**UNITED STATES SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**x****                             ****QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For theQuarterly Period Ended September 30, 2007**

 

**OR**

 

**o****                                ****TRANSITION REPORT PURSUANT TO SECTION 13OR 15(d) OF THE EXCHANGE ACT OF 1934**

 

**For theTransition Period from                     to                         **

 

**Commission file number 0-21321**

 

**CYMER, INC.**

(Exact name of registrant as specified in its charter)

 

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

 

**(858) 385-7300**

(Registrant’s telephone number, including area code)

 

**N/A**

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

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. xYes    oNo 

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 ofthe Exchange Act. (Check one):

 
| x  Large accelerated filer |   | o  Accelerated filer |   | o  Non-accelerated filer |
|----------------------------|--------|----------------------|--------|--------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). oYes  ýNo

 

The total number ofshares of Common Stock, with $0.001 par value, outstanding on November 5,2007 was 30,566,079.

 

 

----

 

**CYMER, INC.**

 

**FORM 10-Q**

 

**For the Quarterly Period Ended September 30,2007**

 

**INDEX**

 

 
| **PART I.**  |       | **FINANCIAL  INFORMATION**                                                                                  | ** ** | ** ** |
|-------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|------------|
|              |       |                                                                                                        |       |       |
| ITEM 1.           |       | Financial Statements (unaudited)                                                                            |       |       |
|              |       |                                                                                                        |       |       |
|              |       | Consolidated  Balance Sheets as of December 31, 2006 and September 30, 2007                       |       |       |
|              |       |                                                                                                        |       |       |
|              |       | Consolidated Statements of Operations for the three  and nine months ended September 30, 2006 and 2007 |       |       |
|              |       |                                                                                                        |       |       |
|              |       | Consolidated  Statements of Cash Flows for the nine months ended September 30, 2006  and 2007          |       |       |
|              |       |                                                                                                        |       |       |
|              |       | 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 1A.          |       | Risk Factors                                                                                                |       |       |
|              |       |                                                                                                        |       |       |
| ITEM 2.           |       | Unregistered  Sales of Equity 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                                                                                                    |       |       |
|              |       |                                                                                                        |       |       |
| **SIGNATURES**    |       |                                                                                                        |

 

2

----

 

**ITEM 1. Financial Statements**

 

**CYMER, INC.**

**CONSOLIDATED BALANCE SHEETS (UNAUDITED)**

**(Inthousands, except share data)**

 
| ** **                                                                                                                                                                                   | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                                   | ** ** | **2006**              | ** ** | **2007**               | ** ** |
| **ASSETS**                                                                                                                                                                                   |       |                  |       |                   |       |
| CURRENT ASSETS:                                                                                                                                                                              |       |                  |       |                   |       |
| Cash and cash equivalents                                                                                                                                                                    |       | $                     | 302,098    |                   | $          | 237,899 |   |
| Short-term investments                                                                                                                                                                       |       | 207,943               |       | 55,067                 |       |
| Accounts receivable - net                                                                                                                                                                    |       | 115,857               |       | 107,724                |       |
| Accounts receivable - related party                                                                                                                                                          |       | 834                   |       | 1,756                  |       |
| Foreign currency forward exchange contracts                                                                                                                                                  |       | 652                   |       | —                 |       |
| Inventories                                                                                                                                                                                  |       | 104,296               |       | 123,433                |       |
| Deferred income taxes                                                                                                                                                                        |       | 46,943                |       | 40,350                 |       |
| Income taxes receivable                                                                                                                                                                      |       | —                |       | 5,228                  |       |
| Prepaid expenses and other assets                                                                                                                                                            |       | 7,143                 |       | 8,585                  |       |
| Total current assets                                                                                                                                                                         |       | 785,766               |       | 580,042                |       |
|                                                                                                                                                                                         |       |                  |       |                   |       |
| PROPERTY AND EQUIPMENT - NET                                                                                                                                                                 |       | 112,074               |       | 109,123                |       |
| LONG-TERM INVESTMENTS                                                                                                                                                                        |       | 8,384                 |       | 27,243                 |       |
| DEFERRED INCOME TAXES                                                                                                                                                                        |       | 12,766                |       | 11,334                 |       |
| GOODWILL - NET                                                                                                                                                                               |       | 8,833                 |       | 8,833                  |       |
| INTANGIBLE ASSETS - NET                                                                                                                                                                      |       | 15,880                |       | 13,714                 |       |
| OTHER ASSETS                                                                                                                                                                                 |       | 5,391                 |       | 5,432                  |       |
|                                                                                                                                                                                         |       |                  |       |                   |       |
| TOTAL ASSETS                                                                                                                                                                                 |       | $                     | 949,094    |                   | $          | 755,721 |   |
|                                                                                                                                                                                         |       |                  |       |                   |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                |       |                  |       |                   |       |
|                                                                                                                                                                                         |       |                  |       |                   |       |
| CURRENT LIABILITIES:                                                                                                                                                                         |       |                  |       |                   |       |
| Accounts payable                                                                                                                                                                             |       | $                     | 18,711     |                   | $          | 18,721 |   |
| Accounts payable - related party                                                                                                                                                             |       | 4,858                 |       | 2,524                  |       |
| Accrued warranty and installation                                                                                                                                                            |       | 29,974                |       | 26,897                 |       |
| Accrued payroll and benefits                                                                                                                                                                 |       | 21,707                |       | 21,358                 |       |
| Accrued patents, royalties and other fees                                                                                                                                                    |       | 4,262                 |       | 4,481                  |       |
| Income taxes payable                                                                                                                                                                         |       | 13,293                |       | —                 |       |
| Deferred revenue                                                                                                                                                                             |       | 2,544                 |       | 4,536                  |       |
| Foreign currency forward exchange contracts                                                                                                                                                  |       | —                |       | 984                    |       |
| Accrued and other current liabilities                                                                                                                                                        |       | 3,715                 |       | 2,614                  |       |
| Total current liabilities                                                                                                                                                                    |       | 99,064                |       | 82,115                 |       |
|                                                                                                                                                                                         |       |                  |       |                   |       |
| CONVERTIBLE SUBORDINATED NOTES                                                                                                                                                               |       | 140,722               |       | 140,722                |       |
| INCOME TAXES PAYABLE                                                                                                                                                                         |       | —                |       | 16,597                 |       |
| DEFERRED REVENUE                                                                                                                                                                             |       | —                |       | 5,563                  |       |
| OTHER LIABILITIES                                                                                                                                                                            |       | 14,781                |       | 16,651                 |       |
|                                                                                                                                                                                         |       |                  |       |                   |       |
| Total liabilities                                                                                                                                                                            |       | 254,567               |       | 261,648                |       |
|                                                                                                                                                                                         |       |                  |       |                   |       |
| MINORITY INTEREST                                                                                                                                                                            |       | 6,633                 |       | 4,270                  |       |
| COMMITMENTS AND CONTINGENCIES                                                                                                                                                                |       |                  |       |                   |       |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                   |       |                  |       |                   |       |
| Preferred stock - $.001 par value per share;  5,000,000 shares authorized; no shares issued or outstanding                                                                                   |       | —                |       | —                 |       |
| Common stock - $.001 par value per share;  100,000,000 shares authorized; 41,774,000 and 42,247,000 shares outstanding  at December 31, 2006 and September 30, 2007, respectively. |       | 42                    |       | 42                     |       |
| Additional paid-in capital                                                                                                                                                                   |       | 557,082               |       | 576,124                |       |
| Treasury stock at cost - 4,536,000 and 11,730,000  common shares at December 31, 2006 and September 30, 2007,  respectively.                                                       |       | (150,704              | )          | (438,664               | )          |
| Accumulated other comprehensive loss                                                                                                                                                         |       | (4,066                | )          | (522                   | )          |
| Retained earnings                                                                                                                                                                            |       | 285,540               |       | 352,823                |       |
| Total stockholders’ equity                                                                                                                                                              |       | 687,894               |       | 489,803                |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                              |       | $                     | 949,094    |                   | $          | 755,721 |   |

 

See Notes to UnauditedConsolidated Financial Statements.

 

3

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**CYMER, INC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS (UNAUDITED)**

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

 
| ** **                                                                | ** ** | **For the three months** | ** ** | **For the nine months** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                | ** ** | **ended September 30,**       | ** ** | **ended September 30,**      | ** ** |
| ** **                                                                | ** ** | **2006**                                | ** ** | **2007**                               | ** ** | **2006** | ** ** | **2007** | ** ** |
|                                                                      |       |                                    |       |                                   |       |   |   |   |   |
| REVENUES:                                                                 |       |                                    |       |                                   |       |   |   |   |   |
| Product sales                                                             |       | $                                       | 142,711    |                                   | $          | 130,292 |   | $ | 399,694 |   | $ | 378,146 |   |
| Product sales - related party                                             |       | 1,098                                   |       | 1,754                                  |       | 6,461 |   | 3,090 |   |
| Other                                                                     |       | 109                                     |       | 79                                     |       | 259 |   | 538 |   |
| Total revenues                                                            |       | 143,918                                 |       | 132,125                                |       | 406,414 |   | 381,774 |   |
|                                                                      |       |                                    |       |                                   |       |   |   |   |   |
| COSTS AND EXPENSES:                                                       |       |                                    |       |                                   |       |   |   |   |   |
| Cost of product sales                                                     |       | 72,487                                  |       | 65,899                                 |       | 211,734 |   | 187,684 |   |
| Research and development                                                  |       | 18,940                                  |       | 21,367                                 |       | 55,867 |   | 60,760 |   |
| Sales and marketing                                                       |       | 8,427                                   |       | 6,845                                  |       | 22,643 |   | 19,595 |   |
| General and administrative                                                |       | 9,085                                   |       | 9,934                                  |       | 27,895 |   | 28,473 |   |
| Total costs and expenses                                                  |       | 108,939                                 |       | 104,045                                |       | 318,139 |   | 296,512 |   |
| OPERATING INCOME                                                          |       | 34,979                                  |       | 28,080                                 |       | 88,275 |   | 85,262 |   |
|                                                                      |       |                                    |       |                                   |       |   |   |   |   |
| OTHER INCOME (EXPENSE):                                                   |       |                                    |       |                                   |       |   |   |   |   |
| Foreign currency exchange gain (loss) - net                               |       | (243                                    | )          | 1,527                                  |       | 856 |   | 1,956 |   |
| Interest and other income                                                 |       | 5,415                                   |       | 4,027                                  |       | 17,894 |   | 16,250 |   |
| Interest and other expense                                                |       | (1,474                                  | )          | (1,704                                 | )          | (4,381 | ) | (4,807 | ) |
| Total other income - net                                                  |       | 3,698                                   |       | 3,850                                  |       | 14,369 |   | 13,399 |   |
|                                                                      |       |                                    |       |                                   |       |   |   |   |   |
| INCOME BEFORE INCOME TAX PROVISION AND MINORITY  INTEREST                 |       | 38,677                                  |       | 31,930                                 |       | 102,644 |   | 98,661 |   |
| INCOME TAX PROVISION                                                      |       | 12,547                                  |       | 11,010                                 |       | 34,680 |   | 34,099 |   |
| MINORITY INTEREST                                                         |       | 902                                     |       | 750                                    |       | 2,273 |   | 2,363 |   |
| NET INCOME                                                                |       | $                                       | 27,032     |                                   | $          | 21,670 |   | $ | 70,237 |   | $ | 66,925 |   |
|                                                                      |       |                                    |       |                                   |       |   |   |   |   |
| EARNINGS PER SHARE:                                                       |       |                                    |       |                                   |       |   |   |   |   |
| Basic earnings per share                                                  |       | $                                       | 0.71       |                                   | $          | 0.69 |   | $ | 1.85 |   | $ | 1.96 |   |
| Weighted average common shares outstanding                                |       | 37,819                                  |       | 31,395                                 |       | 37,995 |   | 34,122 |   |
|                                                                      |       |                                    |       |                                   |       |   |   |   |   |
| Diluted earnings per share                                                |       | $                                       | 0.68       |                                   | $          | 0.65 |   | $ | 1.75 |   | $ | 1.86 |   |
| Weighted average common and dilutive potential  common shares outstanding |       | 41,185                                  |       | 34,588                                 |       | 41,635 |   | 37,400 |   |

 

See Notes to UnauditedConsolidated Financial Statements.

 

4

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**CYMER, INC.**

**CONSOLIDATED STATEMENTS OF CASHFLOWS (UNAUDITED)**

**(In thousands)**

 
| ** **                                                                         | ** ** | **For the nine months ended** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                         | ** ** | **September 30,**                            | ** ** |
| ** **                                                                         | ** ** | **2006**                                          | ** ** | **2007** | ** ** |
|                                                                               |       |                                              |       |   |   |
| OPERATING ACTIVITIES:                                                              |       |                                              |       |   |   |
| Net income                                                                         |       | $                                                 | 70,237     |   | $ | 66,925 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                                              |       |   |   |
| Depreciation and amortization                                                      |       | 18,939                                            |       | 19,016 |   |
| Non-cash stock-based compensation                                                  |       | 7,567                                             |       | 4,363 |   |
| Minority interest                                                                  |       | (2,273                                            | )          | (2,363 | ) |
| Provision for deferred income taxes                                                |       | 9,410                                             |       | 13,162 |   |
| Loss on disposal and impairment of property and  equipment                         |       | 94                                                |       | 298 |   |
| Change in assets and liabilities:                                                  |       |                                              |       |   |   |
| Accounts receivable – net                                                     |       | (25,180                                           | )          | 8,133 |   |
| Accounts receivable – related party                                           |       | (1,601                                            | )          | (922 | ) |
| Income taxes receivable                                                            |       | —                                            |       | (5,228 | ) |
| Foreign currency forward exchange contracts                                        |       | 1,154                                             |       | 1,549 |   |
| Inventories                                                                        |       | (15,480                                           | )          | (19,137 | ) |
| Prepaid expenses and other assets                                                  |       | (1,089                                            | )          | (2,068 | ) |
| Accounts payable                                                                   |       | (3,428                                            | )          | 10 |   |
| Accounts payable - related party                                                   |       | (434                                              | )          | (2,334 | ) |
| Accrued expenses and other liabilities                                             |       | 10,304                                            |       | (2,485 | ) |
| Deferred revenue                                                                   |       | 763                                               |       | 7,555 |   |
| Income taxes payable                                                               |       | (1,676                                            | )          | (1,589 | ) |
|                                                                               |       |                                              |       |   |   |
| Net cash provided by operating activities                                          |       | 67,307                                            |       | 84,885 |   |
|                                                                               |       |                                              |       |   |   |
| INVESTING ACTIVITIES:                                                              |       |                                              |       |   |   |
| Acquisition of property and equipment                                              |       | (9,976                                            | )          | (13,491 | ) |
| Purchases of investments                                                           |       | (188,229                                          | )          | (76,044 | ) |
| Proceeds from sold or matured investments                                          |       | 140,823                                           |       | 210,565 |   |
| Acquisition of patents                                                             |       | (8,200                                            | )          | (121 | ) |
| Acquisition of minority interest                                                   |       | (7,024                                            | )          | — |   |
|                                                                               |       |                                              |       |   |   |
| Net cash provided by (used in) investing activities                                |       | (72,606                                           | )          | 120,909 |   |
|                                                                               |       |                                              |       |   |   |
| FINANCING ACTIVITIES:                                                              |       |                                              |       |   |   |
| Proceeds from issuance of common stock                                             |       | 103,656                                           |       | 12,803 |   |
| Excess tax benefits from stock option exercises                                    |       | 18,947                                            |       | 1,876 |   |
| Repurchase of common stock into treasury                                           |       | (100,704                                          | )          | (287,960 | ) |
|                                                                               |       |                                              |       |   |   |
| Net cash provided by (used in) financing activities                                |       | 21,899                                            |       | (273,281 | ) |
|                                                                               |       |                                              |       |   |   |
| EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH  EQUIVALENTS                      |       | 3,888                                             |       | 3,288 |   |
|                                                                               |       |                                              |       |   |   |
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                               |       | 20,488                                            |       | (64,199 | ) |
| CASH AND CASH EQUIVALENTS AT BEGINNING OF THE PERIOD                               |       | 233,745                                           |       | 302,098 |   |
|                                                                               |       |                                              |       |   |   |
| CASH AND CASH EQUIVALENTS AT END OF THE PERIOD                                     |       | $                                                 | 254,233    |   | $ | 237,899 |   |
|                                                                               |       |                                              |       |   |   |
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                                  |       |                                              |       |   |   |
| Interest paid                                                                      |       | $                                                 | 5,150      |   | $ | 5,252 |   |
| Income taxes paid, net                                                             |       | $                                                 | 7,860      |   | $ | 25,801 |   |

 

See Notes to Unaudited Consolidated Financial Statements.

 

5

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**CYMER, INC.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**Three and Nine Months Ended September 30,2007**

**(Unaudited)**

 

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

 

***UnauditedInterim Financial Statements***

 

The accompanyingconsolidated financial information has been prepared by Cymer, Inc., andits wholly-owned and majority-owned subsidiaries (collectively, “Cymer”),without audit, in accordance with the instructions to Form 10-Q and Article 10of Regulation S-X. The consolidated balance sheet at December 31, 2006 wasderived from the audited financial statements at that date; however, it doesnot include all disclosures required by accounting principles generallyaccepted in the United States.

