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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q



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(Mark One)

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

For the quarterly period ended February 3, 2007

OR



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

For the transition period from  to

Commission file number 0-22366



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CREDENCE SYSTEMS CORPORATION

(Exact name of registrant as specified in its charter)



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|                                                              |  |                                 
|------------------------------------------------------------- |  | --------------------------------
|Delaware                                                      |  | 94-2878499                      
|(State or other jurisdictionof incorporation or organization) |  | (IRS EmployerIdentification No.)

1421 California Circle, Milpitas, California

95035

(Address of principal
executive offices)

(Zip Code)

(408) 635-4300

(Registrants telephone number, including area code)

N/A

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



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

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

Large accelerated
filer ̈Accelerated filer  x    Non-accelerated filer ̈

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

At February 28, 2007, there were 101,153,377 shares of the Registrants common stock, $0.001 par value per share, outstanding.



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##### Table of Contents

CREDENCE SYSTEMS CORPORATION

INDEX



|          |  |                                                                                       |  |         
|--------- |  | ------------------------------------------------------------------------------------- |  | --------
|          |  |                                                                                       |  | PAGE NO.
|PART I.   |  | FINANCIAL INFORMATION                                                                 |  |         
|          |  |                                                                                      
|Item 1.   |  | Financial Statements                                                                  |  | 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 |  | 18      
|          |  |                                                                                      
|Item 3.   |  | Quantitative and Qualitative Disclosures about Market Risk                            |  | 29      
|          |  |                                                                                      
|Item 4.   |  | Controls and Procedures                                                               |  | 30      
|          |  |                                                                                      
|PART II.  |  | OTHER INFORMATION                                                                     |  |         
|          |  |                                                                                      
|Item 1.   |  | Legal Proceedings                                                                     |  | 30      
|          |  |                                                                                      
|Item 1A.  |  | Risk Factors                                                                          |  | 31      
|          |  |                                                                                      
|Item 2.   |  | Unregistered Sales of Equity Securities and Use of Proceeds                           |  | 42      
|          |  |                                                                                      
|Item 3.   |  | Defaults Upon Senior Securities                                                       |  | 42      
|          |  |                                                                                      
|Item 4.   |  | Submission of Matters to a Vote of Security Holders                                   |  | 42      
|          |  |                                                                                      
|Item 5.   |  | Other Information                                                                     |  | 42      
|          |  |                                                                                      
|Item 6.   |  | Exhibits                                                                              |  | 42      
|          |  |                                                                                      
|Signature |  |                                                                                       |  | 43      



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##### Table of Contents

PART I - FINANCIAL INFORMATION

Item 1. - FINANCIAL STATEMENTS

CREDENCE SYSTEMS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

(unaudited)



|                                           |  |                 |         |                  |   |        
|------------------------------------------ |  | --------------- | ------- | ---------------- | - | -------
|                                           |  | February 3,2007 |         | October 31,2006a
|ASSETS                                     |  |                 |         |                  |   |        
|Current assets:                            |  |                 |         |                  |   |        
|Cash and cash equivalents                  |  | $               | 142,930 |                  | $ | 95,635 
|Short-term investments                     |  |                 | 7,179   |                  |   | 7,177  
|Accounts receivable, net                   |  |                 | 113,309 |                  |   | 114,796
|Inventories                                |  |                 | 57,546  |                  |   | 55,200 
|Income tax receivable                      |  |                 | 695     |                  |   | 275    
|Deferred income taxes                      |  |                 | 9,883   |                  |   | 9,875  
|Prepaid expenses and other current assets  |  |                 | 15,292  |                  |   | 14,511 
|                                           |  |                 |         |                  |   |        
|Total current assets                       |  |                 | 346,834 |                  |   | 297,469
|Property and equipment, net                |  |                 | 80,777  |                  |   | 87,175 
|Other intangible assets, net               |  |                 | 80,128  |                  |   | 83,878 
|Other assets                               |  |                 | 51,294  |                  |   | 49,072 
|                                           |  |                 |         |                  |   |        
|Total assets                               |  | $               | 559,033 |                  | $ | 517,594
|                                           |  |                 |         |                  |   |        
|LIABILITIES AND STOCKHOLDERS EQUITY       |  |                 |         |                  |   |        
|Current liabilities:                       |  |                 |         |                  |   |        
|Accounts payable                           |  | $               | 33,312  |                  | $ | 32,477 
|Accrued expenses and other liabilities     |  |                 | 25,376  |                  |   | 37,251 
|Accrued payroll and related liabilities    |  |                 | 16,800  |                  |   | 17,496 
|Deferred revenue                           |  |                 | 25,041  |                  |   | 21,935 
|Income taxes payable                       |  |                 | 14,625  |                  |   | 14,893 
|Accrued warranty                           |  |                 | 14,165  |                  |   | 13,514 
|Deferred profit                            |  |                 | 7,621   |                  |   | 6,143  
|                                           |  |                 |         |                  |   |        
|Total current liabilities                  |  |                 | 136,940 |                  |   | 143,709
|Convertible subordinated notes             |  |                 | 195,000 |                  |   | 145,000
|Long-term restructuring liabilities        |  |                 | 199     |                  |   | 2,545  
|Long-term deferred income taxes            |  |                 | 9,473   |                  |   | 9,473  
|Other liabilities                          |  |                 | 2,531   |                  |   | 4,141  
|Stockholders equity                       |  |                 | 214,890 |                  |   | 212,726
|                                           |  |                 |         |                  |   |        
|Total liabilities and stockholders equity |  | $               | 559,033 |                  | $ | 517,594
|                                           |  |                 |         |                  |   |        

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|a) | Derived from the audited consolidated balance sheet included in the Companys Annual Report on Form 10-K for the year ended October 31, 2006.
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------

See accompanying notes.



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CREDENCE SYSTEMS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)



|                                                                                                                  |  |                    |         |   |                 |   |         |  
|----------------------------------------------------------------------------------------------------------------- |  | ------------------ | ------- | - | --------------- | - | ------- | -
|                                                                                                                  |  | Three Months Ended |        
|                                                                                                                  |  | February 3,2007    |         |   | January 31,2006 |  
|Net sales:                                                                                                        |  |                    |         |   |                 |   |         |  
|Systems, upgrades and software                                                                                    |  | $                  | 90,324  |   |                 | $ | 92,973  |  
|Service and spare parts                                                                                           |  |                    | 28,473  |   |                 |   | 28,832  |  
|                                                                                                                  |  |                    |         |   |                 |   |         |  
|Total net sales                                                                                                   |  |                    | 118,797 |   |                 |   | 121,805 |  
|Cost of goods sold                                                                                                |  |                    |         |   |                 |   |         |  
|Systems, upgrades and software (including stock-based compensation expense of $98 and $77, respectively)          |  |                    | 46,308  |   |                 |   | 48,248  |  
|Service and spare parts                                                                                           |  |                    | 20,987  |   |                 |   | 17,791  |  
|                                                                                                                  |  |                    |         |   |                 |   |         |  
|Gross margin                                                                                                      |  |                    | 51,502  |   |                 |   | 55,766  |  
|Operating expenses:                                                                                               |  |                    |         |   |                 |   |         |  
|Research and development (including stock-based compensation expense of $408 and $336, respectively)              |  |                    | 21,178  |   |                 |   | 24,148  |  
|Selling, general and administrative (including stock-based compensation expense of $1,197 and $564, respectively) |  |                    | 25,839  |   |                 |   | 29,311  |  
|Amortization of purchased intangibles                                                                             |  |                    | 4,455   |   |                 |   | 4,254   |  
|Restructuring charges                                                                                             |  |                    | 492     |   |                 |   | 314     |  
|                                                                                                                  |  |                    |         |   |                 |   |         |  
|Total operating expenses                                                                                          |  |                    | 51,964  |   |                 |   | 58,027  |  
|                                                                                                                  |  |                    |         |   |                 |   |         |  
|Operating loss                                                                                                    |  |                    | (462    | ) |                 |   | (2,261  | )
|Interest income                                                                                                   |  |                    | 1,160   |   |                 |   | 866     |  
|Interest expense                                                                                                  |  |                    | (1,188  | ) |                 |   | (707    | )
|Other income (expenses), net                                                                                      |  |                    | 2,491   |   |                 |   | (313    | )
|                                                                                                                  |  |                    |         |   |                 |   |         |  
|Income (loss) before income tax provision                                                                         |  |                    | 2,001   |   |                 |   | (2,415  | )
|Income taxes                                                                                                      |  |                    | 2,012   |   |                 |   | 1,631   |  
|                                                                                                                  |  |                    |         |   |                 |   |         |  
|Net loss                                                                                                          |  | $                  | (11     | ) |                 | $ | (4,046  | )
|                                                                                                                  |  |                    |         |   |                 |   |         |  
|Net loss per share                                                                                                |  |                    |         |   |                 |   |         |  
|Basic                                                                                                             |  | $                  | (0.00   | ) |                 | $ | (0.04   | )
|                                                                                                                  |  |                    |         |   |                 |   |         |  
|Diluted                                                                                                           |  | $                  | (0.00   | ) |                 | $ | (0.04   | )
|                                                                                                                  |  |                    |         |   |                 |   |         |  
|Number of shares used in computing per share amount                                                               |  |                    |         |   |                 |   |         |  
|Basic                                                                                                             |  |                    | 100,612 |   |                 |   | 99,492  |  
|                                                                                                                  |  |                    |         |   |                 |   |         |  
|Diluted                                                                                                           |  |                    | 100,612 |   |                 |   | 99,492  |  
|                                                                                                                  |  |                    |         |   |                 |   |         |  

See accompanying notes.



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CREDENCE SYSTEMS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)



|                                                                                          |  |                    |         |   |                  |   |         |  
|----------------------------------------------------------------------------------------- |  | ------------------ | ------- | - | ---------------- | - | ------- | -
|                                                                                          |  | Three Months Ended |        
|                                                                                          |  | February 3,2007    |         |   | January 31, 2006 |  
|Cash flows from operating activities:                                                     |  |                    |         |   |                  |   |         |  
|Net loss                                                                                  |  | $                  | (11     | ) |                  | $ | (4,046  | )
|Adjustments to reconcile net loss to net cash provided by (used in) operating activities: |  |                    |         |   |                  |   |         |  
|Depreciation and amortization                                                             |  |                    | 12,565  |   |                  |   | 12,938  |  
|Stock-based compensation charges                                                          |  |                    | 1,821   |   |                  |   | 1,037   |  
|Provision for inventory write downs                                                       |  |                    | 281     |   |                  |   | 396     |  
|Provision for allowance for doubtful accounts                                             |  |                    | (357    | ) |                  |   | 298     |  
|Loss on disposal of property and equipment                                                |  |                    | 859     |   |                  |   | 7       |  
|Realized net gain from sale of available-for-sale securities                              |  |                    |        |   |                  |   | (302    | )
|Gain on exchanged convertible notes                                                       |  |                    | (2,955  | ) |                  |   |        |  
|Changes in operating assets and liabilities:                                              |  |                    |         |   |                  |   |         |  
|Accounts receivable, net                                                                  |  |                    | 2,672   |   |                  |   | (15,461 | )
|Inventories                                                                               |  |                    | (2,852  | ) |                  |   | (7,833  | )
|Income tax receivable and payable                                                         |  |                    | (779    | ) |                  |   | 498     |  
|Prepaid expenses and other current assets                                                 |  |                    | (401    | ) |                  |   | 1,982   |  
|Other assets                                                                              |  |                    | (4,585  | ) |                  |   | (4,158  | )
|Accounts payable                                                                          |  |                    | 763     |   |                  |   | (3,772  | )
|Accrued expenses and other current liabilities                                            |  |                    | (7,275  | ) |                  |   | (9,937  | )
|Deferred profit                                                                           |  |                    | 1,478   |   |                  |   | 4,275   |  
|                                                                                          |  |                    |         |   |                  |   |         |  
|Net cash provided by (used in) operating activities                                       |  |                    | 1,224   |   |                  |   | (24,078 | )
|Cash flows from investing activities:                                                     |  |                    |         |   |                  |   |         |  
|Purchases of available-for-sale securities                                                |  |                    |        |   |                  |   | (19,731 | )
|Sales and maturities of available-for-sale securities                                     |  |                    |        |   |                  |   | 13,057  |  
|Acquisition of property and equipment                                                     |  |                    | (253    | ) |                  |   | (1,593  | )
|Proceeds from sale of property and equipment                                              |  |                    | 2,691   |   |                  |   | 114     |  
|                                                                                          |  |                    |         |   |                  |   |         |  
|Net cash provided by (used in) investing activities                                       |  |                    | 2,438   |   |                  |   | (8,153  | )
|Cash flows from financing activities:                                                     |  |                    |         |   |                  |   |         |  
|Issuance of common stock                                                                  |  |                    | 2       |   |                  |   | 939     |  
|Proceeds from issuance of convertible notes, net of issue costs                           |  |                    | 44,129  |   |                  |   |        |  
|Payments of bank loans                                                                    |  |                    |        |   |                  |   | (5,000  | )
|                                                                                          |  |                    |         |   |                  |   |         |  
|Net cash provided by (used in) financing activities                                       |  |                    | 44,131  |   |                  |   | (4,061  | )
|                                                                                          |  |                    |         |   |                  |   |         |  
|Effects of exchange rate on cash and cash equivalents                                     |  |                    | (498    | ) |                  |   | 739     |  
|                                                                                          |  |                    |         |   |                  |   |         |  
|Net increase (decrease) in cash and cash equivalents                                      |  |                    | 47,295  |   |                  |   | (35,553 | )
|Cash and cash equivalents at beginning of period                                          |  |                    | 95,635  |   |                  |   | 142,180 |  
|                                                                                          |  |                    |         |   |                  |   |         |  
|Cash and cash equivalents at end of period                                                |  | $                  | 142,930 |   |                  | $ | 106,627 |  
|                                                                                          |  |                    |         |   |                  |   |         |  
|Supplemental disclosures of cash flow information:                                        |  |                    |         |   |                  |   |         |  
|Interest paid                                                                             |  | $                  | 1,193   |   |                  | $ | 1,380   |  
|Income taxes paid                                                                         |  | $                  | 2,380   |   |                  | $ | 1,126   |  
|Non-cash investing and financing activities:                                              |  |                    |         |   |                  |   |         |  
|Net transfers of inventory to property and equipment                                      |  | $                  | 541     |   |                  | $ | 303     |  
|Unrealized loss on available-for-sale securities                                          |  | $                  |        |   |                  | $ | 6       |  

See accompanying notes.



