**UNITED STATES SECURITIES ANDEXCHANGE COMMISSIONWASHINGTON, D.C.  20549**

**FORM 10-Q**
| **x**      | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                                        |
|------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                          |
| ** ** | ** ** | **For the  Quarterly Period Ended June 30, 2007**                                                                                                                                                                                                                                                                   |
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                          |
| ** ** | ** ** | **OR**                                                                                                                                                                                                                                                                                                              |
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                          |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE EXCHANGE ACT OF 1934**                                                                                                                                                                                                                                  |
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                          |
| ** ** | ** ** | **For the  Transition Period from                          to                        ** |

 

**Commissionfile 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, ifchanged since last report).

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for the past90 days.  xYes    oNo

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer.  Seedefinition of “accelerated filer” and “large accelerated filer” in Rule 12b-2of the Exchange Act.  (Check one):

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

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). o Yes  x No

The total number of shares of Common Stock, with $0.001 par value,outstanding on August 3, 2007 was 31,953,748.

 

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**CYMER,INC.**

**FORM 10-Q**

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

**INDEX**
| **PART I.**    |       | **FINANCIAL INFORMATION**                                                                         |   |   |
|----------------|------------|---------------------------------------------------------------------------------------------------|--------|--------|
|           |       |                                                                                              |   |   |
| ITEM 1.        |       | Financial  Statements (unaudited)                                                                 |   |   |
|           |       |                                                                                              |   |   |
|           |       | Consolidated  Balance Sheets as of December 31, 2006 and June 30, 2007                            |   |   |
|           |       |                                                                                              |   |   |
|           |       | Consolidated  Statements of Operations for the three and six months ended June 30, 2006 and  2007 |   |   |
|           |       |                                                                                              |   |   |
|           |       | Consolidated  Statements of Cash Flows for the six months ended June 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** |       |                                                                                              |

 

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**ITEM 1. Financial Statements**

**CYMER, INC.**

**CONSOLIDATED BALANCE SHEETS (UNAUDITED)**

**(In thousands, except share data)**
| ** **                                                                                                                                                                         | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                                                                                                                                         | ** ** | **2006**              | ** ** | **2007**          | ** ** |
| **ASSETS**                                                                                                                                                                         | ** ** | ** **            | ** ** | ** **        | ** ** |
|                                                                                                                                                                               |       |                  |       |              |       |
| CURRENT ASSETS:                                                                                                                                                                    |       |                  |       |              |       |
| Cash and cash  equivalents                                                                                                                                                         |       | $                     | 302,098    |              | $          | 330,608 |   |
| Short-term  investments                                                                                                                                                            |       | 207,943               |       | 42,026            |       |
| Accounts  receivable - net                                                                                                                                                         |       | 115,857               |       | 105,885           |       |
| Accounts  receivable - related party                                                                                                                                               |       | 834                   |       | 1,194             |       |
| Foreign currency  forward exchange contracts                                                                                                                                       |       | 652                   |       | 1,039             |       |
| Inventories                                                                                                                                                                        |       | 104,296               |       | 121,284           |       |
| Deferred income  taxes                                                                                                                                                             |       | 46,943                |       | 38,988            |       |
| Income taxes  receivable                                                                                                                                                           |       | —                |       | 6,525             |       |
| Prepaid expenses  and other assets                                                                                                                                                 |       | 7,143                 |       | 8,583             |       |
| Total current  assets                                                                                                                                                              |       | 785,766               |       | 656,132           |       |
|                                                                                                                                                                               |       |                  |       |              |       |
| PROPERTY AND EQUIPMENT  - NET                                                                                                                                                      |       | 112,074               |       | 108,582           |       |
| LONG-TERM INVESTMENTS                                                                                                                                                              |       | 8,384                 |       | 24,123            |       |
| DEFERRED INCOME TAXES                                                                                                                                                              |       | 12,766                |       | 12,779            |       |
| GOODWILL                                                                                                                                                                           |       | 8,833                 |       | 8,833             |       |
| INTANGIBLE ASSETS - NET                                                                                                                                                            |       | 15,880                |       | 14,478            |       |
| OTHER ASSETS                                                                                                                                                                       |       | 5,391                 |       | 5,415             |       |
| TOTAL ASSETS                                                                                                                                                                       |       | $                     | 949,094    |              | $          | 830,342 |   |
|                                                                                                                                                                               |       |                  |       |              |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                     |       |                  |       |              |       |
|                                                                                                                                                                               |       |                  |       |              |       |
| CURRENT LIABILITIES:                                                                                                                                                               |       |                  |       |              |       |
| Accounts payable                                                                                                                                                                   |       | $                     | 18,711     |              | $          | 14,901 |   |
| Accounts payable  - related party                                                                                                                                                  |       | 4,858                 |       | 1,442             |       |
| Accrued warranty  and installation                                                                                                                                                 |       | 29,974                |       | 29,411            |       |
| Accrued payroll  and benefits                                                                                                                                                      |       | 21,707                |       | 17,328            |       |
| Accrued patents,  royalties and other fees                                                                                                                                         |       | 4,262                 |       | 3,661             |       |
| Income taxes  payable                                                                                                                                                              |       | 13,293                |       | —            |       |
| Unearned income                                                                                                                                                                    |       | 2,544                 |       | 2,912             |       |
| Other current  liabilities                                                                                                                                                         |       | 3,715                 |       | 4,356             |       |
| Total current  liabilities                                                                                                                                                         |       | 99,064                |       | 74,011            |       |
|                                                                                                                                                                               |       |                  |       |              |       |
| CONVERTIBLE  SUBORDINATED NOTES                                                                                                                                                    |       | 140,722               |       | 140,722           |       |
| INCOME TAXES PAYABLE                                                                                                                                                               |       | —                |       | 15,085            |       |
| OTHER LIABILITIES                                                                                                                                                                  |       | 14,781                |       | 15,671            |       |
| Total  liabilities                                                                                                                                                                 |       | 254,567               |       | 245,489           |       |
| MINORITY INTEREST                                                                                                                                                                  |       | 6,633                 |       | 5,020             |       |
|                                                                                                                                                                               |       |                  |       |              |       |
| COMMITMENTS AND  CONTINGENCIES                                                                                                                                                     |       |                  |       |              |       |
|                                                                                                                                                                               |       |                  |       |              |       |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                         |       |                  |       |              |       |
| Preferred stock  - $.001 par value; authorized 5,000,000 shares; no shares issued or  outstanding                                                                                  |       | —                |       | —            |       |
| Common stock -  $.001 par value per share; 100,000,000 shares authorized; 41,774,000 and  42,218,000 shares outstanding at December 31, 2006  and June 30, 2007, respectively |       | 42                    |       | 42                |       |
| Additional  paid-in capital                                                                                                                                                        |       | 557,082               |       | 573,955           |       |
| Treasury stock  at cost - 4,536,000 and 8,702,000 common shares at December 31, 2006 and June  30, 2007, respectively                                                              |       | (150,704              | )          | (322,428          | )          |
| Accumulated  other comprehensive loss                                                                                                                                              |       | (4,066                | )          | (2,889            | )          |
| Retained  earnings                                                                                                                                                                 |       | 285,540               |       | 331,153           |       |
| Total  stockholders’ equity                                                                                                                                                   |       | 687,894               |       | 579,833           |       |
| TOTAL LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                   |       | $                     | 949,094    |              | $          | 830,342 |   |

 

See Notes to UnauditedConsolidated Financial Statements.

3

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**CYMER, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)**

**(In thousands, except per share data)**
| ** **                                                                | ** ** | **For the three months** | ** ** | **For the six months** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                | ** ** | **ended June 30,**            | ** ** | **ended June 30,**          | ** ** |
| ** **                                                                | ** ** | **2006**                                | ** ** | **2007**                              | ** ** | **2006** | ** ** | **2007** | ** ** |
| REVENUES:                                                                 |       |                                    |       |                                  |       |   |   |   |   |
| Product sales                                                             |       | $                                       | 132,081    |                                  | $          | 121,695 |   | $ | 256,983 |   | $ | 247,854 |   |
| Product sales -  related party                                            |       | 3,209                                   |       | 870                                   |       | 5,363 |   | 1,336 |   |
| Other                                                                     |       | 89                                      |       | 370                                   |       | 150 |   | 459 |   |
| Total revenues                                                            |       | 135,379                                 |       | 122,935                               |       | 262,496 |   | 249,649 |   |
|                                                                      |       |                                    |       |                                  |       |   |   |   |   |
| COSTS AND EXPENSES:                                                       |       |                                    |       |                                  |       |   |   |   |   |
| Cost of product  sales                                                    |       | 70,556                                  |       | 56,719                                |       | 139,247 |   | 121,785 |   |
| Research and  development                                                 |       | 18,803                                  |       | 20,091                                |       | 36,927 |   | 39,393 |   |
| Sales and  marketing                                                      |       | 7,367                                   |       | 5,781                                 |       | 14,216 |   | 12,750 |   |
| General and  administrative                                               |       | 9,630                                   |       | 9,729                                 |       | 18,810 |   | 18,539 |   |
| Total costs and  expenses                                                 |       | 106,356                                 |       | 92,320                                |       | 209,200 |   | 192,467 |   |
| OPERATING INCOME                                                          |       | 29,023                                  |       | 30,615                                |       | 53,296 |   | 57,182 |   |
|                                                                      |       |                                    |       |                                  |       |   |   |   |   |
| OTHER INCOME (EXPENSE):                                                   |       |                                    |       |                                  |       |   |   |   |   |
| Foreign currency  exchange gain - net                                     |       | 480                                     |       | 2                                     |       | 1,099 |   | 429 |   |
| Interest and  other income                                                |       | 5,493                                   |       | 5,806                                 |       | 12,479 |   | 12,223 |   |
| Interest and  other expense                                               |       | (1,505                                  | )          | (1,524                                | )          | (2,907 | ) | (3,103 | ) |
| Total other  income - net                                                 |       | 4,468                                   |       | 4,284                                 |       | 10,671 |   | 9,549 |   |
|                                                                      |       |                                    |       |                                  |       |   |   |   |   |
| INCOME BEFORE INCOME  TAX PROVISION AND MINORITY INTEREST                 |       | 33,491                                  |       | 34,899                                |       | 63,967 |   | 66,731 |   |
| INCOME TAX PROVISION                                                      |       | 11,579                                  |       | 10,862                                |       | 22,133 |   | 23,089 |   |
| MINORITY INTEREST                                                         |       | 690                                     |       | 897                                   |       | 1,371 |   | 1,613 |   |
| NET INCOME                                                                |       | $                                       | 22,602     |                                  | $          | 24,934 |   | $ | 43,205 |   | $ | 45,255 |   |
|                                                                      |       |                                    |       |                                  |       |   |   |   |   |
| EARNINGS PER SHARE:                                                       |       |                                    |       |                                  |       |   |   |   |   |
| Basic earnings per  share                                                 |       | $                                       | 0.58       |                                  | $          | 0.71 |   | $ | 1.13 |   | $ | 1.25 |   |
| Weighted average  common shares outstanding                               |       | 38,992                                  |       | 35,121                                |       | 38,084 |   | 36,189 |   |
|                                                                      |       |                                    |       |                                  |       |   |   |   |   |
| Diluted earnings per  share                                               |       | $                                       | 0.55       |                                  | $          | 0.67 |   | $ | 1.07 |   | $ | 1.19 |   |
| Weighted average common  and dilutive potential common shares outstanding |       | 42,708                                  |       | 38,423                                |       | 41,892 |   | 39,512 |   |

 

See Notes to Unaudited Consolidated Financial Statements.

4

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**CYMER, INC.**

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

**(In thousands)**
| ** **                                                    | ** ** | **For the six months ended** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                    | ** ** | **June 30,**                                | ** ** |
| ** **                                                    | ** ** | **2006**                                         | ** ** | **2007** | ** ** |
|                                                          |       |                                             |       |   |   |
| OPERATING ACTIVITIES:                                         |       |                                             |       |   |   |
| Net income                                                    |       | $                                                | 43,205     |   | $ | 45,255 |   |
| Adjustments to  reconcile net income to net cash              |       |                                             |       |   |   |
| provided by  operating activities:                            |       |                                             |       |   |   |
| Depreciation and  amortization                                |       | 12,727                                           |       | 12,706 |   |
| Non-cash  stock-based compensation                            |       | 4,958                                            |       | 3,044 |   |
| Minority  interest                                            |       | (1,371                                           | )          | (1,613 | ) |
| Provision for  deferred income taxes                          |       | 8,883                                            |       | 13,102 |   |
| Loss on disposal  and impairment of property and equipment    |       | 6                                                |       | 298 |   |
| Change in assets  and liabilities:                            |       |                                             |       |   |   |
| Accounts receivable  – net                               |       | (25,091                                          | )          | 9,972 |   |
| Accounts  receivable – related party                     |       | (2,922                                           | )          | (360 | ) |
| Income taxes  receivable                                      |       | (3,028                                           | )          | (6,525 | ) |
| Foreign currency  forward exchange contracts                  |       | 1,556                                            |       | (442 | ) |
| Inventories                                                   |       | (24,059                                          | )          | (16,988 | ) |
| Prepaid expenses  and other assets                            |       | (551                                             | )          | (1,854 | ) |
| Accounts payable                                              |       | 2,225                                            |       | (3,810 | ) |
| Accounts payable  - related party                             |       | (366                                             | )          | (3,416 | ) |
| Accrued expenses  and other liabilities                       |       | 7,572                                            |       | (4,084 | ) |
| Unearned income                                               |       | 830                                              |       | 368 |   |
| Income taxes  payable                                         |       | (7,268                                           | )          | (2,983 | ) |
|                                                          |       |                                             |       |   |   |
| Net cash provided  by operating activities                    |       | 17,306                                           |       | 42,670 |   |
|                                                          |       |                                             |       |   |   |
| INVESTING ACTIVITIES:                                         |       |                                             |       |   |   |
| Acquisition of  property and equipment                        |       | (6,478                                           | )          | (7,598 | ) |
| Purchases of  investments                                     |       | (98,271                                          | )          | (44,029 | ) |
| Proceeds from  sold or matured investments                    |       | 61,901                                           |       | 194,369 |   |
| Acquisition of  patents                                       |       | (8,200                                           | )          | (121 | ) |
| Acquisition of  minority interest                             |       | (7,024                                           | )          | — |   |
|                                                          |       |                                             |       |   |   |
| Net cash  provided by (used in) investing activities          |       | (58,072                                          | )          | 142,621 |   |
|                                                          |       |                                             |       |   |   |
| FINANCING ACTIVITIES:                                         |       |                                             |       |   |   |
| Proceeds from  issuance of common stock                       |       | 98,696                                           |       | 12,059 |   |
| Excess tax  benefits from stock option exercises              |       | 17,772                                           |       | 1,770 |   |
| Repurchase of  common stock into treasury                     |       | —                                           |       | (171,724 | ) |
|                                                          |       |                                             |       |   |   |
| Net cash  provided by (used in) financing activities          |       | 116,468                                          |       | (157,895 | ) |
|                                                          |       |                                             |       |   |   |
| EFFECT OF EXCHANGE RATE  CHANGES ON CASH AND CASH EQUIVALENTS |       | 2,694                                            |       | 1,114 |   |
|                                                          |       |                                             |       |   |   |
| NET INCREASE IN CASH  AND CASH EQUIVALENTS                    |       | 78,396                                           |       | 28,510 |   |
| CASH AND CASH  EQUIVALENTS AT BEGINNING OF THE PERIOD         |       | 233,745                                          |       | 302,098 |   |
|                                                          |       |                                             |       |   |   |
| CASH AND CASH  EQUIVALENTS AT END OF THE PERIOD               |       | $                                                | 312,141    |   | $ | 330,608 |   |
|                                                          |       |                                             |       |   |   |
| SUPPLEMENTAL DISCLOSURE  OF CASH FLOW INFORMATION:            |       |                                             |       |   |   |
| Interest paid                                                 |       | $                                                | 2,621      |   | $ | 2,633 |   |
| Income taxes  paid, net                                       |       | $                                                | 4,831      |   | $ | 17,384 |   |

 

See Notes to Unaudited Consolidated Financial Statements.

