<PAGE>   1

1994                                 KLA                        ANNUAL REPORT
                          THE YIELD MANAGEMENT COMPANY

<PAGE>   2


                              Fiscal 1993                             Fiscal 1994
Quarter Ended                   Sept. 30    Dec. 31  March 31   June 30  Sept. 30   Dec. 31  March 31  June 30 
- - --------------------------------------------------------------------------------------------------------------
                                                                       (In millions, except per share amounts) 
<S>                               <C>       <C>      <C>      <C>        <C>       <C>       <C>        <C>
NET SALES                         $ 38.5    $38.6     $42.2    $ 47.9    $ 51.9    $ 57.1    $ 62.6     $72.1
Gross profit                        13.0     13.6      15.6      17.6      20.7      24.7      29.4      35.9
                                    33.8%    35.2%     37.0%     36.7%     39.9%     43.3%     47.0%     49.8%
Engineering, research and
   development expense               4.0      4.2       4.4       3.7       4.9       4.8       5.5       7.2
                                    10.4%    10.9%     10.4%      7.7%      9.4%      8.4%      8.8%     10.0%
Selling, general and
   administrative expense            7.5      7.7       8.4       9.1       9.9      11.3      12.0      15.0
                                    19.5%    19.9%     19.9%     19.0%     19.1%     19.8%     19.2%     20.8%
Net income                           0.6      1.4 (a)   2.0       3.0       4.2       6.3       9.0      10.7
                                     1.6%     3.6%      4.7%      6.3%      8.1%     11.0%     14.4%     14.8%
NET INCOME PER SHARE              $  0.03   $ 0.07    $ 0.10   $  0.15   $  0.20   $  0.30   $  0.40    $ 0.45
Weighted average common
   shares outstanding               18.9     19.5      20.0      20.5      20.8      20.9      22.7      23.7
- - ---------------------------------------------------------------------------------------------------------------

(a) Includes recovery from restructuring of $0.7 million.

NET SALES [chart]

NET INCOME [chart]


<PAGE>   3
                                  [ART WORK]

Chief Executive Officer

Dear Stockholder:

This past year, your Company recorded the best financial results in its 18-year
history, setting new records in bookings, sales and profits.  This outstanding
performance was primarily the result of a strong, technically advanced product
line developed over the past five years and the realization by global
semiconductor manufacturers that these products are the key to increased
manufacturing yields, resulting in a high return on investment. Other key
elements include the exceptional international sales and service network KLA
has constructed over the past ten years and a strengthened commitment to
excellence, efficiency and profitability by employees throughout the Company.

As impressive as our achievements were in 1994, the KLA team views the year as
an intermediate step along the way toward building an even stronger global
organization. This report shares with you the key elements which will position
KLA to achieve its long-term objectives of high value for our customers, a high
rate of return for investors and outstanding career opportunities for our

First, let us look at last year's results. For the year ended June 30, 1994,
your Company recorded sales of $243.7 million, which was 46% higher than 1993
sales of $167.2 million. Net income was $30.2 million, which was 331% higher
than 1993 income of $7.0 million. The order rate was 70% higher than in 1993
and backlog at year-end was $125 million, the largest in the Company's history.

In addition to vastly improved operating results, KLA ended its fiscal year
with its strongest balance sheet ever. As a result of an equity offering in
February 1994 and $11 million generated by operations, we ended the year with
$139 million in cash and cash equivalents. This very strong financial
position will provide the resources to expand our business as appropriate
opportunities present themselves.

While the largest contributor to both sales and earnings was the Wafer
Inspection Business Unit -- the focal point of KLA's yield management
technology -- we are pleased to report that all divisions contributed to a
successful year. New orders in the Reticle Inspection Business Unit reached a
two-year high, thanks to increased demand for the KLA 331 Reticle Inspection
System, while the ATS Division achieved a four-year high in new wafer prober

The Metrology Division, now in its third year as the market leader for optical
metrology, continued to book orders at a high level, leading KLA to a 50%
market share in semiconductors and a 70% share in the important thin-film head
industry. In the fourth quarter, this division introduced its next-generation
overlay metrology system, the KLA 5100, which meets the speed, throughput and
precision requirements needed for sub-half-micron production. This system is
expected to have a positive impact on results in 1995.

Geographically, the U.S. and Japan remained the largest components of our
business. Each accounted for about one-third of total sales, with the remaining
one-third representing Asia Pacific and Europe combined. The Japanese market
showed strong improvement this year, and should continue to do so since our
many customers in that country are just now exploring the yield management
benefits of the KLA 2100 Series. Our KLA Acrotec venture in Japan continued to
make progress in the growing flat panel display market. Its products are now on
order or in use by all of the major flat panel producers in Japan, Korea and

In our annual report three years ago, KLA first announced to stockholders the
goal of networking its data gathering and analysis capability into the
industry's first total yield management systems. At the time we stated that
"Over the next five years, control of defects and yields will make the
difference between profit and loss for semiconductor companies." We began to
realize that goal in 1991 by introducing the KLA 2100 Series Defect Monitoring
Systems. The introduction of the KLA 2550 followed in 1992 and represented the
Company's first data and yield management system capable


<PAGE>   4

Chief Operating Officer

of interfacing with both KLA and non-KLA tools. Together, the 2100 Series and
the 2550 create the industry's first on-line yield management capability. The
semiconductor industry was quick to respond to the prospect of being able, for
the first time, to proactively manage yields through real-time inspection and
data analysis right on the production line. This year has seen continued
improvements in both product lines with the introduction of the KLA 2551
Analysis Station and, in particular, the KLA 2131 All-pattern Defect Monitoring

At first, our customers made single-unit purchases since, without testing, they
were understandably reluctant to accept the value of this new concept. By the
end of 1993, results indicated major yield improvements, and many customers
began to order additional systems. That trend accelerated throughout fiscal
1994, and by the end of the year, 38 wafer fabrication facilities around the
globe had multiple KLA monitors either installed or on order.

Wafer fabs using our 2100 series products already average two systems per
manufacturing facility, with the most advanced facilities having five or six
systems per line. As manufacturers continue to learn how to utilize KLA systems
to increase their "rate-of-learning," our KLA 2100 Series business will grow
accordingly. As linewidths in semiconductor circuits continue to shrink, more
manufacturing lines will use KLA systems, and the average number of systems per
line will trend toward the larger number now used by the most advanced

As our business grows, KLA continues to strengthen our management team. This
past year, Yasuo Mizokami took over the presidency of KLA Japan, while the
newly-created positions of president of KLA Korea and president of KLA Europe
were assumed by Hee-June Choi and Dick Conn, respectively.  In addition, four
new corporate vice presidents were elected in recognition of their excellent
contributions and growing organizational responsibilities. Dr. Ben Tsai is now
vice president, chief technical officer; Dr. Neil Richardson, vice president
and general manager of the Metrology Division; Gary Dickerson, vice president
and business unit director of the Wafer Inspection Business Unit; and Magnus
Ryde, vice president and general manager of the Customer Support Division.

KLA continues to explore new methods to help customers fill their yield
management needs. Just before year-end, your Company announced its entry into
the software business with a planned series of standard, open-architecture
software packages designed to work in conjunction with KLA equipment as well as
other wafer fab systems. The new PRISM (PRocess Information SysteMs) Division
was formed, and Dr. Michael Pliner, a 20-year veteran of the software
business, was named general manager of this new venture. The products from this
division will further expand KLA's ability to help our customers increase their
yields by making better use of the information available on the factory floor.

Since outlining its yield management goal in 1991, KLA has made a key
transition from being a supplier of important, but capacity-dependent,
inspection tools to being a supplier of enabling technology without which our
customers' own design goals cannot be achieved. This reality gives us
confidence in the future of your Company, and we hope that you share that
confidence with us.

/s/ Kenneth Levy
- - --------------------------------
Kenneth Levy
Chief Executive Officer

/s/ Kenneth L. Schroeder
- - --------------------------------
Kenneth L. Schroeder
Chief Operating Officer


<PAGE>   5
           [ARTWORK]                             [ARTWORK]
Thin film, Develop and Etch Monitor       Reticle Defect Inspection
    and Engineerng Analysis
Overlay/Linewidth Metrology


Semiconductor production is one of the most complex manufacturing processes
ever devised by mankind. Yet, for all its technological sophistication, its
manufacturing process is still evolving. As this process matures, the industry
is relying heavily on advanced process control techniques like those pioneered
by KLA.