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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



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

The unaudited
condensed consolidated financial statements and related notes for the three month periods ended February 3, 2007 and January 31, 2006 are unaudited but include all adjustments (consisting solely of normal recurring adjustments except for
restructuring charges adjustments) which are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations of Credence Systems Corporation (Credence or the Company) for the interim periods, in
accordance with U.S. generally accepted accounting principles. The results of operations for the three-month periods ended February 3, 2007 and January 31, 2006 are not necessarily indicative of the operating results to be expected for the
full fiscal year. The information included in this report should be read in conjunction with the Companys audited consolidated financial statements and notes thereto for the fiscal year ended October 31, 2006 included in the
Companys most recent Annual Report on Form 10-K and the additional risk factors contained herein and therein, including, without limitation, risks relating to the importance of timely product introduction, fluctuations in the Companys
quarterly net sales and operating results, limited systems sales, backlog, cyclicality of the semiconductor industry, management of fluctuations in our operating results, expansion of our product lines, limited sources of supply, reliance on the
Companys subcontractors, the Companys highly competitive industry, customization of products, rapid technological change, customer concentration, lengthy sales cycles, changes in financial accounting standards and accounting estimates,
dependence on key personnel, international sales, proprietary rights, legal proceedings, volatility of the Companys stock price, terrorist attacks and other geopolitical instability, effects of the Sarbanes-Oxley Act of 2002, and effects of
certain anti-takeover provisions, as set forth in this Report. Any party interested in receiving a free copy of the Form 10-K or the Companys other publicly available documents should write to the Chief Financial Officer of the Company.

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

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

Basis of Presentation The accompanying unaudited condensed consolidated financial
statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated. Effective in the first quarter of fiscal 2007, the Company reclassified engineering
consulting and customized services as net sales instead of as an offset to selling, general, and administrative expenses. The labor and material associated with the delivery of these services which had previously been reported as selling, general,
and administrative expenses are classified as cost of goods sold. For the three month period ended February 3, 2007 the total amount of engineering consulting and customized services classified as net sales is $5.5 million and the related cost
of goods sold is $3.7 million. For comparative purposes, for the three month period ended January 31, 2006, $3.5 million has been reclassified as net sales. The related cost of goods sold of $2.2 million for the three month period ended
January 31, 2006 has been reclassified to cost of goods sold from selling, general, and administrative expenses. These reclassifications had no effect on the financial position, results of operations, or cash flows for any of the periods
presented.

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



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

Under Securities and Exchange
Commissions Staff Accounting Bulletin No. 104, Revenue Recognition, (SAB 104), the Company recognizes revenue on the sale of semiconductor manufacturing equipment when title and risk of loss have passed to the customer, there
is persuasive evidence of an arrangement, delivery has occurred or services have been rendered, the sales price is fixed or determinable, collectibility is reasonably assured and customer acceptance criteria have been successfully demonstrated.
Revenue recognition policies are applied consistently among the Companys semiconductor manufacturing equipment product lines. Product revenue is recognized upon shipment only when achieving the customer acceptance criteria can be demonstrated
prior to shipment, which generally occurs with mature products. Revenue related to the fair value of the installation obligation is recognized upon completion of the installation. Service revenues are generally recognized upon performance of the
activities requested by the customers. Products are classified as mature after several different customers have accepted similar systems. When the customer acceptance criteria cannot be demonstrated prior to shipment, revenue and the related cost of
goods sold are deferred until customer acceptance. For some customers in certain countries where collections may be an issue, the Company may require a letter of credit to be established or cash receipt in advance before revenue can be recognized.
Lease revenue is recorded in accordance with Statement of Financial Accounting Standard No. 13, Accounting for Leases, (SFAS No. 13), which requires that a lessor account for each lease by either the sales-type or operating
method. Revenue from sales-type leases is recognized at the net present value of future lease payments. Revenue from operating leases is recognized over the lease period.



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During fiscal years 2006 and 2005, the Company introduced several new enhancements, systems and products.
Certain revenue from sales of these new systems and products during fiscal years 2006 and 2005 were deferred until the revenue recognition requirements of the Companys revenue recognition policy are satisfied. This practice will continue in
the future. In the past, the Company experienced significant delays in the introduction and acceptance of new testers as well as certain enhancements to the Companys existing testers. Delays in introducing a product or delays in the
Companys ability to obtain customer acceptance, if they occur in the future, will delay the recognition of revenue and gross profit by the Company.

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

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

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

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

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

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



|3. | Investment
|-- | ----------

Investment consists of an equity
investment in a privately-held company that develops products that are strategic to the Company. During the first quarter of fiscal 2007, the Company entered into an agreement to terminate the equity investment relationship with the privately-held
company. As part of the agreement, the Company is entitled to the intellectual property that was developed; therefore, the remaining carrying value of the investment of $0.7 million was reclassified to intangible assets and is being amortized over a
five year period using the straight-line method.



|4. | Bank Loan
|-- | ---------

The bank loan had an annual interest
rate of prime (approximately 7.0% at November 2, 2005). The loan had a covenant requiring the Company to maintain a minimum aggregated balance of cash, cash equivalents, and short and long-term investments of $100.0 million. The bank loan
expired and was paid in full in November 2005 and was not renewed.



|5. | Guarantees
|-- | ----------

The Company accounts for guarantees in
accordance with Financial Accounting Standards Board (FASB) Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees to Others, an interpretation of



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FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34 (FIN 45). Accordingly, the Company evaluates its guarantees
to determine whether (a) the guarantee is specifically excluded from the scope of FIN 45, (b) the guarantee is subject to FIN 45 disclosure requirements only, but not subject to the initial recognition and measurement provisions, or
(c) the guarantee is required to be recorded in the financial statements at fair value. The Company has evaluated its guarantees and has concluded that they are either not within the scope of FIN 45 or do not require recognition in the
financial statements.

The Companys corporate by-laws require that the Company indemnify its officers and directors, as well as those
who act as directors and officers of other entities at the Companys request, against expenses, judgments, fines, settlements and other amounts actually and reasonably incurred in connection with any proceedings arising out of their services to
the Company. In addition, the Company has entered into separate indemnification agreements with each director and each executive officer of the Company that provide for indemnification of these directors and officers under similar circumstances and
under additional circumstances. The indemnification obligations are more fully described in the by-laws and the indemnification agreements. The Company purchases standard directors and officers insurance to cover claims or a portion of the claims
made against its directors and officers. Since a maximum obligation is not explicitly stated in the Companys by-laws or in the indemnification agreements and will depend on the facts and circumstances that arise out of any future claims, the
overall maximum amount of the obligations cannot be reasonably estimated. Historically, the Company has not been required to make payments related to these obligations, and the fair value for these obligations is zero as of February 3, 2007.

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



|6. | Stock-Based Compensation
|-- | ------------------------

Stock Option Plans

The Company has a stock-based compensation program that provides its Board of Directors broad discretion in creating employee equity incentives. This
program includes incentive and non-statutory stock options, restricted stock units and other type of equity granted under various plans, the majority of which are stockholder approved. Stock options are generally time-based, typically vesting 25% on
each annual anniversary of the hire date over four years and expiring seven years from the grant date. Additionally, the Company has an Employee Stock Purchase Plan (ESPP) that allows employees to purchase shares of common stock at 85% of the fair
market value at the lower of either the date of enrollment or the date of purchase. The total number of shares authorized for grant of stock options is 7.4 million shares. The total number of shares authorized under the ESPP is 1.6 million
shares subject to automatic increases. Shares issued as a result of stock option exercises and our ESPP are generally from our new shares. As of February 3, 2007, the Company had approximately 3.1 million shares of common stock reserved
for future issuance under the stock option plans and ESPP.

On August 9, 2000, the Board of Directors authorized the Companys
Supplemental Stock Option Plan (the 2000 Plan) and authorized 500,000 shares for issuance. This additional reserve of shares supplements the Companys 1993 Stock Option Plan and is for issuance to individuals employed by the Company
who are neither officers of the Company nor members of the Board. On November 27, 2000 the Board of Directors authorized an additional 500,000 shares for issuance under the Supplemental Stock Option Plan. In addition, on November 27, 2001,
the Board of Directors authorized an additional 500,000 shares for issuance under the Supplemental Stock Option Plan.

In fiscal year 2005,
the Companys Board of Directors and stockholders approved the 2005 Stock Incentive Plan (the 2005 Plan) which provides for the grant of options to purchase shares of the Companys common stock, stock appreciation rights and
restricted stock to employees, members of the Board of Directors and consultants. The maximum number of shares available for grant under the 2005 Plan is 5.9 million shares.

During fiscal year 2005, the 1993 Stock Option Plan (the 1993 Plan), under which the Company previously granted options to employees and
members of the Board of Directors, expired. However, outstanding options granted under the 1993 Plan remain exercisable in accordance with the terms of the original grant agreements.

In August 2005, the Companys Board of Directors approved the accelerated vesting of certain unvested and out-of-the-money non-qualified
stock options previously awarded to employees and officers with option exercise prices equal to or greater than



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$9.15. Options held by non-employee directors are excluded from the vesting acceleration. In addition, in order to prevent executive officers from unintended
personal benefits, the Companys executive officers have agreed to the imposition of restrictions on any shares received through the exercise of accelerated options. Those restrictions will prevent the sale of any shares received from the
exercise of an accelerated option until the earlier of the original vesting date of the option or the executive officers termination of employment. The $9.15 price was selected because it was higher than the closing price of the Companys
common stock of $8.84 on August 29, 2005, the date of this acceleration. The accelerated options represent approximately 15 percent or approximately 2.8 million shares of the total of all outstanding Credence options on August 29,
2005. The acceleration was intended to reduce the stock option expense the Company would be required to record after the adoption of SFAS 123(R). This acceleration reduced approximately $10.0 million of stock option expenses under SFAS 123(R) which
would have been recognized as an expense through December 2008.

On November 1, 2005, the Company adopted Statement of Financial
Accounting Standard No. 123(R) (SFAS 123(R)), Share-Based Payment, for its share-based compensation plans. Under SFAS 123(R), the Company is required to recognize stock-based compensation costs based on the estimated fair value at
the grant date for its share-based awards. In accordance with this standard, the Company has elected to recognize the compensation cost of all share-based awards that ultimately vest on a straight-line basis over the vesting period of the award.

On November 10, 2005, the Financial Accounting Standards Board (FASB) issued FASB Staff Position No. FAS 123(R)-3 Transition
Election Related to Accounting for Tax Effects of Share-Based Payment Awards. The Company has elected to adopt the alternative transition method provided in the FASB Staff Position for calculating the tax effects of stock-based compensation
pursuant to SFAS 123(R). The alternative transition method includes simplified methods to establish the beginning balance of the additional paid-in capital pool (APIC pool) related to the tax effects of employee stock-based compensation,
and to determine the subsequent impact on the APIC pool and consolidated statements of cash flows of the tax effects of employee stock-based compensation awards that are outstanding upon adoption of SFAS 123(R).

The Company previously accounted for its employee stock option and ESPP under the recognition and measurement principles of Accounting Principles Board
Opinion (APB) No. 25, Accounting for Stock Issued to Employees, and related Interpretations, and adopted the disclosure-only provisions of Statement of Financial Accounting Standard No. 123, Accounting for Stock-Based
Compensation, (SFAS 123), as amended by Statement of Financial Accounting Standard No. 148, Accounting for Stock-Based CompensationTransition and Disclosures, (SFAS 148). As the ESPP was not compensatory under APB 25, no
compensation expense was recorded in earnings for the awards granted under the ESPP. Compensation expense was recorded in earnings for the Companys stock options if they were awarded with an exercise price less than the market price of the
Companys stock on the date of grant. The pro forma effects on net loss and net loss per share for stock options and ESPP awards were instead disclosed in a footnote to the consolidated financial statements.

The Company has elected to use the modified prospective transition method as permitted by SFAS 123(R) and therefore has not restated its financial
results for prior periods. Under this transition method, in fiscal year 2006, the compensation cost recognized included the cost for all stock-based compensation awards granted prior to, but not yet vested as of November 1, 2005, based on the
grant-date fair value estimated in accordance with the original provisions of SFAS 123 and the grant date fair value estimated in accordance with the provisions of SFAS 123(R) for awards granted or modified on or after November 1, 2005 whose
requisite service period was rendered during fiscal year 2006. The Company determines the fair value of stock options using the single option approach under SFAS 123(R). Prior to the adoption of SFAS 123(R), the Company determined the fair value of
stock options using the multiple option approach. In conjunction with the adoption of SFAS 123(R), the Company changed its method of attributing the value of stock-based compensation to expense from the accelerated multiple-option approach to the
straight-line single option approach for awards granted or modified on or after November 1, 2005. Compensation expense for all share-based payment awards granted prior to November 1, 2005 will continue to be recognized using the
accelerated multiple-option approach.

In calculating the compensation cost, the Company estimates the fair value of each option grant on
the date of grant using the Black-Scholes-Merton options pricing model. The Black-Scholes-Merton option pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable.
In addition, the Black-Scholes-Merton model requires the input of highly subjective assumptions including the expected stock price volatility.

As a result of adopting SFAS 123(R), the Companys loss before income taxes provision and net loss for the three months ended January 31, 2006 was $1.0 million higher than if it had continued to account for share-based
compensation under APB 25. Basic and diluted net loss per share for the three months ended January 31, 2006 would have been $0.01 lower if the Company had not adopted SFAS 123(R), compared to the reported basic and diluted net loss per share of
$0.04. There was no effect on the unaudited condensed consolidated statements of cash flows from adopting SFAS 123(R).



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The following table illustrates the stock-based compensation expense resulting from stock options and
ESPP included in the unaudited condensed consolidated statement of operations for the three-month periods ended February 3, 2007 and January 31, 2006 (in thousands):



|                                                             |  |                                    |       |                                     |   |    
|------------------------------------------------------------ |  | ---------------------------------- | ----- | ----------------------------------- | - | ---
|                                                             |  | Three MonthsEnded February 3, 2007 |       | Three Months Ended January 31, 2006
|Cost of goods sold                                           |  | $                                  | 98    |                                     | $ | 77 
|Research and development                                     |  |                                    | 408   |                                     |   | 336
|Selling, general and administrative                          |  |                                    | 1,197 |                                     |   | 564
|                                                             |  |                                    |       |                                     |   |    
|Stock-based compensation expense before income taxes benefit |  | $                                  | 1,703 |                                     | $ | 977
|Income tax benefit                                           |  |                                    |      |                                     |   |   
|                                                             |  |                                    |       |                                     |   |    
|Stock-based compensation expense after income taxes benefit  |  | $                                  | 1,703 |                                     | $ | 977
|                                                             |  |                                    |       |                                     |   |    

As of February 3, 2007 and January 31, 2006, the Company capitalized $0.1 million of
stock-based compensation expense as inventory, respectively; therefore, such amounts are excluded in the cost of goods sold amounts above.

