  Investing  activities  used $78.3 million and provided
$8.7 million for the nine months ended July 31, 1998 and 1997, respectively.  In
the first nine months of fiscal 1998, the Company  experienced a net increase of
$59.5 million in short-term and long-term investments while also purchasing $8.3


                                       11
<PAGE>
million of property and equipment.  Net cash from financing activities used $9.7
million and  provided  $2.0  million for the nine months ended July 31, 1998 and
1997, respectively.  The use of cash in the first nine months of fiscal 1998 was
primarily due to the Company  repurchasing 500,000 of its shares of common stock
at a cost of approximately  $12.8 million.  The purpose of the repurchase was to
offset  potential  future  dilution  resulting from increases of available stock
under the Company's stock option plan and employee stock purchase plan.

         As of July 31, 1998, the Company had working  capital of  approximately
$211.1  million,  including cash and short-term  investments of $136.0  million,
$53.1  million of accounts  receivable  and $36.3  million of  inventories.  The
Company  expects  accounts  receivable  to continue to  represent a  significant
portion of working capital.  The Company believes that because of the relatively
long manufacturing cycles of many of its testers and the new products it has and
plans to continue to introduce, investments in inventories will also continue to
represent a significant portion of working capital.  Significant  investments in
accounts  receivable  and  inventories  subject the Company to increased  risks,
including  uncollectability  of receivables  and write-offs of both hardware and
software  inventories,  which has and could  continue  to  materially  adversely
affect the Company's  business,  financial  condition and results of operations.
Total current  liabilities  of $37.8 million as of October 31, 1997 increased to
$44.2 million as of July 31, 1998.  The $6.4 million  increase was due primarily
to increases in accrued  liabilities  by $8.3  million,  offset by a decrease in
income taxes payable of $1.9 million.

     The Company's  principal sources of liquidity as of July 31, 1998 consisted
of  approximately  $55.6  million  of  cash  and  cash  equivalents,  short-term
investments  of $75.8  million,  a $10.0 million  accounts  receivable  purchase
agreement  expiring in April 30, 1999 (through  which no  receivables  have been
sold as of July 31,  1998)  and $40.0  million  available  under  the  Company's
unsecured working capital line of credit expiring on July 23, 1999. In addition,
the Company has $27.2 million of available-for-sale  investments,  classified as
long-term.  As of July 31, 1998, no amounts were outstanding under the unsecured
line of credit.  Additionally,  as of July 31, 1998,  the Company has  operating
leases for facilities and test and other equipment totaling  approximately $45.0
million.

RISK FACTORS

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

Fluctuations in Operating Results
---------------------------------

         The   Company's   operating   results  have  in  the  past   fluctuated
significantly and will in the future fluctuate  significantly,  due to a variety
of factors. The Company's operating performance from the first quarter of fiscal
1993   through   the  third   quarter  of  fiscal   1996   produced   sequential
quarter-to-quarter  growth in both net sales and net income,  culminating in net
sales of $67.2  million  and net income of $11.5  million  for the third  fiscal
quarter  of  1996.  The  Company  then  reported  two  consecutive  quarters  of
decreasing net sales and  decreasing  net income,  with fourth quarter of fiscal
1996 net  sales of $44.2  million  and net  income  of $4.3  million,  and first
quarter of fiscal 1997 sales of $40.2  million  and net income of $1.0  million.
During the subsequent four consecutive fiscal quarters,  from the second quarter
of fiscal 1997 through the first quarter of fiscal 1998, the Company's net sales
and net income  increased  sequentially,  excluding the net loss reported in the
third fiscal quarter of 1997 due to a pre-tax charge for in process research and
development  related to an acquisition.  With the charge,  results for the third
quarter of fiscal 1997 reflected a net loss of $0.9 million. Without the charge,
third quarter  fiscal 1997 net income would have been $4.4 million.  At the peak
of this four quarter  period ending in the first quarter of 1998,  net sales for
the first quarter reached $82.4 million and net income reached $9.2 million.  In
the third quarter of fiscal 1998,  net sales and net income  decreased  from the
second quarter of 1998. The decreases prior to the fourth quarter of fiscal 1997
were due  primarily to a continued  weakness in the ATE market which  materially
adversely affected the Company's  business,  financial  condition and results of
operations and several other companies in the semiconductor  equipment industry.
The ATE industry returned to a capacity expansion mode in fiscal 1997, resulting
in  sequential  increases  in  revenues  during the  second,  third,  and fourth
quarters of fiscal  1997 and the first  quarter of fiscal  1998.  However in the
second and third  quarters  of fiscal  1998,  the Company  reported  consecutive
decreasing net sales and net income due to an industry  slowdown and the Company
believes  that in the short term its net sales and net  income,  if any,  may be
lower sequentially than in recent prior periods.  There can be no assurance they
will not continue to decrease in subsequent quarters. This trend may continue to


