**UNITEDSTATES SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C.  20549**

 

**FORM 10-Q**

 

| **ý** |   | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                          |
|------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |   | **For the Quarterly  Period Ended March 31, 2004**                                                                                                                                                                                    |
|       |   |                                                                                                                                                                                                                                       |
|       |   | **OR**                                                                                                                                                                                                                                     |
|       |   |                                                                                                                                                                                                                                       |
| **o**      |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE EXCHANGE ACT OF 1934**                                                                                                                                                    |
|       |   | **For the Transition Period from                    to                  ** |

 

**Commission file number 0-21321**

 

**CYMER, INC.**

(Exact name of registrant as specified in itscharter)

 

| **Nevada**                                                       |   | **33-0175463**                       |
|------------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of  incorporation or  organization) |   | (I.R.S. Employer Identification No.) |
|                                                             |   |                                 |
| **17075 Thornmint Court, San Diego, CA**                         |   | **92127**                            |
| (Address of principal executive offices)                         |   | (Zip Code)                           |

 

Registrant’s telephone number, including area code:           **(858) 385-7300**

 

Former name, former address and former fiscal year, if changed sincelast report.

**  N/A**

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Actof 1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

 

Yes   ý    No  o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Act). Yes  ý     No  o

 

The number of shares of Common Stock, with $0.001 par value,outstanding on May 3, 2004 was 36,753,713.

 

 

----

 

**CYMER,INC.**

 

**FORM10-Q**

 

**Forthe Quarterly Period Ended March 31, 2004**

 

**INDEX**

 

 
| **PART I.**        | **FINANCIAL INFORMATION**                                                                      |   |
|--------------------|------------------------------------------------------------------------------------------------|--------|
|               |                                                                                           |   |
| ITEM 1.            | Consolidated Financial Statements (unaudited)                                                  |   |
|               |                                                                                           |   |
|               | Consolidated Balance Sheets as of  December 31, 2003 and March 31, 2004              |   |
|               |                                                                                           |   |
|               | Consolidated Statements of Operations for  the three months ended March 31, 2003 and 2004 |   |
|               |                                                                                           |   |
|               | Consolidated Statements of Cash Flows for  the three months ended March 31, 2003 and 2004 |   |
|               |                                                                                           |   |
|               | Notes to Consolidated Financial Statements                                                     |   |
|               |                                                                                           |   |
| ITEM 2.            | Management’s  Discussion and Analysis of Financial Condition and Results of Operations    |   |
|               |                                                                                           |   |
| ITEM  3.           | Quantitative  and Qualitative Disclosures About Market Risk                                    |   |
|               |                                                                                           |   |
| ITEM 4.            | Controls  and Procedures                                                                       |   |
|               |                                                                                           |   |
| **PART II.**       | **OTHER INFORMATION**                                                                          |   |
|               |                                                                                           |   |
| ITEM 1.            | Legal  Proceedings                                                                             |   |
|               |                                                                                           |   |
| ITEM 2.            | Changes  in Securities and Use of Proceeds                                                     |   |
|               |                                                                                           |   |
| ITEM 3.            | Defaults  Upon Senior Securities                                                               |   |
|               |                                                                                           |   |
| ITEM 4.            | Submission of Matters to a Vote of Security  Holders                                           |   |
|               |                                                                                           |   |
| ITEM 5.            | Other  Information                                                                             |   |
|               |                                                                                           |   |
| ITEM 6.            | Exhibits  and Reports on Form 8-K                                                              |   |
|               |                                                                                           |   |
| **SIGNATURE PAGE** |                                                                                           |

 

2

----

 

### **PART I. FINANCIAL INFORMATION**

 

 

**ITEM1.  Financial Statements**

 

**CYMER,INC.**

**CONSOLIDATEDBALANCE SHEETS (UNAUDITED)**

**(Inthousands, except share data)**

 
|                                                                                                                                                                                         |   | **December 31,  2003** |    | **March 31,  2004** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|---------|--------------------------|--------|
| **ASSETS**                                                                                                                                                                                   |   |                        |    |                     |   |
|                                                                                                                                                                                         |   |                        |    |                     |   |
| CURRENT ASSETS:                                                                                                                                                                              |   |                        |    |                     |   |
| Cash and cash equivalents                                                                                                                                                                    |   | $                           | 230,657 |                     | $      | 242,562 |   |
| Short-term investments                                                                                                                                                                       |   | 93,474                      |    | 82,078                   |   |
| Accounts receivable – net                                                                                                                                                               |   | 62,819                      |    | 79,141                   |   |
| Inventories                                                                                                                                                                                  |   | 93,012                      |    | 98,209                   |   |
| Deferred income taxes                                                                                                                                                                        |   | 1,407                       |    | 1,422                    |   |
| Prepaid expenses and other assets                                                                                                                                                            |   | 5,513                       |    | 6,038                    |   |
| Total current assets                                                                                                                                                                         |   | 486,882                     |    | 509,450                  |   |
|                                                                                                                                                                                         |   |                        |    |                     |   |
| PROPERTY AND EQUIPMENT – NET                                                                                                                                                            |   | 128,849                     |    | 127,265                  |   |
| LONG-TERM INVESTMENTS                                                                                                                                                                        |   | 77,509                      |    | 74,297                   |   |
| DEFERRED INCOME TAXES                                                                                                                                                                        |   | 80,711                      |    | 80,715                   |   |
| GOODWILL –   NET                                                                                                                                                                   |   | 7,647                       |    | 8,358                    |   |
| INTANGIBLE ASSETS – NET                                                                                                                                                                 |   | 12,925                      |    | 12,292                   |   |
| OTHER ASSETS                                                                                                                                                                                 |   | 8,698                       |    | 8,545                    |   |
|                                                                                                                                                                                         |   |                        |    |                     |   |
| TOTAL ASSETS                                                                                                                                                                                 |   | $                           | 803,221 |                     | $      | 820,922 |   |
|                                                                                                                                                                                         |   |                        |    |                     |   |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                                                                                               |   |                        |    |                     |   |
|                                                                                                                                                                                         |   |                        |    |                     |   |
| CURRENT LIABILITIES:                                                                                                                                                                         |   |                        |    |                     |   |
| Accounts payable                                                                                                                                                                             |   | $                           | 19,099  |                     | $      | 19,461 |   |
| Accrued warranty and installation                                                                                                                                                            |   | 26,486                      |    | 26,726                   |   |
| Accrued payroll and benefits                                                                                                                                                                 |   | 7,196                       |    | 9,929                    |   |
| Accrued patents, royalties and other fees                                                                                                                                                    |   | 8,436                       |    | 7,348                    |   |
| Foreign currency forward exchange contracts                                                                                                                                                  |   | 6,401                       |    | 5,657                    |   |
| Income taxes payable                                                                                                                                                                         |   | 16,473                      |    | 18,563                   |   |
| Accrued and other current liabilities                                                                                                                                                        |   | 4,945                       |    | 3,953                    |   |
| Total current liabilities                                                                                                                                                                    |   | 89,036                      |    | 91,637                   |   |
|                                                                                                                                                                                         |   |                        |    |                     |   |
| CONVERTIBLE SUBORDINATED NOTES                                                                                                                                                               |   | 250,000                     |    | 250,000                  |   |
| OTHER LIABILITIES                                                                                                                                                                            |   | 5,660                       |    | 5,846                    |   |
| MINORITY INTEREST                                                                                                                                                                            |   | 5,195                       |    | 4,680                    |   |
|                                                                                                                                                                                         |   |                        |    |                     |   |
| COMMITMENTS AND CONTINGENCIES                                                                                                                                                                |   |                        |    |                     |   |
|                                                                                                                                                                                         |   |                        |    |                     |   |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                   |   |                        |    |                     |   |
| Preferred stock – authorized 5,000,000  shares; $.001 par value, no shares issued or outstanding                                                                                        |   | —                      |    | —                   |   |
| Common stock – $.001 par value per share;  100,000,000 shares authorized; 36,345,000 and 36,679,000 shares outstanding  at December 31, 2003 and March 31, 2004, respectively |   | 36                          |    | 37                       |   |
| Additional paid-in capital                                                                                                                                                                   |   | 358,988                     |    | 367,205                  |   |
| Unearned compensation                                                                                                                                                                        |   | (146                        | )       | (111                     | )      |
| Accumulated other comprehensive loss                                                                                                                                                         |   | (5,734                      | )       | (5,714                   | )      |
| Retained earnings                                                                                                                                                                            |   | 100,186                     |    | 107,342                  |   |
| Total stockholders’ equity                                                                                                                                                              |   | 453,330                     |    | 468,759                  |   |
|                                                                                                                                                                                         |   |                        |    |                     |   |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                              |   | $                           | 803,221 |                     | $      | 820,922 |   |

 

See Notes to Unaudited Consolidated FinancialStatements.

 

3

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**CYMER,INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS(UNAUDITED)**

**(Inthousands, except per share data)**

 
|                                                                      |   | **For the  three months ended  March 31,** |   |
|---------------------------------------------------------------------------|--------|-------------------------------------------------|--------|
|                                                                      |   | **2003**                                        |   | **2004** |   |
|                                                                      |   |                                            |   |   |   |
| REVENUES:                                                                 |   |                                            |   |   |   |
| Product sales                                                             |   | $                                               | 67,336 |   | $ | 87,871 |   |
| Other                                                                     |   | 57                                              |   | 50 |   |
| Total revenues                                                            |   | 67,393                                          |   | 87,921 |   |
|                                                                      |   |                                            |   |   |   |
| COSTS AND EXPENSES:                                                       |   |                                            |   |   |   |
| Cost of product sales                                                     |   | 42,870                                          |   | 52,168 |   |
| Research and development                                                  |   | 17,318                                          |   | 12,370 |   |
| Sales and marketing                                                       |   | 4,094                                           |   | 5,823 |   |
| General and administrative                                                |   | 5,773                                           |   | 6,615 |   |
| Amortization of intangible assets                                         |   | 40                                              |   | 40 |   |
|                                                                      |   |                                            |   |   |   |
| Total costs and expenses                                                  |   | 70,095                                          |   | 77,016 |   |
|                                                                      |   |                                            |   |   |   |
| OPERATING INCOME (LOSS)                                                   |   | (2,702                                          | )      | 10,905 |   |
|                                                                      |   |                                            |   |   |   |
| OTHER INCOME (EXPENSE):                                                   |   |                                            |   |   |   |
| Foreign currency exchange (loss) gain – net                          |   | (360                                            | )      | 54 |   |
| Interest and other income                                                 |   | 2,489                                           |   | 1,896 |   |
| Interest and other expense                                                |   | (2,475                                          | )      | (2,556 | ) |
|                                                                      |   |                                            |   |   |   |
| Total other expense – net                                            |   | (346                                            | )      | (606 | ) |
|                                                                      |   |                                            |   |   |   |
| INCOME (LOSS) BEFORE INCOME TAX PROVISION  AND MINORITY INTEREST          |   | (3,048                                          | )      | 10,299 |   |
|                                                                      |   |                                            |   |   |   |
| INCOME TAX PROVISION                                                      |   | —                                          |   | 2,369 |   |
| MINORITY INTEREST                                                         |   | (314                                            | )      | (774 | ) |
|                                                                      |   |                                            |   |   |   |
| EARNINGS (LOSS)                                                           |   | $                                               | (3,362 | ) | $ | 7,156 |   |
|                                                                      |   |                                            |   |   |   |
| EARNINGS (LOSS) PER SHARE:                                                |   |                                            |   |   |   |
| Basic earnings (loss) per share                                           |   | $                                               | (0.10  | ) | $ | 0.20 |   |
| Weighted average common shares outstanding                                |   | 34,306                                          |   | 36,586 |   |
|                                                                      |   |                                            |   |   |   |
| Diluted earnings (loss) per share                                         |   | $                                               | (0.10  | ) | $ | 0.19 |   |
| Weighted average common and dilutive  potential common shares outstanding |   | 34,306                                          |   | 38,141 |   |

 

See Notes to Unaudited Consolidated Financial Statements.

 

4

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**CYMER,INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS(UNAUDITED)**

**(Inthousands)**

 
|                                                                                                |   | **For the  three months ended  March 31,** |    |
|-----------------------------------------------------------------------------------------------------|--------|-------------------------------------------------|---------|
|                                                                                                |   | **2003**                                        |    | **2004** |   |
|                                                                                                |   |                                            |    |   |   |
| OPERATING ACTIVITIES:                                                                               |   |                                            |    |   |   |
| Net income (loss)                                                                                   |   | $                                               | (3,362  | ) | $ | 7,156 |   |
| Adjustments to reconcile net income (loss)  to net cash provided by (used in) operating activities: |   |                                            |    |   |   |
| Depreciation and amortization                                                                       |   | 7,974                                           |    | 6,909 |   |
| Non-cash stock-based compensation                                                                   |   | 397                                             |    | 104 |   |
| Amortization of unearned compensation                                                               |   | 277                                             |    | 35 |   |
| Minority interest                                                                                   |   | 314                                             |    | 774 |   |
| Provision for deferred income taxes                                                                 |   | —                                          |    | (32 | ) |
| Loss on disposal and impairment of property  and equipment                                          |   | 194                                             |    | 61 |   |
| Change in assets and liabilities:                                                                   |   |                                            |    |   |   |
| Accounts receivable – net                                                                      |   | (13,261                                         | )       | (16,322 | ) |
| Foreign currency forward exchange contracts                                                         |   | (57                                             | )       | (640 | ) |
| Inventories                                                                                         |   | (4,244                                          | )       | (5,197 | ) |
| Prepaid expenses and other assets                                                                   |   | 303                                             |    | (690 | ) |
| Accounts payable                                                                                    |   | (250                                            | )       | 362 |   |
| Accrued expenses and other liabilities                                                              |   | (4,128                                          | )       | 7,081 |   |
| Income taxes payable                                                                                |   | (1,596                                          | )       | 2,090 |   |
|                                                                                                |   |                                            |    |   |   |
| Net cash provided by (used in) operating  activities                                                |   | (17,439                                         | )       | 1,691 |   |
|                                                                                                |   |                                            |    |   |   |
| INVESTING ACTIVITIES:                                                                               |   |                                            |    |   |   |
| Acquisition of property and equipment                                                               |   | (27,155                                         | )       | (4,435 | ) |
| Purchases of investments                                                                            |   | (25,321                                         | )       | (56,108 | ) |
| Proceeds from sold or matured investments                                                           |   | 36,953                                          |    | 70,397 |   |
| Acquisition of patents (1)                                                                          |   | —                                          |    | (5,990 | ) |
| Acquisition of minority interest                                                                    |   | (180                                            | )       | (2,000 | ) |
|                                                                                                |   |                                            |    |   |   |
| Net cash provided by (used in) investing  activities                                                |   | (15,703                                         | )       | 1,864 |   |
|                                                                                                |   |                                            |    |   |   |
| FINANCING ACTIVITIES:                                                                               |   |                                            |    |   |   |
| Net borrowings under revolving loan and  security agreements                                        |   | 3,334                                           |    | — |   |
| Proceeds from issuance of common stock                                                              |   | 2,466                                           |    | 8,113 |   |
| Payments on capital lease obligations                                                               |   | (13                                             | )       | (12 | ) |
|                                                                                                |   |                                            |    |   |   |
| Net cash provided by financing activities                                                           |   | 5,787                                           |    | 8,101 |   |
|                                                                                                |   |                                            |    |   |   |
| EFFECT OF EXCHANGE RATE CHANGES ON CASH AND  CASH EQUIVALENTS                                       |   | (1,046                                          | )       | 249 |   |
|                                                                                                |   |                                            |    |   |   |
| NET INCREASE (DECREASE) IN CASH AND CASH  EQUIVALENTS                                               |   | (28,401                                         | )       | 11,905 |   |
| CASH AND CASH EQUIVALENTS AT BEGINNING OF  THE PERIOD                                               |   | 196,643                                         |    | 230,657 |   |
|                                                                                                |   |                                            |    |   |   |
| CASH AND CASH EQUIVALENTS AT END OF THE  PERIOD                                                     |   | $                                               | 168,242 |   | $ | 242,562 |   |