 

In the opinion ofmanagement, the unaudited consolidated financial statements for the interimperiod presented reflect all material adjustments, consisting only of normalrecurring adjustments, necessary for a fair presentation of the financialposition and results of operations as of and for such periods indicated,  with the exception of a correction of anerror in the amount of $2.3 million related to previously overstated taxexpense for the fiscal years 2003 through 2006. We evaluated the materiality ofthis $2.3 million correction and concluded that it was immaterial to all priorperiod financial statements and to the forecasted 2007 financial statements.Accordingly, we recorded this tax expense correction in the three months ended September 30,2007.

 

These unauditedconsolidated financial statements and notes hereto should be read inconjunction with the consolidated financial statements and notes theretoincluded in our Annual Report on Form 10-K for the year ended December 31,2006. Results for the interim periods presented herein are not necessarilyindicative of results that may be reported for any other interim period orfor the fiscal year ending December 31, 2007.

 

*Principles of Consolidation* – Theaccompanying consolidated financial statements include our accounts and theaccounts of our wholly owned subsidiaries – Cymer Japan, Inc. (“CymerJapan”), Cymer Singapore Pte. Ltd. (“Cymer Singapore”), Cymer B.V. in theNetherlands (“Cymer B.V.”), Cymer Southeast Asia, Ltd., in Taiwan (“Cymer SEA”),Cymer Semiconductor Equipment Shanghai Co., Ltd., in the People’s Republic ofChina (“Cymer PRC”), Cymer Korea, Inc. (“Cymer Korea”), and ourmajority-owned subsidiary, TCZ Pte. Ltd., a company incorporated in Singapore (“TCZSingapore”), of which we own 60%. All significant intercompany balances andtransactions have been eliminated in consolidation.

 

*Accounting Estimates*– The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requires us tomake estimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period. Actual results may differ from thoseestimates.

 

**2.     STOCKHOLDERS’EQUITY**

 

*2005 Equity Incentive Plan*–We grant stock options and stock units from our 2005 Equity Incentive Plan (the“Incentive Plan”), which provides for the issuance of incentive stock options,non-statutory stock options, stock appreciation rights, stock bonus awards,stock purchase awards, stock unit awards and other stock awards to ouremployees and non-employee directors and consultants. Options issued under theIncentive Plan expire ten years after the options are granted and generallyvest and become exercisable ratably over a four-year period following the dateof grant. Stock units issued under the Incentive Plan generally vest one tofour years from the date granted.

 

6

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At our annual meeting of stockholders held on May 17,2007, our stockholders approved the amendment and restatement of our 2005Equity Incentive Plan to increase the number of shares of common stockauthorized for issuance from a total of 1,000,000 shares to a total of2,000,000 shares and to also expand the type and nature of the awards availablefor grant under the Incentive Plan to include cash awards that qualify as “performance-basedcompensation”.

 

*2007 Long-Term Incentive Plan*–On April 16, 2007, the compensation committee of our board of directorsadopted the Long-Term Incentive Bonus Plan (“LTIP”) for 2007. Per theprovisions of the plan, any bonuses accrued for performance in 2007 will bepaid 50% in cash and 50% in the form of restricted stock unit awards underour Incentive Plan. The number of shares subject to the target restricted stockunit awards for 2007 will be determined by dividing the cash value of the awardby $44.57, the closing price of our common stock as reported on the NasdaqGlobal Select Market on April 16, 2007, the grant date.

 

These restricted stock unit awards represent a form ofstock-based award in which the number of shares received by our key employeesand executive officers ultimately depends on whether certain financial andperformance criteria as set forth in our 2007 LTIP are met. The purpose ofthese awards is to attract and retain key employees and executive officers andto provide an incentive to achieve certain financial and individual corporateobjectives by our key employees and executive officers. These restricted stockunit awards will vest only if specific goals are achieved as outlined in our2007 LTIP. The restricted stock unit award portion of the LTIP will vest inthree equal annual installments beginning January 1, 2009 after it isdetermined that the required service and performance conditions have beenachieved for 2007.

 

Wevalue the stock unit awards which are issued to our non-employee directors andkey employees using an intrinsic calculation based on the price of our stock onthe date that the stock unit award is granted. Compensation expense related tothese stock unit awards is recognized straight line over the service period. Forthose stock unit awards that have performance-based conditions, such as thosegranted under our 2007 LTIP, we adjust the compensation expense over theservice period based upon the expected achievement of the performance conditions.The fair value of stock-based options granted, less expected forfeitures, isrecognized to expense over the requisite service period.

 

*Share-Based Compensation*– Thecomponents of share-based compensation expense for employees, non-employeedirectors and non-employees for the three and nine months ended September 30,2006 and 2007 are as follows (in thousands):

 
| ** **                                        | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                        | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                        | ** ** | **2006**                         | ** ** | **2007**                        | ** ** | **2006** | ** ** | **2007** | ** ** |
| Stock Options - employees                         |       | $                                | 2,137      |                            | $          | 917 |   | $ | 6,627 |   | $ | 3,147 |   |
| Stock Options - non-employees or change in status |       | 298                              |       | 14                              |       | 445 |   | 123 |   |
| Restricted stock unit awards - employees          |       | —                           |       | 213                             |       | — |   | 567 |   |
| Restricted stock units - non-employee directors   |       | 174                              |       | 175                             |       | 495 |   | 526 |   |
| Total Share-Based Compensation                    |       | $                                | 2,609      |                            | $          | 1,319 |   | $ | 7,567 |   | $ | 4,363 |   |

 

The excess tax benefit realized for share-basedcompensation for the nine months ended September 30, 2006 and 2007 totaledapproximately $18.9 million and $1.9 million, respectively.

 

*Stock Repurchase Program* -* *On April 24, 2007, we announced that our board ofdirectors had authorized us to repurchase up to $300 million of our commonstock in the open market or in privately negotiated transactions. The program may bediscontinued at any time. Through September 30, 2007, we had purchased7,194,000 shares for $288.0 million under this program.

 

7

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**3.****              EARNINGSPER SHARE**

 

Basic earnings 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 the potential dilution that could occur ifsecurities or other contracts to issue common stock (convertible subordinatednotes using the “if-converted” method, warrants to purchase common stock andcommon stock options using the treasury stock method) were exercised orconverted into common stock. Potential dilutive securities are excluded fromthe diluted EPS computation in loss periods as their effect would beanti-dilutive.

 

The following table sets forth the reconciliation of netincome, diluted net income, weighted average shares outstanding, dilutedweighted average shares outstanding and basic and diluted EPS (in thousands,except per share information):

 
| ** **                                                                       | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                       | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                                       | ** ** | **2006**                         | ** ** | **2007**                        | ** ** | **2006** | ** ** | **2007** | ** ** |
| ** **                                                                       | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| NET INCOME:                                                                      |       |                             |       |                            |       |   |   |   |   |
| Net income, as reported                                                          |       | $                                | 27,032     |                            | $          | 21,670 |   | $ | 70,237 |   | $ | 66,925 |   |
| Adjustment for interest expense on convertible  subordinated notes, net of taxes |       | 948                              |       | 919                             |       | 2,742 |   | 2,710 |   |
| Net income, diluted (adjusted for assumed  conversion)                           |       | $                                | 27,980     |                            | $          | 22,589 |   | $ | 72,979 |   | $ | 69,635 |   |
|                                                                             |       |                             |       |                            |       |   |   |   |   |
| WEIGHTED AVERAGE SHARES:                                                         |       |                             |       |                            |       |   |   |   |   |
| Basic weighted average common shares outstanding                                 |       | 37,819                           |       | 31,395                          |       | 37,995 |   | 34,122 |   |
| Effect of dilutive securities:                                                   |       |                             |       |                            |       |   |   |   |   |
| Warrants                                                                         |       | —                           |       | —                          |       | 29 |   | — |   |
| Options and stock units                                                          |       | 552                              |       | 379                             |       | 797 |   | 464 |   |
| Convertible subordinated notes                                                   |       | 2,814                            |       | 2,814                           |       | 2,814 |   | 2,814 |   |
|                                                                             |       |                             |       |                            |       |   |   |   |   |
| Diluted weighted average common and potential common  shares outstanding         |       | 41,185                           |       | 34,588                          |       | 41,635 |   | 37,400 |   |
|                                                                             |       |                             |       |                            |       |   |   |   |   |
| Earnings per share:                                                              |       |                             |       |                            |       |   |   |   |   |
| Basic                                                                            |       | $                                | 0.71       |                            | $          | 0.69 |   | $ | 1.85 |   | $ | 1.96 |   |
| Diluted                                                                          |       | $                                | 0.68       |                            | $          | 0.65 |   | $ | 1.75 |   | $ | 1.86 |   |

 

Forthe three months ended September 30, 2006 and 2007, weighted averageoptions to purchase shares of common stock totaling approximately 724,000 and794,000 shares were not included in the computation of diluted earnings pershare as their effect was anti-dilutive. For the nine months ended September 30,2006 and 2007, weighted average options and warrants to purchase shares ofcommon stock totaling approximately 642,000 and 752,000 shares were notincluded in the computation of diluted earnings per share as their effect wasanti-dilutive.

 

**4.****              INVENTORIES**

 

Inventoriesare carried at the lower of cost, which approximates the first-in, first-outmethod, or market and consisted of the following (in thousands):

 

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| ** **       | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
|------------------|------------|-----------------------|------------|------------------------|------------|
| ** **       | ** ** | **2006**              | ** ** | **2007**               | ** ** |
| INVENTORIES:     |       |                  |       |                   |       |
| Raw materials    |       | $                     | 33,472     |                   | $          | 38,562 |   |
| Work-in-progress |       | 19,373                |       | 21,310                 |       |
| Finished goods   |       | 51,451                |       | 63,561                 |       |
| Total            |       | $                     | 104,296    |                   | $          | 123,433 |   |

 

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

 

Comprehensive income includes net income, unrealized gains and losseson effective forward contracts, foreign currency translation adjustments, netunrealized pension gains and losses and unrealized gains and losses onavailable-for-sale securities which are recorded as short-term and long-terminvestments in the accompanying consolidated balance sheets.

 

Totalcomprehensive income consisted of the following (in thousands):

 
| ** **                                                                             | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                             | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                                             | ** ** | **2006**                         | ** ** | **2007**                        | ** ** | **2006** | ** ** | **2007** | ** ** |
|                                                                                   |       |                             |       |                            |       |   |   |   |   |
| Net income                                                                             |       | $                                | 27,032     |                            | $          | 21,670 |   | $ | 70,237 |   | $ | 66,925 |   |
|                                                                                   |       |                             |       |                            |       |   |   |   |   |
| Foreign currency translation adjustments                                               |       | 1,196                            |       | 2,174                           |       | 3,888 |   | 3,288 |   |
| Unrealized gain on available-for-sale investments,  net of tax                         |       | 487                              |       | 211                             |       | 592 |   | 311 |   |
| Net unrealized gain (loss) on foreign currency  forward exchange contracts, net of tax |       | 68                               |       | (20                             | )          | 124 |   | (54 | ) |
| Net unrealized pension gain (loss)                                                     |       | —                           |       | 2                               |       | — |   | (1 | ) |
| Comprehensive income                                                                   |       | $                                | 28,783     |                            | $          | 24,037 |   | $ | 74,841 |   | $ | 70,469 |   |

 

The components ofaccumulated other comprehensive loss are as follows (in thousands):

 
| ** **                                                                         | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **                                                                         | ** ** | **2006**              | ** ** | **2007**               | ** ** |
| Foreign currency translation adjustments                                           |       | $                     | (3,984     | )                      | $          | (696 | ) |
| Unrealized gain (loss) on available-for-sale  investments, net of tax              |       | (92                   | )          | 219                    |       |
| Unrealized gain (loss) on foreign currency forward  exchange contracts, net of tax |       | 17                    |       | (37                    | )          |
| Net unrealized pension loss                                                        |       | (7                    | )          | (8                     | )          |
| Accumulated other comprehensive loss                                               |       | $                     | (4,066     | )                      | $          | (522 | ) |
|                                                                                    |            |                       |            |                        |            |  |  |  |  |

 

**6.****              INCOMETAXES**

 

We adopted the provisionsof Financial Accounting Standard Board (“FASB”) Interpretation No. 48 (“FIN48”), “Accounting for Uncertainty in Income Taxes”, on January 1, 2007.FIN 48 clarifies the accounting for income taxes by prescribing a minimumprobability threshold that a tax position must meet before a financialstatement benefit is recognized. The minimum threshold is defined in FIN 48 asa tax position that is more likely than not to be sustained upon examination bythe applicable taxing authority, including resolution of any related appeals orlitigation processes, based on the technical merits of the position.

 

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As of the date ofadoption, our gross liability for income taxes associated with uncertain taxpositions totaled $19.6 million, including interest and penalties. As a resultof the implementation of FIN 48, we recognized an increase of $9.4 million toreserves for uncertain tax positions, of which $5.7 million was recorded todeferred tax assets, $3.4 million was recorded to long term income taxesreceivable, $687,000 was recorded to tax expense and the remaining $358,000 wasrecorded as a cumulative effect adjustment to increase retained earnings. TheFIN 48 liability is presented net of the related long term income taxesreceivable and deferred tax asset balances on the accompanying consolidatedbalance sheet.

 

As of September 30,2007, our gross liability for income taxes associated with uncertain taxpositions was $21.5 million. Included in the balance of unrecognized taxbenefits at September 30, 2007 was $11.6 million of tax benefits that, ifrecognized, would affect our effective tax rate. Also included in the balanceof unrecognized tax benefits at September 30, 2007 was $9.9 million of taxbenefits that, if recognized, would result in adjustments to other taxaccounts, primarily deferred tax assets and long term income taxes receivable.The net increase in our gross liability for income taxes associated withuncertain tax positions from $19.6 million at the date of our adoption of FIN48 to $21.5 million at September 30, 2007 was primarily due to temporarydifferences that were identified during the tax return to provision true-upprocess and they had no material impact on income tax expense for the period.

 

We recognize interest andpenalties related to uncertain tax positions in income tax expense. As of September 30,2007, we had approximately $864,000 of accrued interest and penalties relatedto uncertain tax positions.

 

We are subject totaxation in the United States and in various states and foreign jurisdictions. Weare currently under Internal Revenue Service (“IRS”) audit for the 2003 through2005 tax years. Though the estimated completion date of the audit is not known,it is possible that the audit will be completed within the next twelve months. Thecompletion of this audit could require a material change to our grossunrecognized tax benefits. However, based on the status of this audit and theprotocol for finalizing such audits, it is not possible to estimate the impactof this audit on previously recorded uncertain tax positions. In addition, wedo not foresee material changes to the state or foreign uncertain tax positionswithin the next twelve months.

 

Our tax years 2003 andforward are subject to examination by the IRS, our tax years 2000 and forwardare subject to examination by material state jurisdictions, and our tax years2002 and forward are subject to examination by material foreign jurisdictions.

 

**7.****              TCZJOINT VENTURE**

 

In July 2005,we entered into a Joint Venture Agreement (the “JV Agreement”) with CarlZeiss SMT AG, a German corporation, and Carl Zeiss Laser OpticsBeteiligungsgesellschaft mbH, a German limited liability company (which werefer to with their affiliated entities as “Zeiss”) toestablish TCZ which is owned 60% by us and 40% by Zeiss. In September 2006,we amended and restated the JV Agreement to move the location of TCZ fromSwitzerland to Singapore and to change our joint venture entity to a Singaporecorporation. During the third quarter of 2007, both we and Zeiss agreed to make anadditional $5.0 million cash contribution to TCZ. This additional contributionwas split following the terms of the Joint Venture Agreement or 60% from us and40% from Zeiss. Although we made our $3 million portion of the contribution toTCZ prior to September 30, 2007, Zeiss’ portion of the contribution of $2million was received subsequent to September 30, 2007. As a result, theminority interest associated with this additional contribution will be recordedin our consolidated financial statements in the fourth quarter of 2007.

 

**8.****              GUARANTEES/WARRANTIES**

 

In the ordinary courseof business, we are not subject to potential obligations under guarantees thatfall within the scope of FASB Interpretation No. 45 (“FIN 45”), “Guarantor’sAccounting and Disclosure

 

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Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others”, except for standard warranty provisionsassociated with product sales and indemnification provisions related tointellectual property that are contained within many of our lithography toolmanufacturer agreements. All of these provisions give rise only to thedisclosure requirements prescribed by FIN 45 except for product warranties.

 

(a)                                  ProductWarranties – Warranty provisions contained within our lithography tool manufacturercustomer agreements are generally consistent with those prevalent in thesemiconductor equipment industry. We record 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 period and terms for light source systems andspares and consumable parts varies by light source system model. We review ourwarranty provision monthly, which is determined using a statistical financialmodel that calculates actual historical expenses, product failure rates, andpotential risks associated with our different product models. We then use thisfinancial model to calculate the future probable expenses related to warrantyand the required level of the warranty provision. Throughout the year we reviewthe risk levels, historical cost information and failure rates used within thismodel and update them as information changes over the product’s life cycle. Ifactual warranty expenditures differ substantially from our estimates, revisionsto the warranty provision would be required. Actual warranty expenditures arerecorded against the warranty provision as they are incurred.