                                       12
<PAGE>

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

Limited Systems Sales; Backlog
------------------------------

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

                                       13
<PAGE>

Cyclicality of Semiconductor Industry
-------------------------------------

         The Company's  business and results of operations depend in significant
part upon the  capital  expenditures  of  manufacturers  of  semiconductors  and
companies   which   specialize   in  contract   packaging   and/or   testing  of
semiconductors,  including manufacturers and contractors that are opening new or
expanding existing  fabrication  facilities,  or upgrading  existing  equipment,
which  in turn  depend  upon the  current  and  anticipated  market  demand  for
semiconductors  and  products  incorporating  semiconductors.  Historically  and
recently,  the  semiconductor  industry has been highly  cyclical with recurring
periods of oversupply, which often have had a severe effect on the semiconductor
industry's  demand for test equipment,  including the systems  manufactured  and
marketed  by the  Company.  The  Company  believes  that the  markets  for newer
generations of semiconductors will also be subject to similar fluctuations.  The
Company has in the past experienced  shipment delays,  delays in commitments and
purchase order  restructuring  by several of its customers and anticipates  that
this may continue to occur in the future.  Accordingly,  the Company can give no
assurance that it will be able to achieve or maintain its current or prior level
of sales or rate of  growth.  Through  the first  three  quarters  of 1997,  the
Company's net sales, gross margins and net income were  significantly  below the
net sales, gross margins and net income,  respectively,  of the comparable prior
year's quarterly results. In the fourth quarter of 1997 and the first quarter of
1998,  the Company's net sales and net income were  significantly  above the net
sales and net  income of the  fourth  quarter  of 1996 and the first  quarter of
1997,  respectively.  However,  in the second and third quarters of fiscal 1998,
net sales and net income  decreased  over the first quarter of fiscal 1998,  the
Company  believes they may decrease  further in the short term, and there can be
no  assurance  that they will not  decrease  from  prior  quarter  or prior year
amounts in future quarters.  The Company  anticipates that a significant portion
of new orders may depend  upon demand from  semiconductor  device  manufacturers
building or expanding fabrication facilities and new device testing requirements
that are not addressable by currently installed test equipment, and there can be
no assurance that such demand will develop to a significant  degree,  or at all.
In  addition,  any factor  adversely  affecting  the  semiconductor  industry or
particular  segments within the semiconductor  industry may adversely affect the
Company's  business,  financial  condition or results of operations.  Therefore,
there can be no assurance that the Company's operating results will not continue
to  be  materially   adversely   affected  if  downturns  or  slowdowns  in  the
semiconductor  industry continue or occur again in the future. The current Asian
financial  crisis has contributed to a widespread  uncertainty and a slowdown in
the  semiconductor  industry.  This slowdown in the  semiconductor  industry has
resulted in reduced spending for semiconductor capital equipment,  including ATE
which the Company sells. This industry slowdown has had and may continue to have
an adverse impact on the Company's product backlog, balance sheet and results of
operations.