5

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**CYMER,INC.**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**Three andSix Months Ended June 30, 2007(Unaudited)**

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

***Unaudited Interim Financial Statements***

The accompanyingconsolidated financial information has been prepared by Cymer, Inc., and itswholly-owned and majority-owned subsidiaries (collectively, “Cymer”), withoutaudit, in accordance with the instructions to Form 10-Q and Article 10 ofRegulation 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. Theseunaudited consolidated 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 or forthe 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. (“Cymer Japan”),Cymer Singapore Pte Ltd. (“Cymer Singapore”), Cymer B.V. in the Netherlands (“CymerB.V.”), Cymer Southeast Asia, Ltd, in Taiwan (“Cymer SEA”), Cymer SemiconductorEquipment Shanghai Co., Ltd, in the People’s Republic of China (“Cymer PRC”),Cymer Korea, Inc. (“Cymer Korea”), and our majority-owned subsidiary, TCZ PteLtd., a company incorporated in Singapore (“TCZ Singapore”), of which we own60%. All significant intercompany balances and transactions have beeneliminated in consolidation.

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

**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 the Incentive Planexpire ten years after the options are granted and generally vest and becomeexercisable ratably over a four-year period following the date of grant. Stockunits issued under the Incentive Plan generally vest one to four years from thedate granted.

Atour annual meeting of stockholders held on May 17, 2007, our stockholdersapproved the amendment and restatement of our 2005 Equity Incentive Plan toincrease the number of shares of common stock authorized for issuance from atotal of 1,000,000 shares to a total of 2,000,000 shares and to also expand thetype and nature of the awards available for grant under the Incentive Plan toinclude cash awards that qualify as “performance-based compensation”.

6

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*2007Long-Term Incentive Plan*– On April 16, 2007, thecompensation committee of our board of directors adopted the Long-TermIncentive Bonus Plan (“LTIP”) for 2007. Per the provisions of the plan, anybonuses accrued for performance in 2007 will be paid 50% in cash and 50% in theform of restricted stock unit awards under our Incentive Plan. The number ofshares subject to the target restricted stock unit awards for 2007 will bedetermined by dividing the cash value of the award by $44.57, the closing priceof our common stock as reported on the Nasdaq Global 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 certain financial and performancecriteria as set forth in our 2007 LTIP are met. The purpose of these awards isto attract and retain key employees and executive officers and to provide anincentive to achieve certain financial and individual corporate objectives byour key employees and executive officers. These restricted stock unit awardswill vest only if specific goals are achieved as outlined in our 2007 LTIP. Therestricted stock unit award portion of the LTIP will vest in three equal annualinstallments beginning January 1, 2009 after it is determined that the requiredservice and performance condition has been achieved for 2007.

We value the stockunit awards which are issued to our non-employee directors and key employeesusing an intrinsic calculation based on the price of our stock on the date thatthe stock unit award is granted.  Compensationexpense related to these stock unit awards is recognized straight line over theservice period.  For those stock unitawards that have performance-based conditions, such as those granted under ourLTIP Plan, we adjust the compensation expense over the service period basedupon the expected achievement of the performance conditions. The fair value ofstock-based options granted, less expected forfeitures, is recognized toexpense over the requisite service period.

*Share-BasedCompensation*– The components of share-based compensation expensefor employees, non-employee directors and non-employees for the three and sixmonths ended June 30, 2006 and 2007 are as follows (in thousands):
|                                                    | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|----------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                         | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                         | ** ** | **2006**                         | ** ** | **2007**                       | ** ** | **2006** | ** ** | **2007** | ** ** |
| Stock Options -  employees                         |       | $                                | 2,209      |                           | $          | 1,072 |   | $ | 4,490 |   | $ | 2,230 |   |
| Stock Options -  non-employees or change in status |       | 55                               |       | 87                             |       | 147 |   | 109 |   |
| Restricted stock  unit awards - employees          |       | —                           |       | 354                            |       | — |   | 354 |   |
| Restricted stock  units - non-employee directors   |       | 175                              |       | 175                            |       | 321 |   | 351 |   |
| Total Share-Based  Compensation                    |       | $                                | 2,439      |                           | $          | 1,688 |   | $ | 4,958 |   | $ | 3,044 |   |

 

 

The actual taxbenefit realized for share-based compensation for the six months ended June 30,2006 and 2007 totaled approximately $17.8 million and $1.8 million, respectively.

*StockRepurchase Program* -* *On April24, 2007, we announced that our board of directors had authorized us torepurchase up to $300 million of our common stock in the open market or inprivately negotiated transactions. The program may be discontinued at any time.Through June 30, 2007, we had purchased 4,166,300 shares for $171.7million under this program.

**3.****             ****EARNINGS PER SHARE**

*Earnings Per Share* — Basicearnings per share (“EPS”) excludes dilution and is computed by dividing netincome or loss attributable to common stockholders by the weighted-average ofcommon shares outstanding for the period.  Diluted EPS reflects thepotential dilution that could occur if securities or other contracts to issuecommon stock (convertible subordinated notes using the “if-converted” method,warrants to purchase common stock and common stock options using the treasurystock method) were 

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exercised or converted into common stock. Potential dilutive securities areexcluded from the diluted EPS computation in loss periods as their effect wouldbe anti-dilutive.

Thefollowing table sets forth the reconciliation of net income, diluted netincome, weighted average shares outstanding, diluted weighted average sharesoutstanding and basic and diluted EPS (in thousands, except per shareinformation):
| ** **                                                                       | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                       | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                                       | ** ** | **2006**                         | ** ** | **2007**                       | ** ** | **2006** | ** ** | **2007** | ** ** |
|                                                                             |       |                             |       | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| NET INCOME:                                                                      |       |                             |       |                           |       |   |   |   |   |
| Net income, as reported                                                          |       | $                                | 22,602     |                           | $          | 24,934 |   | $ | 43,205 |   | $ | 45,255 |   |
| Adjustment for interest  expense on convertible subordinated notes, net of taxes |       | 918                              |       | 967                            |       | 1,791 |   | 1,791 |   |
| Net income, diluted  (adjusted for assumed conversion)                           |       | $                                | 23,520     |                           | $          | 25,901 |   | $ | 44,996 |   | $ | 47,046 |   |
|                                                                             |       |                             |       |                           |       |   |   |   |   |
| WEIGHTED AVERAGE  SHARES:                                                        |       |                             |       |                           |       |   |   |   |   |
| Basic weighted  average common shares outstanding                                |       | 38,992                           |       | 35,121                         |       | 38,084 |   | 36,189 |   |
| Effect of  dilutive securities:                                                  |       |                             |       |                           |       |   |   |   |   |
| Warrants                                                                         |       | 32                               |       | —                         |       | 47 |   | — |   |
| Options and  stock units                                                         |       | 870                              |       | 488                            |       | 947 |   | 509 |   |
| Convertible  subordinated notes                                                  |       | 2,814                            |       | 2,814                          |       | 2,814 |   | 2,814 |   |
| Diluted weighted average  common and potential common shares outstanding         |       | 42,708                           |       | 38,423                         |       | 41,892 |   | 39,512 |   |
|                                                                             |       |                             |       |                           |       |   |   |   |   |
| Earnings per share:                                                              |       |                             |       |                           |       |   |   |   |   |
| Basic                                                                            |       | $                                | 0.58       |                           | $          | 0.71 |   | $ | 1.13 |   | $ | 1.25 |   |
| Diluted                                                                          |       | $                                | 0.55       |                           | $          | 0.67 |   | $ | 1.07 |   | $ | 1.19 |   |

 

Forthe three months ended June 30, 2006 and 2007, weighted average options topurchase shares of common stock totaling approximately 354,000 and 780,000shares were not included in the computation of diluted earnings per share astheir effect was anti-dilutive. For the six months ended June 30, 2006 and2007, weighted average options to purchase shares of common stock totalingapproximately 421,000 and 764,000 shares were not included in the computationof diluted earnings per share as their effect was anti-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):
|                  | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|------------------|------------|-----------------------|------------|-------------------|------------|
| ** **       | ** ** | **2006**              | ** ** | **2007**          | ** ** |
| INVENTORIES:     |       |                  |       |              |       |
| Raw materials    |       | $                     | 33,472     |              | $          | 38,159 |   |
| Work-in-progress |       | 19,373                |       | 22,828            |       |
| Finished goods   |       | 51,451                |       | 60,297            |       |
| Total            |       | $                     | 104,296    |              | $          | 121,284 |   |

 

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

Comprehensiveincome includes net income, unrealized gains and losses on effective forwardcontracts, foreign currency translation adjustments, net unrealized pensiongains and losses and unrealized gains and losses on available-for-salesecurities which are recorded as short-term and long-term investments in theaccompanying consolidated balance sheets.

The following are thecomponents of comprehensive income (in thousands):
|                                                                                        | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                             | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                                             | ** ** | **2006**                         | ** ** | **2007**                       | ** ** | **2006** | ** ** | **2007** | ** ** |
|                                                                                   |       |                             |       |                           |       |   |   |   |   |
| Net income                                                                             |       | $                                | 22,602     |                           | $          | 24,934 |   | $ | 43,205 |   | $ | 45,255 |   |
|                                                                                   |       |                             |       |                           |       |   |   |   |   |
| Foreign currency  translation adjustments                                              |       | 17                               |       | 1,141                          |       | 2,692 |   | 1,114 |   |
| Unrealized gain (loss)  on available-for-sale investments, net of tax                  |       | 61                               |       | (59                            | )          | 105 |   | 100 |   |
| Net unrealized gain  (loss) on foreign currency forward exchange contracts, net of tax |       | (28                              | )          | (40                            | )          | 56 |   | (34 | ) |
| Net unrealized pension  loss                                                           |       | —                           |       | (3                             | )          | — |   | (3 | ) |
| Comprehensive income                                                                   |       | $                                | 22,652     |                           | $          | 25,973 |   | $ | 46,058 |   | $ | 46,432 |   |

 

 

The components of accumulated othercomprehensive loss are as follows (in thousands):
|                                                                                    | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                                         | ** ** | **2006**              | ** ** | **2007**          | ** ** |
| Foreign currency  translation adjustments                                          |       | $                     | (3,984     | )                 | $          | (2,870 | ) |
| Unrealized gain  (loss) on available-for-sale investments, net of tax              |       | (92                   | )          | 8                 |       |
| Unrealized gain  (loss) on foreign currency forward exchange contracts, net of tax |       | 17                    |       | (17               | )          |
| Net unrealized  pension loss                                                       |       | (7                    | )          | (10               | )          |
| Accumulated  other comprehensive loss                                              |       | $                     | (4,066     | )                 | $          | (2,889 | ) |

 

**6.****              INCOME TAXES**

We adopted the provisions of Financial AccountingStandard Board (“FASB”) Interpretation No. 48 (“FIN 48”), “Accounting forUncertainty in Income Taxes”, on January 1, 2007. FIN 48 clarifies theaccounting for income taxes by prescribing a minimum probability threshold thata tax position must meet before a financial statement benefit is recognized.The minimum threshold is defined in FIN 48 as a tax position that is morelikely than not to be sustained upon examination by the applicable taxingauthority, including resolution of any related appeals or litigation processes,based on the technical merits of the position.

As of the date of adoption, our gross liability forincome taxes associated with uncertain tax positions 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.  Included in the balanceof unrecognized tax benefits at January 1, 2007 is $10.5 million of taxbenefits that, if recognized, would affect our effective tax rate.  Also included in the balance of unrecognizedtax benefits at January 1, 2007 is $9.1 million of tax benefits that, ifrecognized, would result in adjustments to other tax accounts, primarilydeferred tax assets and long term income taxes receivable.

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We recognize interest and penalties related to uncertaintax positions in income tax expense.  Asof January 1, 2007, we had approximately $640,000 of accrued interest andpenalties related to uncertain tax positions.

We are subject to taxation in the United States and invarious states and foreign jurisdictions. We are currently under Internal Revenue Service (“IRS”) audit for the2003 and 2004 tax years.  Though theestimated completion date of the audit is not known, it is possible that theaudit will be completed within the next twelve months.  The completion of this audit could require amaterial change to our gross unrecognized tax benefits.  However, based on the status of this auditand the protocol for finalizing such audits, it is not possible to estimate theimpact of this audit on previously recorded uncertain tax positions.  In addition, we do not foresee materialchanges to the state or foreign uncertain tax positions within the next twelvemonths.

Our tax years 2003 and forward are subject toexamination by the IRS, our tax years 2000 and forward are subject toexamination by material state jurisdictions, and our tax years 2002 and forwardare subject to examination by material foreign jurisdictions.

**7.****              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 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 manufactureragreements are generally consistent with those prevalent in the semiconductorequipment industry. We record a provision for warranty for all products,which is included in cost of product sales in the consolidated statements ofoperations and is recorded at the time that the related revenue is recognized.The warranty period and terms for light source systems and spares andconsumable parts varies by light source system model.  We review our warranty provision monthly,which is determined using a statistical financial model that calculates actualhistorical expenses, product failure rates, and potential risks associated withour different product models. We then use this financial model to calculate thefuture probable expenses related to warranty and the required level of thewarranty provision. Throughout the year we review the risk levels, historicalcost information and failure rates used within this model and update them asinformation changes over the product’s life cycle. If actual warrantyexpenditures differ substantially from our estimates, revisions to the warrantyprovision would be required. Actual warranty expenditures are recorded againstthe warranty provision as they are incurred.

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The following tablesummarizes information related to our warranty provision (in thousands):
|                                                                                       | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                            | ** ** | **2006**                                        | ** ** | **2007**                                      | ** ** | **2006** | ** ** | **2007** | ** ** |
| Beginning product  warranty balance                                                   |       | $                                               | 31,050     |                                          | $          | 30,200 |   | $ | 30,191 |   | $ | 29,450 |   |
| Liabilities  accrued for warranties issued,  net of  adjustments and expirations |       | 5,121                                           |       | 2,807                                         |       | 11,470 |   | 7,892 |   |
| Warranty  expenditures incurred                                                       |       | (4,786                                          | )          | (4,032                                        | )          | (10,276 | ) | (8,367 | ) |
| Ending product warranty  balance                                                      |       | $                                               | 31,385     |                                          | $          | 28,975 |   | $ | 31,385 |   | $ | 28,975 |   |

 

(b)                                 IntellectualProperty Indemnifications – We include intellectual property indemnificationclauses within our general terms and conditions with our customers and thegeneral purchase agreements with our three lithography tool manufacturers,ASML, Canon, and Nikon. In general, these indemnification provisions providethat we defend our customers against certain infringement claims directedagainst our products.  Under theindemnification clauses, we would pay costs and damages attributable to theinfringement claims, including attorney’s fees, associated with settlements ordefenses in respect of such claims, provided that the lithography toolmanufacturer used the tool in accordance with our recommendations and did notmodify the tool or incorporate technology or features that were not of ourdesign, and provided further that the lithography tool manufacturer followsspecific procedures for notifying us of such claims and allows us to manage thedefense and settlement proceedings.

An indemnificationprovision was included in the contract manufacturing agreement with SeikoInstruments, Inc. (“Seiko”), our former Japanese manufacturing partner, whichwas terminated March 31, 2003.  We continueto honor this indemnification clause within the agreement after the terminationof the contract manufacturing agreement with respect to those productsmanufactured by Seiko while the agreement was in force as with otherindemnification provisions on intellectual property. Seiko and at least oneJapanese lithography tool manufacturer were notified in 1996 that our lightsource systems in Japan may infringe certain Japanese patents.  We believe, based upon the advice of counsel,that our products do not infringe any valid claim of the asserted patents orthat we are entitled to prior use claims in Japan.

As part of theoriginal research and development agreement signed with Intel Corporation (“Intel”)in 2004 and amended in July 2006, we agreed to provide Intel with indemnityagainst any infringement of the intellectual property rights of any third partyarising from Intel’s purchase and/or use of our EUV source systems.  Under the terms of this agreement, asamended, our obligations to indemnify Intel will be specifically negotiated inany purchase agreement related to such future products.

