**UNITEDSTATES SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 
| **ý** | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                                                                            |
|------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                                                                                                                                                                              |
| ** ** | ** ** | **For the  Quarterly Period Ended June 30, 2005**                                                                                                                                                                                                                                                                                                            |
|       |       |                                                                                                                                                                                                                                                                                                                                                              |
| ** ** | ** ** | **OR**                                                                                                                                                                                                                                                                                                                                                            |
|       |       |                                                                                                                                                                                                                                                                                                                                                              |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE EXCHANGE ACT OF 1934**                                                                                                                                                                                                                                                                      |
|       |       |                                                                                                                                                                                                                                                                                                                                                              |
| ** ** | ** ** | **For the  Transition Period from                             to                           ** |

 

**Commission file number 0-21321**

 

**CYMER, INC.**

(Exact name of registrant as specified in its charter)

 
| **Nevada**                                                                           |   | **33-0175463**                       |
|--------------------------------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of incorporation or  organization)                      |   | (I.R.S. Employer Identification No.) |
|                                                                                 |   |                                 |
| **17075 Thornmint Court, San Diego, CA**                                             |   | **92127**                            |
| (Address of principal executive offices)                                             |   | (Zip Code)                           |
|                                                                                 |   |                                 |
| **(858) 385-7300**                                                                   |
| (Registrant’s telephone number, including area code)                            |
|                                                                                 |   |                                 |
| **N/A**                                                                              |
| (Former name, former address and former fiscal year,  if changed since last report). |

 

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

 

Yes  ý        No  o

 

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

 

The number of shares ofCommon Stock, with $0.001 par value, outstanding on July 29, 2005 was 35,492,216.

 

 

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**CYMER, INC.**

 

**FORM 10-Q**

 

**For the Quarterly Period Ended June 30, 2005**

 

**INDEX**

 
| **PART I.**  | **FINANCIAL INFORMATION**                                                                              | ** ** |
|-------------------|--------------------------------------------------------------------------------------------------------|------------|
|              |                                                                                                   |       |
| ITEM 1.           | Financial Statements (unaudited)                                                                       |       |
|              |                                                                                                   |       |
|              | Consolidated  Balance Sheets as of December 31, 2004 and June 30, 2005                       |       |
|              |                                                                                                   |       |
|              | Consolidated  Statements of Operations for the three and six months ended June 30,  2004 and 2005 |       |
|              |                                                                                                   |       |
|              | Consolidated  Statements of Cash Flows for the six months ended June 30, 2004 and 2005            |       |
|              |                                                                                                   |       |
|              | Notes  to Consolidated Financial Statements                                                            |       |
|              |                                                                                                   |       |
| ITEM 2.           | Management’s Discussion and  Analysis of Financial Condition and Results of Operations            |       |
|              |                                                                                                   |       |
| ITEM 3.           | Quantitative  and Qualitative Disclosures About Market Risk                                            |       |
|              |                                                                                                   |       |
| ITEM 4.           | Controls and  Procedures                                                                               |       |
|              |                                                                                                   |       |
| **PART II.** | **OTHER INFORMATION**                                                                                  | ** ** |
|              |                                                                                                   |       |
| ITEM 1.           | Legal Proceedings                                                                                      |       |
|              |                                                                                                   |       |
| ITEM 2.           | Unregistered Sales of Equity  Securities and Use of Proceeds                                           |       |
|              |                                                                                                   |       |
| ITEM 3.           | Defaults Upon Senior Securities                                                                        |       |
|              |                                                                                                   |       |
| ITEM 4.           | Submission of Matters to a Vote of  Security Holders                                                   |       |
|              |                                                                                                   |       |
| ITEM 5.           | Other Information                                                                                      |       |
|              |                                                                                                   |       |
| ITEM 6.           | Exhibits                                                                                               |       |
|              |                                                                                                   |       |
| **SIGNATURES**    |                                                                                                   |

 

2

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**PART I. FINANCIAL INFORMATION**

 

**ITEM 1.  FinancialStatements**

 

**CYMER, INC.**

**CONSOLIDATED BALANCE SHEETS (UNAUDITED)**

**(Inthousands, except share data)**

 
| ** **                                                                                                                                                                              | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                                                                                                                                              | ** ** | **2004**              | ** ** | **2005**          | ** ** |
| **ASSETS**                                                                                                                                                                              |       |                  |       |              |       |
| ** **                                                                                                                                                                              |       |                  |       |              |       |
| CURRENT ASSETS:                                                                                                                                                                         |       |                  |       |              |       |
| Cash and cash  equivalents                                                                                                                                                              |       | $                     | 114,246    |              | $          | 149,049 |   |
| Short-term  investments                                                                                                                                                                 |       | 175,866               |       | 134,473           |       |
| Accounts  receivable - net                                                                                                                                                              |       | 110,680               |       | 71,032            |       |
| Foreign currency  forward exchange contracts                                                                                                                                            |       | —                |       | 2,060             |       |
| Inventories                                                                                                                                                                             |       | 110,022               |       | 90,350            |       |
| Deferred income taxes                                                                                                                                                                   |       | 7,470                 |       | 7,585             |       |
| Prepaid expenses  and other assets                                                                                                                                                      |       | 5,726                 |       | 5,085             |       |
| Total current  assets                                                                                                                                                                   |       | 524,010               |       | 459,634           |       |
|                                                                                                                                                                                    |       |                  |       |              |       |
| PROPERTY AND  EQUIPMENT - NET                                                                                                                                                           |       | 123,548               |       | 118,606           |       |
| LONG-TERM  INVESTMENTS                                                                                                                                                                  |       | 84,561                |       | 58,810            |       |
| DEFERRED INCOME  TAXES                                                                                                                                                                  |       | 67,722                |       | 67,134            |       |
| GOODWILL                                                                                                                                                                                |       | 8,358                 |       | 8,358             |       |
| INTANGIBLE  ASSETS - NET                                                                                                                                                                |       | 10,394                |       | 9,188             |       |
| OTHER ASSETS                                                                                                                                                                            |       | 7,185                 |       | 6,600             |       |
| TOTAL ASSETS                                                                                                                                                                            |       | $                     | 825,778    |              | $          | 728,330 |   |
|                                                                                                                                                                                    |       |                  |       |              |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                          |       |                  |       |              |       |
|                                                                                                                                                                                    |       |                  |       |              |       |
| CURRENT  LIABILITIES:                                                                                                                                                                   |       |                  |       |              |       |
| Accounts payable                                                                                                                                                                        |       | $                     | 13,949     |              | $          | 13,590 |   |
| Accrued warranty  and installation                                                                                                                                                      |       | 28,546                |       | 27,712            |       |
| Accrued payroll  and benefits                                                                                                                                                           |       | 16,284                |       | 11,954            |       |
| Accrued patents,  royalties and other fees                                                                                                                                              |       | 6,318                 |       | 6,210             |       |
| Foreign currency  forward exchange contracts                                                                                                                                            |       | 1,901                 |       | —            |       |
| Income taxes  payable                                                                                                                                                                   |       | 10,397                |       | 10,478            |       |
| Unearned income                                                                                                                                                                         |       | 6,152                 |       | 4,428             |       |
| Accrued and  other current liabilities                                                                                                                                                  |       | 4,456                 |       | 3,734             |       |
| Total current  liabilities                                                                                                                                                              |       | 88,003                |       | 78,106            |       |
|                                                                                                                                                                                    |       |                  |       |              |       |
| CONVERTIBLE  SUBORDINATED NOTES                                                                                                                                                         |       | 200,753               |       | 140,722           |       |
| DEFERRED INCOME  TAXES                                                                                                                                                                  |       | 6,237                 |       | 6,237             |       |
| OTHER  LIABILITIES                                                                                                                                                                      |       | 7,282                 |       | 8,979             |       |
| Total  liabilities                                                                                                                                                                      |       | 302,275               |       | 234,044           |       |
| MINORITY  INTEREST                                                                                                                                                                      |       | 6,183                 |       | 5,421             |       |
|                                                                                                                                                                                    |       |                  |       |              |       |
| COMMITMENTS AND  CONTINGENCIES                                                                                                                                                          |       |                  |       |              |       |
|                                                                                                                                                                                    |       |                  |       |              |       |
| STOCKHOLDERS’  EQUITY:                                                                                                                                                             |       |                  |       |              |       |
| Preferred stock  - authorized 5,000,000 shares; $.001 par value, no shares issued or  outstanding                                                                                       |       | —                |       | —            |       |
| Common stock -  $.001 par value per share; 100,000,000 shares authorized; 36,993,000 and  37,191,000 shares outstanding at December 31, 2004 and June 30,  2005, respectively |       | 37                    |       | 37                |       |
| Additional paid-in  capital                                                                                                                                                             |       | 378,414               |       | 382,928           |       |
| Treasury stock  at cost (1,943,000 common shares)                                                                                                                                       |       | —                |       | (50,000           | )          |
| Unearned  compensation                                                                                                                                                                  |       | (16                   | )          | —            |       |
| Accumulated  other comprehensive loss                                                                                                                                                   |       | (4,455                | )          | (3,840            | )          |
| Retained  earnings                                                                                                                                                                      |       | 143,340               |       | 159,740           |       |
| Total  stockholders’ equity                                                                                                                                                        |       | 517,320               |       | 488,865           |       |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                        |       | $                     | 825,778    |              | $          | 728,330 |   |

 

See Notes toUnaudited Consolidated Financial Statements.

 

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**CYMER, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)**

**(In thousands, except per share data)**

 
| ** **                                                                | ** ** | **For the three months  ended June 30,** | ** ** | **For the six months  ended June 30,** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                | ** ** | **2004**                                      | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2005** | ** ** |
|                                                                      |       |                                          |       |                                        |       |   |   |   |   |
| REVENUES:                                                                 |       |                                          |       |                                        |       |   |   |   |   |
| Product sales                                                             |       | $                                             | 94,722     |                                        | $          | 95,797 |   | $ | 182,593 |   | $ | 180,406 |   |
| Other                                                                     |       | 185                                           |       | 595                                         |       | 235 |   | 796 |   |
| Total revenues                                                            |       | 94,907                                        |       | 96,392                                      |       | 182,828 |   | 181,202 |   |
|                                                                      |       |                                          |       |                                        |       |   |   |   |   |
| COSTS AND  EXPENSES:                                                      |       |                                          |       |                                        |       |   |   |   |   |
| Cost of product  sales                                                    |       | 49,975                                        |       | 57,731                                      |       | 102,143 |   | 110,762 |   |
| Research and  development                                                 |       | 14,832                                        |       | 16,937                                      |       | 27,202 |   | 31,541 |   |
| Sales and  marketing                                                      |       | 5,879                                         |       | 6,777                                       |       | 11,702 |   | 12,551 |   |
| General and  administrative                                               |       | 8,154                                         |       | 6,022                                       |       | 14,769 |   | 12,326 |   |
| Amortization of  intangible assets                                        |       | 40                                            |       | —                                      |       | 80 |   | 20 |   |
| Total costs and  expenses                                                 |       | 78,880                                        |       | 87,467                                      |       | 155,896 |   | 167,200 |   |
| OPERATING INCOME                                                          |       | 16,027                                        |       | 8,925                                       |       | 26,932 |   | 14,002 |   |
|                                                                      |       |                                          |       |                                        |       |   |   |   |   |
| OTHER INCOME  (EXPENSE):                                                  |       |                                          |       |                                        |       |   |   |   |   |
| Foreign currency  exchange loss - net                                     |       | (399                                          | )          | (573                                        | )          | (345 | ) | (767 | ) |
| Gain on debt  extinguishment                                              |       | —                                        |       | 2,220                                       |       | — |   | 2,220 |   |
| Interest and  other income                                                |       | 1,603                                         |       | 2,597                                       |       | 3,499 |   | 4,998 |   |
| Interest and  other expense                                               |       | (2,511                                        | )          | (1,776                                      | )          | (5,067 | ) | (3,903 | ) |
| Total other  income (expense) - net                                       |       | (1,307                                        | )          | 2,468                                       |       | (1,913 | ) | 2,548 |   |
|                                                                      |       |                                          |       |                                        |       |   |   |   |   |
| INCOME BEFORE  INCOME TAX PROVISION AND MINORITY INTEREST                 |       | 14,720                                        |       | 11,393                                      |       | 25,019 |   | 16,550 |   |
|                                                                      |       |                                          |       |                                        |       |   |   |   |   |
| INCOME TAX  PROVISION                                                     |       | 3,386                                         |       | 912                                         |       | 5,754 |   | 912 |   |
| MINORITY  INTEREST                                                        |       | (1,133                                        | )          | 534                                         |       | (1,908 | ) | 762 |   |
| NET INCOME                                                                |       | $                                             | 10,201     |                                        | $          | 11,015 |   | $ | 17,357 |   | $ | 16,400 |   |
|                                                                      |       |                                          |       |                                        |       |   |   |   |   |
| EARNINGS PER  SHARE:                                                      |       |                                          |       |                                        |       |   |   |   |   |
| Basic earnings  per share                                                 |       | $                                             | 0.28       |                                        | $          | 0.31 |   | $ | 0.47 |   | $ | 0.45 |   |
| Weighted average  common shares outstanding                               |       | 36,735                                        |       | 35,841                                      |       | 36,661 |   | 36,360 |   |
|                                                                      |       |                                          |       |                                        |       |   |   |   |   |
| Diluted earnings  per share                                               |       | $                                             | 0.27       |                                        | $          | 0.30 |   | $ | 0.46 |   | $ | 0.45 |   |
| Weighted average  common and dilutive potential common shares outstanding |       | 37,673                                        |       | 36,166                                      |       | 37,846 |   | 36,695 |   |

 

See Notes to Unaudited Consolidated Financial Statements.

 

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**CYMER, INC.**

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

**(In thousands)**

 
| ** **                                                                         | ** ** | **For the six months ended** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                         | ** ** | **June 30,**            | ** ** |
| ** **                                                                         | ** ** | **2004**                     | ** ** | **2005** | ** ** |
|                                                                               |       |                         |       |   |   |
| OPERATING  ACTIVITIES:                                                             |       |                         |       |   |   |
| Net income                                                                         |       | $                            | 17,357     |   | $ | 16,400 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                         |       |   |   |
| Gain on debt  extinguishment                                                       |       | —                       |       | (2,220 | ) |
| Depreciation and  amortization                                                     |       | 13,949                       |       | 14,440 |   |
| Non-cash  stock-based compensation                                                 |       | 261                          |       | 360 |   |
| Amortization of  unearned compensation                                             |       | 67                           |       | 16 |   |
| Minority  interest                                                                 |       | 1,908                        |       | (762 | ) |
| Provision for  deferred income taxes                                               |       | (490                         | )          | 46 |   |
| Loss on disposal  and impairment of property and equipment                         |       | 58                           |       | 35 |   |
| Change in assets  and liabilities:                                                 |       |                         |       |   |   |
| Accounts  receivable - net                                                         |       | (26,009                      | )          | 39,648 |   |
| Foreign currency  forward exchange contracts                                       |       | (2,127                       | )          | (2,677 | ) |
| Inventories                                                                        |       | (17,776                      | )          | 19,672 |   |
| Prepaid expenses  and other assets                                                 |       | (2,126                       | )          | (277 | ) |
| Accounts payable                                                                   |       | 3,466                        |       | (359 | ) |
| Accrued expenses  and other liabilities                                            |       | 13,998                       |       | (5,451 | ) |
| Income taxes  payable                                                              |       | 4,290                        |       | 81 |   |
| Net cash  provided by operating activities                                         |       | 6,826                        |       | 78,952 |   |
|                                                                               |       |                         |       |   |   |
| INVESTING  ACTIVITIES:                                                             |       |                         |       |   |   |
| Acquisition of  property and equipment                                             |       | (8,140                       | )          | (7,849 | ) |
| Purchases of  investments                                                          |       | (195,602                     | )          | (201,673 | ) |
| Proceeds from  sold or matured investments                                         |       | 189,441                      |       | 268,200 |   |
| Acquisition of  patents                                                            |       | (5,990                       | )          | — |   |
| Acquisition of  minority interest                                                  |       | (2,000                       | )          | — |   |
| Net cash  provided by (used in) investing activities                               |       | (22,291                      | )          | 58,678 |   |
|                                                                               |       |                         |       |   |   |
| FINANCING  ACTIVITIES:                                                             |       |                         |       |   |   |
| Proceeds from  issuance of common stock                                            |       | 10,410                       |       | 4,154 |   |
| Redemption of  convertible subordinated notes                                      |       | —                       |       | (57,336 | ) |
| Payments on  capital lease obligations                                             |       | (24                          | )          | (20 | ) |
| Purchases of  treasury stock                                                       |       | —                       |       | (50,000 | ) |
| Net cash  provided by (used in) financing activities                               |       | 10,386                       |       | (103,202 | ) |
|                                                                               |       |                         |       |   |   |
| EFFECT OF  EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS                      |       | (1,847                       | )          | 375 |   |
| NET INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS                              |       | (6,926                       | )          | 34,803 |   |
| CASH AND CASH  EQUIVALENTS AT BEGINNING OF THE PERIOD                              |       | 110,632                      |       | 114,246 |   |
| CASH AND CASH  EQUIVALENTS AT END OF THE PERIOD                                    |       | $                            | 103,706    |   | $ | 149,049 |   |

 

5

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| ** **                                         | ** ** | **For the six months ended** | ** ** |
|----------------------------------------------------|------------|------------------------------|------------|
| ** **                                         | ** ** | **June 30,**            | ** ** |
| ** **                                         | ** ** | **2004**                     | ** ** | **2005** | ** ** |
|                                               |       |                         |       |   |   |
| SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION: |       |                         |       |   |   |
| Interest paid                                      |       | $                            | 4,482      |   | $ | 4,324 |   |
| Income taxes  paid, net                            |       | $                            | 2,159      |   | $ | 1,569 |   |

 

See Notes toUnaudited Consolidated Financial Statements.

