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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

For the quarterly period ended April 30, 2005

OR

For the transition period from              to             

Commission File Number 000-10761

LTX CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

Registrant’s Telephone Number, Including Area Code (781) 461-1000

Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report.

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by 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 check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2 of the Exchange Act).     Yes  x    No  ¨

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

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LTX CORPORATION

Index

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LTX CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands)

See accompanying Notes to Consolidated Financial Statements

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LTX CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(Unaudited)

(In thousands, except per share data)

See accompanying Notes to Consolidated Financial Statements

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LTX CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

See accompanying Notes to Consolidated Financial Statements

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LTX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. THE COMPANY

LTX Corporation (“LTX” or the “Company”) designs, manufactures, and markets automatic semiconductor test equipment. Semiconductor designers and manufacturers worldwide use semiconductor test equipment to test devices at different stages during the manufacturing process. These devices are incorporated in a wide range of products, including mobile internet equipment such as wireless access points and interfaces, broadband access products such as cable modems and DSL modems, personal communication products such as cell phones and personal digital assistants, consumer products such as televisions, videogame systems, digital cameras and automobile electronics, and for power management in portable and automotive electronics. The Company also sells hardware and software support and maintenance services for its test systems. The Company is headquartered, and has development and manufacturing facilities, in Westwood, Massachusetts, a development facility in San Jose, California, and worldwide sales and service facilities to support its customer base.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and, accordingly, these footnotes condense or omit information and disclosures which substantially duplicate information provided in our latest audited financial statements. These financial statements should be read in conjunction with the financial statements and notes included in our Annual Report on Form 10-K for the year ended July 31, 2004. In the opinion of our management, these financial statements reflect all adjustments, including normal recurring accruals, necessary for a fair presentation of the results for the interim periods presented. The operating results for the three and nine months ended April 30, 2005 are not necessarily indicative of future trends or our results of operations for the entire year.

Revenue Recognition

The Company recognizes revenue based on guidance provided in SEC Staff Accounting Bulletin No. 104 (SAB 104) “Revenue Recognition”. The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the seller’s price is fixed or determinable and collectibility is reasonably assured.

Revenue related to equipment sales is recognized when: (a) we have a written sales agreement; (b) delivery has occurred; (c) the price is fixed or determinable; (d) collectibility is reasonably assured; (e) the product delivered is standard product with historically demonstrated acceptance; and (f) there is no unique customer acceptance provision or payment tied to acceptance or an undelivered element significant to the functionality of the system. Generally, payment terms are net 30 days from shipment. Certain sales include payment terms tied to customer acceptance. If a portion of the payment is linked to product acceptance, which is 20% or less, the revenue is deferred on only the percentage holdback until payment is received or written evidence of acceptance is delivered to the Company. If the portion of the holdback is greater than 20%, the full value of the equipment is deferred until payment is received or written evidence of acceptance is delivered to the Company. When sales to a customer involve multiple elements, revenue is recognized on the delivered element provided that (1) the undelivered element is a standard product, (2) there is a history of acceptance on the product with the customer, and (3) the undelivered element is not essential to the customer’s application. Revenue is deferred on the undelivered element if it meets the criteria set forth in EITF 00-21 for separate units of accounting treatment. Revenue related to spare parts is recognized on shipment. Revenue related to maintenance and service contracts is recognized ratably over the duration of the contracts.

Engineering and Product Development Costs

The Company expenses all engineering, research and development costs as incurred. Expenses subject to capitalization in accordance with the Statement of Financial Accounting Standards (SFAS) No. 86, “Accounting for the Costs of Computer Software To Be Sold, Leased or Otherwise Marketed”, relating to certain software development costs, were insignificant.

Shipping and Handling Costs

Shipping and handling costs are included in cost of sales in the Consolidated Statements of Operations and Comprehensive Income. These costs, when included in the sales price charged for products, are recognized in net sales. Shipping and handling costs were insignificant for the three and nine months ended April 30, 2005 and 2004.

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Income Taxes

In accordance with SFAS No. 109, “Accounting for Income Taxes”, the Company recognizes deferred income taxes based on the expected future tax consequences of differences between the financial statement bases and the tax bases of assets and liabilities, calculated using enacted tax rates for the year in which the differences are expected to be reflected in the tax return. Research and development tax credits are recognized for financial reporting purposes to the extent that they can be used to reduce the tax provision.

Accounting for Stock-Based Compensation

The Company, as permitted by SFAS No. 123, “Accounting for Stock-Based Compensation”, as amended by SFAS No. 148 “Accounting for Stock-Based Compensation Transition and Disclosure”, has elected to continue to apply the provisions of APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations in accounting for its employee stock option and stock purchase plans. No stock-based employee compensation is reflected in net income (loss), as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant.

The following table illustrates the effect on net loss and loss per share as if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation:

The fair value of each option grant is estimated on the grant date using the Black-Scholes option-pricing model with the following weighted average assumptions:

Impairment of Long-Lived Assets Other Than Goodwill

On an on-going basis, management reviews the value and period of amortization or depreciation of long-lived assets. In accordance with SFAS No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets”, the Company reviews whether impairment losses exist on long-lived assets when indicators of impairment are present. During this review, the Company reevaluates the significant assumptions used in determining the original cost of long-lived assets. Although the assumptions may vary, they generally include revenue growth, operating results, cash flows and other indicators of value. Management then determines whether there has been a permanent impairment of the value of long-lived assets based upon events or circumstances that have occurred since acquisition. The extent of the impairment amount recognized is based upon a determination of the impaired asset’s fair value.

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Accounting for Cost Associated with Exit or Disposal Activities

Whenever exit or disposal activities occur, management reviews the accounting and reporting for costs associated with the exit or disposal activity. In accordance with SFAS No. 146 “Accounting for Cost Associated with Exit or Disposal Activities”, the Company ensures that a liability for a cost associated with an exit or disposal be recognized when the liability is incurred.

Product Warranty Costs

Our products are sold with warranty provisions that require us to remedy deficiencies in quality or performance of our products over a specified period of time at no cost to our customers. Our policy is to establish warranty reserves at levels that represent our estimate of the costs that will be incurred to fulfill those warranty requirements at the time that revenue is recognized.

The following table shows the change in the product warranty liability, as required by FASB Interpretation No. (FIN) 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others”, for the nine months ended April 30, 2005 and 2004:

Comprehensive Income

Comprehensive income is comprised of two components, net income and other comprehensive income. Other comprehensive income consists of unrealized gains and losses on the Company’s marketable securities.

Net Loss per Share

Basic net loss per share is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted net loss per share reflects the maximum dilution that would have resulted from the assumed exercise and share repurchase related to dilutive stock options and is computed by dividing net loss by the weighted average number of common shares and all dilutive securities outstanding.

Reconciliation between basic and diluted earnings per share is as follows:

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At April 30, 2005 and 2004, options to purchase 8,622,261 shares and 1,390,528 shares of common stock, respectively, were not included in the calculation of diluted net loss per share because their inclusion would have been anti-dilutive. These options could be dilutive in the future.

