Management’s Discussion and Analysis

Sales and Income

Sales
Amid this severe business climate, consolidated net sales forthe fiscal year ended March 31, 2003 increased 10.2 percent
from the prior fiscal year to ¥460.6 billion. Sales of theCompany’s core Semiconductor Production Equipment (SPE)division grew 12.0 percent, to ¥364.7 billion, supported byfavorable growth in sales of FPD manufacturing equipment
amid the slump in the semiconductor industry. The sales
growth of the Computer Network and Electronic Components
divisions also contributed to overall sales expansion.

Business Environment
In the fiscal year ended March 31, 2003, the global economy
showed signs of recovery at one point, but was derailed
again as accounting scandals at major U.S. firms, the downturn in stock markets worldwide, and the build up to the war
in Iraq spun the economies of the United States and Europe
sharply into decline. Conversely, in Asia, China’s economy
continued to expand strongly, and the economies of South
Korea and Taiwan also showed mild upturns. Meanwhile,
conditions in Japan’s economy took another turn for theworse under pressure from the unrelenting cooling off of private-sector capital investment and personal consumption.

Geographically, domestic sales rose 2.1 percent to ¥190.5
billion and overseas sales expanded 16.8 percent to ¥270.1
billion. As a result, the contribution of overseas sales to net
sales increased to 58.6 percent from 55.4 percent in the previous fiscal year.

In the electronics market, there was a recovery in demand forsome digital consumer products, such as DVD players anddigital cameras, but the mobile phone, PC, and communications devices markets remained at low ebb. Against this backdrop in semiconductor-related markets, postponements or
cutbacks in capital investment started to increase from lastsummer, resulting in a persistently difficult business environment. Moreover, the trend toward consolidation among semiconductor manufacturers has accelerated.

Consolidated orders received for the fiscal year under review
totaled ¥458.5 billion, jumping 55.3 percent from the previous fiscal year. The order backlogs at the fiscal year-end
edged down 1.3 percent to ¥150.7 billion.

Performance by Division•Semiconductor Production Equipment
Semiconductor manufacturers increased their desire for capital investment at the beginning of 2002 because the viewThousands of
U.S. dollars

Millions of yen (percentage of net sales)

2003

2002

2001

2003

Net sales¥460,580 (100.0)¥417,825 (100.0)¥723,880 (100.0)$3,831,782

Cost of sales

326,540

302,270

458,9022,716,637(70.9)(72.3)(63.4)

Gross profit

134,040(29.1)

115,555(27.7)

264,978(36.6)

1,115,145

SG&A expenses

132,921(28.9)

133,865(32.0)

143,892(19.9)

1,105,837

Operating income (loss)

1,119

(0.2)

(18,310)–

121,086(16.7)

9,308

Other income (expenses)(24,129)–(4,609)–(21,954)–(200,743)

Income (loss) before income taxes(23,010)–(22,919)–

99,132(13.7)(191,435)

Provision for income taxes

18,532(4.0)(2,990)–37,099(5.1)

154,180

Minority interest

12

(0.0)

8

(0.0)

21

(0.0)

100

Net income (loss)(41,554)–(19,938)–¥ 62,012(8.6)(345,715)

20Annual Report 2003 — Innovations Ahead

Consolidated orders of the SPE division for the fiscal year
ended March 31, 2003, amounted to ¥363.4 billion, recovering
75.4 percent from the previous fiscal year’s performance,
which was posted amid the worst conditions ever recorded in
the semiconductor industry. Consolidated sales climbed 12.0
percent to ¥364.7 billion. Contribution to consolidated sales
also rose slightly, increasing to 79.2 percent from 78.0 percent.
Sales of flat panel display (FPD) production equipment,
which are also included in this division, expanded significantly compared to last fiscal year. The supply and demand gap
for FPDs contracted during the fiscal year thanks to the progressive replacement of CRT monitors in PCs with LCD monitors and the growth of the new LCD television set market.
Encouraged by these trends, FPD manufacturers in South
Korea and in Taiwan increased their capital investments.
Performance by geographical region was mixed. Sales in
Korea, where capital investment in semiconductor memory