By monitoring wafers after each critical process step, KLA technology enables
early detection, analysis and elimination of process-induced defects. The
result is improved process yield and a steadily increasing KLA system presence
throughout the wafer fabrication line.


Linewidth-Overlay Metrology
Defect Inspection
Defect Repair


Thin Film Deposition    
Thin Film Monitor    
Resist Coat & Develop
Overlay Metrology    
Photo Monitor      
Etch and Clean   
Etch Monitor
Linewidth Metrology

Accomplishing the process steps depicted here requires many highly
sophisticated systems which incorporate electronics, optics, mechanics,
material handling, software and other technologies.

Optical Defect Detection,    
Review and Analysis
SEM-based Defect Detection,
Review and Analysis


Data Analysis and Communication

Die Attach
Wire Bond
Final Test

                                    4 - 5

<PAGE>   6

Reticle Defect Inspection
                                  [ART WORK]

Overlay and Linewidth Metrology

Reticles and masks are to semiconductor fabrication what negatives are to
photography; they contain the master circuit patterns to be transferred to
wafers in the lithography process. KLA yield management starts with inspection
of these reticles for defects before the transfer begins. This is followed by
evaluation of features on the wafer to assure that the pattern has been
accurately transferred, a process which includes overlay and linewidth
metrology. The increased complexity of today's multi-layer circuits requires
reticle inspection and wafer metrology to be highly sensitive and versatile.

The KLA 331 Reticle Inspection System offers the highest defect sensitivity
available and is extendible to advanced lithographic processes such as phase
shift masks. Introduced two years ago, the KLA 331 achieved immediate
acceptance with manufacturers gearing up for production of 64Mb circuits. In
addition, the Company recently introduced an important new reticle inspection
capability called STARlight, which uses reflected and transmitted light
detection techniques simultaneously to identify reticle contaminants, including
airborne particles.

KLA has set the industry standard for wafer metrology following pattern
transfer with the KLA 5000 Series systems, and now holds 50% of the global
market -- twice that of any other vendor. Using proprietary coherence probe
measurement technology, these systems increase lithographic efficiency by
providing improved pattern characterization and real-time control. The KLA 5100
Overlay Metrology System, introduced in June 1994, extends these capabilities
to advanced wafer fabrication facilities that produce devices with features as
small as 0.25 micron with 30% greater throughput than previous systems.

KLA's metrology technology also leads in the characterization of thin-film
heads for computer disk drives, with the company now holding approximately 70%
of this fast-growing market.

                               [ART WORK]
Above: Proprietary KLA image computer technology helps KLA reticle inspection
systems detect leading-edge phase-shift reticle defects.

Right: Patented KLA coherence probe microscopy enhances the repeatability and
accuracy of overlay registration measurements.


<PAGE>   7
"In the case of leading edge semiconductor technologies, the quality of
masks can make the difference between climbing the yield curve or struggling
with too narrow a process window."

Geoff Akiki, mask house manager, IBM Corp., Essex Junction, Vermont (At a 1993
BACUS-sponsored meeting in San Francisco)


<PAGE>   8
"  An emerging practice is the use of in-line process measurements to better
understand specific die yield limiters. (This) includes the statistical
correlation of die yield with process flow tracking and metrology data."

Report on "Improving Semiconductor Manufacturing Competitiveness," from the
Engineering Research Center, University of California, Berkeley


<PAGE>   9
                            Wafer Defect Inspection

                        Electron-beam Defect Inspection

                                  [ART WORK]

During semiconductor wafer fabrication, rapid detection of process-generated
yield-limiting defects is crucial. KLA's systems move this detection from
off-line analysis into the actual fabrication cycle where immediate corrective
action is possible. The KLA 2100 Series, in conjunction with the KLA 2551
Analysis Station, provides a real-time, in-line defect monitor. Throughout the
fab, these systems produce statistical information and defect signature maps
for easy identification and rapid control of defects and their causes. In
addition to these tools, KLA also has partnerships with major universities and
sponsors a forum for the development and dissemination of new yield management
technology and applications. Held throughout the world, these Yield Management
Seminars have had over 700 attendees in their first year, giving KLA a customer
interface which assures that system enhancements are in direct, considered
anticipation of customer needs, and that customers are constantly aware of the
full range of KLA yield management capabilities.

In addition to in-line monitoring, there is still a need for off-line
engineering analysis, both to determine corrective actions and to optimize
processes. With their all-layer, all-defect-types performance, KLA's 2100
Series optical defect detection systems are the industry standard for
addressing these needs. For future technologies, or to complement existing
optical inspection, KLA's SEMSpec Electron-beam Inspection System can detect
and display defects beyond the capabilities of optical technology. As feature
sizes continue to decrease, high-sensitivity SEMSpec inspection will become
more and more integral to leading-edge process optimization and device

                                 [ART WORK]

Above: KLA's scanning electron-beam inspection technology finds defects like
this electrical failure which are beyond the capabilities of optical systems.

Left: High-precision optical systems give the KLA 2131 the ability to find
yield limiting defects like this bridge between two wafer features


<PAGE>   10
Yield and Productivity Improvement Software

Defect Data Analysis

Probe Data Analysis                      [ART WORK]

Networking Systems

Finding defects, measuring critical dimensions and overlay, and locating bad
die are merely data gathering procedures. To truly manage yield, this data must
be stored, analyzed, interpreted, and then shared among the fab areas it
affects. Open architecture software and networking systems are the tools
through which the semiconductor manufacturer's growing reliance on yield data
and its analysis can be realized.

In the wafer fab, KLA's Yield Management System depends upon the KLA 2551
Analysis Station, which stores and analyzes in-line defect data and images,
calculates the detailed statistical information and defect signature maps that
enable corrective actions, and then transmits these results to the appropriate
areas over a variety of industry standard networks.

On the test floor, where finished wafers are first tested for electrical
functionality, KLA's new networking software products, Navigator Plus,
Integrator, and Analyzer, are the direct result of KLA's extensive test floor
presence and experience in the sales and support of the ATS Division's
highly-regarded automated wafer probers. KLA realized that, for a variety of
reasons, there was no easy way to directly correlate test floor results to
wafer fab conditions. In response to this and other test floor needs, KLA's
networking software packages standardize user interfaces, streamline prober
program set-up and storage, monitor test results in real-time, provide data
storage and exchange in a standardized data format and analyze test results for
early problem detection and correlation with the wafer fab.

On a larger scale, continuous overall process monitoring and improvement
requires a way of quickly correlating specific process measurement data with
overall fab yield. Recognizing this, KLA recently formed the PRISM (PRocess
Information SysteMs) Division to continue developing the existing test floor
networking products and to develop new stand-alone software packages. PRISM's
first major development effort, now nearing completion, is a Yield Management
Software System that automatically collects and correlates inputs from major
measurement sources in the fab and on the test floor.


<PAGE>   11
"In the year 2000, computer-assisted analysis will become an absolute
requirement (in semiconductor manufacturing)."

Dr. Robert McDonald, Manager, Materials Technology Department, Intel Corp.,
Santa Clara, California (Quoted in Semiconductor International, January 1994)


<PAGE>   12


Annual Results of Operations

Fiscal 1994 was a breakthrough year for KLA. Earnings per share of $1.37 were
almost four times those of fiscal 1993 and were more than double our previous
best of $0.65, in fiscal 1989. This sharp improvement was the result of several
factors. First and foremost, the industry leaders increased their understanding
of the value of in-line monitoring for improving the yields of their
manufacturing operations. As a result, the industry began a more significant
adoption of the KLA methodology of using more of the KLA monitors on each of
their fabrication lines. Second, the worldwide semiconductor industry, as a
whole, continued to expand and invest in scarce leading edge (0.5 micron)
semiconductor manufacturing capacity. Third, the cost reductions KLA began in
fiscal 1992 and continuing efficiency improvements benefited our bottom line.

