AEHR TEST SYSTEMS, 10-K, 1998-08-28

AEHR TEST SYSTEMS
10-K, 1998-08-28
INSTRUMENTS FOR MEAS & TESTING OF ELECTRICITY & ELEC SIGNALS

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

FORM 10-K

(Mark One)
[X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 (Fee Required).

For the fiscal year ended May 31, 1998

[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 (No Fee Required).

For the transition period from ________________ to ________________

Commission file number: 333-28987.

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AEHR TEST SYSTEMS
(Exact name of Registrant as specified in its charter)

CALIFORNIA 94-2424084
(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)

1667 PLYMOUTH STREET, MOUNTAIN VIEW, CA 94043
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (650) 691-9400

---------------

Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]

<PAGE>
The aggregate market value of the Registrant's Common Stock, par value
$.01 per share, held by non-affiliates of the Registrant, based upon the
closing price of $4.438 on July 31, 1998, as reported on the Nasdaq National
Market, was approximately $24,665,000. For purposes of this disclosure, shares
of Common Stock held by persons who hold more than 5% of the outstanding shares
of Common Stock (other than such persons of whom the Registrant became aware
only through the filing of a Schedule 13G filed with the Securities and
Exchange Commission) and shares held by officers and directors of the
Registrant have been excluded because such persons may be deemed to be
affiliates. This determination of affiliate status is not necessarily
conclusive for other purposes.

The number of shares of Registrant's Common Stock, par value $.01 per
share, outstanding at July 31, 1998 was 6,924,129.

Documents Incorporated By Reference

Certain information required by Items 10, 11, 12 and 13 of this report on
Form 10-K is incorporated by reference from the Registrant's proxy statement
for the Annual Meeting of Shareholders to be held on October 28, 1998 (the
"Proxy Statement"), which will be filed with the Securities and Exchange
Commission within 120 days after the close of the Registrant's fiscal year
ended May 31, 1998.

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AEHR TEST SYSTEMS

FORM 10-K
FISCAL YEAR ENDED MAY 31, 1998

TABLE OF CONTENTS

PART I
Item 1. Business ................................................ 4
Item 2. Properties ............................................. 15
Item 3. Legal Proceedings ....................................... 15
Item 4. Submission of Matters to a Vote of Security Holders ..... 15

PART II

Item 5. Market for the Registrant's Common Equity and Related
Shareholder Matters ................................... 16
Item 6. Selected Financial Data ................................. 18
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations ............................. 19
Item 8. Financial Statements and Supplementary Data ............. 39
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure ................... 60

PART III

Item 10. Directors and Executive Officers of the Registrant ...... 61
Item 11. Executive Compensation .................................. 61
Item 12. Security Ownership of Certain Beneficial Owners and
Management ............................................ 61
Item 13. Certain Relationships and Related Transactions .......... 61

PART IV

Item 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K .............................................. 62

Signatures .............................................. 66

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This Annual Report on Form 10-K contains forward-looking statements with
respect to Aehr Test Systems ("Aehr Test" or the "Company") which involve risks
and uncertainties. The Company's actual results may differ materially from the
results discussed in the forward-looking statements due to a number of factors,
including those described herein and the documents incorporated herein by
reference, and those factors described in Part II, Item 7 under "Factors that
May Affect Future Results of Operations."

PART I

Item 1. Business

THE COMPANY

Aehr Test Systems develops, manufactures and sells systems which are
designed to reduce the cost of testing DRAMs and other memory devices, perform
reliability screening or burn-in of complex logic and memory devices, and
enable IC manufacturers to perform test and burn-in of bare die. Leveraging
its expertise as a long-time leading provider of burn-in equipment, with over
2,000 systems installed world-wide, the Company has developed and introduced
two innovative product families, the MTX system and the DiePak carrier. The
MTX is a massively parallel test system capable of processing thousands of
memory devices simultaneously. The MTX system performs not only burn-in but
also many of the tests traditionally performed in final test by
lower-throughput, higher-cost memory testers. The DiePak carrier is a
reusable, temporary package that enables IC manufacturers to perform
cost-effective final test and burn-in of bare die.

INDUSTRY BACKGROUND

Semiconductor manufacturing is a complex, multi-step process and defects or
weaknesses that may result in the failure of an IC may be introduced at any
process step. Failures may occur immediately or at any time during the
operating life of an IC, sometimes after several months of normal use.
Semiconductor manufacturers rely on testing and reliability screening to detect
failures that occur during the manufacturing process.

Testing and reliability screening involves multiple steps. The first set
of tests is typically performed before the processed semiconductor wafer is cut
into individual die, in order to avoid the cost of packaging defective die into
their plastic or ceramic packages. After the die are packaged and before they
undergo reliability screening, a short test is typically performed in order to
detect packaging defects. Most leading-edge microprocessors, microcontrollers,
digital signal processors, and memory ICs then undergo an extensive reliability
screening and stress testing procedure known as "burn-in." The burn-in process
screens for early failures by operating the IC at elevated voltages and
temperatures, usually at 125 degrees C (257 degrees F), for periods typically
ranging from 12 to 48 hours. Burn-in systems can process thousands of ICs
simultaneously. After burn-in, the ICs undergo a final test process using
automatic test equipment ("testers"). Testers can test up to 64 ICs
simultaneously and perform a variety of tests at multiple temperatures.

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PRODUCTS

The Company manufactures and markets massively parallel test systems,
burn-in systems, die carriers, test fixtures and related accessories.

All of the Company's systems are modular, allowing them to be configured
with optional features to meet customer requirements. Systems can be
configured for use in production applications, where capacity, throughput and
price are most important, or for reliability engineering and quality assurance
applications, where performance and flexibility, such as extended temperature
ranges, are essential.

MASSIVELY PARALLEL TEST SYSTEM

The MTX massively parallel test system is designed to reduce the cost of
memory test by processing thousands of memory devices simultaneously, including
DRAMs, SDRAMs, Rambus DRAMs, SRAMs and most application-specific memories. The
MTX system can perform a significant number of tests usually performed by
memory testers, including pattern sensitivity tests, functional tests, data
retention tests and refresh tests. The Company estimates that transferring
these tests from memory testers to the MTX system can reduce the time that a
memory device must be tested by a memory tester by up to 75%, thereby reducing
the required number of memory testers and, as a result, reducing capital and
operating costs.

The MTX system consists of several subsystems: pattern generation and test
electronics, control software, network interface, environmental chamber and
automation. The MTX system has an algorithmic test pattern generator which
allows it to duplicate most of the tests performed by a memory tester. Pin
electronics at each performance test board ("PTB") position are designed to
provide accurate signals to the memories being tested and detect whether a
device is failing the test. An optional enhanced fault collection capability
allows the MTX to identify which cells in a memory IC are failing, resulting in
information which can be used to sort partially good devices, and for
engineering characterization of new device types.

Devices being tested are placed on PTBs and loaded into environmental
chambers which typically operate at temperatures from 25 degrees C (77 degrees
F) up to 150 degrees C (302 degrees F) (optional chambers can produce
temperatures as low as -55 degrees C (-67 degrees F)). A single PTB can hold
up to 256 64 megabit ("Mb") DRAMs, and a production chamber holds 30 PTBs,
resulting in up to 7,680 devices being tested in parallel in a single system.
For production environments, the systems include an automatic PTB
insertion/ejection mechanism for more efficient handling of production
quantities of PTBs.

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BURN-IN SYSTEMS

The MAX system is designed for dynamic burn-in of memory and low pin-count
logic devices. The production version holds 64 burn-in boards ("BIBs"), each
of which may hold 350 or more devices, resulting in a system capacity of 22,400
or more devices. The MAX system's 48-channel pin electronics and ability to
run stored test patterns also allow it to be used for application-specific
memory devices and many logic devices. The pin electronics are designed to
provide precisely-controlled voltages and signals to the devices on the BIBs
and to protect them from damage during the burn-in process. The MAX2
introduced in July, 1997, features multi-tasking Windows NT-based software
which includes lot tracking and reporting software that are needed for
production and military applications. The MAX3, currently completing
development, increases the pin electronics to 48 channels, and handles the
latest low voltage ICs. The MAX2 and MAX3 also have extended stored test
program capability for more complete exercise of complex logic devices such as
digital signal processors.

The ATX system is designed for dynamic and monitored burn-in of high
pin-count VLSI devices, including microprocessors, microcontrollers,
applications-specific ICs ("ASICs"), and certain memory devices. The ATX
system uses much of the same software as the MAX system and contains additional
features such as an interface to CAE systems for program development and output
monitoring to ensure that the devices receive the specified voltages and
signals. Its 256-channel pin electronics configuration allows it to handle
complex logic devices, and its ability to burn in different device types in
each of the system's 32 BIB positions is useful for quality assurance
applications. The Windows NT-based ATX2, currently completing development,
includes a high current feature to allow the system to burn-in more devices,
plus an extended pattern generation capability.

DIEPAK CARRIERS

The Company's DiePak product line includes a family of reusable, temporary
die carriers and associated sockets which enable the test and burn-in of bare
die using the same test and burn-in systems used for packaged ICs. DiePak
carriers offer cost-effective solutions for providing known good die for most
types of ICs, including memory, microcontroller and microprocessor devices.
The DiePak carrier was introduced in fiscal 1995 following a development effort
that included the Company and Nitto Denko Corporation, which manufactured the
interconnect substrate.

The DiePak carrier consists of an interconnect substrate, which provides
electrical connection between the die pads and the socket contacts, and a
mechanical support system. The substrate is customized for each IC product.
The DiePak carrier comes in 108, 172 and 320 pin versions to handle ICs ranging
from low pin-count memories to high pin-count microprocessors. The DiePak
carrier and socket feature a small footprint which reduces test and burn-in
cost because more devices may be processed simultaneously on a test fixture.

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TEST FIXTURES

The Company manufactures and sells custom designed test fixtures including
performance test boards for use with the MTX massively parallel test system and
burn-in boards for its burn-in systems. PTBs and BIBs hold the devices
undergoing test or burn-in and electrically connect the devices under test to
the system electronics. The capacity of each PTB or BIB depends on the type of
device being tested or burned-in, ranging from several hundred in memory
production to as few as eight for high pin-count complex ASIC devices. PTBs
and BIBs are sold both with new Aehr Test systems and for use with the
Company's installed base of systems. Due to the advanced test requirements of
the MTX system, PTBs are substantially more complex than BIBs. The Company has
patented certain features of the PTB and to date has licensed one other company
to supply PTBs.

CUSTOMERS

The Company markets and sells its products throughout the world to
semiconductor manufacturers, semiconductor contract assemblers, electronics
manufacturers and burn-in and test service companies.

Sales to the Company's five largest customers accounted for approximately
75.2%, 69.2%, and 55.8% of its net sales in fiscal 1998, 1997 and 1996,
respectively. During fiscal 1998, 1997 and 1996, Siemens accounted for 47.0%,
55.7% and 29.1% of the Company's net sales, respectively. Additionally, during
fiscal 1998 Motorola accounted for 12.8% of the Company's net sales. No other
customers represented more than 10% of the Company's net sales for any of such
periods. The Company expects that sales of its products to a limited number of
customers will continue to account for a high percentage of net sales for the
foreseeable future. In addition, sales to particular customers may fluctuate
significantly from quarter to quarter. The loss or reduction or delay in
orders from a significant customer, or a delay in collecting or failure to
collect accounts receivable from a significant customer could adversely affect
the Company's business, financial condition and operating results.

MARKETING, SALES AND CUSTOMER SUPPORT

The Company has sales and service operations in the United States, Japan
and Germany and has established a network of distributors and sales
representatives in other key parts of the world.

The Company's customer service and support program includes system
installation, system repair, applications engineering support, spare parts
inventories, customer training, and documentation. The customer support
organization has both applications engineering and field service personnel
located at the corporate headquarters in Mountain View, California and at the
Company's subsidiaries in Germany and Japan. The Company's distributors
provide applications and field service support in other parts of the world.
The Company customarily provides a warranty on its products. The Company
offers service contracts on its systems directly and through its subsidiaries,
distributors, and representatives.

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BACKLOG

As of May 31, 1998 and 1997, the Company's backlog was $4.6 million and
$20.9 million, respectively. The Company's backlog consists of product orders
for which confirmed purchase orders have been received and which are scheduled
for shipment within 12 months. Most orders are subject to rescheduling or
cancellation by the customer with limited penalties. Because of the
possibility of customer changes in delivery schedules or cancellations and
potential delays in product shipments, the Company's backlog as of a particular
date may not be indicative of net sales for any succeeding period.

RESEARCH AND PRODUCT DEVELOPMENT

The Company historically has devoted a significant portion of its financial
resources to research and development programs and expects to continue to
allocate significant resources to these efforts. The Company's research and
development expenses during fiscal 1998, 1997 and 1996 were approximately $4.5
million, $4.5 million and $4.1 million, respectively.

The Company conducts ongoing research and development to develop new
products and to support and enhance existing product lines. The Company is
currently developing capability and performance enhancements to the MTX, MAX
and ATX systems for future generation ICs. The Company is also developing
DiePak carriers to accommodate additional types of devices.

Building upon the expertise gained in the development of its existing
products, the Company is pursuing a long-term project to develop a system for
performing test and burn-in of entire processed wafers, rather than individual
die or packaged parts. This wafer-level burn-in and test project is being
financed by the Company and Defense Advanced Research Projects Agency ("DARPA")
under a cost-sharing agreement entered into in 1994.

MANUFACTURING

The Company assembles its products from components and parts manufactured
by others, including environmental chambers, power supplies, metal
fabrications, printed circuit assemblies, integrated circuits, burn-in sockets
and interconnect substrates. Final assembly and test are performed within the
Company's facilities. The Company's strategy is to use in-house manufacturing
only when necessary to protect a proprietary process or if a significant
improvement in quality, cost or lead time can be achieved. The Company's
principal manufacturing facility is located in Mountain View, California. The
Company's Tokyo, Japan facility provides final test, limited manufacturing and
product customization.

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The Company relies on subcontractors to manufacture many of the components
or subassemblies used in its products. The Company's MTX, MAX and ATX systems
contain several components, including environmental chambers, power supplies
and certain ICs, which are currently supplied by only one or a limited number
of suppliers. The DiePak products include an interconnect substrate which is
supplied only by Nitto Denko Corporation. The Company's reliance on
subcontractors and single source suppliers involves a number of significant
risks, including the loss of control over the manufacturing process, the
potential absence of adequate capacity and reduced control over delivery
schedules, manufacturing yields, quality and costs. In the event that any
significant subcontractor or single source supplier were to become unable or
unwilling to continue to manufacture subassemblies, components or parts in
required volumes, the Company would have to identify and qualify acceptable
replacements. The process of qualifying subcontractors and suppliers could be
lengthy, and no assurance can be given that any additional sources would be
available to the Company on a timely basis. Any delay, interruption or
termination of a supplier relationship could have a material adverse effect on
the Company's business, financial condition and operating results.

COMPETITION

The semiconductor equipment industry is intensely competitive. Significant
competitive factors in the semiconductor equipment market include price,
technical capabilities, quality, flexibility, automation, cost of ownership,
reliability, throughput, product availability and customer service. In each of
the markets it serves, the Company faces competition from established
competitors and potential new entrants, many of which have greater financial,
engineering, manufacturing and marketing resources than the Company.

Because the Company's MTX system performs burn-in and many of the
functional tests performed by memory testers, the Company expects that the MTX
system will face intense competition from burn-in system suppliers and
traditional memory tester suppliers. The market for burn-in systems is highly
fragmented, with many domestic and international suppliers. Some users, such
as independent test labs, build their own burn-in systems, and some other
users, particularly large Japanese IC manufacturers, acquire burn-in systems
from captive or affiliated suppliers. Competing suppliers of burn-in and
functional test systems include Ando Corporation, Japan Engineering Company and
Reliability Incorporated. In addition, suppliers of memory test equipment
including Advantest Corporation and Teradyne, Inc. may seek to offer
competitive parallel test systems in the future.

