** **

**UNITED STATES 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 September 30, 2003**                                                                                                                                     |
|                                                                                                                                                                                      |
| **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)                           |
|                                                                                                                    |   |                                 |
| Registrant’s  telephone number, including area code:         **(858) 385-7300** |

 

Former name, former address andformer fiscal year, if changed since last report.

  **N/A**

 

Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days.

 

Yes  ý            No o

 

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

 

The number of shares of CommonStock, with $0.001 par value, outstanding on November 6, 2003 was 36,068,501.

 

 

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**CYMER, INC.**

 

**FORM 10-Q**

 

**For the QuarterlyPeriod Ended September 30, 2003**

 

**INDEX**

 
| **PART I.**        | **FINANCIAL INFORMATION**                                                                               |
|--------------------|---------------------------------------------------------------------------------------------------------|
|               |                                                                                                    |
| ITEM 1.            | Consolidated Financial Statements (unaudited)                                                           |
|               |                                                                                                    |
|               | Consolidated Balance Sheets as of December  31, 2002  and September 30, 2003                            |
|               |                                                                                                    |
|               | Consolidated Statements of Operations for  the  three and nine months ended September 30, 2002 and 2003 |
|               |                                                                                                    |
|               | Consolidated Statements of Cash Flows for  the  nine months ended September 30, 2002 and 2003           |
|               |                                                                                                    |
|               | Notes to Consolidated Financial Statements                                                              |
|               |                                                                                                    |
| ITEM 2.            | Management’s Discussion and Analysis of  Financial  Condition and Results of Operations            |
|               |                                                                                                    |
| ITEM 3.            | Quantitative and Qualitative Disclosures  About  Market Risk                                            |
|               |                                                                                                    |
| ITEM 4.            | Controls and Procedures                                                                                 |
|               |                                                                                                    |
| **PART II.**       | **OTHER INFORMATION**                                                                                   |
|               |                                                                                                    |
| ITEM 1.            | Legal Proceedings                                                                                       |
|               |                                                                                                    |
| ITEM 2.            | Changes in Securities and Use of Proceeds                                                               |
|               |                                                                                                    |
| ITEM 3.            | Defaults upon Senior Securities                                                                         |
|               |                                                                                                    |
| ITEM 4.            | Submission of Matters to a Vote of Security  Holders                                                    |
|               |                                                                                                    |
| ITEM 5.            | Other Information                                                                                       |
|               |                                                                                                    |
| ITEM 6.            | Exhibits and Reports on Form 8-K                                                                        |
|               |
| **SIGNATURE PAGE** |

 

2

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### **PARTI.  FINANCIAL INFORMATION**

 

**ITEM 1. Consolidated Financial Statements****(unaudited)**

** **

**CYMER, INC.**

**CONSOLIDATED BALANCE SHEETS (UNAUDITED)**

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

 
|                                                                                                                                                                                   |   | **December  31,  2002** |    | **September  30,  2003** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|---------|--------------------------|--------|
| **ASSETS**                                                                                                                                                                             |   |                    |    |                     |   |
|                                                                                                                                                                                   |   |                    |    |                     |   |
| CURRENT ASSETS:                                                                                                                                                                        |   |                    |    |                     |   |
| Cash and cash  equivalents                                                                                                                                                             |   | $                       | 196,643 |                     | $      | 187,543 |   |
| Short-term investments                                                                                                                                                                 |   | 71,249                  |    | 100,167                  |   |
| Accounts receivable – net                                                                                                                                                         |   | 52,341                  |    | 66,644                   |   |
| Inventories                                                                                                                                                                            |   | 100,119                 |    | 88,910                   |   |
| Deferred  income taxes                                                                                                                                                                 |   | 20,041                  |    | 20,071                   |   |
| Income taxes receivable                                                                                                                                                                |   | —                  |    | 16,725                   |   |
| Prepaid expenses and other assets                                                                                                                                                      |   | 6,029                   |    | 4,749                    |   |
| Total current assets                                                                                                                                                                   |   | 446,422                 |    | 484,809                  |   |
|                                                                                                                                                                                   |   |                    |    |                     |   |
| PROPERTY AND  EQUIPMENT – NET                                                                                                                                                     |   | 112,209                 |    | 128,308                  |   |
| LONG-TERM INVESTMENTS                                                                                                                                                                  |   | 159,029                 |    | 91,888                   |   |
| DEFERRED INCOME TAXES                                                                                                                                                                  |   | 20,553                  |    | 21,350                   |   |
| GOODWILL –   NET                                                                                                                                                             |   | 10,597                  |    | 10,597                   |   |
| INTANGIBLE ASSETS – NET                                                                                                                                                           |   | 8,565                   |    | 7,477                    |   |
| OTHER ASSETS                                                                                                                                                                           |   | 9,512                   |    | 9,053                    |   |
|                                                                                                                                                                                   |   |                    |    |                     |   |
| TOTAL ASSETS                                                                                                                                                                           |   | $                       | 766,887 |                     | $      | 753,482 |   |
|                                                                                                                                                                                   |   |                    |    |                     |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                          |   |                    |    |                     |   |
|                                                                                                                                                                                   |   |                    |    |                     |   |
| CURRENT LIABILITIES:                                                                                                                                                                   |   |                    |    |                     |   |
| Accounts payable                                                                                                                                                                       |   | $                       | 26,499  |                     | $      | 14,405 |   |
| Accrued warranty and installation                                                                                                                                                      |   | 30,078                  |    | 26,217                   |   |
| Accrued payroll and benefits                                                                                                                                                           |   | 7,334                   |    | 7,061                    |   |
| Foreign currency forward exchange contracts                                                                                                                                            |   | 907                     |    | 5,599                    |   |
| Accrued interest                                                                                                                                                                       |   | 3,300                   |    | 1,091                    |   |
| Income taxes payable                                                                                                                                                                   |   | 11,321                  |    | —                   |   |
| Revolving loan                                                                                                                                                                         |   | 6,667                   |    | —                   |   |
| Accrued and other current liabilities                                                                                                                                                  |   | 9,189                   |    | 11,175                   |   |
| Total current liabilities                                                                                                                                                              |   | 95,295                  |    | 65,548                   |   |
|                                                                                                                                                                                   |   |                    |    |                     |   |
| CONVERTIBLE  SUBORDINATED NOTES                                                                                                                                                        |   | 250,000                 |    | 250,000                  |   |
| OTHER  LIABILITIES                                                                                                                                                                     |   | 5,154                   |    | 5,666                    |   |
| MINORITY  INTEREST                                                                                                                                                                     |   | 4,104                   |    | 5,051                    |   |
|                                                                                                                                                                                   |   |                    |    |                     |   |
| 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; 34,227,000 and 35,661,000 shares outstanding  at December 31, 2002 and September 30, 2003, respectively |   | 34                      |    | 36                       |   |
| Additional paid-in capital                                                                                                                                                             |   | 302,501                 |    | 333,428                  |   |
| Unearned compensation                                                                                                                                                                  |   | (2,358                  | )       | (218                     | )      |
| Accumulated other comprehensive loss                                                                                                                                                   |   | (3,429                  | )       | (4,541                   | )      |
| Retained earnings                                                                                                                                                                      |   | 115,586                 |    | 98,512                   |   |
| Total stockholders’ equity                                                                                                                                                        |   | 412,334                 |    | 427,217                  |   |
|                                                                                                                                                                                   |   |                    |    |                     |   |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                        |   | $                       | 766,887 |                     | $      | 753,482 |   |

 

See Notes to UnauditedConsolidated Financial Statements.

 

3

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**CYMER,INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS(UNAUDITED)**

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

 
|                                                                            |   | **For the  three months  ended September 30,** |   | **For the  nine months  ended September 30,** |   |
|---------------------------------------------------------------------------------|--------|------------------------------------------------|--------|-----------------------------------------------|--------|
|                                                                            |   | **2002**                                       |   | **2003**                                      |   | **2002** |   | **2003** |   |
| REVENUES:                                                                       |   |                                           |   |                                          |   |   |   |   |   |
| Product sales                                                                   |   | $                                              | 84,170 |                                          | $      | 63,873 |   | $ | 218,672 |   | $ | 193,386 |   |
| Other                                                                           |   | 314                                            |   | 564                                           |   | 1,464 |   | 1,066 |   |
| Total revenues                                                                  |   | 84,484                                         |   | 64,437                                        |   | 220,136 |   | 194,452 |   |
|                                                                            |   |                                           |   |                                          |   |   |   |   |   |
| COSTS AND EXPENSES:                                                             |   |                                           |   |                                          |   |   |   |   |   |
| Cost of product sales                                                           |   | 47,417                                         |   | 48,029                                        |   | 117,732 |   | 142,930 |   |
| Research and development                                                        |   | 20,581                                         |   | 12,034                                        |   | 53,577 |   | 45,869 |   |
| Sales and marketing                                                             |   | 4,452                                          |   | 3,873                                         |   | 12,294 |   | 12,428 |   |
| General and administrative                                                      |   | 5,423                                          |   | 20,621                                        |   | 13,470 |   | 32,941 |   |
| Amortization of intangibles                                                     |   | 40                                             |   | 40                                            |   | 120 |   | 120 |   |
| Loss on debt extinguishment                                                     |   | —                                         |   | —                                        |   | 163 |   | — |   |
|                                                                            |   |                                           |   |                                          |   |   |   |   |   |
| Total costs and expenses                                                        |   | 77,913                                         |   | 84,597                                        |   | 197,356 |   | 234,288 |   |
|                                                                            |   |                                           |   |                                          |   |   |   |   |   |
| OPERATING INCOME (LOSS)                                                         |   | 6,571                                          |   | (20,160                                       | )      | 22,780 |   | (39,836 | ) |
|                                                                            |   |                                           |   |                                          |   |   |   |   |   |
| OTHER INCOME (EXPENSE):                                                         |   |                                           |   |                                          |   |   |   |   |   |
| Foreign currency exchange gain (loss) – net                                |   | (542                                           | )      | 482                                           |   | (422 | ) | 65 |   |
| Interest and  other income                                                      |   | 2,781                                          |   | 2,078                                         |   | 7,392 |   | 6,964 |   |
| Interest and other expense                                                      |   | (2,683                                         | )      | (2,530                                        | )      | (8,624 | ) | (7,510 | ) |
|                                                                            |   |                                           |   |                                          |   |   |   |   |   |
| Total other  income (expense) – net                                   |   | (444                                           | )      | 30                                            |   | (1,654 | ) | (481 | ) |
|                                                                            |   |                                           |   |                                          |   |   |   |   |   |
| INCOME (LOSS) BEFORE INCOME TAX  PROVISION (BENEFIT) AND MINORITY INTEREST |   | 6,127                                          |   | (20,130                                       | )      | 21,126 |   | (40,317 | ) |
|                                                                            |   |                                           |   |                                          |   |   |   |   |   |
| INCOME TAX PROVISION (BENEFIT)                                                  |   | (687                                           | )      | (12,078                                       | )      | 3,406 |   | (24,190 | ) |
| MINORITY INTEREST                                                               |   | 41                                             |   | (467                                          | )      | (227 | ) | (947 | ) |
|                                                                            |   |                                           |   |                                          |   |   |   |   |   |
| NET INCOME  (LOSS)                                                              |   | $                                              | 6,855  |                                          | $      | (8,519 | ) | $ | 17,493 |   | $ | (17,074 | ) |
|                                                                            |   |                                           |   |                                          |   |   |   |   |   |
| EARNINGS (LOSS) PER SHARE:                                                      |   |                                           |   |                                          |   |   |   |   |   |
| Basic earnings (loss) per share                                                 |   | $                                              | 0.20   |                                          | $      | (0.24 | ) | $ | 0.53 |   | $ | (0.49 | ) |
| Weighted average common shares outstanding  - basic                             |   | 33,983                                         |   | 35,302                                        |   | 33,047 |   | 34,733 |   |
|                                                                            |   |                                           |   |                                          |   |   |   |   |   |
| Diluted earnings (loss) per share                                               |   | $                                              | 0.20   |                                          | $      | (0.24 | ) | $ | 0.51 |   | $ | (0.49 | ) |
| Weighted average common shares outstanding  – diluted                      |   | 34,589                                         |   | 35,302                                        |   | 34,558 |   | 34,733 |   |

 

See Notes to UnauditedConsolidated Financial Statements.