During fiscal 1994, the Wafer Inspection Business Unit (WISARD) was engaged in
an intensive effort to educate the industry on the emerging science of
controlling manufacturing yields. This has resulted in a paradigm shift in our
customers' yield management strategy toward employing multiple in-line,
real-time wafer defect inspection units, rather than the previous strategy of
utilizing a single unit for analysis. The number of fabs worldwide that have
multiple 2100 Series systems increased in fiscal 1994 from 17 to 38. Driven
largely by the growing demand for the 2100 Series, KLA's bookings grew 70% in
fiscal 1994. Backlog rose from $52 million at June 30, 1993, to $125 million at
June 30, 1994.

Sales increased 46% in fiscal 1994 compared with increases of 7% and 5% in
fiscal 1993 and 1992, respectively. Although the dollar sales increase in
fiscal 1994 was primarily attributable to WISARD, the revenue increase in the
Metrology Division was almost as high in percentage increase. Revenue increases
were also recorded in the Reticle and Photomask Business Unit (RAPID) as well
as in the ATS and Watcher Divisions.  The SEM Division sales declined as the
market is just developing for advanced detection capability. The 7% sales
increase in fiscal 1993 reflected strength in the ATS and Metrology Divisions,
which more than offset a decline in the RAPID Business Unit caused by a delay
in completing all the features of its new 300 Series product lines. The 5%
sales increase in fiscal 1992 occurred as WISARD successfully launched the 2100
Series product line and because of an increase in Metrology revenues, offset by
a decline in RAPID revenues from its record level in fiscal 1991. This decline
occurred because of consolidations in the photomask industry and because of the
delayed introduction of the 300 Series product line.

International sales were 57%, 62% and 65% in fiscal years 1992, 1993 and 1994,
respectively. The rising share of international revenues occurred to a large
extent because Korean semiconductor manufacturers were the first to realize the
significance of utilizing multiple process monitors in a single fabrication
line and subsequently made significant investments in adopting this KLA
methodology.  Additionally, in 1994, the Japanese semiconductor industry
completed a recovery to levels of profitability and investment approximating
those of 1990 and 1991.

Gross margins were 36%, 36%, and 45% in fiscal years 1992, 1993 and 1994,
respectively. The sharp improvement in fiscal 1994 was due primarily to an
increase in WISARD's share of overall KLA revenues as well as to an increase in
WISARD's gross margins. Additionally, there were gross margin improvements in
the Customer Support Division coinciding with KLA's assumption of service
responsibilities in Japan. The rise in WISARD's gross margins was due to very
favorable manufacturing efficiencies as unit volumes increased dramatically and
the organization gained experience with the 2100 Series product line. Lower
installation and warranty costs were also achieved as the 2100 Series became
increasingly stable. Finally, the Company benefited in aggregate by a favorable
yen/dollar exchange rate. Gross margins in both fiscal years 1992 and 1993 were
adversely impacted by new product transitions in all divisions which generated
large scrap, rework and overhead variance costs. In RAPID, these transitions,
unlike others in KLA's history, involved redesigns of every significant

Engineering, research and development expenses were 17%, 10% and 9% of revenue
in fiscal 1992, 1993 and 1994, respectively. In absolute dollars, these
expenses rose by $6.1 million or 38% in fiscal 1994. The dollar increase
occurred primarily in WISARD and, secondarily, in Metrology. The decline in the
percent of sales to 9% was due to the fact that WISARD was able to add
engineering staff only half as fast as its revenues were increasing.

Engineering, research and development expenses are shown net of funds KLA
receives from customers, industry groups and government sources. Any
capitalization of software costs also reduces the gross spending. In fiscal
1994, KLA's gross R&D expenses were reduced by 2% from these sources versus
about 4% in fiscal 1992 and 1993. The reduction in percentage was due about
equally to a decline in contract engineering for flat panel inspection products
and to a reduction in the amount of software capitalized by KLA.

Selling, general and administrative costs were 23%, 20% and 20% in fiscal years
1992, 1993 and 1994, respectively. In fiscal 1994, as a percent of sales, both
sales and administration expenses fell slightly. Representative commissions, as
a percent of sales, rose modestly due to an increase in the share of revenue
derived from Japan, Korea and Taiwan, where the bulk of representative
commissions are incurred. Profit-sharing expenses increased substantially,
reflecting the improvement in KLA's financial performance. The reduction in
selling, general and administrative expenses in fiscal 1993 was due to the
restructuring actions and the continuing effects of the reduction in headcount
implemented at the end of fiscal 1992.

Interest income and other, net, increased in fiscal 1994 due to higher average
cash balances of approximately $48 million. Interest income and other, net, did 
not vary significantly between fiscal 1992 and fiscal 1993.             

Interest expense declined in fiscal 1994 due primarily to the resetting in
August 1993 of the interest rate on KLA's mortgage loan for its principal
facility from 10.3% to 5.63%. Interest expense declined in fiscal 1993
primarily due to lower interest rates.

Effective July 1, 1992, the Company adopted Statement of Financial Accounting
Standards No. 109 (FAS 109) "Accounting for Income Taxes." The adoption of FAS
109 changed the Company's method of accounting for


<PAGE>   13
income taxes from the deferred method (APB 11) to an asset and liability 
approach. The asset and liability approach requires the recognition of deferred 
tax liabilities and assets for the expected future tax consequences of 
temporary differences between the carrying amounts and the tax bases of other 
assets and liabilities. Adoption of FAS 109 did not have a significant effect 
on the consolidated financial statements.

The deferred tax assets valuation allowance at July 1, 1992, and at June 30,
1993 and 1994, is attributed to U.S. federal and state deferred tax assets. The
Company has $13.3 million of net deferred tax assets in the U.S. at June 30,
1994. Management believes sufficient uncertainty exists such that a valuation
allowance of $11.1 million against these net deferred tax assets is required.
When these reserved deferred tax assets are ultimately realized, $6.0 million
will reduce the Company's federal and state tax provisions and $5.1 million
will be credited to paid-in capital (related to stock option deductions). The
Company's net deferred tax assets in the U.S. at July 1, 1992, and June 30,
1993 were fully reserved.

Net deferred tax liabilities at June 30, 1994, reflect foreign liabilities of
$3.3 million offset by $2.2 million of U.S. assets. The net deferred tax
liability at July 1, 1992, and at June 30, 1993, relates to foreign operations.

The provision for income taxes on pretax income from continuing operations was
2%, 25% and 25% in fiscal 1992, 1993 and 1994, respectively. In fiscal 1992,
the income tax provision of 2% on pretax loss was due primarily to limited loss
carryback availability in the United States, combined with the effect of
foreign income taxes on the Company's European and Asian operations. In fiscal
1993 and 1994, the income tax rate was lower than the statutory U.S. tax rate
because of tax advantages in Switzerland which lowered the net foreign tax rate
and because of the realization of deferred tax assets previously reserved.
Additionally, the fiscal 1994 rate was reduced by the utilization of $1.9
million in foreign tax credits.

The IRS is currently auditing the Company's federal income tax returns for
fiscal years 1985-1992. Management believes sufficient taxes have been provided
in prior years and that the ultimate outcome of this review will not have a
material adverse impact on the Company's financial position or results of


Cash and cash equivalents increased by $87 million in fiscal 1994 with $69
million from KLA's secondary public offering in February 1994, $11 million from
continuing operations and $9 million from KLA's stock option and stock purchase
plans. Cash provided by operations was reduced somewhat by investments in
working capital to support the 46% rise in revenues.

Capital expenditures totaled approximately $6 million in fiscal 1994, compared
with depreciation charges of approximately $11 million in fiscal 1994. Capital
expenditures for fiscal 1995 are expected to approximate depreciation; however,
this assessment could change if demand continues to exceed estimates and
additional manufacturing capacity is required. No estimate can be made of the
size or cost of any such additional capacity. The Company has begun planning
the construction of one or two additional buildings on undeveloped land at its
campus facility.

KLA currently has a $10 million multicurrency line of credit through Bank of
America. Borrowings under this line of credit were $4.2 million at June 30,
1994. KLA's overseas entities use this facility from time to time for
short-term cash management purposes. In addition, certain of KLA's overseas
entities have local currency borrowings totaling $0.5 million at June 30, 1994.