The Company's MAX dynamic and ATX monitored and dynamic burn-in systems
increasingly have faced and are expected to continue to face severe
competition, especially from local, low cost manufacturers. Also, the MAX
dynamic burn-in system faces severe competition from manufacturers of monitored
burn-in systems that perform limited functional tests, including tests designed
to ensure the devices receive the specified voltages and signals.

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The Company's DiePak products face significant competition. Texas
Instruments Incorporated sells a temporary, reusable bare die carrier which is
intended to enable burn-in and test of bare die, and the Company believes that
several other companies have developed or are developing other such products.
As the bare die market develops, the Company expects that other competitors
will emerge. The Company expects that the primary competitive factors in this
market will be cost, performance, reliability and assured supply.

The Company's test fixture products face numerous competitors. There are
limited barriers to entry into the BIB market, and as a result, many small
companies design and manufacture BIBs, including BIBs for use with the
Company's MAX and ATX systems. The Company's strategy is to provide higher
performance BIBs, and the Company generally does not compete to supply lower
cost, low performance BIBs. The Company has granted a royalty-bearing license
to one company to make PTBs for use with its MTX systems, in order to assure
customers of a second source of supply, and the Company may license others as
well. Sales of PTBs by licensees would result in royalties to the Company but
would reduce the Company's own sales of PTBs.

The Company expects its competitors to continue to improve the performance
of their current products and to introduce new products with improved price and
performance characteristics. New product introductions by the Company's
competitors or by new market entrants could cause a decline in sales or loss of
market acceptance of the Company's products. Increased competitive pressure
could also lead to intensified price-based competition, resulting in lower
prices which could adversely affect the Company's business, financial condition
and operating results. The Company believes that to remain competitive it must
invest significant financial resources in new product development and expand
its customer service and support worldwide. There can be no assurance that the
Company will be able to compete successfully in the future.

PROPRIETARY RIGHTS

The Company relies primarily on the technical and creative ability of its
personnel, its proprietary software, and trade secret and copyright protection,
rather than on patents, to maintain its competitive position. The Company's
proprietary software is copyrighted and licensed to the Company's customers.
The Company currently holds four issued United States patents and has one
additional United States patent application and several foreign patent
applications pending. The Company has one United States trademark
registration. One issued patent covers the method used to connect the PTBs
with the MTX system. Another issued patent relating to the MTX includes claims
covering certain details of the electronic implementation used to obtain high
performance in the MTX system and also covering certain testing methods.

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The Company's ability to compete successfully is dependent in part upon its
ability to protect its proprietary technology and information. Although the
Company attempts to protect its proprietary technology through patents,
copyrights, trade secrets and other measures, there can be no assurance that
these measures will be adequate or that competitors will not be able to develop
similar technology independently. Further, there can be no assurance that
claims allowed on any patent issued to the Company will be sufficiently broad
to protect the Company's technology, that any patent will issue from any
pending application or that foreign intellectual property laws will protect the
Company's intellectual property. Litigation may be necessary to enforce or
determine the validity and scope of the Company's proprietary rights, and there
can be no assurance that the Company's intellectual property rights, if
challenged, will be upheld as valid. Such litigation could result in
substantial costs and diversion of resources and could have a material adverse
effect on the Company's business, financial condition and operating results,
regardless of the outcome of the litigation. In addition, there can be no
assurance that any of the patents issued to the Company will not be challenged,
invalidated or circumvented or that the rights granted thereunder will provide
competitive advantages to the Company.

There are no pending claims against the Company regarding infringement of
any patents or other intellectual property rights of others. However, the
Company may receive, in the future, communications from third parties asserting
intellectual property claims against the Company. Such claims could include
assertions that the Company's products infringe, or may infringe, the
proprietary rights of third parties, requests for indemnification against such
infringement or suggestions that the Company may be interested in acquiring a
license from such third parties. There can be no assurance that any such claim
made in the future will not result in litigation, which could involve
significant expense to the Company, and, if the Company is required or deems it
appropriate to obtain a license relating to one or more products or
technologies, there can be no assurance that the Company would be able to do so
on commercially reasonable terms, or at all.

EMPLOYEES

As of June 30, 1998, the Company and its two foreign subsidiaries employed
155 persons full-time, of whom 41 were engaged in research, development, and
related engineering, 56 in manufacturing, 42 in marketing, sales, and customer
support, and 16 in general administration and finance. 34 persons are employed
by the Company's subsidiary in Japan. In addition, the Company from time to
time employs a number of part-time employees and contractors, particularly in
manufacturing. The Company's success is in part dependent on its ability to
attract and retain highly skilled workers, who are in high demand. None of the
Company's employees is represented by a union and the Company has never
experienced a work stoppage. Management considers its relations with its
employees to be good.

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MANAGEMENT

EXECUTIVE OFFICERS AND DIRECTORS

The executive officers and directors of the Company are as follows:

Name of Executive Officer Age Positions with the Company
- -------------------------- ---- -----------------------------------
Rhea J. Posedel............ 56 President, Chief Executive Officer and
Chairman of the Board of Directors

Gary L. Larson............. 48 Vice President of Finance and Chief
Financial Officer

William D. Barraclough..... 54 Vice President of Test Systems
Engineering

Carl N. Buck............... 46 Vice President of Marketing

Richard F. Sette........... 60 Vice President of Operations

Raul V. Tan................ 38 Vice President of Research and
Development Engineering

Yasushi Naitoh........... 45 President, Aehr Test Systems Japan

William W. R. Elder (1)(2). 59 Director

Mario M. Rosati (1)........ 52 Director and Secretary

David Torresdal (2)........ 60 Director

- ------------------------
(1) Member of the Compensation Committee.

(2) Member of the Audit Committee.

RHEA J. POSEDEL is a founder of the Company and has served as President,
Chief Executive Officer and Chairman of the Board of Directors since its
inception in 1977. Prior to founding the Company, Mr. Posedel held various
project engineering and engineering managerial positions at Lockheed Martin
Corporation (formerly "Lockheed Missile & Space Corporation"), Ampex
Corporation, and Cohu, Inc. He received a B.S. in Electrical Engineering from
the University of California, Berkeley, an M.S. in Electrical Engineering from
San Jose State University and an M.B.A. from Golden Gate University.

GARY L. LARSON joined the Company in April 1991 as Chief Financial Officer
and was elected Vice President of Finance in February 1992. From 1986 to 1990,
he served as Chief Financial Officer, and from 1988 to 1990 also as President
and Chief Operating Officer, of Nanometrics Incorporated, a manufacturer of
measurement and inspection equipment for the semiconductor industry. Mr.
Larson received a B.S. in Mathematics/Finance from Harvey Mudd College.

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WILLIAM D. BARRACLOUGH joined the Company as an Account Manager in February
1989 and held various positions until he was elected Vice President of Test
Systems Engineering in August 1996. From 1984 to 1989, Mr. Barraclough served
as Vice President of Marketing at Thermonics, Inc., a manufacturer of
temperature control equipment for electronics devices. Mr. Barraclough
received a B.S.E.E. from the University of Southern California.

CARL N. BUCK joined the Company as a Product Marketing Manager in 1983 and
held various positions until he was elected Vice President of Engineering in
November 1992, Vice President of Research and Development Engineering in
November 1996, and Vice President of Marketing in September 1997. From 1978 to
1983, Mr. Buck served as Product Marketing Manager at Intel Corporation, an
integrated circuit and microprocessor company. Mr. Buck received a B.S.E.E.
from Princeton University, an M.S. in Electrical Engineering from the
University of Maryland and an M.B.A. from Stanford University.

RICHARD F. SETTE rejoined the Company as Vice President of Operations in
January 1996, after serving in that same position from 1984 to 1987. He served
as Senior Director of Operations of Northrop Grumman Corp., a manufacturer of
aircraft and aircraft subsystems, from 1987 to 1993, as Vice President of
Operations of Symtek, Inc., which manufactures handling equipment for the
semiconductor industry, from 1993 to 1994 and as Director of Engineering at
SatCom Technologies Corp., a developer of energy storage systems, from 1994 to
1995. Mr. Sette received a B.S.E.E. and an M.S.E.E. from Northeastern
University.

RAUL V. TAN joined the Company as Director of Factory Automation in March
1997, and was elected Vice President of Research and Development Engineering in
September 1997. Prior to joining the Company, Mr. Tan served as Director of
Software at Lam Research Corporation. From 1987 to 1991, Mr. Tan held various
engineering management positions with General Signal Corporation's
Semiconductor Group. Mr. Tan received a Master of Engineering in Robotics from
Carnegie-Mellon University and a B.S. cum laude in Mechanical Engineering from
De La Salle University.

YASUSHI NAITOH joined the Company as President, Aehr Test Systems Japan
K.K., the Company's Japanese subsidiary, in October 1997. He was employed at
Tokyo Electron Limited, a leading worldwide semiconductor equipment
manufacturer from 1983 to 1997, during which time he held various positions,
including serving as Senior Department Manager of Test Systems and Senior
Department Manager of Automation Systems. Mr. Naitoh graduated from Kanagawa
University in Kanagawa, Japan where he majored in Mechanical Engineering.

WILLIAM W. R. ELDER has been a director of the Company since 1989. Dr.
Elder was the Chief Executive Officer of Genus, Inc. ("Genus"), a semiconductor
company, from his founding of Genus in 1981 to September 1996, and has been
serving in that same position again since April 1998. Dr. Elder has been a
director of Genus since its inception. Dr. Elder holds a B.S.I.E. and an
honorary Doctorate Degree from the University of Paisley in Scotland.

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MARIO M. ROSATI has served as Secretary and a director of the Company since
1977. He is a member of the law firm of Wilson Sonsini Goodrich & Rosati,
which he joined in 1971. Mr. Rosati is a graduate of Boalt Hall, University of
California at Berkeley. Mr. Rosati is a director of C*ATS Software Inc.,
Genus, Inc., Meridian Data, Inc., Ross Systems, and Sanmina Corporation, as
well as several private companies.

DAVID TORRESDAL has been a director of the Company since 1977. He has been
President of Davtron, Inc., a manufacturer of aircraft electronic equipment,
since 1970. Mr. Torresdal received an A.A.S. in Engineering from Oregon
Technical Institute.

DIRECTORS' COMPENSATION AND OTHER ARRANGEMENTS

Directors of the Company do not receive any cash compensation for their
services as members of the Board of Directors, although they are reimbursed for
certain expenses incurred in attending Board and committee meetings. Directors
are eligible to participate in the Company's option plans. In fiscal 1996, the
Company granted options to purchase 55,000 shares to William Elder at $4.00 per
share, 20,000 shares to Mario Rosati at $4.00 per share, and 20,000 shares to
David Torresdal at $4.00 per share. Directors were granted no options in
fiscal 1997 and 1998.

The Board of Directors has a Compensation Committee and an Audit Committee.
The Compensation Committee, which is comprised of William Elder and Mario
Rosati, makes recommendations to the Board of Directors regarding executive
compensation matters, including decisions relating to salary and bonus and
grants of stock options. The Audit Committee, which is comprised of William
Elder and David Torresdal, approves the Company's independent auditors, reviews
the results and scope of annual audits and other accounting related services,
and reviews and evaluates the Company's internal audit and control functions.

14
<PAGE>

Item 2. Properties

The Company's principal administrative and production facilities are
located in Mountain View, California, in a 61,364 square foot building. The
lease on this building expires in September 1999; the Company has an option to
extend the lease of its headquarters building for an additional five year
period at rates to be negotiated. The Company also leases a sales office in
Irvine, California. The Company's Japan facility is located in Tokyo in a
11,029 square foot building under a lease which expires in 2004. The Company
leases a sales and support office in Utting, Germany. The Company's and its
subsidiaries' annual rental payments currently aggregate approximately $1.1
million. The Company believes that alternate facilities would be available if
needed.

Item 3. Legal Proceedings

Item 4. Submission of matters to a vote of security holders

None.

15
<PAGE>
PART II

Item 5. Market for the registrant's common equity and related shareholder
matters

(a) The Company's Common Stock has been publicly traded on the Nasdaq National
Market under the symbol "AEHR" since the Company's initial public offering
("IPO") on August 15, 1997. The initial public offering price was $12.00 per
share. The following table sets forth, for the periods indicated, the high and
low sale prices for the Common Stock on such market.

High Low
--------- ---------

Fiscal 1998:
First quarter ended August 31, 1997
(beginning August 15, 1997) ...................... $20.25 $14.13
Second quarter ended November 30, 1997............. 25.25 9.00
Third quarter ended February 28, 1998.............. 10.00 5.75
Fourth quarter ended May 31, 1998.................. 7.19 5.75

At August 21, 1998, the Company had 172 holders of record of its
Common Stock. The Company estimates the number of beneficial owners of
the Company's Common Stock at August 21, 1998 to be 708.

The market price of the Company's Common Stock has been volatile.
For a discussion of the factors affecting the Company's stock price, see
"Factors that may affect future results of operations -- possible volatility of
stock price."

The Company has not paid cash dividends on its Common Stock or other
securities. The Company currently anticipates that it will retain all
of its future earnings for use in the expansion and operation of its
business and does not anticipate paying any cash dividends on its Common
Stock in the foreseeable future.

(b) Use of Proceeds from the IPO:

On August 18, 1997, the Company's Registration Statement on Form S-1
covering the IPO of 3,6000,000 shares of the Company's Common Stock, Commission
file number 333-28987, was declared effective. The IPO closed on August 26,
1997, managed by Oppenheimer & Co., Inc. and Needham & Company, Inc. as
representatives of the several underwriters named in the Registration Statement
("Underwriters").

Of the 3,600,000 shares sold pursuant to the Offering, 2,500,000 shares
were sold by the Company and 1,100,000 were sold by certain selling
shareholders ("Selling Shareholders"). In addition, the Underwriters exercised
an over-allotment option to purchase an additional 540,000 shares of the
Company's Common Stock from the Selling Shareholders. The total purchase
prices to the public for the shares offered and sold by the Company and the
Selling Shareholders were $30,000,000 and $19,680,000, respectively.

16
<PAGE>

The amount of expenses incurred for the Company's account in connection
with the IPO are as follows:

Underwriting discounts and commissions: $ 2,100,000
Finders fees None
Expenses paid to or for the Underwriters None
Other expenses 1,067,703
-----------
Total expenses $ 3,167,703
===========

All of the foregoing expenses were direct or indirect payments to persons
other than (i) directors, officers or their associates; (ii) persons owning ten
percent (10%) or more of the Company's Common Stock; or (iii) affiliates of the
Company.

