UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-K
(Mark One)
[X]     ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
        ACT OF 1934 [NO FEE REQUIRED]

For the fiscal year ended October 31, 1998
                                       or
[_]     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES 
        EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

For the transition period from          to

                         Commission file number 0-22366

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

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

 215 Fourier Avenue, Fremont, California                          94539
(Address of principal executive offices)                        (Zip Code)

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


Securities registered pursuant to Section 12(b) of the Act:

     Title of each class:           Name of each exchange on which registered
     --------------------           -----------------------------------------
             None                                  None

Securities registered pursuant to Section 12(g) of the Act: 
                                        Common Stock, $0.001 par value
                                        Preferred Stock Purchase Rights


     Indicate  by check mark  whether the  registrant  (1) has filed all reports
required to be filed by Section 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 a check mark if  disclosure of  delinquent  filers  pursuant to
Item 405 of Regulation S-K is not contained  herein,  and will not be contained,
to the best of the  registrant's  knowledge,  in definitive proxy or information
statements  incorporated  by  reference  in Part  III of this  Form  10-K or any
amendment to this Form 10-K. [ X ]

         The aggregate  market value of voting stock held by  non-affiliates  of
the Registrant,  as of January 20, 1999 was  approximately  $250,141,176  (based
upon the closing price for shares of the  Registrant's  common stock as reported
by the Nasdaq  National  Market for the last  trading  date prior to that date).
Shares of common stock held by each  officer,  director and holder of 5% or more
of the  outstanding  common stock have been excluded in that such persons may be
deemed  to  be  affiliates.  This  determination  of  affiliate  status  is  not
necessarily a conclusive determination for other purposes.

        On January 20, 1999, approximately 20,446,311 shares of the Registrant's
common stock, $0.001 par value, were outstanding.

                       DOCUMENTS INCORPORATED BY REFERENCE

Portions of the  Registrant's  Proxy  Statement  for the 1999 Annual  Meeting of
Stockholders  to be held on March 24, 1999 are  incorporated  by reference  into
Part III.


                                       1
<PAGE>



                                     PART I

ITEM 1.  BUSINESS

       Credence Systems Corporation  designs,  manufactures,  sells and services
automatic  test  equipment  ("ATE")  used for testing  semiconductor  integrated
circuits ("ICs").  The Company also develops,  licenses and distributes  related
software  products.  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 and non-volatile memory  semiconductors.  Credence utilizes
its  proprietary  technologies  to design  products  intended to provide a lower
total cost of ownership than competing  products while meeting the  increasingly
demanding performance requirements of today's ATE market. The Company's products
are primarily designed to test  semiconductors that are produced in high volume.
The Company's  customers  include major  semiconductor  manufacturers as well as
assembly and test services companies.

       Credence was  incorporated  in California in March 1982 to succeed to the
business of a sole  proprietorship and was reincorporated in Delaware in October
1993.  The term  "Credence"  or the  "Company"  includes,  when the  context  so
requires, Credence Systems Corporation, and its subsidiaries,  including Fluence
Technology,  Inc. ("Fluence"),  formerly named Test Systems Strategies,  Inc. (a
Delaware  corporation),  which the Company formed to acquire certain assets from
Test Systems Strategies,  Inc. and its parent,  Summit Design Inc., (the "Summit
Acquisition")  in July 1997. It also includes  certain fault simulation and test
program development products of Zycad Corporation  ("Zycad"),  which the Company
acquired in August 1997 (the "Zycad Acquisition"),  and the memory test business
assets acquired from Heuristics  Physics  Laboratories,  Inc. ("HPL") on June 1,
1998. 1

Background
----------

       Dramatic advances in semiconductor  process  technology have improved the
performance  and lowered the average  selling prices  ("ASPs") of  semiconductor
devices (semiconductors) to levels that now support their use in a wide range of
office, consumer, automotive, communications,  industrial and other products. In
order to  maintain  or improve  gross  margins as  semiconductor  ASPs  decline,
semiconductor  manufacturers are constantly seeking ways to reduce manufacturing
costs.

       Testing is a  principal  element  in the cost  structure  of high  volume
production  of  semiconductors.  As a result of improved  efficiencies  in wafer
fabrication,  test costs have  become a higher  percentage  of the total cost of
manufacturing. This shift in cost structure has changed the traditional criteria
for  selection  of ATE.  Although  performance  was the  dominant  factor in the
selection of ATE in the past, the Company believes that economic  considerations
have assumed much greater importance to semiconductor manufacturers.  Purchasers
of ATE now examine more carefully the total cost of ownership of ATE. Total cost
of ownership  includes the initial purchase price of the tester,  as well as the
tester's   reliability,   flexibility,   size,   power   and  air   conditioning
requirements, upgrade-ability and maintenance costs, including spare parts.

       Traditionally, semiconductor die were minimally tested at wafer probe and
underwent  rigorous  performance  testing  to  full  specification  only  at the
completion  of final  packaging.  Today,  assembly  and  packaging  have  become
increasingly  expensive compared with the cost of the die, such that their costs
may exceed the cost of the die itself.  This trend has influenced  semiconductor
manufacturers to shift performance  testing  increasingly toward wafer probe. By
subjecting devices to performance testing earlier in the manufacturing  process,
defective die are detected and eliminated  before  assembly and packaging  costs
are incurred.

       Increased  facility  costs and the trend  toward  performance  testing at
wafer  probe have led to the  increased  importance  of  smaller  testers in the
semiconductor manufacturing process. Performance testing at wafer probe requires
that the  device  under  test be  located  in close  physical  proximity  to the
measuring  circuits  of  the  tester  in  order  to  minimize  potential  signal
distortions that can negatively impact testing yields.  Smaller testers can more
easily be placed in close  physical  proximity  to such  circuits.  In addition,

----------
 1  "Credence Systems Corporation," "Credence", "SC212," "ValStar," "Quartet," 
"Quartet One,"  "MemBIST,"  "Triton," "EPRO,"  "BOST,"  "Kalos,"  and "DUO" are
trademarks  of  the  Company. This Annual  Report  on  Form 10-K  also  includes
trademarks of other companies.


                                       2
<PAGE>



wafer probe test typically  occurs in a clean room where potential  contaminants
must be  continually  removed and  temperatures  kept  constant.  These  special
maintenance  requirements make clean rooms expensive to operate. Smaller testers
occupy less floor space and therefore  assist in reducing  clean room costs.  In
addition,  smaller  testers that consume less power  generally  have reduced air
conditioning requirements.

       For  over  20  years,   emitter-coupled   logic   ("ECL")  has  been  the
conventional  process technology used by the Company and others for the ICs used
in ATE due to its speed,  repeatability and precision. ECL technology,  however,
results  in low  functionality  per chip and  requires  continuous  power.  As a
result,  conventional  ATE systems  generally  are large,  expensive and require
significant electrical power to operate.

       Another   process   technology   commonly  used  in  the  manufacture  of
semiconductors is complementary metal oxide semiconductor  ("CMOS"). As compared
to ECL, CMOS technology  allows higher  functionality  for a given chip size and
requires less power to operate.  Some ATE manufacturers use a combination of ECL
and CMOS to lower the cost of ATE by reducing the use of ECL.

       The production of ATE based exclusively on CMOS technology,  however, had
been limited by the inability of CMOS to meet the timing and measurement demands
of semiconductor testing. Although the speed of CMOS was acceptable,  its timing
stability  was not.  This problem  results from the tendency of CMOS circuits to
experience  timing  drift as a function of  temperature  and  voltage  variation
during tests.  To fully  benefit from the economic and other  advantages of CMOS
technology, the challenge has been to control this drift characteristic in order
to produce  semiconductors  for ATE that meet the  performance  requirements  of
semiconductor testing.

The Credence Solution and Strategy
----------------------------------

       Credence  has  developed  proprietary  CMOS  stabilization  methods  that
minimize  the drift  characteristic  of CMOS and enable  the  Company to produce
testers  that are  smaller  and  require  less power  than those  based upon ECL
technology and that are intended to provide a lower total cost of ownership than
many  competing  products  currently  available  while  meeting the  performance
demands of today's ATE  market.  CMOS  technology  allows the  circuits  used in
Credence's  testers  to be  reduced,  or  "scaled"  down in  size as IC  process
technology  improves,  resulting in higher  performance and freeing space on the
die for additional  functionality.  This scalability feature enables the Company
to  develop  and  manufacture  smaller,  higher  performance  ICs for use in its
testers at what  Credence  believes to be a lower cost,  and with a  potentially
shorter development cycle, than traditional process technologies.

       Credence's  objective is to be the leading supplier of cost-effective ATE
for production  testing of ICs used in high volume  applications.  The Company's
business strategy incorporates the following key elements:

       o   Technology Leadership. The Company believes that its proprietary CMOS
           stabilization  technology  enables  the  development  of ATE  that is
           designed to meet the performance  and cost of ownership  requirements
           of  semiconductor   manufacturers  and  assembly  and  test  services
           companies.  In addition, the Company believes the scalability of this
           technology will allow it to offer new products and  enhancements in a
           potentially  shorter  time  and at a  lower  cost  than  many  of its
           competitors  that base their  products on  traditional  less-scalable
           architecture.

      o    Lower Total Cost of  Ownership.  The Company  seeks to provide ATE to
           its customers at a lower total cost of ownership  than many competing
           products   currently   available   while   meeting  the   performance
           requirements of its customers.  The Company  believes that the system
           price,  reliability,  flexibility,  size,  power and air conditioning
           requirements,  upgradeability and maintenance costs,  including spare
           parts,  of its testers enable its customers to more cost  effectively
           test ICs.  Credence's  proprietary CMOS  stabilization  technology is
           integral to the successful implementation of this strategy.

     o     Diverse, High-Volume Markets.  Credence's products target the testing
           of digital logic,  mixed-signal  and non-volatile memory devices that
           are used in a broad range of growing  end-user market  segments.  The
           Company's  products  are  designed to  test  semiconductors  that are
           manufactured   in  high   volume   and  are  used  in  a  variety  of
           applications such as automobiles,   appliances,  personal  computers,
           personal  communications   products,   networking  products,  digital
           televisions and multimedia hardware.


                                       3
<PAGE>


     o     Worldwide  Technical Support and Customer  Service.  As semiconductor
           manufacturers  expand their operations  worldwide,  they require that
           their ATE suppliers have the capability to provide global support and
           service and training.  To meet this requirement,  Credence utilizes a
           combination  of direct  sales,  service and support  personnel  and a
           broad network of independent  distributors located in close proximity
           to major  customer  sites.  Credence and its  distributors  currently
           maintain  locations  throughout  the  world to  service  and  support
           Credence's customers.

     o     Reduce  Time-to-Market.  The  Company  believes  that  its  customers
           require increasing  levels of sophisticated  software tools to assist
           in the utilization of ATE that minimizes time-to-market.  The Company
           is focusing  its  software  efforts  on  internal development of, and
           acquisition  of  companies  or  businesses, that  develop such tools.
           Through its Fluence  subsidiary,  the Company has  acquired  the test
           development  series  ("TDS")  and  TDX products  lines,  from  Summit
           Design, Inc. and Zycad, respectively, and has non-exclusive worldwide
           distribution rights  for the Analog  Test and  Analog  BIST (built-in
           self-test) products of Opmaxx, Inc. ("Opmaxx").  In addition, through
           the acquisition  of  certain  assets of HPL, th  Company  obtained an
           array of memory BIST and related in-process  software products.  This
           is expected to add significant market  opportunities  in the next two
           years. The Company  believes it is ideally positioned  to  capitalize
           on the  "Design-to-Test"  and the  "Design-for-Test" markets with its
           new   broad-based software  product lines  that integrate  design and
          test.

Products
--------

       Credence  currently  offers a wide variety of products  that test digital
logic,  mixed-signal and non-volatile  memory ICs. Digital logic  semiconductors
produce discrete "on" and "off" logical sequences that control functions,  store
data,  retrieve  data and move and  manipulate  data at high rates of speed.  An
example  of  digital  logic   semiconductors   include  logic  devices  such  as
microcontrollers.  Certain  digital  devices  which store and retrieve  data are
memory semiconductors. Non-volatile memory semiconductors retain their data when
the power is turned off.  Mixed-signal  semiconductors  combine both digital and
analog  functions.  Analog  semiconductors  control  external  functions such as
sound,  graphics,  and motor controls by producing continuous varying voltage or
current.  When these analog  functions  are combined  onto a digital  integrated
circuit, the resulting device is considered a mixed-signal device.

       The Company's  CMOS-based ATE products - the SC,Valstar,  DUO and Quartet
series - are designed to test high speed  devices used in  applications  such as
networking  and personal  computing as well as multimedia,  digital  television,
high-definition  television and personal  communications.  The Company's  memory
products  Kalos,  EPRO 142 and BTMA test  non-volatile  memory ("NVM")  devices,
including ROM, EPROM, EEPROM and Flash memories used in high volume applications
in the consumer,  automotive and  telecommunications  markets.  During 1997, the
Company  introduced the ValStar 2000, a system which enables the testing of very
complex devices, up to 1024 pins with high speed  requirements.  Also introduced
was the Kalos Flash memory test system, a highly integrated parallel system that
provides multi-site testing and is designed to lower the overall cost of test.

       During  fiscal  1998,  the Company  introduced  the Quartet  series.  The
Quartet,  a new system  which is  compatible  with DUO,  provides  the  enhanced
capabilities  required to test consumer mixed signal  products with 200 MHz I/O,
20 bit analog,  video,  and radio  frequency  ("RF")  input and output.  Quartet
directly addresses the cost sensitive needs of consumer related system-on-a-chip
("SOC") devices.

       During fiscal 1997, the Company acquired two software products lines: the
Test Development  Series ("TDS") product line in the Summit  Acquisition and the
Test Design eXpert ("TDX") product line in the Zycad  Acquisition.  TDS converts
simulation  waveform  data and modifies it under user  control to generate  test
programs for use on ATE. TDX grades and generates test vector sets, and provides
other tools that enhance design testability.

       During fiscal 1998, the Company  acquired the MemBIST  products from HPL.
The MemBIST products generate built-in self-test logic for embedded memories. In
addition,  a sales  representative  agreement  was  signed  between  Opmaxx  and
Fluence.  The Opmaxx products are targeted at analog and mixed signal design and
test applications.

       The following table sets forth the Company's  current product  offerings,
their features and examples of typical devices tested by each product.  Included
in certain of the basic  features are the  anticipated  cycle speed in megahertz
("MHz"), timing accuracy in either picoseconds ("ps") or nanoseconds ("ns"), the
number and characteristics of the pins and the density in megabits ("Mb") of the
device that can be tested:


                                       4
<PAGE>

<TABLE>
<CAPTION>
-------------- --------------- -------------- -------------------------------- ------------------------------------
   Product      Series           Models           Basic Features                    Typical Devices
-------------- --------------- -------------- -------------------------------- ------------------------------------
  <S>           <C>             <C>            <C>                              <C> 
                SC              SC 312         50 - 100 MHz                     Microcontrollers, ASSPs, DSPs and
                                SC Micro       64 - 304 Pins                    FPGAs
                                                + 350-500 ps accuracy

               --------------- -------------- -------------------------------- ------------------------------------
                ValStar         VS2000         200 MHz                          Microprocessors, RISC circuits,
  Digital                                      +  200 ps accuracy               PLDs, FPGAs, ASICs and ASSPs
                                               512-1024 Pins
                               -------------- -------------------------------- ------------------------------------
                                VS2000e        200 MHz                          Microprocessors, RISC circuits,
                                               +  200 ps accuracy               PLDs, FPGAs, ASICs and ASSPs
                                               512-1024 Pins
-------------- --------------- -------------- -------------------------------- ------------------------------------
                DUO             DUO            DUO-SE  -  50 MHz                Multimedia devices, mass storage,
                                DUO-SE         DUO -  100 MHz                   DSPs, ASICs, Datacom and specialty
                                DUO-SX         DUO-SX-  200 MHz                 devices, mobile communication
                                DUO-RF         DUO-RF-50-100 MHz                devices, complex audio devices

  Mixed-       --------------- -------------- -------------------------------- ------------------------------------
  Signal        Quartet         ONE            512 digital                      Multimedia devices, mass storage,
                                               200 MHz                          DSPs, ASICs, Datacom and specialty
                                               +  175 ps accuracy               devices, mobile communication
                                               Analog, Video, Audio, RF         devices, complex audio devices
-------------- --------------- -------------- -------------------------------- -------------------------------------
                EPRO            142/AX         10-50 MHz                        ROM, EEPROM, EPROM, and Flash
                KALOS                          256Mb                            memories
                Personal Kalos                 + 1ns
               --------------- -------------- -------------------------------- ------------------------------------
 Memory         BTMA            2001           Benchtop Memory Analysis and     ROM, EEPROM, EPROM, Flash and SRAM
 Products                       2555           Verification Testers
                                2555A
               --------------- -------------- -------------------------------- ------------------------------------
                BOST                           "Built-Off Self-Test"            Processors, graphics engines,
                                               Embedded memory test             ASIC's and other multimedia devices
                                               External solution for digital
                                               and mixed signal devices
-------------- --------------- -------------- -------------------------------- ------------------------------------
                                Logic          SC Series tester integrated      Microcontrollers, ASSPs and FPGAs
                                               into 8" wafer prober, without
 Workcell       Triton                         extending outside the prober
                                               perimeter
                               -------------- -------------------------------- ------------------------------------
                                Memory         Kalos tester integrated into 8"  ROM, EEPROM, EPROM, and Flash
                                               wafer prober, without extending  memories
                                               outside the prober perimeter
-------------- --------------- -------------- -------------------------------- ------------------------------------
                TDS Tools       Design Test    Generates tester specific        Tools apply to digital logic devices
                                               programs
                                               Verifies timing specifications
               --------------- -------------- -------------------------------- ------------------------------------
                TDX Tools       Design Test    Verifies test vector quality     Tools apply to digital logic devices
                                               Supports design for test
                                               strategies
               --------------- -------------- -------------------------------- ------------------------------------
 Software       HPL             Memory BIST    Generates built-in self-test     Tools apply to all memory devices
                                               (BIST) logic. Partitioned
                                               solutions using BIST, ATE, and
                                               built-off self-test (BOST)
               --------------- -------------- -------------------------------- ------------------------------------
                Opmaxx*         DesignMaxx     Design verification and          Tools apply to analog and
                Design, Test    FaultMaxx      sensitivity analysis, design     mixed-signal devices
                                TestMaxx       fault coverage, test evaluation
                                               and optimization
               --------------- -------------- -------------------------------- ------------------------------------
                Opmaxx*         BISTMaxx       Built-in self-test (BIST)        Tools apply to analog and
                Analog BIST                    generation for analog and        mixed-signal devices
                                               mixed-signal devices
-------------- --------------- -------------- -------------------------------- ------------------------------------
</TABLE>
* The Opmaxx products are not owned by the Company, but are licensed pursuant to
a sales representative agreement.


                                       5
<PAGE>



       Digital Products
       ----------------

       SC.  The model SC 212 was first shipped in 1992 and  incorporates  one of
the Company's proprietary  CMOS stabilization  methods.  This  product  requires
approximately  30 square feet of floor  space and 4  kilowatts  of power for 304
pins. The SC Micro is a  cost-reduced  version of the SC 212. This system offers
the  Company's  customers  a full  capability  test  system at a price as low as
$2,000 per  digital pin  channel.  This per channel  price has  previously  been
available only in test systems with reduced  functionality  - requiring users to
compromise  the  quality  of their  device  testing.  The SC Micro  retains  the
customer's  test quality while  continuing to lower its test costs.  In 1997 the
Company  expanded the SC series by  introducing  and shipping the SC 312,  which
runs at a higher speed (100 MHz) and has improved  accuracy over the SC 212. The
purchase  price of these  testers  typically  ranges  from  $350,000 to $850,000
depending upon configuration.

       ValStar. The VS2000 was introduced in 1997 and the Company believes it is
the  first  system  designed  specifically  with the  desired  performance  cost
structure for volume  production  of high pin count VLSI  devices.  This product
offers up to 1,024 input/output ("I/O") pins at 200 MHz data rates, and requires
less than four square meters of floor space. A fully loaded system consumes only
16 kilowatts of power,  which is generally less than many  competitive  systems,
thus  lowering  operating  costs.  The purchase  price of the VS 2000  typically
ranges from  $1,000,000  to  $3,600,000  depending on  configuration  The latest
system in the ValStar line up was  introduced  in 1998.  Unlike the VS2000,  the
VS2000e uses a customer  specific  external  testhead  positioner.  The purchase
price of the VS2000e typically ranges from $1,000,000 to $3,600,000 depending on
configuration.

       Mixed-Signal Products
       ---------------------

       Quartet.  Quartet  is the  Company's  new high  performance  mixed-signal
product series.  First  introduced in 1998,  Quartet builds on the Duo series by
addressing the needs of device manufacturers  serving the  Consumer-Mixed-Signal
("CMS") marketplace. CMS devices combine the power of digital processors with CD
quality audio,  broadcast video and wireless  communications onto a single, cost
sensitive  system-on-a-chip  ("SOC").  The Quartet One, the first of the Quartet
Series,  addresses all four of these  requirements  in an integrated,  ready for
volume production package. With 200 MHz digital, 20 bit audio, 300 MHz video and
6GHz RF,  Quartet  One is  designed  to meet the needs of the most  complex  SOC
devices. With typical system prices between $750,000 and $2,000,000, the Quartet
provides the low cost of test required by the CMS market.

       Duo.  The Duo Series is the  Company's  proven  solution  for high volume
mixed-signal  testing.  With over 200  systems  in the  field,  Duo has become a
mainstream   solution  for  both  Integrated   Device   Manufacturers   and  the
Semiconductor Manufacturing Service companies. The typical purchase price of the
Duo ranges from $600,000 to $1,500,000.

       Memory Products
       ---------------

       EPRO.  The Company's  EPRO memory product line includes the model 142/AX.
The model 142/AX was first shipped by EPRO in 1982.  The purchase price of these
non-volatile memory testers typically ranges from $30,000 to $80,000,  depending
upon configuration.

       KALOS.  Introduced in November  1997,  the Kalos is a highly  integrated,
parallel  system  designed to test flash memory.  Running at 50 MHz, it provides
multi-site  testing and is designed to lower the  customer's  cost of test.  The
Kalos  features a  unique tester-on-a-card  architecture,  which places all test
functions  for each site on a single card and thus reduces floor space and power
consumption  while  increasing  performance.  The typical  purchase price of the
Kalos ranges from $400,000 to $800,000.

       Personal Kalos.  Personal Kalos is a desktop  engineering  version of the
high-throughput Kalos tester. The typical price for a Personal Kalos ranges from
$100,000 to $120,000.

       BTMA. The 2001, 2555 and 2555A are NVM engineering testers focused on the
lab  environment.  Acquired  from HPL in 1998,  the BTMA line is  designed to be
usable  by  design  engineers  and  other  non-test  specialists  to  debug  and
characterize  NVM designs and yield  problems.  The BTMA software user interface
makes it the premier  platform for this  function.  The purchase price for these
testers typically ranges from $50,000 to $250,000.

                                       6
<PAGE>

       BOST.  Built-Off  Self-Test  ("BOST")  technology  is a  new  element  in
transforming  the role of test from an expensive and passive  device  validation
procedure into a series of solutions that can shrink development cycles,  reduce
costs,  meet  time-to-market  demands and improve die yields.  BOST integrates a
device  specific  Built-In  Self-Test  ("BIST")  engine  directly  into a custom
circuit on the load  board.  Consulting  services  for BOST  memory  testing are
available today and pricing is dependent on configuration.

       Workcell Products
       -----------------

       In 1996, the Company  established the Workcell  product group. A Workcell
enhances manufacturing productivity by integrating previously distinct equipment
into a  single,  highly  efficient  tool.  In  1997,  the  Company  debuted  its
sophisticated  Triton  series of wafer  test  systems.  Triton  Logic and Triton
Memory - the industry's first suite of Workcell wafer test solutions - feature a
production worthy wafer prober integrated with a robust ATE test system.

       Triton Logic.  This is a complete  wafer  probing  Workcell in one of the
industry's  smallest  packages  for use in volume  production  environments  for
microcontrollers and other embedded controller devices with heavy logic demands.
The  Triton  Logic  centralizes  all  operator   functions  and  eliminates  the
unnecessary  duplication  of  manipulators,   monitors  and  keypads  previously
associated with separate testers and probers. A 100 MHz Final Test at Probe test
system, the Triton is capable of matching the performance of package test at the
wafer level.