KLA believes that its current level of liquid assets, working capital and cash
expected to be generated from operations will be sufficient to fund its growth
through at least fiscal 1995. The current policy of KLA is not to pay
dividends. Management believes that it is in the best interests of the
stockholders to continue to reinvest KLA's earnings in the business.


The Company's future results will depend on its ability to continuously
introduce new products and enhancements to its customers as demands for higher
productivity and specifications of semiconductor test equipment change or
increase. Due to the risks inherent in transitioning to new products, the
Company must accurately forecast demand in both volume and configuration and
also manage the transition from older products. The Company's results could be
affected by the ability of competitors to introduce new products which have
technological and/or pricing advantages.  The Company's results also will be
affected by strategic decisions made by management regarding whether to
continue particular product lines, and by volume, mix and timing of orders
received during a period, fluctuations in foreign exchange rates, and changing
conditions in both the semiconductor industry and key semiconductor markets
around the world. As a result, the Company's operating results may fluctuate,
especially when measured on a quarterly basis.


<PAGE>   14

                                                        1990        1991         1992         1993         1994
- - ---------------------------------------------------------------------------------------------------------------
                                                                      (In thousands, except per share amounts)
<S>                                                <C>          <C>          <C>          <C>         <C>
   Net sales                                       $161,642     $148,432     $155,963     $167,236    $243,737
   Restructuring charges (recovery)                       -            -        8,158         (718)          -
   Income (loss) from continuing operations          12,174        2,415      (16,610)       6,961      30,188
   Net income (loss)                                  9,380      (10,585)     (13,810)       6,961      30,188
   Income (loss) per share from continuing 
      operations                                       0.67         0.13        (0.90)        0.35        1.37
   Net income (loss) per share                         0.52        (0.57)       (0.75)        0.35        1.37
   Weighted average common and dilutive
      common equivalent shares outstanding           18,038       18,552       18,451       19,707      22,044

   Cash and cash equivalents                         32,263       31,254       23,711       52,362     139,126
   Working capital                                   99,151       91,116       83,961       93,611     212,873
   Total assets                                     179,276      198,023      188,457      199,089     321,570
   Long-term debt                                         -       24,000       24,000       20,000      20,000
   Stockholders' equity                             122,136      113,161      103,032      114,050     227,382


YEARS ENDED JUNE 30,                                                      1992             1993           1994
- - --------------------------------------------------------------------------------------------------------------
                                                                      (In thousands, except per share amounts)
<S>                                                                   <C>              <C>            <C>
Net sales                                                             $155,963         $167,236       $243,737
- - --------------------------------------------------------------------------------------------------------------  
Costs and expenses:
   Cost of sales                                                        99,993          107,466        133,028
   Engineering, research and development                                25,860           16,314         22,435
   Selling, general and administrative                                  35,537           32,684         48,192
   Restructuring charges (recovery)                                      8,158             (718)             -
- - --------------------------------------------------------------------------------------------------------------
                                                                       169,548          155,746        203,655
- - -------------------------------------------------------------------------------------------------------------- 
Income (loss) from operations                                          (13,585)          11,490         40,082
Interest income and other, net                                           1,170            1,217          2,174
Interest expense                                                        (3,877)          (3,426)        (2,005)
- - -------------------------------------------------------------------------------------------------------------- 
Income (loss) from continuing operations before income taxes           (16,292)           9,281         40,251
Provision for income taxes                                                 318            2,320         10,063
- - --------------------------------------------------------------------------------------------------------------   
Income (loss) from continuing operations                               (16,610)           6,961         30,188
Discontinued operations:
   Recovery of loss on 1991 discontinuance of PCB business               2,800                -              -
- - --------------------------------------------------------------------------------------------------------------
Net income (loss)                                                     $(13,810)        $  6,961       $ 30,188
- - --------------------------------------------------------------------------------------------------------------    
Income (loss) per share from continuing operations                    $  (0.90)        $   0.35       $   1.37
Income per share from discontinued PCB business                           0.15                -              -
- - --------------------------------------------------------------------------------------------------------------
Net income (loss) per share                                           $  (0.75)        $   0.35       $   1.37
- - --------------------------------------------------------------------------------------------------------------
Weighted average common and dilutive common
   equivalent shares outstanding                                        18,451           19,707         22,044
- - --------------------------------------------------------------------------------------------------------------           
See accompanying notes to consolidated financial statements.


<PAGE>   15

AT JUNE 30,                                                                                1993           1994
- - --------------------------------------------------------------------------------------------------------------
                                                                                                (In thousands)
<S>                                                                                  <C>             <C>
Current assets:
   Cash and cash equivalents                                                         $   52,362      $ 139,126
   Accounts receivable, net of allowances of $1,469 and $1,754                           48,077         74,226
   Inventories                                                                           42,489         53,265
   Deferred income taxes                                                                  3,917          7,495
   Other current assets                                                                   4,724          4,343
- - --------------------------------------------------------------------------------------------------------------
      Total current assets                                                              151,569        278,455
- - --------------------------------------------------------------------------------------------------------------
Land, property and equipment, net                                                        39,384         37,149
Other assets                                                                              8,136          5,966
- - --------------------------------------------------------------------------------------------------------------
Total assets                                                                         $  199,089      $ 321,570
- - --------------------------------------------------------------------------------------------------------------

Current liabilities:
   Notes payable and current portion of long-term debt                                 $  6,532      $   4,673
   Accounts payable                                                                       8,953         11,890
   Income taxes payable                                                                   9,403         12,466
   Other current liabilities                                                             33,070         36,553
- - --------------------------------------------------------------------------------------------------------------
      Total current liabilities                                                          57,958         65,582
- - --------------------------------------------------------------------------------------------------------------
Deferred income taxes                                                                     7,081          8,606
Long-term debt                                                                           20,000         20,000
Commitments and contingencies
Stockholders' equity:
   Preferred Stock $.001 par value, 1,000 shares authorized,
      none outstanding                                                                        -              -
   Common shares, $.001 par value, 75,000 shares authorized,
      19,503 and 22,864 shares issued and outstanding                                        20             23
   Capital in excess of par value                                                        64,638        147,358
   Retained earnings                                                                     50,087         80,275
   Treasury stock                                                                          (581)          (581)
   Cumulative translation adjustment                                                       (114)           307
- - --------------------------------------------------------------------------------------------------------------
      Total stockholders' equity                                                        114,050        227,382
- - --------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity                                           $  199,089     $  321,570
- - --------------------------------------------------------------------------------------------------------------

See accompanying notes to consolidated financial statements.


<PAGE>   16

                                Common Stock and Capital
                                  in excess of par value      Retained        Treasury Stock      Translation
                                  Shares         Amount       Earnings       Shares   Amount      Adjustments
- - --------------------------------------------------------------------------------------------------------------
                                                                                                (In thousands)
<S>                               <C>          <C>           <C>              <C>     <C>            <C>
Balance at June 30, 1991          18,298       $ 56,094       56,936          (55)    $(581)         $   712
- - ------------------------------------------------------------------------------------------------------------          
Exercise of stock options            203          1,431
Shares sold in stock
   purchase plan                     195          1,432
Net loss                                                     (13,810)
Translation adjustments                                                                                  818
- - ------------------------------------------------------------------------------------------------------------
Balance at June 30, 1992          18,696         58,957       43,126          (55)     (581)           1,530
- - ------------------------------------------------------------------------------------------------------------
Exercise of stock options            604          4,277
Shares sold in stock
   purchase plan                     203          1,424
Net income                                                     6,961
Translation adjustments                                                                               (1,644)
- - ------------------------------------------------------------------------------------------------------------
Balance at June 30, 1993          19,503         64,658       50,087          (55)     (581)            (114)
- - ------------------------------------------------------------------------------------------------------------
Exercise of stock options            854          6,960
Tax benefit on exercise of
   stock options                                  5,232
Shares sold in stock
   purchase plan                     207          1,965
Shares sold in stock
   offering                        2,300         68,566
Net income                                                    30,188
Translation adjustments                                                                                  421
- - ------------------------------------------------------------------------------------------------------------
Balance at June 30, 1994          22,864       $147,381       80,275          (55)    $(581)         $   307
- - ------------------------------------------------------------------------------------------------------------

See accompanying notes to consolidated financial statements.