Summary of activity under stock option plan for the three months ended February 3, 2007:



|                                               |  |                                         |   |  |                                           |   |  |                                        |       |                                         |   |                                                     |  |     
|---------------------------------------------- |  | --------------------------------------- | - |  | ----------------------------------------- | - |  | -------------------------------------- | ----- | --------------------------------------- | - | --------------------------------------------------- |  | ----
|                                               |  | OptionsAvailablefor Grant(In thousands) |   |  | Number ofOptionsOutstanding(In thousands) |   |  | WeightedAverageExercise Priceper share |       | AggregateIntrinsic Value (In thousands) |   | WeightedAverageRemainingContractual Life
(In years)
|Balance at October 31, 2006                    |  | 4,425                                   |   |  | 17,092                                    |   |  | $                                      | 12.48 |                                         |   |                                                     |  |     
|Options granted                                |  | (1,819                                  | ) |  | 1,739                                     |   |  | $                                      | 4.69  |                                         |   |                                                     |  |     
|Options canceled                               |  | 177                                     |   |  | (177                                      | ) |  | $                                      | 10.96 |                                         |   |                                                     |  |     
|Options forfeited/expired                      |  |                                        |   |  | (1,903                                    | ) |  | $                                      | 13.29 |                                         |   |                                                     |  |     
|Options exercised                              |  |                                        |   |  | (2                                        | ) |  | $                                      | 1.11  |                                         |   |                                                     |  |     
|                                               |  |                                         |   |  |                                           |   |  |                                        |       |                                         |   |                                                     |  |     
|Balance at February 3, 2007                    |  | 2,783                                   |   |  | 16,749                                    |   |  | $                                      | 11.73 |                                         | $ | 16,904                                              |  | 5.29
|                                               |  |                                         |   |  |                                           |   |  |                                        |       |                                         |   |                                                     |  |     
|Vested or expected to vest at February 3, 2007 |  |                                         |   |  | 12,578                                    |   |  | $                                      | 13.39 |                                         | $ | 7,205                                               |  | 4.99
|                                               |  |                                         |   |  |                                           |   |  |                                        |       |                                         |   |                                                     |  |     
|Exercisable at February 3, 2007                |  |                                         |   |  | 12,532                                    |   |  | $                                      | 13.39 |                                         | $ | 7,151                                               |  | 4.99
|                                               |  |                                         |   |  |                                           |   |  |                                        |       |                                         |   |                                                     |  |     

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

The weighted-average grant date fair value per options granted during the three months ended February 3, 2007 and January 31, 2006 was $2.63 and $2.97, respectively. The total intrinsic value of options
exercised during the three months ended February 3, 2007 and January 31, 2006 was $7,000 and $0.2 million, respectively. Cash proceeds from the exercise of stock options were $2,000 and $0.9 million for the three months ended
February 3, 2007 and January 31, 2006, respectively. No income tax benefit was realized from the stock option exercises during the three-month periods ended February 3, 2007 and January 31, 2006. Stock-based compensation expense
related to stock options recognized under SFAS 123(R) for the three months ended February 3, 2007 and January 31, 2006 was $1.4 million and $0.6 million, respectively. The Company generally settles employee stock option exercises with
newly issued common shares. At February 3, 2007, there was $12.2 million of unrecognized stock-based compensation expense related to non-vested options and that is expected to be recognized over a weighted-average period of 3.1 years.

The fair value of option grants was estimated by using the Black-Scholes-Merton model with the following weighted-average assumptions for
the three months ended February 3, 2007 and January 31, 2006, respectively:



|                         |  |                    |   |  |                 |  
|------------------------ |  | ------------------ | - |  | --------------- | -
|                         |  | Three Months Ended |  
|                         |  | February 3,2007    |   |  | January 31,2006 |  
|Expected volatility      |  | 59                 | % |  | 54              | %
|Dividend yield           |  |                   |   |  |                |  
|Risk-free interest rate  |  | 4.6                | % |  | 4.4             | %
|Expected life (in years) |  | 4.0                |   |  | 4.0             |  

Expected Volatility: The Companys computation of expected volatility for the
three-month period ended February 3, 2007 and January 31, 2006 is based on a combination of implied volatilities from traded options on the Companys stock and historical



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volatility. The selection of a combination of the implied and historical volatility approach was based upon the availability of actively traded options on
the Companys stock and the Companys assessment that this combination is more representative of future stock price trends than historical volatility alone.

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

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

Expected Term:The Companys expected term represents the period that the Companys stock-based awards are expected to be outstanding
and was determined for the three-month period ended February 3, 2007 and January 31, 2006 based on historical experience of similar awards, giving consideration to the contractual terms of the stock-based awards, vesting schedules and
expectations of future employee behavior.

Forfeitures Rate: Compensation expense recognized in the consolidated statement of
operations for the three-month period ended February 3, 2007 and January 31, 2006 is based on awards ultimately expected to vest and it reflects estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant
and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Prior to adoption of SFAS 123(R), the Company accounted for forfeitures as they occurred.

Employee Stock Purchase Plan (ESPP)

In 1994, the
Company adopted the 1994 Employee Stock Purchase Plan (the 1994 Plan), which provides direct employees, employed with the Company for at least thirty consecutive days as of the entry date into any offering period, with the opportunity to
acquire shares of the Companys common stock. Employees may contribute up to 10% of their base salary to the plan. The Company has a six-month purchase plan within the offering period. The purchase price is 85% of the fair market value per
share of common stock at the beginning of the offering period or the end of the purchase period, whichever is lower. The plan restricts the maximum number of shares that an employee can purchase to 1,500 shares each semi-annual period and to $25,000
worth of common stock each year. At February 3, 2007, there were 306,249 shares reserved for issuance under the 1994 Plan.

The fair
value of issuances under the 1994 Plan is estimated on the issuance date by applying the principles of FASB Technical Bulletin 97-1 (FTB 97-1), Accounting under Statement 123 for Certain Employee Stock Purchase Plan with a Look Back
Option and using the Black-Scholes-Merton options pricing model. There were no awards granted and no stock purchases under our ESPP during the three months ended February 3, 2007 and January 31, 2006. Stock-based compensation expense
related to employee stock purchases recognized under SFAS 123(R) for the three months ended February 3, 2007 and January 31, 2006 was $0.3 million and $0.4 million, respectively. At February 3, 2007, there was $63,000 of unrecognized
stock-based compensation expense related to outstanding ESPP shares and that is expected to be recognized over one month period.

The fair
value of awards granted under the 1994 Plan stock-based compensation was estimated by using the Black-Scholes-Merton model with the following weighted-average assumptions for the three months ended February 3, 2007 and January 31, 2006,
respectively:



|                         |  |                    |   |  |                 |  
|------------------------ |  | ------------------ | - |  | --------------- | -
|                         |  | Three Months Ended |  
|                         |  | February 3,2007    |   |  | January 31,2006 |  
|Expected volatility      |  | 64                 | % |  | 44              | %
|Dividend yield           |  |                   |   |  |                |  
|Risk-free interest rate  |  | 5.0                | % |  | 3.9             | %
|Expected life (in years) |  | 0.5                |   |  | 0.5             |  



|7. | 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):



|                |  |                 |        |                 |   |       
|--------------- |  | --------------- | ------ | --------------- | - | ------
|                |  | February 3,2007 |        | October 31,2006
|Raw materials   |  | $               | 37,683 |                 | $ | 36,436
|Work-in-process |  |                 | 14,438 |                 |   | 14,097
|Finished goods  |  |                 | 5,425  |                 |   | 4,667 
|                |  |                 |        |                 |   |       
|Total           |  | $               | 57,546 |                 | $ | 55,200
|                |  |                 |        |                 |   |       



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|8. | Balance Sheet Components
|-- | ------------------------

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



|                                                 |  |                 |        |                 |   |       
|------------------------------------------------ |  | --------------- | ------ | --------------- | - | ------
|                                                 |  | February 3,2007 |        | October 31,2006
|Receivable from contract equipment manufacturers |  | $               | 2,691  |                 | $ | 2,565 
|Other prepaid expenses                           |  |                 | 12,601 |                 |   | 11,946
|                                                 |  |                 |        |                 |   |       
|Total                                            |  | $               | 15,292 |                 | $ | 14,511
|                                                 |  |                 |        |                 |   |       

Property and equipment, net (in thousands):



|                              |  |                 |          |   |                 |   |          |  
|----------------------------- |  | --------------- | -------- | - | --------------- | - | -------- | -
|                              |  | February 3,2007 |          |   | October 31,2006 |  
|Land                          |  | $               | 20,849   |   |                 | $ | 24,381   |  
|Buildings                     |  |                 | 35,960   |   |                 |   | 35,876   |  
|Machinery and equipment       |  |                 | 106,751  |   |                 |   | 106,824  |  
|Software                      |  |                 | 33,869   |   |                 |   | 33,731   |  
|Leasehold improvements        |  |                 | 40,928   |   |                 |   | 40,734   |  
|Furniture and fixtures        |  |                 | 10,665   |   |                 |   | 10,696   |  
|                              |  |                 |          |   |                 |   |          |  
|                              |  |                 | 249,022  |   |                 |   | 252,242  |  
|Less accumulated depreciation |  |                 | (168,245 | ) |                 |   | (165,067 | )
|                              |  |                 |          |   |                 |   |          |  
|Total                         |  | $               | 80,777   |   |                 | $ | 87,175   |  
|                              |  |                 |          |   |                 |   |          |  

Other assets consist of the following (in thousands):



|                     |  |                 |        |                 |   |       
|-------------------- |  | --------------- | ------ | --------------- | - | ------
|                     |  | February 3,2007 |        | October 31,2006
|Field service spares |  | $               | 33,386 |                 | $ | 33,633
|Product consignment  |  |                 | 11,178 |                 |   | 9,811 
|Other assets         |  |                 | 6,730  |                 |   | 5,628 
|                     |  |                 |        |                 |   |       
|Total                |  | $               | 51,294 |                 | $ | 49,072
|                     |  |                 |        |                 |   |       

Product spare parts that are used in the Companys service business are classified as other
assets and are depreciated using the straight-line method over five years. Amortization expense was approximately $2.7 million and $2.8 million for three months ended February 3, 2007 and January 31, 2006, respectively.

Product consignments to internal and external customers are classified as other assets and are depreciated using the straight-line method over 36 months.
Amortization expense was approximately $1.3 million and $1.7 million for the three months ended February 3, 2007 and January 31, 2006, respectively.

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



|                               |  |                 |        |                 |   |       
|------------------------------ |  | --------------- | ------ | --------------- | - | ------
|                               |  | February 3,2007 |        | October 31,2006
|Accrued bonuses                |  | $               | 1,759  |                 | $ | 5,914 
|Accrued restructuring expenses |  |                 | 5,270  |                 |   | 8,305 
|Other accrued liabilities      |  |                 | 18,347 |                 |   | 23,032
|                               |  |                 |        |                 |   |       
|Total                          |  | $               | 25,376 |                 | $ | 37,251
|                               |  |                 |        |                 |   |       



|9. | Convertible Subordinated Notes
|-- | ------------------------------

Convertible
Subordinated Notes due 2008

In June 2003, the Company issued $180 million of
11/2% convertible subordinated notes (the Notes) due May 2008 in a private placement. The Notes are unsecured obligations of the Company and are subordinated to all present and future senior indebtedness
of the Company. Interest is payable semiannually on May 15 and November 15, commencing November 15, 2003. The Notes are convertible into common stock of the Company at an initial conversion price of $11.31 per share, subject to
adjustment in certain dilution events. The Notes do not include a beneficial conversion feature or financial covenants. Expenses of $5.8 million associated with the offering were capitalized upon issuance and are included in other current assets and
in other long-term assets in the unaudited condensed consolidated balance sheets. Such expenses are being amortized to interest expenses over the term of the Notes. The Company continues to use the net proceeds of the offering for general corporate
purposes, including working capital and potential acquisitions.



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

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

Unamortized debt issuance costs associated with the Notes were $0.6 million and $1.5 million at February 3, 2007 and October 31, 2006, respectively. Amortization of prepaid loan costs are
classified as other income (expense), net on the unaudited condensed consolidated statements of operations. Amortization of prepaid loan costs were $0.2 million for the three months ended February 3, 2007 and January 31, 2006,
respectively.

Convertible Subordinated Notes due 2010

On December 20, 2006, the Company completed the exchange in an aggregate principal amount of $72.5 million of 1.5% Convertible Subordinated Notes due
in May 2008 for a new series of 3.5% Convertible Senior Subordinated Notes (the New Notes) due in May 2010, as well as the issuance of additional New Notes with an aggregate principal amount of $50.0 million in a private placement. The New Notes are
unsecured obligations of the Company and are subordinated to all present and future senior indebtedness of the Company. Interest is payable semiannually on May 15 and November 15, commencing May 15, 2007. The New Notes contain a
provision known as net share settlement which requires that, upon conversion of the New Notes, the Company will pay holders in cash for the principal amount of the New Notes which are converted. Any amount in excess of converted principal will be
settled in shares of the Companys common stock, or at its option, cash. The New Notes do not have financial covenants.

The New Notes
can be converted under certain circumstances, including among others, 1) during any calendar quarter when the volume weighted average price per share of the Companys common stock has been more than 150% of the conversion price for a specified
period ending on the last trading day of the preceding calendar quarter, or 2) during the five business days when the trading price per $1,000 principal amount of the New Notes for each day within a specified period was less than 98% of the product
of the volume weighted average price of the common stock for each day in that period and the applicable conversion rate per $1,000 principal amount of the New Note, or 3) if the Company distributes to its stockholders, rights or warrants entitling
them to purchase common stock within a specified period at a price less than the closing price of the common stock on the date of issuance, or 4) if the Company distributes to its stockholders, assets or securities of the Company, which distribution
has a per share value exceeding 7.5% of the volume weighted average price of the common stock on the business day preceding the declaration date for such distribution, or 5) in the event a change in control or cessation of trading of the
Companys stock occurs or is anticipated to occur or 6) at any time during the 60 day period prior to the maturity date. In addition, the Company has the ability to terminate the conversion feature of the New Notes in the event that the volume
weighted average price per share of the Companys common stock has been more than 150% of the conversion price for a specified period. If the Company exercises its right to terminate conversion, the holders of the New Notes may convert their
notes within a specified period. The foregoing description of these conversion events is not necessarily complete and reference is made to the Indenture filed as an exhibit to the Companys Form S-3 Registration Statement filed with the SEC on
January 19, 2007.

The Company recorded a discount of $6.1 million related to the New Notes since they were issued at a discount. This
amount is being amortized to interest expense over the life of the New Notes, or sooner upon conversion. During the three months ended February 3, 2007, the Company recorded related amortization of $0.2 million.

Expenses of $3.4 million associated with the New Notes offering were capitalized upon issuance and are included in prepaid expenses and other current
assets and in other assets in the unaudited condensed consolidated balance sheets. Such expenses are being amortized to interest expenses over the term of the New Notes. Unamortized debt issuance costs associated with the New Notes were
$3.3 million at February 3, 2007. Amortization of prepaid loan costs are classified as other income (expense), net on the condensed consolidated statements of operations. Amortization of prepaid loan costs was $0.1 million in the first
fiscal quarter of 2007.



|10. | Other Intangibles
|--- | -----------------

As of November 1, 2002, the
Company also adopted Statement of Financial Accounting Standards No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets, (SFAS 144).

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



|                       |  |      |         |                         |   |         |     |  |   |       
|---------------------- |  | ---- | ------- | ----------------------- | - | ------- | --- |  | - | ------
|February 3, 2007       |  | Cost |         | AccumulatedAmortization |   |         | Net
|Purchased technology   |  | $    | 129,223 |                         | $ | (64,303 | )   |  | $ | 64,920
|Customer relations     |  |      | 21,202  |                         |   | (12,434 | )   |  |   | 8,768 
|Maintenance contracts  |  |      | 13,800  |                         |   | (7,360  | )   |  |   | 6,440 
|Product backlog        |  |      | 4,900   |                         |   | (4,900  | )   |  |   |      
|Trademarks             |  |      | 2,053   |                         |   | (2,053  | )   |  |   |      
|Patents                |  |      | 862     |                         |   | (862    | )   |  |   |      
|Non-compete agreements |  |      | 750     |                         |   | (750    | )   |  |   |      
|                       |  |      |         |                         |   |         |     |  |   |       
|Total                  |  | $    | 172,790 |                         | $ | (92,662 | )   |  | $ | 80,128
|                       |  |      |         |                         |   |         |     |  |   |       



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



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Amortization expenses for the other intangible assets were $4.5 million and $4.3 million for the three
months ended February 3, 2007 and January 31, 2006, respectively.