        Triton Memory.   Leveraging  Credence's  tester-on-a-card  architecture,
Triton  Memory  tests as many as 16 sites in parallel  at speeds of 50 MHz.  All
functions  required  to  test a Flash  memory  device  appear  on one  card.  An
inherently parallel, high-performance system that improves throughput rates, the
Triton Memory tests each device asynchronously from one another - while embedded
within an 8" wafer  prober.  The  tester  is an  integral  part of the  prober's
structure,  eliminating independent vibrations associated with current interface
concepts.  The  typical  price  of a  Triton  memory  ranges  from  $450,000  to
$1,300,000.

      Software Products
      -----------------

      Software  products  provide  tools  to IC  manufacturers  to help  create
detailed tests that ensure product quality and shorten time-to-market.

       TDS. The TDS product line consists  primarily of Converter,  Conditioner,
and WaveBridge products.  Converters take waveform data from  simulator-specific
representations  into an industry-standard  representation.  Conditioners modify
waveform  data to  enable it to fit  specific  tester  environments.  WaveBridge
modules  generate the actual test programs.  Converters are available to support
most  commonly  used  simulators,  and  WaveBridge  modules are  available for a
variety of ATE models.  Other  programs  that analyze  waveform data and provide
other design-to-test functions are also included in the TDS product line.

       TDX.  The TDX product line allows the design  engineer to verify  complex
designs with full timing accuracy, Iddq, pattern generation, scan generation and
testability analysis.

       MemBIST.  MemBIST software generates built-in self-test logic for designs
that use embedded  memories.  The software minimizes the test time and chip area
required for  self-test  logic of embedded  memories.  Users can also  designate
varying  levels of detail for the  diagnostic  information to be produced by the
BIST logic, from simple "pass/fail" to topologically correct bitmaps that can be
used in failure analysis.

       Opmaxx. The Opmaxx product line provides a full set of software tools for
testing  analog  and  mixed  signal  devices,  as well  as  designing  them  for
testability.  DesignMaxx provides analog design optimization,  verification, and
sensitivity analysis. FaultMaxx evaluates analog/mixed-signal fault coverage and
fault-grades test stimulus. TestMaxx evaluates and optimizes analog/mixed-signal
tests.  BISTMaxx  generates  built-in  self-test for analog/mixed  signal device
functionality, both on-chip and off-chip.

                                       7
<PAGE>

Customers, Markets and Applications
-----------------------------------

       Credence targets digital logic, mixed-signal,  non-volatile memory device
and system-on-a-chip  manufacturers that serve a broad range of growing end-user
market segments.  These customers manufacture  semiconductors in high volume for
use  in  applications  such  as  automobiles,  appliances,  personal  computers,
personal communications products,  networking products,  digital televisions and
multimedia hardware.

       In   addition  to   marketing   its   products  to  major   semiconductor
manufacturers,  the Company has developed  relationships  with numerous assembly
and  test   services   companies.   Semiconductor   manufacturers   and  fabless
semiconductor  companies increasingly utilize these subcontractors as a means of
lowering  their  fixed  production   costs,   thus  minimizing  the  effects  of
cyclicality inherent in the semiconductor  industry. As a result, these assembly
and test services companies have become an increasingly important segment of the
ATE market.

       The  Company  believes  that its  success  depends in large part upon the
success  of its major  customers.  The loss of or any  reduction  in orders by a
significant  customer  (including  the  potential  for  reductions  in orders by
assembly and test services companies which that customer may utilize), including
reductions   due  to  market,   economic  or   competitive   conditions  in  the
semiconductor   industry  or  in  other  industries  that  manufacture  products
utilizing  semiconductors has adversely affected,  and may continue to adversely
affect, the Company's  business,  financial  condition or results of operations.
The  Company's  ability to increase  its sales in the future will depend in part
upon  its  ability  to  obtain  orders  from new  customers  as well as upon the
financial condition and success of its customers and the general global economy.
There can be no  assurance  that the  Company's  sales will not  decrease in the
future or that the  Company  will be able to  retain  existing  customers  or to
attract new ones.

       For information on the Company's geographic data and major customers, see
Note 4 to the consolidated  financial  statements included elsewhere herein. The
Company's  international  sales  are  primarily  denominated  in  United  States
dollars.  The Company anticipates that its international  business will continue
to account for a significant portion of net sales in the foreseeable future.

       The Company schedules  production of its systems based upon order backlog
and order  forecast.  The Company  includes in its backlog  only those  customer
orders for  systems  (including  upgrades)  for which it has  accepted  purchase
orders and assigned  shipment  dates within the  following  twelve  months.  The
majority of the Company's  orders are subject to cancellation or rescheduling by
the  customer  with  limited  or no  penalties.  The  Company's  backlog  at any
particular  date may not necessarily be  representative  of actual sales for any
succeeding  period due to orders  received for systems to be shipped in the same
quarter,  possible changes in system delivery schedules,  cancellation of orders
and potential delays in system shipments.  As of October 31, 1998, the Company's
order  backlog for systems  (exclusive of orders for spare parts and service and
support) was approximately $ 32.3 million,  as compared with $97.5 million as of
October 31, 1997.

Sales, Service and Support
--------------------------

       The Company currently markets and sells its products in the United States
principally through its direct sales  organization,  with direct sales employees
and representatives in over 16 locations. Outside the United States, the Company
utilizes both direct sales employees and a broad network of  distributors,  with
direct sales  employees and  distributors  in over 15  countries.  Sales through
distributors  represented  approximately  45%,  36% and 36% of net sales  during
fiscal years 1998, 1997 and 1996, respectively.

       The Company and its  distributors  have sales and support centers located
in the United States, Europe, Israel, and throughout Asia from which both direct
Credence  personnel and independent sales and service  representatives  sell and
support the  equipment.  The Company  believes that field support is critical to
its customers.  Support  encompasses many of the components of the total cost of
ownership for ATE. Credence seeks to develop long-term  relationships with major
ATE customers  through  extensive  support  consisting of teams of  professional
sales, applications, training and service personnel. These personnel are located
in close  physical  proximity  to key  customer  sites in order to  provide  the
required support in a timely fashion.  The sales process includes  consultations
with customers to help them purchase the most cost-effective equipment for their
needs, to help develop custom test programs to optimize  production  throughput,
to assist in  long-term  self-sufficiency  through  training  of  customer  test
engineering  personnel  and to  provide  the  service  capacity  and  preventive


                                       8
<PAGE>

maintenance to reduce downtime for customers' systems. Customer support includes
field personnel and in-house applications personnel who work closely with design
engineering  groups to modify existing  equipment to meet the latest performance
requirements.

       In Japan,  a  wholly-owned  subsidiary of the Company  provides sales and
service to its  customers.  In  addition,  the Company has a  relationship  with
Innotech,  Corporation ("Innotech"),  a distributor of the Company's products in
Japan. In 1997 the Company formed a joint venture with Innotech to engage in the
customization  and  manufacture of ATE products for sale by both  companies.  In
March 1996, the Company  established a service and support  subsidiary in Korea.
The Company  also has a  relationship  with Itek,  Inc.,  a  distributor  of the
Company's products in Korea.

       The  Company's  standard  policy is to warrant  its new  systems  against
defects in design,  materials and  workmanship for one year for parts and labor.
The Company offers its customers additional support after the warranty period in
the form of  maintenance  contracts for specified  time periods.  Such contracts
include various options such as board replacement,  priority  response,  planned
preventive maintenance, scheduled one-on-one training, daily on-site support and
monthly system and performance analysis.

Research and Development
------------------------

       The ATE market is subject to rapid  technological  change and new product
introductions.  The  Company's  ability to be  competitive  in this  market will
depend  in  significant  part  upon its  ability  to  successfully  develop  and
introduce new products,  enhancements and related software tools on a timely and
cost-effective basis. This will enable customers to integrate such products into
their  operations as they begin volume  manufacturing  of the next generation of
semiconductors.

       Credence has pursued a technology  acquisition strategy to complement its
internal  research and development  efforts.  In 1988, the Company completed its
acquisition of Axiom Technology  Corporation,  which added mixed-signal  testing
capability.  In 1989,  the Company  completed  its  acquisition  of ASIX Systems
Corporation  ("Asix"),  which added one of its  proprietary  CMOS  stabilization
methods.   In  1990,  the  Company   acquired  the  STS  Division  of  Tektronix
Inc.("Tektronix"),  which added a second proprietary CMOS stabilization  method.
In 1993, the Company acquired various patents from Tektronix. In March 1995, the
Company acquired EPRO, which added non-volatile  memory testing  capability.  In
July 1997, the Company acquired the test development software assets through the
Summit  Acquisition.  In August 1997, the Company  acquired the fault simulation
and test program  development  products of Zycad,  and in June 1998, the Company
purchased certain assets and assumed certain liabilities  relating to the memory
test business of HPL.

       Each  of the  stabilization  methods  acquired  by  Credence  provides  a
different  solution to the  tendency  of CMOS to  experience  timing  drift as a
function of temperature and voltage  variation.  The first proprietary  solution
uses a timing phase detection  circuit combined with a voltage control mechanism
to compensate for thermal,  voltage and process drift.  The second uses a unique
combination  of counters  and  heating  circuits  to provide  stability  through
thermal means.  These methods allow the Company's  CMOS-based ICs to achieve the
timing repeatability  necessary to meet the performance  requirements of ATE and
to  realize  the  economic  and other  advantages  of CMOS  technology  over ECL
technology. CMOS circuits use less space than those based on ECL as the circuits
require less power and can be more closely packed together.

       During  1998,  the  Company  enhanced  its  Duo  product  line  with  new
capabilities  including  high  performance  audio  testing,  testing  of  analog
circuitry  for wireless  communication  applications  and  embedded  memory test
capability.  These features  enable single  insertion  system-on-a-chip  testing
capability.  The Company will continue to focus research and development efforts
on  ensuring   that  its  products   have  the  ability  to   efficiently   test
state-of-the-art  customer  devices  which  combine  analog,  high speed digital
logic, and memory on a single circuit.

       Credence's ongoing research and development efforts also include focusing
on increased cycle speed,  accuracy and pin counts of its testers.  In addition,
the  Company is working on a software  development  program  that is intended to
provide for upward compatibility  through the Company's products.  Credence will
also continue to focus efforts on providing  software solutions which allow more
rapid,   cost-effective   development   of  ATE  test   programs   which  reduce
time-to-market  of customer  integrated  circuit designs.  The Company currently
intends to continue to invest  significant  resources in the  development of new
products and enhancements for the foreseeable future.

                                       9
<PAGE>

       Research and development ("R&D") expenses were $47.5 million (excluding a
$2 million charge for acquired  in-process R&D),  $37.4 million  (excluding a $6
million charge for acquired  in-process  R&D), and $35.4 million in fiscal 1998,
1997 and 1996, respectively.

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

       The Company  currently holds 34 United States patents,  which expire over
time through  April 2017.  In  addition,  the Company  currently  has 12 foreign
patents,  which expire over time through  September  2011. The two United States
patents  acquired from Asix and Tektronix  underlying the Company's  proprietary
CMOS   stabilization   methods  expire  in  February  2007  and  December  2007,
respectively.

       The Company has granted a license to  Tektronix  with  respect to patents
obtained in the acquisition of the STS Division of Textronix,  and certain other
intellectual property rights (collectively, the "Tektronix Rights"), including a
patent   covering  one  of  the   Company's   proprietary   CMOS   stabilization
technologies,  that were assigned to the Company by Tektronix in 1993. Tektronix
has  a  worldwide,   perpetual,   irrevocable,   non-exclusive,   royalty  free,
fully-paid,  sublicensable  and  transferable  license to the Tektronix  Rights.
Tektronix may not grant rights under the Tektronix  Rights to make, use, sell or
otherwise   distribute   ATE  for   testing   ICs  to  any  entity   other  than
Sony-Tektronix,  a Tektronix  joint  venture  affiliate  that does not currently
offer production ATE, and to a successor-in-interest to Tektronix. Tektronix may
not  grant  or  assign  such  rights  to any  other  party  that  is a  Credence
competitor.   In  addition,   Tektronix  may  not  knowingly   sell   components
incorporating the Tektronix Rights to any other party. The Company and Tektronix
have granted to each other a worldwide, perpetual,  irrevocable,  non-exclusive,
royalty  free,  fully-paid,   sublicensable  and  transferable  license  to  all
improvements,  enhancements,  modifications  or derivative  works created before
August 1996  ("Improvements")  of  intellectual  property  that was  licensed or
assigned pursuant to a Technology  Agreement dated December 31, 1990, as amended
on August 12, 1993,  including the Tektronix  Rights,  to make, use and sell ATE
for testing ICs.  Tektronix's license to the Improvements is subject to the same
restrictions as its license to the Tektronix Rights.

       The Company attempts to protect its intellectual  property rights through
patents,  copyrights,  trademarks  and  maintenance  of trade  secrets and other
measures.  There can be no assurance that others will not independently  develop
equivalent  intellectual  property or that the Company can meaningfully  protect
its  intellectual  property.  There can be no assurance that any patent owned by
the Company will not be invalidated, circumvented or challenged, that the rights
granted  thereunder will provide  competitive  advantages to the Company or that
any of the Company's pending patent  applications  will be issued.  Furthermore,
there  can be no  assurance  that  others  will not  develop  similar  products,
duplicate  the  Company's  products or design  around the  patents  owned by the
Company.  In addition,  litigation  has been and may continue to be necessary to
enforce the Company's patents and other intellectual property rights, to protect
the  Company's  trade  secrets,  to  determine  the  validity  and  scope of the
proprietary  rights of others,  or to defend against claims of  infringement  or
invalidity.   For   additional   information   with  respect  to  the  Company's
intellectual   property,   review  the   information   set  forth   under  "Risk
Factors-Proprietary Rights."

Manufacturing and Suppliers
---------------------------

       The Company's  manufacturing objective is to produce ATE that conforms to
its customers'  requirements at the lowest commercially practical  manufacturing
cost.  Credence relies on outside vendors to manufacture  certain components and
subassemblies including several custom integrated circuits. The Company seeks to
manage  its  inventory  levels  through   agreements  with  both  suppliers  and
subcontractors  that  provide  just-in-time  delivery  of these  components  and
subassemblies.  The Company  assembles  these  components and  subassemblies  to
create  finished  testers in the  configuration  specified by its customers.  In
general,  Credence uses standard  components and  prefabricated  parts available
from numerous suppliers. However, certain components and subassemblies necessary
for the  manufacture of the Company's  testers are obtained from a sole supplier
or a limited  group of suppliers and the Company is in the process of qualifying
a second  source for some of those  components.  There can be no assurance  that
such  alternative  source will be qualified  or  available  to the Company.  The
Company's  reliance  on a sole or a limited  group of  suppliers  and on outside
subcontractors involves certain risks, including a potential inability to obtain
an adequate supply of required components,  and reduced control over pricing and
timely  delivery of components.  See "Risk Factors - Limited  Sources of Supply;
Reliance on Sub-contractor."

                                       10
<PAGE>

Competition
-----------

     The ATE  industry is  intensely  competitive.  Credence  faces  substantial
competition  throughout the world,  primarily from ATE manufacturers  located in
the United States,  Europe and Japan,  as well as from certain of its customers.
The Company's  competitors in the digital  semiconductor  testing market include
Advantest  Corporation  ("Advantest"),  Ando Electric Co., Ltd., LTX Corporation
("LTX"), Schlumberger Ltd. ("Schlumberger"),  Hewlett-Packard Company ("HP") and
Teradyne, Inc. ("Teradyne").  In the mixed-signal  semiconductor testing market,
the  Company's  competitors  include  Teradyne,   LTX,  HP,  Schlumberger,   and
Advantest.  In the non-volatile memory testing market the Company's  competitors
include  Teradyne,  HP and  Advantest.  See "Risk  Factors - Highly  Competitive
Industry."

       The principal  elements of competition  in the Company's  markets and the
basis upon which ATE customers  select  testers  include  throughput,  tools for
reducing customer product time-to-market,  product performance and total cost of
ownership. The Company believes that it competes favorably with respect to these
factors.

Employees
---------

       As of  October  31,  1998,  the  Company  had a total  of 646  employees,
including 160 engaged in manufacturing,  167 in research and development,  60 in
applications,   175  in  sales,   marketing  and  service,  and  84  in  general
administration.  Many of the  Company's  employees are highly  skilled,  and the
Company  believes its future results of operations  will depend in large part on
its  ability  to  attract  and  retain  such  employees.  None of the  Company's
employees are represented by a labor union,  and the Company has not experienced
any work stoppages. The Company considers its employee relations to be good.


RISK FACTORS

Fluctuations in Our Quarterly Net Sales and Operating Results
-------------------------------------------------------------










    [ GRAPH SHOWING THE COMPANY'S NET SALES AND QUARTERLY NET INCOME (LOSS) ]
      [ FOR THE THREE FISCAL YEARS ENDED OCTOBER 31, 1998, IN $ MILLIONS. ]










       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 a number of
reasons,  including:

      o   economic  conditions  in  the  semiconductor  industry   in  general
          capital equipment industry specifically;
      o   timing of new product announcements and new product releases by us  
          or our competitors;


                                       11
<PAGE>



      o   market acceptance of our new products and enhanced version of existing
          products;
      o   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;
      o   manufacturing capacity and  ability to volume produce systems and meet
          customer requirements; 
      o   write-offs of excess and obsolete inventories, and uncollectible
          receivables;
      o   patterns of capital spending  by our customers,  delays, cancellations
          or  rescheduling  of  customer  orders  due  to  customer   financial 
          difficulties or otherwise;
      o   changes in  overhead absorption levels due to changes in the number of
          systems manufactured, the timing  and shipment of orders, availability
          of  components  including  customs ICs,  subassemblies  and  services,
          customization and reconfiguration  of systems and product reliability;
      o   expenses associated with acquisitions and alliances;
      o   operating expense reductions, including  costs  relating to facilities
          consolidations  and related  expenses;
      o   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, product discounts; and
      o   natural  disasters,  political and  economic  instability  regulatory 
          changes and outbreaks of hostilities.

       We  presently   intend  to  introduce   many  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:

      o   manufacturing  inefficiencies;
      o   pricing  concessions   by us and our competitors  and pricing  by  our
          suppliers;
      o   hardware and software product sales mix;
      o   inventory write-downs;
      o   production volume;
      o   new product introductions;
      o   product reliability;
      o   absorption levels and the rate of capacity utilization;
      o   customization and reconfiguration of systems; and 
      o   international and domestic sales mix and field service margins.

       New and enhanced products typically have lower gross margins in the early
stages of commercial introduction and production.  Although we have recorded and
continue  to  record  provisions  for  estimated  sales  returns,  uncollectible
accounts,  and product  warranty  costs, we cannot be certain that our estimates
will be  adequate.  We may be required to record  charges in future  quarters to
reflect, in part, the cost of additional facilities consolidation, as it occurs.

       We  cannot  forecast  with any  certainty  the  impact of these and other
factors on our sales and operating  results in any future  period.  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,  among other factors,  will
make  it  difficult  for  us to  reduce  our  significant  fixed  expenses  in a
particular  period if we don't meet our net sales  goals for that  period.  As a
result,  we cannot be certain  that we will become  profitable  again or that we
will not continue to sustain losses in the future. We believe that we will incur
a net loss in the next  several  quarters  of fiscal  1999.  Due to all of these
things,  our  operating  results  are likely to continue to be below the initial
expectations  of public market  analysts and investors,  as they were frequently
during the last  several  quarters.  If so,  the price of our  Common  Stock may
continue to be materially adversely affected.

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

       We  derive a  substantial  portion  of our net  sales  from the sale of a
relatively  small number of systems that typically  range in price from $350,000
to $3.6 million,  other than certain memory products and software products,  for


                                       12
<PAGE>

which the price range is typically below $50,000. As a result, our net sales and
operating results for a particular period could be 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 even 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.  In addition,  orders in backlog are subject to  cancellation,
delay,  deferral or  rescheduling  by customers  with  limited or no  penalties.
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 that the order is received. Our backlog as of October 31, 1998,
has decreased by approximately 67% since October 31, 1997.

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

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

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

       We have experienced  shipment delays,  delays in commitments and purchase
order   restructurings   by  several   customers   and  we  expect   delays  and
restructurings may 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 be adversely affected
by any factor  adversely  affecting  the  semiconductor  industry  in general or
particular  segments  within  the  semiconductor   industry.  The  recent  Asian
financial  crisis has contributed to a widespread  uncertainty and a slowdown in
the  semiconductor  industry.  This slowdown in the  semiconductor  industry has
resulted in reduced spending for semiconductor capital equipment,  including ATE
which the Company sells. This industry slowdown has had and may continue to have
a material adverse effect on the Company's  product  backlog,  balance sheet and
results of operations.  Therefore,  there can be no assurance that the Company's
operating  results  will not  continue to be  materially  adversely  affected if
downturns or slowdowns in the semiconductor  industry continue or occur again in
the future.

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

       We have over the last several years experienced significant  fluctuations
in our operating results.  In fiscal 1998, we generated revenue of $82.4 million
for the first  quarter and $22.4 million for the fourth  quarter,  a decrease of
73%. Since 1993,  except for cost-cutting  efforts during the past two years, we
have overall  significantly  increased the scale of our operations in general to
support  periods of 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 R&D to support product development,  our establishment of a joint
venture  with  Innotech  and  numerous  acquisitions.  However,  in the past and
including the three quarters ended October 31, 1998, as discussed above, we have
experienced significant revenue declines and reductions in our operations. These
fluctuations  in our sales and operations  have placed 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


                                       13
<PAGE>

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  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.

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

       We are  currently  devoting and intend to continue to devote  significant
resources to the  development  of new products and  technologies.  During fiscal
1999,  we  intend  to  evaluate  these new  products  and to invest  significant
resources in plant and equipment,  leased facilities,  inventory,  personnel and
other costs, to begin or prepare to increase production of these products and to
provide the marketing,  administration and after-sales  service and support,  if
any,  required to service and support these new hardware and software  products.
Accordingly,  we cannot be certain that gross profit margin and inventory levels
will not  continue to be adversely  impacted by continued  delays in new product
introductions  or start-up  costs  associated  with the initial  production  and
installation of these new product lines. These 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  hardware and software
product  development and customer support  requirements  have increased and will
continue to increase the risk of inventory write-offs. We cannot be certain that
operating  expenses will not increase,  relative to sales, as a result of adding
additional marketing and administrative personnel, among other costs, to support
our additional products. If we are unable to achieve significantly increased net
sales or if sales fall below  expectations,  our operating results will continue
to be  materially  adversely  affected.  We cannot be certain that our net sales
will  increase  or  remain at recent  levels  or that any new  products  will be
successfully commercialized or contribute to revenue growth.

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

       We obtain certain  components,  subassemblies and services  necessary for
the  manufacture  of our testers from a limited  group of  suppliers.  We do not
maintain  long-term  supply  agreements with most of our vendors and we purchase
most of our components and subassemblies through individual purchase orders. The
manufacture  of certain of our  components  and  subassemblies  is an  extremely
complex  process.  We also  rely  on  outside  vendors  to  manufacture  certain
components and subassemblies  and to provide certain services.  We have recently
experienced  and continue to  experience  significant  reliability,  quality and
timeliness  problems with several critical  components  including certain custom
integrated  circuits.   In  addition,  we  and  certain  of  our  subcontractors
periodically  experience significant shortages and delays in delivery of various
components and subassemblies.  We cannot be certain that these or other problems
will  not  continue  to occur  in the  future  with  our  suppliers  or  outside
subcontractors.  Our  reliance on a limited  group of  suppliers  and on outside
subcontractors  involves  several  risks,  including  an  inability to obtain an
adequate supply of required  components,  subassemblies and services and reduced
control over the price, timely delivery,  reliability and quality of components,
subassemblies and services.  Shortages,  delays,  disruptions or terminations of
the  sources  for these  components  and  subassemblies  have  delayed and could
continue to delay  shipments of our systems and new products and could  continue
to have a  material  adverse  effect on our  business,  financial  condition  or
results of operations.  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 such 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.

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

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

                                       14
<PAGE>

       We face substantial  competition throughout the world, primarily from ATE
manufacturers located in the United States, Europe and Japan, as well as several
of our customers.  Many competitors  have  substantially  greater  financial and
other resources with which to pursue engineering,  manufacturing,  marketing and
distribution of their products.  Certain competitors have recently introduced or
announced new products with certain performance or price  characteristics  equal
or superior to certain  products we  currently  offer.  These  competitors  have
recently  introduced  products that compete  directly  against our products.  We
believe that if the ATE  industry  continues to  consolidate  through  strategic
alliances  or  acquisitions,  we will  continue to face  significant  additional
competition  from larger  competitors  that may offer product lines and services
more  complete  than  ours.  Our  competitors  are  continuing  to  improve  the
performance   of  their   current   products  and  to  introduce  new  products,
enhancements  and new  technologies  that provide improved cost of ownership and
performance characteristics.  New product introductions by our competitors could
continue  to cause a decline  in our sales or loss of market  acceptance  of our
existing products.