Management of Fluctuations in Operating Results
-----------------------------------------------

         The Company has over the last  several  years  experienced  significant
fluctuations  in its  operating  results.  Since  1993,  the Company has overall
significantly  increased the scale of its operations to support  increased sales
levels and has expanded its operations to address  critical  infrastructure  and
other requirements,  including the hiring of additional  personnel,  significant
investments in research and  development  to support  product  development,  the
March 1995  acquisition of EPRO, the Company's  establishment of a joint venture
with Innotech,  Inc.,  the Company's  acquisition in July 1997 of the assets and
certain  liabilities of Test Systems  Strategies,  Inc. ("TSSI"),  the Company's
acquisition  in August 1997 of a software  product  line from Zycad  Corporation
("Zycad")  and the June 1998  acquisition  of assets and  assumption  of certain
liabilities from Heuristics Physics  Laboratories,  Inc. ("HPL").  However,  the
Company has during certain historical periods,  as discussed above,  experienced
revenue  declines and reductions in its  operations.  These  fluctuations in the
Company's  sales  and  operations  have  placed  a  considerable  strain  on its
management,   financial,   manufacturing  and  other  resources.   In  order  to
effectively  deal with the  changes  brought  on by the  cyclical  nature of the
industry,  the Company has been  required to implement  and improve a variety of
highly flexible operating,  financial and other systems, procedures and controls
capable of expanding or  contracting  consistent  with the  Company's  business.
There can be no  assurance  that any  existing  or new  systems,  procedures  or
controls will be adequate to support fluctuations in the Company's operations or
that its systems,  procedures  and controls  will be  designed,  implemented  or
improved  in a cost  effective  and timely  manner.  Any  failure to  implement,
improve and expand or  contract  such  systems,  procedures  and  controls in an
efficient  manner at a pace consistent with the Company's  business could have a
material  adverse  effect on the  Company's  business,  financial  condition  or
results of operations.

                                       14
<PAGE>

Expansion of Product Lines
--------------------------

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

Limited Sources of Supply; Reliance on Subcontractors
-----------------------------------------------------

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

Highly Competitive Industry
---------------------------

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

                                       15
<PAGE>

         The  Company  faces  substantial   competition  throughout  the  world,
primarily from ATE manufacturers located in the United States, Europe and Japan,
as well as several of the Company's customers. Many of the Company's competitors
have  substantially  greater  financial and other resources with which to pursue
engineering,  manufacturing,  marketing  and  distribution  of  their  products.
Certain of the Company's  competitors have recently  introduced or announced new
products with certain performance or price  characteristics equal or superior to
certain products currently offered by the Company.  The Company believes that if
the ATE  industry  continues  to  consolidate  through  strategic  alliances  or
acquisitions,   the  Company  will  continue  to  face  significant   additional
competition  from larger  competitors that may offer more complete product lines
and services  than the Company.  The  Company's  competitors  are  continuing to
improve the performance of their current products and to introduce new products,
enhancements  and new  technologies  that provide improved cost of ownership and
performance   characteristics.   New  product  introductions  by  the  Company's
competitors  could  continue  to cause a  decline  in  sales  or loss of  market
acceptance of the Company's existing products.  Moreover,  increased competitive
pressure could continue to lead to intensified  price-based  competition,  which
has and could continue to materially  adversely  affect the Company's  business,
financial  condition or results of operations.  The Company has  experienced and
continues to experience  significant price competition in the sale of all of its
testers.  In  addition,  at the end of a product  life cycle and as  competitors
introduce more  technologically  advanced products,  pricing pressures typically
become  more  intense as the  Company  has  experienced  with sales of its older
products.  The Company  believes  that to be  competitive,  it must  continue to
expend significant financial resources in order to, among other items, invest in
new product  development and enhancements  and to maintain  customer service and
support  centers  worldwide.  There can be no assurance that the Company will be
able to compete successfully in the future.

Rapid Technological Change; Importance of Timely Product Introduction
---------------------------------------------------------------------

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

         Significant  delays can occur between a system's  introduction  and the
commencement by the Company of volume production of such system. The Company has
in the past  experienced and continues to experience  significant  delays in the
introduction,  volume  production  and sales of its systems and related  feature
enhancements,   including  new  models  within  the  digital,  mixed-signal  and
non-volatile  memory  product  lines,  due to  technical,  manufacturing,  parts
shortages,  component  reliability  and other  difficulties  and may continue to
experience  similar delays in the future. As a result,  certain of the Company's
significant customers have experienced significant delays in receiving and using
certain of the Company's  testers in production.  There can be no assurance that
these or additional  difficulties  will not continue to arise in the future with
respect  to the  Company's  systems  or that  such  delays  will not  materially
adversely affect customer relationships and future sales. Moreover, there can be
no assurance  that the Company will not  encounter  these or other  difficulties


