**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C.  20549**

**FORM 10-Q**

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

**For the Quarterly Period EndedMarch 31, 2007**

**OR**

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

**For theTransition Period from              to**

**Commissionfile number 0-21321**

**CYMER, INC.**

(Exact name ofregistrant 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’stelephone number, including area code)

**N/A**

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

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  xYes  oNo 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of  “acceleratedfiler” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):

x Largeaccelerated filer           oAccelerated filer            o Non-accelerated filer

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).oYes  xNo

Thetotal number of shares of Common Stock, with $0.001 par value, outstanding onMay 4, 2007 was 36,068,221.

 

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**CYMER,INC.**

**FORM 10-Q**

**For theQuarterly Period Ended March 31, 2007**

**INDEX**
| **PART I.**    | ** ** | **FINANCIAL INFORMATION**                                                                   | ** ** | ** ** |
|----------------|------------|---------------------------------------------------------------------------------------------|------------|------------|
|           |       |                                                                                        |       |       |
| ITEM 1.        |       | Financial Statements  (unaudited)                                                           |       |       |
|           |       |                                                                                        |       |       |
|           |       | Consolidated Balance  Sheets as of December 31, 2006 and March 31, 2007                     |       |       |
|           |       |                                                                                        |       |       |
|           |       | Consolidated Statements  of Operations for the three months ended March 31, 2006 and 2007   |       |       |
|           |       |                                                                                        |       |       |
|           |       | Consolidated  Statements of Cash Flows for the three months ended March 31, 2006 and 2007   |       |       |
|           |       |                                                                                        |       |       |
|           |       | Notes to  Consolidated Financial Statements                                                 |       |       |
|           |       |                                                                                        |       |       |
| ITEM 2.        |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |       |       |
|           |       |                                                                                        |       |       |
| ITEM 3.        |       | Quantitative  and Qualitative Disclosures About Market Risk                                 |       |       |
| ** **     | ** ** | ** **                                                                                  |       |       |
| ITEM 4.        |       | Controls and  Procedures                                                                    |       |       |
| ** **     | ** ** | ** **                                                                                  |       |       |
| **PART II.**   | ** ** | **OTHER INFORMATION**                                                                       |       |       |
|           |       |                                                                                        |       |       |
| ITEM 1.        |       | Legal Proceedings                                                                           |       |       |
|           |       |                                                                                        |       |       |
| ITEM  1A.      |       | Risk  Factors                                                                               |       |       |
|           |       |                                                                                        |       |       |
| ITEM 2.        |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                |       |       |
|           |       |                                                                                        |       |       |
| ITEM 3.        |       | Defaults Upon  Senior Securities                                                            |       |       |
|           |       |                                                                                        |       |       |
| ITEM 4.        |       | Submission of  Matters to a Vote of Security Holders                                        |       |       |
|           |       |                                                                                        |       |       |
| ITEM 5.        |       | Other Information                                                                           |       |       |
|           |       |                                                                                        |       |       |
| ITEM  6.       |       | Exhibits                                                                                    |       |       |
|           |       |                                                                                        |       |       |
| **SIGNATURES** |       |                                                                                        |

 

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**ITEM 1. Financial Statements**

**CYMER, INC.**

**CONSOLIDATED BALANCE SHEETS (UNAUDITED)**

**(In thousands, except share data)**
| ** **                                                                                                                                                                     | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|--------------------|------------|
| ** **                                                                                                                                                                     | ** ** | **2006**              | ** ** | **2007**           | ** ** |
| **ASSETS**                                                                                                                                                                     | ** ** | ** **            | ** ** | ** **         | ** ** |
| ** **                                                                                                                                                                     | ** ** | ** **            | ** ** | ** **         | ** ** |
| CURRENT ASSETS:                                                                                                                                                                |       |                  |       |               |       |
| Cash and cash  equivalents                                                                                                                                                     |       | $                     | 302,098    |               | $          | 327,810 |   |
| Short-term  investments                                                                                                                                                        |       | 207,943               |       | 193,331            |       |
| Accounts  receivable - net                                                                                                                                                     |       | 115,857               |       | 113,082            |       |
| Accounts  receivable - related party                                                                                                                                           |       | 834                   |       | 1,712              |       |
| Foreign currency  forward exchange contracts                                                                                                                                   |       | 652                   |       | 108                |       |
| Inventories                                                                                                                                                                    |       | 104,296               |       | 112,167            |       |
| Deferred income  taxes                                                                                                                                                         |       | 46,943                |       | 43,975             |       |
| Prepaid expenses  and other assets                                                                                                                                             |       | 7,143                 |       | 7,823              |       |
| Total current  assets                                                                                                                                                          |       | 785,766               |       | 800,008            |       |
|                                                                                                                                                                           |       |                  |       |               |       |
| PROPERTY AND EQUIPMENT  - NET                                                                                                                                                  |       | 112,074               |       | 110,775            |       |
| LONG-TERM INVESTMENTS                                                                                                                                                          |       | 8,384                 |       | 22,113             |       |
| DEFERRED INCOME TAXES                                                                                                                                                          |       | 12,766                |       | 12,783             |       |
| GOODWILL                                                                                                                                                                       |       | 8,833                 |       | 8,833              |       |
| INTANGIBLE ASSETS - NET                                                                                                                                                        |       | 15,880                |       | 15,119             |       |
| OTHER ASSETS                                                                                                                                                                   |       | 5,391                 |       | 5,278              |       |
|                                                                                                                                                                           |       |                  |       |               |       |
| TOTAL ASSETS                                                                                                                                                                   |       | $                     | 949,094    |               | $          | 974,909 |   |
|                                                                                                                                                                           |       |                  |       |               |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                 |       |                  |       |               |       |
|                                                                                                                                                                           |       |                  |       |               |       |
| CURRENT LIABILITIES:                                                                                                                                                           |       |                  |       |               |       |
| Accounts payable                                                                                                                                                               |       | $                     | 18,711     |               | $          | 22,474 |   |
| Accounts payable  - related party                                                                                                                                              |       | 4,858                 |       | 4,212              |       |
| Accrued warranty  and installation                                                                                                                                             |       | 29,974                |       | 30,680             |       |
| Accrued payroll  and benefits                                                                                                                                                  |       | 21,707                |       | 16,617             |       |
| Accrued patents,  royalties and other fees                                                                                                                                     |       | 4,262                 |       | 4,503              |       |
| Income taxes  payable                                                                                                                                                          |       | 13,293                |       | 1,448              |       |
| Unearned income                                                                                                                                                                |       | 2,544                 |       | 2,781              |       |
| Foreign currency  forward exchange contracts                                                                                                                                   |       | —                |       | 53                 |       |
| Other current  liabilities                                                                                                                                                     |       | 3,715                 |       | 2,320              |       |
| Total current  liabilities                                                                                                                                                     |       | 99,064                |       | 85,088             |       |
|                                                                                                                                                                           |       |                  |       |               |       |
| CONVERTIBLE  SUBORDINATED NOTES                                                                                                                                                |       | 140,722               |       | 140,722            |       |
| INCOME TAXES PAYABLE                                                                                                                                                           |       | —                |       | 16,069             |       |
| OTHER LIABILITIES                                                                                                                                                              |       | 14,781                |       | 15,478             |       |
| Total  liabilities                                                                                                                                                             |       | 254,567               |       | 257,357            |       |
|                                                                                                                                                                           |       |                  |       |               |       |
| MINORITY INTEREST                                                                                                                                                              |       | 6,633                 |       | 5,918              |       |
|                                                                                                                                                                           |       |                  |       |               |       |
| COMMITMENTS AND  CONTINGENCIES                                                                                                                                                 |       |                  |       |               |       |
|                                                                                                                                                                           |       |                  |       |               |       |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                     |       |                  |       |               |       |
| Preferred stock  - $.001 par value; authorized 5,000,000 shares;  no shares issued or outstanding                                                                              |       | —                |       | —             |       |
| Common stock -  $.001 par value per share; 100,000,000 shares authorized;  41,774,000 and 41,840,000 shares outstanding at December 31, 2006  and March 31, 2007, respectively |       | 42                    |       | 42                 |       |
| Additional  paid-in capital                                                                                                                                                    |       | 557,082               |       | 560,005            |       |
| Treasury stock  at cost - 4,536,000 common shares  at December 31, 2006 and March 31, 2007, respectively                                                                       |       | (150,704              | )          | (150,704           | )          |
| Accumulated  other comprehensive loss                                                                                                                                          |       | (4,066                | )          | (3,928             | )          |
| Retained  earnings                                                                                                                                                             |       | 285,540               |       | 306,219            |       |
| Total  stockholders’ equity                                                                                                                                               |       | 687,894               |       | 711,634            |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                |       | $                     | 949,094    |               | $          | 974,909 |   |

 

SeeNotes to Unaudited Consolidated Financial Statements.