As part of the original supply agreement signed with TCZ in September2005 and amended in September 2006 in connection with the amendment andrestatement of the original TCZ joint venture agreement, we agreed to indemnifyTCZ against any infringement of the intellectual property rights of a thirdparty arising from TCZ’s purchase of our products.  We will defend such actions at our ownexpense and will pay the cost and damage awarded in any such action providedthat TCZ grants us sole control of the defense and settlement of such actionand also provides us with information required for the defense and settlementof such action.

Due to the nature of the indemnification provisions described above,these provisions are indefinite and extend beyond the term of the actualagreements.

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**8.****                   ****RELATED PARTY TRANSACTIONS**

As a result of the formation of our TCZ joint venture in July 2005 andunder the terms of the joint venture agreement which was amended in September2006, Zeiss is a related party. In addition to transactions that occuramong us, Zeiss and TCZ Singapore related to the joint venture, we alsopurchase certain optical parts directly from Zeiss and periodically sell ourlight source system products to Zeiss. Associated with these transactions, werecorded revenue of $3.2 million and $870,000 for the three months ended June30, 2006 and 2007, respectively, and $5.4 million and $1.3 million for the sixmonths ended June 30, 2006 and 2007, respectively.  As of December 31, 2006 and June 30, 2007, wehad accounts receivable balances of $834,000 and $1.2 million, respectively,and accounts payable balances of $4.9 million and $1.4 million, respectively,all of which were associated with these related party transactions with Zeiss.

**9.****              CONTINGENCIES ANDCOMMITMENTS**

We are party to legal actions in the normal course ofbusiness.  Based in part on the advice oflegal counsel, our management does not expect the outcome of legal action inthe normal course of business to have a material impact on our financialposition, liquidity, or results of operations.

Our former Japanese manufacturing partner, Seiko, andone of our Japanese customers were notified in July 1996 that our light sourcesystems in Japan may infringe certain Japanese patents held by another Japanesecompany.  We have agreed to indemnify ourformer Japanese manufacturing partner and our customers against patent infringementclaims under certain circumstances, even after the termination date of thecontract manufacturing agreement.  Webelieve, based upon the advice of counsel, that our products do not infringeany valid claim of the asserted patents or that we are entitled to prior useclaims in Japan.

**10.  SUBSEQUENT EVENT**

Total purchasesunder our $300 million stock repurchase program through August 3, 2007 were $233.7million or 5,745,000 shares of which $171.7 million or 4,166,300 shares wererepurchased through June 30, 2007.  As ofAugust 3, 2007, we have $66.3 million of the original authorization availablefor future purchases of our common stock under this program.

**ITEM2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

*The following discussion of our financial conditionand results of operations should be read in conjunction with our unauditedinterim consolidated financial statements and notes thereto included in “Item1. Financial Statements” of this Quarterly Report on Form 10-Q and the auditedconsolidated financial statements and notes thereto and the section titled “Item7. Managements Discussion and Analysis of Financial Condition and Results ofOperations” in our Annual Report on Form 10-K for the fiscal year ended December31, 2006, filed with the Securities Exchange Commission on February 28, 2007 .*

**Forward-Looking Statements**

Statements in this Quarterly Report on Form 10-Q thatare not strictly historical in nature are forward-looking statements. Thesestatements include, but are not limited to, references to the outlook for thesemiconductor industry and us; expected domestic and international productsales and development; our research and development activities andexpenditures; adequacy of our capital resources and investments; effects ofbusiness cycles in the semiconductor business; our competitive position; andour relationships with customers and third-party manufacturers of our products,and may contain words such as “believes,” “anticipates,” “expects,” “plans,” “intends”and words of similar meaning. These statements are predictions based on currentinformation and our expectations and involve a number of risks and

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uncertainties.The underlying information and our expectations are likely to change overtime.  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 Form10-Q.  Forward-looking statements hereinspeak only as of the date of this Quarterly Report on Form 10-Q.  Unless required by law, we undertake noobligation to update or revise any forward-looking statements to reflect newinformation or future events or developments. Thus, you should not assume that our silence over time means that actualevents are bearing out as expressed or implied in such forward-looking statements.

#### **Overview**

*General*

We are the world’s leading supplier of light source solutions for thesemiconductor industry.  Our products provide the essential light sourcefor deep ultraviolet (“DUV”) photolithography systems.  Almost allconsumer electronic devices manufactured in the last several years contain asemiconductor manufactured using light sources such as ours.  We currentlysupply light sources to each of the three DUV lithography tool manufacturers,ASML, Canon, and Nikon, who in turn supply their wafer steppers and scanners tochipmakers.  In addition, we sell replacement parts and services to thelithography tool manufacturers as well as directly to the chipmakers.  Ourlight source systems currently constitute a substantial majority of all excimerlight sources incorporated in lithography stepper and scanner tools. Ourheadquarters are located in San Diego, California where we develop andmanufacture all of our light source systems and the majority of our replacementparts.  As a large portion of our revenue is derived from customerslocated outside of the U.S., we maintain a replacement parts refurbishmentfacility and field service office in Korea and field service and supportoffices in Japan, the Netherlands, the People’s Republic of China, Singaporeand Taiwan. Japan is currently our only subsidiary office that sells excimerlight source systems. We also maintain field service offices in the U.S. toservice our installed base of light sources located in the U.S.

We are also the majority owner of a joint venturecalled TCZ which is currently headquartered inSingapore.  TCZ is currently developing,and will integrate, market and sell, and support production tools for the flatpanel display manufacturing industry. The joint venture is targeting thegrowing market for low-temperature poly-silicon (“LTPS”) processing used in themanufacture of liquid crystal displays that are brighter, have higherresolution, and consume less power than displays using today’s predominantamorphous silicon films.  Although TCZ’s product is currently in thedevelopment phase, TCZ performed extensive customer demonstrations on its firstgeneration demonstration tool in 2006 and will continue to do so throughout2007.  We currently expect that TCZ willship its first production tool, the TCZ 900X, in 2008.

*Products*

Our productsprimarily consist of photolithography light source systems, replacement parts,and service.

Our excimer lightsources for photolithography produce pulsed light of extremely shortwavelengths within the DUV spectrum.  Thebandwidth of the light is further narrowed through a number of opticaltechniques.  The DUV wavelengths aremeasured in nanometers and the light sources are referred to according toeither the wavelength or the gases that are mixed to produce the light.  Krypton Fluoride (“KrF”) gases produce lightat a 248 nm wavelength, and Argon Fluoride (“ArF”) gases produce light at a 193nm wavelength. The extremely short wavelengths and highly narrowed bandwidthsof light produced by these light sources enable the very fine featureresolution required for patterning or printing the circuitry on silicon wafers.The pulse energy and repetition rate of the light source permit high throughputin wafer processing.  We have designedour light sources to be reliable, easy to install and service and compatiblewith existing semiconductor manufacturing processes.  Our light sources are used to pattern orprint the integrated circuits, which are also called semiconductors or “chips,”that power many of today’s advanced 

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consumer and businesselectronics.  In the second quarter of2007, we sold 49 light source systems at an average selling price of $1.2million.  

Our productdevelopment strategy has been to develop new products in rapid succession to meetcontinually evolving needs in the marketplace, thus rendering our competitors’products obsolete.  This strategystrengthens our market leadership position since the ongoing reduction ofcritical dimension (“CD”) on the wafer drives demand for newer, more advanced,higher value-added light sources.  

Over the years, wehave developed and sold a wide variety of photolithography light sourceproducts.  These products can be dividedinto KrF and ArF product categories and include a number of current products aswell as legacy products that we continue to service in our installed base.  

Certain componentsand subassemblies 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 andusage of our installed base of light sources in production at chipmakersexceeds the original warranty periods, some chipmakers request servicecontracts from us.  Additionally, we provide billable service or servicecontracts directly to the three semiconductor lithography tool manufacturers.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.

#### *Semiconductor Industry Status and Outlook*

Since we derive a substantial portion of our revenuesfrom lithography tool manufacturers, we are subject to the volatile andunpredictable nature of the semiconductor industry. The semiconductor industryis highly cyclical in nature and historically has experienced periodic ups anddowns, many of them quite dramatic. In 2000, the semiconductor equipmentindustry experienced strong growth, which was followed by a severe three yeardownturn from 2001 through late 2003. Since then, industry cycles appear tohave become more muted, and equipment manufacturers have experienced cyclesinvolving relatively short periods of moderate growth, followed by relativelyshort periods when revenue has either flattened or declined moderately.    

More recently,2004 was a growth year for us, 2005 declined moderately and we achieved recordrevenue and net income levels in 2006. Although we initially expected 2007 to be another growth year for us, westarted to see indicators in late 2006 and early 2007 that the growth of thesemiconductor industry was slowing or flattening from the 2006 levels. In thefourth quarter of 2006 and the first quarter of 2007, we experienced delays inour anticipated shipment schedules when we received requests to rescheduleshipment of a number of light sources from each of those quarters intosubsequent quarters.  In the secondquarter of 2007, this trend continued as a number of chipmakers reduced capitalequipment purchases in line with delays in their planned build-outs of newfabs.  As a result of this recent slowingin the semiconductor industry, we have experienced decreases in several of thekey financial metrics that we use to manage our business.  Details on these financial metrics for thefour most recent quarterly periods are included in the table below (inthousands, except for light source system unit shipments and marginpercentages):  

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Cymer, Inc.

10Q Overview Table-Q2-2007
| ** **                      | ** ** | **Quarterly Financial Data** | ** ** |
|---------------------------------|------------|----------------------------------------|------------|
| ** **                      | ** ** | **Three months ended**       | ** ** |
| ** **                      | ** ** | **2006**                               | ** ** | **2007** | ** ** |
| ** **                      | ** ** | **September 30**                  | ** ** | **December 31** | ** ** | **March 31** | ** ** | **June 30 (1)** | ** ** |
|                            |       |                                   |       |   |   |   |   |   |   |
| Light Source  System Units Sold |       | 67                                     |       | 68 |   | 51 |   | 49 |   |
|                            |       |                                   |       |   |   |   |   |   |   |
| Product Sales (2)               |       | $                                      | 143,809    |   | $ | 137,305 |   | $ | 126,625 |   | $ | 122,565 |   |
|                            |       |                                   |       |   |   |   |   |   |   |
| Gross Margin on  Product Sales  |       | 49.59                                  | %          | 49.38 | % | 48.62 | % | 53.72 | % |
|                            |       |                                   |       |   |   |   |   |   |   |
| Operating Income  (1)           |       | $                                      | 34,979     |   | $ | 30,856 |   | $ | 26,567 |   | $ | 30,615 |   |
|                            |       |                                   |       |   |   |   |   |   |   |
| Operating Margin  (1)           |       | 24.30                                  | %          | 22.45 | % | 20.97 | % | 24.90 | % |
|                            |       |                                   |       |   |   |   |   |   |   |
| Net Income                      |       | $                                      | 27,032     |   | $ | 25,411 |   | $ | 20,321 |   | $ | 24,934 |   |
|                            |       |                                   |       |   |   |   |   |   |   |
| Net Margin                      |       | 18.78                                  | %          | 18.49 | % | 16.04 | % | 20.28 | % |

 

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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 grossmargin on product sales and higher operating margin were primarily due tofavorable material reclaim productivity improvements, increasing productreliability realization and lower operating expenses that were achieved duringthe second quarter of 2007.

(2) Consists of light source systems revenue and consumablesand spare parts, upgrades and service revenues and material reclaim andrefurbishment activities.

The outlook for the semiconductor industry is one ofcautious optimism that stronger growth will resume at the end of 2007.  The DRAM segment is still experiencingpricing pressure, but many believe DRAM will be in short supply by the end ofthis year.  In the NAND Flash segment,inventories have decreased and prices improved, with increased quoting activityfor new equipment being reported, driven by concerns about the potentialshortage of Flash due in part to projected demand from products such as Apple Inc.’siPhone.  Further, we anticipate evenstronger growth in 2008 as NAND Flash manufacturers continue to expand theirimmersion capacity and DRAM production reaches the critical dimensionsrequiring immersion.  As the marketleader, we are strongly positioned to benefit from this technology trend.  However, macro-economic factors, such as highenergy prices and interest rates and a slower U.S. housing market, could have anegative impact on consumer spending, including spending on electronicdevices.  Additionally, geopoliticalturmoil can create a heightened sense of uncertainty that can cause consumersto become more cautious in their spending. Either or both of these factors would have a negative effect on thedemand for our products. 

In general, thelonger-term technology and industry trends that affect photolithography arepositive for us.  Chipmakers continue torapidly shrink the CDs on the wafer, which drives ongoing strong demand formore advanced ArF light sources.  To meetthis demand, we shipped 27 of our XLA Series light sources during the secondquarter of 2007, with more than half of these being our XLA 300 and XLA 400products, our most advanced light sources which target high volume immersionproduction.  

To meetanticipated demand for advanced immersion tools for the 45nm production nodeand below, we have developed the XLR 500i, a new light source based on ourproduction proven dual chamber Master Oscillator Power Amplifier (“MOPA”)architecture. This light source replaces the traditional power amplifier with aregenerative ring amplifier, which results in improved stability and controlduring manufacturing, and a significant reduction in cost of operation for thechipmaker.  We shipped the 

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first XLR 500iqualification light source system to one of our lithography tool manufacturingcustomers in April 2007 and expect to ship a second qualification system to oneof our other lithography tool manufacturing customers before the end of thethird quarter of this year.  Weanticipate the adoption ramp for this product will begin in the second half ofthis year, and increase in the first half of 2008.  In addition, we expect that the XLR 500i willbecome the light source of choice for 45nm production. 

As we progress through 2007, we anticipate continuingto focus on better serving our customers, building a better company, andcreating shareholder value. We continue on our path of technology leadershipand innovation, and expect to introduce new, paradigm-shifting light sources inadvance of market needs.  In July 2007,we announced our XLR 600i, the first 90 watt ArF light source designed toenable high volume immersion and double patterning lithography at the 32 nm andbeyond mode.  We have also recentlyachieved some significant breakthroughs in our EUV source development whichsolidify our leadership position in this next generation technology, and weentered into a multi-year EUV supply agreement with ASML for which we havealready received several purchase orders. We will continue our numerous efforts to add even higher levels of valuefor our customers and increase customer satisfaction, while pursuing our manyinitiatives to enhance overall operating efficiencies and improve financialperformance and cash generation.  In thefirst six months of 2007, we generated $42.7 million in cash from operationsand we repurchased approximately 4.2 million shares of our common stock underour $300 million stock repurchase program authorized by our board of directorsin April 2007.  We expect to continuegenerating substantial levels of cash from operations in 2007 and we willcontinue to explore opportunities for the most effective use of our cash. 

#### **Critical Accounting 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 ofAmerica.  The preparation of thesefinancial statements requires us to make estimates and use judgment that mayimpact the reported amounts of assets, liabilities, revenues, expenses, andrelated disclosure of contingent assets and liabilities.  As a part of our ongoing internal processes,we regularly evaluate our estimates and judgments associated with revenuerecognition, valuation of parts used in our refurbishment manufacturingprocess, inventory allowances, warranty provisions, stock-based compensation,income taxes, allowances for bad debts, long-lived assets valuation, intangibleassets valuation, and contingencies and litigation.  We base these estimates and judgments uponhistorical information and other facts and assumptions that we believe to bevalid and/or reasonable under the circumstances. These assumptions and factsform the basis for making judgments and estimates and for determining thecarrying values of our assets and liabilities that are not apparent from othersources.  Actual results could vary fromour estimates if we were to use different assumptions and conditions.

Webelieve that revenue recognition, valuation of parts used in our refurbishmentmanufacturing process, inventory allowances, warranty provisions, stock-basedcompensation, and income taxes require more significant judgments and estimatesin the preparation of our consolidated financial statements than do other ofour accounting estimates and judgments.

*RevenueRecognition*

Our revenuesconsist of product sales, which include sales of light source systems,consumable and spare parts, upgrades, service, service contracts, training, andlimited refurbishments of light source systems. Our revenues also consist of certain funded development activitiesperformed for our customers and under government contracts and licenseagreements.  