<PAGE>   17

YEARS ENDED JUNE 30,                                                     1992             1993            1994
- - --------------------------------------------------------------------------------------------------------------
                                                                                                (In thousands)
<S>                                                                 <C>              <C>             <C>
Cash flows from continuing operating activities:
   Income (loss) from continuing operations                         $ (16,610)       $   6,961       $  30,188
Adjustments required to reconcile income (loss)
   from continuing operations to cash provided
   by (used for) continuing operations:
      Depreciation and amortization                                    10,732            9,646          10,734
      Deferred income taxes                                               142             (466)         (2,053)
      Changes in assets and liabilities:
         Accounts receivable                                           (2,583)             947         (26,149)
         Inventories                                                       70            6,048         (10,776)
         Other current assets                                            (766)           2,062             381
         Accounts payable                                              (1,970)           3,375           2,937
         Income taxes payable                                            (820)            (429)          3,063
         Other current liabilities                                      6,840            2,655           3,483
         Other assets                                                     526             (492)           (520)
- - --------------------------------------------------------------------------------------------------------------
Cash provided by (used for) continuing operations                      (4,439)          30,307          11,288
- - --------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
   Capital expenditures                                                (5,085)          (3,226)         (5,809)
   Other                                                               (1,280)            (357)              -
- - --------------------------------------------------------------------------------------------------------------
Cash (used for) investing activities                                   (6,365)          (3,583)         (5,809)
- - --------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
   Short-term borrowings, net                                             125           (2,881)          2,141
   Payment of current portion of long term debt                             -                -          (4,000)
   Sales of common stock                                                2,863            5,701          82,723
- - --------------------------------------------------------------------------------------------------------------
Cash provided by financing activities                                   2,988            2,820          80,864
- - --------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes                                           273             (893)            421
- - --------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents                       (7,543)          28,651          86,764
Cash and cash equivalents at beginning of year                         31,254           23,711          52,362
- - --------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year                            $  23,711        $  52,362       $ 139,126
- - --------------------------------------------------------------------------------------------------------------

YEARS ENDED JUNE 30,                                                     1992             1993            1994
- - --------------------------------------------------------------------------------------------------------------
Cash paid during the year for:
   Interest                                                         $   3,778        $   3,515       $   2,007
   Income taxes                                                         1,361            1,914           3,369
- - --------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.


<PAGE>   18



PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the
accounts of the Company and all of its subsidiaries. All significant
intercompany accounts and transactions have been eliminated. Subsidiaries with
accounts denominated in foreign currencies have been translated principally
using the local currencies as the functional currencies. Accordingly, the
assets and liabilities of these subsidiaries are translated at the rates of
exchange on the balance sheet date, income and expense items are translated at
average rates of exchange for the year, and the resulting translation gains or
losses are included in stockholders' equity. Foreign currency transaction gains
and losses have not been material and are included in interest income and
other, net.

REVENUE RECOGNITION - The Company recognizes sales of wafer inspection,
metrology, reticle and photomask inspection systems upon acceptance at the
Company's plant, which is when title transfers. Customers may observe and
approve satisfactory completion of the tests. Sales of other systems are
recognized upon shipment. A provision for the estimated future cost of system
installation and warranty is recorded at the time revenue is recognized.
Revenues from service contracts are recognized during the terms of the
contracts on a straight-line basis.

INCOME PER SHARE - Income per common and common equivalent share is computed
using the weighted average number of common and common equivalent shares
outstanding during the respective periods, including the assumed net shares
issuable upon exercise of stock options, when dilutive.

RESEARCH AND DEVELOPMENT - The Company is actively engaged in significant
product improvement and new product development efforts. Research and
development expenses relating to possible future products aggregated
approximately $19.3, $13.4 and $16.8 million for fiscal 1992, 1993 and 1994,

SOFTWARE DEVELOPMENT COSTS - The Company capitalizes software development costs
in accordance with Statement of Financial Accounting Standards No. 86. For the
years 1992, 1993 and 1994, the Company capitalized $1.3, $1.2 million and none,
respectively, of software development costs in connection with the development
of new products and new features and functions on existing products. Such costs
are amortized on a straight-line basis over the estimated useful life of three
years or the ratio of current revenue to the total of current and anticipated
future revenue, whichever is greater. Amortization charged to expense during
the fiscal years ended 1992, 1993 and 1994 was $2.1, $1.9 and $2.8 million,
respectively. Capitalized software, net of software amortization, totaled $5.0,
$4.3 and $1.5 million at June 30, 1992, 1993 and 1994, respectively.

INCOME TAXES - Effective July 1, 1992, the Company adopted Statement of
Financial Accounting Standards No. 109 (FAS 109), "Accounting for Income
Taxes." The adoption of FAS 109 changed the Company's method of accounting for
income taxes from the deferred method (APB 11) to an asset and liability
approach. The asset and liability approach requires the recognition of deferred
tax liabilities and assets for the expected future tax consequences of
temporary differences between the carrying amounts and the tax bases of other
assets and liabilities. Adoption of FAS 109 did not have a significant effect
on the consolidated financial statements. Undistributed earnings of certain of
the Company's foreign subsidiaries, for which no U.S. income taxes have been
provided, aggregated approximately $6.0 million at June 30, 1994. The amount of
the unrecognized deferred tax liability related to this investment is estimated
at approximately $2.2 million at June 30, 1994.

CASH EQUIVALENTS - Cash equivalents consist of highly liquid investments with a
maturity date at acquisition of three months or less. Cash and cash equivalents
are stated at cost, plus accrued interest, which approximates market value.
During 1993 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 115 (FAS 115), "Accounting for Certain
Investments in Debt and Equity Securities," which requires a change in the
method used to account for certain investments. FAS 115 will be effective for
the Company's fiscal 1995. The Company does not believe that the adoption of
this statement will have a material impact on its financial position or results
of operations.

INVENTORIES - Inventories are stated at the lower of cost or market, cost being
determined using standard costs which approximate actual costs on a first-in,
first-out basis.

PROPERTY AND EQUIPMENT - Property and equipment are recorded at cost.
Depreciation and amortization are computed using the straight-line method over
the estimated useful lives of the assets, which are 30 years for buildings and
building improvements, five years for furniture and fixtures, and range from
three to five years for machinery and equipment. The life of the lease or the
useful life, whichever is shorter, is used for the amortization of leasehold

FOREIGN EXCHANGE HEDGING - The Company purchases forward exchange contracts and
options to hedge against currency fluctuations which affect certain foreign
currency denominated sales and purchase transactions. Because the impact of
movements in currency exchange rates on foreign exchange contracts offsets the
related impact on the underlying items being hedged, these financial
instruments do not subject the Company to speculative risk that would otherwise
result from changes in currency exchange rates. Unrealized gains and losses on
these contracts are deferred and accounted for as part of the hedged
transactions. Cash flows from these contracts are classified in the Statement
of Cash Flows in the same category as the hedged transactions.

At June 30, 1993, the Company had foreign exchange contracts maturing
throughout fiscal 1994 to sell approximately $19.2 million in foreign currency,
primarily Japanese yen, and to purchase approximately $0.7 million of Japanese
yen. At June 30, 1994, the Company had foreign exchange contracts maturing
during fiscal 1995 to sell approximately $48.1 million in foreign currency,
primarily Japanese yen, and to purchase approximately $5.8 million of Japanese
yen. Of these contracts, approximately $35.2 million of foreign currency
contracts hedge foreign currency payables and receivables carried on the
balance sheet as of June 30, 1994, and


<PAGE>   19
NOTE 1 (continued)

consequently, the financial statements reflect the fair market value of the
contracts and their underlying transactions. Approximately $16.5 million and
$2.2 million of the contracts hedge firm commitments for future sales and
purchases, respectively, denominated in foreign currency.  The fair market
value of these contracts at June 30, 1994, based upon prevailing market rates
at that date, was approximately $16.7 million and $2.2 million, respectively.