                                       16
<PAGE>

that could  delay  future  introductions  or volume  production  or sales of its
systems or enhancements and related software tools. The Company has incurred and
may   continue  to  incur   substantial   unanticipated   costs  to  ensure  the
functionality  and  reliability of its testers and to increase  feature sets. If
the Company's systems continue to have  reliability,  quality or other problems,
or  the  market  perceives  certain  of the  Company's  products  to be  feature
deficient,  reduced orders,  higher  manufacturing  costs,  delays in collecting
accounts  receivable  and higher  service,  support and  warranty  expenses,  or
inventory write-offs,  among other items, could result. The Company's failure to
have a competitive  tester and related software tools available when required by
a semiconductor  manufacturer could make it substantially more difficult for the
Company to sell testers to that  manufacturer for a number of years. The Company
believes that the continued acceptance,  volume production,  timely delivery and
customer satisfaction of its newer digital, mixed signal and non-volatile memory
testers are of critical importance to its future financial results. As a result,
an inability to correct any  technical,  reliability,  parts  shortages or other
difficulties  associated  with the Company's  systems or to manufacture and ship
the  Company's  systems on a timely basis to meet  customer  requirements  could
damage relationships with current and prospective customers and would materially
adversely  affect the  Company's  business,  financial  condition  or results of
operations.

Customer Concentration; Lengthy Sales Cycle
-------------------------------------------

          One customer (a distributor in the Asia Pacific Region)  accounted for
30%,  33%,  30%, 25% and 17% of the  Company's net sales in the third quarter of
fiscal 1998 and in the first nine  months of fiscal 1998 and fiscal  years 1997,
1996 and 1995, respectively.  Another customer accounted for 11% of net sales in
fiscal  1995.  The  loss of or any  reduction  in  orders  by this or any  other
significant customer,  including losses or reductions due to continuing or other
technical,  manufacturing or reliability  problems with the Company's  products,
continued  slowdowns in the  semiconductor  industry or in other industries that
manufacture products utilizing semiconductors, could materially adversely affect
the  Company's  business,  financial  condition  or results of  operations.  The
Company's  ability to maintain or increase  its sales  levels in the future will
depend in  significant  part upon its ability to obtain orders from existing and
new customers and to manufacture  systems on a timely and cost-effective  basis,
the  financial  condition  and  success  of  its  customers,   general  economic
conditions,  and the Company's ability to meet increasingly  stringent  customer
performance and other  requirements and shipment delivery dates. There can be no
assurance that the Company will be able to maintain or increase the level of its
net sales in the  future  or that the  Company  will be able to retain  existing
customers or attract new ones.

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

Acquisitions
------------

         The Company has  developed  in  significant  part  through  mergers and
acquisitions  of other  companies and  businesses.  Prior to its initial  public
offering in 1993, the Company acquired two companies and the semiconductor  test
division of Tektronix,  Inc. In 1995, the Company acquired EPRO, a memory tester
company.  In July 1997,  the Company  acquired  the assets and  assumed  certain
liabilities of TSSI and, in August 1997,  acquired  certain fault simulation and
test program development products from Zycad. In June 1998, the Company acquired
certain assets and assumed  certain  liabilities of HPL. The Company  intends in
the future to pursue  additional  acquisitions of  complementary  product lines,
technologies and businesses. Any future acquisitions by the Company could result
in potentially dilutive issuance's of equity securities,  the incurrence of debt
and contingent liabilities, expenditures and reserves, and amortization expenses
related to goodwill and other  intangible  assets (which may exceed the benefits
actually derived from the acquisitions), which could materially adversely affect
the  Company's  business,  financial  condition  or  results of  operations.  In
addition,  acquisitions involve numerous other risks,  including difficulties in
the assimilation of the operations,  personnel, technologies and products of the
acquired companies,  the diversion of management's attention from other business
concerns,  risks of  entering  markets  in which the  Company  has no or limited
direct prior experience, and the potential loss of key employees of the acquired


                                       17
<PAGE>

company.  From time to time,  the Company  has  engaged in and will  continue to
engage in discussions with third parties  concerning  potential  acquisitions of
product  lines,   technologies  and  businesses.  In  the  event  that  such  an
acquisition  does occur,  however,  there can be no  assurance  as to the effect
thereof on the Company's business, financial condition or results of operations.