and FPD increased, rose 147.0 percent, to ¥57.3 billion. Sales
in the People’s Republic of China, where full-fledged capital
investment in semiconductor manufacture has gotten underway, surged 168.4 percent, to ¥20.1 billion. Sales in Taiwan
also rose, mainly due to increased purchases of FPD production equipment. On the other hand, sales in the U.S. market
fell 21.6 percent, to ¥74.3 billion under the impact of a reduction in capital investments, particularly for logic devices, bymajor customers.
Sales also varied considerably by product during the fiscal
year. Sales of thermal processing and thin-film formation systems increased thanks to the contributions of such new products as TELFORMULA™ and Trias™SPA. In addition, thedivision’s market share of oxidation etch systems and wafer
probers expanded as did sales. Sales of coaters/developers,
however, declined slightly because of the restraint in capital
investment in lithography equipment. In terms of wafer size,
capital investment in 300mm wafer manufacturing lines continued to rise among semiconductor manufacturers in the
United States and Korea as well as by the foundry manufacturers in Taiwan. In total, the sales portion of 300mm equipment is approaching 50 percent of our SPE sales.
Nevertheless, 200mm-manufacturing lines remain the mostappropriate for many ICs used in the small-lot-wide-variety
production of digital consumer products. Consequently, thedivision expects that demand for 200mm wafer manufacturing equipment will continue to underpin the market for thetime being.

242.2

355.1

619.0

325.7

364.7

96.7
97.4

94.7
74.3

28.3
28.0

23.2
57.3

60.5
67.0

7.5
20.1

460.6

1999

2000

2001

2002

2003

Japan

North Europe
America

Korea

TaiwanChina Southeast
Asia

Japan

270.1

231.3
2001

2002

2003

2002
2003

2000

190.5

1999

186.5

149.8

184.0

299.3

164.0

256.7

424.6

417.8

(¥ Billions)723.9

SPE division’s Sales by Geographic Region(¥ Billions)

440.7

SPE division’s Sales(¥ Billions)
313.8

Domestic and Overseas Sales

14.8
20.6

that inventories were low for some products was spreading
throughout the industry. However, semiconductor demand
did not continue to rise, resulting in excessive inventories
building up for many products, sidetracking a genuine recovery in the industry. During the second half, these conditions
produced a mixed response among semiconductor manufacturers, with some companies postponing capital investments
while others continued to invest.

Overseas
Sales by third-party products imported into Japan are included in Japan Sales

Tokyo Electron 21

•Computer Network
Amid continued severe economic conditions in Japan, net
sales of the Computer Network (CN) division edged forward
0.9 percent, to ¥17.2 billion. The division’s business is principally based on providing customers with Internet and storage area network (SAN) solutions.
One of the products contributing most to sales during the
fiscal year was NetScreen Technologies’ Firewall/VPN. A coreproduct of the division, F5 Networks’ Internet traffic management system also posted favorable sales growth and gained
considerable attention in the market for its high networkavailability and stability. SAN-related products also performed well, with original equipment manufacturing (OEM)sales of Brocade Communications Systems’ Fibre Channel
Fabric Switches climbing 1.3 times year on year. Establishinga base for future growth, TimesTen Performance Software’s
in-memory database products began to be utilized as infrastructure for soft switches in the voice over IP (VoIP) field during the fiscal year.
Among new developments, we established Procket
Networks Japan, Inc., a joint venture that will act as a basefor entry into the Japanese market by Procket Networks, Inc.,a Silicon Valley based communications device venture. The
Japanese joint venture, formed in collaboration with NTTCP

22

Communications, Inc., and Net One Systems Co., Ltd., ismarketing Procket Networks’ advanced packet communications technology products, such as its representative ultrahigh-end routers.
With our own proprietary Ruff Systems, we concentrated
especially on development during the fiscal year to strengthen functions in line with such trends as the progressive shift
to broadband and the digitization of television broadcasting.
Utilizing our accumulated technologies in networks and SAN,
we plan to offer Ruff Systems network as video solutions thatencompass the entire process from content management to
distribution.