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**CYMER, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)**

**(In thousands, except per share data)**
| ** **                                                                | ** ** | **Three months ended** | ** ** |
|---------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                | ** ** | **March 31,**               | ** ** |
| ** **                                                                | ** ** | **2006**                         | ** ** | **2007** | ** ** |
| REVENUES:                                                                 |       |                             |       |   |   |
| Product sales                                                             |       | $                                | 124,902    |   | $ | 126,159 |   |
| Product sales - related party                                             |       | 2,154                            |       | 466 |   |
| Other                                                                     |       | 61                               |       | 89 |   |
| Total revenues                                                            |       | 127,117                          |       | 126,714 |   |
|                                                                      |       |                             |       |   |   |
| COSTS AND  EXPENSES:                                                      |       |                             |       |   |   |
| Cost of product sales                                                     |       | 68,691                           |       | 65,066 |   |
| Research and development                                                  |       | 18,124                           |       | 19,302 |   |
| Sales and marketing                                                       |       | 6,849                            |       | 6,969 |   |
| General and administrative                                                |       | 9,180                            |       | 8,810 |   |
| Total costs and expenses                                                  |       | 102,844                          |       | 100,147 |   |
|                                                                      |       |                             |       |   |   |
| OPERATING INCOME                                                          |       | 24,273                           |       | 26,567 |   |
|                                                                      |       |                             |       |   |   |
| OTHER INCOME  (EXPENSE):                                                  |       |                             |       |   |   |
| Foreign currency exchange gain - net                                      |       | 619                              |       | 427 |   |
| Interest and other income                                                 |       | 6,986                            |       | 6,417 |   |
| Interest and other expense                                                |       | (1,402                           | )          | (1,579 | ) |
| Total other income - net                                                  |       | 6,203                            |       | 5,265 |   |
|                                                                      |       |                             |       |   |   |
| INCOME BEFORE  INCOME TAX PROVISION AND MINORITY INTEREST                 |       | 30,476                           |       | 31,832 |   |
|                                                                      |       |                             |       |   |   |
| INCOME TAX  PROVISION                                                     |       | 10,554                           |       | 12,227 |   |
| MINORITY  INTEREST                                                        |       | 681                              |       | 716 |   |
| NET INCOME                                                                |       | $                                | 20,603     |   | $ | 20,321 |   |
|                                                                      |       |                             |       |   |   |
| EARNINGS PER  SHARE:                                                      |       |                             |       |   |   |
| Basic earnings per share                                                  |       | $                                | 0.55       |   | $ | 0.55 |   |
| Weighted average common shares outstanding                                |       | 37,278                           |       | 37,269 |   |
|                                                                      |       |                             |       |   |   |
| Diluted earnings per share                                                |       | $                                | 0.52       |   | $ | 0.52 |   |
| Weighted average  common and dilutive potential common shares outstanding |       | 41,126                           |       | 40,617 |   |

 

See Notes to Unaudited Consolidated Financial Statements.

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**CYMER, INC.**

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

**(In thousands)**
| ** **                                                                         | ** ** | **For the three months ended** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                         | ** ** | **March 31,**                                 | ** ** |
| ** **                                                                         | ** ** | **2006**                                           | ** ** | **2007** | ** ** |
| OPERATING  ACTIVITIES:                                                             |       |                                               |       |   |   |
| Net income                                                                         |       | $                                                  | 20,603     |   | $ | 20,321 |   |
| Adjustments to reconcile net income to net cash provided  by operating activities: |       |                                               |       |   |   |
| Depreciation and amortization                                                      |       | 6,484                                              |       | 6,364 |   |
| Non-cash stock-based compensation                                                  |       | 2,519                                              |       | 1,356 |   |
| Minority interest                                                                  |       | (681                                               | )          | (716 | ) |
| Provision for deferred income taxes                                                |       | 4,230                                              |       | 8,089 |   |
| Loss on disposal and impairment of property and  equipment                         |       | 6                                                  |       | 5 |   |
| Change in assets and liabilities:                                                  |       |                                               |       |   |   |
| Accounts receivable — net                                                     |       | (21,753                                            | )          | 2,775 |   |
| Accounts receivable — related party                                           |       | (2,201                                             | )          | (878 | ) |
| Foreign currency forward exchange contracts                                        |       | 1,636                                              |       | 606 |   |
| Inventories                                                                        |       | (12,206                                            | )          | (7,871 | ) |
| Prepaid expenses and other assets                                                  |       | 680                                                |       | (762 | ) |
| Accounts payable                                                                   |       | 6,201                                              |       | 3,763 |   |
| Accounts payable - related party                                                   |       | (818                                               | )          | (646 | ) |
| Accrued expenses and other liabilities                                             |       | 2,246                                              |       | (4,889 | ) |
| Unearned income                                                                    |       | 56                                                 |       | 237 |   |
| Income taxes payable                                                               |       | (6,133                                             | )          | (610 | ) |
| Net cash provided by operating activities                                          |       | 869                                                |       | 27,144 |   |
|                                                                               |       |                                               |       |   |   |
| INVESTING  ACTIVITIES:                                                             |       |                                               |       |   |   |
| Acquisition of property and equipment                                              |       | (3,661                                             | )          | (4,114 | ) |
| Purchases of investments                                                           |       | (54,484                                            | )          | (38,834 | ) |
| Proceeds from sold or matured investments                                          |       | 33,572                                             |       | 39,974 |   |
| Acquisition of minority interest                                                   |       | (7,024                                             | )          | — |   |
| Net cash used in investing activities                                              |       | (31,597                                            | )          | (2,974 | ) |
|                                                                               |       |                                               |       |   |   |
| FINANCING  ACTIVITIES:                                                             |       |                                               |       |   |   |
| Proceeds from issuance of common stock                                             |       | 54,090                                             |       | 1,254 |   |
| Excess tax benefits from stock option exercises                                    |       | 10,154                                             |       | 313 |   |
| Net cash provided by financing activities                                          |       | 64,244                                             |       | 1,567 |   |
|                                                                               |       |                                               |       |   |   |
| EFFECT OF  EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS                      |       | 2,676                                              |       | (25 | ) |
|                                                                               |       |                                               |       |   |   |
| NET INCREASE IN  CASH AND CASH EQUIVALENTS                                         |       | 36,192                                             |       | 25,712 |   |
| CASH AND CASH  EQUIVALENTS AT BEGINNING OF THE PERIOD                              |       | 233,745                                            |       | 302,098 |   |
|                                                                               |       |                                               |       |   |   |
| CASH AND CASH  EQUIVALENTS AT END OF THE PERIOD                                    |       | $                                                  | 269,937    |   | $ | 327,810 |   |
|                                                                               |       |                                               |       |   |   |
|                                                                               |       |                                               |       |   |   |
| SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION:                                 |       |                                               |       |   |   |
| Interest paid                                                                      |       | $                                                  | 2,522      |   | $ | 2,551 |   |
| Income taxes  paid, net                                                            |       | $                                                  | 1,536      |   | $ | 4,202 |   |

 

SeeNotes to Unaudited Consolidated Financial Statements.

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**CYMER, INC.**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**Three Months Ended March 31, 2007**

**(Unaudited)**

**1.****              BASIS OFPRESENTATION**

*Unaudited Interim Financial Statements*— 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 toForm 10-Q. The consolidated balance sheet at December 31, 2006 was derived fromthe audited financial statements at that date; however it may not include alldisclosures required by accounting principles generally accepted in the UnitedStates.

In the opinion of management, the unauditedconsolidated financial statements for the interim period presented reflect allmaterial adjustments, consisting only of normal recurring adjustments,necessary for a fair presentation of the financial position and results ofoperations as of and for such periods indicated. These unaudited consolidatedfinancial statements and notes hereto should be read in conjunction with theconsolidated financial statements and notes thereto included in our AnnualReport on Form 10-K for the year ended December 31, 2006. Results for theinterim periods presented herein are not necessarily indicative of results thatmay be reported for any other interim period or for the entire fiscal year.

*Principles of Consolidation* — Theaccompanying consolidated financial statements include our accounts and theaccounts of our wholly owned subsidiaries — Cymer Japan, Inc. (“Cymer Japan”),Cymer Singapore Pte Ltd. (“Cymer Singapore”), Cymer B.V. in the Netherlands (“CymerB.V.”), Cymer Southeast Asia, Ltd, in Taiwan (“Cymer SEA”), Cymer SemiconductorEquipment Shanghai Co., Ltd, in the People’s Republic of China (“Cymer PRC”),Cymer Korea, Inc. (“Cymer Korea”), and our majority-owned subsidiary, TCZ PteLtd., a company incorporated in Singapore (“TCZ Singapore”).  We own 60% of TCZ Pte Ltd.

All significant intercompany balances and transactionshave been eliminated in consolidation.

*Accounting Estimates* — Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires us to makeestimates and assumptions that affect the reported amounts of assets and liabilitiesand disclosure of contingent assets and liabilities at the date of thefinancial statements and the reported amounts of revenues and expenses duringthe reporting period.  Actual results maydiffer from those estimates.

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

We grant stock options and awards from our 2005 EquityIncentive Plan (the “2005 Plan”), which provides for the issuance of incentivestock options, nonstatutory stock options, stock appreciation rights, stockbonus awards, stock purchase awards, stock unit awards and other stock awardsto our employees, directors and consultants. Options issued under the 2005 Plan expire ten years after the optionsare granted and generally vest and become exercisable ratably over a four-yearperiod following the date of grant. Stock unit awards issued under the 2005 Plan generally vest one yearfrom the date granted.  