Dependence on Key Personnel
---------------------------

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

International Sales
-------------------

         International  sales accounted for approximately 61%, 72%, 70%, 67% and
55% of total net sales for the third  quarter  and first  nine  months of fiscal
1998 and  fiscal  years  1997,  1996 and 1995,  respectively.  As a result,  the
Company  anticipates  that  international  sales will  continue to account for a
significant  portion  of  total  net  sales  in the  foreseeable  future.  These
international  sales will  continue  to be subject to certain  risks,  including
changes in regulatory  requirements,  tariffs and other barriers,  political and
economic  instability,  an  outbreak  of  hostilities,  integration  of  foreign
operations of acquired businesses,  foreign currency exchange rate fluctuations,
difficulties  with  distributors,  joint venture  partners,  original  equipment
manufacturers,  foreign subsidiaries and branch operations,  potentially adverse
tax  consequences  and the  possibility  of  difficulty  in accounts  receivable
collection.  The  Company  is also  subject  to the  risks  associated  with the
imposition of legislation  and  regulations  relating to the import or export of
semiconductor  equipment.  The Company cannot predict  whether  quotas,  duties,
taxes or other charges or restrictions  will be implemented by the United States
or any other  country  upon the  importation  or  exportation  of the  Company's
products  in the future.  Any of these  factors or the  adoption of  restrictive
policies  could  have a  material  adverse  effect  on the  Company's  business,
financial  condition  or results of  operations.  Company  net sales to the Asia
Pacific region accounted for  approximately  52%, 64%, 66%, 58% and 45% of total
net sales in the third  quarter  and first nine months of fiscal 1998 and fiscal
years  1997,  1996,  and  1995,  and thus are  subject  to the risk of  economic
instability in that region that might materially adversely affect the demand for
the Company's products.  Countries in the Asia Pacific region,  including Japan,
have  recently  experienced  weaknesses  in their  currency,  banking and equity
markets.  These  weaknesses  could  adversely  affect  demand for the  Company's
products,  the availability and supply of product components to the Company, and
ultimately the Company's  consolidated results of operations.  The current Asian
financial  crisis has contributed to a widespread  uncertainty and a slowdown in
the  semiconductor  industry.  This slowdown in the  semiconductor  industry has
resulted in reduced spending for semiconductor capital equipment,  including ATE
which the Company sells. This industry slowdown has had and may continue to have
an adverse impact on the company's product backlog, balance sheet and results of
operations.

         The Company is currently  in the process of assessing  the issue raised
by the  introduction  of a  Single  European  Currency  (Euro)  scheduled  to be
introduced on January 1, 1999. While still in the assessment  phase, the Company
does not  expect  that the  introduction  and the use of the  Euro  will  have a
material effect on the Company's financial condition or results of operations.

Importance of Japanese Market
-----------------------------

         To date,  the Company has made limited sales of its systems to Japanese
semiconductor  manufacturers.   The  Japanese  semiconductor  market  is  large,
represents a substantial percentage of the worldwide semiconductor manufacturing
capacity,  and is difficult for foreign companies to penetrate.  The Company may
be at a competitive  disadvantage with respect to Japanese semiconductor capital
equipment  suppliers  that have  been  engaged  for some  time in  collaborative
efforts with Japanese semiconductor manufacturers. The Company believes that the
Japanese  companies with which it competes have a competitive  advantage because


                                       18
<PAGE>

of their  dominance of the Japanese market  segment.  The Company  believes that
increased  penetration  of the Japanese  market is  important  to its  financial
results  and intends to continue  to invest  significant  resources  in Japan in
order to meet this objective.  As part of its strategy to penetrate the Japanese
market,  the  Company  entered  into a joint  venture  agreement  with  Innotech
Corporation,  a local distributor of its products, and set up a local subsidiary
in Japan.  The Company  believes  that  Innotech is an important  element of its
strategy to increase its  presence in Japan.  If Innotech is not  successful  in
selling such systems or such agreement is terminated,  the Company's strategy to
increase product sales into the Japanese market would be adversely affected.  In
addition, in recent years, Japanese  semiconductor  manufacturers  substantially
reduced  their  level of capital  spending  on new  fabrication  facilities  and
equipment,  thereby  increasing  competitive  pressures in the  Japanese  market
segment.  There can be no assurance,  however,  that the Company will be able to
achieve  significant  sales to, or will be able to compete  successfully in, the
Japanese semiconductor market segment.