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



|                         |  |        |       
|------------------------ |  | ------ | ------
|Fiscal Years Ending      |  | Amount
|Remainder of fiscal 2007 |  | $      | 13,475
|2008                     |  |        | 16,019
|2009                     |  |        | 13,665
|2010                     |  |        | 10,201
|2011                     |  |        | 8,306 
|Thereafter               |  |        | 18,462
|                         |  |        |       
|Total                    |  | $      | 80,128
|                         |  |        |       



|11. | Net Loss Per Share
|--- | ------------------

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

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



|                                    |  |                    |         |   |                 |   |        |  
|----------------------------------- |  | ------------------ | ------- | - | --------------- | - | ------ | -
|                                    |  | Three Months Ended |        
|                                    |  | February 3,2007    |         |   | January 31,2006 |  
|Numerator:                          |  |                    |         |   |                 |   |        |  
|Net loss                            |  | $                  | (11     | ) |                 | $ | (4,046 | )
|                                    |  |                    |         |   |                 |   |        |  
|Denominator:                        |  |                    |         |   |                 |   |        |  
|Weighted-average shares outstanding |  |                    | 100,612 |   |                 |   | 99,492 |  
|                                    |  |                    |         |   |                 |   |        |  
|Basic net loss per share            |  | $                  | (0.00   | ) |                 | $ | (0.04  | )
|                                    |  |                    |         |   |                 |   |        |  
|Diluted net loss per share          |  | $                  | (0.00   | ) |                 | $ | (0.04  | )
|                                    |  |                    |         |   |                 |   |        |  

At February 3, 2007 and January 31, 2006, there were options to purchase 16,748,548 and
17,872,001 shares of common stock outstanding at a weighted average exercise price of $11.73 and $12.86, respectively, which were excluded from the diluted net loss per share calculation for the three months ended February 3, 2007 and
January 31, 2006 as their effect was anti-dilutive in each period. There were also 6,410,256 shares and 15,915,119 shares issuable under the terms of the convertible subordinated notes issued in June 2003 which were excluded from the diluted
net loss per share calculation for the three months ended February 3, 2007 and January 31, 2006, respectively, as their effect was anti-dilutive in each period. In addition, 7,189,793 shares issuable under the terms of the convertible
subordinated notes issued in December 2006 were excluded from the diluted loss per share calculation for the three months ended February 3, 2007 because they were anti-dilutive.



|12. | Recent Accounting Pronouncements
|--- | --------------------------------

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



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

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



|13. | Commitments and Contingencies
|--- | -----------------------------

The Company leases
some of its facilities and equipment under operating leases that expire periodically through 2013.

The future minimum lease payments at
February 3, 2007 are as follows (in thousands):



|                         |  |                                |       |                                             |   |                                    |  |   |      
|------------------------ |  | ------------------------------ | ----- | ------------------------------------------- | - | ---------------------------------- |  | - | -----
|                         |  | Committed Gross Lease Payments |       | Leases Written Off in Restructuring
Charges |   | Net Estimated Future Lease Expense
|Remainder of fiscal 2007 |  | $                              | 2,554 |                                             | $ | 60                                 |  | $ | 2,494
|2008                     |  |                                | 2,181 |                                             |   | 52                                 |  |   | 2,129
|2009                     |  |                                | 1,384 |                                             |   |                                   |  |   | 1,384
|2010                     |  |                                | 494   |                                             |   |                                   |  |   | 494  
|2011                     |  |                                | 264   |                                             |   |                                   |  |   | 264  
|Thereafter               |  |                                | 462   |                                             |   |                                   |  |   | 462  
|                         |  |                                |       |                                             |   |                                    |  |   |      
|                         |  | $                              | 7,339 |                                             | $ | 112                                |  | $ | 7,227
|                         |  |                                |       |                                             |   |                                    |  |   |      

Some of the components that the Company purchases are unique to the Company and must be purchased
in relatively high minimum quantities with long (in excess of three months) lead times. These business circumstances can lead to the Company holding relatively high inventory levels and associated risks. In addition, purchase commitments for unique
components are relatively inflexible in terms of deferral or cancellation. At February 3, 2007, the Company had open and committed purchase orders totaling approximately $83.5 million.

The following summarizes the Companys minimum contractual cash obligations and other commitments at February 3, 2007, and the effect of such
obligations in future periods (in thousands):



|                                               |  |       |         |                        |   |        |  |      |        |      |   |       |  |            |         |  |   |     |  |   |    
|---------------------------------------------- |  | ----- | ------- | ---------------------- | - | ------ |  | ---- | ------ | ---- | - | ----- |  | ---------- | ------- |  | - | --- |  | - | ---
|                                               |  | Total |         | Remainderof Fiscal2007 |   | 2008   |  | 2009 |        | 2010 |   | 2011  |  | Thereafter
|Contractual Obligations:                       |  |       |         |                        |   |        |  |      |        |      |   |       |  |            |         |  |   |     |  |   |    
|Facilities and equipment operating leases (1)  |  | $     | 7,339   |                        | $ | 2,554  |  | $    | 2,181  |      | $ | 1,384 |  | $          | 494     |  | $ | 264 |  | $ | 462
|Convertible subordinated notes (2)             |  |       | 195,000 |                        |   |       |  |      | 72,500 |      |   |      |  |            | 122,500 |  |   |    |  |   |   
|Interest on convertible subordinated notes     |  |       | 15,557  |                        |   | 4,031  |  |      | 4,922  |      |   | 4,287 |  |            | 2,317   |  |   |    |  |   |   
|Open non-cancelable purchase order commitments |  |       | 83,519  |                        |   | 67,830 |  |      | 15,241 |      |   | 58    |  |            | 390     |  |   |    |  |   |   
|                                               |  |       |         |                        |   |        |  |      |        |      |   |       |  |            |         |  |   |     |  |   |    
|Total contractual cash obligations             |  | $     | 301,415 |                        | $ | 74,415 |  | $    | 94,844 |      | $ | 5,729 |  | $          | 125,701 |  | $ | 264 |  | $ | 462
|                                               |  |       |         |                        |   |        |  |      |        |      |   |       |  |            |         |  |   |     |  |   |    

---

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

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

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

The following table represents the activity in the warranty accrual for
the three months ended February 3, 2007 and January 31, 2006 (in thousands):



|                                                      |  |                    |        |   |                 |   |        |  
|----------------------------------------------------- |  | ------------------ | ------ | - | --------------- | - | ------ | -
|                                                      |  | Three Months Ended |       
|                                                      |  | February 3,2007    |        |   | January 31,2006 |  
|Beginning balance                                     |  | $                  | 13,514 |   |                 | $ | 13,419 |  
|Add: Accruals for warranties issued during the period |  |                    | 5,631  |   |                 |   | 3,630  |  
|Less: Adjustments of prior period accrual estimates   |  |                    | (330   | ) |                 |   | (29    | )
|Warranty spending                                     |  |                    | (4,650 | ) |                 |   | (4,221 | )
|                                                      |  |                    |        |   |                 |   |        |  
|Ending balance                                        |  | $                  | 14,165 |   |                 | $ | 12,799 |  
|                                                      |  |                    |        |   |                 |   |        |  



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

Legal Proceedings

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



|14. | Comprehensive Loss
|--- | ------------------

The Companys accumulated
other comprehensive income consists of the accumulated net unrealized gains or losses on available-for-sale investments and foreign currency translation adjustments. At February 3, 2007 and January 31, 2006, the Company had a balance of
net unrealized losses of $18,000 and $6,000, respectively, on available-for-sale investments. Additionally, at February 3, 2007 and January 31, 2006, the Company had a balance of $2.5 million and $1.3 million, respectively, of net foreign
currency translation gains.

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



|                                                   |  |                    |     |   |                  |   |        |  
|-------------------------------------------------- |  | ------------------ | --- | - | ---------------- | - | ------ | -
|                                                   |  | Three Months Ended |    
|                                                   |  | February 3, 2007   |     |   | January 31, 2006 |  
|Net loss                                           |  | $                  | (11 | ) |                  | $ | (4,046 | )
|                                                   |  |                    |     |   |                  |   |        |  
|Unrealized losses on available-for-sale securities |  |                    |    |   |                  |   | (197   | )
|Currency translation adjustment                    |  |                    | 352 |   |                  |   | 943    |  
|                                                   |  |                    |     |   |                  |   |        |  
|Other comprehensive income                         |  |                    | 352 |   |                  |   | 746    |  
|                                                   |  |                    |     |   |                  |   |        |  
|Total comprehensive income (loss)                  |  | $                  | 341 |   |                  | $ | (3,300 | )
|                                                   |  |                    |     |   |                  |   |        |  



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

During previous years, the
Company has recorded restructuring charges as it rationalized operations in light of customer demand declines and economic downturns. The measures, which included reducing the workforce, consolidating facilities and changing the strategic focus of a
number of sites, was largely intended to align the Companys capacity and infrastructure to anticipated customer demand and transition its operations for higher utilization of facility space. The restructuring charges include employee severance
and benefit costs, and costs related to leased facilities vacated, net of estimated sublease income. Severance and benefit costs and other costs associated with restructuring activities were recorded in compliance with Statement of Financial
Accounting Standard No. 146, Accounting for Costs Associated with Exit or Disposal Activities, (SFAS 146). During October 2004, the Company also adopted Statement of Financial Accounting Standard No. 112, Employers
Accounting for Post Employment Benefits, (SFAS 112), for severance and benefit costs as the Company concluded that (a) the Company has a substantive post employment benefit obligation that is attributed to prior services rendered,
(b) rights to those benefits have vested, and (c) payment is probable and the amount can be reasonably estimated. This accounting for restructuring costs requires the Company to record provisions and charges when it has a formal and
committed restructuring plan.

The following table illustrates the activity for the three-month period ended February 3, 2007 and the
estimated timing of future payouts for major restructuring categories (in thousands):



|                 |  |                            |         |   |         |   |          |  |             |       |  |                            |      |   |  |   |        |  
|---------------- |  | -------------------------- | ------- | - | ------- | - | -------- |  | ----------- | ----- |  | -------------------------- | ---- | - |  | - | ------ | -
|                 |  | Balance atOctober 31, 2006 |         |   | Charges |   | Utilized |  | Adjustments |       |  | Balance atFebruary 3, 2007 |     
|Severance        |  | $                          | (5,029  | ) |         | $ |         |  | $           | 1,511 |  | $                          | (527 | ) |  | $ | (4,045 | )
|Operating leases |  |                            | (5,554  | ) |         |   |         |  |             | 1,949 |  |                            | 35   |   |  |   | (3,570 | )
|                 |  |                            |         |   |         |   |          |  |             |       |  |                            |      |   |  |   |        |  
|Total            |  | $                          | (10,583 | ) |         | $ |         |  | $           | 3,460 |  | $                          | (492 | ) |  | $ | (7,615 | )
|                 |  |                            |         |   |         |   |          |  |             |       |  |                            |      |   |  |   |        |  



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|                                    |  |   |      
|----------------------------------- |  | - | -----
|Estimated timing of future payouts: |  |  
|Remainder of fiscal 2007            |  | $ | 5,028
|Fiscal 2008                         |  |   | 1,338
|Fiscal 2009                         |  |   | 1,249
|                                    |  |   |      
|Total                               |  | $ | 7,615
|                                    |  |   |      

For the three months ended February 3, 2007 and January 31, 2006, the Company recorded
restructuring charges of approximately $0.5 million and $0.3 million, respectively, as operating expenses related to headcount reductions.

In July 2006, the Company entered into a lease buyout agreement with the landlord for the vacant San Jose building. The agreement terminated the initial lease arrangement whereby the Company would occupy and pay for the space through 2009.
According to the terms of the agreement, the Company will pay $8.0 million over a three year period. The Company paid $2.0 million in fiscal 2006 and $2.0 million during the first fiscal quarter of 2007 under this agreement.



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

The Company maintains a
401(k) retirement savings plan for its full-time domestic employees, which allows them to contribute up to 20% of their pre-tax wages subject to IRS limits. The Companys contribution to this plan was approximately $0.4 million and $0.3 million
for the three months ended February 3, 2007 and January 31, 2006.

Outside of the U.S., the Company also assumed several defined
benefit and defined contribution plans that cover substantially all employees as part of its acquisition of NPTest in May 2004. Where applicable, employees are covered by statutory plans. For defined benefit plans, charges to expense are based upon
costs computed by independent actuaries. These plans are substantially fully funded with trustees in respect to past and current service. At February 3, 2007, the pension liability was $0.6 million. The expenses associated with these plans were
not material for the three months ended February 3, 2007 and January 31, 2006.

The Company has a deferred compensation plan for
certain employees (a Rabbi Trust or trust). The assets in the Rabbi Trust, consisting of cash equivalents and debt and equity securities, are recorded at current market prices. The trust assets are available to satisfy claims
of the Companys general creditors in the event of its bankruptcy. The trusts assets of approximately $1.9 million at February 3, 2007 are included in other assets, and the corresponding deferred compensation liability is included in
the other liabilities in the accompanying unaudited condensed consolidated balance sheets.



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

Operating segments are business
units that have separate financial information and are separately reviewed by the Companys chief decision makers. The Companys chief decision makers are the Chief Executive Officer and Chief Financial Officer. The Company and its
subsidiaries currently operate in a single industry segment: the design, development, manufacture, sale and service of advanced semiconductor test and diagnostic systems used in the production of semiconductors. All of the Companys advanced
semiconductor test and diagnostic systems operations are subject to similar economic characteristics, have similar production processes, have common customers, and are distributed using the same channels.

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



|                                 |  |                    |   |  |                 |  
|-------------------------------- |  | ------------------ | - |  | --------------- | -
|                                 |  | Three Months Ended |  
|                                 |  | February 3,2007    |   |  | January 31,2006 |  
|SoC                              |  | 45                 | % |  | 36              | %
|Analog Mixed Signal              |  | 31                 |   |  | 26              |  
|Memory                           |  | 1                  |   |  | 2               |  
|Diagnostics and Characterization |  | 4                  |   |  | 12              |  
|Service and Other                |  | 19                 |   |  | 24              |  
|                                 |  |                    |   |  |                 |  
|Total                            |  | 100                | % |  | 100             | %
|                                 |  |                    |   |  |                 |  

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



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|                             |  |                    |   |  |                 |  
|---------------------------- |  | ------------------ | - |  | --------------- | -
|                             |  | Three Months Ended |  
|                             |  | February 3,2007    |   |  | January 31,2006 |  
|North America                |  | 19                 | % |  | 42              | %
|Singapore                    |  | 32                 |   |  | 6               |  
|Taiwan                       |  | 10                 |   |  | 4               |  
|Southeast Asia               |  | 8                  |   |  | 8               |  
|Japan & rest of Asia Pacific |  | 11                 |   |  | 15              |  
|Germany                      |  | 13                 |   |  | 5               |  
|Europe & Middle East         |  | 7                  |   |  | 20              |  
|                             |  |                    |   |  |                 |  
|Total net sales              |  | 100                | % |  | 100             | %
|                             |  |                    |   |  |                 |  

For the three months ended February 3, 2007, one customer accounted for 43% of the
Companys net sales. For the three months ended January 31, 2006, two customers accounted for 23% and 16% of the Companys net sales.