•Electronic Components
Net sales for the Electronic Components (EC) division rose 5.1
percent to ¥77.4 billion. Sales growth was supported by strong
efforts to sell high-value-added semiconductor devices tocope with the difficult conditions caused by the less-than-fullrecovery in the semiconductor market. The division’s productlineup includes semiconductor devices, board computer products, software, and other electronic components.
Semiconductor products accounted for 88 percent of divisional net sales. Major contributors to sales growth included
Xilinx’s programmable logic devices (PLDs), for which applications are expanding in the consumer electronics market; Pixel

14.1

17.0

17.2

57.7

72.1

89.2

73.7

77.4

(¥ Billions)12.4

EC division’s Sales(¥ Billions)
12.9

CN division’s Sales

1999

2000

2001

2002

2003

1999

2000

2001

2002

2003

Annual Report 2003 — Innovations Ahead

Works’ custom ICs, which boast the number one share of themarket for image enhancement ICs for liquid crystal display(LCD) projectors; and Linear Technology’s analog ICs for
power sources, which enjoyed robust demand for use inmobile devices. Because they require technical support, thesehigh-value-added products provide a particular strong boost
to sales.

In the future, the division will aggressively market high-valueadded products that require technical support. At the sametime, it will improve and expand its lineup of products for digital consumers. Furthermore, the division will work to establish
a strong foundation as a “technology trading company” by
selling high-value-added products that require technical support, utilizing the technical capabilities of its design development centers to design and develop semi-custom ICs, andstrengthening development of original products.

Sales of motherboards, VME boards, and other boards struggled during the fiscal year, resulting in an overall slight decline
in the category. On the other hand, sales of software edged
forward thanks to expanded sales of operating system software for embedded system devices. Sales of general electronic components also advanced slightly due to increased salesof panel programmable controllers and power switches for
consumer electronics devices.

On March 7, 2003, Tokyo Electron Device Ltd., a subsidiary
operating the Electronic Components Division, went public,
listing its shares on the Second Section of the Tokyo Stock
Exchange.

Cost of Sales, SG&A Expenses and Operating
IncomeUtilizing the abundant experience of its design & development centers, the division offers a design service for semi-custom ICs such as PLD and ASIC on a contract basis as well as
developing its own products. In May 2002, the division established a dedicated sales force for its design services, and successfully increased the volume of orders. In proprietaryproduct development, the division created a variety of largescale integrated circuits (LSIs) that achieve synergies with distributing products handled by the division. Examples included
peripheral LSIs for Xilinx’s PLDs and a multi input-output controller for LCD projectors under an alliance with Pixel Works.

Although cost of sales increased 8.0 percent to ¥326.5 billion,
cost of sales as a percentage of net sales declined to 70.9
percent from 72.3 percent for the prior fiscal year. Although
downward pressure on prices by customers negatively affected profitability, the decrease in cost of sales as a percentageof net sales can be primarily attributed to reductions in the
production fixed cost and the increase in plant utilization
rates due to sales growth. Consequently, gross profit amounted to ¥134.0 billion, up 16.0 percent and gross margin rose
1.4 points to 29.1 percent.

Operating Income

R&D Expenses(¥ Billions)(¥ Billions)

Cash Dividends per Share& Payout Ratio

26.8

37.1

52.9

53.8

50.1

12.00

2003

1999

2000

2001

2002

2003

1999

8.00

1.1

2002

8.00

-18.3

2001

38.00

121.1

2000

14.00

35.8

1999

2001

-3.34

10.74

2000

-7.02

12.35

112.14

6.4(¥ / %)

2002

2003

Cash Dividends per Share
Payout Ratio

Tokyo Electron 23

Selling, general and administrative expenses decreased 0.7
percent to ¥132.9 billion. Based on efforts to be selective andfocused in R&D projects that the Company undertakes, R&D
expenses, which are included in SG&A expenses, decreased
6.9 percent to ¥50.1 billion year on year. R&D expenses wereallocated principally to the development of 90 nanometerand-smaller design rule process technology and equipment
as well as new technology.
As a result of the increase in gross profit and the decline in
SG&A expenses, operating income improved ¥19.4 billion
from the ¥18.3 billion loss in the prior fiscal year, to ¥1.1 billion.

