<PAGE>
 
================================================================================
 
                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549
 
                                   FORM 10-Q
 
(Mark One)
 
[X]QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
   ACT OF 1934
 
For the quarterly period ended July 31, 1997
 
                                      OR
 
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
   EXCHANGE ACT OF 1934
 
For the transition period from         to
 
                        COMMISSION FILE NUMBER 0-22366
 
                         CREDENCE SYSTEMS CORPORATION
            (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 

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

    215 FOURIER AVE., FREMONT, CALIFORNIA                     94539
  (Address of principal executive offices)                  (Zip Code)
 
 
       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (510) 657-7400
 
-------------------------------------------------------------------------------
            FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, 
                        IF CHANGED SINCE LAST REPORT.
 
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X]   No [_]
 
                     APPLICABLE ONLY TO CORPORATE ISSUERS:
 
  At July 31, 1997, there were 21,872,792 shares of the Registrant's common
stock, $0.001 par value per share outstanding.
 
================================================================================
<PAGE>
 
                          CREDENCE SYSTEMS CORPORATION
 
<TABLE>
<CAPTION>
                                     INDEX                              PAGE NO.
                                     -----                              --------
 <C>     <S>                                                            <C>
 PART I. FINANCIAL INFORMATION
 Item 1. Financial Statements
         Condensed Consolidated Balance Sheets........................      3
         Condensed Consolidated Statements of Operations..............      4
         Condensed Consolidated Statements of Cash Flows..............      5
         Notes to Condensed Consolidated Financial Statements.........      6
 Item 2. Management's Discussion and Analysis of Financial Condition 
          and Results of Operations...................................      8

 PART II. OTHER INFORMATION
 Item 1. Legal Proceedings............................................     20
 Item 2. Changes in Securities........................................     20
 Item 3. Defaults Upon Senior Securities..............................     20
 Item 4. Submission of Matters to a Vote of Security Holders..........     20
 Item 5. Other Information............................................     20
 Item 6. Exhibits and Reports on Form 8-K.............................     21
</TABLE>
 
                                       2
<PAGE>
 
PART I -- FINANCIAL INFORMATION
 
ITEM I -- FINANCIAL STATEMENTS
 
                          CREDENCE SYSTEMS CORPORATION
 
                     CONDENSED CONSOLIDATED BALANCE SHEETS
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                          JULY 31,   OCTOBER 31,
                                                            1997       1996/a/
                                                         ----------  -----------
<S>                                                      <C>         <C>
                                                         (UNAUDITED)
ASSETS
Current assets:
  Cash and cash equivalents............................. $   42,806   $ 48,649
  Restricted cash.......................................     13,120         --
  Short-term investments................................     23,491     37,643
  Accounts receivable, net..............................     43,951     49,025
  Inventories...........................................     36,405     35,721
  Other current assets..................................     11,328      6,845
                                                         ----------   --------
    Total current assets................................    171,101    177,883
Long-term investments...................................         --      4,284
Property and equipment, net.............................     42,092     32,764
Other assets............................................     12,446      8,111
                                                         ----------   --------
    Total assets........................................   $225,639   $223,042
                                                         ==========   ========
 
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable...................................... $   10,876   $ 13,842
  Accrued liabilities...................................     15,348     17,829
  Income taxes payable..................................      3,615      1,589
                                                         ----------   --------
    Total current liabilities...........................     29,839     33,260
Minority interest.......................................        428         --
Stockholders' equity....................................    195,372    189,782
                                                         ----------   --------
    Total liabilities and stockholders' equity.......... $  225,639   $223,042
                                                         ==========   ========
</TABLE>
 
 
                            See accompanying notes.
--------
/a/ Derived from the audited consolidated balance sheet included in the
    Company's Form 10-K for the year ended October 31, 1996.
 
                                       3
<PAGE>
 
                          CREDENCE SYSTEMS CORPORATION
 
                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
                                  (UNAUDITED)
 
<TABLE>
<CAPTION>
                                         THREE MONTHS ENDED   NINE MONTHS ENDED
                                              JULY 31,            JULY 31,
                                         -------------------- -----------------
                                           1997       1996      1997     1996
                                         ---------  --------- -------- --------
<S>                                      <C>        <C>       <C>      <C>
Net sales............................... $  51,082  $  67,200 $134,698 $194,586
Cost of goods sold......................    21,638     27,088   59,451   77,992
                                         ---------  --------- -------- --------
Gross margin............................    29,444     40,112   75,247  116,594
Operating expenses:
  Research and development..............     9,257      9,588   27,016   27,318
  Selling, general and administrative...    14,529     13,700   37,949   40,596
  In-process research and development...     6,022         --    6,022       --
                                         ---------  --------- -------- --------
    Total operating expenses............    29,808     23,288   70,987   67,914
                                         ---------  --------- -------- --------
Operating income (loss).................      (364)    16,824    4,260   48,680
Interest income, net....................     1,011        989    2,912    3,090
                                         ---------  --------- -------- --------
Income before income taxes..............       647     17,813    7,172   51,770
Income taxes............................     1,542      6,271    3,727   18,355
Minority interest.......................         2         --        2       --
                                         ---------  --------- -------- --------
Net income (loss)....................... $    (897) $  11,542 $  3,443 $ 33,415
                                         =========  ========= ======== ========
Net income (loss) per share............. $   (0.04) $    0.53 $   0.15 $   1.52
                                         =========  ========= ======== ========
Number of shares used in computing per
 share amount...........................    21,857     21,925   22,336   21,930
                                         =========  ========= ======== ========
</TABLE>
 
 
 
                            See accompanying notes.
 
                                       4
<PAGE>
 
                          CREDENCE SYSTEMS CORPORATION
 
                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
                                 (IN THOUSANDS)
                                  (UNAUDITED)
 
<TABLE>
<CAPTION>
                                                            NINE MONTHS ENDED
                                                                JULY 31,
                                                            ------------------
                                                              1997      1996
                                                            --------  --------
<S>                                                         <C>       <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
 Net income................................................ $  3,443  $ 33,415
 Adjustments to reconcile net income to net cash provided
  by operating activities:
  Depreciation and amortization............................    8,760     7,245
  (Gain) Loss on disposal of property and equipment........      (26)       48
  Changes in operating assets and liabilities:
   Accounts receivable, inventories and other current
    assets.................................................  (12,336)  (16,847)
   Accounts payable, accrued liabilities and income taxes
    payable................................................   (3,272)    7,859
                                                            --------  --------
    Net cash provided (used) by operating activities.......   (3,431)   31,720
CASH FLOWS FROM INVESTING ACTIVITIES:
 Purchases of available-for-sale securities................  (29,398)  (59,577)
 Maturities of available-for-sale short-term investments...   44,722    38,114
 Sales of available-for-sale securities....................    3,112        --
 Maturities of held-to-maturity securities.................       --    11,521
 Acquisition of property and equipment.....................   (7,823)  (18,992)
 Other assets..............................................   (3,639)   (3,745)
 Proceeds from sale of property and equipment..............    1,736        --
                                                            --------  --------
    Net cash provided (used) in investing activities.......    8,710   (32,679)
CASH FLOWS FROM FINANCING ACTIVITIES:
 Principal payments under capital lease obligations........       --      (626)
 Issuance of common stock..................................    1,998     1,526
                                                            --------  --------
    Net cash provided by financing activities..............    1,998       900
                                                            --------  --------
Net increase (decrease) in cash and cash equivalents.......    7,277       (59)
Cash and cash equivalents at beginning of period...........   48,649    54,534
                                                            --------  --------
Cash and cash equivalents at end of period................. $ 55,926  $ 54,475
                                                            ========  ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 Interest paid............................................. $      1  $     36
 Income taxes paid......................................... $  2,533  $ 16,261
NONCASH INVESTING ACTIVITIES:
 Net transfers of inventory to property and equipment...... $ 11,684  $  1,338
NONCASH FINANCING ACTIVITIES:
 Income tax benefit from stock option exercises............ $    149  $     70
</TABLE>
 
                            See accompanying notes.
 