For the three months ended February 3, 2007, one customer accounted for 41% of the Companys gross accounts receivable. As of January 31, 2006, three customers accounted for 22%, 17% and 15% of the
Companys gross accounts receivable.

As of February 3, 2007 and January 31, 2006, the majority of the Companys
long-lived assets were attributable to its United States operations.



|18. | Subsequent Event
|--- | ----------------

On February 28, 2007, the
Company entered into a Sale and Purchase Agreement to sell the property located at 1355 and 1421 California Circle, Milpitas (the Property). Pursuant to the Sale and Purchase Agreement, the Company entered into a lease agreement with the Buyer to
lease back the Property. The purchase price for the Property was $30,000, 000. The Company agreed to lease the Property from the buyer for a ten-year period. After the initial term, the Company enjoys four separate, successive renewal options to
extend the term of the lease for five year terms. The Company is obligated to pay minimum lease payments totaling approximately $27.8 million over the initial ten year period of the lease. To secure the performance by the Company of the obligations
under the lease, simultaneously with the execution of the lease, the Company delivered to buyer an unconditional and irrevocable letter of credit in the amount of $5,090,400 which letter of credit will expire no sooner than December 31, 2010
and which buyer will have the right to draw against in the event the Company defaults in any of its obligations under the lease; provided that the buyer will return the letter of credit to the Company upon the earlier of May 15, 2010 or the
Companys satisfaction of certain financial covenants and other conditions.

ITEM2. - MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

This quarterly report on Form 10-Q contains
forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements using terminology such as may,
will, expects, plans, anticipates, goals, estimates, potential, or continue, or the negative thereof or other comparable terminology regarding beliefs,
plans, expectations or intentions regarding the future. Forward-looking statements include statements regarding our revenue recognition practices regarding new products; the impact of the adoption of certain accounting pronouncements on the
Companys financial position, results of operations and cash flow; our belief that our sales, gross margins and operating results will fluctuate significantly in the future, our belief that our embedded software is incidental to our products;
our belief that our tax positions are consistent with the tax positions in the jurisdictions in which we conduct business; estimated future restructuring payments; our anticipation that net sales will be approximately $115 million to $118 million
for the second quarter of fiscal year 2007; our belief that gross margin percent could be flat to slightly higher in the second quarter of fiscal year 2007 compared to the first quarter of fiscal year 2007; ; our anticipation that R&D expenses
will increase 5% to 8% in the second quarter of fiscal year 2007 compared to the first quarter of fiscal 2007; our expectation that SG&A expenses will increase 5% to 8% in the second quarter of fiscal year 2007 compared to the first quarter of
fiscal 2007; our expectation that we will maintain a full valuation allowance on United States deferred assets until we can sustain an appropriate level of profitability; our expectation that we will not recognize any significant tax benefits in our
results of operations; domestic tax benefits; our belief that investment in inventory will continue to represent a significant portion of our working capital; the highly cyclical semiconductor industry which experiences downturns; our belief that
our current cash and investment positions combined with our ability to borrow funds will be sufficient to meet our anticipated business requirements for the next 12 months; the need to use derivatives; our expectation that a 10% change in interest
rate will have any material effect on our interest expense; our belief that our net sales and operating results will continue to fluctuate; our intention to introduce new products and product enhancements; our belief that our gross margins on
systems sales will continue to vary significantly; our expectation that our top ten customers in the aggregate will continue to account for a large portion of our net sales for the foreseeable future; our intent to outsource in the future and our
expectation that we will achieve operational flexibility and costs savings as a result of outsourcing; our belief that significant portions of our new orders are



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##### Table of Contents

dependent upon demand from semiconductor device manufacturers building or expanding fabrication facilities and new device testing requirements; our belief
that stock options and other long-term equity incentives directly motivate our employees to maximize long-term stockholder value and, through the use of vesting, encourage employees to remain with us; our belief that order cancellations and
customer-requested shipment delays will occur in the future; our belief that in the future some of our customers may place orders with us for more systems than they will ultimately require, or they will order a more rapid delivery than they will
ultimately require; our belief that we may continue to incur substantial unanticipated costs to increase feature sets in our systems; our belief that we may continue to suffer reduced orders, higher manufacturing costs, delay in collecting accounts
receivable and higher service, support and warranty expenses, and/or inventory write-offs, among other effects; our belief that the continued acceptance, volume production, timely delivery and customer satisfaction of our newer digital, mixed signal
and non-volatile memory testers is of critical importance to our future financial results; our success in developing new and enhanced systems and new features to our existing systems being dependent upon a variety of factors; our intent to continue
to devote significant resources to the development, enhancement, production and commercialization of new products and technologies; our belief that once a semiconductor manufacturer has selected a particular ATE vendors tester, the
manufacturer is likely to use that tester for a majority of its testing requirements for the market life of that semiconductor and subsequent generations of products; our belief that the ATE industry in total has not been profitable for the last
three years; our belief that we will continue to face significant additional competition from larger competitors that may offer product lines and services more complete than ours; our belief that to be competitive, we must expend significant
financial resources to invest in new product development and enhancements and to maintain customer service and support centers worldwide; the repatriation of our cash from these foreign subsidiaries to the United States and the incurrence of
additional income taxes from repatriation; our anticipation that international sales will continue to account for a significant portion of our total net sales in the foreseeable future; our intent to continue to address the need to develop new
products and enhance existing products through acquisitions of other companies, product lines, technologies and personnel; our expectation to continue to receive notice of patent infringement claims in the future; our expectation that we will incur
additional administrative expense as we implement Section 404 of the Sarbanes-Oxley Act; our expectation that the law, rules and regulations relating to corporate governance will continue to increase the scope, complexity and cost of our corporate
governance, reporting and disclosure practices and make it more difficult and more expense for us to obtain director and officer liability insurance; our belief that our ability to compete in the Automatic Test Equipment market depends upon our
ability to successfully develop and introduce new products and enhancements with enhanced features on a timely and cost-effective basis, including products under development internally as well as products obtained in acquisition; sales levels in
Taiwan; future minimum lease payments; minimum contractual cash obligations and the effect of such obligations in future periods; the highly competitive nature of the automatic test equipment industry which is subject to rapid technological change;
and our expectation regarding the recognition of stock-based compensation expense.

These forward-looking statements involve important
factors that could cause our actual results to differ materially from those in the forward-looking statements. Such important factors involve risks and uncertainties including, but not limited to difficulties in utilizing different technologies;
delays in bringing products to market due to development problems; difficulties in developing new engineering validation test systems; the possibility that our existing systems will become obsolete; excessively high costs in the future related to
enhancing our existing systems; significant changes in customer preferences; difficulties in integrating acquired technology with our product lines; the possibility that competitors will introduce products faster than us; unanticipated difficulties
in building close working relationships with vendors; difficulties in developing the Sapphire platform; less sales of the Sapphire platform products than anticipated; product defects sustained during the manufacturing process; the risk that we may
not be successful in obtaining new orders from major customers; unanticipated decreases in demand for our products in foreign countries; difficulties in providing extensive support to major customers; unanticipated difficulties in manufacturing and
delivering new products, enhancement tools; unanticipated difficulties in integrating our products with customers operations; unanticipated difficulties in integrating developed technology; substantial technological changes in the
semiconductor industry; a lack of the required resources to invest in the development of new products; uncertainties as to the current products provided by our competitors; unanticipated difficulties in locating and evaluating potential product
lines, technologies and business to acquire; the viability of legal claims brought against us; our failure to accurately predict the effect of the ultimate outcome of claims on our business, financial condition or results of



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operations; lower than expected revenues; the risk that we may be required to expend more cash in the future than anticipated; difficulties in obtaining
orders from manufacturers of semiconductors and companies that specialize in contract packaging and/or testing of semiconductors; the timing of orders; an unanticipated lack of resources to invest in property, plant and equipment, purchased and
leased facilities, inventory, personnel and other costs; changing market conditions in Taiwan; inaccuracies in our assumptions regarding our tax positions; uncertainties as to the nature and extent of any potential cyclical downturn in the
semiconductor industry; uncertainties as to the prospect of future orders and sales levels; changes in laws applicable to us regarding revenue recognition practices relating to our new products; uncertainties as to the future level of sales and
revenues; unanticipated budgetary constraints; uncertainties as to the assumptions underlying our calculations regarding estimated annual amortization expenses for purchased intangible assets; uncertainties as to the effects of the adoption by us of
certain accounting policies; the risk that our future working capital will not be sufficient to invest significant portions of such working capital in inventories; uncertainties as to the effect of the adoption of certain accounting pronouncements;
unanticipated difficulties in the remediation of internal control deficiencies; ability of the Company to maintain the requisite level of assets under its deferred compensation plan; increased fragmentation in the ATE industry; cost overruns,
delayed deliveries, shortages, quality issues or other problems resulting from outsourcing; and other factors set forth in Risk Factors and elsewhere herein. Reference is made to the discussion of risk factors detailed in our filings
with the Securities and Exchange Commission, including our reports on Form 10-K and 10-Q. All projections in this Quarterly Report on Form 10-Q are based on limited information currently available to us, which is subject to change. Although any such
projections and the factors influencing them will likely change, we will not necessarily update the information, since we are only to provide guidance at certain points during the year. Actual events or results could differ materially and no reader
of this Form 10-Q should assume that the information provided today would still be valid in the future. Such information speaks only as of the date of this Form 10-Q.

OVERVIEW

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

Major business developments during and subsequent to the three months ended
February 3, 2007 included:



| |  |  | Lavi A. Lev, with more than twenty years of experience in the design tool and semiconductor industries at companies including National Semiconductor, Intel, Sun
Microsystems, Silicon Graphics, MIPS Technologies and Cadence, was appointed president and chief executive officer, effective December 7, 2006.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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

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



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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which
have been prepared in accordance with United States generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues
and expenses, as well as the disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue recognition, allowance for doubtful accounts, inventory valuation and residual values
related to leased products, long-lived assets valuation, warranty accrual, deferred taxes, restructuring charges and stock-based compensation. We base our estimates on historical experience and on various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under
different assumptions or conditions. We discuss the development and selection of the critical accounting estimates with the audit committee of our board of directors on a quarterly basis, and the audit committee has reviewed our disclosure relating
to them in this Quarterly report on Form 10-Q.

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

Revenue Recognition:

Under Securities and Exchange Commissions Staff Accounting Bulletin No. 104, Revenue Recognition, (SAB 104), we
recognize revenue on the sale of semiconductor manufacturing equipment when title and risk of loss have passed to the customer, there is persuasive evidence of an arrangement, delivery has occurred or services have been rendered, the sales price is
fixed or determinable, collectibility is reasonably assured and customer acceptance criteria have been successfully demonstrated. Revenue recognition policies are applied consistently among our semiconductor manufacturing equipment product lines.
Product revenue is recognized upon shipment only when achieving the customer acceptance criteria can be demonstrated prior to shipment, which generally occurs with mature products. Revenue related to the fair value of the installation obligation is
recognized upon completion of the installation. Service revenues are generally recognized upon performance of the activities requested by the customers. Products are classified as mature after several different customers have accepted similar
systems. When the customer acceptance criteria cannot be demonstrated prior to shipment, revenue and the related cost of goods sold are deferred until customer acceptance. For some customers in certain countries where collection may be an issue, we
may require a letter of credit to be established or cash receipt in advance before revenue can be recognized. Lease revenue is recorded in accordance with Statement of Financial Accounting Standard No. 13, Accounting for Leases,
(SFAS No. 13), which requires that a lessor account for each lease by either the sales-type or operating method. Revenue from sales-type leases is recognized at the net present value of future lease payments. Revenue from operating leases is
recognized over the lease period.

During fiscal years 2006 and 2005, we introduced several new enhancements, systems and products. Certain
revenues from sales of these new enhancements, systems and products during fiscal years 2006 and 2005 were deferred until the revenue recognition requirements of our revenue recognition policy are satisfied. This practice will continue in the
future. In the past, we experienced significant delays in the introduction and acceptance of new testers as well as certain enhancements to our existing testers. Delays in introducing a product or delays in our ability to obtain customer acceptance,
if they occur in the future, will delay the recognition of revenue and gross profit by us.

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

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

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



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fundamentally enhance or expand the capability of the equipment with new or revised embedded software. In addition, the equipments principal
performance characteristics are governed by digital speed and pin count which are primarily a function of the hardware.

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

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

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

Allowance for Doubtful Accounts:

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

Inventory Valuation and Residual Values Related to Leased Products:

We evaluate our inventory levels and valuations based on our estimates and forecasts of the next cyclical period in our industry. These forecasts require
us to estimate our ability to sell current and future products in the next cyclical industry period and compare those estimates with our current inventory levels. If these forecasts or estimates change, or our product roadmaps change, then we would
need to adjust our assessment of the inventory valuations. Once inventories are written down, we carry that inventory at its reduced value until it is scrapped or otherwise disposed of.

We monitor our inventory levels in light of product development changes and expectations of the cyclical period ahead. During the four year period ended
October 31, 2006, we recorded a total of $144.7 million in write down of excess and obsolete inventories. We do not as a matter of course scrap all inventory that is identified as excess or obsolete. Our products are capital goods with
potentially long economic lives and, historically, the opportunity to sell these products has both risen and fallen unexpectedly. We have occasionally encountered unexpected demand for old products as well as the inability to transition customers to
newer products. We closely monitor the inventories that have been written down but not scrapped, so that if any sales of these items occur and affect our reported gross margins, the effect, if material, is disclosed. We may be required to take
additional charges for excess and obsolete inventory if a downturn causes further reductions to our current inventory valuations or if our current product development plans change.

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

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



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Long-Lived Asset Valuation:

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

We evaluate the carrying value of our long-lived assets, consisting primarily of purchased intangible assets, and property and equipment, in accordance
with SFAS 144, Accounting for the Impairment or Disposal for Long-Lived Assets, whenever certain events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable, or at least annually. Such
events or circumstances include, but are not limited to, a prolonged industry downturn, a significant decline in our market value, or significant reductions in projected future cash flows. In assessing the recoverability of our long-lived assets, we
compare the carrying value to the undiscounted future cash flows the assets are expected to generate. If the total of the undiscounted future cash flows is less than the carrying amount of the assets, we write down such assets based on the excess of
the carrying amount over the fair value of the assets. Fair value is generally determined by calculating the discounted future cash flows using a discount rate based upon our weighted average cost of capital. Significant judgments and assumptions
are required in the forecast of future operating results used in the preparation of the estimated future cash flows, including profit margins, long-term forecasts of the amounts and timing of overall market growth and our percentage of that market,
groupings of assets, discount rates and terminal growth rates. In addition, significant estimates and assumptions are required in the determination of the fair value of our tangible long-lived assets, including replacement cost, economic
obsolescence, and the value that could be realized in liquidation. Changes in these estimates could have a material adverse effect on the assessment of our long-lived assets, thereby requiring us to write down the assets. We make certain assessments
with respect to the determination of all identifiable assets to be used in the business as well as research and development activities as of an acquisition date. Each of these activities was evaluated by both interviews and data analysis to
determine our state of development and related fair value. The purchased intangibles consist of purchased technology, customer relations, trademarks, patents and non-compete agreements, and they typically have estimated useful lives of one to ten
years.