 

4

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**CYMER, INC.**

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

**(In thousands)**

 
|                                                                                                            |   | **For the  nine months ended  September 30,** |    |
|-----------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------|---------|
|                                                                                                            |   | **2002**                                      |    | **2003** |   |
|                                                                                                            |   |                                          |    |   |   |
| OPERATING ACTIVITIES:                                                                                           |   |                                          |    |   |   |
| Net income (loss)                                                                                               |   | $                                             | 17,493  |   | $ | (17,074 | ) |
| Adjustments to reconcile net income (loss)  to net cash provided by (used in) operating activities:             |   |                                          |    |   |   |
| Loss on debt extinguishment                                                                                     |   | 163                                           |    | — |   |
| Depreciation and amortization                                                                                   |   | 18,574                                        |    | 23,816 |   |
| Non-cash stock-based compensation                                                                               |   | —                                        |    | 1,115 |   |
| Amortization of unearned compensation                                                                           |   | 832                                           |    | 665 |   |
| Minority interest                                                                                               |   | 227                                           |    | 947 |   |
| Provision for deferred income taxes                                                                             |   | (56                                           | )       | (54 | ) |
| Loss on disposal or impairment of property  and equipment                                                       |   | 592                                           |    | 17,635 |   |
| Change in assets and liabilities:                                                                               |   |                                          |    |   |   |
| Accounts receivable – net                                                                                  |   | (21,059                                       | )       | (14,303 | ) |
| Income taxes receivable                                                                                         |   | 2,463                                         |    | (16,725 | ) |
| Foreign currency forward exchange contracts                                                                     |   | 1,404                                         |    | 1,925 |   |
| Inventories                                                                                                     |   | (31,080                                       | )       | 11,209 |   |
| Prepaid expenses and other assets                                                                               |   | (3,532                                        | )       | 786 |   |
| Accounts payable                                                                                                |   | 12,061                                        |    | (12,094 | ) |
| Accrued and other liabilities                                                                                   |   | 3,720                                         |    | (3,627 | ) |
| Income taxes payable                                                                                            |   | —                                        |    | (11,321 | ) |
|                                                                                                            |   |                                          |    |   |   |
| Net cash provided by (used in) operating  activities                                                            |   | 1,802                                         |    | (17,100 | ) |
|                                                                                                            |   |                                          |    |   |   |
| INVESTING ACTIVITIES:                                                                                           |   |                                          |    |   |   |
| Acquisition of property and equipment                                                                           |   | (24,493                                       | )       | (55,509 | ) |
| Purchases of investments                                                                                        |   | (265,370                                      | )       | (84,006 | ) |
| Proceeds from sold or matured investments                                                                       |   | 124,251                                       |    | 121,454 |   |
| Acquisition of minority interest                                                                                |   | (360                                          | )       | (180 | ) |
|                                                                                                            |   |                                          |    |   |   |
| Net cash used in investing activities                                                                           |   | (165,972                                      | )       | (18,241 | ) |
|                                                                                                            |   |                                          |    |   |   |
| FINANCING ACTIVITIES:                                                                                           |   |                                          |    |   |   |
| Net repayments under revolving loan and  security agreements                                                    |   | (1,672                                        | )       | (6,667 | ) |
| Proceeds from issuance of common stock                                                                          |   | 18,271                                        |    | 31,288 |   |
| Redemption of convertible subordinated  notes                                                                   |   | (39,598                                       | )       | — |   |
| Issuance of convertible subordinated notes                                                                      |   | 250,000                                       |    | — |   |
| Issuance of convertible subordinated notes  offering costs                                                      |   | (7,873                                        | )       | — |   |
| Minority interest investments in  subsidiaries                                                                  |   | 1,900                                         |    | — |   |
| Payments on capital lease obligations                                                                           |   | (32                                           | )       | (38 | ) |
|                                                                                                            |   |                                          |    |   |   |
| Net cash provided by financing activities                                                                       |   | 220,996                                       |    | 24,583 |   |
|                                                                                                            |   |                                          |    |   |   |
|                                                                                                            |   |                                          |    |   |   |
| EFFECT OF EXCHANGE RATE CHANGES ON CASH AND  CASH EQUIVALENTS                                                   |   | 95                                            |    | 1,658 |   |
|                                                                                                            |   |                                          |    |   |   |
| NET INCREASE (DECREASE) IN CASH AND CASH  EQUIVALENTS                                                           |   | 56,921                                        |    | (9,100 | ) |
| CASH AND CASH EQUIVALENTS AT BEGINNING  OF PERIOD                                                          |   | 111,195                                       |    | 196,643 |   |
|                                                                                                            |   |                                          |    |   |   |
| CASH AND CASH EQUIVALENTS AT END OF PERIOD                                                                      |   | $                                             | 168,116 |   | $ | 187,543 |   |
|                                                                                                            |   |                                          |    |   |   |
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW  INFORMATION:                                                              |   |                                          |    |   |   |
| Interest paid                                                                                                   |   | $                                             | 10,382  |   | $ | 8,925 |   |
| Income taxes paid, net                                                                                          |   | $                                             | 202     |   | $ | 4,037 |   |
|                                                                                                            |   |                                          |    |   |   |
| SUPPLEMENTAL DISCLOSURE OF NON-CASH  INVESTING AND FINANCING ACTIVITIES:                                        |   |                                          |    |   |   |
| Conversion of subordinated notes to equity                                                                      |   | $                                             | 112,998 |   | $ | — |   |
| Reversal of unearned compensation related  to cancelled stock options previously issued for the ACX acquisition |   | $                                             | —  |   | $ | 1,475 |   |

 

See Notes to UnauditedConsolidated Financial Statements.

 

5

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**CYMER, INC.**

 

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**Three and Nine MonthsEnded September 30, 2003**

**(Unaudited)**

 

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

 

*Unaudited InterimFinancial Data* – The accompanying consolidatedfinancial information has been prepared by Cymer, Inc., and its wholly-ownedand majority-owned subsidiaries (collectively, “Cymer”), without audit, inaccordance with the instructions to Form 10-Q. In the opinion of management,the unaudited consolidated financial statements for the interim periodspresented reflect all material adjustments, consisting only of normal recurringadjustments, necessary for a fair presentation of the financial position andresults of operations as of and for such periods indicated.  These consolidated financial statements andnotes hereto should be read in conjunction with the consolidated financialstatements and notes thereto included in Cymer’s Annual Report on Form 10-K forthe year ended December 31, 2002. Results for the interim periods presented herein are not necessarilyindicative of results which may be reported for any other interim period or forthe entire fiscal year.

 

*Principles ofConsolidation* – The consolidated financial statementsinclude the accounts of Cymer, Inc., its wholly-owned subsidiaries – CymerJapan, Inc. (“Cymer Japan”), Cymer Singapore Pte Ltd. (“Cymer Singapore”),Cymer B.V. in the Netherlands (“Cymer B.V.”), Cymer Southeast Asia, Inc., inTaiwan (“Cymer SEA”),  CymerSemiconductor Equipment Shanghai Co., Ltd, in the People’s Republic of China(“Cymer PRC”), and its majority-owned subsidiary, Cymer Korea, Inc. (“CymerKorea”).  Cymer, Inc. owns 75% of CymerKorea.  During 2002, Active ControleXperts, Inc. or ACX was a wholly-owned subsidiary of Cymer, Inc.  Effective January 1, 2003, ACX was mergedwith and into Cymer, Inc.  Cymer sellsits excimer light sources in Japan primarily through Cymer Japan. Cymer SEA,Cymer PRC, Cymer Singapore and Cymer B.V. are field service offices forcustomers in those respective regions. Cymer Korea provides manufacturing, refurbishment, field service, andadministrative activities for that region. All significant intercompanybalances have been eliminated in consolidation.

 

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

 

*Research and Development –*Research and development costs are expensed in the period incurred and includecosts associated with funded development contracts.  The funded development contracts are generally cost sharing contractsbetween Cymer and a customer where each party pays equal portions of the totaldevelopment costs.  As a result, costsfor the funded development contracts approximate the revenue recorded for thesecontracts in other revenue in the accompanying statements of operations. Theservices performed under the funded development contracts are provided on abest efforts basis.

 

*Reclassifications –*Certain amounts in the prior yearconsolidated financial statements have been reclassified to conform to currentperiod presentation.

 

*Accounting Pronouncements Adopted –*Cymer adopted the provisions ofStatement of Financial Accounting Standards No. 143 (“SFAS No. 143”),“Accounting for Asset Retirement Obligations” on January 1, 2003.  SFAS No. 143 addresses financial accountingand reporting for obligations associated with the retirement of tangiblelong-lived assets and the associated asset retirement costs. SFAS No. 143applies to tangible long-lived assets that have a legal obligation

 

6

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associated with theirretirement that results from the acquisition, construction or development ornormal use of the asset. The adoption of this statement did not have an impacton Cymer’s financial condition or results of operations.

 

Cymer adoptedthe provisions of Statement of Financial Accounting Standards No. 145 (“SFASNo. 145”), “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASBStatement No. 13, and Technical Corrections” on January 1, 2003.  SFAS No. 145 provides guidance on theclassification of gains and losses from the extinguishment of debt and on theaccounting for certain specified lease transactions. Cymer reclassified the2002 loss on extinguishment of debt from an extraordinary loss on debt extinguishmentto operating expenses in the consolidated statements of operations.

 

Cymer adopted the provisions of Statement of Financial AccountingStandards No. 146 (“SFAS No. 146”), “Accounting for Costs Associated with Exit or Disposal Activities”, onJanuary 1, 2003.  SFAS No. 146 revisesthe accounting for specified employee and contract terminations that are partof restructuring activities and allows recognition of a liability for the costassociated with an exit or disposal activity only when the liability isincurred and can be measured at fair value. This statement applies on aprospective basis to exit or disposal activities that are initiated afterDecember 31, 2002.

 

Cymer adopted the initial recognition andmeasurement provisions of Financial Accounting Standards Board (“FASB”)Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers”, on January 1, 2003, which apply on a prospective basis to guaranteesissued or modified after December 31, 2002. Cymer adopted the disclosure provisions of FIN 45 during the quarterended December 31, 2002.  In theordinary course of business, Cymer is not subject to potential obligationsunder guarantees that fall within the scope of FIN 45 except for warrantyprovisions, intellectual property indemnification clauses that are containedwithin many of our customer agreements and third-party bank guarantees that wehad with one of our subsidiaries until June 2003.  These provisions fall within the disclosure requirementsprescribed by FIN 45.

 

Cymer adopted the interim disclosureprovisions of Statement of Accounting Standards No. 148, “Accounting forStock-Based Compensation - Transition and Disclosure”, during the quarter endedSeptember 30, 2003.  Related interimdisclosures are included in footnote 2.

 

In November 2002, the Emerging Issues Task Force (“EITF”) issuedEITF Issue No. 00-21, “Accounting for Revenue Arrangements with MultipleDeliverables.” EITF Issue No. 00-21 addresses how to determine whether arevenue arrangement involving multiple deliverables contains more than one unitof accounting for the purposes of revenue recognition and how the revenuearrangement consideration should be measured and allocated to the separateunits of accounting. EITF Issue No. 00-21 applies to revenue arrangementsentered into after June 15, 2003. The adoption of this statement did nothave a material impact on Cymer’s financial condition or results of operations.

 

In April 2003, the FASB issued Statement of Financial AccountingStandards No. 149 (“SFAS No. 149”), “Amendment of Statement 133 on DerivativeInstruments and Hedging Activities”. SFAS No. 149 amends and clarifies financial accounting and reporting forderivative instruments, including certain derivative instruments embedded inother contracts and for hedging activities under FASB Statement No. 133.  This statement is effective for contractsentered into or modified after June 30, 2003 and for hedging relationships designatedafter June 30, 2003. The adoption of this statement did not have a materialimpact on Cymer’s financial condition or results of operations.

 

In May 2003, the FASB issued Statement of Financial AccountingStandards No.150 (“SFAS No. 150”), “Accounting for Certain Instruments withCharacteristics of Both Liabilities and

 

7

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Equity”. The standardestablishes how an issuer classifies and measures certain freestandingfinancial instruments with characteristics of liabilities and equity andrequires that such instruments be classified as liabilities. The standard iseffective for financial instruments entered into or modified after May 31, 2003and is otherwise effective at the beginning of the first interim periodbeginning after June 15, 2003.  Theadoption of the statement did not have a material impact on Cymer’sconsolidated financial statements.

 

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

 

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

 

All options grantedunder the plans had an exercise price equal to the market value of theunderlying common stock on the date of grant.

 

Cymer accounts for optionsgranted to non-employees under SFAS No. 123 and EITF Issue No. 96-18,“Accounting for Equity Instruments that are Issued to other than Employees forAcquiring or in Conjunction with Selling Goods or Services”.  Cymer measures the fair value of such optionsusing the Black-Scholes option-pricing model at each financial reportingdate.  Cymer accounts for changes infair values between reporting dates in accordance with Financial AccountingInterpretation 28. Stock-based compensation expense for options granted tonon-employees for the three and nine months ended September 30, 2003 was$311,000 and $1.1 million, respectively.

 

Under SFAS 123, theweighted average per share fair value of the options granted for the ninemonths ended 2002 and 2003 was $22.22 and $18.62, respectively, on the date ofgrant.  The fair value under SFAS 123 isdetermined using the Black-Scholes option-pricing model with the assumptionsnoted below.  For risk free interest,Cymer uses the then currently available rate on zero coupon U.S. Governmentissues with a remaining life of five years for valuing options and one year forESPP.