CONCENTRATION OF CREDIT RISK - Financial instruments that potentially subject
the Company to significant concentrations of credit risk consist principally of
cash equivalents, trade accounts receivable and financial instruments used in
hedging activities.

The Company places its cash equivalents in a variety of financial instruments
such as certificates of deposit, commercial paper, municipal debt and U.S.
Government agency debt. Company policy limits the amount of credit exposure to
any one financial institution or commercial issuer.

The Company sells its systems to semiconductor manufacturers throughout the
world. The Company performs ongoing credit evaluations of its customers'
financial condition and, generally, requires no collateral from its customers.
The Company maintains an allowance for uncollectible accounts receivable based
upon expected collectibility of all accounts receivable.

The Company is exposed to credit loss in the event of nonperformance by
counterparties on the foreign exchange contracts used in hedging activities.
The Company does not anticipate nonperformance by any of these counterparties.


                                                                                       1993              1994
- - --------------------------------------------------------------------------------------------------------------
<S>                                                                                <C>          <C>
Inventories:                                                                                    (In thousands)
   Customer service spares                                                           13,530         12,220
   Systems raw materials                                                              8,389         12,597
   Work-in-process                                                                   10,004         13,348
   Demonstration equipment                                                           10,566         15,100
- - --------------------------------------------------------------------------------------------------------------
                                                                                     42,489         53,265
- - --------------------------------------------------------------------------------------------------------------
Land, property and equipment:
   Land                                                                             $10,502         10,502
   Buildings and improvements                                                        20,361         21,928
   Machinery and equipment                                                           30,780         33,143
   Furniture and fixtures                                                             4,625          4,549
   Leasehold improvements                                                             6,321          4,029
- - --------------------------------------------------------------------------------------------------------------
                                                                                     72,589         74,151
   Less accumulated depreciation and amortization                                   (33,205)       (37,002)
- - --------------------------------------------------------------------------------------------------------------
                                                                                     39,384         37,149
- - --------------------------------------------------------------------------------------------------------------
Other current liabilities:
   Accrued compensation and benefits                                                $11,682         16,328
   Accrued warranty and installation                                                 12,188         14,367
   Unearned service contract revenue                                                  2,854          3,054
   Other                                                                              6,346          2,804
- - --------------------------------------------------------------------------------------------------------------
                                                                                     33,070         36,553
- - --------------------------------------------------------------------------------------------------------------


<PAGE>   20

The Company is a leading manufacturer of yield monitoring and process control
systems for the semiconductor manufacturing industry. For geographic reporting,
sales are attributed to the geographic location of the sales and service
organizations and costs directly and indirectly incurred in generating sales
are similarly assigned. During fiscal 1993, one customer accounted for 11% of
net sales. During fiscal 1992 and 1994, no customer accounted for more than 10%
of sales. The following is a summary of operations by geographical territories:

                                                                      1992             1993           1994
- - ----------------------------------------------------------------------------------------------------------
                                                                                            (In thousands)
<S>                                                               <C>              <C>            <C>
Net sales from unaffiliated customers:
   United States                                                  $ 67,240         $ 62,802       $ 84,493
   Western Europe                                                   22,484           34,141         37,854
   Japan                                                            48,825           46,914         79,820
   Asia Pacific                                                     17,414           23,379         41,570
- - ----------------------------------------------------------------------------------------------------------
                                                                  $155,963         $167,236       $243,737
- - ----------------------------------------------------------------------------------------------------------
Operating results:
   United States                                                  $ (5,570)        $  7,558       $ 15,407
   Western Europe                                                      608            6,262          9,234
   Japan                                                            (5,214)          (1,783)        11,166
   Asia Pacific                                                      2,204            3,896         14,544
- - ----------------------------------------------------------------------------------------------------------
                                                                    (7,972)          15,933         50,351
   General corporate expenses                                       (5,613)          (4,443)       (10,269)
- - ----------------------------------------------------------------------------------------------------------
   Operating profit (loss)                                        $(13,585)        $ 11,490       $ 40,082
- - ----------------------------------------------------------------------------------------------------------
Identifiable assets:
   United States                                                  $103,960         $ 96,383       $ 95,041
   Western Europe                                                   15,272           22,631         19,853
   Japan                                                            27,026           18,627         38,444
   Asia Pacific                                                     18,581           13,487         24,264
- - ----------------------------------------------------------------------------------------------------------
                                                                   164,839          151,128        177,602
   General corporate assets                                         23,618           47,961        143,968
- - ----------------------------------------------------------------------------------------------------------
   Total assets                                                   $188,457         $199,089       $321,570
- - ----------------------------------------------------------------------------------------------------------

Intercompany transfers of products from the United States to other regions,
based on cost of products transferred, were approximately $34.2, $39.7 and
$52.1 million in fiscal years 1992, 1993 and 1994, respectively. Transfers from
other regions were not significant in fiscal 1992 and 1993. During fiscal 1994,
transfers to the U.S. from other regions were $9.7 million. Corporate assets
consist primarily of cash and cash equivalents and other investments. Corporate
expenses consist primarily of general, administrative and other expenses not
attributable to geographical regions. Capital expenditures and depreciation
expense have been primarily in the United States.


The Company has a profit sharing program, wherein a percentage of pretax
profits, as determined by the Board of Directors, is accumulated and
distributed quarterly to all employees who have completed a stipulated
employment period. In addition, the Board may approve matching contributions to
the Company's savings and investment plan, a qualified salary reduction plan
under section 401(k) of the Internal Revenue Code. The total charge to
operations under the profit sharing and 401(k) programs aggregated
approximately $0.4, $0.7 and $3.3 million in fiscal 1992, 1993 and 1994,

Under the 1982 Stock Option Plan, as amended, 4,750,000 shares have been
reserved for issuance to eligible employees and directors as either Incentive
Stock Options (ISO's) or non-qualified options. Options under this plan are
granted at prices determined by the Board of Directors, but not less than the
fair market value on the date of grant, and expire ten years after the date of
grant. Generally, options become exercisable within five years of the date of
grant, vesting monthly after a waiting period of six to thirty months.

In October 1990, the Company adopted the 1990 Outside Directors Stock Option
Plan to grant options to non-employee directors. This plan calls for an annual
grant of 2,500 options, at fair market value, to each outside director. The
options become exercisable at one fifty-fourth per month beginning six months
from date of grant and expire ten years from grant date. A total of 100,000
shares have been reserved for issuance under this plan.

In August 1992, the Company allowed all holders of outstanding options, with
the exception of holders who were officers or directors of the Company during
all of fiscal 1992, to exchange higher priced options for new non-qualified
options at $7.50 per share, the fair market value on the date of the Board's
action; 412,000 options were exchanged.


<PAGE>   21

Following is a summary of stock option transactions:

<CAPTION>                                                                                 STOCK       RESERVED 
                                                                                        OPTIONS         SHARES
                                                                  OPTION PRICE      OUTSTANDING      AVAILABLE
- - --------------------------------------------------------------------------------------------------------------
<S>                                                              <C>                  <C>            <C>
Balance at June 30, 1991                                          $ 3.17-21.25        3,109,109        907,286
   Options granted                                                  8.63-11.88          264,050       (264,050)
   Options cancelled                                                3.17-20.25         (231,665)       231,665
   Options exercised                                                3.17-13.00         (202,902)
- - --------------------------------------------------------------------------------------------------------------
Balance at June 30, 1992                                         $  6.13-21.25        2,938,592        874,901
   Options granted                                                  7.50-12.38        1,048,246     (1,048,246)
   Options cancelled                                                6.13-20.50         (594,311)       594,311
   Options exercised                                                6.13-14.00         (603,912)
- - --------------------------------------------------------------------------------------------------------------
Balance at June 30, 1993                                         $  7.00-21.25        2,788,615        420,966
   Options granted                                                 19.13-41.63          235,050       (235,050)
   Options cancelled                                                7.00-31.75         (113,749)       113,749
   Options exercised                                                7.00-31.75         (853,509)
- - --------------------------------------------------------------------------------------------------------------
Balance at June 30, 1994                                         $  7.00-41.63        2,056,407        299,665
- - --------------------------------------------------------------------------------------------------------------

At June 30, 1994, options to purchase 736,686 shares of stock were exercisable
under all option plans.