The net proceeds of the IPO to the Company (after deducting the foregoing
expenses) were $26,832,297. From the effective date of the Registration
Statement, the net proceeds have been used for the following purposes:

Purchase and installation of machinery and equipment $ 327,274
Repayment of indebtedness 4,455,179
Working capital 370,844
Temporary investments, including cash and cash equivalents 21,679,000
------------
Total $26,832,297
============

17
<PAGE>
Item 6. Selected Financial Data (in thousands except per share data):
<TABLE>
<CAPTION>
Fiscal Year Ended May 31,
----------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Net sales..................................... $40,805 $42,020 $33,234 $23,257 $23,204
Cost of sales................................. 24,359 25,715 19,942 16,192 15,761
---------- ---------- ---------- ---------- ----------
Gross profit.................................. 16,446 16,305 13,292 7,065 7,443
---------- ---------- ---------- ---------- ----------
Operating expenses:
Selling, general and administrative......... 8,618 8,878 7,534 6,316 8,077
Research and development.................... 4,529 4,536 4,113 3,783 3,825
Research and development cost
reimbursement--DARPA ..................... (900) (793) (891) (954) (261)
---------- ---------- ---------- ---------- ----------
Total operating expenses.................. 12,247 12,621 10,756 9,145 11,641
---------- ---------- ---------- ---------- ----------
Income (loss) from operations................. 4,199 3,684 2,536 (2,080) (4,198)
Interest income (expense)..................... 904 (577) (446) (341) (347)
Other income (expense), net................... (364) (565) (559) 255 27
---------- ---------- ---------- ---------- ----------
Income (loss) before income taxes and
minority interest in subsidiary... 4,739 2,542 1,531 (2,166) (4,518)
Income tax expense (benefit).................. 2,334 (773) 130 10 17
Minority interest in subsidiary............... - - (1) 189 285
---------- ---------- ---------- ---------- ----------
Net income (loss)............................. $2,405 $3,315 $1,400 $(1,987) $(4,250)
========== ========== ========== ========== ==========

Net income per share (basic).................. $0.38 $0.77 $0.33 $(0.46) $(0.98)
Net income per share (diluted)................ $0.36 $0.74 $0.32 $(0.46) $(0.98)

Shares used in per share calculation
Basic...................................... 6,327 4,297 4,303 4,308 4,320
Diluted.................................... 6,761 4,500 4,364 4,308 4,320
</TABLE>

<TABLE>
<CAPTION>
May 31,
----------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEETS DATA:
Cash and cash equivalents..................... $6,748 $1,176 $535 $598 $2,430
Working capital............................... 36,885 7,895 4,799 3,564 5,685
Total assets.................................. 47,105 24,389 23,749 19,890 20,640
Long-term obligations, less current portion... 168 356 533 1,004 1,325
Total shareholders' equity.................... 39,964 10,070 6,789 5,544 7,439

</TABLE>
18
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations

This Management's Discussion and Analysis section and other parts of this
Annual Report on Form 10-K contain forward-looking statements that involve
risks and uncertainties. The Company's actual results may differ significantly
from the results discussed in the forward-looking statements. Factors that
might cause such a difference include, but are not limited to, those discussed
below and in "Business." The forward-looking statements contained herein are
made as of the date hereof, and the Company assumes no obligation to update
such forward-looking statements or to update reasons actual results could
differ materially from those anticipated in such forward-looking statements.

OVERVIEW

The Company was founded in 1977 to develop and manufacture burn-in and test
equipment for the semiconductor industry. Since its inception, the Company has
sold more than 2,000 systems to semiconductor manufacturers, semiconductor
contract assemblers and burn-in and test service companies worldwide. The
Company's principal products currently are the MTX massively parallel test
system, the MAX and ATX burn-in systems, the DiePak carrier and test fixtures.

Prior to fiscal 1995, the Company primarily sold burn-in systems and
related products. The Company experienced significant operating losses in
fiscal 1993 through fiscal 1995 due to a decline in net sales of burn-in
systems and significant investment in the development of new products. In
fiscal 1993, the Company initiated development of the MTX massively parallel
test system and the DiePak carrier. The Company began shipping the MTX in
March 1995 and DiePak carriers in fiscal 1997.

In 1994, the Company entered into a cost-sharing agreement with DARPA, a
U.S. government agency, under which DARPA is providing co-funding for the
development of wafer-level burn-in and test equipment. The contract provides
for potential payments by DARPA totaling up to $6.5 million. The agreement
provides that (i) the Company shall retain title to all co-funded inventions,
(ii) DARPA will receive a paid-up license to use the inventions for government
purposes and (iii) DARPA can require the Company to license the inventions to
third parties on reasonable terms if the Company fails to adequately
commercialize the inventions. Payments by DARPA depend on satisfaction of
development milestones, and DARPA has the right to terminate project funding at
any time. The level of payments may vary significantly from quarter to
quarter. There can be no assurance that the Company will meet the development
milestones or that DARPA will continue funding the project. DARPA payments are
reflected as credits to research and development expenses. There also can be
no assurance that the development project will result in any marketable
products. The Company has completed certain development milestones and
invoiced $4.1 million through May 31, 1998. The remaining funding is subject
to milestones scheduled to be completed through January 1999, although the
Company expects that completion of certain milestones will be delayed beyond
that date.

19
<PAGE>
The Company has a wholly-owned subsidiary in Germany which performs sales
and service and a 94.8% owned subsidiary in Japan, which performs sales,
service and limited product engineering and manufacturing. The Company's
consolidated financial statements combine the subsidiaries' financial results
with those of the Company but, in order to account for the minority
shareholders' interest in the Japanese subsidiary, the financial statements
include a line item which excludes 5.2% of the total profits or losses of the
Japanese subsidiary, except for periods in which the subsidiary has cumulative
losses in which case no such exclusions are made.

The Company's net sales consist primarily of sales of systems, die
carriers, test fixtures, upgrades and spare parts and revenues from service
contracts. The Company recognizes revenue upon shipment of product and records
a provision for estimated future warranty costs.

A substantial portion of the Company's net sales are derived from the sale
of products for overseas markets, particularly Germany and Japan.
Consequently, an increase in the value of the U.S. Dollar relative to foreign
currencies would increase the cost of the Company's products compared to
products sold by local companies in such markets. Although most sales to
German customers are denominated in dollars, substantially all sales to
Japanese customers are denominated in yen. Since the price is determined at
the time a purchase order is accepted, the Company is exposed to the risks of
fluctuations in the yen dollar exchange rate during the lengthy period from
purchase order to ultimate payment. The exchange rate risk is partially offset
to the extent the Company's Japanese subsidiary incurs yen-denominated
expenses. To date, the Company has not invested in instruments designed to
hedge currency risks, but it may do so in the future. The Company's Japanese
subsidiary typically carries debt owed to the Company and denominated in
dollars. Since its financial statements are based in yen, the Japanese
subsidiary recognizes an income or loss in any period in which the value of the
yen rises or falls in relation to the dollar.

In accordance with SFAS 86, the Company capitalizes its systems software
development costs incurred after a system achieves technological feasibility
and before first commercial shipment. Such costs typically represent a small
portion of total research and development costs. Capitalized costs, net of
accumulated amortization, of approximately $213,000 and $57,000 were included
as of May 31, 1996 and 1997, respectively. System software development costs
were fully amortized as of May 31, 1998.

20
<PAGE>
RESULTS OF OPERATIONS

The following table sets forth statements of income data as a percentage
of net sales for the periods indicated.
<TABLE>
<CAPTION>
Year Ended May 31,
----------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Net sales ................................ 100.0% 100.0% 100.0%
Cost of sales ............................ 59.7 61.2 60.0
---------- ---------- ----------
Gross profit ............................. 40.3 38.8 40.0

Operating expenses:
Selling, general and administrative .... 21.1 21.1 22.7
Research and development ............... 11.1 10.8 12.4
Research and development cost
reimbursement--DARPA .................. (2.2) (1.9) (2.7)
---------- ---------- ----------
Total operating expenses ............. 30.0 30.0 32.4
---------- ---------- ----------
Income from operations ............... 10.3 8.8 7.6

Interest income (expense) ................ 2.2 (1.4) (1.3)
Other expense, net .............. (0.9) (1.3) (1.7)
---------- ---------- ----------
Income before income taxes and
minority interest in subsidiary ....... 11.6 6.1 4.6

Income tax expense (benefit) ............. 5.7 (1.8) 0.4
---------- ---------- ----------
Income before minority interest
in subsidiary ......................... 5.9 7.9 4.2
Minority interest in subsidiary .......... -- -- --
---------- ---------- ----------
Net income ........................... 5.9% 7.9% 4.2%
========== ========== ==========
</TABLE>

FISCAL YEAR ENDED MAY 31, 1998 COMPARED TO FISCAL YEAR ENDED MAY 31, 1997

NET SALES. Net sales consist primarily of sales of systems, die carriers,
test fixtures, upgrades and spare parts and revenues from service contracts.
The Company recognizes revenue upon shipment of product. Net sales decreased
to $40.8 million in the fiscal year ended May 31, 1998 from $42.0 million in
the fiscal year ended May 31, 1997, a decrease of 2.9%. The decrease in net
sales in fiscal 1998 was primarily due to a decline in net sales in the
Company's subsidiary in Japan, and reduced shipment of traditional burn-in
products. The Company anticipates that net sales will decrease in fiscal 1999
compared with fiscal 1998.

21
<PAGE>
GROSS PROFIT. Gross profit consists of net sales less cost of sales. Cost
of sales consists primarily of the cost of materials, assembly and test costs,
and overhead from operations. Gross profit increased to $16.4 million in the
fiscal year ended May 31, 1998 from $16.3 million in the fiscal year ended May
31, 1997, an increase of 0.9%. Gross profit margin increased to 40.3% in the
fiscal year ended May 31, 1998 from 38.8% in the fiscal year ended May 31,
1997. The increase in gross profit margin was primarily due to lower material
costs as a percentage of net sales. The Company anticipates that gross profit
and gross profit margin will decrease in fiscal 1999 compared with fiscal 1998.

SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
("SG&A") expenses consist primarily of salaries and related costs of employees,
customer support costs, commission expenses to independent sales
representatives, product promotion and other professional services. SG&A
expenses decreased to $8.6 million in the fiscal year ended May 31, 1998 from
$8.9 million in the fiscal year ended May 31, 1997, a decrease of 2.9%. The
decrease in SG&A expenses was primarily due to a decrease in commissions paid
to outside sales representatives, partially offset by an increase in warranty
repair expenses and new expenses related to the Company's status of being
publicly held. As a percentage of net sales, SG&A expenses were unchanged at
21.1% in the fiscal year ended May 31, 1998 and in the fiscal year ended May
31, 1997. The Company anticipates that SG&A expenses will decrease in fiscal
1999 compared with fiscal 1998.

RESEARCH AND DEVELOPMENT. Research and development ("R&D") expenses
consist primarily of salaries and related costs of employees engaged in ongoing
research, design and development activities, costs of engineering materials and
supplies, and professional consulting expenses. R&D expenses were unchanged at
$4.5 million in the fiscal year ended May 31, 1998 and in the fiscal year ended
May 31, 1997. An increase in employment related expenses was partially offset
by a decrease in professional consulting expenses. As a percentage of net
sales, R&D expenses increased to 11.1% in the fiscal year ended May 31, 1998
from 10.8% in the fiscal year ended May 31, 1997, reflecting lower net sales.

RESEARCH AND DEVELOPMENT COST REIMBURSEMENT - DARPA. Research and
development cost reimbursement - DARPA ("R&D - DARPA") is a credit representing
reimbursements by DARPA of costs incurred in the Company's wafer-level burn-in
development project. R&D - DARPA increased to $900,000 in the fiscal year
ended May 31, 1998 from $793,000 in the fiscal year ended May 31, 1997, an
increase of 13.5%. Payments by DARPA depend on satisfaction of development
milestones, and the level of payments may vary significantly from fiscal year
to fiscal year.

INTEREST INCOME (EXPENSE). Interest income was $904,000 in the fiscal year
ended May 31, 1998, as compared with interest expense of $577,000 in the fiscal
year ended May 31, 1997. Interest income in the fiscal year ended May 31, 1998
was primarily due to investment income from the proceeds obtained from the
initial public offering in August 1997. Interest expense in the fiscal year
ended May 31, 1997 was primarily related to short term debt which was
subsequently repaid.

OTHER EXPENSE, NET. Other expense, net decreased to $364,000 in the fiscal
year ended May 31, 1998 from $565,000 in the fiscal year ended May 31, 1997, a
decrease of 35.6%. The decrease in other expense, net was primarily due to the
recognition of the Company's 25% interest in ESA Electronics Pte Ltd., a
Singapore corporation, in the fiscal year ended May 31, 1998.

22
<PAGE>
INCOME TAX EXPENSE (BENEFIT). Income tax expense (benefit) was an expense
of $2.3 million in the fiscal year ended May 31, 1998, compared with a benefit
of $773,000 in the fiscal year ended May 31, 1997. The Company recognizes
deferred tax assets and liabilities for the expected future consequences of
temporary differences between the carrying amounts and the tax bases of assets
and liabilities. The Company's Japanese subsidiary experienced significant
cumulative losses since fiscal 1993, and thus generated certain net operating
losses available to offset future taxes payable. As a result of the
subsidiary's cumulative operating losses, a valuation allowance has been
established for the full amount of the subsidiary's net deferred tax assets.
The Company recorded tax benefits totaling $1.1 million in fiscal 1997 related
to recognition of its United States net deferred tax assets. The effective tax
rate for the fiscal year ended May 31, 1998 more closely approximates normal
operations, although it is higher than the statutory U.S. rate because no tax
benefit is recorded for losses in the Company's Japanese subsidiary. The
Company anticipates that the Japanese subsidiary will record a loss in the
first quarter of fiscal 1999.

FISCAL YEAR ENDED MAY 31, 1997 COMPARED TO FISCAL YEAR ENDED MAY 31, 1996

NET SALES. Net sales increased to $42.0 million in fiscal 1997 from $33.2
million in fiscal 1996, an increase of 26.4%. The growth in net sales was caused
primarily by increased shipments of MTX products, primarily to Siemens, and to a
lesser extent by increased shipments of DiePak carriers. These increases
were partially offset by a decline in unit sales of burn-in systems,
particularly in the Japanese market. Siemens accounted for 55.7 % and 29.1% of
net sales for fiscal 1997 and fiscal 1996, respectively.

GROSS PROFIT. Gross profit increased to $16.3 million in fiscal 1997 from
$13.3 million in fiscal 1996, an increase of 22.7%. Gross profit margin
decreased to 38.8% in fiscal 1997 from 40.0% in fiscal 1996. The decrease in
gross profit margin resulted primarily from a change in the product mix toward
products with somewhat higher material costs and increases in provision for
inventory reserves, scrap, and other miscellaneous costs of sales, partially
offset by improvement in production efficiencies due to higher levels of
production.

SELLING, GENERAL AND ADMINISTRATIVE. SG&A expenses increased to $8.9
million in fiscal 1997 from $7.5 million in fiscal 1996, an increase of 17.8%.
As a percentage of net sales, SG&A expenses decreased to 21.1% for fiscal 1997
from 22.7% for fiscal 1996. The increase in SG&A expenses in fiscal 1997 was
due primarily to increased commission expenses to independent sales
representatives related to higher levels of shipments and increased employment
costs. The decrease in SG&A expenses as a percentage of net sales was
primarily due to the increase in net sales.

RESEARCH AND DEVELOPMENT. R&D expenses increased to $4.5 million in fiscal
1997 from $4.1 million in fiscal 1996, an increase of 10.3%. The increase in
R&D expenses was primarily due to an increase in professional consulting
contracts and employment costs. As a percentage of net sales, R&D expenses
decreased to 10.8% for fiscal 1997 from 12.4% for fiscal 1996, reflecting
higher net sales.

23
<PAGE>
RESEARCH AND DEVELOPMENT COST REIMBURSEMENT--DARPA. R&D--DARPA credit
decreased to $793,000 in fiscal 1997 from $891,000 in fiscal 1996, a decrease
of 11.0%. The decrease was due to delays in completion of development
milestones.

INTEREST EXPENSE. Interest expense increased to $577,000 in fiscal 1997
from $446,000 in fiscal 1996, an increase of 29.4%, primarily because of
increased borrowings to support the Company's increased volume of shipments.

OTHER INCOME (EXPENSE), NET. Other expense, net increased to $565,000 in
fiscal 1997 from $559,000 in fiscal 1996, an increase of 1.1%.

INCOME TAX EXPENSE (BENEFIT). Income tax expense consisted primarily of
the minimum federal and state taxes in the U.S., as operating loss
carryforwards offset other taxable income, and taxes on earnings of the
Company's German subsidiary. Income tax benefit was $773,000 in fiscal 1997
compared with income tax expense of $130,000 in fiscal 1996. The Company
recognizes deferred tax assets and liabilities for the expected future
consequences of temporary differences between the carrying amounts and the tax
bases of assets and liabilities. The Company's Japanese subsidiary experienced
significant cumulative losses since fiscal 1993, and thus generated certain net
operating losses available to offset future taxes payable. As a result of the
subsidiary's cumulative operating losses, a valuation allowance has been
established for the full amount of the subsidiary's net deferred tax assets.
The Company has recorded tax benefits totaling $1.1 million in fiscal 1997
related to recognition of its United States net deferred tax assets.