 

The following table summarizes informationrelated to our warranty provision (in thousands):

 

| ** **                                                                     | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                     | ** ** | **2006**                                             | ** ** | **2007**                                            | ** ** | **2006** | ** ** | **2007** | ** ** |
| Beginning product warranty balance                                             |       | $                                                    | 31,385     |                                                | $          | 28,975 |   | $ | 30,191 |   | $ | 29,450 |   |
| Liabilities accrued for warranties issued, net of  adjustments and expirations |       | 3,429                                                |       | 3,251                                               |       | 14,899 |   | 11,143 |   |
| Warranty expenditures incurred                                                 |       | (4,739                                               | )          | (5,741                                              | )          | (15,015 | ) | (14,108 | ) |
| Ending product warranty balance                                                |       | $                                                    | 30,075     |                                                | $          | 26,485 |   | $ | 30,075 |   | $ | 26,485 |   |

 

(b)                                 IntellectualProperty Indemnifications – We include intellectual property indemnificationclauses within our general terms and conditions with all our customers and thegeneral purchase agreements with our three lithography tool manufacturercustomers, ASML, Canon, and Nikon. In general, these indemnification provisionsprovide that we defend our customers against certain infringement claimsdirected against our products. Under the indemnification clauses, we would paycosts and damages attributable to the infringement claims, including attorney’sfees, associated with settlements or defenses in respect of such claims,provided that the lithography tool manufacturer used the tool in accordancewith our recommendations and did not modify the tool or incorporate technologyor features that were not  of our design,and provided further that the lithography tool manufacturer follows specificprocedures for notifying us of such claims and allows us to manage the defenseand settlement proceedings.

 

An indemnification provision was included in the contract manufacturingagreement with Seiko Instruments, Inc. (“Seiko”), our former Japanesemanufacturing partner, which was terminated on March 31, 2003. We continue to honor this indemnification clausewithin the agreement after the termination of the contract manufacturingagreement with respect to those products manufactured by Seiko while theagreement was in force as with other indemnification provisions on intellectualproperty. Seiko and at least one Japanese lithography tool manufacturer werenotified in 1996 that our light source systems in Japan may infringecertain Japanese patents. We believe, based upon the advice of counsel, thatour products do not infringe any valid claim of the asserted patents or that weare entitled to prior use claims in Japan.

 

As part of the original research and development agreement signedwith Intel Corporation (“Intel”) in 2004 and amended in July 2006, weagreed to provide Intel with indemnity against any

 

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infringement of the intellectual property rights of any third partyarising from Intel’s purchase and/or use of our extreme ultraviolet (“EUV”)source systems. Under the terms of this agreement, as amended, our obligationsto indemnify Intel will be specifically negotiated in any purchase agreementrelated to such future products.

 

As part of the original supplyagreement signed with TCZ in September 2005 and amended in September 2006in connection with the amendment and restatement of the original TCZ jointventure agreement, we agreed to indemnify TCZ against any infringement of theintellectual property rights of a third party arising from TCZ’s purchase ofour products. We will defend such actions at our own expense and will pay thecost and damage awarded in any such action provided that TCZ grants us solecontrol of the defense and settlement of such action and also provides us withinformation required for the defense and settlement of such action.

 

Due to the nature of the indemnificationprovisions described above, these provisions are indefinite and extend beyondthe term of the actual agreements.

 

**9.****              RELATEDPARTY TRANSACTIONS**

 

As a result of the formation of our TCZjoint venture in July 2005 and under the terms of the joint ventureagreement which was amended and restated in September 2006, Zeiss is arelated party. In addition to transactions that occur among us, Zeiss andTCZ Singapore related to the joint venture, we also purchase certain opticalparts directly from Zeiss and periodically sell our light source systemproducts to Zeiss. Associated with these transactions, we recorded revenue of$1.1 million and $1.8 million for the three months ended September 30,2006 and 2007, respectively, and $6.5 million and $3.1 million for the ninemonths ended September 30, 2006 and 2007, respectively. As of December 31,2006 and September 30, 2007, we had accounts receivable balances of $834,000and $1.8 million, respectively, and accounts payable balances of $4.9 millionand $2.5 million, respectively, all of which were associated with these relatedparty transactions with Zeiss.

 

**10.****       CONTINGENCIESAND COMMITMENTS**

 

We are from time to time party to legal actions in thenormal course of business. Based in part on the advice of legal counsel,our management does not expect the outcome of legal action in the normal courseof business to have a material impact on our financial position, liquidity, orresults of operations.

 

Our former Japanesemanufacturing partner, Seiko, and one of our Japanese customers were notifiedin July 1996 that our light source systems in Japan may infringecertain Japanese patents held by another Japanese company. We have agreed toindemnify our former Japanese manufacturing partner and our customers againstpatent infringement claims under certain circumstances, even after thetermination date of the contract manufacturing agreement. We believe, basedupon the advice of counsel, that our products do not infringe any valid claimof the asserted patents or that we are entitled to prior use claims in Japan.

 

**ITEM 2. Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

*Thefollowing discussion of our financial condition and results of operationsshould be read in conjunction with our unaudited interim consolidated financialstatements and notes thereto included in “Item 1. Financial Statements” of this Quarterly Report on Form 10-Qand the audited consolidated financial statements and notes thereto and the section titled“Item 7. Managements Discussion and Analysis of Financial Condition and Resultsof Operations” in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2006, filed with the Securities Exchange Commission on February 28,2007 .*

 

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** **

**Forward-Looking Statements**

 

Statements in thisQuarterly Report on Form 10-Q that are not strictly historical in nature areforward-looking statements. These statements include, but are not limited to,references to the outlook for the semiconductor industry and us; expecteddomestic and international product sales and development; our research anddevelopment activities and expenditures; adequacy of our capital resources andinvestments; effects of business cycles in the semiconductor business; our competitiveposition; and our relationships with customers and third-party manufacturers ofour products, and may contain words such as “believes,” “anticipates,” “expects,”“plans,” “intends” and words of similar meaning. These statements arepredictions based on current information and our expectations and involve anumber of risks and uncertainties. The underlying information and ourexpectations are likely to change over time. Actual events or results maydiffer materially from those projected in the forward-looking statements due tovarious factors, including, but not limited to, those contained under thecaption “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. Forward-lookingstatements herein speak only as of the date of this Quarterly Report on Form10-Q. Unless required by law, we undertake no obligation to update or reviseany forward-looking statements to reflect new information or future events ordevelopments. Thus, you should not assume that our silence over time means thatactual events are bearing out as expressed or implied in such forward-lookingstatements.

 

#### **Overview**

#### ** **

Weprovide state-of-the-art lithographic light sources designed to help enable theperformance of leading-edge wafer steppers and scanners built by our threelithography tool manufacturer customers, and field support products customizedto support our chipmaker customers’ production use of these light sources inadvanced wafer patterning application. As the leading supplier of light sources,almost all consumer electronic devices manufactured in the last several yearscontain a semiconductor manufactured using our light sources. We currentlysupply deep ultraviolet (“DUV”) light sources to each of our lithography toolmanufacturer customers, ASML, Canon, and Nikon, who in turn supply their wafersteppers and scanners to chipmakers. In addition, we sell replacement parts andservices to our lithography tool manufacturer customers as well as directly toour chipmaker customers. Our light source systems currently constitute asubstantial majority of all excimer light sources incorporated in lithographywafer stepper and scanner tools at chipmakers worldwide. Our headquarters arelocated in San Diego, California, where we develop and manufacture our lightsource systems and the majority of our replacement parts. To provide bettersupport to our customers located outside of the U.S., we maintain a replacementparts refurbishment facility and field service office in Korea and fieldservice and support offices in Japan, the Netherlands, the People’s Republic ofChina, Singapore and Taiwan. Japan is currently our only subsidiary office thatsells excimer light source systems. We also maintain field service offices inthe U.S. to support our installed base of light sources located at ourchipmaker customers in the U.S.

 

We are also the majority owner of a joint venturecalled TCZ which is currently headquartered in Singapore. TCZis currently developing, and will integrate, market and sell, and supportproduction tools for the flat panel display manufacturing industry. The jointventure is targeting the growing market for low-temperature poly-silicon (“LTPS”)processing used in the manufacture of liquid crystal displays that arebrighter, have higher resolution, and consume less power than displays usingtoday’s predominant amorphous silicon films.  Although TCZ’s product iscurrently in the development phase, TCZ has performed customer demonstrationson its first generation production tool, the TCZ-900X, in 2007. We currentlyexpect that TCZ will ship its first production tool in the first half of 2008.

 

***Products***

** **

Our products primarilyconsist of photolithography light source systems, replacement parts, andservice.

 

Our excimer light sourcesfor photolithography produce pulsed light of extremely short wavelengths withinthe DUV spectrum. The bandwidth of the light is further narrowed through anumber of optical techniques. The DUV wavelengths are measured in nanometersand the light sources are referred 

 

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to according to eitherthe wavelength or the gases that are mixed to produce the light. KryptonFluoride (“KrF”) gases produce light at a 248 nm wavelength, and Argon Fluoride(“ArF”) gases produce light at a 193 nm wavelength. The extremely shortwavelengths and highly narrowed bandwidths of light produced by these lightsources enable the very fine feature resolution required for patterning orprinting the circuitry on silicon wafers. The pulse energy and repetition rateof the light source permit high throughput in wafer processing. We havedesigned our light sources to be reliable, easy to install and service andcompatible with existing semiconductor manufacturing processes. Our lightsources are used to pattern or print the integrated circuits, which are alsocalled semiconductors or “chips,” that power many of today’s advanced consumerand business electronics. In the third quarter of 2007, we sold 47 light sourcesystems at an average selling price of $1.4 million.

 

Our product developmentstrategy has been to develop in rapid succession technologically innovative newproducts that deliver superior performance and lower cost of operation to meetcontinually evolving needs of our customers. This strategy strengthens our marketleadership position since the ongoing reduction of critical dimension (“CD”) onthe wafer drives demand for newer, more advanced, higher value-added lightsources.

 

Over the years, we havedeveloped and sold a wide variety of photolithography light source products. Theseproducts can be divided into KrF and ArF product categories and include anumber of current products as well as legacy products that we continue toservice in our installed base.

 

Certain components andsubassemblies included in our light sources require replacement orrefurbishment following extended operation.  We estimate that a lightsource used in a semiconductor production environment will require one to tworeplacement chambers per year, depending upon the level of usage. Similarly,certain optical components of the light source deteriorate with continuedexposure to DUV light and require periodic replacement.  We provide theseand other spare and replacement parts for our photolithography light sources asneeded by our customers.

 

As the life and usage ofour installed base of light sources in production at chipmakers exceeds theoriginal warranty periods, some chipmaker customers request service contractsfrom us.  Additionally, we provide billable service or service contractsdirectly to our three semiconductor lithography tool manufacturer customers.These service agreements require us to maintain and/or service these lightsources either on an on-call or regular interval basis or both.  Includedin some of the types of service contracts we provide to our customers are thereplacement of consumable parts and non-consumable parts.  The pricing forsuch contracts includes the replacement of these parts.

 

#### ***SemiconductorIndustry Status and Outlook***

#### ** **

Since we derive a substantial portion of our revenuesfrom our lithography tool manufacturer customers, we are subject to thevolatile and unpredictable nature of the semiconductor equipment industry. Thesemiconductor equipment industry is cyclical in nature and historically hasexperienced periodic ups and downs, many of them quite dramatic. More recently,industry cycles appear to have become more muted, involving relatively shortperiods of moderate growth, followed by relatively short periods when revenuehas either flattened or declined moderately.

 

The most recent growthyear was 2006, in which we achieved record revenue and net income levels. Althoughwe initially expected 2007 to be another growth year for us, in the fourthquarter of 2006 and the first quarter of 2007, we received requests toreschedule shipment of a number of light sources from each of those quartersinto subsequent quarters, indicating a slowing trend in the industry. In thesecond quarter of 2007, a number of chipmakers reduced capital equipmentpurchases in line with delays in their planned build-outs of new fabs. Althoughthis trend continued in the third quarter of 2007, with chipmaker capitalspending remaining cautious, our product sales during the quarter increasedfrom the prior quarter primarily due to higher average selling prices thatresulted from the strong product mix shift to our XL series light sources,particularly our XLA 300 and XLA 400 products and an increase in consumablesand spare parts and service product revenue. As a result of this recent slowingand flattening in the semiconductor industry, we have experienced decreases insome of the key financial

 

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metrics that we use tomanage our business. Details on these financial metrics for the four mostrecent quarterly periods are included in the table below (in thousands, exceptfor light source system unit shipments and margin percentages):

 
| ** **                      | ** ** | **Quarterly Financial Data** | ** ** |
|---------------------------------|------------|----------------------------------------|------------|
| ** **                      | ** ** | **Three months ended**       | ** ** |
| ** **                      | ** ** | **December 31,  2006**            | ** ** | **March 31,  2007** | ** ** | **June 30,  2007 (1)** | ** ** | **September  30,  2007** | ** ** |
|                            |       |                                   |       |   |   |   |   |   |   |
| Light Source  System Units Sold |       | 68                                     |       | 51 |   | 49 |   | 47 |   |
|                            |       |                                   |       |   |   |   |   |   |   |
| Product Sales  (2)              |       | $                                      | 137,305    |   | $ | 126,625 |   | $ | 122,565 |   | $ | 132,046 |   |
|                            |       |                                   |       |   |   |   |   |   |   |
| Gross Margin on  Product Sales  |       | 49.38                                  | %          | 48.62 | % | 53.72 | % | 50.09 | % |
|                            |       |                                   |       |   |   |   |   |   |   |
| Operating Income  (1)           |       | $                                      | 30,856     |   | $ | 26,567 |   | $ | 30,615 |   | $ | 28,080 |   |
|                            |       |                                   |       |   |   |   |   |   |   |
| Operating Margin  (1)           |       | 22.45                                  | %          | 20.97 | % | 24.90 | % | 21.25 | % |
|                            |       |                                   |       |   |   |   |   |   |   |
| Net Income                      |       | $                                      | 25,411     |   | $ | 20,321 |   | $ | 24,934 |   | $ | 21,670 |   |
|                            |       |                                   |       |   |   |   |   |   |   |
| Net Margin                      |       | 18.49                                  | %          | 16.04 | % | 20.28 | % | 16.40 | % |

 

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(1) Although totalrevenue was lower in the second quarter of 2007 than other quarterly periodspresented in this table, several of the financial metrics were higher in thesecond quarter of 2007. Higher gross margin on product sales and higheroperating margin were primarily due to favorable material reclaim productivityimprovements, increasing product reliability realization and lower operatingexpenses that were achieved during the second quarter of 2007. Our marginsreturned to more normalized levels during the third quarter.

 

(2) Consists of lightsource systems revenue and consumables and spare parts, upgrades and servicerevenues and material reclaim and refurbishment activities.

 

Regarding our near-term outlook for the industry, theNAND Flash segment of the market is demonstrating solid ongoing demand forequipment in 2007 and is expected to continue growing strongly in the firsthalf of 2008 due partly to capacity expansion. The DRAM market segment has beenunder severe pricing pressure, but it is currently anticipated to begin growingagain by early next year. Logic and microprocessor spending on equipment is nowat fairly low levels, but could be driven higher by increased demand forcomputers and video game consoles. In the foundry segment, capital spending hasremained below historical norms for some time, but light source utilization hasbeen increasing at foundries recently. If this strengthening utilization trendcontinues through the end of the year, it could reflect new foundry capacityrequirements in 2008.

 

In general, the longer-term technology and industrytrends that affect photolithography are positive for us. The overall ongoingaggressive shrink of critical dimensions driving 45nm first production in thefirst half of 2008, combined with capacity expansion at the 65nm productionnode, will drive growing customer demand for our XL series light sources. Chipmakerscontinue to drive DUV light source utilization to ever higher levels, providinga foundation for continuing growth in our non-systems business. We believe weare well-positioned to help enable our customers to realize these industrytrends, and that we have the flexibility to perform well through the phases ofthe semiconductor cycle, and especially well in the near-term growth ahead. However,macro-economic factors, such as high energy prices and interest rates, a slowerU.S. housing market, and increased volatility in the financial markets couldhave a negative impact on consumer spending, including spending on electronicdevices. Additionally, geopolitical turmoil can create a heightened sense ofuncertainty that can cause consumers to become 

 

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more cautious in their spending. Either or both ofthese factors would have a negative effect on the demand for our products.

 

To meet anticipateddemand for advanced immersion tools for the 45nm production node and below, wehave developed the XLR 500i, a new light source based on our production provendual chamber Master Oscillator Power Amplifier (“MOPA”) architecture. Thislight source replaces the traditional power amplifier with a regenerative ringamplifier, which provides our customers with improved performance, stability,and operating cost. We shipped the first XLR 500i qualification light sourcesystem to one of our lithography tool manufacturing customers in April 2007,and shipped a second qualification system to another lithography toolmanufacturing customer in September of this year. We anticipate the adoptionramp for this product to begin in the fourth quarter of this year, and toincrease in the first half of 2008. We expect that the XLR 500i will become thelight source of choice for 45nm production. Additionally, during the thirdquarter of 2007, we introduced the XLR 600i, which offers 90W of output powerand targets immersion double patterning applications at the 32nm productionnode.

 

As we progress through 2007, we anticipate continuingto focus on better serving our customers, building a better company, andcreating shareholder value. Demonstrating our technology leadership andinnovation, we have recently introduced new light sources and performanceenhancing features in advance of market needs, and anticipate continuing to doso in the future. During 2007, we have made significant progress and achievedsome major breakthroughs in our EUV source development which solidify ourleadership position in this next generation technology. In the third quarter of2007, we entered into a multi-year EUV supply agreement with ASML for which wehave already received several purchase orders. As a result, we have entered theproduct development, or commercialization, phase of our EUV program, movingbeyond the technology development phase to enable the first EUV source shipmentwhich is planned for the fourth quarter of 2008. We will continue our numerousefforts to add even higher levels of value for our customers and increasecustomer satisfaction, while pursuing our many initiatives to enhance overall operatingefficiencies and improve financial performance and cash generation. In thefirst nine months of 2007, we generated $84.9 million in cash from operationsand we repurchased approximately 7.2 million shares of our common stock for$288.0 million under our $300 million stock repurchase program authorized byour board of directors in April 2007. We expect to continue generatingsubstantial levels of cash from operations in 2007 and we will continue toexplore opportunities for the most effective use of our cash.