Cash and Cash Equivalents and Marketable Securities

The Company considers all highly liquid investments that are readily convertible to cash and that have original maturity dates of three months or less to be cash equivalents. Investments with remaining maturities greater than three months and that mature within one year from the balance sheet date are considered to be marketable securities. Cash and cash equivalents consist primarily of repurchase agreements, commercial paper and money market funds. Marketable securities consist primarily of debt securities that are classified as available-for-sale and are reported at fair value in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities”. Securities available for sale include corporate and governmental obligations with various contractual maturity dates. Governmental obligations include U.S. Government, State, Municipal and Federal Agency securities.

Gross unrealized gains and losses for the three and nine months ended April 30, 2005 and April 30, 2004 were not significant. The realized profits, losses and interest are included in investment income in the Consolidated Statements of Operations and Comprehensive Income. Unrealized gains and losses are reflected as a separate component of comprehensive income and are included in Stockholders’ Equity.

At April 30, 2005, cash balances of approximately $1.0 million were restricted from withdrawal. These funds primarily served as collateral supporting certain operating equipment leases.

Inventories

Inventories are stated at the lower of cost or market, determined on the first-in, first-out method, and include materials, labor and manufacturing overhead. Inventories consisted of the following at:

Our policy is to establish inventory reserves when conditions exist that suggest our inventory may be in excess of anticipated demand or is obsolete based upon our assumptions about future demand of our products or market conditions. We regularly evaluate the ability to realize the value of our inventory based on a combination of factors including the following: forecasted sales or usage, estimated product end of life dates, estimated current and future market value and new product introductions. Purchasing and alternative usage options are also explored to mitigate inventory exposure. When recorded, our reserves are intended to reduce the carrying value of our inventory to its net realizable value. Pursuant to SAB Topic 5-BB, inventory reserves establish a new cost basis for inventory. Such reserves are not reversed until the related inventory is sold or otherwise disposed of. During the quarter ended April 30, 2005, there were no reversals of reserves related to the sale of previously written down items. For the nine months ended April 30, 2005, we have recorded $0.5 million of gain from sales of previously written down items. This gain was recorded in the quarter ended January 31, 2005. As of April 30, 2005, our inventory of $43.9 million is stated net of inventory reserves of $103.8 million and the net inventory consists principally of second generation Fusion products and engineering materials. Of the $26.7 million comprising the raw materials inventory, $7.3 million consists of “last time buy” custom components for Fusion HFi and $19.4 million consists of raw materials for Fusion HFi and CX, which the Company believes will be consumed over the next 24 months. If actual demand for our products deteriorates or market conditions are less favorable than those that we project, additional inventory reserves may be required.

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Property and Equipment

Property and equipment are summarized as follows:

At April 30, 2005 and July 31, 2004, included in machinery and equipment is equipment acquired under capital leases of $1.1 million and $5.7 million respectively. Accumulated amortization related to those assets was zero and $1.3 million at April 30, 2005 and July 31, 2004, respectively.

Goodwill and Other Intangibles

The Company has adopted the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets”, which requires that goodwill and intangible assets with indefinite useful lives are not amortized. Intangible assets with a definitive useful life are amortized over their estimated useful life. Assets recorded in these categories are tested for impairment at least annually or when a change in circumstances may result in future impairment. Intangible assets are recorded at historical cost. Intangible assets acquired in an acquisition, including purchased research and development, are recorded under the purchase method of accounting. Assets acquired in an acquisition are recorded at their estimated fair values at the date of acquisition. Management uses a discounted cash flow analysis which requires that certain assumptions and estimates be made regarding industry economic factors and future profitability of the acquired business to assess the need for an impairment charge. If the carrying value of the asset is in excess of the present value of the expected future cash flows, the carrying value is written down to fair value in the period identified.

Goodwill totaling $13.7 million at each of April 30, 2005 and July 31, 2004, represents the excess of acquisition costs over the estimated fair value of the net assets acquired from StepTech, Inc. on June 10, 2003.

Other intangible assets consisted of core technology and amounted to the following at April 30, 2005 and July 31, 2004:

Amortization expense for the nine months ended April 30, 2005 and 2004 was $525,000. The estimated aggregate amortization expense for the remainder of fiscal 2005 is $175,000 and for each of the two succeeding fiscal years is $700,000.

Recently Issued Accounting Pronouncements

On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued Statement No. 123 (revised 2004), “Share Based Payment” (“SFAS No. 123R”), which is a revision of Statement No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”). SFAS No. 123R supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees” and amends Statement No. 95, “Statement of Cash Flows”. Under SFAS No. 123R, companies must calculate and record in the income statement the cost of equity instruments, such as stock options, awarded to employees for services received; pro forma disclosure is no longer permitted. The cost of the equity instruments is to be measured based on the fair value of the instruments on the date they are granted and is required to be recognized over the period during which the employees are required to provide services in exchange for the equity instruments. The statement is effective in the first interim or annual reporting period beginning after June 15, 2005.

SFAS No. 123R provides two alternatives for adoption: (1) a “modified prospective” method in which compensation cost is recognized for all awards granted subsequent to the effective date of this statement as well as for the unvested portion of awards outstanding as of the effective date; or (2) a “modified retrospective” method which follows the approach in the “modified prospective” method, but also permits entities to restate prior periods to record compensation cost calculated under SFAS No. 123 for the pro forma disclosure. We plan to adopt SFAS No. 123R using the modified prospective method. Since

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we currently account for stock options granted to employees and shares issued under our employee stock purchase plans in accordance with the intrinsic value method permitted under APB Opinion No. 25, no compensation expense is recognized. The adoption of SFAS No. 123R is expected to have a significant impact on our results of operations. The impact of adopting SFAS No. 123R cannot be accurately estimated at this time, as it will depend on the market value and the amount of share based awards granted in future periods. SFAS No. 123R also requires that tax benefits received in excess of compensation cost be reclassified from operating cash flows to financing cash flows in the Consolidated Statement of Cash Flows. This change in classification could reduce net operating cash flows and increase net financing cash flows in the periods after adoption.

In November 2004, the FASB issued Statement of Financial Accounting Standards No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4” (“SFAS 151”). SFAS 151 modifies the accounting for abnormal inventory costs, and the manner in which companies allocate fixed overhead expenses to inventory.

SFAS 151 is effective for inventory costs incurred during annual periods beginning after June 15, 2005. LTX does not expect SFAS 151 to have a material impact on its financial positions and results of operations.

3. SEGMENT REPORTING

The Company operates predominantly in one industry segment: the design, manufacture and marketing of automatic test equipment for the semiconductor industry that is used to test system-on-a-chip, digital, analog and mixed signal integrated circuits.