Impact of Fluctuation in Foreign Currency
Exchange Rates on Performance
Changes in exchange rates have no material effect on Tokyo
Electron’s results because exports from Japan are generally
denominated in yen. While some settlements are denominated in U.S. dollars, exchange risk is hedged by concluding forward exchange contracts individually at the time orders arereceived. Also, the contribution of foreign currency-denominated transactions involving foreign-made merchandise
imported to Japan is comparatively low and did not have amaterial effect in the year ended March 31, 2003.

Financial Position and Cash Flows
Other Income (Expenses) and Net Income
Financial Position
Net other expenses expanded by ¥19.5 billion to ¥24.1 billion.
The increase can be mainly attributed to an extraordinary lossof ¥20.6 billion related to restructuring expenses. Major
expenses included ¥10.0 billion in devaluation of inventories
that will be disposed and ¥7.8 billion for an expenses reserve
related to the planned reduction of employees in the fiscal
year ending March 2004. Income before income taxes
declined ¥100 million from the prior fiscal year to a loss of¥23.0 billion.
Based on a decision on the potential recovery of deferred tax
assets, a reversal from the deferred tax assets account resulted in provision income taxes of ¥18.5 billion in the fiscal year
under review. Consolidated net loss, therefore, expanded¥21.6 billion, to ¥41.6 billion. Consequently, net loss per sharefell from ¥113.85 to ¥238.57. Cash dividends were ¥8.00 per
share, the same as in the prior fiscal year.

24

Annual Report 2003 — Innovations Ahead

Current assets at March 31, 2003 expanded 0.9 percent year
on year to ¥356.4 billion. Among the main factors in thisincrease were a ¥14.2 billion rise in trade notes and accounts
receivable along with greater sales and a ¥4.6 billion increasein cash and cash equivalents. Inventory, however, declined¥15.5 billion by devaluation and so forth. Excluding accounts
receivable—others, trade notes and accounts receivable
turnover based at the end of fiscal year improved to 135
days, compared with 138 days for the prior fiscal year, andinventory turnover improved to 89 days, compared with 111
days in the previous fiscal year.
Property, plant and equipment declined 11.1 percent to¥119.6 billion year on year. The primary factors contributing
to the decline were the sale of land and buildings by Tokyo

Electron Oregon, LLC and an evaluation loss on buildings
owned by Tokyo Electron Texas, LLC. During the fiscal year,
Tokyo Electron invested ¥12.4 billion in property, plant andequipment, consisting primarily of the purchase of equipment for evaluation and IT-related purchases.

lion, primarily because of the drop in fixed assets.
Current liabilities expanded 46.8 percent to ¥160.7 billion.
There were two major factors behind this increase. There wasan increase in trade notes and accounts payable due togreater procurement necessary for the higher productionlevels. Also, a ¥5.2 billion decline in short-term borrowings
was offset by a ¥25.0 billion increase in commercial paper. In
addition, the outstanding balance of ¥15.5 billion for the
September 2003 scheduled redemption of the 2nd convertible bond was transferred from long-term to current liabilities. Furthermore, a ¥8.6 billion reserve was set up in
preparation for a series of business restructuring measures.