LIQUIDITY AND CAPITAL RESOURCES

The Company's primary source of liquidity has been the cash flow generated
from the Company's August 1997 initial public offering, resulting in net
proceeds to the Company of approximately $26.8 million. As of May 31, 1998,
the Company had $23.3 million in cash and short-term investments.

Net cash used in operating activities was approximately $664,000 for the
fiscal year ended May 31, 1998 and net cash provided by operating activities
was $3.0 million for the fiscal year ended May 31, 1997. For the fiscal year
ended May 31, 1998, net cash used in operating activities was due primarily to
a decrease in accounts payable of $1.9 million and an increase in inventories
of $1.6 million, partially offset by net income of $2.4 million. For the
fiscal year ended May 31, 1997, net cash provided by operating activities was
primarily due to net income of $3.3 million and a decrease in accounts
receivable of $2.6 million, partially offset by an increase in inventory of
$2.9 million.

Net cash used in investing activities was approximately $16.8 million for
the fiscal year ended May 31, 1998 and $213,000 for the fiscal year ended May
31, 1997. The increase in cash used in investing activities during the fiscal
year ended May 31, 1998 was primarily due to the short-term and long-term
investments made with proceeds from the Company's initial public offering in
August 1997.

24
<PAGE>
Financing activities provided cash of approximately $22.9 million in the
fiscal year ended May 31, 1998 and used cash of approximately $2.1 million in
the fiscal year ended May 31, 1997. The increase in cash provided by financing
activities was primarily attributable to the Company's initial public offering.

As of May 31, 1998, the Company had working capital of $36.9 million,
compared with $7.9 million as of May 31, 1997. Working capital consists of
cash and cash equivalents, short-term investments, accounts receivable,
inventory and other current assets, less current liabilities. The increase in
working capital as of May 31, 1998 was primarily due to the proceeds from the
Company's initial public offering.

The Company announced in August 1998 that its board of directors had
authorized the repurchase of up to 1,000,000 shares of its outstanding common
shares. The Company will repurchase the shares in the open market or in
privately negotiated transactions, from time to time, subject to market
conditions. The number of shares of common stock actually acquired by the
Company will depend on subsequent developments and corporate needs, and the
repurchase program may be interrupted or discontinued at any time. Any such
repurchase of shares, if consummated, may use a portion of the Company's
working capital.

From time to time, the Company evaluates potential acquisitions of
businesses, products or technologies that complement the Company's business.
Any such transactions, if consummated, may use a portion of the Company's
working capital or require the issuance of equity. The Company has no present
understandings, commitments or agreements with respect to any material
acquisitions.

The Company anticipates that the existing cash balance together with cash
provided by operations, if any, are adequate to meet its working capital and
capital equipment requirements through fiscal 1999. After fiscal 1999,
depending on its rate of growth and profitability, the Company may require
additional equity or debt financing to meet its working capital requirements or
capital equipment needs. There can be no assurance that additional financing
will be available when required, or if available, that such financing can be
obtained on terms satisfactory to the Company.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." SFAS No. 130 establishes requirements for disclosure of comprehensive
income and becomes effective for the Company for the year ending May 31, 1999.
Comprehensive income includes such items as foreign currency translation
adjustments and unrealized holding gains and losses on available for sale
securities that are currently being presented by the Company as a component of
shareholders' equity. The Company does not expect this pronouncement to
materially impact the Company's results of operations.

25
<PAGE>
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." SFAS No. 131 establishes standards for
disclosure about operating segments in annual financial statements and selected
information in interim financial reports. It also establishes standards for
related disclosures about products and services, geographic areas and major
customers. This statement supersedes SFAS No. 14, "Financial Reporting for
Segments for a Business Enterprise." The new standard becomes effective for
the Company for the year ending May 31, 1999, and requires that comparative
information from earlier years be restated to conform to the requirements of
this standard. The Company does not expect this pronouncement to materially
change the Company's current reporting and disclosures.

FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS

This report on Form 10-K contains forward looking statements within the
meaning of the Securities Act of 1933, as amended and the Securities Exchange
Act of 1934, as amended. The Company's future results of operations could vary
significantly from the results anticipated by such forward-looking statements
as a result of various factors, including those set forth as follows and
elsewhere in this annual report on Form 10-K.

FLUCTUATIONS IN OPERATING RESULTS. The Company has experienced and
expects to continue to experience significant fluctuations in its quarterly
and annual operating results. During fiscal 1997 and 1998, quarterly net sales
have been as low as $5,825,000 and as high as $11,748,000, and gross margins
for quarterly sales have fluctuated between 36.7% and 44.6%. The Company's
future operating results will depend upon a variety of factors, including the
timing of significant orders, the mix of products sold, changes in pricing by
the Company, its competitors, customers or suppliers, the length of sales
cycles for the Company's products, timing of new product announcements and
releases by the Company and its competitors, market acceptance of new products
and enhanced versions of the Company's products, capital spending patterns by
customers, timing of completion and approval of DARPA development milestones,
manufacturing inefficiencies associated with new product introductions by the
Company, the Company's ability to produce systems and products in volume and
meet customer requirements, product returns and customer acceptance of
product shipments, volatility in the Company's targeted markets, political and
economic instability, natural disasters, regulatory changes, possible
disruptions caused by expanding existing facilities or moving into new
facilities, expenses associated with acquisitions and alliances, and various
competitive factors, including price-based competition and competition from
vendors employing other technologies. The Company's gross margins have varied
and will continue to vary based on a variety of factors, including the mix of
products sold, sales volume, and the amount of products sold under volume
purchase arrangements, which tend to have lower selling prices. Accordingly,
past performance may not be indicative of future performance.

26
<PAGE>
DEPENDENCE ON TIMING AND SIZE OF SALES ORDERS AND SHIPMENT. During the
Company's last two fiscal years, net sales in the first fiscal quarter, ended
August 31, have declined compared with the fourth fiscal quarter, ended May 31,
of the preceding fiscal year. The Company expects that fluctuations of this
type may occur in the future. The Company derives a substantial portion of its
revenues from the sale of a relatively small number of systems which typically
range in purchase price from approximately $100,000 to over $1.0 million. As a
result, the loss or deferral of a limited number of system sales could have a
material adverse effect on the Company's net sales and operating results in a
particular period. All customer purchase orders are subject to cancellation or
rescheduling by the customer with limited penalties, and, therefore, backlog at
any particular date is not necessarily indicative of actual sales for any
succeeding period. From time to time, cancellations and reschedulings of
customer orders have occurred, and delays by the Company's suppliers in
providing components or subassemblies to the Company have caused delays in the
Company's shipments of its own products. There can be no assurance that the
Company will not be materially adversely affected by future cancellations and
reschedulings. A substantial portion of net sales typically are realized near
the end of each quarter. A delay or reduction in shipments near the end of a
particular quarter, due, for example, to unanticipated shipment reschedulings,
cancellations or deferrals by customers, customer credit issues, unexpected
manufacturing difficulties experienced by the Company, or delays in deliveries
by suppliers, could cause net sales in a particular quarter to fall
significantly below the Company's expectations. As the Company incurs expenses
in anticipation of future sales levels, the Company's results of operations may
be adversely affected if such sales levels are not achieved.

RECENT OPERATING LOSSES. The Company incurred operating losses of $2.4,
$4.2 and $2.1 million in fiscal 1993, 1994 and 1995, respectively. Although
the Company has operated profitably during fiscal 1996, 1997 and 1998,
increased net sales in those years were substantially the result of sales of
new products, particularly sales of MTX systems to Siemens. During fiscal
1998, 1997 and 1996, Siemens accounted for 47.0%, 55.7% and 29.1% of the
Company's net sales, respectively. Sales to Siemens, which include both the
MTX and other products, are made pursuant to individual purchase orders. There
is no long term volume purchase commitment. In fiscal 1998, the Company began
to feel the industry slowdown due to uncertainties caused primarily by the
financial crisis in Asia and DRAM overcapacity. There can be no assurance that
the industry will rebound soon or that the Company will be able to return to
profitability soon if it incurs net operating losses.

DEPENDENCE ON MARKET ACCEPTANCE OF MTX SYSTEM. A principal element of the
Company's strategy is to capture an increasing share of the memory test
equipment market through sales of the MTX massively parallel test system. The
MTX is a new system designed to perform both burn-in and many of the final test
functions currently performed by high-cost memory testers and the market for
MTX systems is in the early stage of development. The Company's strategy
depends, in part, upon its ability to persuade potential customers that the MTX
system can successfully perform a significant portion of such final test
functions and that transferring such tests to MTX systems will reduce their
overall capital and test costs. There can be no assurance that the Company's
strategy will be successful. The failure of the MTX system to achieve market
acceptance would have a material adverse effect on the Company's business,
financial condition and operating results.

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Market acceptance of the MTX system is subject to a number of risks. To
date, several companies have purchased evaluation units of the MTX systems;
however, only Siemens has purchased production quantities. Sales to Siemens,
which include both the MTX and other products, are made pursuant to individual
purchase orders. There is no long term volume purchase commitment. Although
Siemens has taken delivery of production quantities of MTX systems and has used
the MTX to perform a number of test functions previously performed by memory
testers, the Company believes Siemens has not yet completed the evaluations
necessary for it to transfer additional test functions from standard testers to
MTX systems. Consequently, there can be no assurance that the MTX system will
be accepted by companies other than Siemens for performing memory test
functions in volume production. Future sales to Siemens and other customers
could be adversely affected if for any reason Siemens does not satisfy itself
that additional test functions can successfully be transferred to the MTX
system.

Since most potential customers have successfully relied on memory testers
for many years and their personnel understand the use and maintenance of such
systems, the Company anticipates that they may be reluctant to change their
procedures in order to transfer test functions to the MTX system. Before a
customer will transfer test functions to the MTX, the test programs must be
translated for use with the MTX and lengthy correlation tests must be
performed. Correlation testing may take up to six months or more. Furthermore,
MTX system sales are expected to be primarily limited to new facilities and to
existing facilities being upgraded to accommodate new product generations, such
as the transition from 64Mb to 256Mb DRAMs. Construction of new facilities and
upgrades of existing facilities have in some cases been delayed or canceled
during this semiconductor industry downturn. Other companies have purchased
MTX systems which are being used in quality assurance and engineering
applications, and the Company believes that some of these companies are
evaluating the MTX for use in production applications. Market acceptance of
the MTX system also may be affected by a reluctance of IC manufacturers to rely
on relatively small suppliers such as the Company.

As is common with new complex and software-intensive products, the Company
encountered reliability, design and manufacturing issues as it began volume
production and initial installations of MTX systems at customer sites. The
Company places a high priority on addressing these issues as they arise.
Certain of these issues have been related to components and subsystems supplied
to the Company by third parties which have in some cases limited the ability of
the Company to address such issues promptly. One customer who purchased an MTX
system in 1995 for use in a quality assurance application subsequently
determined that the MTX system did not meet its particular requirements; the
Company purchased the system from that customer at a reduced price and intends
to refurbish the system for resale. Since the Company is still in the early
stages of the MTX systems' life cycle, there can be no assurance that other
reliability, design and manufacturing issues will not be discovered in the
future or that such issues, if they arise, can be resolved to the customers'
satisfaction or that the resolution of such problems will not cause the Company
to incur significant development costs or warranty expenses or to lose
significant sales opportunities.

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The Company's future sales and operating results are also partially
dependent on its sales of performance test boards for use with the MTX system.
Sales of PTBs by the Company and its licensees will depend upon the number of
MTX systems installed by customers.

DEPENDENCE ON DEVELOPMENT OF BARE DIE MARKET AND MARKET ACCEPTANCE OF
DIEPAK CARRIER. Another element of the Company's strategy is to capture an
increasing share of the bare die burn-in and test product market through sales
of its DiePak carrier products. The Company developed the DiePak carrier to
enable burn-in and test of bare die in order to supply known good die ("KGD")
for use in applications such as multichip modules. The Company's DiePak
strategy depends upon increased industry acceptance of bare die as an
alternative to packaged die as well as acceptance of the Company's DiePak
products. There can be no assurance that the Company's strategy will be
successful. The market for carriers to produce KGD has not expanded as rapidly
as expected, as some customers are adopting chip-scale packages ("CSPs"), which
are smaller than traditional packages, as their next packaging strategy. Even
though CSPs are relatively expensive, the Company believes that end users are
expressing a preference for CSPs because they believe that CSPs are more
compatible with their existing PC board assembly equipment This has delayed
the growth of the market for KGD, and therefore for the Company's DiePak
carrier. The failure of the bare die market to expand or of the DiePak carrier
to achieve broad market acceptance would have a material adverse effect on the
Company's business, financial condition and operating results.

The emergence of the bare die market and broad acceptance of the DiePak
carrier are subject to a number of risks. The Company believes that the growth
of the bare die market depends largely on the relative cost and benefits to the
manufacturers of PCs and other electronics products of using bare die rather
than alternative IC packaging methods. There can be no assurance that
electronics manufacturers will perceive that the benefits of KGD justify its
potentially higher cost, and acceptance of KGD for many applications may
therefore be limited. In addition, electronics manufacturers must change their
manufacturing processes in order to use KGD, but electronics manufacturers
typically have substantial investments in existing manufacturing technology and
have historically been slow in transitioning to new technologies.

The adoption of the DiePak products by IC manufacturers and burn-in and
test services companies typically will involve a lengthy qualification. Such
qualification processes have delayed high volume sales of DiePak products by
the Company. Motorola is the only customer to have ordered DiePak products in
production quantities. Motorola accounted for approximately 87% and 48% of the
Company's net sales of DiePak products in fiscal 1998 and 1997, respectively.
Sales to Motorola, which include both DiePak products and other products, are
made pursuant to individual purchase orders. There is no long term volume
purchase commitment. There can be no assurance that the bare die market will
emerge and grow as the Company anticipates, that the DiePak carrier will
achieve commercial acceptance, or that the Company will not experience
difficulties in ramping up production to meet any increased demand for DiePak
products that may develop.

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CUSTOMER CONCENTRATION. The semiconductor manufacturing industry is highly
concentrated, with a relatively small number of large semiconductor
manufacturers and contract assemblers accounting for a substantial portion of
the purchases of semiconductor equipment. Sales to the Company's five largest
customers accounted for approximately 75.2%, 69.2% and 55.8% of its net sales
in fiscal 1998, 1997 and 1996, respectively. During fiscal 1998, 1997 and
1996, Siemens accounted for 47.0%, 55.7% and 29.1% of the Company's net sales,
respectively. During fiscal 1998, Motorola, Inc. accounted for 12.8% of net
sales. No other customers represented more than 10% of the Company's net sales
for any of such periods. The Company expects that sales of its products to a
limited number of customers will continue to account for a high percentage of
net sales for the foreseeable future. In addition, sales to particular
customers may fluctuate significantly from quarter to quarter. The loss of or
reduction or delay in orders from a significant customer, or a delay in
collecting or failure to collect accounts receivable from a significant
customer could adversely affect the Company's business, financial condition and
operating results.

LIMITED MARKET FOR BURN-IN SYSTEMS. Historically, a substantial portion of
the Company's net sales were derived from the sale of burn-in systems. The
market for burn-in systems is mature and estimated to be less than $100 million
per year. In general, process control improvements in the semiconductor
industry have tended to reduce burn-in times. In addition, as a given IC
product generation matures and yields increase, the required burn-in time may
be reduced or eliminated. Some burn-in system suppliers primarily provide
"monitored" burn-in systems optimized for DRAMs. The sale of monitored burn-in
products has reduced the size of the market segment addressed by the Company's
dynamic burn-in systems. IC manufacturers, the Company's primary historical
customer base, increasingly outsource test and burn-in to independent test
labs, who often build their own systems. There can be no assurance that the
market for burn-in systems will grow, and sales of the Company's burn-in
products could decline.