 

 

5

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|                                               |   | **For the  three months ended  March 31,** |   |
|----------------------------------------------------|--------|-------------------------------------------------|--------|
|                                               |   | **2003**                                        |   | **2004** |   |
|                                               |   |                                            |   |   |   |
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW  INFORMATION: |   |                                            |   |   |   |
| Interest paid                                      |   | $                                               | 4,431  |   | $ | 4,435 |   |
| Income taxes paid, net                             |   | $                                               | 1,963  |   | $ | 840 |   |

 
| (1) |   | These patents were aquired in the fourth quarter of 2003 and the  ayment was accrued.  Payment for these  patents was made in the first quarter of 2004. |
|-----|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

See Notes to Unaudited Consolidated Financial Statements.

 

6

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**CYMER,INC.**

 

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**ThreeMonths Ended March 31, 2004**

**(Unaudited)**

 

**1.****              BASISOF PRESENTATION**

 

*Unaudited Interim Financial Data* – Theaccompanying consolidated financial information has been prepared by Cymer,Inc., and its wholly-owned and majority-owned subsidiaries (collectively,“Cymer”), without audit, in accordance with the instructions to Form 10-Q. Inthe opinion of management, the unaudited consolidated financial statements forthe interim periods presented reflect all material adjustments, consisting onlyof normal recurring adjustments, necessary for a fair presentation of thefinancial position and results of operations as of and for such periodsindicated.  These consolidated financialstatements and notes hereto should be read in conjunction with the consolidatedfinancial statements and notes thereto included in Cymer’s Annual Report onForm 10-K for the year ended December 31, 2003.  Results for the interim periods presented herein are notnecessarily indicative of results which may be reported for any other interimperiod or for the entire fiscal year.

 

*Principles of Consolidation* – The consolidatedfinancial statements include the accounts of Cymer, Inc., its wholly-ownedsubsidiaries – Cymer Japan, Inc. (“Cymer Japan”), Cymer Singapore Pte Ltd.(“Cymer Singapore”), Cymer B.V. in the Netherlands (“Cymer B.V.”), CymerSoutheast Asia, Ltd, in Taiwan (“Cymer SEA”), Cymer Semiconductor Equipment Shanghai Co., Ltd, in the People’sRepublic of China (“Cymer PRC”), and its majority-owned subsidiary, CymerKorea, Inc. (“Cymer Korea”).  Cymer,Inc. owns 81% of Cymer Korea.  InFebruary 2004, Cymer acquired 6% of the remaining 25% minority interest inits majority-owned subsidiary, Cymer Korea. Cymer paid a total of $2.0 million for this 6% interest and recorded$1.3 million of the $2.0 million as an additional investment in Cymer Korea andthe remaining $711,000 as goodwill. This transaction increased Cymer’s total interest in Cymer Korea from75% to 81%.  During 2002, Active ControleXperts, Inc. or ACX was a wholly-owned subsidiary of Cymer, Inc.  Effective January 1, 2003, ACX wasmerged with and into Cymer, Inc.  Cymersells its excimer light sources in Japan primarily through Cymer Japan. CymerSEA, Cymer PRC, Cymer Singapore and Cymer B.V. are field service offices forcustomers in those respective regions. Cymer Korea provides refurbishment manufacturing, field service, andadministrative activities for that region. All significant intercompanybalances have been eliminated in consolidation.

 

*AccountingEstimates* – The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesof America requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period.  Actual results may differ from thoseestimates.

 

*Accounting Pronouncements Adopted*–**In January 2003,the FASB issued Interpretation No. 46 (“FIN 46”), “Consolidation of VariableInterest Entities”.  FIN 46 providesguidance on how to identify a variable interest entity (VIE) and determineswhen the assets, liabilities, and results of operations of a VIE need to beincluded in a company’s consolidated financial statements.  FIN 46 also requires additional disclosuresby primary beneficiaries and other significant variable interest holders in aVIE.  The provisions of FIN 46 areeffective immediately for all VIEs created after January 31, 2003.  For VIEs created before February 1,2003, the provisions of FIN 46 must be adopted at the beginning of the firstinterim or annual reporting period beginning after December 15, 2003.  Cymer does not believe that it is subject tothe consolidation or disclosure requirements of FIN 46, and the adoption ofthis interpretation did not have a material effect on the consolidatedfinancial statements.

 

7

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In December 2003, FASB issued Interpretation No.46R, “Consolidation of Variable Interest Entities”, which supersedes FIN46.  The application of the revisedinterpretation is required in the financial statements of companies that haveinterests in special purpose entities for periods after December 15, 2003.  The application of this interpretation didnot have a material effect on the consolidated financial statements.

 

*Reclassifications*–Certain amounts in the prior year consolidated financial statements have beenreclassified to conform to current period presentation.

 

**2.****             ****STOCK-BASED COMPENSATION**

 

Cymer applies the intrinsic value-based method ofaccounting prescribed by Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”,and related interpretations including FASB Interpretation No. 44, “Accounting for Certain Transactionsinvolving Stock Compensation an interpretation of APB Opinion No. 25”**toaccount for its stock option plans. Under this method, employee-based stock compensation expense is measuredon the date of grant only if the then current market price of the underlyingstock exceeded the exercise price and is recorded on a straight-line basis overthe applicable vesting period. Statement of Financial Accounting Standards Board No. 123 (“SFAS No. 123”) “Accounting for Stock-Based Compensation”,established accounting and disclosure requirements using a fair value-basedmethod of accounting for stock-based employee compensation plans.  As allowed by SFAS No. 123, Cymer haselected to continue to apply the intrinsic value-based method of accountingdescribed above, and has adopted the disclosure requirements of SFASNo. 123, as amended by SFAS No. 148, “Accounting for Stock-BasedCompensation—Transition and Disclosure”*.*

 

Alloptions granted under the plans had an exercise price equal to the market valueof the underlying common stock on the date of grant.

 

Cymer accounts for options granted to non-employeesunder SFAS No. 123 and EITF Issue No. 96-18, “Accounting for Equity Instrumentsthat are Issued to other than Employees for Acquiring or in Conjunction withSelling Goods or Services”.  Cymermeasures the fair value of such options using the Black-Scholes option-pricingmodel at each financial reporting date. Cymer accounts for changes in fair values between reporting dates inaccordance with Financial Accounting Interpretation 28.  Stock-based compensation expense for optionsgranted to non-employees and for those employees who changed status for thethree months ended March 31, 2003 and 2004 was $395,000 and $100,000, respectively.

 

Under SFAS 123, the weighted average per share fairvalue of the options granted for the three months ended March 31, 2003 and2004 was $19.72 and $26.81, respectively, on the date of grant.  Fair value under SFAS 123 is determinedusing the Black-Scholes option-pricing model with the assumptions notedbelow.  For risk free interest, Cymeruses the then currently available rate on zero coupon U.S. Government issueswith a remaining life of five years for valuing options and one year for ESPP.

 
|                                  |   | **Three  months ended March 31,** |   |
|---------------------------------------|--------|----------------------------------------|--------|
|                                  |   | **2003**                               |   | **2004** |   |
|                                  |   |                                   |   |   |   |
| Dividend yield                        |   | None                                   |   | None |   |
| Volatility rate                       |   | 83%                                    |   | 79% |   |
| Weighted average risk free interest : |   |                                   |   |   |   |
| Options                               |   | 2.91%                                  |   | 2.98% |   |
| ESPP                                  |   | N/A                                    |   | N/A |   |
| Assumed forfeiture rate               |   | 5%                                     |   | 5% |   |
| Expected life:                        |   |                                   |   |   |   |
| Options                               |   | 6 years                                |   | 6 years |   |
| ESPP                                  |   | .5 years                               |   | .5 years |   |

 

8

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The following tablecompares earnings (loss) per share as reported by Cymer to the pro formaamounts that would be reported had compensation expense been recognized forCymer’s stock-based compensation plans in accordance with SFAS No. 123 (inthousands, except per share amounts):

 
|                                                                                                                                              |   | **Three  months ended March 31,** |    |
|---------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------|---------|
|                                                                                                                                              |   | **2003**                               |    | **2004** |   |
|                                                                                                                                              |   |                                   |    |   |   |
| Net income (loss), as reported                                                                                                                    |   | $                                      | (3,362  | ) | $ | 7,156 |   |
| Deduct: Total stock-based employee  compensation expense determined under the fair value based method for all  awards, net of related tax effects |   | (8,253                                 | )       | (4,102 | ) |
|                                                                                                                                              |   |                                   |    |   |   |
| Pro forma net income (loss)                                                                                                                       |   | $                                      | (11,615 | ) | $ | 3,054 |   |
|                                                                                                                                              |   |                                   |    |   |   |
| Earnings (loss) per share:                                                                                                                        |   |                                   |    |   |   |
| Basic – as reported                                                                                                                          |   | $                                      | (0.10   | ) | $ | 0.20 |   |
| Basic – pro forma                                                                                                                            |   | $                                      | (0.34   | ) | $ | 0.08 |   |
|                                                                                                                                              |   |                                   |    |   |   |
| Diluted – as reported                                                                                                                        |   | $                                      | (0.10   | ) | $ | 0.19 |   |
| Diluted – pro forma                                                                                                                          |   | $                                      | (0.34   | ) | $ | 0.08 |   |

 

**3.****              EARNINGS(LOSS) PER SHARE**

 

*Earnings**(Loss) PerShare* – Basic earnings (loss) per share ("EPS") excludesdilution and is computed by dividing net income or loss attributable to commonstockholders by the weighted-average of common shares outstanding for theperiod.  Diluted EPS reflects thepotential dilution that could occur if securities or other contracts to issuecommon stock (convertible subordinated notes, warrants to purchase common stockand common stock options using the treasury stock method) were exercised orconverted into common stock.  Potentialdilutive securities are excluded from the diluted EPS computation in lossperiods as their effect would be anti-dilutive.

 

The following table sets forth thecomputation of diluted weighted average common and potential common sharesoutstanding for the three months ended March 31, 2003 and 2004,respectively (in thousands):

 
|                                                                     |   | **Three  months ended  March 31,** |   |
|--------------------------------------------------------------------------|--------|-----------------------------------------|--------|
|                                                                     |   | **2003**                                |   | **2004** |   |
|                                                                     |   |                                    |   |   |   |
| Basic weighted average common shares  outstanding                        |   | 34,306                                  |   | 36,586 |   |
|                                                                     |   |                                    |   |   |   |
| Effect of dilutive securities:                                           |   |                                    |   |   |   |
| Warrants                                                                 |   | —                                  |   | 50 |   |
| Options                                                                  |   | —                                  |   | 1,505 |   |
|                                                                     |   |                                    |   |   |   |
| Diluted weighted average common and  potential common shares outstanding |   | 34,306                                  |   | 38,141 |   |

 

9

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Forthe three months ended March 31, 2003 and 2004, weighted average optionsand warrants to purchase 3,738,000 and 824,000 shares of common stock,respectively, were outstanding but not included in the computation of dilutedearnings per share as their effect was anti-dilutive.  In addition, for the three months ended March 31, 2003 and2004, weighted average common shares attributable to convertible subordinatednotes of 5,000,000 were not included in the computation of diluted earnings pershare as their effect was also anti-dilutive.

 

**4.****              INVENTORIES**

 

Inventoriesconsist of the following as of December 31, 2003 and March 31, 2004(in thousands):

 
|                                        |   | **December 31,  2003** |   | **March 31,  2004** |   |
|---------------------------------------------|--------|-----------------------------|--------|--------------------------|--------|
| INVENTORIES:                                |   |                        |   |                     |   |
| Raw materials                               |   | $                           | 37,393 |                     | $      | 39,511 |   |
| Work-in-progress                            |   | 26,949                      |   | 30,725                   |   |
| Finished goods                              |   | 40,698                      |   | 42,258                   |   |
| Allowance for excess and obsolete inventory |   | (12,028                     | )      | (14,285                  | )      |
| Total                                       |   | $                           | 93,012 |                     | $      | 98,209 |   |

 

**5.****              REPORTINGCOMPREHENSIVE INCOME**

 

Comprehensive income (loss) includes netincome (loss), effective unrealized gains and losses on foreign currencyforward exchange contracts, foreign currency translation adjustments, andunrealized gains and losses on available-for-sale securities, which arerecorded as short-term and long-term investments in the accompanyingconsolidated balance sheets.