The sales of our light source systemsgenerally include training and installation services. We determined theseelements qualify as one unit of accounting under Emerging Issues Task Force (“EITF”)Bulletin No. 00-21, “Revenue Arrangements with Multiple Deliverables” as we donot have evidence of fair 

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value for the undelivered training and installation elements. Furthermore,we determined that the undelivered training and installation elements areperfunctory performance obligations and are not essential to the functionalityof our light source systems. Therefore, in accordance with the provisions ofStaff 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 source system revenue atone of following three points, depending on the terms of our arrangement withour customer – 1) shipment of the light source system, 2) delivery of the lightsource system or 3) receipt of an acceptance certificate. For the majority ofour light source system sales, the shipping terms are F.O.B. shipping point andrevenue is recognized upon shipment. For our arrangements which include F.O.B.destination shipping terms, revenue is recognized upon delivery of the lightsource 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 acceptancecertificate.  In addition, we test ourlight source systems in environments similar to those used by our customersprior to shipment to ensure that they meet published specifications.   

Revenue from consumablesand spare parts sales is recognized at the point that legal title passes to thecustomer, which is upon shipment from our facility.  For a significantportion of our spare parts sales, our customers return the consumed assembly tous as part of the sale of the new part.  We reuse some of the materialwithin these core assemblies, mainly metal components, for the future build ofcore assemblies.  As a result, our revenue consists of both cash and thevalue of the reusable parts received from our customers as consideration forthese spare 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 andtraining revenue is recognized as the services are rendered.  

On a very limited basis,we refurbish light source systems owned by our customers to their original ornew condition.  Revenue from refurbishedlight source systems is recognized when the refurbishment process has beencompleted and, depending upon the customer, the proper delivery or acceptanceterms have been met.

For funded developmentcontracts, funds received are accounted for on the percentage-of-completionmethod based on the relationship of costs incurred to total estimated costs.Revenues generated from these types of funded development contracts areincluded in other revenue, and are derived from cost sharing contracts betweencertain customers and us. If milestones on these funded development contractsrequire that specific results be achieved or reported by us, revenue is notrecognized until that milestone is completed.  

*Accounting for Parts Used in RefurbishmentManufacturing Process*

Over the lastseveral years as part of our regular business activities, we have conductedsignificant parts refurbishment and material reclaim activities related to someof our core assemblies, in particular our chamber assemblies. The volume ofthis activity significantly increased in 2004 and we expect volumes to increaseover time as our installed base of light sources continues to rise and webecome more efficient in these refurbishment activities and developcapabilities to reclaim material from and refurbish other core assemblies.These activities involve arrangements with our customers where we sell a newpart to the customer at a reduced sales price if the customer returns theconsumed assembly that the new part replaces. These returned core assemblies contain a certain amount of material,primarily metal components, that may be reused by us in future coreassemblies.  Upon receipt of theseconsumed core assemblies from our customers, we record an entry to recognizethe estimated fair value of the reusable components either 1) as revenue if thereturn of the core assembly relates to a spare part replacement sale or 2) as areduction in cost of product sales if the return of the core assembly isrelated to a part being replaced under our warranty or per the terms of anactive service contract with our customer. The value of the reusable parts contained within the consumed assemblyis determined based upon historical data on the value of the reusable partsthat we typically yield from a consumed assembly.

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As part of ournormal excess and obsolete inventory analysis, these consumed assemblies arealso reviewed on a monthly basis and an inventory allowance is recorded asappropriate for these parts.  The valuethat we assign to these core assemblies can be affected by the current demandfor the reusable parts in our manufacturing operations and the actual yieldrate achieved for reusable parts contained within these consumed coreassemblies.  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.  

***Inventory Allowance***

We perform ananalysis of our inventory allowances on at least a quarterly basis to determinethe adequacy 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 adjust this calculation for inventorythat has a high likelihood of use beyond one year or can be used in otherproducts that may have lower demands. After this adjustment, we arrive at our total exposure for excess andobsolete inventory within our raw materials and production inventory.  As part of this analysis, we also determinewhether there are potential amounts owed to vendors as a result of cancelled ormodified raw material orders.  Weestimate and record a separate liability, which is included in accrued andother liabilities in the accompanying balance sheets for such amounts owed.  

The inventory allowance totaled $15.1 million and$11.8 million at December 31, 2006 and June 30, 2007, respectively. Thedecrease in the inventory allowance at June 30, 2007 as compared to December31, 2006 was primarily due to certain parts in inventory previously reservedthat were either scrapped or sold during the first half of 2007 as well as areduction in the excess and obsolete requirements for parts contained inconsumed assemblies which are received from our customers and are used in ourrefurbishment activities at June 30, 2007 as compared to December 31,2006.  

The methodologiesused to analyze excess and obsolete inventory and determine the inventoryallowance are significantly affected by future demand and usage of ourproducts. There are many factors that could potentially affect the futuredemand or usage of our products, including the following:

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

·                  Rate at whichour lithography tool manufacturers and chipmaker customers take delivery of ourlight source systems and our consumable and spare parts;

·                  Loss of any ofour three major customers or a significant change in demand from any of thesethree customers;

·                  Overall mix oflight source system models or consumable and spare parts and any changes tothat 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 usageperiods for our inventory are substantially different from our estimates,additional inventory allowances may be required, and may have a materialadverse effect on our financial condition and results of operations.

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###### *Warranty Provision*

We maintain anaccrual for the estimated cost of product warranties associated with ourproduct sales.  Warranty costs includethe replacement parts and labor costs to repair our products during thewarranty periods.  At the time revenue isrecognized, we record a warranty provision, which is included in cost ofproduct sales in the accompanying consolidated statements of operations. Thewarranty coverage period and terms for light source systems and consumable andspare parts varies by 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 used to estimate futureexpenses related to warranty and the required warranty provision.  The risk levels and historical costinformation and failure rates used within this model are reviewed throughoutthe year and updated as these inputs change over the product’s life cycle. Dueto the highly technical nature of our light source system products, the newermodel light sources and the modules contained within them have higher inherentwarranty risks with their initial shipments and require higher warrantyprovisions until the technology becomes more mature.  

The total balancein the warranty provision accrual as of December 31, 2006 and June 30, 2007remained relatively stable at $29.5 million and $29.0 million,respectively.  This slight decrease fromperiod to period is primarily due to a lower number of light source systemsbeing under warranty and lower warranty reserve requirements due to an overallimprovement of the reliability of our light source products from period toperiod. 

We actively engagein product improvement programs and processes to limit our warranty costs, butour warranty 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.  Although we classify thesenewly released light source models as having a higher risk in our warrantymodel resulting in higher warranty provisions, we are more likely to havedifferences between the estimated and actual warranty costs for these newproducts.  This is due to limited or no historicalproduct performance data on which to base our future warranty costs.  Warranty provisions for our older and moreestablished light source models are more predictable as we have more historicalinformation available on these products. If actual product failure rates or estimated costs to repair thoseproduct failures were to differ from our estimates, revisions to our estimatedwarranty provision would be required, which could harm our financial conditionand results of operations.

*Stock-BasedCompensation*

We grant optionsto purchase 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 thisplan are share-based payments subject to the provisions of Statement ofFinancial Accounting Standards No. 123R (“SFAS No. 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 per theprovisions of SFAS No.123R. We attribute the value of share-based compensationto expense using the straight-line method for awards granted after December 31,2005. Compensation expense for awards outstanding and unvested as of December31, 2005 are being recognized over the remaining service period using thecompensation 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 related to stock options andstock units before taxes was $2.4 million and $1.7 million, respectively, forthe three months 

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ended June 30, 2006 and2007, respectively, and $5.0 million and $3.0 million for the six months endedJune 30, 2006 and 2007, respectively.  

We value the stockunit awards which are issued to our non-employee directors and key employeesusing the 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 unitawards that have performance based conditions, we adjust the compensationexpense over the service period based upon the expected achievement of theperformance condition.

We value the stockoption awards using the Black-Scholes option pricing model. The determinationof fair value of stock-based payment awards on the date of grant is affected byour stock price as well as assumptions regarding a number of complex andsubjective variables. These assumptions include the expected term of stockoptions and our expected stock price volatility over the expected term of theawards. 

We determine ourexpected volatility by using a combination of historical and impliedvolatility, or blended volatility, to derive our expected volatility assumptionas allowed under SFAS No. 123R and Staff Accounting Bulletin No. 107. Impliedvolatility is based on our six-month traded options on our common stock. Wedetermined that the volatility calculated using a blend of implied volatilityand our historical volatility is more reflective of expected volatility thanusing only historical volatility.  Theexpected term of stock options represents the weighted-average period the stockoptions are expected to remain outstanding. We determine the expected term ofour stock options based on observed historical exercise patterns for ourcompany, which we believe are indicative of 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 rateassumption is based upon the most current available rates on zero coupon U.S.Government issues for the expected term of our stock options. The expecteddividend rate is not applicable to us as we have not historically declared orpaid dividends, nor do we anticipate paying cash 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 thisestimate in the past and will revise this estimate, as necessary, in subsequentperiods if actual forfeiture rates differ from our current estimates. 

If we change anyof the key assumptions that we use in the Black-Scholes option pricing modelsuch as expected 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.  

*IncomeTaxes*

Weaccount for income taxes in accordance with Statement of Financial AccountingStandards No. 109 (“SFAS No. 109”), “Accounting for Income Taxes.”  Pursuant to SFAS No. 109, a deferred taxasset or liability is generally recognized for the estimated future tax effectsattributable to temporary differences, net operating loss (“NOL”) carryforwardsand tax credit carryforwards.  Deferredtax assets are to be reduced by a valuation allowance if, based on the weightof available evidence, it is more likely than not that some portion or all ofthe deferred tax assets will not be realized within the carryback orcarryforward periods.  Information aboutan enterprise’s current financial position and its results of operations forthe current and preceding years, as well as all currently available informationabout future years should be considered. 

We have considered our industry’s outlookfor the future, our historical performance and estimated future taxable income,and ongoing tax planning strategies in assessing the need for a valuationallowance.  Using this information, wehave prepared a model to forecast our expected taxable income in 

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futureyears and to estimate when the benefits of our deferred tax assets are likelyto be realized.  Based upon the analysis,with the exceptions noted below, we believe that it is more likely than notthat the results of future operations will generate sufficient taxable incometo realize all of our deferred tax assets within the period covered by ourmodel and, as such, no valuation allowance has been provided against thesedeferred tax assets.  However, avaluation allowance has been provided against certain deferred tax assetsrelated to TCZ’s business and our French branch operations in the total amountof $1.3 million, as these businesses have not yet developed sufficiently toallow us to assert that these assets will ultimately be realized.

A material adverse change in the outlookfor worldwide lithography tool sales, the expected selling prices or profitmargins for our products or our expected share of the global market forlithography light sources, could cause us to determine that additionalvaluation allowances are needed for some or all of our deferred tax assets, andwould result in an increase to our income tax provision in the period in whichsuch determination is made.

It is our intention to reinvestundistributed earnings of our foreign subsidiaries and thereby indefinitelypostpone their remittance, with the exception of our TCZ joint venture.  Accordingly, we have not provided U.S.federal income and foreign withholding taxes on $62.7 million of undistributedearnings from non-U.S. operations as of June 30, 2007.  It is not practicable to estimate the amountof the deferred tax liability on such unremitted earnings. 

**RESULTSOF OPERATIONS**

Thefollowing table sets forth certain items in our consolidated statements ofoperations as a percentage of total revenues for the periods indicated:
|                                                           | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                | ** ** | **2006**                         | ** ** | **2007**                       | ** ** | **2006** | ** ** | **2007** | ** ** |
| Revenues:                                                 |       |                             |       |                           |       |   |   |   |   |
| Product sales                                             |       | 97.5                             | %          | 99.0                           | %          | 97.9 | % | 99.3 | % |
| Product sales - related party                             |       | 2.4                              |       | 0.7                            |       | 2.0 |   | 0.5 |   |
| Other                                                     |       | 0.1                              |       | 0.3                            |       | 0.1 |   | 0.2 |   |
| Total revenues                                            |       | 100.0                            | %          | 100.0                          | %          | 100.0 | % | 100.0 | % |
|                                                      |       |                             |       |                           |       |   |   |   |   |
| Cost and  expenses:                                       |       |                             |       |                           |       |   |   |   |   |
| Cost of product sales                                     |       | 52.1                             |       | 46.1                           |       | 53.0 |   | 48.8 |   |
| Research and development                                  |       | 13.9                             |       | 16.3                           |       | 14.1 |   | 15.8 |   |
| Sales and marketing                                       |       | 5.5                              |       | 4.7                            |       | 5.4 |   | 5.1 |   |
| General and administrative                                |       | 7.1                              |       | 7.9                            |       | 7.2 |   | 7.4 |   |
| Total costs and expenses                                  |       | 78.6                             |       | 75.0                           |       | 79.7 |   | 77.1 |   |
|                                                      |       |                             |       |                           |       |   |   |   |   |
| Operating income                                          |       | 21.4                             |       | 25.0                           |       | 20.3 |   | 22.9 |   |
| Total other  income - net                                 |       | 3.3                              |       | 3.4                            |       | 4.1 |   | 3.8 |   |
| Income before  income tax provision and minority interest |       | 24.7                             |       | 28.4                           |       | 24.4 |   | 26.7 |   |
| Income tax  provision                                     |       | 8.5                              |       | 8.8                            |       | 8.4 |   | 9.3 |   |
| Minority  interest                                        |       | 0.5                              |       | 0.7                            |       | 0.5 |   | 0.7 |   |
| Net income                                                |       | 16.7                             | %          | 20.3                           | %          | 16.5 | % | 18.1 | % |
| Gross margin on product  sales                            |       | 47.9                             | %          | 53.7                           | %          | 46.9 | % | 51.1 | % |

 

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

*Revenues*. Thefollowing table summarizes certain measures and the components of our revenue (in thousands,except units sold):
|                                                  | ** ** | **For the three months ended** | ** ** |
|--------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                       | ** ** | **June 30,**                                  | ** ** |
| ** **                                       | ** ** | **2006**                                           | ** ** | **2007** | ** ** |
| Light source  systems:                           |       |                                               |       |   |   |
| Revenue                                          |       | $                                                  | 72,629     |   | $ | 58,039 |   |
| Units sold                                       |       | 75                                                 |       | 49 |   |
| Average selling price                            |       | $                                                  | 968        |   | $ | 1,184 |   |
|                                             |       |                                               |       |   |   |
| Consumable and  spare parts and service products |       | $                                                  | 62,661     |   | $ | 64,526 |   |
| Other revenue                                    |       | $                                                  | 89         |   | $ | 370 |   |
|                                             |       |                                               |       |   |   |
| Total revenue                                    |       | $                                                  | 135,379    |   | $ | 122,935 |   |

 

Product sales decreased 9% from $135.3****millionfor the three months ended June 30, 2006 to $122.6 million for the three monthsended June 30, 2007.  This decrease inproduct sales was due to a decline in light source system sales which waspartially offset by an increase in consumable and spare parts and serviceproduct sales for the three months ended June 30, 2007 as compared to the threemonths ended June 30, 2006.  Light sourcesystem revenues decreased 20% from $72.6 million for the three months endedJune 30, 2006 to $58.0 million for the three months ended June 30, 2007.  A total of 75 light source systems were soldin the three months ended June 30, 2006 at an average selling price of$968,000, compared to 49 light source systems sold in the three months endedJune 30, 2007 at an average selling price of $1.2 million.  On a foreign currency adjusted basis, the averageselling price for the three months ended June 30, 2006 and 2007 was $958,000and $1.2 million, respectively. The increase in the average selling price fromperiod to period is due to the product mix being more weighted toward our newerArF light source systems. ArF light source systems represented 76% of lightsource systems revenue for the three months ended June 30, 2007 as compared toonly 64% for the three months ended June 30, 2006. The decrease in quantitiesof light source systems sold from period to period was due to the slowing and flatteningof the semiconductor industry in the first half of 2007 as compared to the 2006levels.