                                       5
<PAGE>
 
                         CREDENCE SYSTEMS CORPORATION
 
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
1. QUARTERLY FINANCIAL STATEMENTS
 
  The condensed consolidated financial statements and related notes for the
three months and nine months ended July 31, 1997 and 1996 are unaudited but
include all adjustments (consisting solely of normal recurring adjustments)
which are, in the opinion of management, necessary for a fair presentation of
financial position and results of operations of the Company for the interim
periods. The results of operations for the three months and nine months ended
July 31, 1997 and 1996 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,
1996 included in the Annual Report on Form 10-K and the risk factors,
including, without limitation, risks relating to fluctuations in operating
results, rapid technological change, importance of timely product
introduction, risks of delays, limited system sales, backlog, cyclicality of
semiconductor industry, expansion of operations, sole or limited sources of
supply, reliance on subcontractors, highly competitive industry, dependence on
key customers, lengthy sales cycle, dependence on key personnel, international
sales, proprietary rights, acquisitions, future capital needs and volatility
of stock price, as set forth in this Report. Any party interested in reviewing
these publicly available documents should write to the SEC or the Chief
Financial Officer of the Company.
 
  USE OF ESTIMATES--The preparation of the accompanying unaudited consolidated
condensed financial statements requires management to make estimates and
assumptions that affect the amounts reported in the financial statements.
Actual results could differ from those estimates.
 
2. INVENTORIES
 
  Inventories are stated at the lower of standard cost (which approximates
first-in, first-out cost) or market. Inventories consist of the following (in
thousands):
<TABLE>
<CAPTION>
                                                                         OCTOBER
                                                                JULY 31,   31,
                                                                -------- -------
                                                                  1997    1996
                                                                -------- -------
   <S>                                                          <C>      <C>
   Raw materials............................................... $ 23,705 $20,482
   Work-in-process.............................................   10,339  10,222
   Finished goods..............................................    2,361   5,017
                                                                -------- -------
                                                                $ 36,405 $35,721
                                                                ======== =======
</TABLE>
 
3. NET INCOME (LOSS) PER SHARE
 
  Net income (loss) per share is based upon the weighted average number of
common and dilutive common equivalent shares (stock options) outstanding
during the period.
 
  In March 1997, the Financial Accounting Standards Board ("FASB") released
Statement of Financial Accounting Standards No. 128 "Earnings Per Share" ("FAS
128"), which is required to be adopted on December 31, 1997. At that time, the
Company will be required to change the method currently used to compute
earnings per share and to restate all prior periods. Under the new
requirements for calculating primary net income per share (basic earnings per
share), the dilutive effect of stock options will be excluded. The Company's
basic and diluted earnings per share as calculated according to FAS 128 would
be as follows:
 
<TABLE>
<CAPTION>
                                                       THREE MONTHS  NINE MONTHS
                                                          ENDED         ENDED
                                                         JULY 31,     JULY 31,
                                                       ------------- -----------
                                                        1997   1996  1997  1996
                                                       ------  ----- ----- -----
   <S>                                                 <C>     <C>   <C>   <C>
   Basic.............................................. $(0.04) $0.54 $0.16 $1.55
   Diluted............................................ $(0.04) $0.53 $0.15 $1.52
</TABLE>
 
 
                                       6
<PAGE>
 
                         CREDENCE SYSTEMS CORPORATION
 
       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
4. CONTINGENCIES
 
  The Company's litigation matters with Megatest Corporation and Teradyne,
Inc., have been resolved. There was no impact on the financial statements as a
result of these settlements.
 
  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.
 
5. ACQUISITION OF THE TEST DEVELOPMENT SERIES BUSINESS OF TEST SYSTEMS
   STRATEGIES, INC. AND SUMMIT DESIGN, INC.
 
  On July 11, 1997, the Company, through its newly formed subsidiary, Test
Systems Strategies, Inc., a Delaware Corporation ("TSSI"), acquired certain
assets and assumed certain liabilities from Summit Design, Inc. and its wholly
owned subsidiary, Test Systems Strategies, Inc., an Oregon Corporation,
including the test development series software ("TDS") and TSSI trademark of
Test Systems Strategies, Inc. (an Oregon Corporation). TDS includes tools
designed to convert gate-level simulation data from electronic design
automation simulators to programs that operate on targeted automatic test
equipment ("ATE") for testing integrated circuits characterized by the gate-
level simulation data. TDS facilitates simulation analysis, stimulus
generation, simulation rules checking, tester resource checking, ATE test
program generation, and test program conversion. The acquisition has been
accounted for by the Company under the purchase method of accounting, and
accordingly, the condensed consolidated financial statements reflect the
impact of TDS operations subsequent to the acquisition date.
 
  The purchase price of $7.3 million, consisted of a cash payment of $7.0
million to Summit Design, Inc. and $300,000 for the assumption of liabilities.
Acquired assets and liabilities were recorded at their estimated fair market
value at the date of the acquisition. The aggregate purchase price, plus
related acquisition expenses, have been allocated to the assets and
liabilities acquired based on valuations. Amounts allocated to in-process
research and development of approximately $6.0 million were written-off at the
acquisition date, representing an estimated value (using risk-adjusted cash
flows, discounted at 35%) of development programs that have not yet reached
technological feasibility. Amounts allocated to developed technology, $1.0
million, and workforce in place, $0.3 million, are being amortized on a
straight line basis over periods of six and three years respectively.
 
6. COMMITMENTS
 
  In addition on May 19, 1997, the Company entered into an agreement with
Summit Design, Inc. for the Company to purchase approximately $18 million of
Summit's Visual Testbench ("VTB") product licenses and maintenance services
through 1999. The restricted cash on the accompanying balance sheet relates to
the amounts yet to be purchased under this agreement.
 
7. SUBSEQUENT EVENTS
 
  On August 20, 1997, the Company through one of its subsidiaries, Test
Systems Strategies, Inc., purchased from Zycad Corporation ("Zycad") and one
of its subsidiaries, Attest Software, Inc. certain assets and assumed certain
liabilities for $2,250,000.
 
  On September 10, 1997, the Company sold $100 million of 5 1/4% convertible
subordinated notes (the "Notes") due 2002 through a private placement within
the U.S. to qualified institutional buyers in accordance with Rule 144A and
outside the U.S., to non-U.S. persons as defined in Regulation S under the
Securities Act of 1933, as amended. The Notes are convertible into common
stock of the Company at a conversion price of $69.15 per share. The Company
has granted to Smith Barney, Inc., the initial purchaser, a 30-day option to
purchase an additional $15 million of Notes to cover over-allotments, if any.
Expense of $3.0 million associated with the offering will be deferred and
included in other assets. Such expenses will be amortized to interest expense
over the term of the Notes.
 