 

The following table summarizes the change in eachcomponent of accumulated other comprehensive income (loss) for the three monthsended March 31, 2004 (in thousands):

 
|                    |   |              |   | **Translation  adjustment,  net of tax** |   | **Total  unrealized  gains on  available-for-sale  investments,  net of tax** |   | **Total  unrealized  gains (losses) on  foreign currency  forward exchange  contracts, net of tax** |   | **Accumulated  other  comprehensive  loss** |   |
|-------------------------|--------|-------------------|--------|------------------------------------------|--------|-------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------|--------|---------------------------------------------|--------|
|                    |   |              |   |                                     |   |                                                                          |   |                                                                                                |   |                                        |   |
| December 31,  2003 |   | Balance           |   | $                                        | (4,473 | )                                                                             | $      | 1,448                                                                                               |   | $                                           | (2,709 | ) | $ | (5,734 | ) |
|                    |   | Period net change |   | 146                                      |   | (188                                                                          | )      | 62                                                                                                  |   | 20                                          |   |
| March 31, 2004     |   | Balance           |   | $                                        | (4,327 | )                                                                             | $      | 1,260                                                                                               |   | $                                           | (2,647 | ) | $ | (5,714 | ) |

 

Totalcomprehensive loss was $3.6 million for the three months ended March 31, 2003.Total comprehensive income was $7.2 million for the three months ended March31, 2004.

 

**6.****              DEVELOPMENTAGREEMENT AND INTELLECTUAL PROPERTY LICENSE AGREEMENT**

 

On January 23, 2004, Cymer entered into aresearch and development agreement with Intel Corporation (“Intel”).  Total funding under the agreement is $20.0million and will provide Cymer with funding over the next three years to acceleratethe development of production-worthy EUV lithography light sources.   The funding to be received from Intel underthis agreement is milestone based and will be netted against Cymer’s totalresearch and development expenses in the period that the milestone is achieved.

 

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On February 4, 2004, Cymer entered intoan intellectual property license agreement with Intel for the use of certainIntel patents and trade secrets related to the EUV technology.  Under the terms of this agreement, Cymerwill pay license fees to Intel if Cymer is successful in commercializing an EUVlithography light source capable of high volume manufacturing by the end of thesecond quarter of 2008.  The licensepayments under this agreement are triggered in the quarter in which Cymersuccessfully ships the first complete high volume manufacturing EUV sourcesystem.  Upon shipment of this firstunit, Cymer is to pay Intel $1.25 million in license fees per quarter for aperiod of sixteen quarters.  Thequarterly license amounts paid to Intel, if any, will be related to Cymer’ssale of EUV light source systems and, as a result, will be recorded as cost ofsales. The methodology and amounts that will be recorded to cost of sales willbe determined when the high volume manufacturing production unit sales or aforecast of sales can be made.

 

**7.****              GOODWILL ANDINTANGIBLE ASSETS**

 

As of the date of adoption of Statement ofFinancial Accounting Standards No. 142 (“SFAS 142”), “Goodwill and OtherIntangible Assets”, on January 1, 2002, Cymer had unamortized goodwill inthe amount of $9.8 million and unamortized identifiable intangible assets,excluding acquired patents, in the amount of $1.1 million, all of which weresubject to the transition provisions of SFAS No. 142.

 

During the fourth quarterof 2003, Cymer completed its annual impairment test of goodwill and intangibleassets, and concluded that no impairment of goodwill existed.

 

Aggregate amortizationexpense was $40,000 for each of the three months ended March 31, 2003 and2004, respectively.  As ofMarch 31, 2004, future estimated amortization expense is expected to be asfollows (in thousands):

 
|                                     |   | **Future  Amortization** |   |
|------------------------------------------|--------|--------------------------|--------|
|                                     |   |                     |   |
| Nine months ended December 31, 2004 |   | $                        | 120    |   |
| Year ended December 31, 2005        |   | $                        | 20     |   |

 

The following tablesummarizes the activity in the carrying amount of goodwill as ofDecember 31, 2003 and March 31, 2004 (in thousands):

 
| Goodwill as of December 31, 2003                                      |   | 7,647 |   |
|----------------------------------------------------------------------------|--------|-------|--------|
| Goodwill acquired with acquisition of  6% minority interest of Cymer Korea |   | 711   |   |
| Goodwill as of March 31, 2004                                         |   | $     | 8,358  |   |
|                                                                            |        |       |        |  |

 

Also included in intangible assets – net on theaccompanying balance sheets are amounts associated with patents which wereacquired in 2001 and 2003.  As ofDecember 31, 2003 and March 31, 2004, the net carrying amount of thesepatents was $12.7 million and $12.2 million, respectively.

 

**8.****             ****GUARANTEES**

 

Cymer adopted the disclosure provisions of FinancialAccounting Standards Board Interpretation No. 45 (“FIN 45”), “Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness to Others”, during the quarter endedDecember 31, 2002 and has adopted the recognition and measurementprovisions as required after December 31, 2002.  FIN 45 provides expanded accounting guidance surroundingliability recognition and disclosure requirements related to guarantees, asdefined by this interpretation.

 

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In the ordinary course ofbusiness, Cymer is not subject to potential obligations under guarantees thatfall within the scope of FIN 45, except for standard warranty provisionsassociated with product sales, indemnification provisions related tointellectual property that are contained within many of its customeragreements, and third-party bank guarantees for subsidiary office lines ofcredit.  All of these provisions giverise only to the disclosure requirements prescribed by FIN 45.

 

ProductWarranties – Warrantyprovisions contained within Cymer’s customer agreements are generally consistentwith those prevalent in the semiconductor equipment industry. The warranty period and terms vary by light sourcemodel.  In general, the light sourcesystem warranty period ranges from 17 to 26 months after shipment.  Cymer also warrants consumables and spareparts sold to its customers and the coverage period varies by spare part typeas some types include time-based warranty periods and others includeusage-based warranty periods. On average, the warranty period for consumablesand spare parts is approximately six months from the date of shipment.  Cymer records a provision for warranty forall products, which is included in cost of product sales in the consolidatedstatements of operations and is recorded at the time that the related revenueis recognized. The warranty provision for light source systems is reviewedmonthly and determined using a financial model, which considers actualhistorical expenses, and potential risks associated with Cymer’s differentlight source system models. This financial model is then used to calculate thefuture probable expenses related to warranty and the required level of thewarranty provision.  The risk levelsused within this model are reviewed and updated as risk levels change by modelover its product life cycle. The warranty provision for consumables and sparesis determined using actual historical data. For both light source systems andconsumables, if actual warranty expenditures differ substantially from Cymer’sestimates, revisions to the warranty provision would be required.  Actual warranty expenditures are recordedagainst the warranty provision as they are incurred.

 

The followingtable summarizes information related to Cymer’s warranty provision for thethree months ended March 31, 2004 (in thousands):

 
|                                                                                              |   | **2004** |   |
|---------------------------------------------------------------------------------------------------|--------|----------|--------|
|                                                                                              |   |     |   |
| Balance, January 1, 2004                                                                     |   | $        | 26,200 |   |
| Liabilities accrued for warranties issued  during the quarter, net of adjustments and expirations |   | 7,231    |   |
| Warranty expenditures incurred during the  quarter                                                |   | (7,031   | )      |
| Balance, March 31, 2004                                                                      |   | $        | 26,400 |   |

 

Intellectual PropertyIndemnifications – Cymer includes intellectual property indemnification clauseswithin its general terms and conditions with its customers and the generalpurchase agreements with its three major customers, ASM Lithography, Canon, andNikon.  In general, theseindemnification provisions provide that Cymer will defend its customers againstany infringement claims that arise related to Cymer’s products.  Under the indemnification clauses, Cymerwill pay all costs and damages, including attorney’s fees, associated with suchsettlements or defenses, provided that the customer follows specific proceduresfor notifying Cymer of such claims and allows Cymer to manage the settlementproceedings. Due to the nature of these indemnification provisions, they areindefinite and extend beyond the term of the actual customer agreements.

 

An indemnification provision is also includedin the contract manufacturing agreement with Seiko, which was terminatedeffective March 31, 2003.  As withCymer’s indemnification provisions on intellectual property, Cymer willcontinue to honor this indemnification clause within the agreement even afterits termination. Seiko and at least one Japanese customer have been notifiedthat Cymer’s light source systems in Japan may infringe certain Japanesepatents.  Cymer believes, based upon theadvice of counsel, that Cymer’s products do not infringe any valid claim of theasserted patents or that Cymer is entitled to prior use claims in Japan.

 

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As part of the research and developmentagreement signed with Intel, Cymer also agreed to provide Intel with indemnityagainst any infringement of the intellectual property rights of any third partyarising from Intel’s purchase and/or use of EUV source systems, such indemnityto be negotiated as part of the purchase agreement related to potential futureproducts.

 

Guarantees on Subsidiary Debt – During the firstquarter of 2003 and part of the second quarter of 2003, Cymer was party to aParent Guarantee associated with a revolving Loan Agreement held by CymerJapan. This guarantee was between a commercial bank in the United States andCymer.  The Parent Guarantee was enteredinto in 2001 in order to establish a banking relationship between thiscommercial bank and Cymer Japan.  Perthe terms of the Parent Guarantee, Cymer guaranteed payment of any obligationsunder the revolving loan agreement in the event that Cymer Japan could not makesuch payments due or defaults on the loan. Cymer Japan made all payments per the terms of the Loan Agreement andthus, Cymer did not incur any guarantor obligations under the ParentGuarantee.  Since Cymer Japan is awholly-owned subsidiary of Cymer and Cymer Japan records the revolving loanoutstanding balance as a liability on its financial statements, the carryingamount of the liability was included in the consolidated balance sheets.  The Loan Agreement expired on June 16,2003 and was paid in full by Cymer Japan. The Loan Agreement was not renewed onthis expiration date.

 

**9.****              CONTINGENCIESAND COMMITMENTS**

 

Cymer is party to legalactions in the normal course of business. Based in part on the advice of legal counsel, management does not expectthe outcome of legal action in the normal course of business to have a materialimpact on the financial position or results of operations of Cymer.

 

Cymer’s former Japanesemanufacturing partner, Seiko, and one of Cymer’s Japanese customers have beennotified that Cymer’s light source systems in Japan may infringe certainJapanese patents held by another Japanese company.  Cymer has agreed to indemnify its former Japanese manufacturingpartner and its customers against patent infringement claims under certaincircumstances, even after the termination date of the contract manufacturingagreement.  Cymer believes, based uponthe advice of counsel, that Cymer’s products do not infringe any valid claim ofthe asserted patents or that Cymer is entitled to prior use claims in Japan.

 

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**ITEM 2.****  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

*In this section, references to “we”, “us” or “our” arereferences to Cymer.**The following discussion ofour financial condition and results of operations should be read in conjunctionwith our consolidated financial statements and notes thereto included in thisquarterly report on Form 10-Q and our consolidated financial statements andnotes thereto included in our annual report on Form 10-K for the year endedDecember 31, 2003.*

 

**ForwardLooking Statement**

 

Statements in this quarterly report on Form 10-Qthat are not strictly historical in nature are forward-looking statements.These statements include, but are not limited to, references to manufacturingactivities; expected domestic and international product sales and development;service and support; research and development activities and expenditures;adequacy of capital resources and investments; effects of business cycles inthe semiconductor business; competitive positioning; and relationships withthird-party manufacturers for product manufacturing, and may contain words suchas “believes,” “anticipates,” “expects,” and words of similar meaning. Thesestatements are only predictions based on current information and expectationsand involve a number of risks and uncertainties. The underlying information andexpectations are likely to change over time. Actual events or results may differ materially from those projected inthe forward-looking statements due to various factors, including, but notlimited to, those set forth under the caption “Risks and Uncertainties That May Affect Results”  and elsewhere in this quarterly report on Form 10-Q.  Forward-looking statements herein speak onlyas of the date of this quarterly report on Form 10-Q and we undertake noobligation to update such statements.

 

#### **Overview**

 

*General*

 

We are the world’sleading supplier of light source solutions for the semiconductor industry.  Our products provide the essential lightsource for deep ultraviolet (“DUV”) photolithography systems.  Almost all consumer electronic devicesmanufactured in the last several years contain a semiconductor manufacturedusing light sources, such as ours.  Wecurrently supply light sources to all three lithography tool manufacturers, ASM Lithography, Canon, and Nikon, whoin turn supply their wafer steppers and scanners to chipmakers.  Inaddition, we sell replacement parts and services to the lithography toolmanufacturers as well as directly to the chipmakers.  Our light source systems currently constitute a substantialmajority of all excimer light sources incorporated in lithography stepper andscanner tools.  A large portion of ourrevenue is derived from customers located outside of the United States.  In order to support our foreign customersand our installed base of light sources in foreign countries, we maintain amanufacturing and field service office in Korea and field service and supportoffices in Japan, Taiwan, Singapore, the People’s Republic of China and theNetherlands. We also maintain field service offices in the United States toservice our installed base of light sources located in the United States.

 

***Products andServices***

 

Our products primarily consist ofphotolithography light source systems, replacement parts and service.

 

Our photolithography light sources producenarrow bandwidth pulses of short wavelength light within the DUV spectrum. Thethree DUV wavelengths are measured in nanometers (“nm”).  One nanometer equals one billionth of ameter.  The light sources are referredto according to the gases mixed to produce the light or by the wavelength.  Krypton Fluoride (“KrF”) gases produce 248nmlight, Argon

 

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Fluoride (“ArF”) gases 193nm light, andFluorine (“F2”) gas 157nm light. The light sources permit very fine featureresolution for imaging the circuitry on the wafer and high throughput in waferprocessing.  We have designed our lightsources to be highly reliable, easy to install and compatible with existingsemiconductor manufacturing processes. Our light sources are used to pattern the integrated circuits, which arealso called semiconductors or “chips”, that power many of today’s advancedconsumer and business electronics. In the first quarter of 2004, we sold 64light source systems at an average selling price of $827,000.

 

Certain components and subassemblies includedin our light sources require replacement or refurbishment following extendedoperation.  For example, the dischargechamber of our light sources has an expected life of approximately three tosixteen billion pulses, depending on the model. We estimate that a light sourceused in a semiconductor production environment will require one to two replacementchambers per year, depending upon the level of usage.  Similarly, certain optical components of the light sourcedeteriorate with continued exposure to DUV light and require periodicreplacement.  We provide these and otherspare and replacement parts for our photolithography light sources as needed byour customers.

 

As the life andusage of our installed base of light sources in production at chipmakersexceeds the original warranty periods (generally 17 to 26 months from date ofshipment), some chipmakers request service contracts from us.  Additionally, we provide service contractsdirectly to the three semiconductor lithography tool manufacturers. Thesecontracts require us to maintain and/or service these light sources either onan on-call or regular interval basis or both. Some of these contracts include replacement of consumable parts.