 

|                                 |   | **Three months ended  September 30,** |   | **Nine months ended  September 30,** |   |
|--------------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
|                                 |   | **2002**                              |   | **2003**                             |   | **2002** |   | **2003** |   |
|                                 |   |                                  |   |                                 |   |   |   |   |   |
| Dividend yield                       |   | None                                  |   | None                                 |   | None |   | None |   |
| Volatility rate                      |   | 83                                    | %      | 83                                   | %      | 83 | % | 83 | % |
| Weighted average risk free interest: |   |                                  |   |                                 |   |   |   |   |   |
| Options                              |   | 4.46                                  | %      | 2.91                                 | %      | 4.08 | % | 2.87 | % |
| ESPP                                 |   | N/A                                   |   | N/A                                  |   | 2.35 | % | 1.22 | % |
| Assumed forfeiture rate              |   | 5                                     | %      | 5                                    | %      | 5 | % | 5 | % |
| Expected life:                       |   |                                  |   |                                 |   |   |   |   |   |
| Options                              |   | 6  years                              |   | 6  years                             |   | 6  years |   | 6  years |   |
| ESPP                                 |   | .5  years                             |   | .5  years                            |   | .5  years |   | .5  years |   |

 

8

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The following table compares net income (loss) per share as reported byCymer to the pro forma amounts that would be reported had compensation expensebeen recognized for Cymer’s stock-based compensation plans in accordance withSFAS No. 123, (in thousands, except per share amounts):

 
|                                                                                                                                              |   | **Three months ended  September 30,** |       | **Nine months ended  September 30,** |       |
|---------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|------------|--------------------------------------|------------|
|                                                                                                                                              |   | **2002**                              |       | **2003**                             |       | **2002** |   | **2003** |   |
|                                                                                                                                              |   |                                  | ** ** |                                 | ** ** |   | ** ** |   | ** ** |
| Net income (loss), as reported                                                                                                                    |   | $                                     | 6,855      |                                 | $          | (8,519 | ) | $ | 17,493 |   | $ | (17,074 | ) |
| Deduct: Total stock-based employee compensation  expense determined under the fair value based method for all awards, net of  related tax effects |   | $                                     | (10,385    | )                                    | (2,293     | ) | (26,449 | ) | (8,291 | ) |
|                                                                                                                                              |   |                                  |       |                                 |       |   |   |   |   |
| Pro forma net loss                                                                                                                                |   | $                                     | (3,530     | )                                    | $          | (10,812 | ) | $ | (8,956 | ) | $ | (25,365 | ) |
|                                                                                                                                              |   |                                  |       |                                 |       |   |   |   |   |
| Earnings (loss) per share:                                                                                                                        |   |                                  |       |                                 |       |   |   |   |   |
| Basic – as reported                                                                                                                          |   | $                                     | 0.20       |                                 | $          | (0.24 | ) | $ | 0.53 |   | $ | (0.49 | ) |
| Basic – pro forma                                                                                                                            |   | $                                     | (0.10      | )                                    | $          | (0.31 | ) | $ | (0.27 | ) | $ | (0.73 | ) |
|                                                                                                                                              |   |                                  |       |                                 |       |   |   |   |   |
| Diluted – as reported                                                                                                                        |   | $                                     | 0.20       |                                 | $          | (0.24 | ) | $ | 0.51 |   | $ | (0.49 | ) |
| Diluted – pro forma                                                                                                                          |   | $                                     | (0.10      | )                                    | $          | (0.31 | ) | $ | (0.27 | ) | $ | (0.73 | ) |

 

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

 

*Earnings (Loss) PerShare* – Basicearnings (loss) per share (“EPS”) excludes dilution and is computed by dividingnet income or loss attributable to common stockholders by the weighted-averageof common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur ifsecurities or other contracts to issue common stock (convertible subordinatednotes, warrants to purchase common stock and common stock options using thetreasury stock method) were exercised or converted into common stock.  Potential dilutive securities are excludedfrom the 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 nine months ended September 30, 2002 and 2003 (inthousands):

 
|                                                  |   | **Three  months ended  September 30,** |   | **Nine  months ended  September 30,** |   |
|-------------------------------------------------------|--------|----------------------------------------|--------|---------------------------------------|--------|
|                                                  |   | **2002**                               |   | **2003**                              |   | **2002** |   | **2003** |   |
|                                                  |   |                                   |   |                                  |   |   |   |   |   |
| Weighted average common shares outstanding  - basic   |   | 33,983                                 |   | 35,302                                |   | 33,047 |   | 34,733 |   |
|                                                  |   |                                   |   |                                  |   |   |   |   |   |
| Effect of dilutive securities:                        |   |                                   |   |                                  |   |   |   |   |   |
| Warrants                                              |   | —                                 |   | —                                |   | 29 |   | — |   |
| Options                                               |   | 606                                    |   | —                                |   | 1,482 |   | — |   |
|                                                  |   |                                   |   |                                  |   |   |   |   |   |
| Weighted average common shares outstanding  - diluted |   | 34,589                                 |   | 35,302                                |   | 34,558 |   | 34,733 |   |

 

Forthe three months ended September 30, 2002 and 2003, weighted average optionsand warrants to purchase 4,401,000 and 2,858,000 shares of common stock,respectively, were

 

9

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outstanding but not included inthe computation of diluted earnings per share as their effect wasanti-dilutive.  In addition, for thethree months ended September 30, 2002 and 2003, weighted average common sharesattributable to convertible subordinated notes of 5,000,000 were not includedin the calculation of diluted earnings per share as their effect was alsoanti-dilutive.

 

Forthe nine months ended September 30, 2002 and 2003, weighted average options andwarrants to purchase 2,375,000 and 4,311,000 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 nine months ended September 30, 2002 and2003, weighted average common shares attributable to convertible subordinatednotes of 5,103,000 and 5,000,000, respectively, were not included in thecalculation of diluted earnings per share as their effect was alsoanti-dilutive.

 

**4.****              INVENTORIES**

 

Inventories consist of the following as ofDecember 31, 2002 and September 30, 2003 (in thousands):

 
|                                        |   | **December  31,  2002** |    | **September  30,  2003** |   |
|---------------------------------------------|--------|-------------------------|---------|--------------------------|--------|
| INVENTORIES:                                |   |                    |    |                     |   |
| Raw materials                               |   | $                       | 44,252  |                     | $      | 38,682 |   |
| Work-in-progress                            |   | 32,718                  |    | 25,114                   |   |
| Finished goods                              |   | 37,849                  |    | 39,940                   |   |
| Allowance for excess and obsolete inventory |   | (14,700                 | )       | (14,826                  | )      |
| Total                                       |   | $                       | 100,119 |                     | $      | 88,910 |   |

** **

**5.****              REPORTINGCOMPREHENSIVE INCOME (LOSS)**

 

Comprehensive income (loss) includes net income (loss), effectiveunrealized gains and losses on foreign currency forward exchange contracts,foreign currency 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 followingtable summarizes the change in each component of accumulated othercomprehensive income (loss) for the nine months ended September 30, 2003 (inthousands):

 
|               |   |               |   | **Translation  adjustment,  net of tax** |   | **Total  unrealized  gains on  available-for-sale  investments,  net of tax** |   | **Total  unrealized  gains (losses) on  foreign currency  forward exchange  contracts, net of tax** |   | **Accumulated  other  comprehensive  loss** |   |
|--------------------|--------|--------------------|--------|------------------------------------------|--------|-------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------|--------|---------------------------------------------|--------|
|               |   |               |   |                                     |   |                                                                          |   |                                                                                                |   |                                        |   |
| December 31, 2002  |   | Balance            |   | $                                        | (5,272 | )                                                                             | $      | 2,342                                                                                               |   | $                                           | (499   | ) | $ | (3,429 | ) |
|               |   | Period net  change |   | 977                                      |   | (456                                                                          | )      | (1,633                                                                                              | )      | (1,112                                      | )      |
| September 30, 2003 |   | Balance            |   | $                                        | (4,295 | )                                                                             | $      | 1,886                                                                                               |   | $                                           | (2,132 | ) | $ | (4,541 | ) |

 

**6.     GOODWILL AND INTANGIBLE ASSETS**

 

As of the dateof adoption of Statement of Financial Accounting Standards No. 142 (“SFAS No.142”), “Goodwill and Other Intangible Assets” on January 1, 2002, Cymer hadunamortized goodwill in the amount of $9.8 million and unamortized identifiableintangible assets, excluding acquired patents, in the amount of $1.1 million,all of which were subject to the transition provisions of SFAS No. 142.

 

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As of December31, 2002 and September 30, 2003, the components of intangible assets acquiredin prior purchase business combinations were as follows (in thousands):

 
|                                  |   | **December  31, 2002**      |   | **September  30, 2003**       |   |
|---------------------------------------|--------|-----------------------------|--------|-------------------------------|--------|
|                                  |   | **Gross  Carrying  Amount** |   | **Accumulated  Amortization** |   | **Gross  Carrying  Amount** |   | **Accumulated  Amortization** |   |
|                                  |   |                        |   |                          |   |   |   |   |   |
| Amortized intangible assets:          |   |                        |   |                          |   |   |   |   |   |
| Existing technology - ACX acquisition |   | $                           | 640    |                          | $      | 300 |   | $ | 640 |   | $ | 420 |   |
|                                  |   |                        |   |                          |   |   |   |   |   |
| Unamortized intangible assets:        |   |                        |   |                          |   |   |   |   |   |
| Goodwill                              |   | $                           | 13,713 |                          | $      | 3,116 |   | $ | 13,713 |   | $ | 3,116 |   |

 

The abovetable only includes intangible assets associated with prior purchase businesscombinations.  Also included inintangible assets – net on the accompanying balance sheets are amountsassociated with patents which were acquired in 2001.  In May 2001, Cymer acquired certain patents for a totalconsideration of $10.3 million, which included a $6.0 million cash payment andthe issuance of 200,000 warrants valued at 4.3 million. The warrants were valuedon the date of issuance using the Black-Scholes pricing model using thefollowing assumptions: 87% volatility, 5.0% risk-free interest rate and 4.6years expected life.  The total value ofthese patents are being amortized over eight years which represents theshortest remaining life of the patents purchased under the agreement. Theamortization of these patents is included in cost of product sales on theaccompanying statements of operations. As of December 31, 2002 and September30, 2003, the net carrying amount of these patents was $8.2 million and $7.3million, respectively.

 

Aggregateamortization expense was $120,000 for each of the nine months ended September30, 2002 and 2003.  As of September 30,2003, future estimated amortization expense is expected to be as follows (inthousands):

 

|                                 |   | **Future  Amortization** |   |
|--------------------------------------|--------|--------------------------|--------|
|                                 |   |                     |   |
| Three months ended December 31, 2003 |   | $                        | 40     |   |
| Year ended December 31, 2004         |   | $                        | 160    |   |
| Year ended December 31, 2005         |   | $                        | 20     |   |

 

**7.     GUARANTEES**

*** ***

Cymer adoptedthe disclosure provisions of FIN 45 during the quarter ended December 31, 2002and has adopted the recognition and measurement provisions as required afterDecember 31, 2002.  FIN 45 providesexpanded accounting guidance surrounding liability recognition and disclosurerequirements related to guarantees, as defined by this interpretation. 

 

In theordinary 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, indemnification provisionsrelated to intellectual property that are contained within many of its customeragreements, and third-party bank guarantees for subsidiary office lines ofcredit.  All of these provisions giverise only to the disclosure requirements prescribed by FIN 45. 

 

*Product Warranties* –Warranty provisions contained within Cymer’s customer agreements are generallyconsistent with those prevalent in the semiconductor equipment industry. Thewarranty period and terms vary by light source model.  In general, the light source system warranty period ranges from17 to 26 months after shipment.  Cymeralso warrants consumables and spare parts sold to its customers and thecoverage period varies by spare part type as some types include time-basedwarranty periods and others include usage-based warranty periods.  On average, the warranty period forconsumables and spare parts is approximately 6 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 determined by using a financial model, which takes into consideration actualhistorical expenses, and potential risks associated with Cymer’s differentlight source system

 

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models. This financial model isthen used to calculate the future probable expenses related to warranty and therequired level of the warranty provision. The risk levels used within this model are reviewed and updated as risklevels change by model over its product life cycle. The warranty provision forconsumables and spares is determined by using actual historical data.  For both light source systems andconsumables, if actual warranty expenditures differ substantially from Cymer’sestimates, revisions to the warranty provision would be required.  Actual warranty expenditures are recordedagainst the warranty provision as they are incurred.

 

The followingtable summarizes information related to Cymer’s warranty provision for the ninemonths ended September 30, 2003 (in thousands):

 

| Balance, January 1, 2003                                                                         |   | $       | 29,600 |   |
|--------------------------------------------------------------------------------------------------|--------|---------|--------|--------|
| Liabilities accrued for warranties issued  during the period, net of adjustments and expirations |   | 9,607   | (1)    |
| Warranty expenditures incurred during the  period                                                |   | (13,382 | )      |
| Balance, September 30, 2003                                                                      |   | $       | 25,825 |   |

 

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(1)  Included in this amount are adjustments to existing warrantyreserves as a result of normal recurring updates made to the risk factors usedin the warranty model during the first quarter of 2003.