                                       7
<PAGE>
 
ITEM 2 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
          RESULTS OF OPERATIONS
 
  The following discussion may contain predictions, estimates and other
forward-looking statements that involve a number of risks and uncertainties.
While this discussion represents the Company's current judgment on the future
direction of the business, such risks and uncertainties could cause actual
results to differ materially from any future performance described herein.
Factors that could cause actual results to differ are identified throughout
the discussion below, as well as the section entitled "Risk Factors" below.
The Company undertakes no obligation to publicly release the result of any
revisions to these forward-looking statements which may be made to reflect
events or circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
 
  The following table sets forth items from the Condensed Consolidated
Statements of Operations as a percentage of net sales for the periods
indicated:
 
<TABLE>
<CAPTION>
                                     THREE MONTHS ENDED     NINE MONTHS ENDED
                                          JULY 31,              JULY 31,
                                     ---------------------  ------------------
                                       1997        1996       1997      1996
                                     ---------   ---------  --------  --------
   <S>                               <C>         <C>        <C>       <C>
   Net sales........................     100.0%      100.0%    100.0%    100.0%
   Cost of goods sold...............      42.4        40.3      44.1      40.1
                                     ---------   ---------  --------  --------
   Gross margin.....................      57.6        59.7      55.9      59.9
   Operating expenses
     Research and development.......      18.1        14.3      20.0      14.0
     Selling, general, and
      administrative................      28.4        20.4      28.2      20.9
     In-process research &
      development...................      11.8          --       4.5        --
                                     ---------   ---------  --------  --------
       Operating expenses...........      58.3        34.7      52.7      34.9
                                     ---------   ---------  --------  --------
   Operating income (loss)..........      (0.7)       25.0       3.2      25.0
   Interest income, net.............       2.0         1.5       2.2       1.6
                                     ---------   ---------  --------  --------
   Income before income taxes.......       1.3        26.5       5.4      26.6
   Income taxes.....................       3.1         9.3       2.8       9.4
                                     ---------   ---------  --------  --------
   Net income (loss)................      (1.8%)      17.2%      2.6%     17.2%
                                     =========   =========  ========  ========
</TABLE>
 
RESULTS OF OPERATIONS
 
NET SALES
 
  Net sales consist of revenues from systems sales, spare parts sales and
maintenance contracts. Net sales were $51.1 million for the third quarter and
$134.7 for the first nine months of fiscal 1997, representing decreases of
24.0% and 30.8%, respectively, over the comparable periods of fiscal 1996.
These decreases were due primarily to a significant weakness in the ATE market
which materially adversely affected the Company and several other companies in
the capital equipment market. International net sales accounted for
approximately 71.3% and 70.0% of the total net sales for the third quarter and
first nine months of fiscal 1997 respectively, compared to approximately 61.2%
and 65.1% for the comparable periods a year ago. The Company's international
sales of its products and spare parts and its service revenues are denominated
primarily in United States dollars.
 
GROSS MARGIN
 
  The Company's gross margin has been and will continue to be affected by a
variety of factors, including manufacturing efficiencies, pricing by
competitors or suppliers, new product introductions, product sales mix,
production volume, product reliability, customization and reconfiguration of
systems, reserves, international and domestic sales mix and field service
margins. Gross margin was 57.6% for the third quarter and 55.9% for the first
nine months of fiscal 1997, compared with 59.7% for the third quarter and
59.9% for the first nine months
 
                                       8
<PAGE>
 
of fiscal 1996. The reduction in gross margin as a percent of sales was due
primarily to an increase in the first quarter of fiscal 1997 in inventory
write down reserves on slower moving parts of older products and changes in
product mix.
 
RESEARCH AND DEVELOPMENT
 
  Research and development expenses were $9.3 million in the third quarter of
fiscal 1997, a slight decrease of $0.3 million or 3.5% as compared to the
third quarter of fiscal 1996. Research and development expenses were $27.0
million in the first nine months of fiscal 1997, which was comparable, in
dollars, to expenses for the first nine months of fiscal 1996. As a percentage
of net sales, these expenses were 18.1% for the third quarter and 20.0% for
the first nine months of fiscal 1997, compared with 14.3% for the third
quarter and 14.0% for the first nine months of 1996. The increase of these
expenses as a percentage of net sales is attributable primarily to the
significant decrease in net sales in fiscal 1997 as compared with the
comparable periods of fiscal 1996. For the foreseeable future, the Company
currently intends to continue to invest significant resources in the
development of new products and enhancements. Accordingly, the Company expects
these expenses to increase in dollars for the remainder of fiscal 1997 as
compared to fiscal 1996 due to the introduction of new products in the latter
half of the year.
 
SELLING, GENERAL AND ADMINISTRATIVE
 
  Selling, general and administrative expenses were $14.5 million in the third
quarter and $37.9 million for the first nine months of fiscal 1997,
representing an increase of $0.8 million or 6.1% in the third quarter of
fiscal 1997 and a decrease of $2.6 million or 6.5% for the first nine months
of fiscal 1997, compared to the comparable periods of fiscal 1996. As a
percentage of net sales, these expenses were 28.4% for the third quarter and
28.2% for the first nine months of fiscal 1997, compared with 20.4% and 20.9%,
respectively, for the corresponding periods in fiscal 1996. The increase of
these expenses as a percentage of net sales is attributable primarily to the
significant decrease in net sales in fiscal 1997 as compared with the
comparable periods of fiscal 1996. The Company expects selling, general and
administrative expenses for the rest of fiscal 1997 to increase in dollars as
compared to fiscal 1996 due to the introduction of new products in the latter
half of the year.
 
INTEREST INCOME, NET
 
  The Company generated net interest income of $1.0 million for the third
quarter and $2.9 million for the first nine months of fiscal 1997, compared to
$989,000 and $3.1 million, respectively, for the corresponding periods of
fiscal 1996. The slight decrease for the nine months of fiscal 1997 was due
primarily to interest earned on lower average cash and cash equivalents and
short-term investments balances during the period. The lower cash and cash
equivalents and short-term investments balances reflected decreased cash
provided by operations.
 
INCOME TAXES
 
  Excluding the impact of the in-process R&D charge, the Company's provision
for income taxes for the third quarter and the first nine months of fiscal
1997 is computed based on the projected annualized effective tax rate of
33.5%. The effective tax rate for the third quarter and the first nine months
of fiscal 1996 was 35.2% and 35.5%, respectively. Excluding the impact of the
in-process R&D charge, the projected effective tax rate for fiscal 1997 is
expected to be less than the combined federal and state statutory tax rate,
and the 1996 effective tax rate, primarily due to the projected benefit of the
Company's foreign sales corporation.
 
                                       9
<PAGE>
 
  The tax provision for the first nine months of 1997 consists of two items: a
$4,420,000 provision on pre-tax book income of $13,194,000 (for a 33.5%
effective tax rate exclusive of the in-process R & D charge), and a $693,000
tax benefit on the $6,022,000 in-process R&D charge.
 
  A valuation allowance has been established in the third quarter of fiscal
1997 to offset a portion of the deferred tax asset attributable to the in-
process R&D charge. Due to the period over which this tax benefit will be
recognized, sufficient uncertainty exists regarding the realizability of a
portion of these assets, and accordingly, a valuation allowance is required.
 
LIQUIDITY AND CAPITAL RESOURCES
 
  Net cash provided (used) by operating activities was ($3.4 million) and
$31.7 million for the nine months ended July 31, 1997 and 1996, respectively.
Net cash flows used by operating activities for the nine months ended July 31,
1997 were primarily attributable to a decrease in accounts receivable, offset
in part by an increase in inventory, $11.7 million of which was transferred to
property and equipment, and reductions in accounts payable ($3.0 million) and
accrued liabilities ($2.5 million). Investing activities provided net cash of
$8.7 million and used net cash of $32.7 million for the nine months ended July
31, 1997 and 1996, respectively. In the first nine months of fiscal 1997, the
Company experienced a net reduction of $14.1 million in short-term investments
while also purchasing $7.8 million of property and equipment. Net cash
provided by financing activities was $2.0 million and $0.9 million for the
nine months ended July 31, 1997 and 1996, respectively.
 
