**UNITEDSTATES SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**ý****                                ****QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**

 

**For theQuarterly Period Ended September 30, 2005**

 

**OR**

 

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

 

**For theTransition Period from                     to                         **

 

**Commission file number 0-21321**

 

**CYMER, INC.**

(Exact name of registrant as specified in its charter)

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

 

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

 

Yes ý            Noo

 

Indicateby check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2of the Act).  Yes ý            Noo

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).  Yes o            Noý

 

The number of shares ofCommon Stock, with $0.001 par value, outstanding on October 27, 2005 was 35,715,978.

 

 

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**CYMER, INC.**

 

**FORM 10-Q**

 

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

 

**INDEX**

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

 

2

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**ITEM 1.  FinancialStatements**

 

**CYMER, INC.**

**CONSOLIDATED BALANCE SHEETS (UNAUDITED)**

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

 
| ** **                                                                                                                                                                                  | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                                  | ** ** | **2004**              | ** ** | **2005**               | ** ** |
| **ASSETS**                                                                                                                                                                                  |       |                  |       |                   |       |
| CURRENT ASSETS:                                                                                                                                                                             |       |                  |       |                   |       |
| Cash and cash equivalents                                                                                                                                                                   |       | $                     | 114,246    |                   | $          | 152,268 |   |
| Short-term investments                                                                                                                                                                      |       | 175,866               |       | 164,458                |       |
| Accounts receivable - net                                                                                                                                                                   |       | 110,680               |       | 84,057                 |       |
| Foreign currency forward exchange contracts                                                                                                                                                 |       | —                |       | 2,175                  |       |
| Inventories                                                                                                                                                                                 |       | 110,022               |       | 86,153                 |       |
| Deferred income taxes                                                                                                                                                                       |       | 7,470                 |       | 7,668                  |       |
| Prepaid expenses and other assets                                                                                                                                                           |       | 5,726                 |       | 7,012                  |       |
| Total current assets                                                                                                                                                                        |       | 524,010               |       | 503,791                |       |
|                                                                                                                                                                                        |       |                  |       |                   |       |
| PROPERTY AND  EQUIPMENT - NET                                                                                                                                                               |       | 123,548               |       | 119,224                |       |
| LONG-TERM  INVESTMENTS                                                                                                                                                                      |       | 84,561                |       | 48,296                 |       |
| DEFERRED INCOME  TAXES                                                                                                                                                                      |       | 67,722                |       | 67,749                 |       |
| GOODWILL                                                                                                                                                                                    |       | 8,358                 |       | 8,358                  |       |
| INTANGIBLE  ASSETS - NET                                                                                                                                                                    |       | 10,394                |       | 8,595                  |       |
| OTHER ASSETS                                                                                                                                                                                |       | 7,185                 |       | 6,588                  |       |
| TOTAL ASSETS                                                                                                                                                                                |       | $                     | 825,778    |                   | $          | 762,601 |   |
|                                                                                                                                                                                        |       |                  |       |                   |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                              |       |                  |       |                   |       |
|                                                                                                                                                                                        |       |                  |       |                   |       |
| CURRENT  LIABILITIES:                                                                                                                                                                       |       |                  |       |                   |       |
| Accounts payable                                                                                                                                                                            |       | $                     | 13,949     |                   | $          | 18,043 |   |
| Accrued warranty and installation                                                                                                                                                           |       | 28,546                |       | 27,343                 |       |
| Accrued payroll and benefits                                                                                                                                                                |       | 16,284                |       | 12,210                 |       |
| Accrued patents, royalties and other fees                                                                                                                                                   |       | 6,318                 |       | 7,308                  |       |
| Foreign currency forward exchange contracts                                                                                                                                                 |       | 1,901                 |       | —                 |       |
| Income taxes payable                                                                                                                                                                        |       | 10,397                |       | 10,506                 |       |
| Unearned income                                                                                                                                                                             |       | 6,152                 |       | 2,000                  |       |
| Accrued and other current liabilities                                                                                                                                                       |       | 4,456                 |       | 2,833                  |       |
| Total current liabilities                                                                                                                                                                   |       | 88,003                |       | 80,243                 |       |
| CONVERTIBLE  SUBORDINATED NOTES                                                                                                                                                             |       | 200,753               |       | 140,722                |       |
| DEFERRED INCOME  TAXES                                                                                                                                                                      |       | 6,237                 |       | 6,237                  |       |
| OTHER  LIABILITIES                                                                                                                                                                          |       | 7,282                 |       | 9,889                  |       |
| Total liabilities                                                                                                                                                                           |       | 302,275               |       | 237,091                |       |
| MINORITY  INTEREST                                                                                                                                                                          |       | 6,183                 |       | 15,854                 |       |
|                                                                                                                                                                                        |       |                  |       |                   |       |
| COMMITMENTS AND  CONTINGENCIES                                                                                                                                                              |       |                  |       |                   |       |
|                                                                                                                                                                                        |       |                  |       |                   |       |
| STOCKHOLDERS’  EQUITY:                                                                                                                                                                 |       |                  |       |                   |       |
| Preferred stock - authorized 5,000,000 shares; $.001  par value, no shares issued or outstanding                                                                                            |       | —                |       | —                 |       |
| Common stock - $.001 par value per share;  100,000,000 shares authorized; 36,993,000 and 37,550,000 shares outstanding  at December 31, 2004 and September 30, 2005, respectively |       | 37                    |       | 38                     |       |
| Additional paid-in capital                                                                                                                                                                  |       | 378,414               |       | 392,006                |       |
| Treasury stock at cost (1,943,000 common shares)                                                                                                                                            |       | —                |       | (50,000                | )          |
| Unearned compensation                                                                                                                                                                       |       | (16                   | )          | —                 |       |
| Accumulated other comprehensive loss                                                                                                                                                        |       | (4,455                | )          | (4,812                 | )          |
| Retained earnings                                                                                                                                                                           |       | 143,340               |       | 172,424                |       |
| Total stockholders’ equity                                                                                                                                                             |       | 517,320               |       | 509,656                |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                             |       | $                     | 825,778    |                   | $          | 762,601 |   |

 

See Notes to Unaudited Consolidated FinancialStatements.

 

3

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**CYMER, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)**

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

 
| ** **                                                                | ** ** | **For the three months**     | ** ** | **For the nine months**      | ** ** |
|---------------------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                                                | ** ** | **ended September 30,** | ** ** | **ended September 30,** | ** ** |
| ** **                                                                | ** ** | **2004**                     | ** ** | **2005**                     | ** ** | **2004** | ** ** | **2005** | ** ** |
|                                                                      |       |                         |       |                         |       |   |   |   |   |
| REVENUES:                                                                 |       |                         |       |                         |       |   |   |   |   |
| Product sales                                                             |       | $                            | 106,751    |                         | $          | 99,592 |   | $ | 289,344 |   | $ | 279,998 |   |
| Other                                                                     |       | 389                          |       | 61                           |       | 624 |   | 857 |   |
| Total revenues                                                            |       | 107,140                      |       | 99,653                       |       | 289,968 |   | 280,855 |   |
|                                                                      |       |                         |       |                         |       |   |   |   |   |
| COSTS AND EXPENSES:                                                       |       |                         |       |                         |       |   |   |   |   |
| Cost of product sales                                                     |       | 56,120                       |       | 57,480                       |       | 158,263 |   | 168,242 |   |
| Research and development                                                  |       | 15,836                       |       | 15,922                       |       | 43,118 |   | 47,483 |   |
| Sales and marketing                                                       |       | 5,784                        |       | 6,281                        |       | 17,486 |   | 18,832 |   |
| General and administrative                                                |       | 8,218                        |       | 7,789                        |       | 22,987 |   | 20,115 |   |
| Total costs and expenses                                                  |       | 85,958                       |       | 87,472                       |       | 241,854 |   | 254,672 |   |
| OPERATING INCOME                                                          |       | 21,182                       |       | 12,181                       |       | 48,114 |   | 26,183 |   |
|                                                                      |       |                         |       |                         |       |   |   |   |   |
| OTHER INCOME (EXPENSE):                                                   |       |                         |       |                         |       |   |   |   |   |
| Foreign currency exchange loss - net                                      |       | (928                         | )          | (165                         | )          | (1,273 | ) | (932 | ) |
| Gain on debt extinguishment                                               |       | 911                          |       | —                       |       | 911 |   | 2,220 |   |
| Interest and other income                                                 |       | 2,401                        |       | 2,693                        |       | 5,900 |   | 7,691 |   |
| Interest and other expense                                                |       | (2,299                       | )          | (1,525                       | )          | (7,366 | ) | (5,428 | ) |
| Total other income (expense) - net                                        |       | 85                           |       | 1,003                        |       | (1,828 | ) | 3,551 |   |
|                                                                      |       |                         |       |                         |       |   |   |   |   |
| INCOME BEFORE INCOME TAX PROVISION AND MINORITY  INTEREST                 |       | 21,267                       |       | 13,184                       |       | 46,286 |   | 29,734 |   |
| INCOME TAX PROVISION                                                      |       | 5,818                        |       | 1,187                        |       | 11,572 |   | 2,099 |   |
| MINORITY INTEREST                                                         |       | (28                          | )          | 687                          |       | (1,936 | ) | 1,449 |   |
| NET INCOME                                                                |       | $                            | 15,421     |                         | $          | 12,684 |   | $ | 32,778 |   | $ | 29,084 |   |
|                                                                      |       |                         |       |                         |       |   |   |   |   |
| EARNINGS PER SHARE:                                                       |       |                         |       |                         |       |   |   |   |   |
| Basic earnings per share                                                  |       | $                            | 0.42       |                         | $          | 0.36 |   | $ | 0.89 |   | $ | 0.81 |   |
| Weighted average common shares outstanding                                |       | 36,788                       |       | 35,501                       |       | 36,704 |   | 36,070 |   |
|                                                                      |       |                         |       |                         |       |   |   |   |   |
| Diluted earnings per share                                                |       | $                            | 0.41       |                         | $          | 0.35 |   | $ | 0.87 |   | $ | 0.80 |   |
| Weighted average common and dilutive potential  common shares outstanding |       | 37,266                       |       | 36,131                       |       | 37,639 |   | 36,502 |   |

 

See Notes toUnaudited Consolidated Financial Statements.

 

4

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**CYMER, INC.**

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

**(In thousands)**

 
| ** **                                                                         | ** ** | **For the nine months ended** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                         | ** ** | **September 30,**        | ** ** |
| ** **                                                                         | ** ** | **2004**                      | ** ** | **2005** | ** ** |
|                                                                               |       |                          |       |   |   |
| OPERATING  ACTIVITIES:                                                             |       |                          |       |   |   |
| Net income                                                                         |       | $                             | 32,778     |   | $ | 29,084 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                          |       |   |   |
| Gain on debt extinguishment                                                        |       | (911                          | )          | (2,220 | ) |
| Depreciation and amortization                                                      |       | 21,004                        |       | 21,512 |   |
| Non-cash stock-based compensation                                                  |       | 141                           |       | 953 |   |
| Amortization of unearned compensation                                              |       | 98                            |       | 16 |   |
| Minority interest                                                                  |       | 1,936                         |       | (1,449 | ) |
| Provision for deferred income taxes                                                |       | (727                          | )          | 22 |   |
| Loss on disposal and impairment of property and  equipment                         |       | 61                            |       | 54 |   |
| Change in assets and liabilities:                                                  |       |                          |       |   |   |
| Accounts receivable – net                                                     |       | (33,491                       | )          | 26,623 |   |
| Foreign currency forward exchange contracts                                        |       | (2,247                        | )          | (2,952 | ) |
| Inventories                                                                        |       | (27,613                       | )          | 23,869 |   |
| Prepaid expenses and other assets                                                  |       | (2,299                        | )          | (2,388 | ) |
| Accounts payable                                                                   |       | 3,835                         |       | 4,094 |   |
| Accrued expenses and other liabilities                                             |       | 13,266                        |       | (2,733 | ) |
| Unearned income                                                                    |       | 3,626                         |       | (4,152 | ) |
| Income taxes payable                                                               |       | 9,185                         |       | 109 |   |
|                                                                               |       |                          |       |   |   |
| Net cash provided by operating activities                                          |       | 18,642                        |       | 90,442 |   |
|                                                                               |       |                          |       |   |   |
| INVESTING  ACTIVITIES:                                                             |       |                          |       |   |   |
| Acquisition of property and equipment                                              |       | (14,584                       | )          | (14,769 | ) |
| Purchases of investments                                                           |       | (502,685                      | )          | (276,968 | ) |
| Proceeds from sold or matured investments                                          |       | 562,170                       |       | 323,612 |   |
| Acquisition of patents                                                             |       | (5,990                        | )          | — |   |
| Acquisition of minority interest                                                   |       | (2,000                        | )          | — |   |
|                                                                               |       |                          |       |   |   |
| Net cash provided by investing activities                                          |       | 36,911                        |       | 31,875 |   |
|                                                                               |       |                          |       |   |   |
| FINANCING  ACTIVITIES:                                                             |       |                          |       |   |   |
| Proceeds from issuance of common stock                                             |       | 11,430                        |       | 12,639 |   |
| Redemption of convertible subordinated notes                                       |       | (47,407                       | )          | (57,336 | ) |
| Cash investment received from minority shareholder                                 |       | —                        |       | 11,120 |   |
| Payments on capital lease obligations                                              |       | (36                           | )          | (20 | ) |
| Purchases of treasury stock                                                        |       | —                        |       | (50,000 | ) |
|                                                                               |       |                          |       |   |   |
| Net cash used in financing activities                                              |       | (36,013                       | )          | (83,597 | ) |
|                                                                               |       |                          |       |   |   |
| EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH  EQUIVALENTS                      |       | (1,345                        | )          | (698 | ) |
|                                                                               |       |                          |       |   |   |
| NET INCREASE IN CASH AND CASH EQUIVALENTS                                          |       | 18,195                        |       | 38,022 |   |
| CASH AND CASH EQUIVALENTS AT BEGINNING OF THE PERIOD                               |       | 110,632                       |       | 114,246 |   |
|                                                                               |       |                          |       |   |   |
| CASH AND CASH EQUIVALENTS AT END OF THE PERIOD                                     |       | $                             | 128,827    |   | $ | 152,268 |   |

 

5

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| ** **                                         | ** ** | **For the nine months ended** | ** ** |
|----------------------------------------------------|------------|-------------------------------|------------|
| ** **                                         | ** ** | **September 30,**        | ** ** |
| ** **                                         | ** ** | **2004**                      | ** ** | **2005** | ** ** |
|                                               |       |                          |       |   |   |
| SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION: |       |                          |       |   |   |
| Interest paid                                      |       | $                             | 8,949      |   | $ | 6,850 |   |
| Income taxes paid, net                             |       | $                             | 2,650      |   | $ | 3,502 |   |

 

See Notes to Unaudited Consolidated FinancialStatements.