The Company’s net sales for the three and nine months ended April 30, 2005 and 2004, along with the long-lived assets at April 30, 2005 and July 31, 2004, are summarized as follows:

Transfer prices on products sold to foreign subsidiaries are intended to produce profit margins that correspond to the subsidiary’s sales and support efforts.

4. REORGANIZATION CHARGES, ASSET IMPAIRMENTS AND INVENTORY PROVISIONS

For the quarter ended October 31, 2004, the Company recorded a reorganization charge of approximately $3.1 million, of which $1.5 million consisted of severance costs relating to a worldwide workforce reduction and $1.6 million related to consolidation of the Company’s facilities in the United Kingdom. The $1.6 million non-cash reorganization charge related to the consolidation of the Company’s facilities in the United Kingdom consisted of future lease obligations net of any rental income. As previously disclosed in a current report on Form 8-K filed on September 20, 2004, the workforce reduction

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undertaken during the quarter eliminated 74 positions, or approximately 11% of the Company’s worldwide workforce. During the first nine months of fiscal 2005, the Company’s cash expenditures related to the reorganization charges were approximately $1.5 million. At April 30, 2005, the remaining reserve was approximately $1.3 million and relates to the consolidation of the Company’s facilities in the United Kingdom. There are no remaining severance costs from the October 31, 2004 workforce reduction to be paid during fiscal year 2005.

During the quarter ended October 31, 2004, the Company recorded a $47.5 million excess and obsolete inventory provision. Of the $47.5 million reserve charged in the quarter, approximately 90% was related to first generation Fusion and consisted of raw materials, work-in-process and finished goods. The remaining 10% was related to excess second generation Fusion products and was made to more accurately reflect the Company’s assessment of current product demand.

During the quarter ended April 30, 2005, the Company recorded a reorganization charge of $28.6 million as a result of a significant corporate-wide restructuring undertaken to more effectively align the Company’s resources with our current business strategy. Of the $28.6 million, approximately $4.0 million related to headcount reduction and approximately $24.6 million related to fixed asset impairment and facilities consolidation.

The $4.0 million charge was taken as a result of a worldwide workforce reduction of approximately 25% on February 15, 2005, which eliminated 153 positions. On February 18, 2005, the Company filed a Form 8-K describing these actions. The Company expects that the workforce reduction will result in cash expenditures, consisting principally of severance and employee benefit payments, of approximately $3.7 million during the Company’s 2005 fiscal year and approximately $0.3 million during the Company’s 2006 fiscal year. For the quarter ended April 30, 2005, the Company’s cash expenditures related to the severance charges were $2.1 million. The remaining reserve at the end of the quarter was approximately $1.9 million.

The $24.6 million reorganization charge relating to fixed asset impairment and facilities consolidation was undertaken as a result of an asset impairment review. This review was triggered by the workforce reduction and business unit reorganization. Of the $24.6 million impairment charge, $18.1 million was related to fixed asset equipment, $4.6 million related to future lease obligations on equipment that will no longer be used and $1.9 related to facilities consolidation. The equipment, which will be disposed of over the next three to six months, consists primarily of older technology having little or no resale value that the Company intends to scrap.

5. CONTINGENCIES AND GUARANTEES

In the ordinary course of business, we agree from time to time to indemnify certain customers against certain third party claims for property damage, bodily injury, personal injury or intellectual property infringement arising from the operation or use of our products. Also, from time to time in agreements with our suppliers, licensors and other business partners, we agree to indemnify these partners against certain liabilities arising out of the sale or use of our products. The maximum potential amount of future payments we could be required to make under these indemnification obligations is theoretically unlimited; however, we have general and umbrella insurance policies that enable us to recover a portion of any amounts paid and many of our agreements contain a limit on the maximum amount, as well as limits on the types of damages recoverable. Based on our experience with such indemnification claims, we believe the estimated fair value of these obligations is minimal. Accordingly, we have no liabilities recorded for these agreements as of April 30, 2005 or July 31, 2004.

Subject to certain limitations, LTX indemnifies its current and former officers and directors for certain events or occurrences. Although the maximum potential amount of future payments LTX could be required to make under these agreements is theoretically unlimited, as there were no known or pending claims, we have not accrued a liability for these agreements as of April 30, 2005 or July 31, 2004.

The Company had various commercial relationships with Ando Electric Co., Ltd. (Ando), a Japanese test equipment manufacturer, since 1993 when Ando was a subsidiary of NEC. The Company had an agreement with Ando to manufacture the Fusion products in Japan.

In fiscal 2002, Yokogawa Electric Corporation, a Japanese manufacturer of semiconductor test equipment, announced the acquisition of most of NEC’s interest in Ando. On May 18, 2001, the Company served Ando with a Demand for Arbitration pursuant to the Fusion Agreement. The Company asserted claims for breach of contract, breach of fiduciary duty, unfair competition and other claims arising out of Ando’s conduct. Ando filed an answer and counterclaims to the Company’s demand for arbitration.

In fiscal 2002, the Company and Ando entered into an agreement providing for the dismissal, with prejudice, of all claims filed under the arbitration proceedings pending with the American Arbitration Association in San Jose, California. Under the terms of this agreement, Ando has forgiven certain loan and other debt obligations totaling approximately $7.0 million and has agreed to certain continuing supply and support obligations for customers in Japan for a transition period. Except for these continuing obligations, the obligations of the parties under the Fusion Agreement and other related agreements have been terminated. In connection with the termination of obligations of the parties under the Fusion Agreement, Ando has also forgiven contractual obligations totaling $1.7 million. At the end of the transition period, the Company will continue to supply and support former Ando customers in Japan. An accrual of $7.9 million was recorded for anticipated expenses associated with this transition period. The Company has incurred a total of $6.6 million of expenditures, leaving an accrual balance of $1.3 million as of January 31, 2005. During the quarter ended April 30, 2005, the Company has determined through negotiation with one customer, that the one remaining guarantee under this agreement will cost the Company approximately $0.6 million. We expect to complete this final commitment within six months. Included in the Consolidated Results Of Operations And Comprehensive Income for the Three and Nine months ended April 30, 2005 is a reversal of the liability in the amount of $0.7 million. The reversal of the accrued liability was recorded in selling, general and administrative expenses. The Ando liability balance of $0.6 million as of April 30, 2005 is included in Other Accrued Liabilities.

The Company has operating lease commitments for certain facilities and equipment and capital lease commitments for certain equipment. Minimum lease payments under non-cancelable leases at April 30, 2005, are as follows:

6. SUBSEQUENT EVENT

On June 3, 2005, the Company closed a $60 million term loan with a lender. The term loan has a five-year term, with interest only payable in the first year. Interest is at the lender’s prime rate and the loan is secured by all assets of the Company located in the United States. The loan has a liquidity covenant requiring the Company to maintain domestic quick assets in an amount equal to or greater than the sum of (a) the outstanding principal and interest under the term loan, plus (b) Thirty Million Dollars ($30,000,000.00), to be tested monthly. The proceeds from this loan will be used to finance repurchases of the Company’s 4.25% convertible subordinated notes and other working capital purposes. Subsequent to the end of the third quarter, we have repurchased $51 million principal amount of the notes.