 

6

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**CYMER, INC.**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**Three and Six Months Ended June 30, 2005**

**(Unaudited)**

 

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

 

*Unaudited Interim Financial Data*– The accompanying consolidated financial information has been prepared byCymer, Inc., and its wholly-owned and majority-owned subsidiaries(collectively, “Cymer”), without audit, in accordance with the instructions to Form 10-Q.In the opinion of management, the unaudited consolidated financial statementsfor the interim periods presented reflect all material adjustments, consistingonly of normal recurring adjustments, necessary for a fair presentation of thefinancial position and results of operations as of and for such periodsindicated.  These unaudited consolidatedfinancial statements and notes hereto should be read in conjunction with theconsolidated financial statements and notes thereto included in Cymer’s AnnualReport on Form 10-K for the year ended December 31, 2004.  Results for the interim periods presentedherein are not necessarily indicative of results that may be reported for anyother interim period or for the entire fiscal year.

 

*Principles of Consolidation*– The consolidated financial statements include the accounts of Cymer, Inc.,its wholly owned subsidiaries – Cymer Japan, Inc. (“Cymer Japan”), CymerSingapore 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”),and its majority-owned subsidiary, Cymer Korea, Inc. (“Cymer Korea”).  Cymer, Inc. owns 81% of CymerKorea.  Cymer Japan is currently the onlysubsidiary office of Cymer that sells excimer light source systems.  In addition, Cymer Japan provides fieldservice to customers in the Japan region. Cymer Singapore, Cymer B.V., CymerSEA, and Cymer PRC are field service offices for customers in those respectiveregions.  Cymer Korea provides refurbishmentmanufacturing, field service, and administrative activities for that region.All significant intercompany balances have been eliminated in consolidation.

 

*Accounting Estimates* – Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America (“GAAP”) requires managementto make estimates and assumptions that affect the reported amounts of assetsand liabilities and disclosure of contingent assets and liabilities at the dateof the financial statements and the reported amounts of revenues and expensesduring the reporting period.  Actualresults may differ from those estimates.

 

*Recent Accounting Pronouncements.*

 

In December 2004, the FinancialAccounting Standards Board (“FASB”) issued Statement of Financial AccountingStandards No. 123R (“SFAS No. 123R”) “Share-Based Payment - AnAmendment to Statement Nos. 123 and 95,” that addresses the accounting forshare-based payment transactions in which an enterprise receives employeeservices in exchange for (a) equity instruments of the enterprise or (b) liabilitiesthat are based on the fair value of the enterprise’s equity instruments or thatmay be settled by the issuance of such equity instruments. This statement willeliminate the ability to account for share-based compensation transactionsusing Accounting Principles Board (“APB”) Opinion No. 25, “Accounting forStock Issued to Employees,” and will instead require that such transactions beaccounted for using a fair-value-based method.  On April 14, 2005,the U.S. Securities and Exchange Commission (“SEC”) announced the deferral ofthe effective date of SFAS No. 123R. The deferral allows companies to adopt the provisions of SFAS No. 123Rbeginning on the first annual period beginning after June 15, 2005.  Based on the new required adoption date,Cymer plans to adopt SFAS No. 123R as of the beginning of the firstquarter of 2006.

 

7

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*Reclassifications*– Certain amounts in the prior year consolidated financialstatements have been reclassified to conform to current periodpresentation.  As of December 31,2004, $86.8 million of auction rate securities were reclassed from cash andcash equivalents to short-term investments.

 

**2.****             ****STOCKHOLDERS’ EQUITY**

 

*StockRepurchase Program.*  On January 27, 2005, Cymer announcedthat its board of directors had authorized Cymer to repurchase up to $50million of Cymer’s common stock in the open market or in privately negotiatedtransactions. Through June 30, 2005 Cymer had purchased 1,942,959 sharesfor $50 million, thereby completing the program.

 

*Equity Incentive Plan. *On May 19, 2005, at Cymer’s annual meeting of stockholders, Cymer’sstockholders approved Cymer’s 2005 Equity Incentive Plan (the “2005 Plan”).  The 2005 Plan provides for the grant or awardof various equity incentives to Cymer’s employees, directors and consultants. Uponapproval of the 2005 Plan by the stockholders, Cymer discontinued the use ofits 1996 Stock Option Plan and 2000 Equity Incentive Plan for future equityawards.  A total of 1,000,000 shares ofcommon stock are reserved for issuance under the 2005 Plan and provides for theissuance of incentive stock options, nonstatutory stock options,  stock appreciation rights, stock bonus awards,stock purchase awards, stock unit awards and other stock awards.

 

*EmployeeStock Purchase Plan.*InFebruary 2005, the board of directors approved an amendment to Cymer’s1996 Employee Stock Purchase Plan (“ESPP”). Effective May 1, 2005, theamendment: a) changed duration of offering periods under the plan from 24months to 6 months, b) reduced the discount to market price used to determinepurchase price for shares of Cymer’s common stock under the plan from 15% to5%, and c) eliminated the “lookback” feature that allowed the purchase price tobe determined as of the beginning of an offering period, or enrollment date, ifthe market price as of the enrollment date was lower than the market price atthe end of the offering period.

 

*Accelerated Vesting of Stock Options. *In February 2005, Cymer’s board of directors approved theacceleration of the vesting of stock options that had exercise prices of $30.50per share or higher held by employees. This acceleration of stock optionsexcluded directors, executive officers and certain vice presidents. The purposeof this acceleration of vesting was to enable Cymer to eliminate recognizing inits statement of operations the compensation expense associated with these “outof the money” stock options in future periods, upon adoption of SFAS No. 123Rin the first quarter of 2006.

 

*Stock-Based Compensation.*Cymerapplies the intrinsic value-based method of accounting prescribed by APBOpinion No. 25, “Accounting forStock Issued to Employees”, and related interpretations including FASBInterpretation No. 44, “Accountingfor Certain Transactions involving Stock Compensation an interpretation of APBOpinion No. 25”**to account forits stock option plans.  Under thismethod, employee-based stock compensation expense is measured on the date ofgrant only if the then current market price of the underlying stock exceededthe exercise price and is recorded on a straight-line basis over the applicablevesting period.  Statement of FinancialAccounting Standards Board No. 123 (“SFASNo. 123”) “Accounting forStock-Based Compensation”, established accounting and disclosurerequirements using a fair value-based method of accounting for stock-basedemployee compensation plans.  As allowed by SFAS No. 123, Cymer has elected tocontinue to apply the intrinsic value-based method of accounting describedabove, and has adopted the disclosure requirements of SFAS No. 123, asamended by SFAS No. 148, “Accounting for Stock-BasedCompensation—Transition and Disclosure”*.*

 

All options granted under the plans had anexercise price equal to the market value of the underlying common stock on thedate of grant.

 

Cymer accounts foroptions granted to non-employees under SFAS No. 123 and Emerging IssuesTask Force Issue No. 96-18, “Accounting for Equity Instruments that areIssued to other than Employees for Acquiring or in Conjunction with SellingGoods or Services”.  Cymer measures thefair value of such

 

8

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options using the Black-Scholes option-pricingmodel at each financial reporting date. Cymer accounts for changes in fair values between reporting dates inaccordance with Financial Accounting Interpretation 28.  Stock-based compensation expense for optionsgranted to non-employees and for those employees who changed status for the sixmonths ended June 30, 2004 and 2005 was $252,000 and $356,000,  respectively.

 

Under SFAS No. 123, the weighted averageper share fair value of the options granted for the six months ended June 30,2004 and 2005 was $25.50 and $16.24, respectively, on the date of grant.  Fair value under SFAS No. 123 isdetermined using the Black-Scholes option-pricing model with the assumptionsnoted below.  For the risk free interestrate, Cymer uses the then currently available rate on zero coupon U.S.Government issues with a remaining life of five years for valuing options andone year for valuing ESPP shares.

 
| ** **                                 | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|--------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                 | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                                 | ** ** | **2004**               | ** ** | **2005**             | ** ** | **2004** | ** ** | **2005** | ** ** |
|                                       |       |                   |       |                 |       |   |   |   |   |
| Dividend yield                             |       | None                   |       | None                 |       | None |   | None |   |
| Volatility rate                            |       | 79%                    |       | 75%                  |       | 79% |   | 75% |   |
| Weighted average  risk free interest rate: |       |                   |       |                 |       |   |   |   |   |
| Options                                    |       | 3.72%                  |       | 3.87%                |       | 3.31% |   | 3.89% |   |
| ESPP                                       |       | 1.55%                  |       | 3.33%                |       | 1.55% |   | 3.33% |   |
| Expected life:                             |       |                   |       |                 |       |   |   |   |   |
| Options                                    |       | 6 years                |       | 6 years              |       | 6 years |   | 6 years |   |
| ESPP                                       |       | .5 years               |       | .5 years             |       | .5years |   | .5 years |   |

 

The following table compares earnings per share as reportedby Cymer to the pro forma amounts that would have been reported hadcompensation expense been recognized for Cymer’s stock-based compensation plansin accordance with SFAS No. 123 (in thousands, except per share amounts):

 
| ** **                                                                                                                                        | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                                                                                        | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                                                                                                                                        | ** ** | **2004**               | ** ** | **2005**             | ** ** | **2004** | ** ** | **2005** | ** ** |
|                                                                                                                                              |       |                   |       |                 |       |   |   |   |   |
| Net income, as  reported                                                                                                                          |       | $                      | 10,201     |                 | $          | 11,015 |   | $ | 17,357 |   | $ | 16,400 |   |
| Add: Stock-based  employee compensation expense included in reported net income, net of related  tax effects                                      |       | 122                    |       | 188                  |       | 202 |   | 340 |   |
| Deduct: Total  stock-based employee compensation expense determined under the fair value  based method for all awards, net of related tax effects |       | (4,706                 | )          | (2,053               | )          | (9,210 | ) | (15,951 | ) |
|                                                                                                                                              |       |                   |       |                 |       |   |   |   |   |
| Pro forma net  income                                                                                                                             |       | $                      | 5,617      |                 | $          | 9,150 |   | $ | 8,349 |   | $ | 789 |   |
|                                                                                                                                              |       |                   |       |                 |       |   |   |   |   |
| Earnings per  share:                                                                                                                              |       |                   |       |                 |       |   |   |   |   |
| Basic - as  reported                                                                                                                              |       | $                      | 0.28       |                 | $          | 0.31 |   | $ | 0.47 |   | $ | 0.45 |   |
| Basic - pro  forma                                                                                                                                |       | $                      | 0.15       |                 | $          | 0.26 |   | $ | 0.15 |   | $ | 0.02 |   |
|                                                                                                                                              |       |                   |       |                 |       |   |   |   |   |
| Diluted - as  reported                                                                                                                            |       | $                      | 0.27       |                 | $          | 0.30 |   | $ | 0.46 |   | $ | 0.45 |   |
| Diluted - pro  forma                                                                                                                              |       | $                      | 0.15       |                 | $          | 0.25 |   | $ | 0.15 |   | $ | 0.02 |   |

 

9

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Theacceleration of vesting of “out of the money” stock options in the six monthsended June 30, 2005, contributed approximately $10.4 million of pro formastock-based compensation expense during the six months ended June 30,2005.

 

As a result of the amendment to Cymer’s ESPP as of May 1, 2005, thisplan is a non-compensatory plan according to the valuation and disclosure requirementsunder SFAS No. 123.  Therefore,Cymer no longer calculates pro forma stock-based compensation expense for ESPP.

 

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

 

*Earnings Per Share*– Basic earnings per share (“EPS”)excludes dilution and is computed by dividing net income or loss attributableto common stockholders by the weighted-average of common shares outstanding forthe period.  Diluted EPS reflects thepotential dilution that could occur if securities or other contracts to issuecommon stock (convertible subordinated notes, warrants to purchase common stockand common stock options using the treasury stock method) were exercised orconverted into common stock. Potential dilutive securities are excluded fromthe diluted EPS computation in loss periods as their effect would beanti-dilutive.

 

The following table sets forth thecomputation of diluted weighted average common and potential common sharesoutstanding for the three and six months ended June 30, 2004 and 2005 (inthousands):

 
| ** **                                                               | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|--------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                               | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                                                               | ** ** | **2004**               | ** ** | **2005**             | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                               | ** ** | ** **             | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic weighted  average common shares outstanding                        |       | 36,735                 |       | 35,841               |       | 36,661 |   | 36,360 |   |
|                                                                     |       |                   |       |                 |       |   |   |   |   |
| Effect of  dilutive securities:                                          |       |                   |       |                 |       |   |   |   |   |
| Warrants                                                                 |       | 23                     |       | —               |       | 37 |   | — |   |
| Options                                                                  |       | 915                    |       | 325                  |       | 1,148 |   | 335 |   |
|                                                                     |       |                   |       |                 |       |   |   |   |   |
| Diluted weighted  average common and potential common shares outstanding |       | 37,673                 |       | 36,166               |       | 37,846 |   | 36,695 |   |

 

Forthe three months ended June 30, 2004 and 2005, weighted average optionsand warrants to purchase 2,959,000 and 5,706,000 shares of common stock,respectively, were outstanding but not included in the computation of dilutedearnings per share as their effect was anti-dilutive.  In addition, for the three months ended June 30,2004 and 2005, weighted average common shares attributable to convertiblesubordinated notes of 5,000,000 and 3,451,000, respectively, were not includedin the computation of diluted earnings per share as their effect was alsoanti-dilutive.

 

Forthe six months ended June 30, 2004 and 2005, weighted average options andwarrants to purchase 1,425,000 and 5,724,000 shares of common stock,respectively, were outstanding but not included in the computation of dilutedearnings per share as their effect was anti-dilutive.  In addition, for the six months ended June 30,2004 and 2005, weighted average common shares attributable to convertiblesubordinated notes of 5,000,000 and 3,732,000, respectively, were not includedin the computation of diluted earnings per share as their effect was alsoanti-dilutive.

 

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**4.****              INVENTORIES**

 

Inventories consisted of the following as of December 31,2004 and June 30, 2005 (in thousands): 

 
| ** **                                   | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|----------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                   | ** ** | **2004**              | ** ** | **2005**          | ** ** |
| INVENTORIES:                                 |       |                  |       |              |       |
| Raw materials                                |       | $                     | 48,131     |              | $          | 42,372 |   |
| Work-in-progress                             |       | 24,344                |       | 15,891            |       |
| Finished goods                               |       | 46,093                |       | 38,231            |       |
| Allowance for  excess and obsolete inventory |       | (8,546                | )          | (6,144            | )          |
| Total                                        |       | $                     | 110,022    |              | $          | 90,350 |   |

 

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

 

Comprehensive income includesnet income, effective unrealized gains and losses on forward contracts, foreigncurrency translation adjustments, and unrealized gains and losses onavailable-for-sale securities, which are recorded as short-term and long-terminvestments in the accompanying consolidated balance sheets.