Proprietary Rights
------------------

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

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

         This prior art, however, is relevant to the scope of certain claims set
forth in the United States patent covering another of the Company's  proprietary
CMOS stabilization  methods. The European examiner referred to this prior art in
the  corresponding  European patent  application.  The European  application was
approved, but with narrower claims than the United States patent. This prior art
was not referenced in the corresponding United States patent. Based in part upon
the advice of outside patent counsel, and on the Company's review of its current
products,  the Company believes that this patent will continue to be valuable to
the Company in preventing  imitation of the Company's  products  covered by this
patent.  Additionally,  in mid-1992, a third party suggested that certain claims
set forth in this  patent  might be invalid as a result of other  alleged  prior
art. On November 13, 1997,  the Company  requested  the United States Patent and
Trademark Office (USPTO) to re-examine the subject United States patent in light
of the two prior art references. On January 7, 1998, USPTO responded by granting
the Company's  request for  re-examination.  On May 21, 1998, the USPTO notified
the  Company of its intent to issue a  re-examination  certificate  with  claims
comparable in scope to the European patent.  The  re-examination  certificate is
scheduled to issue on September 1, 1998.

         In July, 1998, inTEST IP Corporation ("inTEST") alleged in writing that
one of the Company's products is purportedly infringing a patent held by inTEST.
The  Company  may also be  obligated  to other  third  parties  relating to this
allegation. The Company is currently investigating the allegation.  There can be


                                       19
<PAGE>

no  assurance  that the Company  will be  successful  in  defending  this patent
infringement  claim or claims for  indemnification  resulting from  infringement
claims.

         Certain  of  the  Company's   customers   have   received   notices  of
infringement from Jerome Lemelson alleging that the manufacture of semiconductor
products  and/or  the  equipment  used  to  manufacture  semiconductor  products
infringes  certain patents issued to such person.  The Company was notified by a
customer in 1990 and a  different  customer in late 1994 that the Company may be
obligated to defend or settle claims that the Company's  products  infringe such
person's  patents,  and,  in the event it is  subsequently  determined  that the
customer  infringes  such  person's  patents,  such  customer  intends  to  seek
reimbursement from the Company for damages and other related expenses.

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

Future Capital Needs
--------------------

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

Year 2000 Compliance
--------------------

         The "Year 2000" issue  results  from the use in computer  hardware  and
software of two digits  rather than four digits to define the  applicable  year.
When computer  systems must process dates both before and after January 1, 2000,
two-digit year "fields" may create processing  ambiguities that can cause errors
and system failures. The results of these errors may range from minor undetected
errors to complete shutdown of an affected system.  These errors or failures may
have  limited  effects,  or the  effects  may be  widespread,  depending  on the
computer chip, system or software, and its location and function. The effects of
the Year 2000 problem are exacerbated because of the interdependence of computer
and  telecommunications  systems in the United States and  throughout the world.
Because  of this  interdependence,  the  failure  of one  system may lead to the
failure of many other systems even though the other systems are themselves "Year
2000 compliant."

         The  Company's  Board of  Directors  has  reviewed  the Year 2000 issue
generally and as it may affect the Company's business  activity.  The Company is
implementing a Year 2000 plan (the "Plan") which is designed to cover all of the
Company's  activities,  which will be  modified as  circumstances  change and is
monitored by a  sub-committee  of the Company's  Board of  Directors.  Under the
Plan,  the Company is using a five phase  methodology  for addressing the issue.
The phases are Awareness, Assessment, Renovation, Validation and Implementation.