During the three months ended March 31, 2006 and 2007,we recognized stock-based compensation expense related to stock options of $2.4million and $1.3 million, respectively; of which $146,000 and $176,000,respectively, are related to stock unit awards. We also recognized an incometax benefit related to stock-based compensation during the three months endedMarch 31, 2006 and 2007 of $10.2 million and $313,000, respectively. The fairvalue of stock-based options granted, less expected forfeitures, is recognizedto expense over the requisite service period.

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

*Earnings Per Share* — Basicearnings per share (“EPS”) excludes dilution and is computed by dividing netincome or loss attributable to common stockholders by the weighted-average ofcommon shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securitiesor other contracts to issue common stock (convertible subordinated notes usingthe “if-converted” method, warrants to purchase common stock and common stockoptions using the treasury stock method) were exercised or converted intocommon stock. Potential dilutive securities are excluded from the diluted EPScomputation in loss periods as their effect would be anti-dilutive.

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The following table sets forth the basic and dilutedEPS (in thousands, except per share information):

|                                                                                  | ** ** | **Three months ended** | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                       | ** ** | **March 31,**               | ** ** |
| ** **                                                                       | ** ** | **2006**                         | ** ** | **2007** | ** ** |
| NET INCOME:                                                                      |       |                             |       |   |   |
| Net income, as reported  (used for basic EPS)                                    |       | $                                | 20,603     |   | $ | 20,321 |   |
| Adjustment for interest  expense on convertible subordinated notes, net of taxes |       | 873                              |       | 822 |   |
|                                                                             |       |                             |       |   |   |
| Net income, as adjusted  for assumed conversion (used for diluted EPS)           |       | $                                | 21,476     |   | $ | 21,143 |   |
|                                                                             |       |                             |       |   |   |
| WEIGHTED AVERAGE  SHARES:                                                        |       |                             |       |   |   |
| Basic weighted  average common shares outstanding                                |       | 37,278                           |       | 37,269 |   |
| Effect of  dilutive securities:                                                  |       |                             |       |   |   |
| Warrants                                                                         |       | 57                               |       | — |   |
| Options and  stock units                                                         |       | 977                              |       | 534 |   |
| Convertible  subordinated notes                                                  |       | 2,814                            |       | 2,814 |   |
| Diluted weighted  average common and potential common shares outstanding         |       | 41,126                           |       | 40,617 |   |
|                                                                             |       |                             |       |   |   |
| Earnings per share:                                                              |       |                             |       |   |   |
| Basic                                                                            |       | $                                | 0.55       |   | $ | 0.55 |   |
| Diluted                                                                          |       | $                                | 0.52       |   | $ | 0.52 |   |

 

Forthe three months ended March 31, 2006, weighted average options and warrants topurchase shares of common stock totaling approximately 1.0 million shares werenot included in the computation of diluted earnings per share as their effectwas anti-dilutive. For the three months ended March 31, 2007, weighted averageoptions to purchase shares of common stock totaling approximately 739,000shares were not included in the computation of diluted earnings per share astheir effect was anti-dilutive.

**4.****              INVENTORIES**

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

|                  | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
|------------------|------------|-----------------------|------------|--------------------|------------|
| ** **       | ** ** | **2006**              | ** ** | **2007**           | ** ** |
| INVENTORIES:     |       |                  |       |               |       |
| Raw materials    |       | $                     | 33,472     |               | $          | 35,303 |   |
| Work-in-progress |       | 19,373                |       | 21,504             |       |
| Finished goods   |       | 51,451                |       | 55,360             |       |
| Total            |       | $                     | 104,296    |               | $          | 112,167 |   |

 

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

Comprehensive income includes net income, effectiveunrealized gains and losses on forward contracts, foreign currency translationadjustments, net unrealized pension gains and losses, and 

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unrealizedgains and losses on available-for-sale securities, which are recorded asshort-term and long-term investments in the accompanying consolidated balancesheets.

The following table summarizes the change in eachcomponent of accumulated other comprehensive loss for the three months endedMarch 31, 2007 (in thousands):
| ** **                  | ** ** | ** **      | ** ** | **Total unrealized**    | ** ** | ** **                | ** ** | ** **              | ** ** | ** **        | ** ** |
|-----------------------------|------------|-----------------|------------|------------------------------|------------|---------------------------|------------|-------------------------|------------|-------------------|------------|
| ** **                  | ** ** | ** **      | ** ** | **gain (loss) on** | ** ** | **Total unrealized** | ** ** | ** **              | ** ** | **Accumulated**   | ** ** |
| ** **                  | ** ** | ** **      | ** ** | **available-for-sale**       | ** ** | **gain on**          | ** ** | ** **              | ** ** | **other**         | ** ** |
| ** **                  | ** ** | **Translation** | ** ** | **investments,**             | ** ** | **derivatives,**          | ** ** | **Net unrealized** | ** ** | **comprehensive** | ** ** |
| ** **                  | ** ** | **adjustment**  | ** ** | **net of tax**     | ** ** | **net of tax**  | ** ** | **pension loss**   | ** ** | **loss**          | ** ** |
| Balance, December 31,  2006 |       | $               | (3,984     | )                            | $          | (92                       | )          | $                       | 17         |              | $          | (7 | ) | $ | 4,066 |   |
| Period, net change          |       | (27             | )          | 159                          |       | 6                         |       | —                  |       | 138               |       |
| Balance, March 31, 2007     |       | $               | (4,011     | )                            | $          | 67                        |       | $                       | 23         |              | $          | (7 | ) | $ | (3,928 | ) |

 

Comprehensive income consisted of the followingcomponents (in thousands):

|                                                                              | ** ** | **Three months ended** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                   | ** ** | **March 31,**               | ** ** |
| ** **                                                                   | ** ** | **2006**                         | ** ** | **2007** | ** ** |
| Net income                                                                   |       | $                                | 20,603     |   | $ | 20,321 |   |
|                                                                         |       |                             |       |   |   |
| Foreign currency  translation adjustments                                    |       | 2,674                            |       | (27 | ) |
| Unrealized gains on  available- for-sale investments, net of tax             |       | 44                               |       | 159 |   |
| Unrealized gains on  foreign currency forward exchange contracts, net of tax |       | 84                               |       | 6 |   |
| Comprehensive income                                                         |       | $                                | 23,405     |   | $ | 20,459 |   |

 

**6.****              GOODWILL ANDINTANGIBLE ASSETS**

We account for our goodwill and other indefinite lifeintangible assets in accordance with Statement of Accounting Standards No. 142(“SFAS No. 142”), “Goodwill and Other Intangible Assets”. Under SFAS No. 142,our goodwill is subject to an annual impairment test.  During the fourth quarter of 2006 wecompleted our annual impairment test of goodwill and intangibles and concludedthat no impairment of goodwill or intangibles existed.  The carrying amount of goodwill was $8.8million as of December 31, 2006 and March 31, 2007.

Intangible assets — net, within the accompanyingbalance sheets represent amounts associated with patents that were acquired in2001, 2003, 2005 and 2006.  As of December31, 2006 and March 31, 2007, the net carrying amount of these patents was $15.9million and $15.1 million, respectively. The accumulated amortization of thesepatents at December 31, 2006 and March 31, 2007 was $11.1 million and $11.9million, respectively.  Amortizationexpense for our patents was $635,000 and $762,000, for the three months endedMarch 31, 2006 and 2007, respectively.

Asof March 31, 2007, future estimated amortization expense for these patents forthe next five years and beyond is expected to be as follows (in thousands):

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|                                       | ** ** | **Future**       | ** ** |
|---------------------------------------|------------|------------------|------------|
| ** **                            | ** ** | **Amortization** | ** ** |
| Nine months ending  December 31, 2007 |       | $                | 2,285      |   |
| Year ending December  31, 2008        |       | 3,046            |       |
| Year ending December  31, 2009        |       | 1,564            |       |
| Year ending December  31, 2010        |       | 675              |       |
| Year ending December  31, 2011        |       | 675              |       |
| Thereafter                            |       | 6,874            |       |
|                                       |            |                  |            |  |

 

**7.****              INCOME TAXES**

Weadopted the provisions of Financial Accounting Standard Board (“FASB”) InterpretationNo. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes, on January 1, 2007.FIN 48 clarifies the accounting for income taxes by prescribing a minimumprobability threshold that a tax position must meet before a financialstatement benefit is recognized. The minimum threshold is defined in FIN 48 asa tax position that is more likely than not to be sustained upon examination bythe applicable taxing authority, including resolution of any related appeals orlitigation processes, based on the technical merits of the position.  

Asof the date of adoption, our gross liability for income taxes associated withuncertain tax positions totaled $19.6 million, including interest andpenalties.  As a result of theimplementation of FIN 48, we recognized an increase of $9.4 million to reservesfor uncertain tax positions, of which $5.7 million was recorded to deferred taxassets, $3.4 million was recorded to income taxes receivable, $687,000 wasrecorded to tax expense and the remaining $358,000 was recorded as a cumulativeeffect adjustment to increase retained earnings. The FIN 48 liability ispresented net of the related income tax receivable balance on the accompanyingconsolidated balance sheet.  Included inthe balance of unrecognized tax benefits at January 1, 2007 is $10.5million of tax benefits that, if recognized, would affect our effective taxrate.  Also included in the balance ofunrecognized tax benefits at January 1, 2007 is $9.1 million of taxbenefits that, if recognized, would result in adjustments to other taxaccounts, primarily deferred tax assets and income taxes receivable.