LENGTHY SALES CYCLE. Sales of the Company's systems depend, in significant
part, upon the decision of a prospective customer to increase manufacturing
capacity or to restructure current manufacturing facilities, either of which
typically involve a significant commitment of capital. In view of the
significant investment or strategic issues that may be involved in a decision
to purchase MTX systems or DiePak carriers, the Company may experience delays
following initial qualification of the Company's systems as a result of delays
in a customer's approval process. Furthermore, the approval process for MTX
and DiePak carrier sales may require lengthy qualification and correlation
testing. For this and other reasons, the Company's systems typically have a
lengthy sales cycle during which the Company may expend substantial funds and
management effort in securing a sale. Lengthy sales cycles subject the Company
to a number of significant risks, including inventory obsolescence and
fluctuations in operating results, over which the Company has little or no
control. The loss of individual orders due to the lengthy sales and evaluation
cycle, or delays in the sale of even a limited number of systems could have a
material adverse effect on the Company's business, operating results and
financial condition and, in particular, could contribute to significant
fluctuations in operating results on a quarterly basis.

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DEPENDENCE ON INTERNATIONAL SALES AND OPERATIONS. Approximately 70.5%,
92.5% and 90.4% of the Company's net sales for fiscal 1998, 1997 and 1996,
respectively, were attributable to sales to customers for delivery outside of
the United States. The Company maintains a sales, service, product engineering
and manufacturing organization in Japan, and a sales and service organization
in Germany. The Company expects sales of products for delivery outside of the
United States will continue to represent a substantial portion of its future
revenues. The future performance of the Company will depend, in significant
part, upon its ability to continue to compete in foreign markets which in turn
will depend, in part, upon a continuation of current trade relations between
the United States and foreign countries in which semiconductor manufacturers or
assemblers have operations. A change toward more protectionist trade
legislation in either the United States or such foreign countries, such as a
change in the current tariff structures, export compliance or other trade
policies, could adversely affect the Company's ability to sell its products in
foreign markets. In addition, the Company is subject to other risks associated
with doing business internationally, including longer receivables collection
periods and greater difficulty in accounts receivable collection, the burden of
complying with a variety of foreign laws, difficulty in staffing and managing
global operations, risks of civil disturbance or other events which may limit
or disrupt markets, international exchange restrictions, changing political
conditions and monetary policies of foreign governments.

A substantial portion of the Company's sales are in Asia. Recent turmoil
in the Asian financial markets has resulted in dramatic currency devaluations,
stock market declines, restriction of available credit and general financial
weakness. In addition, DRAM prices have fallen dramatically and may continue
to do so as some Asian IC manufacturers may be selling DRAMS at or near cost in
order to raise cash. These developments may affect the Company in several
ways. Currency devaluations may make dollar-denominated goods such as the
Company's more expensive for Asian clients. The Company believes that Asian
manufacturers are limiting capital spending (including the purchase of MTXs),
and that the uncertainty of the DRAM market is causing most manufacturers
worldwide to delay capital spending plans. These circumstances may also affect
the ability of the Company's customers to meet their payment obligations,
resulting in the cancellations or deferrals of existing orders and the
limitation of additional orders. In addition, some portion of fab construction
has been subsidized by Asian governments. Financial turmoil may reduce these
governments' willingness to continue such subsidies. Such developments could
have a material adverse affect on the Company's business, financial condition
and results of operations.

Because a substantial portion of the Company's net sales is from sales of
products for delivery outside the United States, including particularly Germany
and Japan, an increase in the value of the U.S. Dollar relative to foreign
currencies would increase the cost of the Company's products compared to
products sold by local companies in such markets. Approximately 90.4%, 9.1%
and 0.5% of the Company's net sales for fiscal 1998 were denominated in U.S.
Dollars, Japanese Yen and German Marks, respectively. Although most sales to
German customers are denominated in dollars, substantially all sales to
Japanese customers are denominated in Japanese Yen. Since the price is
determined at the time a purchase order is accepted, the Company is exposed to
the risks of fluctuations in the yen-dollar exchange rate during the lengthy

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period from purchase order to ultimate payment. This exchange rate risk is
partially offset to the extent the Company's Japanese subsidiary incurs
yen-denominated expenses. To date, the Company has not invested in instruments
designed to hedge currency risks. In addition, the Company's Japanese
subsidiary typically carries debt owed to the Company and denominated in
dollars. Since the subsidiary's financial statements are based in yen, it
recognizes an income gain or loss in any period in which the value of the yen
rises or falls in relation to the dollar. In fiscal 1998, 1997 and 1996, the
Company experienced foreign currency losses of $385,000, $393,000 and $573,000,
respectively.

A substantial portion of the world's manufacturers of memory devices are in
Korea, Japan and Taiwan and growth in the Company's net sales depends in large
part upon its ability to penetrate the Korean and Japanese markets. Both the
Korean and Japanese markets are difficult for foreign companies to penetrate.
The Company has served the Japanese market through its Japanese subsidiary,
which has experienced limited success and incurred operating losses in recent
years. Sales into Korea have not been significant in recent years. The
Company formerly served the Korean market through a direct support operation,
which was closed in 1996. The Company is currently represented by a local
distributor, but its sales into Korea remain low. The lack of local
manufacturing may impede the Company's efforts to develop the Korean market.
Taiwan also represents an increasingly important portion of the memory
manufacturer market. The Company relies on an independent distributor in
Taiwan and does not have any direct operations in Taiwan. There can be no
assurances that the Company's efforts in Japan, Korea or Taiwan will be
successful or that the Company will be able to achieve and sustain significant
sales to, or be able to successfully compete in, the Japanese, Korean or
Taiwanese test and burn-in markets.

RAPID TECHNOLOGICAL CHANGE; IMPORTANCE OF TIMELY PRODUCT INTRODUCTION. The
semiconductor equipment industry is subject to rapid technological change and
new product introductions and enhancements. The Company's ability to remain
competitive will depend in part upon its ability to develop new products and to
introduce these products at competitive prices and on a timely and
cost-effective basis. The Company's success in developing new and enhanced
products depends upon a variety of factors, including product selection, timely
and efficient completion of product design, timely and efficient implementation
of manufacturing and assembly processes, product performance in the field and
effective sales and marketing. Because new product development commitments
must be made well in advance of sales, new product decisions must anticipate
both future demand and the technology that will be available to supply that
demand. Furthermore, introductions of new and complex products typically
involve a period in which design, engineering and reliability issues are
identified and addressed by the Company and its suppliers. This process in the
past has required and in the future is likely to require the Company to incur
unreimbursed engineering expenses, and from time to time to experience warranty
claims or product returns. There can be no assurance that the Company will be
successful in selecting, developing, manufacturing and marketing new products
that satisfy market demand. Any such failure would materially adversely affect
the Company's business, financial condition and results of operations.

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Because of the complexity of the Company's products, significant delays can
occur between a product's introduction and the commencement of volume
production of such product. The Company has experienced significant delays
from time to time in the introduction of, and technical and manufacturing
difficulties with, certain of its products and may experience delays and
technical and manufacturing difficulties in future introductions or volume
production of new products, and there can be no assurance that the Company will
not encounter such difficulties in the future. The Company's inability to
complete product development, products or to manufacture and ship products in
volume and in time to meet customer requirements would materially adversely
affect the Company's business, financial condition and results of operations.

Future improvements in semiconductor design and manufacturing technology
may reduce or eliminate the need for the Company's products. For example, the
introduction of viable wafer-level burn-in and test systems, improvements in
built-in self test ("BIST") technology, and improvements in conventional test
systems, such as reduced cost or increased throughput, may significantly reduce
or eliminate the market for one or more of the Company's products.

UNCERTAINTIES RELATING TO DARPA FUNDING FOR RESEARCH AND DEVELOPMENT. In
1994, the Company entered into a cost-sharing agreement with DARPA, a U.S.
government agency, under which DARPA is providing co-funding for the
development of wafer-level burn-in and test equipment. The contract provides
for potential payments by DARPA totaling up to $6.5 million. The agreement
provides that (i) the Company shall retain title to all co-funded inventions,
(ii) DARPA will receive a paid-up license to use the inventions for government
purposes and (iii) DARPA can require the Company to license the inventions to
third parties on reasonable terms if the Company fails to adequately
commercialize the inventions. Payments by DARPA depend on satisfaction of
development milestones, and DARPA has the right to terminate project funding at
any time. The level of payments may vary significantly from quarter to
quarter. There can be no assurance that the Company will meet the development
milestones or that DARPA will continue funding the project. If DARPA funding
were discontinued and the Company continued the project, the Company's
operating results would be adversely affected. There also can be no assurance
that the development project will result in any marketable products. The
Company has completed certain development milestones and invoiced $4.1 million
through May 31, 1998. The remaining funding is subject to milestones scheduled
to be completed through January 1999, although the Company expects that
completion of certain milestones will be delayed beyond that date.

INTENSE COMPETITION. In each of the markets it serves, the Company faces
competition from established competitors and potential new entrants, many of
which have greater financial, engineering, manufacturing and marketing
resources than the Company. The Company expects its competitors to continue to
improve the performance of their current products and to introduce new products
with improved price and performance characteristics. In addition, continuing
consolidation in the semiconductor equipment industry, and potential future
consolidation, could adversely affect the ability of smaller companies such as
the Company to compete with larger, integrated competitors. New product
introductions by the Company's competitors or by new market entrants could
cause a decline in sales or loss of market acceptance of the Company's existing
products. Increased competitive pressure could also lead to intensified

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price-based competition, resulting in lower prices which could adversely affect
the Company's business, financial condition and operating results. The Company
believes that to remain competitive it must invest significant financial
resources in new product development and expand its customer service and
support worldwide. There can be no assurance that the Company will be able to
compete successfully in the future.

Because the Company's MTX system performs burn-in and many of the
functional tests performed by memory testers, the Company expects that the MTX
System will face intense competition from burn-in system suppliers and
traditional memory tester suppliers. The market for burn-in systems is highly
fragmented, with many domestic and international suppliers. Some users, such as
independent test labs, build their own burn-in systems, and some other users,
particularly large Japanese IC manufacturers, acquire burn-in systems from
captive or affiliated suppliers. Competing suppliers of burn-in and functional
test systems include Ando Corporation, Japan Engineering Company and
Reliability Incorporated. In addition, suppliers of memory test equipment
including Advantest Corporation and Teradyne, Inc. may seek to offer
competitive parallel test systems in the future.

The Company's DiePak products face significant competition. Texas
Instruments Incorporated sells a temporary, reusable bare die carrier which is
intended to enable burn-in and test of bare die, and the Company believes that
several other companies have developed or are developing other such products.
As the bare die market develops, the Company expects that other competitors
will emerge. The Company expects that the primary competitive factors in this
market will be cost, performance, reliability and assured supply.

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The Company expects its competitors to continue to improve the performance
of their current products and to introduce new products with improved price and
performance characteristics. New product introductions by the Company's
competitors or by new market entrants could cause a decline in sales or loss of
market acceptance of the Company's products. Increased competitive pressure
could also lead to intensified price-based competition, resulting in lower
prices which could adversely affect the Company's business, financial condition
and operating results. The Company believes that to remain competitive it must
invest significant financial resources in new product development and expand
its customer service and support worldwide. There can be no assurance that the
Company will be able to compete successfully in the future.

CYCLICALITY OF SEMICONDUCTOR INDUSTRY AND CUSTOMER PURCHASES; RISK OF
CANCELLATIONS AND RESCHEDULINGS. The Company's operating results depend
primarily upon the capital expenditures of semiconductor manufacturers,
semiconductor contract assemblers and burn-in and test service companies
worldwide, which in turn depend on the current and anticipated market demand
for integrated circuits and products utilizing integrated circuits. The
semiconductor and semiconductor equipment industries in general, and the market
for DRAMs and other memories in particular, historically have been highly
volatile and have experienced periodic downturns and slowdowns, which have had
a severe negative effect on the semiconductor industry's demand for
semiconductor capital equipment, including test and burn-in systems
manufactured and marketed by the Company. These downturns and slowdowns have
adversely affected the Company's operating results in the past and in fiscal
1998. In addition, the purchasing patterns of the Company's customers are also
highly cyclical because most customers purchase the Company's products for use
in new production facilities or for upgrading existing test lines for the
introduction of next generation products. Construction of new facilities and
upgrades of existing facilities have in some cases been delayed or canceled
during this semiconductor industry downturn. A large portion of the Company's
net sales are attributable to a few customers and therefore a reduction in
purchases by one or more customers could materially adversely affect the
Company's financial results. There can be no assurance that the semiconductor
industry will grow in the future at the same rates it has grown historically.
Any downturn or slowdown in the semiconductor industry would have a material
adverse effect on the Company's business, financial condition and operating
results. In addition, the need to maintain investment in research and
development and to maintain customer service and support will limit the
Company's ability to reduce its expenses in response to any such downturn or
slowdown period.

The semiconductor equipment manufacturing industry has historically been
subject to a relatively high rate of purchase order cancellation by customers
as compared to other high technology industry sectors. Manufacturing companies
that are the customers of semiconductor equipment companies frequently revise,
postpone and cancel capital facility expansion plans. In such cases,
semiconductor equipment companies may experience a significant rate of
cancellations and reschedulings of purchase orders, as was the case in the
industry in late 1995 and early 1996, and as is the case in 1998. There can be
no assurance that the Company will not be materially adversely affected by
future cancellations and reschedulings.

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DEPENDENCE ON SUBCONTRACTORS; SOLE OR LIMITED SOURCES OF SUPPLY. The
Company relies on subcontractors to manufacture many of the components or
subassemblies used in its products. The Company's MTX, MAX and ATX systems
contain several components, including environmental chambers, power supplies
and certain ICs, which are currently supplied by only one or a limited number
of suppliers. The DiePak products include an interconnect substrate which is
supplied only by Nitto Denko Corporation. Nitto Denko and the Company developed
the interconnect substrate in cooperation with each other pursuant to a joint
development agreement. The Company does not have formal written supply
agreements with Nitto Denko. While there have been no significant
interruptions in supply of components by Nitto Denko, there can be no assurance
that Nitto Denko will be able to respond to a high volume order within an
acceptable timeframe. The Company's reliance on subcontractors and single
source suppliers involves a number of significant risks, including the loss of
control over the manufacturing process, the potential absence of adequate
capacity and reduced control over delivery schedules, manufacturing yields,
quality and costs. In the event that any significant subcontractor or single
source supplier were to become unable or unwilling to continue to manufacture
subassemblies, components or parts in required volumes, the Company would have
to identify and qualify acceptable replacements. The process of qualifying
subcontractors and suppliers could be lengthy, and no assurance can be given
that any additional sources would be available to the Company on a timely
basis. Any delay, interruption or termination of a supplier relationship could
have a material adverse effect on the Company's business, financial condition
and operating results.

MANAGEMENT OF CHANGING BUSINESS. If the Company is to be successful, it
must expand its operations. Such expansion will place a significant strain on
the Company's administrative, operational and financial resources. Such
expansion will result in a continuing increase in the responsibility placed
upon management personnel and will require development or enhancement of
operational, managerial and financial systems and controls. If the Company is
unable to manage the expansion of its operations effectively, the Company's
business, financial condition and operating results will be materially and
adversely affected.

DEPENDENCE ON KEY PERSONNEL. The Company's success depends to a
significant extent upon the continued service of Rhea Posedel, its President
and Chief Executive Officer, as well as other executive officers and key
employees. The Company does not maintain key person life insurance for its
benefit on any of its personnel, and none of the Company's employees is subject
to a noncompetition agreement with the Company. The loss of the services of
any of its executive officers or a group of key employees could have a material
adverse effect on the Company's business, financial condition and operating
results. The Company's future success will depend in significant part upon its
ability to attract and retain highly skilled technical, management, sales and
marketing personnel. There is a limited number of personnel with the requisite
skills to serve in these positions, and it has become increasingly difficult
for the Company to hire such personnel. Competition for such personnel in the
semiconductor equipment industry is intense, and there can be no assurance that

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the Company will be successful in attracting or retaining such personnel. The
Company's inability to attract and retain the executive management and other
key personnel it requires could have a material adverse effect on the Company's
business, financial condition and operating results.