 

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

 

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

 

*Guarantees on Subsidiary Debt*–During the first quarter of 2003 and part of the second quarter of 2003, Cymerwas party to a Parent Guarantee associated with a revolving Loan Agreement heldby Cymer Japan. This guarantee was between a commercial bank in the UnitedStates and Cymer.  The Parent Guaranteewas entered into in 2001 in order to establish a banking relationship betweenthis commercial bank and Cymer Japan. Per the terms of the Parent Guarantee, Cymer guaranteed payment of anyobligations under the revolving loan agreement in the event that Cymer Japancould not make such payments due or defaults on the loan.  Cymer Japan made all payments per the termsof the Loan Agreement and thus, Cymer did not incur any guarantor obligationsunder the Parent Guarantee.  Since CymerJapan is a wholly-owned subsidiary of Cymer and Cymer Japan records therevolving loan outstanding balance as a liability on its financial statements,the carrying amount of the liability was included in the consolidated balancesheets.  The Loan Agreement expired onJune 16, 2003 and was paid in full by Cymer Japan. The Loan Agreement was notrenewed on this expiration date.

 

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**8.     ACQUISITION OF ACTIVE CONTROL EXPERTS, INC.**

** **

On February 13, 2001, Cymer acquired the Cambridge, Massachusetts basedcompany, Active Control Experts, Inc. (“ACX”) in an all-stock transactionincluding 689,000 shares of Cymer stock and 336,000 stock options. ACX was aleading developer, manufacturer and marketer of hardware, software and firmwaresolutions for vibrations and nano-motion. The ACX technology can be physically embedded, creating adaptive “smartstructures” to intrinsically improve the stability and precision of nano-motioncontrol in next-generation semiconductor capital equipment. The acquisition wasaccounted for using the purchase method of accounting, and the results ofoperations of ACX are included in Cymer’s consolidated financial statementsfrom the acquisition date. The total consideration for the purchase wasapproximately $24.8 million which included common stock of $15.0 million, $3.0million liabilities assumed, $5.9 million employee stock options assumed, and$0.9 million capitalized transaction costs. Cymer valued the 689,000 shares ofcommon stock issued to acquire ACX at $21.75 per share, which was the averageclosing price for Cymer’s common stock for the period of ten trading dayscommencing five trading days immediately preceding the announcement of thetransaction on November 20, 2000.  Atotal of $12.3 million was recorded as goodwill based on the totalconsideration of $24.8 million less $1.5 million of acquired tangible assets,$1.4 million of acquired identifiable intangible assets, a $5.1 million inprocess research and development charge, and $4.5 million of unearnedcompensation recorded related to the assumed stock options.

 

The purchased in-process research and development (“IPR&D”)totaling $5.1 million, which related to one vibration control developmentproject, was expensed upon acquisition because the application of ACX’stechnology to semiconductor manufacturing required further research anddevelopment before reaching technological feasibility and commercialviability.  In valuing the ACXIPR&D, consideration was given to key characteristics of the product underdevelopment, as well as the technology’s life cycle, and the project's stage ofdevelopment.  A discounted cash flowmodel was used to value the ACX IPR&D which included key assumptionsrelated to ACX’s revenue growth, cost of goods levels, selling, general, andadministrative expenses, research and development expenses, and income taxrates, all over a four year projection period from 2001 through 2004.  The estimated cash flows attributable to thetechnology were converted to present value equivalents using a 20% discountrate.  The value of the ACX IPR&Dwas then calculated by summing the net present value amounts over the four yearprojection period, adding the tax amortization benefit, and applying a 70%percentage of completion factor for the project.

 

Cymer continued to conduct research and development on the vibrationcontrol project that related to this IPR&D charge following the acquisitionin February 2001.  The core technologywas pursued as both a stand-alone product and one that could be embedded intoCymer’s future light source system products. Development of this technology as a stand-alone product was conductedthrough the end of the third quarter 2001. At that time, Cymer and a potential customer for the stand-alone productdecided not to pursue this product further. During the same period, Cymer further developed this same coretechnology so that it could be embedded in certain core modules of its lightsource system products.  This ACXtechnology was successfully embedded in the Nanolith 7000 light source system,which was introduced in the third quarter of 2001.  The project completion date was consistent with the Company’s originalestimate at the time of the acquisition. This technology is also embedded in several of the core modules ofCymer’s newest light source system products, the ELS-7000 and the XLA 100 lightsources, which were released in early 2002 and 2003, respectively.   During the period that the core technologywas being completed as an application in the semiconductor industry, Cymerincurred and expensed additional costs of approximately $2.5 million, whichwere consistent with the costs originally anticipated to complete theproject.  The technology as embedded inthe Cymer’s existing light systems projects has been consistent with the salesprojections used in determining the value of the IPR&D.  As with Cymer’s other core technologies,Cymer intends to continue to develop ACX vibration control technology so thatit can expand the technology’s application further within Cymer’s existinglight source system products and include it in newly developed products.

 

Given the successful completion of the above research program andperformance of the associated product, Cymer believes the assumptions used todetermine the IPR&D charge are reasonable.

 

**9.     CONTINGENCIES AND COMMITMENTS**

 

Cymer is party to legal actions in the normal course of business.  Based in part on the advice of legalcounsel, management does not expect the outcome of legal action in the normalcourse of business to have a material impact on the financial position orresults of operations of Cymer.

 

Cymer’s former Japanese manufacturing partner, Seiko, and one ofCymer’s Japanese customers have been notified that Cymer’s light source systemsin Japan 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 user rights in Japan.

 

In July 2002,Cymer entered into an agreement with a contractor for the construction of a265,000 square foot building adjacent to its corporate headquarters located inSan Diego, California. The construction of the manufacturing and officefacility will be completed in multiple phases, the majority of which wascompleted by the end of the third quarter of 2003.  Cymer has financed the cost of the construction project, which isestimated to be approximately $60 million, using existing capitalresources.  Total capital expendituresfor this construction project to date are approximately $54.8 million.

 

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

 

**ForwardLooking Statement**

 

*Statements in this quarterly report on Form 10-Q thatare not strictly historical in nature are forward-looking statements.  These statements include, but are notlimited to, references to manufacturing activities; expected product sales anddevelopment; service and support; research and development expenditures;expected product development; expected international product sales, developmentand revenue; adequacy of capital resources and investments; effects of businesscycles in the semiconductor business; competitive positioning; and continuingrelationships with third-party manufacturers for product manufacturing, and maycontain words such as “believes,” “anticipates,” “expects,” and words ofsimilar meaning.  These statements areonly predictions based on current information and expectations and involve anumber 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 in this Item 2and under the caption  “Risks andUncertainties That May Affect Results” and  elsewhere in this quarterlyreport on Form 10-Q.*

 

*The following discussion of the financial conditionand results of operations of Cymer should be read in conjunction with Cymer’sconsolidated financial statements and notes thereto included in this quarterlyreport on Form 10-Q and its consolidated financial statements and notes theretoincluded in Cymer’s annual report on Form 10-K for the year ended December 31,2002.*

 

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#### **Overview**

 

Cymeris the world’s leading supplier of excimer light sources, the essential lightsource for deep ultraviolet, (“DUV”), photolithography systems. DUVphotolithography is a key enabling technology that has allowed thesemiconductor industry to meet the exacting specifications and manufacturingrequirements for volume production of today’s most advanced semiconductorchips. Cymer’s light sources are incorporated into step-and-repeat (“steppers”)and step-and-scan (“scanners”) photolithography systems for use in themanufacture of semiconductors with critical feature sizes below 0.35microns.  One micron equals onemillionth of a meter.  Cymer’s excimerlight sources constitute a substantial majority of all excimer light sourcesincorporated in DUV photolithography tools. Cymer’s products consist ofphotolithography light sources, replacement parts and service. Cymer maintainsa worldwide service organization that supports its installed base of  light sources.  Cymer’s customers include all three manufacturers of DUVphotolithography systems:  ASMLithography, Canon and Nikon.

 

#### **Products and Services**

 

Cymer’s products primarily consist of photolithography light sources,replacement parts and service.

 

***Photolithography Light Sources***

 

Cymer’sphotolithography light sources produce narrow bandwidth pulses of shortwavelength light within the DUV spectrum. The three DUV wavelengths aremeasured in nanometers (“nm”). One nanometer equals one billionth of ameter.  The light sources are referredto according to the gases mixed to produce the light or by the wavelength.  Krypton Fluoride (“KrF”) gases produce 248nm light, Argon Fluoride (“ArF”) gases 193 nm light, and Fluorine (“F2”) gas157 nm light. The light sources permit very fine feature resolution for imagingthe circuitry on the wafer and high throughput in wafer processing.  Cymer has designed its light sources to behighly reliable, easy to install and compatible with existing semiconductormanufacturing processes.  Cymer’s lightsources are used to pattern the integrated circuits, or “chips”, that powermany of today’s advanced consumer and business electronics.

 

*ReplacementParts*

 

Certain components and subassemblies included in Cymer’s light sourcesrequire replacement or refurbishment following extended operation.  For example, the discharge chamber ofCymer’s light sources has an expected life of approximately three to tenbillion pulses, depending on the model. Cymer estimates that a light sourceused in a semiconductor production environment will require one to tworeplacement chambers per year, depending upon the level of usage.  Similarly, certain optical components of thelight source deteriorate with continued exposure to DUV light and requireperiodic replacement.  Cymer provides theseand other spare and replacement parts for its photolithography light sources asneeded by its customers.

 

*Service*

 

As the life and usage ofCymer’s installed base of light sources in production at chipmakers exceeds theoriginal warranty periods (generally 17 to 26 months from date of shipment),some chipmakers request service contracts from Cymer.  Additionally, Cymer provides service contracts directly to thethree semiconductor DUV photolithography equipment manufacturers. Thesecontracts require Cymer to maintain and/or service these light sources eitheron an on-call or regular interval basis or both.  Some of these contracts include replacement of consumable parts.

 

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

 

Cymer’s discussion andanalysis of its financial condition and results of operations are based uponCymer’s consolidated financial statements, which have been prepared inaccordance with accounting principles generally accepted in the United Statesof America.  The preparation of thesefinancial statements requires Cymer to make estimates and use judgment that mayimpact the reported amounts of assets, liabilities, revenues, expenses, andrelated disclosure of contingent assets and liabilities.  As a part of its ongoing internal processes,Cymer evaluates its estimates, including those related to inventory allowances,warranty provisions, revenue recognition, allowances for bad debts, long-livedassets valuation, intangible assets valuation, income taxes, and contingenciesand litigation.  Cymer bases theseestimates upon both historical information and other assumptions that itbelieves to be valid and reasonable under the circumstances.  These assumptions form the basis for makingjudgments and determining the carrying values of assets and liabilities thatare not apparent from other sources. Actual results could vary from those estimates under differentassumptions and conditions.

 

Cymer believes that inventoryallowances and warranty provisions require more significant judgments andestimates in the preparation of its consolidated financial statements thanother accounting estimates.

 

Cymer maintains an inventoryallowance to record inventory at net realizable value.  The value of this allowance is determined bytaking into consideration certain assumptions related to market conditions andfuture demands for its products, which may result in excess or obsoleteinventory.  In addition to estimatingexcess and obsolete inventory, Cymer estimates and records a separate liabilitywhich is included in accrued and other liabilities in the accompanying balancesheets for any vendor amounts owed by Cymer as a result of cancelled ormodified orders.  If actual marketconditions are more or less favorable than projected by management, adjustmentsto this inventory allowance or these liabilities may be required.

 

Cymer providesfor the estimated cost of product warranties at the time the related revenue isrecognized. The warranty coverage period and terms vary by light sourcemodel.  In general, the light sourcesystem warranty period ranges from 17 to 26 months after shipment.  Cymer also warrants consumables and spareparts sold to its customers and the coverage period varies by spare part typeas some types include time based warranty periods and others include usagebased warranty periods.  On average, thewarranty period for consumables and spare parts is approximately 6 months fromthe date of shipment.  Cymer records aprovision for warranty for all products, which is included in cost of productsales in the consolidated statements of operations and is recorded at the timethat the related revenue is recognized. The warranty provision for light source systems is determined by using afinancial model, which takes into consideration actual historical expenses, andpotential risks associated with Cymer’s different light source system models.This financial model is then used to calculate the future probable expensesrelated to warranty and the required level of the warranty provision.  The risk levels used within this model arereviewed and updated as risk levels change by model over its product lifecycle.  The warranty provision forconsumables and spares is determined by using actual historical data.  Although Cymer engages in productimprovement programs and processes, its warranty obligation is affected byproduct failure rates and costs incurred to correct those product failures atcustomer sites.  Should actual productfailure rates or estimated costs to repair those product failures differ fromCymer’s estimates, revisions to its estimated warranty provision would berequired.