Werecognize interest and penalties related to uncertain tax positions in incometax expense.  As of January 1, 2007,we had approximately $640,000 of accrued interest and penalties related touncertain tax positions.  

Weare subject to taxation in the United States and in various states and foreignjurisdictions.  We are currently under InternalRevenue Service (“IRS”) audit for the 2003 and 2004 tax years.  Though the estimated completion date of theaudit is not known, it is possible that the audit will be completed within thenext twelve months.  The completion ofthis audit could require a material change to our gross unrecognized taxbenefits.  However, based on the statusof this audit and the protocol for finalizing such audits, it is not possibleto estimate the impact of this audit on previously recorded uncertain taxpositions.  In addition, we do notforesee material changes to the state or foreign uncertain tax positions withinthe next twelve months. 

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Ourtax years 2003 and forward are subject to examination by the IRS, our tax years2000 and forward are subject to examination by material state jurisdictions,and our tax years 2002 and forward are subject to examination by materialforeign jurisdictions.

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

In the ordinary course of business, we are not subjectto potential obligations under guarantees that fall within the scope of FASBInterpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers”, except for standard warranty provisions associated with product salesand indemnification provisions related to intellectual property that arecontained within many of our lithography tool manufacturer agreements. All ofthese provisions give rise only to the disclosure requirements prescribed byFIN 45 except for product warranties.

(a)                ProductWarranties — Warranty provisions contained within our lithography toolmanufacturer agreements are generally consistent with those prevalent in thesemiconductor equipment industry. The warranty period and terms for lightsource systems and spares and consumable parts varies by light source systemmodel.  We record a provision forwarranty for all products, which is included in cost of product sales in theconsolidated statements of operations and is recorded at the time that therelated revenue is recognized. We review our warranty provision monthly, whichis determined using a statistical financial model which calculates actualhistorical expenses, product failure rates, and potential risks associated withour different product models. We then use this financial model to calculate thefuture probable expenses related to warranty and the required level of thewarranty provision. Throughout the year we review the risk levels, historicalcost information and failure rates used within this model and update them asinformation changes over the product’s life cycle. If actual warrantyexpenditures differ substantially from our estimates, revisions to the warrantyprovision would be required. Actual warranty expenditures are recorded againstthe warranty provision as they are incurred.

The following tablesummarizes information related to our warranty provision for the three monthsended March 31, 2007 (in thousands):

| Balance, January 1, 2007                                                       |   | $      | 29,450 |   |
|--------------------------------------------------------------------------------|--------|--------|--------|--------|
| Liabilities accrued for  warranties issued, net of adjustments and expirations |   | 5,085  |   |
| Warranty expenditures  incurred                                                |   | (4,335 | )      |
| Balance, March 31, 2007                                                        |   | $      | 30,200 |   |

 

(b)               IntellectualProperty Indemnifications — We include intellectual property indemnificationclauses within our general terms and conditions with our customers and thegeneral purchase agreements with our three lithography tool manufacturers,ASML, Canon, and Nikon. In general, these indemnification provisions providethat we defend our customers against any infringement claims directed againstour products.  Under the indemnificationclauses, we pay all costs and damages, including attorney’s fees, associatedwith such settlements or defenses, provided that the lithography toolmanufacturer follows specific procedures for notifying us of such claims andallows us to manage the settlement proceedings.

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An indemnificationprovision was also included in the contract manufacturing agreement with SeikoInstruments, Inc. (“Seiko”), which was terminated effective March 31,2003.  As with our indemnificationprovisions on intellectual property, we continue to honor this indemnificationclause within the agreement even after its termination. Seiko and at least oneJapanese lithography tool manufacturer have been notified that our light sourcesystems in Japan may infringe certain Japanese patents.  We believe, based upon the advice of counsel,that our products do not infringe any valid claim of the asserted patents orthat we are entitled to prior use claims in Japan.

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

As part of the supply agreement signed with TCZ in September 2005 andamended in September 2006 in connection with the amendment and restatement ofthe original TCZ joint venture agreement, we agreed to indemnify TCZ againstany infringement of the intellectual property rights of a third party arisingfrom TCZ’s purchase of our products.  Wewill defend such actions at our own expense and will pay the cost and damageawarded in any such action provided that TCZ grants us sole control of thedefense and settlement of such action and also provides us with informationrequired for the defense and settlement of such action.

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

**9.****             ****RELATED PARTY TRANSACTIONS**

As a result of the formation of our TCZjoint venture in July 2005 and under the terms of the joint venture agreementwhich was amended in September 2006, Zeiss is a related party.  In addition to transactions that occur amongus, Zeiss and TCZ Singapore related to the joint venture, we also purchasecertain optical parts directly from Zeiss and periodically sell our lightsource system products to Zeiss . We recorded revenue associated with thisrelated party of $2.2 million and $466,000 for the three months ended March 31,2006 and 2007, respectively.  As ofDecember 31, 2006 and March 31, 2007, we had accounts receivable balances of$834,000 and $1.7 million, respectively, and accounts payable balances of $4.9million and $4.2 million, respectively, all of which were associated with theserelated party transactions with Zeiss.

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

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

Our former Japanese manufacturing partner, Seiko, andone of our Japanese customers were notified in July 1996 that our light sourcesystems in Japan may infringe certain Japanese patents held by another Japanesecompany.  We have agreed to indemnify ourformer Japanese manufacturing partner and our customers against patentinfringement claims under certain circumstances, even after the terminationdate of the contract manufacturing agreement. We believe, based upon the advice of counsel, that our products do notinfringe any valid claim of the asserted patents or that we are entitled toprior use claims in Japan.

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

On April 24, 2007, weannounced that our board of directors authorized us to repurchase up to $300million of our common stock. The purchases will be made from time to time inthe open market or in privately negotiated transactions. The program may bediscontinued at any time. Total purchases through May 4, 2007 were $54.9million or 1,334,500 shares under this program.

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

*The following discussion of our financial conditionand results of operations should be read in conjunction with our consolidatedfinancial statements and notes thereto included in this Quarterly Report onForm 10-Q.*

**Forward-Looking Statements**

Statementsin this Quarterly Report on Form 10-Q that are not strictly historical innature are forward-looking statements. These statements include, but are notlimited to, references to the outlook for the semiconductor industry and us;expected domestic and international product sales and development; our researchand development activities and expenditures; adequacy of our capital resourcesand investments; effects of business cycles in the semiconductor business; ourcompetitive position; and our relationships with customers and third-partymanufacturers of our products, and may contain words such as “believes,” “anticipates,”“expects,” “plans,” “intends” and words of similar meaning. These statementsare predictions based on current information and our expectations and involve anumber of risks and uncertainties. The underlying information and ourexpectations are likely to change over time. Actual events or results may differ materially from those projected inthe forward-looking statements due to various factors, including, but notlimited to, those contained under the caption “Risk Factors” and elsewhere inthis Quarterly Report on Form 10-Q. Forward-looking statements herein speak only as of the date of thisQuarterly Report on Form 10-Q.  Unlessrequired by law, we undertake no obligation to update or revise anyforward-looking statements to reflect new information or future events ordevelopments.  Thus, you should notassume that our silence over time means that actual events are bearing out asexpressed or implied in such forward-looking statements.

#### **Overview**

*General*

We are the world’s leading supplier oflight source solutions for the semiconductor industry.  Our productsprovide the essential light source for deep ultraviolet (“DUV”) photolithographysystems.  Almost all consumer electronic devices manufactured in the lastseveral years contain a semiconductor manufactured using light sources such asours.  We currently supply light sources to each of the three DUVlithography tool manufacturers, ASML, Canon, and Nikon, who in turn supplytheir wafer steppers and scanners to chipmakers.  In addition, we sellreplacement parts and services to the lithography tool manufacturers as well asdirectly to the chipmakers.  Our light source systems currently constitutea substantial majority of all excimer light sources incorporated in lithographystepper and scanner tools. Our headquarters are located in San Diego,California where we develop and manufacture all of our light source systems andthe majority of our replacement parts.  As a large portion of our revenueis derived from customers located outside of the U.S., we maintain a spareparts refurbishment facility and field service office in Korea and fieldservice and support offices in Japan, the Netherlands, the People’s Republic ofChina, Singapore and Taiwan. Japan is currently our only subsidiary office thatsells excimer light source systems. We also maintain field service offices inthe U.S. to service our installed base of light sources located in the U.S.

Our TCZ joint venture which isheadquartered in Singapore, is currently developing, and will integrate, marketand sell, and support production tools for the flat panel display manufacturingindustry. 

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The joint venture is targeting the growing market for low-temperaturepoly-silicon (“LTPS”) processing used in the manufacture of liquid crystaldisplays that are brighter, have higher resolution, and consume less power thandisplays using today’s predominant amorphous silicon films.  Although TCZ’sproduct is currently in the development phase, TCZ performed extensive customerdemonstrations on its first generation demonstration tool in 2006 and we expectthat TCZ will ship its first production tool, the TCZ 900X, in late 2007 orearly 2008.