 

The following tablesummarizes the change in each component of accumulated other comprehensive lossfor the six months ended June 30, 2005 (in thousands):

 
| ** **         | ** ** | ** **         | ** ** | **Total unrealized**   | ** ** | **Total unrealized**  | ** ** | ** **                | ** ** |
|--------------------|------------|--------------------|------------|------------------------|------------|-----------------------|------------|---------------------------|------------|
| ** **         | ** ** | ** **         | ** ** | **losses on**          | ** ** | **gains (losses) on** | ** ** | **Accumulated**           | ** ** |
| ** **         | ** ** | **Translation**    | ** ** | **available-for-sale** | ** ** | **foreign currency**  | ** ** | **other**                 | ** ** |
| ** **         | ** ** | **adjustment,**    | ** ** | **investments,**       | ** ** | **forward exchange**  | ** ** | **comprehensive**         | ** ** |
| ** **         | ** ** | ** **         | ** ** | **net of tax**         | ** ** | **net of tax**        | ** ** | **contracts, net of tax** | ** ** | **loss** | ** ** |
| ** **         | ** ** | ** **         | ** ** | ** **             | ** ** | ** **            | ** ** | ** **                | ** ** | ** ** | ** ** |
| December 31,  2004 |       | Balance            |       | $                      | (3,776     | )                     | $          | (224                      | )          | $ | (455 | ) | $ | (4,455 | ) |
|               |       | Period net  change |       | 221                    |       | (364                  | )          | 758                       |       | 615 |   |
| June 30, 2005      |       | Balance            |       | $                      | (3,555     | )                     | $          | (588                      | )          | $ | 303 |   | $ | (3,840 | ) |

 

Comprehensive income consistedof the following components (in thousands):

 
| ** **                                                                   | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                   | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                                                                   | ** ** | **2004**               | ** ** | **2005**             | ** ** | **2004** | ** ** | **2005** | ** ** |
|                                                                         |       |                   |       |                 |       |   |   |   |   |
| Net income                                                                   |       | $                      | 10,201     |                 | $          | 11,015 |   | $ | 17,357 |   | $ | 16,400 |   |
|                                                                         |       |                   |       |                 |       |   |   |   |   |
| Foreign currency  translation adjustments, net of tax                        |       | (1,235                 | )          | (64                  | )          | (1,089 | ) | 221 |   |
| Unrealized gains  (losses) on available for sale investments, net of tax     |       | (1,006                 | )          | 230                  |       | (1,194 | ) | (364 | ) |
| Unrealized gains  on foreign currency forward exchange contracts, net of tax |       | 1,124                  |       | 82                   |       | 1,186 |   | 758 |   |
| Comprehensive  income                                                        |       | $                      | 9,084      |                 | $          | 11,263 |   | $ | 16,260 |   | $ | 17,015 |   |

 

11

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

 

In January 2004, Cymer entered into a researchand development agreement with Intel Corporation (“Intel”). Under thisagreement, Intel will provide Cymer a total of $20.0 million over a three-yearperiod to accelerate the development of production-worthy extreme ultraviolet (“EUV”)lithography light sources.  The fundingfrom Intel under this agreement is milestone based and is netted against Cymer’stotal research and development expenses in the period that the milestone isachieved.  Due to the complexity of theEUV technology, Cymer and Intel have regular communications on the milestonesunder the contract and the timing and requirements for their completion. Thetotal funded amounts recorded under this agreement for the three months ended June 30,2004 and 2005 were $1.6 million and $104,000, respectively.  Funding amounts recorded for the six monthsended June 30, 2004 and 2005 were $2.4 million and $1.7 million,respectively.

 

InFebruary 2004, Cymer entered into an intellectual property licenseagreement with Intel for the use of certain Intel patents and trade secretsrelated to EUV technology. Under the terms of this agreement, Cymer will paylicense fees to Intel if Cymer is successful in commercializing an EUVlithography light source capable of high volume manufacturing by the end of thesecond quarter of 2008. The license payments under this agreement are triggeredin the quarter in which Cymer successfully ships the first complete high volumemanufacturing EUV source system.  Commencingwith shipment of this first unit, Cymer will pay Intel $1.25 million in licensefees per quarter for a period of sixteen quarters.  The quarterly license amounts paid to Intel,if any, will be related to Cymer’s sale of EUV light source systems and, as aresult, will be recorded as cost of product sales.  The methodology and amounts that will berecorded to cost of product sales will be determined when the high volumemanufacturing production unit sales or a forecast of sales can be made.  No amounts have been earned under this arrangementas of June 30, 2005.

 

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

 

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

 

Duringthe fourth quarter of 2004, Cymer completed its annual impairment test ofgoodwill and intangible assets, and concluded that no impairment of goodwillexisted.

 

The carrying amount of goodwill was $8.4 million as ofDecember 31, 2004 and June 30, 2005.

 

Aggregate amortization expense for identifiable intangibles, excludingpatents, was $80,000 and $20,000 for the six months ended June 30, 2004and 2005, respectively. Costs associated with these identifiable intangibles,excluding patents, were fully amortized as of March 31, 2005 and thus, noadditional amortization was recorded for the three months ended June 30,2005.

 

Also included in intangible assets – net on the accompanying balancesheets are amounts associated with patents that were acquired in 2001 and2003.  As of December 31, 2004 and June 30,2005, the net carrying amount of these patents was $10.4 million and $9.2million, respectively.  Amortizationexpense for these patents which is included in research and developmentexpenses and cost of product sales was $593,000 for each of the three monthsended June 30, 2004 and 2005.  Amortizationexpense was $1.2 million in total for each of the six months ended June 30,2004 and 2005.

 

As of June 30, 2005, future estimatedamortization expense for these patents is expected to be as follows (inthousands):

 

12

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| ** **                                | ** ** | **Future**       | ** ** |
|-------------------------------------------|------------|------------------|------------|
| ** **                                | ** ** | **Amortization** | ** ** |
|                                      |       |             |       |
| Six months  ending December 31, 2005 |       | $                | 1,186      |   |
| Year ending  December 31, 2006       |       | $                | 2,371      |   |
| Year ending  December 31, 2007       |       | $                | 2,371      |   |
| Year ending  December 31, 2008       |       | $                | 2,371      |   |
| Year ending  December 31, 2009       |       | $                | 889        |   |

 

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

 

Cymer adopted the disclosureprovisions of Financial Accounting Standards Board Interpretation No. 45 (“FIN45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees,Including Indirect Guarantees of Indebtedness to Others”, during the quarterended December 31, 2002 and adopted the recognition and measurementprovisions as required after December 31, 2002.  FIN 45 provides expanded accounting guidancesurrounding liability recognition and disclosure requirements related toguarantees, as defined by this interpretation.

 

Inthe ordinary course of business, Cymer is not subject to potential obligationsunder guarantees that fall within the scope of FIN 45, except for standardwarranty provisions associated with product sales and indemnificationprovisions related to intellectual property that are contained within many ofits customer agreements.  All of theseprovisions give rise only to the disclosure requirements prescribed by FIN 45.

 

ProductWarranties – Warranty provisions contained within Cymer’s customer agreementsare generally consistent with those prevalent in the semiconductor equipmentindustry. The warranty period and terms vary by light source system model.  In general, the light source system warrantyperiod ranges from 17 to 26 months after shipment. Cymer also warrantsconsumables and spare parts sold to its customers and the coverage periodvaries by spare part type as some types include time-based warranty periods andothers include usage-based warranty periods. On average, the warranty periodfor consumables and spare parts is approximately six months from the date ofshipment.  Cymer records a provision forwarranty for all products, which is included in cost of product sales in theconsolidated statements of operations and is recorded at the time that therelated revenue is recognized. The warranty provision for light source systemsis reviewed monthly and determined using a statistical financial model, whichconsiders actual historical expenses, and potential risks associated with Cymer’sdifferent light source system models. This model is then used to calculate thefuture probable expenses related to warranty and the required level of thewarranty provision.  The risk levels andhistorical cost information used within this model are reviewed throughout theyear and updated as risk levels change over the light source system’s lifecycle. The warranty provision for consumables and spares is determined usingactual historical data. For both light source systems and consumables, ifactual warranty expenditures differ substantially from Cymer’s estimates,revisions to the warranty provision would be required.  Actual warranty expenditures are recordedagainst the warranty provision as they are incurred.

 

The following tablesummarizes information related to Cymer’s warranty provision for the six monthsended June 30, 2005 (in thousands):

 

| ** **                                                                                            | ** ** | **2005** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|----------|------------|
|                                                                                                  |       |     |       |
| Balance,  December 31, 2004                                                                      |       | $        | 28,200     |   |
| Liabilities  accrued for warranties issued during the six months, net of adjustments and  expirations |       | 10,599   |       |
| Warranty  expenditures incurred during the six months                                                 |       | (11,594  | )          |
| Balance,  June 30, 2005                                                                          |       | $        | 27,205     |   |

 

IntellectualProperty Indemnifications – Cymer includes intellectual propertyindemnification clauses within its general terms and conditions with itscustomers and the general purchase agreements with its three major customers,ASM Lithography, Canon, and Nikon.  Ingeneral, these indemnification

 

13

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provisionsprovide that Cymer will defend its customers against any infringement claimsthat arise related to Cymer’s products. Under the indemnification clauses, Cymer will pay all costs and damages,including attorney’s fees, associated with such settlements or defenses,provided that the customer follows specific procedures for notifying Cymer ofsuch claims and allows Cymer to manage the settlement proceedings. Due to thenature of these indemnification provisions, they are indefinite and extendbeyond the term of the actual customer agreements.

 

An indemnification provision was also included in the contractmanufacturing agreement with Seiko Instruments, Inc. (“Seiko”), which wasterminated effective March 31, 2003. As with Cymer’s indemnification provisions on intellectual property,Cymer will continue to honor this indemnification clause within the agreementeven after its termination. Seiko and at least one Japanese customer have beennotified that Cymer’s light source systems in Japan may infringe certainJapanese patents.  Cymer believes, basedupon the advice of counsel, that Cymer’s products do not infringe any validclaim of the asserted patents or that Cymer is entitled to prior use claims inJapan.

 

As part of the research and development agreement signed with Intel in2004, Cymer also agreed to provide Intel with indemnity against anyinfringement of the intellectual property rights of any third party arisingfrom Intel’s purchase and/or use of Cymer’s EUV source systems.  Details of such indemnity will be negotiatedas part of a purchase agreement related to potential future products.

 

**9.****             ****CONVERTIBLE SUBORDINATED NOTES**

 

In February 2002, Cymer issued$250.0 million principal amount of unsecured fixed rate 3.50% convertiblesubordinated notes due February 15, 2009 with interest payable on February 15and August 15 of each year. These notes are convertible into shares ofCymer common stock at a conversion rate of 20 shares per $1,000 principalamount or an effective conversion price of $50.00 per share. Cymer mayredeem the 2002 Notes on or after February 20, 2005.  The 2002 Notes are subordinated to Cymer’sexisting and future senior indebtedness and effectively subordinated to allindebtedness and other liabilities of Cymer’s subsidiaries.  As of December 31, 2004, Cymer had $200.8million principal amount of convertible subordinated notes outstanding.  In the secondquarter of 2005, Cymer repurchased, at a discount to par, $60.0 million principalamount of these notes. As a result of this repurchase, Cymer recognized a gainon debt extinguishment of $2.2 million for the six months ended June 30,2005. As of June 30, 2005, Cymer had $140.7 million principal amount ofconvertible subordinated notes outstanding.

 

**10.****       COMMITMENTSAND CONTINGENCIES**

 

Cymer is party to legal actions in the normal courseof business.  Based in part on the adviceof legal counsel, management does not expect the outcome of legal action in thenormal course of business to have a material impact on the financial position,liquidity, or results of operations of Cymer.

 

Cymer’s former Japanese manufacturing partner, Seiko, and one of Cymer’sJapanese customers have been notified that Cymer’s light source systems inJapan may infringe certain Japanese patents held by another Japanesecompany.  Cymer has agreed to indemnifyits former Japanese manufacturing partner and its customers against patentinfringement claims under certain circumstances, even after the terminationdate of the contract manufacturing agreement. Cymer believes, based upon the advice of counsel, that Cymer’s productsdo not infringe any valid claim of the asserted patents or that Cymer isentitled to prior use claims in Japan.

 

**11.****       SUBSEQUENT EVENT**

 

On July 15, 2005, Cymer entered into a Joint Venture Agreement(the “JV Agreement”) with (i) Carl Zeiss SMT AG, a German corporation (“SMT”);(ii) Carl Zeiss Laser Optics Beteiligungsgesellschaft mbH, a Germanlimited liability company (“LOB”); and (iii) the Swiss liability company thatwill be formed

 

14

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as part of the JV Agreement and named TCZ GmbH (“TCZ”).  TCZ is expected to develop, integrate, marketand sell and support tools employing an excimer laser beam to inducecrystallization of low-temperature poly-silicon (“LTPS”) processing for themanufacture of flat panel displays.  LOBand SMT, together with their affiliated entities, are collectively referred toas “Zeiss”.

 

TCZ will be owned 60% by Cymer and 40% by Zeiss.  As an initial capital contribution to TCZ,Cymer plans to contribute approximately $14.2 million in cash in the thirdquarter of 2005.  Cymer anticipatesconsolidating the financial position and results of operations of TCZ and reflectingZeiss interest or ownership in TCZ as minority interest in the consolidatedfinancial statements.  If TCZ isdissolved, the intellectual property owned by TCZ will be distributed to themembers as joint owners, and the remaining assets, net of liabilities, will bedistributed to the members in accordance with their percentage interests.

 

Once TCZ is formed, Cymerwill enter into various agreements with TCZ. Included in these agreements will be a long-term supply agreement whichwill allow Cymer to provide TCZ with components for TCZ’s products and anintellectual property agreement which will dictate the use of any intellectualproperty developed by Cymer for the JV.

 

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

 

*Inthis section, references to “we”, “us” or “our” are references to Cymer.**The following discussion of ourfinancial condition and results of operations should be read in conjunctionwith our consolidated financial statements and notes thereto included in thisquarterly report on Form 10-Q and our consolidated financial statementsand notes thereto included in our annual report on Form 10-K for the yearended December 31, 2004.*

 

**Forward-Looking Statements**

 

Statementsin this Quarterly Report on Form 10-Q that are not strictly historical innature are forward-looking statements. These statements include, but are notlimited to, references to expected domestic and international product sales anddevelopment; research and development activities and expenditures; adequacy ofcapital resources and investments; effects of business cycles in thesemiconductor business; competitive positioning; and relationships withcustomers and third-party manufacturers for product manufacturing, and maycontain words such as “believes,” “anticipates,” “expects,” and words ofsimilar meaning. These statements are predictions based on current informationand expectations and involve a number of risks and uncertainties. Theunderlying information and expectations are likely to change over time.  Actual events or results may differmaterially from those projected in the forward-looking statements due tovarious factors, including, but not limited to, those set forth under thecaption “Risks and Uncertainties That May Affect Results” and elsewhere inthis Quarterly Report on Form 10-Q. Forward-looking statements herein speak only as of the date of thisQuarterly Report on Form 10-Q.

 

#### **Overview**

 

*General*

 

Weare the world’s leading supplier of light source solutions for thesemiconductor industry.  Our productsprovide the essential light source for 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 currently supply light sources to allthree lithography tool manufacturers, ASM Lithography, Canon, and Nikon, who inturn supply their wafer steppers and scanners to chipmakers.  In addition,we sell replacement parts and services to the lithography tool manufacturers aswell as directly to the chipmakers.  Ourlight source systems currently constitute a substantial majority of all excimerlight sources incorporated in lithography stepper and scanner tools. We areheadquartered in San Diego, California where we develop and manufacture all ofour light source systems.  As a largeportion of our revenue is derived from customers located outside of the United

 

15

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States, we maintain a manufacturing spares facility and field serviceoffice in Korea and field service and support offices in Japan, Taiwan,Singapore, the People’s Republic of China and the Netherlands. We also maintainfield service offices in the United States to service our installed base oflight sources located in the United States.

 

InJuly 2005, we announced that we are forming a joint venture with Zeiss.The joint venture is named TCZ GmbH and it will develop, integrate, market andsell and support production tools for the flat panel display manufacturingindustry.  The joint venture will beheadquartered in San Diego and will be owned 60% by us and 40% by Zeiss. Thejoint venture is targeting the growing market for low-temperature poly-silicon(“LTPS”) processing used in the manufacture of liquid crystal displays that arebrighter, have higher resolution, and consume less power than displays usingtoday’s predominant amorphous silicon films. We currently expect that TCZ will ship its first production tool, theTCZ 900X, in the second or third quarter of 2006, and we expect that TCZ willbreak even from a financial standpoint in 2008.

 

***Products***

 

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

 

Our photolithography light sources produce narrowbandwidth pulses of short wavelength light within the DUV spectrum. The DUVwavelengths are measured in nanometers (“nm”). One nanometer equals onebillionth of a meter.  The light sourcesare referred to according to the gases mixed to produce the light or by thewavelength.  Krypton Fluoride (“KrF”)gases produce 248 nm light and Argon Fluoride (“ArF”) gases produce 193 nmlight. The light sources permit very fine feature resolution for imaging thecircuitry on the wafer and high throughput in wafer processing.  We have designed our light sources to behighly reliable, easy to install and compatible with existing semiconductormanufacturing processes. Our light sources are used to pattern the integratedcircuits, which are also called semiconductors or “chips,” that power many oftoday’s advanced consumer and business electronics. In the second quarter of2005, we sold 56 light source systems at an average selling price of $940,000.

 

Certain components and subassemblies included in ourlight sources require replacement or refurbishment following extendedoperation.  For example, the dischargechamber of our light sources has an expected life of approximately three totwenty-four billion pulses, depending on the model. 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 these and other spare andreplacement parts for our photolithography light sources as needed by ourcustomers.

 

Asthe life and usage of our installed base of light sources in production atchipmakers exceeds the original warranty periods (generally 17 to 26 monthsfrom date of shipment), some chipmakers request service contracts from us.  Additionally, we provide billable service orservice contracts directly to the three semiconductor lithography toolmanufacturers. These service agreements require us to maintain and/or servicethese light sources either on an on-call or regular interval basis orboth.  Some of these contracts includereplacement of consumable parts and non-consumable parts.