Warranty Accrual:

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

Deferred Taxes:

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

Our net deferred tax asset balance as of February 3, 2007 was $0.4 million which relates to taxable income generated at our foreign subsidiaries. Our domestic tax assets reflect a full valuation allowance due to
uncertainties surrounding our ability to generate future taxable income and our corresponding ability to utilize our deferred tax assets.

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

Restructuring Charges:

During previous years, we have recorded restructuring charges as we
rationalized operations in light of customer demand declines and economic downturns. These measures, which included major changes in senior management, workforce reduction, facilities consolidation and changes to the strategic focus of a number of
sites, were largely intended to align our capacity and infrastructure to anticipate customer demand and to transition our operations to lower cost regions. The restructuring charges include employee severance and benefit costs, write-offs of
property and equipment and costs related to leased facilities vacated and subleased. Severance and benefit costs and other costs associated with restructuring activities were recorded in accordance with Statement of Financial Accounting Standard
No. 146, Accounting for Costs Associated with Exit or Disposal Activities, (SFAS 146). We also record severance and benefit costs in accordance with Statement of Financial Accounting Standard No. 112, Employers
Accounting for Post Employment Benefits, (SFAS 112), as we conclude that (a) we have a substantive post



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employment benefit obligation that is attributed to prior services rendered, (b) rights to those benefits have vested, and (c) payment is probable
and the amount can be reasonably estimated. The current accounting for restructuring costs requires us to record provisions and charges when we have a formal and committed restructuring plan.

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

Stock-Based Compensation:

In December 2004, the FASB issued Statement of Financial Accounting Standard No. 123(R), Share Based Payment, (SFAS 123(R)). This
statement requires that the cost resulting from all share-based payment transactions be recognized in the consolidated financial statements. In March 2005, the Securities and Exchange Commission (SEC) released SEC Staff Accounting
Bulletin No. 107, Share-Based Payment (SAB No. 107). SAB No. 107 provides the SECs staffs position regarding the application of SFAS No. 123(R) and certain SEC rules and regulations,
and also provides the staffs views regarding the valuation of share-based payment arrangements for public companies. We adopted SFAS 123(R), utilizing the modified prospective method and will continue to evaluate the impact of
SFAS 123(R) on our operating results and financial condition. Our assessment of the estimated compensation charges is affected by our stock price as well as assumptions regarding a number of complex and subjective variables and the related tax
impacts. These variables include, but are not limited to, our stock price volatility and employee stock option exercise behaviors. See Note 6 Stock-Based Compensation of the Notes to the consolidated financial statements for further
discussion.

We estimate the fair value of options granted using the Black-Scholes-Merton option valuation model and the assumptions
discussed in Note 6, Stock-Based Compensation, of the consolidated financial statements. We estimate the expected term of options granted based on historical experience of similar awards, giving consideration to the contractual terms of
the stock-based awards, vesting schedules and expectations of future employee behavior. We estimate the volatility of our common stock at the date of grant based on a combination of historical and implied volatilities, consistent with SFAS 123(R)
and SEC SAB No. 107. Prior to the adoption of SFAS 123(R), we relied exclusively on the historical prices of our common stock in the calculation of expected volatility. We base the risk-free interest rate that we use in the Black-Scholes-Merton
option valuation model on the implied yield in effect at the time of option grant. We have never paid any cash dividends on our common stock and we do not anticipate paying any cash dividends in the foreseeable future. Consequently, we use an
expected dividend yield of zero in the Black-Scholes-Merton option valuation model. We use historical data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest. For
options granted before November 1, 2005, we estimated the fair value using the multiple option approach and we are amortizing the fair value on a graded vesting basis. For options granted on or after November 1, 2005, we estimate the fair
value using a single option approach and amortize the fair value on a straight-line basis. All options are amortized over the requisite service periods of the awards, which are generally the vesting periods. We may elect to use different assumptions
under the Black-Scholes-Merton option valuation model in the future if our current experience indicates that a different measure is preferable, which could materially affect our net income or loss and net income or loss per share.

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

RESULTS OF OPERATIONS

The following table sets forth items from the unaudited condensed consolidated statements of operations as a percentage of net sales for the periods indicated:



|                                                                |  |                    |    |  |                 |   
|--------------------------------------------------------------- |  | ------------------ | -- |  | --------------- | --
|                                                                |  | Three Months Ended |   
|                                                                |  | February 3,2007    |    |  | January 31,2006 |   
|Net sales                                                       |  | 100.0              | %  |  | 100.0           | % 
|Cost of goods sold                                              |  | 56.7               |    |  | 54.0            |   
|                                                                |  |                    |    |  |                 |   
|Gross margin                                                    |  | 43.3               |    |  | 46.0            |   
|Operating expenses                                              |  |                    |    |  |                 |   
|Research and development                                        |  | 17.8               |    |  | 20.4            |   
|Selling, general and administrative                             |  | 21.7               |    |  | 23.6            |   
|Amortization of purchased intangibles and deferred compensation |  | 3.8                |    |  | 3.6             |   
|Restructuring charges                                           |  | 0.4                |    |  | 0.3             |   
|                                                                |  |                    |    |  |                 |   
|Total operating expenses                                        |  | 43.7               |    |  | 47.9            |   
|                                                                |  |                    |    |  |                 |   
|Operating loss                                                  |  | (0.4               | )  |  | (1.9            | ) 
|                                                                |  |                    |    |  |                 |   
|Net loss                                                        |  | (0.0               | )% |  | (3.4            | )%
|                                                                |  |                    |    |  |                 |   



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Net sales consist of revenues from systems sales, upgrades, spare parts sales, maintenance contracts and
lease income. Net sales were $118.8 million for the three months ended February 3, 2007 representing a decrease of 2.5% from sales of $121.8 million during the three months ended January 31, 2006. The decrease in net sales was due to
delays in customer acceptance of our Diagnostics and Characterization products and declines in our service business. Sustainability of our revenue levels is dependent upon the economic and geopolitical climate as well as other risks described under
the title Risk Factors herein. We anticipate net sales will be approximately $115.0 million to $118.0 million for the second quarter of fiscal year 2007.

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



|                                 |  |                    |   |  |                 |  
|-------------------------------- |  | ------------------ | - |  | --------------- | -
|                                 |  | Three Months Ended |  
|                                 |  | February 3,2007    |   |  | January 31,2006 |  
|SoC                              |  | 45                 | % |  | 36              | %
|Analog Mixed Signal              |  | 31                 |   |  | 26              |  
|Memory                           |  | 1                  |   |  | 2               |  
|Diagnostics and Characterization |  | 4                  |   |  | 12              |  
|Service                          |  | 19                 |   |  | 24              |  
|                                 |  |                    |   |  |                 |  
|Total                            |  | 100                | % |  | 100             | %
|                                 |  |                    |   |  |                 |  

For the three months ended February 3, 2007, net sales from our SoC and analog mixed signal
increased 4.8% to $172.3 million from $164.4 million in the three months ended January 31, 2006. This increase resulted primarily from increased sales of our Sapphire, ASL3000RF and D-10 products. Combined net sales from our Diagnostics and
Characterization product line and our service business decreased 38.5% to $27.7 million during the three months ended February 3, 2007 from $45.1 million during the three months ended January 31, 2006.

International net sales accounted for approximately 81% and 58% of total net sales in the three months ended February 3, 2007 and January 31,
2006, respectively. Our net sales to the Asia Pacific region accounted for approximately 60% and 54% of total net sales in the three months ended February 3, 2007 and January 31, 2006, respectively. The demand for automated test and
engineering capital equipment in Asian markets historically has been highly volatile, and in some Asian regions there has been geopolitical unrest, both of which have resulted in economic instabilities. These potential economic instabilities could
materially adversely affect demand for our products.

Gross Margin

Our gross margin has been and will continue to be affected by a variety of factors, including manufacturing efficiencies, excess and obsolete inventory write downs, sell through of previously written down inventory,
pricing by competitors or suppliers, new product introductions, product sales mix, production volume, customization and reconfiguration of systems, international and domestic sales mix and field service margins. Our gross margin as a percentage of
net sales decreased to 43.4% during the three months ended February 3, 2007 from 45.7% during the months ended January 31, 2006. The decrease in gross margins was primarily due to a less favorable product mix, specifically lower
Diagnostics and Characterization sales and higher service freight costs. Gross margin for the three months ended February 3, 2007 and January 31, 2006 include $0.1 million, respectively, of stock-based compensation expense on our costs of
sales related to employee stock options and employee stock purchases under SFAS 123(R). In addition, our gross margin benefited by approximately $0.4 million or 0.8% and $0.4 million or 0.7% from the sale of fully reserved inventory during the three
months ended February 3, 2007 and January 31, 2006, respectively. We believe gross margin percent could be flat to slightly higher in the second quarter of fiscal year 2007 compared to the first quarter of fiscal year 2007.

Research and Development

Research and development,
or R&D, expenses were $21.2 million in the three months ended February 3, 2007, representing a decrease of 12.3% from $24.1 million in the three months ended January 31, 2006. The decrease in expenses in the three months ended
February 3, 2007 resulted primarily from a $2.5 million decrease in compensation expenses due to previous headcount reductions and a $0.5 million decrease in maintenance costs. The decrease in R&D expenses was offset by increases in
stock-based compensation expenses of $0.4 million and $0.3 million related to employee stock options and employee stock purchases under SFAS 123(R) that were charged to R&D in the three months ended February 3, 2007 and January 31,
2006, respectively. R&D expenses as



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a percentage of net sales were 17.8% and 20.4% in the three months ended February 3, 2007 and January 31, 2006, respectively. The decrease in
R&D expenses as a percentage of net sales was primarily attributable to lower expenses. We anticipate that R&D expenses will increase 5% to 8% in the second quarter of fiscal year 2007 compared to first quarter of fiscal 2007.

Selling, General and Administrative

Selling, general
and administrative, or SG&A, expenses were $25.8 million in the three months ended February 3, 2007, representing a decrease of 11.8% from $29.3 million in the three months ended January 31, 2006. The decrease was primarily due to the
reduction of compensation expenses of $1.4 million due to previous headcount reductions, a decrease in commissions of $0.8 million, a decrease in travel expenses of approximately $0.2 million, a decrease in depreciation expense of $0.3 million, a
decrease in marketing expenses of $0.1 million, a decrease in facilities and supplies expenses of $0.4 million, a reduction of consigned inventory expenses of $0.5 million and release of allowance for doubtful accounts of $0.8 million due to
collections of past due trade receivables. The decrease was offset by increases in consulting costs of $0.7 million, increases in compliance fees of $0.6 million and increases in stock-based compensation expense of $0.6 million. As a percentage of
net sales, SG&A expenses were 21.8% and 23.6% in the three months ended February 3, 2007 and January 31, 2006, respectively. The decrease in SG&A expenses as a percentage of net sales is primarily attributable to lower SG&A
expenses. We anticipate that SG&A expenses will increase 5% to 8% in the second quarter of fiscal year 2007 compared to first quarter of fiscal 2007.

Amortization of Purchased Intangibles

Amortization of purchased intangible assets expenses were $4.5 million and $4.3
million in the three months ended February 3, 2007 and January 31, 2006, respectively. The increase in amortization of purchased intangible assets in the three months ended February 3, 2007 is due primarily to purchased intangible
assets resulting from our Hypervision, Inc. acquisition in the third quarter of fiscal year 2006.

Restructuring Charges

During the three months ended February 3, 2007 and January 31, 2006, we recorded a restructuring charge of approximately $0.5 million and $0.3
million for severance charges related to headcount reductions and facility consolidation related expenses.

Interest Income

We generated interest income of $1.2 million and $0.9 million in the three months ended February 3, 2007 and January 31, 2006, respectively. The
increase in the three months ended February 3, 2007 was primarily due to higher average cash balances compared to the three months ended January 31, 2006.

Interest Expense

Interest expenses were $1.2 million and $0.7 million for the three months ended
February 3, 2007 and January 31, 2006, respectively. The increase in interest expense was primarily due to interest on our 3.5% New Notes with a principal aggregate amount of $122.5 million as well as interest on the note payable that
resulted from the lease buyout in July of fiscal year 2006.

Other Income (Expenses), Net

Other income (expenses), net was $2.5 million of income and $0.3 million of expenses for the three months ended February 3, 2007 and January 31,
2006, respectively. The net change to other income the three months ended February 3, 2007 from other net expense in the three months ended January 31, 2006 was primarily due to a gain of $3.0 million in the convertible notes exchange and
a gain on a favorable change in foreign currency valuation of $0.8 million offset by a loss on the sale of our Oregon real property of $0.9 million.

Income Taxes

We recorded an income tax provision of $2.0 million and $1.6 million for the three months ended
February 3, 2007 and January 31, 2006, respectively. The income tax expense for the periods consists primarily of foreign tax on earnings generated in foreign jurisdictions.

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



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Stock Options and Incentive Plan

We have a stock-based compensation program that provides our Board of Directors broad discretion in creating employee equity incentives. This program includes incentive and non-statutory stock options granted under
various plans, the majority of which are stockholder approved. Stock options are generally time-based, typically vesting 25% on each annual anniversary of the hire date over four years and expiring seven years from the grant date. Additionally, we
have an Employee Stock Purchase Plan (ESPP) that allows employees to purchase shares of common stock at 85% of the fair market value at the lower of either the date of enrollment or the date of purchase. Shares issued as a result of stock option
exercises and our ESPP are generally from our new shares. As of February 3, 2007, we had approximately 3.1 million shares of common stock reserved for future issuance under the stock option plans and ESPP.

On November 1, 2005, we adopted the provision of Statement of Financial Accounting Standard No. 123(R) (SFAS 123(R)), Share-Based
Payment, for our share-based compensation plans. Under SFAS 123(R), we are required to recognize stock-based compensation costs based on the estimated fair value at the grant date for our share-based awards. We previously accounted for our
employee stock option and employee stock purchase plans (ESPP) under the intrinsic value recognition and measurement principles of Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to
Employees, and related Interpretations, and adopted the disclosure-only provisions of Statement of Financial Accounting Standard No. 123, Accounting for Stock-Based Compensation, (SFAS 123), as amended by Statement of
Financial Accounting Standard No. 148, Accounting for Stock-Based Compensation  Transition and Disclosures, (SFAS 148).

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

As a result of adopting SFAS 123(R), our loss before income taxes and net loss for the three months ended January 31, 2006 was $1.0
million higher than if we had continued to account for share-based compensation under APB 25. Basic and diluted net loss per share for the three months ended January 31, 2006 would have been $0.03 if we had not adopted SFAS 123(R), compared to
the reported basic and diluted net loss per share of $0.04. There was no effect on the unaudited consolidated statements of cash flows from adopting SFAS 123(R).