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

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

       The ATE market is subject to rapid  technological  change. Our ability to
compete in this  market  depends  upon our ability to  successfully  develop and
introduce  new  hardware  and software  products  and  enhancements  and related
software  tools with  greater  features  on a timely and  cost-effective  basis,
including the products under development that we acquired in the EPRO merger and
the Summit,  Zycad and HPL product  line  acquisitions.  Our  customers  require
testers and software  products with additional  features and higher  performance
and other capabilities. We are therefore required to enhance the performance and
other  capabilities  of our existing  systems and software  products and related
software tools.  Any success we may have in developing new and enhanced  systems
and software  products  and new  features to our  existing  systems and software
products will depend upon a variety of factors, including:

      o   product selection;
      o   timely and efficient completion of product design;
      o   implementation of manufacturing and assembly processes;
      o   successful coding and debugging of software;  
      o   product performance; 
      o   reliability in the field; and
      o   effective sales and marketing.

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

       Significant  delays can occur  between the time we introduce a system and
the time we are able to  produce  that  system  in  volume.  We have in the past
experienced significant delays in the introduction,  volume production and sales
of  our  new  systems  and  related  feature   enhancements  and  are  currently


                                       15
<PAGE>

experiencing  significant delays in the introduction of our Valstar, Quartet and
Kalos series testers as well as certain  enhancements to our existing SC and DUO
series  testers.  These delays have been  primarily  related to our inability to
successfully  complete product hardware and software engineering within the time
frame originally anticipated, including design errors and redesigns of ICs. As a
result,  certain customers have experienced  significant delays in receiving and
using certain of our testers in  production.  We cannot be certain that these or
additional  difficulties will not continue to arise or that such delays will not
continue to materially adversely affect customer relationships and future sales.
Moreover,  we  cannot  be  certain  that we will  not  encounter  these or other
difficulties that could delay future introductions or volume production or sales
of our systems or enhancements  and related software tools. We have incurred and
may   continue  to  incur   substantial   unanticipated   costs  to  ensure  the
functionality  and  reliability of our testers and to increase  feature sets. If
our systems  continue to have  reliability,  quality or other  problems,  or the
market perceives certain of our products to be feature deficient,  we may suffer
reduced  orders,  higher  manufacturing  costs,  delays in  collecting  accounts
receivable  and higher  service,  support and  warranty  expenses,  or inventory
write-offs,  among other effects.  Our failure to have a competitive  tester and
related  software tools available when required by a semiconductor  manufacturer
could  make it  substantially  more  difficult  for us to sell  testers  to that
manufacturer  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.

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

       One customer, Spirox Corporation, (a distributor in Taiwan) accounted for
34%, 30% and 25% of our net sales in fiscal 1998, 1997, and 1996,  respectively.
Consequently,  our business, financial condition and results of operations could
be  materially  adversely  affected by the loss of or any reduction in orders by
this or any other  significant  customer,  including losses or reductions due to
continuing or other technical,  manufacturing  or reliability  problems with our
products  or  continued  slow-downs  in the  semiconductor  industry or in other
industries that manufacture  products utilizing  semiconductors.  Our ability to
maintain or increase sales levels will depend upon:  

     o    our ability to obtain orders from existing and new customers;  
     o    our ability to manufacture systems on a timely and cost-effective
          basis; 
     o    our ability to complete the development of our new hardware and 
          software products; 
     o    our customers' financial condition and success; 
     o    general economic conditions; and
     o    our ability to meet increasingly stringent customer performance and 
          other requirements and shipment delivery dates.

       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 testers are subject
to a variety of factors we cannot control. In addition, the decision to purchase
a tester  generally  involves a  significant  commitment  of  capital,  with the
attendant delays frequently  associated with significant  capital  expenditures.
For these and other reasons,  our systems have lengthy sales cycles during which
we may  expend  substantial  funds  and  management  effort  to  secure  a sale,
subjecting  us to a number of  significant  risks.  We cannot be certain that we
will be able to maintain or increase  net sales in the future or that we will be
able to retain existing customers or attract new ones.

Risks Associated with Acquisitions
----------------------------------

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


                                       16
<PAGE>

acquisitions  properly,  the U.S. Securities and Exchange Commission (the "SEC")
has recently been  reviewing more closely the  accounting  for  acquisitions  by
companies,  particularly  in the area of  "in-process"  research and development
costs. If we are required by the SEC to restate any charge that we recognized in
an  acquisition  so far,  that  could  result in a lesser  charge to income  and
increased  amortization expense, which could also have a material adverse effect
on our business, financial condition and results of operations.

       In addition, acquisitions involve numerous other risks, including:
       
      o    difficulties  assimilating the  operations,  personnel, technologies
           and products of the acquired companies;  
      o    diversion of our management's attention from other business concerns;
      o    risks of entering  markets in which we have no or limited experience;
           and
      o    the potential loss of key employees of the acquired companies.

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

Changes in Financial Accounting Standards and Accounting Estimates
------------------------------------------------------------------

       We prepare our financial  statements to conform with  generally  accepted
accounting  principles  ("GAAP").  GAAP are  subject  to  interpretation  by the
American Institute of Certified Public  Accountants,  the SEC and various bodies
formed to interpret  and create  appropriate  accounting  policies.  A change in
those policies can have a significant  effect on our reported  results,  and may
even  affect  our  reporting  of  transactions  completed  before  a  change  is
announced.  Accounting  policies  affecting  many other aspects of our business,
including  rules  relating to purchase and  pooling-of-interests  accounting for
business  combinations,  employee stock purchase plans and stock options grants,
have recently  been revised or are under  review.  Changes to those rules or the
questioning  of  current  practices  may have a material  adverse  effect on our
reported financial results or on the way we conduct our business.

       In addition,  our preparation of financial  statements in accordance with
GAAP requires that we make  estimates and  assumptions  that affect the recorded
amounts of assets and liabilities, disclosure of those assets and liabilities at
the date of the financial statements and the recorded amounts of expenses during
the reporting period. A change in the facts and circumstances  surrounding those
estimates  could result in a change to our estimates and could impact our future
operating results.

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

       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 such  personnel  is intense,  and we cannot  ensure
success in attracting or retaining such  personnel.  There may be only a limited
number of persons with the requisite  skills to serve in these  positions and it
may be  increasingly  difficult  for us to hire such  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.

Transition in Our Executive Management
--------------------------------------

       We have experienced several transitions in executive management in recent
years. In conjunction with the departure in December 1998 of our former chairman
and chief executive officer,  our Board of Directors appointed David A. Ranhoff,
executive vice president,  and Dennis P. Wolf,  executive vice president,  chief
financial  officer and secretary,  jointly to the office of the  president.  The
Board also named a new chairman, Dr. William Howard, Jr., and began a search for
a new chief executive  officer.  Mr. Wolf joined us as senior vice president and
chief  financial  officer in March 1998 after the December 1997 departure of the
Company's  previous  chief  financial  officer.  These  transitions  have placed
significant  demands on our operational,  administrative and financial staff and
we  anticipate  that these  demands will increase in the near term. We cannot be
certain that such  transitions  will not have a material  adverse  effect on our
business,  financial  condition  and  results of  operations,  on the way we are
perceived by the market or on the price of our Common Stock.

                                       17
<PAGE>

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

       International  sales accounted for approximately  69%, 70% and 67% of our
total net sales for the fiscal  years 1998,  1997 and 1996,  respectively.  As a
result,  we anticipate that  international  sales will continue to account for a
significant  portion  of our total net sales in the  foreseeable  future.  These
international sales will continue to be subject to certain risks,  including:  o
changes in regulatory requirements;

     o    tariffs and other barriers;

     o    political and economic instability;

     o    an outbreak of hostilities;

     o    integration of foreign operations of acquired businesses;

     o    foreign currency exchange rate fluctuations;

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

     o    potentially adverse tax consequences; and

     o    the possibility of difficulty in accounts receivable collection.


       We are also  subject  to the  risks  associated  with the  imposition  of
domestic  and  foreign  legislation  and  regulations  relating to the import or
export of  semiconductor  equipment.  We cannot  predict  whether the import and
export of our products will be subject to quotas, duties, taxes or other charges
or restrictions imposed by the United States or any other country in the future.
Any of these  factors  or the  adoption  of  restrictive  policies  could have a
material  adverse  effect on our  business,  financial  condition  or results of
operations.  Net sales to the Asia Pacific  region  accounted for  approximately
60%, 66% and 58% of our total net sales in the fiscal years 1998, 1997 and 1996,
and thus demand for our products is subject to the risk of economic  instability
in that region and could continue to be materially adversely affected. Countries
in the Asia Pacific region, including Korea and Japan, have recently experienced
weaknesses in their currency, banking and equity markets. These weaknesses could
continue to adversely  affect  demand for our  products,  the  availability  and
supply of our product  components,  and our consolidated  results of operations.
The current Asian financial  crisis has contributed to a widespread  uncertainty
and a slowdown in the  semiconductor  industry.  This  slowdown  has resulted in
reduced spending on semiconductor capital equipment, including ATE, and has had,
and may  continue to have,  a material  adverse  effect on our product  backlog,
balance sheet and results of operations.

       We are  currently  in the process of assessing  the issues  raised by the
introduction of a single  European  currency  ("Euro")  introduced on January 1,
1999.  While  still  in  the  assessment  phase,  we  do  not  expect  that  the
introduction  and the use of the Euro will have a material adverse effect on our
business, financial condition or results of operations.

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

       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've entered will protect
our  intellectual   property  rights.   Inability  or  failure  to  protect  our
intellectual  property  rights  could have a material  adverse  effect  upon our
business,  financial condition and results of operations.  We have been involved
in  extensive,   expensive  and   time-consuming   reviews  of,  and  litigation
concerning,  patent  infringement  claims.  In  addition,  we have at times been
notified that we may be infringing intellectual property rights of third parties
and we expect to continue to receive notice of such claims in the future.

                                       18
<PAGE>

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

       In July, 1998, inTEST IP Corporation  ("inTEST")  alleged in writing that
one of our products is  purportedly  infringing a patent held by inTEST.  We may
also be obligated to other third  parties  relating to this  allegation.  We are
currently investigating the allegation.  Based in part on the opinion of outside
counsel,  we believe we have  meritorious  defenses to the claims.  However,  we
cannot be certain of success in  defending  this  patent  infringement  claim or
claims for indemnification resulting from infringement claims.

       Certain of our customers have received  notices from Mr. Jerome  Lemelson
alleging that the  manufacture of  semiconductor  products  and/or the equipment
used to manufacture  semiconductor  products infringes certain patents issued to
Mr. Lemelson. We were notified by a customer in 1990 and by a different customer
in late 1994 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
customer  infringes  Mr.  Lemelson's  patents,  such  customer  intends  to seek
indemnification  from us for damages  and other  related  expenses.  We have not
received further communications from such customers regarding these matters.

       We cannot be certain of success  in  defending  current or future  patent
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
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.

Future Capital Needs; Leverage
------------------------------

       Developing and  manufacturing  new ATE systems and enhancements is highly
capital  intensive.  In  order  to be  competitive,  we  must  make  significant
investments in capital equipment,  expansion of operations,  systems, procedures
and controls,  research and development and worldwide training, customer service
and  support,  among many  other  items.  We may be unable to obtain  additional
financing in the future on acceptable  terms,  or at all. In connection with our
issuance in September 1997 of  convertible  promissory  notes ("the Notes"),  we
incurred  $115 million of  indebtedness  which  resulted in a ratio of long-term
debt to total  capitalization  at October  31, 1998 of  approximately  43%. As a
result, our principal and interest obligations have increased substantially. The
degree to which we are leveraged could  materially  adversely affect our ability
to obtain  financing for working  capital,  acquisitions  or other  purposes and
could make our business more  vulnerable to industry  downturns and  competitive
pressures.  Our ability to meet debt service  obligations will be dependent upon
our future performance,  which will be subject to financial,  business and other
factors  affecting our operations,  many of which are beyond our control.  If we
raise additional funds by issuing equity  securities,  our stockholders could be
significantly  diluted.  We may exchange Notes for shares of our common stock or
may refinance or exchange the Notes,  which may also dilute our stockholders and
may make it difficult for us to obtain additional future financing, if needed.

                                       19
<PAGE>

       If we are  unable  to  obtain  adequate  funds,  we may  be  required  to
restructure or refinance our debt or to delay,  scale back or eliminate  certain
of our research and development,  acquisition or manufacturing  programs. We may
also need to obtain funds  through  arrangements  with partners or others and we
may be required to relinquish rights to certain of our technologies or potential
products or other assets.

Year 2000 Readiness
-------------------

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

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

       The  Awareness  phase  consisted  of defining  the Year 2000  problem and
gaining   executive   level  support  and  sponsorship  for  addressing  it.  We
established a Year 2000 program team and created an overall strategy. During the
Assessment phase, we inventoried all internal systems, products and supply chain
partners and  prioritized  each for  renovation.  We believe we have completed a
majority of the Awareness and Assessment  phases;  however,  we will continue to
work in these areas as we complete  our  assessment  of  existing  supply  chain
partners and enter into new supply chain relationships in the ordinary course of
business. Renovation consists of converting, replacing, upgrading or eliminating
systems   that  have  Year  2000   problems.   We  have  begun   Renovation   on
mission-critical  systems  and  have  targeted  completion  by March  31,  1999.
Validation involves ensuring that hardware and software fixes will work properly
in 1999 and beyond and can occur both before and after implementation.  We began
the Validation  phase in late 1998 and will continue  through June 1999 to allow
for thorough testing before the Year 2000. Implementation is the installation of
Year 2000 ready hardware and software  components in a live environment.  We are
in the early stages of the Implementation phase.

       The impact of Year 2000  issues on our  business  will depend not only on
corrective  actions  that we  take,  but also on the way Year  2000  issues  are
addressed by  governmental  agencies,  businesses  and other third  parties that
provide us with  services or data or receive  services or data from us, or whose
financial condition or operational capability is important to us. To reduce this
exposure,   we  have  an  ongoing   process  of   identifying   and   contacting
mission-critical  third party  vendors and other  significant  third  parties to
determine their Year 2000 plans and target dates. Risks associated with any such
third parties  located  outside the United States may be higher insofar as it is
generally  believed that non-U.S.  businesses  may not be addressing  their Year
2000  issues  on as  timely  a basis  as U.S.  businesses.  Notwithstanding  our
efforts, we cannot be certain that we,  mission-critical  third party vendors or
other significant third parties will adequately address their Year 2000 issues.

       We  are   developing   contingency   plans   in  the   event   that   we,
mission-critical  third party vendors or other significant third parties fail to
adequately address Year 2000 issues.  Such plans principally involve identifying
alternative  vendors or  internal  remediation.  We cannot  ensure that any such
plans will fully mitigate any such failures or problems.  Furthermore, there may
be certain mission-critical third parties, such as utilities,  telecommunication
companies, or material vendors for which alternative arrangements or sources are
limited or unavailable.

       Although  it  is  difficult  for  us  to  estimate  the  total  costs  of
implementing  the Plan,  our  preliminary  estimate  is that such  costs will be
approximately  $2.5 million through June 1999 and beyond.  However,  although we
believe that our estimates are reasonable, we cannot be certain, for the reasons
stated in the next  paragraph,  that the actual costs of  implementing  the Plan
will not differ  materially from the estimated  costs. We have incurred costs of
approximately  $500,000  through October 31, 1998 in connection with the Plan. A
significant  portion of total  Year 2000  project  expenses  is  represented  by


                                       20
<PAGE>

existing staff that have been redeployed to this project. We do not believe that
the  redeployment  of existing staff will have a material  adverse effect on our
business,  results  of  operations  or  financial  position.  Nor  do we  expect
incremental  expenses  related  to the Year 2000  project to  materially  impact
operating results in any one period.

       For a number of reasons,  we cannot  predict or  quantify  the extent and
magnitude of the Year 2000 problem as it will affect our business, either before
or for some period after January 1, 2000. Among the most important  reasons are:

     o    lack of control over systems used by third parties critical to our
          operation;

     o    dependence on third party software vendors to deliver Year 2000 
          upgrades in a timely manner; 

     o    complexity of testing inter-connected networks and applications that
          depend on third party networks; and

     o    the uncertainty surrounding how others will deal with liability issues
          raised by Year 2000 related failures.

       For example, we cannot be certain that systems used by third parties will
be Year 2000 ready by January 1, 2000,  or by some  earlier  date,  so as not to
create a material disruption to our business.  Moreover,  the estimated costs of
implementing  the Plan do not take into account the costs, if any, that might be
incurred  as a result of Year  2000-related  failures  that  occur  despite  our
implementation of the Plan.

       Although we are not aware of any material  operational  issues associated
with preparing our internal systems for the Year 2000 or of material issues with
respect to the  adequacy  of  mission-critical  third party  systems,  we cannot
ensure that we will not experience material  unanticipated negative consequences
and/or material costs caused by undetected  errors or defects in such systems or
by our failure to adequately  prepare for the results of such errors or defects,
including  the  costs  of  related  litigation,  if  any.  The  impact  of  such
consequences  could have a material  adverse  effect on our business,  financial
condition or results of operations.

Volatility of Our Stock Price
-----------------------------
       We believe that factors such as announcements of developments  related to
our business,  fluctuations  in our  financial  results,  general  conditions or
developments in the semiconductor and capital equipment industry and the general
economy,   sales  or  purchases   of  our  Common  Stock  in  the   marketplace,
announcements of our  technological  innovations or new products or enhancements
or those of our  competitors,  developments  in  patents  or other  intellectual
property rights, developments in our relationships with customers and suppliers,
or a  shortfall  or changes in  revenue,  gross  margins  or  earnings  or other
financial  results from analysts'  expectations or an outbreak of hostilities or
natural  disasters,  could  continue  to cause the price of our Common  Stock to
fluctuate,  perhaps substantially.  In recent years the stock market in general,
and the market  for  shares of small  capitalization  companies  in  particular,
including ours, have experienced  extreme price  fluctuations,  which have often
been unrelated to the operating performance of affected companies.  For example,
in fiscal 1997,  the price of our Common Stock ranged from a high of $55.00 to a
low of $13.75.  In fiscal 1998, the price of our Common Stock ranged from a high
of $35.25 to a low of $9.31.  The market  price of our Common Stock is likely to
continue  to  fluctuate  significantly  in the  future,  including  fluctuations
unrelated to our performance.

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

ITEM 2.  PROPERTIES

         The  Company   maintains   its  corporate   headquarters   in  Fremont,
California.  This  leased  facility,  totaling  104,400  square  feet,  contains
corporate administration,  sales, marketing,  applications,  engineering,  local
customer support and memory products  manufacturing.  The lease on this facility
expires in June 2004.  The  Company's  digital  and mixed  signal  manufacturing
facilities,  as well as  additional  marketing,  applications,  engineering  and
customer  support  functions,  are located in a 90,000  square foot  facility in
Beaverton,  Oregon.  The lease covering this 90,000 square foot facility expires
in November 2002. An additional  42,000 square foot building  houses  Beaverton,
Oregon sales,  administration and customer service groups under a lease expiring


                                       21
<PAGE>

in February  2001.  The Company's  software  business is primarily  located in a
22,000  square foot building in  Beaverton,  Oregon.  The lease on this building
expires in August 2002. The Company  maintains  various remote sales and service
offices in the United States.

       During  the  first  half of  fiscal  1998  the  Company  entered  into an
agreement  to lease  an  additional  35,000  square  feet of  space in  Fremont,
California  which was  intended  to be used  primarily  for  sales and  service.
Additionally, the Company entered into an agreement covering 175,000 square feet
of space in  Hillsboro,  Oregon which is intended to become the new location for
all of the Company's Oregon  operations  except for its software business and is
scheduled for occupancy by the Company  during the third fiscal quarter of 1999.
The  Company  has,  however,  during the last  three  quarters  of fiscal  1998,
experienced a significant decrease in its net sales as compared to the preceding
quarters and as compared to its expectations at the beginning of fiscal 1998 and
a  corresponding  reduction  in its  anticipated  headcount.  Consequently,  the
Company's  current  facilities  exceed its  current and  anticipated  short term
needs. At October 31, 1998, the Company was in the process of finding  qualified
new or sub- tenants for its vacant 35,000  square foot facility in Fremont,  for
its  currently  occupied  42,000  square foot and 90,000  square foot  Beaverton
facilities and for a portion of its to be occupied  175,000 square foot facility
in  Hillsboro.  The  Company  also  maintains a 14,000  square foot  facility in
Fremont that was  subleased in September,  1998.  The lease and sublease on this
14,000 square foot facility both expire in November, 1999. There is no assurance
that the Company  will be able to sublease  any or all of its excess  facilities
for an amount  that  would  equal or exceed its total  committed  costs for such
facilities and the related leasehold improvements.

       In January 1999, the Company  negotiated the termination of the lease for
its 42,000  square  foot  Beaverton  facility  whereby  the  landlord  agreed to
terminate  the  lease  effective  March,   1999.  As  a  result  of  this  lease
termination,  the Company  will be required to expense  approximately  $750,000,
related  primarily  to lease  termination  fees  and  write-off  of  unamortized
leaseholds.  The Company believes there is a reasonable  likelihood that similar
expenses will be required as the Company finds new or sub- tenants for its other
excess facilities,  or if it is unable to find any such new or sub- tenants. Due
to the  significant  uncertainties  surrounding  the  timing  and amount of such
potential  write-offs,  no accrual for such future  expenses had been made as of
October 31, 1998.

ITEM 3.  LEGAL PROCEEDINGS

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

ITEM 4.       SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS

       None




                                       22
<PAGE>



                      EXECUTIVE OFFICERS AND KEY EMPLOYEES

       The executive  officers and key employees of the Company,  and their ages
and positions as of December 15, 1998, are as follows:
<TABLE>
<CAPTION>

            Name              Age       Position
     <S>                       <C>      <C>        
     Dr. William Howard, Jr.   56       Chairman
     David A. Ranhoff          43       Executive Vice President, Sales and Marketing *
     Dennis P. Wolf            45       Executive Vice President, Chief Financial Officer and Secretary *
     Clyde Armstrong           54       Vice President, Worldwide Sales
     Jerry Bruce               42       Vice President, Treasurer and Corporate Controller *
     Rick Carmichael           50       Senior Vice President, Corporate Marketing
     David K. Cheung           45       Senior Vice President, Engineering
     George W. DeGeer          52       Senior Vice President, Operations
     John DiGirolamo           57       CEO and President of Fluence Technology, Inc.
     Robert E. Huston          57       Vice President, Test Technology
     Dave O'Brien              42       Senior Vice President, Information Technology
</TABLE>

*Executive officer

     Dr.  William  Howard,  Jr.,  has served as a Director of the Company  since
February 1995 and as Chairman  since December 1998. His current term as Director
ends in  2001.  Dr.  Howard  has been a  self-employed  consultant  for  various
semiconductor and  microelectronics  companies since December 1990. From October
1987 to December 1990, Dr. Howard was a senior fellow at the National Academy of
Engineering conducting studies of technology management. Dr. Howard held various
management  positions at Motorola,  Inc. between 1969 and 1987, most recently as
Senior Vice  President  and Director of Research  and  Development.  Dr.  Howard
serves on the boards of directors of VLSI  Technology,  Inc.,  BEI  Electronics,
Inc., Ramtron International,  Inc., and Xilinx, Inc., as well as several private
companies.

       David A.  Ranhoff,  along with Mr.  Wolf,  was named to the Office of the
President in December  1998.  Mr.  Ranhoff  became  Executive  Vice President in
January 1997 and had served as Senior Vice  President,  Sales and Marketing from
July 1996 to January 1997 and as Senior Vice  President,  Sales,  Marketing  and
Service  from  July  1995 to June  1996.  Mr.  Ranhoff  served  as  Senior  Vice
President,  Sales  and  Service  from  August  1993  to  July  1995  and as Vice
President,  Sales from January 1993 to August 1993. He served as Vice President,
European  Operations  from July 1990 to December  1992.  From March 1988 to June
1990,  Mr.  Ranhoff  served as Managing  Director of European  Operations of the
Company and as National  Sales  Manager  from July 1985 to March 1988.  Prior to
joining the Company,  Mr.  Ranhoff  served for eight years in various  sales and
management positions for GenRad, Inc.