         Awareness  consists  of  defining  the Year 2000  problem  and  gaining
executive  level  support  and  sponsorship.   A  Year  2000  program  team  was
established and an overall strategy  created.  During  Assessment,  all internal
systems,  products and supply chain partners are inventoried and prioritized for
renovation.  The Company  believes it has  completed a majority of the Awareness
and Assessment phases, however,  ongoing work will be required in these areas as
the Company  completes  its  assessment  of existing  supply chain  partners and
enters into new supply chain  relationships  in the ordinary course of business.


                                       20
<PAGE>

Renovation consists of converting,  replacing,  upgrading or eliminating systems
that have Year 2000 problems.  Renovation has begun on mission-critical  systems
and is  targeted  for  completion  by December  31,  1998.  Validation  involves
ensuring that hardware and software  fixes will work properly in 1999 and beyond
and can occur both  before and after  implementation.  Validation  will start in
late 1998 and continue  through June 1999 to allow for thorough  testing  before
the Year 2000.  Implementation  is the  installation  of hardware  and  software
components  in a live  environment.  The  Company is in the early  stages of the
Implementation phase.

         The impact of Year 2000 issues on the  Company  will depend not only on
corrective  actions  that the Company  takes,  but also on the way in which Year
2000 issues are  addressed by  governmental  agencies,  business and other third
parties that provide  services or data to, or receive services or data from, the
Company, or whose financial condition or operational  capability is important to
the  Company.  To reduce this  exposure,  the Company has an ongoing  process of
identifying  and  contacting  mission-critical  third  party  vendors  and other
significant  third parties to determine  their Year 2000 plans and target dates.
Risks  associated  with any such third parties located outside the United States
may be higher insofar as it is generally  believed that non-U.S.  businesses may
not be  addressing  their  Year  2000  issues  on as  timely  a  basis  as  U.S.
businesses.  Notwithstanding  the Company's  efforts,  there can be no assurance
that the  Company,  mission-critical  third party  vendors or other  significant
third parties will adequately address their Year 2000 issues.

         The Company is developing  contingency plans for  implementation in the
event  that  the  Company,   mission-critical   third  party  vendors  or  other
significant  third  parties fail to  adequately  address Year 2000 issues.  Such
plans  principally   involve   identifying   alternative   vendors  or  internal
remediation.  There can be no assurance  that any such plans will fully mitigate
any  such   failures   or   problems.   Furthermore,   there   may  be   certain
mission-critical third parties, such as utilities,  telecommunication companies,
or material  vendors where  alternative  arrangements  or sources are limited or
unavailable.

         Although it is difficult  to estimate  the total costs of  implementing
the Plan,  through June 1999 and beyond, the Company's  preliminary  estimate is
that such costs will be approximately $2.5 million. However, although management
believes  its  estimates  are  reasonable,  there can be no  assurance,  for the
reasons stated in the next paragraph,  that the actual costs of implementing the
Plan will not differ  materially  from the  estimated  costs.  The  Company  has
incurred  approximately $500,000 through July 31, 1998. A significant portion of
total Year 2000 project  expenses is represented by existing staff that has been
redeployed to this project.  The Company does not believe that the  redeployment
of existing staff will have a material  adverse effect on its business,  results
of operations or financial  position.  Incremental  expenses related to the Year
2000 project are not expected to materially  impact operating results in any one
period.

         The extent and magnitude of the Year 2000 Problem as it will affect the
Company, both before and for some period after January 1, 2000, are difficult to
predict or quantify for a number of reasons.  Among the most  important are lack
of control over  systems that are used by third  parties who are critical to the
Company's operation,  dependence on third party software vendors to deliver Year
2000 upgrades in a timely manner, complexity of testing inter-connected networks
and  applications  that  depend  on third  party  networks  and the  uncertainty
surrounding  how  others  will deal with  liability  issues  raised by Year 2000
related  failures.  There can be no assurance for example,  that systems used by
third parties will be adequately  remediated so that they are Year 2000 ready by
January  1,  2000,  or by some  earlier  date,  so as not to  create a  material
disruption  to  the  Company's  business.   Moreover,  the  estimated  costs  of
implementing  the Plan do not take into account the costs, if any, that might be
incurred  as a result of Year 2000  related  failures  that  occur  despite  the
Company's implementation of the Plan.