INTELLECTUAL PROPERTY PROTECTION AND INFRINGEMENT. The Company's ability
to compete successfully is dependent in part upon its ability to protect its
proprietary technology and information. Although the Company attempts to
protect its proprietary technology through patents, copyrights, trade secrets
and other measures, there can be no assurance that these measures will be
adequate or that competitors will not be able to develop similar technology
independently. Further, there can be no assurance that claims allowed on any
patent issued to the Company will be sufficiently broad to protect the
Company's technology, that any patent will issue from any pending application
or that foreign intellectual property laws will protect the Company's
intellectual property. Litigation may be necessary to enforce or determine the
validity and scope of the Company's proprietary rights, and there can be no
assurance that the Company's intellectual property rights, if challenged, will
be upheld as valid. Such litigation could result in substantial costs and
diversion of resources and could have a material adverse effect on the
Company's business, financial condition and operating results, regardless of
the outcome of the litigation. In addition, there can be no assurance that any
of the patents issued to the Company will not be challenged, invalidated or
circumvented or that the rights granted thereunder will provide competitive
advantages to the Company.

ENVIRONMENTAL REGULATIONS. Federal, state and local regulations impose
various controls on the use, storage, discharge, handling, emission,
generation, manufacture and disposal of toxic or other hazardous substances
used in the Company's operations. The Company believes that its activities
conform in all material respects to current environmental and land use
regulations applicable to its operations and its current facilities and that it
has obtained environmental permits necessary to conduct its business.
Nevertheless, the failure to comply with current or future regulations could
result in substantial fines being imposed on the Company, suspension of
production, alteration of its manufacturing processes or cessation of
operations. Such regulations could require the Company to acquire expensive
remediation equipment or to incur substantial expenses to comply with

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environmental regulations. Any failure by the Company to control the use,
disposal or storage of, or adequately restrict the discharge of, hazardous or
toxic substances could subject the Company to significant liabilities.

POSSIBLE VOLATILITY OF STOCK PRICE. The Company believes that factors such
as announcements of developments related to the Company's business,
fluctuations in the Company's operating results, failure to meet securities
analysts' expectations, general conditions in the semiconductor and
semiconductor equipment industries and the worldwide economy, announcements of
technological innovations, new systems or product enhancements by the Company
or its competitors, fluctuations in the level of cooperative development
funding, acquisitions, changes in governmental regulations, developments in
patents or other intellectual property rights and changes in the Company's
relationships with customers and suppliers could cause the price of the
Company's Common Stock to fluctuate substantially. In addition, in recent
years the stock market in general, and the market for small capitalization and
high technology stocks in particular, has experienced extreme price
fluctuations which have often been unrelated to the operating performance of
affected companies. Such fluctuations could adversely affect the market price
of the Company's Common Stock.

YEAR 2000. The Company and its subsidiaries are taking action to provide
that their computer systems are capable of processing for the period of Year
2000 and beyond. The costs associated with these actions are not expected to
significantly affect operating cash flows. There can be no assurance, however,
that the Company's computer systems will be fully Year 2000 compliant in a
timely or cost effective manner, and a failure by the Company to make its
internal systems Year 2000 compliant in a timely, cost effective manner could
have a material adverse effect on the Company's business, financial condition
and results of operations.

38
<PAGE>
Item 8. Financial Statements and Supplementary Data

AEHR TEST SYSTEMS AND SUBSIDIARIES

Index to Financial Statements

Report of Independent Accountants .................................. 40

Consolidated Balance Sheets at May 31, 1998 and 1997 ............... 41

Consolidated Statements of Income for the years ended May 31, 1998,
1997 and 1996 .................................................... 42

Consolidated Statements of Shareholders' Equity for the years
ended May 31, 1998, 1997 and 1996 ................................ 43

Consolidated Statements of Cash Flows for the years ended
May 31, 1998, 1997 and 1996 ...................................... 44

Notes to Consolidated Financial Statements ......................... 45

39
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Shareholders of
Aehr Test Systems:

In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of income, shareholders' equity and cash flows
present fairly, in all material respects, the financial position of Aehr Test
Systems at May 31, 1998 and 1997, and the results of their operations and their
cash flows for each of the three years in the period ended May 31, 1998, 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.

PricewaterhouseCoopers LLP

San Jose, California
July 10, 1998

40
<PAGE>
AEHR TEST SYSTEMS AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
May 31,
----------------------
1998 1997
---------- ----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents .......................... $6,748 $1,176
Short-term investments ............................ 16,579 1,614
Accounts receivable, net of allowance for doubtful
accounts of $260 and $270 at May 31, 1998 and
1997, respectively ............................... 7,182 7,515
Inventories ........................................ 11,942 10,498
Deferred income taxes............................... 1,157 900
Prepaid expenses and other ......................... 250 155
---------- ----------
Total current assets ........................... 43,858 21,858

Property and equipment, net .......................... 1,541 1,691
Long-term investments ................................ 904 --
Other assets, net .................................... 802 685
Deferred income taxes................................. -- 155
---------- ----------
Total assets ................................... $47,105 $24,389
========== ==========

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
Notes payable -- banks ............................. $ -- $4,656
Current portion of long-term debt .................. 86 117
Accounts payable ................................... 2,084 4,482
Accrued expenses ................................... 4,492 4,495
Deferred revenue ................................... 311 213
---------- ----------
Total current liabilities ...................... 6,973 13,963

Long-term debt, net of current portion ............... 113 136
Deferred lease commitment ............................ 55 220
---------- ----------
Total liabilities .............................. 7,141 14,319
---------- ----------
Commitments (Note 7).

Shareholders' equity:
Preferred stock, $.01 par value:
Authorized: 10,000 shares;
Issued and outstanding: none -- --
Common stock, $.01 par value:
Authorized: 75,000 shares;
Issued and outstanding: 6,917 shares and 4,296
shares at May 31, 1998 and 1997, respectively... 69 43
Additional paid-in capital ......................... 35,467 8,085
Retained earnings (accumulated deficit)............. 2,275 (130)
Cumulative translation adjustment .................. 2,153 2,072
---------- ----------
Total shareholders' equity ..................... 39,964 10,070
---------- ----------
Total liabilities and shareholders' equity ..... $47,105 $24,389
========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
41
<PAGE>
AEHR TEST SYSTEMS AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Year Ended May 31,
----------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Net sales ................................ $40,805 $42,020 $33,234
Cost of sales ............................ 24,359 25,715 19,942
---------- ---------- ----------
Gross profit ............................. 16,446 16,305 13,292
---------- ---------- ----------

Operating expenses:
Selling, general and administrative .... 8,618 8,878 7,534
Research and development ............... 4,529 4,536 4,113
Research and development cost
reimbursement--DARPA .................. (900) (793) (891)
---------- ---------- ----------
Total operating expenses ............. 12,247 12,621 10,756
---------- ---------- ----------
Income from operations ............... 4,199 3,684 2,536

Interest income (expense) ................ 904 (577) (446)
Other expense, net .............. (364) (565) (559)
---------- ---------- ----------
Income before income taxes and
minority interest in subsidiary ....... 4,739 2,542 1,531

Income tax expense (benefit) ............. 2,334 (773) 130
---------- ---------- ----------
Income before minority interest
in subsidiary ......................... 2,405 3,315 1,401
Minority interest in subsidiary .......... -- -- (1)
---------- ---------- ----------
Net income ........................... $2,405 $3,315 $1,400
========== ========== ==========

Net income per share (basic).............. $0.38 $0.77 $0.33
Net income per share (diluted)............ $0.36 $0.74 $0.32

Shares used in per share calculation
Basic.................................. 6,327 4,297 4,303
Diluted................................ 6,761 4,500 4,364

</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.

42
<PAGE>
AEHR TEST SYSTEMS AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
Retained
Common Stock Additional Earnings Cumulative
------------------ Paid-in (Accumulated Translation
Shares Amount Capital Deficit) Adjustment Total
--------- -------- ----------- ------------ ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
Balances, May 31, 1995.............. 4,308 $43 $8,138 $(4,845) $2,208 $5,544
Issuance of common stock.......... 1 -- 3 -- -- 3
Repurchase of common stock........ (11) -- (47) -- -- (47)
Net income........................ -- -- -- 1,400 -- 1,400
Translation adjustment............ -- -- -- -- (111) (111)
--------- -------- ----------- ------------ ----------- ---------
Balances, May 31, 1996.............. 4,298 43 8,094 (3,445) 2,097 6,789
Repurchase of common stock........ (2) -- (9) -- -- (9)
Net income........................ -- -- -- 3,315 -- 3,315
Translation adjustment............ -- -- -- -- (25) (25)
--------- -------- ----------- ------------ ----------- ---------
Balances, May 31, 1997.............. 4,296 43 8,085 (130) 2,072 10,070
Issuance of common stock in initial
public offering, net of
issuance costs of $1,068 ....... 2,500 25 26,807 -- -- 26,832
Issuance of common stock
under employee plans ........... 121 1 576 -- -- 577
Repurchase of common stock........ -- -- (1) -- -- (1)
Net income........................ -- -- -- 2,405 -- 2,405
Translation adjustment............ -- -- -- -- 81 81
--------- -------- ----------- ------------ ----------- ---------
Balances, May 31, 1998.............. 6,917 $69 $35,467 $2,275 $2,153 $39,964
========= ======== =========== ============ =========== =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.

43
<PAGE>
AEHR TEST SYSTEMS AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
Year Ended May 31,
-----------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income..................................... $2,405 $3,315 $1,400
Adjustments to reconcile net income to net
cash provided by (used in) operating
activities:
Minority interest in subsidiary.............. -- -- 1
Provision for doubtful accounts.............. 131 34 71
Loss on disposition of fixed assets.......... 11 9 34
Depreciation and amortization................ 479 633 622
Deferred income taxes........................ (102) (1,055) --
Changes in operating assets and liabilities:
Accounts receivable........................ 36 2,608 (4,367)
Inventories................................ (1,627) (2,854) (2,631)
Accounts payable........................... (1,871) (795) 2,092
Accrued expenses and deferred revenue...... 143 1,180 2,043
Deferred lease commitment.................. (165) (167) (143)
Other current assets....................... (104) 118 124
--------- --------- ---------
Net cash provided by (used in)
operating activities................... (664) 3,026 (754)
--------- --------- ---------
Cash flows from investing activities:
(Increase) decrease in short-term
investments............................. (15,323) 188 16
Increase in long-term investments........... (904) -- --
Additions to property and equipment.......... (315) (647) (581)
(Increase) decrease in other assets.......... (213) 246 105
--------- --------- ---------
Net cash used in investing activities.... (16,755) (213) (460)
--------- --------- ---------
Cash flows from financing activities:
Increase (decrease) in notes payable--banks.. (4,535) (1,784) 1,914
Borrowings under long-term debt.............. 96 141 327
Long-term debt and capital lease
principal payments......................... (111) (488) (1,069)
Proceeds from issuance of common stock
and exercise of stock options.............. 27,409 -- 3
Repurchase of common stock................... (1) (9) (47)
--------- --------- ---------
Net cash provided by (used in)
financing activities................... 22,858 (2,140) 1,128
--------- --------- ---------

Effect of exchange rates on cash................. 133 (32) 23
--------- --------- ---------
Net increase (decrease) in cash and
cash equivalents....................... 5,572 641 (63)

Cash and cash equivalents, beginning of period... 1,176 535 598
--------- --------- ---------
Cash and cash equivalents, end of period......... $6,748 $1,176 $535
========= ========= =========

Supplemental cash flow information:
Cash paid during the year for:
Interest .................................. $148 $522 $473
Income taxes .............................. 2,281 155 30

</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
44
<PAGE>
AEHR TEST SYSTEMS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

BUSINESS:

Aehr Test Systems ("Company") was incorporated in California in June 1977
and primarily designs, engineers and manufactures test and burn-in equipment
used in the semiconductor industry. The Company's principal products are the
MTX massively parallel test system, the MAX and ATX burn-in systems, test
fixtures and the DiePak carrier.

CONSOLIDATION:

The financial statements include the accounts of the Company, its wholly
owned foreign sales corporation ("FSC") and both its wholly owned and majority
owned foreign subsidiaries. Intercompany accounts and transactions have been
eliminated.

FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS:

Assets and liabilities of the Company's foreign subsidiaries are translated
into U.S. dollars using the exchange rate in effect at the balance sheet date.
Additionally, their revenues and expenses are translated using exchange rates
approximating average rates prevailing during the fiscal year. Translation
adjustments that arise from translating their financial statements from their
local currencies to U.S. dollars are accumulated and reflected as a separate
component of shareholders' equity.

Transaction gains and losses that arise from exchange rate changes
denominated in currencies other than the local currency are included in the
statements of operations as incurred.

USE OF ESTIMATES:

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

CASH EQUIVALENTS:

Cash equivalents consist of money market instruments, commercial paper and
other highly liquid investments purchased with an original maturity of three
months or less.

45
<PAGE>
CONCENTRATION OF CREDIT RISK:

The Company sells its products primarily to semiconductor manufacturers in
North America, the Far East, and Europe. As of May 31, 1998, approximately
46%, 19% and 35% of accounts receivable are from customers located in the
United States, Europe and the Far East, respectively. As of May 31, 1997,
approximately 15%, 28% and 57% of accounts receivable are from customers
located in the United States, Europe and the Far East, respectively. Three
customers accounted for 34%, 16% and 14% of accounts receivable at May 31,
1998, and one customer accounted for 44% of accounts receivable at May 31,
1997. The Company performs ongoing credit evaluations of its customers and
generally does not require collateral. The Company also maintains allowances
for potential credit losses and such losses have been within management's
expectations. The Company uses letter of credit terms for some of its
international customers.

Primarily all of the Company's cash, cash equivalents and short-term cash
deposits are deposited with major banks in the United States and Japan. The
Company invests its excess cash in money market funds and short-term cash
deposits. The money market funds and short-term cash deposits bear the risk
associated with each fund. The money market funds have variable interest rates,
and the short-term cash deposits have fixed rates. The Company has not
experienced any losses on its money market funds or short-term cash deposits.

INVENTORIES:

Inventories are stated at the lower of standard cost (which approximates
cost on a first-in, first-out basis) or market.

PROPERTY AND EQUIPMENT:

Property and equipment are stated at cost. Leasehold improvements are
amortized over the lesser of their estimated useful lives or the term of the
related lease. Furniture, fixtures, machinery and equipment are depreciated on
a straight-line basis over their estimated useful lives. The ranges of
estimated useful lives for furniture, fixtures, machinery and equipment are as
follows:

Furniture and fixtures................................ 2 to 15 years

Machinery and equipment............................... 4 to 11 years

GOODWILL:

Cost in excess of the fair value of net assets of acquired companies of
$956,000 is being amortized on a straight-line basis over 24.5 years and is
included in other assets, net of accumulated amortization of $490,000 and
$454,000 at May 31, 1998 and 1997, respectively.

46
<PAGE>
REVENUE RECOGNITION:

Revenue is recognized upon shipment of product and a provision for the
estimated future cost of warranty is recorded. Actual warranty costs incurred
have not materially differed from those provided.

PRODUCT DEVELOPMENT COSTS AND CAPITALIZED SOFTWARE:

Costs incurred in the research and development of new products or systems
are charged to operations as incurred.

Costs incurred in the development of software programs for the Company's
products are charged to operations as incurred until technological feasibility
of the software has been established. Generally, technological feasibility is
established when the software module performs its primary functions described
in its original specifications, contains features required for it to be usable
in a production environment, is completely documented and the related hardware
portion of the product is complete. After technological feasibility is
established, any additional costs are capitalized. Capitalized costs are
amortized over the estimated life of the related software product using the
greater of the units of sales or straight-line methods over ten years.
Capitalized costs, net of accumulated amortization, of approximately $57,000
are included in other assets at May 31, 1997. System software development
costs were fully amortized at May 31, 1998.

During 1994, the Company entered into a cost-sharing research agreement
with the Defense Advanced Research Projects Agency ("DARPA"), a U.S. government
agency, under which DARPA will provide co-funding up to a maximum amount of
$6.5 million during fiscal 1994 through January 1999 for the development of a
new product that will allow for burn-in at the wafer level. Payments from
DARPA will be received upon DARPA's approval of the achievement by the Company
of milestones as outlined in the contract. The Company recognizes such
reimbursements as a reduction to research and development expenses in an amount
equal to actual reimbursable project costs incurred. At May 31, 1998, no
payment was due from DARPA. $500,000 was due from DARPA at May 31, 1997.