 

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**RESULTS OF OPERATIONS**

 

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

 
|                                                                       |   | **Three  months ended  September 30,** |   | **Nine  months ended  September 30,** |   |
|----------------------------------------------------------------------------|--------|----------------------------------------|--------|---------------------------------------|--------|
|                                                                       |   | **2002**                               |   | **2003**                              |   | **2002** |   | **2003** |   |
|                                                                       |   |                                   |   |                                  |   |   |   |   |   |
| Revenues:                                                                  |   |                                   |   |                                  |   |   |   |   |   |
| Product sales                                                              |   | 99.6                                   | %      | 99.1                                  | %      | 99.3 | % | 99.5 | % |
| Other                                                                      |   | .4                                     |   | .9                                    |   | .7 |   | .5 |   |
| Total revenues                                                             |   | 100.0                                  | %      | 100.0                                 | %      | 100.0 | % | 100.0 | % |
|                                                                       |   |                                   |   |                                  |   |   |   |   |   |
| Cost and expenses:                                                         |   |                                   |   |                                  |   |   |   |   |   |
| Cost of product sales                                                      |   | 56.1                                   |   | 74.5                                  |   | 53.5 |   | 73.5 |   |
| Research and development                                                   |   | 24.4                                   |   | 18.7                                  |   | 24.3 |   | 23.6 |   |
| Sales and marketing                                                        |   | 5.3                                    |   | 6.0                                   |   | 5.6 |   | 6.4 |   |
| General and administrative                                                 |   | 6.4                                    |   | 32.0                                  |   | 6.1 |   | 16.9 |   |
| Amortization of goodwill and intangible  assets                            |   | —                                 |   | .1                                    |   | .1 |   | .1 |   |
| Loss on debt extinguishment                                                |   | —                                 |   | —                                |   | .1 |   | — |   |
| Total costs and expenses                                                   |   | 92.2                                   |   | 131.3                                 |   | 89.7 |   | 120.5 |   |
|                                                                       |   |                                   |   |                                  |   |   |   |   |   |
| Operating income (loss)                                                    |   | 7.8                                    |   | (31.3                                 | )      | 10.3 |   | (20.5 | ) |
| Other income (expense) – net                                          |   | (0.5                                   | )      | .1                                    |   | (.7 | ) | (.2 | ) |
|                                                                       |   |                                   |   |                                  |   |   |   |   |   |
| Income (loss) before income tax provision  (benefit) and minority interest |   | 7.3                                    |   | (31.2                                 | )      | 9.6 |   | (20.7 | ) |
|                                                                       |   |                                   |   |                                  |   |   |   |   |   |
| Income tax provision (benefit)                                             |   | (0.8                                   | )      | (18.7                                 | )      | 1.6 |   | (12.4 | ) |
| Minority interest                                                          |   | —                                 |   | (0.7                                  | )      | (.1 | ) | (.5 | ) |
|                                                                       |   |                                   |   |                                  |   |   |   |   |   |
| Net income (loss)                                                          |   | 8.1                                    | %      | (13.2                                 | )%     | 7.9 | % | (8.8 | )% |
| Gross margin on product sales                                              |   | 43.7                                   | %      | 24.8                                  | %      | 46.2 | % | 26.1 | % |

 

**THREEMONTHS ENDED SEPTEMBER 30, 2002 AND 2003**

 

*Revenues*.  Cymer’s revenues consistof product sales, which include sales of light source systems, consumable andspare parts, upgrades, service, service contracts and training.  Cymer’s revenues also consist of otherrevenues which include revenue from funded development activities performed forcustomers and government contracts and license agreements.  Cymer does not recognize any revenue forlight source systems prior to shipment. The systems are tested by Cymer in environments similar to those used bythe customers prior to shipment to ensure that they meet the customers’specifications and will interface with the customers’ software.  Cymer’s installation obligations areperfunctory within the framework of Staff Accounting Bulletin 101.  One of Cymer’s customers has an acceptanceprovision, which is satisfied by the issuance of an acceptance certificatefollowing a visual inspection of the system by the customer.  Cymer does not recognize revenue on systemsshipped to that customer until Cymer receives the acceptance certificate.  There are no customer retentions.  Revenue from consumables and spare partssales is recognized at the point that legal title passes to the customer, whichis generally upon shipment from the Cymer facility.  Service and training revenue is generally recognized at the timethat the services are rendered or the training class is completed.  Service contract revenues are generallyrecorded as revenue ratably over the life of the contract or per the specificterms of the agreement. Funded development contracts are accounted for on thepercentage-of-completion method based on the relationship of costs incurred tototal estimated costs.  Revenuesgenerated from funded

 

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development contracts arederived from cost sharing contracts between Cymer and certain customers.  The costs associated with these contractsare included in research and development expenses in the period incurred andare not listed separately as other cost or expenses in the consolidated statementsof operations.  If milestones on fundeddevelopment contracts require that specific results be achieved or reported byCymer, revenue is not recognized until that milestone is completed.

 

Product sales decreased 24%from $84.2** **million for the three monthsended September 30, 2002 to $63.9 million for the three months ended September30, 2003, primarily due to a 36%, or $21.7 million decrease in light sourcesystem revenue offset by a 6%, or $1.4 million increase in non-system productrevenue (consisting of consumable and spare parts, service revenue and othernon-system product revenue) from period to period.  The decrease in light source system revenue was primarilydue to a 60% decrease in the number of light source system units sold offset byan increase in the average selling price for light source systems sold.   A total of 86 light source systems were sold in the three months endedSeptember 30, 2002 at an average selling price of $708,000, compared to 34 systems sold in the three months ended September30, 2003 at an average selling price of $1.2 million.  On a foreign currency adjusted basis, the average selling pricefor the three months ended September 30, 2002 was $679,000 as compared to $1.1million for the three months ended September 30, 2003.  This increase in average selling prices fromperiod to period primarily reflects the shift in the product mix in 2003 toCymer’s most advanced, higher priced XLA 100 light source system, thedual-discharge chamber Master Oscillator Power Amplifier (“MOPA”) designproduct.  The XLA 100 accounted for 71%of light source systems units sold in the three months ended September 30,2003.  The total non-system productrevenue was $23.3 million or 28% of revenue for the three months endedSeptember 30, 2002 as compared to $24.7 million or 38% of revenue for the threemonths ended September 30, 2003.  Theincrease in non-system product revenue from period to period was due toincreased utilization of Cymer’s DUV light sources by chipmakers and anincreased installed base in the three months ended September 30, 2003.  Revenues from funded development projectswere $314,000 and $564,000 for the three months ended September 30, 2002 and2003, respectively.

 

Cymer’s backlog at September30, 2002 was $83.6 million compared to $109.5 million at September 30,2003.  Bookings for the three monthsended September 30, 2002 and September 30, 2003 were $55.2 million and $67.5million, respectively.  The book-to-billratio for the three months ended September 30, 2002 was .69 compared to 1.15for the three months ended September 30, 2003. This increase in bookings and book-to-bill ratio was primarily due toincreased orders of light source systems and spare parts in the third quarter of2003 compared to the third quarter of 2002.

 

Cymer installed 61 lightsources at chipmakers and other end-users during the third quarter of 2002 ascompared to 48 light sources installed during the third quarter of 2003.

 

Cymer’s sales are generated primarily byshipments to customers in Japan, the Netherlands, and the United States.  Approximately 92% and 90% of Cymer’s salesfor the three months ended September 30, 2002 and 2003, respectively, werederived from customers outside the United States.  Cymer maintains a wholly-owned Japanese subsidiary, which sellsto Cymer’s Japanese customers.  Revenuesfrom Japanese customers, generated primarily by this subsidiary, accounted for39% and 48% of revenues for the three months ended September 30, 2002 and 2003,respectively.  The activities of Cymer’sJapanese subsidiary are limited to sales and service of products purchased bythe subsidiary from the parent corporation. Cymer anticipates thatinternational sales will continue to account for a significant portion of itsnet sales.

 

In April 2003, Cymer implemented costreduction efforts in response to the continued downturn in the semiconductorindustry.  These cost reductionactivities included a reduction in work force and the write down of certaincorporate assets.  The asset write downstotaled approximately $1.8 million. The cost reduction activities impacted allareas of 

 

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Cymer, and resulted inadditional expenses being recorded during the second quarter of 2003.  Cymer realized the benefit from these costreduction efforts starting in the third quarter of 2003.  As of September 30, 2003, there were$206,000 in outstanding liabilities remaining from the second quarter 2003reduction in force.  This amount isincluded in accrued payroll and benefits on the accompanying balance sheets.

 

                In the third quarter of 2003, Cymertransferred all manufacturing activities and corporate services from two of itsleased facilities to the new Cymer-owned manufacturing and office facilitylocated in San Diego, California.  As aresult of this transfer, Cymer completed the closure of these two leasedfacilities and recorded a $15.6 million tenant improvement write-off associatedwith these facilities. This tenant improvement write-off was recorded as ageneral and administrative expense in the statements of operations.

 

*Cost of Product Sales*.  Cost of product sales includes directmaterial and labor, warranty expenses, license fees, and manufacturing andservice overhead, and foreign exchange gains and losses on foreign currencyforward exchange contracts associated with purchases of Cymer’s products by itsJapanese subsidiary for resale under firm third-party sales commitments.  Shipping costs associated with Cymer’s productsales are also included in cost of product sales.  Cymer does not charge its customers for shipping fees and suchcosts are not significant.  In absolutedollars, the cost of product sales remained relatively flat from period toperiod increasing only 1% from $47.4 million for the three months endedSeptember 30, 2002 to $48.0 million for the three months ended September 30,2003.  However, the number of lightsource systems recorded as revenue was significantly lower in the third quarterof 2003 compared to the third quarter of 2002. These flat costs on lower revenues from period to period, resulted in agross margin on product sales of 43.7% for the three months ended September 30,2002 as compared to 24.8% for the same three-month period in 2003.  This lower gross margin in the third quarterof 2003 reflects the higher overall costs associated with the introduction ofCymer’s new XL series light source system and its initial transition tomanufacturing in 2003 as well as lower than forecasted inventory balances tiedto the timing of raw material receipts and the associated reduced manufacturingoverhead absorption. In addition, Cymer incurred additional Korean customsexpenses associated with its Korean operations during the third quarter of 2003which negatively impacted its gross margin for the period.  Cymer anticipates that the gross marginswill moderately increase in the next couple of quarters as a result of improvedefficiencies associated with the production of the XL series light source andthe continued benefits resulting from the cost savings measures taken in thesecond quarter of 2003.

 

*Research and Development*. Research and development expenses include costs of internally-funded andexternally-funded projects as well as continuing research support expenses,which primarily include employee and material costs, depreciation of equipmentand other engineering related costs. Research and development expensesdecreased 42% from $20.6 million for the three months ended September 30, 2002to $12.0 million for the three months ended September 30, 2003, due primarilyto Cymer’s product development efforts associated with the MOPA technologywhich uses the XL platform. Cymer’s investment in this product was high in 2002due to its initial development. This investment has decreased in 2003 as the XLseries light source transitioned to manufacturing.  Cymer shipped the first light source system that utilizes theMOPA technology, the XLA 100, in February 2003.  Cymer also continues to invest in extreme ultra violet (“EUV”),F2 and Beam Delivery Unit (“BDU”) technology and to focus on next generationKrF and ArF products.  As a percentageof total revenues, such research and development expenses decreased from 24.4%to 18.7% for the three months ended September 30, 2002 compared to the samethree-month period in 2003.  Weanticipate R&D spending in absolute dollars and as a percentage of totalrevenues, will decrease as the XLA 100 completes the final phase of transitionto manufacturing.

 

*Sales and Marketing*. Sales and marketing expenses include theexpenses of the sales, marketing and customer support staff and other marketingexpenses.  Sales and marketing expensesdecreased 13% from $4.5 million for the three months ended September 30, 2002to $3.9 million for the three months ended September 30, 2003, due to costsavings realized from the second quarter 2003 cost reduction efforts and lowerexpenses resulting from

 

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the movement of various seniormembers of sales and marketing to general and administrative functions as partof an organizational structure change made in the last quarter of 2002.  As a percentage of total revenues, suchsales and marketing expenses increased from 5.3% to 6.1% primarily due to thelower revenue levels in 2003 compared to 2002.

 

*General and Administrative*. General and administrative expensesconsist primarily of management and administrative personnel costs,professional services and administrative operating costs.  General and administrative expensesincreased 280% from $5.4 million for the three months ended September 30, 2002to $20.6 million for the three months ended September 30, 2003 due primarily toa $15.6 million tenant improvement write-off associated with thefacilities  vacated during the thirdquarter of 2003.  This write-off waspartially offset by the cost savings realized in the third quarter of 2003 as aresult of the cost reduction efforts implemented in the second quarter of 2003.  In addition, general and administrativeexpenses in 2003 were increased from the 2002 levels due to the movement ofvarious senior personnel from sales and marketing to general and administrativefunctions in the last quarter of 2002. As a percentage of total revenues, such expenses increased from 6.4% to32% primarily due to the tenant improvement write-off and lower revenue levelsin 2003 compared to 2002.

 

*Amortization of intangible assets. *Amortization ofintangible assets totaled $40,000 for each of the three months ended September30, 2002 and 2003.  This amortization ofintangible assets expense is consistent from period to period and relates tothe existing technology associated with the ACX acquisition, which wascompleted in early 2001.  With theadoption of SFAS 142 on January 1, 2002, Cymer discontinued the amortization ofgoodwill and intangible assets with indefinite useful lives associated withprevious purchase business combinations.

