<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 April 30, 2001

                                      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 June 4, 2001, there were approximately 52,728,222 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......................................................   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................................................................   9
Item 3.     Quantitative and Qualitative Disclosures about Market Risk................  24

PART II.    OTHER INFORMATION
Item 1.     Legal Proceedings.........................................................  26
Item 2.     Changes in Securities.....................................................  26
Item 3.     Defaults Upon Senior Securities...........................................  26
Item 4.     Submission of Matters to a Vote of Securityholders........................  26
Item 5.     Other Information.........................................................  26
Item 6.     Exhibits and Reports on Form 8-K..........................................  26
</TABLE>

                                       2
<PAGE>

PART I - FINANCIAL INFORMATION

Item I - Financial Statements

                         CREDENCE SYSTEMS CORPORATION
                     CONDENSED CONSOLIDATED BALANCE SHEETS
                                (in thousands)


<TABLE>
<CAPTION>
                                                                                   April 30,               October 31,
                                                                                     2001                     2000a
                                                                                ---------------        ---------------
<S>                                                                               <C>                    <C>
ASSETS                                                                            (unaudited)
Current assets:
  Cash and cash equivalents.................................................           $ 61,969               $119,089
  Short-term investments....................................................             75,118                124,545
  Accounts receivable, net..................................................             62,696                175,794
  Inventories...............................................................            109,192                102,034
  Other current assets......................................................             43,520                 29,420
                                                                                ---------------        ---------------
    Total current assets....................................................            352,495                550,882
Long-term investments.......................................................            206,320                133,804
Property and equipment, net.................................................            110,501                 94,853
Goodwill from acquisitions, net.............................................             57,461                 55,133
Other intangible assets, net................................................             44,155                 42,161
Other assets................................................................              8,509                  2,404
                                                                                ---------------        ---------------
    Total assets............................................................           $779,441               $879,237
                                                                                ===============        ===============

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable..........................................................           $ 18,769               $ 53,287
  Accrued liabilities.......................................................             54,854                 71,202
  Income taxes payable......................................................                 --                 23,866
                                                                                ---------------        ---------------
    Total current liabilities...............................................             73,623                148,355
Other liabilities...........................................................             10,343                  8,332
Minority interest...........................................................                165                    323
Stockholders' equity........................................................            695,310                722,227
                                                                                ---------------        ---------------
    Total liabilities and stockholders' equity..............................           $779,441               $879,237
                                                                                ===============        ===============
</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, 2000.

                                       3
<PAGE>

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

<TABLE>
<CAPTION>

                                                                 Three Months Ended                       Six Months Ended
                                                                      April 30,                              April 30,
                                                        -----------------------------------     ----------------------------------
                                                              2001               2000                2001               2000
                                                        ----------------    ---------------     ---------------     --------------
<S>                                                       <C>                 <C>                 <C>                 <C>
Net sales............................................           $ 43,293           $153,754            $166,470           $255,522
Cost of goods sold -on net sales.....................             22,434             62,796              74,994            105,819
Cost of goods sold-special charges...................             45,020                 --              45,020                 --
                                                        ----------------    ---------------     ---------------     --------------
Gross margin.........................................            (24,161)            90,958              46,456            149,703
Operating expenses:
   Research and development..........................             18,990             15,525              39,411             28,686
   Selling, general and administrative...............             21,691             24,891              47,453             44,235
   Amortization of purchased intangibles.............              6,113              1,355              11,291              2,131
   Special charges...................................              1,968                 --               1,968                 --
                                                        ----------------    ---------------     ---------------     --------------
       Total operating expenses......................             48,762             41,771             100,153             75,052
                                                        ----------------    ---------------     ---------------     --------------
Operating income (loss)..............................            (72,923)            49,187             (53,967)            74,651
Interest and other income, net.......................              4,660              2,809               8,871              3,492
                                                        ----------------    ---------------     ---------------     --------------
Income (loss) before income tax provision............            (68,263)            51,996             (44,826)            78,143
Income tax (benefit).................................            (24,525)            18,458             (15,689)            27,740
Minority interest (benefit)..........................                (26)                44                (160)                47
                                                        ----------------    ---------------     ---------------     --------------
Net income...........................................           $(43,712)          $ 33,494            $(28,977)          $ 50,356
                                                        ================    ===============     ===============     ==============
Net income per share
    Basic............................................             $(0.83)             $0.70              $(0.55)             $1.10
                                                        ================    ===============     ===============     ==============
    Diluted..........................................             $(0.83)             $0.63              $(0.55)             $1.00
                                                        ================    ===============     ===============     ==============
Number of shares used in computing per share amount
    Basic............................................             52,494             47,984              52,448             45,900
                                                        ================    ===============     ===============     ==============
    Diluted..........................................             52,494             53,010              52,448             50,386
                                                        ================    ===============     ===============     ==============
</TABLE>




                            See accompanying notes.

                                       4
<PAGE>

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

<TABLE>
<CAPTION>
                                                                                            Six Months Ended
                                                                                               April 30,
                                                                                 -----------------------------------
                                                                                       2001                2000
                                                                                 ---------------      --------------
<S>                                                                                <C>                  <C>
Cash flows from operating activities:
 Net income (loss)............................................................         $ (28,977)          $  50,356
 Adjustments to reconcile net income to net cash used in operating activity
   Depreciation and amortization..............................................            25,910              12,609
   Non cash special charges...................................................            45,670                  --
   (Gain) loss on disposal of property and equipment..........................               475                (277)
   Minority interest..........................................................              (158)                  3
   Changes in operating assets and liabilities:
     Accounts receivable, inventories and other current assets................            46,059             (79,137)
     Accounts payable, accrued liabilities and income taxes payable...........           (73,433)             42,486
                                                                                 ---------------      --------------
       Net cash provided by operating activities..............................            15,546              26,040
Cash flows from investing activities:
 Purchases of available-for-sale securities...................................          (184,951)           (189,545)
 Maturities of available-for-sale short-term securities.......................            11,137              14,350
 Sales of available-for-sale securities.......................................           151,422              17,532
 Acquisition of property and equipment........................................           (27,541)            (11,474)
 Acquisition of intangible and other assets...................................           (21,719)             (3,737)
 Proceeds from the sale of assets.............................................                80                 616
                                                                                 ---------------      --------------
       Net cash used in investing activities..................................           (71,572)           (172,258)
Cash flows from financing activities:
 Issuance of common & treasury stock..........................................             5,391             295,635
 Repurchase of common stock...................................................            (6,485)                 --
                                                                                 ---------------      --------------
       Net cash provided by (used in) financing activities....................            (1,094)            295,448
                                                                                 ---------------      --------------
Net increase (decrease) in cash and cash equivalents..........................           (57,120)            149,230
Cash and cash equivalents at beginning of period..............................           119,089              52,104
                                                                                 ---------------      --------------
Cash and cash equivalents at end of period....................................         $  61,969           $ 201,334
                                                                                 ===============      ==============
Supplemental disclosures of cash flow information:
 Interest paid................................................................         $      --           $   2,536
 Income taxes paid............................................................         $  22,852           $   9,062
Other noncash activities:
 Net transfers of inventory to property and equipment.........................         $   2,409           $   3,709
 Income tax benefit from stock option exercises...............................         $     935           $   7,399
 Issuance of common or treasury stock for convertible subordinated  notes.....         $      --           $     579
 Exchange of convertible notes for common stock plus issuance costs...........         $      --           $     579
</TABLE>