FAIR VALUE OF FINANCIAL INSTRUMENTS:

Carrying amounts of certain of the Company's financial instruments
including cash and cash equivalents, short-term investments, accounts
receivable, accounts payable and accrued expenses approximate fair value due to
their short maturities. Based on borrowing rates currently available to the
Company for loans with similar terms, the carrying value of notes payable
approximates fair value.

The Company's investments are composed primarily of government and
corporate fixed income securities, certificates of deposit and commercial
paper. While it is the Company's general intent to hold such securities until
maturity, management will occasionally sell particular securities for cash flow
purposes. Therefore, the Company's investments are classified as
available-for-sale and are carried at fair value. Through May 31, 1998, no
material losses had been experienced on such investments.

47
<PAGE>
Unrealized gains and losses, net of losses, net of tax, are
computed on the basis of specific identification and are included in retained
earnings. Realized gains, realized losses, and declines in value, judged to be
other-than-temporary, are included in other income. The cost of securities
sold is based on the specific identification method and interest earned is
included in other income.

CARRYING VALUE OF LONG-TERM ASSETS:

The Company writes off the carrying value of long-term assets to the extent
that projected net operating income is not sufficient to recover the carrying
value of these assets over their remaining useful life.

INCOME TAXES:

Deferred tax assets and liabilities are determined based on differences
between financial reporting and tax bases of assets and liabilities and are
measured using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse. Valuation allowances are established when
necessary to reduce deferred tax assets to amounts expected to be realized.

STOCK-BASED COMPENSATION:

In October 1995, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 123 ("SFAS No. 123"),
"Accounting for Stock-Based Compensation." SFAS No. 123 allows companies to
either account for stock-based compensation under the new provisions of SFAS
No. 123 or under the provisions of Accounting Principles Board Opinion No. 25
("APB No. 25"), "Accounting for Stock Issued to Employees," but requires pro
forma disclosure in the footnotes to the financial statements as if the
measurement provisions of SFAS No. 123 had been adopted. The Company accounts
for its stock based compensation in accordance with the provisions of APB No.
25 and presents disclosures required by SFAS No. 123.

EARNINGS PER SHARE ("EPS") DISCLOSURES:

The Company has adopted the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 128, "Earnings Per Share," and all prior periods have
been restated accordingly. Basic EPS is computed by dividing income available
to common shareholders by the weighted average number of common shares
outstanding for the period. Diluted EPS is computed giving effect to all
dilutive potential common shares that were outstanding during the period.
Dilutive potential common shares consist of the incremental common shares
issuable upon exercise of stock options for all periods.

In February 1998, the Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") No. 98, which addresses the computation of EPS in
an initial public offering. The Company has determined that no incremental
shares should be included in the computation of EPS in accordance with the SAB
and basic and diluted EPS has been restated accordingly.

48
<PAGE>
In accordance with the disclosure requirements of SFAS No. 128, a
reconciliation of the numerator and denominator of basic and diluted EPS is
provided as follows:

<TABLE>
<CAPTION>
Year Ended May 31,
----------------------------------
1998 1997 1996
---------- ---------- ----------
(in thousands, except per share amounts)
<S> <C> <C> <C>
Numerator: Net income....................... $2,405 $3,315 $1,400
---------- ---------- ----------
Denominator for basic income per share:
Weighted-average shares outstanding ...... 6,327 4,297 4,303
---------- ---------- ----------
Shares used in basic per share calculation.. 6,327 4,297 4,303

Effect of dilutive securities:
Employee stock options................... 434 203 61
---------- ---------- ----------
Denominator for diluted income
per share................................ 6,761 4,500 4,364
---------- ---------- ----------

Basic income per share...................... $0.38 $0.77 $0.33
========== ========== ==========
Diluted income per share.................... $0.36 $0.74 $0.32
========== ========== ==========
</TABLE>

RECENT ACCOUNTING PRONOUNCEMENTS:

In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." SFAS No. 131 establishes standards for
disclosure about operating segments in annual financial statements and selected
information in interim financial reports. It also establishes standards for
related disclosures about products and services, geographic areas and major
customers. This statement supersedes SFAS No. 14, "Financial Reporting for
Segments for a Business Enterprise." The new standard becomes effective for
the Company for the year ending May 31, 1999, and requires that comparative
information from earlier years be restated to conform to the requirements of
this standard. The Company does not expect this pronouncement to materially
change the Company's current reporting and disclosures.

49
<PAGE>
2. INVENTORIES:

Inventories are comprised of the following (in thousands):

<TABLE>
<CAPTION>
May 31,
-------------------------
1998 1997
------------ ------------
<S> <C> <C>
Raw materials and subassemblies......... $5,688 $4,376
Work in process......................... 5,173 5,508
Finished goods.......................... 1,081 614
------------ ------------
$11,942 $10,498
============ ============
</TABLE>

3. PROPERTY AND EQUIPMENT:

Property and equipment comprise (in thousands):
<TABLE>
<CAPTION>
May 31,
-------------------------
1998 1997
------------ ------------
<S> <C> <C>
Leasehold improvements.................. $393 $473
Furniture and fixtures.................. 2,996 3,617
Machinery and equipment................. 2,569 3,174
Test equipment.......................... 1,944 2,283
------------ ------------
7,902 9,547
Less accumulated depreciation
and amortization...................... (6,361) (7,856)
------------ ------------
$1,541 $1,691
============ ============
</TABLE>

4. NOTES PAYABLE--BANKS:

At May 31, 1998 and 1997 short-term bank borrowings totaled $0 and
$4,656,000 respectively. Outstanding borrowings at May 31, 1997 were comprised
of borrowings under a domestic line of credit and of short-term bank loans of
the Company's majority owned Japanese subsidiary for $1,897,000 at an interest
rate of 3.8%, respectively. These borrowings were partially collateralized by
certain time deposits and accounts receivable.

The Company's majority owned Japanese subsidiary has overdraft facilities
with a bank up to a limit of $216,000 against which certain time deposits and
accounts receivable are pledged as collateral for the facilities.

50
<PAGE>
5. LONG-TERM DEBT:

Long-term debt comprises (in thousands):

<TABLE>
<CAPTION>
May 31,
-------------------------
1998 1997
------------ ------------
<S> <C> <C>
Various notes payable to Japanese banks, denominated
in Japanese Yen, bearing interest at 1.3% to 4.1%
per annum. These notes are payable in monthly
principal installments of $1,000 to $4,000 plus
accrued interest, maturing through April 2003
and are collateralized by certain time deposits
and accounts receivable............................ $199 $253

Less current portion................................. (86) (117)
------------ ------------
$113 $136
============ ============
</TABLE>

The long-term debt agreements contain certain cross-default covenants under
which outstanding borrowings would become payable on demand if the Company were
to be in default of any other debt agreement and any lender were to accelerate
the other debt.

Principal payments under long-term debt obligations for each of the next
five fiscal years as of May 31, 1998 are as follows (in thousands):

1999................................. $86
2000................................. 48
2001................................. 27
2002................................. 25
2003................................. 13
------------
$199
============

51
<PAGE>
6. ACCRUED EXPENSES:

Accrued expenses comprise (in thousands):
<TABLE>
<CAPTION>
May 31,
-------------------------
1998 1997
------------ ------------
<S> <C> <C>
Payroll related......................... $866 $993
Commissions and bonuses................. 903 1,882
Warranty................................ 511 173
Deferred rent, current.................. 166 290
Other................................... 2,046 1,157
------------ ------------
$4,492 $4,495
============ ============
</TABLE>

7. COMMITMENTS:

The Company leases most of its manufacturing and office space under
operating leases. The Company has entered into a noncancelable operating lease
agreement for its United States manufacturing and office facilities, which
commenced in October 1991 and expires in September 1999. Under the lease
agreement, the Company is responsible for payments of utilities, taxes and
insurance.

Minimum annual rentals payable under operating leases in each of the next
five fiscal years and thereafter are as follows (in thousands):

1999.................................... $1,277
2000.................................... 568
2001.................................... 196
2002.................................... 186
2003 and thereafter..................... 388

Rent expense for the years ended May 31, 1998, 1997 and 1996 was
approximately $1,067,000, $1,226,000 and $1,425,000, respectively.

The Company has a $67,000 certificate of deposit held by a financial
institution representing a security deposit for its United States manufacturing
office and facilities lease.

52
<PAGE>
8. CAPITAL STOCK:

PREFERRED STOCK:

The Board of Directors is authorized to determine the rights of the
preferred shareholders.

STOCK OPTIONS:

The Company has reserved 1,256,167 shares of common stock for issuance to
employees and consultants under its two stock option plans. Both plans provide
that qualified options be granted at an exercise price equal to the fair market
value at the date of grant, as determined by the Board of Directors (85% of
fair market value in the case of nonstatutory options and purchase rights and
110% of fair market value in certain circumstances). Options generally expire
five years from date of grant. Most options become exercisable in increments
over a four-year period from the date of grant. Options to purchase
approximately 514,103 shares were exercisable at May 31, 1998.

Activity under the Company's stock option plans was as follows:

Outstanding Options
--------------------------------------
Number
Available of
Shares Shares Price per Share Total
--------- -------- -------------------- --------
(in thousands, except per share data)
<S> <C> <C> <C> <C>
Balances, May 31, 1995........ 57 407 $3.00 -- $6.00 $1,341
Options granted............. (548) 548 $4.00 2,193
Options exercised........... -- (1) $3.00 (3)
Options terminated.......... 222 (222) $3.00 -- $6.00 (712)
Additional shares reserved.. 335 -- -- --
1978 Plan expiration........ (27) -- -- --
1983 Plan expiration........ (37) -- -- --
--------- -------- --------
Balances, May 31, 1996........ 2 732 $3.25 -- $6.00 2,819
Additional shares reserved.. 650 -- -- --
Options granted............. (70) 70 $4.25 -- $6.00 397
Options terminated.......... 43 (43) $3.25 -- $6.00 (167)
1986 Plan expiration........ (43) -- -- -
--------- -------- --------
Balances, May 31, 1997........ 582 759 $3.25 -- $6.00 3,049
Additional shares reserved.. -- -- --
Options granted............. (151) 151 $6.19 -- $17.00 1,429
Options terminated.......... 17 (17) $3.25 -- $7.50 (85)
Options exercised........... -- (77) $3.25 -- $6.00 (287)
1986 Plan expiration........ (8) --
--------- -------- --------
Balances, May 31, 1998........ 440 816 $3.25 -- $17.00 $4,106
========= ======== ========
</TABLE>
53
<PAGE>
The following information concerning the Company's stock option and employee
stock purchase plans is provided in accordance with SFAS No. 123, "Accounting
for Stock-Based Compensation." The Company accounts for such plans in accordance
with APB No. 25 and related Interpretations.

The fair value of each option grant has been estimated on the date of grant
using the Black-Scholes option pricing model with the following weighted average
assumptions used for grants:

<TABLE>
<CAPTION>
Year Ended May 31,
----------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Risk-free Interest Rates............. 6.47% 6.47% 6.47%
Expected Life........................ 5 years 5 years 5 years
Volatility........................... 0.94 -- --
Dividend Yield....................... -- -- --

</TABLE>

The weighted average expected life was calculated based on the exercise
behavior. The weighted average fair value of those options granted in 1998 and
1997 was $9.37 and $4.01, respectively.

The following pro forma income information has been prepared following the
provisions of SFAS No. 123:

<TABLE>
<CAPTION>
Year Ended May 31,
----------------------------------
1998 1997 1996
---------- ---------- ----------
(amounts in thousands, except per share data)
<S> <C> <C> <C>
Net income--as reported............. $2,405 $3,315 $1,400
Net income--pro forma............... $2,240 $3,215 $1,339
Net income per share--as reported:
Basic............................. $0.38 $0.77 $0.33
Diluted........................... $0.36 $0.74 $0.32
Net income per share--pro forma:
Basic............................. $0.35 $0.75 $0.31
Diluted........................... $0.33 $0.71 $0.30

</TABLE>

The above pro forma effects on income may not be representative of the
effects on net income for future years as option grants typically vest over
several years and additional options are generally granted each year.

54
<PAGE>
The following table summarizes information with respect to stock options at
May 31, 1998:
<TABLE>
<CAPTION>
Options Oustanding Options Exercisable
----------------------------------- -----------------------
Weighted
Number Average Weighted Number Weighted
Outstanding Remaining Average Exercisable Average
Range of at Contractual Exercise at Exercise
Exercise Prices May 31, 1998 Life (Years) Price May 31, 1998 Price
- -------------------- ------------ ----------- ---------- ------------ ----------
<S> <C> <C> <C> <C> <C>
$3.2500 128,901 1.22 $3.2500 119,305 $3.2500
$4.0000 407,734 2.53 $4.0000 303,116 $4.0000
$4.2500 9,500 3.40 $4.2500 3,758 $4.2500
$4.4000 70,000 2.64 $4.4000 52,708 $4.4000
$6.0000 53,188 3.79 $6.0000 15,454 $6.0000
$6.1875 20,750 4.90 $6.1875 427 $6.1875
$6.6880 42,250 4.56 $6.6880 4,184 $6.6880
$7.5000 35,000 4.05 $7.5000 8,014 $7.5000
$8.2500 5,000 4.05 $8.2500 1,145 $8.2500
$13.3130 20,000 4.44 $13.3130 2,500 $13.3130
$17.0000 24,000 4.38 $17.0000 3,492 $17.0000
------------ ------------
$3.2500 - 17.0000 816,323 2.75 $5.0303 514,103 $4.1502
============ ============
</TABLE>

9. EMPLOYEE BENEFIT PLANS

EMPLOYEE STOCK BONUS PLAN:

The Company has a noncontributory, trusteed employee stock bonus plan for
full-time employees who have completed three consecutive months of service and
for part time employees who have completed one year of service and have attained
an age of 21. The Company can contribute either shares of the Company's stock or
cash to the plan. The contribution is determined annually by the Company and
cannot exceed 15% of the annual aggregate salaries of those employees eligible
for participation in the plan. Individuals' account balances vest at a rate of
25% per year commencing upon completion of three years of service. Nonvested
balances, which are forfeited, are allocated to the remaining employees in the
plan. Contributions made to the plan during fiscal 1996, 1997 and 1998 were
$50,000, $200,000 and $150,000, respectively.

401(K) PLAN:

The Company maintains a 401(k) profit-sharing plan for its full-time
employees who have completed three consecutive months of service and for
part-time employees who have completed one year of service and have attained an
age of 21. Each participant in the plan may elect to contribute from 1% to 20%
of their annual salary to the plan, subject to certain limitations. The Company,
at its discretion, may make an annual contribution to the plan. No contributions
were made by the Company to the plan during fiscal 1996, 1997 and 1998.

55
<PAGE>
EMPLOYEE STOCK PURCHASE PLAN:

The Company's 1997 Employee Stock Purchase Plan was adopted by the Board of
Directors in June 1997. A total of 300,000 shares of Common Stock have been
reserved for issuance under the plan. The plan has consecutive, overlapping,
twenty-four month offering periods. The offering periods generally begin on the
first trading day on or after April 1 and October 1 each year, except that the
first such offering period commences with the effectiveness of the Company's
initial public offering and ends on the last trading day on or before March 31,
1999. Shares are purchased through employee payroll deductions at exercise
prices equal to 85% of the lesser of the fair market value of the Company's
Common Stock at either the first day of an offering period or the last day of
such offering period. If a participant's rights to purchase stock under all
employee stock purchase plans of the Company accrue at a rate which exceeds
$25,000 worth of stock for a calendar year, such participant may not be granted
an option to purchase stock under the 1997 Employee Stock Purchase Plan. To
date, 20,186 shares have been issued under the plan.