*Products*

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

Our excimer lightsources for photolithography produce pulsed light of extremely shortwavelengths within the DUV spectrum.  Thebandwidth of the light is further narrowed through a number of opticaltechniques.  The DUV wavelengths aremeasured in nanometers and the light sources are referred to according toeither the wavelength or the gases that are mixed to produce the light.  Krypton Fluoride (“KrF”) gases produce lightat a 248 nm wavelength, and Argon Fluoride (“ArF”) gases produce light at a 193nm wavelength. The extremely short wavelengths and highly narrowed bandwidthsof light produced by these light sources enable the very fine featureresolution required for patterning or printing the circuitry on silicon wafers.The pulse energy and repetition rate of the light source permit high throughputin wafer processing.  We have designedour light sources to be reliable, easy to install and service and compatiblewith existing semiconductor manufacturing processes.  Our light sources are used to pattern orprint the integrated circuits, which are also called semiconductors or “chips,”that power many of today’s advanced consumer and business electronics.  In the first quarter of 2007, we sold 51light source systems at an average selling price of $1.2 million.

Ourproduct development strategy has been to develop new products in rapidsuccession to meet continually evolving needs in the marketplace, and toobsolete our own products as quickly as possible, thus rendering ourcompetitors’ products obsolete.  Thisstrategy strengthens our market leadership position since the ongoing reductionof critical dimension (“CD”) on the wafer drives demand for newer, moreadvanced, higher value-added light sources.

Overthe years, we have developed and sold a wide variety of photolithography lightsource products.  These products can bedivided into KrF and ArF product categories and include a number of currentproducts as well as legacy products that we continue to service in ourinstalled base.

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

Asthe life and usage of our installed base of light sources in production atchipmakers exceeds the original warranty periods, some chipmakers requestservice contracts from us.  Additionally, we provide billable service orservice contracts directly to the three semiconductor lithography toolmanufacturers. These service agreements require us to maintain and/or servicethese light sources either on an on-call or regular interval basis orboth.  Included in some of the types of service contracts we provide toour customers are the replacement of consumable parts and non-consumableparts.  The pricing for such contracts includes the replacement of theseparts.

*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 

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the last several years illustrate this cyclicality. In2000, the semiconductor industry experienced strong growth, which was followedby a three year downturn from 2001 through late 2003. Growth resumed in late2003, but one year later, in late 2004, the industry again declined for severalmonths.  Business activity then leveledoff early in 2005 and began toslightly improve quarter-over-quarter thereafter until late 2005, whenorders for our light sources increased substantially from the levels seenearlier in the year.  Our chipmakercustomers began indicating that increasing demand for chips would require themto expand production capacity, and our lithography tool manufacturing customersbegan placing orders for a growing number of light sources to meet increasingdemand for scanners. By the end of 2005, it appeared that we were againentering a strong industry growth cycle and upturn.

Severaltrends that continued throughout 2006 drove our revenue and net income torecord levels for the year.  These trendsincluded:

·                  Strongcontinuing demand for our ArF light sources as chipmakers purchased systems toenable production at advanced technology nodes.

·                  Stronger thananticipated demand for our KrF light sources, which chipmakers purchased toexpand production capacity and pattern a growing number of less critical layerswith DUV light sources.

·                  Substantialongoing growth in our non-systems revenue which was driven by high light sourceutilization at chipmakers and high overall fab utilization.

Inthe fourth quarter of 2006, however, we experienced delays in our anticipatedshipment schedule when a customer requested that we reschedule shipment of anumber of our most advanced ArF light sources, specifically the XLA 300, intothe first quarter of 2007.  Again inMarch 2007, one of our customers requested that we delay shipment of a certainnumber of our light sources, several models of both KrF and ArF products.  This was due to a major rescheduling andproduct mix shift of their scanner deliveries, which required that they changemix configuration and push out receipt of a number of our light sources intothe second half of the 2007. As a result, in the first quarter of 2007, weshipped 51 light sources and revenue totaled $126.7 million, compared toshipment of 68 light sources and total revenue of $137.4 million in the fourthquarter of 2006.  Utilization of ourlight source systems at chipmakers continued to increase in the first quarterof 2007 compared to the fourth quarter of 2006. This increased utilization whencoupled with our growing installed base of light sources systems drove ournon-systems product revenue, which consists of consumables and spare parts,upgrades, and service, to $67.8 million for the first quarter of 2007, equal to53% of total revenue for the quarter, slightly higher than the $66.9 million innon-systems revenue recorded in the fourth quarter of 2006, equal to 49% oftotal revenue. Operating income totaled $26.6 million, yielding an operatingmargin of 21.0% for the first quarter of 2007, compared to operating income of$30.9 million and operating margin of 22.5% in the fourth quarter of 2006. Netincome for the first quarter of 2007 was $20.3 million, equal to $0.52 pershare fully diluted, compared to net income of $25.4 million, equal to $0.65per share fully diluted, in the fourth quarter of 2006.  The positive effects of our ongoingoperational efficiency improvements are evident in our gross margin for thefirst quarter of 2007 coming in at 48.6% compared to 49.4% gross margin in thefourth quarter of 2006, even though first quarter 2007 revenue declined 8%compared to the prior quarter’s revenue.

Ingeneral, the longer-term technology and industry trends that affectphotolithography are positive.  Demandfor our most advanced ArF light sources remained strong in the first quarter of  2007 and we shipped 32 of our XLA Series light sources during thequarter.  With ArF immersion lithographya production reality in leading NAND Flash memory manufacturers’ fabs near theend of 2006, lithography tool manufacturers have been seeing growing demand forArF immersion scanners.  Further, NANDFlash memory manufacturers continue to aggressively shrink CDs, and will movefrom 55nm production at this time toward 45nm by the end of 2007, and topattern the growing number of critical layers with immersion scanners, thesemanufacturers will need to make additional immersion tool purchases to increasecritical layer capacity.  Immersionlithography is in production in a growing number of chipmakers’ fabs, and weanticipate that an increasing number of chipmakers will adopt this advancedproduction technique over the next several years.

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Tomeet this demand for advanced immersion tools for the 45nm production node andbelow, we have developed the XLR 500i, a new light source based on ourproduction proven dual chamber Master Oscillator Power Amplifier (“MOPA”)architecture. This light source replaces the traditional power amplifier with aregenerative ring amplifier, which results in improved stability and controlduring manufacturing, and a significant reduction in cost of operation for thechipmaker.  We shipped the first XLR 500ito one of our lithography tool manufacturing customers in April 2007, andanticipate the adoption ramp for this product will begin in the second half ofthis year, and increase in the first half of 2008.  We anticipate that the XLR 500i will becomethe light source of choice for 45nm production.

Demand for ArF immersiontools in the dynamic random access memory (“DRAM”) segment of the market isexpected to grow this year as these manufacturers begin using the most advancedArF tools in production before year-end. Immersion demand from integrated device manufacturers (“IDMs”) shouldbecome more significant next year. Additionally, the 65 nm production ramp iswell underway, and a significant number of new fabs are expected to be in orentering production at that node by the end of 2007.  Currently, there are significant research anddevelopment efforts underway at the 45 nm node, which is driving demand, andthe first leading edge chipmakers are expected to begin production at 45 nm bythe end of 2007.

Recently, many industryand market forecasters have been lowering their expectations for 2007.  The FLASH segment of the market continues toexperience significant price pressure and we anticipate a decrease in its investmentsin capacity expansion in the second half of this year.  DRAM prices have been recently firming, andthis has led to significant difficulty in forecasting investment allocationdecisions between FLASH and DRAM capacity and absolute delivery timing requirementsat memory manufacturers.  However, memorymanufacturers have not announced reductions in their overall strategic capitalspending plans.  DUV foundry utilizationpicked up in the first quarter of 2007, and industry analysts anticipate that theywill begin to expand capacity and increase their spending as the yearprogresses.  Some manufacturers in thelogic segment of the industry are reducing spending, but we expect suchspending reduction to be offset by other manufacturers who may spend more tocontinue their rapid CD shrink.  Thoughwe continue to believe that semiconductor capital spending this year will decreaseslightly from 2006 spending levels, we expect the DUV lithography market togrow due to an increase in production of critical layers at the 65 nm node anddevelopment at the 45 nm node, and we believe that we are well-positioned tobenefit from these trends.  However,macro-economic factors, such as high energy prices and interest rates and aslower U.S. housing market, could have a negative impact on consumer spending,including spending on electronic devices. Additionally, geopolitical turmoil can create a heightened sense ofuncertainty that can cause consumers to become more cautious in theirspending.  Either or both of thesefactors would have a negative effect on the demand for our products.

As we progress through2007, we anticipate continuing to focus on better serving our customers,building a better company, and creating shareholder value. We continue on ourpath of technology leadership and innovation, and expect to introduce new,paradigm-shifting light sources in advance of market needs.  We will continue our numerous efforts to addeven higher levels of value for our customers and increase customersatisfaction, while pursuing our many initiatives to enhance overall operatingefficiencies and improve financial performance and cash generation, In thefirst quarter of 2007, we generated $27.1 million in cash from operations andon April 24, 2007, we announced that our Board of Directors authorized therepurchase of up to $300 million of our common stock.  We expect to continue generating substantiallevels of cash from operations in 2007 and we will continue to exploreopportunities for the most effective use of our cash.