 

*Other Income (Expense) – Net.*  Netother income (expense) consists primarily of interest income and expense andforeign currency exchange gains and losses associated with fluctuations in thevalue of the functional currencies of Cymer’s foreign subsidiary officesagainst the United States dollar.  Netother expense totaled $444,000 for the three months ended September 30, 2002 ascompared to a net other income of $30,000 for the three months ended September30, 2003.  The change from net otherexpense to net other income was primarily due to foreign currency exchangegains recorded in the third quarter of 2003 compared to foreign currencyexchange losses recorded in the third quarter of 2002 which were offset bya  decrease in interest income fromperiod to period.  The decreasedinterest income in the third quarter of 2003 was primarily due to lower averagecash and investment balances in the third quarter of 2003 as compared to 2002as a result of cash used during 2003 for the continued construction of Cymer’snew manufacturing and office facility in San Diego and cash used in operatingactivities.  Foreign currency exchangelosses totaled $542,000, interest income totaled $2.8 million and interestexpense totaled $2.7 million for the three months ended September 30, 2002,compared to a foreign currency exchange gain of $482,000, interest income of$2.1 million and interest expense of $2.5 million for the three months endedSeptember 30, 2003.

 

*Income Tax Benefit*.  Thetax benefit of $687,000 and $12.1 million for the three months ended September30, 2002 and 2003, respectively, reflect an annual effective rate of 16% and60%, respectively. Due to the pre-tax loss recorded in the first nine months of2003, and the expectation that there will be no significant industry recoveryduring the remainder of 2003, Cymer currently estimates the 2003 annualeffective tax benefit rate to be approximately 60 percent.  The annual effective tax rates for bothperiods differ from the U.S. statutory rate of 35% primarily as a result ofpermanent book/tax differences and tax credits.  The tax benefit rate for 2003 reflects the increased impact ofCymer’s tax credits and foreign sales incentives in a low income or lossenvironment.

 

**NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2003**

 

*Revenues.* Product sales decreased 12% from $218.7****millionfor the nine months ended September 30, 2002 to $193.4 million for the ninemonths ended September 30, 2003, primarily

 

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due to a 24%, or $37.7 milliondecrease in light source system revenue offset by a 20%, or $12.4 millionincrease in non-system product revenue (consisting of sales of consumable andspare parts, service revenue and other non-system product revenue).  The decrease in light source system revenueresulted from a 44% decrease in the number of light source system units soldoffset by an increase in the average selling price for light source systemssold from period to period. A total of 218 light source systems were sold inthe nine months ended September 30, 2002 at an average selling price of$717,000, compared to 121 systems sold in the nine months ended September 30,2003 at an average selling price of $980,000. On a foreign currency adjusted basis, the average selling price for thenine months ended September 30, 2002 was $714,000 compared to $966,000 for thenine months ended September 30, 2003. This increase in average selling prices from period to period primarilyreflects the increased participation in the product mix of the higher pricedXLA 100 light source system in the first nine months of 2003.  Sales of the XLA 100 light source systemaccounted for 42% of light source systems sold in the nine months endedSeptember 30, 2003.  Total non-systemproduct revenue totaled $62.4 million or 28% of revenue and $74.8 million or38% of revenue for the nine months ended September 30, 2002 and 2003, respectively.  The increase in non-system product revenuewas due to increased utilization of Cymer’s DUV light sources by chipmakers andan increased installed base in the nine months ended September 30, 2003, whichboth resulted in increased demand for consumables and spare parts.    Revenues from funded development projectswere $1.5 million and $1.1 million for the nine months ended September 30, 2002and 2003, respectively.

 

Approximately 90% of Cymer’s sales foreach of the nine months ended September 30, 2002 and 2003 were derived fromcustomers outside the United States. Revenues from Japanese customers, generated primarily by Cymer Japan,accounted for 41% and 46% of revenues for the nine months ended September 30,2002 and 2003, respectively.

 

Sales to Cymer’s three largest customers,ASM Lithography, Canon, and Nikon, amounted to 34%, 19% and 24%, respectively,of total revenue for nine months ended September 30, 2002, and 22%, 26% and22%, respectively, of total revenue for the nine months ended September 30,2003.

 

*Cost of Product Sales*.  Although the number of light sourcesystems recorded as revenue was significantly lower in the first nine months of2003 as compared to the first nine months of 2002, the cost of product salesincreased 21% from $117.7 million for the nine months ended September 30, 2002to $142.9 million for the nine months ended September 30, 2003.  This increase from period to period isprimarily due to the higher overall costs associated with the introduction ofCymer’s new XL series light source system and its initial transition tomanufacturing during the first quarter of 2003.  These cost of product sales were partially offset by a decreasein warranty expenses on more mature product models during 2003.  As a result of the higher XL series productcosts, the gross margin on product sales was 26.1% for the nine months endedSeptember 30, 2003 as compared to 46.2% for the same nine-month period in 2002.Gross margins were also negatively impacted by additional expenses recorded in thesecond quarter of 2003 associated with the cost reduction efforts, whichtotaled approximately $4.2 million in the manufacturing areas, and includedcosts associated with the reduction in work force and the write down of certainmanufacturing assets.  Gross marginswere further reduced in the first nine months of 2003 as a result of Koreancustoms expenses incurred in the third quarter of 2003 associated with Cymer’sKorean operations.  Cymer anticipatesthat the gross margins will increase in the next couple of quarters as a resultof improved efficiencies associated with the production of the XL series lightsource and the continued benefit of cost savings measures taken in the secondquarter of 2003.

 

*Research and Development*. Research and development expenses decreased 14% from $53.6 million forthe nine months ended September 30, 2002 to $46.0 million for the nine monthsended September 30, 2003, due primarily to the first quarter 2003 introductionof Cymer’s most recent product development effort, the XL series which uses theMOPA technology.  Cymer shipped thefirst light source system that utilizes the MOPA technology, the XLA 100, inFebruary

 

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2003.  Cymer also continued to invest in EUV, F2 and BDU technology anda focus on next generation KrF and ArF products.  As a percentage of total revenues, research and developmentexpenses decreased slightly from 24.3% to 23.6%, primarily due to the lowerrevenue levels in 2003 as compared to 2002. Cymer anticipates R&D spending for DUV associated with the XLplatform in absolute dollars and as a percentage of total revenues, willdecrease as the XLA 100 productization and the transition to manufacturing iscompleted.

 

*Sales and Marketing*. Sales and marketing expenses increased 1% from $12.3 million for thenine months ended September 30, 2002 to $12.4 million for the nine months endedSeptember 30, 2003.  During the firstnine months of 2003, sales and marketing expenses were slightly higher than the2002 levels due to additional expenses associated with the reduction in workforce and asset write offs which occurred during the second quarter of2003.  These increased expenses in 2003were offset by lower expenses resulting from the movement of various seniormembers of sales and marketing to general and administrative functions in thelast quarter of 2002.   As a percentageof total revenues, sales and marketing expenses increased from 5.6% to 6.4%.

 

*General and Administrative*. General and administrative expenses increased 145% from $13.5 millionfor the nine months ended September 30, 2002 to $32.9 million for the ninemonths ended September 30, 2003, due to a number of factors. During the firstnine months of 2003, general and administrative expenses were significantlyincreased from the 2002 levels primarily due to the $15.6 million tenantimprovement write-off associated with facilities vacated in the third quarterof 2003.  General and administrativeexpenses were also elevated in the first nine months of 2003 due to themovement of various senior personnel from sales and marketing to general andadministrative functions as part of an organizational structure change in thelast quarter of 2002 and increased costs associated with the reduction in work forceconducted in the second quarter of 2003. As a percentage of total revenues, general and administrative expensesincreased from 6.1% to 16.9%.

 

*Amortization of intangible assets. *Amortization ofintangible assets totaled $120,000 for each of the nine month periods endedSeptember 30, 2002 and 2003.  Thisamortization of intangible assets is consistent from period to period andrelates to the existing technology associated with the ACX acquisition, whichwas completed in early 2001.  With theadoption of SFAS 142 on January 1, 2002 Cymer discontinued the amortization ofgoodwill and intangible assets with indefinite useful lives associated withprevious purchase business combinations.

 

*Other Income (Expense) – Net.*  Net other expense totaled $1.7 million and$481,000 for the nine months ended September 30, 2002 and 2003,respectively.  The decrease in net otherexpense was primarily due to decreased interest expense and foreign currencyexchange gains recorded in the first nine months of 2003 compared to foreigncurrency exchange losses recorded in the first nine months of 2002.  These were both offset by a decrease ininterest income from period to period. The decreased interest expense fromperiod to period was caused by the lower interest rate on the 2002 convertiblenotes issued by Cymer in 2002, which is reflected in the interest expenseamounts for the first nine months of 2003 as compared to additional interestwhich was recorded in the first nine months of 2002 as the result of bothCymer’s old convertible notes issued in 1997 and the convertible notes issuedin 2002 being outstanding during part of that nine month period. The decreasedinterest income in the first nine months of 2003 was primarily due to loweraverage cash and investment balances during 2003 compared to 2002 as a resultof cash used during 2003 for the continued construction of Cymer’s newmanufacturing and office facility in San Diego, California.  Foreign currency exchange losses totaled $422,000,interest income totaled $7.4 million and interest expense totaled $8.6 millionfor the nine months ended September 30, 2002, compared to a foreign currencyexchange gain of $65,000, interest income of $7.0 million and interest expenseof $7.5 million for the nine months ended September 30, 2003.

 

*Income Tax Provision (Benefit)*.  Thetax provision of $3.4 million and the tax benefit of $24.2 million for the ninemonths ended September 30, 2002 and 2003, respectively, reflect an

 

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annual effective rate of 16%and 60%, respectively.  The annualeffective tax rates for both periods differ from the U.S. statutory rate of 35%primarily as a result of permanent book/tax differences and tax credits.  The tax benefit rate for 2003 reflects theincreased impact of Cymer’s tax credits and foreign sales incentives in a lowincome or loss environment.

 

# **LIQUIDITYAND CAPITAL RESOURCES**

 

As of September 30, 2003,Cymer had approximately $187.5 million in cash and cash equivalents, $100.2million in short-term investments, $91.9 million in long-term investments,and  $419.3 million in working capital.

 

InAugust 1997, Cymer issued $172.5 million in aggregate principal amount in aprivate placement of notes. These 31⁄2% / 71⁄4% Step-Up Convertible Subordinated Notes were due on August 6, 2004 and were convertible at the option of theholder into shares of common stock of Cymer. The conversion rate on the 1997Notes was 21.2766 shares per $1,000 principal amount or an effective conversionprice of $47.00 per share.  In 2001,Cymer repurchased a total of $24.9 million of the 1997 notes thenoutstanding.  The 1997 Notes were calledfor redemption on March 25, 2002. Immediately prior to the March 25, 2002 redemption date, holders of$113.0 million of the outstanding principal amount converted their 1997 Notesinto shares of Cymer’s common stock.  Asa result of these conversions, 2,325,542 shares of Cymer common stock wereissued to the note holders and the remaining $38.0 million of the outstandingprincipal amount of the 1997 Notes was redeemed.

 

InFebruary 2002, Cymer issued $250.0 million in aggregate principal amount in aprivate placement of notes.  The 2002Notes are due on February 15, 2009 with interest payable semi-annually onFebruary 15 and August 15 of each year at 31⁄2% per annum.  These 2002 Notes are convertible into sharesof Cymer common stock at a conversion rate of 20 shares per $1,000 principalamount or an effective conversion price of $50.00 per share.  Cymer used a portion of the net proceedsfrom this private placement to redeem the 1997 Notes. The remaining proceedswill be used for Cymer’s future operating, investing and financing activities.

 

Net cash provided byoperating activities was approximately $1.8 million for the nine months endedSeptember 30, 2002 compared to $17.1 million net cash used in operatingactivities for the nine months ended September 30, 2003.  The net cash provided by operatingactivities for the nine months ended September 30, 2002 was primarilyattributable to net income and increases in accounts payable and accrued andother liabilities offset by increases in accounts receivable andinventories.  Due to the continueddownturn in the semiconductor industry and the resulting net loss for theperiod, net cash was used in operating activities during the nine months endedSeptember 30, 2003. This use of cash in the first nine months of 2003 was alsocaused by increases in accounts receivable and decreases in accounts payable,accrued liabilities and income taxes payable for the period. This use of cashin the first nine months of 2003 was partially offset by a decrease ininventories from period to period.

 

Net cash used in investingactivities was approximately $166.0 million and $18.2 million for the ninemonths ended September 30, 2002 and 2003, respectively.  The decrease in cash used in investingactivities from period to period was primarily attributable to the timing ofshort-term and long-term investments maturing and being invested due in part tothe private placement offering offset by increases in cash used for capitalexpenditures in the first nine months of 2003. During the first nine months of2002, capital expenditures totaled $24.5 million as compared to capitalexpenditures of $55.5 million for the first nine months of 2003.  This increased level of capital expenditureswas primarily due to the continued construction of the new manufacturing andoffice facility located in San Diego, California and purchases of requiredmanufacturing equipment for this new facility.