       Dennis P. Wolf,  Executive Vice President,  Chief  Financial  Officer and
Secretary,  joined Credence Systems Corporation in March of 1998 and, along with
Mr. Ranhoff, was named to the Office of the President in December 1998. Mr. Wolf
joined  Credence from Centigram  Communications  Corporation  where he began his
tenure as Senior  Vice  President  and Chief  Financial  Officer and then became
acting Chief Executive Officer.  Prior to joining  Centigram,  Mr. Wolf was Vice
President and Chief  Financial  Officer of Pyramid  Technology  after serving as
Vice   President  and  Chief   Financial   Officer  of  Dynacraft,   a  National
Semiconductor  Company.   Additionally,   he  had  held  various  executive  and
managerial positions at Apple Computer and Sun Microsystems.

     Clyde  Armstrong  joined  Credence as Vice  President,  Worldwide  Sales in
October 1996. Prior to joining Credence,  Mr. Armstrong was at LTX/Trillium from
1994 to 1996 as Vice  President and General  Manager of Digital  Business  Unit,
responsible  for  engineering,  marketing and support  operations.  From 1981 to
1984,  Mr.  Armstrong was at Eaton  Corporation  as Vice President of Board Test
Product Group. From 1967 to 1981, Mr. Armstrong worked in International Sales at
Fairchild Test Systems.  Mr. Armstrong has extensive experience working in Asia,
Brazil and Europe  during the past  twenty  years and managed  direct  sales and
support  organizations as well as distributors and sales  representatives  world
wide. Mr. Armstrong  possesses over 30 years of experience in the  semiconductor
industry.

                                       23
<PAGE>

     Jerry Bruce joined  Credence in May 1993 and has served as Vice  President,
Treasurer and  Corporate  Controller  since August 1998,  as Vice  President and
Corporate  Controller  from  March  1998 to  August  1998,  as  Vice  President,
Controller,  Acting Chief Financial  Officer and Secretary from December 1997 to
March 1998, as Vice  President,  Controller  from July 1997 to December 1997, as
Vice President,  Treasurer from January 1995 to July 1997 and as Vice President,
Controller  from May 1993 to January 1995. From June 1988 to May 1993, Mr. Bruce
held various  financial  management  positions at Silicon  Valley Group,  Inc. a
semiconductor  equipment  manufacturer.  From July 1986 to June 1988,  Mr. Bruce
served as Chief Financial Officer of CXR Telcom, Inc. a telecommunications  test
equipment manufacturer. From June 1980 to July 1986, Mr. Bruce held positions of
increasing responsibility in the audit practice of Ernst & Young LLP.

     Richard C. Carmichael rejoined the Company in September 1996 and has served
as Senior Vice  President,  Corporate  Marketing since that time. From September
1995 to December 1995 Mr.  Carmichael  served as Vice  President of Marketing at
Megatest  Corporation and then, after the acquisition of Megatest Corporation by
Teradyne, Inc., Mr. Carmichael held the position of Marketing Manager,  Megatest
Division for Teradyne,  Inc.  until  September  1996. Mr.  Carmichael  served as
Senior Vice  President,  Marketing for the Company from August 1993 until August
1995 and Vice President, Marketing from July 1992 to August 1993. Mr. Carmichael
first  joined  the  Company in  January  1991 and  served as Western  Area Sales
Manager from January 1991 to July 1992.  From January 1989 to December 1990, Mr.
Carmichael  was the Regional  Sales  Manager for the STS Division of  Tektronix.
Prior to joining the Company,  Mr.  Carmichael  served for nine years in various
sales and  marketing  positions,  most  recently as Vice  President of Sales for
Megatest Corporation, a semiconductor test manufacturer

     David K.  Cheung has served as Senior  Vice  President,  Engineering  since
January 1995, as Vice President,  Engineering  from May 1994 to January 1995 and
as Director of Engineering from October 1993 to May 1994. From September 1992 to
October  1993,  Mr.  Cheung served as Director of  Engineering  at  Schlumberger
Technologies, Inc., where he led the development of advanced digital IC testers.
Mr.  Cheung held  various  management  positions  at  Schlumberger  from 1982 to
September 1992.

     George W.  DeGeer has served as Senior  Vice  President,  Operations  since
August,  1996,  as Senior Vice  President,  Manufacturing  from  January 1995 to
August,  1996,  as Vice  President,  Manufacturing  from October 1993 to January
1995, as Director of Manufacturing  from July 1992 to October 1993, and as Vista
Manufacturing  Manager  from  January  1991 to July 1992.  Prior to joining  the
Company, Mr. DeGeer held various manufacturing management positions at Tektronix
for more than twenty years.

     John  DiGirolamo  has served as Chief  Executive  Officer and  President of
Fluence Technology, Inc. ("Fluence" formerly TSSI) since October 1997. From July
1997 to October 1997, Mr. DiGirolamo served as Vice President of Worldwide Sales
and Marketing for Fluence.  Mr. DiGirolamo served as Director of Sales at Summit
Design,  Inc., from May 1996 to July 1997. Mr.  DiGirolamo served at the Company
as Vice  President,  Worldwide  Sales  from  June 1995 to April  1996.  Prior to
joining  the  Company in 1995,  Mr.  DiGirolamo  held a variety of senior  level
positions  within the  industry,  including a tenure at GenRad,  Inc. as General
Manager and Director of Sales & Marketing for Western operations. Mr. DiGirolamo
possesses  over 33 years of experience in the  semiconductor  equipment and test
industry.

     Robert E. Huston has served as Vice President, Test Technology since August
1992.  From February 1983 to August 1992, Mr. Huston was a co-founder and fellow
of Trilium  Corporation and was the architect of the Micromaster  series of test
systems.  Mr.  Huston  was a fellow  at LTX from  August  1988 to  August  1992,
developing  high  frequency  test  strategies.   He  served  in  various  senior
engineering  positions  beginning  in 1967 at  Fairchild  working with a team to
develop the LSI test system.

     David O'Brien has served as Senior Vice President,  Information  Technology
since July 1995. Mr. O'Brien served as Senior Vice President, Marketing from May
1994 to July 1995, as Senior Vice President, Engineering from August 1993 to May
1994 and as Vice  President,  Engineering  from July 1992 to  August  1993.  Mr.
O'Brien served as Vice President,  Beaverton  Business Unit from October 1991 to
July 1992; Vice President, Marketing - Vista from August 1991 to September 1991;
Vice President Software Products from October 1990 to July 1991; Vice President,
Engineering  from July 1987 to  September  1990;  Director of  Engineering  from
October 1986 to June 1987; and Software  Engineering Manager of the Company from
January 1983 to September 1986.

     Officers  serve at the  discretion of the Board of  Directors,  until their
successors  are appointed.  There are no family  relationships  among  executive
officers or directors of the Company.

                                       24
<PAGE>


                                     PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
         MATTERS

       The Company's  common stock is traded on the Nasdaq National Market under
the symbol CMOS. High and low stock prices for the last two fiscal years were:
<TABLE>
<CAPTION>

                                 1998               1997
                            --------------     --------------
         Quarter Ended       High    Low        High    Low
         --------------     ------  ------     ------  ------
         <S>                <C>     <C>        <C>     <C>

         January 31         $35.25  $18.13     $25.75  $13.75
         April 30            34.00   24.87      24.25   13.88
         July 31             28.50   16.87      36.63   15.75
         October 31          20.56    9.31      55.00   26.88
</TABLE>


       There were  approximately 307 stockholders of record at December 5, 1998.
To date,  the Company has not declared or paid any cash  dividends on its common
stock. The Company does not anticipate  paying any dividends on its common stock
in the foreseeable future and, under its current credit agreements, such payment
would require prior bank approval.

ITEM 6.  SELECTED FINANCIAL DATA

       The comparability of the following selected financial data is affected by
a variety of factors,  and this data is  qualified by reference to and should be
read in conjunction with the consolidated financial statements and notes thereto
elsewhere in this Annual Report on Form 10-K and the Management's Discussion and
Analysis of Financial Condition and Results of Operations.
<TABLE>
<CAPTION>
  
                                                                   Year ended October 31,
                                                ----------  ----------   ----------  ---------- ----------
   (in thousands, except per share amounts)        1998        1997         1996        1995       1994
                                                ----------  ----------   ----------  ---------- ----------
   <S>                                          <C>         <C>          <C>         <C>         <C>
   Consolidated Statement of Operations Data:
   Net sales ................................   $ 216,803    $ 204,092   $ 238,788   $ 176,805   $ 118,211
   Operating income (loss) ..................     (42,572)      15,063      54,334      43,817      24,208
   Income (loss) before taxes ...............     (41,270)      18,230      58,267      46,649      24,939
   Net income (loss) ........................     (26,282)      10,693      37,703      30,354      19,193
   Net income (loss) per basic share ........   $   (1.22)   $    0.49   $    1.75   $    1.50   $    1.04

   Net income (loss) per diluted share ......   $   (1.22)   $    0.47   $    1.72   $    1.45   $    0.97

   Consolidated Balance Sheet Data:
   Working capital ..........................   $ 184,606    $ 250,336   $ 144,623   $ 126,395   $  64,101
   Total assets .............................     306,189      358,141     223,042     186,593     103,668
   Long-term debt, less current maturities ..     115,000      115,000        --          --           655
   Retained earnings ........................      68,440       94,722      84,029      46,326      16,604
   Stockholders' equity .....................     150,017      204,911     189,782     150,286      78,213

-------------------------------------------------------------------------------------------------------------------
</TABLE>
Quarterly 1998
<TABLE>
<CAPTION>

   (in thousands, except per share amounts)   1st        2nd        3rd         4th
   (unaudited)
   <S>                                   <C>        <C>        <C>         <C>     
   Net sales .........................   $ 82,375   $ 74,660   $ 37,322    $ 22,446
   Gross profit (loss) ...............     46,937     42,996       (531)      2,045
   Operating income (loss) ...........     13,138     12,832    (49,311)    (19,231)
   Income (loss) before taxes ........     14,096     13,032    (49,318)    (19,080)
   Net income (loss) .................      9,191      8,787    (33,586)    (10,674)
   Net income (loss) per basic share .   $   0.42   $   0.41   $  (1.55)   $  (0.51)
   Net income (loss) per diluted share   $   0.41   $   0.40   $  (1.52)   $  (0.51)
</TABLE>

                                       25
<PAGE>


Quarterly 1997
<TABLE>
<CAPTION>

   (in thousands, except per share amounts)   1st        2nd        3rd*        4th
   (unaudited)
<S>                                      <C>        <C>        <C>         <C>    
   Net sales .........................   $ 40,261   $ 43,355   $ 51,082    $ 69,394
   Gross profit ......................     20,822     24,981     29,444      38,889
   Operating income (loss) ...........        585      4,039       (364)     10,803
   Income before taxes ...............      1,612      4,913        647      11,058
   Net income (loss) .................      1,054      3,286       (897)      7,250
   Net income (loss) per basic share .   $   0.05   $   0.15   $  (0.04)   $   0.33
   Net income (loss) per diluted share   $   0.05   $   0.15   $  (0.04)   $   0.32
</TABLE>


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

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS

Overview
--------

       The  following  discussions  should  be  read  in  conjunction  with  the
consolidated financial statements, and notes thereto, included elsewhere herein.
Certain  of the  statements  contained  in this  Annual  Report  on Form 10-K to
Stockholders  are  forward-looking  statements and involve a number of risks and
uncertainties.

       The Company's 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 the  Company's  results to fluctuate  include  cyclicality  or
downturns in the  semiconductor  market and the markets  served by the Company's
customers,  the timing of new product  announcements and releases by the Company
or its competitors,  market  acceptance of new products and enhanced versions of
the Company's products,  manufacturing  inefficiencies associated with the start
up of new  products,  changes  in  pricing  by  the  Company,  its  competitors,
customers or suppliers,  the ability to volume produce systems and meet customer
requirements, inventory obsolescence, patterns of capital spending by customers,
delays,  cancellations  or  reschedulings  of orders due to  customer  financial
difficulties or otherwise,  expenses associated with acquisitions and alliances,
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.  Due to these and  additional  factors,
historical results and percentage  relationships discussed in this Annual Report
on Form 10-K will not necessarily be indicative of the results of operations for
any future period. For a further discussion of the Company's business,  and risk
factors  affecting  its  results  of  operations,  please  refer to the  section
entitled "Risk Factors" included elsewhere herein.

Results of Operations
---------------------

1998 vs 1997


       NET  SALES.  Net sales  consist  of  revenues  from the sale of  systems,
upgrades,  spare parts,  maintenance contracts and software. Net sales increased
6% to $216.8 million in fiscal 1998 from $204.1 million in fiscal 1997; however,
the  Company's  net sales  decreased  from $82.4 million in the first quarter of


                                       26
<PAGE>

fiscal  1998 to $22.4  million  for the  fourth  quarter  of  fiscal  1998.  The
year-over-year  increase over 1997 was driven  primarily by increased  worldwide
demand  for  semiconductor  automatic  test  equipment  ("ATE"),  including  the
Company's  products,  during the end of calendar  1997 and  including  the first
quarter of the Company's  fiscal 1998.  This was followed by a very  significant
decline in  worldwide  demand  for  semiconductor  ATE,  which led to a material
decline in net sales of the  Company's  products  in the last three  quarters of
fiscal 1998.  During fiscal 1998,  the Company's net sales were also  materially
adversely   affected  by  its   inability  to  complete   three  major   product
introductions,  consisting of the VS2000  high-performance  digital tester,  the
Quartet  high-performance  mixed signal tester and the Kalos memory tester.  The
Company  believes  that its existing  completed  products  were being  primarily
purchased when its customers  required  increased  capacity and that these three
newer products, once completed, will be primarily purchased by customers seeking
increased  functionality  instead of or in addition to increased  capacity.  The
Company  believes  it will be unable to achieve a  significant  increase  in net
sales until either  increased  demand for  semiconductors  causes an increase in
"capacity buys" or until the Company  completes its major product  introductions
and can generate increased "functionality buys" with its newer products.

       International  net sales accounted for approximately 69% and 70% of total
net sales in fiscal 1998 and 1997, respectively.  The Company's net sales to the
Asia Pacific region accounted for  approximately  60% and 66% of total net sales
in  fiscal  1998 and 1997,  respectively,  and thus are  subject  to the risk of
economic  instability  in that region that  materially  adversely  affected  the
demand for the Company's  products in 1998.  Capital  markets in Korea and other
areas of Asia have been highly  volatile,  resulting in economic  instabilities.
These  instabilities may continue or worsen,  which could continue to materially
adversely affect demand for the Company's products.

       GROSS  MARGIN.  The  Company's  gross margin as a percentage of net sales
decreased  to 42.2% in fiscal 1998 from 55.9% in fiscal  1997.  The decrease was
due  primarily  to  special  charges  taken  in  fiscal  1998 as a  result  of a
significant decrease in net sales in the last three quarters of fiscal 1998. The
Company  recorded  special  charges to cost of goods sold in 1998 totaling $28.4
million, consisting primarily of write-offs for excess or obsolete inventory, as
more fully described below. Additionally, gross margins were negatively impacted
due to lower  average  selling  prices  caused by increased  competition  in the
markets  the  Company  serves  and due to  inefficiencies  caused  by the  lower
manufacturing volumes.

       RESEARCH AND DEVELOPMENT.  Research and development ("R&D") expenses as a
percentage  of net  sales  were  21.9%  and  18.3%,  in  fiscal  1998 and  1997,
respectively.  R&D expenses increased to $47.5 million in fiscal 1998 from $37.4
million in fiscal 1997,  reflecting continued  investments in the development of
new products,  as well as  enhancements of existing  product lines.  The Company
currently intends to continue to invest significant resources in the development
of new  products and  enhancements  for the  foreseeable  future;  however,  the
Company  has  taken  steps to  reduce  operating  expenses  in light of  current
industry conditions.

       SELLING, GENERAL AND ADMINISTRATIVE.  Selling, general and administrative
("SG&A")  expenses  increased to $64.2 million in fiscal 1998 from $55.7 million
in fiscal  1997,  an increase  of 15.3%.  The  increase in fiscal 1998  resulted
primarily from marketing  costs  associated with new product  introductions  and
higher operating expenses  associated with acquisitions made during 1998 and the
last half of fiscal 1997,  partially  offset by decreases in expenditures in the
latter  three  quarters of fiscal 1998 as the Company  responded  to the general
downturn  in  the  semiconductor  industry.  During  this  period  of  depressed
revenues,  the  Company  has  undertaken  a project to replace a majority of its
financial,  manufacturing,  distribution,  planning and control systems with the
R/3 system from SAP  America,  Inc.,  and  anticipates  that this system will be
operational  before the end of fiscal 1999.  This project is intended to improve
operational efficiencies to support anticipated future growth in the business.

       IN-PROCESS RESEARCH AND DEVELOPMENT.  In June 1998, the Company purchased
from Heuristics  Physics  Laboratories,  Inc. ("HPL") certain assets and assumed
certain liabilities relating to their memory self test business for $8.0 million
in cash and the  assumption of $0.2 million in  liabilities.  Additionally,  the
Company agreed to make payments to the shareholder  representatives of HPL in an
amount  equal to 10% of the  Company's  net sales of products  derived  from the
assets  acquired  from HPL's design for test  division for a period of two years
following the acquisition.  In connection with the HPL acquisition,  the Company
recognized  $2.0  million  of  acquired   in-process  research  and  development
("IPR&D").  The  remaining  $6.2  million  has been  capitalized,  of which $5.3
million is for purchased  technology and other  intangible  assets which will be
amortized ratably over their estimated useful lives of five years.

       The Company's  management  made certain  assessments  with respect to the
determination  of all  identifiable  assets  resulting  from,  or to be used in,


                                       27
<PAGE>

research and development  activities as of the  acquisition  date. Each of these
activities was evaluated, by both interviews and data analysis, to determine its
state of development and related fair value. The Company's review indicated that
the  IPR&D  had  not  reached  a  state  of  technological  feasibility  and the
underlying  technology  had no  alternative  future use to the  Company in other
research  and  development  projects or  otherwise.  In the case of IPR&D,  fair
values  of the  corresponding  technologies  were  determined  using  an  income
approach,  which included a discounted future earnings  methodology.  Under this
methodology,  the value of the  in-process  technology is comprised of the total
present  value of the  anticipated  after-tax  cash  flows  attributable  to the
in-process  project,  discounted to net present  value,  taking into account the
uncertainty surrounding the successful development of the purchased IPR&D.

       The HPL acquired IPR&D consists of projects  related to memory self test.
These  projects are aimed at the  development  of products that can perform self
testing of on-chip memories, self testing of off-chip memories, automated memory
test vector  generation,  built-in memory repair analysis and built-in automated
memory  circuit  repair.  The Company  estimated that  approximately  50% of the
research and development effort, based on complexity,  had been completed at the
date of the  acquisition.  The significant  work remaining on these projects was
estimated  to take  approximately  16  engineering  person  years,  at a cost of
approximately  $1.3 million and be completed in late fiscal 1999 or early fiscal
2000. As of October 31, 1998, the Company  believed that the projections of time
and cost had not materially  changed. As of the acquisition date, HPL was in the
alpha stage of  development  and required the  resolution of certain memory self
test  technological  hurdles  in order to  complete  the  technology.  The items
remaining to be  addressed  at the  acquisition  date  included  the  following:
expansion  of built-in  self test (BIST)  capability  to address  large  (beyond
mega-bit)  embedded  memories  used  in the  emerging  system-on-a-chip  market,
completion of third generation BIST, automation tools allowing the generation of
user-configurable  test  algorithms  on the active load board of a test  system,
completion of manufacturing  oriented memory BIST architecture enabling parallel
test execution and full  diagnostics for  engineering  debug and yield analysis,
and completion of the first  built-in  redundancy  analyzer,  software to direct
laser repair stations and embedded memory self repair.

       There can be no assurance that these projects will achieve  technological
feasibility  or that the Company will be able to  successfully  market  products
based on such technology.  Should these  in-process  projects fail, the value of
the Company's investment in these incomplete technologies would be diminimous or
zero. A failure to  successfully  develop and market  memory self test  products
could  have a  material  adverse  affect on the  Company's  business,  financial
condition or results of operations.

       During fiscal 1997, the Company  expensed $6.0 million of IPR&D resulting
from the  acquisition  of certain  assets of Summit  Design,  Inc., and Summit's
wholly owned subsidiary, Test Systems Strategies, Inc. (the "TSSI acquisition").
The IPR&D associated with the TSSI  acquisition  related to the development of a
standard tester interface  language  ("STIL").  The STIL development  project is
approximately 35% complete as of October 31, 1998. The significant technological
hurdles  remaining to be  addressed  include:  the ability to parse  mega-vector
files and make them immediately  available to the application program interface;
the ability to effectively  process both batch and online input from engineering
design  automation  ("EDA")  simulation  tools,  the  development  of  efficient
algorithms for taking event data from EDA  simulation  tools and mapping it into
the  limited  resources  of a given ATE system  according  to a standard  set of
rules; and the development of additional STIL constructs which enable the use of
STIL as a design stimulus language, enable the use of STIL for representing test
patterns  for  embedded  cores,  representing  the  test  program  flow in STIL,
representing  test  methods in STIL and  defining  voltage  and  current  levels
associated  with STIL  waveforms.  The Company  estimates that as of October 31,
1998, the remaining  research and development work on the STIL project will take
approximately  13  engineering  person years,  at a cost of  approximately  $2.0
million and will be completed in fiscal 2000.  The project has  progressed  more
slowly than originally  projected due to lower than  anticipated  staffing.  The
lower staffing levels were a result of the Company's  actions to reduce expenses
during a period of reduced revenues and earnings. There can be no assurance that
the Company will be able to complete the development and successful marketing of
any STIL based products. A failure to successfully develop and market STIL based
products  could  have a  material  adverse  effect  on the  Company's  business,
financial condition or results of operations.

       SPECIAL  CHARGES.  In the third and fourth  quarters of fiscal 1998,  the
Company recorded special charges totaling $48.7 million,  of which $28.4 million
was classified as cost of goods sold and the balance was classified as operating
expenses. These charges were recorded as a result of the Company's response to a
major  downturn in the current and forecasted  business  outlook for the ATE and
related  semiconductor and semiconductor  equipment  industries which took place
during the  period.  As a result of this  industry  downturn,  the  Company  has


                                       28
<PAGE>

downsized its operations  including reducing  headcount,  reducing the volume of
products being produced and cancelling and delaying various projects,  including
facilities expansions and certain research and development projects.  The impact
of this  downturn  and  these  decisions  is  that  significant  amounts  of the
Company's inventories,  receivables, fixed assets, prepaid expenses, investments
and purchased  technologies have been impaired and certain liabilities have been
incurred.  As a result, the Company has written down the related assets to their
net realizable values and made provision for the estimated liabilities.

       Of the $48.7 million in charges,  approximately $28.4 million was charged
as cost of goods  sold,  of which  approximately  $26.7  million  was related to
write-down of excess or obsolete inventories. The elements of the charges during
fiscal 1998 are as follows (in thousands):
<TABLE>
<CAPTION>
   
   <S>                                                                <C>
   Write down of inventories to net realizable value
    (including expected losses on supplier commitments) ...........   $26,678
   Write down of excess fixed assets to fair value ................     7,272
   Write down of purchased technology and investments to fair value     5,118
   Write-off of prepaid and other current assets ..................     2,444
   Excess facility costs ..........................................     2,641
   Provision for uncollectible receivables ........................     3,389
   Employee termination benefits and accrued liabilities ..........     1,196
                                                                      -------
                                                                      $48,738
</TABLE>

       At October 31, 1998,  approximately  $4.8 million in accrued  liabilities
related to special charges  remained on the Company's  balance sheet,  primarily
the accrued loss on supplier  commitments of $2.4 million and approximately $1.9
million for rent on excess  facilities.  The cash  expenditures  associated with
these  obligations  will  occur  primarily  in fiscal  1999.  Cash  expenditures
associated  with the  special  charges  during  fiscal  1998 were  approximately
$700,000, relating primarily to excess facilities and to severance costs.

       INTEREST INCOME.  The Company  generated  interest income of $8.5 million
and $4.8 million in fiscal 1998 and 1997, respectively.  The increase was due to
interest earned on  significantly  higher average cash and investments  balances
provided by the  receipt of proceeds  from the  convertible  subordinated  notes
issued in late fiscal 1997.

       INTEREST AND OTHER  EXPENSES.  Interest and other  expenses  increased to
$7.2 million in fiscal 1998 from $1.6 million in fiscal 1997,  primarily  due to
the interest expense on the Company's convertible subordinated notes.

       INCOME TAX. Excluding the impact of in-process  research and development,
the  Company's  effective  tax  rate for  fiscal  1998 and 1997 was 37% and 34%,
respectively.  Excluding the impact of the in-process  research and development,
the tax benefit rate in fiscal 1998  approximated the combined federal and state
statutory rate, while the effective tax rate in 1997 was lower, primarily due to
the benefit of the Company's foreign sales corporation.