#### **CriticalAccounting 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 

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ongoing internalprocesses, we regularly evaluate our estimates and judgments associated withrevenue recognition, valuation of parts used in our refurbishment manufacturingprocess, inventory allowances, warranty provisions, stock-based compensation,income taxes, allowances for bad debts, long-lived assets valuation, intangibleassets valuation, and contingencies and litigation.  We base these estimates and judgments uponhistorical information and other facts and assumptions that we believe to bevalid and/or reasonable under the circumstances. These assumptions and factsform the basis for making judgments and estimates and for determining thecarrying values of our assets and liabilities that are not apparent from othersources.  Actual results could vary fromour estimates if we were to use different assumptions and conditions.

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

*Revenue Recognition*

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

The sales of our light source systemsgenerally include training and installation services. We determined theseelements qualify as one unit of accounting under Emerging Issues Task Force (“EITF”)Bulletin No. 00-21, “Revenue Arrangements with Multiple Deliverables” as we donot have evidence of fair value for the undelivered training and installationelements. Furthermore, we determined that the undelivered training andinstallation elements are perfunctory performance obligations and are notessential to the functionality of our light source systems. Therefore, inaccordance with the provisions of Staff Accounting Bulletin No. 104, werecognize revenue when the revenue recognition criteria are met for the lightsource system, and accrue the costs of providing the training and installationservices.  We recognize light sourcesystem revenue at one of following three points, depending on the terms of ourarrangement with our customer — 1) shipment of the light source system, 2)delivery of the light source system or 3) receipt of an acceptance certificate.For the majority of our light source system sales, the shipping terms areF.O.B. shipping point and revenue is recognized upon shipment. For our arrangementswhich include F.O.B. destination shipping terms, revenue is recognized upondelivery of the light source system to our customer.  Lastly, one of our arrangements includes anacceptance provision, which is satisfied by the issuance of an acceptance certificateby the customer. For these transactions, we recognize revenue upon receipt ofthe acceptance certificate.  In addition,we test our light source systems in environments similar to those used by ourcustomers prior to shipment to ensure that they meet published specifications.

Revenue from consumablesand spare parts sales is recognized at the point that legal title passes to thecustomer, which is upon shipment from our facility.  For a significantportion of our spare parts sales, our customers return the consumed assembly tous as part of the sale of the new part.  We reuse some of the materialwithin these core assemblies, mainly metal components, for the future build ofcore assemblies.  As a result, our revenue consists of both cash and thevalue of the reusable parts received from our customers as consideration forthese spare part sales. Revenue associated with our customers’ return of coreassemblies is recognized upon receipt of the returned core assembly.  Theamount of the revenue is determined based upon the fair value of the reusableparts that we expect to yield from the returned core assembly based onhistorical experience.  Service andtraining revenue is recognized as the services are rendered.

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

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For funded developmentcontracts, funds received are accounted for on the percentage-of-completionmethod based on the relationship of costs incurred to total estimated costs.Revenues generated from these types of funded development contracts are, exceptas noted below, included in other revenue, and are derived from cost sharingcontracts between certain customers and us. If milestones on these fundeddevelopment contracts require that specific results be achieved or reported byus, revenue is not recognized until that milestone is completed.  For someof the 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 conditionsare met, these funds are not recorded as revenue but rather are offset againstour own internal research and development expenses in the period that themilestone is achieved. These funded development contracts are not material toour operations.

*Accounting for Parts Used in RefurbishmentManufacturing Process*

Overthe last several years as part of our regular business activities, we haveconducted significant parts refurbishment and material reclaim activitiesrelated to some of our core assemblies, in particular our chamber assemblies.The volume of this activity significantly increased in 2004 and we expectvolumes to increase over time as our installed base of light sources continuesto rise and we become more efficient in these refurbishment activities anddevelop capabilities to reclaim material from and refurbish other coreassemblies. These activities involve arrangements with our customers where wesell a new part to the customer at a reduced sales price if the customerreturns the consumed assembly that the new part replaces.  These returned core assemblies contain acertain amount of material, primarily metal components, that may be reused byus in future core assemblies.  Uponreceipt of these consumed core assemblies from our customers, we record anentry to recognize the estimated fair value of the reusable components either1) as revenue if the return of the core assembly relates to a spare partreplacement sale or 2) as a reduction in cost of product sales if the return ofthe core assembly is related to a part being replaced under our warranty or perthe terms of an active service contract with our customer.  The value of the reusable parts containedwithin the consumed assembly is determined based upon historical data on thevalue of the reusable parts that we typically yield from a consumedassembly.  As part of our normal excessand obsolete inventory analysis, these consumed assemblies are also reviewed ona monthly basis and an inventory allowance is recorded as appropriate for theseparts.  The value that we assign to thesecore assemblies can be affected by the current demand for the reusable parts inour manufacturing operations and the actual yield rate achieved for reusableparts contained within these consumed core assemblies.  We believe that our methodology for valuingthe reusable parts within these returned core assemblies is reasonable, but anydecreases in the demand for the parts or any changes in the yield of thereusable parts included in these core assemblies could have a material adverseeffect on our financial condition and results of operations.  In the first quarter of 2007, the amount bywhich the value of these core assemblies was affected by decreases in demandand changes in yields was immaterial.

***InventoryAllowance***

Weperform an analysis of our inventory allowances on at least a quarterly basisto determine the adequacy of this allowance on our financial statements. Theamount of the inventory allowance is determined by taking into considerationcertain assumptions related to market conditions and future demands for ourproducts, including changes to product mix, new product introductions, and/orproduct discontinuances, which may result in excess or obsolete inventory. Wedetermine the level of excess and obsolete inventory associated with our rawmaterials and production inventory, which includes all parts on hand from ourrefurbishment activities, by comparing the on hand inventory balances andinventory on order to the next 12 months of forecasted demand.  We then adjust this calculation for inventorythat has a high likelihood of use beyond one year or can be used in otherproducts that may have lower demands. After this adjustment, we arrive at our total exposure for excess andobsolete inventory within our raw materials and production inventory.  As part of this analysis, we also determinewhether there are potential amounts owed to vendors as a result of cancelled ormodified raw material orders.  We estimateand record a separate liability, which is included in accrued and other liabilitiesin the accompanying balance sheets for such amounts owed.

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The inventory allowancetotaled $15.1 million and $13.1 million at December 31, 2006 and March 31,2007, respectively. The decrease in the inventory allowance at March 31,2007 as compared to December 31, 2006 was primarily due to certain parts ininventory previously reserved that were either scrapped or sold during thefirst quarter of 2007 as well as changes to the 12 month demand for certain rawmaterials which resulted in lower reserve requirements during the quarter ascompared to December 31, 2006.  Thesewere partially offset by a new vendor liability incurred during the firstquarter of 2007 related to excess and obsolete inventory.

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 factors that could potentially affect the futuredemand or usage of our products, including the following:

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

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

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

·                  Overall mix oflight source system models or consumable and spare parts and any changes tothat mix required by our customers;

·                  Utilizationrates of our light sources at chipmakers; and

·                  Engineeringchange orders.

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, additional inventory allowances may be required, and may have amaterial adverse effect on our financial condition and results of operations.

###### *Warranty Provision*

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 with their initial shipmentsand require higher warranty provisions until the technology becomes moremature.

Thetotal balance in the warranty provision accrual as of December 31, 2006 andMarch 31, 2007 was $29.5 million and $30.2 million, respectively.  This slight increase from period to period isprimarily due to the higher level of consumables and spare parts sales in thefirst quarter of 2007 as compared to the fourth quarter of 2006 and the requiredwarranty reserves for those sales and additional reserves which were recordedfor specific parts on our XLA model light sources during the three months endedMarch 31, 2007.  These increases to thewarranty provision were partially offset by a lower number of light sourcesystems being under warranty from period to 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 to 

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rapidtechnological change, and as a result, we periodically introduce newer, morecomplex 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 couldharm our financial condition and results of operations.

*Stock-BasedCompensation*

Wegrant options to purchase our common stock to our employees and grant stockunit awards to our non-employee directors under our 2005 Equity IncentivePlan.  The benefits provided under thisplan are share-based payments subject to the provisions of Statement ofFinancial Accounting Standards No. 123R (“SFAS No. 123R”), “Share-Based Payment”.  SFAS No. 123R addresses the accounting forshare-based payment transactions in which an enterprise receives employeeservices in exchange for (a) equity instruments of the enterprise or(b) liabilities that are based on the fair value of the enterprise’sequity instruments or that may be settled by the issuance of such equityinstruments. As a result of this accounting requirement, our consolidatedfinancial statements include compensation expense as calculated per theprovisions of SFAS No.123R. We attribute the value of share-based compensationto expense using the straight-line method for awards granted after December 31,2005. Compensation expense for awards outstanding and unvested as of December31, 2005 are being recognized over the remaining service period using thecompensation expense calculated according to the pro forma disclosureprovisions under SFAS No. 123, “Accounting for Stock-Based Compensation” whichuses an accelerated expense recognition method for those awards with a gradedvesting schedule. Share-based compensation expense related to stock options andstock units was $2.4 million and $1.3 million before taxes for the three monthsended March 31, 2006 and 2007, respectively.