 

Net cash provided byfinancing activities was approximately $221.0 million and $24.6 million for thenine months ended September 30, 2002 and 2003, respectively.  The decrease in cash provided by financingactivities was primarily attributable to the activity on Cymer’s

 

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convertible subordinated notesduring the first nine months of 2002. The private placement of the 2002 Notesresulted in net proceeds of approximately $242.2 million, offset by a use of$39.6 million to redeem a portion of Cymer’s 1997 Notes.  Cash provided by employee stock optionexercises was higher in the first nine months of 2003 as compared to the firstnine months of 2002 due to increased option exercise activity during the third quarterof 2003.  Proceeds from the exercise ofemployee stock options were $18.3 million and $31.3 million for the nine monthsended September 30, 2002 and 2003, respectively.  In the nine months ended September 30, 2003, cash provided byfinancing activities was offset by a $6.7 million payoff of Cymer’s Japaneserevolving loan.

 

Cymer hadcertain loan agreements with a commercial bank which provided for unsecuredrevolving loan facilities allowing for borrowings of $10.0 million and $20.0million under a U.S. line of credit and Japanese line of credit,respectively.  Under the loanagreements, Cymer was able to borrow in U.S. dollars or Japanese yen, andinterest accrued on outstanding borrowings at LIBOR plus 1.75% on U.S.dollar-denominated borrowings and at the yen Cost of Funds rate plus 1.5% onyen-denominated borrowings. The loan agreements required Cymer to maintaincompliance with certain financial and other covenants, including tangible networth, quick ratio and profitability requirements.  The loan agreements expired on June 16, 2003 and were notrenewed.

 

Since its initial****publicoffering and a secondary public offering, both in 1996, Cymer has funded itsoperations primarily from cash generated from operations, the proceeds ofconvertible subordinated note offerings in August 1997 and February 2002, bankborrowings, and the proceeds from employee stock option exercises.

 

Cymer requires substantialworking capital to fund its business, particularly to finance inventories andaccounts receivable and for capital expenditures. Cymer’s future capitalrequirements depend on many factors, including Cymer’s manufacturing activity,the timing and extent of spending to support product development efforts,expansion of sales and marketing and field service and support, competitivelabor market compensation requirements, the timing of introductions of newproducts and enhancements to existing products, and the market acceptance ofCymer’s products. Cymer believes that it has sufficient working capital to sustainoperations and provide for the future expansion of its business for at leastthe next 12 months.

 

At September 30, 2002 and2003, Cymer did not have any relationship with unconsolidated entities orfinancial partnerships, such as entities often referred to as structuredfinance variable interest, or special purpose entities, which would have beenestablished for the purpose of facilitating off-balance sheet arrangements orother contractually narrow or limited purposes.  In addition, Cymer did not engage in trading activities involvingnon-exchange traded contracts.  As aresult, Cymer is not exposed to any financing, liquidity, market or credit riskthat could arise if it had engaged in such relationships.  Cymer does not have relationships andtransactions with persons and entities that derive benefits from theirnon-independent relationship with Cymer or its related parties except asdisclosed herein.

 

# **RECENT ACCOUNTING PRONOUNCEMENTS**

 

InJanuary 2003, the FASB issued Interpretation No. 46 (“FIN 46”), “Consolidationof Variable Interest Entities”.  FIN 46provides guidance on how to identify a variable interest entity (VIE) anddetermines when the assets, liabilities, and results of operations of a VIEneed to be included in a company’s consolidated financial statements.  FIN 46 also requires additional disclosuresby primary beneficiaries and other significant variable interest holders in aVIE.  The provisions of FIN 46 areeffective immediately for all VIEs created after January 31, 2003.  For VIEs created before February 1, 2003,the provisions of FIN 46 must be adopted at the beginning of the first interimor annual reporting period beginning after December 15, 2003.  Cymer does not believe that it will be subjectto the consolidation or disclosure requirements of FIN 46.

 

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#### **Risks andUncertainties That May Affect Results**

 

*In this section, references to“we”, “us” or “our” are references to Cymer. Our business faces significant risks. The risks described below may notbe the only risks we face. Additional risks that we do not yet know of or thatwe currently think are immaterial may also impair our business operations.  If any of the events or circumstances describedin the following risks actually occur, our business, financial condition orresults of operations could suffer, and the trading price of our common stockcould 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 September 30, 2003. Thesefactors include:

 

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

•                  cyclicality in themarket for semiconductor manufacturing equipment;

•                  rates at whichsemiconductor device manufacturers take delivery of photolithography tools fromphotolithography tool manufactures (“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 semiconductor manufacturers;

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

•                  changes in the price andprofitability of our products;

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

•                  changes in marketpenetration by our competitors;

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

 

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

 

Thesemiconductor equipment industry is highly cyclical. We derive a substantialpercentage of our revenues from photolithography tool manufacturers (“ourcustomers”). Our customers depend in turn on the demand for theirphotolithography tool products from their customers, the semiconductor devicemanufacturers. The capital equipment expenditures of semiconductormanufacturers depend on a number of factors, including the current andanticipated market demand for semiconductors and products using semiconductors.

 

Thesemiconductor industry is cyclical in nature and historically has experiencedperiodic ups and downs and is currently in a significant and prolongeddownturn. This cyclical nature of the industry in which we operate affects ourability to accurately predict future revenue and thus, future expense levels.When cyclical fluctuations result in lower than expected revenue levels,operating results may be adversely affected and cost reduction measures may benecessary in order for us to remain competitive and financially sound.  During a down cycle, we must be in aposition to adjust our cost and expense structure to prevailing market conditionsand to continue to motivate and retain our key employees.  In addition, during periods of rapid growth,we must be able to increase manufacturing capacity and personnel to meetcustomer demand.  We can provide noassurance that these objectives can be met in a timely manner in response toindustry cycles.

 

Thecurrent downturn has had a severe effect on the demand for semiconductormanufacturing equipment, including photolithography tools that our customersproduce. We are not able to predict when the semiconductor industry willrecover. If overall market conditions continue to deteriorate in the near term,our current operating levels may negatively impact our profitability. Webelieve that downturns in the semiconductor manufacturing industry will occurperiodically, and result in periodic decreases in demand for all semiconductormanufacturing equipment, including photolithography tools our customersmanufacture. As a result, fluctuating levels of investment by semiconductordevice manufacturers and pricing volatility will continue to materially affectour aggregate bookings, revenues and operating results. Also, even duringperiods of reduced revenues we believe we must continue to invest in researchand development and to maintain extensive ongoing worldwide customer serviceand support capabilities to remain competitive, which may temporarily harm ourfinancial results.  Accordingly, thesedownturns are likely to continue to adversely affect our business, financialcondition and operating results and our operating results may fall below theexpectations of public market analysts or investors in some future quarter orquarters. Such failure to meet operating result expectations would materiallyadversely 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 semiconductordevice manufacturers. Market conditions in the industry and productionefficiency of the photolithography tool manufacturers can cause our customersto expand or reduce their orders for new light source systems as they try tomanage their inventories and production requirements to these levels. Wecontinue to work with our customers to better understand these issues. However,we cannot guarantee that we will be successful in understanding our customers’inventory management and production requirements or that our customers will notbuild up an excess inventory of light source products. If our customers retainan excess inventory of light source products, our revenue could be reduced infuture periods as the excess inventory is utilized, which could adverselyaffect our operating results, financial condition and cash flows.  In addition, if our customers demand shorterproduct lead times as a solution to improve their inventory and cash positions,our inventory management and cash position may be impacted, which may adverselyaffect our operating results, financial condition and cash flows.

 

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

 

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

 

|            |   | **Nine months ended  September 30,** |   |
|-----------------|--------|--------------------------------------|--------|
|            |   | **2002**                             |   | **2003** |   |
| ASM Lithography |   | 34                                   | %      | 22 | % |
| Canon           |   | 19                                   | %      | 26 | % |
| Nikon           |   | 24                                   | %      | 22 | % |
|            |   |                                 |   |   |   |
| Total           |   | 77                                   | %      | 70 | % |

 

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

 

|            |   | **December 31,  2002** |   | **September 30,  2003** |   |
|-----------------|--------|------------------------|--------|-------------------------|--------|
| ASM Lithography |   | 43                     | %      | 21                      | %      |
| Canon           |   | 13                     | %      | 17                      | %      |
| Nikon           |   | 19                     | %      | 33                      | %      |
|            |   |                   |   |                    |   |
| Total           |   | 75                     | %      | 71                      | %      |

 

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:

 

•      achange in a customer’s competitive position in its industry;

•      acustomer experiencing DUV photolithography tool production problems;

•      adecision to purchase light sources from other suppliers;

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

•                  a decline in acustomer’s financial condition.

 

**A substantial percentage of our revenueis derived from the sale of a limited number of primary products.**

 

Ouronly product line is excimer light source systems, which include KrF, ArF andF2, and we expect these primary products to continue to account for a largepercentage of our revenues in the near term. Continued market acceptance of ourprimary products is, therefore, critical to our future success. The primarymarket for excimer light sources is in the use of DUV photolithographyequipment for manufacturing deep-submicron semiconductor devices using smallercircuit geometries. The demand for our products depends in part on the rate at whichsemiconductor device manufacturers further adopt excimer light sources as thechosen light

 

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source for theirphotolithography tools. The rate with which semiconductor manufacturers adoptexcimer light sources may vary for a variety of reasons, including:

 

•                  inadequate performanceof photoresists used in advanced DUV photolithography;

•      potentialshortages of specialized materials used in DUV optics;

•      productivityof 300mm lithography relative to 200mm tools; and

•      consolidationof chipmakers.

 

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

 

•      adecline in demand for our customers’ DUV photolithography tools;

•      afailure to achieve continued market acceptance of our products;

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

•      technologicalchange that we are unable to address with our products; and

•      a failure torelease new enhanced versions of our products on a timely basis.

** **

**We depend on theintroduction of new products for our success, and we are subject to risksassociated 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 capabilities.  Due to the risksinherent in transitioning to new products, we must forecast accurate demand fornew products while managing the transition from older products.

 

Ournewest product introduction project consists of a technology change from asingle- discharge-chamber designed excimer light source to adual-discharge-chamber design called MOPA. This MOPA design represents a paradigm shift from current lithographytechnology and is projected to enable higher power, tighter bandwidth and lowercost of operation for future optical lithography applications across all threeDUV wavelengths – 248nm, 193nm and 157nm. There are risks inherent in transitioning to this new technology.  These risks include effective execution of theproduct development plan, adoption of the product by photolithography toolmanufacturers and semiconductor manufacturers, manufacturability and costeffectiveness of the new products and the development of a comparable productby our competitors.

 

We believethat semiconductor device manufacturers are currently developing a capabilityto produce devices that are measured at 0.13 micron or less, and these effortsare driving the current demand for our light source products for DUVphotolithography systems. After semiconductor device manufacturers have thiscapability, their demand for our light source products will depend, in part, onwhether they want to expand their capacity to manufacture these devices. Thiswill in turn depend on whether their sales forecasts and projectedmanufacturing process yields justify the necessary investments.

 

Futuretechnologies, such as EUV and electron projection lithography (“EPL”), mayrender our excimer light source products obsolete. We must manage producttransitions, as introduction of new products could adversely affect our salesof existing products. If new products are not introduced on time, or havereliability or quality problems, our performance may be impacted by reducedorders, higher manufacturing costs, delays in acceptance of and payment for newproducts, and additional service and warranty expenses. We may not be able todevelop and

 

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introducenew products or enhancements to our existing products and processes in a timelyor cost effective manner that satisfies customer needs or achieves marketacceptance. Failure to develop and introduce these new products andenhancements could materially adversely affect our operating results, financialcondition and cash flows.

 

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

 

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

 

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

 

•      closelymanage our global operations;

•      improveour process and other internal management systems;

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

•      quicklyadapt to changing sales and marketing channels;

•      effectivelymanage our inventory levels; and

•      attract,train, retain and manage key personnel.

 

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

 

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

 

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 tocontinue to account for a very large portion of our total revenues. In order tosupport our foreign customers, we maintain a manufacturing and field servicesubsidiary in Korea as well as field service and support subsidiaries in Japan,Taiwan, Singapore, the People’s Republic of China and the Netherlands.

 

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

 

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

 

•      unexpectedchanges in regulatory requirements,

•      fluctuationsin exchange rates and currency controls,

•      politicaland economic conditions 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,

•      difficultiesin staffing and managing foreign subsidiary and branch operations,

•      limitedintellectual property protection in some countries,

•      potentiallyadverse tax consequences in some countries,

 

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•      thepossibility of accounts receivable collection difficulties,

•      in thecase of Asia, the risk of business interruption and damage from earthquakes,

•      theeffect of acts of terrorism and war; and

•      theburdens of complying with a variety of foreign laws.

 

Many of our major customers and many of thesemiconductor device manufacturers who use our light source products in theirphotolithography systems are located in Asia. Economic problems and currencyfluctuations affecting these regions in Asia could create a larger risk for us.Further, even though it has not been difficult for us to comply with UnitedStates export controls, these export rules could change in the future and makeit more difficult or impossible for us to export our products to manycountries.  Any of these vulnerabilitiescould have a material adverse effect on our business, financial condition andresults of operations.