 

In addition to service contracts, we provide an on-line diagnosticproduct, CymerOnLineTM. CymerOnLine is a diagnostic and performancesoftware product which delivers critical laser diagnostics and performanceinformation in near real-time directly to authorized users anywhere.  The software simplifies reporting and allowsusers to efficiently manage consumables management.  CymerOnLine features a user-friendly browser-based interfacewhich features a robust design and provides a secure data environment.  Event-initiated messages sent to pagers,email, mobile phones, or other handheld devices enable up-to-the minute communicationand proactive management.

 

# ***SemiconductorIndustry Status and Outlook***

 

Since we derive a substantial portion of our revenues from thelithography tool manufacturers, we are subject to the volatile andunpredictable nature of the semiconductor industry. The semiconductor industryis highly cyclical in nature and historically has experienced periodic ups anddowns. Since 2000, the last peak year in the cycle, the semiconductor industryhas experienced one of the longest downturns in its history. Although thisdownturn has negatively impacted our business and results of operations during2001, 2002 and 2003, we have been able to maintain our revenues at a constantlevel and remain profitable during most of this three year period.  We are very conscious of the volatile natureof the semiconductor industry and make every effort to manage our businessthrough the cycles such that we maintain our profitability during the downturnand take the necessary steps during the downturns to strategically positionourselves for the next upturn.  Over thelast three years, we have made several such strategic investments including thecompletion of our new manufacturing facilities in San Diego and Korea, thedevelopment and introduction of our new Master Oscillator Power Amplifier(“MOPA”) technology and XL platform on which all of our future DUV lightsources are planned to reside, and the ongoing work to improve businessprocesses that leverage the overall efficiency of our workforce.

 

In the lasthalf of 2003, there were several indicators that the extended downturn in thesemiconductor industry which started in 2001 was coming to an end and that anupturn was in sight.  During the finalmonths of 2003, we experienced strong order growth and our direct customersannounced 

 

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increasingorders and extended delivery times. In addition, the chipmakers’ utilization ofour DUV light sources exceeded the levels achieved in 2000, the peak of thelast upturn and the mix of our light source models shipped shifted toward KrF,reflecting the chipmakers’ need for more capacity expansion.

 

As we entered the first quarter of 2004, we continued to see many ofthe same positive indicators that we saw at the end of 2003, and alsoexperienced revenue growth during the first quarter that is indicative of anupturn.  The first quarter of 2004financial results turned out better than we had anticipated even as recently asour quarterly update in early March 2004. Revenue for the quarter grew 21% over fourth quarter 2003 levels due toincreased light source shipments and, late in the quarter, stronger thanforecasted demand for consumables and spares to support the record level lightsource utilization.  As in the fourthquarter of 2003, the light source product mix was heavily weighted toward KrFproducts, reflecting chipmakers’ need to expand capacity to meet currentindustry demands.  Our gross margin forthe first quarter of 2004 was above recent guidance, and we continued to gainefficiencies and aggressively control operating expenses.

 

We believe we are well positioned to take advantage of this most recentupturn in the semiconductor industry due to the key investments that we madeduring the three year downturn.  As weenter this latest upturn, we expect that we will experience sequentialquarterly increases in our light source unit shipments for the remainder of2004 and high light source system utilization levels at our chipmaker customerswill continue to drive our consumables and spares demand to higher levels.  Based upon our first quarter 2004performance and the continued positive industry indicators, we expect that 2004will be a record revenue year overall for Cymer.

 

#### **Critical Accounting Policies and Estimates**

 

The discussion and analysis of our financial condition and results ofoperations are based upon our consolidated financial statements, which havebeen prepared in accordance with accounting principles generally accepted inthe United States of America.  Thepreparation of these financial statements requires us to make estimates and usejudgment that may impact the reported amounts of assets, liabilities, revenues,expenses, and related disclosure of contingent assets and liabilities.  As a part of our ongoing internal processes,we regularly evaluate our estimates, including those related to inventoryallowances, warranty provision, income taxes, allowances for bad debts,long-lived assets valuation, intangible assets valuation, and contingencies andlitigation.  We base these estimatesupon both historical information and other assumptions that we believe to bevalid and reasonable under the circumstances. These assumptions form the basis for making judgments and determiningthe carrying values of assets and liabilities that are not apparent from othersources.  Actual results could vary fromour estimates if we were to use different assumptions and conditions.

 

We believe that inventory allowances, warranty provisions, and incometaxes require more significant judgments and estimates in the preparation ofour consolidated financial statements than do other of our accountingestimates.

 

*Inventory Allowance*

 

We perform an analysis of our inventory allowances on at least aquarterly basis to determine the adequacy of this allowance on our financialstatements.  The amount of the inventoryallowance is determined by taking into consideration certain assumptionsrelated to market conditions and future demands for our products, includingchanges to product mix, new product introductions, and/or productdiscontinuances, which may result in excess or obsolete inventory. We determinethe level of excess and obsolete inventory associated with our raw materialsand production inventory by comparing the on hand inventory balances andinventory on order to the next 12 months of forecasted demand.  We then adjust this calculation forinventory that has a high likelihood of use beyond one year or can be used inother

 

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products which may have lower demands. After this adjustment, we arrive at our total exposure for excess andobsolete inventory within our raw materials and production inventory.  As part of this analysis, we also determinewhether there are potential amounts owed to vendors as a result of cancelled ormodified raw material orders.  Weestimate and record a separate liability which is included in accrued and otherliabilities in the accompanying balance sheets for such amounts owed. For spareparts inventory, we calculate the inventory allowance based upon a percentageof total spare parts inventory balances. This percentage is calculated using certain estimates and assumptions,including comparisons of on hand inventory to build forecasts, historicalobsolescence in our spare parts warehouses, and spare parts specificallyidentified as excess or obsolete.

 

Both methodologies for analyzing excess and obsolete inventory anddetermining the inventory allowance are significantly affected by future demandand usage of our products.  There aremany factors that could potentially affect the future demand or usage of ourproducts, including the following:

 

•                  Overallcondition of the semiconductor industry, which is highly cyclical in nature;

•                  Rateat which our customers take delivery of our light source systems;

•                  Lossof any of our three major customers or significant change in demand from any ofthese three customers;

•                  Mixof light source system models and any changes to that mix required by ourcustomers; and

•                  Utilizationrates of our light sources at chipmakers.

 

Based upon our experience, we believe that the estimates we use incalculating the inventory allowance are reasonable and properly reflect therisk of excess and obsolete inventory. If actual demand or the usage period for our inventory are substantiallydifferent from our estimates, adjustments to our inventory allowance may berequired, which could have a material adverse effect on our financial conditionand results of operations.

 

###### *Warranty Provision*

 

We maintain an accrual for the estimated cost of product warrantiesassociated with our product sales. Warranty costs include the replacement parts and labor costs to repairour products during the warranty periods. At the time revenue is recognized, we record a warranty provision, whichis included in cost of product sales in the accompanying consolidatedstatements of operations. The warranty coverage period and terms vary by lightsource model.  In general, the lightsource system warranty period ranges from 17 to 26 months after shipment.  We also warrant consumables and spare partssold to our customers and the coverage period varies by spare part type as sometypes include time based warranty periods and others include usage basedwarranty periods.  On average, thewarranty period for consumables and spare parts is approximately six monthsfrom the date of shipment. The warranty provision for light source systems isreviewed monthly and determined by using a financial model, which takes intoconsideration actual historical expenses, and potential risks associated withour different light source system models. This financial model is then used to estimate future expenses related towarranty and the required warranty provision. The risk levels used within this model are reviewed and updated as risklevels change by model over its product life cycle.  Due to the highly technical nature of our light source systemproducts, the newer model light sources have higher inherent warranty risks andrequire higher warranty provisions. The warranty provision for consumables andspare parts is determined by using actual historical data.

 

We actively engage in product improvement programs and processes tolimit our warranty costs, but our warranty obligation is affected by thecomplexity of our product, product failure rates and costs incurred to correctthose product failures at customer sites. The industry in which we operate issubject to rapid technological change, and as a result, we periodicallyintroduce newer, more complex light sources. 

 

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Although we classify these newly released light source models as havinga higher risk in our warranty financial model resulting in higher warrantyprovisions, we are more likely to have differences between the estimated andactual warranty costs for these new products. This is due to limited or no historical product performance data onwhich to base our future warranty costs. Warranty provisions for our older and more established light sourcemodels are more predictable as we have more historical information available onthese products.  If actual productfailure rates or estimated costs to repair those product failures were todiffer from our estimates, revisions to our estimated warranty provision wouldbe required, which could have a material adverse effect on our financialcondition and results of operations.

 

*Income Taxes*

 

We account for income taxes in accordance with Statement of FinancialAccounting Standards  No. 109 (“SFAS109”), “Accounting for Income Taxes.” Pursuant to SFAS 109, a deferred tax asset or liability is generallyrecognized for the estimated future tax effects attributable to temporarydifferences, net operating loss carryforwards and tax creditcarryforwards.  Deferred tax assets areto be reduced by a valuation allowance if, based on the weight of availableevidence, it is more likely than not that some portion or all of the deferredtax assets will not be realized within the carryback or carryforwardperiods.  Information about anenterprise’s current financial position and its results of operations for thecurrent and preceding years, as well as all currently available informationabout future years should be considered.

 

We have consideredour industry’s outlook for the future, our historical performance and estimatedfuture taxable income, and ongoing tax planning strategies in assessing theneed for a valuation allowance.  Usingthis information, we have prepared a model to forecast our expected taxableincome in future years in order to estimate when the benefits of our deferredtax assets are likely to be realized. Based upon the analysis, we believe that it is more likely than not thatthe results of future operations will generate sufficient taxable income to realizethe deferred tax assets within the period allowed by current applicable tax lawand, as such, no valuation allowance against deferred tax assets is provided.

 

A material adversechange in the outlook for worldwide lithography tool sales, in the expectedselling prices or profit margins for our products, or in our expected share ofthe global market for lithography light sources could cause us to determinethat a valuation allowance is needed for some or all of our deferred taxassets, and would result in an increase to our income tax provision in theperiod in which such determination is made.

 

**RESULTS OF OPERATIONS**

 

The following table sets forth certain items inCymer’s consolidated statements of operations as a percentage of total revenuesfor the periods indicated:

 
|                                            |   | **Three  months ended  March 31,** |   |
|-------------------------------------------------|--------|-----------------------------------------|--------|
|                                            |   | **2003**                                |   | **2004** |   |
| Revenues:                                       |   |                                    |   |   |   |
| Product sales                                   |   | 99.9                                    | %      | 99.9 | % |
| Other                                           |   | 0.1                                     |   | 0.1 |   |
| Total revenues                                  |   | 100.0                                   | %      | 100.0 | % |
|                                            |   |                                    |   |   |   |
| Cost and expenses:                              |   |                                    |   |   |   |
| Cost of product sales                           |   | 63.6                                    |   | 59.3 |   |
| Research and development                        |   | 25.7                                    |   | 14.1 |   |
| Sales and marketing                             |   | 6.1                                     |   | 6.6 |   |
| General and administrative                      |   | 8.5                                     |   | 7.5 |   |
| Amortization of goodwill and intangible  assets |   | 0.1                                     |   | 0.1 |   |
| Total costs and expenses                        |   | 104.0                                   |   | 87.6 |   |

 

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| Operating (loss) income                                                    |   | (4.0   | )      | 12.4   |   |
|----------------------------------------------------------------------------|--------|--------|--------|--------|--------|
|                                                                       |   |   |   |   |   |
| Other expense – net                                                   |   | (0.5   | )      | (0.7   | )      |
|                                                                       |   |   |   |   |   |
| Income (loss) before income tax provision  (benefit) and minority interest |   | (4.5   | )      | 11.7   |   |
|                                                                       |   |   |   |   |   |
| Income tax provision                                                       |   | — |   | 2.7    |   |
| Minority interest                                                          |   | (0.5   | )      | (0.9   | )      |
|                                                                       |   |   |   |   |   |
| Net income (loss)                                                          |   | (5.0   | )%     | 8.1    | %      |
| Gross margin on product sales                                              |   | 36.3   | %      | 40.6   | %      |

 

## **THREE MONTHS ENDEDMARCH 31, 2003 AND 2004**

 

*Revenues*. Our revenues consist of productsales, which include sales of light source systems, consumable and spare parts,upgrades, service, service contracts and training. Our revenues also consist ofother revenues, which include revenue from certain funded developmentactivities performed for customers and under government contracts and licenseagreements.  We do not recognize anyrevenue for light source systems prior to shipment.  The systems are tested by us in environments similar to thoseused by our customers prior to shipment to ensure that they meet the customers’specifications and will interface with the customers’ software.  Our installation obligations are perfunctorywithin the framework of Staff Accounting Bulletin 104.  One of our customers has an acceptanceprovision, which is satisfied by the issuance of an acceptance certificatefollowing a visual inspection of the system by the customer. We do notrecognize revenue on systems shipped to that customer until we receive theacceptance certificate.  There are nocustomer retentions with the exception of one customer where a small portion ofour light source product revenue is delayed to align with the end-useracceptance of the integrated scanner. Revenue from consumables and spare parts sales is recognized at thepoint that legal title passes to the customer, which is generally upon shipmentfrom our facility.  Service and trainingrevenue is generally recognized at the time that the services are rendered orthe training class is completed. Service contract revenues are generally recorded as revenue ratably overthe life of the contract or per the specific terms of the agreement. For fundeddevelopment contracts which are included in other revenue, funds received areaccounted for on the percentage-of-completion method based on the relationshipof costs incurred to total estimated costs. Revenues generated from these funded development contracts are derivedfrom cost sharing contracts between us and certain customers.  The costs associated with these particularcontracts are included in research and development expenses in the periodincurred and are not listed separately as other cost or expenses in theconsolidated statements of operations. If milestones on these funded development contracts require thatspecific results be achieved or reported by us, revenue is not recognized untilthat milestone is completed.  For someof the funded development contracts which we enter into with customers andgovernment agencies, we evaluate certain criteria to determine whetherrecording the funds received as revenue is appropriate.  If certain conditions are met, these fundsare not recorded as revenue and are rather offset against our own internalresearch and development expenses in the period that the milestone is achievedor per the terms of the contract.