Prior to the adoption of SFAS 123(R), in August 2005, our Board of Directors approved the accelerated vesting of certain unvested and out-of-the-money non-qualified stock options previously awarded to
employees and officers with option exercise prices equal to or greater than $9.15. Options held by non-employee directors were excluded from the vesting acceleration. In addition, in order to prevent executive officers from unintended personal
benefits, our executive officers agreed to the imposition of restrictions on any shares received through the exercise of accelerated options. Those restrictions prevent the sale of any shares received from the exercise of an accelerated option until
the earlier of the original vesting date of the option or the executive officers termination of employment. The $9.15 price was selected because it was higher than the closing price of our common stock of $8.84 on August 29, 2005, the
date of this acceleration. The accelerated options represented approximately 15 percent or approximately 2.8 million shares of the total of all outstanding options on August 29, 2005. The acceleration was intended to reduce the stock
option expense we would be required to record after the adoption of SFAS 123(R).

At February 3, 2007, there was $12.2 million of
unrecognized stock-based compensation expense related to non-vested options that is expected to be recognized over a weighted-average period of 3.1 years. At February 3, 2007, there was $0.3 million of unrecognized stock-based compensation
expense related to outstanding ESPP shares that is expected to be recognized over a month period.

See our stock-based compensation
discussion in Note 6 Stock-Based Compensation of the Notes to the unaudited condensed consolidated financial statements for further discussion.

LIQUIDITY AND CAPITAL RESOURCES

In the three months ended February 3, 2007, net cash provided by operating activities
was $1.2 million. The net cash flows used in operating activities for the three months ended February 3, 2007 were due to increases in working capital of $11.0 million and a gain on convertible notes exchanged of $3.0 million, offset by
depreciation and amortization of $12.6 million, non-cash charges related to provision for inventory write-downs of $0.3 million, stock-based compensation expense related to employee stock options and employee stock purchases under SFAS 123(R) of
$1.8 million and the loss on the sale of the Oregon real property of $0.9 million.

Net cash provided by investing activities was $2.4
million during the three months ended February 3, 2007, primarily attributable to proceeds from the sale of the Oregon real property of $2.7 million offset by $0.3 million used to purchase property and equipment to support our business.



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Net cash provided by financing activities was $44.1 million during the three months ended
February 3, 2007. The cash provided by financing activities was attributable to the issuance of New Notes.

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

On December 20, 2006, we completed the exchange of an aggregate principal amount of $72.5 million of our 1.5% Convertible Subordinated Notes due in
May 2008 for a new series of 3.5% Convertible Senior Subordinated Notes (the New Notes) due in May 2010, as well as the issuance of additional New Notes with an aggregate principal amount of $50.0 million in a private placement. The New Notes are
unsecured obligations and are subordinated to all our present and future senior indebtedness. Interest is payable semiannually on May 15 and November 15, commencing May 15, 2007. The New Notes contain net share settlement provisions
that require us, upon conversion of the New Notes, to pay holders in cash up to the principal amount of the converted New Notes. Any amount in excess of the converted principal will be settled in shares of our common stock, or at our option, cash.
See Note 9 Convertible Subordinated Notes of the Notes to the unaudited condensed consolidated financial statements for further discussion.

As of February 3, 2007, we had working capital of $209.9 million, including cash and short-term investments of $150.1 million, and accounts receivable and inventories totaling $170.9 million. We believe that
because of the relatively long manufacturing cycles of many of our testers and the new products we presently offer and plan to introduce, investments in inventories will continue to represent a significant portion of our working capital. The
semiconductor industry has historically been highly cyclical and has experienced downturns, which have had a material adverse effect on the semiconductor industrys demand for automatic test equipment, including equipment we manufacture and
market. In addition, the automatic test equipment industry is highly competitive and subject to rapid technological change. It is reasonably possible that events related to these factors may occur in the near term, which would cause a change to our
estimate of the net realizable value of receivables, inventories or other assets, and the adequacy of accrued liabilities.

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

We lease some of our facilities and equipment under operating leases that expire periodically through 2013. The approximate future minimum lease payments at February 3, 2007 are as follows (in thousands):



|                         |  |                                |       |                                             |   |                                    |  |   |      
|------------------------ |  | ------------------------------ | ----- | ------------------------------------------- | - | ---------------------------------- |  | - | -----
|                         |  | Committed Gross Lease Payments |       | Leases Written Off in Restructuring
Charges |   | Net Estimated Future Lease Expense
|Remainder of fiscal 2007 |  | $                              | 2,554 |                                             | $ | 60                                 |  | $ | 2,494
|2008                     |  |                                | 2,181 |                                             |   | 52                                 |  |   | 2,129
|2009                     |  |                                | 1,384 |                                             |   |                                   |  |   | 1,384
|2010                     |  |                                | 494   |                                             |   |                                   |  |   | 494  
|2011                     |  |                                | 264   |                                             |   |                                   |  |   | 264  
|Thereafter               |  |                                | 462   |                                             |   |                                   |  |   | 462  
|                         |  |                                |       |                                             |   |                                    |  |   |      
|                         |  | $                              | 7,339 |                                             | $ | 112                                |  | $ | 7,227
|                         |  |                                |       |                                             |   |                                    |  |   |      

The following summarizes our minimum contractual cash obligations and other commitments at
February 3, 2007, and the effect of such obligations in future periods (in thousands):



|                                               |  |       |         |                        |   |        |  |      |        |      |   |       |  |            |         |  |   |     |  |   |    
|---------------------------------------------- |  | ----- | ------- | ---------------------- | - | ------ |  | ---- | ------ | ---- | - | ----- |  | ---------- | ------- |  | - | --- |  | - | ---
|                                               |  | Total |         | Remainderof Fiscal2007 |   | 2008   |  | 2009 |        | 2010 |   | 2011  |  | Thereafter
|Contractual Obligations:                       |  |       |         |                        |   |        |  |      |        |      |   |       |  |            |         |  |   |     |  |   |    
|Facilities and equipment operating leases (1)  |  | $     | 7,339   |                        | $ | 2,554  |  | $    | 2,181  |      | $ | 1,384 |  | $          | 494     |  | $ | 264 |  | $ | 462
|Convertible subordinated notes (2)             |  |       | 195,000 |                        |   |       |  |      | 72,500 |      |   |      |  |            | 122,500 |  |   |    |  |   |   
|Interest on convertible subordinated notes     |  |       | 15,557  |                        |   | 4,031  |  |      | 4,922  |      |   | 4,287 |  |            | 2,317   |  |   |    |  |   |   
|Open non-cancelable purchase order commitments |  |       | 83,519  |                        |   | 67,830 |  |      | 15,241 |      |   | 58    |  |            | 390     |  |   |    |  |   |   
|                                               |  |       |         |                        |   |        |  |      |        |      |   |       |  |            |         |  |   |     |  |   |    
|Total contractual cash obligations             |  | $     | 301,415 |                        | $ | 74,415 |  | $    | 94,844 |      | $ | 5,729 |  | $          | 125,701 |  | $ | 264 |  | $ | 462
|                                               |  |       |         |                        |   |        |  |      |        |      |   |       |  |            |         |  |   |     |  |   |    

---

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

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



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Some of the components that we purchase are unique to us and must be purchased in relatively high minimum
quantities with long (four and five month) lead times. These business circumstances can lead us to hold relatively high inventory levels giving rise to associated risks. In addition, purchase commitments for unique components often are relatively
inflexible in their deferral or cancellation terms. At February 3, 2007, we had open and committed non-cancelable purchase orders totaling approximately $83.5 million. The contractual cash obligations and commitments table presented above
contains our minimum obligations at February 3, 2007 under these arrangements and others. Actual expenditures will vary based on the volume of transactions and the length of contractual service provided. In addition to minimum spending
commitments, certain of these arrangements provide for charges in the event of cancellation.

As of February 3, 2007, our principal
sources of liquidity consisted of approximately $142.9 million of cash and cash equivalents and short-term investments of $7.2 million.

RECENT
ACCOUNTING PRONOUNCEMENTS

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

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

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

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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



|                       |  |                        |         |   |                        |   |         |                                                           |  |   |         |   |  |      |       |   |      |   |            |   |  |   |   |  |   |  
|---------------------- |  | ---------------------- | ------- | - | ---------------------- | - | ------- | --------------------------------------------------------- |  | - | ------- | - |  | ---- | ----- | - | ---- | - | ---------- | - |  | - | - |  | - | -
|                       |  |                        |         |   |                        |   |         | Future maturities of investments held at February 3, 2007
|                       |  | BalanceOctober 31,2006 |         |   | BalanceFebruary 3,2007 |   |         | 2007                                                      |  |   | 2008    |   |  | 2009 |       |   | 2010 |   | Thereafter
|Cash equivalents       |  |                        |         |   |                        |   |         |                                                           |  |   |         |   |  |      |       |   |      |   |            |   |  |   |   |  |   |  
|Amounts                |  | $                      | 95,635  |   |                        | $ | 142,930 |                                                           |  | $ | 142,930 |   |  |      |      |   |      |   |           |   |  |   |  |  |   | 
|Average rate           |  |                        | 3.62    | % |                        |   | 4.30    | %                                                         |  |   | 4.30    | % |  |      |      |   |      |   |           |   |  |   |  |  |   | 
|Short-term investments |  |                        |         |   |                        |   |         |                                                           |  |   |         |   |  |      |       |   |      |   |            |   |  |   |   |  |   |  
|Amounts                |  | $                      | 7,177   |   |                        | $ | 7,179   |                                                           |  | $ | 1,198   |   |  | $    | 3,985 |   |      | $ | 1,996      |   |  |   |  |  |   | 
|Average rate           |  |                        | 5.04    | % |                        |   | 5.04    | %                                                         |  |   | 5.00    | % |  |      | 4.88  | % |      |   | 5.38       | % |  |   |  |  |   | 
|                       |  |                        |         |   |                        |   |         |                                                           |  |   |         |   |  |      |       |   |      |   |            |   |  |   |   |  |   |  
|Total investment       |  | $                      | 102,812 |   |                        | $ | 150,109 |                                                           |  | $ | 144,128 |   |  | $    | 3,985 |   |      | $ | 1,996      |   |  | $ |  |  | $ | 
|Average rate           |  |                        | 3.72    | % |                        |   | 4.34    | %                                                         |  |   | 4.31    | % |  |      | 4.88  | % |      |   | 5.38       | % |  |   |  |  |   | 

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



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The sensitivity analysis model used by us for interest rate exposure compares interest income on current
investment interest rates versus current investment levels at current interest rates with a 10% increase. Based on this model, a 10% increase or decrease would result in an increase or a decrease in interest income of approximately $0.2 million.
There can be no assurances that the above projected interest rate increase will materialize. Fluctuations of interest rates are beyond our control.

Foreign Exchange

We generate a significant portion of our sales from customers located outside the United States,
principally in Asia and, to a lesser extent, Europe. International sales are made mostly to foreign distributors and some foreign subsidiaries and are typically denominated in U.S. dollars, but occasionally are denominated in the local currency for
European and Japanese customers. The subsidiaries also incur most of their expenses in the local currencies. Our automotive product line is developed and manufactured in Germany and thus, those expenses are Euro based. Accordingly, some of our
foreign subsidiaries use the local currency as their functional currency. Foreign currency (losses) gains were approximately $0.3 million and $(0.4) million for the three months ended February 3, 2007 and January 31, 2006, respectively.

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

Interest Rate
Risk

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

ITEM 4.  CONTROLS AND PROCEDURES

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

Changes in Internal Control over Financial Reporting. There was no change in our internal control over financial reporting during the three months
ended February 3, 2007 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II.  OTHER INFORMATION



|Item 1. | Legal Proceedings.
|------- | ------------------

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



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Item 1A. Risk Factors.

RISK FACTORS

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

LOGO

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



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



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



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



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



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



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



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



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



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



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



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



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



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



| |  |  | the proportion of our direct sales and sales through third parties, including distributors and OEMs, the mix of products sold, the length of manufacturing and sales
cycles, and product discounts; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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

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



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



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



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



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



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



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



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



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



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



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



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



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

New and enhanced products typically have lower gross margins in their early stages of commercial introduction and production, and we may build substantial finished goods inventories of such new products. If delays in
or cancellations of orders for those products occur, it may require a future inventory write-down, which would negatively affect our future financial performance. Although we have recorded and continue to record inventory write-downs, product
warranty costs, and deferred revenue, we cannot be certain that our estimates will be adequate.

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

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

Over time, we have expanded our base of
customers; however, a large portion of our net sales are generated from a small number of key customers. In particular, one customer, Advanced Micro Devices, Inc. accounted for 43% of our net sales for the three months ended February 3, 2007.
Our top ten customers accounted for 79%, 65% and 66% of our net sales for the three months ended February 3, 2007, fiscal years 2006 and 2005, respectively. We expect that our top ten customers in the aggregate will continue to account for a
large portion of our net sales for the foreseeable future, and the loss of one or more of these customers or collaborative



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partners or material reductions in capital spending by one or more of these customers or collaborative partners would harm our business and operating
results. The loss of a significant customer could also be perceived as a loss of momentum in our business and an adverse impact on our financial results, and this may cause the market price of our common stock to fall.

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

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

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

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

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

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

The semiconductor industry is cyclical.

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

As a result of the cyclical nature of the semiconductor industry, we have experienced shipment delays, delays in
commitments and restructured purchase orders by customers and we expect this activity to continue. Accordingly, we cannot be certain that we will be able to achieve or maintain our current or prior level of sales or rate of growth. We anticipate
that a significant portion of new orders may depend upon demand from semiconductor device manufacturers building or expanding fabrication facilities and new device testing requirements that are not addressable by currently installed test equipment,
and there can be no assurance that such demand will develop to a significant degree, or at all. In addition, our business, financial condition or results of operations may continue to be materially adversely affected by any factor materially
adversely affecting the semiconductor industry in general or particular segments within the semiconductor industry.



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

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

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

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

For example, since our inception, we have used stock
options and other long-term equity incentives as a fundamental component of our employee compensation packages. We believe that stock options and other long-term equity incentives directly motivate our employees to maximize long-term stockholder
value and, through the use of vesting, encourage employees to remain with Credence. The FASB issued changes to U. S. GAAP that requires us to record a charge to earnings for new and unvested employee stock option grants beginning on November 1,
2005. This regulation has made it more expensive to grant stock options to employees and has negatively impacted our reported earnings by $1.7 million and $3.3 million for the three months ended February 3, 2007 and fiscal year 2006,
respectively.

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

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

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

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

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

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

We have in the past experienced significant delays in the development, introduction,
volume production and sales of our new systems and related feature enhancements. These delays related to our inability to successfully complete product hardware engineering



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within the time frame originally anticipated, including design errors and redesigns of ICs. As a result, some customers have experienced significant delays
in receiving and using our testers in production. Delays in introducing a product or delays in our ability to obtain customer acceptance, if they occur in the future, will delay the recognition of revenue and gross profit by us. We cannot be certain
that these or additional difficulties will not continue to arise or that delays will not continue to materially adversely affect customer relationships and future sales. Moreover, we cannot be certain that we will not encounter these or other
difficulties that could delay future introductions or volume production or sales of our systems or enhancements. In the past, we have incurred and we may continue to incur substantial unanticipated costs to increase feature sets in our systems. If
our systems experience reliability, quality or other problems, or the market perceives our products to be feature deficient, we may continue to suffer reduced orders, higher manufacturing costs, delay in collecting accounts receivable and higher
service, support and warranty expenses, and/or inventory write-offs, among other effects. Our failure to have a competitive test system available when required by a customer could make it substantially more difficult for us to sell testers to that
customer for a number of years. We believe that the continued acceptance, volume production, timely delivery and customer satisfaction of our newer digital and mixed signal testers are of critical importance to our future financial results. As a
result, our inability to correct any technical, reliability, parts shortages or other difficulties associated with our systems or to manufacture and ship the systems on a timely basis to meet customer requirements could damage our relationships with
current and prospective customers and would continue to materially adversely affect our business, financial condition and results of operations. In addition, the consolidation of our manufacturing operations in a single site exposes us to the
increased risk of manufacturing delays or disruption in the event of natural disasters or other calamities at the site. Any delays or disruptions could materially adversely affect our business, financial condition and results of operations.