10. INCOME TAXES:

Domestic and foreign components of pretax income (loss) are as follows (in
thousands):

<TABLE>
<CAPTION>
Year Ended May 31,
--------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Domestic.......................... $6,526 $3,672 $1,283
Foreign........................... (1,787) (1,130) 248
------------ ------------ ------------
$4,739 $2,542 $1,531
============ ============ ============

</TABLE>

56
<PAGE>
The provision (benefit) for income taxes consists of the following (in
thousands):

<TABLE>
<CAPTION>
Year Ended May 31,
--------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Federal income taxes:
Current......................... $2,182 $150 $40
Deferred........................ (124) (910) --
State income taxes:
Current......................... 266 15 5
Deferred........................ 22 (145) --
Foreign income taxes:
Current......................... (12) 117 85
Deferred........................ -- -- --
------------ ------------ ------------
$2,334 ($773) $130
============ ============ ============
</TABLE>

The components of the net deferred tax asset (liability) are as follows (in
thousands):
<TABLE>
<CAPTION>
May 31,
-------------------------
1998 1997
------------ ------------
<S> <C> <C>
Noncurrent assets:
Net operating losses..................... $1,783 $1,836
Credit carryforwards..................... -- 24
Depreciation and amortization............ (103) (7)
------------ ------------
1,680 1,853
Less valuation allowance................... (1,680) (1,698)
------------ ------------
-- 155
------------ ------------
Current assets:
Inventory and other revenues............. 1,201 1,295
Accrued liabilities...................... 913 860
------------ ------------
2,114 2,155
Less valuation allowance................... (957) (1,255)
------------ ------------
1,157 900
------------ ------------
Net deferred tax asset..................... $1,157 $1,055
============ ============
</TABLE>

57
<PAGE>
The Company's effective tax rate differs from the U.S. federal statutory tax
rate, as follows:

<TABLE>
<CAPTION>
Year Ended May 31,
--------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Maximum statutory rate.. 34.0% 34.0% 34.0%
Net operating loss utilized....... -- (34.0) (34.0)
Foreign taxes..................... -- 4.6 5.4
State taxes, net of federal tax
effect.......................... 6.9 0.6 0.3
Other............................. (0.7) 5.9 2.8
Foreign earnings not currently
benefitted ..................... 7.2 -- --
Foreign Sales Corporation (4.7) -- --
Change in valuation allowances.... 6.6 (41.5) --
------------ ------------ ------------
Effective tax rate................ 49.3% (30.4)% 8.5%
============ ============ ============
</TABLE>

Foreign net operating loss carryforwards of approximately $3,700,000 are
available to reduce future foreign taxable income and expire in 2003 if not
utilized. A valuation allowance has been provided for the deferred tax assets of
the Japanese subsidiary as management does not believe it is more likely than
not the tax assets will be realized, due to the subsidiary's cumulative losses.

11. OTHER EXPENSE, NET:

Other Expense, Net comprises the following:

<TABLE>
<CAPTION>
Year Ended May 31,
--------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Foreign exchange loss ............ ($385) ($393) ($573)
Other, net........................ 21 (172) 14
------------ ------------ ------------
($364) ($565) ($559)
============ ============ ============
</TABLE>

58
<PAGE>
12. SEGMENT INFORMATION:

FOREIGN OPERATIONS:

The Company develops, manufactures and sells systems to semiconductor
manufacturers and operates in one industry segment. The following presents
information about the Company's operations in different geographic areas (in
thousands):

<TABLE>
<CAPTION>
United Adjust-
States Asia Europe ments Total
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
1996:
Net sales...................... $21,486 $14,204 $3,497 $(5,953) $33,234
Portion of U.S. net sales
from export sales............ 13,150 -- -- -- 13,150
Income from operations......... 1,330 707 199 300 2,536
Identifiable assets............ 18,515 9,453 1,103 (5,322) 23,749

1997:
Net sales...................... $35,404 $8,718 $3,986 $(6,088) $42,020
Portion of U.S. net sales
from export sales............ 27,102 -- -- -- 27,102
Income (loss) from operations.. 3,972 (668) (32) 412 3,684
Identifiable assets............ 22,983 5,093 910 (4,597) 24,389

1998:
Net sales...................... $37,748 $3,703 $2,926 $(3,572) $40,805
Portion of U.S. net sales
from export sales............ 25,724 -- -- -- 25,724
Income (loss) from operations.. 5,511 (1,206) (53) (53) 4,199
Identifiable assets............ 50,396 2,173 1,500 (6,964) 47,105

</TABLE>

The Company's foreign operations are primarily those of its Japanese
subsidiary. Substantially all of their sales are made to unaffiliated Japanese
customers. Net sales and income (loss) from operations from outside the United
States include the operating results of Aehr Test Systems Japan K.K. and Aehr
Test Systems GmbH. Adjustments consist of intercompany eliminations.
Identifiable assets are all assets identified with operations in each geographic
area.

MAJOR CUSTOMERS:

Two customers accounted for 47% and 13% of net sales in fiscal 1998,
respectively. One customer accounted for 56% and 29% of net sales in fiscal
1997 and 1996, respectively.

59
<PAGE>
(13) Quarterly Results (unaudited)

The following table (presented in thousands, except per share data)
sets forth selected statement of income data for each of the four quarters of
the fiscal years ended May 31, 1998 and May 31, 1997. The unaudited quarterly
information has been prepared on the same basis as the annual information
presented elsewhere herein and, in the Company's opinion, includes all
adjustments (consisting only of normal recurring entries) necessary for a fair
presentation of the information for the quarters presented. The operating
results for any quarter are not necessarily indicative of results for any
future period.

<TABLE>
<CAPTION>
Three Months Ended
------------------------------------------
Aug. 31, Nov. 30, Feb. 28, May 31,
1996 1996 1997 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net sales......................... $9,071 $10,486 $10,745 $11,718
Gross profit...................... 3,326 3,992 4,381 4,606
Net income........................ $367 $423 $590 $1,935
Net income per share (basic)...... $0.09 $0.10 $0.14 $0.45
Net income per share (diluted).... $0.08 $0.10 $0.13 $0.43

</TABLE>

<TABLE>
<CAPTION>
Three Months Ended
------------------------------------------
Aug. 31, Nov. 30, Feb. 28, May 31,
1997 1997 1998 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net sales......................... $11,665 $11,748 $11,567 $5,825
Gross profit...................... 4,604 4,582 4,660 2,600
Net income........................ $614 $908 $831 $52
Net income per share (basic)...... $0.13 $0.13 $0.12 $0.01
Net income per share (diluted).... $0.12 $0.12 $0.12 $0.01

</TABLE>

Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure

None.

60
<PAGE>
PART III

Item 10. Directors and Executive Officers of the Registrant

The information required by this item relating to directors is incorporated
by reference to the information under the caption "Proposal 1 -- Election of
Directors" in the Proxy Statement. The information required by this item
relating to executive officers is incorporated by reference to the information
under the caption "Management -- Executive Officers and Directors" at the end
of Part I of this report on Form 10-K.

Item 11. Executive Compensation

The information required by this item is incorporated by reference to the
section entitled "Compensation of Executive Officers" of the Proxy Statement.

Item 12. Security Ownership of Certain Beneficial Owners and Management

The information required by this item is incorporated by reference to the
section entitled "Security Ownership of Certain Beneficial Owners, Directors
and Management" of the Proxy Statement.

Item 13. Certain Relationships and Related Transactions

The information required by this item is incorporated by reference to the
section entitled "Certain Relationships and Related Transactions" of the Proxy
Statement.

61
<PAGE>
PART IV

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K

(a) The following documents are filed as part of this Report:

1. Financial Statements

Report of Independent Accountants

Consolidated Balance Sheets at May 31, 1998 and 1997

Consolidated Statements of Income for the years ended May 31, 1998, 1997
and 1996

Consolidated Statements of Shareholders' Equity for the years ended May 31,
1998, 1997 and 1996

Consolidated Statements of Cash Flows for the years ended May 31, 1998, 1997
and 1996

Notes to Consolidated Financial Statements

2. Financial Statement Schedule

The following consolidated financial statement schedule is filed as part of
this report and should be read in conjunction with the consolidated financial
statements:

Schedule

II Valuation and Qualifying Accounts

All other schedules have been omitted since the required information is not
present or not present in amounts sufficient to require submission of the
schedule or because the information required is included in the consolidated
financial statements or notes thereto.

62
<PAGE>
Report of Independent Accountants on Financial Statement Schedule
- -----------------------------------------------------------------

To the Board of Directors and Shareholders
Aehr Test Systems
Mountain View, California

Our report on the consolidated financial statements of Aehr Test Systems is
included on page 40 of this Form 10-K. In connection with our audits of such
financial statements, we have also audited the related financial statement
schedule listed on Item 14 of this Form 10-K.

In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic consolidated financial statements taken as
a whole, presents fairly, in all material respects, the information required to
be included therein.

PricewaterhouseCoopers LLP

San Jose, California
July 10, 1998

63
<PAGE>
SCHEDULE II

AEHR TEST SYSTEMS AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)

<TABLE>
<CAPTION>
Additions
Balance at Charged to Balance
beginning costs and at end
of year expenses Deductions of year
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Allowance for doubtful
accounts receivable:

May 31, 1998 $270 $131 $141 $260
========== ========== ========== ==========

May 31, 1997 $241 $29 $ -- $270
========== ========== ========== ==========

May 31, 1996 $170 $71 $ -- $241
========== ========== ========== ==========
</TABLE>

(b) Reports on Form 8-K.

None

64
<PAGE>
3. Exhibits

The following exhibits are filed as part of or incorporated by
reference into this Report:

Exhibit
No. Description
- ------- ---------------------------------------------------------------

3.1+ Restated Articles of Incorporation of Registrant.
3.2+ Bylaws of Registrant.
4.1++ Form of Common Stock certificate.
10.1+ Amended 1986 Incentive Stock Plan and form of agreement thereunder.
10.2++ 1996 Stock Option Plan (as amended and restated) and forms of Incentive
Stock Option Agreement and Nonstatutory Stock Option Agreement
thereunder.
10.3++ 1997 Employee Stock Purchase Plan and form of subscription agreement
thereunder.
10.4++ Form of Indemnification Agreement entered into between Registrant and
its directors and executive officers.
10.5+ Capital Stock Purchase Agreement dated September 11, 1979 between
Registrant and certain holders of Common Stock.
10.6+ Capital Stock Investment Agreement dated April 12, 1984 between
Registrant and certain holders of Common Stock.
10.7+ Amendment dated September 17, 1985 to Capital Stock Purchase Agreement
dated April 12, 1984 between Registrant and certain holders of Common
Stock.
10.8+ Amendment dated February 26, 1990 to Capital Stock Purchase Agreement
dated April 12, 1984 between Registrant and certain holders of Common
Stock.
10.9+ Stock Purchase Agreement dated September 18, 1985 between Registrant
and certain holders of Common Stock.
10.10+ Common Stock Purchase Agreement dated February 26, 1990 between
Registrant and certain holders of Common Stock.
10.11+ Lease dated May 14, 1991 for facilities located at 1667 Plymouth
Street, Mountain View, California.
11.1++ Computations of Net Income (Loss) Per Share.
21.1+ Subsidiaries of the Company.
23.1 Consent of Independent Accountants.
24.1 Power of Attorney (see page 66).
27.1 Financial Data Schedule.

- ------------------------

+ Incorporated by reference to the same numbered exhibit previously filed with
the Company's Registration Statement on Form S-1 filed June 11, 1997 (File No.
333-28987)

++ Incorporated by reference to the same-numbered exhibit previously filed
with Amendment No.1 to the Company's Registration Statement on Form S-1 filed
July 17, 1997 (File No. 333-28987).

65
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant has duly caused this
Report on Form 10-K to be signed on its behalf by the undersigned,
thereunto duly authorized.

Dated: August 27, 1998
AEHR TEST SYSTEMS

By: /s/ RHEA J. POSEDEL
----------------------------------------
Rhea J. Posedel
PRESIDENT, CHIEF EXECUTIVE OFFICER AND
CHAIRMAN OF THE BOARD OF DIRECTORS

POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Rhea J. Posedel and Gary L. Larson,
jointly and severally, his attorneys-in-fact, each with the power of
substitution, for him in any and all capacities, to sign any and all
amendments to this Report on Form 10-K, and to file the same, with exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, hereby ratifying and confirming all that each of said
attorneys-in-fact, or his substitute or substitutes, may do or cause to be
done by virtue hereof.

Pursuant to the requirements of the Securities Act of 1934, this
Report on Form 10-K has been signed below by the following persons on
behalf of the Registrant and in the capacities and on the dates
indicated.

Signature Title Date
- -------------------------- ----------------------------------- -------------
/s/ RHEA J. POSEDEL President, Chief Executive August 27, 1998
- --------------------------- Officer and Chairman of
Rhea J. Posedel the Board of Directors
(Principal Executive Officer)

/s/ GARY L. LARSON Vice President of Finance August 27, 1998
- --------------------------- and Chief Financial Officer
Gary L. Larson (Principal Financial and
Accounting Officer)

/s/ WILLIAM W. R. ELDER Director August 27, 1998
- ---------------------------
William W. R. Elder

/s/ MARIO M. ROSATI Director
- --------------------------- August 27, 1998
Mario M. Rosati

/s/ DAVID TORRESDAL Director
- ---------------------------
David Torresdal August 27, 1998

Exhibit 23.1

Consent of Independent Accountants
-----------------------------------

We consent to the incorporation by reference in the Registration Statement of
Aehr Test Systems on Form S-8 (File No. 333-28987) of our reports dated July
10, 1998 on our audits of the consolidated financial statements and financial
statement schedule of Aehr Test Systems and Subsidiaries as of May 31, 1998 and
1997, and for each of the three years in the period ended May 31, 1998, which
report is included in this Annual Report on Form 10-K.

PricewaterhouseCoopers LLP

San Jose, California
August 27, 1998

<ARTICLE> 5
<LEGEND> This schedule contains summary financial information extracted
from the Balance Sheets and Statements of Income included in the
Company's Form 10-K for the year ended May 31, 1998 and is
qualified in its entirety by reference to such Financial Statements.
</LEGEND>
<MULTIPLIER>1000

<S> <C> <C> <C>
<FISCAL-YEAR-END> May-31-1998 May-31-1997 May-31-1996
<PERIOD-START> Jun-01-1997 Jun-01-1996 Jun-01-1995
<PERIOD-END> May-31-1998 May-31-1997 May-31-1996
<PERIOD-TYPE> 12-MOS 12-MOS 12-MOS
<CASH> 6,748 1,176 2,481
<SECURITIES> 16,579 1,614 0
<RECEIVABLES> 7,442 7,785 10,806
<ALLOWANCES> 260 270 241
<INVENTORY> 11,942 10,498 7,921
<CURRENT-ASSETS> 43,858 21,858 21,226
<PP&E> 7,902 9,547 9,449
<DEPRECIATION> 6,361 7,856 8,067
<TOTAL-ASSETS> 47,105 24,389 23,749
<CURRENT-LIABILITIES> 6,973 13,963 16,427
<BONDS> 0 0 0
0 0 0
0 0 0
<COMMON> 69 43 8,137
<OTHER-SE> 39,895 10,027 (1,348)
<TOTAL-LIABILITY-AND-EQUITY> 47,105 24,389 23,749
<SALES> 40,805 42,020 33,234
<TOTAL-REVENUES> 40,805 42,020 33,234
<CGS> 24,359 25,715 19,942
<TOTAL-COSTS> 24,359 25,715 19,942
<OTHER-EXPENSES> 12,247 12,621 10,756
<LOSS-PROVISION> 0 0 0
<INTEREST-EXPENSE> (904) 577 446
<INCOME-PRETAX> 4,739 2,542 1,531
<INCOME-TAX> 2,334 (773) 130
<INCOME-CONTINUING> 2,405 3,315 1,400
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 2,405 3,315 1,400
<EPS-PRIMARY> $0.38 $0.77 $0.33
<EPS-DILUTED> $0.36 $0.74 $0.32

</TABLE>