       Realization  of a portion of the net  deferred tax assets is dependent on
the Company's  ability to generate  approximately  $30,000,000 of future taxable
income. Management believes that it is more likely than not that the assets will
be realized, based on forecasted income. However, there can be no assurance that
the Company will meet its expectations of future income.  A valuation  allowance
has been  established  in both  fiscal  1998 and 1997 to offset a portion of the
deferred tax assets attributable to the in-process research and development. Due
to the period  over which  these tax  benefits  will be  recognized,  sufficient
uncertainty  exists regarding the  realizability of a portion of these assets to
warrant a valuation allowance. Management will evaluate the realizability of the
deferred  tax assets  quarterly  and assess  the need for  additional  valuation
allowances.

1997  vs.  1996

       NET SALES.  Net sales  decreased  14.5% to $204.1  million in fiscal 1997
from $238.8  million in fiscal  1996.  The  decrease  was  primarily  due to the
effects  of  a  worldwide   downturn  in  the  demand  for  semiconductor   ATE.
International  sales accounted for  approximately 70% in fiscal 1997 compared to
67% in fiscal 1996. The Company's net sales to the Asia Pacific region accounted
for  approximately  66% and 58% of total  net  sales in  fiscal  1997 and  1996,
respectively.

       GROSS  MARGIN.  The  Company's  gross margin as a percentage of net sales
decreased to 55.9% in fiscal 1997 from 59.4% in fiscal 1996.  The decreases were
due primarily to a significant  decrease in revenue  shipments  beginning in the
fourth  fiscal  quarter  of  1996,  which  resulted  in an  underutilization  of


                                       29
<PAGE>

manufacturing  capacity,  offset partially by decreased  expenses resulting from
the resizing of certain areas in  operations.  The fiscal 1997 decrease was also
due in part to inventory write-downs taken for obsolete items as a result of the
Company's introduction of new products and modification and phasing out of older
products.

       RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses as a
percentage of net sales were 18.3% in fiscal 1997 as compared to 14.8% in fiscal
1996,  reflecting  increased  expenses  and lower  net  sales in fiscal  1997 as
compared to fiscal 1996.  Research and development  expenses  increased to $37.4
million in fiscal 1997 from $35.4 million in fiscal 1996,  reflecting  continued
investments  in the  development  of new products,  as well as  enhancements  of
existing product lines.

       SELLING, GENERAL AND ADMINISTRATIVE.  Selling, general and administrative
expenses  increased  7.1% to $55.7  million in fiscal 1997 from $52.0 million in
fiscal  1996.  The increase in fiscal 1997  resulted  primarily  from  marketing
costs, associated with new product introductions,  operating expenses associated
with acquisitions made during the year, costs of increasing the Company's global
infrastructure  such as offices in Southeast  Asia, and legal and other expenses
for patent  litigation  that was  settled in fiscal  1997 and  acquisitions.  In
fiscal 1997, selling, general and administrative expenses as a percentage of net
sales increased over fiscal 1996, due primarily to the reduced net sales.

       IN-PROCESS  RESEARCH AND  DEVELOPMENT.  During  fiscal 1997,  the Company
expensed $6.0 million of IPR&D  resulting from the acquisition of certain assets
of Summit  Design,  Inc.,  and Summit's  wholly owned  subsidiary,  Test Systems
Strategies,  Inc. (the "TSSI  acquisition").  The IPR&D associated with the TSSI
acquisition  related to the development of a standard tester interface  language
("STIL").  The STIL  development  project is  approximately  35%  complete as of
October  31,  1998.  The  significant  technological  hurdles  remaining  to  be
addressed  include:  the  ability  to parse  mega-vector  files  and  make  them
immediately  available  to the  application  program  interface;  the ability to
effectively  process  both  batch  and  online  input  from  engineering  design
automation ("EDA") simulation tools, the development of efficient algorithms for
taking  event data from EDA  simulation  tools and  mapping it into the  limited
resources of a given ATE system  according  to a standard set of rules;  and the
development  of  additional  STIL  constructs  which enable the use of STIL as a
design stimulus language,  enable the use of STIL for representing test patterns
for embedded  cores,  representing  the test program flow in STIL,  representing
test methods in STIL and defining  voltage and current  levels  associated  with
STIL waveforms. The Company estimates that as of October 31, 1998, the remaining
research and  development  work on the STIL project will take  approximately  13
engineering  person years, at a cost of  approximately  $2.0 million and will be
completed in fiscal 2000. The project has progressed more slowly than originally
projected due to lower than anticipated staffing. The lower staffing levels were
a result of the Company's  actions to reduce expenses during a period of reduced
revenues and earnings.  There can be no assurance  that the Company will be able
to complete the development and successful marketing of any STIL based products.
A failure to  successfully  develop and market STIL based  products could have a
material  adverse  effect on the  Company's  business,  financial  condition  or
results of operations.

       INTEREST INCOME.  The Company  generated  interest income of $4.8 million
and $4.2 million in fiscal 1997 and fiscal 1996, respectively.  The increase was
due to interest earned on significantly  higher cash and short-term  investments
balances  provided by operations  and the receipt of proceeds  from  convertible
subordinated  notes, offset in part by cash used to increase accounts receivable
and inventory as well as for capital expenditures and acquisitions.

       INTEREST AND OTHER  EXPENSES.  Interest and other  expenses  increased to
$1.6 million in fiscal 1997 from $0.2 million in fiscal 1996,  primarily  due to
the interest expense on the Company's convertible subordinated notes.

       INCOME TAX. The  effective tax rate of 35% for fiscal 1996 was lower than
the  combined  federal  and state  statutory  rate in effect for that year,  due
primarily  to the  foreign  sales  corporation  benefits.  In fiscal  1997,  the
Company's  effective tax rate increased to 41%, primarily due to the recognition
of only a portion of the tax benefit associated with the in-process research and
development  charge.  In-process research and development amounts are deductible
over an  extended  period of time,  and  therefore,  a valuation  allowance  was
established to offset a portion of the resulting deferred tax asset.

Year 2000 Readiness
-------------------

       The "Year  2000" issue  results  from the use in  computer  hardware  and
software of two digits  rather than four digits to define the  applicable  year.
When computer  systems must process dates both before and after January 1, 2000,
two-digit year "fields" may create processing  ambiguities that can cause errors


                                       30
<PAGE>

and system failures. The results of these errors may range from minor undetected
errors to the complete shutdown of an affected system.  These errors or failures
may have limited  effects,  or the effects may be  widespread,  depending on the
computer chip, system or software, and its location and function. The effects of
the Year 2000 problem are exacerbated because of the interdependence of computer
and  telecommunications  systems in the United States and  throughout the world.
Because  of this  interdependence,  the  failure  of one  system may lead to the
failure of many other  systems,  even though the other  systems  are  themselves
"Year 2000 compliant."

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

       The  Awareness  phase  consisted  of defining  the Year 2000  problem and
gaining  executive-level  support and sponsorship for addressing it. A Year 2000
program  team was  established  and an  overall  strategy  created.  During  the
Assessment phase, all internal systems,  products and supply-chain partners were
inventoried  and  prioritized  for  renovation.  The  Company  believes  it  has
completed a majority of the Awareness and Assessment  phases;  however,  ongoing
work will be required in these areas as the Company  completes its assessment of
existing supply-chain partners and enters into new supply-chain relationships in
the ordinary course of business.  Renovation consists of converting,  replacing,
upgrading or eliminating  systems that have Year 2000  problems.  Renovation has
begun on  mission-critical  systems and is targeted for  completion by March 31,
1999.  Validation  involves  ensuring that hardware and software fixes will work
properly in 1999 and beyond and can occur both before and after  implementation.
Validation started in late 1998 and will continue through June 1999 to allow for
thorough  testing before the Year 2000.  Implementation  is the  installation of
Year 2000 ready  hardware and software  components  in a live  environment.  The
Company is in the early stages of the Implementation phase.

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

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

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

       The extent and  magnitude  of the Year 2000 problem as it will affect the
Company, both before and for some period after January 1, 2000, are difficult to
predict or quantify for a number of reasons.  Among the most  important are lack
of control over  systems that are used by third  parties who are critical to the
Company's operation,  dependence on third-party software vendors to deliver Year
2000 upgrades in a timely manner, complexity of testing inter-connected networks
and  applications  that  depend  on  third-party  networks  and the  uncertainty
surrounding  how  others  will deal with  liability  issues  raised by Year 2000


                                       31
<PAGE>

related failures.  There can be no assurance,  for example, that systems used by
third  parties  will be Year 2000 ready by January 1, 2000,  or by some  earlier
date,  so as not to create a  material  disruption  to the  Company's  business.
Moreover,  the estimated costs of implementing the Plan do not take into account
the costs,  if any,  that  might be  incurred  as a result of Year 2000  related
failures that occur despite the Company's implementation of the Plan.

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

Introduction of the Euro
------------------------

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

Liquidity and Capital Resources
-------------------------------

       In fiscal 1998,  the Company's  operations  provided $10.2 million in net
cash,  primarily as a result of cash  generated  from the $26.3 million net loss
after  reconciling  the non-cash  impact of special charges of $48.7 million and
depreciation  and amortization of $21.1 million.  Additionally,  the increase in
the  Company's  deferred  income taxes  provided  cash of $10.5  million.  These
amounts  were  partially  offset by the use of cash caused by changes in working
capital  accounts.  The decrease in accounts  receivable  provided cash of $18.0
million,  primarily as a result of lower fourth  quarter sales volumes year over
year.  During  fiscal  1998,  the  Company  purchased  product  licenses of $7.6
million,  thereby utilizing restricted cash. The increase in inventories,  which
utilized cash of $31.1  million,  was due in part to the Company's  inability to
anticipate the drop in demand which occurred during the year, and in part due to
purchases  of  inventories  for new  products  which  subsequently  did not meet
revenue  expectations,  due  primarily to  engineering  delays.  The increase in
prepaid expenses and other current assets, which utilized cash of $19.4 million,
was due  primarily  to the increase of $18.7  million in prepaid and  refundable
income taxes,  which was caused  primarily by the Company's net loss. A decrease
in accounts payable, primarily due to reduced purchases of inventories, provided
cash of $5.3 million.

       Net cash  used in  investing  activities  during  fiscal  1998 was  $65.0
million. Net purchases of available-for-sale  securities were $40.0 million. Net
acquisitions  of property and  equipment  were $11.3  million and an  additional
$15.0 million of cash was used to purchase other assets.

       Net cash used in financing  activities of $30.0 million was primarily due
the use of $32.8  million to  repurchase  the  Company's  common  stock,  offset
partially by issuances of common stock under the Company's  equity benefit plans
totaling $3.2 million.  As of October 31, 1998, the Company's  principal sources
of liquidity  consisted of $133.9 million in cash, cash equivalents,  restricted
cash and available-for-sale securities,  compared with $186.3 million at October
31, 1997. The Company has $40.0 million  available under its unsecured bank line
of credit  expiring  in July 1999.  At October 31,  1998,  there were no amounts
outstanding  under these  agreements.  Borrowings  are subject to the  Company's
compliance with financial and other  covenants.  The Company  received  waivers,
effective October 31, 1998, of compliance with certain  financial  covenants and
has  subsequently  renegotiated  the applicable  financial  covenants  under the
credit facility.  The Company has outstanding debt of $115.0 million  consisting
of convertible subordinated notes, due in 2002. Additionally,  as of October 31,
1998,  the  Company  has  operating  leases  for  facilities  and test and other
equipment  totaling  approximately  $47.5 million due through 2014.  The Company
expects that its  existing  cash and  investments  balances,  together  with its
current or successor line of credit and  anticipated  cash flow from  operations
will satisfy its financing requirements for at least the next 12 months.

       The Company  believes that because of the relatively  long  manufacturing
cycles of many of its testers and the new  products it has and plans to continue
to  introduce,   investments  in  inventories   will  continue  to  represent  a
significant  portion of working  capital.  Significant  investments  in accounts
receivable and  inventories  subject the Company to increased  risks,  and could
continue  to  materially  adversely  affect the  Company's  business,  financial


                                       32
<PAGE>

condition and results of operations. 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 the Company.  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 the Company's  estimate of the net  realizable  value of  receivables,
inventories or other assets,  and the adequacy of costs accrued for warranty and
other liabilities.  Such changes could materially adversely affect the Company's
business, financial condition and results of operations.


ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK


       The  Company's  exposure to market  risk for  changes in  interest  rates
relates  primarily to the Company's  investment  portfolio  and  long-term  debt
obligations.  The Company maintains a strict investment policy which ensures the
safety and preservation of its invested funds by limiting  default risk,  market
risk, and  reinvestment  risk. The Company's  investments  consist  primarily of
commercial  paper,  medium term notes,  asset backed  securities,  U.S. Treasury
notes and obligations of U.S. Government agencies, bank certificates of deposit,
auction rate preferred  securities,  corporate  bonds and municipal  bonds.  The
table below  presents  notional  amounts and related  weighted-average  interest
rates by year of maturity for the Company's  investment  portfolio and long-term
debt obligations (in thousands, except percentages).
<TABLE>
<CAPTION>
                                  1999       2000        2001       2002        2003    Thereafter
<S>                           <C>         <C>          <C>       <C>         <C>        <C>
Cash equivalents
    Fixed rate                $  42,379           -          -           -          -           -
    Average rate                   5.04%          -          -           -          -           -
Restricted cash
    Fixed rate                    2,400           -          -           -          -           -
    Average rate                   4.11%          -          -           -          -           -
Short term investments
    Fixed rate                $  62,777           -          -           -          -           -
    Average rate                   5.74%          -          -           -          -           -
Long term investments
    Fixed rate                        -   $  20,357          -           -          -           -
    Average rate                      -        5.81%         -           -          -           -
                               ---------   ---------   --------   ---------   --------   ---------
Total investment securities   $ 107,556   $  20,357    $     -   $       -   $      -   $       -
Average rate                       5.43%       5.81%

Long term debt                        -           -          -   $ 115,000          -           -
    Fixed rate
    Average rate                      -           -          -        5.25%         -           -
</TABLE>

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

       The Company has no cash flow  exposure  due to rate  changes for its $115
million Convertible  Subordinated Notes. The Company has a $40.0 million line of
credit  under  which it can  borrow  either  at the  bank's  prime  rate or as a
function  of the  LIBOR  rate.  As of  October  31,  1998,  the  Company  had no
borrowings under its line of credit.



                                       33
<PAGE>




ITEM 8.       FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

For the years ended October 31, 1998, 1997 and 1996

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


                                                                            Page
Report of Ernst & Young LLP, Independent Auditors                            35

Consolidated Balance Sheets 
     -- October 31, 1998 and 1997                                            36

Consolidated Statements of Operations 
     -- Years Ended October 31, 1998, 1997 and 1996                          37

Consolidated Statements of Stockholders' Equity
     -- Years Ended October 31, 1998, 1997 and 1996                          38

Consolidated Statements of Cash Flows 
     -- Years Ended October 31, 1998, 1997 and 1996                          39

Notes to Consolidated Financial Statements                                   40



                                       34
<PAGE>



REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS


The Board of Directors and Stockholders
Credence Systems Corporation

       We have audited the accompanying  consolidated balance sheets of Credence
Systems   Corporation  as  of  October  31,  1998  and  1997,  and  the  related
consolidated statements of operations,  stockholders' equity, and cash flows for
each of the three years in the period ended  October 31,  1998.  Our audits also
included  the  financial  statement  schedule  listed in the  Index  14(a).These
financial  statements and this schedule are the  responsibility of the Company's
management.  Our  responsibility  is to express  an  opinion on these  financial
statements and this schedule based on our audits.

       We conducted our audits in accordance  with generally  accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

       In our opinion,  the consolidated  financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Credence Systems  Corporation at October 31, 1998 and 1997, and the consolidated
results of its  operations and its cash flows for each of the three years in the
period ended October 31, 1998, in conformity with generally accepted  accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered  in  relation  to the basic  financial  statements  taken as a whole,
presents fairly, in all material respects, the information set forth therein.


                                                  /s/  ERNST & YOUNG LLP



San Jose, California
November 25, 1998



                                       35
<PAGE>


                          CREDENCE SYSTEMS CORPORATION

                           CONSOLIDATED BALANCE SHEETS
                    (in thousands, except per share amounts)
                                                                           
<TABLE>
<CAPTION>
                                                                                                      October 31,
ASSETS                                                                                             1998         1997
                                                                                                   ----         ----
<S>                                                                                             <C>          <C>   
Current assets:
     Cash and cash equivalents ..............................................................   $  48,391    $ 132,761
     Restricted cash ........................................................................       2,400       10,002
     Short-term investments .................................................................      62,777       35,013
     Accounts receivable, net of allowance for doubtful accounts of $5,409 and $1,763 in 1998
         and 1997, respectively .............................................................      33,901       55,246
     Inventories ............................................................................      37,406       42,125
     Deferred income taxes ..................................................................      16,609        5,853
     Prepaid expenses and other current assets ..............................................      24,067        7,148
                                                                                                ---------    ---------
         Total current assets ...............................................................     225,551      288,148
Long-term investments .......................................................................      20,357        8,561
Property and equipment, net .................................................................      41,764       43,050
Other assets, net of accumulated amortization of  $10,102 and $5,043 in 1998 and 1997,
     respectively ...........................................................................      18,517       18,382
                                                                                                ---------    ---------
         Total assets .......................................................................   $ 306,189    $ 358,141
                                                                                                =========    =========

LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities:
     Accounts payable .......................................................................   $   8,090    $  13,182
     Accrued expenses and other liabilities .................................................      26,978       20,346
     Income taxes payable ...................................................................       5,877        4,284
                                                                                                ---------    ---------
         Total current liabilities ..........................................................      40,945       37,812
Convertible subordinated notes ..............................................................     115,000      115,000
Minority interest ...........................................................................         227          418
Stockholders' equity:
     Preferred stock:
         Authorized shares-- 1,000 ($0.001 par value); no shares issued .....................           -            -
     Common stock:
         Authorized shares -- 40,000 ($0.001 par value)
         Issued and outstanding shares--  21,723 in 1998 and 21,981 in 1997 .................          21           22
         Additional paid-in capital .........................................................     111,818      110,167
         Treasury stock, at cost, 1,332 shares in 1998 ......................................     (19,979)           -
     Retained earnings ......................................................................      58,157       94,722
                                                                                                ---------    ---------
         Total stockholders' equity .........................................................     150,017      204,911
                                                                                                ---------    ---------
         Total liabilities and stockholders' equity .........................................   $ 306,189    $ 358,141
                                                                                                =========    =========

</TABLE>



                             See accompanying notes.


                                       36
<PAGE>



                          CREDENCE SYSTEMS CORPORATION

                      CONSOLIDATED STATEMENTS OF OPERATIONS
                    (in thousands, except per share amounts)
<TABLE>
<CAPTION>

                                                              Year Ended October 31,
                                                       ---------    ---------   ---------
                                                          1998         1997        1996
                                                       ---------    ---------   ---------
<S>                                                    <C>          <C>         <C>
Net sales:
       Systems and upgrades ........................   $ 187,887    $ 186,264   $ 221,096
       Service, spare parts and software ...........      28,916       17,828      17,692
                                                       ---------    ---------   ---------
           Total net sales .........................     216,803      204,092     238,788
Cost of goods sold - on net sales ..................      97,004       89,956      97,010
Cost of goods sold - special charges ...............      28,352         --          --
                                                       ---------    ---------   ---------
Gross margin .......................................      91,447      114,136     141,778
Operating expenses:
       Research and development ....................      47,484       37,350      35,442
       Selling, general and administrative .........      64,151       55,701      52,002
       In-process research and development .........       1,998        6,022           -
       Special charges .............................      20,386            -           -
                                                       ---------    ---------   ---------
       Total operating expenses ....................     134,019       99,073      87,444
                                                       ---------    ---------   ---------
Operating income (loss) ............................     (42,572)      15,063      54,334
                                                       ---------    ---------   ---------

Interest income ....................................       8,497        4,769       4,155
Interest & other (income) expenses, net ............       7,195        1,602         222
                                                       ---------    ---------   ---------
Income (loss) before income tax provision (benefit)      (41,270)      18,230      58,267
Income tax provision (benefit) .....................     (14,785)       7,531      20,564
                                                       ---------    ---------   ---------
Income (loss) before minority interest .............     (26,485)      10,699      37,703
Minority interest ..................................        (203)           6           -
                                                       =========    =========   =========
Net income (loss) ..................................   $ (26,282)   $  10,693   $  37,703
                                                       =========    =========   =========

Net income (loss) per share
       Basic .......................................   $   (1.22)   $    0.49   $    1.75
                                                       =========    =========   =========
       Diluted .....................................   $   (1.22)   $    0.47   $    1.72
                                                       =========    =========   =========

Number of shares used in computing per share amounts
       Basic .......................................      21,533       21,865      21,532
                                                       =========    =========   =========
       Diluted .....................................      21,533       22,512      21,977
                                                       =========    =========   =========
</TABLE>








                                              See accompanying notes.



                                       37
<PAGE>



                          CREDENCE SYSTEMS CORPORATION

                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                                 (in thousands)

<TABLE>
<CAPTION>

                                                     Common Stock   Additional   Treasury Stock                Total
                                                  -----------------  Paid-in   ------------------  Retained  Stockholders'
                                                   Shares   Amount   Capital    Shares     Amount  Earnings    Equity
                                                  -------- -------- ---------- --------  --------  --------  ------------

<S>                <C> <C>                         <C>      <C>      <C>       <C>      <C>        <C>         <C> 
Balance at October 31, 1995                        21,421   $  21    $103,939        -  $      -   $ 46,326    $150,286
Issuance of common stock on exercise of options
     under incentive stock option plans               133       1         243        -         -          -         244
Issuance of common stock under employee stock
     purchase plan                                     89       -       1,232        -         -          -       1,232
Income tax benefit from stock option exercises          -       -         317        -         -          -         317
Net income                                              -       -           -        -         -     37,703      37,703
                                                  -------- -------- ---------- --------  --------  --------    --------

Balance at October 31, 1996                        21,643      22     105,731        -         -     84,029      89,782
Issuance of common stock on exercise of options
     under incentive stock option plans               226       -       1,971        -         -          -       1,971
Issuance of common stock under employee stock
     purchase plan                                    112       -       1,564        -         -          -       1,564
Income tax benefit from stock option exercises          -       -         901        -         -          -         901
Net income                                              -       -           -        -         -     10,693      10,693
                                                  -------- -------- ---------- --------  --------  --------    --------

Balance at October 31, 1997                        21,981      22     110,167        -         -     94,722     204,911
Issuance of common stock on exercise of options
     under incentive stock option plans               141       -       1,260        -         -          -       1,260
Issuance of common stock under employee stock
     purchase plan                                    101       -       1,931        -         -          -       1,931
Repurchase and retirement of common stock            (500)     (1)     (2,512)       -         -    (10,283)    (12,796)
Purchase of treasury shares                             -       -           -   (1,332)  (19,979)         -     (19,979)
Income tax benefit from stock option exercises          -       -         972        -         -          -         972
 Net loss                                               -       -           -        -         -    (26,282)    (26,282)
                                                  ======== ======== ========== ========  ========  ========    ========

Balance at October 31, 1998                        21,723    $ 21    $111,818   (1,332) $(19,979)  $ 58,157    $150,017
                                                  ======== ======== ========== ========  ========  ========    ========
</TABLE>









                                              See accompanying notes.