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

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



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



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



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



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



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



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



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

Because we must make new product development commitments well in advance of sales, new product decisions must anticipate both future demand and the availability of technology to satisfy that demand. We cannot be certain that we will be
successful in selecting, developing, manufacturing and marketing new hardware products or enhancements. Our inability to introduce new products that contribute significantly to net sales, gross margins and net income would have a material adverse
effect on our business, financial condition and results of operations. New product or technology introductions by our competitors could cause a decline in sales or loss of market acceptance of our existing products. If we introduce new products,
existing customers may curtail purchases of the older products resulting in inventory write-offs and they may delay new product purchases. In addition, capacity utilization at outsourced assembly and test houses, while improving, continues at low
levels that is likely to depress our non-integrated device manufacturers, or non-IDM business until such time that demand and supply conditions improve. Any decline in demand for our hardware products could have a material adverse effect on our
business, financial condition or results of operations.

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

We are currently devoting and intend to continue to devote significant resources to the development, enhancement, production and commercialization of new products and technologies. During fiscal years 2006 and 2005, we introduced several
enhancements as well as new products that are evolutions or derivatives of existing products as well as products that were largely new. Under our revenue recognition policy adopted in accordance with Staff Accounting Bulletin No. 104,
Revenue Recognition, (SAB 104) we defer revenue for transactions that involve newly introduced products or when customers specify acceptance criteria that cannot be demonstrated prior to the shipment. This results in a delay in the
recognition of revenue as compared to the historic norm of recognizing revenue upon shipment. Product introduction delays, if they occur in the future, will delay the recognition of revenue and



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gross profit and may result in delayed cash receipts by us that could materially adversely affect our business, financial condition and results of
operations. We invested and continue to invest significant resources in property, plant and equipment, purchased and leased facilities, inventory, personnel and other costs to begin or prepare to increase production of these products. A significant
portion of these investments will provide the marketing, administration and after-sales service and support required for these new products. Accordingly, we cannot be certain that gross profit margin and inventory levels will not continue to be
materially adversely affected by delays in new product introductions or start-up costs associated with the initial production and installation of these new product lines. We also cannot be certain that we can manufacture these systems per the time
and quantity required by our customers. The start-up costs include additional manufacturing overhead, additional inventory and warranty reserve requirements and the enhancement of after-sales service and support organizations. In addition, the
increases in inventory on hand for new product development and customer support requirements have increased and will continue to increase the risk of significant inventory write-offs. We cannot be certain that our net sales will increase or remain
at historical levels or that any new products will be successfully commercialized or contribute to revenue growth or that any of our additional costs will be covered.

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

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

We face substantial competition from ATE manufacturers throughout the world. A substantial portion of our net sales is derived from sales of mixed-signal testers. We face in some cases seven and in other cases nine
competitors in our primary market segments of digital, mixed signal, and RF wireless ATE. We believe that the ATE industry in total has not been profitable for the last three years, indicating a very competitive and volatile marketplace. Several of
these competitors have substantially greater financial and other resources with which to pursue engineering, manufacturing, marketing and distribution of their products. In addition, three of our competitors recently completed initial public
offerings. The success of these companies could make the competitive environment substantially more severe. Certain competitors have introduced or announced new products with certain performance or price characteristics equal or superior to products
we currently offer. These competitors have introduced products that compete directly against our products. We believe that if the ATE industry continues to consolidate through strategic alliances or acquisitions, we will continue to face significant
additional competition from larger competitors that may offer product lines and services more complete than ours. Our competitors are continuing to improve the performance of their current products and to introduce new products, enhancements and new
technologies that provide improved cost of ownership and performance characteristics. New product introductions by our competitors could cause a decline in our sales or loss of market acceptance of our existing products.

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

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

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

We rely on Spirox Corporation and customers in Taiwan for a significant portion of our revenues and the termination of this distribution relationship
would materially adversely affect our business.

Spirox Corporation, a distributor in Taiwan that sells to end-user customers in Taiwan
and China, accounted for approximately 10%, 13% and 14% of our net sales in the three months ended February 3, 2007 and fiscal years ended October 31, 2006 and 2005, respectively. Our agreement with Spirox has no minimum purchase
commitment and can be terminated for any reason on 180 days



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prior written notice. On May 31, 2005, we entered into an agreement with Spirox to combine our Taiwan operation with Spiroxs T1 division into a
corporation named Credence Spirox Integration Corporation, an operation owned 90% by Spirox and 10% by us. This corporation is dedicated to supporting our products in the Taiwan region. Consequently, our business, financial condition and results of
operations could be materially adversely affected by the loss of or any reduction in orders by Spirox, any termination of the Spirox relationship, or the loss of any significant Spirox customer, including the potential for reductions in orders by
assembly and tester service companies due to technical, manufacturing or reliability problems with our products or continued slow-downs in the semiconductor industry or in other industries that manufacture products utilizing semiconductors. Our
ability to maintain or increase sales levels in Taiwan will depend upon:



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



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



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



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



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



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

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

As of February 3, 2007, we had $72.5 million principal amount of 1.5% Convertible Subordinated Notes, or 1.5% Notes, due in May 2008 and $122.5
million principal amount of 3.50% Convertible Senior Subordinated Notes, due 2010 (the New Notes). The New Notes contain net share settlement provisions which require that, upon conversion of the New Notes, we will pay holders in cash up to the
principal amount of the converted New Notes. Any amounts in excess of this converted amount will be settled in shares of our common stock or, at our option, cash. The initial conversion price is $8.25.

The level of indebtedness, among other things, could:



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



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



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



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



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



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

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

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



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

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

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

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

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

Sales of our systems depend in part upon the decision of semiconductor manufacturers to develop and manufacture new
semiconductor devices or to increase manufacturing capacity. As a result, sales of our products are subject to a variety of factors we cannot control. The decision to purchase our products generally involves a significant commitment of capital, with
the attendant delays frequently associated with significant capital expenditures. For these and other reasons, our systems have lengthy sales cycles during which we may expend substantial funds and management effort to secure a sale, subjecting us
to a number of significant risks, including a risk that our competitors may compete for the sale, a further downturn in the economy or other economic factors causing our customers to withdraw or delay their orders or a change in technological
requirements of the customer. As a result, our business, financial condition and results of operations may be materially adversely affected by our long and variable sales cycle and the uncertainty associated with expending substantial funds and
effort with no guarantee that a sale will be made.

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

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

Our international business exposes us to additional risks.

International sales accounted for approximately 81%, 69% and 69% of our total net sales in the three months ended February 3, 2007 and fiscal years ended October 31, 2006 and 2005, respectively. We anticipate that international
sales will continue to account for a significant portion of our total net sales in the foreseeable future. These international sales will continue to be subject to certain risks, including:



| |  |  | changes in regulatory requirements;
| | - |  | -----------------------------------



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



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



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



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



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



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



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



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



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



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



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

We are also subject to the risks associated with the imposition of domestic and foreign legislation and regulations relating to the import or export of semiconductor equipment products. We cannot predict whether the
import and export of our products will be adversely affected by changes in or new quotas, duties, taxes or other charges or restrictions imposed by the United States or any other country in the future. Any of these factors or the adoption of
restrictive policies could have a material adverse effect on our business, financial condition or results of operations. Net sales to the Asia-Pacific region accounted for approximately 60%, 51% and 47% of our total net sales for the three months
ended February 3, 2007 and fiscal years ended October 31, 2006 and 2005, respectively, and thus demand for our products is subject to the risk of economic instability in that region and health risks. Countries in the Asia-Pacific region,
including Korea and Japan, have experienced weaknesses in their currency, banking and equity markets in the recent past. These weaknesses could continue to adversely affect demand for our products, the availability and supply of our product
components and our consolidated results of operations.

No single end-user customer headquartered in Asia accounted for more than 10% of
our net sales during the three months ended February 3, 2007 and fiscal years ended October 31, 2006 and 2005. No single end-user customer headquartered in Europe accounted for more than 10% of our net sales during the three months ended
February 3, 2007 and fiscal years ended October 31, 2006 and 2005. One customer headquartered in the United States, Advanced Micro Devices, Inc. accounted for 43% of our net sales in the three months ended February 3, 2007. Advanced
Micro Devices, Inc. and Intel Corporation, headquartered in the United States, accounted for 23% and 15% of our net sales fiscal year ended October 31, 2006, respectively. Intel Corporation and Advanced Micro Devices, Inc. accounted for 25% and
14% of our net sales fiscal year ended October 31, 2005, respectively.

In addition, one of our major distributors, Spirox
Corporation, which accounted for 10%, 13% and 14% of our net sales in the three months ended February 3, 2007 and fiscal years ended October 31, 2006 and 2005, respectively, is a Taiwan-based company. This subjects a significant portion of
our receivables and future revenues to the risks associated with doing business in a foreign country, including political and economic instability, currency exchange rate fluctuations, fears related to health risks and regulatory changes. Disruption
of business in Asia caused by the previously mentioned factors could continue to have a material impact on our business, financial condition or results of operations.

We operate in a volatile industryindicators of goodwill and other long-lived assets impairment under SFAS 142 and SFAS 144 may be present from time-to-time.

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

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



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

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

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

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



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



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



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



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



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



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



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

Acquisitions may also cause us to:



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



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



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



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



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



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

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

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



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

Our future operating results depend substantially upon the continued service of our executive officers and key personnel. Our chief executive officer,
Lavi A. Lev, recently joined us and has limited experience in our business. Our future operating results also depend in significant part upon our ability to attract and retain qualified management, manufacturing, technical, engineering, marketing,
sales and support personnel. Competition for qualified personnel is intense, and we cannot ensure success in attracting or retaining qualified personnel. There may be only a limited number of persons with the requisite skills to serve in these
positions and it may be increasingly difficult for us to hire personnel over time. Our business, financial condition and results of operations could be materially adversely affected by the loss of any of our key employees, by the failure of any key
employee to perform in his or her current position, or by our inability to attract and retain skilled employees.

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

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

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

We have at times been notified that we may be infringing intellectual property rights of third parties and we have litigated patent infringement claims in the past. We expect to continue to receive notice of such
claims in the future. We cannot be certain of the success in defending patent infringement claims or claims for indemnification resulting from infringement claims.

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

We may be materially adversely affected by legal proceedings.

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

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

Recently enacted
and proposed changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002, have increased and will continue to increase our expenses as we evaluate the implications of new rules and
devote resources to respond to the new requirements. Sarbanes-Oxley Act mandates, among other things, that companies adopt new corporate governance measures and imposes comprehensive reporting and disclosure requirements, sets stricter independence
and financial expertise standards for audit committee members and imposes increased civil and criminal penalties for companies, their chief executive officers and chief financial officers and directors for securities law violations. In particular,
we incurred and expect to incur additional administrative expense as we implement Section 404 of the Sarbanes-Oxley Act, which requires management to report on, and our independent registered public accounting firm to attest to, our internal
control over financial reporting. In addition, The Nasdaq Global Select Market, on which our common stock is listed, has also adopted comprehensive rules and regulations



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relating to corporate governance. These laws, rules and regulations have increased and will continue to increase the scope, complexity and cost of our
corporate governance, reporting and disclosure practices, which could harm our results of operations and divert managements attention from business operations. We also expect these developments to continue to make it more difficult and more
expensive for us to obtain director and officer liability insurance in the future, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. Further, our board members, Chief Executive Officer and
Chief Financial Officer could face an increased risk of personal liability in connection with the performance of their duties. As a result, we may have difficultly attracting and retaining qualified board members and executive officers, which would
adversely affect our business.

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

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

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

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

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

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

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



|Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds.
|------- | ------------------------------------------------------------

None



|Item 3. | Defaults upon Senior Securities.
|------- | --------------------------------

None



|Item 4. | Submission of Matters to a Vote of Security Holders.
|------- | ----------------------------------------------------

None



|Item 5. | Other Information.
|------- | ------------------

None



|Item 6. | Exhibits.
|------- | ---------



| | (a) | See Exhibit Index
| | --- | -----------------



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SIGNATURES

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



|               |  |                                                             
|-------------- |  | ------------------------------------------------------------
|               |  | CREDENCE SYSTEMS CORPORATION                                
|               |  | (Registrant)                                                
|               | 
|March 13, 2007 |  | /s/ JOHN C. BATTY                                           
|Date           |  | John C. Batty                                               
|               |  | Senior Vice President, Chief Financial Officer and Secretary
|               |  | (Principal Financial and Chief Accounting Officer)          



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EXHIBIT INDEX



|              |  |                                                                                                                       
|------------- |  | ----------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  |                                                                                                                       
|3.1(1)        |  | Amended and Restated Certificate of Incorporation of the Company, as currently in effect.                             
|              | 
|3.2(2)        |  | Amended and Restated Bylaws of the Company, as currently in effect.                                                   
|              | 
|4.1(3)        |  | Indenture, dated as of June 2, 2003 between Credence Systems Corporation and The Bank of New York, as Trustee.        
|              | 
|4.2(3)        |  | Form of global 1.5% Convertible Subordinated Note due 2008 (included in Exhibit 4.3).                                 
|              | 
|4.3(4)        |  | Indenture, dated as of December 20, 2006, between the Company and The Bank of New York, as Trustee.                   
|              | 
|4.4(4)        |  | Form of global 3.5% Convertible Senior Subordinated Note due 2010 (included in Exhibit 4.4).                          
|              | 
|10.1(5)       |  | Form of Indemnification Agreement between the Company and each of its officers and directors.                         
|              | 
|10.2(4)       |  | Form of Exchange and Purchase Agreement, dated December 14, 2006.                                                     
|              | 
|10.3(4)       |  | Form of Registration Rights Agreement, dated December 20, 2006.                                                       
|              | 
|10.4          |  | Sale and Purchase Agreement, dated as of January 31, 2007.                                                            
|              | 
|10.5          |  | Lease dated February 28, 2007 between NRFC Milpitas Holdings, LLC and the Company.                                    
|              | 
|10.6          |  | Executive Employment Agreement, dated and effective as of March 13, 2007, by and between the Company and Lavi A. Lev. 
|              | 
|31.1          |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
|              | 
|31.2          |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
|              | 
|32.1          |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
|              | 
|32.2          |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

---

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

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

|(3) | Incorporated by reference to Exhibit 4.3 to the Companys Registration Statement on Form S-3 (File No. 333-108069) as filed with the Commission on August 19, 2003.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Exhibits 4.5, 4.5, 10.30 and 10.31 are incorporated herein by reference to Exhibit 4.1, 4.2, 10.1 and 10.2 to the Companys Current Report on Form 8-K (File No. 000-22366)
filed on December 21, 2006.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | Exhibit 10.1 is incorporated herein reference to Exhibit 10.1 to the Companys Annual Report on Form 10-K for the fiscal year ended October 31, 2003.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------