Wevalue our share-based payment awards using the Black-Scholes option pricingmodel. The determination of fair value of stock-based payment awards on thedate of grant is affected by our stock price as well as assumptions regarding anumber of complex and subjective variables. These assumptions include theexpected term of stock options and our expected stock price volatility over theexpected term of the awards.

Wedetermine our expected volatility by using a combination of historical andimplied volatility, or blended volatility, to derive our expected volatilityassumption as allowed under SFAS No. 123R and Staff Accounting Bulletin No.107. Implied volatility is based on our six-month traded options on our commonstock. We determined that the volatility calculated using a blend of impliedvolatility and our historical volatility is more reflective of expectedvolatility than using only historical volatility.  The expected term of stock options representsthe weighted-average period the stock options are expected to remainoutstanding. We determine the expected term of our stock options based onobserved historical exercise patterns for our company, which we believe areindicative of future exercise behavior.

Otherassumptions required for estimating fair value under the Black-Scholes optionpricing model include the expected risk-free interest rate and expecteddividend yield of our stock.  Ourrisk-free interest rate assumption is based upon the most current availablerates on zero coupon U.S. Government issues for the expected term of our stockoptions. The expected dividend rate is not applicable to us as we have nothistorically declared or paid dividends, nor do we anticipate paying cashdividends in the future.

SFASNo. 123R also requires forfeitures to be estimated at the time of grant and wehave estimated our forfeitures based on historical experience.  We have revised this estimate in the past andwill revise this estimate, as necessary, in subsequent periods if actualforfeiture rates differ from our current estimates.

Ifwe change any of the key assumptions that we use in the Black-Scholes optionpricing model such as expected volatility or expected term or if we decide touse a different valuation model in the future 

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or change ourforfeiture rate, the compensation expense that we record under SFAS No. 123Rmay differ significantly in the future from what we have recorded in thecurrent period.

*IncomeTaxes*

We account for incometaxes in accordance with Statement of Financial Accounting Standards No. 109 (“SFASNo. 109”), “Accounting for Income Taxes.” Pursuant to SFAS No. 109, a deferred tax asset or liability is generallyrecognized for the estimated future tax effects attributable to temporarydifferences, net operating loss (“NOL”) carryforwards and tax creditcarryforwards.  Deferred tax assets areto be reduced by a valuation allowance if, based on the weight of availableevidence, it is more likely than not that some portion or all of the deferredtax 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.

Wehave considered our industry’s outlook for the future, our historicalperformance and estimated future taxable income, and ongoing tax planningstrategies in assessing the need for a valuation allowance.  Using this information, we have prepared amodel to forecast our expected taxable income in future years and to estimatewhen the benefits of our deferred tax assets are likely to be realized.  Based upon the analysis, with the exceptionsnoted below, we believe that it is more likely than not that the results offuture operations will generate sufficient taxable income to realize all of ourdeferred tax assets within the period covered by our model and, as such, novaluation allowance has been provided against these deferred tax assets.  However, a valuation allowance has beenprovided against certain deferred tax assets related to TCZ’s business and ourFrench branch operations in the total amount of $1.3 million, as thesebusinesses have not yet developed sufficiently to allow us to assert that theseassets will ultimately be realized.

AtMarch 31, 2007, we had federal tax credit carryforwards of $11.7 million whichbegin to expire in 2018.  At March 31,2007, we had state tax credit carryforwards of $14.2 million, which  may be carried forward indefinitely.  At March 31, 2007, we had foreign NOLcarryforwards of $2.6 million which may be carried forward indefinitely.

Amaterial adverse change in the outlook for worldwide lithography tool sales,the expected selling prices or profit margins for our products or our expectedshare of the global market for lithography light sources, could cause us todetermine that additional valuation allowances are needed for some or all ofour deferred tax assets, and would result in an increase to our income taxprovision in the period in which such determination is made.

Itis our intention to reinvest undistributed earnings of our foreign subsidiariesand thereby indefinitely postpone their remittance, with the exception of ourTCZ joint venture.  Accordingly, we havenot provided U.S. federal income and foreign withholding taxes on $60.0 millionof undistributed earnings from non-U.S. operations as of March 31, 2007.  It is not practicable to estimate the amountof the deferred tax liability on such unremitted earnings.

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**RESULTS OF OPERATIONS**

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

|                                                           | ** ** | **Three months ended** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                | ** ** | **March 31,**               | ** ** |
| ** **                                                | ** ** | **2006**                         | ** ** | **2007** | ** ** |
| Revenues:                                                 |       |                             |       |   |   |
| Product sales                                             |       | 98.2                             | %          | 99.5 | % |
| Product sales –  related party                       |       | 1.7                              |       | 0.4 |   |
| Other                                                     |       | 0.1                              |       | 0.1 |   |
| Total revenues                                            |       | 100.0                            | %          | 100.0 | % |
|                                                      |       |                             |       |   |   |
| Cost and expenses:                                        |       |                             |       |   |   |
| Cost of product  sales                                    |       | 54.0                             |       | 51.3 |   |
| Research and  development                                 |       | 14.3                             |       | 15.2 |   |
| Sales and marketing                                       |       | 5.4                              |       | 5.5 |   |
| General and  administrative                               |       | 7.2                              |       | 7.0 |   |
| Total costs and  expenses                                 |       | 80.9                             |       | 79.0 |   |
|                                                      |       |                             |       |   |   |
| Operating income                                          |       | 19.1                             |       | 21.0 |   |
|                                                      |       |                             |       |   |   |
| Other income – net                                   |       | 4.9                              |       | 4.1 |   |
|                                                      |       |                             |       |   |   |
| Income before income  tax provision and minority interest |       | 24.0                             |       | 25.1 |   |
|                                                      |       |                             |       |   |   |
| Income tax provision                                      |       | 8.3                              |       | 9.6 |   |
| Minority interest                                         |       | 0.5                              |       | 0.6 |   |
| Net income                                                |       | 16.2                             | %          | 16.0 | % |
| Gross margin on product sales                             |       | 45.9                             | %          | 48.6 | % |

 

***ThreeMonths Ended March 31, 2006 and 2007***

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

|                                                  | ** ** | **For the three months ended** | ** ** |
|--------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                       | ** ** | **March 31,**                                 | ** ** |
| ** **                                       | ** ** | **2006**                                           | ** ** | **2007** | ** ** |
| Light source systems:                            |       |                                               |       |   |   |
| Revenue                                          |       | $                                                  | 68,035     |   | $ | 58,869 |   |
| Units sold                                       |       | 70                                                 |       | 51 |   |
| Average selling  price                           |       | $                                                  | 972        |   | $ | 1,154 |   |
|                                             |       |                                               |       |   |   |
| Consumable and spare  parts and service products |       | $                                                  | 59,021     |   | $ | 67,756 |   |
| Other revenue                                    |       | $                                                  | 61         |   | $ | 89 |   |
|                                             |       |                                               |       |   |   |
| Total revenue                                    |       | $                                                  | 127,117    |   | $ | 126,714 |   |

 

Product sales decreased slightly from $127.1****million for the three months ended March 31, 2006 to $126.6million for the three months ended March 31, 2007.  This decrease in product sales was due to adecline in light source system sales which was offset by an increase inconsumable and spare parts and service product sales for the three months endedMarch 31, 2007 as compared to the three months ended March 31, 2006.  Light source system revenues decreased 14%from $68.0 million for the three months ended March 31, 2006 to $58.9 millionfor the three months ended March 31, 2007. A total of 70 light 

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source systems were sold in the three months ended March 31, 2006 at anaverage selling price of $972,000, compared to 51 light source systems sold inthe three months ended March 31, 2007 at an average selling price of $1.2million.  On a foreign currency adjustedbasis, the average selling price for the three months ended March 31, 2006 was$970,000 compared to $1.2 million for the three months ended March 31, 2007.The increase in the average selling price from period to period reflects theshift in the product mix to higher priced technology buys of advanced ArFproducts which represented 80% of light source systems revenue for the threemonths ended March 31, 2007 as compared to only 59% of light source systemrevenue for the three months ended March 31 2006. The decrease in quantities oflight source systems sold from period to period was due to an unanticipatedpush out of light source systems deliveries from one of our direct customersfrom the first quarter of 2007 to the second half of 2007.

Growth in the installed base and steady utilizationof our light source systems continues to increase demand for consumables andspare parts and service products. The increase in consumable and spare partsdemand resulted in an increase in consumables and spare parts and serviceproduct revenue of 14% from $59.0 million for the three months ended March 31,2006 to $67.8 million for the three months ended March 31, 2007.  Revenues from funded development contractswere $61,000 and $89,000 for three months ended March 31, 2006 and 2007,respectively. There were no revenues recorded or earned associated with the TCZjoint venture for the three months ended March 31, 2006 or 2007.

For the period ended March 31, 2007, our backlogtotaled $83.4 million and total bookings were $115.7 million which yielded abook-to-bill ratio of 0.91 compared to the period ended March 31, 2006, whereour backlog was $99.3 million and total bookings were $135.6 million whichyielded a book-to-bill ratio of 1.07. The decrease in our backlog and book to bill ratio primarily reflectsoperational efficiency improvements we have made over the last nine monthswhich has resulted in lower lead times and product cycle times, particularlyfor our light source systems. As a result of these improvements, we are able totake an order for a light source system and ship it within the quarter for ahigher percentage of our orders.