 

 

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The following table summarizes the components of our revenue (in thousands,except units sold):

 
|                                             |   | **March 31,** |   |
|--------------------------------------------------|--------|--------------------|--------|
|                                             |   | **2003**           |   | **2004** |   |
| Light  source systems:                           |   |               |   |   |   |
| Revenue                                          |   | $                  | 43,442 |   | $ | 52,661 |   |
| Units sold                                       |   | 56                 |   | 64 |   |
| Average selling price                            |   | $                  | 776    |   | $ | 827 |   |
|                                             |   |               |   |   |   |
| Consumable and spare parts and service  products |   | $                  | 23,894 |   | $ | 35,210 |   |
| Other revenue                                    |   | $                  | 57     |   | $ | 50 |   |
|                                             |   |               |   |   |   |
| Total revenue                                    |   | $                  | 67,393 |   | $ | 87,921 |   |

 

Product sales increased 31% from $67.3****millionfor the three months ended March 31, 2003 to $87.9****million for the three monthsended March 31, 2004, primarily due to a 47% increase in sales ofconsumable and spare parts and service products from $23.9 million in the threemonths ended March 31, 2003 to $35.2 million in the three months endedMarch 31, 2004.  The increase inthis type of product sales was due to increased utilization of our DUV lightsource by chipmakers and an increased installed base in the three months endedMarch 31, 2004.  Product sales werefurther increased due to a 14% increase in the number of light source systemunits sold and a 7% increase in the average selling price.  A total of 56 light source systems were soldin the three months ended March 31, 2003 at an average selling price of$776,000, compared to 64 systems sold in the three months ended March 31,2004 at an average selling price of $827,000. On a foreign currency adjusted basis, the average selling price for thethree months ended March 31, 2003 was $768,000 compared to $805,000 forthe three months ended March 31, 2004. The increase in the average sellingprice from period to period reflects the inclusion in our product mix of thehigher priced XLA 100 light source system which was introduced in the firstquarter of 2003 and has a higher average selling price.   Revenues from funded development contractswere $57,000 and $50,000 for the three months ended March 31, 2003 and2004, respectively.  We anticipate thatour total revenues will increase sequentially for the remainder of 2004 as aresult of the upturn in the semiconductor industry.

 

Ourbacklog at March 31, 2003 was $97.1 million compared to $105.5 million atMarch 31, 2004.  Bookings for thethree months ended March 31, 2003 and March 31, 2004 were $63.5million and $89.5 million, respectively. The book-to-bill ratio for the quarter ended March 31, 2003 was .94compared to 1.02 for the quarter ended March 31, 2004.  The increase in all three of these areas wasprimarily due to higher systems bookings and record bookings of consumable andspare parts in the first quarter of 2004.

 

Weinstalled 67 light sources at chipmakers and other end-users during the quarterended March 31, 2003 as compared to 65 light sources installed during thequarter ended March 31, 2004.

 

Our sales aregenerated primarily by shipments to customers in Japan, Europe, and the United States.  Approximately 88% and 87% of our sales forthe three months ended March 31, 2003 and 2004, respectively, were derivedfrom customers outside the United States. We maintain a wholly-owned Japanese subsidiary, which sells to ourJapanese customers.  Revenues fromJapanese customers, generated primarily by this subsidiary, accounted for 41%and 38% in the three months ended March 31, 2003 and 2004,respectively.  The activities of ourJapanese subsidiary are limited to sales and service of products purchased bythe subsidiary from the parent corporation. We anticipate that international sales will continue to account for asignificant portion of our net sales.

 

Salesto our three largest customers, ASM Lithography, Canon, and Nikon, amounted to30%, 23% and 19%, respectively, of total revenue for the three months endedMarch 31, 2003, and 31%, 20% and 19%, respectively, of total revenue forthe three months ended March 31, 2004.

 

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*Costof Product Sales*. Cost of product sales includes direct material and labor, warrantyexpenses, license fees, and manufacturing and service overhead, and foreignexchange gains and losses on foreign currency forward exchange contractsassociated with purchases of our products by our Japanese subsidiary for resaleunder firm third-party sales commitments. Shipping costs associated withour product sales are also included in cost of product sales.  We do not charge our customers for shippingfees and such costs are not significant.

 

The cost of product sales increased 22% from $42.9 million for the threemonths ended March 31, 2003 to $52.2 million for the three months ended March31, 2004. This increase in the cost of product sales is primarily due to theoverall increase in sales from period to period.  Both light source system sales and sales of consumables and spareparts and service products were higher for the three months ended March 31,2004 compared to the same three-month period in 2003.

 

The grossmargin on product sales was 36% for the three months ended March 31, 2003 ascompared to 41% for the same three-month period in 2004.  This higher gross margin in 2004 reflectsimproved efficiencies associated with the XLA series product introduction andongoing overall manufacturing cost reduction efforts.  We anticipate that the gross margins will increase moderatelyover the next couple of quarters as we reduce spending through ongoing processimprovements, increased manufacturing yields, reductions in material costs anda more mature product mix.

 

*Research and Development*. Research and development expenses include costs of internally-funded andexternally-funded projects as well as continuing product development supportexpenses, which consist primarily of employee and material costs, depreciationof equipment and other engineering related costs.  Our research and development expenses are offset by amountsassociated with certain of our externally funded research and developmentcontracts.  These amounts were $206,000and $1.6 million for the three months ended March 31, 2003 and 2004,respectively.  Research and developmentexpenses decreased 29% from $17.3 million for the for the three months endedMarch 31, 2003 to $12.4 million for the three months ended March 31, 2004, dueprimarily to costs associated with the final productization and introduction ofthe XLA 100 light source which was initially shipped in the first quarter of2003.  We also continued to invest inextreme ultraviolet (“EUV”), F2 and beam delivery unit technology and to focuson next generation KrF and ArF products based on the XL platform.  As a percentage of total revenues, researchand development expenses decreased from 25.7% for the three months ended March31, 2003 to 14.1% for the same three-month period in 2004.  We anticipate research and developmentexpenses to increase slightly in the next few quarters due to increasedspending in EUV development and other product development opportunityinvestigations.

 

*Sales and Marketing*. Sales and marketing expenses include theexpenses of the sales, marketing and customer support staff and other marketingexpenses.  Sales and marketing expensesincreased 42% from $4.1 million for the three months ended March 31, 2003 to$5.8 million for the three months ended March 31, 2004.  This increase in sales and marketingexpenses from period to period primarily reflects the expenses associated withthe profit sharing and bonus plans which were funded in the first quarter of2004.  This increase in expenses alsoreflects increases in general marketing expenses associated with ourinternational subsidiaries.  As apercentage of total revenues, such sales and marketing expenses increased from6.1% for the three months ended March 31, 2003 to 6.6% for the same three-monthperiod in 2004.  We anticipate sales andmarketing expenses to increase over the next few quarters due primarily toincreases in profit sharing and incentive bonuses associated with increased profitability.

 

*General and Administrative*. General and administrative expenses consistprimarily of management and administrative personnel costs, professionalservices and administrative operating costs. General and administrative expenses increased 15% from $5.8 million forthe three months ended March 31, 2003 to $6.6 million for the three monthsended March 31, 2004 due primarily to expenses associated with the profitsharing and bonus plans which were funded in the first quarter of 2004 andincreased

 

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consulting and advisory fees associated withthe implementation of the Sarbanes-Oxley section 404 requirements.  As a percentage of total revenues, suchexpenses decreased from 8.5% for the three months ended March 31, 2003 to 7.5%for the same three-month period in 2004. We anticipate general and administrative expenses to increase on anabsolute dollar basis over the next few quarters due primarily to increases inprofit sharing and incentive bonuses associated with increased profitability,as well as additional costs which will be incurred implementing theSarbanes-Oxley section 404 requirements.

 

*Amortization ofintangible assets. *Amortization of intangible assets totaled$40,000 for the three months ended March 31, 2003 and 2004. This amortizationof intangible assets expense is consistent from year to year and relates to theexisting technology associated with the acquisition of Active Control eXperts,Inc., or ACX, which was completed in early 2001.  With our adoption of SFAS 142 on January 1, 2002, we discontinuedthe amortization of goodwill and intangible assets with indefinite useful livesassociated with previous purchase business combinations.

 

*Other Income (Expense) - Net.*  Netother income (expense) consists primarily of interest income and expense andforeign currency exchange gains and losses associated with fluctuations in thevalue of the functional currencies of our foreign subsidiary offices againstthe United States dollar.  Net otherexpense totaled $346,000 and $606,000 for the three months ended March 31, 2003and 2004, respectively.  The increase innet other expense was primarily due to decreases in interest income from periodto period.  This decreased interestincome was primarily due to lower market interest rates for our short-term andlong-term investments in the first quarter of 2004 as compared to the firstquarter of 2003.  The average cash andinvestments balances were also slightly lower in the first quarter of 2004 ascompared to the first quarter of 2003 as a result of cash used during 2003 forthe construction of our new manufacturing and office facility in San Diego,which was completed in the third quarter of 2003.  Foreign currency exchange losses totaled $360,000, interestincome totaled $2.5 million and interest expense totaled $2.5 million for thethree months ended March 31, 2003, compared to a foreign currency exchange gainof $54,000, interest income of $1.9 million and interest expense of $2.6million for the three months ended March 31, 2004.

 

*Income Tax Provision*.  Thetax provision of $2.4 million for the three months ended March 31, 2004reflects an annual effective rate of 23%.  There was no tax provisionfor the three months ended March 31, 2003. The change in the annual effective tax rate during the three monthsended March 31, 2003 from 0% to a provision rate of 23% for the three monthsended March 31, 2004 is primarily attributable to the increase in pre-taxearnings. The annual effective tax rates for both periods are less than the U.S.statutory rate of 35% primarily as a result of permanent book/tax differencesand tax credits.  The effective taxrate is a function of current tax law and geographic location of pre-taxincome.  There is currently pendinglegislation to repeal the existing U.S. export incentives.  Should these incentives be repealed with noreplacement benefits, our effective tax rate would likely increase.

 

## **LIQUIDITYAND CAPITAL RESOURCES**

 

As of March 31, 2004, we hadapproximately $242.6 million in cash and cash equivalents, $82.1 million inshort-term investments, $74.3 million in long-term investments, and $417.8million in working capital.

 

InFebruary 2002, we issued $250.0 million in aggregate principal amount in aprivate placement of notes.  These 2002Notes are due on February 15, 2009 with interest payable semi-annually onFebruary 15 and August 15 of each year at 31⁄2% per annum.  The 2002 Notes are convertible into sharesof our common stock at a conversion rate of 20 shares per $1,000 principalamount or an effective conversion price of $50.00 per share.  We used a portion of the net proceeds fromthis private placement

 

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to redeem theconvertible subordinated notes then outstanding. The remaining proceeds will beused for our future operating, investing and financing activities.

 

Net cash used in operatingactivities was approximately $17.4 million for the three months ended March 31,2003, compared to $1.7 million net cash provided by operating activities for thethree months ended March 31, 2004.  Netcash used in operating activities for the three months ended March 31, 2003primarily reflects the net loss for the period, higher accounts receivablebalances primarily due to the timing of sales and related customer invoicinglate in the quarter and increases in inventories and accrued liabilities forthe period.   Net cash provided byoperating activities for the three months ended March 31, 2004 primarilyreflects net income for the period, increases in accounts payable and otherliabilities which were offset by increases in accounts receivable andinventories.  The increase in accountsreceivable reflects the increased revenue for the three months ended March 31,2004.  The increase in inventories wasprimarily due to an increase in spares inventories in the field to support thecontinuing high light source utilization rates as well as support overallincreasing product demand.

 

Net cash used in investingactivities was approximately $15.7 million for the three months ended March 31,2003 compared to $1.9 million net cash provided by investing activities for thethree months ended March 31, 2004.  Net cash used in investing activities for thethree months ended March 31, 2003 was due primarily to the construction costsfor our new manufacturing and office facility in San Diego.  This capital expenditure during the quarterwas offset by the timing of short-term and long-term investments that maturedand were reinvested during the period. Net cash provided by investing activities for the three months endedMarch 31, 2004 was due primarily to the timing of short-term and long-terminvestments maturing and being reinvested during the quarter offset by a $6.0million payment to acquire patents and a $2.0 million payment to acquire anadditional 6% minority interest in our Cymer Korea subsidiary.

 

Netcash provided by financing activities was approximately $5.8 million and $8.1million for the three months ended March 31, 2003 and 2004, respectively.  The increase in cash provided byfinancing activities from period to period was attributable to increases in theproceeds from employee stock option exercises. In the three months ended March31, 2003, financing activities includes cash borrowed during the period of $3.3million on our Japanese revolving loan.

 

We had certain loan agreements with a commercial bank which providedfor unsecured revolving loan facilities allowing for borrowings of $10.0million and $20.0 million under a U.S. line of credit and Japanese line of credit,respectively.  Under the loanagreements, we were able to borrow in U.S. dollars or Japanese yen, andinterest accrued on outstanding borrowings at LIBOR plus 1.75% on U.S.dollar-denominated borrowings and at the yen cost of funds rate plus 1.5% on yen-denominatedborrowings. The loan agreements required us to maintain compliance with certainfinancial and other covenants, including tangible net worth, quick ratio andprofitability requirements.  The loanagreements expired on June 16, 2003 and were not renewed.

 

Since our initial****publicoffering and a secondary public offering, both in 1996, we have funded ouroperations primarily from cash generated from operations, the proceeds of the1997 and 2002 Notes offerings in August 1997 and February 2002, bankborrowings, and the proceeds from employee stock option exercises.

 

We require substantialworking capital to fund our business, particularly to finance inventories,including purchase orders with our vendors, accounts receivable, and forcapital expenditures. Our future capital requirements depend on many factors,including our manufacturing activity, the timing and extent of spending tosupport product development efforts, expansion of sales and marketing and fieldservice and support, competitive labor market compensation requirements, thetiming of introductions of new products and enhancements to existing products,and the market acceptance of our products. We believe that we 

 

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have sufficient working capital to sustainoperations and provide for the future expansion of our business for at leastthe next 12 months.