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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Industry Conditions and Outlook

We sell capital equipment and services to companies that design, manufacture, assemble or test semiconductor devices. The semiconductor industry is highly cyclical, causing in turn a cyclical impact on our financial results. As a capital equipment provider, our revenue is driven by the capital expenditure budgets and spending patterns of our customers, who often delay or accelerate purchases in reaction to variations in their business. The level of capital expenditures by these semiconductor companies depends on the current and anticipated market demand for semiconductor devices and the products that incorporate them. Therefore, demand for our semiconductor test equipment is dependent on growth in the semiconductor industry. In particular, three primary characteristics of the semiconductor industry drive the demand for semiconductor test equipment:

The semiconductor industry is highly cyclical, causing in turn a cyclical impact on our financial results. Our operating results were negatively impacted by a severe industry-wide slowdown in the semiconductor industry, which began to affect the semiconductor test industry in fiscal 2001 and continued through our fiscal year ended July 31, 2003. However the industry entered a period of growth during our fiscal year ended July 31, 2004 and the Company’s quarterly revenues increased sequentially each quarter during the fiscal year. The period of growth was short and we experienced a sharp decline in orders in the first quarter of fiscal year 2005, which has continued into our second fiscal quarter. Although the Company experienced improved order levels in our third fiscal quarter, it is unclear whether we are entering into another period of growth. The Company’s results of operations would be further adversely affected if we were to experience lower than anticipated order levels, cancellations of orders in backlog, extended customer delivery requirements or pricing pressure as a result of this slowdown. At lower levels of revenue, there is a higher likelihood that these types of changes in our customers’ requirements would adversely affect our results of operations because in any particular quarter a limited number of transactions accounts for an even greater portion of sales for the quarter.

Consistent with our business strategy, we have continued to invest significant amounts in engineering and product development to develop and enhance our Fusion platform during slowdowns. We believe that our competitive advantage in the semiconductor test industry is primarily driven by the ability of our Fusion platform to meet or exceed the highest technical specifications required for the testing of the most advanced semiconductor devices in a cost-efficient manner. We believe this will continue to differentiate the Fusion platform from the product offerings of our competitors.

We are also exposed to the risks associated with the current emerging recovery in the U.S. and global economies. The lack of visibility regarding whether or when there will be a sustained recovery in the sale of electronic goods and information technology equipment, and uncertainty regarding the magnitude of the recovery, underscores the need for caution in predicting growth in the semiconductor test equipment industry in general and in our revenues and profits specifically. Slow or negative growth in the domestic economy may continue to materially and adversely affect our business, financial condition and results of operations for the foreseeable future.

Critical Accounting Policies and the 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 amount of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base these estimates and assumptions on historical experience, and evaluate them on an on-going basis to ensure they remain reasonable under current conditions. Actual results could differ from those estimates. We discuss the development and selection of the critical accounting estimates with the audit committee of our board of directors on a quarterly basis, and the audit committee has reviewed the Company’s critical accounting estimates as described in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s Annual Report on Form 10-K for the fiscal year ended July 31, 2004. For the nine months ended April 30, 2005, there have been no changes to these critical accounting policies.

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Results of Operations

The following table sets forth for the periods indicated the principal items included in the Consolidated Statement of Operations as percentages of net sales.

The discussion below contains certain forward-looking statements relating to, among other things, estimates of economic and industry conditions, sales trends, expense levels and capital expenditures. Actual results may vary from those contained in such forward-looking statements. See “Business Risks” below.

Three and Nine Months Ended April 30, 2005 Compared to the Three and Nine Months Ended April 30, 2004.

Net sales. Net sales consist of both semiconductor test equipment and related hardware and software support and maintenance services, net of returns and allowances. Net sales for the three months ended April 30, 2005 decreased 63.7% to $25.5 million as compared to $70.3 million in the same quarter of the prior year. Net sales for the nine months ended April 30, 2005 were $95.6 million as compared to $175.4 million for the nine months ended April 30, 2004, a 45.5 % decrease. The decrease in net sales year over year is primarily a result of sluggish demand for semiconductors resulting in reduced demand for semiconductor test equipment. In the first quarter of fiscal 2005, our major customers reduced their forecasts for capital equipment purchases, which resulted in a sudden and substantial drop in revenues and orders for the Company, which has continued into our second quarter of fiscal 2005, although the Company experienced a modest increase in orders in its third fiscal quarter. The impact to the Company of any industry slowdown is exacerbated by the fact that the semiconductor industry is highly concentrated, and a small number of device manufacturers and contract assemblers account for a substantial portion of the purchases of semiconductor test equipment, including the Company’s equipment. Sales to our ten largest customers accounted for 81.8% and 76.1% of revenues for the three months and nine months, respectively, ended April 30, 2005 and 88.8% and 87.3% for the three months and nine months, respectively, ended April 30, 2004. Reduced sales from any one of our largest customers could have a significant effect on our sales.

Service revenue accounted for $7.4 million, or 29.2% of net sales, and $9.9 million, or 14.0% of net sales, for the three months ended April 30, 2005 and 2004, respectively, and $24.2 million or 25.3% of net sales, and $28.5 million, or 16.3% of net sales, for the nine months ended April 30, 2005 and 2004, respectively. Geographically, sales to customers outside of the United States were 68.9% and 71.0% of net sales for the three months ended April 30, 2005 and April 30, 2004, respectively, and 69.4%, and 65.5%, for the nine months ended April 30, 2005 and 2004, respectively.

Gross Profit Margin. The gross profit margin was 26.8% of net sales for the three months ended April 30, 2005, as compared to 41.6% of net sales for the same quarter of the prior year. The decrease in gross profit margin percentage is primarily due to declining economies of scale resulting from lower sales revenue. For the nine months ended April 30, 2005, the gross profit margin was ($18.7 million) or (19.5%) of net sales as compared to $66.4 million or 37.9 % for the nine months ended April 30, 2004. Cost of sales in the fiscal quarter ended October 31, 2004 includes an inventory related provision of $47.5 million. The decrease in gross margin in the first three quarters of fiscal year 2005 compared to the same period of the prior year is due to the inventory related provision of $47.5 million and lower net sales.