                                       38
<PAGE>



                          CREDENCE SYSTEMS CORPORATION
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (in thousands)
                                                                                

<TABLE>
<CAPTION>
                                                                                     Year Ended October 31,
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                  1998         1997        1996
                                                                                ---------   ---------    ---------
Cash flows from operating activities
<S>                                                                               <C>       <C>          <C>      
    Net income (loss) ......................................................   $ (26,282)   $  10,693    $  37,703
    Adjustments to reconcile net income (loss) to net cash provided by (used
    in) operating activities:
      Depreciation and amortization ........................................      21,146       13,984       11,485
      Acquired in-process research and development .........................       1,998            -            -
      Loss related to special charges ......................................      48,738            -            -
      Loss (gain) on disposal of property and equipment ....................         (38)         430         (123)
      Deferred income taxes ................................................     (10,504)      (3,432)       1,039
      Minority interest ....................................................        (203)           6            -
      Changes in operating assets and liabilities
         Restricted cash ...................................................       7,602      (10,002)           -
         Accounts receivable ...............................................      17,955       (6,221)      (4,976)
         Inventories .......................................................     (31,094)     (16,440)     (13,339)
         Prepaid expenses and other current assets .........................     (19,363)      (4,242)       1,303
         Accounts payable ..................................................      (5,292)        (660)       2,571
         Accrued expenses and other liabilities ............................       2,995        2,517       (1,852)
         Income taxes payable ..............................................       2,565        3,654       (2,794)
                                                                               ---------    ---------    ---------
              Net cash provided by (used in) operating activities ..........      10,223       (9,713)      31,017
Cash flows from investing activities
    Purchases of available-for-sale securities .............................    (152,808)     (68,983)     (80,028)
    Maturities of available-for-sale securities ............................      90,548       56,663       55,625
    Sales of available-for-sale securities .................................      22,700       10,673            -
    Proceeds from the maturity of held-to-maturity securities ..............           -            -       11,521
    Acquisition of property and equipment ..................................     (11,268)     (16,223)     (24,689)
    Other assets ...........................................................     (15,022)      (9,201)      (4,209)
    Proceeds from sale of property and equipment ...........................         829        2,007        4,057
                                                                               ---------    ---------    ---------
              Net cash used in investing activities ........................     (65,021)     (25,064)     (37,723)
Cash flows from financing activities
    Principal payments under capital lease obligations .....................           -            -         (655)
    Issuance of common stock ...............................................       3,191        3,477        1,476
    Repurchase of common stock .............................................     (32,775)           -            -
    Issuance of 5 1/4% convertible subordinated notes ......................           -      115,000            -
    Other ..................................................................          12          412            -
                                                                               ---------    ---------    ---------
              Net cash provided by (used in) financing activities ..........     (29,572)     118,889          821
                                                                               ---------    ---------    ---------
Net increase (decrease) in cash and cash equivalents .......................     (84,370)      84,112       (5,885)
Cash and cash equivalents at beginning of the period .......................     132,761       48,649       54,534
                                                                               =========    =========    =========
Cash and cash equivalents at end of the period .............................   $  48,391    $ 132,761    $  48,649
                                                                               =========    =========    =========
Supplemental disclosures of cash flow information:
    Interest paid ..........................................................   $   6,121    $       1    $      48
    Income taxes paid ......................................................   $  11,746    $   7,443    $  22,319
Noncash investing activities:
    Net transfers of inventory to property and equipment ...................   $   9,135    $  10,036    $   3,505

</TABLE>
                             See accompanying notes.

                                       39
<PAGE>



                          CREDENCE SYSTEMS CORPORATION

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1
Organization and Summary of Significant Accounting Policies

Organization
------------

       Credence   Systems   Corporation   ("Credence"   or  the  "Company")  was
incorporated  under the laws of the State of  California  in March  1982 and was
reincorporated  in Delaware in October 1993. The principal  business activity of
the  Company  is the  design,  development,  manufacture,  sale and  service  of
automatic test equipment used in the production of  semiconductors.  As a result
of acquisitions  made during fiscal 1997 and 1998,  Credence is also involved in
the design,  development,  sale and service of software enabling the development
of customer test programs used by automatic  test  equipment.  The Company has a
subsidiary  in Japan  engaged in sales,  marketing  and service of the Company's
products and a subsidiary in Korea engaged in service of the Company's products.
Also, the Company has a joint venture with Innotech Corporation in Japan engaged
in the  customization,  development  and manufacture of product for sale by both
companies.  The joint venture is 50.1% owned by the Company and is  consolidated
in the financial  statements.  The  operations of and net  investment in foreign
subsidiaries are not material.

Basis of Presentation
---------------------

       The accompanying  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  Consolidated  Financial  Statements and related notes
have been reclassified to conform to the current year's presentation.

Revenue Recognition
-------------------

       Revenue  and  related  warranty  expenses  are  recognized  upon  product
shipment.  Net sales consist of product and service  sales,  less  discounts and
estimated  allowances.  A  provision  for the  estimated  costs to  enhance  the
functionality  and  reliability  of the  installed  base is  recorded  when such
requirements  become  known.  Revenues  from service  contracts  are  recognized
ratably over the contract  period.  The Company  recognizes  software revenue in
accordance with the American Institute of Certified Public Accountants Statement
of Position 97-2,  which calls for  recognizing  revenue when a  non-cancellable
license agreement has been signed, the software product has been shipped,  there
are no  uncertainties  surrounding  product  acceptance,  the fees are fixed and
determinable,  and  collection  is  considered  probable.  For customer  license
agreements  that meet the  Company's  revenue  recognition  policy,  the portion
allocated to software  license fees will  generally be recognized in the current
period,  while the portion  allocated to services is  recognized as the services
are performed.

Cash, Cash Equivalents, and Short-term Investments
--------------------------------------------------

       For purposes of cash flow  reporting,  the Company  considers  all highly
liquid investments with minimum yield risks and original maturity dates of three
months or less to be cash equivalents.  Short-term 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 carried
at amortized costs adjusted to fair market value.

       Management  classifies  investments  as  trading,  available-for-sale  or
held-to-maturity  at the time of purchase  and  periodically  re-evaluates  such
classification. There were no securities classified as trading as of October 31,
1998 or 1997. Securities are classified as held-to-maturity when the Company has
the  positive   intent  and  ability  to  hold  the   securities   to  maturity.
Held-to-maturity  securities are stated at cost with  corresponding  premiums or
discounts  amortized over the life of the investment to interest  income.  There
were no  securities  classified  as  held-to-maturity  as of October 31, 1998 or
1997.   Securities  not  classified  as   held-to-maturity   are  classified  as
available-for-sale and reported at fair market value. Unrealized gains or losses
on  available-for-sale  securities,  if material,  are included,  net of tax, in
equity until disposition. Realized gains and losses and declines in value judged
to be  other-than-temporary  on  available-for-sale  securities  are included in
interest  income.  The  cost  of  securities  sold  is  based  on  the  specific
identification method.


                                       40
<PAGE>

       The fair market value of cash equivalents, restricted cash and short-term
and  long-term  investments  is  substantially  equal to the carrying  value and
represents the quoted market prices at the balance sheet dates.
Cash and cash equivalents are categorized as follows (in thousands):

<TABLE>
<CAPTION>

      October 31,                                           1998        1997
                                                          ---------   ---------
      <S>                                                <C>         <C>      
     Money market ...................................... $   11,799   $  20,866
     Commercial paper ..................................      8,304      73,277
     Auction rate preferred securities .................          -      25,000
     Corporate bonds ...................................      2,061       5,000
     Obligations of U.S. Government agencies............        215       1,978
     Other debt securities .............................          -       7,614
                                                          ---------   ---------
       Cash equivalents ................................      2,379      33,735
     Cash ..............................................      6,012        (974)
                                                          ---------   ---------
       Cash and cash equivalents .......................  $  48,391   $ 132,761
                                                          =========   =========
</TABLE>

       The  short-term  investments  mature in less than one year. All long-term
investments  have  maturities of one to two years. At October 31, 1998 and 1997,
these  investments are classified as  available-for-sale  and are categorized as
follows (in thousands):

<TABLE>
<CAPTION>
      October 31,                                             1998       1997
                                                            --------   --------
      <S>                                                   <C>        <C>      
Commercial paper and medium term notes ...................  $ 28,048   $ 22,186
Treasury notes and obligations of U.S. Government agencies     8,542      9,173
Asset backed securities ..................................    13,332          -
Auction rate preferred securities ........................     2,060          -
Certificates of deposit ..................................     1,999      7,997
Corporate bonds ..........................................    18,345        412
Municipal bonds ..........................................    10,808          -
Other debt securities ....................................         -      3,806
                                                             -------    -------
                                                             $83,134   $ 43,574
                                                             =======    =======
</TABLE>

Restricted Cash
---------------


       Restricted  cash  represents cash in escrow related to commitments by the
Company  under an  agreement  with  Summit  Design,  Inc.  to  purchase  product
licenses. These funds are invested in a money market account.

Inventories

       Inventories are stated at the lower of standard cost (which  approximates
first-in,  first-out cost) or market.  Inventories  consist of the following (in
thousands):
<TABLE>
<CAPTION>

     October 31,                                               1998      1997
                                                              -------   -------
     <S>                                                      <C>       <C>   

     Raw materials . ........................................ $ 9,860   $24,862
     Work-in-process ........................................  21,609    14,173
     Finished goods .........................................   5,937     3,090
                                                              -------   -------
                                                              $37,406   $42,125
                                                              =======   =======
</TABLE>

                                       41
<PAGE>


Prepaid Expenses and Other Current Assets
-----------------------------------------

       Prepaid  expenses and other current  assets  consist of the following (in
thousands):
<TABLE>
<CAPTION>
       October 31,                                             1998       1997
                                                              -------   -------
       <S>                                                    <C>       <C>

       Prepaid and refundable income taxes .................. $18,682   $     -
       Prepaid expenses and other ...........................   5,385     7,148
                                                              -------   -------
                                                              $24,067   $ 7,148
                                                              =======   =======
</TABLE>


Property and Equipment and Other Assets
---------------------------------------


       Property and equipment are stated at cost and are  depreciated  using the
straight-line  method over the assets'  estimated  useful lives of three to five
years.  Assets under  capitalized  leases are amortized using the  straight-line
method over the shorter of the  estimated  useful life of the asset or the lease
term. Property and equipment consist of the following (in thousands):

<TABLE>
<CAPTION>

       October 31,                                            1998       1997
                                                            --------   --------
       <S>                                                  <C>        <C>    

       Machinery and equipment ...........................  $ 43,013   $ 36,816
       Software ..........................................    10,223     10,830
       Leasehold improvements ............................    11,798      8,248
       Furniture and fixtures ............................     4,840      5,039
       Spare parts .......................................    18,390     17,026
                                                             -------    -------
                                                              88,264     77,959
       Less accumulated depreciation and amortization ....    46,500     34,909
                                                              ------    -------
       Net property and equipment ........................  $ 41,764   $ 43,050
                                                             =======    =======
</TABLE>

       Other  assets  consist   primarily  of  purchased   technologies,   other
intangibles  and related  rights  which are  amortized  using the  straight-line
method  over  the  assets'  estimated  useful  lives  of  three  to five  years.
Accumulated  amortization  associated  with intangible  assets is  approximately
$10,102,000 and $5,043,000 at October 31, 1998 and 1997, respectively.

       In 1995, the Financial  Accounting  Standards Board ("FASB") released the
Statement  of  Financial  Accounting  Standards  ("SFAS")  No.  121 (SFAS  121),
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be disposed  of." SFAS 121 requires  recognition  of  impairment  of  long-lived
assets  in the  event  the net book  value of such  assets  exceeds  the  future
undiscounted  cash flows  attributable to such assets.  The Company adopted SFAS
121 on  November  1, 1996.  Adoption  of SFAS 121 had a  material  impact on the
Company's  financial  position and results of operations as described more fully
in Note 3 herein.


Accrued Expenses and Other Liabilities
--------------------------------------

       Accrued  expenses  and other  liabilities  consist of the  following  (in
thousands):
<TABLE>
<CAPTION>

       October 31,                                           1998        1997
                                                           --------    --------
       <S>                                                 <C>         <C>     
       Accrued payroll and related liabilities             $  6,767    $  6,061
       Accrued warranty                                       3,874       3,277
       Accrued distributor commissions                        1,706       3,174
       Deferred revenue                                       3,065       2,748
       Accrued loss on supplier commitments                   2,400           -
       Other accrued liabilities                              9,166       5,086
                                                           --------    --------
                                                           $ 26,978    $ 20,346
                                                           ========    ========
</TABLE>

                                       42
<PAGE>


Net Income (Loss) Per Share
---------------------------

       The Company  adopted  SFAS No.  128,  "Earnings  Per  Share",  (SFAS 128)
beginning  in the first  quarter of fiscal 1998.  Accordingly,  basic net income
(loss)  per share is based upon the  weighted  average  number of common  shares
outstanding during the period. Diluted net income (loss) per share is based upon
the  weighted-average  number of common  shares  and  dilutive-potential  common
shares  outstanding during the period.  The Company's  convertible  subordinated
notes are not dilutive-potential  common shares and, accordingly,  were excluded
from the  calculation  of diluted net income (loss) per share.  Weighted-average
options to purchase  932,998 shares at an average price of $28.58 per share were
outstanding  at October 31, 1998,  but were not included in the  computation  of
diluted net loss per share because the options'  exercise price was greater than
the average  market  price of the common  shares and the Company  incurred a net
loss. Therefore, the effect of including the options would be antidilutive.  All
net income  (loss) per share  amounts for all  periods  have been  presented  to
conform to SFAS 128 requirements. The following table sets forth the computation
of basic and diluted net income (loss) per share (in thousands, except per share
amounts):

<TABLE>
<CAPTION>
                                                                   1998        1997       1996
                                                                  --------    --------   --------
<S>                                                               <C>         <C>        <C>
Numerator:
  Numerator for basic and diluted net income (loss) per share -
  net income (loss) ...........................................   $(26,282)   $ 10,693   $ 37,703
                                                                  --------    --------   --------
Denominator:
  Denominator for basic net income (loss) per share -
  weighted-average shares .....................................     21,533      21,865     21,532

Effect of dilutive securities - employee stock options ........        647         445
                                                                  --------    --------   --------
Denominator for diluted net income(loss) per share - adjusted
weighted-average shares and assumed exercises .................     21,533      22,512     21,977
                                                                  --------    --------   --------

  Basic net income (loss) per share ...........................   $  (1.22)   $   0.49   $   1.75
  Diluted net income (loss) per share .........................   $  (1.22)   $   0.47   $   1.72
</TABLE>


Recent Accounting Pronouncements
--------------------------------

       In June 1997,  the FASB released SFAS No. 130,  "Reporting  Comprehensive
Income",  (SFAS 130).  SFAS 130  establishes  standards  for the  reporting  and
display  of  comprehensive  income and its  components  in a full set of general
purpose  financial  statements and is effective for fiscal years beginning after
December  15,  1997.  Adoption  of SFAS 130 is not  expected  to have a material
impact on the Company's  consolidated  financial  statements.  In June 1997, the
FASB released SFAS No. 131,  "Disclosures  about  Segments of an Enterprise  and
Related Information",  (SFAS 131). SFAS 131 will change the way companies report
selected segment  information in annual  financial  statements and also requires
those  companies to report  selected  segment  information in interim  financial
reports to stockholders.  SFAS 131 is effective for fiscal years beginning after
December 15, 1997.  Adoption of SFAS 131 will  require  disclosure  by operating
segment of information such as profit and loss, assets and capital expenditures,
major customers and types of products from which revenue is derived.

       In June 1998,  the FASB issued SFAS No. 133,  "Accounting  for Derivative
Instruments and Hedging Activities," (SFAS 133), which is required to be adopted
in fiscal years  beginning  after June 15, 1999.  The  Statement  permits  early
adoption as of the  beginning  of any fiscal  quarter  after its  issuance.  The
Company is currently  evaluating whether to adopt the new statement earlier than
is required.  SFAS 133 will require the Company to recognize all  derivatives on
the  balance  sheet  at fair  value.  Derivatives  that are not  hedges  must be
adjusted to fair value through earnings. If the derivative is a hedge, depending
on the nature of the hedge, changes in the fair value of derivatives will either
be offset against the change in the fair value of the hedged assets, liabilities
or firm  commitments  through  earnings,  or recognized  in other  comprehensive
income until the hedged item is recognized in earnings.  The ineffective portion
of a  derivative's  change  in fair  value  will be  immediately  recognized  in
earnings.  Adoption of SFAS 133 is not expected to have a material impact on the
Company's financial condition or results of operations.


                                       43
<PAGE>

Use of Estimates
----------------

       The  preparation  of financial  statements in conformity  with  generally
accepted  accounting  principles  requires  management  to  make  estimates  and
assumptions  that  affect the  reported  amounts of assets and  liabilities  and
disclosure of  contingent  assets and  liabilities  at the date of the financial
statements  and the  reported  amounts  of  revenues  and  expenses  during  the
reporting period.

       Actual  results  inevitably  will  differ from those  estimates  and such
differences may be material to the financial statements.


Note 2
Acquisitions

       In July 1997, the company, through a subsidiary, Fluence Technology, Inc.
(formerly  known as Test  Systems  Strategies,  Inc.),  a  Delaware  corporation
("Fluence"), acquired certain assets and assumed certain liabilities from Summit
Design, Inc. and its wholly owned subsidiary, Test Systems Strategies,  Inc., an
Oregon  corporation,  including the test  development  series software  products
("TDS")  and  TSSI  trademark  of  Test  Systems  Strategies,  Inc,  the  Oregon
corporation  (the "TSSI  acquisition").  TDS includes  tools designed to convert
gate-level  simulation  data from  electronic  design  automation  simulators to
programs that operate on targeted  automatic test equipment  ("ATE") for testing
integrated  circuits  characterized  by  the  gate-level  simulation  data.  TDS
facilitates simulation analysis, stimulus generation, simulation rules checking,
tester  resource  checking,  ATE  test  program  generation,  and  test  program
conversion.  The  consolidated  financial  statements  reflect the impact of TDS
operations subsequent to the acquisition date.

       The purchase  price of $7.3  million  consisted of a cash payment of $7.0
million to Summit Design,  Inc. and $300,000 for the assumption of  liabilities.
Acquired  assets and  liabilities  were recorded at their  estimated fair market
value at the date of the acquisition. The aggregate purchase price, plus related
acquisition expenses, have been allocated to the assets and liabilities acquired
based on valuations.  Amounts  allocated to in-process  research and development
("IPR&D") of  approximately  $6.0  million  were written off at the  acquisition
date,   representing  an  estimated  value  (using   risk-adjusted  cash  flows,
discounted   at  35%)  of   development   programs  that  had  not  yet  reached
technological  feasibility.  Amounts  allocated  to developed  technology,  $1.0
million,  and  workforce  in  place,  $0.3  million,  are being  amortized  on a
straight-line basis over periods of six and three years, respectively.

       The IPR&D associated with the TSSI acquisition related to the development
of a standard tester interface language ("STIL").  The STIL development  project
is  approximately   35%  complete  as  of  October  31,  1998.  The  significant
technological  hurdles remaining to be addressed  include:  the ability to parse
mega-vector files and make them immediately available to the application program
interface;  the ability to effectively  process both batch and online input from
engineering  design  automation  ("EDA")  simulation  tools,  the development of
efficient algorithms for taking event data from EDA simulation tools and mapping
it into the limited  resources of a given ATE system according to a standard set
of rules; and the development of additional STIL constructs which enable the use
of STIL as a design stimulus  language,  enable the use of STIL for representing
test patterns for embedded  cores,  representing  the test program flow in STIL,
representing  test  methods in STIL and  defining  voltage  and  current  levels
associated  with STIL  waveforms.  The Company  estimates that as of October 31,
1998, the remaining  research and development work on the STIL project will take
approximately  13  engineering  person years,  at a cost of  approximately  $2.0
million and will be completed in fiscal 2000.  The project has  progressed  more
slowly than originally  projected due to lower than  anticipated  staffing.  The
lower staffing levels were a result of the Company's  actions to reduce expenses
during a period of reduced revenues and earnings. There can be no assurance that
the Company will be able to complete the development and successful marketing of
any STIL based products. A failure to successfully develop and market STIL based
products  could  have a  material  adverse  effect  on the  Company's  business,
financial condition or results of operations.

       In August 1997,  Fluence purchased from Zycad  Corporation  ("Zycad") and
one of its subsidiaries, Attest Software, Inc. certain assets, including the TDX
software product line ("TDX"). TDX consists of software products that facilitate
the  development  of ATE test  programs  to aid in  ensuring  the  integrity  of
integrated circuit designs prior to incurring the expense of wafer fabrication.

       The purchase  price  consisted of a cash payment to Zycad of  $2,250,000.
Acquired  assets were recorded at their  estimated fair market value at the date


                                       44
<PAGE>

of the  acquisition.  The aggregate  purchase  price,  plus related  acquisition
expenses,  have been  allocated  to the  assets  acquired  based on  valuations.
Amounts  allocated to developed  technology,  $2.0 million,  workforce in place,
$0.1  million,  and  fixed  assets,  $0.1  million  are  being  amortized  on  a
straight-line basis over periods of five, three and five years, respectively.

       In June 1998, the Company purchased from Heuristics Physics Laboratories,
Inc.  ("HPL")  certain assets and assumed  certain  liabilities  relating to its
memory self test  business for $8.0 million in cash and the  assumption  of $0.2
million in liabilities. Additionally, the Company agreed to make payments to the
shareholder  representatives  of HPL in an amount equal to 10% of the  Company's
net sales of products  derived  from the assets  acquired  from HPL's design for
test division for a period of two years following the acquisition. In connection
with the HPL acquisition, the Company recognized $2.0 million of acquired IPR&D.
The remaining  $6.2 million has been  capitalized,  of which $5.3 million is for
purchased technology and other intangible assets which will be amortized ratably
over their estimated useful lives of five years.

       The Company's  management  made certain  assessments  with respect to the
determination  of all  identifiable  assets  resulting  from,  or to be used in,
research and development  activities as of the  acquisition  date. Each of these
activities was evaluated, by both interviews and data analysis, to determine its
state of development and related fair value. The Company's review indicated that
the  IPR&D  had  not  reached  a  state  of  technological  feasibility  and the
underlying  technology  had no  alternative  future use to the  Company in other
research  and  development  projects or  otherwise.  In the case of IPR&D,  fair
values  of the  corresponding  technologies  were  determined  using  an  income
approach,  which included a discounted future earnings  methodology.  Under this
methodology,  the value of the  in-process  technology is comprised of the total
present  value of the  anticipated  after-tax  cash  flows  attributable  to the
in-process  project,  discounted to net present  value,  taking into account the
uncertainty surrounding the successful development of the purchased IPR&D.

       The HPL acquired IPR&D consists of projects  related to memory self test.
These  projects are aimed at the  development  of products that can perform self
testing of on-chip memories, self testing of off-chip memories, automated memory
test vector  generation,  built-in memory repair analysis and built-in automated
memory  circuit  repair.  The Company  estimated that  approximately  50% of the
research and development effort, based on complexity,  had been completed at the
date of the  acquisition.  The significant  work remaining on these projects was
estimated  to take  approximately  16  engineering  person  years,  at a cost of
approximately  $1.3 million and be completed in late fiscal 1999 or early fiscal
2000. As of October 31, 1998, the Company  believed that the projections of time
and cost had not materially  changed. As of the acquisition date, HPL was in the
alpha stage of  development  and required the  resolution of certain memory self
test  technological  hurdles  in order to  complete  the  technology.  The items
remaining to be  addressed  at the  acquisition  date  included  the  following:
expansion  of built-in  self test (BIST)  capability  to address  large  (beyond
mega-bit)  embedded  memories  used  in the  emerging  system-on-a-chip  market,
completion of third generation BIST, automation tools allowing the generation of
user-configurable  test  algorithms  on the active load board of a test  system,
completion of manufacturing  oriented memory BIST architecture enabling parallel
test execution and full  diagnostics for  engineering  debug and yield analysis,
and completion of the first  built-in  redundancy  analyzer,  software to direct
laser repair stations and embedded memory self repair.

       There can be no assurance that these projects will achieve  technological
feasibility  or that the Company will be able to  successfully  market  products
based on such technology.  Should these  in-process  projects fail, the value of
the Company's investment in these incomplete technologies would be diminimous or
zero. A failure to  successfully  develop and market  memory self test  products
could  have a  material  adverse  affect on the  Company's  business,  financial
condition or results of operations.


Note 3
Special Charges

       In the third and fourth  quarters of fiscal  1998,  the Company  recorded
special charges  totaling $48.7 million,  of which $28.4 million were classified
as cost of goods sold and the  balance was  classified  as  operating  expenses.
These  charges are the result of the Company's  response to a major  downturn in
the  current  and   forecasted   business   outlook  for  the  ATE  and  related
semiconductor and semiconductor equipment industries which took place during the
period.  As a result of this  industry  downturn,  the Company has downsized its
operations,  including reducing headcount, reducing the volume of products being
produced and  cancelling and delaying  various  projects,  including  facilities
expansions and certain  research and  development  projects.  The impact of this
downturn  and these  decisions  is that  significant  amounts  of the  Company's
inventories,  receivables,  fixed  assets,  prepaid  expenses,  investments  and
purchased  technologies  have been  impaired and certain  liabilities  have been
incurred.  As a result, the Company has written down the related assets to their
net realizable values and made provision for the estimated liabilities.


                                       45
<PAGE>

       Of the $48.7 million in charges,  approximately $28.4 million was charged
as cost of goods  sold,  of which  approximately  $26.7  million  was related to
write-down of excess or obsolete inventories. The elements of the charges during
fiscal 1998 are as follows (in thousands):
<TABLE>
<CAPTION>

     <S>                                                                <C>
     Write-down of inventories to net realizable value
          (including expected losses on supplier commitments) .......   $26,678
     Write-down of excess fixed assets to fair value ................     7,272
     Write-down of purchased technology and investments to fair value     5,118
     Write-off of prepaid and other current assets ..................     2,444
     Excess facility costs ..........................................     2,641
     Provision for uncollectible receivables ........................     3,389
     Employee termination benefits and accrued liabilities ..........     1,196
                                                                        -------
                                                                        $48,738
</TABLE>

       At October 31, 1998,  approximately  $4.8 million in accrued  liabilities
related to special charges  remained on the Company's  balance sheet,  primarily
the accrued loss on supplier  commitments of $2.4 million and approximately $1.9
million for rent on excess  facilities.  The cash  expenditures  associated with
these  obligations  will  occur  primarily  in fiscal  1999.  Cash  expenditures
associated  with the  special  charges  during  fiscal  1998 were  approximately
$700,000, relating primarily to excess facilities and to severance costs.


Note 4
Concentration of Risks

Credit Risk and Geographic Data
-------------------------------

       Financial   instruments   that   potentially   subject   the  Company  to
concentrations  of  credit  risk  consist  principally  of  investments  in cash
equivalents,  restricted  cash,  short-term and long-term  investments and trade
receivables.  The Company is exposed to credit  risks in the event of default by
the financial  institutions or customers to the extent of the amount recorded on
the balance sheet.

       The Company and its subsidiaries  operate in two industry  segments:  the
design, development, manufacture, sale and service of ATE used in the production
of  semiconductors;  and,  as a result of  acquisitions  made in fiscal 1998 and
1997, the design, development,  sale and service of software that assists in the
development  of test  programs  used in ATE.  Revenues  from  software  were not
material to the Company's operations in fiscal 1998 and 1997.

       The  Company   sells  its   products   primarily  to   distributors   and
semiconductor  manufacturers  located in the United  States,  Asia  Pacific  and
Europe.  The Company  performs  ongoing credit  evaluations of its customers and
generally  does not require  collateral.  The  Company  maintains  reserves  for
potential credit losses and such losses  historically  have been both immaterial
and within management's expectations.

       Export  sales,  which  are  denominated  in U.S.  dollars  and  represent
substantially all of the Company's  international sales,  represent sales to the
Company's customers primarily  throughout Asia Pacific and Europe.  Sales by the
Company to customers in different geographic areas, expressed as a percentage of
revenue, for the periods ended were:
<TABLE>
<CAPTION>

         Year ended October 31,         1998  1997    1996
                                        ----  ----    ----
<S>                                     <C>    <C>    <C>
         Domestic ... .................  31%    30%    33%
         Asia Pacific .................  60     66     58
         Europe .......................   9      4      9
                                        ---    ---    ---
         Total sales                    100%   100%   100%
                                        ===    ===    ===
</TABLE>

                                       46
<PAGE>

       One  customer  (a  distributor)  accounted  for  34%,  30% and 25% of the
Company's net sales in fiscal 1998, 1997 and 1996,  respectively.  The Company's
major distributor sells product into Taiwan. This subjects a significant portion
of the Company's  receivables and future  revenues to the risks  associated with
doing  business  in  a  foreign  country,   including   political  and  economic
instability,   currency  exchange  rate  fluctuations  and  regulatory  changes.
Disruption of business in Asia caused by the previously  mentioned factors could
have a material impact on the Company's business, financial condition or results
of operations.

Other Risks
-----------

       The  semiconductor  industry  has  historically  been  cyclical  and  has
experienced  downturns,  which  have  had  a  material  adverse  effect  on  the
semiconductor  industry's demand for ATE, including  equipment  manufactured and
marketed by the Company.  Differences  between the Company's  forecast of market
demand for its  products and actual  demand could have a material  effect on the
financial statements.  In addition, the ATE industry is highly competitive,  and
subject to rapid  technological  change.  The  Company  has  experienced  and is
continuing to experience significant delays in the introduction of new products.
It is reasonably  possible that events related to the above factors may occur in
the near term which  would cause a change to the  Company's  estimate of the net
realizable value of receivables,  inventories or other assets,  and the adequacy
of costs accrued for warranty and other liabilities. Such changes have and could
continue  to  materially  adversely  affect the  Company's  business,  financial
condition and results of operations.

       In addition,  the Company relies on several  suppliers and  manufacturing
subcontractors to provide many of the key components and  subassemblies  used in
the Company's products. Some of these items are available from only one supplier
or a limited group of suppliers.  Any  disruption in the delivery of these items
could materially  adversely affect the Company's  business,  financial condition
and results of operations.


Note 5
Credit Facilities

       The  Company  has a  $40,000,000  unsecured  bank  line of  credit,  with
interest at the bank's  prime rate (8% at October 31,  1998) which  expires July
23,  1999.  This line  supports  the  issuance  of letters of credit and foreign
exchange  contracts.  At  October  31,  1998,  the  Company  had  no  borrowings
outstanding  under this line of credit.  Borrowings under the line of credit are
subject to the Company's ability to meet certain financial  covenants  including
profitability and leverage ratios and require the Company to obtain certain bank
approvals for the payment of dividends.  The Company was not in compliance  with
certain  financial  covenants at October 31, 1998, but it received  waivers from
the banks and has subsequently  renegotiated the applicable  financial covenants
under the credit facility.  There were no foreign exchange contracts outstanding
at October 31, 1998 or 1997.

Note 6
Lease Obligations and Other Commitments

     The  Company  leases its  facilities  under  operating  leases  that expire
periodically through 2014.

     The approximate  future minimum lease payments under  operating  leases for
facilities and equipment at October 31, 1998 are as follows (in thousands):
<TABLE>
<CAPTION>

                           Lease Payments
                           --------------
           <S>                <C>     
          1999                $ 5,145
          2000                  5,236
          2001                  4,900
          2002                  4,684
          2003                  3,636
     Thereafter                23,874
                               ------
                              $47,475
</TABLE>

     Rent expense was approximately $4,336,000,  $4,147,000,  and $4,132,000 for
the years ended October 31, 1998, 1997 and 1996, respectively.

       The  Company  has an  agreement  with a  distributor  whereby the Company
issued a guaranty in favor of a bank with respect to certain  obligations of the


                                       47
<PAGE>

distributor to the bank. Under this agreement,  the distributor  agreed to grant
to the Company a security  interest to secure the obligations of the distributor
as a result of any payments by the Company pursuant to the guaranty.  At October
31,  1998,  the  maximum  allowable  debt  of the  distributor  subject  to this
guaranty, $1,000,000, was outstanding.


Note 7
Convertible Subordinated Notes

       In September  1997,  the Company sold $115 million of 5 1/4%  convertible
subordinated notes (the "Notes") due 2002 through a private placement. The Notes
are unsecured obligations of the Company and are subordinated to all present and
future  senior  indebtedness  of the  Company.  The Notes do not  provide  for a
sinking fund and are  redeemable  at the option of the  Company,  in whole or in
part, at any time on or after September 20, 2000, at certain  redemption prices.
Interest is payable  semiannually on March 15 and September 15, commencing March
15,  1998.  The Notes are  convertible  into  common  stock of the Company at an
initial conversion price of $69.15 per share. To date $6.1 million has been paid
in interest expense.  Expenses of $3.3 million associated with the offering have
been deferred and included in other assets. Such expenses are being amortized to
interest expense over the term of the Notes. In November 1997, the Company filed
a Registration  Statement with the Securities and Exchange Commission under Form
S-3 to permit public secondary trading of the Notes,  and, upon conversion,  the
underlying common stock. Such registration  statement was declared  effective in
December  1997.  As of October  31,  1998,  the fair value of the Notes based on
quotes from a major brokerage firm was approximately $74.4 million.


Note 8
Stockholders' Equity

       Treasury Stock and Common Stock Repurchases
       -------------------------------------------

       During the year, the Company repurchased a total of 1.8 million shares of
its  common  stock at a cost of $32.8  million.  Out of the  total  1.8  million
shares,  500,000 were canceled and retired and the balance of 1.3 million shares
were put in treasury stock.

       Stock Option Plans and Stock Purchase Plan
       ------------------------------------------

       The  Company  grants  options to  employees  and  members of the Board of
Directors  under the 1993 Stock Option Plan (the "1993 Plan").  The 1993 Plan is
divided into two separate components: (i) the Discretionary Option Grant Program
and  (ii)  the  Automatic  Option  Grant  Program.  Options  granted  under  the
Discretionary  Option Grant Program will have an exercise price equal to 100% of
the fair market value of such shares on the date of grant, and a maximum term of
ten years,  and are exercisable  over a vesting  period,  generally four to five
years.   Under  the  Automatic   Option  Grant  Program,   options  are  granted
automatically at periodic  intervals to non-employee  members of the Board at an
exercise  price equal to 100% of the fair market  value of the option  shares on
the date of grant and a maximum term of ten years,  and are  exercisable  over a
vesting period,  generally four to five years.  Under the Automatic Option Grant
Program, options are granted automatically at periodic intervals to non-employee
members of the Board at an exercise price equal to 100% of the fair market value
of the option shares on the date of grant and a maximum term of ten years.

       On  March  25,  1998,  the  stockholders  approved  an  amendment  to the
Company's  1993 Stock Option Plan that  increased the number of shares of Common
Stock  reserved for issuance  thereunder  by an additional  500,000  shares to a
total of 4,625,001 shares.

       On  March  25,  1998,  the  stockholders  approved  an  amendment  to the
Company's 1993 Stock Option Plan that  implemented  an automatic  share increase
feature  pursuant to which the number of shares available for issuance under the
1993 Stock  Option  Plan (the "1993  Plan") will  automatically  increase on the
first trading day of each fiscal year (the "First Trading Day"),  beginning with
the 1999 fiscal year and  continuing  through the fiscal year 2003, by an amount
equal to two percent (2%) of the total number of shares  outstanding on the last
trading day of the  immediately  preceding  fiscal year.  The 1993 Plan provides
that at the end of each First Trading Day the number of then outstanding options
under the Company's stock option plans shall not exceed fifteen percent (15%) of
the then  outstanding  voting shares of capital  stock of the Company,  together
with all then actually  outstanding  stock  options  under the  Company's  stock
option plans, together with all options in the reserve then available for future
grant under the Company's Stock Option Plans.

                                       48
<PAGE>

       A summary of the activity under all plans, excluding the Fluence Plan, as
defined below (in thousands, except per share amounts) is as follows:
<TABLE>
<CAPTION>

                                           Options Available        Number of         Price            Weighted
                                               for Grant             Shares            Per             Average
                                             (Authorized)          Outstanding        Share          Exercise Price
                                          --------------------     -----------    ---------------   ---------------
<S>                                             <C>                      <C>      <C>      <C>         <C>   
Balance at October 31, 1995 .............          652                   1,041    $ 0.44 - $33.00      $13.46
Increase in authorized shares ...........          500                       -           -                  -
Options granted .........................       (1,107)                  1,107    $12.75 - $29.00      $15.48
Options canceled ........................          227                    (227)   $ 0.54 - $33.00      $23.48
Options exercised .......................            -                    (133)   $ 0.52 - $16.50      $ 1.83
Options expired .........................           (8)                      -           -                  -
                                          --------------------     -----------    ---------------    --------
Balance at October 31, 1996 .............          264                   1,788    $ 0.44 - $33.00      $14.29
Increase in authorized shares ...........          500                       -           -                  -
Options granted .........................         (408)                    408    $19.00 - $29.50      $25.23
Options canceled ........................          170                    (170)   $ 1.00 - $33.00      $19.11
Options exercised .......................            -                    (226)   $ 0.44 - $33.00      $ 9.69
Options expired .........................           (2)                      -           -                  -
                                          --------------------     -----------    ---------------    --------
Balance at October 31, 1997 .............          524                   1,800    $ 0.44 - $33.00      $16.90
Increase in authorized shares ...........          500                       -           -                  -
Options granted .........................         (699)                    699    $14.50 - $29.50      $26.31
Options canceled ........................          145                    (145)   $ 0.54 - $30.00      $19.47
Options exercised .......................            -                    (141)   $ 0.44 - $23.12      $ 9.09
                                          ====================     ===========    ===============    ========
Balance at October 31, 1998 .............          470                   2,213    $ 0.44 - $33.00      $20.20
                                          ====================     ===========    ===============    ========
</TABLE>

       The Company has reserved for issuance  approximately  2,683,000 shares of
common stock in  connection  with the stock option  plans.  At October 31, 1998,
approximately  907,000 shares were exercisable at an aggregate exercise price of
$15,515,000.

       The following table summarizes  information about options outstanding and
exercisable at October 31, 1998, excluding the Fluence Plan (in thousands except
per share amounts).

<TABLE>
<CAPTION>
                         Options Outstanding                           Options Exercisable
                                      Weighted-Avg.      Weighted    Options             Weighted
                      Options         Remaining          Average     Currently           Average
Range of              Outstanding at  Contractual Life   Exercise    Exercisable at      Exercise
Exercise Prices       Oct. 31, 1998      (years)         Price       October 31, 1998    Price
-------------------  ---------------  ----------------  ----------  -----------------   -----------
<S>        <C>           <C>                <C>           <C>           <C>                <C>    
  $ 0.44 - $13.25        816,311            7.04          $11.69        489,020            $ 10.78
  $14.17 - $26.25        568,895            8.24          $19.18        216,544            $ 19.64
  $26.44 - $29.00        155,236            8.93          $27.49         37,026            $ 28.07
  $29.50 - $33.00        672,726            8.70          $29.69        164,428            $ 30.11
===================  =============    ================  ==========  =================   ===========
  $ 0.44 - $33.00      2,213,168            7.99          $20.20        907,018            $ 17.11
===================  =============    ================  ==========  =================   ===========
</TABLE>

       These  options  will expire,  if not  exercised,  at specific  dates from
February 1999 to August 2008.

       In 1997, the Company's subsidiary,  Fluence,  adopted a 1997 Stock Option
Plan (the  "Fluence  Plan")  under  which  incentive  stock  options to purchase
Fluence common stock could be granted to employees,  non-employee members of the
Board or the  non-employee  members of the Board of  Directors  of any parent or
subsidiary,  and consultants and other independent advisors who provide services
to Fluence (or any parent or  subsidiary).  Under the Fluence  Plan,  options to
purchase Fluence common stock can be granted at prices no less than 85% of their
fair value on the date of grant.  Generally,  options  granted  are  immediately


                                       49
<PAGE>

exercisable and the resulting  shares issued to employees under the Fluence Plan
are  subject to certain  repurchase  rights by  Fluence,  at the  discretion  of
Fluence,  upon the  individual's  cessation  of service  prior to vesting in the
shares at the original  purchase price. As of October 31, 1998,  634,000 options
were granted at fair value to employees and are  exercisable  by employees at an
exercise  price of $0.10 per share.  These shares vest over a four-year  period.
Activity under this plan (in thousands, except per share amounts) is as follows:
<TABLE>
<CAPTION>

                                                        Options Outstanding
                                                  ------------------------------

                               Options Available     Number     Weighted Average
                                  For Grant         of Shares     Exercise Price
<S>                                <C>               <C>            <C>    
Balance at October 31, 1996             -                 -         $     -
Initial shares authorized .         2,000                 -               -
Options granted ...........         ( 851)              851            0.10
                                   ------            ------           -----
Balance at October 31, 1997         1,149               851            0.10
Grants ....................          (195)              195            0.10
Cancellations .............           410              (410)           0.10
Exercises .................             -                (2)           0.10
                                   ======            ======           =====
Balance at October 31, 1998         1,364               634        $   0.10
                                   ======            ======           =====
</TABLE>

       Fluence has  reserved  for  issuance  approximately  2,000,000  shares of
common stock in connection with the Fluence Plan.

       The following  table  summarizes  information  about options  outstanding
under the  Fluence  Plan at October  31, 1998  (option  amounts are  recorded in
thousands except per share amounts):
<TABLE>
<CAPTION>

                                                 Options Outstanding                       Options Exercisable

                                                                                    Options              Weighted
                     Options               Weighted-Avg.                            Currently            Average
 Range of            Outstanding           Remaining            Weighted-Avg.       Exercisable at       Exercise
 Exercise Price      at Oct. 31, 1998      Contractual Life      Exercise Price     October 31, 1998     Price
                                               (years)

<S>  <C>                    <C>                     <C>                <C>                <C>             <C>  
     $0.10                  634                     9.07               $0.10              634             $0.10
</TABLE>

       These  options  will expire,  if not  exercised,  at specific  dates from
October 2007 to August 2008.

       In 1994, the Company adopted the 1994 Employee Stock Purchase Plan, which
provides  eligible  employees  with the  opportunity  to  acquire  shares of the
Company's  common stock.  The purchase price is 85% of the fair market value per
share of common stock on the date on which the purchase  period begins or on the
date on which the  purchase  period  ends,  whichever  is  lower.  Approximately
101,023,  114,940 and 89,000 shares were acquired  pursuant to the plan in 1998,
1997 and 1996,  respectively.  At October 31, 1998, approximately 113,334 shares
were reserved for issuance under the plan.

       The Company has  elected to follow APB  Opinion No. 25,  "Accounting  for
Stock  Issued to  Employees,"  in  accounting  for its  employee  stock  options
because,  as discussed below, the alternative fair value accounting provided for
under SFAS No. 123, "Accounting for Stock-Based  Compensation," requires the use
of option  valuation  models that were not developed for use in valuing employee
stock  options.  Under APB No. 25,  because the exercise  price of the Company's
employee stock options  equals the market price of the  underlying  stock on the
date of the grant,  no  compensation  expense  is  recognized  in the  Company's
financial statements.

       Pro forma  information  regarding net income (loss) and net income (loss)
per share is  required  by SFAS No.  123.  This  information  is  required to be
determined  as if the Company  had  accounted  for its  employee  stock  options
(including  shares issued under the Employee Stock  Purchase Plan,  collectively
called  "options")  granted  subsequent to October 31, 1995 under the fair value
method of SFAS No. 123.

       In  calculating  pro forma  compensation,  the fair value of each  option
grant is estimated on the date of grant using the  Black-Scholes  option pricing
model.  The  Black-Scholes  option  valuation  model  was  developed  for use in


                                       50
<PAGE>

estimating the fair value of traded  options which have no vesting  restrictions
and are fully  transferable.  In addition,  the Black-Scholes 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  models do not
necessarily  provide a reliable single measure of its stock-based  awards to its
employees. The fair value of each option grant is estimated assuming no expected
dividends and the following weighted-average assumptions:
<TABLE>
<CAPTION>

                                         1998          1997          1996
                                         ----          ----          ----

<S>                                     <C>           <C>            <C> 
Expected life (years) .................  3.03          3.35           3.19
Expected stock price volatility .......  0.70          0.65           0.58
Risk-free interest rate ...............  4.28%         5.67%          5.64%
</TABLE>


     The grant date  weighted-average  fair value of options  granted during the
year were $12.58, $25.23 and $15.48 for 1998, 1997 and 1996, respectively.

       The pro forma net income  (loss) and net income  (loss) per share include
expense related to the Company's Employee Stock Purchase Plan. The fair value of
issuances  under the Employee  Stock  Purchase Plan is estimated on the issuance
date using the  Black-Scholes  model  assuming  no  expected  dividends  and the
following  weighted-average  assumptions  for issuances  made in 1998,  1997 and
1996:
<TABLE>
<CAPTION>

                                        1998          1997          1996
                                        ----          ----          ----
<S>                                     <C>           <C>           <C> 
Expected life (years) ................  0.50          0.50          0.50
Expected stock price volatility.......  0.82          0.65          0.58
Risk-free interest rate ..............  4.55%         5.67%         5.64%
</TABLE>

       The  weighted-average  fair value of purchase  rights  granted during the
year were $9.42, $7.49 and $6.82 for 1998, 1997 and 1996, respectively.

       For pro  forma  purposes,  the  estimated  fair  value  of the  Company's
stock-based  awards to its  employees  is amortized  over the  option's  vesting
period and the Employee Stock Purchase Plan's  six-month  purchase  period.  The
Company's pro forma  information is as follows (in  thousands,  except per share
amounts):
<TABLE>
<CAPTION>

                                                      1998          1997         1996
                                                   ----------    ----------   ----------
<S>                                                <C>           <C>          <C>    
Net income (loss) as reported ..................   $  (26,282)   $   10,693   $   37,703
Pro forma net income (loss) ....................   $  (30,725)   $    8,316   $   36,547
Pro forma basic net income (loss) per share ....   $    (1.43)   $     0.38   $     1.70
Diluted net income (loss)  per share as reported   $    (1.22)   $     0.47   $     1.72
Pro forma diluted net income (loss) per share ..   $    (1.43)   $     0.37   $     1.67
</TABLE>

       Because SFAS 123 is  applicable  only to options  granted  subsequent  to
October 31, 1995, its pro forma effect will not be fully  reflected until fiscal
2000.

Rights Plan
-----------

       On June 1, 1998,  the Company  adopted the Credence  Systems  Corporation
Stockholder Rights Plan (the "Rights Plan"). Pursuant to the Rights Plan, rights
were  distributed  as a dividend  at the rate of one right for each of  Credence
common  stock,  par value  $0.001 per share  ("Right")  of the  Company  held by
stockholders  of record as of the close of business on June 22, 1998. The Rights
will expire on June 22, 2008,  unless  redeemed or  exchanged.  Under the Rights
Plan, each Right initially will entitle the registered holder to buy one unit of
a share of preferred stock for $165.00.  The Rights will become exercisable only
if a person or group (other than  stockholders  currently owning 15% of Credence
common stock) acquires beneficial  ownership of 15% or more of Credence's common
stock, or commences a tender offer or exchange offer upon  consummation of which
such person or group would  beneficially  own 15% or more of  Credence's  common
stock.

                                       51
<PAGE>


Note 9
Employee Benefit Plans

       The Company maintains a 401(k) retirement  savings plan for its full-time
domestic  employees,  which allows them to contribute up to 20% of their pre-tax
wages subject to IRS limits.  The Company's only  contribution  to this plan was
$441,000 in fiscal 1997.

       The Company maintains a profit sharing plan for those domestic  employees
that are not otherwise eligible for incentive-based compensation.  Contributions
to this  plan are  subject  to the  discretion  of the Board of  Directors.  The
Company made  contributions  of  $1,285,000,  $476,000 and  $3,721,000 in fiscal
1998, 1997 and 1996, respectively.


Note 10
Income Taxes

       The tax provision consists of the following (in thousands):
<TABLE>
<CAPTION>

     Year Ended October 31,     1998        1997        1996
                              --------    --------    --------
<S>    <C>                    <C>         <C>         <C>    
Federal:
       Current                $ (3,786)   $  9,062    $ 16,317
       Deferred                 (8,868)     (3,059)      1,647
                               -------     -------     -------
                               (12,654)      6,003      17,964
State:
       Current                    (539)      1,818       2,358
       Deferred                 (1,636)       (373)        220
                               --------    --------    -------
                                (2,175)      1,445       2,578
Foreign:
       Current                      44          83          22
                               ========    ========    =======
                              $(14,785)   $  7,531    $ 20,564
                               ========    ========    =======
</TABLE>

     Pre-tax income (loss) from foreign  operations was approximately  $6,000 in
1998, $(206,000) in 1997 and $56,000 in 1996.

     A reconciliation between the Company's effective tax rate (36% in 1998, 41%
in 1997  and 35% in  1996)  and  the  U.S.  statutory  rate  is as  follows  (in
thousands):

<TABLE>
<CAPTION>
      Year Ended October 31,                                                    1998         1997         1996
                                                                             ----------    --------    ----------
<S>                                                                           <C>           <C>         <C>    
      Tax computed at statutory rate                                          $(14,373)     $6,380       $20,394
      State income tax (net of federal benefit)                                 (1,414)        935         1,687
      Foreign sales corporation benefit                                             --        (862)       (1,626)
      In-process research and development not currently benefited                  466       1,264             -
      Net operating loss carryforward benefit                                       --        (141)         (141)
      Research and development credits                                            (300)       (370)            -
      Other items                                                                  836         325           250
                                                                             ==========    ========    ==========
                                                                              $(14,785)     $7,531       $20,564
                                                                             ==========    ========    ==========
</TABLE>

       At October  31,  1998,  the  Company  has unused net  operating  loss and
research  tax  credit   carryforwards   for  federal   income  tax  purposes  of
approximately  $2,000,000  and  $194,000,  respectively,  which  expire  in 2003
through 2005. Utilization of the net operating loss carryforwards at October 31,
1998 is limited to  approximately  $401,000  annually  under the  provisions  of
Section 382 of the Internal Revenue Code of 1986, as amended.
Utilization of the credit carryforwards is similarly limited.