Growth in the installed base and steady utilization of our light sourcesystems has generated demand for consumables and spare parts and serviceproducts. The increase in this demand resulted in an increase in consumablesand spare parts and service product revenue of 3% from $62.7 million for thethree months ended June 30, 2006 to $64.5 million for the three months endedJune 30, 2007.  Revenues from funded developmentcontracts were $89,000 and $370,000 for three months ended June 30, 2006 and2007, respectively. There were no revenues recorded or earned associated withthe TCZ joint venture for the three months ended June 30, 2006 or 2007.

For the period ended June 30, 2007, our backlog totaled $91.9 millionand total bookings were $131.5 million which yielded a book-to-bill ratio of1.07 compared to the period ended June 30, 2006, where our backlog was $92.2million and total bookings were $128.3 million yielding a book-to-bill ratio of0.95.  The increase in bookings and bookto bill ratio primarily reflects the strength of demand for our most advancedArF immersion products and their corresponding higher selling prices.

We installed 80 light sources at chipmakers and other end-users duringthe quarter ended June 30, 2006 as compared to 60 light sources installedduring the quarter ended June 30, 2007.

Our sales aregenerated primarily by shipments to customers in Europe, Japan, Korea, Taiwan,and the U.S.  Approximately 85% of oursales for both the three months ended June 30, 2006 and 2007, were derived fromcustomers outside the U.S.  We maintain awholly owned Japanese subsidiary, Cymer Japan, which sells to our Japanesecustomers.  Revenues from Japanesecustomers, generated primarily 

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by Cymer Japan, accountedfor 21% of total revenues for both the three months ended June 30, 2006 and2007. The activities of Cymer Japan are limited to sales and service ofproducts purchased by Cymer Japan from us as the parent corporation. Weanticipate that international sales will continue to account for a significantportion 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 costs associated with our productsales are also included in cost of product sales and are not charged to ourcustomers.

The cost of product sales decreased 20% from $70.6 million for thethree months ended June 30, 2006 to $56.7 million for the three months endedJune 30, 2007. This decrease in cost of product sales was primarily due tolower light source system sales and a decrease in warranty costs for the threemonths ended June 30, 2007 compared to the three months ended June 30, 2006.  Thegross margin on product sales was 48% for the three months ended June 30, 2006as compared to 54% for the three months ended June 30, 2007 This higher grossmargin from period to period primarily resulted from favorable material reclaimproductivity improvements and reduced warranty costs due to increased productreliability realization during the period. Although we will continue to lookfor opportunities to enhance operating efficiencies and benefits from ouron-going product cost reduction activities for the remainder of 2007, we do notexpect to achieve the same high level of gross margin on product sales that wedid in the second quarter of 2007.

*Research and Development*.  Research and developmentexpenses include costs of internally-funded projects as well as continuingproduct development support expenses, which consist primarily of employee andmaterial costs, depreciation of equipment and other engineering relatedcosts.  Research and development expenses increased 7% from $18.8 million forthe three months ended June 30, 2006 to $20.1 million for the three monthsended June 30, 2007 due primarily to costs associated with our LTPS productdevelopment efforts and EUV light source development. In addition to ourdevelopment of EUV and LTPS technologies, we also continued to focus on nextgeneration ArF and KrF products. Included in our ArF product development efforts for 2007 is the designof our XLR series light sources.   As apercentage of total revenues, research and development expenses increased from13.9% for the three months ended June 30, 2006 to 16.3% for the three monthsended June 30, 2007.  We expect that ourinvestment in research and development will continue.

*Sales and Marketing*. Sales and marketing expenses includesales, marketing and customer support staff expenses and other marketingexpenses.  Sales and marketing expenses decreased 22%from $7.4 million for the three months ended June 30, 2006 to $5.8 million forthe three months ended June 30, 2007. The decrease in sales and marketingexpenses from period to period primarily reflects a decrease in profit sharing,bonuses and stock-based compensation expenses totaling approximately $858,000.  Additionally, remaining sales and marketingexpenses were lower period over period as a result of decreased spending intravel and recruiting expenses as well as a decrease in expenses related tofacilities and information technology.  Asa percentage of total revenues, sales and marketing expenses decreased from5.5% for the three months ended June 30, 2006 compared to 4.7% for the threemonths ended June 30, 2007.  Weanticipate that sales and marketing expenses will increase slightly in thethird quarter of 2007.

*General and Administrative*.  General and administrative expenses consistprimarily of management and administrative personnel costs, professionalservices, including external audit and consultant fees, and administrativeoperating costs.  General andadministrative expenses increased 1% from $9.6 million for the three monthsended June 30, 2006 to $9.7 million for the three months ended June 30, 2007 primarilydue to an increase in accounting professional service fees and expenses relatedto facilities and information technology. These increased expenses from periodto period were almost completely offset by a $1.0 million decline in profitsharing and bonuses and a $651,000 decline in stock-based compensation

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expense.As a percentage of total revenues, general and administrative expensesincreased from 7.1% for the three months ended June 30, 2006 to 7.9% for thethree months ended June 30, 2007.  Weanticipate that general and administrative expenses will increase slightly inthe third quarter of 2007.

*TotalOther Income - Net.*  Net other income consists primarily ofinterest income and expense, 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 totaled $4.5 million and $4.3 million for the threemonths ended June 30, 2006, and 2007, respectively. The decrease in net otherincome was primarily due to a decrease in the foreign currency exchange gainsfrom period to period which was partially offset by an increase in interestincome period over period. During the second quarter of 2007, we utilized amajority of our short-term investment portfolio when we repurchased 4.2 millionshares of our outstanding common stock under our $300 million board approvedstock repurchase program. Interest income increased from period to period dueto better interest rate yields on larger average cash and investment balancesduring the second quarter of 2007 compared to the same period in 2006. Foreigncurrency exchange gains totaled $480,000, interest income and other incometotaled $5.5 million, and interest and other expense totaled $1.5 million forthe three months ended June 30, 2006, compared to a foreign currency exchangegain of $2,000, interest and other income of $5.8 million, and interest andother expense of $1.5 million for the three months ended June 30, 2007.

*Income TaxProvision. * The tax provision of $11.6 million and $10.9million for the three months ended June 30, 2006 and 2007, respectively,reflects an annual effective rate of 34.6% for both periods.  The annual effective tax rate was consistentfrom period to period as increases in certain tax benefits were offset bydiscrete tax expense items.  The tax ratefor the three months ended June 30, 2007 of 31.1% differs from the annualeffective tax rate of 34.6% due to a revision of the annual effective tax rate estimatethat was calculated for the three months ended March 31, 2007 and certain taxexpense items that were recorded discretely in the second quarter of 2007. Theannual effective tax rate for the three months ended June 30, 2007 wasapproximately equal to the statuatory rate of 35%. The effective tax rate is afunction of current tax law and geographic location of pre-tax income.

***SixMonths Ended June 30, 2006 and 2007***

*Revenues*. The following table summarizescertain measures and the components of our revenue (in thousands, except units sold):
|                                                  | ** ** | **For the six months ended  June 30,** | ** ** |
|--------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                       | ** ** | **2006**                                                        | ** ** | **2007** | ** ** |
| Light source  systems:                           |       |                                                            |       |   |   |
| Revenue                                          |       | $                                                               | 140,664    |   | $ | 116,908 |   |
| Units sold                                       |       | 145                                                             |       | 100 |   |
| Average selling price                            |       | $                                                               | 970        |   | $ | 1,169 |   |
|                                             |       |                                                            |       |   |   |
| Consumable and  spare parts and service products |       | $                                                               | 121,682    |   | $ | 132,282 |   |
| Other revenue                                    |       | $                                                               | 150        |   | $ | 459 |   |
|                                             |       |                                                            |       |   |   |
| Total revenue                                    |       | $                                                               | 262,496    |   | $ | 249,649 |   |

 

Product sales decreased 5% from $262.3****million for the six months ended June 30, 2006 to $249.2million for the six months ended June 30, 2007. This decrease in product sales was due to a decline in light sourcesystem sales which was offset by an increase in consumable and spare parts andservice product sales for the six months ended June 30, 2007 as compared to thesix months ended June 30, 2006.  Lightsource system revenues decreased 17% from $140.7 million for the six monthsended June 30, 2006 to $116.9 million for the six months ended June 30,2007.  A total of 145 light sourcesystems were sold in the six months ended June 30, 2006 at an average sellingprice of $970,000, compared to 100 light source systems sold in the six monthsended June 30, 2007 at an average selling price of $1.2 million.  On a foreign currency adjusted basis, theaverage selling price for the six months 

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ended June 30, 2006 was $964,000 compared to $1.2 million for the six monthsended June 30, 2007. The increase in the average selling price from period toperiod reflects the shift in the product mix to higher priced technology buysof our newer advanced ArF products which represented 78% of light sourcesystems revenue for the six months ended June 30, 2007 as compared to only 62%of light source system revenue for the six months ended June 30, 2006. Thedecrease in quantities of light source systems sold from period to period wasdue to the slowing and flattening of the semiconductor industry in the firsthalf of 2007 as compared to the 2006 levels.

The continued increase in our installed base of lightsource systems and the steady utilization of them by our chipmaker customersresulted in an increase in consumables and spare parts and service productrevenue of 9% from $121.7 million for the six months ended June 30, 2006 to$132.3 million for the six months ended June 30, 2007.  Revenues from funded development contractswere $150,000 and $459,000 for six months ended June 30, 2006 and 2007,respectively. There were no revenues recorded or earned associated with the TCZjoint venture for the six months ended June 30, 2006 or 2007.

Sales to our three lithography tool manufacturingcustomers, ASML, Canon, and Nikon, amounted to 37%, 6% and 17%, respectively,of total revenue for the six months ended June 30, 2006, and 37%, 5% and 16%,respectively, of total revenue for the six months ended June 30, 2007.

Approximately84% and 85% of our sales for the six months ended June 30, 2006 and 2007,respectively, were derived from customers outside the U.S. Revenues fromJapanese customers, generated primarily by Cymer Japan, accounted for 23% and20% of total revenues for the six months ended June 30, 2006 and 2007,respectively.

*Cost of Product Sales*.  The cost of product sales decreased 13% from$139.2 million for the six months ended June 30, 2006 to $121.8 million for thesix months ended June 30, 2007. This decrease in cost of product sales wasprimarily due to lower light source system sales and a decrease in warrantycosts for the six months ended June 30, 2007 compared to the six months endedJune 30, 2006.  The gross margin on product sales was 47%for the six months ended June 30, 2006 as compared to 51% for the six monthsended June 30, 2007. This higher gross margin from period to period isprimarily due to increased factory yield and utilization, reduced product leadand cycle times, reduced warranty costs which resulted from product reliabilityrealization and favorable material reclaim productivity improvements fromperiod to period.

*Research and Development*. Research and development expenses increased 7% from $36.9 million forthe six months ended June 30, 2006 to $39.4 million for the six months endedJune 30, 2007 due primarily to costs associated with our LTPS productdevelopment efforts and EUV light source development. In addition to ourdevelopment of EUV and LTPS technologies, we also continued to focus on nextgeneration ArF and KrF products. Included in our ArF product development efforts for 2007 is the designof our XLR series light sources.   As apercentage of total revenues, research and development expenses increased from14.1% for the six months ended June 30, 2006 to 15.8% for the six months endedJune 30, 2007.

*Salesand Marketing*.  Sales and marketing expenses decreased 10%from $14.2 million for the six months ended June 30, 2006 to $12.8 million forthe six months ended June 30, 2007. The decrease in sales and marketingexpenses from period to period primarily reflects decreases in profit sharing, bonusesand stock-based compensation expenses as well as a decrease in expenses relatedto facilities and information technology totaling $748,000. Sales and marketingexpenses for 2006 includes higher employer payroll taxes related to stockoption exercises which occurred in the first half of 2006 of approximately$228,000. As a percentage of total revenues, sales and marketing expensesdecreased from 5.4% for the six months ended June 30, 2006 compared to 5.1% forthe six months ended June 30, 2007.

*General and Administrative*.  General and administrative expenses decreased1% from $18.8 million for the six months ended June 30, 2006 to $18.5 millionfor the six months ended June 30, 2007 primarily due to a $1.7 million declinein profit sharing and bonuses and a $1.3 million decline in stock-basedcompensation expense.  These amounts wereoffset by a 

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$1.9million increase in professional fees which were primarily related to theadoption and implementation of FIN 48. In addition, general and administrativeexpenses for the six months ended June 30, 2007 were higher than the same timeperiod in 2006 due to increased expenses related to facilities and informationtechnology. As a percentage of total revenues, general and administrative expensesincreased slightly from 7.2% for the six months ended June 30, 2006 to 7.4% forthe six months ended June 30, 2007.

*TotalOther Income - Net.*   Net other income totaled $10.7 million and$9.5 million for the six months ended June 30, 2006, and 2007, respectively.The decrease in net other income was primarily due to the receipt of $3.2million in life insurance proceeds following the death of one of our executiveofficers in the first half of 2006 and a decrease in foreign currency exchangegains from period to period. These decreases in other income were offset by anincrease in interest income period over period. . During the second quarter of2007, we liquidated a majority of our investment portfolio when we repurchased4.2 million shares of our outstanding common stock under our $300 million boardapproved stock repurchase program. Even with this liquidation, interest incomeincreased during the period due to better interest rate yields on largeraverage cash and investment balances during the first six months of 2007compared to the same period in 2006. Foreign currency exchange gains totaled$1.1 million, interest income and other income totaled $12.5 million, andinterest and other expense totaled $2.9 million for the six months ended June30, 2006, compared to a foreign currency exchange gain of $429,000, interestand other income of $12.2 million, and interest and other expense of $3.1million for the six months ended June 30, 2007.

*Income Tax Provision* The tax provision of $22.1 million and $23.1million for the six months ended June 30, 2006 and 2007, respectively, reflectsan annual effective rate of 34.6% for both periods The annual effective taxrate for the six months ended June 30, 2006 and 2007 was approximately equal tothe U.S. statutory rate of 35%. The effective tax rate is a function of currenttax law and geographic location of pre-tax income.

**LIQUIDITY AND CAPITAL RESOURCES**

Historicallywe have funded our operations primarily from cash generated from operations,the proceeds of the note offerings, bank borrowings, and the proceeds fromemployee stock option exercises.  As ofJune 30, 2007, we had approximately $330.6 million in cash and cashequivalents, $42.0 million in short-term investments, $24.1 million inlong-term investments, and $582.1 million in working capital. Cash and cashequivalents increased $28.5 million in the six month period from December 31,2006 to June 30, 2007.

In February 2002, we issued$250.0 million in aggregate principal amount in a private 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 areconvertible into shares of our common stock at a conversion rate of 20 sharesper $1,000 principal amount or an effective conversion price of $50.00 pershare.  We used a portion of the netproceeds from this private placement to redeem the previously issued notes thatwere then outstanding. The remaining proceeds are being used for our operating,investing and financing activities.  Withthe approval of our board of directors, we have periodically repurchased thesenotes in the open market.  We repurchased$49.2 million and $60.0 million principal amount of these notes in 2004 and2005, respectively. As of June 30, 2007, there were $140.7 million principalamount of notes outstanding.

Netcash provided by operating activities was approximately $17.3 million and $42.7million for the six months ended June 30, 2006 and 2007, respectively. Net cashprovided by operating activities for the six months ended June 30, 2006primarily reflects net income for the period and increases in accounts payableand accrued and other liabilities which were almost completely offset byincreases in accounts receivable and increases in inventories during theperiod.  The increases in accountsreceivable were due to back-end loaded shipments during the quarter andincreases in inventory were due to front-end loaded inventory levels to supporthigher forecasted demand. Net cash used in operating activities for the sixmonths ended June 30, 2007 primarily reflects net income for the period and adecrease in the accounts receivable balances which were offset by  increases in inventories and decreases inaccounts payable and

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accruedand other liabilities.  The decrease inaccounts receivable was primarily due to collection efforts during the periodand the increase in inventories was primarily due to reschedules of a number oflight source system shipments from the first half of 2007 to the second half of2007 and an increase in our field inventory to support chipmaker pulseutilization rates and customer service contracts.