 

At March 31, 2004, we did not have any relationship with unconsolidatedentities or financial partnerships, such as entities often referred to asstructured finance variable interest, or special purpose entities, which wouldhave been established for the purpose of facilitating off-balance sheetarrangements or other contractually narrow or limited purposes.  In addition, we did not engage in tradingactivities involving non-exchange traded contracts.  As a result, we are not exposed to any financing, liquidity,market or credit risk that could arise if we had engaged in such relationships.  We do not have relationships andtransactions with persons and entities that derive benefits from theirnon-independent relationship with us or our related parties except as disclosedherein.

 

#### **Risks and Uncertainties That May Affect Results**

 

*The risks described below maynot be the only risks we face. Additional risks that we do not currently thinkare material may also impair our business operations.  If any of the events or circumstances described in the followingrisks actually occur, our business, financial condition or results ofoperations could suffer, and the trading price of our common stock coulddecline.*

 

Ourrevenues and operating results from quarter-to-quarter have varied in the pastand our future operating results may continue to fluctuate significantly due tomany factors including those listed in this section and throughout thisquarterly report on Form 10-Q for the period ended March 31, 2004. Thesefactors include:

 

•                  demand forsemiconductors in general and, in particular, for leading edge devices withsmaller circuit geometries;

•                  cyclicality in the market for semiconductormanufacturing equipment;

•                  rates at whichchipmakers take delivery of photolithography tools from lithography toolmanufacturers (“our customers”);

•                  rates at which our customers take delivery of lightsource systems from us;

•                  timing and size oforders from our small base of customers;

•                  product lead timedemands from our customers and the chipmakers;

•                  mix of light sourcemodels, consumable and spare parts and service revenues in our total revenues;

•                  changes in the price and profitability of our products;

•                  our ability to develop and implement new technologiesand introduce new products;

•                  changes in market penetration by our competitors;

•                  utilization rates of light sources and sales ofconsumable and spare parts and services;

•                  our ability to manage our manufacturing requirements;

•                  foreign currencyexchange rate fluctuations, principally with respect to the Japanese yen (inwhich sales by our Japanese subsidiary are denominated);

•                  worldwide political instability;

•                  changing global economic conditions; and

•                  intellectual property protection.

 

We alsohave historically derived a large portion of our quarterly and annual revenuesfrom selling a small number of light source systems. Because we sell a smallnumber of products, the precise time that we recognize revenue from an ordermay have a significant impact on our total revenue for a particular period. Ourcustomers may cancel or reschedule orders with little or no penalty. Ordersexpected in one quarter could shift to another period due to changes in theanticipated timing of customers’ purchase decisions or rescheduled deliverydates requested by our customers. Our operating results for a particularquarter or year may be adversely affected if our customers, particularly ourthree largest customers,

 

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cancel or rescheduleorders, or if we cannot fill orders in time due to unexpected delays inmanufacturing, testing, shipping, and product acceptance.

 

Wemanage our expense levels based, in large part, on expected future revenues. Asa result, our expenses are relatively fixed for the short term, and if ouractual revenue decreases below the level we expect, our operating results willbe adversely affected.  As a result ofthese or other factors, we could fail to achieve our expectations as to futurerevenue, gross profit and operating income. Our failure to meet the performance expectations set and published byexternal sources could result in a sudden and significant drop in the price ofour stock, particularly on a short-term basis, and could negatively affect thevalue of any investment in our stock.

 

**Our business depends onthe semiconductor equipment industry, which is highly volatile andunpredictable.**

 

The semiconductorindustry is highly cyclical. We derive a substantial percentage of our revenuesfrom lithography tool manufacturers within the semiconductor industry. Ourcustomers depend in turn on the demand for their photolithography tool productsfrom their customers, the chipmakers. The capital equipment expenditures ofchipmakers depend on a number of factors, including the current and anticipatedmarket demand for semiconductors and products using semiconductors.

 

Thesemiconductor industry is cyclical in nature and historically has experiencedperiodic ups and downs and currently appears to be recovering from asignificant and prolonged downturn. This cyclical nature of the industry inwhich we operate affects our ability to accurately predict future revenue andthus, future expense levels. When cyclical fluctuations result in lower thanexpected revenue levels, operating results may be adversely affected and costreduction measures may be necessary in order for us to remain competitive andfinancially sound.  During a down cycle,we must be in a position to adjust our cost and expense structure to prevailingmarket conditions and to continue to motivate and retain our key employees.  In addition, during periods of rapid growth,we must be able to increase manufacturing capacity and personnel to meetcustomer demand.  We can provide noassurance that these objectives can be met in a timely manner in response toindustry cycles.

 

Althoughthere is evidence that the prolonged downturn in the semiconductor industry maybe over, we are not able to predict with any certainty the recovery of thesemiconductor industry or the order of magnitude of any recovery.  The recent downturn has had a severe effecton the demand for semiconductor manufacturing equipment, includingphotolithography tools that our customers produce.  If overall market conditions deteriorate in the near term, ourcurrent operating levels may negatively impact our profitability. We believethat downturns in the semiconductor industry will occur periodically, andresult in periodic decreases in demand for all semiconductor manufacturingequipment, including photolithography tools our customers manufacture. As aresult, fluctuating levels of investment by chipmakers and pricing volatilitywill continue to materially affect our aggregate bookings, revenues andoperating results. Also, even during periods of reduced revenues we believe wemust continue to invest in research and development and to maintain extensiveongoing worldwide customer service and support capabilities to remaincompetitive, which may temporarily harm our financial results.  Accordingly, these downturns are likely tocontinue to adversely affect our business, financial condition and operatingresults and our operating results may fall below the expectations of publicmarket analysts or investors in some future quarter or quarters. Such failureto meet operating result expectations would materially adversely affect theprice of our common stock.

 

Ourcustomers try to manage their inventories and production requirements toappropriate levels that best reflect their expected sales to chipmakers. Marketconditions in the industry and production efficiency of the lithography toolmanufacturers can cause our customers to expand or reduce their orders for newlight source systems as they try to manage their inventories and productionrequirements to these

 

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levels. We continue towork with our customers to better understand these issues. However, we cannotguarantee that we will be successful in understanding our customers’ inventorymanagement and production requirements or that our customers will not build upan excess inventory of light source products. If our customers retain an excessinventory of light source products, our revenue could be reduced in futureperiods as the excess inventory is utilized, which could adversely affect ouroperating results, financial condition and cash flows.  In addition, if our customers demand shorterproduct lead times as a solution to improve their inventory and cash positions,our inventory management and cash position may be impacted, which may adverselyaffect our operating results, financial condition and cash flows.

 

**A significant percentage of our revenueis derived from sales to a few large customers, and if we are not able toretain these customers, or they reschedule, reduce or cancel orders, delay ordefault on payments, our revenues would be reduced and our financial conditionand cash flows would suffer.**

 

Threelarge companies, ASM Lithography, Canon and Nikon dominate the photolithographytool business. Collectively, these three companies accounted for the followingpercentage of our total revenue during the periods indicated:

 
|            |   | **Three months ended  March 31,** |   |
|-----------------|--------|-----------------------------------|--------|
|            |   | **2003**                          |   | **2004** |   |
|            |   |                              |   |   |   |
| ASM Lithography |   | 30%                               |   | 31% |   |
| Canon           |   | 23%                               |   | 20% |   |
| Nikon           |   | 19%                               |   | 19% |   |
|            |   |                              |   |   |   |
| Total           |   | 72%                               |   | 70% |   |

 

Collectively,these three companies account for the following percentage of our totalaccounts receivable at the dates indicated:

 
|            |   | **December 31,  2003** |   | **March 31,  2004** |   |
|-----------------|--------|------------------------|--------|---------------------|--------|
|            |   |                   |   |                |   |
| ASM Lithography |   | 38%                    |   | 35%                 |   |
| Canon           |   | 14%                    |   | 14%                 |   |
| Nikon           |   | 18%                    |   | 21%                 |   |
|            |   |                   |   |                |   |
| Total           |   | 70%                    |   | 70%                 |   |

 

Weexpect that sales of our light source products to these three customers willcontinue to account for a substantial majority of our revenue in theforeseeable future. None of our customers are obligated to purchase a minimumnumber of our products in the aggregate or during any particular period. Theloss of any significant business from or production problems for any one ofthese three customers may have a material adverse effect on our business andfinancial condition. Sales to these customers may be affected by many factors,some of which are beyond our control. These factors include:

 

•                  a change in a customer’scompetitive position in its industry;

•                  a customer experiencinglithography tool production problems;

•                  a decision to purchaselight sources from other suppliers;

•                  changes in economicconditions in the semiconductor or the photolithography tool industries; and

•                  a decline in acustomer’s financial condition.

 

**A substantial percentageof our revenue is derived from the sale of a limited number of primaryproducts.**

 

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Ouronly product line is excimer light source systems, which include KrF and ArFsystems, and we expect these primary products to continue to account for alarge percentage of our revenues in the near term. Continued market acceptanceof our primary products is, therefore, critical to our future success. Theprimary market for excimer light sources is in the use of DUV photolithographyequipment for manufacturing deep-submicron semiconductor devices using smallercircuit geometries. The demand for our products depends in part on the rate atwhich chipmakers further adopt excimer light sources as the chosen light sourcefor their photolithography tools. The rate with which chipmakers adopt excimerlight sources may vary for a variety of reasons, including:

 

•                  inadequate performanceof photoresists used in advanced DUV photolithography;

•                  potential shortages ofspecialized materials used in DUV optics;

•                  productivity of 300mmlithography relative to 200mm tools; and

•                  consolidation ofchipmakers.

 

Wecannot guarantee that these factors can or will be overcome or that the demandfor our excimer light source products will not be materially reduced. Thedemand for our light source products, and therefore our operating results,financial condition and cash flows, could be adversely affected by a number offactors, including:

 

•                  a decline in demand forour customers’ DUV photolithography tools;

•                  a failure to achievecontinued market acceptance of our products;

•                  an improved version ofproducts being offered by a competitor in the market we participate in;

•                  technological change that we are unable to address withour products; and

•                  a failure to release new enhanced versions of ourproducts on a timely basis.

** **

**We depend on theintroduction of new products for our success, and we are subject to risks associatedwith rapid technological change.**

** **

Rapidtechnological changes in semiconductor manufacturing processes subject us toincreased pressure to develop technological advances enabling such processes.We believe that our future success depends in part upon our ability to develop,manufacture and timely introduce new light source products with improvedcapabilities and to continue to enhance our existing light source systems andprocess capabilities.  Due to the risksinherent in transitioning to new products, we must forecast accurate demand fornew products while managing the transition from older products.

 

Ournewest product introduction project consists of a technology change from asingle- discharge-chamber designed excimer light source to a dual-discharge-chamberdesign called MOPA.  This MOPA designrepresents a paradigm shift from current lithography technology and isprojected to enable higher power, tighter bandwidth and lower cost of operationfor future optical lithography applications across all three DUV wavelengths –248nm, 193nm and 157nm.  There are risksinherent in transitioning to this new technology.  These risks include effective execution of the product developmentplan, adoption of the product by lithography tool manufacturers and chipmakers,manufacturability and cost effectiveness of the new products and thedevelopment of a comparable product by our competitors.

 

Webelieve that chipmakers are currently developing a capability to producedevices that are measured at 0.13 micron or less, and these efforts are drivingthe current demand for our light source products for DUV photolithographysystems. After chipmakers have this capability, their demand for our lightsource products will depend, in part, on whether they want to expand theircapacity to manufacture these devices. This will in turn depend on whethertheir sales forecasts and projected manufacturing process yields justify thenecessary investments.

 

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Futuretechnologies, such as EUV and EPL, may render our excimer light source productsobsolete. We must manage product transitions, as introduction of new productscould adversely affect our sales of existing products. If new products are notintroduced on time, or have reliability or quality problems, our performancemay be impacted by reduced orders, higher manufacturing costs, delays inacceptance of and payment for new products, and additional service and warrantyexpenses. We may not be able to develop and introduce new products orenhancements to our existing products and processes in a timely or costeffective manner that satisfies customer needs or achieves market acceptance.Failure to develop and introduce these new products and enhancements couldmaterially adversely affect our operating results, financial condition and cashflows.

 

Weexpect to face significant competition from multiple current and futurecompetitors. We believe that other companies are developing systems andproducts that are competitive to ours and are planning to introduce newproducts to this market, which may affect our ability to sell our new products.Furthermore, new products represent significant investments of our resourcesand their success, or lack thereof, could have a material effect on ourfinancial results.

 

**We must effectively manage changes inour business.**

 

In order to respondto the business cycles of the semiconductor industry, in the past few years wehave sharply expanded and contracted the scope of our operations and the numberof employees in many of our departments. As the semiconductor industry growsand contracts we will need to:

 

•                  closely manage ourglobal operations;

•                  improve our process andother internal management systems;

•                  improve our qualitycontrol, order fulfillment, field service and customer support capabilities;

•                  quickly adapt tochanging sales and marketing channels;

•                  effectively manage ourinventory levels; and

•                  attract, train, retainand manage key personnel.

 

If wefail to effectively manage changes in our business, our operating results,financial condition and cash flows would be adversely affected.

 

**Economic, political,regulatory and other events in geographic areas where we have significant salesor operations could interfere with our business.**

 

We servean increasingly global market.  A largeportion of our total revenues is derived from customers located outside of theUnited States, particularly in Asian countries.  We expect our international sales to continue to account for avery large portion of our total revenues. In order to support our foreigncustomers, we maintain a manufacturing and field service subsidiary in Korea aswell as field service and support subsidiaries in Japan, Taiwan, Singapore, thePeople’s Republic of China and the Netherlands.

 

We maynot be able to manage our operations to address and support our globalcustomers effectively. Further, our investments in these types of activitiesmay not make us competitive in the global market or we may not be able to meetthe service, support, and manufacturing levels required by our globalcustomers.

 

Additionally,we are subject to the risks inherent in doing business globally, including:

 

•                  unexpected changes inregulatory requirements;

•                  fluctuations in exchangerates and currency controls;

•                  political and economicconditions and instability;

 

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•                  imposition of tradebarriers and restrictions, including changes in tariff and freight rates,foreign customs and duties;

•                  difficulty in coordinatingour management and operations in several different countries;

•                  difficulties in staffingand managing foreign subsidiary and branch operations;

•                  limited intellectualproperty protection in some countries;

•                  potentially adverse taxconsequences in some countries;

•                  the possibility ofaccounts receivable collection difficulties;

•                  in the case of Asia, therisk of business interruption and damage from earthquakes;

•                  the effect of acts ofterrorism and war; and

•                  the burdens of complyingwith a variety of foreign laws.