The Company has reserved 1,700,000 shares of common stock to be issued under
the 1981 Employee Stock Purchase Plan. The Plan permits eligible employees to
purchase common stock, through payroll deductions, at 85% of the lower of the
fair market value of the common stock on the date at the beginning of the
two-year offering period or the last day of the purchase period. Substantially
all employees are eligible to participate in the Plan. At June 30, 1994,
204,393 shares were available for future issuance under the Plan.


At June 30, 1994, the Company had a $20 million interest-only mortgage on its
principal facility due August 1995 bearing interest of 5.63% per annum through
August 1994.  Under the terms of the loan, the interest rate will be reset in
August 1994 to 7.62%.  The mortgage, which is secured by $32.4 million in land,
buildings and building improvements at June 30, 1994, requires the Company to
maintain, among other things, minimum working capital and tangible net worth.

As of June 30, 1994, the Company had a $10 million multicurrency line of credit
with a bank, expiring December 31, 1994.  The line of credit has a facility fee
of 0.25% per annum.  Interest on domestic and foreign borrowings is charged at
the bank's reference rate and at the bank's offshore reference rate plus
0.875%, respectively.  The agreement requires the Company to maintain, among
other things, minimum quick ratio, tangible net worth and profitability.  At
June 30, 1994, the Company was in compliance with all of these covenants.  As
of June 30, 1994, approximately $4.2 million had been borrowed at the related
offshore interest rate of 3.91% per annum.

In addition, certain of the Company's foreign subsidiaries had short-term local
currency borrowings of approximately $0.5 million at an average interest rate
of 4.62% at June 30, 1994.

Based upon interest rates available to the Company for issuance of debt with
similar terms and remaining maturities, the fair value of the long-term
mortgage debt and notes payable was approximately equal to the recorded value.


The Company has entered into research and development arrangements with certain
key customers and other entities to partially fund the development of new
technology on a best efforts basis. The financial risks of these research and
development arrangements are substantively and genuinely those of the funding
entities. In fiscal 1992, 1993 and 1994, revenues of $6.1, $6.8 and $5.7
million, respectively, have been recognized on these research and development
contracts on the percentage of completion basis. These revenues are offset
against gross engineering, research and development expenses.


During fiscal 1991, the Company invested approximately $0.2 million cash for an
8% equity investment in Acrotec, a Japanese company developing an automated
optical inspection device for flat panel displays utilizing base technology
provided by the Company. In addition, the Company has a research and
development arrangement with Acrotec to provide research, development and
engineering on a best efforts cost reimbursement basis. The Company received
$2.5, $2.1 and $1.6 million in fiscal 1992, 1993 and 1994, respectively, under
this research and development arrangement, and has recorded these amounts as a
reduction of sales, administrative, engineering, research and development
expenses (see Note 6).


<PAGE>   22

The components of income (loss) from continuing operations before income taxes
were as follows:

                                                                         1992          1993        1994
                                                                                         (In thousands)
- - -------------------------------------------------------------------------------------------------------
<S>                                                                  <C>             <C>        <C>
Domestic                                                             $(22,582)       $1,828     $31,515
Foreign                                                                 6,290         7,453       8,736
- - -------------------------------------------------------------------------------------------------------          
                                                                     $(16,292)       $9,281     $40,251
- - -------------------------------------------------------------------------------------------------------                     

The provisions for income taxes charged to continuing operations were as

                                                                         1992            1993         1994
                                                                                            (In thousands)
- - ----------------------------------------------------------------------------------------------------------
<S>                                                                   <C>             <C>          <C>
   Currently payable (refundable)                                     $(1,698)        $   495     $  7,587
   Deferred                                                               204               -       (2,195)
- - ----------------------------------------------------------------------------------------------------------                        
                                                                       (1,494)            495        5,392
- - ----------------------------------------------------------------------------------------------------------         
- - ----------------------------------------------------------------------------------------------------------
   Currently payable                                                      175             321        2,222
   Deferred                                                              (175)              -            -
- - ----------------------------------------------------------------------------------------------------------
                                                                            -             321        2,222
- - ----------------------------------------------------------------------------------------------------------                       
   Currently payable                                                      867           2,679        2,307
   Deferred                                                               945          (1,175)         142
- - ----------------------------------------------------------------------------------------------------------
                                                                        1,812           1,504        2,449
- - ----------------------------------------------------------------------------------------------------------                          
Provision for income taxes from continuing operations                 $   318         $ 2,320     $ 10,063
- - ----------------------------------------------------------------------------------------------------------

The following is a reconciliation of the effective income tax rates from
   continuing operations and the United States statutory federal income tax

                                                                          1992              1993         1994
- - -------------------------------------------------------------------------------------------------------------
<S>                                                                      <C>               <C>           <C>
Statutory federal income tax rate                                        (34.0)%            34.0%        35.0%
State income taxes, net of federal tax benefits                              -               2.3          3.6
Effect of foreign operations at lower tax rates                           (2.0)            (11.1)        (1.7)
Non-taxable FSC income                                                       -                 -         (1.5)
Financial statement operating loss carryforward
   not recognized because realization is uncertain                        35.3                 -            -
Foreign tax credit                                                           -                 -         (4.8)
Realized deferred tax assets previously reserved                             -              (3.8)        (5.8)
Other                                                                      2.7               3.6          0.2
- - -------------------------------------------------------------------------------------------------------------
Effective tax rate                                                         2.0%             25.0%        25.0%
- - -------------------------------------------------------------------------------------------------------------

Deferred tax liabilities (assets) at July 1, 1992, June 30, 1993 and 1994 are
comprised of the following:

                                                                   July 1,         June 30,       June 30,
                                                                      1992             1993           1994
                                                                                            (In thousands)
- - ----------------------------------------------------------------------------------------------------------
<S>                                                                 <C>            <C>            <C>
Deferred tax liabilities:                                                        
   Depreciation                                                   $  4,342         $  4,317          5,157
   Unremitted earnings of foreign subsidiaries not 
     permanently reinvested                                          3,902            2,726          6,327
   Capitalized software                                              1,963            1,679            641
   Other                                                               963            1,596          1,255
- - ----------------------------------------------------------------------------------------------------------                       
                                                                    11,170           10,318         13,380
- - ----------------------------------------------------------------------------------------------------------           
Deferred tax assets:
   Inventory reserves and basis differences                         (9,357)          (9,876)       (11,483)
   Federal and state loss and credit carryforwards                  (5,279)          (4,816)        (4,696)
   Other asset valuation reserves                                   (2,079)          (1,874)        (2,008)
   Reserves for restructured and discontinued operations            (1,749)            (668)          (331)
   Employee benefit accruals                                        (1,026)          (1,528)        (1,885)
   Warranty and installation accruals                                 (674)            (934)        (1,880)
   Other                                                              (984)            (853)        (1,064)
- - ----------------------------------------------------------------------------------------------------------
                                                                   (21,148)         (20,549)       (23,347)
- - ----------------------------------------------------------------------------------------------------------
Deferred tax assets valuation allowance                             13,746           13,395         11,078
- - ----------------------------------------------------------------------------------------------------------
Total net deferred tax liabilities                                $  3,768         $  3,164          1,111
- - ----------------------------------------------------------------------------------------------------------


<PAGE>   23

The deferred tax assets valuation allowance at June 30, 1993 and 1994, is
attributed to U.S. federal and state deferred tax assets. The Company has $13.3
million of net deferred tax assets in the U.S. at June 30, 1994. Management
believes sufficient uncertainty exists such that a valuation allowance of $11.1
million against these net deferred tax assets is required. When these reserved
deferred tax assets are ultimately realized, $6.0 million will reduce the
Company's federal and state tax provisions and $5.1 million will be credited to
paid-in capital (related to stock option deductions). The Company's deferred
tax assets in the U.S. at July 1, 1992, and June 30, 1993, were fully reserved.
During fiscal 1993 and 1994, the Company realized $0.4 and $2.3 million,
respectively, of deferred tax assets previously reserved, reducing the
valuation allowance by corresponding amounts.