 

#### **CriticalAccounting Policies and Estimates**

#### ** **

*General*

 

The discussion andanalysis of our financial condition and results of operations are based uponour consolidated financial statements, which have been prepared in accordancewith accounting principles generally accepted in the 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 apart of our ongoing internal processes, we regularly evaluate our estimates andjudgments associated with revenue recognition, valuation of parts used in ourrefurbishment manufacturing process, inventory allowances, warranty provisions,stock-based compensation, income taxes, allowances for bad debts, long-livedassets valuation, intangible assets valuation, and contingencies and litigation.We base these estimates and judgments upon historical information and otherfacts and assumptions that we believe to be valid and/or reasonable under thecircumstances. These assumptions and facts form the basis for making judgmentsand estimates and for determining the carrying values of our assets andliabilities that are not apparent from other sources. Actual results could varyfrom our estimates if we were to use different assumptions and conditions.

 

We believe that revenuerecognition, valuation of parts used in our refurbishment manufacturingprocess, inventory allowances, warranty provisions, stock-based compensation,and income taxes require more significant judgments and estimates in thepreparation of our consolidated financial statements than do other of ouraccounting estimates and judgments.

 

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*RevenueRecognition*

 

Our revenues consist ofproduct sales, which include sales of light source systems, consumable andspare parts, upgrades, service, service contracts, training, and limitedrefurbishments of our light source systems. Our revenues also consist ofcertain funded development activities performed for our customers and undergovernment contracts and license agreements.

 

The sales of our light source systems generally include training andinstallation services. We determined these elements qualify as one unit ofaccounting under Emerging Issues Task Force Bulletin No. 00-21, “RevenueArrangements with Multiple Deliverables” (“EITF 00-21”), as we do not haveevidence of fair value for the undelivered training and installation elements.Furthermore, we determined that the undelivered training and installationelements are perfunctory performance obligations and are not essential to thefunctionality of our light source systems. Therefore, in accordance with the provisionsof Staff Accounting Bulletin No. 104, we recognize revenue when the revenuerecognition criteria are met for the light source system, and accrue the costsof providing the training and installation services. We recognize light sourcesystem revenue at one of following three points, depending on the terms of ourarrangement with our customer — 1) shipment of the light source system, 2)delivery of the light source system or 3) receipt of an acceptance certificate.For the majority of our light source system sales, the shipping terms areF.O.B. shipping point and revenue is recognized upon shipment. For ourarrangements which include F.O.B. destination shipping terms, revenue isrecognized upon delivery of the light source system to our customer. Lastly,one of our arrangements includes an acceptance provision, which is satisfied bythe issuance of an acceptance certificate by the customer. For thesetransactions, we recognize revenue upon receipt of the acceptance certificate. Inaddition, we test our light source systems in environments similar to thoseused by our customers prior to shipment to ensure that they meet publishedspecifications.

 

Revenue from consumables and spare parts salesis recognized at the point that legal title passes to the customer, which isgenerally upon shipment from our facility.  For a significant portion ofour spare parts sales, our customers return the consumed assembly to us as partof the sale of the new part.  We reuse some of the material within thesecore assemblies, mainly metal components, for the future build of coreassemblies.  As a result, our revenue consists of both cash and the valueof the reusable parts received from our customers as consideration for thesespare part sales. Revenue associated with our customers’ return of coreassemblies is recognized upon receipt of the returned core assembly.  Theamount of the revenue is determined based upon the fair value of the reusableparts that we expect to yield from the returned core assembly based onhistorical experience.

 

Service and training revenue is recognized asthe services are rendered.  For our service contracts, revenue isrecognized based on the terms of the contract. Generally, revenue is recognizedstraight line over the term of the contract, but there are certain clausesincluded in some of our service contracts that we have to evaluate further froma revenue recognition standpoint. In most cases, these amounts are alsorecognized straight line over the contract period, but there could be situationswhere we recognize the revenue based on historical evidence, or informationspecific to the clause in the service contract.

 

On a very limited basis, we refurbish lightsource systems owned by our customers to their original or new condition. Revenuefrom refurbished light source systems is recognized when the refurbishmentprocess has been completed and, depending upon the customer, the properdelivery or acceptance terms have been met.

 

Certain of our product sales transactions areaccounted for as multiple-element arrangements in accordance with EITF 00-21*.*A multiple-element arrangement is atransaction which may involve the delivery or performance of multiple products,or services, and performance may occur at different points in time or overdifferent periods of time. We allocate consideration to multiple elementtransactions based on the relative fair values of each separate element whichwe determine based on prices charged for such items when sold on a stand alonebasis. In cases where there is objective and reliable evidence of the fairvalue of the undelivered item(s) in an arrangement but no such evidence for thedelivered item(s), we 

 

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use the residual method to allocate the arrangementconsideration. If there is no objective and reliable evidence of the fair valueof the undelivered item, we account for the transaction as a single unit ofaccounting per the requirements of EITF 00-21. Our sales arrangements do notinclude general rights of return, so we do not have to consider this whenevaluating and accounting for our multiple element transactions.

 

For funded development contracts, funds receivedare accounted for on the percentage-of-completion method based on therelationship of costs incurred to total estimated costs. Revenues generatedfrom these types of funded development contracts are included in other revenue,and are derived from cost sharing contracts between certain customers and us.If milestones on these funded development contracts require that specificresults be achieved or reported by us, revenue is not recognized until thatmilestone is completed.

 

Deferred revenue represents payments received from ourcustomers in advance of the delivery of products and/or services, or before thesatisfaction of all revenue recognition requirements as described above.

 

*Accounting for Parts Used in RefurbishmentManufacturing Process*

* *

Over the last severalyears as part of our regular business activities, we have conducted significantparts refurbishment and material reclaim activities related to some of our coreassemblies, in particular our chamber assemblies. The volume of this activitysignificantly increased in 2004 and we expect volumes to increase over time asour installed base of light sources continues to rise and we become moreefficient in these refurbishment activities and develop capabilities to reclaimmaterial from and refurbish other core assemblies. These activities involvearrangements with our customers where we sell a new part to the customer at areduced sales price if the customer returns the consumed assembly that the newpart replaces. These returned core assemblies contain a certain amount ofmaterial, primarily metal components, that may be reused by us in future coreassemblies. Upon receipt of these consumed core assemblies from our customers,we record an entry to recognize the estimated fair value of the reusablecomponents either 1) as revenue if the return of the core assembly relates to aspare part replacement sale or 2) as a reduction in cost of product sales ifthe return of the core assembly is related to a part being replaced under ourwarranty or per the terms of an active service contract with our customer. Thevalue of the reusable parts contained within the consumed assembly isdetermined based upon historical data on the value of the reusable parts thatwe typically yield from a consumed assembly.

 

As part of our normalexcess and obsolete inventory analysis, these consumed assemblies are alsoreviewed on a monthly basis and an inventory allowance is recorded asappropriate for these parts. The value that we assign to these core assembliescan be affected by the current demand for the reusable parts in ourmanufacturing operations and the actual yield rate achieved for reusable partscontained within these consumed core assemblies. We believe that ourmethodology for valuing the reusable parts within these returned coreassemblies is reasonable, but any decreases in the demand for the parts or anychanges in the yield of the reusable parts included in these core assembliescould have a material adverse effect on our financial condition and results ofoperations.

 

***InventoryAllowance***

** **

We perform an analysis ofour inventory allowances on at least a quarterly basis to determine theadequacy of this allowance on our financial statements. The amount of theinventory allowance is determined by taking into consideration certainassumptions related to market conditions and future demands for our products,including changes 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, which includes all parts on hand from ourrefurbishment activities, by comparing the on hand inventory balances andinventory on order to the next 12 months of forecasted demand. We then adjustthis calculation for inventory that has a high likelihood of use beyond oneyear or can be used in other products that may have lower demands. After thisadjustment, we arrive at our total exposure for excess and obsolete inventorywithin our raw 

 

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materials and productioninventory. As part of this analysis, we also determine whether there arepotential amounts owed to vendors as a result of cancelled or modified rawmaterial orders. We estimate and record a separate liability, which is includedin accrued and other liabilities in the accompanying balance sheets for suchamounts owed.

 

The inventory allowance totaled $15.1 million and$10.5 million at December 31, 2006 and September 30, 2007, respectively. Thedecrease in the inventory allowance at September 30, 2007 as compared toDecember 31, 2006 was primarily due to certain parts in inventory previouslyreserved that were either scrapped or sold during the first nine months of2007.

 

The methodologies used toanalyze excess and obsolete inventory and determine the inventory allowance aresignificantly affected by future demand and 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 cyclical in nature;

•                  Rateat which our lithography tool manufacturers and chipmaker customers takedelivery of our light source systems and our consumable and spare parts;

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

•                  Overallmix of light source system models or consumable and spare parts and any changesto that mix required by our customers;

•                  Utilizationrates of our light sources at chipmakers; and

•                  Engineeringchange orders.

 

Based upon ourexperience, we believe that the estimates we use in calculating the inventoryallowance are reasonable and properly reflect the risk of excess and obsoleteinventory. If actual demand or the usage periods for our inventory aresubstantially different from our estimates, additional inventory allowances maybe required, and may have a material adverse effect on our financial conditionand results of operations.

 

###### *WarrantyProvision*

###### * *

We maintain an accrualfor the estimated cost of product warranties associated with our product sales.Warranty costs include the replacement parts and labor costs to repair ourproducts during the warranty periods. At the time revenue is recognized, werecord a warranty provision, which is included in cost of product sales in theaccompanying consolidated statements of operations. The warranty coverageperiod and terms for light source systems and consumable and spare parts variesby light source system model. The warranty provision for our products isreviewed monthly and determined by using a statistical financial model, whichtakes into consideration actual historical expenses, product failure rates, andpotential risks associated with our different products. This model is then usedto estimate future expenses related to warranty and the required warrantyprovision. The risk levels and historical cost information and failure ratesused within this model are reviewed throughout the year and updated as theseinputs change over the product’s life cycle. Due to the highly technical natureof our light source system products, the newer model light sources and themodules contained within them have higher inherent warranty risks with theirinitial shipments and require higher warranty provisions until the technologybecomes more mature.

 

The total balance in thewarranty provision accrual as of December 31, 2006 and September 30, 2007 wasat $29.5 million and $26.5 million, respectively. This decrease from period toperiod is primarily due to a lower number of light source systems being underwarranty and lower warranty reserve requirements due to an overall improvementof the reliability of our light source products.

 

We actively engage inproduct improvement programs and processes to limit our warranty costs, but ourwarranty obligation is affected by the complexity of our product, productfailure rates and costs incurred to correct those product failures at customersites. The industry in which we operate is subject to rapid technologicalchange, and as a result, we periodically introduce newer, more complex lightsources. 

 

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Although we classifythese newly released light source models as having a higher risk in ourwarranty model resulting in higher warranty provisions, we are more likely tohave differences between the estimated and actual warranty costs for these newproducts. This is due to limited or no historical product performance data onwhich to base our future warranty costs. Warranty provisions for our older andmore established light source models are more predictable as we have morehistorical information available on these products. If actual product failurerates or estimated costs to repair those product failures were to differ fromour estimates, revisions to our estimated warranty provision would be required,which could harm our financial condition and results of operations.

 

*Stock-BasedCompensation*

 

We grant options topurchase our common stock to our employees, stock unit awards to ournon-employee directors and performance-based stock unit awards to keyemployees, including our executive officers, under our 2005 Equity IncentivePlan. The benefits provided under this plan are share-based payments subject tothe provisions of Statement of Financial Accounting Standards No. 123R (“SFASNo. 123R”), “Share-Based Payment”. SFAS No. 123R addresses the accounting forshare-based payment transactions in which an enterprise receives employeeservices in exchange for (a) equity instruments of the enterprise or(b) liabilities that are based on the fair value of the enterprise’sequity instruments or that may be settled by the issuance of such equityinstruments. As a result of this accounting requirement, our consolidatedfinancial statements include compensation expense as calculated under theprovisions of SFAS No.123R. We attribute the value of share-based compensationto expense as options vest using the straight-line method for awards grantedafter December 31, 2005. Compensation expense for awards outstanding and unvestedas of December 31, 2005 are being recognized over the remaining service periodusing the compensation expense calculated according to the pro forma disclosureprovisions under SFAS No. 123, “Accounting for Stock-Based Compensation”, whichuses an accelerated expense recognition method for those awards with a gradedvesting schedule. Share-based compensation expense for employees andnon-employee directors related to stock options and stock units before taxeswas $2.3 million and $1.3 million, respectively, for the three months endedSeptember 30, 2006 and 2007, respectively, and $7.1 million and $4.2 millionfor the nine months ended September 30, 2006 and 2007, respectively.

 

We value the stock unitawards which are issued to our non-employee directors and key employees usingthe fair market value of the underlying stock at the date of grant. Compensationexpense related to these stock unit awards is recognized straight line over theservice period. For those stock unit awards that have performance based conditions,we adjust the compensation expense over the service period based upon theexpected achievement of the performance condition.

 

We value the stock optionawards using the Black-Scholes option pricing model. The determination of fairvalue of stock-based payment awards on the date of grant is affected by ourstock price as well as assumptions regarding a number of complex and subjectivevariables. These assumptions include the expected term of stock options and ourexpected stock price volatility over the expected term of the awards.

 

We determine our expectedvolatility by using a combination of historical and implied volatility, orblended volatility, to derive our expected volatility assumption as allowedunder SFAS No. 123R and Staff Accounting Bulletin No. 107. Implied volatilityis based on our six-month traded options on our common stock. We determinedthat the volatility calculated using a blend of implied volatility and ourhistorical volatility is more reflective of expected volatility than using onlyhistorical volatility. The expected term of stock options represents theweighted-average period the stock options are expected to remain outstanding.We determine the expected term of our stock options based on observedhistorical exercise patterns for our company, which we believe are indicativeof future exercise behavior.

 

Other assumptionsrequired for estimating fair value under the Black-Scholes option pricing modelinclude the expected risk-free interest rate and expected dividend yield of ourstock. Our risk-free interest rate assumption is based upon the most currentavailable rates on zero coupon U.S. Government issues

 

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for the expected term ofour stock options. The expected dividend rate is not applicable to us as wehave not historically declared or paid dividends, nor do we anticipate payingcash dividends in the future.

 

SFAS No. 123R alsorequires forfeitures to be estimated at the time of grant of the stock optionor stock unit award and we have estimated our forfeitures based on historicalexperience. We have revised this estimate in the past and will revise thisestimate, as necessary, in subsequent periods if actual forfeiture rates differfrom our current estimates.

 

If we change any of thekey assumptions that we use in the Black-Scholes option pricing model such asexpected volatility or expected term or if we decide to use a differentvaluation model in the future or change our forfeiture rate, the compensationexpense that we record under SFAS No. 123R may differ significantly in thefuture from what we have recorded in the current period.

 

*Income Taxes*

* *

We account for incometaxes in accordance with Statement of Financial Accounting Standards No. 109 (“SFASNo. 109”), “Accounting for Income Taxes.” Pursuant to SFAS No. 109, a deferred tax asset or liability is generallyrecognized for the estimated future tax effects attributable to temporarydifferences, net operating loss (“NOL”) carryforwards and tax creditcarryforwards. Deferred tax assets are to be reduced by a valuation allowanceif, based on the weight of available evidence, it is more likely than not thatsome portion or all of the deferred tax assets will not be realized within thecarryback or carryforward periods. Information about an enterprise’s currentfinancial position and its results of operations for the current and precedingyears, as well as all currently available information about future years shouldbe considered.

 

We have considered ourindustry’s outlook for the future, our historical performance and estimatedfuture taxable income, and ongoing tax planning strategies in assessing theneed for a valuation allowance. Using this information, we have prepared amodel to forecast our expected taxable income in future years and to estimatewhen the benefits of our deferred tax assets are likely to be realized. Basedupon the analysis, with the exceptions noted below, we believe that it is morelikely than not that the results of future operations will generate sufficienttaxable income to realize all of our deferred tax assets within the periodcovered by our model and, as such, no valuation allowance has been providedagainst these deferred tax assets. However, a valuation allowance has beenprovided against certain deferred tax assets related to TCZ’s business and ourFrench branch operations, as these businesses have not yet developedsufficiently to allow us to assert that these assets will ultimately berealized.

 

A material adversechange in the outlook for worldwide lithography tool sales, the expectedselling prices or profit margins for our products or our expected share of theglobal market for lithography light sources, could cause us to determine thatadditional valuation allowances are 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.