 

In addition to service contracts, we offer CymerOnLineTM,a diagnostic and performance software product, which delivers criticallaser diagnostics and performance information in near real-time directly toauthorized users anywhere.  The softwaresimplifies reporting and allows users to efficiently manage consumablesusage.  CymerOnLine features auser-friendly browser-based interface, which features a robust design andprovides a secure data environment. Event-initiated messages sent to pagers, e-mail, mobile phones, or otherhandheld devices enable up-to-the minute communication and proactivemanagement.

 

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#### ***Semiconductor Industry Status and Outlook***

 

Since we derive a substantial portion of our revenues from lithographytool manufacturers, we are subject to the volatile and unpredictable nature ofthe semiconductor industry. The semiconductor industry is highly cyclical innature and historically has experienced periodic ups and downs. Since 2000, thefinal year of the last significant and prolonged peak in the cycle, thesemiconductor industry experienced one of the longest downturns in its historyfrom 2001 through late 2003. Although this downturn and others like itnegatively impact our business and results of operations, we make every effortto manage our business through the cycles by maintaining our annualprofitability and taking the necessary steps during the downturns to bestrategically positioned for the next upturn. For example, during this extended downturn, we made several such strategicinvestments including the completion of our new manufacturing facilities in SanDiego and Korea, the development and introduction of our new Master OscillatorPower Amplifier (“MOPA”) technology and XL platform, on which our two-chamberArF DUV light sources reside, and the ongoing work to improve businessprocesses that leverage the overall efficiency of our workforce.

 

We were once again subjected to the volatility andswings in the semiconductor industry during the period from late 2003 through theend of 2004. In the latter half of 2003, we saw several indicators that theextended downturn in the semiconductor industry was coming to an end and thatan upturn was in sight.  During the finalmonths of 2003, we experienced strong order growth, and the chipmakers’utilization of our DUV light sources exceeded the levels achieved in 2000, thepeak of the last extended upturn.  As weentered 2004, these positive indicators translated into increased levels ofshipments of our light source products and increased levels of overallrevenue.  We experienced these higherrevenue levels and revenue growth for the first nine months of 2004.  However, during the third quarter of 2004, thoughour business remained strong and we had received no order push outs, manysemiconductor and equipment companies issued warnings about potentialshortfalls in revenue and earnings. Starting in September 2004 and continuing through the end of 2004,the utilization rates of our light sources experienced significant declines andwe received notification of light source push outs from our directcustomers.  By the end of 2004 and goinginto 2005, it was clear that the upturn in the semiconductor industry had beentruncated and we had entered what appeared to be a slowdown in the industry.  Though this slowdown initially resulted in anincrease in our uncertainty in the semiconductor industry and reduced ourvisibility and ability to forecast, more recent indicators have turned somewhatpositive.

 

One of these positive indicators was a 14% increase inour total revenues in the second quarter of 2005 as compared to the firstquarter of 2005.  Our revenues werehigher than expected in the second quarter of 2005 due to stronger thanforecasted demand for our consumables and spare parts.  In addition, the utilization rates of ourlight sources at chipmakers in the second quarter of 2005 was up over thelevels recorded in the prior two quarters, and improved over the year-end 2004levels in every region.  Overallsemiconductor fab utilization picked up slightly to the 87% or 88% range in thesecond quarter from the mid 80% range in the first quarter of 2005.  Our most advanced technology products arecurrently the main driver of our light source system demand, and we expect thatin the near term, it will continue to be a significant portion of our bookings.

 

There is currently little agreement amongsemiconductor industry experts about what the second half of 2005 holds, withestimates for equipment shipments ranging from between down slightly to upslightly.  Recently, some equipmentcompanies have indicated that their businesses have leveled off and that theyexpect order levels to improve late this year. While the increase in our light source system utilization rates in thesecond quarter of 2005 is encouraging, until overall semiconductor fabutilization is sustained at levels well above 90%, we would expect our businessto be volatile and remain at or near its current levels.

 

During 2005 and going into 2006, we plan to continueto focus on improving asset management with particular emphasis on improvinginventory management and increasing operating efficiency. We will also continueour efforts to generate a significant amount of cash and improve shareholderreturns by achieving higher returns on assets, which includes increasing ourinventory turns and return on invested capital during the year.  In addition, we will continue to exploreopportunities on the most effective use of our cash, including the additionalpurchase of our own stock and convertible subordinated notes.

 

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

 

*General*

 

The discussion and analysis of our financial conditionand results of operations are based upon our consolidated financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States of America. The preparation of these financial statements requires us to makeestimates and use judgment that may impact the reported amounts of assets,liabilities, revenues, expenses, and related disclosure of contingent assetsand liabilities.  As a part of ourongoing internal processes, we regularly evaluate our estimates and judgments associatedwith revenue recognition, valuation of parts used in our refurbishmentmanufacturing process, inventory allowances, warranty provisions, income taxes,allowances for bad debts, long-lived assets valuation, intangible assetsvaluation, and contingencies and litigation. We base these estimates and judgments upon historical information andother facts and assumptions that we believe to be valid and/or reasonable underthe circumstances.  These assumptions andfacts form 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.

 

We believe that revenue recognition, valuation ofparts used in our refurbishment manufacturing process, inventory allowances,warranty provisions, and income taxes require more significant judgments andestimates in the preparation of our consolidated financial statements than doother of our accounting estimates and judgments.

 

*RevenueRecognition*

 

Our revenues consistof product sales, which include sales of light source systems, consumable andspare parts, upgrades, service, service contracts and training.  Our revenues also consist of certain fundeddevelopment activities performed for our customers and under governmentcontracts and license agreements.  We donot recognize any revenue for light source systems prior to shipment.  We test the systems in environments similarto those used by our customers prior to shipment to ensure that they meet thecustomers’ specifications and will interface with the customers’ software.  Our installation obligations are perfunctorywithin the framework of Staff Accounting Bulletin No. 104 (“SAB 104”).  The shipping terms vary by customer for lightsource systems shipments.  The majorityof light source shipment terms are F.O.B. shipping point and revenue isrecognized upon shipment.  For thosecustomers with F.O.B. destination shipping terms, revenue is recognized upondelivery of the light source system to the customer.  One of our customers has an acceptanceprovision, which is satisfied by the issuance of an acceptance certificatefollowing a visual inspection of the system by the customer. We do notrecognize revenue on systems shipped to that customer until we receive theacceptance certificate.  We have onearrangement where a portion of the light source system fee is not payable untilthe system is successfully installed at the end-user.  In accordance with SAB 104, given the installationis not essential to the functionality of the system, we defer this portion ofthe fee until the system is installed. Revenue from consumables and spare parts sales is recognized at thepoint that legal title passes to the customer, which is generally upon shipmentfrom our facility.  For a significantportion of our spare parts sales, our customers return the consumed assembly tous as part of the sale of a new part.  Wereuse some of the material within these core assemblies, mainly metal components,for the future build of core assemblies. As a result, our revenue consists of both cash and the value of thereusable parts received from our customers as consideration for these sparepart sales. Revenue associated with our customers’ return of core assemblies isrecognized upon receipt of the returned core assembly.  The amount of the revenue is determined basedupon the fair value of the reusable parts that we expect to yield from thereturned core assembly.  Service andtraining revenue is generally recognized at the time that the services arerendered or the training class is completed. Service contract revenues are generally recorded as revenue ratably overthe life of the contract or per the specific terms of the agreement. For fundeddevelopment contracts, which are included in other revenue, funds received areaccounted for on the percentage-of-completion method based on the relationshipof costs incurred to total estimated costs. Revenues generated from these typesof funded development contracts 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.  For some of the funded development contractsthat we enter into with customers and government agencies, we evaluate

 

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certain criteria to determine whether recording the funds received asrevenue is appropriate.  If certainconditions are met, these funds are not recorded as revenue but rather areoffset against our own internal research and development expenses in the periodthat the milestone is achieved or per the terms of the contract.

 

*Valuation of Parts Used in RefurbishmentManufacturing Process and Corrected Accounting Method*

 

Over the last several years as part of our regularbusiness activities, we have conducted significant parts refurbishmentactivities related to some of our core assemblies, in particular our chamberassemblies. The volume of this activity significantly increased in 2004. Theseactivities involve arrangements with our customers where we sell a new part tothe customer at a reduced sales price if the customer returns the consumedassembly 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 core assemblies.  Upon receipt of these consumed assembliesfrom our customers, we record an entry to recognize the estimated fair value ofthe reusable components as inventory and revenue.  The value of the reusable parts containedwithin the consumed assembly is determined based upon historical data on thevalue of the reusable parts that we typically yield from a consumedassembly.  The costs of refurbishment arealso capitalized as part of ending inventory as incurred.   As part of our normal excess and obsoleteinventory analysis, these consumed assemblies are also reviewed on a quarterlybasis and an inventory allowance is recorded as appropriate for theseparts.  The value that we assign to thesecore assemblies can be affected by the current demand for the reusable parts inour manufacturing operations and the actual yield rate achieved for partswithin these consumed core assemblies. We believe that our methodology for valuing the reusable parts withinthese returned core assemblies is reasonable, but any changes in the demand forthe parts or the yield of the parts included in these core assemblies couldhave a material adverse effect on our financial condition and results ofoperations.

 

Prior to the fourth quarter of 2004, we recorded thevalue of this material as a reduction of our cost of product sales in theperiod that the returned assembly was disassembled by our manufacturingoperations and the value of the reusable parts could be determined.  Upon further review of United States generallyaccepted accounting principles in the fourth quarter of 2004, we determinedthat we should instead estimate the value and record these consumed assembliesas inventory at the time that we receive the returned assembly from ourcustomer and concurrently record this amount as revenue rather than as areduction of cost of product sales.  During the fourth quarter of 2004, wecorrected our accounting treatment for these refurbishment activities andrecorded the financial impact for all of 2004 and prior years in our fourthquarter of 2004 financial statements.

 

***InventoryAllowance***

 

We perform an analysis of our inventory allowances onat least a quarterly basis to determine the adequacy of this allowance on ourfinancial 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 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 $8.5 million and $6.1million at December 31, 2004 and June 30, 2005, respectively.  The decrease in this allowance from December 31,2004 to June 30, 2005 was primarily due to the write-off of certainobsolete materials during the second quarter of 2005 and an overall decrease ininventory levels as of June 30, 2005.

 

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Themethodologies used to analyze excess and obsolete inventory and determine theinventory allowance are significantly affected by future demand and usage ofour products.  There are many factorsthat could potentially affect the future demand or usage of our products,including the following:

 

•                  Overall condition of thesemiconductor industry, which is highly cyclical in nature;

•                  Rate at which our customers takedelivery of our light source systems;

•                  Loss of any of our three majorcustomers or significant change in demand from any of these three customers;

•                  Mix of light source system models andany changes to that mix required by our customers; and

•                  Utilization rates of our lightsources at chipmakers.

 

Based upon our experience, we believe that theestimates we use in calculating the inventory allowance are reasonable andproperly reflect the risk of excess and obsolete inventory.  If actual demand or the usage periods for ourinventory are substantially different from our estimates, adjustments to ourinventory allowance may be required, which could have a material adverse effecton our financial condition and results of operations.

 

###### *WarrantyProvision*

###### * *

We maintain an accrual for the estimated cost ofproduct warranties associated with our product sales.  Warranty costs include the replacement partsand labor costs to repair our products during the warranty periods.  At the time revenue is recognized, we recorda warranty provision, which is included in cost of product sales in theaccompanying consolidated statements of operations. The warranty coverageperiod and terms vary by light source system model.  In general, the light source system warrantyperiod ranges from 17 to 26 months after shipment.  We also warrant consumables and spare partssold to our customers and the coverage period varies by spare part type as sometypes include time based warranty periods and others include usage basedwarranty periods.  On average, thewarranty period for consumables and spare parts is approximately six monthsfrom the date of shipment. The warranty provision for light source systems isreviewed monthly and determined by using a statistical financial model, whichtakes into consideration actual historical expenses, and potential risksassociated with our different light source systems.  This model is then used to estimate futureexpenses related to warranty and the required warranty provision.  The risk levels and historical costinformation used within this model are reviewed throughout the year and updatedas risk levels change over the light source system’s life cycle. Due to thehighly technical nature of our light source system products, the newer modellight sources and the modules contained within them have higher inherentwarranty risks and require higher warranty provisions. The warranty provisionfor consumables and spare parts is determined by using actual historical data.

 

The total balance in the warranty provision accrual asof December 31, 2004 and June 30, 2005 was $28.2 million and $27.2million, respectively.  This decreasefrom period to period is primarily due to a decrease in spares and consumableparts sales and a change in the overall mix of light source systems underwarranty to those with lower warranty provision requirements.

 

We actively engage in product improvement programs andprocesses to limit our warranty costs, but our warranty obligation is affectedby the complexity of our product, product failure rates and costs incurred tocorrect those product failures at customer sites. The industry in which weoperate is subject to rapid technological change, and as a result, weperiodically introduce newer, more complex light sources.  Although we classify these newly releasedlight source models as having a higher risk in our warranty model resulting inhigher warranty provisions, we are more likely to have differences between theestimated and actual warranty costs for these new products.  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

 

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differ from our estimates, revisions to our estimated warrantyprovision would be required, which could have a material adverse effect on ourfinancial condition and results of operations.

 

*Income Taxes*

* *

Weaccount for income taxes in accordance with Statement of Financial AccountingStandards No. 109 (“SFAS 109”), “Accounting for Income Taxes.”  Pursuant to SFAS 109, a deferred tax asset orliability is generally recognized for the estimated future tax effectsattributable to temporary differences, net operating loss carryforwards and taxcredit carryforwards.  Deferred taxassets are to be reduced by a valuation allowance if, based on the weight ofavailable evidence, it is more likely than not that some portion or all of thedeferred tax assets will not be realized within the carryback or carryforwardperiods.  Information about an enterprise’scurrent financial position and its results of operations for the current andpreceding years, as well as all currently available information about futureyears 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 future yearsand to estimate when the benefits of our deferred tax assets are likely to berealized.  Based upon the analysis, webelieve that it is more likely than not that the results of future operationswill generate sufficient taxable income to realize the deferred tax assetswithin the period allowed by current applicable tax law and, as such, novaluation allowance against deferred tax assets is provided.

 

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 a valuationallowance is needed for some or all of our deferred tax assets, and wouldresult in an increase to our income tax provision in the period in which suchdetermination is made.

 

Our resultsreflect the impact of the American Jobs Creation Act of 2004, which repealedthe Extraterritorial Income Exclusion (“ETI”) subject to certain transitionrules.  The ETI benefit is being replacedwith a Manufacturing Activity deduction under Internal Revenue Code (“IRC”) Section 199,with a phase out of ETI benefits in 2005 and 2006.  Our estimated ETI benefit for 2005 reflectsthe transition rules. We will not take advantage of the Section 199deduction in 2005 due to the taxable income limitation.

 

We have not provided U.S. federal income and foreign withholding taxes on $35.2million of undistributed earnings from non-U.S. operations as of June 30,2005 as it has been our intention to reinvest undistributed earnings of ourforeign subsidiaries and thereby indefinitely postpone their remittance.  Accordingly, no provision has been made forforeign withholding taxes or United States income taxes which may becomepayable if undistributed earnings of foreign subsidiaries were paid asdividends to us.

 

Currently, we arenot considering the repatriation of any foreign earnings and as such, no impactis reported in the financial statements as of June 30, 2005.  However, we are still evaluating the impactof repatriation of foreign earnings under IRC Section 965. The AmericanJobs Creation Act of 2004, and IRC Section 965 allow a temporary 85%dividends received deduction on repatriated foreign earnings if the funds arereinvested in the United States.  FASBStaff Position No. 109-2, Accounting and Disclosure Guidance for theForeign Earnings Repatriation Provision within the American Jobs Creation Act, allowscompanies additional time to evaluate whether foreign earnings will berepatriated under the provisions of the new law.  We are evaluating current regulatory guidanceto determine what amount, if any, will be repatriated.  As such, at this time, we have not determineda range of potential repatriated amounts, if any. We expect to complete ouranalysis and determine what amount, if any, to repatriate by September 30,2005.