         Although  the Company is not aware of any material  operational  issues
associated  with  preparing its internal  systems for the Year 2000, or material
issues with respect to the  adequacy of  mission-critical  third party  systems,
there  can be no  assurance  that  the  Company  will  not  experience  material
unanticipated  negative  consequences and/or material costs caused by undetected
errors or defects  in such  systems or by the  Company's  failure to  adequately
prepare  for the  results  of such  errors or  defects,  including  the costs of
related  litigation,  if any.  The  impact  of such  consequences  could  have a
material  adverse  effect on the  Company's  business,  financial  condition  or
results of operations.

                                       21
<PAGE>

Volatility of Stock Price
-------------------------

         The Company believes that factors such as announcements of developments
related to the  Company's  business,  fluctuations  in the  Company's  financial
results,  general  conditions or developments in the  semiconductor  and capital
equipment industry and the general economy,  sales or purchases of the Company's
Common Stock in the marketplace,  announcements of technological  innovations or
new products or enhancements by the Company or its competitors,  developments in
patents or other  intellectual  property  rights,  developments in the Company's
relationships  with its  customers and  suppliers,  or a shortfall or changes in
revenue,  gross margins or earnings or other  financial  results from  analysts'
expectations or an outbreak of hostilities or natural disasters, could cause the
price of the Company's  Common Stock to  fluctuate,  perhaps  substantially.  In
recent  years the stock  market in  general,  and the market for shares of small
capitalization  stocks in particular,  including the Company,  have  experienced
extreme  price  fluctuations,  which have often been  unrelated to the operating
performance of affected companies. For example, in fiscal 1997, the price of the
Company's  Common Stock ranged from a high of $55.00 to a low of $13.75.  In the
first nine months of fiscal 1998,  the price of the  Company's  Common Stock has
ranged from a high of $33.88 to a low of $17.06.  There can be no assurance that
the market price of the  Company's  Common Stock will not continue to experience
significant   fluctuations  in  the  future,  including  fluctuations  that  are
unrelated to the Company's performance.

Leverage
--------

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

Effects of Certain Anti-Takeover Provisions
-------------------------------------------

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


                                       22
<PAGE>



PART II.  - OTHER INFORMATION

Item 1. Legal Proceedings

         None
Item 2. Changes in Securities

         None

Item 3. Defaults upon Senior Securities

         None

Item 4. Submission of Matters to a Vote of Securityholders

         None

Item 5. Other Information

         None

Item 6. Exhibits and Reports on Form 8-K

         (a)      See Exhibit Index on page 22.

         (b)      A  current  report  on Form 8-K was  filed  on July 10,  1998,
                  disclosing  the effect of the  Company's  adoption of FAS 128,
                  "Earnings  per Share," on the Company's  Financial  Statements
                  for the  fiscal  year  ended  October  31,  1997  and  related
                  Financial Data Schedules for the applicable periods.

         (c)      A report on From 8-K was filed on June 3, 1998, disclosing the
                  Shareholders Rights Plan.

         (d)      A report on Form 8-K was filed on May 20, 1998, disclosing the
                  Registrant's  financial  results for the second  quarter ended
                  April 30, 1998.




                                       23
<PAGE>




                                   SIGNATURES

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


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



             September 11, 1998                  /s/ DENNIS P. WOLF
             ------------------          ------------------------------------
                   Date                              Dennis P. Wolf
                                               Senior Vice President and
                                                Chief Financial Officer






                                       24
<PAGE>



EXHIBIT INDEX

Exhibit
Number                                                                      Page

 4.1   Shareholder Rights Plan -  Incorporated  by reference to an 
       exhibit to the Company's current report on Form 8-K as filed
       with the Commission on June 3, 1998.

10.1   Amendment to Loan Agreement dated July 24, 1998 between Silicon
       Valley Bank, Bank of Hawaii and Credence Systems Corporation.          26

10.2   Non-Recourse Receivables Purchase Agreement dated May 1, 1998
       between Silicon Valley Financial Services and Credence  Systems
       Corporation.                                                           30

27.1   EDGAR Financial Data Schedule                                          36




















                                       25
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