 

Many of our major customers and many of thechipmakers who use our light source products in their photolithography systemsare located in Asia. Economic problems and currency fluctuations affectingthese regions in Asia could create a larger risk for us. Further, even thoughit has not been difficult for us to comply with United States export controls,these export rules could change in the future and make it more difficult orimpossible for us to export our products to many countries.  Any of these vulnerabilities could have amaterial adverse effect on our business, financial condition and results ofoperations.

 

**We depend on a few key suppliers forpurchasing components and subassemblies that are included in our products.**

 

We purchase a limited number of components and subassemblies includedin our light source products from a single supplier or a small group ofsuppliers.  For certainoptical components used in our light source systems, we currently utilize asingle supplier.  To reduce the riskassociated with this single supplier, we carry a significant strategicinventory of these components. Strategic inventories are managed as a percentage of future demand.  We have also negotiated to havevendor-managed inventory of critical components to further reduce the risk of asingle supplier.  In addition, we contract the manufacture ofvarious subassemblies more often than in the past. Further, some of oursuppliers have specialized in supplying equipment or manufacturing services tosemiconductor equipment manufacturers and therefore were adversely affected bythe industry downturn. Because many of these suppliers cut their work forces orotherwise downsized during the downturn they may not be able to meet ourrequirements or respond quickly enough as the upturn gains momentum.  Due to the nature of our product developmentrequirements, these key suppliers must rapidly advance their own technologiesand production capabilities in order to support the introduction schedule ofour new products. These suppliers may not be able to provide new modules andsubassemblies when they are needed to satisfy our product schedulerequirements. If we cannot purchase enough of these materials, components orsubassemblies, or if these items do not meet our quality standards, there couldbe delays or reductions in our product shipments, which would have a materialadverse effect on our operating results, financial condition and cash flows.

 

**We face competition fromtwo companies and may face competition from additional competitors who enterthe market.**

** **

We arecurrently aware of two significant competitors that sell light sources for DUVphotolithography applications. These competitors are:

 

•                  Gigaphoton, a jointventure between two large companies, Komatsu and Ushio, which is headquarteredin Japan; and

•                  Lambda-Physik, a companyheadquartered in Germany, owned by Coherent, Inc., a U.S. company.  In 2003, Coherent purchased an additional 34%of the outstanding shares of Lambda-Physik, increasing Coherent’s ownership to94%.

 

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Webelieve that Gigaphoton and Lambda-Physik are aggressively trying to gainlarger market penetration in the excimer light source industry. We know thatour customers have purchased products from these two competitors and that ourcustomers have approved these competitors’ light sources for use with theirproducts.  We know that Gigaphoton, inparticular, has been approved by chipmakers in Japan, the U.S. and elsewherefor producing excimer light sources. Also, we believe that Lambda-Physik has been approved by chipmakers inthe U.S. and Europe for producing excimer light source products.

 

Themarket for excimer light sources is still small and immature. Largercompetitors with substantially greater resources, such as other manufacturersof industrial light sources for advanced lithography, may attempt to sellcompetitive products to our customers. Potential competitors may also beattracted to our growing installed base of light sources and may attempt tosupply consumable products and refurbished parts to that installed base. If anyexisting or future competitors gain market acceptance we could lose marketshare and our growth could slow or decline, which could have a material adverseeffect on our operating results, financial condition and cash flows.

 

**We depend on keypersonnel, especially management and technical personnel, who may be difficultto attract and retain.**

** **

We are highlydependent on the services of many key employees in various areas, including:

 

•                  engineering;

•                  research anddevelopment;

•                  sales and marketing;

•                  field service;

•                  manufacturing; and

•                  management.

 

Inparticular, there are a limited number of experts in excimer light sourcetechnology, and we require highly-skilled hardware and software engineers.Competition for qualified personnel is intense and we cannot guarantee that wewill be able to continue to attract and retain qualified personnel asneeded.  We do not have employmentagreements with most of our employees. We believe that our future growth andoperating results will depend on:

 

•                  the continued servicesof our engineering, research and development, sales and marketing,manufacturing and field service, and management personnel;

•                  our ability to attract,train and retain highly-skilled key personnel; and

•                  the ability of ourpersonnel and key employees to continue to expand, train and manage ouremployee base.

 

If weare unable to hire, train and retain key personnel as required, our operatingresults, financial condition and cash flows could be adversely affected.

 

**Decreasedeffectiveness of equity compensation could adversely affect our ability toattract and retain employees, and proposed changes in accounting for equitycompensation could adversely affect earnings.**

 

We have historically used stock options and other forms ofequity-related incentives as a key component of our employee compensationpackages. We believe that stock options and other long-term equity incentivesdirectly motivate our employees to maximize long-term stockholder value and,through the use of long-term vesting, encourage employees to remain withus.  The Financial Accounting StandardsBoard and other agencies have proposed, and are currently considering, changesto accounting principles generally accepted in the United States of Americathat would require us to record a

 

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chargeto earnings for employee stock option grants and other equity incentives.Moreover, applicable stock exchange listing standards relating to obtainingstockholder approval of equity compensation plans could make it more difficultor expensive for us to grant options to employees in the future, which mayresult in changes in our equity compensation strategy. These and otherdevelopments in the provision of equity compensation to employees could make itmore difficult to attract, retain and motivate employees, and such a change inaccounting rules may adversely impact our future financial condition andoperating results.

 

**Failure to maintain effectively ourdirect field service and support organization could have a material adverseeffect on our business.**

 

Webelieve it is critical for us to provide quick and responsive service directlyto the chipmakers throughout the world that use our light source products intheir photolithography systems, and that it is essential to maintain our ownpersonnel or trained third-party resources to provide these services.  Accordingly, we have an ongoing effort todevelop our direct support system with locations in the United States, Japan,Europe, Korea, Singapore, Taiwan and the People’s Republic of China. Thisrequires us to do the following:

 

•                  recruit and trainqualified field service personnel;

•                  identify qualifiedindependent firms; and

•                  maintain effective andhighly trained organizations that can provide service to our customers invarious countries.

 

Wemight not be able to attract and train qualified personnel to maintain ourdirect support operations successfully. We may not be able to find and engagequalified third-party resources to supplement and enhance our direct supportoperations.  Further, we may incursignificant costs in providing these support services. Failure to implement ourdirect support operation effectively could have a material adverse effect onour operating results, financial condition and cash flows.

 

**Our ability to compete could bejeopardized if we are unable to protect our intellectual property rights. Thesetypes of claims could seriously harm our business or require us to incursignificant costs.**

 

Webelieve our success and ability to compete depend in large part upon protectingour proprietary technology. We rely on a combination of patent, trade secret,copyright and trademark laws, nondisclosure and other contractual agreementsand technical measures to protect our proprietary rights.

 

As ofMarch 31, 2004, we owned 205 United States patents covering certain aspects oftechnology related to light sources and piezo techniques. These patents willexpire at various times during the period from January 2008 to November2021.  As of March 31, 2004, we hadapplied for 79 additional patents in the United States.  As of March 31, 2004, we owned 277 foreignpatents and had 330 patent applications pending in various foreign countries.

 

Ourpending patent applications and any future applications might not be approved.Our patents might not provide us with a competitive advantage and may bechallenged by third parties. In addition, third parties’ patents might have anadverse effect on our ability to do business. As a result of cost constraints,we did not begin filing in Japan and other countries our patents for inventionscovered by United States patents and patent applications until 1993.  As a result we do not have the right to seekforeign patent protection for some of our early inventions.  Additionally, laws of some foreign countriesin which our products are or may be developed, manufactured or sold, including variouscountries in Asia, may not protect our products or intellectual property rightsto the same extent as do the laws of the United States. Thus, the possibilityof piracy of our technology and products are more likely in these countries.

 

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Further, third partiesmight independently develop similar products, duplicate our products or, designaround patents that are granted to us.

 

Othercompanies or persons may have filed or may file in the future patentapplications that are similar or identical to ours. We may have to participatein interference proceedings declared by the United States Patent and TrademarkOffice (“USPTO”) in order for the patent office to determine the priority ofinventions. The patent office may determine that these third-party patentapplications have priority over our patent applications. Loss of priority inthese interference proceedings could result in substantial cost to us.

 

We alsorely on the following to protect our confidential information and our otherintellectual property:

 

•                  trade secret protection;

•                  employee nondisclosureagreements;

•                  third-partynondisclosure agreements; and

•                  other intellectualproperty protection methods.

 

However,we may not be successful in protecting our confidential information and intellectualproperty, particularly our trade secrets, because third parties may:

 

•                  independently developsubstantially the same proprietary information and techniques;

•                  gain access to our tradesecrets; or

•                  disclose our technology.

 

**The parties to whom weprovide research and development services may dispute the ownership of theintellectual property that we develop performing these services.**

** **

In thepast, funds from research and development arrangements with third parties havebeen used to pay for a portion of our own research and development expenses. Wereceive these funds from government-sponsored programs, customers and fromSEMATECH, a research consortium, in connection with our designing anddeveloping specific products. Currently, funds from SEMATECH, lithography toolmanufacturers and chipmakers are used to fund a small portion of ourdevelopment expenses. In providing these research and development services tothese manufacturers and SEMATECH, we try to make clear who owns theintellectual property that results from the research and development serviceswe perform. However, disputes over the ownership or rights to use or marketthis intellectual property may arise between us and the lithography toolmanufacturers and SEMATECH. Any dispute over ownership of the intellectualproperty we develop could restrict our ability to market our products and havea material adverse effect on our business.

 

**In the future, we may besubject to patent litigation to enforce patents issued to us and defendourselves against claimed infringement by our competitors or any other thirdparty.**

 

Thirdparties have notified us in the past, and may notify us in the future, that weare infringing their intellectual property rights. Also, we have notified thirdparties in the past, and may notify them in the future, that they may beinfringing our intellectual property rights.

 

Specifically,Komatsu has notified us that we may be infringing some of its Japanese patents.During our discussions with Komatsu, they also asserted that we or our formerJapanese manufacturing partner, Seiko, may be infringing on some of Komatsu’sUnited States patents and a number of its additional Japanese patents. Komatsuhas also notified one of our customers, Nikon, of its belief that our light sourcesinfringe several of Komatsu’s Japanese and U.S. patents. As a result, westarted proceedings in the Japanese Patent Office to oppose certain patents andpatent applications of Komatsu. 

 

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The Japanese PatentOffice has dismissed some of our opposition claims. Thus, litigation may resultin connection with Komatsu’s Japanese patents or U.S. patents. Also, Komatsumight claim that we infringe other or additional patents. Komatsu notifiedSeiko that it intends to enforce its rights against Seiko with respect to itsJapanese patents if Seiko continued to engage in manufacturing activities forus. In connection with our former manufacturing agreement with Seiko, we agreeto pay Seiko under certain conditions for damages associated with these typesof claims. Seiko may not prevail in any litigation against Komatsu, andtherefore, we may be required to pay Seiko for such damages.

 

We havenotified our competitors and others of our United States patent portfolio.Specifically, we have notified Komatsu that they may be infringing on some ofour U.S. patents. We have discussed with Komatsu our claims against eachother.  Komatsu challenged one of ourU.S. patents in the USPTO but it was subsequently re-issued by the USPTO.  Also, Komatsu transferred its lithographylight source business to one of our competitors, Gigaphoton.  We also have had discussions withLambda-Physik (a subsidiary of Coherent, Inc.), another competitor, regardingallegations by each party against the other for possible patent infringement.Any of these discussions with our competitors may not be successful andlitigation could result.

 

In thefuture, patent litigation may result due to a claim of infringement by ourcompetitors or any other third party or may be necessary to enforce patentsissued to us.  Any such litigation couldresult in substantial cost and diversion of effort by us, which would have anadverse effect on our business, financial condition and operating results.Furthermore, our customers and the end users of our products might assert otherclaims for indemnification that arise from infringement claims against them. Ifthese assertions are successful, our business, financial condition andoperating results may be materially affected. Instead of litigation, we mayseek a license from third parties to use their intellectual property. However,we may not be able to obtain a license on reasonable terms. In the alternative,we may design around the third party’s intellectual property rights or we maychallenge these claims in legal proceedings. Any adverse determination in alegal proceeding could result in one or more of the following, any of whichcould have a substantial adverse effect on our business, financial conditionand operating results:

 

•                  loss of our proprietaryrights;

•                  exposure to significantliabilities by other third parties;

•                  requirement that we geta license from third parties on terms that are not favorable; or

•                  restriction frommanufacturing or selling our products.

 

Any ofthese actions could be costly and would divert the efforts and attention ofCymer’s management and technical personnel, which would materially adverselyaffect Cymer’s business, financial condition and results of operations.

 

**Trademark infringement claims againstour registered and unregistered trademarks would be expensive and we may haveto stop using such trademarks and pay damages.**

 

Weregistered the trademark ‘‘CYMER’’ & “INSIST ON CYMER” and others in theUnited States and in some other countries. We are also trying to registeradditional trademarks in the United States and in other countries.  We use these trademarks and many other marksin our advertisements and other business materials, which are distributedthroughout the world. We may be subject to trademark infringement actions forusing these marks and other marks on a worldwide basis and this would be costlyto defend. If a trademark infringement action was successful, we would have tostop using the mark and possibly pay damages.

 

**We are dependent on air transport toconduct our business and disruption of domestic and international air transportsystems could adversely affect our business.**

 

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Wedepend on regular and reliable air transportation on a worldwide basis for manyof our routine business functions. If civil aviation in the United States orabroad is disrupted by terrorist activities or security responses to the threatof terrorism or for any other reason, our business could be adversely affectedin the following ways:

 

•                  supplies of rawmaterials and components for the manufacture of our products or our customers’products may be disrupted;

•                  we may not be able todeliver our products to our customers in a timely manner;

•                  we may not be able toprovide timely support of installed light sources for chipmakers; and

•                  our sales and marketingefforts may be disrupted.

 

**We are exposed to risks related to thefluctuations in the currency exchange rates for the Japanese yen.**

 

If wesell products to our Japanese subsidiary, the sale is denominated in U.S.dollars. If our Japanese subsidiary sells our products directly to customers inJapan, the sale is denominated in Japanese yen. Thus, our results of operationsmay fluctuate based on the changing value of the Japanese yen to the U.S.dollar. Our Japanese subsidiary manages its exposure to these fluctuationsthrough foreign currency forward exchange contracts to hedge its purchasecommitments. We will continue to monitor our exposure to these currencyfluctuations, and, when appropriate, use hedging transactions to minimize theeffect of these currency fluctuations. However, exchange rate fluctuations maystill have a material adverse effect on our operating results. In the future, wemay need to sell our products in other foreign currencies other than theJapanese yen and the management of more currency fluctuations will be moredifficult and expose us to greater risks in this area.

 

**Compliance with changingregulation of corporate governance and public disclosure may result inadditional expenses***.*

 

Changinglaws, regulations and standards relating to corporate governance and publicdisclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations,Nasdaq Stock Market rules, and new accounting pronouncements are creatinguncertainty and additional complexities for companies such as ours. To maintainhigh standards of corporate governance and public disclosure, we intend toinvest all reasonable necessary resources to comply with evolving standards.This investment may result in increased general and administrative expenses anda diversion of management time and attention from strategic revenue-generatingand cost management activities.

 

**We are subject to manystandards and regulations of foreign governments and, even though we intend tocomply, we may not always be in compliance with these rules, or we may beunable to design or redesign our products to comply with these rules.**

 

Manyforeign government standards and regulations apply to our products. Thesestandards and regulations are always being amended. Although we intend to meetall foreign standards and regulations, our products may not comply with theseforeign government standards and regulations. Further, it might not be costeffective for us to redesign our products to comply with these foreigngovernment standards and regulations. Our inability to design or redesignproducts to comply with foreign standards therefore could have a materialadverse effect on our business.

 

**Chipmakers’ prolonged useof our products in high volume productions may not produce the results theydesire and, as a result, our reputation and that of our customers who supplyphotolithography tools to the chipmakers could be damaged in the semiconductorindustry.**

 

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Overtime, our light source products may not meet chipmakers’ productionspecifications or operating cost requirements after the light source is usedfor a long period in high volume production. If any chipmaker cannotsuccessfully achieve or sustain their volume production using our lightsources, our reputation could be damaged with the chipmakers and our customerswho are the limited number of lithography tool manufacturers. This would have amaterial adverse effect on our business.

** **

**We have in the past andmay in the future acquire a business that will involve numerous risks. We maynot be able to address these risks successfully without substantial expense,delay or other operational and financial problems.**

** **

Therisks involved with acquiring a new company include the following:

 

•                  diversion ofmanagement’s attention and resources to integrate the new company;

•                  failure to retain keypersonnel;

•                  amortization of acquireddefinite-lived intangible assets and deferred compensation;

•                  client dissatisfactionor performance problems with the acquired company;

•                  the cost associated withacquisitions and the integration of acquired operations;

•                  failure to commercializepurchased technologies;

•                  ability of the acquiredcompanies to meet their financial projections;

•                  assumption of unknownliabilities or other unanticipated events or circumstances; and

•                  compliance with theSarbanes-Oxley Act of 2002, new SEC regulations, Nasdaq Stock Market rules andnew accounting pronouncements.

 

Mergersand acquisitions are inherently subject to multiple significant risks, and theinability to effectively manage these risks could have a material adverseeffect on our business.  Any of theserisks could materially harm our business, financial condition and operatingresults. Further, any business that we acquire may not achieve anticipatedrevenues or operating results.

 

**We must develop andmanufacture enhancements to our existing products and introduce new products inorder to continue to grow our business. We may not effectively manage ourgrowth and integrate these new enhancements and products, which couldmaterially harm our business.**

** **

Tocontinue to grow our business, our existing light source products and theirprocess capabilities must be enhanced, and we must develop and manufacture newproducts to serve other semiconductor applications. We cannot guarantee that wewill be able to manage our growth effectively. Nor can we guarantee that wewill be able to accelerate the development of new enhancements to our existingproducts and create new products. Further, we may not be able to effectivelyintegrate new products and applications into our current operations. Any ofthese risks could materially harm our business, financial condition and resultsof operations.

 

## **Weare dependent on our manufacturing facilities and subcontractors to assembleand test our products.**

 

Operationsat our primary manufacturing facility and our subcontractors are subject todisruption for a variety of reasons, including work stoppages, terrorism, fire,earthquake, energy shortages, flooding or other natural disasters.  Such disruptions could cause delays inshipments of our products to our customers. We cannot ensure that alternate production capacity would be availableif a major disruption were to occur or that, if it were available, it could beobtained on favorable terms.  Suchdisruption could result in cancellation of orders or loss of customers, whichwould have a material adverse effect on our operating results, financialcondition and cash flows.

 

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**Our operations are subject toenvironmental and other government regulations that may expose us toliabilities for noncompliance.**

 

We aresubject to federal, state and local regulations, such as regulations related tothe environment, land use, public utility utilization and the fire code, inconnection with the storage, handling, discharge and disposal of substancesthat we use in our manufacturing process and on our facilities.  We believe that our activities comply withcurrent government regulations that are applicable to our operations andcurrent facilities. We may be required to purchase additional capital equipmentor other requirements for our processes to comply with these governmentregulations in the future if they change. Further, these government regulationsmay restrict us from expanding our operations. Adopting measures to comply withchanges in the government regulations, our failure to comply with environmentaland land use regulations, or restrictions on our ability to discharge hazardoussubstances, could subject us to future liability or cause our manufacturingoperations to be reduced or stopped.

 

**Our products are subjectto potential product liability claims if personal injury or death result.**

 

We areexposed to significant risks for product liability claims if personal injury ordeath results from the use of our products. We may experience material productliability losses in the future. We maintain insurance against product liabilityclaims. However, our insurance coverage may not continue to be available onterms that we accept. This insurance coverage also may not adequately coverliabilities that we incur. Further, if our products are defective, we may berequired to recall or redesign these products. A successful claim against usthat exceeds our insurance coverage level, or any claim or product recall thatresults in adverse publicity against us, could have a material adverse effecton our business, financial condition and results of operations.

 

**The price of our common stock has fluctuated and may continueto fluctuate widely.**

 

Theprice of our common stock has fluctuated in the past. The market price of ourcommon stock will continue to be subject to significant fluctuations in thefuture in response to a variety of factors, including the risk factorscontained in this report.

 

Variousfactors may significantly affect the market price of our common stock, including:

 

•                  the cyclical nature ofthe semiconductor industry;

•                  actual or anticipatedfluctuations in our operating results;

•                  conditions and trends inthe light source device and other technology industries;

•                  announcements ofinnovations in technology;

•                  new products offered byus or our competitors;

•                  developments of patentsor proprietary rights;

•                  changes in financialestimates by securities analysts;

•                  general worldwidepolitical, economic, and market conditions;

•                  United States political,economic, and market conditions; and

•                  failure to properlymanage any single or combination of risk factors listed in this section.

 

Inaddition, the stock market has experienced extreme price and volumefluctuations that have particularly affected the market price for many hightechnology companies. Such fluctuations have in some cases been unrelated tothe operating performance of these companies. Severe price fluctuations in acompany’s stock have frequently been followed by securities litigation.  Any such litigation can result in

 

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substantial costs and adiversion of management’s attention and resources and therefore could have amaterial adverse effect on Cymer’s business, financial condition and results ofoperations.

** **

**We have implemented stepsto protect our company from hostile takeovers.**

 

Nevadalaw and our articles of incorporation contain provisions that discourage aproxy contest and provisions that make an acquisition of a substantial block ofour common stock more difficult. In addition, our board of directors isauthorized to issue, without stockholder approval, shares of preferred stock.Such shares of preferred stock may have voting, conversion and other rights andpreferences that may be superior to those of the common stock and this couldadversely affect the voting power or other rights of holders of common stock.Our board can use the issuance of the preferred stock or rights to purchase thepreferred stock to discourage any unsolicited acquisition proposal or attempt.

 

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#### **ITEM3. **Quantitativeand Qualitative Disclosures About Market Risk

 

# **Foreign Currency Risk**

 

Cymer conducts business in severalinternational currencies through its global operations. Due to the large volumeof Cymer’s business that is conducted in Japan, the Japanese operation posesthe greatest foreign currency risk. Cymer uses financial instruments, principally foreign currency forwardexchange contracts, in Japan to manage its foreign currency exposures. Cymerenters into foreign currency forward exchange contracts in order to reduce theimpact of currency fluctuations related to purchases of Cymer’s inventories byCymer Japan in U.S. dollars for resale under firm third-party sales commitmentsdenominated in Japanese yen.  Cymer doesnot enter into foreign currency forward exchange contracts for tradingpurposes.

 

As of March 31, 2004, Cymer hadoutstanding foreign currency forward exchange contracts to buy U.S. $81.4million for 9.1 billion yen under foreign currency exchange facilities withcontract rates ranging from 105.82 yen to 118.4****yen per U.S. dollar.  These contracts expire on various datesthrough June 2005.

 

Cymer’sforeign currency forward exchange contracts qualify for hedge accountingtreatment per the provisions of Statement of Financial Accounting Standards No.133, “Accounting for Derivative Instruments and Hedging Activities”.  As a result, Cymer defers changes in thefair value of these contracts and records the amount in other comprehensiveincome (loss) and subsequently reclassifies the gain or loss to cost of productsales in the same period that the related sale is made to the third party. Theunrealized loss or fair value of these contracts and the deferred loss totaled$5.7 million and $2.6 million, respectively, as of March 31, 2004.  The fair value of these foreign currencyforward exchange contracts as of March 31, 2004 would have changed by $14.1million if the foreign currency exchange rate for the Japanese yen to the U.S.dollar on these forward contracts had changed by 10%.

 

# **Investment and Debt Risk**

 

Cymer maintains an investment portfolioconsisting primarily of government and corporate fixed income securities,certificates of deposit and commercial paper. While it is Cymer’s general intent to hold such securities untilmaturity, Cymer will occasionally sell certain securities for cash flowpurposes. Therefore, Cymer’s investments are classified as available-for-saleand are carried on the balance sheet at fair value.  Due to the conservative nature of the investment portfolio, asudden change in interest rates would not have a material effect on the valueof the portfolio.

 

In February 2002, Cymerissued $250.0 million principal amount of unsecured fixed rate 31⁄2% ConvertibleSubordinated Notes due February 15, 2009. Interest on these 2002 Notes is payable on February 15 and August 15 ofeach year, commencing August 15, 2002. The 2002 Notes are convertible into shares of Cymer’s common stock at aconversion rate of 20 shares per $1,000 principal amount subject to adjustmentunder certain conditions. Cymer may redeem the 2002 Notes on or after February20, 2005, or earlier if the price of its common stock reaches certain levels.  The 2002 Notes are subordinated to Cymer’sexisting and future senior indebtedness and effectively subordinated to allindebtedness and other liabilities of Cymer’s subsidiaries.  Because the interest rate is fixed, webelieve there is no risk of increased interest expense. These 2002 Notes arerecorded at face value on the consolidated balance sheets.  The fair value of such debt based on quotedmarket prices on March 31, 2004 was $263.3 million.

 

#### **ITEM 4**.  Controls and Procedures

 

*Evaluation ofdisclosure controls and procedures*.  Cymer’schief executive officer and its chief financial officer, after evaluating theeffectiveness of Cymer’s disclosure controls and procedures (as

 

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definedin Exchange Act Rule 13a-15(e) and 15d-15(e)) as of March 31, 2004, haveconcluded that as of such date, Cymer’s disclosure controls and procedures wereadequate and sufficient to ensure that information required to be disclosed byCymer in the reports that it files under the Securities Exchange Act 

 

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of1934 is recorded, processed, summarized and reported within the time periodspecified in the Commission’s rules and forms.

 

*Changes in internal controls*.There has been no change in Cymer’s internal control over financial reportingduring the fiscal quarter ended March 31, 2004 that has materially affected, oris reasonably likely to materially affect, Cymer’s internal control overfinancial reporting.

 

**PART II.  OTHER INFORMATION**

 
| **ITEM 1**. |   | **Legal  Proceedings**                                  |
|-------------|--------|---------------------------------------------------------|
|        |   |                                                    |
|        |   | None.                                                   |
|        |   |                                                    |
| **ITEM 2**. |   | **Changes  in Securities and Use of Proceeds**          |
|        |   |                                                    |
|        |   | None.                                                   |
|        |   |                                                    |
| **ITEM 3**. |   | **Defaults  Upon Senior Securities**                    |
|        |   |                                                    |
|        |   | None.                                                   |
|        |   |                                                    |
| **ITEM 4.** |   | **Submission of**Matters to  a Vote of Security Holders |
|        |   |                                                    |
|        |   | None.                                                   |
|        |   |                                                    |
| **ITEM 5**. |   | **Other  Information**                                  |
|        |   |                                                    |
|        |   | None.                                                   |
|        |   |                                                    |
| **ITEM 6**. |   | **Exhibits  and Reports on Form 8-K**                   |

 
| **(a)** |   | 10.1*  |   | Development  Agreement dated January 23, 2004, by and between Cymer, Inc. and Intel  Corporation.                   |
|---------|--------|--------|--------|---------------------------------------------------------------------------------------------------------------------|
|    |   |   |   |                                                                                                                |
|    |   | 10.2*  |   | Intellectual  Property License Agreement dated February 4, 2004, by and between Cymer, Inc.  and Intel Corporation. |
|    |   |   |   |                                                                                                                |
|    |   | 31.1   |   | Certification  of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act                         |
|    |   |   |   |                                                                                                                |
|    |   | 31.2   |   | Certification  of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act                         |
|    |   |   |   |                                                                                                                |
|    |   | 32.1   |   | Certification  of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act                         |
|    |   |   |   |                                                                                                                |
|    |   | 32.2   |   | Certification  of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act                         |

 

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* Confidential treatment requested

 

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**(b)  Reports on Form 8-K**

 

On January 27, 2004, Cymer furnished a Form 8-K announcing its fourthquarter 2003 financial results.

 

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**SIGNATURES**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused thisquarterly report on Form 10-Q to be signed on its behalf by the undersignedthereunto duly authorized.

 

 
|                    |   | CYMER, INC.                   |
|-------------------------|--------|-------------------------------|
|                    |   |                          |
|                    |   |                          |
| Date:  May 6, 2004 | By:    | /s/ NANCY J.  BAKER           |   |
|                    |   |                          |
|                    |   | Nancy J.  Baker               |
|                    |   | Senior Vice  President and    |
|                    |   | Chief  Financial Officer      |
|                    |   | (Duly  Authorized Officer and |
|                    |   | Principal  Financial Officer) |

 

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