 

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**RESULTS OF OPERATIONS**

 

The following table sets forth certainitems in our consolidated statements of operations as a percentage of totalrevenues for the periods indicated:

 
| ** **                                                | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|-----------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                                                | ** ** | **2004**               | ** ** | **2005**             | ** ** | **2004** | ** ** | **2005** | ** ** |
|                                                      |       |                   |       |                 |       |   |   |   |   |
| Revenues:                                                 |       |                   |       |                 |       |   |   |   |   |
| Product sales                                             |       | 99.8%                  |       | 99.4%                |       | 99.9% |   | 99.6% |   |
| Other                                                     |       | 0.2                    |       | 0.6                  |       | 0.1 |   | 0.4 |   |
| Total revenues                                            |       | 100.0%                 |       | 100.0%               |       | 100.0% |   | 100.0% |   |
|                                                      |       |                   |       |                 |       |   |   |   |   |
| Cost and  expenses:                                       |       |                   |       |                 |       |   |   |   |   |
| Cost of product  sales                                    |       | 52.6                   |       | 59.9                 |       | 55.9 |   | 61.1 |   |
| Research and  development                                 |       | 15.6                   |       | 17.6                 |       | 14.9 |   | 17.4 |   |
| Sales and  marketing                                      |       | 6.2                    |       | 7.0                  |       | 6.4 |   | 6.9 |   |
| General and  administrative                               |       | 8.6                    |       | 6.2                  |       | 8.0 |   | 6.8 |   |
| Amortization of  intangible assets                        |       | 0.1                    |       | —               |       | 0.1 |   | — |   |
| Total costs and  expenses                                 |       | 83.1                   |       | 90.7                 |       | 85.3 |   | 92.2 |   |
|                                                      |       |                   |       |                 |       |   |   |   |   |
| Operating income                                          |       | 16.9                   |       | 9.3                  |       | 14.7 |   | 7.8 |   |
|                                                      |       |                   |       |                 |       |   |   |   |   |
| Total other  income (expense) - net                       |       | (1.4)                  |       | 2.5                  |       | (1.0) |   | 1.4 |   |
|                                                      |       |                   |       |                 |       |   |   |   |   |
| Income before  income tax provision and minority interest |       | 15.5                   |       | 11.8                 |       | 13.7 |   | 9.2 |   |
|                                                      |       |                   |       |                 |       |   |   |   |   |
| Income tax  provision                                     |       | 3.5                    |       | 1.0                  |       | 3.2 |   | 0.5 |   |
| Minority  interest                                        |       | (1.2)                  |       | 0.6                  |       | (1.0) |   | 0.4 |   |
|                                                      |       |                   |       |                 |       |   |   |   |   |
| Net income                                                |       | 10.8%                  |       | 11.4%                |       | 9.5% |   | 9.1% |   |
| Gross margin on  product sales                            |       | 47.2%                  |       | 39.7%                |       | 44.1% |   | 38.6% |   |

 

**THREEMONTHS ENDED JUNE 30, 2004 AND 2005**

 

*Revenues*. The types of revenue that we generateand how we recognize revenue for each is explained in the Revenue Recognition section ofItem 2. Management’s Discussion and Analysis of Financial Condition and Resultsof Operations under Critical Accounting Policies and Estimates.

 

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

 
| ** **                                       | ** ** | **For the three months ended,** | ** ** |
|--------------------------------------------------|------------|---------------------------------|------------|
| ** **                                       | ** ** | **June 30,**               | ** ** |
| ** **                                       | ** ** | **2004**                        | ** ** | **2005** | ** ** |
|                                             |       |                            |       |   |   |
| Light source  systems:                           |       |                            |       |   |   |
| Revenue                                          |       | $                               | 58,719     |   | $ | 54,797 |   |
| Units sold                                       |       | 81                              |       | 56 |   |
| Average selling  price (1)                       |       | $                               | 737        |   | $ | 940 |   |
| Consumable and  spare parts and service products |       | $                               | 36,003     |   | $ | 41,000 |   |
| Other revenue                                    |       | $                               | 185        |   | $ | 595 |   |
|                                             |       |                            |       |   |   |   |   |
| Total revenue                                    |       | $                               | 94,907     |   | $ | 96,392 |   |

 

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(1)          Calculation of averageselling price includes $943,000 deferred light source revenue for the threemonths ended June 30, 2004 and excludes $2.2 million deferred light sourcerevenue that was recognized for the three months ended June 30, 2005.  We have one arrangement where a portion ofthe light source system fee is not payable until the system is installedsuccessfully at the end-user.

 

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Product sales increased 1%from $94.7****million for the three months ended June 30,2004 to $95.8 million for the three months ended June 30, 2005.  This slight increase in product sales was dueto higher consumable and spare parts and service product revenues offset bylower light source system revenues during the three months ended June 30,2005 as compared to the same period in 2004. Revenues associated with our consumable and spare parts and serviceproducts increased 14% from $36.0 million for the three months ended June 30,2004 to $41.0 million for the three months ended June 30, 2005.  Included in the consumable and spare partsand service revenues for the three months ended June 30, 2005 and makingup a majority of the percentage increase are revenues associated with thereceipt of reusable material contained within consumed core assemblies returnedfrom our customers. There were no such revenues recorded in the threemonths ended June 30, 2004 due to the timing in 2004 of our correction inaccounting treatment for these refurbishment activities. See further discussion on change inaccounting method for refurbishment activities under Item 2. Management’sDiscussion and Analysis of Financial Condition and Results of Operations underCritical Accounting Policies and Estimates. This increase in consumables andspare parts revenue was offset by a 7% decrease in light source system revenuefrom $58.7 million for the three months ended June 30, 2004 to $54.8million for the three months ended June 30, 2005.  A total of 81 light source systems were soldin the three months ended June 30, 2004 at an average selling price of $737,000,compared to 56 systems sold in the three months ended June 30, 2005 at anaverage selling price of $940,000.  On aforeign currency adjusted basis, the average selling price for the three monthsended June 30, 2004 was $736,000 compared to $941,000 for the three monthsended June 30, 2005. The increase in the average selling price from periodto period reflects the shift in the product mix from capacity driven lowerpriced KrF products in the three months ended June 30, 2004 to higherpriced technology buys of advanced ArF products in the same three-month periodin 2005.  Revenues from fundeddevelopment contracts were $185,000 for the three months ended June 30,2004, compared to $595,000 for the three months ended June 30, 2005.

 

Our backlog at June 30,2004 was $107.7 million compared to $75.6 million at June 30, 2005.  Bookings for the three months ended June 30,2004 and June 30, 2005 were $97.1 million and $96.4 million,respectively.  The book-to-bill ratio forthe quarter ended June 30, 2004 was 1.02 compared to 1.0 for the quarterended June 30, 2005.  The decreasein the backlog from period to period is due to the condition of thesemiconductor industry.  The backlog asof June 30, 2004 reflected the brief upturn in the semiconductor industrythat began in early 2004, whereas the backlog as of June 30, 2005 reflectsthe slowdown and flattening of the semiconductor industry that started late in2004.  The decrease in bookings wasprimarily due to reduced orders of light source systems offset by a higherlevel of orders for consumables and spare parts in the second quarter of 2005 ascompared to the second quarter of 2004.

 

We installed 73 light sourcesat chipmakers and other end-users during the quarter ended June 30, 2004as compared to 77 light sources installed during the quarter ended June 30,2005.

 

Our sales are generated primarily byshipments to customers in Japan, Europe, and the United States.  Approximately 88% and 86% of our sales forthe three months ended June 30, 2004 and 2005, respectively, were derivedfrom customers outside the United States. We maintain a wholly owned Japanese subsidiary, which sells to ourJapanese customers.  Revenues fromJapanese customers, generated primarily by Cymer Japan, accounted for 35% and 29%of total revenues for the three months ended June 30, 2004 and 2005,respectively.  The activities of ourJapanese subsidiary are limited to

 

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sales and service of products purchased by them from us as the parentcorporation. We anticipate that international sales will continue to accountfor a significant portion of our net sales.

 

*Cost of Product Sales*. Cost ofproduct sales includes direct material and labor, warranty expenses, licensefees, and manufacturing and service overhead, and foreign exchange gains andlosses on foreign currency forward exchange contracts (“forward contracts”),associated with purchases of our products by our Japanese subsidiary for resaleunder firm third-party sales commitments. Shipping costs associated with our product sales are also included incost of product sales.  We do not chargeour customers for shipping fees and such costs are not significant.

 

The cost of product sales increased 16% from $50.0 million for thethree months ended June 30, 2004 to $57.7 million for the three monthsended June 30, 2005, respectively. This increase in the costs of productsales is partly due to the change in our accounting treatment for parts used inour refurbishment manufacturing processes and the classification of these transactions as revenue rather than acredit to cost of product sales.  Inaddition, the increase in the cost of product sales from period to period isdue to the shift in the product mix to higher cost systems and consumables andspare parts in the second quarter of 2005 as compared to the second quarter of2004.

 

The gross margin on product sales was 47% for the three months ended June 30,2004 as compared to 40% for the three months ended June 30, 2005.  This lower gross margin for the three monthsended June 30, 2005 was due to our accounting change associated withrefurbishment activities and the overall product mix of parts sold during theperiod.  In addition, gross margins werepositively impacted in the second quarter of 2004 due to increased factoryloading associated with the increase in spares inventory balances over theperiod, whereas margins were negatively impacted in the second quarter of 2005due to reduced factory loading which resulted from our reducing our inventorylevels.

 

*Research and Development*. Research and development expenses include costs of internally-funded andexternally-funded projects as well as continuing product development supportexpenses, which consist primarily of employee and material costs, depreciationof equipment and other engineering related costs.  Our research and development expenses wereoffset by amounts associated with certain of our externally funded research anddevelopment contracts.  Research anddevelopment expenses increased 14% from $14.8 million for the three monthsended June 30, 2004 to $16.9 million for the three months ended June 30,2005, due primarily to costs associated with our EUV light source developmentand the timing of achievement of milestones under our EUV development agreementwith Intel. Research and development expenses were offset by amounts related toour externally funded research and development contracts of $2.1 million and$204,000 for the three months ended June 30, 2004 and 2005, respectively.  In addition to our development of EUV, wealso continued to focus on next generation ArF products based on the XLplatform, next generation KrF products and new business opportunity development.  As a percentage of total revenues, researchand development expenses increased from 15.6% for the three months ended June 30,2004 to 17.6% for the three months ended June 30, 2005 due primarily to increasedcosts and lower revenues in 2005 compared to the same period in 2004.  As a result of our decision to enter the flatpanel display manufacturing tools market and the July 2005 announcement of ourjoint venture in support of this market opportunity, our research anddevelopment expenses going forward will also include a greater focus on LTPSproduct development efforts.

 

*Sales and Marketing*. Sales and marketing expenses include theexpenses of the sales, marketing and customer support staff and other marketingexpenses.  Sales and marketing expenses increased15% from $5.9 million for the three months ended June 30, 2004 to $6.8million for the three months ended June 30, 2005. This increase in salesand marketing expenses from period to period primarily reflects increased salesexpenses associated with chipmaker customers at our foreign locations in thesecond quarter of 2005. This increase in sales and marketing expenses waspartially offset by decreased profit sharing and bonus expense from period toperiod.  As a percentage of totalrevenues, such sales and marketing expenses increased from 6.2% for the threemonths ended June 30, 2004 to 7.0% for the three months ended June 30,2005.  As a result of the joint venturewhich we announced in July 2005, sales and marketing expenses goingforward will include market development costs associated with the TCZ entity.

 

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*General and Administrative*.General and administrative expenses consist primarily of management andadministrative personnel costs, professional services and administrativeoperating costs.  General andadministrative expenses decreased 26% from $8.2 million for the three monthsended June 30, 2004 to $6.0 million for the three months ended June 30,2005 primarily due to the receipt of rent payments in the second quarter of2005 from the tenants in two of our San Diego facilities, which we subleased inthe third and fourth quarters of 2004. In addition, there was a decrease in profit sharing and bonus expensefrom period to period.  As a percentageof total revenues, such expenses decreased from 8.6% for the three months endedJune 30, 2004 to 6.2% for the three months ended June 30, 2005.

 

*Amortization of Intangible Assets. *Amortization of intangible assets totaled $40,000 for the three monthsended June 30, 2004 and there were no such expenses for the same period in2005. This amortization of intangible assets expense relates to the existingtechnology associated with the acquisition of Active Control eXperts, Inc.(“ACX”), which was completed in early 2001. Costs associated with theseidentifiable intangibles were fully amortized as of March 31, 2005, so noadditional amortization associated with these assets will be recorded goingforward.  Amortization expense for patents which isincluded in research and development expenses and cost of product sales was$593,000 in total for each of the three months ended June 30, 2004 and2005.

 

*Total Other Income (Expense) -Net.*  Net other income (expense) consistsprimarily of interest income and expense and foreign currency exchange gainsand losses associated with fluctuations in the value of the functional currenciesof our foreign subsidiaries against the United States dollar.  Net other expense totaled $1.3 million forthe three months ended June 30, 2004, compared to net other income of $2.5million for the three months ended June 30, 2005.  The change from net other expense to netother income was primarily due to a $2.2 million gain on debt extinguishmentrecorded for the repurchase of $60.0 million principal amount of our convertiblesubordinated notes in the second quarter of 2005, and an increase in interestincome and a decrease in interest expense from period to period. The increasein interest income from 2004 to 2005 reflects higher market interest rates forour short-term and long-term investments. The decrease in interest expense fromperiod to period is due to our lower debt balances as a result of therepurchase of notes that we made in the third quarter of 2004 and the secondquarter of 2005. Foreign currency exchange losses totaled $399,000, interestincome totaled $1.6 million and interest expense totaled $2.5 million for thethree months ended June 30, 2004, compared to a foreign currency exchangeloss of $573,000, interest income of $2.6 million, interest expense of $1.8million, and gain on debt extinguishment of $2.2 million for the three monthsended June 30, 2005.

 

*Income Tax Provision.* The tax provision of $3.4 million and$912,000 for the three months ended June 30, 2004 and 2005, respectively,reflects an annual effective rate of 23% and 5.5%, respectively. Due to the 0%annual effective tax rate estimated for the first quarter of 2005, ayear-to-date change in the tax provision was made in the second quarter of2005.  This resulted in a quarterly taxrate of 8% for the three months ended June 30, 2005.  The change in the annual effective tax rate fromperiod to period was primarily attributable to the decrease in pre-tax earningsas well as tax benefits from U.S. export incentive programs and research anddevelopment and manufacturing investment credits. The annual effective taxrates for both periods were less than the U.S. statutory rate of 35% primarilyas a result of permanent book/tax differences and tax credits. The effectivetax rate is a function of current tax law and geographic location of pre-taxincome.  The Research and ExperimentationCredit was extended under the Working Families Tax Relief Act for amounts paidor incurred after June 30, 2004 and before 2006.  The American Jobs Creation Act of 2004repealed the ETI exclusion subject to certain transition rules.  The ETI exclusion is being replaced with aManufacturing Activity deduction under IRC Section 199. The benefit isavailable to us for tax years beginning in 2005, subject to certain transitionrules. We anticipate that the benefit available to us under both regimes is comparablefor years in which we have taxable income.

 

**SIXMONTHS ENDED JUNE 30, 2004 AND 2005**

 

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

 

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| ** **                                       | ** ** | **For the six months ended,** | ** ** |
|--------------------------------------------------|------------|-------------------------------|------------|
| ** **                                       | ** ** | **June 30,**             | ** ** |
| ** **                                       | ** ** | **2004**                      | ** ** | **2005** | ** ** |
|                                             |       |                          |       |   |   |
| Light source  systems:                           |       |                          |       |   |   |
| Revenue                                          |       | $                             | 111,380    |   | $ | 103,333 |   |
| Units sold                                       |       | 145                           |       | 104 |   |
| Average selling  price (1)                       |       | $                             | 777        |   | $ | 972 |   |
|                                             |       |                          |       |   |   |
| Consumable and  spare parts and service products |       | $                             | 71,213     |   | $ | 77,073 |   |
| Other revenue                                    |       | $                             | 235        |   | $ | 796 |   |
|                                             |       |                          |       |   |   |
| Total revenue                                    |       | $                             | 182,828    |   | $ | 181,202 |   |

 

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(1)           Calculation of averageselling price includes $1.2 million deferred light source revenue for the sixmonths ended June 30, 2004 and excludes $2.2 million deferred light sourcerevenue that was recognized for the six months ended June 30, 2005.  We have one arrangement where a portion of thelight source system fee is not payable until the system is installedsuccessfully at the end-user.

 

Product sales decreased 1%from $182.6****million for the six months ended June 30,2004 to $180.4 million for the six months ended June 30, 2005, primarilydue to a decrease in light source system sales which was offset by higher salesof consumables and spare parts and service products from period to period.  Light source system revenue decreased 7% from$111.4 million for the six months ended June 30, 2004 to $103.3 millionfor the six months ended June 30, 2005. A total of 145 light source systems were sold in the six months ended June 30,2004 at an average selling price of $777,000, compared to 104 systems sold inthe six months ended June 30, 2005 at an average selling price of $972,000.  On a foreign currency adjusted basis, theaverage selling price for the six months ended June 30, 2004 was $767,000compared to $966,000 for the six months ended June 30, 2005. The increasein the average selling price from period to period reflects the shift in theproduct mix from capacity driven lower priced KrF products in the six monthsended June 30, 2004 to higher priced technology buys of advanced ArFproducts in the same six-month period in 2005. The decrease in product sales was offset by an 8% increase in revenueassociated with consumable and spare parts and service products from $71.2million for the six months ended June 30, 2004 to $77.1 million for the sixmonths ended June 30, 2005. Included in the sales of consumable and spare parts and service revenuesand making up the majority of the percentage change for the six months ended June 30,2005 are revenues associated with the receipt of reusable material containedwithin consumed core assemblies returned from our customers. There wereno such revenues recorded in the six month period ended June 30, 2004 dueto the timing in 2004 of our correction in accounting treatment for theserefurbishment activities.Revenues from funded development contracts were $235,000 for the six monthsended June 30, 2004, compared to $796,000 for the six months ended June 30,2005.