 

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**RESULTS OF OPERATIONS**

 

The following table setsforth certain items in our consolidated statements of operations as apercentage of total revenues for the periods indicated:

 
| ** **                       | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|----------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                       | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                       | ** ** | **2006**                         | ** ** | **2007**                        | ** ** | **2006** | ** ** | **2007** | ** ** |
| Revenues:                        |       |                             |       |                            |       |   |   |   |   |
| Product sales                    |       | 99.2                             | %          | 98.6                            | %          | 98.3 | % | 99.1 | % |
| Product sales -  related party   |       | 0.7                              |       | 1.3                             |       | 1.6 |   | 0.8 |   |
| Other                            |       | 0.1                              |       | 0.1                             |       | 0.1 |   | 0.1 |   |
| Total revenues                   |       | 100.0                            | %          | 100.0                           | %          | 100.0 | % | 100.0 | % |
|                             |       |                             |       |                            |       |   |   |   |   |
| Cost and  expenses:              |       |                             |       |                            |       |   |   |   |   |
| Cost of product  sales           |       | 50.4                             |       | 49.9                            |       | 52.1 |   | 49.2 |   |
| Research and  development        |       | 13.1                             |       | 16.2                            |       | 13.7 |   | 15.9 |   |
| Sales and  marketing             |       | 5.9                              |       | 5.2                             |       | 5.6 |   | 5.1 |   |
| General and  administrative      |       | 6.3                              |       | 7.5                             |       | 6.9 |   | 7.5 |   |
| Total costs and  expenses        |       | 75.7                             |       | 78.8                            |       | 78.3 |   | 77.7 |   |
|                             |       |                             |       |                            |       |   |   |   |   |
| Operating income                 |       | 24.3                             |       | 21.2                            |       | 21.7 |   | 22.3 |   |
|                             |       |                             |       |                            |       |   |   |   |   |
| Total other  income - net        |       | 2.6                              |       | 2.9                             |       | 3.5 |   | 3.5 |   |
|                             |       |                             |       |                            |       |   |   |   |   |
| Income before  income tax        |       |                             |       |                            |       |   |   |   |   |
| provision and  minority interest |       | 26.9                             |       | 24.1                            |       | 25.2 |   | 25.8 |   |
|                             |       |                             |       |                            |       |   |   |   |   |
| Income tax  provision            |       | 8.7                              |       | 8.3                             |       | 8.5 |   | 8.9 |   |
| Minority  interest               |       | 0.6                              |       | 0.6                             |       | 0.6 |   | 0.6 |   |
|                             |       |                             |       |                            |       |   |   |   |   |
| Net income                       |       | 18.8                             | %          | 16.4                            | %          | 17.3 | % | 17.5 | % |
| Gross margin on  product sales   |       | 49.6                             | %          | 50.1                            | %          | 47.9 | % | 50.8 | % |

 

***ThreeMonths Ended September 30, 2006 and 2007***

 

*Revenues*. The following table summarizes certainmeasures and the components of our revenue (in thousands, except units sold):

** **
| ** **                                     | ** ** | **For the three months ended** | ** ** |
|------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                     | ** ** | **September 30,**                             | ** ** |
| ** **                                     | ** ** | **2006**                                           | ** ** | **2007** | ** ** |
| Light source  systems:                         |       |                                               |       |   |   |
| Revenue                                        |       | $                                                  | 71,352     |   | $ | 64,079 |   |
| Units sold                                     |       | 67                                                 |       | 47 |   |
| Average selling  price (1)                     |       | $                                                  | 1,065      |   | $ | 1,376 |   |
|                                           |       |                                               |       |   |   |
| Consumables,  spare parts and service products |       | $                                                  | 72,457     |   | $ | 67,967 |   |
| Product sales                                  |       | $                                                  | 143,809    |   | $ | 132,046 |   |
| Other revenue                                  |       | $                                                  | 109        |   | $ | 79 |   |
|                                           |       |                                               |       |   |   |
| Total revenue                                  |       | $                                                  | 143,918    |   | $ | 132,125 |   |

 

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(1)   Calculationof average selling price includes $591,000 of deferred light source systemrevenue for the three months ended September 30, 2007.

 

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Productsales decreased 8% from $143.8****million forthe three months ended September 30, 2006 to $132.0 million for the threemonths ended September 30, 2007 primarily due to a 10%, or $7.3 million declinein light source system sales and a 6%, or $4.5 million decrease in consumables,spare parts and service product sales for the three months ended September 30,2007 as compared to the three months ended September 30, 2006. A total of 67light source systems were sold in the three months ended September 30, 2006 atan average selling price of $1.1 million, compared to 47 light source systemssold in the three months ended September 30, 2007 at an average selling priceof $1.4 million. The increase in the average selling price from period toperiod is due to the product mix being more heavily weighted toward our newerArF light source systems, particularly our XLA 300 and XLA 400 light sourceswhich sell at higher prices. ArF light source systems represented 91% of lightsource systems revenue for the three months ended September 30, 2007 ascompared to 73% for the three months ended September 30, 2006. The decrease inquantities of light source systems sold from period to period was due to theslowing and flattening of the semiconductor industry sales in the first ninemonths of 2007 as compared to the 2006 levels.

 

Growthin the installed base and steady utilization of our light source systems hascontinued to generate strong demand for our consumables and spare parts andservice products. Although revenue generated from such sales decreased 6% from$72.5 million for the three months ended September 30, 2006 to $68.0 millionfor the three months ended September 30, 2007, this was due primarily to thethird quarter of 2006 being favorably impacted by sales which were recorded inthis category of revenue related to a laser replacement agreement we enteredinto at the beginning of 2006. If we were to exclude these laser replacementsales from the three months ended September 30, 2006, consumables, spare partsand service products revenue would have remained relatively flat from period toperiod. Revenues from funded development contracts were $109,000 and $79,000for three months ended September 30, 2006 and 2007, respectively. There were norevenues recorded or earned associated with the TCZ joint venture for the threemonths ended September 30, 2006 or 2007.

 

Forthe period ended September 30, 2007, our backlog totaled $110.9 million andtotal bookings were $151.1 million which yielded a book-to-bill ratio of 1.14compared to the period ended September 30, 2006, where our backlog was $90.3million and total bookings were $142.0 million yielding a book-to-bill ratio of0.99. The increase from period to period in bookings, backlog and our book tobill ratio primarily reflects the strong demand for our most advanced ArFimmersion products and their corresponding higher selling prices.

 

Weinstalled 91 light sources at chipmakers and other end-users during the quarterended September 30, 2006 as compared to 55 light sources installed during thequarter ended September 30, 2007.

 

Our sales are generatedprimarily by shipments to customers in Europe, Japan, Korea, Taiwan, and theU.S. Approximately 84% and 86% of our sales for the three months endedSeptember 30, 2006 and 2007, respectively, were derived from customers outsidethe U.S. We maintain a wholly owned Japanese subsidiary, Cymer Japan, whichsells to our Japanese customers. Revenues from Japanese customers, generatedprimarily by Cymer Japan, accounted for 19% and 26% of total revenues for thethree months ended September 30, 2006 and 2007, respectively. The activities ofCymer Japan are limited to sales and service of products purchased by CymerJapan from us as the parent corporation. We anticipate that international saleswill continue to account for a significant portion of our sales.

 

*Cost of Product Sales*. Cost ofproduct sales includes direct material and labor, warranty expenses, licensefees, manufacturing and service overhead. Cost of product sales also includesforeign exchange gains and losses on foreign currency forward exchangecontracts (“forward contracts”) associated with purchases of our products byCymer Japan for resale under firm third-party sales commitments. Shipping costsassociated with our product sales are also included in cost of product salesand are not charged to our customers.

 

The cost of product sales decreased 9% from $72.5million for the three months ended September 30, 2006 to $65.9 million for thethree months ended September 30, 2007. This decrease in 

 

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cost of product sales was primarily due to lower lightsource system sales and slightly lower warranty costs for the three monthsended September 30, 2007 compared to the three months ended September 30, 2006.The gross margin on product sales was 49.6% for the three months endedSeptember 30, 2006 as compared to 50.1% for the three months ended September30, 2007. This slight increase in gross margin from period to period primarilyreflects our enhanced operating efficiencies.

 

*Research and Development*. Research and development expenses include costs ofinternally-funded projects as well as continuing product development supportexpenses, which consist primarily of employee and material costs, depreciationof equipment and other engineering related costs. Research and development expenses increased 13% from $18.9 million forthe three months ended September 30, 2006 to $21.4 million for the three monthsended September 30, 2007 due primarily to costs associated with our increasedfocus on EUV light source development and the beginning stages of itscommercialization and LTPS product development efforts. In addition to ourdevelopment of EUV and LTPS technologies, we also continued to focus on nextgeneration ArF products. Included in our ArF product development efforts for2007 is the design of our XLR series light sources. As a percentage of totalrevenues, research and development expenses increased from 13.1% for the threemonths ended September 30, 2006 to 16.2% for the three months ended September30, 2007. We expect that our investment in research and development willcontinue and we expect that research and development expenses will increaseslightly in the fourth quarter as compared to the third quarter levels.

 

*Sales and Marketing*. Sales and marketing expenses includesales, marketing and customer support staff expenses and other marketingexpenses. Sales and marketing expensesdecreased 19% from $8.4 million for the three months ended September 30, 2006to $6.8 million for the three months ended September 30, 2007. The decrease insales and marketing expenses from period to period primarily reflects adecrease in employee compensation which includes profit sharing, bonuses andstock-based compensation expenses totaling approximately $1.4 million. Stockcompensation expense decreased from period to period due to the significantreduction in the number of stock options that we grant to our employees. As apercentage of total revenues, sales and marketing expenses decreased from 5.9%for the three months ended September 30, 2006 compared to 5.2% for the threemonths ended September 30, 2007. We anticipate that sales and marketingexpenses will increase slightly in the fourth quarter of 2007.

 

*Generaland Administrative.* General and administrative expensesconsist primarily of management and administrative personnel costs,professional services, including external audit and consultant fees, andadministrative operating costs. General and administrative expenses increased9.4% from $9.1 million for the three months ended September 30, 2006 to $9.9million for the three months ended September 30, 2007 primarily due to anincrease in accounting professional service fees, compensation expenses,recruiting expenses and expenses related to facilities and informationtechnology. These increased expenses from period to period were partiallyoffset by a $638,000 decline in stock-based compensation expense which are dueto a significant reduction in the number of stock options granted to ouremployees. As a percentage of total revenues, general and administrativeexpenses increased from 6.3% for the three months ended September 30, 2006 to7.5% for the three months ended September 30, 2007. We anticipate that generaland administrative expenses will increase slightly in the fourth quarter of2007.

 

*TotalOther Income - Net.* Net other income consists primarily ofinterest income and expense, and foreign currency exchange gains and lossesassociated with fluctuations in the value of the functional currencies of ourforeign subsidiaries against the U.S. dollar. Net other income increased 4%from $3.7 million for the three months ended September 30, 2006 to $3.9 millionfor the same period in 2007. The increase in net other income was primarily dueto foreign currency exchange gains which were offset by a decrease in interestincome period over period. During the second and third quarter of 2007, weheavily utilized our short-term investment portfolio when we repurchased 7.2million shares of our outstanding common stock under our $300 million boardapproved stock repurchase program. Interest income decreased from period toperiod due to lower average cash and investment balances during the thirdquarter of 2007 compared to the same period in 2006. Foreign currency exchangelosses totaled $243,000, interest income and other income totaled $5.4 million,and interest and other expense totaled

 

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$1.5 million for thethree months ended September 30, 2006, compared to a foreign currency exchangegain of $1.5 million, interest and other income of $4.0 million, and interestand other expense of $1.7 million for the three months ended September 30,2007.

 

*IncomeTax Provision.* The tax provision of $12.5 million and $11.0million for the three months ended September 30, 2006 and 2007, respectively,reflects an annual effective rate of 33.8% and 34.6%, respectively. Included inincome tax expense for the three months ended September 30, 2007 is a discretetax benefit item that totaled $2.3 million and was a correction of previouslyoverstated income tax expense related to fiscal years 2003 through 2006. Weevaluated the materiality of this $2.3 million correction and concluded that itwas immaterial to all prior period financial statements and to the forecasted2007 financial statements. Accordingly, we recorded this tax expense correctionin the three months ended September 30, 2007. This $2.3 million tax benefit wasalmost completely offset by a decrease in the expected benefit from ourresearch and development tax credit for the year.

 

The annual effective taxrate for the three months ended September 30, 2006 was less than the U.S.statutory rate of 35% primarily as a result of permanent book/tax differencesand tax credits. The annual effective tax rate for the three months endedSeptember 30, 2007 was approximately equal to the statutory rate of 35%. Theeffective tax rates for the periods are a function of current tax law and thegeographic location of pre-tax income.

 

***NineMonths Ended September 30, 2006 and 2007***

 

*Revenues.* The following table summarizes certain measuresand the components of our revenue (in thousands, except units sold):

 
| ** **                                     | ** ** | **For the nine months ended** | ** ** |
|------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                     | ** ** | **September 30,**                            | ** ** |
| ** **                                     | ** ** | **2006**                                          | ** ** | **2007** | ** ** |
|                                           |       |                                              |       |   |   |
| Light source  systems:                         |       |                                              |       |   |   |
| Revenue                                        |       | $                                                 | 212,016    |   | $ | 180,987 |   |
| Units sold                                     |       | 212                                               |       | 147 |   |
| Average selling  price (1)                     |       | $                                                 | 1,000      |   | $ | 1,235 |   |
|                                           |       |                                              |       |   |   |
| Consumables,  spare parts and service products |       | $                                                 | 194,139    |   | $ | 200,249 |   |
| Product sales                                  |       | $                                                 | 406,155    |   | $ | 381,236 |   |
| Other revenue                                  |       | $                                                 | 259        |   | $ | 538 |   |
|                                           |       |                                              |       |   |   |
| Total revenue                                  |       | $                                                 | 406,414    |   | $ | 381,774 |   |
|                                                |            |                                                   |            |  |  |  |  |  |

 

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(1)      Calculation ofaverage selling price includes $591,000 of deferred light source system revenuefor the nine months ended September 30, 2007.

 

Product sales decreased6% from $406.2 million for the nine months ended September 30, 2006 to $381.2million for the nine months ended September 30, 2007. This decrease in productsales was due to a 15%, or $31.0 million decline in light source system saleswhich were partially offset by a 3%, or $6.1 million increase in consumables,spare parts and service product sales for the nine months ended September 30,2007 as compared to the nine months ended September 30, 2006. A total of 212light source systems were sold in the nine months ended September 30, 2006 atan average selling price of $1.0 million, compared to 147 light source systemssold in the nine months ended September 30, 2007 at an average selling price of$1.2 million. The increase in the average selling price from period to periodreflects the shift in the product mix to higher priced technology buys of ournewer advanced ArF products which represented 82% of light source systemsrevenue for the nine months ended September 30, 2007 as compared to only 65% oflight source system revenue for the nine months ended September 30, 2006. 

 

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The decrease inquantities of light source systems sold from period to period was due to theslowing and flattening of the semiconductor industry in the first nine monthsof 2007 as compared to the 2006 levels.

 

The continued increase inour installed base of light source systems and the steady utilization of themby our chipmaker customers resulted in an increase in consumables and spareparts and service product revenue of 3% from $194.1 million for the nine monthsended September 30, 2006 to $200.2 million for the nine months ended September30, 2007. In 2006, consumables, spare parts and service products revenue wasfavorably impacted by sales which were recorded in this category of revenuerelated to a laser replacement agreement we entered into at the beginning of2006. If we were to exclude these laser replacement sales from the nine monthsended September 30, 2006, consumables, spare parts and service products revenuewould have increased 10% in the first nine months of 2007 as compared to thefirst nine months of 2006. Revenues from funded development contracts were$259,000 and $538,000 for nine months ended September 30, 2006 and 2007,respectively. There were no revenues recorded or earned associated with the TCZjoint venture for the nine months ended September 30, 2006 or 2007.

 

Sales to our threelithography tool manufacturing customers, ASML, Canon, and Nikon, amounted to38%, 6% and 15%, respectively, of total revenue for the nine months endedSeptember 30, 2006, and 35%, 4% and 18%, respectively, of total revenue for thenine months ended September 30, 2007.

 

Approximately 84% and 86%of our sales for the nine months ended September 30, 2006 and 2007,respectively, were derived from customers outside the U.S. Revenues fromJapanese customers, generated primarily by Cymer Japan, accounted for 21% and22% of total revenues for the nine months ended September 30, 2006 and 2007,respectively.

 

*Cost ofProduct Sales.* The cost of product sales decreased 11% from$211.7 million for the nine months ended September 30, 2006 to $187.7 millionfor the nine months ended September 30, 2007. This decrease in cost of productsales was primarily due to lower light source system sales and a decrease inwarranty costs for the nine months ended September 30, 2007 compared to thenine months ended September 30, 2006. The gross margin on product sales was47.9% for the nine months ended September 30, 2006 as compared to 50.8% for thenine months ended September 30, 2007. This higher gross margin from period toperiod is primarily due to increased factory yield and utilization, reducedproduct lead and cycle times, reduced warranty costs which resulted fromproduct reliability realization and favorable material reclaim productivityimprovements from period to period.

 

*Researchand Development.* Research and development expenses increased9% from $55.9 million for the nine months ended September 30, 2006 to $60.8million for the nine months ended September 30, 2007 due primarily to costsassociated with our increased focus on EUV light source development and thebeginning stages of its commercialization and LTPS product development efforts.In addition to our development of EUV and LTPS technologies, we also continuedto focus on next generation ArF products. Included in our ArF productdevelopment efforts for 2007 is the design of our XLR series light sources. Asa percentage of total revenues, research and development expenses increasedfrom 13.7% for the nine months ended September 30, 2006 to 15.9% for the ninemonths ended September 30, 2007.

 

*Sales andMarketing.* Sales and marketing expenses decreased 14% from$22.6 million for the nine months ended September 30, 2006 to $19.6 million forthe nine months ended September 30, 2007. The decrease in sales and marketingexpenses from period to period primarily reflects decreases in employeecompensation which includes profit sharing, bonuses and stock-basedcompensation expenses as well as decreases in recruiting expenses totalingapproximately $2.8 million. In addition, sales and marketing expenses for 2006include higher employee payroll taxes related to stock option exercises whichoccurred in the first nine months of 2006 of approximately $228,000. As apercentage of total revenues, sales and marketing expenses decreased from 5.6%for the nine months ended September 30, 2006 compared to 5.1% for the ninemonths ended September 30, 2007.

 

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*Generaland Administrative*. General and administrative expensesincreased 2% from $27.9 million for the nine months ended September 30, 2006 to$28.5 million for the nine months ended September 30, 2007. This increase wasprimarily due to a $2.3 million increase in accounting professional servicefees which were related to the implementation of FIN 48 and tax consulting andsupport, increases in employee compensation and benefits and expenses relatedto facilities and information technology. These increased expenses from periodto period were substantially offset by a $1.9 million decline in stock-basedcompensation expense and a $1.6 million decline in profit sharing and bonuses. Asa percentage of total revenues, general and administrative expenses increasedslightly from 6.9% for the nine months ended September 30, 2006 to 7.5% for thenine months ended September 30, 2007.

 

*Total Other Income - Net.*Netother income decreased 7% from $14.4 million for the nine months endedSeptember 30, 2006 to $13.4 million for the same period in 2007. The decreasein net other income was primarily due to the receipt of $3.2 million in lifeinsurance proceeds following the death of one of our executive officers earlyin 2006 and an increase in interest expense related to the present valuecalculations associated with our long-term incentive bonus program. These netdecreases were offset by an increase in foreign currency exchange gains fromperiod to period and increases in interest income during the first nine monthsof 2007 compared to the same period in 2006. During the second and thirdquarter of 2007, we utilized a significant portion of our investment portfoliowhen we repurchased 7.2 million shares of our outstanding common stock for$288.0 million under our $300 million board approved stock repurchase program.Even with this heavy utilization of our investments, interest income increaseddue to higher average investments in the first half of 2007 and better interestrate yields on those investments from period to period. Foreign currencyexchange gains totaled $856,000, interest income and other income totaled $17.9million, and interest and other expense totaled $4.4 million for the ninemonths ended September 30, 2006, compared to a foreign currency exchange gain of$2.0 million, interest and other income of $16.3 million, and interest andother expense of $4.8 million for the nine months ended September 30, 2007.

 

*Income Tax Provision.*The taxprovision of $34.7 million and $34.1 million for the nine months ended September30, 2006 and 2007, respectively, reflects annual effective tax rates of 33.8%and 34.6%, respectively. Included in income tax expense for the nine monthsended September 30, 2007 is a discrete tax benefit item that was recorded inthe third quarter of 2007. This tax benefit item totaled $2.3 million and was acorrection of previously overstated income tax expense related to fiscalyears 2003 through 2006. We evaluated the materiality of this $2.3 millioncorrection and concluded that it was immaterial to all prior period financialstatements and to the forecasted 2007 financial statements. Accordingly, werecorded this tax expense correction in the three months ended September 30,2007. This $2.3 million tax benefit was almost completely offset by a decreasein the expected benefit from our research and development tax credit for theyear.

 

The annual effective tax rate forthe nine months ended September 30, 2006 was less than the U.S. statutory rateof 35% primarily as a result of permanent book/tax differences and tax creditsThe annual effective tax rate for the nine months ended September 30, 2007was approximately equal to the statutory rate of 35%. The effective tax ratesfor the periods are a function of current tax law and the geographic locationof pre-tax income.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

Historically we havefunded our operations primarily from cash generated from operations, theproceeds of note offerings, bank borrowings, and the proceeds from employeestock option exercises. As of September 30, 2007, we had approximately $237.9million in cash and cash equivalents, $55.1 million in short-term investments,$27.2 million in long-term investments, and $497.9 million in working capital.Cash and cash equivalents decreased $64.2 million in the nine month period fromDecember 31, 2006 to September 30, 2007.

 

InFebruary 2002, we issued $250.0 million in aggregate principal amount in aprivate placement of notes. These notes are due on February 15, 2009 withinterest payable semi-annually on February 15 and August 15 of each year at3.50% per annum. The notes are convertible into shares of our common 

 

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stockat a conversion rate of 20 shares per $1,000 principal amount or an effective conversionprice of $50.00 per share. With the approval of our board of directors, we haveperiodically repurchased these notes in the open market. To date we haverepurchased $109.3 million in principal amount of these notes and at September30, 2007, there were $140.7 million in principal amount of these notesoutstanding.

 

Net cash provided by operating activities wasapproximately $67.3 million and $84.9 million for the nine months endedSeptember 30, 2006 and 2007, respectively. Although net income for the ninemonths ended September 30, 2007 was lower by approximately $3.3 million thanthe same time period in 2006, cash provided by operating activities was muchhigher in the first nine months of 2007 as compared to the first nine months of2006. This is primarily due to significant decreases in accounts receivable andincreases in deferred revenue which were offset by decreases in accruedexpenses and other liabilities for the nine months ended September 30, 2007 ascompared to significant increases in accounts receivable for the nine monthsended September 30, 2006 which were offset by increases in accrued expenses andother liabilities during the same period. The decrease in accounts receivablefor the nine months ended September 30, 2007 was primarily due to increasedcollection efforts during the period whereas the  increases in accounts receivable in the firstnine months of 2006 were due to back-end loaded shipments during the thirdquarter of 2006. The increase in deferred revenue from period to periodprimarily reflects prepayments received from ASML during the third quarter of2007 for purchase orders we received from them under our multi-year EUV supplyagreement.

 

Net cash used ininvesting activities for the nine months ended September 30, 2006 wasapproximately $72.6 million compared to net cash provided by investingactivities of $120.9 million for the nine months ended September 30, 2007. Netcash used in investing activities for the nine months ended September 30, 2006was due primarily to the timing of short-term and long-term investments thatmatured and were reinvested during the period, a $7.0 million payment toacquire the final 19% minority interest in our Cymer Korea subsidiary, an $8.2million payment to acquire certain patent license rights and the acquisition of$10.0 million of property and equipment. Net cash provided by investingactivities during the nine months ended September 30, 2007 reflects the timingof short-term and long-term investments that matured and were reinvested duringthe period, the acquisition of $13.5 million of property and equipment and a$121,000 payment to acquire certain patent license rights. The majority of theproceeds from sold and matured investments during the nine months endedSeptember 30, 2007 were used to help fund the repurchase of 7,194,000 shares ofcommon stock for $288.0 million during the second  and third quarters of 2007 under our $300million board approved stock repurchase program.

 

Net cash provided byfinancing activities was approximately $21.9 million for the nine months endedSeptember 30, 2006 compared to net cash of $273.3 million used in financingactivities for the nine months ended September 30, 2007. Net cash provided byfinancing activities for the nine months ended September 30, 2006 reflects theproceeds received from the exercise of employee stock options totaling $103.7million and excess tax benefits for the period from stock options exercisestotaling $18.9 million. This cash provided by financing activities was offset bythe repurchase of treasury stock totaling $100.7 million during the thirdquarter of 2006. Net cash used in financing activities for the nine monthsended September 30, 2007 primarily reflects the repurchase of shares of ourcommon stock totaling $288.0 million. This cash used in financing activitieswas slightly offset by proceeds received from the exercise of employee stockoptions totaling $12.8 million and the excess tax benefits for the period fromstock options exercises totaling $1.9 million.

 

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 cash generated fromoperations along with the liquidity provided by our existing cash balances andshort-term investments will be sufficient to sustain operations and provide forany potential future expansion of our business for at least the next 12 months.

 

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**OFF BALANCE SHEET ARRANGEMENTSAND CONTRACTUAL OBLIGATIONS**

 

We did not have anyrelationships with unconsolidated entities or financial partnerships, such asentities often referred to as structured finance, variable interest, or specialpurpose entities, which would have been established for the purpose offacilitating off-balance sheet arrangements or other contractually narrow orlimited purposes. In addition, we did not engage in trading activitiesinvolving non-exchange traded contracts. As a result, we are not exposed to anyfinancing, liquidity, market or credit risk that could arise if we had engagedin such relationships. We do not have relationships and transactions withpersons and entities that derive benefits from their non-independentrelationship with us or our related parties except as disclosed herein.

 

We have no significantcontractual obligations that are not recorded in our consolidated financialstatements or fully disclosed in the notes thereto.

 

As a September 30, 2007,we had a gross liability for income taxes associated with uncertain taxpositions of approximately $21.5 million related to our adoption of FIN 48. Weare not providing an updated contractual obligations table from the onepresented in our Annual Report on Form 10-K for the year ended December 31,2006 because the timing of any payments which could result from these unrecognizedtax benefits will depend on a number of factors. Accordingly, we cannot makereasonably reliable estimates of the amount and period of potential cashsettlements, if any, with taxing authorities.

 

**RECENT ACCOUNTING PRONOUNCEMENTS**

 

In September 2006, the FASB issuedStatement of Financial Accounting Standards No. 157, “Fair Value Measurements”(“SFAS 157”). SFAS 157 defines fair value, establishes a framework formeasuring fair value using generally accepted accounting principles, andexpands disclosures related to fair value measurements. This Statement appliesto other accounting pronouncements that require or permit fair valuemeasurements. Accordingly, SFAS 157 does not require any new fair valuemeasurements. However, for some entities, the application of this Statementwill change current practice. This Statement is effective for us on January 1,2008. We are currently evaluating the impact of this pronouncement on ourconsolidated financial statements.

 

In September 2006, FASB issued SFAS No.158, “Employers’ Accounting for Defined Benefit Pension and OtherPostretirement Plans—an Amendment of FASB Statements No. 87, 88, 106, and132(R)” (“SFAS 158”). We adopted all provisions of SFAS 158 in December 2006except for the provision which will require us to measure the funded status ofour pension plans as of the date of our year-end statement of financialposition. This provision will be effective for us for the fiscal year endingDecember 31, 2008, and we do not expect its adoption to have a material impacton our consolidated financial statements.

 

In February 2007, the FASB issued SFAS No.159, “The Fair Value Option for Financial Assets and Financial Liabilities –Including an Amendment of FASB Statement No. 115” (“SFAS 159”). Thisstatement permits companies to choose to measure many financial assets andliabilities at fair value. Unrealized gains and losses on items for which thefair value option has been elected are reported in net income. This statementalso establishes presentation and disclosure requirements to facilitatecomparisons between entities that choose different measurement attributes forsimilar types of assets and liabilities. SFAS 159 is effective for fiscal yearsbeginning after November 15, 2007. We are currently assessing the impactof SFAS 159 on our consolidated financial statements.

 

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#### **Item 3. Quantitative andQualitative Disclosures About Market Risk**

#### ** **

**Foreign Currency Risk**

 

We conduct business inseveral international currencies through our global operations. Due to thelarge volume of our business that we conduct in Japan, the Japanese operationposes our greatest foreign currency risk. We use financial instruments,principally forward contracts, to manage our foreign currency risk exposures.We enter into forward contracts in order to reduce the impact of currencyfluctuations related to purchases of our inventories by Cymer Japan in U.S.dollars for resale under firm third-party sales commitments denominated in Japaneseyen, as well as other foreign currency exposures including exposures related tointercompany debt. We do not enter into forward contracts for speculativepurposes.

 

As of September 30,2007, we had outstanding forward contracts to buy U.S. $45.0 million for 5.3billion yen under foreign currency exchange facilities with contract ratesranging from 111.30 yen to 121.30****yen per U.S.dollar. These contracts expire on various dates through March 2008.

 

Our forward contracts generally qualify for hedgeaccounting treatment according to the provisions of Statement of FinancialAccounting Standards No. 133, “Accounting for Derivative Instruments andHedging Activities”. As a result, we defer changes in the fair value for theeffective portion of these hedges and record the amount in other comprehensiveincome and subsequently reclassify the gain or loss to cost of product sales inthe same period that the related sale is made to the third party. The fairvalue of all of our forward contracts and the unrealized loss, net of tax, forthose that qualify for hedge accounting treatment totaled $984,000 and $37,000,respectively, as of September 30, 2007.

 

The fair value of these forward contracts as ofSeptember 30, 2007 would have fluctuated by $3.9 million if the foreigncurrency exchange rate for the Japanese yen to the U.S. dollar on these forwardcontracts had changed by 10%.

 

# **Investment and Debt Risk**

# ** **

We maintain aninvestment portfolio consisting primarily of government and corporate fixedincome securities, certificates of deposit and commercial paper. While it isour general intent to hold such securities until maturity, we will occasionallysell certain securities for cash flow purposes. Therefore, our investments areclassified as available-for-sale and are carried on the balance sheet at fairvalue. A change in market interest rates of 10% would have impacted our netincome from these investments by approximately $824,000 for the nine monthsended September 30, 2007.

 

In February 2002, weissued $250.0 million principal amount of unsecured fixed rate 3.50%Convertible Subordinated Notes due February 15, 2009. Interest on these notesis payable on February 15 and August 15 of each year. The notes are convertibleinto shares of our common stock at a conversion rate of 20 shares per $1,000principal amount subject to adjustment under certain conditions. As of February21, 2005, we may redeem the notes at certain redemption prices expressed as apercentage of the principal amount. The notes are subordinated to our existingand future senior indebtedness and effectively subordinated to all indebtednessand other liabilities of our subsidiaries. Because the interest rate is fixed,we believe there is no risk of increased interest expense. These notes arerecorded at face value on the consolidated balance sheets. In the third quarterof 2004 and the second quarter of 2005, we repurchased, at a discount to par,$49.2 million and $60.0 million principal amount, respectively, of these notes.The principal amount of the notes outstanding at September 30, 2007 was$140.7 million and the fair value of such debt based on quoted market prices atSeptember 30, 2007 was $142.1 million.

 

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**ITEM4. Controls and Procedures**

 

*Evaluationof disclosure controls and procedures*. For the third quarterof 2007, our chief executive officer and our chief financial officer, evaluatedthe effectiveness of our disclosure controls and procedures (as defined inRules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, asamended (the “Exchange Act”)) as of September 30, 2007, and concluded that asof such date, our disclosure controls and procedures were not effective inensuring that information required to be disclosed by us in the reports that wefile under the Exchange Act is recorded, processed, summarized and reportedwithin the time period specified in the rules and forms of the Securities andExchange Commission.

 

This conclusion was basedsolely on our assessment of the company’s processes and controls related to ouraccounting for income taxes described in our Annual Report on Form 10-K for theyear ended December 31, 2006, more specifically those policies and procedureswhich were not designed to include adequate management review of various incometax calculations, reconciliations and related supporting documentation toensure that our accounting for income taxes was in accordance with generallyaccepted accounting principles. These deficiencies resulted in material errorsin our consolidated tax provision for our year ended December 31, 2006. Sucherrors were corrected prior to the issuance of our consolidated financialstatements at and for the year ended December 31, 2006. These deficiencies alsoresulted in a more than remote likelihood that a material misstatement to ourconsolidated financial statements would not be prevented or detected. Asdescribed in Part II, Item 9A of our Annual Report on Form 10-K for the yearended December 31, 2006, we have developed a plan to remediate this materialweakness and will implement all steps in the plan and any others that we deemnecessary throughout 2007.

 

*Changesin internal control over financial reporting.*There has beenno change in our internal control over financial reporting during the quarterended September 30, 2007 that has materially affected, or is reasonably likelyto materially affect, our internal control over financial reporting other thanthe steps taken by us to remediate the material weakness that was disclosed byus in our Annual Report on Form 10-K for the year ended December 31, 2006,relating to our accounting for income taxes.

 

As described in Part II, Item 9A of our Annual Report on Form 10-K for the year ended December 31, 2006, we have identified several steps we will take throughout 2007 with the goal of remediating this material weakness prior to December 31, 2007. Per our original remediation plan and our continued evaluation of the design of our internal controls in the tax area, we have made the following improvements in our internal controls over our accounting for income taxes for the nine months ended September 30, 2007:

 

•                  Improvedthe communications between our tax department and our accounting department,and increased the level of involvement of our accounting department in thereviews of income tax reconciliations and certain key tax schedules;

•                  Redesignedand implemented new review and approval procedures and processes associatedwith all income tax provision workpapers and the consolidated income tax reconciliationschedules;

•                  Completedthe implementation of an automated tax provision software tool that will reducethe number of manual spreadsheets that we use to calculate our effective taxrate on a quarterly and annual basis;

•                  Increasedour use of outside tax consultants to assist us with all tax calculations andtax provision workpapers until we can identify and hire all of the appropriateadditional tax personnel;

•                  Restructuredthe income tax department, including the roles and responsibilities of ouroutside tax consultants, to allow for proper review and approval procedures andprocesses; and,

•                  Hireda vice president of tax to oversee all tax department personnel, policies,processes and internal controls.

 

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There are additionalremediation steps that we have identified from our original remediation plan.Some of these were completed in the third quarter of 2007 and we intend tocomplete the remainder in the fourth quarter of 2007.

 

Since most of the moresignificant improvements to our internal controls over the accounting forincome taxes were designed early in 2007 and were implemented as part of ourfirst quarter and second quarter of 2007 tax provision calculations, we testedall of these internal control changes in the third quarter of 2007. No controldeficiencies were identified during this testing. Further, we will test anyadditional changes that we make to our internal controls over our accountingfor income taxes in the fourth quarter of 2007 or in early 2008, immediatelyfollowing their completion and execution to ensure that they are properlydesigned and working effectively. We will continue to make any changes thatmanagement deems necessary to these new tax internal controls based on the results of this testing.

 

**PART II. OTHER INFORMATION**

 

# **ITEM1.**                                                     LegalProceedings

# ** **

# **None.**

 

# **ITEM1A.**                                            Risk Factors

 

*The risks described below may not be the only risks we face. Additionalrisks that we do not currently think are material may also impair our businessoperations. The risk factors set forth below with an asterisk (*) next to thetitle contain changes to the description of the risk factors associated withour business as previously disclosed in Item 1A to our Annual Report on Form10-K for the fiscal year ended December 31, 2006. If any of the events orcircumstances described in the following risks actually occur, our business,financial condition or results of operations could suffer, and the tradingprice of our common stock could decline.*

 

**Ourrevenues and operating results from quarter-to-quarter have varied in the pastand our future operating results may continue to fluctuate significantly.**

 

Factorsthat contribute to fluctuations in our revenues and operating results include:

 

•                  demand for semiconductors in general and, inparticular, for leading edge devices with smaller circuit geometries;

•                  cyclicality in the market for semiconductormanufacturing equipment;

•                  rates at which chipmakers take delivery ofphotolithography tools from lithography tool manufacturers;

•                  rates at which lithography tool manufacturercustomers take delivery of light source systems from us;

•                  timing and size of orders from our customers;

•                  changes in market penetration by our competitor;

•                  product lead time demands from our customers;

•                  mix of light source models, consumable and spareparts and service revenues in our total revenues;

•                  changes in the price and profitability of ourproducts;

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

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

•                  our ability to manage customer satisfaction,product reliability, and direct field service and support effectiveness;

•                  our ability to manage our manufacturingrequirements;

 

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•                  foreign currency exchange rate fluctuations,principally with respect to the Japanese yen (in which sales by our Japanesesubsidiary are denominated);

•                  worldwide political instability;

•                  changing global economic conditions, includingrising energy prices; and

•                  intellectual property protection.

 

Wehave 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. Orders expectedin one quarter could shift to another period due to changes in the anticipatedtiming of our customers’ purchase decisions or rescheduled delivery datesrequested by our customers. Our operating results for a particular quarter oryear may be adversely affected if our customers, particularly our three largestcustomers, cancel or reschedule orders, or if we cannot fill orders in time dueto unexpected delays in manufacturing, testing, shipping, and productacceptance.

 

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 of these or other factors, we could fail toachieve our expectations as to future revenue, gross profit, operating income,net income, earnings per share, and cash flows. Our failure to meet theperformance expectations set and published by external sources could result ina sudden and significant drop in the price of our stock, particularly on ashort-term basis, and could negatively affect the value of any investment inour stock.

 

***Our business depends on the semiconductor and thesemiconductor capital equipment industries, which are volatile andunpredictable.**

 

Wederive a substantial portion of our revenues from our lithography toolmanufacturer customers who, as original equipment manufacturers (“OEMs”),incorporate our light source systems in photolithography tools that they sellto semiconductor manufacturers, or chipmakers, and from our chipmaker customerswho purchase consumables, spare parts, upgrades and service directly from us insupport of the light source products. Like us, our OEM customers depend on demandfor their products from the chipmakers. The capital equipment and relatedoperating expenditures of chipmakers depend on a number of factors, includingthe current and anticipated market demand for semiconductors and the manyproducts using semiconductors. That demand is volatile and unpredictable.

 

Asa result of the cyclicality of the semiconductor industry, the semiconductorcapital equipment industry historically has experienced periodic ups and downs.The cyclical nature of the semiconductor and the semiconductor capitalequipment industries affects our ability to accurately predict future revenueand therefore our ability to manage our future expense levels. When cyclicalfluctuations result in lower than expected revenue levels, operating results maybe adversely affected and cost reduction measures may be necessary in order forus to remain competitive and financially sound. During a down cycle orslowdown, we must be in a position to adjust our cost and expense structure toprevailing market conditions while still being able to maintain the longer termstrategies of the company as well as motivate and retain our key employees.During periods of rapid growth, we must be able to increase manufacturingcapacity and personnel to meet customer demand. We can provide no assurancethat these objectives can be met in a timely manner in response to industrycycles. We are not able to predict with any certainty the duration of anyindustry cycle or the timing or order of magnitude of any recovery.

 

Downturnsin the semiconductor industry often result in decreases in demand forsemiconductor manufacturing equipment, including the photolithography toolsthat our OEM customers produce. Downturns in the semiconductor industry havegenerally had severe effects on the demand for semiconductor manufacturingequipment and the associated parts and support services. Fluctuating levels ofinvestment by chipmakers and resulting pricing volatility will continue tomaterially affect our aggregate bookings, revenues and operating results. Evenduring periods of reduced revenues we believe we must continue to invest inresearch and development and to maintain extensive ongoing worldwide 

 

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customerservice and support capabilities to remain competitive. Continued spending infurtherance of these objectives may temporarily harm our financial results. Semiconductorindustry downturns and slowdowns are likely to continue to adversely affect ourbusiness, financial condition and operating results, and our operating resultsmay fall below the expectations of public market analysts or investors infuture quarters. Any failure to meet such expectations could materiallyadversely affect the price of our common stock.

 

OurOEM customers try to manage their inventories and production requirements toappropriate levels that reflect their expected sales to chipmakers. Marketconditions in the semiconductor industry and our OEM customers’ productionefficiency can cause them to expand or reduce their orders for new light sourcesystems as they try to manage their inventories and production requirements. Wecontinue to work with our OEM customers to better understand these issues.However, we cannot guarantee that we will be successful in understanding ourOEM customers’ inventory management and production requirements or that our OEMcustomers will not build up an excess inventory of light source systems. If ourOEM customers retain an excess inventory of light source systems, our revenuecould be reduced in future periods as the excess inventory is utilized, whichcould adversely affect our operating results, financial condition and cashflows. If our OEM customers demand shorter product lead times to improve theirinventory and cash positions, our inventory management and cash position may benegatively impacted, which may adversely affect our operating results,financial condition and cash flows.

 

***Asignificant percentage of our revenue is derived from sales to our lithographytool manufacturer customers, and if we are not able to retain these customers,or they reschedule, reduce or cancel orders, or delay or default on payments,our revenues would be reduced and our financial condition and cash flows wouldsuffer.**

 

Threelarge companies, ASML, Nikon and Canon dominate the photolithography toolbusiness. Collectively, these three companies accounted for the followingpercentage of our total revenue during the periods indicated:

 

| ** ** | ** ** | **Nine months ended** | ** ** |
|------------|------------|---------------------------------|------------|
| ** ** | ** ** | **September 30,**          | ** ** |
| ** ** | ** ** | **2006**                        | ** ** | **2007** | ** ** |
|       |       |                            |       |   |   |
| ASML       |       | 38                              | %          | 35 | % |
| Nikon      |       | 15                              | %          | 18 | % |
| Canon      |       | 6                               | %          | 4 | % |
|       |       |                            |       |   |   |
| Total      |       | 59                              | %          | 57 | % |

 

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

 

| ** ** | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
|------------|------------|-----------------------|------------|------------------------|------------|
| ** ** | ** ** | **2006**              | ** ** | **2007**               | ** ** |
|       |       |                  |       |                   |       |
| ASML       |       | 48                    | %          | 38                     | %          |
| Nikon      |       | 19                    | %          | 27                     | %          |
| Canon      |       | 3                     | %          | 2                      | %          |
|       |       |                  |       |                   |       |
| Total      |       | 70                    | %          | 67                     | %          |

 

Weexpect that sales of our light source products to these customers will continueto account for a substantial portion of our revenue in the foreseeable future.None of our customers are obligated to purchase a minimum number of ourproducts in the aggregate or during any particular period. We can provide noassurance that any of our customers will continue to purchase our products atpast or current levels. Sales to any of these customers may be affected by manyfactors, some of which are beyond our control. These factors include:

 

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•                  a change in a customer’s competitive position inits industry;

•                  a customer experiencing lithography toolproduction problems;

•                  a decision to purchase light sources from othersuppliers;

•                  changes in economic conditions in thesemiconductor or the photolithography tool industries; and

•                  a decline in a customer’s financial condition.

 

Atvarying degrees, the loss of any significant business from or productionproblems for any one of these customers would harm our business and financialcondition.

 

***Ourrevenue is derived from the sale of a limited number of models of our lightsource systems, and consumable and support service products surrounding thesesystems.**

** **

Wesell excimer light source systems, including KrF and ArF systems, and support,including consumable and spare parts and service support. We expect these lightsource systems and the related support to continue to account for a substantialmajority of our revenues in the near term. Continued market acceptance of ourlight source system 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.

 

Therate with which chipmakers adopt excimer light sources may vary for a varietyof reasons, including:

 

•                  inadequate performance of photoresists used inadvanced DUV photolithography, especially new ArF immersion-specific resists;

•                  potential shortages of specialized materials usedin DUV optics;

•                  productivity of ArF immersion lithography tools,and in the future, productivity of double-patterning ArF lithography tools; and

•                  consolidation of chipmakers.

 

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 for our customers’ DUVphotolithography tools;

•                  a failure to achieve continued market acceptanceof our products;

•                  a failure to manage customer satisfaction,product reliability, and direct field service and support effectiveness;

•                  an improved version of products being offered bya competitor in the market in which we participate;

•                  technological change that we are unable toaddress with our products; and

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

 

***We dependon the introduction of new products for our success, and we are subject torisks associated with 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, timely introduce and support new light source products withimproved capabilities and to continue to enhance our existing light sourcesystems and process capabilities. Due to the risks inherent in transitioning tonew products, we must forecast accurate demand for new products while managingthe transition from older products.

 

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Inearly 2003, we effected our most significant product introduction in severalyears with the initial shipment of a light source based on a technology changefrom a single-discharge-chamber excimer light source to adual-discharge-chamber design called MOPA. The MOPA design represented aparadigm shift from previously accepted lithography technology by offeringchipmakers higher power, tighter bandwidth and lower cost of operation fortheir current optical lithography applications. More recently, we introducedthe next generation advanced dual discharge chamber light source, the XLR 500i,that replaces the conventional power amplifier chamber with a regenerative ringamplifier. This light source provides our customers with a step functionimprovement in performance and a significantly lower cost of operation. Thereare risks inherent in the MOPA and ring technologies, including effectiveexecution of our product development roadmap, continuing adoption of theproduct by lithography tool manufacturers and chipmakers, manufacturability,cost effectiveness, and product performance in the field of the new productsand the development of a comparable product by our competitor.

 

Atthis time, chipmakers are continuing to expand their manufacturing capacity at65 nm, and a growing number of manufacturers of certain types of memory chipsare in production at 55 nm and below. Some advanced logic chips are now inproduction at 45 nm, while memory manufacturers are expected to be inproduction at 45 nm in early 2008. Additionally, other types of chipmakers havea significant level of development underway at this node. These efforts, alongwith expanding use of ArF immersion lithography in production among certainmemory manufacturers, are driving demand for our most advanced ArF lightsources. At the same time chipmakers also need tools for the less criticallayers on wafers, and there remains strong demand for our KrF light sourceproducts for DUV photolithography systems as well. After chipmakers have builttheir capacity to levels appropriate to meet existing demand, their demand forour light source products will depend, in part, on their sales forecasts andtheir estimates regarding the duration and magnitude of the current industrycycle and whether their projected manufacturing process yields will enableongoing investments in whatever capacity seems necessary.

 

Futuretechnologies such as EUV, nano-imprint lithography, and certain masklesslithography techniques may render our excimer light source products obsolete.We must manage product transitions, as introduction of new products couldadversely 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 could materiallyadversely affect our operating results, financial condition and cash flows.

 

Weexpect to face significant competition from current and future competitors. Webelieve that other companies are developing systems and products that arecompetitive to ours and are planning to introduce new products to this market,which may affect our ability to sell our new products. Furthermore, newproducts represent significant investments of our resources and their success,or lack thereof, could have a material effect on our financial results.

 

*** Failureto maintain effectively our direct field service and support organization couldhave a material adverse effect on our business.**

 

Webelieve it is critical for us to provide quick and responsive service directlyto our chipmaker customers throughout the world that use our light sourceproducts in their photolithography systems, and that it is essential tomaintain our own personnel or trained third-party resources to provide theseservices. Accordingly, we have an ongoing effort to develop our direct supportsystem with locations in Europe, Korea, Japan, the People’s Republic of China,Singapore, Taiwan and the U.S. This requires us to do the following:

 

•                  recruit and train qualified field servicepersonnel;

•                  identify qualified independent firms; and

 

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•                  maintain effective and highly trainedorganizations that can provide service to our customers in various countries.

 

Wemay not be able to attract and train qualified personnel to maintain our directsupport operations successfully. We may not be able to find and engagequalified third-party resources to supplement and enhance our direct supportoperations. Further, we may incur significant costs in providing these supportservices. Failure to implement our direct support operation effectively couldharm our operating results, financial condition and cash flows.

 

**Wemust develop and manufacture enhancements to our existing products andintroduce new products in order to continue to grow our business. We may noteffectively manage our growth and integrate these new enhancements andproducts, which could materially 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 business to grow effectively. Nor can we guaranteethat we will be able to accelerate the development of new enhancements to ourexisting products and create new products. Further, we may not be able toeffectively integrate new products and applications into our currentoperations. Any of these risks could materially harm our business, financialcondition and results of operations.

 

**Weface competition from one company and may face competition from additionalcompetitors who enter the market.**

** **

Wecurrently have one significant competitor that sells light sources for DUVphotolithography applications. This competitor, Gigaphoton, is a joint venturebetween two large companies, Komatsu and Ushio, and is headquartered in Japan. Gigaphotonis aggressively trying to gain larger market penetration in the excimer lightsource industry. We know that our customers have purchased products from thiscompetitor and that our customers have approved this competitor’s light sourcesfor use with their products.

 

Largercompanies with substantially greater resources, such as other manufacturers ofindustrial 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 which represents asteady and significant consumable and spare parts revenue stream for us, andthey may attempt to supply consumable and spare parts to that installed base.If any existing or future competitors gain market acceptance, we could losemarket share and our growth could slow or decline, which could have a materialadverse effect on our operating results, financial condition and cash flows.

 

***We musteffectively manage changes in our business.**

 

Inorder to respond to the business cycles of the semiconductor industry, in thepast few years we have sharply expanded and contracted the scope of ouroperations and the number of employees in many of our locations anddepartments. As the semiconductor industry cycle moves between growth andcontraction we will need to:

 

•                  improve our product reliability through qualitycontrol, and our order fulfillment, field service and customer supportcapabilities;

•                  closely manage our global operations;

•                  improve our processes and other internalmanagement systems;

•                  quickly adapt to changing sales and marketingchannels;

•                  effectively manage our inventory levels; and

•                  attract, train, retain and manage key personnel.

 

Ifwe fail to effectively manage changes in our business, our operating results,financial condition and cash flows will be adversely affected.

 

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**We dependon a few key suppliers for purchasing components and subassemblies that areincluded in our products.**

 

Wepurchase a limited number of components and subassemblies included in our lightsource products from a single supplier or a small group of suppliers. Forcertain optical, control system and pulse power components and subassembliesused in our light source systems, we currently utilize a single supplier. Toreduce the risk associated with this single supplier, we carry a significantstrategic inventory of these components. Strategic inventories are managed as apercentage of future demand. We have also negotiated to have vendor-managedinventory of critical components to further reduce the risk of a single supplier.In addition, we contract the manufacture ofvarious subassemblies of our products and depend on our contract manufacturersto deliver to our required specifications, schedule, and quality standards.Further, some of our suppliers have specialized in supplying equipment ormanufacturing services to semiconductor equipment manufacturers and thereforeare susceptible to industry ups and downs and subject to the same risks anduncertainties regarding their ability to respond to changing market conditions.Because many of these suppliers reduce the size of their workforce in anindustry downturn and increase it in an upturn, they may not be able to meetour requirements or respond quickly enough as an upturn begins and gainsmomentum. Due to the nature of our product development requirements, these keysuppliers must rapidly advance their own technologies and productioncapabilities in order to support the introduction schedule of our new products.These suppliers may not be able to provide new modules and subassemblies whenthey are needed to satisfy our product schedule requirements. If we cannotpurchase enough of these materials, components or subassemblies, or if theseitems do not meet our quality standards, there could be delays or reductions inour product shipments, which would harm our operating results, financialcondition and cash flows.

 

## **We are dependent on ourmanufacturing facilities and subcontractors to assemble and 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. Suchdisruptions could cause delays in shipments of our products to our customers. Weprovide no assurance that alternate production capacity would be available if amajor disruption were to occur or that, if it were available, it could beobtained on favorable terms. Such disruption could result in cancellation oforders or loss of customers, which would have a material adverse effect on ouroperating results, financial condition and cash flows.

 

**Wedepend on key personnel, especially management and technical personnel, who maybe difficult to attract and retain.**

** **

Weare highly dependent on the services of many key employees in various areas,including:

 

•                  research and development;

•                  engineering;

•                  sales and marketing;

•                  field service and support;

•                  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 as needed. Wedo not have employment agreements with most of our employees. We believe thatour future growth and operating results will depend on:

 

•                  the continued services of our research anddevelopment, engineering, sales and marketing, field service and support, manufacturing, and management personnel;

 

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

•                  the ability of our personnel and key employees tocontinue to expand, train and manage our employee base.

 

Ifwe are unable to hire, train and retain key personnel as required, ouroperating results,  financial conditionand cash flows could be adversely affected.

 

**Economic,political, regulatory and other events in geographic areas where we havesignificant sales or operations could interfere with our business.**

** **

Weserve an increasingly global market. A large portion of our total revenues isderived from customers located outside of the U.S. We expect our internationalsales to continue to account for a very large portion of our total revenues. Inorder to support our foreign customers, we maintain a manufacturing and fieldservice subsidiary in Korea as well as field service and support subsidiariesin Japan, the Netherlands, the People’s Republic of China, Singapore andTaiwan.

 

Wemay not 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 in regulatory requirements;

•                  fluctuations in exchange rates and currencycontrols;

•                  political and economic conditions andinstability;

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

•                  difficulty in coordinating our management andoperations in several different countries;

•                  difficulties in staffing and managing foreignsubsidiary and branch operations;

•                  limited intellectual property protection in somecountries;

•                  potentially adverse tax consequences in some countries;

•                  the possibility of accounts receivable collectiondifficulties;

•                  in the case of Asia, the risk of businessinterruption and damage from earthquakes;

•                  the effect of acts of terrorism and war; and

•                  the burdens of complying with a variety of foreignlaws.

 

Manyof our major customers and many of the chipmakers who use our light sourceproducts in their photolithography systems are located in Asia. Economicproblems and currency fluctuations affecting these regions in Asia could createa larger risk for us. Further, even though it has not been difficult for us tocomply with U.S. export controls, these export rules could change in the futureand make it more difficult or impossible for us to export our products to manycountries. Any of these vulnerabilities could have a material adverse effect onour business, financial condition and results of operations.

 

***Ourability to compete could be jeopardized if we are unable to protect ourintellectual property rights. These types of claims could seriously harm ourbusiness or require us to incur significant costs.**

 

Webelieve our success and ability to compete depend in part upon protecting ourproprietary 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.

 

Weown and have numerous patents pending in the U.S. and various foreign countriescovering certain aspects of technology related to light sources and piezo techniques.These patents will expire at various times during the period from January 2008to September 2025.

 

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Ourpending patent applications and any future applications might not be approved.Our patents might not provide us with a competitive advantage and may besuccessfully challenged by third parties. In addition, third parties’ patentsmight have an adverse effect on our ability to do business. Due to costconstraints, we do not seek international patent protection for all inventionsthat are covered by U.S. patents and patent applications. As a result we do nothave foreign patent protection for some of our inventions. Additionally, lawsof some foreign countries in which our products are or may be developed,manufactured or sold, including various countries in Asia, may not protect ourproducts or intellectual property rights to the same extent as do the laws ofthe U.S. Thus, the likelihood of piracy of our technology and products isgreater in these countries. Further, third parties might independently developsimilar products, duplicate our products, or design around patents that aregranted 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 appropriate proceedings in the courts or the patent offices to determine thepriority of inventions. These proceedings may determine that these third-partypatent applications have priority over our patent applications. Loss ofpriority in these interference proceedings could result in substantial cost tous and loss of rights.

 

Wealso rely on the following to protect our confidential information and ourother intellectual property:

 

•                  trade secret protection;

•                  employee nondisclosure agreements;

•                  third-party nondisclosure agreements; and

•                  other intellectual property protection methods.

 

However,we may not be successful in protecting our confidential information andintellectual property, particularly our trade secrets, because third partiesmay:

 

•                  independently develop substantially the sameproprietary information and techniques;

•                  gain access to our trade secrets from unrelatedthird parties and/or without obligation of confidentiality; or

•                  disclose our technology following expiration oftheir confidentiality obligation.

 

***Theparties to whom we provide research and development services may dispute theownership of the intellectual property that we develop while performing theseservices.**

 

Inthe past, funds from research and development arrangements with third partieshave been used to pay for a portion of our own research and developmentexpenses. We receive these funds from government-sponsored programs andcustomers, in connection with our designing and developing specific products.Periodically, funds from lithography tool manufacturers and chipmakers are usedto fund a small portion of our research and development expenses. In providingthese research and development services to these manufacturers, we try to makecontractually clear who owns the intellectual property that results from theresearch and development services we perform. However, disputes over theownership or rights to use or market this intellectual property may arisebetween the funding organizations and us. Any dispute over ownership of theintellectual property we develop could restrict our ability to market ourproducts and have a material adverse effect on our business.

 

***Inthe future, we may be subject to patent litigation to enforce patents issued tous and defend ourselves against claimed infringement by our competitor or anyother third party.**

** **

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.

 

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Specifically,Komatsu notified us in 1996 that we may be infringing some of its Japanesepatents. During our subsequent discussions, Komatsu also asserted that ourformer Japanese manufacturing partner, Seiko, or we may be infringing on someof Komatsu’s U.S. patents and a number of its additional Japanese patents.Komatsu has also notified one of our customers, Nikon, of its belief that ourlight sources infringe several of Komatsu’s Japanese and U.S. patents. As aresult, we started proceedings in the Japanese Patent Office to oppose certainpatents and patent applications of Komatsu. The Japanese Patent Office hasdismissed our opposition claims. Thus, litigation may result in connection withKomatsu’s Japanese patents or U.S. patents. Also, Komatsu might claim that weinfringe other or additional patents. Komatsu notified Seiko that it intends toenforce its rights against Seiko with respect to its Japanese patents if Seikocontinued to engage in manufacturing activities for us. In connection with ourformer manufacturing agreement with Seiko, we agreed to pay Seiko under certainconditions for damages associated with these types of claims. Seiko may notprevail in any litigation against Komatsu, and therefore, we may be required topay Seiko for such damages.

 

Wehave notified our competitor and others of our U.S. patent portfolio.Specifically, we have notified Komatsu that it may be infringing some of ourU.S. patents. We have discussed with Komatsu our claims against each other. Komatsuchallenged one of our U.S. patents in the United States Patent and TrademarkOffice (“USPTO”) but our patent was subsequently re-issued by the USPTO. Also,Komatsu transferred its lithography light source business to our competitor,Gigaphoton. We also have had discussions with a former competitor,Lambda-Physik (a subsidiary of Coherent, Inc.), regarding allegations by eachparty against the other for possible patent infringement. Any of thesediscussions with our competitor or former competitor may not be successful andlitigation could result.

 

Inthe future, patent litigation may result due to a claim of infringement by ourcompetitor or any other third party or may be necessary to enforce patentsissued to us. Any such litigation could result in substantial cost to us anddiversion of our effort, which would have an adverse effect on our business,financial condition and operating results. Furthermore, our customers and theend-users of our products might assert other claims for indemnification thatarise from infringement claims against them. If these assertions aresuccessful, our business, financial condition and operating results may bematerially affected. Instead of litigation, or as a result thereof, we may seeka license from third parties to use their intellectual property. However, wemay not be able to obtain a license. Alternatively, we may design around thethird party’s intellectual property rights or we may challenge these claims inlegal proceedings. Any adverse determination in a legal proceeding could resultin one or more of the following, any of which could harm our business,financial condition and operating results:

 

•                  loss of our proprietary rights;

•                  exposure to significant liabilities by otherthird parties;

•                  requirement that we get a license from thirdparties on terms that are not favorable to us or not available at all; or

•                  injunction prohibits us  from manufacturing or selling our products.

 

Anyof these actions could be costly and would divert the efforts and attention ofour management and technical personnel, which would materially adversely affectour business, financial condition and results of operations.

 

**Wemay acquire a business or enter a new market that will involve numerous risks. Wemay not be able to address these risks successfully without substantialexpense, delay or other operational and financial challenges.**

** **

Therisks involved with acquiring a new company, forming a joint venture, orentering a new market include the following:

 

•                  diversion of management’s attention and resourcesto integrate the new company or new business opportunity;

•                  failure to retain key personnel;

 

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•                  client dissatisfaction or performance problemswith the acquired company or new product in a new market;

•                  amortization of acquired definite-lived intangibleassets and deferred compensation;

•                  costs associated with acquisitions and jointventures and the integration of acquired operations;

•                  costs associated with developing, marketing,introducing and supporting a new product in a new market;

•                  failure to commercialize purchased technologies;

•                  ability of the acquired companies, joint venturesor new markets to meet their financial projections;

•                  assumption of unknown liabilities or otherunanticipated events or circumstances; and

•                  compliance with the Sarbanes-Oxley Act of 2002,new SEC regulations, NASDAQ Stock Market rules and new accountingpronouncements as they relate to the new company or joint venture.

 

Mergers,acquisitions and joint ventures, as well as entry into new markets, areinherently subject to multiple significant risks, and the inability toeffectively manage these risks could have a material adverse effect on ourbusiness. In July 2005, we formed our TCZ joint venture with Zeiss to producetools for the manufacture of flat panel displays. This is a new market for bothCymer and Zeiss and may involve numerous risks. Any of these risks couldmaterially harm our business, financial condition and operating results.Further, any business that we acquire joint venture that we form or new marketwe may enter may not achieve anticipated revenues or operating results.

 

**Compliance with changing regulations of corporategovernance and public disclosure may result in additional expenses***.*

 

Changing laws, regulations and standardsrelating to corporate governance and public disclosure, including theSarbanes-Oxley Act of 2002, new SEC regulations, including accelerated SECfiling timelines and new Proxy rules, new NASDAQ Stock Market rules, and newaccounting pronouncements are creating uncertainty and additional complexitiesfor companies such as ours. In particular, the Section 404 internal controlevaluation requirements under the Sarbanes-Oxley Act have added and willcontinue to add complexity and costs to our business and require a significant investmentof our time and resources to complete each year. We take these requirementsseriously and expect to continue to make every effort to ensure that we receiveclean attestations on our internal controls each year from our outsideauditors. To maintain high standards of corporate governance and publicdisclosure, we intend to invest all reasonably necessary resources to complywith all other evolving standards. These investments may result in increasedgeneral and administrative expenses and a diversion of management time andattention from strategic revenue generating and cost management activities.

 

**We aredependent on air transport to conduct our business and disruption of domesticand international air transport systems could adversely affect our business.**

 

Wedepend on regular and reliable air transportation on a worldwide basis for manyof our routine business functions. If civil aviation in the U.S. or abroad isdisrupted by terrorist activities or security responses to the threat ofterrorism or for any other reason, our business could be adversely affected inthe following ways:

 

•                  supplies of raw materials and components for themanufacture of our products or our customers’ products may be disrupted;

•                  we may not be able to deliver our products to ourcustomers in a timely manner;

•                  we may not be able to provide timely service ofor support for installed light sources for chipmakers; and

•                  our sales and marketing efforts may be disrupted.

 

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**We areexposed to risks related to the fluctuations in the currency exchange rates forall foreign currencies in which we do business, but particularly for theJapanese yen.**

 

**When wesell products to our Japanese subsidiary, the sale is denominated in U.S. dollars.When our Japanese subsidiary sells our products directly to**customers in Japan, the sale is denominated in Japanese yen.Thus, our results of operations may fluctuate based on the changing value ofthe Japanese yen to the U.S. dollar. We manage the exposure of our Japanesesubsidiary to these fluctuations through forward contracts to hedge thesubsidiary’s purchase commitments. We will continue to monitor our exposure tothese currency fluctuations, and, when appropriate, use hedging transactions tominimize the effect of these currency fluctuations. However, exchange ratefluctuations may still have a material adverse effect on our operating results.In the future, we may need to sell a more significant portion of our productsin foreign currencies other than the Japanese yen and the management of morecurrency fluctuations will be more difficult and expose us to greater risks inthis area.

** **

**Weare subject to many standards and regulations of foreign governments and, eventhough we intend to comply, we may not always be in compliance with theserules, or we may be unable to design or redesign our products to comply withthese 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 products tocomply with foreign standards therefore could have a material adverse effect onour business.**

** **

*** Ourchipmaker customers’ prolonged use of our products in high volume productionmay not produce the results they desire and, as a result, our reputation andthat of our customers who supply photolithography tools to the chipmakers couldbe damaged in the semiconductor industry.**

** **

Overtime, our light source products may not meet chipmakers’ productionspecifications or operating cost requirements after the light source has beenused for 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 chipmakers and lithography toolmanufacturers. This would harm our business.

 

**Ouroperations are subject to environmental and other government regulations thatmay expose us to liabilities for noncompliance.**

 

Weare subject to federal, state and local regulations, such as regulationsrelated to the environment, land use, public utility utilization and the firecode, in connection with the storage, handling, discharge and disposal ofsubstances that we use in our manufacturing process and on our facilities. Webelieve that our activities comply with current government regulations that areapplicable to our operations and current facilities. We may be required topurchase additional capital equipment or other requirements for our processesto comply with these government regulations in the future if they change.Further, these government regulations may restrict us from expanding ouroperations. Adopting measures to comply with changes in the governmentregulations, our failure to comply with environmental and land use regulations,or restrictions on our ability to discharge hazardous substances, could subjectus to future liability or cause our manufacturing operations to be reduced orstopped.

 

**Ourproducts are subject to potential product liability claims if personal injuryor death results from their use.**

** **

Weare exposed to significant risks for product liability claims if personalinjury or death results from the use of our products. We may experiencematerial product liability losses in the future. We maintain insurance againstproduct liability claims. However, our insurance coverage may not continue to

 

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beavailable on terms that we accept. This insurance coverage also may notadequately cover liabilities that we incur. Further, if our products aredefective, we may be required to recall or redesign these products. Asuccessful claim against us that exceeds our insurance coverage level, or anyclaim or product recall that results in adverse publicity against us, couldhave a material adverse effect on our business, financial condition and resultsof operations.

 

**Trademarkinfringement claims against our registered and unregistered trademarks would beexpensive and we may have to stop using such trademarks and pay damages.**

 

Weregistered the trademarks “CYMER” and “INSIST ON CYMER” and others in the U.S.and in some other countries. We are also trying to register additionaltrademarks in the U.S. and in other countries. We use these trademarks and manyother marks in our advertisements and other business materials, which aredistributed throughout the world. We may be subject to trademark infringementactions for using these marks and other marks on a worldwide basis which wouldbe costly to defend. If a trademark infringement action were successful, wewould have to stop using one or more of the marks and possibly pay damages.

 

**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 of the semiconductorindustry;

•                  actual or anticipated fluctuations in ouroperating results, including our net income, product gross margins and freecash flow;

•                  conditions and trends in the light source deviceand other technology industries;

•                  announcements of innovations in technology;

•                  new products offered by us or our competitor;

•                  developments of patents or proprietary rights;

•                  changes in financial estimates by securitiesanalysts;

•                  general worldwide political, economic, and marketconditions;

•                  U.S. political, economic, and market conditions;and

•                  failure to properly manage any single orcombination 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. Anysuch litigation can result in substantial costs and a diversion of management’sattention and resources and therefore could have a material adverse effect onour business, financial condition and results of operations.**

** **

**ITEM2.**  Unregistered Sales of Equity Securitiesand Use of Proceeds

** **

(a)          Not applicable

 

(b)         Not applicable

 

(c)          On April 24,2007, we announced that our board of directors authorized us to repurchase upto $300 million of our common stock. The purchases have been made from time totime in the open market or in privately negotiated transactions. The programdoes not have a fixed expiration date and may be discontinued at any time.

 

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The following tableprovides information with respect to the shares of common stock repurchased byus during the three months ended September 30, 2007:

 
| **Period**                               | ** ** | **Total number of  shares  purchased** | ** ** | **Average price  paid per share** | ** ** | **Total number of  shares  purchased as  part of publicly  announced plans  or programs** | ** ** | **Approximate dollar  value of shares that  may yet be  purchased under the  plans or programs** | ** ** |
|------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                     |       |                                             |       |                                             |       |                                                                                                                         |       |                                                                                                                                               |       |
| July 1, 2007 to  July 31, 2007           |       | 1,579,100                                        |       | $                                                | 39.23      |                                                                                                                         | 1,579,100  |                                                                                                                                               | $          | 66.3 Million |   |
| August 1, 2007  to August 31, 2007       |       | 1,448,600                                        |       | $                                                | 37.43      |                                                                                                                         | 1,448,600  |                                                                                                                                               | $          | 12 Million |   |
| September 1,  2007 to September 30, 2007 |       | —                                           |       | —                                           |       | —                                                                                                                       |       | $                                                                                                                                                  | 12 Million |   |
| Total                                    |       | 3,027,700                                        |       | $                                                | 38.37      |                                                                                                                         | 3,027,700  |                                                                                                                                               |       |   |

 

# **ITEM3.**     Defaults Upon Senior Securities

# ** **

# **None.**

# ** **

# **ITEM 4.**  Submissionof Matters to a Vote of Security Holders

# ** **

None.

 

**ITEM 5.****     Other Information**

 

(a)          None.

 

(b)         There were no materialchanges to the procedures by which security holders may recommend nominees toour board of directors.

 

# **ITEM 6.**  Exhibits

# ** **

3.1       Amendedand restated Bylaws of Cymer (incorporated herein by reference to Exhibit 3.1to Cymer’s Current Report on Form 8-K filed on August 17, 2007).

 

31.1     Certificationof Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act.

 

31.2     Certificationof Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act.

 

32.1     Certificationof Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act.

 

32.2     Certificationof Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act.

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this Quarterly Report on Form 10-Q to be signed on its behalf by theundersigned thereunto duly authorized.

 

 
|                   | CYMER, INC.                   |
|------------------------|-------------------------------|
|                   |                          |
|                   |                          |
| Date: November 7, 2007 | 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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