In accordance with FAS 109, the valuation allowance is allocated pro-rata to
federal and state current and non-current deferred tax assets. Net deferred tax
liabilities at June 30, 1994, of $1.1 million, reflect foreign liabilities of
$3.3 million offset by $2.2 million of U.S. assets.  The net deferred tax
liability at July 1, 1992 and June 30, 1993 relates to foreign operations.

The Company has federal research and development and other tax credit
carryovers of approximately $4.6 million that will expire primarily in fiscal
1998 through 2009.

The Company's manufacturing operations in Switzerland are exempt from taxes
through 2001. The effect of this tax exemption was to increase net income in
fiscal 1993 and 1994 by approximately $0.6 million for each year.

The IRS is currently auditing the Company's federal income tax returns for
fiscal years 1985 to 1992. Management believes sufficient taxes have been
provided in prior years and that the ultimate outcome of these reviews will not
have a material adverse impact on the Company's financial position or results
of operations.


The Company leases several facilities under operating leases expiring at
various dates through fiscal 2025 with renewal options at fair market value for
additional periods ranging up to ten years. The aggregate minimum rental
commitment under these lease agreements as of June 30, 1994, excluding property
taxes, insurance and certain other costs to be paid by the Company, are
approximately $2.3, $1.4, $1.0, $1.0, $0.5 and $1.3 million in fiscal 1995
through 1999 and thereafter, respectively. Total rental expense under all
operating leases was $3.2, $2.9 and $2.5 million in fiscal 1992, 1993 and 1994,

The Company is the plaintiff in two patent infringement suits in which the
defendants filed counterclaims alleging interference with business.  In
addition the Company has also filed suit against two of its vendors for
defective merchandise delivered by them. One of these resulted in a
counterclaim. The Company is also a defendant in three suits arising out of the
discontinued printed circuit board inspection business. In one of them the
trial court ruled in favor of the Company on all causes of action asserted
against it. This case is presently under appeal. The remaining cases are in the
early discovery stage. The Company also filed a complaint against another
semiconductor equipment manufacturer in which the Company holds a minority
interest. The Company alleges that its ownership was unjustly diluted by the
defendant. In addition to the above, the Company from time to time is put on
notice by its customers regarding possible patent infringement. Management does
not believe that any of these matters will have an adverse material effect on
the Company's financial position or results of operations.


In February 1994, the Company sold 2,300,000 shares of common stock at $ 31.50
per share in a public offering resulting in $68.6 million of proceeds to the
Company, net of offering expenses.

In March 1989, the Company implemented a plan to protect stockholders' rights
in the event of a proposed takeover of the Company. Under the plan, each share
of the Company's outstanding common stock carries one Common Stock Purchase
Right (Right). The Right entitles the holder, under certain circumstances, to
purchase common stock of the Company or its acquirer at a discounted price. The
Rights are redeemable by the Company and expire in 1999.


Restructuring charges in fiscal 1992 of $8.2 million include $2.4 million for
costs associated with the discontinuance of the EMMI product line, $1.6 million
of expenses for eliminating one corporate facility, $0.9 million in severance
costs, and $3.3 million for costs associated with a redefinition of certain
product strategies. During fiscal 1993, a $0.7 million recovery was recognized
on the sale of the EMMI product line.


In December 1990, the Company divested its printed circuit board (PCB)
inspection business and recorded a $15 million pretax charge as a result. In
October 1991, the Company entered into an agreement to sell substantially all
of the assets and related technology of the PCB business for approximately $4.3
million plus future royalties. The agreement required the Company to transfer
the technology, provide training and develop certain software to enhance the
product. The Company recognized a $2.8 million recovery of the fiscal 1991
provision in the third quarter of fiscal 1992 upon substantial completion of
its obligations under the sale agreement.


<PAGE>   24


To the Stockholders and
Board of Directors of
KLA Instruments Corporation

In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, stockholders' equity and cash flows
present fairly, in all material respects, the financial position of KLA
Instruments Corporation and its subsidiaries at June 30, 1993 and 1994, and the
results of their operations and their cash flows for each of the three years in
the period ended June 30, 1994, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.


San Jose, California
July 26, 1994

Common Stock                                                     1993                                  1994
                                                          High          Low                     High          Low
- - -----------------------------------------------------------------------------------------------------------------
<S>                                                     <C>          <C>                      <C>         <C>
First Quarter                                            9            7 1/8                   26 1/2       17
Second Quarter                                          12 1/4        7 3/4                   28           19
Third Quarter                                           14 3/4       10 5/8                   43           25 7/8
Fourth Quarter                                          19 1/2       11 1/4                   43 1/4       32 1/4
- - ----------------------------------------------------------------------------------------------------------------- 

The Company's common stock is traded on the NASDAQ National Market System under
the symbol "KLAC." All common stock prices reflect closing prices per the
NASDAQ National Market System.

The Company has not paid cash dividends on its common stock and does not plan
to pay cash dividends to its stockholders in the near future. The Company
presently intends to retain its earnings to finance further growth of its
business. As of June 30, 1994, the Company had approximately 1,014 stockholders
of record.


<PAGE>   25


Kenneth Levy
Chairman of the Board
Chief Executive Officer

Kenneth L. Schroeder
Chief Operating Officer

Robert J. Boehlke
Vice President Finance
  and Administration,
  Chief Financial Officer

Gary E. Dickerson
Vice President

Michael D. McCarver
Vice President

Neil Richardson, Ph. D.
Vice President

Magnus O. W. Ryde
Vice President

Arthur P. Schnitzer
Vice President

Ben Tsai, Ph. D.
Vice President
Chief Technical Officer

Virginia DeMars
Vice President,
Human Resources

Christopher Stoddart

William Turner
Vice President,

Paul E. Kreutz, Esq.


Kenneth Levy
Chairman of the Board
Chief Executive Officer

Kenneth L. Schroeder
Chief Operating Officer

Leo J. Chamberlain
Private Investor

Robert E. Lorenzini
Private Investor

Yoshio Nishi
Research & Development Center

Samuel Rubinovitz
Executive Vice President
EG&G, Inc.

Dag Tellefsen
General Partner
Glenwood Venture Management


KLA Instruments Corporation
160 Rio Robles
P.O. Box 49055
San Jose, California 95161-9055
(408) 434-4200

KLA Instruments Ltd.
4 The Business Center
Molly Millars Lane
Wokingham, Berkshire
RG11 2QZ, United Kingdom

KLA Instruments GmbH
Leonrodstrasse 58
80636 Muenchen, Germany

KLA Instruments France, S.A.
25 Rue Michael Faraday
78180 Montigny-le-Bretonneux

KLA Instruments Israel Corporation
4 Science Avenue
North Industrial Center
P.O. Box 143
Migdal Ha'Emek 10500, Israel

KLA Instruments Malaysia Sd Bhd
60 Jalan Timah 7
Taman Sri Putri
81300 Skudai
Johor Bahru, Malaysia

KLA Japan, Ltd.
Endo Dai-Ni Building
1-31-11 Akebono-Cho
Tachikawa City
Tokyo 190, Japan

KLA Acrotec Company, Ltd.
20-16 Hikawadai
Nerima-Ku 3-Chome
Tokyo 179, Japan

KLA Instruments, S.A.
Chemin de Buchaux 38
CH-2022 Bevaix

KLA Instruments Korea
4th Floor Chunil Building
961-1 Daechi 3-Dong
Kangnam-Ku, Seoul 135-283
Republic of Korea

KLA Instruments Taiwan
Fifth Floor
115 Ming Sheng Road
Hsinchu City, Taiwan
Republic of China


Price Waterhouse LLP
San Jose, California

Gray Cary Ware & Freidenrich
Palo Alto, California

First National Bank of Boston
Boston, Massachusetts

Additional copies of this report, as well as copies of SEC Form 10K, for the
year ended June 30, 1994, may be obtained from the Company without charge by
writing to:

KLA Instruments Corporation
Attn:  Investor Relations
P.O. Box 49055
San Jose, CA  95161-9055


<PAGE>   26
                        (C) KLA Instruments Corporation
                          Printed in U.S.A.  1094-15M