 

Sales to our three largestcustomers, ASM Lithography, Canon, and Nikon, amounted to 32%, 19% and 19%,respectively, of total revenue for the six months ended June 30, 2004, and33%, 8% and 26%, respectively, of total revenue for the six months ended June 30,2005.

 

Approximately 87% and 85% of our sales forthe six months ended June 30, 2004 and 2005, respectively, were derivedfrom customers outside the United States. Revenues from Japanese customers,generated primarily by Cymer Japan, accounted for 37% and 33% of total revenuesfor the six months ended June 30, 2004 and 2005, respectively.

 

*Cost of Product Sales. *The cost of product sales increased 8%from $102.1 million for the six months ended June 30, 2004 to $110.8million for the six months ended June 30, 2005, respectively. Thisincrease in the costs of product sales is primarily due to the change in ouraccounting treatment for parts used in our refurbishment manufacturingprocesses and the classification of thesetransactions as revenue rather than a credit to cost of product sales.

 

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The gross margin on product sales was 44% for the six months ended June 30,2004 as compared to 39% for the six months ended June 30, 2005.  This lower gross margin for the six monthsended June 30, 2005 was primarily due to our accounting change associatedwith our refurbishment activities and reduced factory loading which was theresult of our reducing our inventory levels.

 

*Research and Development*. Research and development expenses increased 16% from $27.2 million forthe six months ended June 30, 2004 to $31.5 million for the six monthsended June 30, 2005 due primarily to costs associated with our EUV lightsource development and the timing of milestone achievements on our EUV developmentcontract with Intel.  Research anddevelopment expenses were offset by amounts related to our externally fundedresearch and development contracts of $3.6 million and $1.8 million for the sixmonths ended June 30, 2004 and 2005, respectively.  In addition to our development of EUV, wealso continued to focus on next generation ArF products based on the XLplatform, next generation KrF products and new business opportunity development.  As a percentage of total revenues, researchand development expenses increased from 14.9% for the six months ended June 30,2004 to 17.4% for the six months ended June 30, 2005 due primarily toincreased costs and lower revenues in the first six months of 2005 compared tothe same period in 2004.

 

*Sales and Marketing*.  Salesand marketing expenses increased 8% from $11.7 million for the six months endedJune 30, 2004 to $12.6 million for the six months ended June 30, 2005due primarily to increased sales expenses associated with our chipmakercustomers at our foreign locations offset by decreased profit sharing and bonusexpenses recorded from period to period.  As a percentage of total revenues, such sales and marketing expensesincreased from 6.4% for the six months ended June 30, 2004 to 6.9% for thesix months ended June 30, 2005.

 

*General and Administrative*.General and administrative expenses decreased 17% from $14.8 million for the sixmonths ended June 30, 2004 to $12.3 million for the six months ended June 30,2005 primarily due to the receipt of rent payments in the first six months of2005 from the tenants in two of our San Diego facilities, which we subleased inthe third and fourth quarters of 2004, and decreases in profit sharing andbonus expenses from period to period. This decrease in general and administration expenses was partiallyoffset by additional external audit fees associated with our compliance withthe internal control requirements under Section 404 of the Sarbanes-OxleyAct.  As a percentage of total revenues,such expenses decreased from 8.0% for the six months ended June 30, 2004to 6.8% for the six months ended June 30, 2005.

 

*Amortization of Intangible Assets. *Amortization of intangible assets totaled $80,000 and $20,000 for the sixmonths ended June 30, 2004 and 2005, respectively. This amortization ofintangible assets expense relates to the existing technology associated withthe acquisition of ACX, which was completed in early 2001.  Amortization expense for patents which isincluded in research and development expenses and cost of product sales intotal was $1.2 million for each of the six months ended June 30, 2004 and2005.

 

*Total Other Income (Expense) -Net.*  Net other expense totaled $1.9 millionfor the six months ended June 30, 2004, compared to net other income of $2.5million for the six months ended June 30, 2005.  The change from net other expense to netother income was primarily due to a $2.2 million gain on debt extinguishmentrecorded for the repurchase of $60.0 million principal amount of our convertiblesubordinated notes in the second quarter of 2005, an increase in interestincome and a decrease in interest expense from period to period. The increasein interest income from 2004 to 2005 reflects higher market interest rates forour short-term and long-term investments. The decrease in interest expense fromperiod to period is due to our lower debt balances as a result of therepurchase of notes that we made in the third quarter of 2004 and the secondquarter of 2005. Foreign currency exchange losses totaled $345,000, interestincome totaled $3.5 million and interest expense totaled $5.1 million for the sixmonths ended June 30, 2004, compared to a foreign currency exchange lossof $767,000, interest income of $5.0 million, interest expense of $3.9 million anda gain on debt extinguishment of $2.2 million for the six months ended June 30,2005.

 

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*Income Tax Provision.*  Thetax provision of $5.8 million and $912,000 for the six months ended June 30,2004 and 2005, respectively, reflects an annual effective rate of 23% and 5.5%,respectively. The change in the annual effective tax rate from period to periodwas primarily attributable to the decrease in pre-tax earnings as well as taxbenefits from U.S. export incentive programs and research and development andmanufacturing investment credits. The annual effective tax rates for bothperiods were less than the U.S. statutory rate of 35% primarily as a result ofpermanent book/tax differences and tax credits. The effective tax rate is afunction of current tax law and geographic location of pre-tax income.  The Research and Experimentation Credit wasextended under the Working Families Tax Relief Act for amounts paid or incurredafter June 30, 2004 and before 2006. The American Jobs Creation Act of 2004 repealed the ETI exclusionsubject to certain transition rules.  TheETI exclusion is being replaced with a Manufacturing Activity deduction underIRC Section 199. The benefit is available to us for tax years beginning in2005, subject to certain transition rules. We anticipate that the benefitavailable to us under both regimes is comparable for years in which we havetaxable income.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

As of June 30, 2005, wehad approximately $149.0 million in cash and cash equivalents, $134.5 millionin short-term investments, $58.8 million in long-term investments, and $381.5million in working capital.

 

In February 2002,we issued $250.0 million in aggregate principal amount in a private placementof notes.  These 2002 notes are due on February 15,2009 with interest payable semi-annually on February 15 and August 15of each year at 3.50% per annum.  The2002 notes are convertible into shares of our common stock at a conversion rateof 20 shares per $1,000 principal amount or an effective conversion price of$50.00 per share.  We used a portion ofthe net proceeds from this private placement to redeem the previously issuednotes that were outstanding. The remaining proceeds are being used for ouroperating, investing and financing activities. Per the terms of the notes and based upon the approval of our board ofdirectors, we have periodically purchased these notes in the open market.  As of June 30, 2005, there were $140.7million principal amount of 2002 notes outstanding.

 

Net cash provided by operating activitieswas approximately $6.8 million and $79.0 million for the six months ended June 30,2004 and 2005, respectively. The increase in cash provided by operatingactivities from period to period was primarily attributable to significant decreasesin accounts receivable and inventory in the six months ended June 30, 2005compared to increases in both for the same six-month period in 2004.  This increase to cash provided by operating activities from period toperiod was offset by decreases in accrued expenses and other liabilities in thesix months ended June 30, 2005 compared to increases in these accrued expensesin the same six-month period in 2004. The decrease inaccounts receivable reflects collections we made on our receivable balancesthat were outstanding at December 31, 2004. The fourth quarter 2004 salesactivities were more back-end loaded than typical, causing the accountsreceivable balance to increase at December 31, 2004. The decrease in inventoryreflects the reduction in our field and factory inventory as result of ourongoing initiative to improve asset management by reducing inventory andincreasing inventory turns.

 

Net cash used in investing activities wasapproximately $22.3 million for the six months ended June 30, 2004 comparedto $58.7 million provided by investing activities for the six months ended June 30,2005. Net cash used in investing activities for the six months ended June 30,2004 was due primarily to the timing of short-term and long-term investmentsmaturing and being reinvested during the quarter, a $6.0 million payment toacquire certain patents, a $2.0 million payment to acquire an additional 6%minority interest in our Cymer Korea subsidiary, and the acquisition of propertyand equipment in the amount of $8.1 million. Net cash provided by investingactivities for the six months ended June 30, 2005 reflects the timing ofshort-term and long-term investments that matured and were reinvested duringthe period and the acquisition of $7.8 million of property and equipment.

 

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Net cash provided by financing activities was approximately $10.4million for the six months ended June 30, 2004 compared to cash used infinancing activities of $103.2 million for the six months ended June 30,2005. Net cash provided by financing activities for the six months ended June 30,2004 reflects proceeds received from the exercise of employee stock optionstotaling $10.4 million. Net cash used in financing activities for the sixmonths ended June 30, 2005 reflects the purchase of treasury stock of $50.0million and the purchase of approximately $60.0 million principal amount of ourconvertible subordinated notes, at a discount to par, in the second quarter of2005.  The treasury stock and notepurchases were partially offset by proceeds received from the exercise ofemployee stock options totaling $4.2 million during the six months ended June 30,2005.

 

Since our initial****public offering and a secondary public offering, both in1996, we have funded our operations primarily from cash generated fromoperations, the proceeds of the note offerings in August 1997 and February 2002,bank borrowings, and the proceeds from employee stock option exercises.

 

We require substantialworking capital to fund our business, particularly to finance inventories,including purchase orders with our vendors, accounts receivable, and forcapital expenditures. In addition, we plan to contribute approximately $14.2million in cash in the third quarter of 2005 as an initial contribution to theTCZ joint venture. Our future capital requirements depend on many factors,including our manufacturing activity, the timing and extent of spending tosupport product development efforts, expansion of sales and marketing and fieldservice and support, competitive labor market compensation requirements, thetiming of introductions of new products and enhancements to existing products,and the market acceptance of our products. We believe that cash generated fromoperations along with the liquidity provided by our existing cash balances andshort-term investments will be sufficient to sustain operations and provide forany potential future expansion of our business for at least the next 12 months.

 

At June 30, 2004 and 2005, we did not have anyrelationship with unconsolidated entities or financial partnerships, such asentities often referred to as structured finance variable interest, or specialpurpose entities, which would have been established for the purpose offacilitating off-balance sheet arrangements or other contractually narrow orlimited purposes.  In addition, we didnot engage in trading activities involving non-exchange traded contracts.  As a result, we are not exposed to anyfinancing, liquidity, market or credit risk that could arise if we had engagedin such relationships.  We do not haverelationships and transactions with persons and entities that derive benefitsfrom their non-independent relationship with us or our related parties exceptas disclosed herein.

 

**SUBSEQUENTEVENT**

 

On July 15, 2005, we entered into a Joint Venture Agreement (the “JVAgreement”) with (i) Carl Zeiss SMT AG, a German corporation (“SMT”); (ii) CarlZeiss Laser Optics Beteiligungsgesellschaft mbH, a German limited liabilitycompany (“LOB”); and (iii) the Swiss liability company that will be formedas part of the JV Agreement and named TCZ GmbH (“TCZ”).  TCZ is expected to develop, integrate, marketand sell and support tools employing an excimer laser beam to inducecrystallization of LTPS processing for the manufacture of flat paneldisplays.  LOB and SMT, together withtheir affiliated entities, are collectively referred to as “Zeiss”.

 

TCZ will be owned 60% by us and 40% by Zeiss.  As an initial capital contribution to TCZ, weplan to contribute approximately $14.2 million in cash in the third quarter of2005.  We anticipate consolidating thefinancial position and results of operations of TCZ and reflecting the Zeissinterest or ownership in TCZ as minority interest in the consolidated financialstatements.  If TCZ is dissolved, theintellectual property owned by TCZ will be distributed to the members as jointowners, and the remaining assets, net of liabilities, will be distributed tothe members in accordance with their percentage interests.

 

Once TCZ is formed, we will enter into various agreements with TCZ.  Included in these agreements will be along-term supply agreement which will allow us to provide TCZ with componentsfor TCZ’s products and an intellectual property agreement which will dictatethe use of any intellectual property developed by us for the JV.

 

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**RECENTACCOUNTING PRONOUNCEMENTS**

 

In December 2004, FASB issued SFAS No. 123R,“Share-Based Payment - An Amendment to Statement Nos. 123 and 95,” thataddresses the accounting for share-based payment transactions in which anenterprise receives employee services in exchange for (a) equityinstruments of the enterprise or (b) liabilities that are based on thefair value of the enterprise’s equity instruments or that may be settled by theissuance of such equity instruments. This statement will eliminate the abilityto account for share-based compensation transactions using Accounting PrinciplesBoard (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,”and will require instead that such transactions be accounted for using afair-value-based method.  On April 14, 2005, the SEC announced thedeferral of the effective date of SFAS No. 123R. The deferral allowscompanies to adopt the provisions of SFAS No. 123R beginning on the firstannual period beginning after June 15, 2005. Based on the new requiredadoption date, we plan to adopt SFAS No. 123R as of the beginning of thefirst quarter of 2006.

 

We are currently evaluatingthe impact and implementation of SFAS No.123R and how this new pronouncementwill effect our consolidated financial statements. Our evaluation includes adetermination on how future stock awards will be valued based on an appropriatefair value model upon adoption of SFAS No. 123R as well as the impact ofstock compensation expense associated with unvested stock options outstandingas of December 31, 2005.  Inaddition, as a result of the amendment to our ESPP, effective May 1, 2005,our ESPP is a non-compensatory plan under SFAS 123R, and, therefore, no stockcompensation expense will be recorded under the ESPP upon the adoption of SFAS No. 123R.  We are also required to elect the transitionmethod that we will use as part of the adoption of SFAS No. 123R. Theallowed transition methods include prospective and retroactive adoptionalternatives. The prospective method requires that compensation expense berecorded for all unvested stock options and awards prospectively at thebeginning with the first quarter adoption of SFAS No. 123R, while theretroactive method would require us to record compensation expense for allunvested stock options and awards beginning with the first period restated. Atthis time, we plan to use the prospective transition method upon our adoptionof SFAS No. 123R effective January 1, 2006.

 

In November 2004, the FASB issued Statement of Financial Accounting Standards No. 151 (“SFAS No. 151),  “Inventory Costs, an amendment of ARB 43, Chapter 4”.  This statement amends Accounting Research Bulletin No. 43 (“ARB No. 43”), Chapter 4, to clarify accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material.  SFAS No. 151 requires that those items be recognized as current-period charges.  SFAS No. 151 is effective for fiscal years beginning after June 15, 2005.  We are still assessing the impact that the adoption of SFAS No. 151 will have on our consolidated financial statements.

 

In December 2004,the FASB issued Statement of Financial Accounting Standards No. 153 (“SFASNo. 153), “Exchange of Nonmonetary Assets”, an amendment of APB Opinion No. 29.SFAS No. 153 replaces the exception from fair value measurement in APB OpinionNo. 29, with a general exception from fair value measurement for exchangesof nonmonetary assets that do not have commercial substance. The statement isto be applied prospectively and is effective for nonmonetary asset exchangesoccurring in fiscal periods beginning after June 15, 2005.  We do not believe that SFAS No. 153 willhave a material impact on our results of operations or cash flows.

 

In May 2005, the FASB issued Statement No. 154, “AccountingChanges and Error Corrections—a replacement of APB Opinion No. 20 and FASBStatement No. 3” (“SFAS No. 154”). This Statement replaces APBOpinion No. 20, “Accounting Changes”, and FASB Statement No. 3, “ReportingAccounting Changes in Interim Financial Statements”, and changes therequirements for the accounting for and reporting of a change in accountingprinciple. This Statement applies to all voluntary changes in accountingprinciple. It also applies to changes required by an accounting pronouncementin the unusual instance that the pronouncement does not include specifictransition provisions. When a pronouncement includes specific transitionprovisions, those provisions should be followed. SFAS No. 154 is effectivefor accounting changes and corrections of errors made in fiscal years beginningafter December 15, 2005. Therefore, we will adopt the provisions of SFAS No. 154for our fiscal year beginning January 1, 2006 as

 

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applicable. Wedo not believe that adoption of the provisions of SFAS No. 154 will have amaterial impact on our consolidated financial statements.

 

In March 2005, the FASB issued FASB Interpretation No. 47,  “Accounting for Conditional Asset RetirementObligations and Interpretation of FASB Statement No. 143” (“FIN 47”).  FIN 47 clarifies that an entity must record aliability for a “conditional” asset retirement obligation if the fair value ofthe obligation can be reasonably estimated. FIN 47 is effective no later thanthe end of fiscal years ending after December 15, 2005.  We do not expect that the adoption of FIN 47will have a material impact on our results of operations or cash flows.

 

PCAOB Release No. 2005-014, Ethics andIndependence Rules Concerning Independence, Tax Services, and ContingentFees, dated July 26, 2005, adopts rules to promote the ethics and independenceof registered public accounting firms that audit and review financialstatements of U.S. public companies.  Therules limit the tax services independent auditors could provide to theirpublic company audit clients. Specifically, the rules prohibit contingent fee or commissionarrangements; treat the firm as not independent if the firm provided assistancein planning or provided tax advice on potentially abusive tax transactions orprovided tax services to certain senior officers of the audit client; andrequire accounting firms to provide certain information to the audit committeeof an audit client in connection with seeking pre-approval to providenon-prohibited tax services to the audit client. Our independent registeredpublic accountant does not currently provide services to us, which areconsidered prohibited under the adopted guidelines. Based on our analysis ofthe adopted requirements, we are currently in compliance with the adoptedguidelines.