 

6

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**CYMER, INC.**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**Three  and NineMonths Ended September 30, 2005**

**(Unaudited)**

 

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

 

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

 

*Principles of Consolidation* – Theconsolidated financial statements include the accounts of Cymer, Inc., itswholly owned subsidiaries – Cymer Japan, Inc. (“Cymer Japan”), CymerSingapore Pte Ltd. (“Cymer Singapore”), Cymer B.V. in the Netherlands (“CymerB.V.”), Cymer Southeast Asia, Ltd, in Taiwan (“Cymer SEA”), Cymer SemiconductorEquipment Shanghai Co., Ltd, in the People’s Republic of China (“Cymer PRC”),and its majority-owned subsidiaries, Cymer Korea, Inc. (“Cymer Korea”) andTCZ GmbH (“TCZ”).  Cymer, Inc. owns81% of Cymer Korea and 60% of TCZ.  CymerJapan is currently the only subsidiary office of Cymer that sells excimer lightsource systems.  In addition, Cymer Japanprovides field service to customers in the Japan region. Cymer Singapore, CymerB.V., Cymer SEA, and Cymer PRC are field service offices for customers in thoserespective regions.  Cymer Korea providesrefurbishment manufacturing, field service, and administrative activities forthat region. TCZ is currently developing and will integrate, market and sell,and support tools employing an excimer laser beam to induce crystallization oflow-temperature poly-silicon (“LTPS”) processing for the manufacture of flatpanel displays.  All significantintercompany balances have been eliminated in consolidation.

 

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

 

*RecentAccounting Pronouncements.*

 

In December 2004, the FinancialAccounting Standards Board (“FASB”)issued Statement of Financial Accounting Standards No. 123R (“SFAS No. 123R”)“Share-Based Payment - An Amendment to Statement Nos. 123 and 95,” that addressesthe accounting for share-based payment transactions in which an enterprisereceives employee services in exchange for (a) equity instruments of theenterprise or (b) liabilities that are based on the fair value of theenterprise’s equity instruments or that may be settled by the issuance of suchequity instruments. This statement will eliminate the ability to account forshare-based compensation transactions using Accounting Principles Board (“APB”)Opinion No. 25, “Accounting for Stock Issued to Employees,” and will insteadrequire that such transactions be accounted for using a fair-value-basedmethod.  In April 2005, the U.S. Securities and Exchange Commission (“SEC”)announced the deferral of the effective date of SFAS No. 123R.  The deferral allows companies to adopt theprovisions of SFAS No. 123R beginning on the first annual period beginningafter June 15, 2005.  Based on thenew required adoption date, Cymer plans to adopt SFAS No. 123R as of thebeginning of the first quarter of 2006.

 

7

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*Reclassifications*– Certain amounts in theprior year consolidated financial statements have been reclassified to conformto current period presentation.  As of December 31,2004, $86.8 million of auction rate securities were reclassified from cash andcash equivalents to short-term investments.

 

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

 

*Stock Repurchase Program.*  In January 2005, Cymerannounced that its board of directors had authorized Cymer to repurchase up to $50million of Cymer’s common stock in the open market or in privately negotiatedtransactions. Through May 31, 2005, Cymer had repurchased 1,942,959 sharesfor $50 million, thereby completing the program.

 

*Equity Incentive Plan. *In May 2005, at Cymer’s annual meeting of stockholders, Cymer’sstockholders approved Cymer’s 2005 Equity Incentive Plan (the “2005 Plan”).  The 2005 Plan provides for the grant or awardof various equity incentives to Cymer’s employees, directors and consultants. Uponapproval of the 2005 Plan by the stockholders, Cymer discontinued the use ofits  1996 Stock Option Plan and 2000Equity Incentive Plan for future equity awards.  A total of 1,000,000 shares of common stockare reserved for issuance under the 2005 Plan, which provides for the issuanceof incentive stock options, nonstatutory stock options,  stock appreciation rights, stock bonusawards, stock purchase awards, stock unit awards and other stock awards. Optionsto purchase 296,600 shares were outstanding and 703,264 shares remained availablefor grants under the 2005 Plan as of September 30, 2005.

 

*Employee Stock Purchase Plan.*In February 2005, the board of directorsapproved an amendment to Cymer’s 1996 Employee Stock Purchase Plan (“ESPP”).Effective May 1, 2005, the amendment: a) changed duration of offeringperiods under the plan from 24 months to 6 months, b) reduced the discount tomarket price used to determine purchase price for shares of Cymer’s commonstock under the plan from 15% to 5%, and c) eliminated the “lookback” featurethat allowed the purchase price to be determined as of the beginning of anoffering period, or enrollment date, if the market price as of the enrollmentdate was lower than the market price at the end of the offering period.

 

*AcceleratedVesting of Stock Options. *In February 2005,Cymer’s board of directors approved the acceleration of the vesting of stockoptions that had exercise prices of $30.50 per share or higher held byemployees. This acceleration of stock options excluded directors, executive officersand certain vice presidents. The purpose of this acceleration of vesting was toenable Cymer to eliminate recognizing in its statement of operations thecompensation expense associated with these “out of the money” stock options infuture periods, upon adoption of SFAS No. 123R in the first quarter of2006.

 

*Stock-Based Compensation.*Cymerapplies the intrinsic value-based method of accounting prescribed by APBOpinion No. 25, “Accounting forStock Issued to Employees”, and related interpretations including FASBInterpretation No. 44, “Accountingfor Certain Transactions involving Stock Compensation, an interpretation of APBOpinion No. 25”**to account forits stock option plans.  Under thismethod, employee-based stock compensation expense is measured on the date ofgrant only if the then current market price of the underlying stock exceeds theexercise price. Employee-based stock compensation expense is recorded on astraight-line basis over the applicable vesting period.  Statement of Financial Accounting Standards 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 has elected tocontinue to apply the intrinsic value-based method of accounting describedabove, and has adopted the disclosure requirements of SFAS No. 123, asamended by Statement of Financial Accounting Standards No. 148, “Accountingfor Stock-Based Compensation—Transition and Disclosure”*.*

 

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

 

Cymer accounts for options granted to non-employeesunder SFAS No. 123 and Emerging Issues Task Force Issue No. 96-18, “Accountingfor Equity Instruments that are Issued to other than Employees

 

8

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for Acquiring or in Conjunction with Selling Goods orServices”.  Cymer measures the fair valueof such options using the Black-Scholes option-pricing model at each financialreporting date.  Cymer accounts forchanges in fair values between reporting dates in accordance with FASBInterpretation No. 28.  Stock-basedcompensation expense for options granted to non-employees and for thoseemployees who changed status during the nine months ended September 30,2004 and 2005 was $126,000 and $949,000, respectively.

 

UnderSFAS No. 123, the weighted average per share fair value of the options grantedfor the nine months ended September 30, 2004 and 2005 was $24.07 and $17.70,respectively, on the date of grant.  Fairvalue under SFAS No. 123 is determined using the Black-Scholesoption-pricing model with the assumptions noted below.  For the risk free interest rate, Cymer usesthe then currently available rate on zero coupon U.S. Government issues with aremaining life of five years for valuing options and one year for valuing ESPPshares.

 
| ** **                                 | ** ** | **Three months ended** | ** ** | **Nine months ended**  | ** ** |
|--------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                 | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                 | ** ** | **2004**               | ** ** | **2005**               | ** ** | **2004** | ** ** | **2005** | ** ** |
|                                       |       |                   |       |                   |       |   |   |   |   |
| Dividend yield                             |       | None                   |       | None                   |       | None |   | None |   |
| Volatility rate                            |       | 79                     | %          | 75                     | %          | 79 | % | 75 | % |
| Weighted average  risk free interest rate: |       |                   |       |                   |       |   |   |   |   |
| Options                                    |       | 3.51                   | %          | 4.04                   | %          | 3.38 | % | 3.95 | % |
| ESPP                                       |       | 2.28                   |       | N/A                    |       | 1.55 | % | 3.33 | % |
| Expected life:                             |       |                   |       |                   |       |   |   |   |   |
| Options                                    |       | 6 years                |       | 6 years                |       | 6 years |   | 6 years |   |
| ESPP                                       |       | .5 years               |       | N/A                    |       | .5 years |   | .5 years |   |

 

Thefollowing table compares earnings per share as reported by Cymer to the proforma amounts that would have been reported had compensation expense beenrecognized for Cymer’s stock-based compensation plans in accordance with SFAS No. 123(in thousands, except per share amounts):

 
| ** **                                                                                                                                        | ** ** | **Three months ended** | ** ** | **Nine months ended**  | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                                                                                        | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                                                                                                        | ** ** | **2004**               | ** ** | **2005**               | ** ** | **2004** | ** ** | **2005** | ** ** |
|                                                                                                                                              |       |                   |       |                   |       |   |   |   |   |
| Net income, as reported                                                                                                                           |       | $                      | 15,421     |                   | $          | 12,684 |   | $ | 32,778 |   | $ | 29,084 |   |
| Add: Stock-based employee compensation expense  included in reported net income, net of related tax effects                                       |       | (96                    | )          | 546                    |       | 106 |   | 886 |   |
| Deduct: Total stock-based employee compensation  expense determined under the fair value based method for all awards, net of  related tax effects |       | (4,126                 | )          | (2,889                 | )          | (13,336 | ) | (18,840 | ) |
| Pro forma net income                                                                                                                              |       | $                      | 11,199     |                   | $          | 10,341 |   | $ | 19,548 |   | $ | 11,130 |   |
| Earnings per share:                                                                                                                               |       |                   |       |                   |       |   |   |   |   |
| Basic - as reported                                                                                                                               |       | $                      | 0.42       |                   | $          | 0.36 |   | $ | 0.89 |   | $ | 0.81 |   |
| Basic - pro forma                                                                                                                                 |       | $                      | 0.30       |                   | $          | 0.29 |   | $ | 0.53 |   | $ | 0.31 |   |
| Diluted - as reported                                                                                                                             |       | $                      | 0.41       |                   | $          | 0.35 |   | $ | 0.87 |   | $ | 0.80 |   |
| Diluted - pro forma                                                                                                                               |       | $                      | 0.30       |                   | $          | 0.29 |   | $ | 0.52 |   | $ | 0.30 |   |

 

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

 

9

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

 

**3.****              JOINTVENTURE AGREEMENT**

 

In July 2005, Cymerentered into a Joint Venture Agreement (the “JV Agreement”) with (i) CarlZeiss SMT AG, a German corporation (“SMT”); (ii) Carl Zeiss Laser OpticsBeteiligungsgesellschaft mbH, a German limited liability company (“LOB”); and (iii) TCZ,the Swiss liability company that was formed as part of the JV Agreement. TCZ iscurrently developing and will integrate, market and sell, and support toolsemploying an excimer laser beam to induce crystallization of low-temperaturepoly-silicon (“LTPS”) processing for the manufacture of flat paneldisplays.  LOB and SMT, together withtheir affiliated entities, are collectively referred to as “Zeiss”.

 

TCZ is owned 60% by Cymerand 40% by Zeiss and earnings will be distributed according to the samepercentages.  As an initial capitalcontribution to TCZ, Cymer  contributedcertain intellectual property and approximately $14.2 million in cash in thethird quarter of 2005.  Cymer consolidatesthe financial position and results of operations of TCZ and reflects Zeiss’interest in TCZ as minority interest in the consolidated financialstatements.  If TCZ is dissolved, theintellectual property owned by TCZ will be distributed to the members as jointowners, and the remaining assets, net of liabilities, will be distributed tothe members in accordance with their percentage interests.

 

Although TCZ meets thedefinition of a separate operating segment under theprovisions of Statement of Financial Accounting Standards No. 131 (“SFASNo. 131”) “Disclosures about Segmentsof an Enterprise and Related Information,” Cymer has not reported TCZ asa separate operating segment for the period ending September 30, 2005 asTCZ’s results did not exceed the established quantitative thresholds includedin SFAS No. 131.”

 

As a result of theformation of TCZ, Cymer entered into various agreements with TCZ.  Included in these agreements was a long-termsupply agreement which requires Cymer to provide TCZ with components for TCZ’sproducts and an intellectual property agreement which controls the use of anyintellectual property developed by Cymer for the joint venture (“JV”).

 

**4.****              EARNINGSPER SHARE**

 

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

 

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The following table sets forth the computation of dilutedweighted average common and potential common shares outstanding for the threeand nine months ended September 30, 2004 and 2005 (in thousands):

 
| ** **                                                               | ** ** | **Three months ended** | ** ** | **Nine months ended**  | ** ** |
|--------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                               | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                               | ** ** | **2004**               | ** ** | **2005**               | ** ** | **2004** | ** ** | **2005** | ** ** |
|                                                                     |       |                   |       |                   |       |   |   |   |   |
| Basic weighted  average common shares outstanding                        |       | 36,788                 |       | 35,501                 |       | 36,704 |   | 36,070 |   |
| Effect of  dilutive securities:                                          |       |                   |       |                   |       |   |   |   |   |
| Warrants                                                                 |       | —                 |       | 5                      |       | 21 |   | — |   |
| Options                                                                  |       | 478                    |       | 625                    |       | 914 |   | 432 |   |
| Diluted weighted average common and potential common  shares outstanding |       | 37,266                 |       | 36,131                 |       | 37,639 |   | 36,502 |   |

 

For the three months ended September 30,2004 and 2005, weighted average options and warrants to purchase 4,922,000 and 3,601,000shares of common stock, respectively, were outstanding but not included in thecomputation of diluted earnings per share as their effect was anti-dilutive.  In addition, for the three months ended September 30,2004 and 2005, weighted average common shares attributable to convertiblesubordinated notes of 4,572,000 and 2,814,000, respectively, were not includedin the computation of diluted earnings per share as their effect was alsoanti-dilutive.

 

For the nine months ended September 30,2004 and 2005, weighted average options and warrants to purchase 2,978,000 and 4,927,000shares of common stock, respectively, were outstanding but not included in thecomputation of diluted earnings per share as their effect wasanti-dilutive.  In addition, for the ninemonths ended September 30, 2004 and 2005, weighted average common sharesattributable to convertible subordinated notes of 4,856,000 and 3,423,000,respectively, were not included in the computation of diluted earnings pershare as their effect was also anti-dilutive.

 

**5.****              INVENTORIES**

 

Inventoriesconsisted of the following as of December 31, 2004 and September 30,2005 (in thousands): 

 
| ** **                                  | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
|---------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **                                  | ** ** | **2004**              | ** ** | **2005**               | ** ** |
| INVENTORIES:                                |       |                  |       |                   |       |
| Raw materials                               |       | $                     | 48,131     |                   | $          | 39,774 |   |
| Work-in-progress                            |       | 24,344                |       | 15,743                 |       |
| Finished goods                              |       | 46,093                |       | 37,086                 |       |
| Allowance for excess and obsolete inventory |       | (8,546                | )          | (6,450                 | )          |
| Total                                       |       | $                     | 110,022    |                   | $          | 86,153 |   |

 

**6.****              REPORTINGCOMPREHENSIVE INCOME**

 

Comprehensive income includes net income, effective unrealized gainsand losses on forward contracts, foreign currency translation adjustments, andunrealized gains and losses on available-for-sale securities, which are recordedas short-term and long-term investments in the accompanying consolidatedbalance sheets.