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Inventory Related Provision. In the first quarter of fiscal 2005, our major customers reduced their forecasts for capital equipment purchases, which resulted in a sudden and substantial drop in revenues and orders for the Company. These conditions continued into our second quarter of fiscal 2005. As a result of the shorter than expected upturn in business conditions, and the completion of the Company’s transition to its second generation Fusion, we deemed it appropriate to make an adjustment to our inventory and recorded a $47.5 million excess and obsolete inventory provision in the quarter ended October 31, 2004. Inventory reserves establish a new cost basis for inventory and such reserves are not reversed until the related inventory is sold or otherwise disposed. During the quarter ended April 30, 2005, there were no reversals of reserves related to the sale of previously written down items. For the nine months ended April 30, 2005, we recorded $0.5 million of gain from sales of previously written down items. This gain was recorded in the quarter ended January 31, 2005. As of April 30, 2005, our inventory of $43.9 million is stated net of inventory reserves of $103.8 million and consists of second generation Fusion products and engineering materials. Of the $26.7 million comprising the raw materials inventory, $7.3 million consists of “last time buy” custom components for Fusion HFi and $19.4 million consists of raw materials for Fusion HFi and CX, which the Company believes will be consumed over the next 24 months. If actual demand for our products deteriorates or market conditions are less favorable than those that we project, additional inventory reserves may be required.

Engineering and Product Development Expenses. Engineering and product development expenses were $16.5 million, or 64.6% of net sales, in the three months ended April 30, 2005, as compared to $17.1 million, or 24.4% of net sales, in the same quarter of the prior year. For the nine months ended April 30, 2005, engineering and product development expenses were $52.0 million, or 54.4% of net sales, as compared to $50.2 million, or 28.6% of net sales for the same period of the prior year. The decrease in engineering and product development expenses for the three months ended April 30, 2005 as compared to April 30, 2004 is principally a result of the savings from our September 2004 and February 2005 workforce reductions. The increase in engineering and product development expenses for the nine months ended April 30, 2005 as compared to April 30, 2004 is a result of increased payroll cost associated with a wage increase on August 1, 2004, increased depreciation from the addition of capital equipment to support application development and engineering material expenses for second generation Fusion options, with each expense item constituting approximately one third of the increase.

Selling, General and Administrative Expenses. Selling, general and administrative expenses were $7.3 million, or 28.7% of net sales, in the three months ended April 30, 2005, as compared to $7.0 million, or 10.0% of net sales, in the same quarter of the prior year, an increase of $0.3 million. For the nine months ended April 30, 2005, selling, general and administrative expenses were $23.2 million, or 24.3%, as compared to $20.2 million, or 11.5% for the same period of the prior year. The increase in selling, general and administrative expenses for the three months and nine months ended April 30, 2005 was a result of an increase of six employees in our sales and marketing staff to support new products and marketing programs, the impact of a wage increase implemented on August 1, 2004, and Sarbanes Oxley Section 404 consulting expenses.

Reorganization Costs. The Company recorded a reorganization charge in the quarter ended October 31, 2004 of $3.1 million, of which $1.5 million consisted of severance costs relating to a worldwide workforce reduction and $1.6 million related to consolidation of the Company’s facilities in the United Kingdom. The $1.6 million non-cash reorganization charge related to the consolidation of the Company’s facilities in the United Kingdom consisted of future lease obligations net of any rental income. As previously disclosed in a current report on Form 8-K filed on September 20, 2004, the workforce reduction undertaken during the quarter eliminated 74 positions, or approximately 11% of the Company’s worldwide workforce. As a result of these actions, the Company will realize an annual savings in operating expenses of approximately $8.0 million, which will be offset by approximately $2.0 million as a result of the removal of the salary and wage freeze imposed since 2001. The net effect of the cost reduction actions and the removal of the salary and wage freeze is an annual savings of approximately $6.0 million in operating expenses. During the first nine months of fiscal year 2005, the Company’s cash expenditures related to the charges were approximately $1.8 million. At April 30, 2005, the remaining reserve was approximately $1.3 million and relates to the consolidation of the Company’s facilities in the United Kingdom. There are no remaining severance costs from the October 31, 2004 workforce reduction to be paid during fiscal year 2005.

During the quarter ended April 30, 2005, the Company recorded a reorganization charge of $28.6 million as a result of a significant corporate-wide restructuring undertaken to more effectively align the Company’s resources with our current business strategy. Of the $28.6 million, approximately $4.0 million related to headcount reduction and approximately $24.6 million related to fixed asset impairment and facilities consolidation.

The $4.0 million charge was taken as a result of a worldwide workforce reduction of approximately 25% on February 15, 2005, which eliminated 153 positions. On February 18, 2005, the Company filed a Form 8-K describing these actions. The

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Company expects that the workforce reduction will result in cash expenditures, consisting principally of severance and employee benefit payments, of approximately $3.7 million during the Company’s 2005 fiscal year and approximately $0.3 million during the Company’s 2006 fiscal year. For the quarter ended April 30, 2005, the Company’s cash expenditures related to the severance charges were $2.1 million. The remaining reserve at the end of the quarter was approximately $1.9 million.

The $24.6 million reorganization charge relating to fixed asset impairment and facilities consolidation was undertaken as a result of an asset impairment review. This review was triggered by the workforce reduction and business unit reorganization. Of the $24.6 million impairment charge, $18.1 million was related to fixed asset equipment, $4.6 million related to future lease obligations on equipment that will no longer be used and $1.9 related to facilities consolidation. The equipment, which will be disposed of over the next three to six months, consists primarily of older technology having little or no resale value that the Company intends to scrap.

Interest Expense. Interest expense was $1.5 million and $1.6 million for the three months ended April 30, 2005 and April 30, 2004, respectively. For the nine months ended April 30, 2005 and 2004, interest expense was $4.9 million and $5.0 million, respectively. Approximately $1.6 million of expense for each of the three months ended April 30, 2005 and April 30, 2004 and $4.8 million for the nine months ended April 30, 2005 and 2004 is the interest expense for the 4.25% convertible subordinated notes.

Investment Income. Investment income was $1.5 million for the three months ended April 30, 2005, as compared to $0.8 million for the three months ended April 30, 2004. For the nine months ended April 30, 2005, investment income was $4.1 million as compared to $2.1 million for the same period of the prior year. Investment income was higher in the three and nine months ended April 30, 2005 than the same period of the prior year as a result of higher average cash and cash equivalents and marketable securities balances and improving interest rates.

Income Tax. For the three months ended April 30, 2005, the Company recorded no income tax benefit due to the uncertainty related to utilization of net operating loss carry forwards. As a result of a review undertaken at April 30, 2005 and our cumulative loss position at that date, management concluded that it was appropriate to maintain a full valuation allowance for its operating loss carry forwards and its other net deferred tax assets.

Net Loss. Net loss was $45.7 million, or $0.75 per share, in the three months ended April 30, 2005, as compared to a net income of $4.3 million, or $0.07 per share, in the same quarter of the prior year. Net loss for the third quarter of fiscal 2005 was greater than the net loss for the third quarter of fiscal 2004 due to a $45.8 million drop in revenue and resulting reduction in gross margin on the lower revenue.

For the nine months ended April 30, 2005, net loss was $126.5 million, as compared to a net loss of $6.9 million for the same period of the prior year. The increase in the net loss for the nine months ended April 30, 2005 from the nine months ended April 30, 2004 was principally due to the $47.5 million inventory related provision recorded in the quarter ended October 31, 2004; the $24.6 million asset impairment charge recorded in the quarter ended April 30, 2005; the $4.0 million reorganization charge recorded in the quarter ended April 30, 2005; the $3.1 million reorganization charge recorded in the quarter ended October 31, 2004; and, the decrease in gross margin due to declining economics of scale resulting from lower sales revenue.