Netcash used in investing activities for the six months ended June 30, 2006 wasapproximately $58.1 million compared to net cash of $142.6 million provided byinvesting activities for the six months ended June 30, 2007, respectively.  Net cash used in investing activities for thesix months ended June 30, 2006 was due primarily to the timing of short-termand long-term investments that matured and were reinvested during the period, a$7.0 million payment to acquire the final 19% minority interest in our CymerKorea subsidiary, a $8.2 million payment to acquire certain patent licenserights and the acquisition of $6.5 million of property and equipment. Net cashprovided by investing activities during the six months ended June 30, 2007reflects the timing of short-term and long-term investments that matured andwere reinvested during the period, the acquisition of $7.6 million of propertyand equipment and a $121,000 payment to acquire certain patent license rights.The majority of the proceeds from sold and matured investments during the sixmonths ended June 30, 2007 were used to fund the repurchase of 4,166,300 sharesof common stock during the second quarter of 2007 under our $300 million boardapproved stock repurchase program.

Netcash provided by financing activities was approximately $116.5 million for thesix months ended June 30, 2006 compared to net cash of $157.9 million used infinancing activities for the six months ended June 30, 2007. Net cash providedby financing activities for the six months ended June 30, 2006 reflects theproceeds received from the exercise of employee stock options totaling $98.7million and excess tax benefits for the period from stock options exercisestotaling $17.8 million. Net cash used in financing activities for the sixmonths ended June 30, 2007 primarily reflects the repurchase of shares of ourcommon stock totaling $171.7 million. This cash used in financing activitieswas partially offset by proceeds received from the exercise of employee stockoptions totaling $12.1 million and the excess tax benefits for the period fromstock options exercises totaling $1.8 million.

Werequire substantial working capital to fund our business, particularly tofinance inventories, including purchase orders with our vendors, accountsreceivable, and for capital expenditures. Our future capital requirements depend on many factors, including ourmanufacturing activity, the timing and extent of spending to support productdevelopment efforts, expansion of sales and marketing and field service andsupport, competitive labor market compensation requirements, the timing ofintroductions of new products and enhancements to existing products, and themarket 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.

**OFF BALANCE SHEET ARRANGEMENTSAND CONTRACTUAL OBLIGATIONS**

Wedid not have any relationships with unconsolidated entities or financialpartnerships, such as entities often referred to as structured finance,variable interest, or special purpose entities, which would have beenestablished for the purpose of facilitating off-balance sheet arrangements orother contractually narrow or limited purposes. In addition, we did not engage in trading activities involvingnon-exchange traded contracts.  As aresult, we are not exposed to any financing, liquidity, market or credit riskthat could arise if we had engaged in such relationships.  We do not have relationships and transactionswith persons and entities that derive benefits from their non-independentrelationship with us or our related parties except as disclosed herein.

We have no significant contractual obligations thatare not recorded in our consolidated financial statements or fully disclosed inthe notes thereto.

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**SUBSEQUENT EVENT**

Total purchases under our$300 million stock repurchase program through August 3, 2007 were $233.7million or 5,745,000 shares of which $171.7 million or 4,166,300 shares wererepurchased through June 30, 2007.  As ofAugust 3, 2007 we have $66.3 million of the original authorizationavailable for future purchases of our common stock under this program.

**RECENTACCOUNTING PRONOUNCEMENTS**

In September 2006,the FASB issued Statement of Financial Accounting Standards No. 157, “FairValue Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes aframework for measuring fair value using generally accepted accountingprinciples, and expands disclosures related to fair value measurements. ThisStatement applies to other accounting pronouncements that require or permitfair value measurements. Accordingly, SFAS 157 does not require any new fairvalue measurements. However, for some entities, the application of thisStatement will change current practice. This Statement is effective for us onJanuary 1, 2008. We are currently evaluating the impact of this pronouncementon our consolidated financial statements.

In September 2006,FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pensionand Other Postretirement Plans—an Amendment of FASB Statements No. 87, 88,106, and 132(R)” (“SFAS 158”).  Weadopted all provisions of SFAS 158 in December 2006 except for the provisionwhich will require us to measure the funded status of our pension plans as ofthe date of our year-end statement of financial position.  This provision will be effective for us forthe fiscal year ending December 31, 2008, and we do not expect itsadoption to have a material impact on our consolidated financial statements.

In February 2007,the FASB issued SFAS No. 159 ,“The Fair Value Option for Financial Assets andFinancial Liabilities – Including an Amendment of FASB Statement No. 115” (“SFAS159”).  This statement permitscompanies to choose to measure many financial assets and liabilities at fairvalue. Unrealized gains and losses on items for which the fair value option hasbeen elected are reported in net income. This statement also establishespresentation and disclosure requirements to facilitate comparisons betweenentities that choose different measurement attributes for similar types ofassets and liabilities. SFAS 159 is effective for fiscal years beginning afterNovember 15, 2007. We are currently assessing the impact of SFAS 159 onour consolidated financial statements.

#### **Item 3.  Quantitative and Qualitative Disclosures AboutMarket Risk**

**Foreign Currency Risk**

Weconduct business in several international currencies through our globaloperations. Due to the large volume of our business that we conduct in Japan,the Japanese operation poses our greatest foreign currency risk.  We use financial instruments, principallyforward contracts, to manage our foreign currency risk exposures. We enter intoforward contracts in order to reduce the impact of currency fluctuationsrelated to purchases of our inventories by Cymer Japan in U.S. dollars forresale under firm third-party sales commitments denominated in Japanese yen, aswell as other foreign currency exposures including exposures related tointercompany debt.  We do not enter intoforward contracts for speculative purposes.

Asof June 30, 2007, we had outstanding forward contracts to buy U.S. $37.5million for 5.3 billion yen under foreign currency exchange facilities withcontract rates ranging from 114.28 yen to 122.32****yenper U.S. dollar.  These contracts expireon various dates through January 2008.

Our forwardcontracts generally qualify for hedge accounting treatment according to theprovisions of Statement of Financial Accounting Standards No. 133, “Accountingfor Derivative Instruments and Hedging Activities”. As a result, we deferchanges in the fair value for the effective portion of these 

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hedges and recordthe amount in other comprehensive income and subsequently reclassify the gainor loss to cost of product sales in the same period that the related sale ismade to the third party. The fair value of all of our forward contracts and thedeferred gain, net of tax, for those that qualify for hedge accountingtreatment totaled $1.0 million and $17,000, respectively, as of June 30, 2007.

The fair value ofthese forward contracts as of June 30, 2007 would have fluctuated by $4.8million if the foreign currency exchange rate for the Japanese yen to the U.S.dollar on these forward contracts had changed by 10%.

# **Investment and Debt Risk**

Wemaintain an investment portfolio consisting primarily of government andcorporate fixed income securities, certificates of deposit and commercialpaper.  While it is our general intent tohold such securities until maturity, we will occasionally sell certainsecurities for cash flow purposes. Therefore, our investments are classified asavailable-for-sale and are carried on the balance sheet at fair value.  A change in market interest rates of 10%would have impacted our net income from these investments by approximately$679,000 for the six months ended June 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 notes is payable onFebruary 15 and August 15 of each year. The notes are convertible into sharesof our common stock at a conversion rate of 20 shares per $1,000 principalamount subject to adjustment under certain conditions. As of February 21, 2005,we may redeem the notes at certain redemption prices expressed as a percentageof the principal amount. The notes are subordinated to our existing and futuresenior indebtedness and effectively subordinated to all indebtedness and otherliabilities of our subsidiaries.  Becausethe interest rate is fixed, we believe there is no risk of increased interestexpense. These notes are recorded at face value on the consolidated balancesheets. In the third quarter of 2004 and the second quarter of 2005, werepurchased, at a discount to par, $49.2 million and $60.0 million principalamount, respectively, of these notes.  Theprincipal amount of the notes outstanding and the fair value of such debt basedon quoted market prices at June 30, 2007 was $140.7 million.

**ITEM 4.  Controls andProcedures**

*Evaluation of disclosure controls and procedures*.  For the second quarter of 2007, our chiefexecutive officer and our chief financial officer, evaluated the effectivenessof our disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”))as of June 30, 2007, and concluded that as of such date, our disclosurecontrols and procedures were not effective in ensuring that informationrequired to be disclosed by us in the reports that we file under the ExchangeAct is recorded, processed, summarized and reported within the time periodspecified in the rules and forms of the Securities and Exchange Commission.

Thisconclusion was based solely on our assessment of the company’s processes andcontrols related to our accounting for income taxes described in our annualreport on Form 10-K for the year ended December 31, 2006, more specificallythose policies and procedures which were not designed to include adequatemanagement review of various income tax calculations, reconciliations andrelated supporting documentation to ensure that our accounting for income taxeswas in accordance with generally accepted 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 also resulted in a morethan remote likelihood that a material misstatement to our consolidatedfinancial statements would not be prevented or detected.  As described in Part II, Item 9A of ourannual report on Form 10-K for the year ended December 31, 2006, we havedeveloped a plan to remediate this material weakness and will implement allsteps in the plan and any others that we deem necessary throughout 2007.

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*Changes in internal control over financial reporting.*Therehas been no change in our internal control over financial reporting during thequarter ended June 30, 2007 that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reportingother than the steps taken by us to remediate the material weakness that wasdisclosed by us in our annual report on Form 10-K for the year ended December31, 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 six months ended June 30, 2007:

·      Improved the communicationsbetween our tax department and our accounting department, and increased thelevel of involvement of our accounting department in the reviews of income taxreconciliations;

·      Redesigned and implementednew review and approval procedures and processes associated with all income taxprovision workpapers and the consolidated income tax reconciliation schedules;

·      Identified and madesignificant progress on the implementation of an automated tax provisionsoftware tool that will reduce the number of manual spreadsheets that we use tocalculate and reconcile all income tax accounts on a quarterly and annualbasis;

·      Increased our use of outsidetax consultants to assist us with all tax calculations and tax provisionworkpapers until we can identify and hire the appropriate additional taxpersonnel; and

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

Thereare additional remediation steps that we expect to complete from our originalremediation plan and we intend to complete these in the third quarter or earlyin the fourth quarter of 2007.

Sincemost of the 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 plan totest all of these internal control changes early in the third quarter of 2007.Further, we will test any additional changes that we make to our internalcontrols over our accounting for income taxes in the third and fourth quarterof 2007 immediately following their completion and execution to ensure thatthey are properly designed and working effectively. We will make any changesthat management deems necessary to these new internal controls based on theresults of this testing.

**PART II. OTHER INFORMATION**
| **ITEM 1.**  | ** ** | **Legal Proceedings** |
|--------------|------------|-----------------------|
|         |       |                  |
|         |       | None.                 |
| ** **   | ** ** | ** **            |
| **ITEM 1A.** | ** ** | **Risk Factors**      |

 

*The risks described below may notbe the only risks we face. Additional risks that we do not currently think arematerial may also impair our business operations. The risk factors set forthbelow with an asterisk (*) next to the title contain changes to the descriptionof the risk factors associated with our business as previously disclosed inItem 1A to our Annual Report on Form 10-K for the fiscal year ended December31, 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.*

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**Our revenues and operating results from quarter-to-quarter have variedin the past and our future operating results may continue to fluctuatesignificantly.**

Factors that contribute to fluctuations in our revenuesand operating results include:

·      demand for semiconductors in general and, in particular, for leading edgedevices with smaller circuit geometries;

·      cyclicality in the market for semiconductormanufacturing equipment;

·      rates at which chipmakers take delivery of photolithography tools fromlithography tool manufacturers;

·      rates at which lithography tool manufacturer customers take delivery oflight 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 spare parts and servicerevenues 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 of consumable and spareparts and services;

·      our ability to manage customer satisfaction, product reliability, anddirect field service and support effectiveness;

·      our ability to manage our manufacturingrequirements;

·      foreign currency exchange rate fluctuations, principally with respect tothe Japanese yen (in which sales by our Japanese subsidiary are denominated);

·      worldwide political instability;

·      changing global economic conditions, includingrising energy prices; and

·      intellectual property protection.

We have historically derived a large portion of ourquarterly and annual revenues from selling a small number of light sourcesystems. Because we sell a small number of products, the precise time that werecognize revenue from an order may have a significant impact on our totalrevenue for a particular period. Our customers may cancel or reschedule orderswith little or no penalty. Orders expected in one quarter could shift toanother period due to changes in the anticipated timing of our customers’purchase decisions or rescheduled delivery dates requested by our customers.Our operating results for a particular quarter or year may be adverselyaffected if our customers, particularly our three largest customers, cancel orreschedule orders, or if we cannot fill orders in time due to unexpected delaysin manufacturing, testing, shipping, and product acceptance.

We manage our expense levels based, in large part, onexpected future revenues. As a result, our expenses are relatively fixed forthe short term, and if our actual revenue decreases below the level we expect,our operating results will be adversely affected.  As a result of these or other factors, wecould fail to achieve our expectations as to future revenue, gross profit,operating income, net income, earnings per share, and cash flows.  Our failure to meet the performanceexpectations set and published by external sources could result in a sudden andsignificant drop in the price of our stock, particularly on a short-term basis,and could negatively affect the value of any investment in our stock.

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

We derive a substantial portion of our revenues fromlithography tool manufacturers who, as original equipment manufacturers (“OEMs”),incorporate our light source systems in photolithography tools that they sellto semiconductor manufacturers, or chipmakers, and from chipmakers who purchaseconsumables, spare parts, upgrades and service directly from us in support ofthe light source products. Like us, our OEM customers depend on demand fortheir products from the chipmakers. The capital 

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equipment and related operating expenditures of chipmakers depend on anumber of factors, including the current and anticipated market demand forsemiconductors and the many products using semiconductors.  That demand is highly volatile andunpredictable.

As a result of the cyclicality of the semiconductorindustry, the semiconductor capital equipment industry historically hasexperienced periodic ups and downs. The cyclical nature of the semiconductorand the semiconductor capital equipment industries affects our ability toaccurately predict future revenue and therefore our ability to manage ourfuture expense levels. When cyclical fluctuations result in lower than expectedrevenue levels, operating results may be adversely affected and cost reductionmeasures may be necessary in order for us to remain competitive and financiallysound.  During a down cycle or slowdown,we must be in a position to adjust our cost and expense structure to prevailingmarket conditions while still being able to maintain the longer term strategiesof the company as well as motivate and retain our key employees. During periodsof rapid growth, we must be able to increase manufacturing capacity andpersonnel to meet customer demand.  Wecan provide no assurance that these objectives can be met in a timely manner inresponse to industry cycles.  We are notable to predict with any certainty the duration of any industry cycle or thetiming or order of magnitude of any recovery.

Downturns in the semiconductor industry often result indecreases in demand for semiconductor manufacturing equipment, including thephotolithography tools that our OEM customers produce. Downturns in thesemiconductor industry have generally had severe effects on the demand forsemiconductor manufacturing equipment and the associated parts and support services.Fluctuating levels of investment by chipmakers and resulting pricing volatilitywill continue to materially affect our aggregate bookings, revenues andoperating results. Even during periods of reduced revenues we believe we mustcontinue to invest in research and development and to maintain extensiveongoing worldwide customer service and support capabilities to remaincompetitive. Continued spending in furtherance of these objectives maytemporarily harm our financial results. Semiconductor industry downturns and slowdowns are likely to continue toadversely affect our business, financial condition and operating results, andour operating results may fall below the expectations of public market analystsor investors in future quarters. Any failure to meet such expectations couldmaterially adversely affect the price of our common stock.

Our OEM customers try to manage their inventories andproduction requirements to appropriate levels that reflect their expected salesto chipmakers. Market conditions in the semiconductor industry and our OEMcustomers’ production efficiency can cause them to expand or reduce theirorders for new light source systems as they try to manage their inventories andproduction requirements. We continue to work with our OEM customers to betterunderstand these issues. However, we cannot guarantee that we will besuccessful in understanding our OEM customers’ inventory management andproduction requirements or that our OEM customers will not build up an excessinventory of light source systems. If our OEM customers retain an excessinventory of light source systems, our revenue could be reduced in futureperiods as the excess inventory is utilized, which could adversely affect ouroperating results, financial condition and cash flows.  If our OEM customers demand shorter productlead times to improve their inventory and cash positions, our inventorymanagement and cash position may be negatively impacted, which may adverselyaffect our operating results, financial condition and cash flows.

**A significant percentage of our revenue is derived from sales to thethree lithography tool manufacturers, and if we are not able to retain thesecustomers, or they reschedule, reduce or cancel orders, or delay or default onpayments, our revenues would be reduced and our financial condition and cashflows would suffer. ***

Three large companies, ASML, Nikon and Canon dominatethe photolithography tool business. Collectively, these three companiesaccounted for the following percentage of our total revenue during the periodsindicated:

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|            | ** ** | **Six months ended  June 30,** | ** ** |
|------------|------------|-----------------------------------------------|------------|
| ** ** | ** ** | **2006**                                      | ** ** | **2007** | ** ** |
|       |       |                                          |       |   |   |
| ASML       |       | 37                                            | %          | 37 | % |
| Nikon      |       | 17                                            | %          | 16 | % |
| Canon      |       | 6                                             | %          | 5 | % |
|       |       |                                          |       |   |   |
| Total      |       | 60                                            | %          | 58 | % |

 

Collectively, these three companies accounted for thefollowing percentage of our total accounts receivable at the dates indicated:
|            | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|------------|------------|-----------------------|------------|-------------------|------------|
| ** ** | ** ** | **2006**              | ** ** | **2007**          | ** ** |
|       |       |                  |       |              |       |
| ASML       |       | 48                    | %          | 45                | %          |
| Nikon      |       | 19                    | %          | 18                | %          |
| Canon      |       | 3                     | %          | 2                 | %          |
|       |       |                  |       |              |       |
| Total      |       | 70                    | %          | 65                | %          |

 

We expect that sales of our light source products tothese three customers will continue to account for a substantial portion of ourrevenue in the foreseeable future. None of our customers are obligated topurchase a minimum number of our products in the aggregate or during any particularperiod.  We can provide no assurance thatany of our customers will continue to purchase our products at past or currentlevels.  Sales to any of these customersmay be affected by many factors, some of which are beyond our control. Thesefactors include:

·      a change in a customer’s competitive position in its industry;

·      a customer experiencing lithography tool production problems;

·      a decision to purchase light sources from other suppliers;

·      changes in economic conditions in the semiconductor or thephotolithography tool industries; and

·      a decline in a customer’s financial condition.

At varying degrees, the loss ofany significant business from or production problems for any one of these threecustomers would harm our business and financial condition.

**A substantial percentage of our revenue is derived fromthe sale of a limited number of primary products.**

Our only current product line is excimer light sourcesystems, including KrF and ArF systems, and support, including consumable andspare parts and service support.  Weexpect these light source systems and the related support to continue toaccount for a substantial majority of our revenues in the near term. Continuedmarket acceptance of our light source system products is, therefore, criticalto our future success. The primary market for excimer light sources is in theuse of DUV photolithography equipment for manufacturing deep-submicronsemiconductor devices using smaller circuit geometries. The demand for ourproducts depends in part on the rate at which chipmakers further adopt excimerlight sources as the chosen light source for their photolithography tools.

The rate with which chipmakers adopt excimer lightsources may vary for a variety of reasons, including:

·      inadequate performance of photoresists used in advanced DUVphotolithography, especially new ArF immersion-specific resists;

·      potential shortages of specialized materials used in DUV optics;

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

·      consolidation of chipmakers.

We cannot guarantee that these factors can or will beovercome or that the demand for our excimer light source products will not bematerially reduced. The demand for our light source products, and therefore ouroperating results, financial condition and cash flows, could be adverselyaffected by a number of factors, including:

·      a decline in demand for our customers’ DUV photolithography tools;

·      a failure to achieve continued market acceptance of our products;

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

·      an improved version of products being offered by a competitor in themarket 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 depend on the introduction ofnew products for our success, and we are subject to risks associated with rapidtechnological change. ***

Rapid technological changes in semiconductormanufacturing processes subject us to increased pressure to developtechnological advances enabling such processes. We believe that our futuresuccess depends in part upon our ability to develop, manufacture, timelyintroduce and support new light source products with improved capabilities andto continue to enhance our existing light source systems and processcapabilities.  Due to the risks inherentin transitioning to new products, we must forecast accurate demand for newproducts while managing the transition from older products.

In early 2003, we effected our most significant productintroduction in several years with the initial shipment of a light source basedon a technology change from a single-discharge-chamber excimer light source toa dual-discharge-chamber design called MOPA. The MOPA design represented a paradigm shift from previously acceptedlithography technology by offering chipmakers higher power, tighter bandwidthand lower cost of operation for their current optical lithography applications.More recently, we introduced another significantly advanced dual dischargechamber light source, the XLR 500i, that replaces the conventional poweramplifier chamber with a regenerative ring amplifier. This light sourceprovides chipmakers with a step function improvement in performance andsignificantly lower cost of operation. There are risks inherent in the MOPA and ring technologies, includingeffective execution of our product development roadmap, continuing adoption ofthe product by lithography tool manufacturers and chipmakers,manufacturability, cost effectiveness, and product performance in the field ofthe new products and the development of a comparable product by our competitor.

At this time, chipmakers are continuing to expand theirmanufacturing capacity at 65 nm, and a growing number of manufacturers ofcertain types of memory chips are in production at 55 nm and below, and areexpected to be in production at 45 nm by the end of 2007.  Additionally, other types of chipmakers havea significant level of development underway at 45 nm.  These efforts, along with expanding use ofArF immersion lithography in production among certain memory manufacturers, aredriving demand for our most advanced ArF light sources.  At the same time chipmakers also need toolsfor the less critical layers on wafers, and there remains strong demand for ourKrF light source products for DUV photolithography systems as well. Afterchipmakers have built their capacity to levels appropriate to meet existingdemand, their demand for our light source products will depend, in part, ontheir sales forecasts and their estimates regarding the duration and magnitudeof the current industry cycle and whether their projected manufacturing processyields will enable ongoing investments in whatever capacity seems necessary.

Future technologies such as EUV, nano-imprintlithography, and certain maskless lithography techniques may render our excimerlight source products obsolete. We must manage product transitions, 

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as introduction of new products could adversely affect our sales ofexisting products. If new products are not introduced on time, or havereliability or quality problems, our performance may be impacted by reducedorders, higher manufacturing costs, delays in acceptance of and payment for newproducts, and additional service and warranty expenses. We may not be able todevelop and introduce new products or enhancements to our existing products andprocesses in a timely or cost effective manner that satisfies customer needs orachieves market acceptance. Failure to develop and introduce these new productsand enhancements could materially adversely affect our operating results,financial condition and cash flows.

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

**Failure to maintain effectively our direct field service and supportorganization could have a material adverse effect on our business.**

We believe it is critical for us to provide quick andresponsive service directly to the chipmakers throughout the world that use ourlight source products in their photolithography systems, and that it isessential to maintain our own personnel or trained third-party resources toprovide these services.  Accordingly, wehave an ongoing effort to develop our direct support system with locations inEurope, Korea, Japan, the People’s Republic of China, Singapore, Taiwan and theU.S. This requires us to do the following:

·      recruit and train qualified field service personnel;

·      identify qualified independent firms; and

·      maintain effective and highly trained organizationsthat can provide service to our customers in various countries.

We may not be able to attract and train qualifiedpersonnel to maintain our direct support operations successfully. We may not beable to find and engage qualified third-party resources to supplement andenhance our direct support operations. 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.

**We must develop and manufacture enhancements to ourexisting products and introduce new products in order to continue to grow ourbusiness. We may not effectively manage our growth and integrate these newenhancements and products, which could materially harm our business.**

To continue to grow our business, our existing light source products andtheir process capabilities must be enhanced, and we must develop andmanufacture new products to serve other semiconductor applications. We cannotguarantee that we will be able to manage our business to grow effectively. Norcan we guarantee that we will be able to accelerate the development of newenhancements to our existing products and create new products. Further, we maynot be able to effectively integrate new products and applications into ourcurrent operations. Any of these risks could materially harm our business,financial condition and results of operations.

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

In order to respond to the business cycles of thesemiconductor industry, in the past few years we have sharply expanded andcontracted the scope of our operations and the number of employees in many ofour locations and departments. As the semiconductor industry cycle movesbetween growth and contraction we will need to:

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

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·      closely manage our global operations;

·      improve our process and other internal management systems;

·      quickly adapt to changing sales and marketing channels;

·      effectively manage our inventory levels; and

·      attract, train, retain and manage key personnel.

If we fail to effectively manage changes in ourbusiness, our operating results, financial condition and cash flows will beadversely affected.

**We face competition from one company and may facecompetition from additional competitors who enter the market.**

We currently have one significant competitor that sellslight sources for DUV photolithography applications. This competitor,Gigaphoton, is a joint venture between two large companies, Komatsu and Ushio,and is headquartered in Japan.  Gigaphoton is aggressively trying to gain largermarket penetration in the excimer light source industry. We know that ourcustomers have purchased products from this competitor and that our customershave approved this competitor’s light sources for use with their products.

Larger companies with substantially greater resources,such as other manufacturers of industrial light sources for advancedlithography, may attempt to sell competitive products to our customers.Potential competitors may also be attracted to our growing installed base oflight sources which represents a steady and significant consumable and spareparts revenue stream for us, and they may attempt to supply consumable andspare parts to that installed base. If any existing or future competitors gainmarket acceptance, we could lose market share and our growth could slow ordecline, which could have a material adverse effect on our operating results,financial condition and cash flows.

**We depend on a few key suppliers for purchasing components andsubassemblies that are included in our products.**

We purchase a limited number of components andsubassemblies included in our light source products from a single supplier or asmall group of suppliers.  Forcertain optical, control system and pulse power components and subassembliesused in our light source systems, we currently utilize a single supplier.  To reduce the risk associated with thissingle supplier, we carry a significant strategic inventory of thesecomponents.  Strategic inventories aremanaged as a percentage of future demand. We have also negotiated to have vendor-managed inventory of criticalcomponents to further reduce the risk of a single supplier.  Inaddition, we contract the manufacture of various subassemblies of our productsand depend on our contract manufacturers to deliver to our requiredspecifications, schedule, and quality standards. Further, some of our suppliershave specialized in supplying equipment or manufacturing services tosemiconductor equipment manufacturers and therefore are susceptible to industryups and downs and subject to the same risks and uncertainties regarding theirability to respond to changing market conditions.  Because many of  these suppliers reduce the size of theirworkforce in an industry downturn and increase it in an upturn, they may not beable to meet our requirements or respond quickly enough as an upturn begins andgains momentum.  Due to the nature of ourproduct development requirements, these key suppliers must rapidly advancetheir own technologies and production capabilities in order to support theintroduction schedule of our new products. These suppliers may not be able toprovide new modules and subassemblies when they are needed to satisfy ourproduct schedule requirements. If we cannot purchase enough of these materials,components or subassemblies, or if these items do not meet our qualitystandards, there could be delays or reductions in our product shipments, whichwould harm our operating results, financial condition and cash flows.

## **We are dependent on our manufacturingfacilities and subcontractors to assemble and test our products.**

Operations at our primary manufacturing facility and oursubcontractors are subject to disruption for a variety of reasons, includingwork stoppages, terrorism, fire, earthquake, energy shortages, flooding 

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or other natural disasters.  Suchdisruptions could cause delays in shipments of our products to ourcustomers.  We provide no assurance thatalternate production capacity would be available if a major disruption were tooccur or that, if it were available, it could be obtained on favorableterms.  Such disruption could result incancellation of orders or loss of customers, which would have a materialadverse effect on our operating results, financial condition and cash flows.

**We depend on key personnel, especially management andtechnical personnel, who may be difficult to attract and retain.**

We are highly dependent on the services of many keyemployees in various areas, including:

·      research and development;

·      engineering;

·      sales and marketing;

·      field service and support;

·      manufacturing; and

·      management.

In particular, there are a limited number of experts inexcimer light source technology, and we require highly skilled hardware andsoftware engineers. Competition for qualified personnel is intense and wecannot guarantee that we will be able to continue to attract and retainqualified personnel as needed.  We do nothave employment agreements with most of our employees. We believe that ourfuture growth and operating results will depend on:

·      the continued services of our research and development, engineering,sales and marketing,  field service andsupport, manufacturing, and management personnel;

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

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

If we are unable to hire, train and retain key personnelas required, our operating results, financial condition and cash flows could be adversely affected.

**Economic, political, regulatory and other events ingeographic areas where we have significant sales or operations could interferewith our business.**

We serve an increasingly global market.  A large portion of our total revenues isderived from customers located outside of the U.S.  We expect our international sales to continueto account for a very large portion of our total revenues.  In order to support our foreign customers, wemaintain a manufacturing and field service subsidiary in Korea as well as fieldservice and support subsidiaries in Japan, the Netherlands, the People’sRepublic of China, Singapore and Taiwan.

We may not be able to manage our operations to addressand support our global customers effectively. Further, our investments in these types of activities may not make uscompetitive in the global market or we may not be able to meet the service,support, and manufacturing levels required by our global customers.

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

·      unexpected changes in regulatory requirements;

·      fluctuations in exchange rates and currency controls;

·      political and economic conditions and instability;

·      imposition of trade barriers and restrictions, including changes intariff and freight rates, foreign customs and duties;

·      difficulty in coordinating our management and operations in severaldifferent countries;

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·      difficulties in staffing and managing foreign subsidiary and branchoperations;

·      limited intellectual property protection in some countries;

·      potentially adverse tax consequences in some countries;

·      the possibility of accounts receivable collection difficulties;

·      in the case of Asia, the risk of business interruption and damage fromearthquakes;

·      the effect of acts of terrorism and war; and

·      the burdens of complying with a variety offoreign laws.

Many of our major customers andmany of the chipmakers who use our light source products in theirphotolithography systems are located in Asia. Economic problems and currencyfluctuations affecting these regions in Asia could create a larger risk for us.Further, even though it has not been difficult for us to comply with U.S.export controls, these export rules could change in the future and make it moredifficult or impossible for us to export our products to many countries.  Any of these vulnerabilities could have amaterial adverse effect on our business, financial condition and results ofoperations.

**Our ability to compete could be jeopardized if we are unable to protectour intellectual property rights. These types of claims could seriously harmour business or require us to incur significant costs. ***

We believe our success and ability to compete depend inlarge part upon protecting our proprietary technology. We rely on a combinationof patent, trade secret, copyright and trademark laws, nondisclosure and othercontractual agreements and technical measures to protect our proprietaryrights.

We own and have numerous patents pending in the U.S. andvarious foreign countries covering certain aspects of technology related tolight sources and piezo techniques. These patents will expire at various timesduring the period from January 2008 to September 2025.

Our pending patent applications and any futureapplications might not be approved. Our patents might not provide us with acompetitive advantage and may be challenged by third parties. In addition,third parties’ patents might have an adverse effect on our ability to dobusiness. As a result of cost constraints, we did not begin seeking patentprotection in Japan and other countries for our inventions that are covered byU.S. patents and patent applications until 1993.  As a result we do not have the right to seekforeign patent protection for some of our early inventions.  Additionally, laws of some foreign countriesin which our products are or may be developed, manufactured or sold, includingvarious countries in Asia, may not protect our products or intellectualproperty rights to the same extent as do the laws of the U.S. Thus, thelikelihood of piracy of our technology and products is greater in thesecountries. Further, third parties might independently develop similar products,duplicate our products, or design around patents that are granted to us.

Other companies or persons may have filed or may file inthe future patent applications that are similar or identical to ours. We mayhave to participate in appropriate proceedings in the courts or the  patent offices to determine the priority ofinventions. These proceedings may determine that these third-party patentapplications have priority over our patent applications. Loss of priority inthese interference proceedings could result in substantial cost to us.

We also rely on the following to protect ourconfidential information and our other 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 ourconfidential information and intellectual property, particularly our tradesecrets, because third parties may:

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·      independently develop substantially the same proprietary information andtechniques;

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

·      disclose our technology following expiration oftheir confidentiality obligation.

**The parties to whom we provideresearch and development services may dispute the ownership of the intellectualproperty that we develop performing these services.**

In the past, funds from research and developmentarrangements with third parties have been used to pay for a portion of our ownresearch and development expenses. We receive these funds fromgovernment-sponsored programs and customers, in connection with our designingand developing specific products. Periodically, funds from lithography toolmanufacturers and chipmakers are used to fund a small portion of our researchand development expenses. In providing these research and development servicesto these manufacturers, we try to make contractually clear who owns theintellectual property that results from the research and development serviceswe perform. However, disputes over the ownership or rights to use or marketthis intellectual property may arise between the funding organizations and us.Any dispute over ownership of the intellectual property we develop couldrestrict our ability to market our products and have a material adverse effecton our business.

**In the future, we may be subject to patent litigation toenforce patents issued to us and defend ourselves against claimed infringementby our competitor or any other third party.**

Third parties have notified us in the past, and may notifyus in the future, that we are infringing their intellectual property rights.Also, we have notified third parties in the past, and may notify them in thefuture, that they may be infringing our intellectual property rights.

Specifically, Komatsu notified us in 1996 that we may beinfringing some of its Japanese patents. During our subsequent discussions,Komatsu also asserted that our former Japanese manufacturing partner, Seiko, orwe may be infringing on some of Komatsu’s U.S. patents and a number of itsadditional Japanese patents. Komatsu has also notified one of our customers,Nikon, of its belief that our light sources infringe several of Komatsu’sJapanese and U.S. patents. As a result, we started proceedings in the JapanesePatent Office to oppose certain patents and patent applications of Komatsu. TheJapanese Patent Office has dismissed our opposition claims. Thus, litigationmay result in connection with Komatsu’s Japanese patents or U.S. patents. Also,Komatsu might claim that we infringe other or additional patents. Komatsunotified Seiko that it intends to enforce its rights against Seiko with respectto its Japanese patents if Seiko continued to engage in manufacturingactivities for us. In connection with our former manufacturing agreement withSeiko, we agreed to pay Seiko under certain conditions for damages associatedwith these types of claims. Seiko may not prevail in any litigation againstKomatsu, and therefore, we may be required to pay Seiko for such damages.

We have notified our competitor and others of our U.S.patent portfolio. Specifically, we have notified Komatsu that it may beinfringing some of our U.S. patents. We have discussed with Komatsu our claimsagainst each other.  Komatsu challengedone of our U.S. patents in the United States Patent and Trademark Office (“USPTO”)but our patent was subsequently re-issued by the USPTO.  Also, Komatsu transferred its lithographylight source business to our competitor, Gigaphoton.  We also have had discussions with a formercompetitor, Lambda-Physik (a subsidiary of Coherent, Inc.), regardingallegations by each party against the other for possible patentinfringement.  Any of these discussionswith our competitor or former competitor may not be successful and litigationcould result.

In the future, patent litigation may result due to aclaim of infringement by our competitor or any other third party or may benecessary to enforce patents issued to us. Any such litigation could result in substantial cost to us and diversionof our effort, which would have an adverse effect on our business, financialcondition and operating results. Furthermore, our customers and the end-usersof our products might assert other claims for indemnification that arise frominfringement claims against them. If these assertions are successful, ourbusiness, financial condition and operating results may be materially 

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affected. Instead of litigation, or as a result thereof, we may seek alicense from third parties to use their intellectual property. However, we maynot be able to obtain a license. Alternatively, we may design around the third party’s intellectualproperty rights or we may challenge these claims in legal proceedings.  Any adverse determination in a legalproceeding could result in one or more of the following, any of which couldharm our business, financial condition and operating results:

·      loss of our proprietary rights;

·      exposure to significant liabilities by other third parties;

·      requirement that we get a license from third parties on terms that arenot favorable to us or not available at all; or

·      injunction prohibits us  from manufacturing or selling our products.

Any of these actions could be costly and would divertthe efforts and attention of our management and technical personnel, whichwould materially adversely affect our business, financial condition and resultsof operations.

**We may acquire a business or enter a new market thatwill involve numerous risks.  We may notbe able to address these risks successfully without substantial expense, delayor other operational and financial challenges.**

The risks involved with acquiring a new company, forminga joint venture, or entering 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;

·      client dissatisfaction or performance problems with the acquired companyor new product in a new market;

·      amortization of acquired definite-lived intangible assets and deferredcompensation;

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

·      costs associated with developing, marketing, introducing and supporting anew 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 other unanticipated events orcircumstances; 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 asentry into new markets, are inherently subject to multiple significant risks,and the inability to effectively manage these risks could have a materialadverse effect on our business.  In July2005, we formed our TCZ joint venture with Zeiss to produce tools for themanufacture of flat panel displays.  Thisis a new market for both Cymer and Zeiss and may involve numerous risks. Any ofthese risks could materially harm our business, financial condition andoperating results. Further, any business that we acquire, joint venture that weform or new market we may enter may not achieve anticipated revenues oroperating results.

**Compliancewith changing regulations of corporate governance and public disclosure mayresult in additional expenses***.*

Changinglaws, regulations and standards relating to corporate governance and publicdisclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations,including accelerated SEC filing timelines and new Proxy rules, new NASDAQStock Market rules, and new accounting pronouncements 

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are creating uncertaintyand additional complexities for companies such as ours. In particular, theSection 404 internal control evaluation requirements under the Sarbanes-OxleyAct have added and will continue to add complexity and costs to our businessand require a significant investment of our time and resources to complete eachyear.  We take these  requirements seriously and expect to continueto make every effort to ensure that we receive clean attestations on ourinternal controls each year from our outside auditors. To maintain highstandards of corporate governance and public disclosure, we intend to investall reasonably necessary resources to comply with all other evolving standards.These investments may result in increased general and administrative expensesand a diversion of management time and attention from strategic revenuegenerating and cost management activities.

**We are dependent on air transport to conduct our business anddisruption of domestic and international air transport systems could adverselyaffect our business.**

We depend on regular and reliable air transportation ona worldwide basis for many of our routine business functions. If civil aviationin the U.S. or abroad is disrupted by terrorist activities or securityresponses to the threat of terrorism or for any other reason, our businesscould be adversely affected in the following ways:

·      supplies of raw materials and components for the manufacture of ourproducts or our customers’ products may be disrupted;

·      we may not be able to deliver our products to our customers in a timely manner;

·      we may not be able to provide timely service of or support for installedlight sources for chipmakers; and

·      our sales and marketing efforts may be disrupted.

**We are exposed to risks related to the fluctuations in the currencyexchange rates for all foreign currencies in which we do business, butparticularly for the Japanese yen.**

**When we sell products to our Japanese subsidiary,the sale is denominated in U.S. dollars. When our Japanese subsidiary sells ourproducts directly to**customers in Japan, the sale isdenominated in Japanese yen. Thus, our results of operations may fluctuatebased on the changing value of the Japanese yen to the U.S. dollar. We managethe exposure of our Japanese subsidiary to these fluctuations through forwardcontracts to hedge the subsidiary’s purchase commitments. We will continue tomonitor our exposure to these currency fluctuations, and, when appropriate, usehedging transactions to minimize the effect of these currency fluctuations.However, exchange rate fluctuations may still have a material adverse effect onour operating results. In the future, we may need to sell a more significantportion of our products in foreign currencies other than the Japanese yen andthe management of more currency fluctuations will be more difficult and exposeus to greater risks in this area.

**We are subject to many standards and regulations offoreign governments and, even though we intend to comply, we may not always bein compliance with these rules, or we may be unable to design or redesign ourproducts to comply with these rules.**

**Many foreign government standards and regulationsapply to our products.  These standardsand regulations are always being amended. Although we intend to meet all foreign standards and regulations, ourproducts may not comply with these foreign government standards andregulations.  Further, it might not becost effective for us to redesign our products to comply with these foreigngovernment standards and regulations. Our inability to design products to comply with foreign standardstherefore could have a material adverse effect on our business.**

**Chipmakers’ prolonged use of our products in high volumeproduction may not produce the results they desire and, as a result, ourreputation and that of our customers who supply photolithography tools to thechipmakers could be damaged in the semiconductor industry.**

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Over time, our light source products may not meetchipmakers’ production specifications or operating cost requirements after thelight source has been used for a long period in high volume production. If anychipmaker cannot successfully achieve or sustain their volume production usingour light sources, our reputation could be damaged with chipmakers andlithography tool manufacturers. This would harm our business.

**Our operations are subject to environmental and other governmentregulations that may expose us to liabilities for noncompliance.**

We are subject to federal, state and local regulations,such as regulations related to the environment, land use, public utilityutilization and the fire code, in connection with the storage, handling,discharge and disposal of substances that we use in our manufacturing processand on our facilities.  We believe thatour activities comply with current government regulations that are applicableto our operations and current facilities. We may be required to purchaseadditional capital equipment or other requirements for our processes to complywith these government regulations in the future if they change. Further, thesegovernment regulations may restrict us from expanding our operations. Adoptingmeasures to comply with changes in the government regulations, our failure tocomply with environmental and land use regulations, or restrictions on ourability to discharge hazardous substances, could subject us to future liabilityor cause our manufacturing operations to be reduced or stopped.

**Our products are subject to potential product liabilityclaims if personal injury or death results from their use.**

We are exposed to significant risks for productliability claims if personal injury or death results from the use of ourproducts. We may experience material product liability losses in the future. Wemaintain insurance against product liability claims. However, our insurancecoverage may not continue to be available on terms that we accept. Thisinsurance coverage also may not adequately cover liabilities that we incur.Further, if our products are defective, we may be required to recall orredesign these products. A successful claim against us that exceeds ourinsurance coverage level, or any claim or product recall that results inadverse publicity against us, could have a material adverse effect on ourbusiness, financial condition and results of operations.

**Trademark infringement claims against our registered and unregisteredtrademarks would be expensive and we may have to stop using such trademarks andpay damages.**

We registered the trademarks ‘‘CYMER’’ and “INSIST ONCYMER” and others in the U.S. and in some other countries. We are also tryingto register additional trademarks in the U.S. and in other countries.  We use these trademarks and many other marksin our advertisements and other business materials, which are distributed throughoutthe world. We may be subject to trademark infringement actions for using thesemarks and other marks on a worldwide basis which would be costly to defend. Ifa trademark infringement action were successful, we would have to stop usingone or more of the marks and possibly pay damages.

**The price of our common stock has fluctuated and maycontinue to fluctuate widely.**

The price of our common stock has fluctuated in thepast. The market price of our common stock will continue to be subject tosignificant fluctuations in the future in response to a variety of factors,including the risk factors contained in this report.

Various factors may significantly affect the marketprice of our common stock, including:

·      the cyclical nature of the semiconductor industry;

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

·      conditions and trends in the light source device and other technologyindustries;

·      announcements of innovations in technology;

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·      new products offered by us or our competitor;

·      developments of patents or proprietary rights;

·      changes in financial estimates by securities analysts;

·      general worldwide political, economic, and market conditions;

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

·      failure to properly manage any single orcombination of risk factors listed in this section.

**In addition, the stock market has experienced extreme priceand volume fluctuations that have particularly affected the market price formany high technology companies. Such fluctuations have in some cases beenunrelated to the operating performance of these companies. Severe pricefluctuations in a company’s stock have frequently been followed by securitieslitigation.  Any such litigation canresult in substantial costs and a diversion of management’s attention andresources and therefore could have a material adverse effect on our business,financial condition and results of operations.**

**ITEM 2. **     Unregistered Sales of Equity Securities andUse 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.  Thepurchases have been made from time to time in the open market or in privatelynegotiated transactions.  The programdoes not have a fixed expiration date and may be discontinued at any time.

The followingtable provides information with respect to the shares of common stockrepurchased by us during the three months ended June 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** | ** ** |
|----------------------------------|------------|--------------------------------------------------------------|------------|--------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                             |       |                                                         |       |                                                   |       |                                                                                                                                                       |       |                                                                                                                                                                       |       |
| April 1, 2007 to  April 30, 2007 |       | 477,700                                                      |       | $                                                      | 40.59      |                                                                                                                                                       | 477,700    |                                                                                                                                                                       | $          | 280.6 Million |   |
| May 1, 2007 to  May 31, 2007     |       | 3,398,900                                                    |       | $                                                      | 41.40      |                                                                                                                                                       | 3,398,900  |                                                                                                                                                                       | $          | 139.8 Million |   |
| June 1, 2007 to  June 30, 2007   |       | 289,700                                                      |       | $                                                      | 39.81      |                                                                                                                                                       | 289,700    |                                                                                                                                                                       | $          | 128.3 Million |   |
| Total                            |       | 4,166,300                                                    |       | $                                                      | 41.20      |                                                                                                                                                       | 4,166,300  |                                                                                                                                                                       |       |   |

 

# **   ITEM 3. ****DefaultsUpon Senior Securities**

# None.

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

Cymer held its AnnualMeeting of Stockholders on May 17, 2007. Out of 37,349,393 shares ofcommon stock entitled to vote at such meeting, there were present in person orby proxy 35,300,281 shares. At the Annual Meeting, the stockholders of Cymerapproved the following matters:

Proposal 1. The electionof the following eight directors to serve for one year. The votes for thenominated directors were as follows:

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| Director’s Name | ** ** | **Votes For** | ** ** | **Votes Withheld** | ** ** |
|---------------------------|------------|--------------------|------------|-------------------------|------------|
|                      |       |               |       |                    |       |
| Charles J. Abbe           |       | 32,372,828         |       | 2,927,453               |       |
| Robert P. Akins           |       | 34,190,837         |       | 1,109,444               |       |
| Edward H. Braun           |       | 35,115,694         |       | 184,587                 |       |
| Michael R.  Gaulke        |       | 32,348,698         |       | 2,951,583               |       |
| William G.  Oldham        |       | 34,995,242         |       | 305,039                 |       |
| Peter J. Simone           |       | 31,533,677         |       | 3,766,604               |       |
| Young K. Sohn             |       | 35,115,109         |       | 185,172                 |       |
| Jon D. Tompkins           |       | 35,113,200         |       | 187,081                 |       |

 

Proposal 2. An amendmentto our 2005 Equity Incentive Plan to increase the aggregate number of sharesauthorized for issuance under the Plan by 1,000,000 shares and to expand theawards available for grant under the Incentive Plan to include cash awards thatqualify as “performance-based compensation”. 26,973,676 votes were cast forapproval, 5,049,087 votes were cast against, 41,426 votes were abstained andthere were 3,236,092 broker non-votes.

Proposal 3. Ratificationof the appointment of KPMG LLP as our independent auditors for the year endingDecember 31, 2007. 34,934,580 votes were cast for approval, 360,213 votes werecast against, 5,488 votes were abstained and there were no broker non-votes.

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

(a)   None.

(b)   There were no material changesto the procedures by which security holders may recommend nominees to our boardof directors.

# **ITEM 6.****     Exhibits**

| 10.1   |   | Summary description of Cymer, Inc. 2005 Equity  Incentive Plan, as amended (incorporated herein by reference to Exhibit 99.1  to Cymer’s Current Report on Form 8-K filed on May 18, 2007). |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                             |
| 31.1   |   | Certification of Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act.                                                                                                     |
|   |   |                                                                                                                                                                                             |
| 31.2   |   | Certification of Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act.                                                                                                     |
|   |   |                                                                                                                                                                                             |
| 32.1   |   | Certification of Chief Executive Officer pursuant to  Section 906 of the Sarbanes-Oxley Act.                                                                                                     |
|   |   |                                                                                                                                                                                             |
| 32.2   |   | Certification of Chief Financial Officer pursuant to  Section 906 of the Sarbanes-Oxley Act.                                                                                                     |

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this Quarterly Report on Form 10-Q to be signed on its behalf bythe undersigned thereunto duly authorized.
|                       | CYMER, INC.                  |
|-----------------------|------------------------------|
|                  |                         |
|                  |                         |
| Date: August 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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