 

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The following table summarizes the change in each component ofaccumulated other comprehensive loss for the nine months ended September 30,2005 (in thousands):

 
| ** **               | ** ** | ** **         | ** ** | **Foreign**     | ** ** | **Total unrealized**   | ** ** | **Total unrealized**      | ** ** | ** **        | ** ** |
|--------------------------|------------|--------------------|------------|-----------------|------------|------------------------|------------|---------------------------|------------|-------------------|------------|
| ** **               | ** ** | ** **         | ** ** | **currency**    | ** ** | **losses on**          | ** ** | **gains (losses) on**     | ** ** | **Accumulated**   | ** ** |
| ** **               | ** ** | ** **         | ** ** | **translation** | ** ** | **available-for-sale** | ** ** | **foreign currency**      | ** ** | **other**         | ** ** |
| ** **               | ** ** | ** **         | ** ** | **adjustment,** | ** ** | **investments,**       | ** ** | **forward exchange**      | ** ** | **comprehensive** | ** ** |
| ** **               | ** ** | ** **         | ** ** | **net of tax**  | ** ** | **net of tax**         | ** ** | **contracts, net of tax** | ** ** | **loss**          | ** ** |
| ** **               | ** ** | ** **         | ** ** | ** **      | ** ** | ** **             | ** ** | ** **                | ** ** | ** **        | ** ** |
| December 31,  2004  |       | Balance            |       | $               | (3,776     | )                      | $          | (224                      | )     | $                 | (455       | ) | $ | (4,455 | ) |
|                     |       | Period net  change |       | (413            | )          | (607                   | )     | 663                       |       | (357              | )          |
| September 30,  2005 |       | Balance            |       | $               | (4,189     | )                      | $          | (831                      | )     | $                 | 208        |   | $ | (4,812 | ) |

 

Comprehensive income consisted of the following components (inthousands):

 
| ** **                                                                            | ** ** | **Three months ended** | ** ** | **Nine months ended**  | ** ** |
|---------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                            | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                                            | ** ** | **2004**               | ** ** | **2005**               | ** ** | **2004** | ** ** | **2005** | ** ** |
|                                                                                  |       |                   |       |                   |       |   |   |   |   |
| Net income                                                                            |       | $                      | 15,421     |                   | $          | 12,684 |   | $ | 32,778 |   | $ | 29,084 |   |
|                                                                                  |       |                   |       |                   |       |   |   |   |   |
| Foreign currency translation adjustments, net of tax                                  |       | 296                    |       | (634                   | )          | (793 | ) | (413 | ) |
| Unrealized losses on available-for-sale investments,  net of tax                      |       | (119                   | )          | (243                   | )          | (1,313 | ) | (607 | ) |
| Unrealized gains (losses) on foreign currency  forward exchange contracts, net of tax |       | 1,359                  |       | (95                    | )          | 2,545 |   | 663 |   |
| Comprehensive income                                                                  |       | $                      | 16,957     |                   | $          | 11,712 |   | $ | 33,217 |   | $ | 28,727 |   |

 

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

 

In January 2004,Cymer entered into a research and development agreement with Intel Corporation(“Intel”). Under this agreement, Intel will provide Cymer a total of $20.0million over a three-year period to accelerate the development ofproduction-worthy extreme ultraviolet (“EUV”) lithography light sources.  The funding from Intel under this agreementis milestone based and is netted against Cymer’s total research and developmentexpenses in the period that the milestone is achieved.  Due to the complexity of the EUV technology,Cymer and Intel have regular communications on the milestones under thecontract and the timing and requirements for their completion. The total fundedamounts recorded under this agreement for the three months ended September 30,2004 and 2005 were $2.1 million and $104,000, respectively.  Funded amounts recorded for the nine monthsended September 30, 2004 and 2005 were $4.5 million and $1.8 million,respectively.

 

In February 2004,Cymer entered into an intellectual property license agreement with Intel for theuse of certain Intel patents and trade secrets related to EUV technology. Underthe terms of this agreement, Cymer will pay license fees to Intel if Cymer issuccessful in commercializing an EUV lithography light source capable of highvolume manufacturing by the end of the second quarter of 2008. The licensepayments under this agreement are triggered in the quarter in which Cymersuccessfully ships the first complete high volume manufacturing EUV sourcesystem.  Commencing with shipment of thisfirst unit, Cymer will pay Intel $1.25 million in license fees per quarter fora period of sixteen quarters.  Thequarterly license amounts paid to Intel, if any, will be related to Cymer’ssale of EUV light source systems and, as a result, will be recorded as cost of productsales.  The methodology and amounts thatwill be recorded to cost of product sales will be determined when the highvolume manufacturing production unit

 

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sales or a forecast of sales can be made.  No amounts have been earned under thisarrangement as of September 30, 2005.

 

**8.****              GOODWILL ANDINTANGIBLE ASSETS**

 

Cymer accounts for its goodwill and otherintangible assets in accordance with Statement of Financial AccountingStandards No. 142 (“SFAS No. 142”), “Goodwill and Other IntangibleAssets”. Under SFAS No. 142, Cymer’s goodwill is subject to an annualimpairment test. During the fourth quarter of 2004, Cymer completed itsannual impairment test of goodwill and intangible assets, and concluded that noimpairment of goodwill existed.  Thecarrying amount of goodwill was $8.4 million as of December 31, 2004 and September 30,2005.

 

Included in intangibleassets – net on the accompanying balance sheets are amounts associated withpatents that were acquired in 2001 and 2003. As of December 31, 2004 and September 30, 2005, the netcarrying amount of these patents was $10.4 million and $8.6 million,respectively.  Amortization expense forthese patents which is included in research and development expenses and costof product sales was $593,000 for each of the three months ended September 30,2004 and 2005.  Amortization expense was$1.8 million in total for each of the nine months ended September 30, 2004and 2005.

 

As of September 30,2005, future estimated amortization expense for these patents is expected to beas follows (in thousands):

 

| ** **                                  | ** ** | **Future**       | ** ** |
|---------------------------------------------|------------|------------------|------------|
| ** **                                  | ** ** | **Amortization** | ** ** |
|                                        |       |             |       |
| Three months  ending December 31, 2005 |       | $                | 593        |   |
| Year ending December 31,  2006         |       | $                | 2,371      |   |
| Year ending December 31,  2007         |       | $                | 2,371      |   |
| Year ending December 31,  2008         |       | $                | 2,371      |   |
| Year ending December 31,  2009         |       | $                | 889        |   |

 

**9.****             ****GUARANTEES/WARRANTIES**

 

Cymer adopted the disclosure provisions of FASBInterpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers”, during the quarter ended December 31, 2002 and adopted therecognition and measurement provisions as required after December 31,2002.  FIN 45 provides expandedaccounting guidance surrounding liability recognition and disclosurerequirements related to guarantees, as defined by this interpretation.

 

In the ordinary courseof business, Cymer is not subject to potential obligations under guaranteesthat fall within the scope of FIN 45, except for standard warranty provisionsassociated with product sales and indemnification provisions related tointellectual property that are contained within many of its customeragreements.  All of these provisions giverise only to the disclosure requirements prescribed by FIN 45.

 

ProductWarranties – Warranty provisions contained within Cymer’s customer agreementsare generally consistent with those prevalent in the semiconductor equipmentindustry. The warranty period and terms for light source systems and spares andconsumable parts varies by light source system model.  Cymer records a provision for warranty forall products, which is included in cost of product sales in the consolidatedstatements of operations and is recorded at the time that the related revenueis recognized. The warranty provision for Cymer’s products is reviewed monthlyand determined using a statistical financial model, which calculates actualhistorical expenses, product failure rates, and potential risks associated withCymer’s different product models. This financial model is then used tocalculate the future probable expenses related to warranty and the requiredlevel of the warranty provision. The

 

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risklevels, historical cost information and failure rates used within this modelare reviewed throughout the year and updated as these inputs change over the product’slife cycle. 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.

 

Thefollowing table summarizes information related to Cymer’s warranty provisionfor the nine months ended September 30, 2005 (in thousands):

 

| ** **                                                                                            | ** ** | **2005** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|----------|------------|
|                                                                                                  |       |     |       |
| Balance, December 31,  2004                                                                      |       | $        | 28,200     |   |
| Liabilities accrued for warranties issued during the  nine months, net of adjustments and expirations |       | 17,332   |       |
| Warranty  expenditures incurred during the nine months                                                |       | (18,757  | )          |
| Balance, September 30,  2005                                                                     |       | $        | 26,775     |   |

 

IntellectualProperty Indemnifications – Cymer includes intellectual propertyindemnification clauses within its general terms and conditions with itscustomers and the general purchase agreements with its three major customers, ASMLithography, Canon, and Nikon.  Ingeneral, these indemnification provisions provide that Cymer will defend itscustomers against any infringement claims that arise related to Cymer’sproducts.  Under the indemnificationclauses, Cymer will pay all costs and damages, including attorney’s fees,associated with such settlements or defenses, provided that the customerfollows specific procedures for notifying Cymer of such claims and allows Cymerto manage the settlement proceedings. Due to the nature of theseindemnification provisions, they are indefinite and extend beyond the term ofthe actual customer agreements.

 

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

 

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

 

As part of the supplyagreement signed with TCZ in September 2005, Cymer agreed to indemnify TCZagainst any infringement of the intellectual property rights of a third partyarising from TCZ’s purchase of products from Cymer. Cymer will defend suchactions at its own expense and will pay the cost and damage awarded in any suchaction provided that TCZ grants Cymer sole control of the defense andsettlement of such action and also provides Cymer with information required forthe defense and settlement of such action.

 

**10.****      ****CONVERTIBLE SUBORDINATED NOTES**

 

InFebruary 2002, Cymer issued $250.0 million principal amount of unsecuredfixed rate 3.50% convertible subordinated notes due February 15, 2009 withinterest payable on February 15 and August 15 of each year. Thesenotes are convertible into shares of Cymer common stock at a conversion rate of20 shares per $1,000 principal amount or an effective conversion price of$50.00 per share. Cymer may redeem the 2002 Notes on orafter February 20, 2005.  The 2002Notes are subordinated to Cymer’s

 

14

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existing and future senior indebtednessand effectively subordinated to all indebtedness and other liabilities of Cymer’ssubsidiaries. As of December 31, 2004, Cymer had $200.8 million principalamount of convertible subordinated notes outstanding.  In the secondquarter of 2005, Cymer repurchased, at a discount to par, $60.0 millionprincipal amount of these notes. As a result of this repurchase, Cymerrecognized a gain on debt extinguishment of $2.2 million for the nine monthsended September 30, 2005. As of September 30, 2005, Cymer had $140.7million principal amount of convertible subordinated notes outstanding.

 

**11.****      ****RELATED PARTY TRANSACTIONS**

 

As a result of the TCZ joint venture which was formedin July 2005, Zeiss is now a related party to Cymer.  In addition to transactions that occurbetween Cymer, Zeiss and TCZ related to the joint venture, Cymer also purchasescertain optical parts directly from Zeiss and sells its light source systemproducts to Zeiss periodically.  Cymer hadan accounts receivable balance of $259,000 and an accounts payable balance of$4.2 million as of September 30, 2005 and revenue of $177,000 for the threemonths ended September 30, 2005, all of which were associated with theserelated party transactions with Zeiss.

 

**12.****       COMMITMENTSAND CONTINGENCIES**

 

Cymer isparty to legal actions in the normal course of business.  Based in part on the advice of legal counsel,management does not expect the outcome of legal action in the normal course ofbusiness to have a material impact on the financial position, liquidity, orresults of operations of Cymer.

 

Cymer’s former Japanesemanufacturing partner, Seiko, and one of Cymer’s Japanese customers have beennotified that Cymer’s light source systems in Japan may infringe certainJapanese patents held by another Japanese company.  Cymer has agreed to indemnify its formerJapanese manufacturing partner and its customers against patent infringementclaims under certain circumstances, even after the termination date of thecontract manufacturing agreement.  Cymerbelieves, based upon the advice of counsel, that Cymer’s products do notinfringe any valid claim of the asserted patents or that Cymer is entitled toprior use claims in Japan.

 

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

 

*In this section, references to “we”,“us” or “our” are references to Cymer.**The following discussion of our financial condition and results ofoperations should be read in conjunction with our consolidated financialstatements and notes thereto included in this quarterly report on Form 10-Qand our consolidated financial statements and notes thereto included in ourannual report on Form 10-K for the year ended December 31, 2004.*

 

**Forward-Looking Statements**

 

Statements in thisQuarterly Report on Form 10-Q that are not strictly historical in natureare forward-looking statements. These statements include, but are not limitedto, references to the outlook for the semiconductor industry and us; the impactof rising energy prices on consumer spending; expected domestic andinternational product sales and development; research and developmentactivities and expenditures; adequacy of capital resources and investments;effects of business cycles in the semiconductor business; competitivepositioning; and relationships with customers and third-party manufacturers forproduct manufacturing, and may contain words such as “believes,” “anticipates,”“expects,” and words of similar meaning. These statements are predictions basedon current information and expectations and involve a number of risks anduncertainties. The underlying information and expectations are likely to changeover time.  Actual events or results maydiffer materially from those projected in the forward-looking statements due tovarious factors, including, but not limited to, those set forth under thecaption “Risks and Uncertainties That May Affect Results” and  elsewhere in this Quarterly Report on Form 10-Q.  Forward-looking statements herein speak onlyas of the date of this Quarterly Report on Form 10-Q.

 

#### **Overview**

 

*General*

 

We are the world’sleading supplier of light source solutions for the semiconductor industry.  Our products provide the essential lightsource for deep ultraviolet (“DUV”) photolithography systems.  Almost all consumer electronic devicesmanufactured in the last several years contain a semiconductor manufacturedusing light sources such as ours.  Wecurrently supply light sources to all three lithography tool manufacturers, ASMLithography, Canon, and Nikon, who in turn supply their wafer steppers andscanners to chipmakers.  In addition, we sell replacement parts andservices to the lithography tool manufacturers as well as directly to the chipmakers.  Our light source systems currently constitutea substantial majority of all excimer light sources incorporated in lithographystepper and scanner tools. We are headquartered in San Diego, California wherewe develop and manufacture all of our light source systems.  As a large portion of our revenue is derivedfrom customers located outside of the United States, we maintain amanufacturing spares facility and field service office in Korea and fieldservice and support offices in Japan, Taiwan, Singapore, the People’s Republicof China and the Netherlands. Japan is currently our only subsidiary officethat sells excimer light source systems. We also maintain field service officesin the United States to service our installed base of light sources located inthe United States.

 

In July 2005, we enteredinto a joint venture agreement with (i) Carl Zeiss SMT AG, a Germancorporation (“SMT”); (ii) Carl Zeiss Laser Optics BeteiligungsgesellschaftmbH, a German limited liability company (“LOB”); and (iii) the Swissliability company that was formed as part of the JV Agreement and named TCZGmbH (“TCZ”). LOB and SMT, together with their affiliated entities, arecollectively referred to as “Zeiss”.  TCZis currently developing, and will integrate, market and sell and support,production tools for the flat panel display manufacturing industry.  The joint venture is headquartered in SanDiego and is owned 60% by us and 40% by Zeiss. The joint venture is targetingthe growing market for low-temperature poly-silicon (“LTPS”) processing used inthe manufacture of liquid crystal displays that are brighter, have higherresolution, and consume less power than displays using today’s predominantamorphous silicon films.  We currentlyexpect that TCZ will ship its first production tool, the TCZ 900X, in thesecond half of 2006, and we expect that TCZ will break even from a financialstandpoint in 2008.

 

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*Products*

 

Ourcurrent products primarily consist of photolithography light source systems,replacement parts and service.