Liquidity and Capital Resources

At April 30, 2005, the Company had $175.7 million in cash and cash equivalents and marketable securities and working capital of $189.1 million, as compared to $244.7 million of cash and cash equivalents and marketable securities and $292.9 million of working capital at July 31, 2004. The decrease in the cash and cash equivalents and marketable securities was due primarily to cash used in operations of $60.3 million and cash used in capital purchases of $9.3 million. Cash used in operations consisted of $22.0 million related to purchases of materials to support a higher level of sales than experienced, a $10.9 million reduction in the accounts payable balance relating to inventory purchases, and a loss from operations, offset by a $14.8 million decrease in accounts receivable.

Accounts receivable from trade customers was $24.9 million at April 30, 2005, as compared to $33.0 million at July 31, 2004. The principal reason for the $8.1 million decrease in accounts receivable is a result of decreased sales. The allowance for sales returns and doubtful accounts was $2.0 million, or 7.5% of gross trade accounts receivable, at April 30, 2005 and $2.0 million, or 5.8% of gross trade accounts receivable at July 31, 2004. The increase in the allowance as a percentage of gross accounts receivable is due to a decline in current receivable balances on the lower sales volume. The allowance generally relates to past due amounts. The allowance as a percentage of past due amounts did not change significantly.

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Management reviews the allowance for sales returns on a quarterly basis or upon any change in circumstances that may warrant a change in the allowance. Accounts receivable from other sources decreased $6.5 million to $5.0 million at April 30, 2005, as compared to $11.5 million at July 31, 2004. The decrease was attributed to the decrease in the sale of component inventory at cost to our outsource suppliers.

Net inventories decreased by $25.3 million to $43.9 million at April 30, 2005 as compared to $69.2 million at July 31, 2004. The decrease was primarily the result of an inventory related provision of $47.5 million recorded in our first quarter ended October 31, 2004. Offsetting the charge of $47.5 million to the excess reserve was an increase in inventories to support Fusion HFi and CX of $22.2 million. Of the $22.2 million, $1.8 million consisted of deposits previously made to suppliers of critical components to ensure delivery and $20.4 million consisted of new inventory purchases. Approximately $18.7 million of the $22.2 million increase in inventory was a result of the sudden and substantial drop in revenue in the first quarter of fiscal 2005 compared to revenue in the fourth quarter of fiscal year 2004. The Company expects to consume this excess Fusion HFi and CX inventory within the next 24 months.

Prepaid expense decreased by $4.1 million to $5.7 million at April 30, 2005 as compared to $9.8 million at July 31, 2004. The decrease was attributed to the receipt of inventory against prepayments and amortization of prepaid insurance premiums and maintenance contract prepayments. Inventory related deposits were zero at April 30, 2005 and $2.0 million at July 31, 2004.

Capital expenditures totaled $9.3 million for the nine months ended April 30, 2005, as compared to $12.6 for the nine months ended April 30, 2004. Capital expenditures include the purchase of additional capital equipment to support increased applications development, and spare parts to support our two new products, Fusion HFi and Fusion CX.

On June 3, 2005, the Company closed a $60 million term loan with a lender. The term loan has a five year term, with interest only payable in the first year. Interest is at the lender’s prime rate and the loan is secured by all assets of the Company located in the United States. The proceeds from this loan will be used to finance repurchases of the Company’s 4.25% convertible subordinated notes and other working capital purposes. Subsequent to the end of the third fiscal quarter, we have repurchased $51 million principal amount of the notes.

The Company has a second credit facility with another lender for a revolving credit line of $20.0 million. This facility is secured by cash and bears interest (at our option) at either: (i) the greater of the federal funds rate plus 0.5% or the bank’s prime rate, in each case, minus 1.0% or (ii) LIBOR plus 0.4%. This facility expires on July 23, 2005. No amounts were outstanding under this credit facility at April 30, 2005.

In January 2004, we filed a shelf registration statement on Form S-3 to register up to $250 million of common stock, debt securities and warrants. On February 19, 2004, we closed an offering made pursuant to the registration statement relating to the sale of 8,050,000 shares of our common stock at $16.50 per share. The offering included 1,050,010 shares sold as a result of the exercise, in full, by the underwriters of their option to purchase additional shares of common stock. Gross proceeds from the stock offering totaled approximately $132.8 million. Proceeds to LTX, net of $6.3 million in underwriters’ commissions and discounts and other expenses, totaled approximately $126.5 million.

The Company operates in a highly cyclical industry and we may experience, with relatively short notice, significant fluctuations in demand for our products. This could result in a material effect on our liquidity position. To mitigate the risk, we have completed a substantial and lengthy process of converting our manufacturing process to an outsource model. As such, we believe we can react to a downturn or a significant upturn much faster than in the past. We believe that our balances of cash and cash equivalents, cash flows expected to be generated by future operating activities, our ready access to capital markets for competitively priced instruments and funds available under our credit facility will be sufficient to meet our cash requirements over the next twelve months.

Commitments and Contingencies

Our major outstanding contractual obligations are related to our convertible subordinated notes, facilities leases and other capital and operating leases. The Company has 4.25% convertible subordinated notes due in 2006. Interest on the notes is payable on February 15 and August 15 of each year, commencing February 15, 2002. The outstanding principal of the notes was $150.0 million as of April 30, 2005.

The aggregate outstanding amount of the contractual obligations is $185.2 million as of April 30, 2005. These obligations and commitments represent maximum payments based on current operating forecasts. Certain of the commitments could be reduced if changes to our operating forecasts occur in the future.

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The following summarizes LTX’s contractual obligations, net of sub-lease revenue, at January 31, 2005 and the effect such obligations are expected to have on its liquidity and cash flow in the future periods:

BUSINESS RISKS

This report includes or incorporates forward-looking statements that involve substantial risks and uncertainties and fall within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. You can identify these forward-looking statements by our use of the words “believes,” “anticipates,” “plans,” “expects,” “may,” “will,” “would,” “intends,” “estimates,” and similar expressions, whether in the negative or affirmative. We cannot guarantee that we actually will achieve these plans, intentions or expectations. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements we make. We have included important factors in the cautionary statements, particularly under the heading “Business Risks,” that we believe could cause our actual results to differ materially from the forward-looking statements that we make. We do not assume any obligation to update any forward-looking statement we make.

Our sole market is the highly cyclical semiconductor industry, which causes a cyclical impact on our financial results.

We sell capital equipment to companies that design, manufacture, assemble, and test semiconductor devices. The semiconductor industry is highly cyclical, causing in turn a cyclical impact on our financial results. Our recent operating results have been negatively impacted by an industry-wide slowdown in the semiconductor industry, which began to impact us in the latter half of the fourth quarter of fiscal 2004. Any failure to expand in cycle upturns to meet customer demand and delivery requirements or contract in cycle downturns at a pace consistent with cycles in the industry could have an adverse effect on our business.