Investments and other assets dropped 29.2 percent to ¥48.9
billion. The main factors in the decrease in investments andother assets were the ¥13.2 billion fall in deferred tax assets
compared with the previous fiscal year and a ¥2.3 billion
decrease in investments in securities due to mark-to-market
adjustments. Total assets declined 5.7 percent to ¥524.9 bil-Thousands of
U.S. dollars

Millions of yen (percentage of total assets)

Total assets

2003

2002

2003

¥524,901 (100.0)¥556,915 (100.0)$4,366,899

Cash and cash equivalents

52,982(10.1)

48,409(8.7)

440,784

Trade notes and accounts receivable

182,218(34.7)

167,982(30.2)

1,515,953

Inventories

111,810(21.3)

127,352(22.9)

930,201

Investments and other assets

48,851(9.3)

68,981(12.4)

406,419

Property, plant and equipment

119,611(22.8)

134,511(24.2)

995,101

Total liabilities

268,402(51.1)

249,278(44.8)

2,232,958

Short-term borrowings

8,729

(1.7)

13,924(2.5)

72,623

Trade notes and accounts payable

48,279(9.2)

41,053(7.4)

401,656

Accrued income taxes

3,645

(0.7)

1,663

(0.3)

30,325Long-term debt, less current portion

70,230(13.4)

105,452(18.9)

584,271

Shareholders’ equity

252,904(48.2)¥307,579(55.2)

2,104,029

0.45

0.62

0.51

0.60

1999

0.39

2003

195.7

2002

(Times)
243.9

2001

309.8

221.7

2000

228.7

12.4

1999

Debt-to-Equity Ratio

1999

2000

2001

2002

2003

2000

2001

2.2

2.3

2.6

3.2

4.2

30.9

(¥ Billions / Times)
49.4(¥ Billions)
19.0

Working Capital &Current Ratio

16.9

Capital Expenditure for
Property, Plant and Equipment

2002

2003

Working Capital
Current Ratio

Tokyo Electron 25

Working capital contracted to ¥195.7 billion from ¥243.9 billion in the previous fiscal year, and the current ratio declined
to 2.2 to 1 from 3.2 to 1 a year earlier.

flow, defined as the sum of net income and depreciation andamortization, dropped from ¥6.4 billion to minus ¥14.2 billion. Growth in accounts receivables due to increased sales
contributed to the decline in net cash flow provided by operating activities.

Because of the transfer of the current portion of convertible
and straight bonds to current liabilities, Tokyo Electron’slong-term debt declined 23.0 percent year on year to ¥107.7
billion.

Net cash used in investing activities was ¥7.3 billion, downfrom ¥35.8 billion in the prior fiscal year. Investment in property, plant and equipment totaling ¥7.0 billion mainly comprised the purchase of equipment for R&D.

The balance of equity-linked bonds outstanding at March 31,
2003 was ¥25.5 billion.

Net cash used in financing activities amounted to ¥9.9 billion
compared with ¥57.2 billion a year earlier. Tokyo Electron
had significant outlays during the fiscal year related to theredemption of the 6th unsecured bond issue, the repaymentof short-term borrowings, the acquisition of treasury stock,and the payment of dividends. These outlays were offset,
however, by proceeds from the issue of commercial paperand from the initial public offering of Tokyo Electron Device.
Cash and cash equivalents at the end of the year totaled¥53.0 billion, up ¥4.6 billion from ¥48.4 billion at the end of
the prior fiscal year.

Shareholders’ equity decreased 17.8 percent to ¥252.9 billion, due to the contraction in retained earnings and theincrease of treasury stock. As a percentage of total assets,shareholders’ equity declined to 48.2 percent from 55.2 percent a year earlier. Return on average total shareholders’equity was minus 14.8 percent.

Cash FlowsNet cash provided by operating activities amounted to ¥21.4
billion, decreasing from ¥77.6 billion a year earlier. Net cash

19.8

39.3

83.7

6.4

-14.2

1999

252.9

2003

307.6

2002

333.3

2001

1999

2000

2001

2002

2003

2001

-14.8

2000

-6.2

0.7

20.4

257.7

2000

273.6

48.2

1999

7.5

55.2

(¥ Billions)

45.7

Net Cash Flow(¥ Billions / %)54.8

Shareholders’ Equity & ROE

(%)
62.1

Shareholders’ Equity Ratio

2002

2003

Shareholders’ Equity
Return on Equity
Net Cash Flow =Net income + Depreciation and Amortization

26

Annual Report 2003 — Innovations Ahead