                                       52
<PAGE>

       Significant  components  of the  Company's  deferred  tax  assets  are as
follows (in thousands):
<TABLE>
<CAPTION>

October 31,                                     1998        1997
                                              --------    --------
<S>                                           <C>         <C>   
Deferred tax assets:
Accounting for inventories ................   $  8,277    $  4,417
Allowance for doubtful accounts ...........      2,168         884
Accruals not currently  deductible ........      6,506       2,236
Net operating loss carryforwards ..........        703         703
Acquired technology .......................      2,766       2,283
Research credit carryforwards .............        194         194
                                              --------    --------
      Total deferred tax assets ...........     20,614      10,717
Valuation allowance for deferred tax assets     (2,572)     (2,106)
                                              --------    --------
                                                18,042       8,611
Deferred tax liability:
Tax over book depreciation ................       (166)     (1,239)
                                              --------    --------

      Total deferred tax liability ........       (166)     (1,239)
                                              --------    --------
      Net deferred tax assets .............   $ 17,876    $  7,372
                                              ========    ========
</TABLE>

     The change in the  valuation  allowance  was a net increase of $466,000 and
$1,209,000  in 1998 and 1997,  respectively,  and a net  decrease of $140,000 in
1996.

     Realization of a portion of the net deferred tax assets is dependent on the
Company's  ability  to  generate  approximately  $30,000,000  of future  taxable
income. Management believes that it is more likely than not that the assets will
be realized based on forecasted income.  However, there can be no assurance that
the  Company  will meet its  expectations  of  future  income.  Management  will
evaluate the  realizability  of the deferred tax assets quarterly and assess the
need for additional valuation allowances.


Note 11
Contingencies

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


Note 12
Related Party Transactions

       Bernard V.  Vonderschmitt,  a director of the Company, is the founder and
chairman of Xilinx,  Inc. For the years ended  October 31, 1998,  1997 and 1996,
the  Company  sold   approximately   $2,868,000,   $1,356,000  and   $7,887,000,
respectively,  of products and services to Xilinx.  The amounts  receivable from
Xilinx  were  approximately  $554,000  and $2,000 at October  31, 1998 and 1997,
respectively.

     Dr.  William G. Howard,  a director of the Company,  has been a director of
VLSI Technology,  Inc.  ("VLSI") since May 31, 1996. The Company's sales to VLSI
were approximately $2,011,000,  $171,000 and $8,508,000 in fiscal 1998, 1997 and
1996, respectively. The amounts receivable from VLSI were approximately $568,000
and $166,000 at October 31, 1998 and 1997, respectively.  Dr. Howard also serves
as a director of Ramtron International, Inc. ("Ramtron"). The Company's sales to
Ramtron were  approximately  $151,000,  $6,000 and zero in fiscal 1998, 1997 and
1996,  respectively.  Amounts receivable from Ramtron were approximately  $1,000
and zero at October 31, 1998 and 1997, respectively.

       The Company  sells  products  and  services to Israeli  Test House,  Inc.
("ITH"),  a company in which the Company has an investment.  For the years ended
October 31, 1998,  1997 and 1996,  sales to ITH totaled  approximately  $21,000,
$6,000  and  $2,754,000,  respectively.  The  amounts  receivable  from ITH were
approximately $345,000 and $324,000 at October 31, 1998 and 1997, respectively.

                                       53
<PAGE>


Note 13
Subsequent Event - Repricing (unaudited)

       On November 5, 1998, the Compensation Committee of the Company's Board of
Directors  approved a stock option repricing program pursuant to which employees
of the Company  (excluding Board members and consultants)  could elect to cancel
certain  unexercised  stock  options in exchange  for new stock  options with an
exercise  price of $17.19 per share equal to the closing  price of the Company's
common stock on the Nasdaq National  Market on December 14, 1998.  Approximately
898,000 options were eligible for repricing, of which approximately 571,000 were
repriced.  The vesting  schedules and expiration dates of repriced stock options
were restarted at the new vesting commencement date of December 14, 1998.


ITEM 9.    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
           FINANCIAL DISCLOSURE.

       Not Applicable.





                                       54
<PAGE>



                                                     PART III

ITEM 10.      DIRECTORS AND OFFICERS OF THE REGISTRANT.

       The information required by this item relating to the Company's directors
and nominees and  disclosure  relating to  compliance  with Section 16(a) of the
Securities  Exchange  Act of 1934 is included  under the  captions  "Election of
Directors" and "Compliance with Section 16(a) of the Securities  Exchange Act of
1934"  in  the  Company's  Proxy  Statement  for  the  1999  Annual  Meeting  of
Stockholders and is incorporated herein by reference.  The information  required
by this item relating to the Company's  executive  officers and key employees is
included under the caption  "Executive  Officers and Key Employees" in Part I of
this Form 10-K Annual Report.

ITEM 11.      EXECUTIVE COMPENSATION.

       The  information  required  by this item is  included  under the  caption
"Executive   Compensation  and  Related  Information"  in  the  Company's  Proxy
Statement for the 1999 Annual Meeting of Stockholders and is incorporated herein
by reference.

ITEM 12.      SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

       The  information  required  by this item is  included  under the  caption
"Ownership of Securities" in the Company's  Proxy  Statement for the 1999 Annual
Meeting of Stockholders and is incorporated herein by reference.

ITEM 13.      CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

       The  information  required  by this item is  included  under the  caption
"Certain   Relationships  and  Related  Transactions"  in  the  Company's  Proxy
Statement for the 1999 Annual Meeting of Stockholders and is incorporated herein
by reference.





                                       55
<PAGE>



                                     PART IV

ITEM 14.      EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K.

(a) The following documents are filed as part of the Annual Report on Form 10-K:

     1.   Financial Statements.  The following Consolidated Financial Statements
          of Credence Systems  Corporation are included in Item 8 of this Annual
          Report on Form 10-K:

                                                                            Page
               Report of Ernst & Young LLP, Independent Auditors             35
               Consolidated Balance Sheets --
                        October 31, 1998 and 1997                            36
               Consolidated Statements of Operations --
                        Years Ended October 31, 1998, 1997 and 1996          37
               Consolidated Statements of Stockholders' Equity --
                        Years Ended October 31, 1998, 1997 and 1996          38
               Consolidated Statements of Cash Flows --
                        Years Ended October 31, 1998, 1997 and 1996          39
               Notes to Consolidated Financial Statements                    40

       2.  Financial  Statement  Schedule.  The  following  financial  statement
           schedule of Credence Systems Corporation, for the years ended October
           31, 1998,  1997 and 1996,  is filed as part of this Annual  Report on
           Form 10-K and  should be read in  conjunction  with the  Consolidated
           Financial Statements of Credence Systems Corporation:
                                                                            Page
               Schedule II --   Valuation and Qualifying Accounts            59

           Schedules  other than the one listed  above have been  omitted  since
           they are either not  required,  are not  applicable  or the  required
           information  is shown in the  consolidated  financial  statements  or
           related notes.

       3.  Exhibits.  See Exhibit Index on page 60.


(b)    Reports on Form 8-K were filed during the last quarter of the fiscal year
       covered by this Annual  Report on Form 10-K.  The Company filed a Current
       Report on Form 8-K on August 20, 1998,  reporting its  financial  results
       for the third fiscal quarter ended July 31, 1998.

(c)    See Exhibit Index on page 60.

(d)    The  following   financial   statement   schedule  of  Credence   Systems
       Corporation,  for the years ended  October 31,  1998,  1997 and 1996,  is
       filed as part of this  Annual  Report on Form 10-K and  should be read in
       conjunction  with  the  Consolidated  Financial  Statements  of  Credence
       Systems Corporation:
                                                                            Page
           Schedule II --    Valuation and Qualifying Accounts               59

       Schedules  other than the one listed above have been  omitted  since they
       are either not required,  are not applicable or the required  information
       is shown in the consolidated financial statements or related notes.




                                       56
<PAGE>



SIGNATURES

       Pursuant  to the  requirements  of Section 13 or 15(d) 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,  on
January 29, 1999.


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



                       By:   /s/ WILLIAM G. HOWARD, JR.
                          -------------------------------------------
                            Chairman of the Board of Directors


                            /s/ DENNIS P. WOLF
                          -------------------------------------------
                          Dennis P. Wolf
                          Executive Vice President, Chief Financial Officer and
                          Secretary (Principal Financial and Accounting Officer)



                                       57
<PAGE>



                                POWER OF ATTORNEY

       KNOW ALL  PERSONS BY THESE  PRESENTS,  that each person  whose  signature
appears below  constitutes and appoints Dennis P. Wolf and Jerry Bruce, and each
of them, as his true and lawful attorneys-in-fact and agents, with full power of
substitution and  re-substitution,  for him and in his name, place and stead, in
any and all  capacities,  to sign any and all  amendments to this Report on Form
10-K, and to file the same,  with all exhibits  thereto,  and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
said attorneys-in-fact and agents, and each of them, full power and authority to
do and perform each and every act and thing  requisite  and necessary to be done
in  connection  therewith,  as fully to all intents and  purposes as he might or
could  do  in  person,   hereby   ratifying   and   confirming   all  that  said
attorneys-in-fact  and agents,  or any of them,  or their or his  substitute  or
substitutes, may lawfully do or cause to be done by virtue hereof.


       Pursuant to the requirements of the Securities Exchange Act of 1934, this
report  has  been  signed  below  by the  following  persons  on  behalf  of the
Registrant and in the capacities and on the dates indicated.

       Signature                  Title                              Date


/s/ WILLIAM G. HOWARD, JR.     Chairman of the                  January 28, 1999
---------------------------    Board of Directors
William G. Howard, Jr.


/s/ DENNIS P. WOLF             Executive Vice President,        January 28, 1999
---------------------------    Chief Financial Officer
Dennis P. Wolf                 andSecretary


/s/ HENK J. EVENHUIS           Director                         January 28, 1999
---------------------------
Henk J. Evenhuis


/s/ JOS C. HENKENS             Director                         January 28, 1999
---------------------------
Jos C. Henkens


/s/ BERNARD V. VONDERSCHMITT   Director                         January 28, 1999
----------------------------
Bernard V. Vonderschmitt



                                       58
<PAGE>


                                                                     Schedule II


                          CREDENCE SYSTEMS CORPORATION
                        VALUATION AND QUALIFYING ACCOUNTS
                                 (in thousands)


<TABLE>
<CAPTION>

                                                       Additions
                                       Balance at      Charged to                  Balance at
                                        Beginning      Costs and                      End
Description                              of Year       Expenses      Write-offs     of Year
<S>                                     <C>             <C>           <C>            <C>    

Year ended October 31, 1998
     Allowance for doubtful accounts    $1,763          $4,325        $  679         $5,409

Year ended October 31, 1997
     Allowance for doubtful accounts    $1,781          $  762        $  780         $1,763

Year ended October 31, 1996
     Allowance for doubtful accounts    $1,692          $  270        $  181         $1,781
</TABLE>


                                       59
<PAGE>



                                  EXHIBIT INDEX

  Exhibit
   Number                                                                   
   ------                                                                   
   2.1(1)   Agreement and Plan of Merger dated  October  5, 1993  between
            Credence Systems  Corporation, a California Corporation, and the
            Company.
   2.2(1)   Asset  Purchase  Agreement  dated  December  31, 1990  between  
            Tektronix,  Inc.  and the  Company, including Amendment No. 1 to
            the Asset Purchase Agreement dated December 31, 1990.
   2.3(1)   Technology Agreement between Tektronix, Inc. and the Company 
            dated December 31, 1990.
   2.4(1)   Letter Agreement between Tektronix, Inc. and the  Company  dated
            September 30, 1992.
   2.5(1)   Amendment Agreement dated as of August 12,1993 between 
            Tektronix, Inc. and the Company.
   2.6(1)   1990 Plan of Purchase Price Adjustment Recapitalization.
   2.7(1)   Letter Agreement between Tektronix, Inc. and the Company dated 
            August 11, 1993.
  2.8(11)   Agreement  and Plan of  Reorganization  dated as of  February 6,
            1994 among the Registrant,  Semiconductor Test Solutions,  Inc.,
            EPRO and the shareholders of EPRO listed therein.
  2.9(18)   Asset  Purchase  Agreement,  dated  as of May  19,  1997,  among
            Credence Systems Corporation,  Test Systems Strategies,  Inc., a
            Delaware  corporation  and  wholly-owned  subsidiary of Credence
            Systems Corporation, and Test Systems Strategies, Inc. an Oregon
            Corporation and wholly-owned subsidiary of Summit Design, Inc.
  2.10(26)  Asset  Purchase  Agreement,  dated as of August 20, 1997,  among
            Zycad  Corporation,  a Delaware  Corporation,  its wholly  owned
            subsidiary, Attest Software and Test Systems Strategies, Inc., a
            Delaware Corporation and wholly owned subsidiary of the Company.
  2.11(24)  Asset  Purchase  Agreement,  dated as of June 1,  1998,  between
            Credence Systems Corporation, a Delaware corporation and Yervant
            David Lepejian and Lawrence Kraus, as authorized representatives
            of all of the shareholders of Heuristics  Physics  Laboratories,
            Inc., a California corporation.
  3.1(14)   Amended and Restated Certificate of Incorporation of the Company.
   3.2(1)   Bylaws of the Company.
   4.1(1)   Investor  Rights  Agreement  dated October 15, 1989 by and among
            the  Company  and  the  investors   listed  therein,   including
            Amendment  Agreement to the Investor Rights Agreement dated June
            15, 1990,  Second  Amendment  Agreement  to the Investor  Rights
            Agreement  dated  September  30,  1992 and the  Third  Amendment
            Agreement to Investor Rights Agreement dated August 8, 1993.
   4.2(4)   Fourth Amendment Agreement to the Investor Rights Agreement 
            dated March 10, 1994.
  4.3(19)   Purchase  Agreement  between the Company and Smith Barney,  Inc.
            for purchase of $115,000,000  5 1/4%
            Convertible Subordinated Notes due 2002, dated September 4,1997.
  4.4(19)   Indenture  between the  Company and State  Street Bank and Trust
            Company of  California,  N.A.,  as Trustee  dated  September 10,
            1997.
  4.5(19)   Form of 5 1/4% Convertible Subordinated Note due 2002.
  4.6(19)   Registration  Rights Agreement between the Company and Smith 
            Barney, Inc. dated as of September 4, 1997.
  4.7(21)   Form of Rights Agreement, dated as of June 2, 1998, by and 
            between the Company and BankBoston, N.A., as Rights Agent.
  4.8(21)   Form of Certificate of Designation for the Series A Junior 
            Participating Preferred Stock of the Company.
  4.9(21)   Form of Rights Certificate.


                                       60
<PAGE>

  4.10(10)  Fifth Amendment Agreement to the Investor Rights Agreement dated
            May 26, 1995.
  10.1(1)   Form of Indemnification Agreement Between the Company and each 
            of its officers and directors
  10.2(1)   Underwriting  Agreement dated October 28, 1993 by and among the 
            Company and the underwriters  named therein.
  10.3(4)   Underwriting  Agreement  dated March 31, 1994 by and among the 
            Company and the underwriters  named therein.
  10.4(10)  Underwriting  Agreement  dated June 14, 1995 by and among the 
            Company and the underwriters named therein.
  10.5(1)   Industrial Space Lease between Renco Investment  Company and the
            Company dated August 12, 1992 including the First Addendum dated
            August 14,  1992,  Option to renew Lease dated  August 14, 1992,
            First  Amendment to Lease dated October 22, 1992 and  Acceptance
            Agreement dated November 25, 1992.
  10.6(1)   Indenture  (lease  agreement)  between Pen Nom I Corporation and
            the Company dated April 3, 1991,  including the First  Amendment
            to Lease dated  August 16, 1991,  the Second  Amendment to Lease
            dated  December  10,  1991,  the Third  Amendment to Lease dated
            August 7, 1992, the Fourth  Amendment to Lease dated October 13,
            1992 and the Fifth Amendment to Lease dated November 15, 1993.
  10.7(1)   Master Equipment Lease Agreement between the Company and 
            Financing for Science and Industry, Inc. dated February 26,1993.
  10.8(7)   Leaseline Agreement between Comdisco and the Company dated
            July 29, 1994.
  10.9(2)   Indemnification  and Security Agreement between Credence Capital
            Corporation and the Company dated October 28, 1994.
  10.10(4)  Stock Transfer Agreement by and among the Company, Richard Cann,
            Rene Verhaegen and Credence  Europa Limited dated as of February
            28, 1994.
  10.11(4)  Secured Line of Credit Agreement between Credence Europa Limited
            and the Company dated as of February 28, 1994.
  10.12(9)  Lease by and between the Company and The Mutual Life Insurance
            Company of New York dated June 16, 1995.
 10.13(13)  First  Amendment  to Lease by and  between  the  Company and The
            Mutual Life  Insurance  Company of New York dated  December  29,
            1995.
 10.14(14)  Loan and  Security  Agreement  between  the  Company and Silicon
            Valley Bank and Comerica  Bank-California  dated April 28, 1995,
            as amended.
 10.15(12)  Domestic  and  International  Master  Agreement  for Purchase of
            Equipment and Product  Support between the Company and Comdisco,
            Inc., dated January 31, 1995.
 10.16(13)  Employment Agreement by and between the Company and 
            Elwood H. Spedden dated October 31, 1995.
 10.17(14)  Master Lease Purchase Agreement, Lease Purchase Closing Schedule
            and Lease Purchase Addendum No. One between Metlife Capital
            Corporation and the Company dated April 30, 1996.
 10.18(15)  Loan Agreement among Silicon Valley Bank, Bank of Hawaii and the
            Company, dated July 26, 1996.
 10.19(16)  License Agreement between the Company and Kinetix Test Systems, 
            LLC, dated July 31, 1996.


                                       61
<PAGE>

 10.20(16)  Lease Agreement between Petula Associates, Ltd and Koll Portland
            Associates,  dba KBC - Tigard II and the Company dated
            September 12, 1995.
 10.21(16)  Sixth Amendment to Lease by and between the Company and Pen Nom I
            Corporation dated March 10, 1995.
 10.22(18)* Software OEM License Agreement between the Company, Test Systems
            Strategies, Inc. and Summit Design, Inc. dated May 19, 1997.
 10.23(18)  Joint Venture Agreement dated June 10, 1997, between the Company
            and Innotech Corporation.
 10.24(23)  Lease Agreement between the Company and Bedford Property 
            Investors, Inc. dated December 10, 1997
 10.25(24)  Lease Agreement between the Company and Pacific Realty 
            Associates, L.P., dated April 10, 1998.
 10.26(25)  Amendment to Loan Agreement  dated July 24, 1998 between the 
            Company, Silicon Valley Bank and Bank of Hawaii.
 10.27(25)  Non-Recourse  Receivables  Purchase  Agreement dated May 1, 1998
            between the Company and Silicon Valley Financial Services.
   10.28    Employment offer letter, dated March 24, 1998, by and between 
            the Company and Dennis P. Wolf.
   10.29    Letter Agreement, dated January 19, 1999, by and between the 
            Company and Dr. Wilmer R. Bottoms.
    21.1    Subsidiaries of the Company.
    23.1    Consent of Ernst & Young LLP, Independent Auditors.
    24.1    Power of Attorney (reference is made to page 58 of this report).
    27.1    EDGAR Financial Data Schedule.

  99.1(22)  1993 Stock Option Plan, as Amended and Restated through 
            February 13, 1998.
  99.2(20)  Form of Notice of Grant to be generally used in connection with 
            the 1993 Stock Option Plan.
  99.3(20)  Form of Stock Option Agreement to be generally used in 
            connection with the 1993 Stock Option Plan.
  99.4(20)  Addendum to the Stock Option Agreement (Special Tax Elections).
  99.5(20)  Addendum to the Stock Option Agreement (Limited Stock 
            Appreciation Rights).
  99.6(20)  Addendum to the Stock Option Agreement (Change in Control).
  99.7(20)  Addendum to the Stock Option Agreement (Financial Assistance).
  99.8(20)  Form of Notice of Grant of Stock Option (Non-Employee  Director)
            to be generally used in connection with the automatic option
            grant program of the 1993 Stock Option Plan.
  99.9(20)  Form of Stock  Option  Agreement  (Non-Employee  Director) to be
            generally  used in connection  with the  automatic  option grant
            program of the 1993 Stock Option Plan.
  99.10(17) Employee Stock Purchase Plan
  99.11(8)  Compensation Agreement between the Company and Jos C. Henkens, 
            dated November 5, 1993.
  99.12(8)  Compensation Agreement between the Company and Wilmer R. Bottoms,
            dated November 5, 1993.
  99.13(8)  Compensation Agreement between the Company and Robert F. Kibble,
            dated November 5, 1993.
  99.14(8)  Compensation Agreement between the Company and Bernard V.
            Vonderschmitt, dated November 5, 1993.


                                       62
<PAGE>

  99.15(8)  Compensation Agreement between the Company and Henk J. Evenhuis,
            dated November 4, 1993.
 99.16(20)  Form of Stock Purchase Agreement
 99.17(20)  Form of Enrollment/Change Form
---------------------

     (1)    Incorporated by reference to an exhibit to the  Company's
            Registration Statement on Form S-1 (Registration No. 33-68438) as
            amended.
     (2)    Incorporated by reference to an exhibit to the Company's 1994 Annual
            Report on Form 10-K.
     (3)    Incorporated  by reference to an exhibit to the Company's 
            Registration Statement on Form S-8 (Registration No. 33-71856).
     (4)    Incorporated by  reference to an  exhibit  to  the   Company's
            Registration Statement on Form S-1 (Registration No. 33-76264) as
            amended.
     (5)    Incorporated   by  reference   to  an  exhibit  to  the   Company's
            Registration Statement on Form S-8 (Registration No. 33-76542).
     (6)    Incorporated by reference to an exhibit to the Company's  Quarterly
            Report on Form 10-Q for the quarterly period ended April 30, 1994.
     (7)    Incorporated by reference to an exhibit to the Company's  Quarterly
            Report on Form 10-Q for the quarterly period ended July 31, 1994.
     (8)    Management contract or compensatory plan filed pursuant to 
            Item 14(c).
     (9)    Incorporated by reference to an exhibit to the Company's  Quarterly
            Report on Form 10-Q for the quarterly period ended July 31, 1995.
    (10)    Incorporated   by  reference   to  an  exhibit  to  the   Company's
            Registration Statement on Form S-3 (Registration No. 33-92802),  as
            amended.
    (11)    Incorporated  by reference to an exhibit to the  Company's  Current
            Report on Form 8-K as filed with the  Commission on March 29, 1995,
            as amended on May 26, 1995.
    (12)    Incorporated by reference to an exhibit to the Company's  Quarterly
            Report on Form 10-Q for the quarterly period ended April 30, 1995.
    (13)    Incorporated  by reference to an exhibit to the Company's 1995 
            Annual Report on Form 10-K (14) Incorporated by reference to an
            exhibit to the Company's Quarterly Report on Form 10-Q for the
            quarterly period ended April 30, 1996.
    (15)    Incorporated by reference to an exhibit to the Company's  Quarterly
            Report on Form 10-Q for the quarterly period ended July 31, 1996.
    (16)    Incorporated by reference to an exhibit to the Company's 1996
            Annual Report on Form 10-K (17)Incorporated by reference to an 
            exhibit to the Company's Quarterly Report on Form 10-Q for the
            quarterly period ended April 30, 1997.
    (18)    Incorporated by reference to an exhibit to the Company's  Quarterly
            Report on Form 10-Q for the quarterly period ended July 31, 1997.
    (19)    Incorporated   by  reference   to  an  exhibit  to  the   Company's
            Registration  Statement on Form S-3 (Registration No. 333-39387) as
            amended.


                                       63
<PAGE>

    (20)    Exhibits  99.2  through  99.9  and  Exhibit  99.16  and  99.17  are
            incorporated  herein by reference to identically  numbered exhibits
            included in the Company's  Registration Statement on Form S-8 (File
            No. 333-27499)  declared effective with the Securities and Exchange
            Commission on May 20, 1997.
    (21)    Incorporated  by reference to an exhibit to the  Company's  Current
            Report on Form 8-K as filed with the Commission on June 3, 1998.
    (22)    Incorporated   by  reference   to  an  exhibit  to  the   Company's
            Registration  Statement on Form S-8 (File No.  333-59051)  as filed
            with the Commission on July14, 1998.
    (23)    Incorporated by reference to an exhibit to the Company's  Quarterly
            Report on Form 10-Q for the  quarterly  period  ended  January  31,
            1998.
    (24)    Incorporated by reference to an exhibit to the Company's  Quarterly
            Report on Form 10-Q for the quarterly period ended April 30, 1998.
    (25)    Incorporated by reference to an exhibit to the Company's  Quarterly
            Report on Form 10-Q for the quarterly period ended July 31, 1998.
    (26)    Incorporated  by reference to an exhibit to the Company's Annual
            Report on Form 10-K for the year ended October 31, 1997.

      *     Confidential treatment has been granted for certain portions of 
            this exhibit.




                                       64
<PAGE>