Any significant downturn in the markets for our customers’ semiconductor devices or in general economic conditions would likely result in a reduction in demand for our products and would hurt our business. Although the Company experienced improved order levels in our fiscal 2005 third quarter, it is unclear whether we are entering another period of growth. Downturns in the semiconductor test equipment industry have been characterized by diminished product demand, excess production capacity, accelerated erosion of selling prices and excessive inventory levels. We believe the markets for newer generations of devices, including system-on-a-chip (“SOC”), will also experience similar characteristics. Our market is also characterized by rapid technological change and changes in customer demand. In the past, we have experienced delays in commitments, delays in collecting accounts receivable and significant declines in demand for our products during these downturns, and we cannot be certain that we will be able to maintain or exceed our current level of sales.

Additionally, as a capital equipment provider, our revenue is driven by the capital expenditure budgets and spending patterns of our customers who often delay or accelerate purchases in reaction to variations in their businesses. Because a high proportion of our costs are fixed, we are limited in our ability to reduce expenses and inventory purchases quickly in response to decreases in orders and revenues. In a contraction, we may not be able to reduce our significant fixed costs, such as continued investment in research and development and capital equipment requirements and materials purchases from our suppliers.

The market for semiconductor test equipment is highly concentrated, and we have limited opportunities to sell our products.

The semiconductor industry is highly concentrated, and a small number of semiconductor device manufacturers and contract assemblers account for a substantial portion of the purchases of semiconductor test equipment generally, including our test equipment. Sales to Texas Instruments accounted for 58% of our net sales in fiscal 2004 and for 58% of our net sales in fiscal 2003. Sales to our ten largest customers accounted for 76% of revenues for the nine months ended April 30, 2005 and 87.3% in the same nine months for the prior year. Our customers may cancel orders with few or no penalties. If a major customer reduces orders for any reason, our revenues, operating results, and financial condition will be hurt.

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Our ability to increase our sales will depend in part upon our ability to obtain orders from new customers. Semiconductor manufacturers select a particular vendor’s test system for testing the manufacturer’s new generations of devices and make substantial investments to develop related test program software and interfaces. Once a manufacturer has selected one test system vendor for a generation of devices, that manufacturer is more likely to purchase test systems from that vendor for that generation of devices, and, possibly, subsequent generations of devices as well. Therefore, the opportunities to obtain orders from new customers may be limited.

Our sales and operating results have fluctuated significantly from period to period, including from one quarter to another, and they may continue to do so.

Our quarterly and annual operating results are affected by a wide variety of factors that could adversely affect sales or profitability or lead to significant variability in our operating results or our stock price. This may be caused by a combination of factors, including the following:

We cannot predict the impact of these and other factors on our sales and operating results in any future period. Results of operations in any period, therefore, should not be considered indicative of the results to be expected for any future period. Because of this difficulty in predicting future performance, our operating results may fall below expectations of securities analysts or investors in some future quarter or quarters. Our failure to meet these expectations would likely adversely affect the market price of our common stock.

A substantial amount of the shipments of our test systems for a particular quarter occur late in the quarter. Our shipment pattern exposes us to significant risks in the event of problems during the complex process of final integration, test and acceptance prior to shipment. If we were to experience problems of this type late in our quarter, shipments could be delayed and our operating results could fall below expectations.

We depend on Jabil Circuit to produce and test our family of Fusion products, and any failures or other problems at or with Jabil could cause us to lose customers and revenues.

We have selected Jabil Circuit, Inc. to manufacture our Fusion test systems. If for any reason Jabil cannot provide us with these products and services in a timely fashion, or at all, whether due to labor shortage, slow down or stoppage, deteriorating financial or business conditions or any other reason, we would not be able to sell or ship our Fusion family of products to our customers. All of the products Jabil tests and assembles for us are assembled in one facility in Massachusetts. If this facility were to become unable to meet our production requirements, transitioning assembly to an alternative Jabil facility could result it production delays of several weeks or more. We have no written supply agreement with Jabil. We also may be unable to engage alternative production and testing services on a timely basis or upon terms favorable to us, if at all. This relationship with Jabil may not result in a reduction of our fixed expenses.

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We also may be unable to engage alternative production and testing services on a timely basis or upon terms favorable to us, if at all. If we are required for any reason to seek a new manufacturer of our test systems, an alternate manufacturer may not be available and, in any event, transitioning to a new manufacturer would require a significant lead time of six months or more and would involve substantial expense and disruption of our business. Our test systems are highly sophisticated and complex capital equipment, with many custom components, and require specific technical know-how and expertise. These factors could make it more difficult for us to find a new manufacturer of our test systems if our relationship with Jabil is terminated for any reason, which would cause us to lose revenues and customers.

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

We have in the past, and may in the future, seek to acquire or invest in additional complementary businesses, products, technologies or engineers. For example, in June 2003, we completed our acquisition of StepTech, Inc. We may have to issue debt or equity securities to pay for future acquisitions, which could be dilutive to then current stockholders. We have also incurred and may continue to incur certain liabilities or other expenses in connection with acquisitions, which could continue to materially adversely affect our business, financial condition and results of operations.

Mergers and acquisitions of high-technology companies are inherently risky, and no assurance can be given that future acquisitions will be successful and will not materially adversely affect our business, operating results or financial condition. Our past and future acquisitions may involve many risks, including:

Any of the events described in the foregoing paragraphs could have an adverse effect on our business, financial condition and results of operations and could cause the price of our common stock to decline.

Our dependence on subcontractors and sole source suppliers may prevent us from delivering an acceptable product on a timely basis.

We rely on subcontractors to manufacture Fusion and many of the components and subassemblies for our products, and we rely on sole source suppliers for certain components. We may be required to qualify new or additional subcontractors and suppliers due to capacity constraints, competitive or quality concerns or other risks that may arise, including a result of a change in control of, or deterioration in the financial condition of, a supplier or subcontractor. The process of qualifying subcontractors and suppliers is a lengthy process. Our reliance on subcontractors gives us less control over the manufacturing process and exposes us to significant risks, especially inadequate capacity, late delivery, substandard quality, and high costs. In addition, the manufacture of certain of these components and subassemblies is an extremely complex process. If a supplier became unable to provide parts in the volumes needed or at an acceptable price, we would have to identify and qualify acceptable replacements from alternative sources of supply, or manufacture such components internally. The failure to qualify acceptable replacements quickly would delay the manufactured delivery of our products, which could cause us to lose revenues and customers.

We are dependent on two semiconductor device manufacturers, Vitesse Semiconductor and Maxtech Components. Each is a sole source supplier of components manufactured in accordance with our proprietary design and specifications. We have no written supply agreements with these sole source suppliers and purchase our custom components through individual purchase orders. Vitesse Semiconductor is also a Fusion customer.