                            See accompanying notes.

                                       5
<PAGE>

             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.   Quarterly Financial Statements

     The condensed consolidated financial statements and related notes for the
three months ended April 30, 2001 and 2000 are unaudited but include all
adjustments (consisting solely of normal recurring adjustments) which are, in
the opinion of management, necessary for a fair presentation of the financial
position and results of operations of the Company for the interim periods. The
results of operations for the three months ended April 30, 2001 and 2000 were
not necessarily indicative of the operating results to be expected for the full
fiscal year. The information included in this report should be read in
conjunction with the Company's audited consolidated financial statements and
notes thereto for the fiscal year ended October 31, 2000 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
fluctuations in our quarterly net sales and operating results, limited systems
sales, backlog, cyclicality of semiconductor industry, management of
fluctuations in our operating results, expansion of our product lines, limited
sources of supply, reliance on our subcontractors, highly competitive industry,
rapid technological change, importance of timely product introduction, customer
concentration, lengthy sales cycle, risks associated with acquisitions, changes
in financial accounting standards and accounting estimates, dependence on key
personnel, transition in our executive management, international sales,
proprietary rights, future capital needs, leverage, volatility of our stock
price and effects of certain anti-takeover provisions, as set forth in this
Report. Any party interested in reviewing a free copy of the Form 10-K or the
Company's other publicly available documents should write to the Chief Financial
Officer of the Company.

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

     BASIS OF PRESENTATION - Certain prior year amounts in the Condensed
Consolidated Financial Statements and related notes have been reclassified to
conform to the current year's presentation.

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):


                                           April 30,             October 31,
                                             2001                    2000
                                       --------------          --------------
                                         (unaudited)
Raw materials........................        $ 48,664                $ 39,736
Work-in-process......................          25,404                  44,704
Finished goods.......................          35,124                  17,594
                                       --------------          --------------
                                             $109,192                $102,034
                                       ==============          ==============

3.   Net Income Per Share

     Basic net income 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.  Options to purchase approximately
9,054,972 shares at an average price of $21.34 per share were outstanding at
April 30, 2001, but were not included in the computation of diluted net loss per
share because options are anti-dilutive in periods when the Company incurs a net
loss.  The following table sets forth the computation of basic and diluted net
income per share (in thousands, except per share amounts):

                                       6
<PAGE>

<TABLE>
<CAPTION>
                                                                              Six Months Ended
                                                                                  April 30,
                                                                    -----------------------------------
                                                                          2001                 2000
                                                                    --------------       --------------
<S>                                                                   <C>                  <C>
Numerator:
 Numerator for basic and diluted net income (loss) per share--
 net income (loss)                                                        $(28,977)             $50,356
                                                                    --------------       --------------
Denominator:
 Denominator for basic net income (loss) per share-
 weighted-average shares                                                    52,448               45,900
Effect of dilutive securities-employee stock options                            --                3,554
Effect of dilutive securities-subordinated convertible notes                    --                  932
                                                                    --------------       --------------
Denominator for diluted earnings per share-adjusted
weighted-average shares and assumed conversions                             52,448               50,386
                                                                    --------------       --------------
 Basic net income (loss) per share                                        $ ( 0.55)             $  1.10
                                                                    ==============       ==============
 Diluted net income (loss) per share                                      $ ( 0.55)             $  1.00
                                                                    ==============       ==============
</TABLE>

4.   Recent Accounting Pronouncements

     In November 2000, the Company adopted SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," (SFAS 133).  SFAS 133 requires
the Company to recognize all derivatives on the balance sheet at fair value.
Derivatives that are not hedges must be adjusted to fair value through earnings.
If the derivative is a hedge, depending on the nature of the hedge, changes in
the fair value of derivatives will either be offset against the change in the
fair value of the hedged assets, liabilities or firm commitments through
earnings, or recognized in other comprehensive income (loss) until the hedged
item is recognized in earnings. The ineffective portion of a derivative's change
in fair value will be immediately recognized in earnings. Adoption of SFAS 133
did not have a material impact on the Company's financial condition or results
of operations.

     In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin 101 ("SAB 101") "Revenue Recognition in Financial
Statements". SAB 101 provides guidance on the recognition, presentation, and
disclosure of revenue in financial statements. All registrants are expected to
apply the accounting principles and disclosure described in SAB 101. Because the
Company has complied with generally accepted accounting principles for its
historical revenue recognition, the change in its revenue policy resulting from
SAB 101 will be reported as a cumulative effect adjustment resulting from a
change in accounting principle effective November 1, 2000, in the fourth quarter
of fiscal 2001. Adoption of SAB 101 will also require the Company to re-state
the quarterly results for the three fiscal quarters ended July 31, 2001. The
Company is currently in the process of assessing SAB 101 and how it will impact
its reported revenues and income and is therefore unable to determine the impact
of SAB 101 on its financial statements.

5.   Contingencies

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

     We have at times been notified that we may be infringing intellectual
property rights of third parties and we have litigated patent infringement
claims in the past. We expect to continue to receive notice of such claims in
the future. In July 1998, inTEST IP Corporation, or inTEST, alleged in writing
that certain of our products are infringing a patent held by inTEST. We have
since then engaged in sporadic discussions with inTEST concerning this matter.
On December 15, 2000, inTEST filed a complaint in the U.S. District Court for
the District of Delaware against us, alleging infringement of inTEST U.S. patent
number 4,589,815 and seeking damages and injunctive relief. On April 10, 2001,
the Company was served with the complaint.  We may also be obligated to other
third parties relating to

                                       7
<PAGE>

this allegation. We believe we have meritorious defenses to the claims. However,
we cannot be certain of success in defending this patent infringement claim or
claims for indemnification resulting from infringement claims.

6.   Accumulated Other Comprehensive Income (Loss)

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

<TABLE>
<CAPTION>
                                           Six Months                   Fiscal Years Ended
                                        Ended April 30,                     October 31,
                                    ---------------------      ----------------------------------
<S>                                   <C>                        <C>                 <C>
                                             2001                   2000                1999
                                    ---------------------      --------------      --------------
Beginning balance gain (loss)                      $2,217              $ (661)              $(241)
Unrealized gain (loss) on available-
for-sale securities                                   (48)              3,158                (517)
Currency translation adjustment                       746                (280)                 97
                                    ---------------------      --------------      --------------
Total                                              $2,915              $2,217               $(661)
                                    =====================      ==============      ==============
</TABLE>

7.   Acquisition

     In February 2001, the Company acquired certain assets of Rich Rabkin &
Associates, Inc. ("Rabkin") for approximately $6.0 million in cash.  Rabkin
specializes in providing interface solutions and test head positioning devices
for the semiconductor test market through its patented solution for high
parallel memory testing.  Rabkin has six employees based in Sausalito,
California.  Rabkin will be integrated into the Company's Memory Products
Division.

8.   Special Charges

     The Company recorded a special charge for costs of goods sold of
approximately $45 million related to the write down of excess inventories.
Approximately $19 million of this charge is for the Company's logic product
lines and is principally for raw materials and work in process. The remaining
$26 million is primarily for the mixed signal product lines and is principally
for raw materials, work in process and purchase commitment liabilities.

     The Company recorded a special operating charge of approximately $2 million
for severance payments and asset disposals associated with the Company's recent
headcount reductions.  Approximately $1.3 million was for severance payments and
the rest of the charge was for asset disposals.  The cash expenditures
associated with this charge largely occurred in the second quarter with the
remaining amounts expected to be paid in the third fiscal quarter of 2001.

9.   Subsequent Event

     In May 2001, the Company entered into a definitive agreement pursuant to
which the Company would acquire Integrated Measurement Systems, Inc. ("IMS") for
approximately $170 million. IMS (Nasdaq: IMSC) is a leader in the design and
delivery of high performance integrated circuit validation systems and software
solutions. IMS is headquartered in Beaverton, Oregon. Under the terms of the
agreement, and subject to various closing conditions and approval of IMS
shareholders, the Company will acquire IMS in a stock-for-stock transaction
which is intended to be accounted for as a pooling-of-interests. Each share of
IMS common stock outstanding as of the closing date of the merger will be
converted into 0.90 shares of the Company's common stock on a fixed exchange
ratio basis. The transaction is subject to various closing conditions and it is
anticipated to close in the second half of calendar year 2001.

                                       8
<PAGE>

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

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

     Revenue growth has slowed in the first six months of fiscal 2001 in the
test and assembly sector of the semiconductor equipment industry during what we
believe is a cyclical downturn in the industry. There is uncertainty as to if
and when the next cyclical growth phase will occur. Until such time as we return
to a growth period, we expect a continuing decline in orders and therefore
expect that the July 31, 2001 fiscal quarter's revenue will decline from the
levels experienced by us during the second quarter of fiscal 2001.

     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           Six Months Ended
                                                                    April 30,                   April 30,
                                                           -----------------------------------------------------
                                                               2001         2000              2001       2000
                                                           ------------  -----------      ----------  ----------
<S>                                                            <C>            <C>              <C>           <C>
Net sales                                                         100.0%       100.0%          100.0%      100.0%
Cost of goods sold - on net sales                                  51.8         40.8            45.1        41.4
Cost of goods sold - special charges                              104.0                         27.0
                                                           ------------  -----------      ----------  ----------
Gross margin                                                      (55.8)        59.2            27.9        58.6
Operating expenses
  Research and development                                         43.9         10.1            23.7        11.2
  Selling, general and administrative                              50.1         16.2            28.5        17.3
  Amortization of purchased intangible assets                      14.1          0.9             6.8         0.9
  Special charges                                                   4.5           --             1.1          --
                                                           ------------  -----------      ----------  ----------
    Operating expenses                                            112.6         27.2            60.1        29.4
                                                           ------------  -----------      ----------  ----------
Operating income (loss)                                          (168.4)        32.0           (32.2)       29.2
Interest and other income                                          10.6          1.8             5.3         1.4
                                                           ------------  -----------      ----------  ----------
Income (loss) before income tax provision (benefit)              (157.8)        33.8           (26.9)       30.6
Income tax provision (benefit)                                    (56.8)        12.0            (9.5)       10.9
                                                           ------------  -----------      ----------  ----------
Net income (loss)                                                (101.0)        21.8           (17.4)       19.7
                                                           ============  ===========      ==========  ==========
</TABLE>

RESULTS OF OPERATIONS

NET SALES

     Net sales consist of revenues from systems sales, spare parts sales,
maintenance contracts and software sales. Net sales were $43.3 million for the
second quarter of fiscal 2001, representing a decrease of 72% from the net sales
of $153.8 million in the comparable period of fiscal 2000.  Net sales declined
65% from the first quarter of fiscal 2001, when the Company recorded $123.2
million in revenue.

     During fiscal years 1999 and 2000, our net sales improved each sequential
quarter because of four principal factors:

   .   a significant increase in the worldwide demand for semiconductor ATE;

                                       9
<PAGE>

   .   improved business and economic conditions in Asia, particularly in
       Taiwan;

   .   the increased sales of two major products: the Quartet high-performance
       mixed signal tester and the Kalos memory tester; and

   .   the acquisition of the TMT, Inc. ("TMT") product lines in May 2000.

     Since October 2000, revenue has declined in each fiscal quarter of 2001 in
the test and assembly sector of the semiconductor equipment industry during what
is now believed to be a cyclical downturn in the industry.  This belief is based
on weakening order activity, order cancellations, and customer-requested
shipment delays from our existing backlog.  This business weakness is being
experienced throughout the industry with particularly strong declines in Asia.

     International net sales accounted for approximately 75%, 80%, and 64% of
total net sales in the first six months of fiscal 2001 and fiscal years 2000 and
1999, respectively. Our net sales to the Asia-Pacific region accounted for
approximately 46%, 69% and 55% of total net sales in the first six months of
fiscal 2001 and fiscal years 2000 and 1999, respectively, and thus are subject
to the risk of economic instability in that region that materially adversely
affected the demand for our products in 1998. Capital markets in Korea and other
areas of Asia have been highly volatile, resulting in economic instabilities.
These instabilities may reoccur, which could materially adversely affect demand
for our products.

     Our net sales by product line in the first six months of fiscal 2001 and
fiscal years 2000 and 1999 consisted of:

<TABLE>
<CAPTION>
                                            Six Months                          Fiscal Years Ended
                                         Ended April 30,                           October 31,
                                   -------------------------       -----------------------------------------
                                              2001                       2000                     1999
                                   -------------------------       -----------------       -----------------
<S>                                  <C>                             <C>                     <C>
Mixed-Signal                                              68%                     72%                     65%
Logic                                                      5                      12                      16
Memory                                                    15                      11                       7
Service and software                                      12                       5                      12
                                   -------------------------       -----------------       -----------------
Total                                                    100%                    100%                    100%
                                   =========================       =================       =================
</TABLE>

     The increase in the memory percentage and the high percentage of net sales
attributable to mixed-signal products are principally derived from the sales of
the Kalos and Quartet products, respectively.  Revenues from software were not
material to our operations in the first six months of 2001 and fiscal years 2000
and 1999, representing less than 4% of our net sales in each period.

GROSS MARGIN

     Our gross margin has been and will continue to be affected by a variety of
factors, including manufacturing efficiencies, 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 margins for the second quarter and the
first half of fiscal 2001 were impacted by charges for the disposal of excess
inventories. During the second quarter of fiscal 2001, we recorded approximately
$45.0 million of special charges related to the write down of excess inventory
and purchase commitment liabilities, of which approximately $19 million was
related to the logic product lines with the rest largely earmarked for the mixed
signal product lines. Our gross margin (excluding these charges), was 48.2% and
54.9% for the three and six month periods ended April 30, 2001, respectively,
compared with 59.2% and 58.6% for the comparable periods in fiscal 2000. The
falling gross margins are the results of lower average selling prices in fiscal
2001 as well as higher costs caused by under-absorption of manufacturing
expenses.

RESEARCH AND DEVELOPMENT

     Research and development ("R&D") expenses were $39.4 million in the first
six months of fiscal 2001, an increase of $10.7 million or 37.4% over the same
period of fiscal 2000. The higher level of spending in fiscal 2001 reflects the
acquisitions of TMT, Modulation Instruments, Inc. ("MI"), and NewMillennia
Solutions, Inc. ("NMS"),

                                       10
<PAGE>

in fiscal 2000 as well as increases in internal R&D project expenses. As a
percentage of net sales, R&D expenses were 23.7% for the first six months of
fiscal 2001, an increase from 11.2% in the first six months of fiscal 2000. The
Company currently intends to continue to invest significant resources in the
development of new products and enhancements of existing products for the
foreseeable future. Accordingly, the Company expects these expenses to be
relatively stable in absolute dollars for the remainder of fiscal 2001.

SELLING, GENERAL AND ADMINISTRATIVE

     Selling, general and administrative expenses ("SG&A") were $47.5 million in
the first six months of fiscal 2001, representing a $3.2 million, or 7.3%,
increase from the comparable period of fiscal 2000.  The higher spending in 2001
was primarily due to increased payroll related expenses due to a higher
headcount in fiscal 2001.  In the latter half of fiscal 2000, we added SG&A
headcount through the acquisitions of TMT and Credence Europa as well as general
recruitment.  As a percentage of net sales, SG&A expenses were 28.5% for the
first six months of fiscal 2001, compared with 17.3% for the corresponding
period in fiscal 2000.  The Company expects SG&A expenses for the remainder of
fiscal 2001 to decline slightly in absolute dollars because of the headcount
reductions effected in February and May 2001 as well as other cost saving
measures.

AMORTIZATION OF PURCHASED INTANGIBLE ASSETS

     Amortization of purchased intangible expenses increased to $11.3 million in
the first six months of fiscal 2001 from $2.1 million in the comparable period
of fiscal 2000, an increase of 430%. In May 2000, we purchased TMT for
approximately $80.0 million, in August 2000 we purchased MI for approximately
$20.5 million and Credence Europa for approximately $8.4 million, in October
2000 we purchased NMS for approximately $11.3 million, and earlier this calendar
year we purchased Dimensions Consulting, Inc. and Rabkin.  These acquisitions
have resulted in approximately $2.8 million, $1.1 million, $0.4 million, $0.7
million, $0.5 and $0.4 million, respectively, in quarterly charges for
amortization of purchased intangibles assets.

SPECIAL CHARGES

     In the second quarter of fiscal 2001, we recorded approximately $47 million
of special charges as a result of a major downturn in the semiconductor
equipment industry. The recent headcount reductions have reduced our worldwide
headcount from approximately 1,450 at October 31, 2000 to 1,140 today. In
addition we have instituted a reduced work schedule and implemented pay cuts for
our remaining employees.

     We recorded a special charge for costs of goods sold of approximately $45
million related to the write down of excess inventories. Approximately $19
million of this charge is for our logic product lines and is principally for raw
materials and work in process. The remaining $26 million is primarily for the
mixed signal product lines and is principally for raw materials, work in process
and purchase commitment liabilities.

     We recorded a special operating charge of approximately $2 million for
severance payments and asset disposals associated with our recent headcount
reductions.  Approximately $1.3 million was for severance payments and the rest
of the charge was for asset disposals.  The cash expenditures associated with
this charge largely occurred in the second fiscal quarter with the remaining
amounts expected to be paid in the third fiscal quarter of 2001.

INTEREST AND OTHER INCOME/EXPENSES, NET

     We generated net interest and other income of $8.9 million for the first
six months of fiscal 2001, as compared to $3.5 million for the first six months
of fiscal 2000. The increase in fiscal 2001 was due to higher average cash and
investment balances in fiscal 2001 as compared to fiscal 2000. These higher
average balances were the result of the cash received in our secondary public
offering in February 2000 offset by cash outlays for acquisitions and the
purchase of our Hillsboro, Oregon facility. In addition, in September 2000, we
called for redemption the remaining outstanding Convertible Subordinated Notes.

                                       11
<PAGE>

INCOME TAXES

     Our estimated effective tax benefit rate for the first six months of
fiscal 2001 was 35.0%, compared to an effective tax rate of 35.5% in the first
six months of fiscal 2000.  The estimated tax benefit rate for fiscal 2001 is
less than the combined federal and state statutory rate primarily due to the
impact of  non-deductible goodwill amortization.  The effective tax rate in
fiscal 2000 was less than the combined federal and state statutory rate
primarily due to the benefits of our foreign sales corporation.  The tax rate
applied to pre-tax book income for the first six months is computed based on a
projected effective tax rate for the year.

LIQUIDITY AND CAPITAL RESOURCES

     Operating activities provided net cash flows of $15.5 million and $26.0
million for the six months ended April 30, 2001 and 2000, respectively. Net cash
flows provided by operating activities for the first six months of 2001 were
primarily due to the net income before special non-cash charges and depreciation
and amortization of $42.6 million offset by an increase in working capital of
$27 million.

     Investing activities used net cash flows of approximately $71.6 million and
$172.4 million in the six months ended April 30, 2001 and 2000, respectively.
For fiscal 2001, approximately $22.4 million was used for net purchases of
available-for-sale securities, $27.5 million for purchases of property and
equipment to support our business, and we disbursed approximately $13 million
for the acquisition of DCI and the assets of Rabkin.  We also provided a $5
million dollar loan in the form of a note receivable to a distributor during the
first half of fiscal 2001.

     Financing activities used net cash flows of $1.1 million and provided
$295.4 million for the six months ended April 30, 2001 and 2000, respectively.
The use of cash for the first six months of fiscal 2001 was primarily due to our
repurchase of 325,000 shares of our common stock for $6.5 million, offset by our
issuance of common stock through our employee equity plans.

     As of April 30, 2001, we had working capital of approximately $278.9
million, including cash and short-term investments of $137.1 million, and
accounts receivable and inventories representing $171.9 million. We expect our
receivables to continue to represent a significant portion of working capital.
We believe that because of the relatively long manufacturing cycles of many of
our testers and the new products we have and plan to continue to introduce,
investments in inventories will also continue to represent a significant portion
of working capital. Significant investments in accounts receivable and
inventories may subject us to increased risks which could materially adversely
affect our business, financial condition and results of operations. Total
current liabilities of $73.6 million as of April 30, 2001 decreased from $148.4
million as of October 31, 2000.

     Our principal sources of liquidity as of April 30, 2001 consisted of
approximately $62.0 million of cash and cash equivalents, and short-term
investments of $75.1 million.  In addition, we had $206.3 million of available-
for-sale securities, classified as long-term investments at April 30, 2001.

     In May 2001, we entered into a definitive agreement pursuant to which we
would acquire Integrated Measurement Systems, Inc. ("IMS") for approximately
$170 million.  IMS (Nasdaq: IMSC) is a leader in the design and delivery of high
performance integrated circuit validation systems and software solutions.  IMS
is headquartered in Beaverton, Oregon.  Under the terms of the agreement, and
subject to various closing conditions and approval of IMS shareholders, we will
acquire IMS in a stock-for-stock transaction which is intended to be accounted
for as a pooling-of-interests.  Each share of IMS common stock outstanding as of
the closing date of the merger will be converted into 0.90 shares of our common
stock on a fixed exchange ratio basis.  The transaction is subject to various
closing conditions and it is anticipated to close in the second half of calendar
year 2001.

RECENT ACCOUNTING PRONOUNCEMENTS

     In November 2000, we adopted SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," (SFAS 133).  SFAS 133 requires us to
recognize all derivatives on the balance sheet at fair value. Derivatives that
are not hedges must be adjusted to fair value through earnings. If the
derivative is a hedge, depending on the nature of the hedge, changes in the fair
value of derivatives will either be offset against the change

                                       12
<PAGE>

in the fair value of the hedged assets, liabilities or firm commitments through
earnings, or recognized in other comprehensive income (loss) until the hedged
item is recognized in earnings. The ineffective portion of a derivative's change
in fair value will be immediately recognized in earnings. Adoption of SFAS 133
did not have a material impact on our financial condition or results of
operations.

     In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin 101 ("SAB 101") "Revenue Recognition in Financial
Statements".  SAB 101 provides guidance on the recognition, presentation, and
disclosure of revenue in financial statements. All registrants are expected to
apply the accounting principles and disclosure described in SAB 101. Because we
have complied with generally accepted accounting principles for our historical
revenue recognition, the change in our revenue policy resulting from SAB 101
will be reported as a cumulative effect adjustment resulting from a change in
accounting principle effective November 1, 2000, in the fourth quarter of fiscal
2001.  Adoption of SAB 101 will also require us to restate our quarterly results
for the three fiscal quarters ended July 31, 2001.  We are currently in the
process of assessing SAB 101 and how it will impact our reported revenues and
income and we are, therefore, unable to determine the impact of  SAB 101 on our
financial statements.

                                       13
<PAGE>

RISK FACTORS

Our operating results may fluctuate significantly which may adversely affect our
stock price.

     [GRAPH OF NET SALES AND NET INCOME (LOSS), Q1 1998 THROUGH Q2 2001,
                                 APPEARS HERE]

          1998                1999                2000                2001
           Q1   Q2   Q3   Q4   Q1   Q2   Q3   Q4   Q1   Q2   Q3   Q4   Q1   Q2
Net Sales  82   75   37   22   26   38   52   80  102  154  204  220  123   43
Net Income  9    9  (34) (11)  (7)  (5)   3    8   17   33   41   49   15 (43.7)

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

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

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

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

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

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

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

   .   supply constraints;

   .   ability to obtain adequate facilities;

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

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

   .   expenses associated with acquisitions and alliances;

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

                                       14
<PAGE>

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

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

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

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

   .   manufacturing inefficiencies;

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

   .   hardware and software product sales mix;

   .   inventory write-downs;

   .   production volumes;

   .   new product introductions;

   .   product reliability;

   .   absorption levels and the rate of capacity utilization;

   .   customization and reconfiguration of systems;

   .   international and domestic sales mix and field service margins; and

   .   facility relocations and expansions.

     New and enhanced products typically have lower gross margins in the early
stages of commercial introduction and production. Although we have recorded and
continue to record provisions for estimated sales allowances and price
adjustments, accounts receivable that might not be collectible, and product
warranty costs, we cannot be certain that our estimates will be adequate.

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

   .   research and development;

   .   support costs for the distribution channels;

   .   marketing and other expenses for new products;

   .   capital equipment purchases and world-wide training; and

   .   customer support and service.

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

                                       15
<PAGE>

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

     Other than some memory products and software products, for which the price
range is typically below $50,000, we obtain most of our net sales from the sale
of a relatively few number of systems that typically range in price from
$350,000 to $2.5 million.  This has resulted and could continue to result in our
net sales and operating results for a particular period being significantly
impacted by the timing of recognition of revenue from a single transaction.  Our
net sales and operating results for a particular period could also be materially
adversely affected if an anticipated order from just one customer is not
received in time to permit shipment during that period.  Backlog at the
beginning of a quarter typically does not include all orders necessary to
achieve our sales objectives for that quarter. Orders in backlog are subject to
cancellation, delay, deferral or rescheduling by customers with limited or no
penalties.  In the first half of fiscal 2001, we experienced customer-requested
shipment delays and order cancellations, and we believe it is probable that
orders will be canceled in the future.  Consequently, our quarterly net sales
and operating results have in the past and will in the future, depend upon our
obtaining orders for systems to be shipped in the same quarter in which the
order is received.

     We believe that 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 actually delivered to
them or other customers.

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

The semiconductor industry has been cyclical.

     Revenue growth has slowed in the test and assembly sector of the
semiconductor equipment industry during what we now believe is a cyclical
downturn in the industry. There is uncertainty as to if and when the next
cyclical growth phase will occur.  This belief is based on weakening order
activity, order cancellation activity, and customer-requested shipment delays
from our existing backlog.  This business weakness is worldwide but we see it in
particular with customers in Asia.  Until such time as we return to a growth
period, we expect a continuing decline in orders and therefore expect that the
July 31, 2001 fiscal quarter's revenue will decline from the levels we
experienced during the second quarter of fiscal 2001.  In light of that belief,
we reduced our worldwide workforce by approximately 21%, or 300 people.  We took
a charge related to this reduction in force of approximately $2 million in our
second fiscal quarter of 2001.  Additionally, all remaining employees will be
required to take eight days of time off per quarter through July 2001.  Other
initiatives, including a domestic pay cut, the consolidation and reorganization
of certain functions and operations, and the curtailment of discretionary
expenses, are also being implemented.  If we continue to reduce our workforce,
it may adversely impact our ability to respond rapidly to any renewed growth
opportunities in the future.

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

                                       16
<PAGE>

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

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

     In the first half of fiscal 2001 our net sales fell 35% from the same
period in fiscal 2000 as the industry began a cyclical downturn.  In fiscal
2000, we generated revenue of $101.8 million in the first quarter and $220.2
million in the fourth quarter, an increase of 116%.  In fiscal 1999, we
generated revenue of $26.5 million in the first quarter and $80.2 million in the
fourth quarter, an increase of 203%.  In fiscal 1998, we generated revenue of
$82.4 million for the first quarter and $22.4 million for the fourth quarter, a
decrease of 73%.  Since 1993, except for the current cost-cutting efforts and
those during fiscal 1998 and most of fiscal 1999, we have overall significantly
increased the scale of our operations in general to support periods of generally
increased sales levels and expanded product offerings and have expanded
operations to address critical infrastructure and other requirements, including
the hiring of additional personnel, significant investments in research and
development to support product development, acquisition of the new facilities in
Oregon, further investments in our ERP system and numerous acquisitions.  These
fluctuations in our sales and operations have placed and are placing a
considerable strain on our management, financial, manufacturing and other
resources.  In order to effectively deal with the changes brought on by the
cyclical nature of the industry, we have been required to implement and improve
a variety of highly flexible operating, financial and other systems, procedures
and controls capable of expanding, or contracting consistent with our business.
However, we cannot be certain that any existing or new systems, procedures or
controls, including our ERP system, will be adequate to support fluctuations in
our operations or that our systems, procedures and controls will be cost-
effective or timely. Any failure to implement, improve and expand or contract
such systems, procedures and controls efficiently and at a pace consistent with
our business could have a material adverse effect on our business, financial
condition or results of operations.

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

     We are currently devoting and intend to continue to devote significant
resources to the development, production and commercialization of new products
and technologies. In late fiscal 1999 and into 2000, we shipped three major new
products.  We invested and continue to invest significant resources in plant and
equipment, leased facilities, inventory, personnel and other costs to begin or
prepare to increase production of these products. A significant portion of these
investments will provide the marketing, administration and after-sales service
and support required for these new hardware and software products. Accordingly,
we cannot be certain that gross profit margin and inventory levels will not be
adversely impacted by delays in new product introductions or start-up costs
associated with the initial production and installation of these new product
lines. We also cannot be certain that we can manufacture these systems per the
time and quantity required by our customers.  The start-up costs include
additional manufacturing overhead, additional inventory and warranty reserve
requirements and the enhancement of after-sales service and support
organizations.  In addition, the increases in inventory on hand for new product
development and customer support requirements have increased and will continue
to increase the risk of inventory write-offs.  We cannot be certain that our net
sales will increase or remain at recent levels or that any new products

                                       17
<PAGE>

will be successfully commercialized or contribute to revenue growth or that any
of our additional costs will be covered.

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

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

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

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

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

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

                                       18
<PAGE>

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.

Our markets are subject to rapid technological change.

     Our ability to compete in our markets depends upon our ability to
successfully develop and introduce new hardware and software products and
enhancements and related software tools with greater features on a timely and
cost-effective basis, including products under development internally as well as
products obtained in acquisitions. Our customers require testers and software
products with additional features and higher performance and other capabilities.
We are therefore required to enhance the performance and other capabilities of
our existing systems and software products and related software tools. Any
success we may have in developing new and enhanced systems and software products
and new features to our existing systems and software products will depend upon
a variety of factors, including:

   .   product selection;

   .   timely and efficient completion of product design;

   .   implementation of manufacturing and assembly processes;

   .   successful coding and debugging of software;

   .   product performance;

   .   reliability in the field; and

   .   effective sales and marketing.

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

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

     We have in the past experienced significant delays in the introduction,
volume production and sales of our new systems and related feature enhancements.
For example, we have experienced significant delays in the introduction of our
VS2000 and Kalos series testers as well as certain enhancements to our existing
testers. These delays have been primarily related to our inability to
successfully complete product hardware and software engineering within the 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. We cannot be certain that these or additional
difficulties will not continue to arise or that delays will not continue to
materially adversely affect customer relationships and future sales. Moreover,
we cannot be certain that we will not encounter these or other difficulties that
could delay future introductions or volume production or sales of our systems or
enhancements and related software tools. We have incurred and may continue to
incur substantial unanticipated costs to ensure the functionality and
reliability of our testers and to increase feature sets. If our systems continue
to have reliability, quality or other problems, or the market perceives our
products to be feature deficient, we may suffer reduced orders, higher
manufacturing costs, delays in collecting accounts receivable and higher
service, support and warranty expenses, or inventory write-offs, among other
effects. Our failure to have a competitive tester and related

                                       19
<PAGE>

software tools available when required by a customer could make it substantially
more difficult for us to sell testers to that customer for a number of years. We
believe that the continued acceptance, volume production, timely delivery and
customer satisfaction of our newer digital, mixed signal and non-volatile memory
testers are of critical importance to our future financial results. As a result,
our inability to correct any technical, reliability, parts shortages or other
difficulties associated with our systems or to manufacture and ship the systems
on a timely basis to meet customer requirements could damage our relationships
with current and prospective customers and would continue to materially
adversely affect our business, financial condition and results of operations.

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

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

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

     Spirox Corporation, a distributor in Taiwan that sells to end-user
customers in Taiwan and China, accounted for approximately 20%, 45%, and 39% of
our net sales in the first half of fiscal 2001 and fiscal years 2000 and 1999,
respectively. One end-user customer headquartered in Taiwan accounted for
approximately 19% of our net sales in fiscal 2000. Our agreement with Spirox can
be terminated for any reason on 90 days prior written notice. The semiconductor
industry is highly concentrated, and a small number of semiconductor device
manufacturers and contract assemblers account for a substantial portion of the
purchases of semiconductor test equipment generally, including our test
equipment. Our top ten end user customers have recently accounted for a
substantial portion of our net sales. Consequently, our business, financial
condition and results of operations could be materially adversely affected by
the loss of or any reduction in orders by Spirox, any termination of the Spirox
relationship, or any other significant customer, including the potential for
reductions in orders by assembly and tester service companies which that
customer may utilize or reductions due to continuing or other technical,
manufacturing or reliability problems with our products or continued slow-downs
in the semiconductor industry or in other industries that manufacture products
utilizing semiconductors. Our ability to maintain or increase sales levels will
depend upon:

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

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

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

   .   our customers' financial condition and success;

   .   general economic conditions; and

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

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

     Sales of our systems depend in part upon the decision of semiconductor
manufacturers to develop and manufacture new semiconductor devices or to
increase manufacturing capacity. As a result, sales of our products are subject
to a variety of factors we cannot control. The decision to purchase our products
generally involves a significant commitment of capital, with the attendant
delays frequently associated with significant capital

                                       20
<PAGE>

expenditures. For these and other reasons, our systems have lengthy sales cycles
during which we may expend substantial funds and management effort to secure a
sale, subjecting us to a number of significant risks. We cannot be certain that
we will be able to maintain or increase net sales in the future or that we will
be able to retain existing customers or attract new ones.

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

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

     In addition, acquisitions involve numerous other risks, including:

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

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

   .   increased complexity and costs associated with internal management
       structures;

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

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

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

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

     We prepare our financial statements to conform with generally accepted
accounting principles, or GAAP. GAAP are subject to interpretation by the
American Institute of Certified Public Accountants, the SEC and various bodies
formed to interpret and create appropriate accounting policies. A change in
those policies can have a significant effect on our reported results and may
even affect our reporting of transactions completed before a change is
announced. Accounting policies affecting many other aspects of our business,
including rules relating to purchase and pooling-of-interests accounting for
business combinations, in-process research and development charges, revenue
recognition, employee stock purchase plans and stock option grants have recently
been revised or are under review. Changes to those rules or the questioning of
current practices may have a material adverse effect on our reported financial
results or on the way we conduct our business. For example, in the fourth
quarter of fiscal 2001, we will be required to implement SAB 101 (see Note 4 of
the Notes to the Condensed Consolidated Financial Statements). In addition, our
preparation of financial statements in accordance with GAAP requires that we
make estimates and assumptions that affect the recorded amounts of assets and
liabilities, disclosure of those assets and liabilities at the date of the
financial statements and the recorded amounts of expenses during the reporting
period. A change in the facts and circumstances surrounding those estimates
could result in a change to our estimates and could impact our future operating
results.

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

     Our future operating results depend substantially upon the continued
service of our executive officers and key personnel, none of whom are bound by
an employment or non-competition agreement. Our future operating results also
depend in significant part upon our ability to attract and retain qualified
management, manufacturing, technical, engineering, marketing, sales and support
personnel. Competition for qualified personnel is intense, and we cannot ensure
success in attracting or retaining qualified personnel. There may be only a
limited number of persons with the requisite skills to serve in these positions
and it may be increasingly difficult for us to hire personnel

                                       21
<PAGE>

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. In December 2000, our Chief
Financial Officer resigned from his positions with us. In connection with his
resignation, our board of directors promoted John R. Detwiler to the position of
Senior Vice President of Finance, Chief Financial Officer and Secretary in
February 2001.

Our international business exposes us to additional risks.

     International sales accounted for approximately 75%, 80%, and 64% of our
total net sales for the first half of fiscal 2001 and fiscal 2000 and 1999,
respectively. As a result, we anticipate that international sales will continue
to account for a significant portion of our total net sales in the foreseeable
future. These international sales will continue to be subject to certain risks,
including:

   .   changes in regulatory requirements;

   .   tariffs and other barriers;

   .   political and economic instability;

   .   an outbreak of hostilities;

   .   integration and management of foreign operations of acquired businesses;

   .   foreign currency exchange rate fluctuations;

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

   .   potentially adverse tax consequences; and

   .   the possibility of difficulty in accounts receivable collection.

     We are also subject to the risks associated with the imposition of domestic
and foreign legislation and regulations relating to the import or export of
semiconductor equipment and software products.  We cannot predict whether the
import and export of our products will be subject to quotas, duties, taxes or
other charges or restrictions imposed by the United States or any other country
in the future. Any of these factors or the adoption of restrictive policies
could have a material adverse effect on our business, financial condition or
results of operations. Net sales to the Asia-Pacific region accounted for
approximately 46%, 69%, and 55% of our total net sales in the first half of
fiscal 2001 and fiscal 2000 and 1999, respectively, and thus demand for our
products is subject to the risk of economic instability in that region and could
continue to be materially adversely affected. Countries in the Asia-Pacific
region, including Korea and Japan, have experienced weaknesses in their
currency, banking and equity markets in the recent past. These weaknesses could
continue to adversely affect demand for our products, the availability and
supply of our product components and our consolidated results of operations. The
1997/1998 Asian financial crisis contributed to widespread uncertainty and a
slowdown in the semiconductor industry. This slowdown resulted in reduced
spending on semiconductor capital equipment, including ATE, and has had, and may
in the future have, a material adverse effect on our product backlog, balance
sheet and results of operations. Further, many of our customers in the Asia-
Pacific region built up capacity in ATE during fiscal 2000 in anticipation of a
steep ramp up in wafer fabrication. However, this steep ramp up in output has
not fully materialized leaving some customers with excess capacity. Therefore,
it is now probable that these customers will spend less in the aggregate this
year than they did in fiscal 2000.

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

                                       22
<PAGE>

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

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

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

     We have at times been notified that we may be infringing intellectual
property rights of third parties and we have litigated patent infringement
claims in the past. We expect to continue to receive notice of such claims in
the future. In July 1998, inTEST IP Corporation, or inTEST, alleged in writing
that certain of our products are infringing a patent held by inTEST. We have
since then engaged in sporadic discussions with inTEST concerning this matter.
On December 15, 2000, inTEST filed a complaint in the U.S. District Court for
the District of Delaware against us, alleging infringement of inTEST U.S. patent
number 4,589,815 and seeking damages and injunctive relief.  On April 10, 2001
we were served with the complaint.  We may also be obligated to other third
parties relating to this allegation. We believe we have meritorious defenses to
the claims. However, we cannot be certain of success in defending this patent
infringement claim or claims for indemnification resulting from infringement
claims.

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

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

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

     In recent years, the stock market in general, and the market for shares of
high-tech companies in particular, including ours, have experienced extreme
price fluctuations, which have often been unrelated to the operating performance
of affected companies. For example, in fiscal 1999, the price of our common
stock ranged from a closing high of $24.94 to a closing low of $7.19. In fiscal
2000 and through June 13, 2001, the price of our common stock has ranged from a
closing high of $74.59 to a closing low of $16.13.  The market price of our
common stock is likely to continue to fluctuate significantly in the future,
including fluctuations unrelated to our performance.

We believe that fluctuations of our stock price may be caused by a variety of
factors, including:

   .   announcements of developments related to our business;

   .   fluctuations in our financial results;

                                       23
<PAGE>

   .   general conditions or developments in the semiconductor and capital
       equipment industry and the general economy;

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

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

   .   developments in patents or other intellectual property rights;

   .   developments in our relationships with customers and suppliers;

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

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

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

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

ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

<TABLE>
                                     2001            2002           2003           2004        2005        Thereafter
                                  ---------        -------        -------        -------   -------------  -------------
<S>                            <C>            <C>            <C>            <C>            <C>            <C>
Cash Equivalents
    Fixed  rate............        $ 61,969             --             --             --              --             --
    Average rate...........            4.85%            --             --             --              --             --
Short term investments
    Fixed rate.............        $ 60,384        $14,734             --             --              --             --
    Average rate...........            6.66%          7.49%            --             --              --             --
Long term investments
    Fixed rate.............              --        $63,476        $98,692        $28,549              --        $12,913
    Average rate...........              --           6.16%          4.71%          5.62%             --           5.72%
                                  -------------------------------------------------------------------------------------
Total investment securities        $122,353        $78,210        $98,692        $28,549              --        $12,913
Average rate                           5.74%          6.40%          4.71%          5.62%             --           5.72%
Equity investments                 $  2,690             --             --             --              --             --
</TABLE>

                                       24
<PAGE>

     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.

                                       25
<PAGE>

PART II. - OTHER INFORMATION

Item 1.   Legal Proceedings

     In July 1998, we received a written allegation from inTEST that we were
infringing on a patent held by inTEST.  We have since then engaged in sporadic
discussions with inTEST concerning this matter. On December 15, 2000, inTEST
filed a complaint in the U.S. District Court for the District of Delaware
against us, alleging infringement of inTEST U.S. patent number 4,589,815 and
seeking damages and injunctive relief.  On April 10, 2001 we were served with
the complaint.  In addition to direct costs and diversion of resources which may
result, we may be obligated to indemnify third parties for costs related to this
allegation.

Item 2.   Changes in Securities

     None

Item 3.   Defaults upon Senior Securities

     None

Item 4.   Submission of Matters to a Vote of Securityholders

     The following proposals were voted upon by our stockholders at the Annual
Meeting of Stockholders held on March 21, 2001.

     1.   A proposal to elect two directors to serve for three-year terms ending
          in 2004 or until their respective successors are elected and
          qualified, was approved as follows:

     Jos C. Henkens            For 48,643,375, Withheld 310,019
     William G. Howard, Jr.    For 48,643,375, Withheld 310,019

     2.   A proposal to ratify the appointment of Ernst & Young LLP as
          independent auditors of the Company for the fiscal year ended October
          31, 2001, was approved as follows:

     In Favor     48,826,647
     Opposed      104,679
     Abstain      22,068

Item 5.   Other Information

     None

Item 6.   Exhibits and Reports on Form 8-K

     (a)  Exhibits

          See Exhibit Index on page 28.

     (b)  Reports on Form 8-K

          None.

                                       26
<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)



    June 14, 2001                            /S/ JOHN R. DETWILER
---------------------             ----------------------------------------------
        Date                                    John R. Detwiler
                                  John R. Detwiler, Senior Vice President, Chief
                                         Financial Officer and Secretary

                                       27
<PAGE>

EXHIBIT INDEX

  Exhibit
  Number
-----------
 10.37(1)    Employment Agreement, dated March 30, 2001, by and between
             Credence Systems Corporation and John R. Detwiler.


---------------------
(1)  Incorporated by reference to an exhibit to the Company's Registration
     Statement on Form S-4 (Registration Statement No. 333-62386), as amended.

                                       28