 

Ourphotolithography light sources produce narrow bandwidth pulses of shortwavelength light within the DUV spectrum. The DUV wavelengths are measured innanometers (“nm”). One nanometer equals one billionth of a meter.  The light sources are referred to accordingto the gases mixed to produce the light or by the wavelength.  Krypton Fluoride (“KrF”) gases produce 248 nmlight and Argon Fluoride (“ArF”) gases produce 193 nm light. These lightsources permit very fine feature resolution for imaging the circuitry on thewafer and high throughput in wafer processing. We have designed our light sources to be highly reliable, easy toinstall and compatible with existing semiconductor manufacturing processes. Ourlight sources are used to pattern the integrated circuits, which are alsocalled semiconductors or “chips,” that power many of today’s advanced consumerand business electronics. In the third quarter of 2005, we sold 55 light sourcesystems at an average selling price of $944,000.

 

Certaincomponents and subassemblies included in our light sources require replacementor refurbishment following extended operation. For example, the discharge chamber of our light sources has an expectedlife of approximately three to twenty-four billion pulses, depending on themodel. We estimate that a light source used in a semiconductor productionenvironment will require one to two replacement chambers per year, dependingupon the level of usage. Similarly, certain optical components of the lightsource deteriorate with continued exposure to DUV light and require periodicreplacement.  We provide these and otherspare and replacement parts for our photolithography light sources as needed byour customers.

 

As the life and usage ofour installed base of light sources in production at chipmakers exceeds theoriginal warranty periods, some chipmakers request service contracts fromus.  Additionally, we provide billableservice or service contracts directly to the three semiconductor lithographytool manufacturers. These service agreements require us to maintain and/orservice these light sources either on an on-call or regular interval basis orboth.  Some of these contracts includereplacement of consumable parts and non-consumable parts.

 

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

 

*SemiconductorIndustry Status and Outlook*

 

Since we derive asubstantial portion of our revenues from lithography tool manufacturers, we aresubject to the volatile and unpredictable nature of the semiconductor industry.The semiconductor industry is highly cyclical in nature and historically hasexperienced periodic ups and downs, and the activities of the last few yearsillustrate this cyclicality.  In 2000,the semiconductor industry experienced strong growth, which was followed by athree year decline from 2001 through late 2003. Growth resumed in the finalquarter of 2003 and continued through the third quarter of 2004.  In the final quarter of 2004, the industrydeclined briefly, then leveled off early in 2005.  More recently, fab utilization rates haveturned upward, and other business indicators have become more positive.  For example, a number of chipmakers haverecently announced that they intend to increase their capital spending over thenext year, and demand for certain kinds of memory chips is growingstrongly.  Though these indicators arequite positive, the consensus among industry forecasters is that results forsemiconductor capital equipment suppliers in 2006 will be flat or slightlybetter than 2005.

 

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One positive indicatorfor us has been two sequential quarters of revenue growth in 2005, with totalthird quarter revenue up three percent over the second quarter, and secondquarter revenue up 14% over the first quarter of 2005.  Our revenues were higher than expected in thethird quarter of 2005 due to stronger than forecasted demand for ourconsumables and spare parts.  In addition,the utilization rates of our light sources at chipmakers in the third quarterof 2005 reached a record high level overall, and improved over the levels inprevious quarters in every region. Overall semiconductor fab utilization rose to about the 90% range in thethird quarter from the 87% to 88% range in the second quarter of 2005.  Our most advanced technology productscontinue to be the main driver of our light source system demand, as they havebeen throughout 2005, and we expect that in the near term, they will continueto be a significant portion of our bookings.

 

At this time, there seemsto be a growing industry consensus on the near-term future. Most  semiconductor equipment industry experts nowsay that, though revenue in the fourth quarter of 2005 could be slightly belowrevenue in the third quarter, they expect bookings to increase.  In terms of capital spending, they expect2006 to be generally flat or slightly better than 2005.  We are particularly encouraged by the strongand growing demand for a particular kind of memory chip called NAND Flash, andthe production opportunity it presents to enable the expansion of the marketfor a growing number of consumer video entertainment products.  More specific to our own industry, increasingfab utilization especially at foundries, growing demand for more capable flashmemory, and tight capacity for critical and mid-critical layers on siliconwafers support our view that 2006 should be positive for equipment supplierswell-positioned to participate in these growth segments.  Our position as the leading supplier of lightsources for advanced dry and immersion ArF lithography, the growth segment ofthe DUV market, makes us optimistic about our longer-term prospects.

 

On a macro-economiclevel, we have concerns about the impact that rising energy prices will have onconsumer spending.  Consumers couldrespond to these price increases by reducing their spending on non-necessitiessuch as electronic devices.  On the otherhand, consumers could decide to spend more time at home in response to theincreasing gasoline prices and invest more in home electronics.  Since our light sources are involved in theproduction of many electronic devices, we are uncertain how higher energyprices will affect our earnings in the near term.

 

During 2005 and goinginto 2006, we plan to continue to focus on improving asset management withparticular emphasis on improving inventory management and increasing operatingefficiency. We will also continue our efforts to generate a significant amountof cash and improve shareholder returns by achieving higher returns on assets,which includes increasing our inventory turns and return on invested capitalduring the year.  In addition, we willcontinue to explore opportunities on the most effective use of our cash,including the potential additional repurchase of our own stock and convertiblesubordinated notes.

 

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

 

*General*

 

Thediscussion and analysis of our financial condition and results of operationsare based upon our consolidated financial statements, which have been preparedin accordance with accounting principles generally accepted in the UnitedStates of America.  The preparation ofthese financial statements requires us to make estimates and use judgment thatmay impact the reported amounts of assets, liabilities, revenues, expenses, andrelated disclosure of contingent assets and liabilities.  As a part of our ongoing internal processes,we regularly evaluate our estimates and judgments associated with revenuerecognition, valuation of parts used in our refurbishment manufacturingprocess, inventory allowances, warranty provisions, income taxes, allowancesfor bad debts, long-lived assets valuation, intangible assets valuation, andcontingencies and litigation.  We basethese estimates and judgments upon historical information and other facts andassumptions that we believe to be valid and/or reasonable under thecircumstances.  These assumptions andfacts form the basis for making judgments and estimates and for determining thecarrying values of our assets and liabilities that are not apparent from othersources.  Actual results could vary fromour estimates if we were to use different assumptions and conditions.

 

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

 

*RevenueRecognition*

 

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

 

•                  We do not recognize any revenue forlight source systems prior to shipment. We test the systems in environments similar to those used by ourcustomers prior to shipment to ensure that they meet the customers’specifications and will interface with the customers’ software.  Our installation obligations are perfunctorywithin the framework of Staff Accounting Bulletin No. 104 (“SAB 104”).  The shipping terms vary by customer for lightsource systems shipments.  The majorityof light source shipment terms are F.O.B. shipping point and revenue isrecognized upon shipment.  For thosecustomers with F.O.B. destination shipping terms, revenue is recognized upondelivery of the light source system to the customer.  One of our customers has an acceptanceprovision, which is satisfied by the issuance of an acceptance certificatefollowing a visual inspection of the system by the customer. We do notrecognize revenue on systems shipped to that customer until we receive the acceptancecertificate.  We had one arrangementwhere a portion of the light source system fee was not payable until the systemwas successfully installed at the end-user. In accordance with SAB 104, given the installation was not essential tothe functionality of the system, we deferred this portion of the fee until thesystem was installed.  This arrangementexpired in March 2005 for new light source system shipments but deferredamounts related to prior shipments were recognized to revenue through September 30,2005.

 

•                  Revenue from consumables and spareparts sales is recognized at the point that legal title passes to the customer,which is generally upon shipment from our facility.  For a significant portion of our spare partssales, our customers return the consumed assembly to us as part of the sale ofa new part.  We reuse some of thematerial within these core assemblies, mainly metal components, for the futurebuild of core assemblies.  As a result,our revenue consists of both cash and the value of the reusable parts receivedfrom our customers as consideration for these spare part sales. Revenueassociated with our customers’ return of core assemblies is recognized uponreceipt of the returned core assembly. The amount of the revenue is determined based upon the fair value of thereusable parts that we expect to yield from the returned core assembly.

 

•                  Service and training revenue isgenerally recognized at the time that the services are rendered or the trainingclass is completed.  Service contractrevenues are generally recorded as revenue ratably over the life of thecontract or per the specific terms of the agreement.

 

•                  For funded development contracts,which are included in other revenue, funds received are accounted for on thepercentage-of-completion method based on the relationship of costs incurred tototal estimated costs. Revenues generated from these types of fundeddevelopment contracts are derived from cost sharing contracts between certaincustomers and us. If milestones on these funded development contracts requirethat specific results be achieved or reported by us, revenue is not recognized untilthat milestone is completed.  For some ofthe funded development contracts that we enter into with customers andgovernment agencies, we evaluate certain criteria to determine whetherrecording the funds received as revenue is appropriate.  If certain conditions are met, these fundsare not recorded as

 

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revenuebut rather are offset against our own internal research and developmentexpenses in the period that the milestone is achieved or per the terms of thecontract.

 

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

 

Overthe last several years as part of our regular business activities, we haveconducted significant parts refurbishment activities related to some of ourcore assemblies, in particular our chamber assemblies. The volume of thisactivity significantly increased in 2004. These activities involve arrangementswith our customers where we sell a new part to the customer at a reduced salesprice if the customer returns the consumed assembly that the new partreplaces.  These returned core assembliescontain a certain amount of material, primarily metal components, that may bereused by us in future core assemblies. Upon receipt of these consumed assemblies from our customers, we recordan entry to recognize the estimated fair value of the reusable components asinventory and revenue.  The value of thereusable parts contained within the consumed assembly is determined based uponhistorical data on the value of the reusable parts that we typically yield froma consumed assembly. The costs of refurbishment are also capitalized as part ofending inventory as incurred.   As partof our normal excess and obsolete inventory analysis, these consumed assembliesare also reviewed on a quarterly basis and an inventory allowance is recordedas appropriate for these parts.  Thevalue that we assign to these core assemblies can be affected by the currentdemand for the reusable parts in our manufacturing operations and the actualyield rate achieved for parts within these consumed core assemblies.  We believe that our methodology for valuingthe reusable parts within these returned core assemblies is reasonable, but anychanges in the demand for the parts or the yield of the parts included in thesecore assemblies could have a material adverse effect on our financial conditionand results of operations.

 

Priorto the fourth quarter of 2004, we recorded the value of this material as areduction of our cost of product sales in the period that the returned assemblywas disassembled by our manufacturing operations and the value of the reusableparts could be determined.  Upon furtherreview of United States generally accepted accounting principles in the fourthquarter of 2004, we determined that we should instead estimate the value andrecord these consumed assemblies as inventory at the time that we receive thereturned assembly from our customer and concurrently record this amount asrevenue rather than as a reduction of cost of product sales.  Duringthe fourth quarter of 2004, we corrected our accounting treatment for theserefurbishment activities and recorded the financial impact for all of 2004 andprior years in our fourth quarter of 2004 financial statements. 

 

***InventoryAllowance***

 

Weperform an analysis of our inventory allowances on at least a quarterly basisto determine the adequacy of this allowance on our financial statements.  The amount of the inventory allowance isdetermined by taking into consideration certain assumptions related to marketconditions and future demands for our products, including changes to productmix, new product introductions, and/or product discontinuances, which mayresult in excess or obsolete inventory. We determine the level of excess andobsolete inventory associated with our raw materials and production inventoryby comparing the on hand inventory balances and inventory on order to the next12 months of forecasted demand.  We thenadjust this calculation for inventory that has a high likelihood of use beyondone year or can be used in other products that may have lower demands.  After this adjustment, we arrive at our totalexposure for excess and obsolete inventory within our raw materials andproduction inventory.  As part of thisanalysis, we also determine whether there are potential amounts owed to vendorsas a result of cancelled or modified raw material orders.  We estimate and record a separate liability,which is included in accrued and other liabilities in the accompanying balancesheets for such amounts owed.

 

Theinventory allowance totaled $8.5 million and $6.5 million at December 31,2004 and September 30, 2005, respectively. The decrease in this allowancefrom December 31, 2004 to September 30, 2005 was primarily due to thedisposal of certain obsolete materials during 2005 and an overall decrease ininventory levels as of September 30, 2005.

 

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

 

•                  Overall condition of the semiconductorindustry, which is highly cyclical in nature;

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

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

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

•                  Utilization rates of our lightsources at chipmakers.

 

Basedupon our experience, we believe that the estimates we use in calculating theinventory allowance are reasonable and properly reflect the risk of excess andobsolete inventory.  If actual demand orthe usage periods for our inventory are substantially different from ourestimates, adjustments to our inventory allowance may be required, which couldhave a material adverse effect on our financial condition and results ofoperations.

 

###### *WarrantyProvision*

 

Wemaintain an accrual for the estimated cost of product warranties associatedwith our product sales.  Warranty costsinclude the replacement parts and labor costs to repair our products during thewarranty periods.  At the time revenue isrecognized, we record a warranty provision, which is included in cost ofproduct sales in the accompanying consolidated statements of operations. The warrantycoverage period and terms for light source systems and consumable and spareparts varies by light source system model. The warranty provision for our products is reviewed monthly anddetermined by using a statistical financial model, which takes intoconsideration actual historical expenses, product failure rates, and potentialrisks associated with our different products. This model is then used to estimate future expenses related to warrantyand the required warranty provision.  Therisk levels and historical cost information and failure rates used within thismodel are reviewed throughout the year and updated as these inputs change overthe product’s life cycle. Due to the highly technical nature of our lightsource system products, the newer model light sources and the modules containedwithin them have higher inherent warranty risks and require higher warrantyprovisions.

 

Thetotal balance in the warranty provision accrual as of December 31, 2004and September 30, 2005 was $28.2 million and $26.8 million,respectively.  This decrease from periodto period is primarily due to the overall mix of light source systems underwarranty to those with lower warranty provision requirements and the highernumber of light source systems at September 30, 2005 which were at the endof the warranty period.

 

Weactively engage in product improvement programs and processes to limit ourwarranty costs, but our warranty obligation is affected by the complexity ofour product, product failure rates and costs incurred to correct those productfailures at customer sites. The industry in which we operate is subject torapid technological change, and as a result, we periodically introduce newer,more complex light sources.  Although weclassify these newly released light source models as having a higher risk inour warranty model resulting in higher warranty provisions, we are more likelyto have differences between the estimated and actual warranty costs for thesenew products.  This is due to limited orno historical product performance data on which to base our future warrantycosts.  Warranty provisions for our olderand more established light source models are more predictable as we have morehistorical information available on these products.  If actual product failure rates or estimatedcosts to repair those product failures were to differ from our estimates,revisions to our estimated warranty provision would be required, which couldhave a material adverse effect on our financial condition and results ofoperations.

 

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*Income Taxes*

 

We account for incometaxes in accordance with Statement of Financial Accounting Standards No. 109(“SFAS No. 109”), “Accounting for Income Taxes.”  Pursuant to SFAS No. 109, a deferred taxasset or liability is generally recognized for the estimated future tax effectsattributable to temporary differences, net operating loss carryforwards and taxcredit carryforwards.  Deferred taxassets are to be reduced by a valuation allowance if, based on the weight ofavailable evidence, it is more likely than not that some portion or all of thedeferred tax assets will not be realized within the carryback or carryforwardperiods.  Information about an enterprise’scurrent financial position and its results of operations for the current andpreceding years, as well as all currently available information about futureyears should be considered.

 

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

 

A material adversechange in the outlook for worldwide lithography tool sales, the expectedselling prices or profit margins for our products or our expected share of theglobal market for lithography light sources, could cause us to determine that avaluation allowance is needed for some or all of our deferred tax assets, andwould result in an increase to our income tax provision in the period in whichsuch determination is made.

 

Ourresults reflect the impact of the American Jobs Creation Act of 2004, whichrepealed the Extraterritorial Income Exclusion (“ETI”) subject to certaintransition rules. The ETI benefit is being replaced with a ManufacturingActivity deduction under Internal Revenue Code (“IRC”) Section 199, with aphase out of ETI benefits in 2005 and 2006. Our estimated ETI benefit for 2005 reflects the transition rules. Wewill not take advantage of the Section 199 deduction in 2005 due to thetaxable income limitation.

 

Wehave not provided U.S. federal income andforeign withholding taxes on $34.6 million of undistributed earnings fromnon-U.S. operations as of September 30, 2005 as it has been our intentionto reinvest undistributed earnings of our foreign subsidiaries and therebyindefinitely postpone their remittance. Accordingly, no provision has been made for foreign withholding taxes orUnited States income taxes which may become payable if undistributed earningsof foreign subsidiaries were paid as dividends to us.

 

The American Jobs Creation Act of 2004 and IRC Section 965allow a temporary 85% dividends received deduction on repatriated foreignearnings if the funds are reinvested in the United States.  We have evaluated the impact of repatriationof foreign earnings under IRC Section 965 and concluded that we will notrepatriate any foreign earnings under these provisions.

 

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**RESULTS OF OPERATIONS**

 

Thefollowing table sets forth certain items in our consolidated statements ofoperations as a percentage of total revenues for the periods indicated:

 
| ** **                                                | ** ** | **Three months ended** | ** ** | **Nine months ended**  | ** ** |
|-----------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                | ** ** | **2004**               | ** ** | **2005**               | ** ** | **2004** | ** ** | **2005** | ** ** |
| Revenues:                                                 |       |                   |       |                   |       |   |   |   |   |
| Product sales                                             |       | 99.6                   | %          | 99.9                   | %          | 99.8 | % | 99.7 | % |
| Other                                                     |       | 0.4                    |       | 0.1                    |       | 0.2 |   | 0.3 |   |
| Total revenues                                            |       | 100.0                  | %          | 100.0                  | %          | 100.0 | % | 100.0 | % |
| Cost and expenses:                                        |       |                   |       |                   |       |   |   |   |   |
| Cost of product sales                                     |       | 52.4                   |       | 57.7                   |       | 54.6 |   | 59.9 |   |
| Research and development                                  |       | 14.8                   |       | 16.0                   |       | 14.9 |   | 16.9 |   |
| Sales and marketing                                       |       | 5.4                    |       | 6.3                    |       | 6.0 |   | 6.7 |   |
| General and administrative                                |       | 7.7                    |       | 7.8                    |       | 7.9 |   | 7.2 |   |
| Total costs and expenses                                  |       | 80.3                   |       | 87.8                   |       | 83.4 |   | 90.7 |   |
| Operating income                                          |       | 19.7                   |       | 12.2                   |       | 16.6 |   | 9.3 |   |
| Total other income (expense) - net                        |       | 0.1                    |       | 1.0                    |       | (0.6 | ) | 1.3 |   |
| Income before income tax provision and minority  interest |       | 19.8                   |       | 13.2                   |       | 16.0 |   | 10.6 |   |
| Income tax provision                                      |       | 5.4                    |       | 1.2                    |       | 4.0 |   | 0.7 |   |
| Minority interest                                         |       | —                 |       | 0.7                    |       | (0.7 | ) | 0.5 |   |
| Net income                                                |       | 14.4                   | %          | 12.7                   | %          | 11.3 | % | 10.4 | % |
| Gross margin on product sales                             |       | 47.4                   | %          | 42.3                   | %          | 45.3 | % | 39.9 | % |

 

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

 

*Revenues*. Thetypes of revenue that we generate and how we recognize revenue for each isexplained in the Revenue Recognition section of Item 2. Management’sDiscussion and Analysis of Financial Condition and Results of Operations underCritical Accounting Policies and Estimates.

 

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

 
| ** **                                       | ** ** | **For the three months ended,** | ** ** |
|--------------------------------------------------|------------|---------------------------------|------------|
| ** **                                       | ** ** | **September 30,**          | ** ** |
| ** **                                       | ** ** | **2004**                        | ** ** | **2005** | ** ** |
|                                             |       |                            |       |   |   |
| Light source  systems:                           |       |                            |       |   |   |
| Revenue                                          |       | $                               | 67,717     |   | $ | 53,848 |   |
| Units sold                                       |       | 86                              |       | 55 |   |
| Average selling price (1)                        |       | $                               | 798        |   | $ | 944 |   |
|                                             |       |                            |       |   |   |
| Consumable and  spare parts and service products |       | $                               | 39,034     |   | $ | 45,744 |   |
| Other revenue                                    |       | $                               | 389        |   | $ | 61 |   |
| Total revenue                                    |       | $                               | 107,140    |   | $ | 99,653 |   |

 

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(1)          Calculation of averageselling price includes $943,000 deferred light source revenue during the threemonths ended September 30, 2004 and excludes $1.9 million deferred lightsource revenue that was recognized for the three months ended September 30,2005.  We had one arrangement where aportion of the light source system fee is not payable until the system isinstalled successfully at the end-user.  Thisarrangement expired in March 2005.

 

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Product sales decreased 7% from $106.8****million for the three months ended September 30, 2004to $99.6 million for the three months ended September 30, 2005.  This decrease in product sales was due tolower light source system revenues partially offset by higher consumable andspare parts and service product revenues during the three months ended September 30,2005 as compared to the same period in 2004. Light source system revenuesdecreased 21% from $67.7 million for the three months ended September 30,2004 to $53.8 million for the three months ended September 30, 2005.  A total of 86 light source systems were soldin the three months ended September 30, 2004 at an average selling priceof $798,000, compared to 55 systems sold in the three months ended September 30,2005 at an average selling price of $944,000. On a foreign currency adjusted basis, the average selling price for thethree months ended September 30, 2004 was $798,000 compared to $952,000for the three months ended September 30, 2005. The increase in the averageselling price from period to period reflected the shift in the product mix fromcapacity driven lower priced KrF products in the three months ended September 30,2004 to higher priced technology buys of advanced ArF products in the samethree-month period in 2005. The decrease in quantities of light source systemssold from period to period was due to the brief upturn in the semiconductorindustry in 2004 compared to the slowdown and flattening of the industry in2005. This decrease in light source system revenues from period to period wasoffset by a 17% increase in revenues associated with our consumable and spareparts and service products from $39.0 million for the three months ended September 30,2004 to $45.7 million for the three months ended September 30, 2005.  Included in the consumable and spare partsand service revenues for the three months ended September 30, 2005 andmaking up a majority of the percentage increase were revenues associated withthe receipt of reusable material contained within consumed core assembliesreturned from our customers. There were no such revenues recorded in thethree months ended September 30, 2004 due to the timing in 2004 of ourcorrection in accounting treatment for these refurbishment activities. See further discussion on change inaccounting method for refurbishment activities under Item 2. Management’sDiscussion and Analysis of Financial Condition and Results of Operations underCritical Accounting Policies and Estimates. Revenues from funded development contracts were $389,000 for the threemonths ended September 30, 2004, compared to $61,000 for the three monthsended September 30, 2005.  Therewere no revenues recorded or earned associated with the TCZ joint venture forthe three months ended September 30, 2005.

 

Our backlog at September 30, 2004 was $104.6million compared to $73.8 million at September 30, 2005.  Bookings for the three months ended September 30,2004 and September 30, 2005 were $104.0 million and $97.7 million,respectively.  The book-to-bill ratio forthe quarter ended September 30, 2004 was 0.97 compared to 0.98 for thequarter ended September 30, 2005.  Thedecrease in the backlog from period to period is due to the condition of thesemiconductor industry.  The backlog asof September 30, 2004 reflected the brief upturn in the semiconductorindustry that began in early 2004, whereas the backlog as of September 30,2005 reflected the slowdown and flattening of the semiconductor industry thatstarted late in 2004.  The decrease inbookings was primarily due to reduced orders of light source systems offset bya higher level of orders for consumables and spare parts in the third quarterof 2005 as compared to the third quarter of 2004.

 

Oursales are generated primarily by shipments to customers in Japan, Europe, andthe United States.  Approximately 87% and83% of our sales for the three months ended September 30, 2004 and 2005,respectively, were derived from customers outside the United States.  We maintain a wholly owned Japanese subsidiary,which sells to our Japanese customers. Revenues from Japanese customers, generated primarily by Cymer Japan,accounted for 31% of total revenues for both of the three months ended September 30,2004 and 2005.  The activities of ourJapanese subsidiary are limited to sales and service of products purchased bythem from us as the parent corporation. We anticipate that international saleswill continue to account for a significant portion of our net sales.

 

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

 

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The cost of product salesincreased 2% from $56.1 million for the three months ended September 30,2004 to $57.5 million for the three months ended September 30, 2005,respectively. This slight increase in the costs of product sales was partly dueto the change in our accounting treatment for parts used in our refurbishmentmanufacturing processes andthe classification of these transactions as revenue rather than a credit tocost of product sales.  In addition, theincrease in the cost of product sales from period to period was due to theshift in the product mix to higher cost light source systems and consumablesand spare parts in the third quarter of 2005 as compared to the third quarterof 2004.

 

The gross margin onproduct sales was 47.4% for the three months ended September 30, 2004 ascompared to 42.3% for the three months ended September 30, 2005.  This lower gross margin for the three monthsended September 30, 2005 was due to our accounting change associated withrefurbishment activities and the overall product mix of parts sold during theperiod.  The change in the accounting forour refurbishment activities accounted for approximately 4% of this grossmargin decrease from period to period.  Inaddition, gross margins were positively impacted in the third quarter of 2004due to increased factory yield and utilization, whereas factory loading has leveled throughout 2005.

 

*Research and Development*.  Research and developmentexpenses include costs of internally-funded and externally-funded projects aswell as continuing product development support expenses, which consistprimarily of employee and material costs, depreciation of equipment and otherengineering related costs.  Our researchand development expenses are offset by amounts associated with certain of ourexternally funded research and development contracts.  Research and development expenses increased1% from $15.8 million for the three months ended September 30, 2004 to$15.9 million for the three months ended September 30, 2005, due primarilyto costs associated with our LTPS product development efforts and extremeultraviolet (“EUV”) light source development. Research and development expenseswere offset by amounts related to our externally funded research anddevelopment contracts of $2.4 million and $604,000 for the three months ended September 30,2004 and 2005, respectively.  In additionto our development of EUV, we also continued to focus on next generation ArFproducts based on the XL platform, next generation KrF products and the LTPSproduct development efforts associated with the TCZ joint venture. As apercentage of total revenues, research and development expenses increased from14.8% for the three months ended September 30, 2004 to 16.0% for the threemonths ended September 30, 2005 due primarily to lower revenues in 2005compared to the same period in 2004.  Asa result of our decision to enter the flat panel display manufacturing toolsmarket with the formation of TCZ, our research and development expenses goingforward will also include a greater focus on LTPS product development efforts.

 

*Sales and Marketing*. Sales and marketing expenses include the expenses of the sales,marketing and customer support staff and other marketing expenses.  Sales and marketing expenses increased 9%from $5.8 million for the three months ended September 30, 2004 to $6.3million for the three months ended September 30, 2005. This increase insales and marketing expenses from period to period primarily reflects marketdevelopment costs associated with the TCZ joint venture which was formed in thethird quarter of 2005.  As a percentageof total revenues, such sales and marketing expenses increased from 5.4% forthe three months ended September 30, 2004 to 6.3% for the three monthsended September 30, 2005.

 

*Generaland Administrative*. General and administrative expensesconsist primarily of management and administrative personnel costs,professional services and administrative operating costs.  General and administrative expenses decreased5% from $8.2 million for the three months ended September 30, 2004 to $7.8million for the three months ended September 30, 2005 primarily due to thereceipt of rent payments in the third quarter of 2005 from the tenants in twoof our San Diego facilities, which we subleased in the third and fourthquarters of 2004. This was offset by stock-based compensation expenseassociated with non-employees and initial expenses associated with the TCZjoint venture during the three months ended September 30, 2005.  General and administrative expenses in thethree months ended September 30, 2004 also included $1.4 million in costsassociated with revisions of our estimates related to the timing and marketrates for subleasing the San Diego and Boston facilities, which we exited

 

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in 2003. As a percentageof total revenues, general and administrative expenses increased slightly from7.7% for the three months ended September 30, 2004 to 7.8% for the three monthsended September 30, 2005.

 

*TotalOther Income (Expense) - Net.*  Net other income(expense) consists primarily of interest income and expense and foreigncurrency exchange gains and losses associated with fluctuations in the value ofthe functional currencies of our foreign subsidiaries against the United Statesdollar.  Net other income totaled $85,000for the three months ended September 30, 2004, compared to $1.0 millionfor the three months ended September 30, 2005.  The increase in net other income wasprimarily due to an increase in interest income, a decrease in interestexpense, and a decrease in foreign currency exchange loss in the third quarterof 2005 compared to the same three-month period in 2004. The increase ininterest income from 2004 to 2005 reflects higher market interest rates for ourshort-term and long-term investments. The decrease in interest expense fromperiod to period is due to our lower debt balances as a result of therepurchase of our convertible subordinated notes that we made in the third quarterof 2004 and the second quarter of 2005.  Theforeign currency loss in the third quarter of 2004 reflects the loss of $1.1million from the discontinuance of certain of our cash flow hedges during theperiod. Also included in the 2004 third quarter other income (expense) is a$911,000 gain on debt extinguishment which was recorded for the repurchase of$49.2 million principle of our notes and a $281,000 gain related to the sale ofinvestments.  Foreign currency exchangelosses totaled $928,000, interest income totaled $2.4 million, interest expensetotaled $2.3 million and gain on debt extinguishment totaled $911,000 for thethree months ended September 30, 2004, compared to a foreign currencyexchange loss of $165,000, interest income of $2.7 million, and interestexpense of $1.5 million for the three months ended September 30, 2005.

 

*Income Tax Provision.* The tax provision of $5.8 million and $1.2 million for the threemonths ended September 30, 2004 and 2005, respectively, reflected anannual effective rate of 27% and 9%, respectively.  The change in the annual effective tax ratefrom period to period was primarily attributable to the decrease in pre-taxearnings as well as tax benefits from U.S. export incentive programs andresearch and development and manufacturing investment credits. The annualeffective tax rates for both periods were less than the U.S. statutory rate of35% primarily as a result of permanent book/tax differences and tax credits.The effective tax rate is a function of current tax law and geographic locationof pre-tax income.  The Research andExperimentation Credit was extended under the Working Families Tax Relief Actfor amounts paid or incurred after June 30, 2004 and before 2006.  The American Jobs Creation Act of 2004repealed the ETI exclusion subject to certain transition rules.  The ETI exclusion is being replaced with aManufacturing Activity deduction under IRC Section 199 with a phase out ofETI benefits for 2005 and 2006.  Ourestimated ETI benefit for 2005 reflects the transition rules.  We will not take advantage of the Section 199deduction in 2005 due to the taxable income limitation.  The benefit is available to us for tax yearsbeginning in 2005, subject to certain transition rules. We anticipate that thebenefit available to us under both regimes will be comparable for years inwhich we have taxable income.  Due to theexpected realization of anticipated discrete fourth quarter tax events, it islikely that our fourth quarter 2005 annualized effective tax rate will be a taxbenefit, resulting in a full year annual tax rate for 2005 of approximately 0%.

 

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**NINEMONTHS ENDED SEPTEMBER 30, 2004 AND 2005**

 

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

 
| ** **                                      | ** ** | **For the nine months ended,** | ** ** |
|-------------------------------------------------|------------|--------------------------------|------------|
| ** **                                      | ** ** | **September 30,**         | ** ** |
| ** **                                      | ** ** | **2004**                       | ** ** | **2005** | ** ** |
|                                            |       |                           |       |   |   |
| Light source systems:                           |       |                           |       |   |   |
| Revenue                                         |       | $                              | 179,097    |   | $ | 157,181 |   |
| Units sold                                      |       | 231                            |       | 159 |   |
| Average selling  price (1)                      |       | $                              | 785        |   | $ | 962 |   |
|                                            |       |                           |       |   |   |
| Consumable and spare parts and service products |       | $                              | 110,247    |   | $ | 122,817 |   |
| Other revenue                                   |       | $                              | 624        |   | $ | 857 |   |
|                                            |       |                           |       |   |   |
| Total revenue                                   |       | $                              | 289,968    |   | $ | 280,855 |   |

 

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(1)          Calculation of averageselling price includes $2.2 million deferred light source revenue during the ninemonths ended September 30, 2004 and excludes $4.2 million deferred lightsource revenue that was recognized for the nine months ended September 30,2005.  We had one arrangement where aportion of the light source system fee is not payable until the system isinstalled successfully at the end-user.  Thisarrangement expired in March 2005.

 

Product sales decreased 3% from $289.3****million for the nine months ended September 30, 2004to $280.0 million for the nine months ended September 30, 2005, primarilydue to a decrease in light source system sales which was offset by higher salesof consumable and spare parts and service products from period to period.  Light source system revenues decreased 12% from$179.1 million for the nine months ended September 30, 2004 to $157.2million for the nine months ended September 30, 2005.  A total of 231 light source systems were soldin the nine months ended September 30, 2004 at an average selling price of$785,000, compared to 159 systems sold in the nine months ended September 30,2005 at an average selling price of $962,000. On a foreign currency adjusted basis, the average selling price for the ninemonths ended September 30, 2004 was $776,000 compared to $961,000 for the ninemonths ended September 30, 2005. The increase in the average selling pricefrom period to period reflected the shift in the product mix from capacitydriven lower priced KrF products in the nine months ended September 30,2004 to higher priced technology buys of advanced ArF products in the same nine-monthperiod in 2005. The decrease in light source system sales was offset by an 11%increase in revenue associated with consumable and spare parts and serviceproducts from $110.2 million for the nine months ended September 30, 2004to $122.8 million for the nine months ended September 30, 2005.  Included in the sales of consumable and spareparts and service revenues and accounting for all of the increase for the ninemonths ended September 30, 2005 were revenues associated with the receiptof reusable material contained within consumed core assemblies returned fromour customers. There were no such revenues recorded in the nine monthperiod ended September 30, 2004 due to the timing in 2004 of ourcorrection in accounting treatment for these refurbishment activities. Revenues from funded development contractswere $624,000 for the nine months ended September 30, 2004, compared to $857,000for the nine months ended September 30, 2005.  There were no revenues recorded or earnedassociated with the TCZ joint venture for the nine months ended September 30,2005.

 

Sales to our three largest customers, ASMLithography, Canon, and Nikon, amounted to 35%, 14% and 21%, respectively, oftotal revenue for the nine months ended September 30, 2004, and 32%, 8%and 25%, respectively, of total revenue for the nine months ended September 30,2005.

 

Approximately87% and 84% of our sales for the nine months ended September 30, 2004 and2005, respectively, were derived from customers outside the United States.Revenues from Japanese customers, generated primarily by Cymer Japan, accountedfor 35% and 32% of total revenues for the nine months ended September 30,2004 and 2005, respectively.

 

*Cost of Product Sales. *The cost of product sales increased 6%from $158.3 million for the nine months ended September 30, 2004 to $168.2million for the nine months ended September 30, 2005,

 

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respectively. This increase in the costsof product sales was primarily due to the change in our accounting treatmentfor parts used in our refurbishment manufacturing processes andthe reclassification of these transactions as revenue rather than a credit tocost of product sales, and a shift in  the overall product mix in 2005 which includedhigher cost products.

 

The gross margin onproduct sales was 45.3% for the nine months ended September 30, 2004 ascompared to 39.9% for the nine months ended September 30, 2005.  This lower gross margin for the nine monthsended September 30, 2005 was primarily due to our accounting changeassociated with our refurbishment activities and reduced factory loading whichwas the result of reducing our inventory levels. The change in the accountingfor our refurbishment activities accounted for approximately 3% of this grossmargin decrease from period to period. The higher gross margin in 2004 also reflectedimproved efficiencies associated with the XL series product, overallmanufacturing costs reduction efforts and increased factory yield andutilization.

 

*Research and Development*.  Research and developmentexpenses increased 10% from $43.1 million for the nine months ended September 30,2004 to $47.5 million for the nine months ended September 30, 2005 dueprimarily to costs associated with our LTPS product development efforts and EUVlight source development and the timing of milestone achievements on our EUVdevelopment contract with Intel. Research and development expenses were offset by amounts related to ourexternally funded research and development contracts of $6.0 million and $2.4million for the nine months ended September 30, 2004 and 2005,respectively.  In addition to ourdevelopment of EUV, we also continued to focus on next generation ArF productsbased on the XL platform, particularly the XLA-200 and XLA-300 light sourcesystems, next generation KrF products and the LTPS product development effortsassociated with the TCZ joint venture. As a percentage of total revenues, research and development expensesincreased from 14.9% for the nine months ended September 30, 2004 to 16.9%for the nine months ended September 30, 2005 due primarily to increasedcosts and lower revenues in the first nine months of 2005 compared to the sameperiod in 2004.

 

*Sales and Marketing*.  Sales and marketing expenses increased8% from $17.5 million for the nine months ended September 30, 2004 to $18.8million for the nine months ended September 30, 2005 due primarily toincreased sales expenses associated with our chipmaker customers at our foreignlocations and market development costs associated with the TCZ joint venture.This was offset by decreased profit sharing and bonus expenses incurred fromperiod to period.   As a percentage oftotal revenues, such sales and marketing expenses increased from 6.0% for the ninemonths ended September 30, 2004 to 6.7% for the nine months ended September 30,2005.

 

*Generaland Administrative*. General and administrative expensesdecreased 13% from $23.0 million for the nine months ended September 30,2004 to $20.1 million for the nine months ended September 30, 2005primarily due to the receipt of rent payments in the first nine months of 2005from the tenants in two of our San Diego facilities, which we subleased in thethird and fourth quarters of 2004, and decreases in profit sharing and bonusexpenses incurred from period toperiod.  This decrease in general andadministration expenses was offset by additional external accounting and legalcosts associated with the formation of the TCZ entity, additional externalaudit fees associated with our compliance with the internal controlrequirements under Section 404 of the Sarbanes-Oxley Act, and stockcompensation expense for non-employees during the period.  General and administrative expenses in thenine months ended September 30, 2004 also included $1.4 million in costsassociated with revisions of our estimates related to the timing and marketrates for subleasing the San Diego and Boston facilities, which we exited in2003.  As a percentage of total revenues,such expenses decreased from 7.9% for the nine months ended September 30,2004 to 7.2% for the nine months ended September 30, 2005.

 

*TotalOther Income (Expense) - Net.*  Net other expense totaled$1.8 million for the nine months ended September 30, 2004, compared to netother income of $3.6 million for the nine months ended September 30,2005.  The change from net other expenseto net other income was primarily due to an increase in interest income, adecrease in interest expense and a higher gain on debt extinguishment relatedto our notes repurchase activities from period to period.  The increase in interest income from 2004 to2005 reflects higher market interest rates for our short-term and long-terminvestments. The decrease in interest expense from period to period is due toour lower debt balances as a result of the repurchase of notes that we made inthe third quarter of 2004 and the second quarter of 2005. Foreign

 

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currency exchange losses totaled $1.3 million,interest income totaled $5.9 million, interest expense totaled $7.4 million anda gain on debt extinguishment totaled $911,000 for the nine months ended September 30,2004, compared to a foreign currency exchange loss of $932,000, interest incomeof $7.7 million, interest expense of $5.4 million and a gain on debtextinguishment of $2.2 million for the nine months ended September 30,2005.

 

*Income Tax Provision.*  The tax provision of$11.6 million and $2.1 million for the nine months ended September 30,2004 and 2005, respectively, reflects an annual effective rate of 25% and7.06%, respectively. The change in the annual effective tax rate from period toperiod was primarily attributable to the decrease in pre-tax earnings as wellas tax benefits from U.S. export incentive programs and research anddevelopment and manufacturing investment credits. The annual effective taxrates for both periods were less than the U.S. statutory rate of 35% primarilyas a result of permanent book/tax differences and tax credits. The effectivetax rate is a function of current tax law and geographic location of pre-taxincome.  The Research and ExperimentationCredit was extended under the Working Families Tax Relief Act for amounts paidor incurred after June 30, 2004 and before 2006.  The American Jobs Creation Act of 2004repealed the ETI exclusion subject to certain transition rules.  The ETI exclusion is being replaced with aManufacturing Activity deduction under IRC Section 199 with a phase out ofETI benefits for 2005 and 2006. Our estimated ETI benefit for 2005 reflects thetransition rules. We will not take advantage of the Section 199 deduction in2005 due to the taxable income limitation. The benefit is available to us fortax years beginning in 2005, subject to certain transition rules. We anticipatethat the benefit available to us under both regimes will be comparable foryears in which we have taxable income. Due to the expected realization of anticipated discrete fourth quartertax events, it is likely that our fourth quarter 2005 annualized effective taxrate will be a tax benefit, resulting in a full year annual tax rate for 2005of approximately 0%.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

Historically we have funded our operations primarilyfrom cash generated from operations, the proceeds of the note offerings in August 1997and February 2002, bank borrowings, and the proceeds from employee stockoption exercises.  As of September 30,2005, we had approximately $152.3 million in cash and cash equivalents, $164.5million in short-term investments, $48.3 million in long-term investments, and$423.5 million in working capital.

 

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

 

Netcash provided by operating activities was approximately $18.6 million and $90.4million for the nine months ended September 30, 2004 and 2005,respectively. The increase in cash provided by operating activities from periodto period was primarily attributable to significant decreases in accountsreceivable and inventory in the nine months ended September 30, 2005compared to increases in both for the same nine-month period in 2004.  This increase to cash provided by operating activities from period toperiod was offset by decreases in accrued expenses and other liabilities, unearnedincome and income taxes payable in the nine months ended September 30,2005 compared to increases in these accrued expenses in the same nine-monthperiod in 2004. The decrease inaccounts receivable reflects collections we made on our receivable balancesthat were outstanding at December 31, 2004.  A higher percentage of sales were incurredtowards the end of the fourth quarter 2004, causing the accounts receivablebalance to increase at December 31, 2004. The decrease in inventoryreflects the reduction in our field and factory inventory as result of ourongoing initiative in 2005 to improve asset management by reducing inventoryand increasing inventory turns.

 

Netcash provided by investing activities was approximately $36.9 million and $31.9million for the nine months ended September 30, 2004 and 2005,respectively.  Net cash provided byinvesting activities for the nine months ended September 30, 2004 was dueprimarily to the timing of short-term and long-term investments maturing andbeing reinvested during 2004, a $6.0 million payment to acquire

 

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certain patents,a $2.0 million payment to acquire an additional 6% minority interest in ourCymer Korea subsidiary, and the acquisition of property and equipment in theamount of $14.6 million. Net cash provided by investing activities for the ninemonths ended September 30, 2005 reflects the timing of short-term andlong-term investments that matured and were reinvested during the period and theacquisition of $14.8 million of property and equipment.

 

Net cash used infinancing activities was approximately $36.0 million and $83.6 million for thenine months ended September 30, 2004 and 2005, respectively. Net cash usedin financing activities for the nine months ended September 30, 2004reflected the repurchase of approximately $49.2 million principal amount of ourconvertible subordinated notes during September 2004. This was offset byproceeds received from the exercise of employee stock options totaling $11.4million during the nine months ended September 30, 2004. Net cash used infinancing activities for the nine months ended September 30, 2005 reflectedthe repurchase of treasury stock of $50.0 million and the repurchase ofapproximately $60.0 million principal amount of our convertible subordinatednotes, at a discount to par,  in the firstand second quarters of 2005.  Thetreasury stock and note repurchases were offset by proceeds received from the exerciseof employee stock options totaling $12.6 million and the minority interestinvestment received from Zeiss in the TCZ joint venture of $11.1 million duringthe nine months ended September 30, 2005.

 

We require substantial working capital to fund ourbusiness, particularly to finance inventories, including purchase orders withour vendors, accounts receivable, and for capital expenditures.  Our future capital requirements depend onmany factors, including our manufacturing activity, the timing and extent ofspending to support product development efforts, expansion of sales andmarketing and field service and support, competitive labor market compensationrequirements, the timing of introductions of new products and enhancements toexisting products, and the market acceptance of our products. We believe thatcash generated from operations along with the liquidity provided by ourexisting cash balances and short-term investments will be sufficient to sustainoperations and provide for any potential future expansion of our business forat least the next 12 months.

 

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

 

**RECENT ACCOUNTING PRONOUNCEMENTS**

 

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

 

Weare currently evaluating the impact and implementation of SFAS No.123R and howthis new pronouncement will effect our consolidated financial statements. Weanticipate that the adoption of SFAS No. 123R will have a significantimpact on our consolidated statements of operations, although it will have noimpact on our cash position.  Ourevaluation includes a determination on how future stock awards

 

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will be valued based on anappropriate fair value model upon adoption of SFAS No. 123R as well as theimpact of stock compensation expense associated with unvested stock optionsoutstanding as of December 31, 2005. In addition, as a result of the amendment to our employee stock purchaseplan, effective May 1, 2005, our employee stock purchase plan is anon-compensatory plan under SFAS No. 123R, and, therefore, no stockcompensation expense will be recorded under the employee stock purchase planupon the adoption of SFAS No. 123R. We are also required to elect the transition method that we will use aspart of the adoption of SFAS No. 123R. The allowed transition methodsinclude prospective and retroactive adoption alternatives. The prospectivemethod requires that compensation expense be recorded for all unvested stockoptions and awards prospectively beginning with the first quarter adoption ofSFAS No. 123R, while the retroactive method would require us to recordcompensation expense for all unvested stock options and awards beginning withthe first period restated. At this time, we plan to use the prospective transitionmethod upon our adoption of SFAS No. 123R effective January 1, 2006.

 

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

 

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

 

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

 

PCAOBRelease No. 2005-014, Ethics and Independence Rules ConcerningIndependence, Tax Services, and Contingent Fees, dated July 26, 2005,adopts rules to promote the ethics and independence of registered publicaccounting firms that audit and review financial statements of U.S. publiccompanies.  The rules limit the taxservices independent auditors could provide to their public company audit clients.  Specifically, the rules prohibitcontingent fee or commission arrangements; treat the firm as not independent ifthe firm provided assistance in planning or provided tax advice on potentiallyabusive tax transactions or provided tax services to certain senior officers ofthe audit client; and require accounting firms to provide certain informationto the audit committee of an audit client in connection with seekingpre-approval to provide non-prohibited tax services to the audit client. Ourindependent registered public accountant does not currently provide services tous which are considered prohibited under the adopted guidelines. Based on ouranalysis of the adopted requirements, we are currently in compliance with theadopted guidelines.

 

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

 

*The risks described below may notbe the only risks we face. Additional risks that we do not currently think arematerial may also impair our business operations.  If any of the events or circumstancesdescribed in the following risks actually occur, our business, financialcondition or results of operations could suffer, and the trading price of ourcommon stock could decline.*

 

Our revenues and operatingresults from quarter-to-quarter have varied in the past and our futureoperating results may continue to fluctuate significantly due to many factorsincluding those listed in this section and throughout this QuarterlyReport on Form 10-Q for the period ended September 30, 2005.

 

These factors include:

 

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

•                  cyclicality in themarket for semiconductor manufacturing equipment;

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

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

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

•                  product lead time demandsfrom our customers and the chipmakers;

•                  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 competitor;

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

•                  our ability to manageour manufacturing requirements;

•                  our ability to managecustomer satisfaction, product reliability, and direct field service andsupport effectiveness;

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

•                  worldwide politicalinstability;

•                  changing global economicconditions, including rising energy prices; and

•                  intellectual propertyprotection.

 

We have historically derived alarge portion of our quarterly and annual revenues from selling a small numberof light source systems. Because we sell a small number of products, theprecise time that we recognize revenue from an order may have a significantimpact on our total revenue for a particular period. Our customers may cancelor reschedule orders with little or no penalty. Orders expected in onequarter could shift to another period due to changes in the anticipated timingof customers’ purchase decisions or rescheduled delivery dates requested by ourcustomers. Our operating results for a particular quarter or year may beadversely affected if our customers, particularly our three largest customers,cancel or reschedule orders, or if we cannot fill orders in time due tounexpected delays in manufacturing, testing, shipping, and product acceptance.

 

We manage our expense levelsbased, in large part, on expected future revenues. As a result, our expensesare relatively fixed for the short term, and if our actual revenue decreasesbelow the level we expect, our operating results will be adversely affected.  As a result of these or other factors, wecould fail to achieve our expectations as to future revenue, gross profit andoperating income.  Our failure to meetthe performance expectations set and published by external sources could resultin a sudden and significant drop in the price of our stock, particularly on ashort-term basis, and could negatively affect the value of any investment inour stock.

 

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

 

The semiconductor industry is highly cyclical. Wederive a substantial percentage of our revenues from photolithography toolmanufacturers that serve the semiconductor industry. Our customers depend inturn on the demand for their photolithography tool products from thechipmakers. The capital equipment expenditures of chipmakers depend on a numberof factors, including the current and anticipated market demand forsemiconductors and the many products using semiconductors.  

 

The semiconductor industry historically hasexperienced periodic ups and downs and currently appears to be in flux, withindustry experts’ estimates for the rest of 2005 and full year of 2006 rangingbetween flat to up slightly. The cyclical nature of the semiconductor industryaffects our ability to accurately predict future revenue and therefore ourability to manage our future expense levels. When cyclical fluctuations resultin lower than expected revenue levels, operating results may be adversely affectedand cost reduction measures may be necessary in order for us to remaincompetitive and financially sound. During a down cycle or an industry slowdown, we must be in a position toadjust our cost and expense structure to prevailing market conditions whilestill being able to motivate and retain our key employees.  During periods of rapid growth, we must beable to increase manufacturing capacity and personnel to meet customer demand.  We can provide no assurance that theseobjectives can be met in a timely manner in response to industry cycles.  We are not able to predict with any certaintythe duration of any industry cycle or the timing or order of magnitude of anyrecovery. 

 

Downturns in the semiconductor industry often resultin decreases in demand for semiconductor manufacturing equipment, including thephotolithography tools that our customers produce.  The previous downturn in the semiconductorindustry had a severe effect on the demand for semiconductor manufacturingequipment.  Fluctuating levels ofinvestment by chipmakers and resulting pricing volatility will continue tomaterially affect our aggregate bookings, revenues and operating results.  Even during periods of reduced revenues webelieve we must continue to invest in research and development and to maintainextensive ongoing worldwide customer service and support capabilities to remaincompetitive.  Continued spending infurtherance of these objectives may temporarily harm our financial results.  Semiconductor industry downturns and slowdownsare likely to continue to adversely affect our business, financial conditionand operating results, and our operating results may fall below theexpectations of public market analysts or investors in future quarters. Anyfailure to meet such expectations could materially adversely affect the priceof our common stock.

 

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

 

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

 

Three large companies, ASMLithography, Canon and Nikon dominate the photolithography tool business.Collectively, these three companies accounted for the following percentage ofour total revenue during the periods indicated:

 
| ** **      | ** ** | **Nine months ended**  | ** ** |
|-----------------|------------|------------------------|------------|
| ** **      | ** ** | **September 30,** | ** ** |
| ** **      | ** ** | **2004**               | ** ** | **2005** | ** ** |
|            |       |                   |       |   |   |
| ASM Lithography |       | 35                     | %          | 32 | % |
| Canon           |       | 14                     | %          | 8 | % |
| Nikon           |       | 21                     | %          | 25 | % |
| Total           |       | 70                     | %          | 65 | % |

 

Collectively, these threecompanies account for the following percentage of our total accounts receivableat the dates indicated:

 
| ** **      | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
|-----------------|------------|-----------------------|------------|------------------------|------------|
| ** **      | ** ** | **2004**              | ** ** | **2005**               | ** ** |
|            |       |                  |       |                   |       |
| ASM Lithography |       | 46                    | %          | 41                     | %          |
| Canon           |       | 5                     | %          | 6                      | %          |
| Nikon           |       | 31                    | %          | 25                     | %          |
| Total           |       | 82                    | %          | 72                     | %          |

 

We expect that sales of ourlight source products to these three customers will continue to account for asubstantial majority of our revenue in the foreseeable future. None of ourcustomers are obligated to purchase a minimum number of our products in theaggregate or during any particular period. The loss of any significant businessfrom or production problems for any one of these three customers may have amaterial adverse effect on our business and financial condition. Sales to thesecustomers may be affected by many factors, some of which are beyond our control.These factors include:

 

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

•                  a customer experiencinglithography tool production problems;

•                  a decision to purchaselight sources from other suppliers;

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

•                  a decline in a customer’sfinancial condition.

 

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

 

Our only current product lineis excimer light source systems, including KrF and ArF systems, and support,including consumable and spare parts and service support.  We expect these light source systems and therelated support to continue to account for a large percentage of our revenuesin the near term. Continued market acceptance of our light source systemproducts is, therefore, critical to our future success. The primary market forexcimer light sources is in the use of DUV photolithography equipment formanufacturing deep-submicron semiconductor devices using smaller circuitgeometries. The demand for our products depends in part on the rate at whichchipmakers further adopt excimer light sources as the chosen light source fortheir photolithography tools.

 

The rate with which chipmakersadopt excimer light sources may vary for a variety of reasons, including:

 

•                  inadequate performanceof photoresists used in advanced DUV photolithography;

•                  potential shortages ofspecialized materials used in DUV optics;

 

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

•                  consolidation ofchipmakers.

 

We cannot guarantee that thesefactors can or will be overcome or that the demand for our excimer light sourceproducts will not be materially reduced. The demand for our light sourceproducts, and therefore our operating results, financial condition and cashflows, could be adversely affected by a number of factors, including:

 

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

•                  a failure to achievecontinued market acceptance of our products;

•                  a failure to managecustomer satisfaction, product reliability, and direct field service andsupport effectiveness;

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

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

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

 

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

 

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

 

Our most significant productintroduction in recent years consisted of a technology change from a single-discharge-chamberexcimer light source to a dual-discharge-chamber design called MasterOscillator Power Amplifier (“MOPA”).  TheMOPA design represents a paradigm shift from previously accepted lithographytechnology and offers chipmakers higher power, tighter bandwidth and lower costof operation for their current – and is expected to offer the same benefits fortheir future – optical lithography applications.  As originally designed, the MOPA architecturewas projected to provide its benefits across all three DUV wavelengths – 248nm, 193 nm, and 157 nm – but at this time, the semiconductor industry has onlyadopted MOPA at the 193 nm wavelength, due to the successful extension of 248nm single chamber technology, and the omission of 157 nm lithography from theroadmap.  There are risks inherent in theongoing transition to the MOPA technology, including effective execution of ourproduct development roadmap, continuing adoption of the product by lithographytool manufacturers and chipmakers, manufacturability, cost effectiveness, andproduct performance in the field of the new products and the development of acomparable product by our competitor.

 

We believe that chipmakers arecurrently developing a capability to produce devices that are measured at 90nanometers or less, and these efforts are driving the current demand for ourlight source products for DUV photolithography systems. After chipmakers havethis capability, their demand for our light source products will depend, inpart, on whether they want to expand their capacity to manufacture thesedevices. This will in turn depend on whether their sales forecasts andprojected manufacturing process yields justify the necessary investments.

 

Future technologies such asEUV, electron projection lithography, and maskless lithography may render ourexcimer light source products obsolete. We must manage product transitions, asintroduction of new products could adversely affect our sales of existingproducts. If new products are not introduced on time, or have reliability orquality problems, our performance may be impacted by reduced orders, highermanufacturing costs, delays in acceptance of and payment for new products, andadditional service and warranty expenses. We may not be able to develop and introducenew products or enhancements to our existing products and processes in a timelyor cost effective manner that satisfies customer needs or

 

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achieves market acceptance. Failure to develop andintroduce these new products and enhancements could materially adversely affectour operating results, financial condition and cash flows.

 

We expect to face significantcompetition from current and future competitors. We believe that othercompanies are developing systems and products that are competitive to ours andare planning to introduce new products to this market, which may affect ourability to sell our new products. Furthermore, new products representsignificant investments of our resources and their success, or lack thereof,could have a material effect on our financial results.

 

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

 

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

 

•                  recruit and trainqualified field service personnel;

•                  identify qualifiedindependent firms; and

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

 

We may not be able to attractand train qualified personnel to maintain our direct support operationssuccessfully. We may not be able to find and engage qualified third-partyresources to supplement and enhance our direct support operations.  Further, we may incur significant costs inproviding these support services. Failure to implement our direct supportoperation effectively could have a material adverse effect on our operatingresults, financial condition and cash flows.

 

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

 

Over time, our light sourceproducts may not meet chipmakers’ production specifications or operating costrequirements after the light source has been used for a long period in highvolume production. If any chipmaker cannot successfully achieve or sustaintheir volume production using our light sources, our reputation could bedamaged with the chipmakers and our customers who are the limited number oflithography tool manufacturers. This would have a material adverse effect onour business.

 

**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.**

 

To continue to grow ourbusiness, our existing light source products and their process capabilitiesmust be enhanced, and we must develop and manufacture new products to serveother semiconductor applications. We cannot guarantee that we will be able tomanage our business to grow effectively. Nor can we guarantee that we will beable to accelerate the development of new enhancements to our existing productsand create new products. Further, we may not be able to effectively integratenew products and applications into our current operations. Any of these riskscould materially harm our business, financial condition and results ofoperations.

 

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**We must effectively managechanges in our business.**

 

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

 

•                  closely manage ourglobal operations;

•                  improve our process andother internal management systems;

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

•                  quickly adapt tochanging sales and marketing channels;

•                  effectively manage ourinventory levels; and

•                  attract, train, retainand manage key personnel.

 

If we fail to effectivelymanage changes in our business, our operating results, financial condition andcash flows would be adversely affected.

 

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

 

We purchase a limited number of components andsubassemblies included in our light source products from a single supplier or asmall group of suppliers.  Forcertain optical components used in our light source systems, we currentlyutilize a single supplier.  To reduce therisk associated with this single supplier, we carry a significant strategicinventory of these components.  Strategicinventories are managed as a percentage of future demand.  We have also negotiated to havevendor-managed inventory of critical components to further reduce the risk of asingle supplier.  In addition, we contract the manufacture of various subassemblies moreoften than in the past. Further, some of our suppliers have specialized insupplying equipment or manufacturing services to semiconductor equipmentmanufacturers and therefore are susceptible to industry ups and downs andsubject to the same risks and uncertainties regarding their ability to respondto changing market conditions.  Becausemany of  these suppliers reduce the sizeof their workforce in an industry downturn and increase it in an upturn, theymay not be able to meet our requirements or respond quickly enough as an upturnbegins and gains momentum.  Due to the nature of ourproduct development requirements, these key suppliers must rapidly advancetheir own technologies and production capabilities in order to support theintroduction schedule of our new products. These suppliers may not be ableto provide new modules and subassemblies when they are needed to satisfy ourproduct schedule requirements. If we cannot purchase enough of thesematerials, components or subassemblies, or if these items do not meet ourquality standards, there could be delays or reductions in our productshipments, which would have a material adverse effect on our operating results,financial condition and cash flows.

 

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

** **

We are currently aware of onesignificant competitor that sells light sources for DUV photolithographyapplications. This competitor is Gigaphoton, a joint venture between two largecompanies, Komatsu and Ushio, which is headquartered in Japan.  Additionally, late in 2004, a former competitorCoherent, Inc., a U.S. company, announced that their Lambda-Physiksubsidiary would no longer pursue the excimer light source systems business forphotolithography in the semiconductor industry.

 

We believe that Gigaphoton isaggressively trying to gain larger market penetration in the excimer lightsource industry. We know that our customers have purchased products from thiscompetitor and that our customers have approved this competitor’s light sourcesfor use with their products.  We knowthat Gigaphoton has been approved by chipmakers in Japan, the U.S. andelsewhere for producing excimer light sources.

 

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Larger companies withsubstantially greater resources, such as other manufacturers of industriallight sources for advanced lithography, may attempt to sell competitiveproducts to our customers. Potential competitors may also be attracted to ourgrowing installed base of light sources which represents a steady andsignificant consumable and spare parts revenue stream for us, and they mayattempt to supply consumable and spare 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 on the services of many keyemployees in various areas, including:

 

•                  research anddevelopment;

•                  engineering;

•                  sales and marketing;

•                  field service andsupport;

•                  manufacturing; and

•                  management.

 

In particular, there are alimited number of experts in excimer light source technology, and we requirehighly skilled hardware and software engineers. Competition for qualifiedpersonnel is intense and we cannot guarantee that we will be able to continueto 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 research and development, engineering, sales and marketing,  field service and support, manufacturing andmanagement personnel;

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

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

 

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

 

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

** **

We serve an increasingly globalmarket.  A large portion of our totalrevenues is derived from customers located outside of the United States,particularly in Asian countries.  Weexpect our international sales to continue to account for a very large portionof 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,the Netherlands, the People’s Republic of China, Singapore and Taiwan.

 

We may not be able to manageour operations to address and support our global customers effectively.  Further, our investments in these types ofactivities may not make us competitive in the global market or we may not beable to meet the service, support, and manufacturing levels required by ourglobal customers.

 

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

 

•                  unexpected changes inregulatory requirements;

•                  fluctuations in exchangerates and currency controls;

•                  political and economicconditions and instability;

 

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

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

•                  difficulties in staffingand managing foreign subsidiary and branch operations;

•                  limited intellectualproperty protection in some countries;

•                  potentially adverse taxconsequences in some countries;

•                  the possibility ofaccounts receivable collection difficulties;

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

•                  the effect of acts ofterrorism and war; and

•                  the burdens of complyingwith a variety of foreign laws.

 

Many of our major customers andmany of the chipmakers who use our light source products in theirphotolithography systems are located in Asia. Economic problems and currencyfluctuations affecting these regions in Asia could create a larger risk for us.Further, even though it has not been difficult for us to comply with UnitedStates export controls, these export rules could change in the future andmake it 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 may acquire a businessor enter a new market that will involve numerous risks.  We may not be able to address these riskssuccessfully without substantial expense, delay or other operational andfinancial challenges.**

** **

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

 

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

•                  failure to retain keypersonnel;

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

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

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

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

•                  failure to commercializepurchased technologies;

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

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

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

 

Mergers, acquisitions and jointventures as well as entering new markets are inherently subject to multiplesignificant risks, and the inability to effectively manage these risks couldhave a material adverse effect on our business. In July 2005, we formed a joint venture with Zeiss named TCZ GmbH,to produce tools for the manufacture of flat panel displays.  This is a new market for both Cymer and Zeissand may involve numerous risks.  Any ofthese risks could materially harm our business, financial condition andoperating results. Further, any business that we acquire, joint venture that weform or new market we may enter may not achieve anticipated revenues oroperating results.

 

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

 

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

 

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

 

We have historically used broad based stock optionprograms and other forms of equity-related incentives as a key component of ouremployee compensation packages. We believe that stock options and otherlong-term equity incentives directly motivate a broader base of employees tomaximize long-term stockholder value and, through the use of long-term vesting,encourage employees to remain with us. The FASB has issued SFAS No. 123R, of which the date of adoptionwas deferred by the SEC to be effective for annual periods beginning after June 15,2005.  This new rule will require usto record an expense to earnings for employee stock option grants and otherequity incentives. Moreover, applicable stock exchange listing standardsrelating to obtaining stockholder approval of equity compensation plans hasmade it more difficult and expensive for us to grant options to employees, whichhas resulted in changes to our equity compensation strategy, including areduction in the number of stock options granted to employees.  We have already developed alternative cashcompensation arrangements for our employees to replace these stock optionprograms and may be required to offer additional alternative cash compensationarrangements in the future. These and other developments in the provision ofequity compensation to employees could make it more difficult to attract,retain and motivate employees, and such a change in accounting rules andalternative cash compensation programs may adversely impact our futureoperating results, financial condition and cash flows.

 

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

 

We believe our success andability to compete depend in large part upon protecting our proprietarytechnology. We rely on a combination of patent, trade secret, copyright andtrademark laws, nondisclosure and other contractual agreements and technicalmeasures to protect our proprietary rights.

 

As of September 30, 2005,we owned 226 United States patents covering certain aspects of technologyrelated to light sources and piezo techniques. These patents will expire atvarious times during the period from January 2008 to September 2023.  As of September 30, 2005, we had appliedfor 104 additional patents in the United States.  As of September 30, 2005, we owned 323foreign patents and had 333 patent applications pending in various foreigncountries.

 

Our pending patent applicationsand any future applications might not be approved. Our patents might notprovide us with a competitive advantage and may be challenged by third parties.In addition, third parties’ patents might have an adverse effect on our abilityto do business. As a result of cost constraints, we did not begin filing inJapan and other countries our patents for inventions covered by United Statespatents and patent applications until 1993. As a result we do not have the right to seek foreign patent protectionfor some of our early inventions. Additionally, laws of some foreign countries in which our products areor may be developed, manufactured or sold, including various countries in Asia,

 

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may not protect our products or intellectual propertyrights to the same extent as do the laws of the United States. Thus, thepossibility of piracy of our technology and products are more likely in thesecountries. Further, third parties might independently develop similar products,duplicate our products, or design around patents that are granted to us.

 

Other companies or persons mayhave filed or may file in the future patent applications that are similar oridentical to ours. We may have to participate in appropriate proceedings in thecourts or the  patent offices todetermine the priority of inventions. These proceedings may determine thatthese third-party patent applications have priority over our patentapplications. Loss of priority in these interference proceedings could resultin substantial cost to us.

 

We also rely on the followingto protect our confidential information and our other intellectual property:

 

•                  trade secret protection;

•                  employee nondisclosureagreements;

•                  third-partynondisclosure agreements; and

•                  other intellectualproperty protection methods.

 

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

 

•                  independently developsubstantially the same proprietary information and techniques;

•                  gain access to our tradesecrets; or

•                  disclose our technology.

 

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

 

In the past, funds fromresearch and development arrangements with third parties have been used to payfor a portion of our own research and development expenses. We receive thesefunds from government-sponsored programs and customers, in connection with ourdesigning and developing specific products. Currently, funds from lithographytool manufacturers and chipmakers are used to fund a small portion of ourdevelopment expenses. In providing these research and development services tothese manufacturers, we try to make clear who owns the intellectual propertythat results from the research and development services we perform. However,disputes over the ownership or rights to use or market this intellectualproperty may arise between the funding organizations and us. Any dispute overownership of the intellectual property we develop could restrict our ability tomarket our products 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 competitor or any other thirdparty.**

 

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

 

Specifically, Komatsu hasnotified us that we may be infringing some of its Japanese patents. During ourdiscussions with Komatsu, they also asserted that our former Japanesemanufacturing partner, Seiko, or we may be infringing on some of Komatsu’s UnitedStates patents and a number of its additional Japanese patents. Komatsu hasalso notified one of our customers, Nikon, of its belief that our light sourcesinfringe several of Komatsu’s Japanese and U.S. patents. As a result, westarted proceedings in the Japanese Patent Office to oppose certain patents andpatent applications of Komatsu. The Japanese Patent Office has dismissed ouropposition claims. Thus, litigation may result in connection with Komatsu’sJapanese patents or U.S. patents. Also, Komatsu might claim that we infringeother or

 

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additional patents. Komatsu notified Seiko that itintends to enforce its rights against Seiko with respect to its Japanesepatents if Seiko continued to engage in manufacturing activities for us. Inconnection with our former manufacturing agreement with Seiko, we agree to paySeiko under certain conditions for damages associated with these types ofclaims. Seiko may not prevail in any litigation against Komatsu, and therefore,we may be required to pay Seiko for such damages.

 

We have notified our competitorand others of our United States patent portfolio. Specifically, we havenotified Komatsu that they may be infringing on some of our U.S. patents. Wehave discussed with Komatsu our claims against each other.  Komatsu challenged one of our U.S. patents inthe United States Patent and Trademark Office (“USPTO”) but it was subsequentlyre-issued by the USPTO.  Also, Komatsutransferred its lithography light source business to our competitor,Gigaphoton.  We also have had discussionswith Lambda-Physik (a subsidiary of Coherent, Inc.) regarding allegationsby each party against the other for possible patent infringement. Any of thesediscussions with our competitor or former competitor may not be successful andlitigation could result.

 

In the future, patentlitigation may result due to a claim of infringement by our competitor or anyother third party or may be necessary to enforce patents issued to us.  Any such litigation could result insubstantial cost and diversion of effort by us, which would have an adverseeffect on our business, financial condition and operating results. Furthermore,our customers and the end-users of our products might assert other claims forindemnification that arise from infringement claims against them. If theseassertions are successful, our business, financial condition and operatingresults may be materially affected. Instead of litigation, or as a resultthereof, we may seek a license from third parties to use their intellectualproperty. However, we may not be able to obtain a license.  In the alternative, we may design around thethird party’s intellectual property rights.  Any adverse determination in a legalproceeding could result in one or more of the following, any of which couldhave a substantial adverse effect on our business, financial condition andoperating results:

 

•                  loss of our proprietaryrights;

•                  exposure to significantliabilities by other third parties;

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

•                  restriction frommanufacturing or selling our products.

 

Any of these actions could becostly and would divert the efforts and attention of our management andtechnical personnel, which would materially adversely affect our business,financial condition and results of operations.

 

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

 

We registered the trademarks ‘‘CYMER’’and “INSIST ON CYMER” and others in the United States and in some othercountries. We are also trying to register additional trademarks in the UnitedStates and in other countries.  We usethese trademarks and many other marks in our advertisements and other businessmaterials, which are distributed throughout the world. We may be subject totrademark infringement actions for using these marks and other marks on aworldwide basis and this would be costly to defend. If a trademark infringementaction were successful, we would have to stop using the mark and possibly paydamages.

 

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

 

We depend on regular andreliable air transportation on a worldwide basis for many of our routinebusiness functions. If civil aviation in the United States or abroad isdisrupted by terrorist activities or security responses to the threat ofterrorism or for any other reason, our business could be adversely affected inthe following ways:

 

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

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

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

•                  our sales and marketingefforts may be disrupted.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

We are subject to federal,state and local regulations, such as regulations related to the environment,land use, public utility utilization and the fire code, in connection with thestorage, handling, discharge and disposal of substances that we use in ourmanufacturing process and on our facilities. We believe that our activities comply with current governmentregulations that are applicable to our operations and current facilities. Wemay be required to purchase additional capital equipment or other requirementsfor our processes to comply with these government regulations in the future ifthey change. Further, these government regulations may restrict us fromexpanding our operations. Adopting measures to comply with changes in thegovernment regulations, our failure to comply with environmental and land useregulations,

 

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or restrictions on our ability to discharge hazardoussubstances, could subject us to future liability or cause our manufacturingoperations to be reduced or stopped.

 

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

** **

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

 

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

 

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

 

Various factors maysignificantly affect the market price of our common stock, including:

 

•                  the cyclical nature ofthe semiconductor industry;

•                  actual or anticipatedfluctuations in our operating results;

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

•                  announcements ofinnovations in technology;

•                  new products offered byus or our competitor;

•                  developments of patentsor proprietary rights;

•                  changes in financialestimates by securities analysts;

•                  general worldwidepolitical, economic, and market conditions;

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

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

 

**In addition, the stock market has experiencedextreme price and volume fluctuations that have particularly affected themarket price for many high technology companies. Such fluctuations have in somecases been unrelated to the operating performance of these companies. Severeprice fluctuations in a company’s stock have frequently been followed bysecurities litigation.  Any suchlitigation can result in substantial costs and a diversion of management’sattention and resources and therefore could have a material adverse effect onour business, financial condition and results of operations.**

** **

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

 

# **ForeignCurrency Risk**

 

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

 

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Asof September 30, 2005, we had outstanding forward contracts to buy U.S. $46.2million for 4.9 billion yen under foreign currency exchange facilities withcontract rates ranging from 101.2 yen to 110.7****yenper U.S. dollar.  These contracts expireon various dates through March 2006.

 

Our forward contractsgenerally qualify for hedge accounting treatment per the provisions ofStatement of Financial Accounting Standards No. 133, “Accounting forDerivative Instruments and Hedging Activities”. As a result, we defer changesin the fair value for the effective portion of these hedges and record theamount in other comprehensive income (loss) and subsequently reclassify thegain or loss to cost of product sales in the same period that the related saleis made to the third party. The fair value of all of our forward contracts and thedeferred gain (net of tax) for those that qualify for hedge accountingtreatment totaled $2.2 million and $208,000, respectively, as of September 30,2005.

 

The fair value of theseforward contracts as of September 30, 2005 would have fluctuated by $4.6million if the foreign currency exchange rate for the Japanese yen to the U.S.dollar on these forward contracts had changed by 10%.

 

# **Investmentand Debt Risk**

 

Wemaintain an investment portfolio consisting primarily of government andcorporate fixed income securities, certificates of deposit and commercialpaper.  While it is our general intent tohold such securities until maturity, we will occasionally sell certainsecurities for cash flow purposes. Therefore, our investments are classified asavailable-for-sale and are carried on the balance sheet at fair value.  Due to the conservative nature of theinvestment portfolio, a sudden change in interest rates would not have amaterial effect on the value of the portfolio.

 

In February 2002,we issued $250.0 million principal amount of unsecured fixed rate 3.50%Convertible Subordinated Notes due February 15, 2009.  Interest on these 2002 notes is payable on February 15and August 15 of each year.  The2002 notes are convertible into shares of our common stock at a conversion rateof 20 shares per $1,000 principal amount subject to adjustment under certainconditions. We may redeem the 2002 notes on or after February 20, 2005, orearlier if the price of our common stock reaches certain levels. The 2002 notesare subordinated to our existing and future senior indebtedness and effectivelysubordinated to all indebtedness and other liabilities of oursubsidiaries.  Because the interest rateis fixed, we believe there is no risk of increased interest expense. These 2002notes are recorded at face value on the consolidated balance sheets. In thethird quarter of 2004 and second quarter of 2005, we repurchased, at a discountto par, approximately $49.2 million and $60.0 million principal amount,respectively, of these 2002 notes.  As ofSeptember 30, 2005, $140.7 million principal amount of the 2002 notes wereoutstanding.  The fair value of such debtbased on quoted market prices on September 30, 2005 was $135.4 million.

 

**ITEM4.  Controls and Procedures**

 

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

 

*Changes in internal control over financial reporting.*Therehas been no change in our internal control over financial reporting during thequarter ended September 30, 2005 that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

 

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**PART II.  OTHER INFORMATION**

 

**ITEM 1.****                        LegalProceedings**

 

None.

 

**ITEM 2.****                        UnregisteredSales of Equity Securities and Use of Proceeds**

 

None.

 

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| **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**                                             |
|        |                                                     |
|        | 10.1*                                                    | Joint Venture  Agreement, dated July 15, 2005, among TCZ GmbH, Cymer, Inc., Carl  Zeiss SMT AG and Carl Zeiss Laser Optics Beteiligungsgesellschaft mbH. |
|        |                                                     |   |
|        | 10.2                                                     | Amendment No. 1  to Joint Venture Agreement of TCZ GmbH, dated September 16, 2005, among  TCZ GmbH, Cymer, Inc., Carl Zeiss SMT AG and Carl Zeiss Laser  Optics Beteiligungsgesellschaft mbH. |
|        |                                                     |   |
|        | 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. |
|        |                                                     |   |
|             |
|        | *                                                        | Confidential  treatment was requested with respect to certain portions of this  exhibit.Omitted portions were filed separately with the Securities and  Exchange Commission. |
|             |                                                          |  |  |

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, theregistrant has duly caused this quarterly report on Form 10-Q to be signedon its behalf by the undersigned thereunto duly authorized.

 

 
|                         | CYMER, INC.                   |
|------------------------------|-------------------------------|
|                         |                          |
|                         |                          |
| Date:  November 2, 2005 | By:                           | /s/ Nancy J.  Baker |   |
|                         |                          |   |   |
|                         | Nancy J. Baker                |
|                         | Senior Vice  President and    |
|                         | Chief Financial  Officer      |
|                         | (Duly Authorized  Officer and |
|                         | Principal  Financial Officer) |

 

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