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

We must develop and deliver customized hardware and software to meet our customers’ specific test requirements. Our test equipment may fail to meet our customers’ technical or cost requirements and may be replaced by competitive equipment or an alternative technology solution. Our inability to provide a test system that meets requested performance criteria when required by a device manufacturer would severely damage our reputation with that customer. This loss of reputation may make it substantially more difficult for us to sell test systems to that manufacturer for a number of years. We have, in the past, experienced delays in introducing some of our products and enhancements.

Our dependence on international sales and non-U.S. suppliers involves significant risk.

International sales have constituted a significant portion of our revenues in recent years, and we expect that this composition will continue. International sales accounted for 69.4% of our revenues for the nine months ended April 30, 2005 and 65.5% of our revenue for the nine months ended April 30, 2004. In addition, we rely on non-U.S. suppliers for several components of the equipment we sell. As a result, a major part of our revenues and the ability to manufacture our products are subject to the risks associated with international commerce. A reduction in revenues or a disruption or increase in the cost of our manufacturing materials could hurt our operating results. These international relationships make us particularly sensitive to changes in the countries from which we derive sales and obtain supplies. International sales and our relationships with suppliers may be hurt by many factors, including:

In the past, we have incurred expenses to meet new regulatory requirements in Europe, experienced periodic difficulties in obtaining timely payment from non-U.S. customers, and been affected by the recession in several Asian countries. Our foreign sales are typically invoiced and collected in U.S. dollars. A strengthening in the dollar relative to the currencies of those countries where we do business would increase the prices of our products as stated in those currencies and could hurt our sales in those countries. Significant fluctuations in the exchange rates between the U.S. dollar and foreign currencies could cause us to lower our prices and thus reduce our profitability. These fluctuations could also cause prospective customers to push out or delay orders because of the increased relative cost of our products. In the past, there have been significant fluctuations in the exchange rates between the dollar and the currencies of countries in which we do business. While we have not entered into significant foreign currency hedging arrangements, we may do so in the future. If we do enter into foreign currency hedging arrangements, they may not be effective.

Our market is highly competitive, and we have limited resources to compete.

The test equipment industry is highly competitive in all areas of the world. Many other domestic and foreign companies participate in the markets for each of our products, and the industry is highly competitive. Our competitors in the market for semiconductor test equipment include Agilent Technologies, Credence Systems, and Teradyne. These major competitors have substantially greater financial resources and more extensive engineering, manufacturing, marketing, and customer support capabilities.

We expect our competitors to enhance their current products and to introduce new products with comparable or better price and performance. The introduction of competing products could hurt sales of our current and future products. In addition, new competitors, including semiconductor manufacturers themselves, may offer new testing technologies, which may in turn reduce the value of our product lines. Increased competition could lead to intensified price-based competition, which would

hurt our business and results of operations. Unless we are able to invest significant financial resources in developing products and maintaining customer support centers worldwide, we may not be able to compete effectively.

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Development of our products requires significant lead-time, and we may fail to correctly anticipate the technical needs of our customers.

Our customers make decisions regarding purchases of our test equipment while their devices are still in development. Our test systems are used by our customers to develop, test and manufacture their new devices. We therefore must anticipate industry trends and develop products in advance of the commercialization of our customers’ devices, requiring us to make significant capital investments to develop new test equipment for our customers well before their devices are introduced. If our customers fail to introduce their devices in a timely manner or the market does not accept their devices, we may not recover our capital investment through sales in significant volume. In addition, even if we are able to successfully develop enhancements or new generations of our products, these enhancements or new generations of products may not generate revenue in excess of the costs of development, and they may be quickly rendered obsolete by changing customer preferences or the introduction of products embodying new technologies or features by our competitors. Furthermore, if we were to make announcements of product delays, or if our competitors were to make announcements of new test systems, these announcements could cause our customers to defer or forego purchases of our existing test systems, which would also hurt our business.

Our success depends on attracting and retaining key personnel.

Our success will 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 success will depend on our ability to attract and retain highly qualified managers and technical, engineering, marketing, sales and support personnel. Competition for such specialized personnel is intense, and it may become more difficult for us to hire or retain them. Our volatile business cycles only aggravate this problem. Our layoffs in any industry downturn could make it more difficult for us to hire or retain qualified personnel. 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 positions, or by our inability to attract and retain skilled employees.

We may not be able to protect our intellectual property rights.

Our success depends in part on our ability to obtain intellectual property rights and licenses and to preserve other intellectual property rights covering our products and development and testing tools. To that end, we have obtained certain domestic patents and may continue to seek patents on our inventions when appropriate. We have also obtained certain trademark registrations. To date, we have not sought patent protection in any countries other than the United States, which may impair our ability to protect our intellectual property in foreign jurisdictions. The process of seeking intellectual property protection can be time consuming and expensive. We cannot ensure that:

If we do not successfully enforce our intellectual property rights, our competitive position could suffer, which could harm our operating results. We also rely on trade secrets, proprietary know-how and confidentiality provisions in agreements with employees and consultants to protect our intellectual property. Other parties may not comply with the terms of their agreements with us, and we may not be able to adequately enforce our rights against these people.

Third parties may claim we are infringing their intellectual property, and we could suffer significant litigation costs, licensing expenses or be prevented from selling our products.

Intellectual property rights are uncertain and involve complex legal and factual questions. We may be unknowingly infringing on the intellectual property rights of others and may be liable for that infringement, which could result in significant liability for us. If we do infringe the intellectual property rights of others, we could be forced to either seek a license to intellectual property rights of others or alter our products so that they no longer infringe the intellectual property rights of others. A license could be very expensive to obtain or may not be available at all. Similarly, changing our products or processes to avoid infringing the rights of others may be costly or impractical.

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We are responsible for any patent litigation costs. If we were to become involved in a dispute regarding intellectual property, whether ours or that of another company, we may have to participate in legal proceedings. These types of proceedings may be costly and time consuming for us, even if we eventually prevail. If we do not prevail, we might be forced to pay significant damages, obtain licenses, modify our products or processes, stop making products or stop using processes.

Our stock price is volatile.

In the twelve-month period ending on April 30, 2005, our stock price ranged from a low of $3.81 to a high of $11.67. The price of our common stock has been and likely will continue to be subject to wide fluctuations in response to a number of events and factors, such as:

In addition, the stock market in general, and the market prices for semiconductor-related companies in particular, have experienced significant price and volume fluctuations that often have been unrelated to the operating performance of the companies affected by these fluctuations. These broad market fluctuations may adversely affect the market price of our common stock, regardless of our operating performance.

We have substantial indebtedness.

We have $150 million original principal amount of 4.25% Convertible Subordinated Notes (the “Notes”) due 2006, although subsequent to the end of the quarter, we repurchased $51 million of principal. We may incur substantial additional indebtedness in the future. The level of indebtedness, among other things, could