 

#### **RISKS AND UNCERTAINTIESTHAT MAY AFFECT RESULTS**

 

*Therisks described below may not be the only risks we face. Additional risks thatwe do not currently think are material may also impair our businessoperations.  If any of the events orcircumstances described in the following risks actually occur, our business,financial condition or results of operations could suffer, and the tradingprice of our common stock could decline.*

 

Ourrevenues and operating results from quarter-to-quarter have varied in the pastand our future operating results may continue to fluctuate significantly due tomany factors including those listed in this section and throughout thisQuarterly Report on Form 10-Q for the period ended June 30, 2005.

 

These factors include:

 

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

•                  cyclicality in themarket for semiconductor manufacturing equipment;

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

•                  rates at which ourcustomers take delivery of light source systems from us;

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

•                  product lead timedemands from our customers and the chipmakers;

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

 

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•                  changes in the price andprofitability of our products;

•                  our ability to developand implement new technologies and introduce new products;

•                  changes in marketpenetration by our competitor;

•                  utilization rates oflight sources and sales of consumable and spare parts and services;

•                  our ability to manageour manufacturing requirements;

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

•                  worldwide politicalinstability;

•                  changing global economicconditions; and

•                  intellectual propertyprotection.

 

We havehistorically derived a large portion of our quarterly and annual revenues fromselling a small number of light source systems. Because we sell a small numberof products, the precise time that we recognize revenue from an order may havea significant impact on our total revenue for a particular period. Ourcustomers may cancel or reschedule orders with little or no penalty.Orders expected in one quarter could shift to another period due to changes inthe anticipated timing of customers’ purchase decisions or rescheduled deliverydates requested by our customers. Our operating results for a particularquarter or year may be adversely affected if our customers, particularly ourthree largest customers, cancel or reschedule orders, or if we cannot fillorders in time due to unexpected delays in manufacturing, testing, shipping,and product acceptance.

 

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

 

**Our business depends on the semiconductor equipmentindustry, which is highly volatile and unpredictable.**

 

The semiconductor industry ishighly cyclical. We derive a substantial percentage of our revenues fromlithography tool manufacturers within the semiconductor industry. Our customersdepend in turn on the demand for their photolithography tool products fromtheir customers, the chipmakers. The capital equipment expenditures ofchipmakers depend on a number of factors, including the current and anticipatedmarket demand for semiconductors and products using semiconductors.

 

Thesemiconductor industry historically has experienced periodic ups and downs andcurrently appears to be in flux, with industry experts’ estimates for thesecond half of the year ranging between down slightly to up slightly. This cyclicalnature of the industry in which we operate affects our ability to accuratelypredict future revenue and thus, future expense levels. When cyclicalfluctuations result in lower than expected revenue levels, operating resultsmay be adversely affected and cost reduction measures may be necessary in orderfor us to remain competitive and financially sound.  During a down cycle or an industry slowdown,we must be in a position to adjust our cost and expense structure to prevailingmarket conditions and to continue to motivate and retain our keyemployees.  In addition, 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 believe the industry hasslowed or flattened, particularly in regards to purchasing capacity drivensemiconductor manufacturing equipment. Therefore, we are not able to predict with any certainty the duration ofthis slowdown or flattening of the semiconductor industry or the timing andorder of magnitude of any future recovery. The previous downturn had a severeeffect on the demand for

 

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semiconductor manufacturing equipment, includingphotolithography tools that our customers produce.  If overall market conditions deteriorate inthe near term, our current operating levels may negatively impact ourprofitability. We believe that downturns in the semiconductor industry willoccur periodically, and result in periodic decreases in demand for allsemiconductor manufacturing equipment, including photolithography tools ourcustomers manufacture. As a result, fluctuating levels of investment bychipmakers and pricing volatility will continue to materially affect ouraggregate bookings, revenues and operating results. Also, even during periodsof reduced revenues we believe we must continue to invest in research anddevelopment and to maintain extensive ongoing worldwide customer service andsupport capabilities to remain competitive, which may temporarily harm ourfinancial results.  Accordingly, thesedownturns and industry slowdowns are likely to continue to adversely affect ourbusiness, financial condition and operating results and our operating resultsmay fall below the expectations of public market analysts or investors in somefuture quarter or quarters. Such failure to meet operating result expectationswould materially adversely affect the price of our common stock.

 

Ourcustomers try to manage their inventories and production requirements toappropriate levels that best reflect their expected sales to chipmakers. Marketconditions in the industry and production efficiency of the lithography toolmanufacturers can cause our customers to expand or reduce their orders for newlight source systems as they try to manage their inventories and productionrequirements to these levels. We continue to work with our customers to betterunderstand these issues. However, we cannot guarantee that we will besuccessful in understanding our customers’ inventory management and productionrequirements or that our customers will not build up an excess inventory oflight source products. If our customers retain an excess inventory of lightsource products, our revenue could be reduced in future periods as the excessinventory is utilized, which could adversely affect our operating results,financial condition and cash flows.  Inaddition, if our customers demand shorter product lead times as a solution toimprove their inventory and cash positions, our inventory management and cashposition may be impacted, which may adversely affect our operating results,financial condition and cash flows.

 

**A significant percentage of ourrevenue is derived from sales to a few large customers, and if we are not ableto retain these customers, or they reschedule, reduce or cancel orders, ordelay or default on payments, our revenues would be reduced and our financialcondition and cash flows would suffer.**

 

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

 

| ** **      | ** ** | **Six months ended** | ** ** |
|-----------------|------------|----------------------|------------|
| ** **      | ** ** | **June 30,**    | ** ** |
| ** **      | ** ** | **2004**             | ** ** | **2005** | ** ** |
|            |       |                 |       |   |   |
| ASM Lithography |       | 32%                  |       | 33% |   |
| Canon           |       | 19%                  |       | 8% |   |
| Nikon           |       | 19%                  |       | 26% |   |
|            |       |                 |       |   |   |
| Total           |       | 70%                  |       | 67% |   |

 

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

 
| ** **      | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|-----------------|------------|-----------------------|------------|-------------------|------------|
| ** **      | ** ** | **2004**              | ** ** | **2005**          | ** ** |
|            |       |                  |       |              |       |
| ASM Lithography |       | 46%                   |       | 48%               |       |
| Canon           |       | 5%                    |       | 6%                |       |
| Nikon           |       | 31%                   |       | 16%               |       |
|            |       |                  |       |              |       |
| Total           |       | 82%                   |       | 70%               |       |

 

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

 

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

•                  a customer experiencinglithography tool production problems;

•                  a decision to purchaselight sources from other suppliers;

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

•                  a decline in a customer’sfinancial condition.

 

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

 

Ouronly current product line is excimer light source systems, including KrF andArF systems, and support, including consumables and service support.  We expect these light source systems andsupport to continue to account for a large percentage of our revenues in thenear term. Continued market acceptance of our light source system products is,therefore, critical to our future success. The primary market for excimer lightsources is in the use of DUV photolithography equipment for manufacturingdeep-submicron semiconductor devices using smaller circuit geometries. Thedemand for our products depends in part on the rate at which chipmakers furtheradopt excimer light sources as the chosen light source for theirphotolithography tools.

 

 The rate withwhich chipmakers adopt excimer light sources may vary for a variety of reasons,including:

 

•                  inadequate performanceof photoresists used in advanced DUV photolithography;

•                  potential shortages ofspecialized materials used in DUV optics;

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

•                  consolidation ofchipmakers.

 

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

 

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

•                  a failure to achievecontinued market acceptance of our products;

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

•                  technological changethat we are unable to address with our products; and

•                  a failure to release newenhanced versions of our products on a timely basis.

 

**We depend on the introduction of new products for our success, and weare subject to risks associated with rapid technological change.**

 

Rapidtechnological changes in semiconductor manufacturing processes subject us toincreased pressure to develop technological advances enabling such processes.We believe that our future success depends in part upon our ability to develop,manufacture and timely introduce new light source products with improvedcapabilities and to continue to enhance our existing light source systems andprocess

 

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capabilities. Due to the risks inherent in transitioning to new products, we mustforecast accurate demand for new products while managing the transition fromolder products.

 

Ourmost significant product introduction in recent years consisted of a technologychange from a single-discharge-chamber excimer light source to adual-discharge-chamber design called MOPA. The MOPA design represents a paradigm shift from previously acceptedlithography technology and offers chipmakers higher power, tighter bandwidthand lower cost of operation for their current – and is expected to offer thesame benefits for their future – optical lithography applications.  As originally designed, the MOPA architecturewas projected to provide its benefits across all three DUV wavelengths – 248nm, 193 nm, and 157 nm – but at this time, the semiconductor industry has onlyadopted MOPA at the 193 nm wavelength, due to the successful extension of 248nm single chamber technology, and the omission of 157 nm lithography from theroadmap.  There are risks inherent in theongoing transition to the MOPA technology, including effective execution of ourproduct development roadmap, continuing adoption of the product by lithographytool manufacturers and chipmakers, manufacturability and cost effectiveness ofthe new products and the development of a comparable product by our competitor.

 

Webelieve that chipmakers are currently developing a capability to producedevices that are measured at 90 nanometers or less, and these efforts aredriving the current demand for our light source products for DUVphotolithography systems. After chipmakers have this capability, their demandfor our light source products will depend, in part, on whether they want toexpand their capacity to manufacture these devices. This will in turn depend onwhether their sales forecasts and projected manufacturing process yieldsjustify the necessary investments.

 

Futuretechnologies such as EUV, electron projection lithography, and masklesslithography may render our excimer light source products obsolete. We mustmanage product transitions, as introduction of new products could adverselyaffect our sales of existing products. If new products are not introduced ontime, or have reliability or quality problems, our performance may be impactedby reduced orders, higher manufacturing costs, delays in acceptance of andpayment for new products, and additional service and warranty expenses. We maynot be able to develop and introduce new products or enhancements to ourexisting products and processes in a timely or cost effective manner thatsatisfies customer needs or achieves market acceptance. Failure to develop andintroduce these new products and enhancements could materially adversely affectour operating results, financial condition and cash flows.

 

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

 

**We must effectively managechanges 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 departments. As the semiconductor industry grows and contracts we will needto:

 

•                  closely manage ourglobal operations;

•                  improve our process andother internal management systems;

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

•                  quickly adapt tochanging sales and marketing channels;

•                  effectively manage ourinventory levels; and

•                  attract, train, retainand manage key personnel.

 

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

 

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

 

We purchase a limited number ofcomponents and subassemblies included in our light source products from asingle supplier or a small group of suppliers. For certain optical components used in our light source systems,we currently utilize a single supplier. To reduce the risk associated with this single supplier, we carry asignificant strategic inventory of these components.  Strategic inventories are managed as apercentage of future demand.  We havealso negotiated to have vendor-managed inventory of critical components tofurther reduce the risk of a single supplier. In addition, we contract themanufacture of various subassemblies more often than in the past. Further, someof our suppliers have specialized in supplying equipment or manufacturingservices to semiconductor equipment manufacturers and therefore are susceptibleto industry ups and downs and subject to the same risks and uncertaintiesregarding their ability to respond to changing market conditions.  Because many of these suppliers reduce thesize of their workforce in an industry downturn and increase it in an upturn,they may not be able to meet our requirements or respond quickly enough as anupturn begins and gains 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 ableto provide new modules and subassemblies when they are needed to satisfy ourproduct schedule requirements. If we cannot purchase enough of thesematerials, components or subassemblies, or if these items do not meet ourquality standards, there could be delays or reductions in our productshipments, which would have a material adverse effect on our operating results,financial condition and cash flows.

 

**We face competition fromone company and may face competition from additional competitors who enter themarket.**

 

We arecurrently aware of one significant competitor that sells light sources for DUVphotolithography applications. This competitor is Gigaphoton, a joint venturebetween two large companies, Komatsu and Ushio, which is headquartered inJapan. Additionally, late in 2004, a former competitor Coherent, Inc., aU.S. company, announced that their Lambda-Physik subsidiary would no longerpursue the excimer light source systems business for photolithography in thesemiconductor industry.

 

Webelieve that Gigaphoton is aggressively trying to gain larger marketpenetration in the excimer light source industry. We know that our customershave purchased products from this competitor and that our customers haveapproved this competitor’s light sources for use with their products.  We know that Gigaphoton has been approved bychipmakers in Japan, the U.S. and elsewhere for producing excimer lightsources.

 

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

 

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

 

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

 

•                  research anddevelopment;

 

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•                  engineering;

•                  sales and marketing;

•                  field service;

•                  manufacturing; and

•                  management.

 

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

 

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

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

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

 

If we are unable to hire, trainand retain key personnel as required, our operating results,  financial condition and cash flows could beadversely affected.

 

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

 

Weserve an increasingly global market.  Alarge portion of our total revenues is derived from customers located outsideof the United States, particularly in Asian countries.  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 maynot be able to manage our operations to address and support our globalcustomers effectively.  Further, ourinvestments in these types of activities may not make us competitive in theglobal market or we may not be able to meet the service, support, andmanufacturing levels required by our global customers.

 

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

 

•                  unexpected changes inregulatory requirements;

•                  fluctuations in exchangerates and currency controls;

•                  political and economicconditions and instability;

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

•                  difficulty incoordinating our management and operations in several different countries;

•                  difficulties in staffingand managing foreign subsidiary and branch operations;

•                  limited intellectualproperty protection in some countries;

•                  potentially adverse taxconsequences in some countries;

•                  the possibility ofaccounts receivable collection difficulties;

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

•                  the effect of acts ofterrorism and war; and

•                  the burdens of complyingwith a variety of foreign laws.

 

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Many ofour major customers and many of the chipmakers who use our light sourceproducts in their photolithography systems are located in Asia. Economicproblems and currency fluctuations affecting these regions in Asia could createa larger risk for us. Further, even though it has not been difficult for us tocomply with United States export controls, these export rules could changein the future and make it more difficult or impossible for us to export ourproducts to many countries.  Any of thesevulnerabilities could have a material adverse effect on our business, financialcondition and results of operations.

 

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

 

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

 

•                  recruit and trainqualified field service personnel;

•                  identify qualifiedindependent firms; and

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

 

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

 

**We may acquire a businessor enter a new market that will involve numerous risks.  We may not be able to address these riskssuccessfully without substantial expense, delay or other operational andfinancial challenges.**

 

The risks involved withacquiring a new company, forming a joint venture, or entering a new marketinclude the following:

 

•                  diversion of management’sattention and resources to integrate the new company or new businessopportunity;

•                  failure to retain keypersonnel;

•                  client dissatisfactionor performance problems with the acquired company or new product in a newmarket;

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

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

•                  the cost associated withdeveloping, marketing, introducing and supporting a new product in a newmarket;

•                  failure to commercializepurchased technologies;

•                  ability of the acquiredcompanies, joint ventures or new markets to meet their financial projections;

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

•                  compliance with theSarbanes-Oxley Act of 2002, new SEC regulations, Nasdaq Stock Market rules andnew accounting pronouncements as they relate to the new company or jointventure.

 

Mergers,acquisitions and joint ventures as well as entering new markets are inherentlysubject to multiple significant risks, and the inability to effectively managethese risks could have a material adverse

 

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effect on our business.  In July 2005, we announced the formationof a joint venture with Zeiss named TCZ GmbH, to produce tools for themanufacture of flat panel displays.  Thisis a new market for both Cymer and Zeiss and may involve numerous risks.  Any of these risks could materially harm ourbusiness, financial condition and operating results. Further, any business thatwe acquire, joint venture that we form or new market we may enter may notachieve anticipated revenues or operating results.

 

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

 

Changinglaws, regulations and standards relating to corporate governance and publicdisclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations,Nasdaq Stock Market rules, and new accounting pronouncements are creatinguncertainty and additional complexities for companies such as ours. Inparticular, the Section 404 internal control requirements under theSarbanes-Oxley Act have added and will continue to add complexity and costs toour business and require a significant investment of our time and resources tocomplete each year.  We take these newrequirements seriously and expect to continue to make every effort to ensurethat we receive clean attestations on our internal controls each year from ouroutside auditors. To maintain high standards of corporate governance and publicdisclosure, we intend to invest all reasonably necessary resources to complywith all other evolving standards. These investments may result in increasedgeneral and administrative expenses and a diversion of management time andattention from strategic revenue generating and cost management activities.

 

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

 

We have historically usedbroad based stock option programs and other forms of equity-related incentivesas a key component of our employee compensation packages. We believe that stockoptions and other long-term equity incentives directly motivate a broader baseof employees to maximize long-term stockholder value and, through the use oflong-term vesting, encourage employees to remain with us.  The FASB has issued SFAS No. 123R, ofwhich the date of adoption was deferred by the SEC to be effective for annualperiods beginning after June 15, 2005. This new rule will require us to record an expense to earnings foremployee stock option grants and other equity incentives. Moreover, applicablestock exchange listing standards relating to obtaining stockholder approval ofequity compensation plans has made it more difficult and expensive for us togrant options to employees,  which hasresulted in changes to our equity compensation strategy, including a reductionin the number of stock options granted to employees. In the future, we may berequired to offer alternative cash compensation arrangements to employees toreplace these stock option programs. These and other developments in theprovision of equity compensation to employees could make it more difficult toattract, retain and motivate employees, and such a change in accounting rules andalternative cash compensation programs may adversely impact our futureoperating results, financial condition and cash flows.

 

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

 

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

 

As of June 30,2005, we owned 222 United States patents covering certain aspects of technologyrelated to light sources and piezo techniques. These patents will expire atvarious times during the period from January 2008 to September 2023.  As of June 30, 2005, we had applied for 96additional patents in the United States. As of June 30, 2005, we owned 306 foreign patents and had 329patent applications pending in various foreign countries.

 

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Ourpending patent applications and any future applications might not be approved.Our patents might not provide us with a competitive advantage and may bechallenged by third parties. In addition, third parties’ patents might have anadverse effect on our ability to do business. As a result of cost constraints,we did not begin filing in Japan and other countries our patents for inventionscovered by United States patents and patent applications until 1993.  As a result we do not have the right to seekforeign patent protection for some of our early inventions.  Additionally, laws of some foreign countriesin which our products are or may be developed, manufactured or sold, includingvarious countries in Asia, may not protect our products or intellectualproperty rights to the same extent as do the laws of the United States. Thus,the possibility of piracy of our technology and products are more likely inthese countries. Further, third parties might independently develop similarproducts, duplicate our products, or design around patents that are granted tous.

 

Othercompanies or persons may have filed or may file in the future patentapplications that are similar or identical to ours. We may have to participatein appropriate proceedings in the courts or the patent offices to determine thepriority of inventions. These proceedings may determine that these third-partypatent applications have priority over our patent applications. Loss ofpriority in these interference proceedings could result in substantial cost tous.

 

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

 

•                  trade secret protection;

•                  employee nondisclosureagreements;

•                  third-partynondisclosure agreements; and

•                  other intellectualproperty protection methods.

 

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

 

•                  independently developsubstantially the same proprietary information and techniques;

•                  gain access to our tradesecrets; or

•                  disclose our technology.

 

**The parties to whom we provide research and development services maydispute the ownership of the intellectual property that we develop performingthese services.**

 

In thepast, funds from research and development arrangements with third parties havebeen used to pay for a portion of our own research and development expenses. Wereceive these funds from government-sponsored programs and customers, inconnection with our designing and developing specific products. Currently,funds from lithography tool manufacturers and chipmakers are used to fund asmall portion of our development expenses. In providing these research anddevelopment services to these manufacturers, we try to make clear who owns theintellectual property that results from the research and development serviceswe perform. However, disputes over the ownership or rights to use or marketthis intellectual property may arise between 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 besubject to patent litigation to enforce patents issued to us and defendourselves against claimed infringement by our competitor or any other thirdparty.**

 

Third parties have notified usin the past, and may notify us in the future, that we are infringing theirintellectual property rights. Also, we have notified third parties in the past,and may notify them in the future, that they may be infringing our intellectualproperty rights.

 

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Specifically,Komatsu has notified us that we may be infringing some of its Japanese patents.During our discussions with Komatsu, they also asserted that our formerJapanese manufacturing partner, Seiko, or we may be infringing on some ofKomatsu’s United States patents and a number of its additional Japanesepatents. Komatsu has also notified one of our customers, Nikon, of its beliefthat our light sources infringe several of Komatsu’s Japanese and U.S. patents.As a result, we started proceedings in the Japanese Patent Office to opposecertain patents and patent applications of Komatsu. The Japanese Patent Officehas dismissed our opposition claims. Thus, litigation may result in connectionwith Komatsu’s Japanese patents or U.S. patents. Also, Komatsu might claim thatwe infringe other or additional patents. Komatsu notified Seiko that it intendsto enforce its rights against Seiko with respect to its Japanese patents ifSeiko continued to engage in manufacturing activities for us. In connectionwith our former manufacturing agreement with Seiko, we agree to pay Seiko undercertain conditions for damages associated with these types of claims. Seiko maynot prevail in any litigation against Komatsu, and therefore, we may berequired to pay Seiko for such damages.

 

We havenotified our competitor and others of our United States patent portfolio.Specifically, we have notified Komatsu that they may be infringing on some ofour U.S. patents. We have discussed with Komatsu our claims against eachother.  Komatsu challenged one of our U.S.patents in the United States Patent and Trademark Office (“USPTO”) but it wassubsequently re-issued by the USPTO. Also, Komatsu transferred its lithography light source business to ourcompetitor, Gigaphoton.  We also have haddiscussions with Lambda-Physik (a subsidiary of Coherent, Inc.) regardingallegations by each party against the other for possible patent infringement.Any of these discussions with our competitor or former competitor may not besuccessful and litigation could result.

 

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

 

•                  loss of our proprietaryrights;

•                  exposure to significantliabilities by other third parties;

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

•                  restriction frommanufacturing or selling our products.

 

Any ofthese actions could be costly and would divert the efforts and attention of ourmanagement and technical personnel, which would materially adversely affect ourbusiness, financial condition and results of operations.

 

**Trademark infringement claimsagainst our registered and unregistered trademarks would be expensive and wemay have to stop using such trademarks and pay damages.**

 

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

 

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**We are dependent on air transportto conduct our business and disruption of domestic and international airtransport systems could adversely affect our business.**

 

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

 

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

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

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

•                  our sales and marketingefforts may be disrupted.

 

**We are exposed to risks relatedto the fluctuations in the currency exchange rates for all foreign currenciesin which we do business, but particularly for the Japanese yen.**

 

**When we sell products to ourJapanese subsidiary, the sale is denominated in U.S. dollars. When our Japanesesubsidiary sells our products 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 its purchase commitments. We will continue to monitor ourexposure to these currency fluctuations, and, when appropriate, use hedgingtransactions to minimize the effect of these currency fluctuations. However,exchange rate fluctuations may still have a material adverse effect on ouroperating results. In the future, we may need to sell our products in foreigncurrencies other than the Japanese yen and the management of more currencyfluctuations will be more difficult and expose us to greater risks in thisarea.**

 

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

 

**Many foreign government standardsand regulations apply to our products. These standards and regulations are always being amended.  Although we intend to meet all foreignstandards and regulations, our products may not comply with these foreigngovernment standards and regulations. Further, it might not be cost effective for us to redesign our productsto comply with these foreign government standards and regulations.  Our inability to design products to complywith foreign standards therefore could have a material adverse effect on ourbusiness.**

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

**Our products are subjectto potential product liability claims if personal injury or death results fromtheir use.**

 

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

 

**The price of our common stock hasfluctuated and may continue to fluctuate widely.**

 

The price of our common stockhas fluctuated in the past. The market price of our common stock will continueto be subject to significant fluctuations in the future in response to avariety of factors, including the risk factors contained in this report.

 

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

 

•                  the cyclical nature ofthe semiconductor industry;

•                  actual or anticipatedfluctuations in our operating results;

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

•                  announcements ofinnovations in technology;

•                  new products offered byus or our competitor;

•                  developments of patentsor proprietary rights;

•                  changes in financialestimates by securities analysts;

•                  general worldwidepolitical, economic, and market conditions;

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

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

 

**In addition, the stock market hasexperienced extreme price and volume fluctuations that have particularlyaffected the market price for many high technology companies. Such fluctuationshave in some cases been unrelated to the operating performance of thesecompanies. Severe price fluctuations in a company’s stock have frequently beenfollowed by securities litigation.  Anysuch litigation can result in substantial costs and a diversion of management’sattention and resources and therefore could have a material adverse effect onour business, financial condition and results of operations.**

** **

#### **Item3.  Quantitative and QualitativeDisclosures About Market Risk**

 

# **ForeignCurrency Risk**

 

We conduct business in severalinternational currencies through our global operations. Due to the large volumeof our business that we conduct in Japan, the Japanese operation poses thegreatest foreign currency risk.  We usefinancial instruments, principally forward contracts, to manage our foreigncurrency exposures. We enter into forward contracts in order to reduce theimpact of currency fluctuations related to purchases of our inventories byCymer Japan in U.S. dollars for resale under firm third-party sales commitmentsdenominated in Japanese yen, as well as other foreign currency exposures includingexposures related to intercompany debt. We do not enter into forward contracts for speculative purposes.

 

As of June 30, 2005, we hadoutstanding forward contracts to buy U.S. $39.5 million for 4.1 billion yenunder foreign currency exchange facilities with contract rates ranging from 101.2yen to 110.0****yen per U.S. dollar.  These contracts expire on various datesthrough February 2006.

 

Our forward contracts generally qualify for hedge accounting treatmentper the provisions of Statement of Financial Accounting Standards No. 133,“Accounting for Derivative Instruments and Hedging Activities”. As a result, wedefer changes in the fair value for the effective portion of these hedges andrecord the amount in other comprehensive income (loss) and subsequentlyreclassify the gain or loss to cost of product sales in the same period thatthe related sale is made to the third party. The fair value of all of ourforward contracts and the deferred gain (net of tax) for those that qualify forhedge accounting treatment totaled $2.1 million and $303,000, respectively, asof June 30, 2005.

 

The fair value of these forward contracts as of June 30, 2005would have fluctuated by $3.9 million if the foreign currency exchange rate forthe Japanese yen to the U.S. dollar on these forward contracts had changed by10%.

 

# **Investmentand Debt Risk**

 

We maintain an investment portfolioconsisting primarily of government and corporate fixed income securities, certificatesof deposit and commercial paper.  Whileit is our general intent to hold such securities until maturity, we willoccasionally sell certain securities for cash flow purposes. Therefore, ourinvestments are classified as available-for-sale and are carried on the balancesheet at fair value.  Due to

 

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the conservative nature of the investment portfolio, a sudden change ininterest rates would not have a material effect on the value of the portfolio.

 

In February 2002, we issued $250.0 millionprincipal amount of unsecured fixed rate 3.50% Convertible Subordinated Notesdue February 15, 2009.  Interest onthese 2002 notes is payable on February 15 and August 15 of eachyear.  The 2002 notes are convertibleinto shares of our common stock at a conversion rate of 20 shares per $1,000principal amount subject to adjustment under certain conditions. We may redeemthe 2002 notes on or after February 20, 2005, or earlier if the price ofour common stock reaches certain levels. The 2002 notes are subordinated to ourexisting and future senior indebtedness and effectively subordinated to allindebtedness and other liabilities of our subsidiaries.  Because the interest rate is fixed, webelieve there is no risk of increased interest expense. These 2002 notes arerecorded at face value on the consolidated balance sheets. In the third quarterof 2004 and second quarter of 2005, we repurchased, at a discount to par,approximately $49.2 million and $60.0 million principal amount, respectively,of these 2002 notes.  As of June 30,2005, $140.7 million principal amount of the 2002 notes were outstanding.  The fair value of such debt based on quotedmarket prices on June 30, 2005 was $127.0 million.

 

**ITEM4.  Controls and Procedures**

 

*Evaluationof disclosure controls and procedures*.  Our chief executive officer and our chieffinancial officer, after evaluating the effectiveness of our disclosurecontrols and procedures (as defined in Rules 13a-15(e) and 15d-15(e) ofthe Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of June 30,2005, have concluded that as of such date, our disclosure controls andprocedures were adequate and sufficient to ensure that information required tobe disclosed by us in the reports that we file under the Exchange Act isrecorded, processed, summarized and reported within the time period specifiedin the rules and forms of the Securities and Exchange Commission.

 

*Changesin internal control over financial reporting.*There has beenno change in our internal control over financial reporting during the quarterended June 30, 2005 that has materially affected, or is reasonably likelyto materially affect, our internal control over financial reporting.

 

**PART II.  OTHER INFORMATION**

 
| **ITEM  1.** | ** ** | **Legal Proceedings**                                            |
|--------------|------------|------------------------------------------------------------------|
|         |       |                                                             |
|         |       | None.                                                            |
|         |       |                                                             |
| **ITEM 2.**  | ** ** | **Unregistered Sales of  Equity Securities and Use of Proceeds** |
|         |       |                                                             |
|         | (a)        |                                                             | Not applicable. |
|         |       |                                                             |   |
|         | (b)        |                                                             | Not applicable. |
|         |       |                                                             |   |
|         | (c)        |                                                             | On January 27,  2005, we announced that our board of directors had authorized us to  repurchase up to $50,000,000 of our common stock. The purchases have been  made from time to time in the open market or in privately negotiated  transactions. The program does not have a fixed expiration date and may be  discontinued at any time. |
|         |       |                                                             |   |
|         |       |                                                             | The following  table provides information with respect to the shares of common stock  repurchased by us during the six months ended June 30, 2005: |

 

 

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| **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** | ** ** |
|--------------------------------------------------|------------|----------------------------------------|------------|-----------------------------------|------------|--------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------|------------|
| January 1,  2005 to January 31, 2005   |       | —                                 |       | —                            |       | —                                                                                     |       | $                                                                                                 | 50         |  Million |
| February 1,  2005 to February 28, 2005 |       | 292,841                                |       | $                                 | 28.27      |                                                                                       | 292,841    |                                                                                              | $          | 41.7 |  Million |
| March 1,  2005 to March 31, 2005       |       | —                                 |       | —                            |       | —                                                                                     |       | $                                                                                                 | 41.7       |  Million |
| April 1,  2005 to April 30, 2005       |       | 559,195                                |       | $                                 | 24.93      |                                                                                       | 559,195    |                                                                                              | $          | 27.8 |  Million |
| May 1, 2005  to May 31, 2005           |       | 1,090,923                              |       | $                                 | 25.41      |                                                                                       | 1,090,923  |                                                                                              | —     |   |
| June 1,  2005 to June 30, 2005         |       | —                                 |       | —                            |       | —                                                                                     |       | —                                                                                            |       |
| Total                                            |       | 1,942,959                              |       | $                                 | 25.70      |                                                                                       | 1,942,959  |                                                                                              |       |   |

 
| **ITEM  3.** | ** ** | **Defaults Upon Senior  Securities**                                                                                                                                                                                                                                                            |
|--------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |       |                                                                                                                                                                                                                                                                                            |
|         |       | None.                                                                                                                                                                                                                                                                                           |
|         |       |                                                                                                                                                                                                                                                                                            |
| **ITEM  4.** | ** ** | **Submission of Matters  to a Vote of Security Holders**                                                                                                                                                                                                                                        |
|         |       |                                                                                                                                                                                                                                                                                            |
|         |       | Cymer held its  Annual Meeting of Stockholders on May 19, 2005. Out of 36,815,509 shares  of common stock entitled to vote at such meeting, there were present in  person or by proxy 33,692,792 shares. At the Annual Meeting, the stockholders  of Cymer approved the following matters: |
|         |       |                                                                                                                                                                                                                                                                                            |
|         |       | Proposal 1. The  election of the following eight directors to serve for one year. The votes  for the nominated directors were as follows:                                                                                                                                                       |

 
| **Director’s Name** | ** ** | **Votes For** | ** ** | **Votes Withheld** | ** ** |
|--------------------------|------------|---------------|------------|--------------------|------------|
|                     |       |          |       |               |       |
| Charles J. Abbe          |       | 32,322,151    |       | 1,370,641          |       |
| Robert R. Akins          |       | 30,651,370    |       | 3,041,422          |       |
| Edward H. Braun          |       | 32,331,148    |       | 1,361,644          |       |
| Michael R.  Gaulke       |       | 32,139,205    |       | 1,553,587          |       |
| William G.  Oldham       |       | 32,521,687    |       | 1,171,105          |       |
| Peter J. Simone          |       | 20,857,140    |       | 12,835,652         |       |
| Young K. Sohn            |       | 32,329,201    |       | 1,363,591          |       |
| Jon D. Tompkins          |       | 32,162,916    |       | 1,529,876          |       |

 

Proposal2.  Approval of Cymer’s 2005 EquityIncentive Plan.  22,099,353 votes werecast for approval, 6,717,999 votes were cast against, 39,408 votes wereabstained and there were 4,836,032 broker non-votes.

 

Proposal3.  Ratification of the selection of KPMGLLP as the independent auditors of Cymer for the year ending December 31,2005.  31,186,114 votes were cast forapproval, 2,491,650 votes were cast against, 15,028 votes were abstained andthere were no broker non-votes.

 

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| **ITEM 5.**  | ** ** | **Other  Information** |
|--------------|------------|------------------------|
|         |       |                   |
|         |       | None.                  |
|         |       |                   |
| **ITEM  6.** | ** ** | **Exhibits**           |
| ** **   | ** ** | ** **             |
|         |       | 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**

 

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

 

 
|                                  | CYMER, INC.                   |
|---------------------------------------|-------------------------------|
|                                  |                          |
|                                  |                          |
| Date:  August 3,  2005 | 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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