We installed 63 light sources at chipmakers and otherend-users during the quarter ended March 31, 2006 as compared to 47 lightsources installed during the quarter ended March 31, 2007.

Sales to our three lithography tool manufacturingcustomers, ASML, Canon, and Nikon, amounted to 35%, 8% and 17%, respectively,of total revenue for the three months ended March 31, 2006, and 38%, 6% and14%, respectively, of total revenue for the three months ended March 31, 2007.

Oursales are generated primarily by shipments to customers in Europe, Japan,Korea, Taiwan, and the U.S. Approximately 83% and 86% of our sales for the three months ended March31, 2006 and 2007, respectively, were derived from customers outside theU.S.  We maintain a wholly owned Japanesesubsidiary, Cymer Japan, which sells to our Japanese customers.  Revenues from Japanese customers, generatedprimarily by Cymer Japan, accounted for 24% and 20% of total revenues for thethree months ended March 31, 2006 and 2007, respectively. The activities ofCymer Japan are limited to sales and service of products purchased by CymerJapan from us as the parent corporation. We anticipate that international saleswill continue to account for a significant portion of our sales.

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

The cost of product salesdecreased 5% from $68.7 million for the three months ended March 31, 2006 to$65.1 million for the three months ended March 31, 2007. This decrease in costof product sales was primarily due to lower light source system sales and adecrease in warranty costs for the three 

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months ended March 31,2007 compared to the three months ended March 31, 2006.  Thegross margin on product sales was 46% for the three months ended March 31, 2006as compared to 49% for the three months ended March 31, 2007. This higher grossmargin from period to period was primarily due to increased factory yield andutilization, reduced product lead and cycle times and reduced warranty costswhich resulted from our on-going product reliability improvements.  We will continue to look for opportunities toenhance operating efficiencies and benefits from our on-going product costreduction activities for the remainder of 2007.

*Research and Development*.  Researchand development expenses include costs of internally-funded projects as well ascontinuing product development support expenses, which consist primarily ofemployee and material costs, depreciation of equipment and other engineeringrelated costs.  Our research anddevelopment expenses are offset by amounts associated with certain of ourexternally funded research and development contracts. Research and development expenses increased 7% from $18.1 million forthe three months ended March 31, 2006 to $19.3 million for the three monthsended March 31, 2007 due primarily to costs associated with our LTPS productdevelopment efforts and EUV light source development. In addition to ourdevelopment of EUV and LTPS technologies, we also continued to focus on nextgeneration ArF and KrF products. Included in our ArF product development efforts for 2007 is the designof an enhanced universal platform for our XL series light sources.   As a percentage of total revenues, researchand development expenses increased from 14.3% for the three months ended March31, 2006 to 15.2% for the three months ended March 31, 2007.  We expect that our investment in research anddevelopment will continue.

*Salesand Marketing*.Sales and marketing expenses include sales, marketing and customer supportstaff expenses and other marketing expenses.  Sales and marketing expensesincreased 2% from $6.8 million for the three months ended March 31, 2006 to$7.0 million for the three months ended March 31, 2007. The increase in salesand marketing expenses from period to period primarily reflects an increase insalaries, benefits, profit sharing and bonuses due to an increase in headcountpartially offset by a decrease in stock-based compensation expense. As apercentage of total revenues, sales and marketing expenses increased from 5.4%for the three months ended March 31, 2006 compared to 5.5% for the three monthsended March 31, 2007.  We anticipate thatsales and marketing expenses will remain flat or increase slightly in thesecond quarter of 2007.

*General and Administrative*.General and administrative expenses consist primarily of management andadministrative personnel costs, professional services, including external auditand consultant fees, and administrative operating costs.  General and administrative expenses decreased4% from $9.2 million for the three months ended March 31, 2006 to $8.8 millionfor the three months ended March 31, 2007 primarily due to a $634,000 declinein profit sharing and bonuses and a $624,000 decline in stock-basedcompensation expense.  These amounts werepartially offset by $795,000 in advisory fees associated with our adoption andimplementation of FIN 48. As a percentage of total revenues, general andadministrative expenses decreased slightly from 7.2% for the three months endedMarch 31, 2006 to 7.0% for the three months ended March 31, 2007.  We anticipate that general and administrativeexpenses will remain relatively flat or increase slightly in the second quarterof 2007.

*TotalOther Income - Net.*  Net other income consists primarily ofinterest income and expense, foreign currency exchange gains and lossesassociated with fluctuations in the value of the functional currencies of ourforeign subsidiaries against the U.S. dollar. Net other income totaled $6.2 million and $5.3 million for the threemonths ended March 31, 2006, and 2007, respectively. The decrease in net otherincome was primarily due to the receipt of $3.2 million in life insuranceproceeds following the death of one of our executive officers in the firstquarter of 2006, which was partially offset by an increase in interest incomeof $2.6 million period over period. The increase in interest income from the firstquarter of 2006 to the first quarter of 2007 reflects higher market interestrate yields on larger cash and investment balances. In addition, net otherincome reflects a decrease in foreign currency exchange gains and an increasein interest and other expenses in the first quarter of 2007 compared to thefirst quarter of 2006. The increase in interest and other expenses primarilyreflects the accretion of interest expenses associated with our long termincentive bonus plan. Foreign currency exchange gains totaled $619,000,interest income and other income totaled $7.0 million, and interest and otherexpense totaled $1.4 million 

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for the three months ended March 31, 2006, compared toa foreign currency exchange gain of $427,000, interest and other income of $6.4million, and interest and other expense of $1.6 million for the three monthsended March 31, 2007.

*IncomeTax Provision.* The tax provision of $10.6 million and $12.2 millionfor the three months ended March 31, 2006 and 2007, respectively, reflects anannual effective rate of 34.6% and 38.4%, respectively.  The change in the annual effective tax ratefrom period to period was primarily attributable to the increase in pre-taxearnings as well as a reduction in tax benefits from U.S. export incentiveprograms. The annual effective tax rate for the three months ended March 31,2007 was greater than the U.S. statutory rate of 35% primarily as a result ofpermanent book/tax differences and the effect of foreign earnings taxed athigher rates. The effective tax rate is a function of current tax law andgeographic location of pre-tax income.

**LIQUIDITY AND CAPITAL RESOURCES**

Historicallywe have funded our operations primarily from cash generated from operations,the proceeds of the note offerings, bank borrowings, and the proceeds fromemployee stock option exercises.  As ofMarch 31, 2007, we had approximately $327.8 million in cash and cashequivalents, $193.3 million in short-term investments, $22.1 million in long-terminvestments, and $715.0 million in working capital.

In February 2002, we issued$250.0 million in aggregate principal amount in a private placement ofnotes.  These notes are due on February15, 2009 with interest payable semi-annually on February 15 and August 15 of eachyear at 3.50% per annum.  The notes areconvertible into shares of our common stock at a conversion rate of 20 sharesper $1,000 principal amount or an effective conversion price of $50.00 pershare.  We used a portion of the netproceeds from this private placement to redeem the previously issued notes thatwere then outstanding. The remaining proceeds are being used for our operating,investing and financing activities.  Withthe approval of our board of directors, we have periodically repurchased thesenotes in the open market.  We repurchased$49.2 million and $60.0 million principal amount of these notes in 2004 and2005, respectively. As of March 31, 2007, there were $140.7 million principalamount of notes outstanding.

Netcash provided by operating activities was approximately $869,000 and $27.1million for the three months ended March 31, 2006 and 2007, respectively.Although net income for the three months ended March 31, 2007 was slightlylower than the same period in 2006, cash provided by operating activities wasmuch higher in the first three months of 2007 as compared to the first threemonths of 2006. Net cash provided by operating activities for the three monthsended March 31, 2006 primarily reflects net income for the period and increasesin accounts payable and accrued and other liabilities which were almostcompletely offset by increases in accounts receivable and increases ininventories during the period.  Theincreases in accounts receivable were due to back-end loaded shipments duringthe quarter and increases in inventory were due to front-end loaded inventorylevels. Net cash used in operating activities for the three months ended March31, 2007 primarily reflects net income for the period, a decrease in accountsreceivable balances and increases in inventories and accrued and otherliabilities.  The decrease in accountsreceivable was primarily due to collection efforts during the period and theincrease in inventories was primarily due to the unanticipated  push out of light source system deliveries fromone of our direct customers from the first quarter of 2007 to the second halfof 2007.

Netcash used in investing activities was approximately $31.6 million and $3.0million for the three months ended March 31, 2006 and 2007, respectively.  Net cash used in investing activities for thethree months ended March 31, 2006 was due primarily to the timing of short-termand long-term investments that matured and were reinvested during the period, a$7.0 million payment to acquire the final 19% minority interest in our CymerKorea subsidiary and the acquisition of $3.7 million of property and equipment.Net cash used in investing activities during the three months ended March 31,2007 reflects the timing of short-term and long-term investments that matured andwere reinvested during the period, and the acquisition of $4.1 million ofproperty and equipment.

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Netcash provided by financing activities was approximately $64.2 million and $1.6million for the three months ended March 31, 2006 and 2007, respectively. