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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q



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(Mark One)

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



For the quarterly period ended July 31, 2004



OR



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



For the transition period from  to



Commission file number 0-22366



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CREDENCE SYSTEMS CORPORATION

(Exact name of registrant as specified in its charter)



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



1421 California
Circle, Milpitas, California

95035

(Address of principal executive offices)

(Zip Code)



(408) 635-4300

(Registrants telephone number, including area code)





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



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



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



At September 1, 2004, there were 85,312,421 shares of the Registrants
common stock, $0.001 par value per share, outstanding.



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CREDENCE SYSTEMS CORPORATION



INDEX



|           |  |                                                                                       |  |         
|---------- |  | ------------------------------------------------------------------------------------- |  | --------
|           |  |                                                                                       |  | PAGE NO.
|PART I.    |  | FINANCIAL INFORMATION                                                                 |  |         
|           |  |                                                                                      
|Item 1.    |  | Financial Statements                                                                  |  | 3       
|           |  |                                                                                      
|           |  | Condensed Consolidated Balance Sheets                                                 |  | 3       
|           |  |                                                                                      
|           |  | Condensed Consolidated Statements of Operations                                       |  | 4       
|           |  |                                                                                      
|           |  | Condensed Consolidated Statements of Cash Flows                                       |  | 5       
|           |  |                                                                                      
|           |  | Notes to Condensed Consolidated Financial Statements                                  |  | 6       
|           |  |                                                                                      
|Item 2.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 21      
|           |  |                                                                                      
|Item 3.    |  | Quantitative and Qualitative Disclosures about Market Risk                            |  | 44      
|           |  |                                                                                      
|Item 4.    |  | Controls and Procedures                                                               |  | 45      
|           |  |                                                                                      
|PART II.   |  | OTHER INFORMATION                                                                     |  |         
|           |  |                                                                                      
|Item 1.    |  | Legal Proceedings                                                                     |  | 45      
|           |  |                                                                                      
|Item 2.    |  | Unregistered Sales of Equity Securities and Use of Proceeds                           |  | 45      
|           |  |                                                                                      
|Item 3.    |  | Defaults Upon Senior Securities                                                       |  | 45      
|           |  |                                                                                      
|Item 4.    |  | Submission of Matters to a Vote of Security holders                                   |  | 45      
|           |  |                                                                                      
|Item 5.    |  | Other Information                                                                     |  | 45      
|           |  |                                                                                      
|Item 6.    |  | Exhibits and Reports on Form 8-K                                                      |  | 45      
|           | 
|SIGNATURES |  | 46                                                                                   



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PART IFINANCIAL INFORMATION



ITEM 1.  FINANCIAL STATEMENTS



CREDENCE SYSTEMS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)



|                                               |  |               |           |                   |   |        
|---------------------------------------------- |  | ------------- | --------- | ----------------- | - | -------
|                                               |  | July 31, 2004 |           | October 31, 2003a
|ASSETS                                         |  |               |           |                   |   |        
|Current assets:                                |  |               |           |                   |   |        
|Cash and cash equivalents                      |  | $             | 129,152   |                   | $ | 27,318 
|Short-term investments                         |  |               | 31,273    |                   |   | 258,578
|Accounts receivable, net                       |  |               | 171,790   |                   |   | 65,627 
|Inventories                                    |  |               | 134,664   |                   |   | 79,573 
|Prepaid expenses and other current assets      |  |               | 52,276    |                   |   | 15,981 
|                                               |  |               |           |                   |   |        
|Total current assets                           |  |               | 519,155   |                   |   | 447,077
|Long-term investments                          |  |               | 16,898    |                   |   | 50,682 
|Property, plant and equipment, net             |  |               | 109,461   |                   |   | 93,960 
|Goodwill                                       |  |               | 419,394   |                   |   | 37,531 
|Other intangible assets, net                   |  |               | 122,740   |                   |   | 31,285 
|Other assets                                   |  |               | 51,692    |                   |   | 37,958 
|                                               |  |               |           |                   |   |        
|Total assets                                   |  | $             | 1,239,340 |                   | $ | 698,493
|                                               |  |               |           |                   |   |        
|LIABILITIES AND STOCKHOLDERS EQUITY           |  |               |           |                   |   |        
|Current liabilities:                           |  |               |           |                   |   |        
|Bank loans and notes payable  leased products |  | $             | 6,426     |                   | $ | 9,350  
|Accounts payable                               |  |               | 65,551    |                   |   | 23,303 
|Accrued expenses and other current liabilities |  |               | 130,573   |                   |   | 45,770 
|Deferred profit                                |  |               | 15,094    |                   |   | 4,556  
|                                               |  |               |           |                   |   |        
|Total current liabilities                      |  |               | 217,644   |                   |   | 82,979 
|Convertible subordinated notes                 |  |               | 180,000   |                   |   | 180,000
|Notes payable  leased products                |  |               |          |                   |   | 1,058  
|Other liabilities                              |  |               | 34,117    |                   |   | 3,829  
|Stockholders equity                           |  |               | 807,579   |                   |   | 430,627
|                                               |  |               |           |                   |   |        
|Total liabilities and stockholders equity     |  | $             | 1,239,340 |                   | $ | 698,493
|                                               |  |               |           |                   |   |        

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|a) | Derived from the audited consolidated balance sheet included in our Form 10-K for the year ended October 31, 2003.
|-- | ------------------------------------------------------------------------------------------------------------------



See accompanying notes.



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CREDENCE SYSTEMS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)



|                                                                                                    |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|--------------------------------------------------------------------------------------------------- |  | --------------------------- | ------- | - | -------------------------- | - | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                                                    |  | Three Months Ended July 31, |         |   | Nine Months Ended July 31, |  
|                                                                                                    |  | 2004                        |         |   | 2003                       |   |         | 2004 |  |   | 2003    |  
|                                                                                                    |  | (unaudited)                 |         |   | (unaudited)                |  
|Net sales                                                                                           |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|Systems, upgrades, software                                                                         |  | $                           | 137,980 |   |                            | $ | 35,743  |      |  | $ | 277,489 |   |  | $ | 93,542  |  
|Services, spare parts                                                                               |  |                             | 25,738  |   |                            |   | 9,717   |      |  |   | 49,491  |   |  |   | 31,092  |  
|                                                                                                    |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|Total net sales                                                                                     |  |                             | 163,718 |   |                            |   | 45,460  |      |  |   | 326,980 |   |  |   | 124,634 |  
|                                                                                                    |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|Cost of goods sold                                                                                  |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|Systems, upgrades, software                                                                         |  |                             | 68,372  |   |                            |   | 22,645  |      |  |   | 135,732 |   |  |   | 60,360  |  
|Services, spare parts                                                                               |  |                             | 17,158  |   |                            |   | 5,946   |      |  |   | 31,675  |   |  |   | 19,530  |  
|Special charges                                                                                     |  |                             | 46,206  |   |                            |   | 1,937   |      |  |   | 46,206  |   |  |   | 1,937   |  
|                                                                                                    |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|Total cost of goods sold                                                                            |  |                             | 131,736 |   |                            |   | 30,528  |      |  |   | 213,613 |   |  |   | 81,827  |  
|Gross margin                                                                                        |  |                             | 31,982  |   |                            |   | 14,932  |      |  |   | 113,367 |   |  |   | 42,807  |  
|Operating expenses:                                                                                 |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|Research and development                                                                            |  |                             | 23,856  |   |                            |   | 17,504  |      |  |   | 54,945  |   |  |   | 56,753  |  
|Selling, general and administrative                                                                 |  |                             | 36,977  |   |                            |   | 24,341  |      |  |   | 87,646  |   |  |   | 67,723  |  
|In-process research and development                                                                 |  |                             | 7,900   |   |                            |   |        |      |  |   | 7,900   |   |  |   | 1,510   |  
|Restructuring charges                                                                               |  |                             | 2,969   |   |                            |   | 2,197   |      |  |   | 3,622   |   |  |   | 3,589   |  
|Amortization of purchased intangible assets & deferred compensation (1)                             |  |                             | 5,345   |   |                            |   | 2,622   |      |  |   | 10,589  |   |  |   | 6,834   |  
|                                                                                                    |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|Total operating expenses                                                                            |  |                             | 77,047  |   |                            |   | 46,664  |      |  |   | 164,702 |   |  |   | 136,409 |  
|                                                                                                    |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|Operating loss                                                                                      |  |                             | (45,065 | ) |                            |   | (31,732 | )    |  |   | (51,335 | ) |  |   | (93,602 | )
|                                                                                                    |  |                             |         |  
|Interest income                                                                                     |  |                             | 245     |   |                            |   | 2,527   |      |  |   | 2,770   |   |  |   | 5,632   |  
|Interest expense                                                                                    |  |                             | (1,695  | ) |                            |   | (1,452  | )    |  |   | (3,349  | ) |  |   | (1,884  | )
|Other income and (expense), net                                                                     |  |                             | 14,828  |   |                            |   | (707    | )    |  |   | 15,539  |   |  |   | (679    | )
|                                                                                                    |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|Loss before income tax provision                                                                    |  |                             | (31,687 | ) |                            |   | (31,364 | )    |  |   | (36,375 | ) |  |   | (90,533 | )
|Income tax                                                                                          |  |                             | 1,479   |   |                            |   | 238     |      |  |   | 3,904   |   |  |   | 435     |  
|                                                                                                    |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|Loss before minority interest (benefit)                                                             |  |                             | (33,166 | ) |                            |   | (31,602 | )    |  |   | (40,279 | ) |  |   | (90,968 | )
|Minority interest (benefit)                                                                         |  |                             | (1      | ) |                            |   | 109     |      |  |   | 103     |   |  |   | 36      |  
|                                                                                                    |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|Net loss                                                                                            |  | $                           | (33,165 | ) |                            | $ | (31,711 | )    |  | $ | (40,382 | ) |  | $ | (91,004 | )
|                                                                                                    |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|Net loss per share                                                                                  |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|Basic                                                                                               |  | $                           | (0.42   | ) |                            | $ | (0.50   | )    |  | $ | (0.58   | ) |  | $ | (1.46   | )
|                                                                                                    |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|Diluted                                                                                             |  | $                           | (0.42   | ) |                            | $ | (0.50   | )    |  | $ | (0.58   | ) |  | $ | (1.46   | )
|                                                                                                    |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|Number of shares used in computing per share amount                                                 |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|Basic                                                                                               |  |                             | 78,647  |   |                            |   | 63,191  |      |  |   | 69,407  |   |  |   | 62,474  |  
|                                                                                                    |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|Diluted                                                                                             |  |                             | 78,647  |   |                            |   | 63,191  |      |  |   | 69,407  |   |  |   | 62,474  |  
|                                                                                                    |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|(1)    Amortization of deferred compensation related to the following expense categories by period: | 
|                                                                                                    |  |                             |         |  
|Cost of goods sold                                                                                  |  | $                           | 84      |   |                            | $ |        |      |  | $ | 106     |   |  | $ |        |  
|Research and development                                                                            |  |                             | 129     |   |                            |   |        |      |  |   | 129     |   |  |   |        |  
|Selling, general and administrative                                                                 |  |                             | 498     |   |                            |   | 151     |      |  |   | 893     |   |  |   | 303     |  
|                                                                                                    |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|Total amortization of deferred compensation                                                         |  | $                           | 711     |   |                            | $ | 151     |      |  | $ | 1,128   |   |  | $ | 303     |  
|                                                                                                    |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |         |  



See accompanying notes.



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CREDENCE SYSTEMS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)



|                                                                             |  |                            |          |   |      |   |          |  
|---------------------------------------------------------------------------- |  | -------------------------- | -------- | - | ---- | - | -------- | -
|                                                                             |  | Nine Months Ended July 31, |         
|                                                                             |  | 2004                       |          |   | 2003 |  
|                                                                             |  | (unaudited)                |         
|Cash flows from operating activities:                                        |  |                            |          |   |      |   |          |  
|Net loss                                                                     |  | $                          | (40,382  | ) |      | $ | (91,004  | )
|Adjustments to reconcile net loss to net cash used in operating activities:  |  |                            |          |   |      |   |          |  
|Depreciation and amortization                                                |  |                            | 39,626   |   |      |   | 28,992   |  
|Non-cash cost of goods sold - special charges and restructuring charges      |  |                            | 43,872   |   |      |   | 3,564    |  
|Provision for inventory write downs                                          |  |                            | 6,130    |   |      |   | 4,476    |  
|In-process research and development                                          |  |                            | 7,900    |   |      |   | 1,510    |  
|Provision for allowance for doubtful accounts                                |  |                            | (939     | ) |      |   | 1,221    |  
|Loss (gain) on disposal of property and equipment                            |  |                            | (1,166   | ) |      |   | 2,839    |  
|Realized loss on available-for-sale securities                               |  |                            | 369      |   |      |   | 1,817    |  
|Minority interest                                                            |  |                            | 55       |   |      |   | 36       |  
|Changes in operating assets and liabilities:                                 |  |                            |          |   |      |   |          |  
|Accounts receivable, net                                                     |  |                            | (67,424  | ) |      |   | (12,069  | )
|Inventories                                                                  |  |                            | (44,102  | ) |      |   | 2,836    |  
|Income tax receivable and payable                                            |  |                            | (10,788  | ) |      |   | 26,113   |  
|Prepaid expenses and other current assets                                    |  |                            | 971      |   |      |   | (5,941   | )
|Accounts payable                                                             |  |                            | 22,187   |   |      |   | (2,309   | )
|Accrued expenses and other current liabilities                               |  |                            | 24,597   |   |      |   | (3,234   | )
|Deferred profit                                                              |  |                            | 10,541   |   |      |   | (6,517   | )
|                                                                             |  |                            |          |   |      |   |          |  
|Net cash used in operating activities                                        |  |                            | (8,553   | ) |      |   | (47,670  | )
|Cash flows from investing activities:                                        |  |                            |          |   |      |   |          |  
|Purchases of available-for-sale securities                                   |  |                            | (187,251 | ) |      |   | (187,963 | )
|Sales and maturities of available-for-sale securities                        |  |                            | 464,506  |   |      |   | 163,790  |  
|Acquisition of property, plant and equipment                                 |  |                            | (16,742  | ) |      |   | (4,801   | )
|Acquisition of NPTest and SZ GmbH, net of cash and cash equivalents acquired |  |                            | (159,866 | ) |      |   |         |  
|Acquisition of other assets                                                  |  |                            | (919     | ) |      |   | (4,340   | )
|Proceeds from sale of property, plant and equipment and leased equipment     |  |                            | 1,612    |   |      |   |         |  
|                                                                             |  |                            |          |   |      |   |          |  
|Net cash provided by (used in) investing activities                          |  |                            | 101,340  |   |      |   | (33,314  | )
|Cash flows from financing activities:                                        |  |                            |          |   |      |   |          |  
|Issuance of 11/2% convertible notes, net of transaction costs                |  |                            |         |   |      |   | 174,604  |  
|Issuance of common & treasury stock                                          |  |                            | 11,547   |   |      |   | 3,111    |  
|Payments of liabilities related to leased products                           |  |                            | (2,815   | ) |      |   | (4,880   | )
|Other                                                                        |  |                            | (213     | ) |      |   | 150      |  
|                                                                             |  |                            |          |   |      |   |          |  
|Net cash provided by financing activities                                    |  |                            | 8,519    |   |      |   | 172,985  |  
|Effects of exchange rate on cash and cash equivalents                        |  |                            | 528      |   |      |   |         |  
|                                                                             |  |                            |          |   |      |   |          |  
|Net increase in cash and cash equivalents                                    |  |                            | 101,834  |   |      |   | 92,001   |  
|Cash and cash equivalents at beginning of period                             |  |                            | 27,318   |   |      |   | 50,192   |  
|                                                                             |  |                            |          |   |      |   |          |  
|Cash and cash equivalents at end of period                                   |  | $                          | 129,152  |   |      | $ | 142,193  |  
|                                                                             |  |                            |          |   |      |   |          |  
|Supplemental disclosures of cash flow information:                           |  |                            |          |   |      |   |          |  
|Interest paid                                                                |  | $                          | 2,573    |   |      | $ | 708      |  
|Income taxes paid (received)                                                 |  | $                          | 252      |   |      | $ | (22,536  | )
|Noncash investing activities:                                                |  |                            |          |   |      |   |          |  
|Net transfers of inventory to property and equipment                         |  | $                          | 1,296    |   |      | $ | 3,107    |  
|Acquisition of Optonics using Credence common stock                          |  | $                          |         |   |      | $ | 21,046   |  
|Acquisition of NPTest using Credence common stock                            |  | $                          | 414,622  |   |      | $ |         |  
|Unrealized loss on available-for-sale securities                             |  | $                          | 594      |   |      | $ | 1,237    |  



See accompanying notes.



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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



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



The condensed consolidated financial statements and related notes for the three and nine month periods ended July 31, 2004 and 2003 are unaudited but
include all adjustments (consisting solely of normal recurring adjustments except for acquisition, special charges related to cost of goods sold and restructuring charges adjustments) which are, in the opinion of management, necessary for a fair
presentation of the financial position and results of operations of Credence Systems Corporation (Credence or the Company) for the interim periods, in accordance with accounting principles generally accepted in the United States. The results of
operations for the three and nine month periods ended July 31, 2004 and 2003 are not necessarily indicative of the operating results to be expected for the full fiscal year. The information included in this report should be read in conjunction with
the Companys audited consolidated financial statements and notes thereto for the fiscal year ended October 31, 2003 included in the Companys most recent Annual Report on Form 10-K and the additional risk factors contained herein and
therein, including, without limitation, risks relating to the importance of timely product introduction, successful integration of acquisitions, fluctuations in our quarterly net sales and operating results, limited systems sales, backlog,
cyclicality of semiconductor industry, management of fluctuations in our operating results, expansion of our product lines, limited sources of supply, reliance on our subcontractors, our highly competitive industry, customization of products, rapid
technological change, customer concentration, lengthy sales cycles, changes in financial accounting standards and accounting estimates, dependence on key personnel, international sales, proprietary rights, legal proceedings, volatility of our stock
price, terrorist attacks and other geopolitical instability, effects of Sarbanes-Oxley Act of 2002, and effects of certain anti-takeover provisions, as set forth in this Report. Any party interested in receiving a free copy of the Form 10-K or the
Companys other publicly available documents should write to the Chief Financial Officer of the Company.



Description of Business - Credence Systems Corporation (Credence or the Company) was incorporated in California in March 1982 to succeed a sole
proprietorship and was reincorporated in Delaware in October 1993. The principal business activity of the Company is the design, development, manufacture, sale and service of engineering validation test equipment diagnostic and failure analysis
products and automatic test equipment (ATE) used for testing semiconductor integrated circuits, or ICs. The Company also develop, license and distribute software products that provide automation solutions in the IC design and test flow fields. The
Company serves a broad spectrum of the semiconductor industrys testing needs through a wide range of products that test digital logic, mixed-signal, system-on-a-chip, radio frequency, volatile and static and non-volatile memory semiconductors.



In May 2004, the Company completed its acquisition of NPTest
Holding Corporation (NPTest). NPTest designed, developed and manufactured advanced semiconductor test and diagnostic systems and provided related services for the semiconductor industry. The addition of NPTest expands the Companys customer
base and enables the Company to provide customers with a broader portfolio of solutions. In accordance with Statement of Financial Accounting Standard No. 141 (SFAS 141), Business Combinations, the acquisition was accounted for as a
purchase transaction, and the Company has included in its results of operations, for the three and nine months ended July 31, 2004, the results of NPTest beginning on May 29, 2004.



Basis of Presentation  The accompanying unaudited condensed consolidated financial statements include the
accounts of the Company and its wholly-owned and majority-owned subsidiaries. All significant intercompany transactions and balances have been eliminated. Certain prior year amounts in the condensed consolidated financial statements and related
notes have been reclassified to conform to the current years presentation. These reclassifications had no effect on the financial position, results of operations, or cash flows for any of the period presented.



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



Minority Interest - The Company liquidated Credence-Innotech
Corporation, its joint venture with Innotech Corporation in Japan during the third quarter of 2004.



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



Under Securities and Exchange Commissions Staff Accounting Bulletin No. 104 (SAB 104), Revenue Recognition, the Company recognizes
revenue on the sale of semiconductor manufacturing equipment when title and risk of loss have passed to the customer, there is persuasive evidence of an arrangement, delivery has occurred or services have been rendered, the sales price is fixed or
determinable, collectibility is reasonably assured and customer acceptance criteria have been successfully demonstrated. Revenue recognition policies are applied consistently among the Companys semiconductor manufacturing equipment product
lines. Product revenue is recognized upon shipment when the product is classified as mature and the customer acceptance criteria can be demonstrated prior to shipment. Revenue related to the fair value of the installation obligation is recognized
upon completion of the



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installation. Products are classified as mature after several different customers have accepted similar systems. For
sales of new products or when the customer acceptance criteria cannot be demonstrated prior to shipment, revenue and the related cost of goods sold are deferred until customer acceptance. Lease revenue is recorded in accordance with Statement of
Financial Accounting Standard No. 13 (SFAS No. 13), Accounting for Leases, which requires that a lessor account for each lease by either the direct financing, sales-type or operating method. Revenue from sales-type leases is recognized
at the net present value of future lease payments. Revenue from operating leases is recognized over the lease period.



Under the SAB 104 revenue recognition policy, the Company defers revenue for transactions that involve newly introduced products or when customers specify
acceptance criteria that cannot be demonstrated prior to the shipment. During fiscal 2002 and 2003, the Company introduced several new systems and products. Certain revenues from sales of these new systems and products during fiscal 2003 and the
nine months of fiscal 2004 were deferred until the revenue recognition requirements of our revenue recognition policy are satisfied. This practice will continue in the future with new products. In the past, the Company experienced significant delays
in the introduction and acceptance of new testers as well as certain enhancements to our existing testers. As a result, some customers have experienced significant delays in receiving and accepting the Companys testers in production. Delays in
introducing a product or delays in the Companys ability to obtain customer acceptance, if they occur in the future, will delay the recognition of revenue and gross profit by us.



When the Company is able to separate multiple deliverables from one another, it recognizes revenue for each deliverable,
based on each deliverables fair value, when the revenue recognition criteria for that specific deliverable is achieved. In the vast majority of cases orders are shipped complete. In rare instances when there are multiple shipments due to
materials shortages, revenue and related cost of sales are recognized only for the items that are physically shipped. If the items not shipped on an order are required for the functionality of the delivered items, revenue and related cost of sales
are deferred on the delivered items and recognized only upon the shipment of the required items. If there are specific customer acceptance criteria, revenue is deferred until the specified performance has been completed in accordance with our
revenue recognition policy. Installation in the majority of the cases occurs within two weeks of shipment. Installation is considered to be inconsequential and perfunctory. The cost of installation can be reliably estimated and is accrued at
shipment. In order to comply with Emerging Issues Task Force Accounting for Revenue Arrangements with Multiple Deliverables, (EITF 00-21), beginning in the fourth quarter of fiscal 2003, revenue related to the total value of
installations not completed at the end of the period was deferred.



Sales in the United States are principally through the Companys direct sales organization consisting of direct sales employees and representatives. Sales outside the United States utilize both direct sales employees and distributors.
There are no significant differences in revenue recognition policies based on the sales channel, due to the business practices that have been adopted with the Companys distributor relationships. Because of these business circumstances, the
Company does not use price protection, stock rotation or similar programs with its distributors. The Company does not typically sell inventory to its distributors for eventual sale to end-users, but rather the Company sells
product to the distributors on the basis of a purchase order received from an end-user. The Company evaluates any revenue recognition issues with respect to the end customer in light of its revenue recognition policy and in accordance with SAB 104.



The Company sells stand-alone software products and the
revenue recognition policies related to these sales fall within the scope of American Institute of Certified Public Accountants (AICPA) Statement of Position No. 97-2 (SOP 97-2), Software Revenue Recognition. The stand-alone software
products are applications for integrated circuit, or IC manufacturers and test and assembly contractors to help improve quality and shorten development lead times. The Company also has embedded software in its semiconductor manufacturing equipment.
The Company believes this embedded software is incidental to its products and therefore is excluded from the scope of SOP 97-2 since the embedded software in its products is not sold separately, cannot be used on another vendors products, and
the Company cannot fundamentally enhance or expand the capability of the equipment with new or revised software. In addition, the equipments principal performance characteristics are governed by digital speed, instrumentation, and pin count,
which are primarily a function of the hardware.



Deferred
revenue, which is included in accrued expenses and other liabilities on the balance sheet, includes deferred revenue related to maintenance contracts (and other undelivered services). Deferred profit is related to equipment that was shipped to
certain customers, but the revenue and cost of goods sold were not recognized because either the customer-specified acceptance criteria has not been met as of the fiscal period end or the product is not classified as mature as of the fiscal period
end and has not been accepted by the customer.



|3. | Stock-Based Compensation
|-- | ------------------------



At July 31, 2004, the Company had several stock-based employee compensation plans. The Company accounts for stock-based compensation under Accounting
Principles Boards Opinion No. 25 (APB 25), Accounting for Stock Issued to Employees and related interpretations, using the intrinsic value method. In addition, the Company applies the disclosure requirements of Financial
Acccounting Standards Board (FASB) SFAS No. 123 (SFAS 123), Accounting for Stock-Based Compensation, as amended by SFAS No. 148 (SFAS 148), Accounting for Stock-Based Compensation-Transition and Disclosure. Under SFAS 123, as
amended



7



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##### Table of Contents

by SFAS 148, the Company determines stock-based compensation costs based on the estimated fair value at the grant date
for its stock options, and the estimated fair value at the issuance date for its employee stock purchase plan. Under APB 25, the Company does not recognize compensation expense unless the exercise price of the Companys employee stock options
is less than the market price of the underlying stock on the date of grant. The Company grants its stock options at the fair market value of the underlying stock on the date of grant. Consequently, the Company has not recorded such expense in the
periods presented.



In calculating pro forma compensation, the
fair value of each option grant is estimated on the date of grant using the Black-Scholes options pricing model. The Black-Scholes options pricing model was developed for use in estimating the fair value of traded options that have no vesting
restrictions and are fully transferable. In addition, the Black-Scholes options pricing model requires the input of highly subjective assumptions including the expected stock price volatility. Because the Companys stock-based awards to
employees have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in managements opinion, the existing model does not
necessarily provide a reliable single measure of the value of its stock-based awards to its employees. Stock based compensation expense already included in the reported net loss is primarily a result of amortization of deferred compensation related
to acquisitions.



The following table illustrates the effect on
reported net loss and loss per share for the three and nine months ended July 31, 2004 and 2003, respectively, as if the Company had applied the fair value recognition provisions of FAS 123 to stock-based compensation (in thousands, except per share
data):



|                                                                                                                                           |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |          |  
|------------------------------------------------------------------------------------------------------------------------------------------ |  | --------------------------- | ------- | - | -------------------------- | - | ------- | ---- |  | - | ------- | - |  | - | -------- | -
|                                                                                                                                           |  | Three Months Ended July 31, |         |   | Nine Months Ended July 31, |  
|                                                                                                                                           |  | 2004                        |         |   | 2003                       |   |         | 2004 |  |   | 2003    |  
|Net loss as reported                                                                                                                       |  | $                           | (33,165 | ) |                            | $ | (31,711 | )    |  | $ | (40,382 | ) |  | $ | (91,004  | )
|Stock-based employee compensation expense included in reported net loss, net of related tax effects(1) (2)                                 |  |                             | 711     |   |                            |   | 151     |      |  |   | 1,128   |   |  |   | 303      |  
|Less: Stock-based employee compensation expense determined under fair value based methods for all awards net of related tax effects(1) (2) |  |                             | (7,085  | ) |                            |   | (3,946  | )    |  |   | (22,915 | ) |  |   | (18,745  | )
|                                                                                                                                           |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |          |  
|Pro forma net loss                                                                                                                         |  | $                           | (39,539 | ) |                            | $ | (35,506 | )    |  | $ | (62,169 | ) |  | $ | (109,446 | )
|                                                                                                                                           |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |          |  
|Basic net loss per share as reported                                                                                                       |  | $                           | (0.42   | ) |                            | $ | (0.50   | )    |  | $ | (0.58   | ) |  | $ | (1.46    | )
|Basic net loss per share pro forma                                                                                                         |  | $                           | (0.50   | ) |                            | $ | (0.56   | )    |  | $ | (0.90   | ) |  | $ | (1.75    | )
|Diluted net loss per share as reported                                                                                                     |  | $                           | (0.42   | ) |                            | $ | (0.50   | )    |  | $ | (0.58   | ) |  | $ | (1.46    | )
|Diluted net loss per share pro forma                                                                                                       |  | $                           | (0.50   | ) |                            | $ | (0.56   | )    |  | $ | (0.90   | ) |  | $ | (1.75    | )

---

|(1) | The Company has recorded a full valuation allowance for its net deferred tax assets. Therefore, for the three and nine months ended July 31, 2004 and 2003, total
stock based compensation expense has not been tax effected.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | For the three and nine months ended July 31, 2004, total stock-based compensation expense included NPTest converted stock options.
|--- | ----------------------------------------------------------------------------------------------------------------------------------



4. 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):



|                |  |               |         |                  |   |       
|--------------- |  | ------------- | ------- | ---------------- | - | ------
|                |  | July 31, 2004 |         | October 31, 2003
|Raw materials   |  | $             | 69,392  |                  | $ | 50,561
|Work-in-process |  |               | 29,729  |                  |   | 14,009
|Finished goods  |  |               | 35,543  |                  |   | 15,003
|                |  |               |         |                  |   |       
|Total           |  | $             | 134,664 |                  | $ | 79,573
|                |  |               |         |                  |   |       



5. Balance Sheets Components



Prepaid expenses and other current assets:



|                             |  |               |        |                  |   |       
|---------------------------- |  | ------------- | ------ | ---------------- | - | ------
|                             |  | July 31, 2004 |        | October 31, 2003
|Short-term lease receivables |  | $             | 1,165  |                  | $ | 1,261 
|Deferred tax assets          |  |               | 29,362 |                  |   |      
|Other prepaid expenses       |  |               | 21,749 |                  |   | 14,720
|                             |  |               |        |                  |   |       
|Total                        |  | $             | 52,276 |                  | $ | 15,981
|                             |  |               |        |                  |   |       



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Property, plant and equipment:



|                                  |  |               |          |   |                  |   |          |  
|--------------------------------- |  | ------------- | -------- | - | ---------------- | - | -------- | -
|                                  |  | July 31, 2004 |          |   | October 31, 2003 |  
|Land                              |  | $             | 26,886   |   |                  | $ | 26,509   |  
|Buildings                         |  |               | 35,911   |   |                  |   | 31,422   |  
|Machinery and equipment           |  |               | 109,075  |   |                  |   | 95,222   |  
|Software                          |  |               | 27,736   |   |                  |   | 26,712   |  
|Leasehold improvements            |  |               | 39,850   |   |                  |   | 26,800   |  
|Furniture and fixtures            |  |               | 11,253   |   |                  |   | 10,786   |  
|                                  |  |               |          |   |                  |   |          |  
|                                  |  |               | 250,711  |   |                  |   | 217,451  |  
|Less accumulated depreciation     |  |               | (141,250 | ) |                  |   | (123,491 | )
|                                  |  |               |          |   |                  |   |          |  
|Net property, plant and equipment |  | $             | 109,461  |   |                  | $ | 93,960   |  
|                                  |  |               |          |   |                  |   |          |  



Other assets:



|                            |  |               |        |                  |   |       
|--------------------------- |  | ------------- | ------ | ---------------- | - | ------
|                            |  | July 31, 2004 |        | October 31, 2003
|Long-term lease receivables |  | $             | 5,277  |                  | $ | 7,001 
|Lease assets                |  |               | 3,884  |                  |   | 9,871 
|Field service spares        |  |               | 29,538 |                  |   | 11,934
|Other assets                |  |               | 12,993 |                  |   | 9,152 
|                            |  |               |        |                  |   |       
|Total                       |  | $             | 51,692 |                  | $ | 37,958
|                            |  |               |        |                  |   |       



Accrued expenses and
other current liabilities:



|                                        |  |               |         |                  |   |       
|--------------------------------------- |  | ------------- | ------- | ---------------- | - | ------
|                                        |  | July 31, 2004 |         | October 31, 2003
|Accrued payroll and related liabilities |  | $             | 22,630  |                  | $ | 9,009 
|Accrued bonuses                         |  |               | 4,825   |                  |   |      
|Accrued warranties                      |  |               | 16,949  |                  |   | 5,501 
|Deferred revenue                        |  |               | 17,474  |                  |   | 9,981 
|Income taxes payable                    |  |               | 13,676  |                  |   | 7,581 
|Contingent payable to Schlumberger      |  |               | 15,200  |                  |   |      
|Accrued restructuring charges           |  |               | 1,896   |                  |   | 2,601 
|Accrued distributor commissions         |  |               | 7,496   |                  |   | 2,395 
|Other accrued liabilities               |  |               | 30,427  |                  |   | 8,702 
|                                        |  |               |         |                  |   |       
|Total                                   |  | $             | 130,573 |                  | $ | 45,770
|                                        |  |               |         |                  |   |       



Other liabilities:



|                            |  |               |        |                  |   |      
|--------------------------- |  | ------------- | ------ | ---------------- | - | -----
|                            |  | July 31, 2004 |        | October 31, 2003
|Other long-term liabilities |  | $             | 4,654  |                  | $ | 3,829
|Deferred tax liabilities    |  |               | 29,463 |                  |   |     
|                            |  |               |        |                  |   |      
|Total                       |  | $             | 34,117 |                  | $ | 3,829
|                            |  |               |        |                  |   |      



6. Acquisitions



NPTest Holding Corporation:



In May 2004, the Company acquired 100%
of the outstanding common stock of NPTest Holding Corporation (NPTest), a company that designed, developed and manufactured advanced semiconductor test and diagnostic systems and provided related services for the semiconductor industry. The addition
of NPTest expands the Companys customer base and enables the Company to provide customers with a broader portfolio of solutions. The acquisition resulted in a total cash payment to shareholders of NPTest of approximately $230 million and the
right to receive approximately 32 million shares of the Companys common stock, including the assumed conversion of 203,036 shares of preferred stock at a conversion ratio of 100 to 1, with a fair value of approximately $376.5 million. The
common stock issued in the acquisition was valued using the average closing price of the Companys common stock over a five-day trading period beginning two days before and ending two days after the date



9



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the transaction was announced. The Company also assumed all of the outstanding NPTest stock options with a fair value of
approximately $38.1 million. The options were valued using the Black-Scholes option pricing model with the following assumptions: volatility of 0.77, expected life of 6.35 years, risk-free interest rate of 3.45% and a market value of the
Companys common stock of $11.77 per share, which was determined as described above. The Company also incurred direct costs associated with the acquisition of approximately $5.9 million. Below is a summary of the total preliminary purchase
price (in thousands):



|                          |  |   |        
|------------------------- |  | - | -------
|Cash                      |  | $ | 229,950
|Common stock              |  |   | 376,514
|Outstanding stock options |  |   | 38,108 
|Direct acquisition costs  |  |   | 5,863  
|                          |  |   |        
|Total purchase price      |  | $ | 650,435
|                          |  |   |        



The majority owner of
NPTest, who owned approximately 63% of NPTests common stock, received 203,036 shares of non-voting convertible stock of the Company as the result of the acquisition. Each share of NPTest common stock held by this majority owner was exchanged
into 0.008 of a share of the Companys non-voting convertible stock. Each share of the non-voting convertible stock is convertible into 100 shares of the Companys common stock. The non-voting convertible stock is identical in all respects
to the Companys common stock except that, prior to conversion, it has no voting rights, but has a liquidation preference of $0.001 per share. The non-voting convertible stock is classified as preferred stock. As of July 31, 2004, the majority
owner had converted 79,754 shares of the Companys non-voting convertible stock into 7,975,400 shares of the Companys common stock leaving 123,282 shares outstanding which are convertible into 12,328,200 shares of the Companys
common stock.



In accordance with SFAS No. 141 (SFAS 141),
Business Combinations, the purchase was accounted for as a purchase transaction and the Company has included in its results of operations, for the three and nine months ended July 31, 2004, the results of NPTest beginning on May 29,
2004. The Company allocated the purchase price to the tangible and intangible assets acquired and liabilities assumed, including in-process research and development, based on their estimated fair values, and deferred stock compensation. The excess
purchase price over those fair values was recorded as goodwill. The fair value assigned to tangible and intangible assets acquired and liabilities assumed were based on estimates and assumptions provided by management, and other information compiled
by management, including valuations that utilize established valuation techniques appropriate for the high technology industry. Goodwill recorded as a result of these acquisitions is not expected to be deductible for tax purposes. In accordance with
SFAS 142, Goodwill and Other Intangible Assets, goodwill and purchased intangible assets with indefinite lives are not amortized but will be reviewed at least annually for impairment. Purchased intangible assets with finite lives will be
amortized on a straight-line basis over their respective estimated useful lives. The total purchase price has been preliminarily allocated as follows (dollars in thousands):



|                                                |  |        |         |   |                    |   |                    |  |     
|----------------------------------------------- |  | ------ | ------- | - | ------------------ | - | ------------------ |  | ----
|                                                |  | Amount |         |   | AnnualAmortization |   | UsefulLives(Years)
|Purchase Price Allocation:                      |  |        |         |   |                    |   |                    |  |     
|Cash and cash equivalents                       |  | $      | 76,103  |   |                    | $ |                   |  |    
|Short-term investments                          |  |        | 19,481  |   |                    |   |                   |  |    
|Accounts receivable                             |  |        | 37,673  |   |                    |   |                   |  |    
|Inventories                                     |  |        | 60,027  |   |                    |   |                   |  |    
|Prepaid expenses and other current assets       |  |        | 35,037  |   |                    |   |                   |  |    
|Property, plant and equipment                   |  |        | 18,238  |   |                    |   |                   |  |    
|Other assets                                    |  |        | 24,185  |   |                    |   |                   |  |    
|Accounts payable                                |  |        | (19,777 | ) |                    |   |                   |  |    
|Other accrued expenses and liabilities          |  |        | (41,318 | ) |                    |   |                   |  |    
|Contingent payable to Schlumberger              |  |        | (29,450 | ) |                    |   |                   |  |    
|Other long-term liabilities                     |  |        | (695    | ) |                    |   |                   |  |    
|                                                |  |        |         |   |                    |   |                    |  |     
|Net tangible assets assumed                     |  |        | 179,504 |   |                    |   |                   |  |    
|Intangible assets acquired:                     |  |        |         |   |                    |   |                    |  |     
|Developed technology                            |  |        | 70,300  |   |                    |   | 7,030              |  | 10  
|Maintenance agreements                          |  |        | 13,800  |   |                    |   | 2,760              |  | 5   
|Customer relationships                          |  |        | 12,100  |   |                    |   | 1,729              |  | 7   
|Product backlog                                 |  |        | 4,900   |   |                    |   | 4,900              |  | 1   
|                                                |  |        |         |   |                    |   |                    |  |     
|Total amortizable intangible assets             |  |        | 101,100 |   |                    |   | 16,419             |  |    
|In-process research and development             |  |        | 7,900   |   |                    |   |                   |  |    
|Deferred compensation on unvested stock options |  |        | 9,967   |   |                    |   | 3,067              |  | 3.25
|Deferred tax                                    |  |        | (29,362 | ) |                    |   |                   |  |    
|Goodwill                                        |  |        | 381,326 |   |                    |   |                   |  |    
|                                                |  |        |         |   |                    |   |                    |  |     
|Total purchase price                            |  | $      | 650,435 |   |                    | $ | 19,486             |  |     
|                                                |  |        |         |   |                    |   |                    |  |     



The purchase price
allocation is subject to change if the Company obtains additional information concerning the fair value of certain tangible assets and liabilities of NPTest.



Net Tangible Assets



NPTests assets and liabilities as of May 28, 2004 were reviewed and adjusted, if necessary, to their fair value. Reserves and allowances were
reviewed for appropriateness and approved by management. Management also reviewed the liabilities to ensure that the proper value was recorded.



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As result of the NPTest acquisition, the Company may be required to make a payment to Schlumberger
Limited (Schlumberger ) at a date in the future pursuant to a provision in the acquisition agreement between NPTest and Schlumberger under which NPTest was acquired by Francisco Partners, L.P. from Schlumberger. The future payment date may be
triggered by various events, including certain distributions by NPTest Holding, LLC to its members, or at Schlumbergers option, it can be triggered on December 16, 2004 or on May 28, 2005. The payment amount is contingent upon the value of the
Companys common stock at the time of distribution. If payment is triggered at Schlumbergers option, the Company may generally settle this payment in cash or stock. If payment is triggered by a distribution by NPTest Holding, LLC to its
members, the payment to Schlumberger is required to be in the same form and may have to be made in cash, stock or both. This contingent liability is required to be marked to market at the end of each fiscal quarter until settled using the
Companys closing stock price on the last day of the fiscal quarter, and the changes in carrying value will flow through other income or expense in the condensed consolidated statements of operations. As of July 31, 2004, this obligation was
approximately $15.2 million and is included in the condensed consolidated balance sheet as accrued other liabilities.



The Company also accrued for charges of $1.5 million primarily related to severance, relocation and facility charges. The Company recognized these costs
in accordance with EITF Issue No. 95-3 (EITF 95-3), Recognition of Liabilities in Connection with Purchase Business Combinations. Twenty-two former NPTest employees were identified for termination at the time of the acquisition and the
related severance will be paid by the end of the fiscal year. The relocation charges are expected to be paid by the end of the fiscal year. The facility lease charges, net of possible sublease income of approximately $0.1 million, will be paid
through the end of the lease terms, which extend through June 2008. As of July 31, 2004, $0.8 million remained to be paid for these charges.



Amortizable Intangible Assets



Developed technology consists of products that have reached technological feasibility. Developed technology was valued using the discounting forecasted
cash flow (DCF) method. This method calculates the value of the intangible asset as being the net present value of the after tax cash flows potentially attributable to it. The Company amortizes the fair value of the developed technology on a
straight-line basis over the remaining estimated useful life of ten years.



Maintenance agreements represent the revenue generated by contracts with customers who pay for annual maintenance and support. The DCF method was used to value the maintenance contracts, which includes estimating the
beginning balance of customer service agreements, expected contract renewal rates, specific cost of sales estimates, and estimated general and administrative costs. The Company amortizes the fair value of the maintenance agreements on a
straight-line basis over the remaining estimated useful life of five years.



Customer relationships represent the value of the installed base of NPTests products and the relationships developed over time with those customers. The customer relationships were valued using an income
approach, which takes into account the loss of revenue if the existing customer relationships were not in place, and also the cost required to identify, pursue, and secure the existing customer relationships. The Company amortizes the fair value of
the customer relationships on a straight-line basis over the remaining estimated useful life of seven years.



Product backlog represents the value of the standing orders for products. The product backlog was valued using the DCF method, which accounts for the
expected profit related to the existing firm purchase orders in place at the time of acquisition. The Company amortizes the fair value of the product backlog on a straight-line basis over the remaining estimated useful life of one year.



In-process Research and Development



In-process research and development (IPR&D) represents projects that
have not reached technological feasibility and which have no alternative future use. Technological feasibility is determined when a product reaches the beta-phase, and there is no remaining risk relating to the development. At the time of
acquisition, NPTest had multiple IPR&D efforts under way for current product lines. These efforts included developing the next generation of the Sapphire product and OptiFIB product. The Company utilized the DCF method to value the IPR&D,
using discount rates ranging from 19% to 21%, depending on the estimated useful life of the technology. To determine the value of the technology in the development stage, the Company considered, among other factors, the stage of development of each
project, the time and resources needed to complete each project, expected income and associated risks. Associated risks included the inherent difficulties and uncertainties in completing the project and thereby achieving technological feasibility,
and the risks related to the viability of and potential changes to future target markets. In applying the DCF method, the analysis resulted in $7.9 million of the purchase price being charged to acquired IPR&D. At the time of the NPTest
acquisition, the Company estimates these projects to be 20% completed based on research and development complexity, costs, and time expended to date relative to the expected remaining costs and time to reach technological feasibility. The next
generation Sapphire product is estimated to launch in 2005, and will require approximately $10.4 million in additional costs to complete. The next generation OptiFIB product is estimated to launch in 2005 and will require an additional investment of
approximately eight engineering man-years.



11



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Deferred Compensation



Unvested stock options valued at approximately $10.0 million at the time of the NPTest acquisition have been allocated to
deferred compensation in the purchase price allocation and are being amortized to expense using the straight-line vesting method. The portion of the purchase price allocated to deferred compensation cost was based on the portion of the intrinsic
value at the consummation date related to the future vesting period. Options assumed in conjunction with the acquisition had exercise prices ranging from $5.86 to $13.56 per share, with a weighted-average exercise price of $6.71 per share and a
weighted average remaining contractual life of approximately 9.25 years. The Company is amortizing the fair value of the deferred compensation on a straight-line basis over the remaining vesting period of approximately 3.25 years. The Company
assumed approximately 4.1 million stock options.



Deferred
Income Taxes



The acquisition of NPTest during the quarter
resulted in the addition of $9.5 million in net deferred tax assets, but such deferred tax assets have been subject to a full valuation allowance similar to Credences other deferred tax assets. Should these $9.5 million in net deferred tax
assets be recognized in the future, the benefit will result in a reduction in goodwill otherwise recorded as part of the purchase accounting. While no net deferred tax assets were recorded as part of the acquisition, the addition of the individual
deferred tax assets and liabilities of NPTest has effectively resulted in a gross up on the balance sheet of current deferred tax assets and noncurrent deferred tax liabilities as required by GAAP.



The deferred tax assets primarily represent the benefits of future tax
deductions for inventory reserves, while the deferred tax liabilities primarily represent book-tax basis differences in the non-goodwill intangible assets acquired in the acquisition.



Pro Forma Results



The following pro forma financial information presents the combined results of operations of the Company and NPTest as if the acquisition had occurred as
of the beginning of the periods presented. Certain adjustments to reflect charges to cost of goods sold for inventory and fixed assets write-up, charges to operating expense for the amortization of the intangible assets, IPR&D, deferred
compensation and restructuring charges of $3.0 million and $20.4 million have been made to the combined results of operations for the three months ended July 31, 2004 and 2003, respectively. Such adjustments were $53.4 million and $70.9 million have
been made to the combined results of operations for the nine months ended July 31, 2004 and 2003, respectively. The unaudited pro forma financial information is not intended to represent or be indicative of the consolidated results of operations or
financial condition of the Company that would have been reported had the acquisition been completed as of the dates presented, and should not be taken as representative of the future consolidated results of operations or financial condition of the
Company.



|                                         |  |                            |         |   |                            |   |         |      |  |   |         |   |  |   |          |  
|---------------------------------------- |  | -------------------------- | ------- | - | -------------------------- | - | ------- | ---- |  | - | ------- | - |  | - | -------- | -
|                                         |  | Three Months EndedJuly 31, |         |   | Nine Months Ended July 31, |  
|(in thousands, except per share amounts) |  | 2004                       |         |   | 2003                       |   |         | 2004 |  |   | 2003    |  
|Net revenue                              |  | $                          | 222,358 |   |                            | $ | 104,337 |      |  | $ | 440,630 |   |  | $ | 291,961  |  
|Net loss                                 |  |                            | (34,815 | ) |                            |   | (84,667 | )    |  |   | (60,937 | ) |  |   | (159,720 | )
|Basic net loss per share                 |  | $                          | (0.35   | ) |                            | $ | (1.02   | )    |  | $ | (0.68   | ) |  | $ | (1.94    | )
|                                         |  |                            |         |   |                            |   |         |      |  |   |         |   |  |   |          |  
|Diluted net loss per share               |  | $                          | (0.35   | ) |                            | $ | (1.02   | )    |  | $ | (0.68   | ) |  | $ | (1.94    | )
|                                         |  |                            |         |   |                            |   |         |      |  |   |         |   |  |   |          |  



The pro forma
financial information above includes the following material, non-recurring charges for all periods presented (in thousands):



|                                                     |  |   |       
|---------------------------------------------------- |  | - | ------
|COGS from inventory write-up                         |  | $ | 14,567
|Amortization of the product backlog intangible asset |  | $ | 4,900 
|In-process research and development                  |  | $ | 7,900 
|Special cost of goods sold charges                   |  | $ | 46,206
|Restructuring charges                                |  | $ | 2,969 
|Integration costs                                    |  | $ | 1,849 



The pro forma
information above for the three and nine months ended July 31, 2004 excluded the impact of material, non-recurring charges related to the acquisition of NPTest Inc. from Schlumberger by NPTest Holding Corporation, which was incorporated by Francisco
Partners, and the initial public offering effect on NPTest. Those charges include, among others, 1) the amortization of intangible assets, 2) amortization of tangible assets written up to fair value, 3) indirect costs associated with its initial
public offering such as preferred stock dividends, annual advisory fees to Francisco Partners and interest expense on the senior debt, and 4) the tax effect associated with excluding these charges which totaled $2.4 million and $53.8 million,
respectively. For the nine months ended July 31, 2003, the pro forma information above excluded $8.7 million of a one-time gain on curtailment of pensions and employee benefits.



Credence  SZ GmbH:



In February 2004, the Company acquired all of the outstanding stock of Credence - SZ GmbH (SZ GmbH) for approximately $649,000 in cash, and thereafter
merged SZ GmbH with and into Credence - SZ GmbH, a wholly-owned subsidiary of the Company. Of the $649,000 paid, approximately $537,000 was accounted for as goodwill and included in the Companys condensed consolidated balance sheet at April
30, 2004. SZ GmbH was the employer of the employees that were contracted to Credence-SZ Testsysteme GmbH. Credence-SZ Testsysteme GmbH is based in Amerang, Germany, with approximately 135 employees and is



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managed within the Companys Mobile Products Group. The acquisition was accounted for as a purchase transaction in
accordance with SFAS No. 141, and accordingly, the assets acquired and liabilities assumed were recorded at their estimated fair value at the date of the acquisition. Pro forma results of operations have not been presented because the effect of the
acquisition was not material.



7. Goodwill, Other Intangible Assets and
Long-Lived Assets



Effective November 1, 2002, the Company
adopted Statement of Financial Accounting Standard No. 142, Goodwill and Other Intangible Assets, (SFAS 142), which was issued by the FASB in July 2001. Under this standard, the Company ceased amortizing goodwill effective November 1,
2002. In addition, on adoption, the Company reclassified certain intangible assets with a net book value of $0.4 million, consisting of acquired workforce, which is no longer defined as an acquired intangible under SFAS 142 to goodwill.



SFAS 142 makes use of the concept of reporting units. All acquisitions
must be assigned to a reporting unit or units. Reporting units have been defined under the standards to be the same as or one level below an operating segment, as defined in SFAS No. 131, Disclosures About Segments of an Enterprise and Related
Information. A reporting unit would be one level below the operating segment if a component of an operating segment is a business as described under U.S. Generally Accepted Accounting Principles and (1) is a separable unit that engages in
business activities for which discrete financial information is available, (2) has economic characteristics different from other components of the operating segment, and (3) operating results of the component are reviewed regularly by the segment
manager. The Company had operated in two industry segments: (1) the design, development, manufacture, sale and service of advanced semiconductor test and diagnostic systems and (2) the design, development, sale and service of software that assists
in the development of test programs used in semiconductor test. Revenues from the software segment were not material to the Companys operations in fiscal years 2002, 2001, and 2000. During 2003, the software segment was significantly decreased
in size and the remaining software operations were merged with the semiconductor test and diagnostic systems segment. Currently, the Company operates in one industry segment, semiconductor test and diagnostic systems. We also have a single reporting
unit for purposes of SFAS 142, semiconductor test and diagnostic systems, primarily because all of the components of the Companys semiconductor test and diagnostic systems segment are subject to similar economic characteristics. In addition,
all the Companys products have common production processes, customers, and product life cycles.



The Company tests goodwill for possible impairment on an annual basis or at any other time if events occur or circumstances indicate that the carrying
amount of goodwill may not be recoverable. Circumstances that could trigger an impairment test include but are not limited to: a significant adverse change in the business climate or legal factors; the Companys market capitalization is less
than the Companys net assets; unanticipated competition; loss of key personnel, a significant change in direction with respect to investment in a product or market segment; the likelihood that a significant portion of the business will be sold
or disposed of; or the results of testing for recoverability of a significant asset group within a reporting unit determined in accordance with SFAS 142.



No impairment loss was recognized in connection with the adoption of SFAS No. 142 or during the first nine months of fiscal 2004. However, no assurances
can be given that future evaluations of goodwill will not result in charges as a result of future impairment.



The determination as to whether a write-down of goodwill is necessary involves significant judgment based on short-term and long-term projections of the
future performance of the reporting unit to which the goodwill is attributed. The assumptions supporting the estimated future cash flows of the reporting unit, including discount rate used and estimated terminal value, reflect the Companys
best estimates.



The Company evaluates the carrying value of
its long-lived assets, consisting primarily of its facilities, purchased and other identifiable intangible assets, and property, plant and equipment, whenever certain events or changes in circumstances indicate that the carrying amount of these
assets may not be recoverable. Such events or circumstances include, but are not limited to, a change in the Companys product investment strategy, a prolonged industry downturn, a significant decline in the Companys market value, or
significant reductions in projected future cash flows. In assessing the recoverability of the Companys long-lived assets, the Company compares the carrying value of these assets to the undiscounted future cash flows the assets are expected to
generate. If the total of the undiscounted future cash flows is less than the carrying amount of these assets, such assets are written down based on the excess of the carrying value over the fair value of these assets. Fair value is generally
determined by calculating the discounted future cash flows using a discount rate based upon the Companys weighted average cost of capital. Significant judgments and assumptions are required in the forecast of future operating results used in
the preparation of the estimated future cash flows, including profit margins, long-term forecasts of the amounts and timing of overall market growth and the Companys percentage of that market, groupings of assets, discount rates and terminal
growth rates. In addition, significant estimates and assumptions are required in the determination of the fair value of the Companys tangible long-lived assets, including replacement cost, economic obsolescence, and the value that could be
realized in liquidation. Changes in these estimates could have a material adverse effect on the assessment of the Companys long-lived assets, thereby requiring the Company to write down the assets. The purchased intangible assets consist of
purchased technology, customer relations, maintenance contracts, product backlog, trademarks, patents and non-compete agreements and the purchased intangible assets typically have estimated useful lives ranging from one to ten years.



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##### Table of Contents

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



|                       |  |      |         |                          |   |         |     |  |   |        
|---------------------- |  | ---- | ------- | ------------------------ | - | ------- | --- |  | - | -------
|July 31, 2004          |  | Cost |         | Accumulated Amortization |   |         | Net
|Purchased technology   |  | $    | 125,206 |                          | $ | (33,194 | )   |  | $ | 92,012 
|Customer relations     |  |      | 19,802  |                          |   | (7,165  | )   |  |   | 12,637 
|Maintenance contracts  |  |      | 13,800  |                          |   | (460    | )   |  |   | 13,340 
|Product backlog        |  |      | 4,900   |                          |   | (817    | )   |  |   | 4,083  
|Trademarks             |  |      | 2,053   |                          |   | (1,745  | )   |  |   | 308    
|Patents                |  |      | 862     |                          |   | (689    | )   |  |   | 173    
|Non-compete agreements |  |      | 750     |                          |   | (563    | )   |  |   | 187    
|                       |  |      |         |                          |   |         |     |  |   |        
|Total                  |  | $    | 167,373 |                          | $ | (44,633 | )   |  | $ | 122,740
|                       |  |      |         |                          |   |         |     |  |   |        
|                       |  |      |        
|October 31, 2003       |  | Cost |         | AccumulatedAmortization  |   |         | Net
|Purchased technology   |  | $    | 54,906  |                          | $ | (27,001 | )   |  | $ | 27,905 
|Customer relations     |  |      | 7,702   |                          |   | (5,708  | )   |  |   | 1,994  
|Trademarks             |  |      | 2,053   |                          |   | (1,437  | )   |  |   | 616    
|Patents                |  |      | 862     |                          |   | (560    | )   |  |   | 302    
|Non-compete agreements |  |      | 750     |                          |   | (282    | )   |  |   | 468    
|                       |  |      |         |                          |   |         |     |  |   |        
|Total                  |  | $    | 66,273  |                          | $ | (34,988 | )   |  | $ | 31,285 
|                       |  |      |         |                          |   |         |     |  |   |        



Amortization expense
for the other intangible assets was $4.7 million for the three months ended July 31, 2004, as compared to $2.6 million for the three months ended July 31, 2003. Amortization expense for the other intangible assets was $9.6 million for the nine
months ended July 31, 2004, as compared to $6.8 million for the nine months ended July 31, 2003.



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



|                              |  |        |        
|----------------------------- |  | ------ | -------
|Year Ending October 31,       |  | Amount
|2004 (remaining three months) |  | $      | 5,858  
|2005                          |  |        | 20,443 
|2006                          |  |        | 16,604 
|2007                          |  |        | 16,466 
|2008                          |  |        | 14,518 
|2009                          |  |        | 12,718 
|Thereafter                    |  |        | 36,133 
|                              |  |        |        
|Total                         |  | $      | 122,740
|                              |  |        |        



8. Net Loss Per Share



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



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



|                                                                                                          |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|--------------------------------------------------------------------------------------------------------- |  | --------------------------- | ------- | - | -------------------------- | - | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                                                          |  | Three Months Ended July 31, |         |   | Nine Months Ended July 31, |  
|                                                                                                          |  | 2004                        |         |   | 2003                       |   |         | 2004 |  |   | 2003    |  
|Numerator:                                                                                                |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|Net loss                                                                                                  |  | $                           | (33,165 | ) |                            | $ | (31,711 | )    |  | $ | (40,382 | ) |  | $ | (91,004 | )
|                                                                                                          |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|Denominator:                                                                                              |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|Denominator for basic and diluted loss per share-adjusted weighted-average shares and assumed conversions |  |                             | 78,647  |   |                            |   | 63,191  |      |  |   | 69,407  |   |  |   | 62,474  |  
|                                                                                                          |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|Basic net loss per share                                                                                  |  | $                           | (0.42   | ) |                            | $ | (0.50   | )    |  | $ | (0.58   | ) |  | $ | (1.46   | )
|                                                                                                          |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|Diluted net loss per share                                                                                |  | $                           | (0.42   | ) |                            | $ | (0.50   | )    |  | $ | (0.58   | ) |  | $ | (1.46   | )
|                                                                                                          |  |                             |         |   |                            |   |         |      |  |   |         |   |  |   |         |  



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At July 31, 2004 and 2003, there were options outstanding to purchase 18,398,552 and 14,030,027 shares of
common stock at a weighted average exercise price of $15.61 and $17.65, respectively, which were excluded from the diluted net loss per share calculation for the three and nine months ended July 31, 2004 and 2003 as their effect was anti-dilutive in
each respective period. There also were issuable 15,915,119 shares of common stock under the terms of the convertible subordinated notes issued in June 2003 and 12,328,200 shares of preferred stock that were excluded from the diluted net loss per
share calculation for the three and nine months ended July 31, 2004 as their effect was anti-dilutive in those periods.



9. Recent Accounting Pronouncements



In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46). FIN 46 addresses consolidation
by business enterprises of variable interest entities. Under that interpretation, certain entities known as Variable Interest Entities (VIEs) must be consolidated by the primary beneficiary of the entity. The primary beneficiary is generally defined
as having the majority of the risks or rewards arising from the VIE. For VIEs in which a significant (but not majority) variable interest is held, certain disclosures are required. The Company has not entered into any arrangements or made any
investments which qualify as a VIE after January 31, 2003 and therefore the initial implementation of FIN 46 had no impact on the Companys financial statements. For VIEs acquired before February 1, 2003, FIN 46 required the Company to apply
the accounting and disclosure rules in the first quarter of fiscal 2004. This requirement was superseded by issuance of revision to FIN 46, as noted below.



In December 2003, the FASB issued a revision to Interpretation No. 46 (FIN 46R) which replaced FIN 46. The revised interpretation further refines the
definition of VIEs and provides guidelines on identifying them and assessing an enterprises interests in a VIE to decide whether to consolidate that entity. FIN 46R applies at different dates to different types of enterprises and entities, and
special provisions apply to enterprises that have fully or partially applied FIN 46 prior to the issuance of FIN 46R. Generally, application of FIN 46R is required in financial statements of public entities that have interests in VIEs or potential
VIEs commonly referred to as special-purpose entities for periods ending after December 15, 2003. Application by public entities for all other types of entities is required in financial statements for periods ending after March 15, 2004. The
adoption of FIN 46R did not have a material impact on the results of operations or financial condition of the Company.



On December 17, 2003, the Staff of the Securities and Exchange Commission (SEC) issued SAB 104, which supersedes Staff Accounting Bulletin No. 101,
Revenue Recognition in Financial Statements (SAB 101). SAB 104s primary purpose is to rescind the accounting guidance contained in SAB 101 related to multiple-element revenue arrangements that was superseded as a result of the
issuance of EITF 00-21, Accounting for Revenue Arrangements with Multiple Deliverables. Additionally, SAB 104 rescinds the SECs related Revenue Recognition in Financial Statements Frequently Asked Questions and Answers issued with SAB 101 that
had been codified in SEC Topic 13, Revenue Recognition. While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104, which was
effective upon issuance. The adoption of SAB 104 did not have a material effect on the Companys financial position or results of operations.



In March 2004, the Task Force reached a consensus on Issue No. 03-1 (EITF 03-1), The Meaning of Other-Than-Temporary Impairment and Its Application
to Certain Investments. EITF 03-1 provides guidance for determining when an investment is other-than-temporarily impaired and disclosure requirement about those impairments. EITF 03-1 is effective for fiscal year ending after December 31,
2003. The adoption of EITF 03-1 did not have any impact on the Companys financial position or results of operations.



10. Contingencies and Guarantees



The Companys corporate by-laws require that the Company indemnify its officers and directors, as well as those who act as directors and officers of
other entities at the Companys request, against expenses, judgments, fines, settlements and other amounts actually and reasonably incurred in connection with any proceedings arising out of their services to Credence. In addition, the Company
has entered into separate indemnification agreements with each director and each executive officer of Credence that provide for indemnification of these directors and officers under similar circumstances and under additional circumstances. The
indemnification obligations are more fully described in the by-laws and the indemnification agreements. The Company purchases standard directors and officers insurance to cover claims or a portion of the claims made against its directors
and officers. Since a maximum obligation is not explicitly stated in the Companys by-laws or in the indemnification agreements and will depend on the facts and circumstances that arise out of any future claims, the overall maximum amount of
the obligations cannot be reasonably estimated. Historically, the Company has not made payments related to these obligations, and the fair value for these obligations is zero on the consolidated balance sheet as of July 31, 2004 and October 31,
2003.



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



The Company may be required to make a payment to Schlumberger at a date in the future pursuant to a provision in the acquisition agreement between NPTest
and Schlumberger under which NPTest was acquired by Francisco Partners, L.P. from Schlumberger. As of July 31, 2004, the fair value of this obligation was approximately $15.2 million and is included in the condensed consolidated balance sheet as
accrued other liabilities. See Note 6 of the Notes to the Condensed Consolidated Financial Statements for further discussion.



The Company leases some of its facilities and equipment under operating leases that expire through 2010 of which $0.7 million and $0.2 million have been
written-off to special operating charges during the first nine months of fiscal 2004 and 2003, respectively. See Note 13 of the Notes to the Condensed Consolidated Financial Statements for further discussion.



Some of the components that the Company purchases are unique to the Company
and must be purchased in relatively high minimum quantities with long (four and five month) lead times. These business circumstances can lead to the Company holding relatively high inventory levels and associated risks. In addition, purchase
commitments for unique components are relatively inflexible in terms of deferral or cancellation. At July 31, 2004, the Company had open and committed purchase orders totaling approximately $103.6 million.



The following summarizes our minimum contractual cash obligations and other
commitments at July 31, 2004, and the effect of such obligations in future periods (in thousands):



|                                                                                            |  |       |         |                        |   |            |  |            |        |            |   |            |  |            |       |            |   |         |  |   |       |  |   |      
|------------------------------------------------------------------------------------------- |  | ----- | ------- | ---------------------- | - | ---------- |  | ---------- | ------ | ---------- | - | ---------- |  | ---------- | ----- | ---------- | - | ------- |  | - | ----- |  | - | -----
|                                                                                            |  | Total |         | Remainderof Fiscal2004 |   | Fiscal2005 |  | Fiscal2006 |        | Fiscal2007 |   | Fiscal2008 |  | Fiscal2009 |       | Thereafter
|Contractual Obligations:                                                                    |  |       |         |                        |   |            |  |            |        |            |   |            |  |            |       |            |   |         |  |   |       |  |   |      
|Facilities and equipment operating leases                                                   |  | $     | 31,900  |                        | $ | 2,024      |  | $          | 7,602  |            | $ | 6,180      |  | $          | 5,331 |            | $ | 4,834   |  | $ | 4,793 |  | $ | 1,136
|Bank loans and notes payable related to leased products                                     |  |       | 6,426   |                        |   | 368        |  |            | 6,058  |            |   |           |  |            |      |            |   |        |  |   |      |  |   |     
|Interest on liabilities related to leased products                                          |  |       | 320     |                        |   | 82         |  |            | 220    |            |   | 18         |  |            |      |            |   |        |  |   |      |  |   |     
|Convertible subordinated notes                                                              |  |       | 180,000 |                        |   |           |  |            |       |            |   |           |  |            |      |            |   | 180,000 |  |   |      |  |   |     
|Interest on convertible subordinated notes                                                  |  |       | 10,238  |                        |   | 675        |  |            | 2,700  |            |   | 2,700      |  |            | 2,700 |            |   | 1,463   |  |   |      |  |   |     
|Minimum payable for information technology outsourcing including fees for early termination |  |       | 11,008  |                        |   | 1,696      |  |            | 9,312  |            |   |           |  |            |      |            |   |        |  |   |      |  |   |     
|Contingent liability to Schlumberger (NPTests former parent company)(1)                    |  |       | 15,200  |                        |   |           |  |            | 15,200 |            |   |           |  |            |      |            |   |        |  |   |      |  |   |     
|Open and non-cancelable purchase order commitments                                          |  |       | 103,555 |                        |   | 103,555    |  |            |       |            |   |           |  |            |      |            |   |        |  |   |      |  |   |     
|                                                                                            |  |       |         |                        |   |            |  |            |        |            |   |            |  |            |       |            |   |         |  |   |       |  |   |      
|Total contractual cash and other obligations                                                |  | $     | 358,647 |                        | $ | 108,400    |  | $          | 41,092 |            | $ | 8,898      |  | $          | 8,031 |            | $ | 186,297 |  | $ | 4,793 |  | $ | 1,136
|                                                                                            |  |       |         |                        |   |            |  |            |        |            |   |            |  |            |       |            |   |         |  |   |       |  |   |      

---

|(1) | The Company assumed that the contingent liability will be triggered and settled in fiscal year 2005.
|--- | ----------------------------------------------------------------------------------------------------



The Company provides reserves for the estimated costs of product warranties
at the time revenue is recognized. The Company estimates the costs of warranty obligations based on historical experience of known product failure rates, use of materials to repair or replace defective products and service delivery costs incurred in
correcting product failures. The warranty accrual is included in the accrued expenses and other liabilities in the condensed consolidated balance sheets.



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The following table represents the activity in the warranty accrual for the nine months ended July 31,
2004 and 2003 (in thousands):



|                                                 |  |                   |        |   |              |   |        |  
|------------------------------------------------ |  | ----------------- | ------ | - | ------------ | - | ------ | -
|                                                 |  | Nine Months Ended |       
|                                                 |  | July 31,2004      |        |   | July 31,2003 |  
|Beginning balance                                |  | $                 | 5,501  |   |              | $ | 4,316  |  
|Accruals for warranties issued during the period |  |                   | 13,882 |   |              |   | 3,604  |  
|Acquired pre-existing warranty obligations       |  |                   | 7,110  |   |              |   | 683    |  
|Adjustments of prior period accrual estimates    |  |                   | (464   | ) |              |   | (447   | )
|Warranty claims made during the period           |  |                   | (9,079 | ) |              |   | (3,810 | )
|                                                 |  |                   |        |   |              |   |        |  
|Ending balance                                   |  | $                 | 16,950 |   |              | $ | 4,346  |  
|                                                 |  |                   |        |   |              |   |        |  



11. Accounts Receivable Factoring
without Recourse



During the third quarter of 2004, the
Company entered into an agreement to sell its trade receivables under non-recourse transactions. Under the terms of the agreement, the Company can sell up to $30 million of its trade receivables at any one time. The Company was retained by the bank
to service the collection aspect of the trade receivables sold. The trade receivables are sold at a discount plus administrative and other fees. The discount amount is included in interest expense, while the administrative and other fees are
accounted for in selling, general and administrative expenses in the condensed consolidated statements of operations. In the third quarter of 2004, interest expense amounted to approximately $82,000, and administrative and other fees were
approximately $52,000. Sales of trade receivables are reflected as a reduction of accounts receivable in the accompanying condensed consolidated balance sheets. The proceeds received are included as cash in the accompanying condensed consolidated
balance sheets and as operating activities on the condensed consolidated statements of cash flows. During the third quarter of 2004, the Company recorded approximately $16.8 million in gross proceeds from the sale of trade receivables.



12. Comprehensive Loss



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



|                                                                       |  |                            |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|---------------------------------------------------------------------- |  | -------------------------- | ------- | - | -------------------------- | - | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                       |  | Three Months EndedJuly 31, |         |   | Nine Months Ended July 31, |  
|                                                                       |  | 2004                       |         |   | 2003                       |   |         | 2004 |  |   | 2003    |  
|Net loss                                                               |  | $                          | (33,165 | ) |                            | $ | (31,711 | )    |  | $ | (40,382 | ) |  | $ | (91,004 | )
|                                                                       |  |                            |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|Unrealized gains (losses) on available-for sale securities, net of tax |  |                            | 239     |   |                            |   | (484    | )    |  |   | (578    | ) |  |   | (1,237  | )
|Currency translation adjustment, net of tax                            |  |                            | 498     |   |                            |   | 65      |      |  |   | 478     |   |  |   | (2,026  | )
|                                                                       |  |                            |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|Other comprehensive gain (loss)                                        |  |                            | 737     |   |                            |   | (419    | )    |  |   | (100    | ) |  |   | (3,263  | )
|                                                                       |  |                            |         |   |                            |   |         |      |  |   |         |   |  |   |         |  
|Total comprehensive loss                                               |  | $                          | (32,428 | ) |                            | $ | (32,130 | )    |  | $ | (40,482 | ) |  | $ | (94,267 | )
|                                                                       |  |                            |         |   |                            |   |         |      |  |   |         |   |  |   |         |  



13. Special Charges and
Restructuring



Special charges  cost of goods sold



The Company reviews excess and obsolete inventory
annually based on information available from the strategic and operating planning process and also on a quarterly basis identifying and addressing significant events that might have an impact on inventories and related reserves. See Note 1 of the
Notes to the Condensed Consolidated Financial Statements included in the Companys Annual Report on Form 10-K under the heading Inventories for further discussion of the Companys reserve methodology.



The schedule below shows transactions relating to inventory that were
expensed as a special charge to cost of goods sold. The total charges from the second and fourth quarter of fiscal 2001, the fourth quarter of fiscal 2002, and the third quarter of fiscal 2004 were approximately $134.1 million. Of this,
approximately $44.2 million was scrapped, $19.5 million was written off and largely disposed of, $1.3 million was donated, $7.2 million was written down for lower of cost or market provisions, $2.0 million was sale of fully reserved inventory and
the remaining $59.9 million was still on hand as of July 31, 2004.



In the third quarter of 2004, the Company recorded special charges to cost of goods sold totaling approximately $46.2 million. These charges consisted primarily of excess and
obsolete inventory and other charges related to the Companys decision to discontinue significant future investment in its redundant product lines stemming from the acquisition of NPTest. Of the $46.2 million, $41.6 million was directly related
to inventory write-downs. These write-downs were related to the acquisition of NPTest which resulted in duplicate product lines. The Company evaluated the redundant product lines using internal and external marketing data, the development roadmap
for each product line, existing and potential customers and demand for the product. As a result of the evaluation, we identified production inventory, finished goods, consignment and demo inventory, and field service spares in excess of estimated
future customer demand of approximately $ 35.2 million; write-downs to estimated current market value of approximately $6.4 million; purchase commitments of approximately $1.0 million; field service spares of approximately $0.9 million, and other
assets and expenses of approximately $2.7 million.



17



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##### Table of Contents

The following table illustrates the activity in special charges related to inventory write-downs for the
periods ended July 31, 2004 (in thousands):



|                                                                          |  |         |         |   |         |   |        |         |  |   |         |   |  |   |       
|------------------------------------------------------------------------- |  | ------- | ------- | - | ------- | - | ------ | ------- |  | - | ------- | - |  | - | ------
|                                                                          |  | Q2 FY01 |         |   | Q4 FY01 |   |        | Q4 FY02 |  |   | Q3 FY04
|Special Charges                                                           |  | $       | 45,020  |   |         | $ | 38,003 |         |  | $ | 9,440   |   |  | $ | 41,620
|FY01 Capacity Write-off                                                   |  |         | (3,904  | ) |         |   |       |         |  |   |        |   |  |   |      
|FY01 Scrapping                                                            |  |         | (24,118 | ) |         |   |       |         |  |   |        |   |  |   |      
|FY01 ValStar write-off and disposal                                       |  |         | (7,868  | ) |         |   |       |         |  |   |        |   |  |   |      
|FY01 Write-off and largely disposed                                       |  |         | (6,410  | ) |         |   |       |         |  |   |        |   |  |   |      
|                                                                          |  |         |         |   |         |   |        |         |  |   |         |   |  |   |       
|10/31/01 Balance                                                          |  |         | 2,720   |   |         |   | 38,003 |         |  |   |        |   |  |   |      
|                                                                          |  |         |         |   |         |   |        |         |  |   |         |   |  |   |       
|FY02 Scrapping                                                            |  |         | (1,326  | ) |         |   | (6,205 | )       |  |   |        |   |  |   |      
|FY02 Write-off and largely disposed                                       |  |         | (221    | ) |         |   | (1,150 | )       |  |   |        |   |  |   |      
|FY02 Donation                                                             |  |         | (1,173  | ) |         |   | (91    | )       |  |   |        |   |  |   |      
|                                                                          |  |         |         |   |         |   |        |         |  |   |         |   |  |   |       
|10/31/02 Balance                                                          |  |         |        |   |         |   | 30,557 |         |  |   | 9,440   |   |  |   |      
|                                                                          |  |         |         |   |         |   |        |         |  |   |         |   |  |   |       
|FY03 Scrapping                                                            |  |         |        |   |         |   | (7,538 | )       |  |   | (3,134  | ) |  |   |      
|                                                                          |  |         |         |   |         |   |        |         |  |   |         |   |  |   |       
|10/31/03 Balance                                                          |  |         |        |   |         |   | 23,019 |         |  |   | 6,306   |   |  |   |      
|                                                                          |  |         |         |   |         |   |        |         |  |   |         |   |  |   |       
|FY04 Scrapping                                                            |  |         |        |   |         |   | (1,656 | )       |  |   |        |   |  |   |      
|FY04 Sale on fully reserved inventory                                     |  |         |         |   |         |   | (2,153 | )       |  |   |         |   |  |   |       
|FY04 Kalos lower of cost or market adjustment on fully reserved inventory |  |         |        |   |         |   | (7,215 | )       |  |   |        |   |  |   |      
|                                                                          |  |         |         |   |         |   |        |         |  |   |         |   |  |   |       
|7/31/04 Balance of inventory written off but still on hand                |  | $       |        |   |         | $ | 11,995 |         |  | $ | 6,306   |   |  | $ | 41,620
|                                                                          |  |         |         |   |         |   |        |         |  |   |         |   |  |   |       



Restructuring  operating
expenses



For the quarter ended January 31, 2003, the
Company recorded restructuring charges of approximately $1.4 million as operating expenses related to headcount reductions and facility consolidations, which the Company implemented in the quarter. During this period, the Company reduced headcount
by approximately 70. The bulk of the affected employees were in selling, general and administrative (SG&A) functions and a smaller number were in research and development (R&D). Also, during the quarter, the Company completed its plans to
exit the IMS facility in Beaverton, Oregon and consolidated the remaining Oregon employees into its Hillsboro, Oregon facility. In addition to these restructuring charges, the Company also recorded a charge of $1.5 million in the first quarter of
fiscal 2003 for IPR&D resulting from the purchase of Optonics, Inc. in January 2003.



In January 2004, the Company relocated its corporate headquarters to its owned facilities in Milpitas, California and vacated its previously leased buildings in Fremont, California. The lease for three of the
buildings expired at the end of December 2003. The Company will attempt to sublease the final building, consisting of 27,000 square feet. This lease expires in June 2005. During the quarter ended January 31, 2004, a special charge was recorded in
the amount of $0.7 million to write-off the remaining lease payments for this lease, net of expected sublease income for a lease in Austin, Texas.



In the third quarter of 2004, in connection with the NPTest acquisition, the Company recorded a restructuring charge of approximately $3.0 million. Of the
$3.0 million, $1.9 million related to the write-off of equipment and liabilities incurred related to the decision to discontinue significant future investments in redundant product lines stemming from the acquisition of NPTest. In addition, the
Company incurred severance and related charges of $1.1 million relating to the termination of sixty employees from Credence to eliminate certain duplicated activities. Of the sixty employees, sixteen were from manufacturing, twenty-nine were from
research and development, and fifteen were from selling, general and administrative functions. Fifty-six of the employees were from the U.S. and four were from international locations. These employees were in addition to the twenty-two former NPTest
employees that were also terminated as noted above in Note 6. These charges were accounted for in accordance with SFAS 146 (SFAS 146), Accounting for Costs Associated with Exit or Disposal Activities. As of July 31, 2004, there was $0.4
million remaining to be paid. The above restructuring charges are based on the Companys restructuring plans that have been committed by management. Any changes to the estimates of the approved plans will be reflected in the Companys
future condensed consolidated results of operations.



The
restructuring accrual is included in the accrued expenses and other liabilities in the condensed consolidated balance sheets. The following table illustrates the activity for the periods ended July 31, 2004 and the estimated timing of future
payments for major restructuring categories in the restructuring accrual (in thousands):



|                                    |  |           |        |   |                 |   |        |                  |  |   |        |   |  |   |        |  
|----------------------------------- |  | --------- | ------ | - | --------------- | - | ------ | ---------------- |  | - | ------ | - |  | - | ------ | -
|                                    |  | Severance |        |   | OperatingLeases |   |        | OtherLiabilities |  |   | Total  |  
|Balance at October 31, 2003         |  | $         | (233   | ) |                 | $ | (2,368 | )                |  | $ |       |   |  | $ | (2,601 | )
|Additional charges                  |  |           | (1,049 | ) |                 |   |       |                  |  |   | (1,920 | ) |  |   | (2,969 | )
|Operating leases written off        |  |           |       |   |                 |   | (653   | )                |  |   |       |   |  |   | (653   | )
|Equipment written off               |  |           |       |   |                 |   |       |                  |  |   | 1,392  |   |  |   | 1,392  |  
|Cash payments                       |  |           | 920    |   |                 |   | 1,487  |                  |  |   | 528    |   |  |   | 2,935  |  
|                                    |  |           |        |   |                 |   |        |                  |  |   |        |   |  |   |        |  
|Balance at July 31, 2004            |  | $         | (362   | ) |                 | $ | (1,534 | )                |  | $ |       |   |  | $ | (1,896 | )
|                                    |  |           |        |   |                 |   |        |                  |  |   |        |   |  |   |        |  
|Estimated timing of future payouts: |  |           |        |   |                 |   |        |                  |  |   |        |   |  |   |        |  
|                                    |  |           |        |  
|Fiscal 2004                         |  |           | 362    |   |                 |   | 467    |                  |  |   |       |   |  |   | 829    |  
|Fiscal 2005                         |  |           |       |   |                 |   | 1,067  |                  |  |   |       |   |  |   | 1,067  |  
|                                    |  |           |        |   |                 |   |        |                  |  |   |        |   |  |   |        |  
|Total                               |  | $         | 362    |   |                 | $ | 1,534  |                  |  | $ |       |   |  | $ | 1,896  |  
|                                    |  |           |        |   |                 |   |        |                  |  |   |        |   |  |   |        |  



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##### Table of Contents

The opening balances at October 31, 2003 in the above table are associated with headcount reductions and
facility consolidations implemented by the Company.



14. Industry Segment



Operating segments are business units that have separate
financial information and are separately reviewed by the Companys chief decision makers. The Companys chief decision makers are the Chief Executive Officer and Chief Operating Officer. The Company and its subsidiaries currently operate
in a single industry segment: the design, development, manufacture, sale and service of advanced semiconductor test and diagnostic systems used in the production of semiconductors. The Company had operated in two industry segments: (1) the design,
development, manufacture, sale and service of advanced semiconductor test and diagnostic systems and (2) the design, development, sale and service of software that assists in the development of test programs used in semiconductor test. Revenues from
the software product line were not material to the Companys operations in the first three and nine months of fiscal 2004 and 2003, representing less than 4% of net sales. The Company had a single reporting unit for purposes of SFAS 142,
advanced semiconductor test and diagnostic systems, primarily because all of the components of the Companys advanced semiconductor test and diagnostic systems segment are subject to similar economic characteristics. In addition, all the
Companys products have common production processes, customers, and product life cycles. The acquisition of NPTest did not change the Company products economic characteristics; thus, the Company determined that it is still operate as a
single reporting unit.



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



|                          |  |                             |   |  |                            |   |  |      |   |  |      |  
|------------------------- |  | --------------------------- | - |  | -------------------------- | - |  | ---- | - |  | ---- | -
|                          |  | Three Months Ended July 31, |   |  | Nine Months Ended July 31, |  
|                          |  | 2004                        |   |  | 2003                       |   |  | 2004 |   |  | 2003 |  
|Digital and Mixed-Signal  |  | 48                          | % |  | 57                         | % |  | 54   | % |  | 54   | %
|Memory                    |  | 31                          |   |  | 15                         |   |  | 24   |   |  | 12   |  
|Service                   |  | 19                          |   |  | 21                         |   |  | 17   |   |  | 25   |  
|Diagnostic Systems        |  | 1                           |   |  |                           |   |  | 4    |   |  | 3    |  
|Software, Lease and Other |  | 1                           |   |  | 7                          |   |  | 1    |   |  | 6    |  
|                          |  |                             |   |  |                            |   |  |      |   |  |      |  
|Total                     |  | 100                         | % |  | 100                        | % |  | 100  | % |  | 100  | %
|                          |  |                             |   |  |                            |   |  |      |   |  |      |  



Most of the
Companys products are manufactured in the U.S. export sales from the U.S. are primarily denominated in U.S. dollars but occasionally denominated in Japanese Yen or in the Euro. A relatively small portion of the Digital and Mixed Signal product
line is manufactured in Germany and these sales are denominated in U.S. dollars, Japanese Yen and the Euro. All of the Companys products are shipped to the Companys customers throughout North America, Asia Pacific, Europe, and the Middle
East. Sales by the Company to customers in different geographic areas, expressed as a percentage of revenue, for the periods ended were:



|                     |  |                             |   |  |                           |   |  |      |   |  |      |  
|-------------------- |  | --------------------------- | - |  | ------------------------- | - |  | ---- | - |  | ---- | -
|                     |  | Three Months Ended July 31, |   |  | Nine Months EndedJuly 31, |  
|                     |  | 2004                        |   |  | 2003                      |   |  | 2004 |   |  | 2003 |  
|North America        |  | 21                          | % |  | 40                        | % |  | 25   | % |  | 38   | %
|Taiwan               |  | 25                          |   |  | 15                        |   |  | 23   |   |  | 15   |  
|China                |  | 6                           |   |  | 3                         |   |  | 7    |   |  | 4    |  
|Southeast Asia       |  | 21                          |   |  | 11                        |   |  | 21   |   |  | 10   |  
|Rest of Asia Pacific |  | 4                           |   |  | 6                         |   |  | 5    |   |  | 13   |  
|Europe & Middle East |  | 23                          |   |  | 25                        |   |  | 19   |   |  | 20   |  
|                     |  |                             |   |  |                           |   |  |      |   |  |      |  
|Total net sales      |  | 100                         | % |  | 100                       | % |  | 100  | % |  | 100  | %
|                     |  |                             |   |  |                           |   |  |      |   |  |      |  



19



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##### Table of Contents

For the three months ended July 31, 2004, one customer accounted for 19% of the Companys net sales.
For the nine months ended July 31, 2004, two customers accounted for 14% and 11% of the Companys net sales, respectively. For the three and nine months ended July 31, 2003, no single customer accounted for 10% or more of the Companys net
sales.



As of July 31, 2004, two customers accounted for 22%
and 24% of the Companys gross accounts receivable, respectively. As of October 31, 2003, two customers accounted for 25% and 24% of the Companys gross accounts receivable, respectively.



As of July 31, 2004 and 2003, the majority of the Companys long-lived
assets were attributable to its U.S. operations.



20



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##### Table of Contents

ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS



This quarterly report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended,
including statements using terminology such as may, will, expects, plans, anticipates, goals, estimates, potential, or continue, or the
negative thereof or other comparable terminology regarding beliefs, plans, expectations or intentions regarding the future. Forward-looking statements include statements regarding the continuing of revenue recognition practices; estimated future
restructuring payments; expected launch dates and related costs for certain products; attempts to sublease the Fremont, California facility; recovery of test and assembly sector of semiconductor industry and the future outlook of our orders and
sales; anticipation that net sales for the fourth quarter will decrease by approximately 9% to 15% from the third quarter of fiscal 2004; expectations that gross margins will be lower for the foreseeable future; R&D expenses remaining relatively
flat in absolute dollars; investment of significant resources in the development and completion of new products and product enhancements; SG&A expenses remaining relatively flat in absolute dollars; estimated annual amortization expenses;
recordation of full valuation allowance on tax benefits and the recognition of tax benefits; investments in inventory representing a significant portion of working capital; payment to Schlumberger Limited, and discussions with Schlumberger Limited
regarding such payment; belief that current cash and investment positions combined with the ability to borrow funds will be sufficient to meet anticipated business requirements for the next 12 months and in the foreseeable future; the introduction
of new products and product enhancements in the future; intent to pursue additional acquisitions; intent to develop new products that combine NPTests products and intellectual property with ours; intention to focus future investment on the
development of the NPTest Sapphire product rather than our Octet product; significant increases in the ASL and Kalos product line revenues; higher shipment levels of larger production versions of Kalos 2; and assessments of the need for derivatives.
These forward-looking statements involve risks and uncertainties and actual results could differ materially from those discussed in the forward-looking statements. These risks and uncertainties include, but are not limited to, risks relating to
fluctuations in our quarterly net sales and operating results, the costs and anticipated benefits of acquisitions, the integration of NPTest into our organization, customer and employee uncertainty related to the NPTest acquisition, additional
charges for excess and obsolete inventory and impairment of fixed assets relating to the NPTest acquisition, costs of the NPTest acquisition, cyclicality of the semiconductor industry, backlog, delays in development, introduction, production in
volume, and recognition of revenue from sales of our products, limited sources of supply, the importance of timely product introduction, strain on our management, financial, manufacturing and other resources due to fluctuations in our sales and
operations, new products contribution to revenue growth, the highly competitive nature of our industry, the reliance on Spirox Corporation and customers in Taiwan for a significant portion of our revenues, our long and variable sales cycle,
changes to financial accounting standards, our dependence on executive officers and certain key personnel, international sales, proprietary rights, legal proceedings, terrorist attacks and geopolitical instability, the Sarbanes-Oxley Act of 2002,
effects of certain anti-takeover provisions, and those described under the heading Risk Factors as well as risks described immediately prior to or following some forward-looking statements. All forward-looking statements and risk factors
included in this document are made as of the date hereof, based on information available to us as of the date thereof, and we assume no obligation to update any forward-looking statement or risk factors.



OVERVIEW



We design, manufacture, sell and service engineering validation test equipment, diagnostics and failure analysis products
and automatic test equipment, or ATE, used for testing semiconductor integrated circuits, or ICs. We also develop, license and distribute software products that provide automation solutions in the IC design and test flow fields. We serve a broad
spectrum of the semiconductor industrys testing needs through a wide range of products that test digital logic, mixed-signal, system-on-a-chip, radio frequency, volatile, and static and non-volatile memory semiconductors. We utilize our
proprietary technologies to design products which are intended to provide a lower total cost of ownership than many competing products currently available while meeting the increasingly demanding performance requirements of todays engineering
validation test, diagnostics and failure analysis and ATE markets. Our hardware products are designed to test semiconductors at two stages of their lifecycle; first, at the prototype stage, and, second, as they are produced in high volume. Our
software products enable design and test engineers to develop and troubleshoot production test programs prior to fabrication of the device prototype. Collectively, our customers include major semiconductor manufacturers, fabless design houses,
foundries and assembly and test services companies.



Major
business developments during the third quarter of fiscal 2004 include:



| |  | In May 2004, we acquired NPTest Holding Corporation (NPTest), a company that designs, develops and manufactures advanced semiconductor test and diagnostic systems and provides
related services for the semiconductor industry. The addition of NPTest expands our base of customers and enables us to provide customers with a broader portfolio of solutions. In connection with this acquisition, we paid to the former stockholders
of NPTest consideration comprised of cash in the aggregate amount of approximately $230.0 million and the right to approximately 32 million shares of our common stock, including the assumed conversion of 203,036 shares of preferred stock at a
conversion ratio of 100 to 1, with a fair value of approximately $376.5 million. We also assumed all of the outstanding NPTest stock options with a fair value of approximately $38.1 million. We incurred direct costs associated with the acquisition
of approximately $5.9 million. In accordance with Statement of Financial Accounting Standard (SFAS) No. 141, Business Combinations, the acquisition has been accounted for as a purchase transaction, and we have included in our results of
operations, for the three and nine months ended July 31, 2004, the results of NPTest beginning on May 28, 2004. Our quarter ending October 31, 2004 will include a full quarter of results for the combined company.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



21



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##### Table of Contents

| |  | We added over 900 employees across all functions as a result of the acquisition. These employees resulted in higher operating expenses compared to prior periods. In addition, the
acquisition resulted in $101.1 million of intangible assets that will be amortized over the next one to ten years and $10.0 million of deferred stock compensation that will be amortized over the next 39 months.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In the third quarter of 2004, we had special charges for cost of goods sold of $46.2 million, which primarily includes inventory and liabilities related to decisions to discontinue
significant future investments in redundant product lines stemming from the acquisition.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In the third quarter ended July 31, 2004, we had restructuring charges of approximately $3.0 million which consisted of $1.9 million in equipment and liabilities related to our
decision to discontinue significant future investments in redundant product lines, and approximately $1.1 million in severance and related charges.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Stronger sales from our ASL and Kalos product lines.
| | - | ----------------------------------------------------



| |  | We noted increased caution on the part of customers, particularly those based in Asia in the final weeks of July 2004. This caution has resulted in shipment delays and lower order
rates than those experienced in the period ending mid July. We expect net sales in the fourth fiscal quarter of 2004 to be between 9 and 15 percent lower than the net sales recorded in the third fiscal quarter of 2004.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



We believe that most of the major ATE industry participants have not been
consistently profitable for the years 2001 through 2003, indicating a very competitive marketplace mired in a cyclical downturn of unprecedented length and depth. Our revenue remained relatively weak throughout fiscal 2002 and began to grow
sequentially beginning in the second quarter of fiscal 2003. The test and assembly sector of the semiconductor equipment industry appears to be recovering from the severe downturn that began in fiscal 2001. There have been recent sequential
improvements in the business environment; however, there is current evidence that the industry again has slowed and there is uncertainty as to the strength and length of the current growth phase. Until such time as we return to a period of
sustainable profitability and due to continued low visibility, we maintain a cautious outlook for future orders and sales levels.



Our sales, gross margins and operating results have in the past fluctuated significantly and will, in the future, fluctuate significantly depending upon a
variety of factors. The factors that have caused and will continue to cause our results to fluctuate include cyclicality or downturns in the semiconductor market and the markets served by our customers, the timing of new product announcements and
releases by us or our competitors, market acceptance of new products and enhanced versions of our products, manufacturing inefficiencies associated with the start up of new products, changes in pricing by us, our competitors, customers or suppliers,
the ability to volume produce systems and meet customer requirements, excess and obsolete inventory, patterns of capital spending by customers, delays, cancellations or rescheduling of orders due to customer financial difficulties or otherwise,
expenses associated with acquisitions and alliances, our ability to effectively integrate acquisitions, product discounts, product reliability, the proportion of direct sales and sales through third parties, including distributors and original
equipment manufacturers, the mix of products sold, the length of manufacturing and sales cycles, natural disasters, political and economic instability, regulatory changes and outbreaks of hostilities. On May 28, 2004, we completed our acquisition of
NPTest for a purchase price of $650 million consisting of stock, cash, assumption of NPTest stock options, and direct acquisition costs. Our ability to effectively integrate NPTest will affect our future sales, gross margins and operating results.
Due to these and additional factors, historical results and percentage relationships discussed in this Report on Form 10-Q will not necessarily be indicative of the results of operations for any future period. For a further discussion of our
business, and risk factors affecting our results of operations, please refer to the section entitled Risk Factors included elsewhere herein.



CRITICAL ACCOUNTING POLICIES AND ESTIMATES



Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues
and expenses, as well as the disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to bad debts, inventories, investments, residual values, intangible assets, income taxes, warranty
obligations, restructuring, and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We discuss the development and selection of the
critical accounting estimates with the audit committee of our board of directors on a quarterly basis, and the audit committee has received our disclosure related to them in this quarterly report of Form 10-Q.



22



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##### Table of Contents

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



Revenue
Recognition



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



Under the SAB 104 revenue recognition policy, we defer revenue for transactions that involve newly introduced products or when customers specify acceptance criteria that cannot be demonstrated prior to the shipment.
During fiscal 2002 and 2003, we introduced several new systems and products. Certain revenues from sales of these new systems and products during fiscal 2003 and the first nine months of fiscal 2004 have been deferred until the revenue recognition
requirements of our revenue recognition policy are satisfied. This practice will continue in the future with new products. In the past, we experienced significant delays in the introduction and acceptance of new testers as well as certain
enhancements to our existing testers. As a result, some customers have experienced significant delays in receiving and accepting our testers in production. Delays in introducing a product or delays in our ability to obtain customer acceptance, if
they occur in the future, will delay the recognition of revenue and related gross profit by us.



When we are able to separate multiple deliverables from one another, we recognize revenue for each deliverable, based on each deliverables fair
value, when the revenue recognition criteria for that specific deliverable is achieved. In the vast majority of cases, our orders are shipped complete. In rare instances when there are multiple shipments due to materials shortages, revenue and
related cost of sales are recognized only for the items that are physically shipped. If the items not shipped on an order are required for the functionality of the delivered items, revenue and related cost of sales are deferred on the delivered
items and recognized only upon the shipment of the required items. If there are specific customer acceptance criteria, revenue is deferred until the specified performance has been completed in accordance with our revenue recognition policy.
Installation in the majority of the cases occurs within two weeks of shipment. Installation is considered to be inconsequential and perfunctory. The cost of installation can be reliably estimated and is accrued at shipment. In order to comply with
Emerging Issues Task Force Accounting for Revenue Arrangements with Multiple Deliverables, (EITF 00-21), beginning in the fourth quarter of fiscal 2003, revenue related to the total value of installations not completed at the end of the
period was deferred.



Sales in the United States are
principally through our direct sales organization consisting of direct sales employees and representatives. Sales outside the United States utilize both direct sales employees and distributors. There are no significant differences in our revenue
recognition policies based on the sales channel, due to the business practices that we have adopted with our distributor relationships. Because of these business circumstances we do not use price protection, stock rotation,
or similar programs with our distributors. We do not typically sell inventory into our distributors for eventual sale to end-users, but rather we sell product to the distributors on the basis of a purchase order received from an end-user. We
evaluate any revenue recognition issues with respect to the end customer in light of our revenue recognition policy and in accordance with SAB 104.



We sell stand-alone software products and the revenue recognition policies related to these sales fall within the scope of AICPA Statement of Position No.
97-2 (SOP 97-2), Software Revenue Recognition. The stand-alone software products are applications for integrated circuit, or IC, manufacturers and test and assembly contractors to help improve quality and shorten development lead times.
We also have embedded software in our semiconductor manufacturing equipment. We believe this embedded software is incidental to our products and therefore is excluded from the scope of SOP 97-2 since the embedded software in our products is not sold
separately, cannot be used on another vendors products, and we cannot fundamentally enhance or expand the capability of the equipment with new or revised software. In addition, the equipments principal performance characteristics are
governed by digital speed and pin count which are primarily a function of the hardware.



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Accounts Receivable Factoring



During the third fiscal quarter of 2004, we entered into an agreement to sell our trade receivables under non-recourse
transactions. These receivables were not included in our condensed consolidated balance sheet for the third fiscal quarter of 2004 as the criteria for sale treatment established by SFAS 140 had been met. Under SFAS 140, after a transfer of financial
assets, an entity derecognizes financial assets when the control has been surrendered. We believe our factoring agreement meets the criteria of a true sale of these assets since the acquiring party retains the title to these receivables and has
assumed the risk that the receivables will be collectible. The trade receivables were sold at a discount plus administrative and other fees. The discount amount is included in interest expense, while the administrative and other fees are accounted
for in selling, general and administrative expenses in the condensed consolidated statements of operations. The proceeds received are included as cash in the accompanying condensed consolidated balance sheets and as operating activities on the
condensed consolidated statements of cash flows.



Allowance for Doubtful
Accounts



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



Inventory Valuation and Residual Values Related to Leased Products



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



In the third quarter of fiscal 2004, we recorded special charges to cost of
goods sold of $46.2 million. Of this $46.2 million, $41.6 million was directly related to inventory write-downs. These write-downs were related to the acquisition of NPTest which resulted in duplicate product lines. We evaluated the redundant
product lines using internal and external marketing data, the development roadmap for each product line, existing and potential customers and demand for the product. As a result of the evaluation, we identified production inventory, finished goods,
consignment and demo inventory, and field service spares in excess of estimated future customer demand of approximately $ 35.2 million; write-downs to estimated current market value of approximately $6.4 million; purchase commitments of
approximately $1.0 million; field service spares of approximately $0.9 million, and other assets and expenses of approximately $2.7 million.



Due to the dramatic decline in the semiconductor business cycle and corresponding impact on revenue in the period 2001 through 2003 and continued
uncertainty regarding the timing and strength of the recovery in semiconductor equipment sales, we continue to monitor our inventory levels in light of product development changes and expectations of the cyclical period ahead. In the third quarter
of fiscal 2003, we recorded special charges to cost of goods sold of $1.3 million due to a legal settlement on cancelled purchase contracts with an inventory vendor and $0.6 million due to spare part write-offs related to our Valstar product line.
In addition, over the past three years we have recorded a total of $134.1 million in charges for the write-offs of excess and obsolete inventories. We may be required to take additional charges for excess and obsolete inventory if a downturn causes
further reductions to our current inventory valuations or our current product development plans change.



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



Deferred Taxes



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



Our net deferred tax asset
balance as of July 31, 2004 was zero reflecting a full valuation allowance due to uncertainties surrounding our ability to generate future taxable income and our corresponding ability to utilize our deferred tax assets.



Restructuring and Special Charges



In connection with restructuring activities, we have recorded estimated
restructuring charges in our operating expenses for severance and other costs associated with our reduction in workforce of $1.4 million in the first quarter of fiscal 2003, $2.2 million in



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the third quarter of fiscal 2003, and $1.1 million in the third quarter of fiscal 2004. During the third quarter of
fiscal 2004, we also incurred restructuring charges of $1.9 million in equipment and liabilities related to our decision to discontinue significant future investments in redundant product lines stemming from our acquisition of NPTest. Given the
significance of, and the timing of the execution of such activities, this process is complex and involves periodic reassessments of original estimates. We continually evaluate the adequacy of the remaining liabilities under our restructuring
initiatives and other special charges. Although we believe that these estimates accurately reflect the costs of our restructuring and other plans, actual results may differ, thereby requiring us to record additional provisions or reverse a portion
of such provisions.



We recorded cost of sales-special charges
of $1.9 million in the third quarter of fiscal 2003 due to a $1.3 million settlement on cancelled purchase orders reached with an inventory supplier and $0.6 million for spare part write-downs associated with the Valstar product line.



In the third quarter of 2004, we recorded cost of sales  special
charges of $46.2 million. Of this amount, $4.6 million was related to vendors liabilities, spare part write-downs, long-lived assets write-off, the scrapping of existing work orders, and workforce reduction. The remaining balance related to
inventory write-downs as discussed above.



Long-Lived Assets



We evaluate the carrying value of our long-lived assets, consisting
primarily of goodwill and identifiable intangible assets, and property, plant and equipment, whenever certain events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Such events or circumstances
include, but are not limited to, a prolonged industry downturn, a significant decline in our market value, or significant reductions in projected future cash flows. In assessing the recoverability of our long-lived assets, we compare the carrying
value to the undiscounted future cash flows the assets are expected to generate. If the total of the undiscounted future cash flows is less than the carrying amount of the assets, we write down such assets based on the excess of the carrying amount
over the fair value of the assets. Fair value is generally determined by calculating the discounted future cash flows using a discount rate based upon our weighted average cost of capital. Significant judgments and assumptions are required in the
forecast of future operating results used in the preparation of the estimated future cash flows, including profit margins, long-term forecasts of the amounts and timing of overall market growth and our percentage of that market, groupings of assets,
discount rates and terminal growth rates. In addition, significant estimates and assumptions are required in the determination of the fair value of our tangible long-lived assets, including replacement cost, economic obsolescence, and the value that
could be realized in an orderly liquidation. Changes in these estimates could have a material adverse effect on the assessment of our long-lived assets, thereby requiring us to write down the assets.



During the third quarter of 2004, we recorded an impairment charge of $1.8
million for long-lived assets related to our Octet and Quartet product lines. This impairment charge was related to our decision to discontinue significant future investment in redundant product lines stemming from the acquisition of NPTest.



Warranty Accrual



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



RESULTS OF OPERATIONS



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



|                                                                    |  |                             |    |  |                            |    |  |       |    |  |       |   
|------------------------------------------------------------------- |  | --------------------------- | -- |  | -------------------------- | -- |  | ----- | -- |  | ----- | --
|                                                                    |  | Three Months Ended July 31, |    |  | Nine Months Ended July 31, |   
|                                                                    |  | 2004                        |    |  | 2003                       |    |  | 2004  |    |  | 2003  |   
|Net sales                                                           |  | 100.0                       | %  |  | 100.0                      | %  |  | 100.0 | %  |  | 100.0 | % 
|Cost of goods sold  on net sales                                   |  | 52.2                        |    |  | 62.9                       |    |  | 51.2  |    |  | 64.1  |   
|Cost of goods sold  special charges                                |  | 28.2                        |    |  | 4.3                        |    |  | 14.1  |    |  | 1.6   |   
|                                                                    |  |                             |    |  |                            |    |  |       |    |  |       |   
|Gross margin                                                        |  | 19.6                        |    |  | 32.8                       |    |  | 34.7  |    |  | 34.3  |   
|Operating expenses                                                  |  |                             |    |  |                            |    |  |       |    |  |       |   
|Research and development                                            |  | 14.6                        |    |  | 38.5                       |    |  | 16.8  |    |  | 45.5  |   
|Selling, general and administrative                                 |  | 22.6                        |    |  | 53.5                       |    |  | 26.8  |    |  | 54.3  |   
|Amortization of purchased intangible assets & deferred compensation |  | 3.3                         |    |  | 5.8                        |    |  | 3.2   |    |  | 5.5   |   
|Restructure charges including IPR&D                                 |  | 6.6                         |    |  | 4.8                        |    |  | 3.5   |    |  | 4.1   |   
|                                                                    |  |                             |    |  |                            |    |  |       |    |  |       |   
|Total operating expenses                                            |  | 47.1                        |    |  | 102.6                      |    |  | 50.3  |    |  | 109.4 |   
|                                                                    |  |                             |    |  |                            |    |  |       |    |  |       |   
|Operating loss                                                      |  | (27.5                       | )  |  | (69.8                      | )  |  | (15.6 | )  |  | (75.1 | ) 
|                                                                    |  |                             |    |  |                            |    |  |       |    |  |       |   
|Interest and other income, net                                      |  | 8.2                         |    |  | 0.8                        |    |  | 4.5   |    |  | 2.5   |   
|                                                                    |  |                             |    |  |                            |    |  |       |    |  |       |   
|Loss before income tax provision                                    |  | (19.3                       | )  |  | (69.0                      | )  |  | (11.1 | )  |  | (72.6 | ) 
|Income tax                                                          |  | 0.9                         |    |  | 0.5                        |    |  | 1.2   |    |  | 0.4   |   
|Minority interest                                                   |  | 0.0                         |    |  | 0.3                        |    |  | 0.0   |    |  | 0.0   |   
|                                                                    |  |                             |    |  |                            |    |  |       |    |  |       |   
|Net loss                                                            |  | (20.2                       | )% |  | (69.8                      | )% |  | (12.3 | )% |  | (73.0 | )%
|                                                                    |  |                             |    |  |                            |    |  |       |    |  |       |   



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Net sales consist of revenues from systems sales, spare part sales, maintenance contracts, lease and
rental income and software sales. Net sales were $163.7 million for the third quarter of fiscal 2004, representing an increase of approximately 260% from net sales of $45.5 million in the comparable period for fiscal 2003. Net sales increased
approximately 72% from $95.1 million in the second quarter of fiscal 2004. Net sales increased $202.3 million, or 162%, to $327.0 million for the nine months ended July 31, 2004 from $124.6 million for the nine months ended July 31, 2003. These
improvements in net sales were due primarily to a general upturn in the industry and due to our purchase of NPTest in the third quarter of fiscal 2004. In particular, revenue from our digital and mixed signal products increased from $25.7 million
during the third quarter of fiscal 2003 to $78.4 million during the same period of 2004. Revenue from our memory product increased from $6.7 million during the third quarter of fiscal 2003 to $51.3 million during the same period of 2004. Also our
service revenue increased from $9.7 million to $31.1 million during the third quarter of 2003 and 2004, respectively. For the nine months ended July 31, 2004 and 2003, revenue from our digital and mixed signal products were $177.3 million and $66.9
million, respectively. Revenue from our memory product increased from $15.3 million during the first nine months of fiscal 2003 to $79.8 million during the same period of 2004. Also our service revenue increased from $31.1 million to $54.9 million
during the first nine months of 2003 and 2004, respectively. The acquisition of NPTest brought an additional $23.8 million of digital and mixed signal revenues, $0.5 million of diagnostic system revenues, and $19.1 million of service revenues.
Sustainability of these revenue levels is dependent upon the economic and geopolitical climate, as well as other risks described under the heading Risk Factors herein. We anticipate that net sales for the fourth quarter will decrease by
approximately 9% to 15% from the third quarter of fiscal year 2004.



International net sales accounted for approximately 79% of total net sales in the third quarter of fiscal 2004 compared with 60% in the third quarter of fiscal 2003. During the third quarter of fiscal 2004, NPTest international net sales
were 16% of total net sales. International net sales accounted for approximately 75% and 62% of total net sales in the first nine months of fiscal 2004 and 2003, respectively. Our net sales to the Asia Pacific region accounted for approximately 56%
and 42% of total net sales in the first nine months of fiscal 2004 and 2003, respectively, and thus are subject to the risk of economic instability in that region that may materially adversely affect the demand for our products. Capital markets in
Korea and other areas of Asia have been historically highly volatile, resulting in economic instabilities. These instabilities may recur which could materially adversely affect demand for our products. In addition, the economic impact of
geopolitical instabilities on the Korean peninsula as well as a recurrence of the Severe Acute Respiratory Syndrome or other health risks in the Asian region may affect future orders to this region and the timing of or payment for shipments made to
this region.



Our net sales by product line in the first three
and nine months of fiscal 2004 and 2003 consisted of:



|                           |  |                             |   |  |                            |   |  |      |   |  |      |  
|-------------------------- |  | --------------------------- | - |  | -------------------------- | - |  | ---- | - |  | ---- | -
|                           |  | Three Months Ended July 31, |   |  | Nine Months Ended July 31, |  
|                           |  | 2004                        |   |  | 2003                       |   |  | 2004 |   |  | 2003 |  
|Digital and Mixed-Signal   |  | 48                          | % |  | 57                         | % |  | 54   | % |  | 54   | %
|Memory                     |  | 31                          |   |  | 15                         |   |  | 24   |   |  | 12   |  
|Service                    |  | 19                          |   |  | 21                         |   |  | 17   |   |  | 25   |  
|Diagnostic Systems         |  | 1                           |   |  |                           |   |  | 4    |   |  | 3    |  
|Software, Leases and Other |  | 1                           |   |  | 7                          |   |  | 1    |   |  | 6    |  
|                           |  |                             |   |  |                            |   |  |      |   |  |      |  
|Total                      |  | 100                         | % |  | 100                        | % |  | 100  | % |  | 100  | %
|                           |  |                             |   |  |                            |   |  |      |   |  |      |  



Revenues from software
were not material to our operations in the first three and nine months of fiscal years 2004 and 2003, representing less than 4% of our net sales in each period.



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Gross Margin



Our gross margin has been and will continue to be affected by a variety of factors, including manufacturing efficiencies, excess and obsolete inventory
write downs, sell through of previously written down inventory, pricing by competitors or suppliers, new product introductions, product sales mix, production volume, customization and reconfiguration of systems, international and domestic sales mix,
special charges, and field service margins. Our gross margin was 20% and 35% for the three and nine-month periods ended July 31, 2004, respectively. For the comparable periods ended July 31, 2003 the gross margins were 33% and 34% respectively. The
decrease in gross margins was primarily due to special charges in cost of sales of $46.2 million in the three and nine months ended July 31, 2004, compared to $1.9 million in the three and nine months ended July 31, 2003. These charges in three and
nine months ended July 31, 2004 consisted primarily of excess and obsolete inventory and other charges related to our decision to discontinue significant future investment in our redundant product lines stemming from the acquisition of NPTest. Of
the $46.2 million, $41.6 million was directly related to inventory write-downs. The remaining $4.6 million related to vendors liabilities, spare part write-downs, long-lived assets write-off, the scrapping of existing work orders, and
workforce reduction. In addition, during the three and nine month periods ended July 31, 2004, our gross margin benefited by $1.7 million and $2.2 million, respectively, from the sale of fully reserved inventory. Our gross margin also benefited from
the sale of our Kalos ASIC devices previously written-down for a lower of cost or market provision in the amount of $1.7 million and $2.6 million for the three and nine month periods ended July 31, 2004. Excluding the effect of the special charges,
we expect gross margins to be lower for the foreseeable future primarily due to a mix of lower gross margin products as well as lower manufacturing efficiencies resulting from lower business levels.



Research and Development



Research and development, or R&D, expenses were $23.9 million in the
three months ended July 31, 2004, compared to $17.5 million for the same period in the prior fiscal year, an increase of 36%. R&D expenses were $54.9 million in the first nine months of fiscal 2004, compared to $56.8 million from the same period
of fiscal 2003, a decrease of 3%. The increase in spending during the third quarter of 2004 resulted primarily from the acquisition of NPTest, which brought an additional $6.6 million of expenses. As a percentage of net sales, R&D expenses were
15% and 17% for the three and nine months ending July 31, 2004, respectively, compared to 39% and 46% for the same periods in fiscal 2003, respectively. The decrease in R&D expenses as a percentage of net sales is primarily attributable to the
higher sales levels during the three and nine months of 2004 as compared with the same periods in fiscal 2003. We currently intend to continue to invest significant resources in the development and completion of new products and product
enhancements. Accordingly, we anticipate that R&D expenses will remain relatively flat in absolute dollars for the rest of the fiscal year as compared to the third quarter of 2004.



Selling, General and Administrative



Selling, general and administrative, or SG&A, expenses were $37.0 million in the three months ended July 31, 2004, compared to $24.3 million for the
same period in the prior fiscal year, an increase of 52%. SG&A expenses were $87.6 million in the first nine months of fiscal 2004, compared to $67.7 million for the same period in the prior fiscal year, an increase of 29%. The increase is
primarily due to the addition of NPTest, which brought an additional $7.6 million of expenses to the quarter and year-to-date. For the nine month period ended July 31, 2004 there was an increase in variable compensation of $4.0 million related to
our overall increase in net sales and profitability. In addition, in the current third quarter of fiscal 2004, we recorded approximately $1.8 million of expenses for costs associated with the integration of NPTest which primarily include acquisition
consulting fees related to workforce and product line decisions. As a percentage of net sales, SG&A expenses were 23% and 27% for the three and nine months ending July 31, 2004, respectively, compared with 54% and 54% for the same periods in
fiscal 2003, respectively. We expect SG&A expenses for the remainder of fiscal 2004 to remain relatively flat in absolute dollars as compared to the third quarter of 2004.



Amortization of Purchased Intangible Assets



Amortization of purchased intangible assets and deferred compensation expenses were $5.3 million for the three months ended July 31, 2004, compared to
$2.6 million for the same period of the prior fiscal year. Amortization of purchased intangible assets and deferred compensation expenses were $10.6 million for the nine months of fiscal 2004, compared to $6.8 million for the same period in the
prior fiscal year, an increase of 55%. Amortization of purchased intangible assets was higher in the third quarter of fiscal 2004 due primarily to the acquisition of NPTest in May 2004. The amortization of intangible assets associated with NPTest
and deferred compensation are expected to be approximate $6.8 million in the fourth quarter of fiscal 2004. Remaining estimated annual amortization expense for purchased intangible assets and deferred compensation is expected to be $24.2 million,
$19.9 million, and $19.7 million, for the fiscal years ending in 2005 through 2007, respectively. As of November 1, 2002 we adopted Statements of Financial Accounting Standards No. 142 (SFAS 142), Goodwill and Other Intangible Assets.
Under SFAS 142, goodwill and indefinite lived intangible assets are no longer amortized, but are reviewed annually (or more frequently if impairment indicators arise) for impairment.



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Restructuring Charges and In-process Research and Development



In the third quarter of fiscal 2004, we recorded operating expense
restructuring charges of approximately $3.0 million of which $1.9 million was related to equipment write-offs and liabilities incurred due to our decision to discontinue significant future investments in redundant product lines stemming from our
acquisition of NPTest and $1.1 million was related to severance and related charges. Approximately 60 employees were affected with 56 employees being in the United States. In addition, in the third quarter of fiscal 2004, we recorded a charge of
$7.9 million for the write-off of in-process research and development resulting from the acquisition of NPTest.



In January 2004, we relocated our corporate headquarters to our owned facilities in Milpitas, California and vacated our previously leased buildings in
Fremont, California. The lease for three of the buildings expired at the end of December 2003. We will attempt to sublease the final building, consisting of 27,000 square feet. This lease expires in June 2005. During the quarter ended January 31,
2004, we recorded a restructuring charge in the amount of $0.7 million to write-off the remaining lease payments for this lease, net of expected sublease income for a lease in Austin, Texas.



For the quarter ended July 31, 2003, we recorded restructuring charges of
approximately $2.2 million as operating expenses related to headcount reductions. The reduction in force included the elimination of approximately 163 positions or 15 percent of the Companys worldwide employee base. Approximately 151 positions
in the United States were affected, with the remaining reduction in other locations.



In the first quarter of fiscal 2003, we recorded restructuring charges of approximately $1.4 million for severance charges, and a lease write-off that was included in operating expenses. These charges were associated
with headcount reductions and the completion of the consolidation of our IMS facility in Beaverton, Oregon into our Hillsboro, Oregon site. During the first quarter of fiscal 2003, we reduced our headcount by approximately 70 persons. The bulk of
the affected employees were in SG&A and a smaller number were in R&D.



In addition, we also recorded a charge of $1.5 million in the first quarter of fiscal 2003 for the write-off of in-process research and development resulting from the purchase of Optonics. The charge was recorded as
an operating expense.



Interest and Other Income, Net



We generated net interest and other income of $13.4 million and $15.0
million for the first three and nine months of fiscal 2004, respectively, as compared to $0.4 million and $3.1 million for the same periods of fiscal 2003, respectively. The increase in net interest and other income in fiscal 2004 was primarily due
to the mark down to fair value of an acquired liability owed to the former parent of NPTest from $29.5 million to $15.2 million. The current value of the liability is based on our stock price as of the end of the current quarter (see Note 6 in the
notes to condensed consolidated financial statements for description of the acquired contingent liability).



Income Taxes



We
recorded an income tax provision of $1.5 million and $3.9 million for the three and nine months ending July 31, 2004, respectively, as compared to $0.2 million and $0.4 million, respectively, for the same periods of fiscal 2003. NPTest acquisition
gave rise to income tax expense of approximately $0.5 million. The income tax expense in 2004 consists of foreign tax on earnings and foreign withholding taxes generated from our foreign operations.



We expect to record a full valuation allowance on domestic tax benefits until
we can sustain an appropriate level of profitability. Until such time, we would not expect to recognize any significant tax benefits in our results of operations.



LIQUIDITY AND CAPITAL RESOURCES



Net cash used in operating activities during the nine months ended July 31, 2004 were $8.6 million. Net cash used reflects a net loss of $40.4 million,
depreciation and amortization of $39.6 million, non-cash cost of goods sold - special charges and restructuring charges of $43.9 million, provision for inventory of $6.1 million, in-process research and development of $7.9 million, and a decrease in
working capital of $64.0 million. Key movements within working capital include increase in accounts receivable of $67.4 million, inventory of $44.1 million, accounts payable of $22.2 million and accrued expenses and other current liabilities of
$24.6 million. Working capital increased primarily due to the net assets acquired in the NPTest acquisition as well as the significant increases in inventories and accounts receivable associated with increased business volumes, offset partially by
improved profitability.



Net cash provided by investing
activities was $101.3 million in the nine months ended July 31, 2004 resulting primarily from net sales of available-for-sale securities of $277.3 million, offset by $159.9 million of net cash used to purchase NPTest, $3.5 million used to purchase a
facility in Germany, and $8.4 million of cash used for the structural and tenant improvements for our new Milpitas headquarters and other property, plant and equipment to support our business.



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Net cash provided by financing activities was $8.5 million for the nine months ended July 31, 2004. This
was primarily attributable to $11.5 million received from the issuance of common stock relating to our employee equity plans which was offset in part by payments of bank loans and notes payable related to leased products of $2.8 million.



As of July 31, 2004, we had working capital of approximately $301.5
million, including cash and short-term investments of $160.4 million, and accounts receivable and inventories totaling $306.5 million. We believe that because of the relatively long manufacturing cycles of many of our testers and the new products we
have and plan to continue to introduce, investments in inventories will also continue to represent a significant portion of our working capital. The semiconductor industry has historically been highly cyclical and has experienced downturns, which
have had a material adverse effect on the semiconductor industrys demand for automatic test equipment, including equipment manufactured and marketed by us. In addition, the automatic test equipment industry is highly competitive and subject to
rapid technological change. It is reasonably possible that events related to the above factors may occur in the near term which would cause a change to our estimate of the net realizable value of receivables, inventories or other assets, and the
adequacy of accrued liabilities. See discussion of Critical Accounting Policies and Estimates above.



In May 2004, we acquired NPTest for a total cash payment to the former stockholders of NPTest of approximately $230.0 million and the right of
approximately 32 million shares of our common stock, including the assumed conversion of 203,036 shares of preferred stock at a conversion ratio of 100 to 1, with a fair value of approximately $376.5 million. The common stock issued in the
acquisition was valued using the average closing price of our common stock over a five-day trading period beginning two days before and ending two days after the date the transaction was announced. We also assumed all of the outstanding NPTest stock
options with a fair value of approximately $38.1 million. The options were valued using the Black-Scholes option pricing model with the following assumptions: volatility of 0.77, expected life of 6.35 years, risk-free interest rate of 3.45% and a
market value of our common stock of $11.77 per share, which was determined as described above. We also incurred direct costs associated with the acquisition of approximately $5.9 million.



As a result of the NPTest acquisition, we may be required to make a payment to Schlumberger Limited (Schlumberger) at a date
in the future pursuant to a provision in the acquisition agreement between NPTest and Schlumberger under which NPTest was acquired by Francisco Partners, L.P. from Schlumberger. The future payment date may be triggered by various events, including
certain distributions by NPTest Holding, LLC to its members, or at Schlumbergers option, it can be triggered on December 16, 2004 or on May 28, 2005. The payment amount is contingent upon the value of our common stock at the time of
distribution. If triggered by Schlumbergers option, we may generally settle this payment in cash or stock. As of July 31, 2004, this obligation was approximately $15.2 million. If payment is triggered at Schlumbergers option, we may
generally settle this payment in cash or stock. If payment is triggered by a distribution by NPTest Holding, LLC to its members, the payment to Schlumberger is required to be in the same form and may have to be made in cash, stock or both. We may
engage in discussions with Schlumberger with regard to this payment, such discussions may include acceleration of the payment and the payment of the obligation in the form of cash or stock.



During the third quarter of 2004, we entered into an agreement to sell our
trade receivables under non-recourse transactions. We can sell up to $30 million of our trade receivables at any one time. We were retained by the bank to service the collection aspect of the trade receivables sold. The trade receivables are sold at
a discount plus administrative and other fees. The discount amount is included in interest expense, while the administrative and other fees are accounted for in selling, general and administrative expenses in the condensed consolidated statements of
operations. In the third quarter of 2004, interest expense amounted to approximately $82,000, and administrative and other fees were approximately $52,000. Sales of trade receivables are reflected as a reduction of accounts receivable in the
accompanying condensed consolidated balance sheets. The proceeds received are included as cash in the accompanying condensed consolidated balance sheets and as operating activities on the condensed consolidated statements of cash flows. During the
third quarter of 2004, we recorded approximately $16.8 million in gross proceeds from the sale of trade receivables.



We lease our facilities and equipment under operating leases that expire periodically through 2010. Approximately $0.7 million of related lease
obligations, net of expected sublease income, have been written-off to special operating charges this fiscal year. In addition to the lease commitments, at July 31, 2004, we have open and committed purchase orders totaling approximately $103.6
million.



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The following summarizes our minimum contractual cash obligations and other commitments at July 31, 2004,
and the effect of such obligations in future periods (in thousands):



|                                                                                            |  |       |         |                        |   |             |  |             |        |             |   |             |  |             |       |            |   |         |  |   |       |  |   |      
|------------------------------------------------------------------------------------------- |  | ----- | ------- | ---------------------- | - | ----------- |  | ----------- | ------ | ----------- | - | ----------- |  | ----------- | ----- | ---------- | - | ------- |  | - | ----- |  | - | -----
|                                                                                            |  | Total |         | Remainderof Fiscal2004 |   | Fiscal 2005 |  | Fiscal 2006 |        | Fiscal 2007 |   | Fiscal 2008 |  | Fiscal 2009 |       | Thereafter
|Contractual Obligations:                                                                    |  |       |         |                        |   |             |  |             |        |             |   |             |  |             |       |            |   |         |  |   |       |  |   |      
|Facilities and equipment operating leases                                                   |  | $     | 31,900  |                        | $ | 2,024       |  | $           | 7,602  |             | $ | 6,180       |  | $           | 5,331 |            | $ | 4,834   |  | $ | 4,793 |  | $ | 1,136
|Bank loans and notes payable related to leased products                                     |  |       | 6,426   |                        |   | 368         |  |             | 6,058  |             |   |            |  |             |      |            |   |        |  |   |      |  |   |     
|Interest on liabilities related to leased products                                          |  |       | 320     |                        |   | 82          |  |             | 220    |             |   | 18          |  |             |      |            |   |        |  |   |      |  |   |     
|Convertible subordinated notes                                                              |  |       | 180,000 |                        |   |            |  |             |       |             |   |            |  |             |      |            |   | 180,000 |  |   |      |  |   |     
|Interest on convertible subordinated notes                                                  |  |       | 10,238  |                        |   | 675         |  |             | 2,700  |             |   | 2,700       |  |             | 2,700 |            |   | 1,463   |  |   |      |  |   |     
|Minimum payable for information technology outsourcing including fees for early termination |  |       | 11,008  |                        |   | 1,696       |  |             | 9,312  |             |   |            |  |             |      |            |   |        |  |   |      |  |   |     
|Contingent liability Schlumberger (NPTests former parent company)(1)                       |  |       | 15,200  |                        |   |            |  |             | 15,200 |             |   |            |  |             |      |            |   |        |  |   |      |  |   |     
|Open and non-cancelable purchase order commitments                                          |  |       | 103,555 |                        |   | 103,555     |  |             |       |             |   |            |  |             |      |            |   |        |  |   |      |  |   |     
|                                                                                            |  |       |         |                        |   |             |  |             |        |             |   |             |  |             |       |            |   |         |  |   |       |  |   |      
|Total contractual cash and other obligations                                                |  | $     | 358,647 |                        | $ | 108,400     |  | $           | 41,092 |             | $ | 8,898       |  | $           | 8,031 |            | $ | 186,297 |  | $ | 4,793 |  | $ | 1,136
|                                                                                            |  |       |         |                        |   |             |  |             |        |             |   |             |  |             |       |            |   |         |  |   |       |  |   |      

---

|(1) | We assumed that the contingent liability will be triggered and settled in fiscal year 2005.
|--- | -------------------------------------------------------------------------------------------



For the quarter
ended July 31, 2004, we reduced headcount by approximately 60 positions or 3% percent of the combined global employee base primarily in response to redundancies identified from the acquisition of NPTest. The impact of these headcount reductions were
reflected in restructuring charges in operating expenses of $1.1 million, of which the majority was paid in cash during the quarter. Also in the third quarter of fiscal 2004, we recorded additional special charges in cost of sales of approximately
$1.9 million related to equipment write-offs and liabilities assumed associated with the decision to discontinue significant future investments in redundant product lines stemming from the acquisition of NPTest.



Net transfers of inventory to property, plant and equipment were $1.3 million
for the first nine months ended July 31, 2004. We capitalize a small number of finished systems into the manufacturing function for use in de-bug, quality control, and software development as well as the sales function for use in demonstrations and
application development. When capitalized finished goods are sold to third parties, the transaction is recorded as a sale of a fixed asset.



The open and non-cancelable purchase order commitments are primarily for inventory purchases being made to support the anticipated revenues for the
upcoming quarters of fiscal 2004 and 2005.



Our principal
sources of liquidity as of July 31, 2004 consisted of approximately $129.2 million of cash and cash equivalents, and short-term investments of $31.3 million. In addition, we had $16.9 million of available-for-sale securities, classified as long-term
investments at July 31, 2004.



We believe our current cash and
investment positions will be sufficient to meet our anticipated business requirements for the next 12 months and in the foreseeable future, including potential acquisitions or strategic investments, capital expenditures, and working capital
requirements.



RECENT ACCOUNTING PRONOUNCEMENTS



In January 2003, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities. FIN 46 addresses consolidation by business enterprises of variable interest entities. Under that interpretation, certain entities known as Variable Interest
Entities (VIEs) must be consolidated by the primary beneficiary of the entity. The primary beneficiary is generally defined as having the majority of the risks or rewards arising from the VIE. For VIEs in which a significant (but not majority)
variable interest is held, certain disclosures are required. We have not entered into any arrangements or made any investments which qualify as a VIE after January 31, 2003 and therefore the initial implementation of FIN 46 had no impact on our
financial statements. For VIEs acquired before February 1, 2003, FIN 46 required us to apply the accounting and disclosure rules in the first quarter of fiscal 2004. This requirement was superseded by issuance of a revision to Interpretation No. 46,
as noted below.



In December 2003, the FASB issued revision to
Interpretation No. 46 (FIN 46R) which replaced FIN 46. The revised interpretation further refines the definition of VIEs and provides guidelines on identifying them and assessing an enterprises interests in a VIE to decide whether to
consolidate that entity. FIN 46R applies at different dates to different types of enterprises and entities, and special provisions apply to enterprises that have fully or partially applied FIN 46 prior to issuance of FIN 46R. Generally,



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application of FIN 46R is required in financial statements of public entities that have interests in VIEs or potential
VIEs commonly referred to as special-purpose entities for periods ending after December 15, 2003. Application by public entities for all other types of entities is required in financial statements for periods ending after March 15, 2004. The
adoption of FIN 46R did not have a material impact on our results of operations or financial condition.



On December 17, 2003, the Staff of the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 104 (SAB 104), Revenue
Recognition, which supersedes Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements (SAB 101). SAB 104s primary purpose is to rescind the accounting guidance contained in SAB 101 related to
multiple-element revenue arrangements that was superseded as a result of the issuance of EITF 00-21, Accounting for Revenue Arrangements with Multiple Deliverables. Additionally, SAB 104 rescinds the SECs related Revenue Recognition in
Financial Statements Frequently Asked Questions and Answers issued with SAB 101 that had been codified in SEC Topic 13, Revenue Recognition. While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition
principles of SAB 101 remain largely unchanged by the issuance of SAB 104, which was effective upon issuance. The adoption of SAB 104 did not have a material effect on our financial position or results of operations.



In March 2004, the Task Force reached a consensus on Issue No. 03-1 (EITF
03-1), The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. EITF 03-1 provides guidance for determining when an investment is other-than-temporarily impaired and disclosure requirement about those
impairments. EITF 03-1 is effective for fiscal year ending after December 31, 2003. The adoption of EITF 03-1 did not have any impact on our financial position or results of operations.



RISK FACTORS



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



LOGO



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:



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



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



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



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



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



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



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



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



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



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



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



| |  | difficulties integrating NPTest into our organization;
| | - | ------------------------------------------------------



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



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



| |  | natural disasters, political and economic instability, currency fluctuations, regulatory changes and outbreaks of hostilities and of Severe Acute Respiratory Syndrome, or SARS,
especially in Asia.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



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



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



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



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



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



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



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



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



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| |  | the possible sale of inventory previously written-off;
| | - | ------------------------------------------------------



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



| |  | facility relocations and closures; and
| | - | --------------------------------------



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



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 inventory write-offs, product warranty costs, and deferred revenue, we cannot be certain that our estimates will be adequate.



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



When 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 large part through mergers and acquisitions of other
companies and businesses. We intend in the future to pursue additional acquisitions of product lines, technologies and businesses. We may utilize cash or we may continue to issue debt or equity securities to pay for future acquisitions, which may 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 affected 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 domestic and international operations, personnel, research and development, technologies, sales channels, manufacturing, products and corporate
information technology and administrative infrastructure of the acquired companies;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | demonstrating to customers and distributors that the transaction will not result in adverse changes in client service standards or business focus and helping customers conduct
business easily;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | diversion of our managements attention from other business concerns;
| | - | ---------------------------------------------------------------------



| |  | increased complexity and costs associated with international and domestic internal management structures;
| | - | ---------------------------------------------------------------------------------------------------------



| |  | risks of entering markets in which we have no or limited experience; and
| | - | ------------------------------------------------------------------------



| |  | the potential loss of key employees or key distributing, marketing, customer and other business relationships of the acquired companies.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------



On May 28, 2004, we consummated the purchase of NPTest. The size and scope of
this transaction with NPTest increases both the scope and consequence of these ongoing integration risks. Even if the acquisition is successfully integrated, we may not receive all of the expected benefits of the transaction.



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



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If we are not successful in integrating NPTest into our organization, the anticipated benefits of the merger may not
be realized.



Achieving the anticipated benefits of the
merger will depend, in part, on the integration of technology, operations and personnel of Credence and NPTest. We cannot assure you that the integration will be successful or that the anticipated benefits of the merger will be fully realized. The
challenges involved in this integration include the following:



| |  | satisfying the needs of the combined companys customers in a timely and efficient manner;
| | - | ------------------------------------------------------------------------------------------



| |  | persuading the employees that our business culture is compatible with NPTests business culture and retaining the combined companys key personnel;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------



| |  | maintaining the dedication of the combined companys management resources to integration activities without diverting attention from the day-to-day business of the combined
company;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | maintaining the combined companys managements ability to focus on anticipating, responding to or utilizing changing technologies in the IC test equipment industry;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | maintaining NPTests key supplier relationships; and
| | - | ----------------------------------------------------



| |  | introduction by competitors of new, disruptive technologies to the marketplace which reduce NPTests market share prior to the successful integration of the two companies.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In addition, after the transaction, we intend to
develop new products that combine NPTests products and intellectual property with our products and intellectual property. This may result in longer product development cycles, which may cause the revenue and operating income of our businesses
to fluctuate and fail to meet expectations. To date, we have not completed our investigation into the challenges (technological, market-driven or otherwise) of developing and marketing these new products. There can be no assurance that we will be
able to overcome these challenges, or that a market for such new products will develop after the merger.



It is not certain that we can successfully integrate NPTest in a timely manner or at all or that any of the anticipated benefits will be realized. In
addition, we cannot assure you that there will not be substantial unanticipated costs associated with the integration process, that integration activities will not result in a decrease in revenues, a decrease in the value of our common stock, or
that there will not be other material adverse effects from our integration efforts.



If we are unable to successfully integrate NPTest, or if the benefits of the merger do not meet the expectations of financial or industry analysts, the market price of our common stock may decline.



Customer and employee uncertainty related to the NPTest acquisition could harm us.



In response to the announcement of the merger, some of
our customers may and some of our customers have delayed or deferred purchasing decisions. Some of our and NPTests products may have similar qualities. Any delay or deferral in purchasing decisions by our or NPTests customers could
seriously harm the business of the combined company. Similarly, our employees may experience uncertainty about their future role with the combined company until or after strategies with regard to the combined company are announced or executed. This
may adversely affect the combined companys ability to attract and retain key management, marketing, sales, customer support and technical personnel, which could harm the combined company.



As a result of our acquisition of NPTest, we may be required to take additional charges
for excess and obsolete inventory and impairment of fixed assets.



Under our inventory valuation policy, we review excess and obsolete inventory on a quarterly basis for significant events that might have an impact on inventory valuations. We believe the decisions regarding future product development
stemming from the NPTest acquisition are a significant event and thus we evaluated the current inventory valuations of our products to determine if the inventory values have been impaired. The primary area of market segment overlap is in the
higher-end system-on-a-chip marketplace where we have chosen to focus future investment on the development of the NPTest Sapphire product rather than our Octet product. The review and evaluation resulted in a special charge of $46.2 million in the
third quarter of 2004. Of this amount, $41.6 million was directly related to inventory write-downs. The remaining $4.6 million related to vendors liabilities, spare part write-downs, long-lived assets write-off, the scrapping of existing work
orders, and workforce reductions. We may be required to take additional charges for excess and obsolete inventory and impairment of fixed assets as a result of this integration in the future.



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Credence and NPTest expect to incur significant costs associated with the merger.



To date, the combined company has incurred approximately $5.9 million in
direct costs associated with the merger which will be capitalized as part of the overall purchase price. In addition, in the third quarter of 2004, we recorded a charge of $7.9 million for the write off of in-process research and development and
incurred $3.0 million of restructuring charges resulting from the purchase of NPTest. We believe the combined entity may incur additional charges to operations, which are not reasonably capable of estimation at this time. There is no assurance that
the combined company will not incur additional material charges in subsequent quarters to reflect additional costs associated with the merger.



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



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



The semiconductor industry has been cyclical.



Our revenue growth has been materially adversely affected by the cyclical
downturn in the semiconductor industry and its resulting impact upon the semiconductor equipment sector. Although the test and assembly sector of the semiconductor equipment industry has been recovering from a severe downturn, there is current
evidence of a slowing in the business and uncertainty as to the strength and length of the current cyclical phase. The downturn contributed to weakened order activity, order cancellation activity, and customer-requested shipment delays from our
backlog. Until such time as we return to a sustained growth period, we expect a continuing volatility in order activity. Though revenue levels have improved throughout fiscal 2004, we expect that our net revenues will decline in the fourth quarter
of fiscal 2004 and may decline thereafter due to the uncertainty of a sustainable recovery in the semiconductor and related capital equipment industry. As a result of the cyclical downturn, in fiscal 2001 we reduced our worldwide workforce by
approximately 23%, or more than 400 people. In fiscal 2002, we reduced our worldwide workforce by 21%, or about 225 people. Throughout fiscal 2003, we reduced our worldwide workforce by 233 people, excluding the effect of the acquisitions for a
total of 20% over the 2003 fiscal year. To date, in fiscal 2004, we reduced our workforce by approximately 60 people, primarily located in the U.S. We took charges related to these reductions in force of $3.2 million throughout fiscal 2001, $5.7
million during fiscal 2002, $3.4 million during fiscal 2003 and $1.1 million to date in fiscal 2004. Additionally, remaining employees were required to take time off during certain periods throughout fiscal 2001-2004. Other initiatives during fiscal
years 2001  2003 included a temporary domestic and European pay cut during 2001 and 2002, a domestic salary realignment in 2003, a four-day work week for most manufacturing and some operating employees, the consolidation and reorganization of
certain functions and operations, and the curtailment of discretionary expenses. If we continue to reduce our workforce or adopt additional cost-saving measures, it may adversely impact our ability to respond rapidly to any renewed growth
opportunities in the future should they occur.



As a result of
the rapid and steep decline in revenue during the latest downturn, we continue to monitor our inventory levels in light of product development changes and a possible eventual upturn. We recorded a charge of $9.4 million in the fourth fiscal quarter
of 2002 for the write-off of excess inventories. In addition, during the third quarter of fiscal 2003, we recorded special charges in cost of goods sold of $1.9 million related to a settlement with an inventory supplier and spare part write-offs
associated with a discontinued product line.



We have
approximately $103.6 million of open and non-cancelable purchase order commitments outstanding at July 31, 2004. These are primarily for inventory purchases being made to support the anticipated revenues for the fourth quarters of fiscal 2004. In
particular, we are anticipating a significant increase in the ASL and Kalos product line revenues; if such increases in revenues do not occur, it could have a material adverse effect on our business, financial condition or results of operations.



In the third quarter of 2004, we recorded restructuring
charges of approximately $3.0 million as operating expenses related to equipment write-offs and liabilities incurred due to our decision to discontinue significant future investments in redundant product lines stemming from the acquisition of NPTest
and severance and related charges.



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.



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



We have a limited backlog and obtain most of our net sales from products that typically range in price from $0.2 million to $2 million and we generally ship products
generating most of our net sales near the end of each quarter, which can result in fluctuations of quarterly results.



Other than certain memory products and software products, for which the price range is typically below $50,000, we obtain most of our net sales from the
sale of a relatively few number of systems that typically range in selling price from $0.2 million to $2.0 million. This has resulted and could continue to result in our net sales and operating results for a particular period being significantly
impacted by the timing of recognition of revenue from a single transaction. Our net sales and operating results for a particular period could also be materially adversely affected if an anticipated order from just one customer is not received in
time to permit shipment during that period. Backlog at the beginning of a quarter typically does not include all orders necessary to achieve our sales objectives for that quarter. Orders in backlog are subject to cancellation, delay, deferral or
rescheduling by customers with limited or no penalties. Throughout the recent fiscal years, we have experienced customer-requested shipment delays and order cancellations, and we believe it is probable that orders will be canceled and delayed in the
future. Consequently, our quarterly net sales and operating results have in the past, and will in the future, depend upon our obtaining orders for systems to be shipped in the same quarter in which the order is received.



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



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



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



We have in the past experienced significant delays in the development, introduction, volume production and sales of our new
systems and related feature enhancements. In the past, we experienced significant delays in the introduction of our Octet, ValStar 2000 and Kalos series testers as well as certain enhancements to our other testers. The Octet tester was first shipped
in October 2002 and minimal revenue has been recognized from the Octet product family through July 31, 2004. Following the acquisition of NPTest, we have chosen to focus future investment on the Sapphire product rather than our Octet product. We are
currently moving to higher volume manufacturing of our Kalos 2 product. Revenue for this product line has been limited to the personal engineering version to-date. We are anticipating higher shipment levels of the larger production versions of this
product in the upcoming months and toward that end have begun to make significant inventory purchases and commitments. We have historically experienced some delays 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. In addition, under our revenue
recognition policy that is in accordance with SAB 104, we defer revenue for transactions that involve newly introduced products or when customers specify acceptance criteria that cannot be demonstrated prior to the shipment. This results in a delay
in the recognition of revenue as compared to the historic norm of generally recognizing revenue upon shipment. We introduced several new systems and products during fiscal 2003. Revenues from sales of



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those new systems and products may be deferred until the revenue recognition requirements of our revenue recognition
policy are satisfied. Delays in introducing a product or delays in our ability to obtain customer acceptance, if they occur in the future, will delay the recognition of revenue and gross profit by us. We cannot be certain that these or additional
difficulties will not continue to arise or that delays will not continue to materially adversely affect customer relationships and future sales. Moreover, we cannot be certain that we will not encounter these or other difficulties, including
difficulties resulting from the integration of NPTest, that could delay future introductions or volume production or sales of our systems or enhancements and related software tools. In the past, we have incurred and we may continue to incur
substantial unanticipated costs to ensure the functionality and reliability of our testers and to increase feature sets. If our systems continue to have reliability, quality or other problems, or the market perceives our products to be feature
deficient, we may continue to suffer reduced orders, higher manufacturing costs, delays in collecting accounts receivable and higher service, support and warranty expenses, and/or inventory write-offs, among other effects. Our failure to have a
competitive tester and related software tools available when required by a customer could make it substantially more difficult for us to sell testers to that customer for a number of years. We believe that the continued acceptance, volume
production, timely delivery and customer satisfaction of our newer digital, mixed signal and non-volatile memory testers are of critical importance to our future financial results. As a result, our inability to correct any technical, reliability,
parts shortages or other difficulties associated with our systems or to manufacture and ship the systems on a timely basis to meet customer requirements could damage our relationships with current and prospective customers and would continue to
materially adversely affect our business, financial condition and results of operations.



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



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



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



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



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



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



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



| |  | successful coding and debugging of software;
| | - | --------------------------------------------



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



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



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



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



Because we must make new product development commitments well in advance of sales, new product decisions must anticipate both future demand and the
availability of technology to satisfy that demand. We cannot be certain that we will be successful in selecting, developing, manufacturing and marketing new hardware 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. If we introduce new products, existing customers may curtail purchases of the older products resulting in inventory write-offs and
they may delay new product purchases. In addition, weakness in IC demand may cause integrated device manufacturers, or IDMs, to curtail or discontinue the outsourcing of testing to test houses, relying instead on in-house testing. Because less of
our market share is from the IDMs, this trend may reduce the demand for our products. Any decline in demand for our hardware or software products could have a materially adverse effect on our business, financial condition or results of operations.



The fluctuations in our sales and operations have placed and are continuing
to place a considerable strain on our management, financial, manufacturing and other resources.



Over the last several years we have experienced significant fluctuations in our operating results. In the first nine months of fiscal 2004, our net sales
increased by 162% from those recorded in the first nine months of fiscal 2003, and in fiscal 2003, our net sales increased by 11% from those recorded in fiscal 2002; however, in fiscal 2002, our net sales fell 46% from those recorded in fiscal 2001
as the semiconductor industry continued in a steep cyclical downturn. Since 1993, except for the recent and current cost-cutting efforts and those during fiscal 1998 and the first half of fiscal 1999, we have overall significantly increased the
scale of our operations 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 and California, further investments in our ERP system and numerous acquisitions. These fluctuations in our sales and
operations have placed and are continuing to place a considerable strain on our management, financial, manufacturing and other resources. In order to effectively deal with the changes brought on by the cyclical nature of the industry, we have been
required to implement and improve a variety of highly flexible operating, financial and other systems, procedures and controls capable of expanding, or contracting consistent with our business. However, we cannot be certain that any existing or new
systems, procedures or controls, including our ERP system, will be adequate to support fluctuations in our operations or that our systems, procedures and controls will be cost-effective or timely. Any failure to implement, improve and expand or
contract such systems, procedures and controls efficiently and at a pace consistent with our business could have a material adverse effect on our business, financial condition or results of operations.



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



We are currently devoting and intend to continue to devote significant resources to the development, production and commercialization of new products and
technologies. During fiscal 2001, we primarily introduced products that are either evolutions or derivatives of existing products. During fiscal 2002, 2003 and 2004, we introduced several products that are evolutions or derivatives of existing
products as well as products that were largely new. Under our revenue recognition policy adopted in accordance with SAB 104, we defer revenue for transactions that involve newly introduced products or when customers specify acceptance criteria that
cannot be demonstrated prior to the shipment. This results in a delay in the recognition of revenue as compared to the historic norm of recognizing revenue upon shipment. Product introduction delays, if they occur in the future, will delay the
recognition of revenue and gross profit and may result in delayed cash receipts by us that could materially adversely affect our business, financial condition and results of operations. We invested and continue to invest significant resources in
property, plant and equipment, purchased and leased facilities, inventory, personnel and other costs to begin or prepare to increase production of these products. A significant portion of these investments will provide the marketing, administration
and after-sales service and support required for these new hardware and software products. Accordingly, we cannot be certain that gross profit margin and inventory levels will not continue to be materially adversely affected by delays in new product
introductions or start-up costs associated with the initial production and installation of these new product lines. We also cannot be certain that we can manufacture these systems per the time and quantity required by our customers. The start-up
costs include additional manufacturing overhead, additional inventory and warranty reserve requirements and the enhancement of after-sales service and support organizations. In addition, the increases in inventory on hand for new product development
and customer support requirements have increased and will continue to increase the risk of significant inventory write-offs. We cannot be certain that our net sales will increase or remain at historical levels or that any new products will be
successfully commercialized or contribute to revenue growth or that any of our additional costs will be covered.



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The ATE industry is intensely competitive which can adversely affect our ability to maintain our current net sales and
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 particular large ATE customer or achieve significant sales to any ATE customer could have a material adverse effect on our business, financial
condition or results of operations.



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



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



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



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



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



Spirox Corporation, a distributor in Taiwan that sells to end-user customers in Taiwan and China, accounted for
approximately 26%, 19%, 20% and 13% of our net sales in the first nine months of fiscal 2004 and in the fiscal years ended October 31, 2003, 2002 and 2001, respectively. Our agreement with Spirox has no minimum purchase commitment and can be
terminated for any reason on 180 days prior written notice. Consequently, our business, financial condition and results of operations could be materially adversely affected by the loss of or any reduction in orders by Spirox, any termination of the
Spirox relationship, or the loss of any significant Spirox customer, including the potential for reductions in orders by assembly and tester service companies due to technical, manufacturing or reliability problems with our products or continued
slow-downs in the semiconductor industry or in other industries that manufacture products utilizing semiconductors. Our ability to maintain or increase sales levels in Taiwan will depend upon:



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



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



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



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



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



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



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



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



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



We prepare our financial statements to conform to
generally accepted accounting principles, or GAAP. GAAP are subject to interpretation by the American Institute of Certified Public Accountants, the SEC and various bodies formed to interpret and create appropriate accounting policies. A change in
those policies can have a significant effect on our reported results and may even affect our reporting of transactions completed before a change is announced. Accounting rules affecting many aspects of our business, including rules relating to
accounting for business combinations, asset impairment, revenue recognition, restructuring or disposal of long-lived assets, arrangements involving multiple deliverables, consolidation of variable interest entities, employee stock purchase plans and
stock option grants have recently been revised or are currently under review. Changes to those rules or current interpretation of those rules may have a material adverse effect on our reported financial results or on the way we conduct our business.
For example, effective November 1, 1999, we changed our method of accounting for systems revenue based on guidance provided in SAB 101. Adoption of SAB 101 required us to restate our quarterly results for the seven fiscal quarters ended July 31,
2001 (see Note 1 of the Notes to the Consolidated Financial Statements in our Annual Report on Form 10-K and Note 2 of the Notes to the Condensed Consolidated Financial Statements included in this Form 10-Q for further discussion). In addition, the
preparation of our financial statements in accordance with GAAP requires that we make estimates and assumptions that affect the recorded amounts of assets and liabilities, disclosure of those assets and liabilities at the date of the financial
statements and the recorded amounts of expenses during the reporting period. A change in the facts and circumstances surrounding those estimates could result in a change to our estimates and could impact our future operating results.



Also, on June 29, 2001, the FASB pronounced under Statement of Financial
Accounting Standards No. 142, Goodwill and Other Intangible Assets, (FAS 142), that purchased goodwill should not be amortized, but rather, it should be periodically reviewed for impairment. Such impairment could be caused by internal factors as
well as external factors beyond our control. The FASB has further determined that at the time goodwill is considered impaired an amount equal to the impairment loss should be charged as an operating expense in the statement of operations. The timing
of such an impairment (if any) of goodwill acquired in past and future transactions is uncertain and difficult to predict. Our results of operations in periods following any such impairment could be materially adversely affected.



In addition, there has been an ongoing public debate whether employee stock
option and employee stock purchase plans shares should be treated as a compensation expense and, if so, how to properly value such charges. If we were to elect or were required to record an expense for our stock-based compensation plans using the
fair value method, we could have significant compensation charges. For example, for the three and nine months ended July 31, 2004, had we accounted for stock-based compensation plans using FAS 123 as amended by FAS 148, diluted earnings per share
would have been reduced by $0.08 and $0.32, respectively. Although we are currently not required to record any compensation expense using the fair value method in connection with option grants that have an exercise price at or above fair market
value and for shares issued under our employee stock purchase plan, it is possible that future laws or regulations will require us to treat all stock-based compensation as a compensation expense using the fair value method. See Notes 1 and 7 of the
Notes to the Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended October 31, 2003 and Note 3 of the Notes to the Condensed Consolidated Financial Statements included in this Form 10-Q for a discussion of
stock-based compensation.



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



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



Our international business exposes us to additional risks.



International sales accounted for approximately 75%, 62%, 64%, and 55% of our total net sales for the first nine months of fiscal 2004, and for the fiscal
years 2003, 2002 and 2001, respectively. We anticipate that international sales will continue to account for a significant portion of our total net sales in the foreseeable future. These international sales will continue to be subject to certain
risks, including:



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



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



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



| |  | the adverse effect of fears surrounding any recurrence of SARS or other health risks on our business and sales and that of our customers, especially in Taiwan, Hong Kong and China;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



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



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



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



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



| |  | greater difficulty in maintaining U.S. accounting standards; and
| | - | ----------------------------------------------------------------



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



We are also subject to the risks associated with the imposition of domestic and foreign legislation and regulations relating to the import or export of
semiconductor equipment and software products. We cannot predict whether the import and export of our products will be adversely affected by changes in or new quotas, duties, taxes or other charges or restrictions imposed by the United States or any
other country in the future. Any of these factors or the adoption of restrictive policies could have a material adverse effect on our business, financial condition or results of operations. Net sales to the Asia-Pacific region accounted for
approximately 56% of our total net sales during the nine months quarter of fiscal 2004 and 38%, 42% and 38% of our total net sales in fiscal years 2003, 2002 and 2001, respectively, and thus demand for our products is subject to the risk of economic
instability in that region and fears surrounding SARS or other health risks 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. 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.



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No single foreign end-user customer accounted for more than 10% of our net sales during the first nine
months 2004 or 2003. However, one end-user customer headquartered in Europe accounted for 10% of our net sales in fiscal 2003.



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, fears related to SARS or other health risks and regulatory changes. Disruption of
business in Asia caused by the previously mentioned factors could continue to have a material impact on our business, financial condition or results of operations.



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



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



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



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



Some of our customers have received notices from the foundation of 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, those customers may 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.



We may be materially adversely
affected by legal proceedings.



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



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



The terrorist attacks in September 2001 in the United States and ensuing events and the resulting decline in consumer confidence has had a material adverse effect on the economy. If consumer confidence does not fully recover, our revenues
and profitability will continue to be adversely impacted in fiscal 2004 and beyond.



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



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



The Sarbanes-Oxley Act of 2002 that became law in July 2002 requires changes in some of our corporate governance and securities disclosure or compliance
practices. That Act also requires the SEC to promulgate new rules on a variety of subjects, in addition to rule proposals already made, and Nasdaq has revised and continues to revise its requirements for companies that are Nasdaq-listed. These
developments have increased our legal compliance and financial reporting costs. We expect these developments to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept
reduced coverage or incur substantially higher costs to obtain coverage. These developments could make it more difficult for us to attract and retain qualified members of our board of directors, or qualified executive officers. We are presently
evaluating and monitoring regulatory developments and cannot estimate the timing or magnitude of additional costs we may incur as a result.



Failure to achieve and maintain effective internal controls in accordance with Section 404 of the Sarbanes-Oxley Act could have a material adverse effect on our
business and stock price.



We are in the process of
documenting and testing our internal control procedures in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act, which requires annual management assessments of the effectiveness of our internal controls over financial
reporting and a report by our Independent Auditors addressing these assessments. During the course of our testing we may identify deficiencies which we may not be able to remediate in time to meet the deadline imposed by the Sarbanes-Oxley Act for
compliance with the requirements of Section 404. In addition, if we fail to maintain the adequacy of our internal controls, as such standards are modified, supplemented or amended from time to time, we may not be able to ensure that we can conclude
on an ongoing basis that we have effective internal controls over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act. Failure to achieve and maintain an effective internal control environment could have a material adverse
effect on our stock price.



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



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



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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



Our exposure to market risk from changes in interest rates relates primarily
to our cash equivalents and investment portfolio. We maintain a strict investment policy, which ensures the safety and preservation of our invested funds by limiting default risk, market risk, and reinvestment risk. Our investments consist primarily
of commercial paper, medium term notes, asset backed securities, U.S. Treasury notes and obligations of U.S. Government agencies, bank certificates of deposit, auction rate preferred securities, corporate bonds and municipal bonds. Part of our
investment portfolio may include minority equity investments in publicly traded companies, the values of which are subject to market price volatility. These investments are generally classified as available-for-sale and, consequently, are recorded
on our balance sheets at fair value with unrealized gains or losses reported as a separate component of stockholders equity.



Investments in both fixed-rate and floating-rate interest earning instruments carry a degree of interest rate risk. The fair market values of our
fixed-rate securities decline if interest rates rise, while floating-rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may be less than expected because of
changes in interest rates or we may suffer losses in principal if forced to sell securities that have experienced a decline in market value because of changes in interest rates.



The table below presents notional amounts and related weightedaverage interest rates by year of maturity for our
investment portfolio (in thousands, except percentage amounts).



|                            |  |                     |         |   |                                                        |   |         |      |  |   |        |   |  |      |   |   |            |   |   |   |  |   |   |  
|--------------------------- |  | ------------------- | ------- | - | ------------------------------------------------------ | - | ------- | ---- |  | - | ------ | - |  | ---- | - | - | ---------- | - | - | - |  | - | - | -
|                            |  |                     |         |   | Future maturities of investments held at July 31, 2004 |  
|                            |  | Balance at 10/31/03 |         |   | 2004                                                   |   |         | 2005 |  |   | 2006   |   |  | 2007 |   |   | Thereafter |  
|Cash equivalents            |  |                     |         |   |                                                        |   |         |      |  |   |        |   |  |      |   |   |            |   |   |   |  |   |   |  
|Fixed rate                  |  | $                   | 27,318  |   |                                                        | $ | 145,090 |      |  | $ |       |   |  | $    |  |   |            | $ |  |   |  | $ |  |  
|Average rate                |  |                     | 0.46    | % |                                                        |   | 0.12    | %    |  |   |       | % |  |      |  | % |            |   |  | % |  |   |  | %
|Short term investments      |  |                     |         |   |                                                        |   |         |      |  |   |        |   |  |      |   |   |            |   |   |   |  |   |   |  
|Fixed rate                  |  | $                   | 258,578 |   |                                                        | $ | 8,500   |      |  | $ | 6,409  |   |  | $    |  |   |            | $ |  |   |  | $ |  |  
|Average rate                |  |                     | 2.94    | % |                                                        |   | 1.64    | %    |  |   | 5.80   | % |  |      |  | % |            |   |  | % |  |   |  | %
|Long term investments       |  |                     |         |   |                                                        |   |         |      |  |   |        |   |  |      |   |   |            |   |   |   |  |   |   |  
|Fixed rate                  |  | $                   | 50,184  |   |                                                        | $ |        |      |  | $ | 16,897 |   |  | $    |  |   |            | $ |  |   |  | $ |  |  
|Average rate                |  |                     | 4.08    | % |                                                        |   |        | %    |  |   | 1.63   | % |  |      |  | % |            |   |  | % |  |   |  | %
|                            |  |                     |         |   |                                                        |   |         |      |  |   |        |   |  |      |   |   |            |   |   |   |  |   |   |  
|Total investment securities |  | $                   | 336,080 |   |                                                        | $ | 153,590 |      |  | $ | 23,306 |   |  | $    |  |   |            | $ |  |   |  | $ |  |  
|Average rate                |  |                     | 2.91    | % |                                                        |   | 0.20    | %    |  |   | 2.77   | % |  |      |  | % |            |   |  | % |  |   |  | %
|Equity instruments          |  | $                   | 498     |   |                                                        | $ | 427     |      |  | $ |       |   |  | $    |  |   |            | $ |  |   |  | $ |  |  



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 to maintain a prudent amount of diversification.



The sensitivity analysis model used by us for interest rate exposure compares interest income on current investment interest rates versus current
investment levels at current interest rates with a 10% increase. Based on this model, a 10% increase or decrease would result in an increase or a decrease in interest income of approximately $72,000. There can be no assurances that the above
projected interest rate increase will materialize. Fluctuations of interest rates are beyond the control of our management.



Foreign Exchange



We generate a significant portion of our net sales from sales to customers located outside the United States, principally in Asia and to a lesser extent
Europe. International sales are made mostly to foreign distributors and some foreign subsidiaries and are typically denominated in U.S. dollars and occasionally are denominated in the local currency for European and Japanese customers. The
subsidiaries also incur most of their expenses in the local currency. Accordingly, some of our foreign subsidiaries use the local currency as their functional currency. Foreign currency gains (losses) were approximately $14,000 and ($266,000) for
the three and nine months ended July 31, 2004.



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



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ITEM 4. CONTROLS AND PROCEDURES



As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our Chief Executive
Officer and Chief Financial Officer of the effectiveness of the design and operation of our disclosure controls and procedures. While our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives,
the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions
regardless of how remote. However, based on the evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and
procedures were effective in timely alerting them to material information required to be included in our periodic SEC filings at the reasonable assurance level.



There have been no changed in our internal control over financial reporting that occurred during our most recent fiscal quarter that has materially
affected or is reasonably likely to materially affect our internal control over financial reporting.



PART II.OTHER INFORMATION



Item 1. Legal Proceedings



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



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



None



Item 3. Defaults upon Senior Securities



None



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



At a special meeting of our stockholders held on May 27, 2004, the following proposal was approved:



| | 1. | Approve the issuance of securities of the Company pursuant to the Agreement and Plan of Merger dated as of February 22, 2004, by and among the Company, Cataline Corporation and
NPTest Holding Corporation.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                  |  |                |  |          
|----------------- |  | -------------- |  | ---------
|Affirmative Votes |  | Negative Votes |  | Abstained
|44,394,888        |  | 4,017,557      |  | 52,618   



Item 5. Other Information



The
Company has been informed that four of its executive officers, Graham J. Siddall, David A. Ranhoff, John R. Detwiler, and Brett L. Hooper have adopted stock selling plans in June 2004, June 2004, September 2004, and June 2004, respectively, under
Rule 10b5-1 of the Securities Exchange Act of 1934, as amended, pursuant to which they intend to sell shares of the Companys common stock from time to time.



The term of Dr. Siddalls plan begins on October 1, 2004 and terminates on March 31, 2005. The plan provides for sales
of stock on a monthly basis subject to certain market prices. No more than 200,000 shares may be sold in any given quarter. The plan will terminate if and when an aggregate of 497,937 shares have been sold pursuant to the plan.



The term of Mr. Ranhoffs plan begins on October 1, 2004 and terminates
on June 28, 2005. The plan provides for sales of stock on a monthly basis subject to certain market prices. The plan will terminate if and when an aggregate of 495,724 shares have been sold pursuant to the plan.



The term of Mr. Detwilers plan begins on January 1, 2005 and terminates
on December 31, 2005. The plan provides for sales of stock on a monthly basis subject to certain market prices. The plan will terminate if and when an aggregate of 132,700 shares have been sold pursuant to the plan.



The term of Mr. Hoopers plan begins on October 1, 2004 and terminates
on June 29, 2005. The plan provides for sales of stock on a monthly basis subject to certain market prices. The plan will terminate if and when an aggregate of 96,000 shares have been sold pursuant to the plan.



The Company has been informed that one of its directors, Ashok Belani, has
adopted a stock selling plan in June 2004, under Rule 10b5-1 of the Securities Exchange Act of 1934, as amended, pursuant to which he intends to sell shares of the Companys common stock from time to time.



The term of Mr. Belanis plan begins on
October 1, 2004 and terminates on March 31, 2005. The plan provides for sales of stock on a monthly basis subject to certain market prices. The plan will terminate if and when an aggregate of 400,000 shares have been sold pursuant to the plan.



Item 6. Exhibits and Reports on Form 8-K



| | (a) | See Exhibit Index on page 47.
| | --- | -----------------------------



| | (b) | Reports on Form 8-K
| | --- | -------------------



1) The Company furnished a report on Form 8-K on May 19, 2004, containing the Companys preliminary results for its second fiscal quarter ended April
30, 2004.



2) The Company filed a report on Form 8-K on May 28,
2004 announcing the closing of the merger of NPTest Holding Corporation with and into Cataline Corporation, a wholly-owned subsidiary of the Company.



3) The Company filed a report on Form 8-K on June 8, 2004, containing the pro forma financial information of the combined companies.



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##### Table of Contents

SIGNATURES



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



|                        |  |                                                                                                                                                   
|----------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------
|                        |  | CREDENCE SYSTEMS CORPORATION                                                                                                                      
|                        |  | (Registrant)                                                                                                                                      
|                        | 
|September 14, 2004 Date |  | /s/ JOHN R. DETWILERJohn R. Detwiler John R. Detwiler, Senior Vice President, Chief Financial Officer (Principal Financial and Accounting Officer)



46



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##### Table of Contents

EXHIBIT INDEX



|               |  |                                                                                                                                                   
|-------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  |                                                                                                                                                   
|2.1 (1)        |  | Agreement and Plan of Reorganization dated February 22, 2004, by and among the Registrant, Cataline Corporation and NPTest Holding Corporation    
|               | 
|3.1 (2)        |  | Amended and Restated Certificate of the Company                                                                                                   
|               | 
|3.2 (3)        |  | Amended and Restated Bylaws of the Company, as Currently in Effect                                                                                
|               | 
|4.1 (4)        |  | Certificate of Designation for the Non-Voting Convertible Stock of the Registrant                                                                 
|               | 
|10.4 (5)       |  | Amended Executive Employment Agreement, dated as of September 9, 2004 and effective May 28, 2004, by and between the Company and David A. Ranhoff.
|               | 
|10.5 (5)       |  | Amended Executive Employment Agreement, dated as of September 9, 2004 and effective May 28, 2004, by and between the Company and John R. Detwiler.
|               | 
|10.6 (5)       |  | Amended Executive Employment Agreement, dated as of September 9, 2004 and effective May 28, 2004, by and between the Company and Fred Hall.       
|               | 
|10.7 (5)       |  | Executive Employment Agreement, dated as of September 9, 2004 and effective May 28, 2004, by and between the Company and Byron W. Milstead.       
|               | 
|31.1           |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                            
|               | 
|31.2           |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                            
|               | 
|32.1           |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                            
|               | 
|32.2           |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                            

---

|(1) | Incorporated by reference to Exhibit 2.1 to the Registrants Report on Form 8-K (File No. 000-22366) filed on February 24, 2004.
|--- | --------------------------------------------------------------------------------------------------------------------------------



|(2) | Incorporated by reference to Exhibit 3.1 to the Registrants Quarterly Report on Form 10-Q (File No. 000-22366) filed on June 13, 2000.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------



|(3) | Incorporated by reference to Exhibit 3.2 to the Registrants Quarterly Report on Form 10-Q (File No. 000-22366) filed on March 15, 2002.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------



|(4) | Incorporated by reference to Exhibit 4.7 to the Registrants Registration Statement on Form S-4 (File No. 333-113990) filed on March 29, 2004.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------



|(5) | Incorporated by reference to Exhibits to the Registrants Report on Form 8-K (File No. 000-22366) filed on September 14, 2004.
|--- | ------------------------------------------------------------------------------------------------------------------------------



47