  As of July 31, 1997, the Company had working capital of approximately $141.3
million, including cash of $42.8 million, restricted cash of $13.1 million,
and short-term investments of $23.5 million, $44.0 million of accounts
receivable and $36.4 million of inventories. The Company expects accounts
receivable to continue to represent a significant portion of working capital.
The Company believes that because of the relatively long manufacturing cycles
of many of its testers, investments in inventories will also continue to
represent a significant portion of working capital. Additionally, the Company
expects to continue investing in inventories for its new products, which may
be slower moving at the beginning of the product introduction cycle.
Significant investments in accounts receivable and inventories may subject the
Company to increased risks which could materially adversely affect the
Company's business, financial condition and results of operations. Total
liabilities of $33.3 million as of October 31, 1996 decreased to $29.8 million
as of July 31, 1997. The $3.5 million decrease was due primarily to decreases
in accounts payable of $3.0 million.
 
  The Company has entered into an agreement with Summit Design, Inc. for the
Company to purchase approximately $18 million of VTB product licenses and
maintenance services through 1999. The restricted cash relates to the amounts
yet to be purchased under this agreement.
 
  The Company's principal sources of liquidity as of July 31, 1997 consisted
of approximately $55.9 million of cash and cash equivalents and restricted
cash, short-term investments of $23.5 million and $20.0 million available
under the Company's unsecured working capital line of credit expiring on July
24, 1998. As of July 31, 1997, no amounts were outstanding under the line of
credit. Additionally, as of July 31, 1997, the Company has operating leases
for test and other equipment with remaining payments totaling approximately
$2.6 million.
 
  On September 10, 1997, the Company sold $100 million of 5 1/4% convertible
subordinated notes (the "Notes") due 2002 through a private placement within
the U.S. to qualified institutional buyers in accordance with Rule 144A and
outside the U.S., to non-U.S. persons as defined in Regulation S under the
Securities Act of 1933, as amended. The Notes are convertible into common
stock of the Company at a conversion price of $69.15 per share. The Company
has granted to Smith Barney, Inc., the initial purchaser, a 30-day option to
purchase an additional $15 million of Notes to cover over-allotments, if any.
Expense of $3.0 million associated with the offering will be deferred and
included in other assets. Such expenses will be amortized to interest expense
over the term of the Notes.
 
RISK FACTORS
 
  The Company's results of operations are affected by a variety of factors,
including the following:
 
 
                                      10
<PAGE>
 
Fluctuations in Operating Results
 
  The Company's operating results have in the past fluctuated significantly
and will in the future fluctuate significantly, due to a variety of factors.
The Company's operating performance from the first quarter of fiscal 1993
through the third quarter of fiscal 1996 produced sequential quarter-to-
quarter growth in both net sales and net income. In the fourth quarter of
fiscal 1996, however, net sales decreased 34% from the third quarter of fiscal
1996 and 17% from the fourth quarter of fiscal 1995. Net income for the fourth
quarter of fiscal 1996 decreased 63% from the third quarter of fiscal 1996 and
55% from the fourth quarter of fiscal 1995. In the first quarter of fiscal
1997, net sales decreased 9% from the fourth quarter of fiscal 1996 and
decreased 34% from the first quarter of fiscal 1996. Net income for the first
quarter of fiscal 1997 decreased 75% from the fourth quarter of fiscal 1996
and decreased 90% from the first quarter of fiscal 1996. In the second quarter
of fiscal 1997, net sales increased 8% from the first quarter of fiscal 1997
and decreased 35% from the second quarter of fiscal 1996. Net income for the
second quarter of fiscal 1997 increased 212% from the first quarter of fiscal
1997 and decreased 71% from the second quarter of fiscal 1996. In the third
quarter of fiscal 1997, net sales increased 15% from the second quarter of
fiscal 1997 but decreased 24% from the third quarter of fiscal 1996. The
Company incurred a net loss of $897,000 for the third quarter of fiscal 1997
resulting in a decrease of 127% when compared to the $3.3 million net income
for the second quarter of fiscal 1997 and a 108% decrease from the third
quarter of fiscal 1996. The decreases were due primarily to a significant
weakness in the ATE market which materially adversely affected the Company and
several other companies in the semiconductor equipment industry. The factors
that have caused and will continue to cause the Company's results to fluctuate
include the timing of new product announcements and releases by the Company or
its competitors, market acceptance of new products and enhanced versions of
the Company's products, manufacturing inefficiencies associated with the start
up of new products, changes in pricing by the Company, its competitors,
customers or suppliers, manufacturing capacity, the ability to volume produce
systems and meet customer requirements, inventory obsolescence, patterns of
capital spending by customers, delays, cancellations or reschedulings of
orders due to customer financial difficulties or otherwise, changes in
overhead absorption levels due to changes in the number of systems
manufactured, the timing and shipment of orders, availability of components,
subassemblies and services, expenses associated with acquisitions and
alliances, product discounts, customization and reconfiguration of systems,
product reliability, the proportion of direct sales and sales through third
parties, including distributors and original equipment manufacturers, the mix
of products sold, the length of manufacturing and sales cycles, cyclicality or
downturns in the semiconductor market and the markets served by the Company's
customers, natural disasters, political and economic instability, regulatory
changes and outbreaks of hostilities. The Company presently intends to
introduce many new products and product enhancements in this current fiscal
year, which will affect its operating results, financial condition and
business. The Company's gross margins on system sales have varied
significantly, especially in the last twelve months, and will continue to vary
significantly based on a variety of factors, including manufacturing
efficiencies, pricing by competitors or suppliers, product sales mix,
reserves, production volume, new product introductions, product reliability,
customization and reconfiguration of systems, international and domestic sales
mix and field service margins. In addition, new and enhanced products
typically have lower gross margins in the early stages of commercial
introduction and production. While the Company has recorded and continues to
record allowances for estimated sales returns and uncollectable accounts,
there can be no assurance that such estimates regarding allowances will be
adequate.
 
Limited System Sales; Backlog
 
  The Company derives a substantial portion of its net sales from the sale of
a relatively small number of systems that typically range in price from
$350,000 to $2.0 million, excluding the current memory products, for which the
price range is typically below $100,000. As a result, the timing of
recognition of revenue from a single transaction could have a significant
impact on the Company's net sales and operating results for a particular
period. The Company's net sales and operating results for a particular period
could be materially adversely affected if an anticipated order for even one
system is not received in time to permit shipment during that period. The
Company's backlog at the beginning of a quarter typically does not include all
tester orders needed to achieve the Company's sales objectives for that
quarter. In addition, orders in backlog are subject to cancellation, delay,
deferral or rescheduling by a customer with limited or no penalties.
Consequently, the Company's net
 