 

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

 

We purchase some of the components and subassemblies included in ourlight source products from a single supplier or a limited group ofsuppliers.  For certainoptical components used in our light source systems, we currently utilize asingle supplier.  Although we have notaggressively pursued other vendors for these optical components, we haveattempted to qualify one other vendor. To date, this vendor has beenunsuccessful in producing these optical components and has not been qualifiedby us. To reduce the risk associated with this single supplier, we carry a twoyear supply of these optical components. This two year supply is based upon current business activities, so anysignificant increase in production would likely result in a quicker consumptionof these optical components. In addition,we outsource the manufacture of various subassemblies more often than in thepast. Further, some of our suppliers have specialized in supplying equipment ormanufacturing services to semiconductor equipment manufacturers and thereforehave been adversely affected by the current industry downturn. If the currentdownturn continues for an extended period of time, these suppliers may not beable to continue to meet our requirements or respond quickly enough.  Due to the nature of our product developmentrequirements, these key suppliers must rapidly advance their own technologiesand production capabilities in order to support the introduction schedule ofour new products. These suppliers may not be able to provide new modules andsubassemblies when they are needed to satisfy our product schedulerequirements. If we cannot purchase enough of these materials, components orsubassemblies, or if these items do not meet our quality standards, there couldbe delays or reductions in our product shipments, which would have a materialadverse effect on our operating results, financial condition and cash flows.

 

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

** **

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

 

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

•                  Lambda-Physik, a companyheadquartered in Germany, owned by Coherent, Inc., a U.S. company.

 

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

 

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

 

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

** **

We are highly dependent onthe services of many key employees in various areas, including:

 

•      engineering;

•      researchand development;

•      salesand marketing;

•      fieldservice;

•      manufacturing;and

•      management.

 

Inparticular, there are a limited number of experts in excimer light sourcetechnology, and we require highly-skilled hardware and software engineers.Competition for qualified personnel is intense and we cannot guarantee that wewill be able to continue to attract and retain qualified personnel as needed.  We do not have employment agreements withmost of our employees. We believe that our future growth and operating resultswill depend on:

 

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

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

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

 

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

 

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

 

Webelieve it is critical for us to provide quick and responsive service directlyto the semiconductor device manufacturers throughout the world that use ourlight source products in their photolithography systems, and that it isessential to maintain our own personnel or trained third-party resources toprovide these services.  Accordingly, wehave an ongoing effort to develop our direct support system with locations inthe United States, Japan, Europe, Korea, Singapore, Taiwan and the People’sRepublic of China. This requires us to do the following:

 

•      recruitand train qualified field service personnel;

•      identifyqualified independent 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

 

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providingthese support services. Failure to implement our direct support operationeffectively could have a material adverse effect on our operating results,financial condition and cash flows.

 

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

 

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

 

As ofSeptember 30, 2003, we owned 192 United States patents covering certain aspectsof technology related to light sources and piezo techniques. These patents willexpire at various times during the period from January 2008 to November 2021.  As of September 30, 2003, we also hadapplied for 75 additional patents in the United States.  As of September 30, 2003, we owned 234foreign patents and had filed 325 patent applications pending in variousforeign countries.

 

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

 

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

 

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

 

•      tradesecret protection,

•      employeenondisclosure agreements,

•      third-partynondisclosure agreements; and

•      otherintellectual property protection methods.

 

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

 

•      independentlydevelop substantially the same proprietary information and techniques,

•      gainaccess to our trade secrets, or

•      discloseour technology.

 

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

 

In thepast, revenues from research and development arrangements with third partieshave been used to pay for a portion of our own research and developmentexpenses. We receive these revenues from government-sponsored programs,customers and from SEMATECH, a research consortium, in connection with ourdesigning and developing specific products. Currently, revenues from SEMATECH,photolithography tool manufacturers and semiconductor manufacturers are used tofund a small portion of our development expenses. In providing these researchand development services to these manufacturers and SEMATECH, we try to makeclear who owns the intellectual property that results from the research anddevelopment services we perform. However, disputes over the ownership or rightsto use or market this intellectual property may arise between us and thephotolithography tool manufacturers and SEMATECH. Any dispute over ownership ofthe intellectual property we develop could restrict our ability to market ourproducts and have a material adverse effect on our business.

 

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

 

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

 

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

 

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

 

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

 

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intellectualproperty rights or we may challenge these claims in legal proceedings. Anyadverse determination in a legal proceeding could result in one or more of thefollowing, any of which could have a substantial adverse effect on ourbusiness, financial condition and operating results:

 

•      loss ofour proprietary rights,

•      exposureto significant liabilities by other third parties,

•      requirementthat we get a license from third parties on terms that are not favorable; or

•      restrictionfrom manufacturing or selling our products.

 

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

 

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

 

Weregistered the trademark ‘‘CYMER’’ & “INSIST ON CYMER” in the United Statesand in some other countries. We are also trying to register additionaltrademarks 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 for usingthese marks and other marks on a worldwide basis and this would be costly todefend. If a trademark infringement action was successful, we would have tostop using the mark and possibly pay damages.

 

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

 

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 maynot be able to deliver our products to our customers in a timely manner;

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

•      oursales and marketing efforts may be disrupted.

 

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

 

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

 

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

 

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

 

**New accounting rules may impact our operating results.**

 

Recently,the FASB announced plans to require all companies to expense the value ofemployee stock options measured according to the fair value of theoptions.  Such a change in accountingrules may adversely impact our future financial condition and operatingresults.

** **

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

 

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

 

**Semiconductor devicemanufacturers’ prolonged use of our products in high volume productions may notproduce the results they desire and, as a result, our reputation and that ofour customers who supply photolithography tools to the semiconductormanufacturers could be damaged in the semiconductor industry.**

** **

Overtime, our light source products may not meet semiconductor devicemanufacturers’ production specifications or operating cost requirements afterthe light source is used for a long period in high volume production. If anysemiconductor device manufacturer cannot successfully achieve or sustain theirvolume production using our light sources, our reputation could be damaged withthe semiconductor device manufacturers and our customers who are the limitednumber of photolithography tool manufacturers. This would have a materialadverse effect on our business.

** **

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

** **

Therisks involved with acquiring a new company include the following:

 

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

•                  failure to retain keypersonnel,

•      amortizationof acquired definite-lived intangible assets and deferred compensation,

•      clientdissatisfaction or performance problems with the acquired company,

•      thecost associated with acquisitions and the integration of acquired operations,

•      failureto commercialize purchased technologies,

 

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•      abilityof the acquired companies to meet their financial projections; and

•      assumptionof unknown liabilities or other unanticipated events or circumstances.

 

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

 

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

 

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

 

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

 

Operationsat our primary manufacturing facility and our subcontractors are subject todisruption for a variety of reasons, including work stoppages, terrorism, fire,earthquake, energy shortages, flooding or other natural disasters.  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, which wouldhave 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 that we lease.We believe that our activities comply with current government regulations thatare applicable to our operations and current facilities. We may be required topurchase additional capital equipment or other requirements for our processesto comply with these government regulations in the future if they change.Further, these government regulations may restrict us from expanding ouroperations. Adopting measures to comply with changes in the governmentregulations, our failure to comply with environmental and land use regulations,or restrictions on our ability to discharge hazardous substances, could subjectus to future liability or cause our manufacturing operations to be reduced orstopped.

 

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

 

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

 

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insurancecoverage level, or any claim or product recall that results in adversepublicity against us, could have a material adverse effect on our business,financial condition and results of operations.

 

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

 

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

 

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

 

•      thecyclical nature of the semiconductor industry,

•      actualor anticipated fluctuations in our operating results,

•      conditionsand trends in the light source device and other technology industries,

•      announcementsof innovations in technology,

•      newproducts offered by us or our competitors,

•      developmentsof patents or proprietary rights,

•      changesin financial estimates by securities analysts,

•      generalworldwide political, economic, and market conditions,

•      UnitedStates political, economic, and market conditions; and

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

 

Inaddition, the stock market has experienced extreme price and volumefluctuations that have particularly affected the market price for many hightechnology companies. Such fluctuations have in some cases been unrelated tothe operating performance of these companies. Severe price fluctuations in acompany’s stock have frequently been followed by securities litigation.  Any such litigation can result insubstantial costs and a diversion of management’s attention and resources andtherefore could have a material adverse effect on Cymer’s business, financial conditionand results of operations.

 

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

 

Nevada law and our articles of incorporation containprovisions that discourage a proxy contest and provisions that make anacquisition of a substantial block of our common stock more difficult. Inaddition, our board of directors is authorized to issue, without stockholderapproval, shares of preferred stock. Such shares of preferred stock may havevoting, conversion and other rights and preferences that may be superior tothose of the common stock and this could adversely affect the voting power orother rights of holders of common stock. Our board can use the issuance of thepreferred stock or rights to purchase the preferred stock to discourage anyunsolicited acquisition proposal or attempt.

 

#### **Item 3. Quantitative and Qualitative Disclosures About Market Risk**

 

# **ForeignCurrency Risk**

 

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

 

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As of September 30, 2003, Cymer hadoutstanding foreign currency forward exchange contracts to buy US $85.7 millionfor 10.1 billion yen under foreign currency exchange facilities with contractrates ranging from 115.36 yen to 120.60****yen per U.S. dollar.  These contracts expire on various datesthrough December 2004.

 

Cymer’s foreign currency forward exchangecontracts qualify for hedge accounting treatment per the provisions ofStatement of Financial Accounting Standards No. 133, “Accounting for DerivativeInstruments and Hedging Activities”.  Asa result, Cymer defers changes in the fair value of these contracts and recordsthe amount in other comprehensive income (loss) and subsequently reclassifiesthe gain or loss to cost of product sales in the same period that the relatedsale is made to the third party. The unrealized loss or fair value of thesecontracts and the deferred loss totaled $5.6 million and $2.1 million,respectively, as of September 30, 2003. The fair value of these foreign currency forward exchange contracts asof September 30, 2003 would have changed by $8.9 million if the foreigncurrency exchange rate for the Japanese Yen to the US dollar on these forwardcontracts had changed by 10%.

 

# **Investmentand Debt Risk**

 

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

 

In February 2002, Cymerissued $250.0 million principal amount of unsecured fixed rate 31⁄2% ConvertibleSubordinated Notes due February 15, 2009. Interest on these 2002 Notes is payable on February 15 and August 15 ofeach year, commencing August 15, 2002.  The2002 Notes are convertible into shares of Cymer’s common stock at a conversionrate of 20 shares per $1,000 principal amount subject to adjustment undercertain conditions. Cymer may redeem the 2002 Notes on or after February 20,2005, or earlier if the price of its common stock reaches certain levels.  The 2002 Notes are subordinated to Cymer’sexisting and future senior indebtedness and effectively subordinated to allindebtedness and other liabilities of Cymer’s subsidiaries.  Because the interest rate is fixed, webelieve there is no risk of increased interest expense.  These Notes are recorded at face value onthe consolidated balance sheets.  Thefair value of such debt based on quoted market prices on September 30, 2003 was$271.4 million.

 

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

 

*Evaluation ofdisclosure controls and procedures*.  Cymer’schief executive officer and its chief financial officer, after evaluating theeffectiveness of Cymer’s disclosure controls and procedures (as defined inExchange Act Rule 13a-15(e) and 15d-15(e)) as of September 30, 2003, haveconcluded that as of such date, Cymer’s disclosure controls and procedures wereadequate and sufficient to ensure that information required to be disclosed byCymer in the reports that it files under the Securities Exchange Act of 1934 isrecorded, processed, summarized and reported within the time period specifiedin the Commission’s rules and forms.

 

*Changes in internalcontrols*.There has been no change in our internal control over financial reportingduring the fiscal quarter ended September 30, 2003 that has materially affected,or is reasonably likely to materially affect, our internal control overfinancial reporting.

 

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**PART II.  OTHER INFORMATION**

 
| **ITEM 1.**  | **Legal Proceedings**                                    |
|--------------|----------------------------------------------------------|
|         |                                                     |
|         | None.                                                    |
|         |                                                     |
| **ITEM 2.**  | **Changes in Securities  and Use of Proceeds**           |
|         |                                                     |
|         | None.                                                    |
|         |                                                     |
| **ITEM 3.**  | **Defaults upon Senior  Securities**                     |
|         |                                                     |
|         | None.                                                    |
|         |                                                     |
| **ITEM 4.**  | **Submission of Matters  to a Vote of Security Holders** |
|         |                                                     |
|         | None.                                                    |
|         |                                                     |
| **ITEM  5.** | **Other Information**                                    |
|         |                                                     |
|         | None.                                                    |
|         |                                                     |
| **ITEM 6.**  | **Exhibits and Reports  on Form 8-K**                    |
|         |                                                     |
|         | **(a)**                                                  | 10.1 | Employment Agreement, effective as of October 1, 2003, by and between  James M. Caltrider and Cymer. |
|         |                                                     |   |   |
|         |                                                     | 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. |
|         |                                                     |   |   |
|         | **(b)   Reports on Form 8-K**                       |
|         |                                                     |   |
|         |                                                     | On July 22, 2003, Cymer filed a Form 8-K announcing its second  quarter 2003 financial results. |

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this quarterly report on Form 10-Q to be signed on its behalf bythe undersigned thereunto duly authorized.

 

 
|                         |   |   | CYMER, INC.                   |
|------------------------------|--------|--------|-------------------------------|
|                         |   |   | (Registrant)                  |
|                         |   |   |                          |
|                         |   |   |                          |
| Date:  November 7, 2003 |   | 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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