                                      11
<PAGE>
 
sales and operating results for a quarter have in the past and will in the
future depend upon the Company obtaining orders for systems to be shipped in
the same quarter that the order is received. Furthermore, products generating
most of the Company's net sales continue to be shipped near the end of each
quarter. Accordingly, the failure to receive an anticipated order or a delay
or rescheduling in a shipment near the end of a particular period due, for
example, to an order cancellation, a delay by a customer, manufacturing,
technical, reliability or other difficulties, including difficulties relating
to customization and reconfiguration of systems, a delay in the supply of
components, subassemblies or services or a delay due to competitive or
economic factors, may cause net sales in a particular period to fall
significantly below the Company's expectations, which could have a material
adverse effect upon the Company's business, financial condition or results of
operations. The relatively long manufacturing cycle of many of its testers has
caused and could continue to cause future shipments of such products to be
delayed from one quarter to the next, which could materially adversely affect
the Company's business, financial condition or results of operations.
Furthermore, announcements by the Company or its competitors of new products
and technologies could cause customers to defer or cancel purchases of the
Company's existing systems, which could also have a material adverse effect on
the Company's business, financial condition or results of operations. The
impact of these and other factors on the Company's sales and operating results
in any future period cannot be forecasted with certainty. In addition, the
need for continued significant expenditures for research and development,
marketing and other expenses for new products, capital equipment purchases and
worldwide training and customer service and support, among other factors, will
make it difficult for the Company to reduce its significant fixed expenses in
a particular period if the Company's net sales goals for such period are not
met. Accordingly, there can be no assurance that the Company will be able to
be profitable or that it will not again sustain losses in future periods. Due
to all of the foregoing factors, it is likely that in some future quarter the
Company's operating results will be below the expectations of public market
analysts and investors, as they were in the first and second quarters of 1997.
In such event, the price of the Company's Common Stock may be materially
adversely affected.
 
Cyclicality of Semiconductor Industry
 
  The Company's business and results of operations depend in significant part
upon the capital expenditures of manufacturers of semiconductors and companies
which specialize in contract packaging and/or testing of semiconductors,
including manufacturers and contractors that are opening new or expanding
existing fabrication facilities, or upgrading existing equipment, which in
turn depend upon the current and anticipated market demand for semiconductors
and products incorporating semiconductors. Historically and recently, the
semiconductor industry has been highly cyclical with recurring periods of
oversupply, which often have had a severe effect on the semiconductor
industry's demand for test equipment, including the systems manufactured and
marketed by the Company. The Company believes that the markets for newer
generations of semiconductors will also be subject to similar fluctuations.
The Company has in the past, and during the last twelve months in particular,
experienced shipment delays, delays in commitments and purchase order
restructurings by several of its customers and anticipates that this may
continue to occur in the future. Accordingly, the Company can give no
assurance that it will be able to achieve or maintain its current or prior
level of sales or rate of growth. During the last four quarters, including the
third quarter of 1997, the Company's net sales, gross margins and net income
have been significantly below the net sales, gross margins and net income,
respectively, of the comparable prior year's quarterly results. The Company
anticipates that a significant portion of new orders may depend upon demand
from semiconductor device manufacturers building or expanding fabrication
facilities and new device testing requirements that are not addressable by
currently installed test equipment, and there can be no assurance that such
demand will develop to a significant degree, or at all. In addition, any
factor adversely affecting the semiconductor industry or particular segments
within the semiconductor industry may adversely affect the Company's business,
financial condition or results of operations. Therefore, there can be no
assurance that the Company's operating results will not continue to be
materially adversely affected if downturns or slowdowns in the semiconductor
industry continue or occur again in the future.
 
Management of Fluctuations in Operating Results
 
  The Company has over the last several years experienced significant
fluctuations in its operating results. Since 1993, the Company has overall
significantly increased the scale of its operations to support increased sales
 
                                      12
<PAGE>
 
levels and has expanded its operations to address critical infrastructure and
other requirements, including the hiring of additional personnel, significant
investments in research and development to support product development, the
March 1995 acquisition of EPRO, the Company's establishment of a joint venture
with Innotech, Inc., the Company's acquisition in July 1997 of the assets and
certain liabilities of TSSI and the Company's acquisition in August of 1997 of
a software product line from Zycad. However, the Company has during certain
historical periods, particularly over the past twelve months, experienced
revenue declines and reductions in its operations.
 
  Fluctuations in the Company's sales and operations have placed a
considerable strain on its management, financial, manufacturing and other
resources. In order to effectively deal with the changes brought on by the
cyclical nature of the industry, the Company has been required to implement
and improve a variety of highly flexible operating, financial and other
systems, procedures and controls capable of expanding or contracting
consistent with the Company's business. There can be no assurance that any
existing or new systems, procedures or controls will be adequate to support
fluctuations in the Company's operations or that its systems, procedures and
controls will be designed, implemented or improved in a cost effective and
timely manner. Any failure to implement, improve and expand or contract such
systems, procedures and controls in an efficient manner at a pace consistent
with the Company's business could have a material adverse effect on the
Company's business, financial condition or results of operations.
 
Expansion of Operations
 
  Currently, the Company is devoting significant resources to the development
of new products and technologies. During 1997, the Company will conduct
evaluations of these products and will continue to invest significant
additional resources in plant and equipment, inventory, personnel and other
costs, to begin production of these products and to provide the marketing,
administration and after-sales service and support, if any, required to
service and support these new products. Accordingly, there can be no assurance
that gross profit margin and inventory levels will not be adversely impacted
in the future by start-up costs associated with the initial production and
installation of these new product lines. These start-up costs include, but are
not limited to, additional manufacturing overhead, additional inventory and
warranty reserve requirements and the creation of after-sales service and
support organizations. Additionally, there can be no assurance that operating
expenses will not increase, relative to sales, as a result of adding
additional marketing and administrative personnel, among other costs, to
support the Company's additional products. If the Company is unable to achieve
significantly increased net sales or its sales fall below expectations, the
Company's operating results will be materially adversely affected. There can
be no assurance that net sales will increase or remain at recent levels or
that such products will be successfully commercialized.
 
Limited Sources of Supply; Reliance on Subcontractors
 
  Certain components, subassemblies and services necessary for the manufacture
of the Company's testers are obtained from a limited group of suppliers. The
Company does not maintain any long-term supply agreements with any of its
vendors and purchases its components and subassemblies through individual
purchase orders. The manufacture of certain of the Company's components and
subassemblies is an extremely complex process. The Company also relies on
outside vendors to manufacture certain components and subassemblies and to
provide certain services. In addition, the Company and certain of its
subcontractors periodically experience significant shortages and delays in
delivery of various components and subassemblies. There can be no assurance
that these or other problems will not continue to occur in the future with
these or the Company's other suppliers or outside subcontractors. The
Company's reliance on a limited group of suppliers and the Company's reliance
on outside subcontractors involve several risks, including 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 has delayed
and could continue to delay shipments of the Company's systems and could have
a material adverse effect on the Company's business, financial condition or
results of operations. Any continuing inability to obtain adequate yields or
timely deliveries or any other circumstance that would
 
                                      13
<PAGE>
 
require the Company to seek alternative sources of supply or to manufacture
such components internally could have a material adverse effect on the
Company's business, financial condition or results of operations. Such delays,
shortages and disruptions would also damage relationships with current and
prospective customers and could allow competitors to penetrate such customer
accounts. There can be no assurance that the Company's internal manufacturing
capacity and that of its suppliers and subcontractors will be sufficient to
meet customer requirements.
 
Highly Competitive Industry
 
  The ATE industry is intensely competitive. Because of the substantial
investment required to develop test application software and interfaces, the
Company believes that once a semiconductor manufacturer has selected a
particular ATE vendor's tester, the semiconductor manufacturer is likely to
use that tester for a majority of its testing requirements for the market life
of that semiconductor and, to the extent possible, subsequent generations of
similar products. As a result, once an ATE customer chooses a system for the
testing of a particular device, it is difficult for competing vendors to
achieve significant ATE sales to such customer for similar use. The inability
of the Company to achieve significant sales to any ATE customer could have a
material adverse effect on the Company's business, financial condition or
results of operations.
 
  The Company faces substantial competition throughout the world, primarily
from ATE manufacturers located in the United States, Europe and Japan, as well
as several of the Company's customers. Many of the Company's competitors have
substantially greater financial and other resources with which to pursue
engineering, manufacturing, marketing and distribution of their products.
Certain of the Company's competitors have recently introduced or announced new
products with certain performance or price characteristics equal or superior
to certain products currently offered by the Company. The Company believes
that if the ATE industry continues to consolidate through strategic alliances
or acquisitions, the Company will continue to face significant additional
competition from larger competitors that may offer more complete product lines
and services than the Company. The Company's competitors are continuing to
improve the performance of their current products and to introduce new
products, enhancements and new technologies that provide improved cost of
ownership and performance characteristics. New product introductions by the
Company's competitors could continue to cause a decline in sales or loss of
market acceptance of the Company's existing products. Moreover, increased
competitive pressure could continue to lead to intensified price-based
competition, which could materially adversely affect the Company's business,
financial condition or results of operations. The Company has experienced and
continues to experience significant price competition in the sale of all of
its testers. In addition, at the end of a product life cycle and as
competitors introduce more technologically advanced products, pricing
pressures typically become more intense. The Company believes that to be
competitive, it will continue to require significant financial resources in
order to, among other items, invest in new product development and
enhancements and to maintain customer service and support centers worldwide.
There can be no assurance that the Company will be able to compete
successfully in the future.
 
Rapid Technological Change; Importance of Timely Product Introduction
 
  The ATE market is subject to rapid technological change and new product
introductions and enhancements and related software tools. The Company's
ability to be competitive in this market will depend in significant part upon
its ability to successfully develop and introduce new products and
enhancements and related software tools with greater features on a timely and
cost-effective basis, including the products under development acquired in the
EPRO merger and the TSSI and Zycad product line acquisitions. The Company's
customers require testers with additional features and higher performance and
other capabilities. The Company is therefore required to enhance the
performance and other capabilities of its existing systems and related
software tools. Any success by the Company in developing new and enhanced
systems and related software tools and new features to its existing systems
depends upon a variety of factors, including product selection, timely and
efficient completion of product design, timely and efficient implementation of
manufacturing and assembly processes, product performance and reliability in
the field and effective sales and marketing. Because new product development
 
                                      14
<PAGE>
 
commitments must be made well in advance of sales, new product decisions must
anticipate both future demand and the availability of technology to satisfy
that demand. There can be no assurance that the Company will be successful in
selecting, developing, manufacturing and marketing new products or
enhancements and related software tools. The inability of the Company to
introduce new products and related software tools that contribute
significantly to net sales, gross margins and net income would have a material
adverse effect on the Company's business, financial condition or results of
operations. New product or technology introductions by the Company's
competitors could cause a decline in sales or loss of market acceptance of the
Company's existing products. In addition, new product introductions by the
Company may cause confusion among the Company's customers if they transition
to such new products, and may delay product purchases.
 
  Significant delays can occur between a system's introduction and the
commencement by the Company of volume production of such system. The Company
has been and is experiencing significant delays in the introduction, volume
production and sales of its systems and related feature enhancements,
including new models within the digital, mixed-signal and non-volatile memory
product lines, due to technical, manufacturing, parts shortages, component
reliability and other difficulties and may continue to experience similar
delays in the future. As a result, certain of the Company's significant
customers have experienced significant delays in receiving and using certain
of the Company's testers in production. There can be no assurance that these
or additional difficulties will not continue to arise in the future with
respect to the Company's systems or that such delays will not materially
adversely affect customer relationships and future sales. Moreover, there can
be no assurance that the Company will not encounter these or other
difficulties that could delay future introductions or volume production or
sales of its systems or enhancements and related software tools. The Company
has incurred and may continue to incur substantial unanticipated costs to
ensure the functionality and reliability of its testers and to increase
feature sets. If the Company's systems continue to have reliability, quality
or other problems, or the market perceives certain of the Company's products
to be feature deficient, reduced orders, higher manufacturing costs, delays in
collecting accounts receivable and higher service, support and warranty
expenses, or inventory write-offs, among other items, could result. The
Company's failure to have a competitive tester and related software tools
available when required by a semiconductor manufacturer could make it
substantially more difficult for the Company to sell testers to that
manufacturer for a number of years. The Company believes that the continued
acceptance, volume production, timely delivery and customer satisfaction of
its newer digital, mixed signal and non-volatile memory testers are of
critical importance to its future financial results. As a result, an inability
to correct any technical, reliability, parts shortages or other difficulties
associated with the Company's systems or to manufacture and ship the Company's
systems on a timely basis to meet customer requirements could damage
relationships with current and prospective customers and would materially
adversely affect the Company's business, financial condition or results of
operations.
 
Customer Concentration; Lengthy Sales Cycle
 
  During the nine months ended July 31, 1997, three customers accounted for
22%, 12% and 9%, respectively, of the Company's net sales. One customer (a
distributor) accounted for 25%, 17% and 13% of the Company's net sales in
fiscal 1996, 1995 and 1994, respectively. The loss of or any reduction in
orders by a significant customer, including losses or reductions due to
continuing or other technical, manufacturing, reliability or other
difficulties associated with the Company's products or market, economic or
competitive conditions in the semiconductor industry or in other industries
that manufacture products utilizing semiconductors could materially adversely
affect the Company's business, financial condition or results of operations.
The Company's ability to maintain or increase its sales levels in the future
will depend in significant part upon its ability to obtain orders from
existing and new customers and to manufacture systems on a timely and cost-
effective basis, the financial condition and success of its customers, general
economic conditions, and the Company's ability to meet increasingly stringent
customer performance and other requirements and shipment delivery dates. There
can be no assurance that the Company will be able to maintain or increase the
level of its net sales in the future or that the Company will be able to
retain existing customers or attract new ones.
 
  Sales of the Company's systems depend in significant part upon the decision
of a semiconductor manufacturer to develop and manufacture new semiconductor
devices or to increase manufacturing capacity. As
 
                                      15
<PAGE>
 
a result, sales of the Company's testers are subject to a variety of factors
outside of the Company's control. In addition, the decision to purchase a
tester generally involves a significant commitment of capital, with the
attendant delays frequently associated with significant capital expenditures.
For these and other reasons, the Company's systems have lengthy sales cycles
during which the Company may expend substantial funds and management effort to
secure a sale and subject the Company to a number of significant risks.
 
Acquisitions
 
  The Company has developed in significant part through mergers and
acquisitions of other companies and businesses. Prior to its initial public
offering in 1993, the Company acquired two companies and the semiconductor
test systems division of Tektronix, Inc. In 1995, the Company acquired EPRO, a
memory tester company. In July 1997, the Company acquired the TDS assets of
Summit Design, Inc. and, in August 1997, acquired the TDX fault simulation and
test program development products from Zycad. The Company intends in the
future to pursue additional acquisitions of complementary product lines,
technologies and businesses. Any future acquisitions by the Company, if any,
could result in potentially dilutive issuances of equity securities, the
incurrence of debt and contingent liabilities, expenditures and reserves, and
amortization expenses related to goodwill and other intangible assets, which
could materially adversely affect the Company's business, financial condition
or results of operations. The Company's one-time charge for in-process
research and development for the TSSI asset acquisition accounted for the
Company's net loss for the third quarter of 1997. In addition, acquisitions
involve numerous other risks, including difficulties in the assimilation of
the operations, technologies and products of the acquired companies, the
diversion of management's attention from other business concerns, risks of
entering markets in which the Company has no or limited direct prior
experience, and the potential loss of key employees of the acquired company.
From time to time, the Company has engaged in and will continue to engage in
discussions with third parties concerning potential acquisitions of product
lines, technologies and businesses. In the event that such an acquisition does
occur, however, there can be no assurance as to the effect thereof on the
Company's business, financial condition or results of operations.
 
Dependence on Key Personnel
 
  The Company's future operating results depend in significant part upon the
continued service of its key personnel, none of whom are bound by an
employment or non-competition agreement. The Company's future operating
results also depend in significant part upon its ability to attract and retain
qualified management, manufacturing, technical, engineering and marketing and
sales and support personnel. Competition for such personnel is intense, and
there can be no assurance that the Company will be successful in attracting or
retaining such personnel. There may be only a limited number of persons with
the requisite skills to serve in these positions and it may be increasingly
difficult for the Company to hire such personnel over time. The loss of any
key employee, the failure of any key employee to perform in his or her current
position, or the Company's inability to attract and retain skilled employees,
as needed, could materially adversely affect the Company's business, financial
condition or results of operations.
 
  Recently, the Company has experienced an increased level of employee
turnover. The Company believes that this increase is due to several factors,
including the recent semiconductor industry slowdown; an expanding economy
within the geographic area where the Company maintains its principal business
offices, making it more difficult for the Company to retain its employees; and
the declining value of stock options granted to employees, relative to their
total compensation, as a result of full vesting of options granted prior to
the Company's initial public offering. Due to these and other factors, the
Company may continue to experience high levels of employee turnover, which
could materially adversely impact the Company's business, financial condition
and results of operations.
 
International Sales
 
  International sales accounted for approximately 70%, 67% and 55% of total
net sales for the first nine months of fiscal 1997, and for fiscal years 1996
and 1995, respectively. The Company is also attempting to
 
                                      16
<PAGE>
 
increase its sales to non-U.S.-based customers. As a result, the Company
anticipates that international sales will continue to account for a
significant portion of total net sales in the foreseeable future. These
international sales will continue to be subject to certain risks, including
changes in regulatory requirements, tariffs and other barriers, political and
economic instability, an outbreak of hostilities, integration of foreign
operations of acquired businesses, foreign currency exchange rate
fluctuations, difficulties with distributors, joint venture partners, original
equipment manufacturers, foreign subsidiaries and branch operations,
potentially adverse tax consequences and the possibility of difficulty in
accounts receivable collection. The Company is also subject to the risks
associated with the imposition of legislation and regulations relating to the
import or export of semiconductor equipment. The Company cannot predict
whether quotas, duties, taxes or other charges or restrictions will be
implemented by the United States or any other country upon the importation or
exportation of the Company's products in the future. Any of these factors or
the adoption of restrictive policies could have a material adverse effect on
the Company's business, financial condition or results of operations.
 
Proprietary Rights
 
  The Company attempts to protect its intellectual property rights through
patents, copyrights, trade secrets and other measures, including
confidentiality agreements. There can be no assurance that others will not
independently develop substantially equivalent proprietary information and
techniques or otherwise gain access to the Company's trade secrets and other
intellectual property rights or disclose such technology or that the Company
can meaningfully protect its trade secrets or other intellectual property
rights. There can be no assurance that patents owned by the Company will not
be invalidated, deemed unenforceable, circumvented or challenged, or that the
rights granted thereunder will provide competitive advantages to the Company
or that any of the Company's pending or future patent applications will be
issued with claims of the scope sought by the Company, if at all. Furthermore,
there can be no assurance that others will not develop similar products,
duplicate the Company's products or design around the patents owned by the
Company. In addition, there can be no assurance that foreign intellectual
property laws or the Company's agreements will protect the Company's
intellectual property rights. Failure to protect the Company's intellectual
property rights could have a material adverse effect upon the Company's
business, financial condition or results of operations. The Company has been
involved in extensive, expensive and time-consuming reviews of, and litigation
concerning, patent infringement claims. In addition, the Company has at times
been notified of other claims that it may be infringing intellectual property
rights possessed by third parties and expects to continue to receive notice of
such claims in the future.
 
  The European patent application relating to one of the proprietary CMOS
stabilization methods owned by the Company was abandoned by the prior owner
after the European patent examiner cited prior art. This prior art was not
referenced in the corresponding United States patent application. Based upon
its review to date of the cited prior art and the European examiner's
objections, and in part upon the advice of Smith-Hill and Bedell, P.C.,
outside patent counsel to the Company ("SHB"), the Company believes that such
prior art is unlikely to affect the validity or scope of the claims of the
United States issued patent.
 
  This prior art may, however, render invalid or significantly narrow the
scope of certain claims set forth in the United States patent covering the
Company's other proprietary CMOS stabilization method. The European examiner
referred to this prior art in the corresponding European patent application.
The European application was approved, but with narrower claims than the
United States patent. This prior art was not referenced in the corresponding
United States patent. Based in part upon the advice of SHB, and on the
Company's review of its current products, the Company believes that this
patent will continue to be valuable to the Company in preventing imitation of
the Company's products covered by this patent. Additionally, in mid-1992, a
third party suggested that certain claims set forth in this patent might be
invalid as a result of other alleged prior art. The Company believes, based in
part upon the advice of SHB, that the prior art alleged by the third party is
less relevant than the prior art referenced by the European examiner. However,
there can be no assurance that any of the aforementioned prior art or other
prior art will not be successfully asserted and used to invalidate or narrow
the scope of any claim of the United States patents or any other patents or
other patent applications of the Company.
 
                                      17
<PAGE>
 
  Certain of the Company's customers have received notices of infringement
from Jerome Lemelson alleging that the manufacture of semiconductor products
and/or the equipment used to manufacture semiconductor products infringes
certain patents issued to such person. The Company was notified by a customer
in 1990 and a different customer in late 1994 that the Company may be
obligated to defend or settle claims that the Company's products infringe such
person's patents, and, in the event it is subsequently determined that the
customer infringes such person's patents, such customer intends to seek
reimbursement from the Company for damages and other related expenses. There
can be no assurance that the Company will be successful in defending current
or future patent infringement claims or claims for indemnification resulting
from infringement claims. An award of damages, injunctive relief or
expenditures by the Company of significant amounts in defending any such
action could materially adversely affect the Company's business, financial
condition or results of operations, regardless of the outcome of any
litigation. With respect to any claims, the Company may seek to obtain a
license under the third party's intellectual property rights. There can be no
assurance, however, that a license will be available on reasonable terms or at
all. The Company could decide, in the alternative, to continue to resort to
litigation to challenge such claims. Such challenges have been and could
continue to be extremely expensive and time consuming, and could materially
adversely affect the Company's business, financial condition or results of
operations, regardless of the outcome of any litigation.
 
Future Capital Needs
 
  The development and manufacture of new ATE systems and enhancements are
highly capital intensive. In order to be competitive, the Company must make
significant investments in capital equipment, expansion of operations,
systems, procedures and controls, research and development and worldwide
training, customer service and support, among many items. The Company expects
that cash on hand and cash equivalents, including restricted cash, proceeds
from the $100 million private placement, short-term investments, funds
available under its bank line of credit, anticipated cash flow from operations
and equipment lease arrangements will satisfy its financing requirements for
at least the next 18 months.
 
Volatility of Stock Price
 
  The Company believes that factors such as announcements of developments
related to the Company's business, fluctuations in the Company's financial
results, general conditions or developments in the semiconductor and capital
equipment industry and the general economy, sales of the Company's Common
Stock into the marketplace, an outbreak of hostilities, natural disasters,
announcements of technological innovations or new products or enhancements by
the Company or its competitors, developments in patents or other intellectual
property rights, developments in the Company's relationships with its
customers and suppliers, or a shortfall or changes in revenue, gross margins
or earnings or other financial results from analysts' expectations could cause
the price of the Company's Common Stock to fluctuate, perhaps substantially.
In recent years the stock market in general, and the market for shares of
small capitalization stocks in particular, including the Company, have
experienced extreme price fluctuations, which have often been unrelated to the
operating performance of affected companies. There can be no assurance that
the market price of the Company's Common Stock will not continue to experience
significant fluctuations in the future, including fluctuations that are
unrelated to the Company's performance.
 
Leverage
 
  In connection with the sale of the $100 million aggregate principal amount
of the Note due 2002, the Company will incur $100 million of indebtedness
which will result in a ratio of long-term debt to total capitalization at July
31, 1997 of approximately 34% on an as-adjusted basis. As a result of this
indebtedness, the Company's principal and interest obligations will increase
substantially. The degree to which the Company will be leveraged could
materially adversely affect Company's ability to obtain financing for working
capital, acquisitions or other purposes and could make it more vulnerable to
industry downturns and competitive pressures. The Company's ability to meet
its debt service obligations will be dependent upon the Company's
 
                                      18
<PAGE>
 
future performance, which will be subject to financial, business and other
factors affecting the operations of the Company, many of which are beyond its
control.
 
Effects of Certain Anti-Takeover Provisions
 
  Certain provisions of the Company's Certificate of Incorporation, equity
incentive plans, Bylaws and Delaware law may discourage certain transactions
involving a change in control of the Company. In addition to the foregoing,
the Company's classified board of directors, the shareholdings of the
Company's officers, directors and persons or entities that may be deemed
affiliates and the ability of the Board of Directors to issue "blank check"
preferred stock without further stockholder approval could have the effect of
delaying, deferring or preventing a change in control of the Company and may
adversely affect the voting and other rights of holders of Common Stock.
 
                                      19
<PAGE>
 
PART II.--OTHER INFORMATION
 
ITEM 1. LEGAL PROCEEDINGS
 
  Reference is made to Note 4 of notes to condensed consolidated financial
statements.
 
ITEM 2. CHANGES IN SECURITIES
 
  None
 
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
 
  None
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
  None
 
ITEM 5. OTHER INFORMATION
 
  On July 11, 1997, the Company, through its newly formed subsidiary, Test
Systems Strategies, Inc., a Delaware Corporation ("TSSI"), acquired certain
assets and assumed certain liabilities from Summit Design, Inc. and its wholly
owned subsidiary, Test Systems Strategies, Inc., an Oregon Corporation,
including the test development series software ("TDS") and TSSI trademark of
Test Systems Strategies, Inc. (an Oregon Corporation). TDS includes tools
designed to convert gate-level simulation data from electronic design
automation simulators to programs that operate on targeted automatic test
equipment ("ATE") for testing integrated circuits characterized by the gate-
level simulation data. TDS facilitates simulation analysis, stimulus
generation, simulation rules checking, tester resource checking, ATE test
program generation, and test program conversion. The acquisition has been
accounted for by the Company under the purchase method of accounting, and
accordingly, the condensed consolidated financial statements reflect the
impact of TDS operations subsequent to the acquisition date.
 
  The purchase price of $7.3 million, consisted of a cash payment of $7.0
million to Summit Design, Inc. and $300,000 for the assumption of liabilities.
Acquired assets and liabilities were recorded at their estimated fair market
value at the date of the acquisition. The aggregate purchase price, plus
related acquisition expenses, have been allocated to the assets and
liabilities acquired based on valuations. Amounts allocated to in-process
research and development of approximately $6.0 million were written-off at the
acquisition date, representing an estimated value (using risk-adjusted cash
flows, discounted at 35%) of development programs that have not yet reached
technological feasibility. Amounts allocated to developed technology, $1.0
million and workforce in place, $0.3 million, are being amortized on a
straight line basis over periods of six and three years respectively.
 
  In addition, on May 19, 1997, the Company entered into an agreement with
Summit Design, Inc. for the Company to purchase approximately $18 million of
Summit's Visual Testbench ("VTB") product licenses and maintenance services
through 1999.
 
  On August 20, 1997, the Company, through one of its subsidiaries, Test
Systems Strategies, Inc., purchased from Zycad Corporation and one of its
subsidiaries, Attest Software, Inc. certain assets and assumed certain
liabilities for $2,250,000.
 
  On September 10, 1997, the Company sold $100 million of 5 1/4% convertible
subordinated notes (the "Notes") due 2002 through a private placement within
the U.S. to qualified institutional buyers in accordance with Rule 144A and
outside the U.S., to non-U.S. persons as defined in Regulation S under the
Securities Act of 1933, as amended. The Notes are convertible into common
stock of the Company at a conversion price of $69.15 per share. The Company
has granted to Smith Barney, Inc., the initial purchaser, a 30-day option to
purchase an
 
                                      20
<PAGE>
 
additional $15 million of Notes to cover over-allotments, if any. Expense of
$3.0 million associated with the offering will be deferred and included in
other assets. Such expenses will be amortized to interest expense over the term
of the Notes.
 
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
 
  (a)See Exhibit Index on page 23.
 
  (b)No reports on Form 8-K have been filed during the quarter ended July 31,
   1997.
 
                                       21
<PAGE>
 
                                  SIGNATURES
 
  Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the registrant duly caused this Report to be signed on its behalf by
the undersigned thereunto duly authorized.
 
                                          CREDENCE SYSTEMS CORPORATION
                                 ----------------------------------------------
                                                  (Registrant)
 
      September 12, 1997                     /s/ RICHARD Y. OKUMOTO
-------------------------------  ----------------------------------------------
             Date                              Richard Y. Okumoto
                                   Executive Vice President, Chief Financial
                                             Officer and Secretary
 
                                      22
<PAGE>
 
                                 EXHIBIT INDEX
 
<TABLE>
<CAPTION>
 EXHIBIT
 NUMBER                                                                    PAGE
 -------                                                                   ----
 <C>     <S>                                                               <C>
  2.9    Asset Purchase Agreement, dated as of May 19, 1997, among
         Credence Systems Corporation, Summit Design, Inc., Test Systems
         Strategies, Inc., a Delaware corporation and wholly-owned
         subsidiary of Credence Systems Corporation, and Test Systems
         Strategies, Inc., an Oregon Corporation and wholly-owned
         subsidiary of Summit Design, Inc................................   24
 10.23*  Software OEM License Agreement between Credence Systems
         Corporation, Test Systems Strategies, Inc. and Summit Design,
         Inc. dated May 19, 1997.........................................   52
 10.24   Joint Venture Agreement, dated June 10, 1997, between Credence
         Systems Corporation and Innotech Corporation....................   69
 11.1    Computation of Net Income (Loss) Per Share......................  130
 27.1    EDGAR Financial Data Schedule...................................  131
</TABLE>
--------
* Confidential treatment has been requested for certain portions of this
exhibit.
 
                                       23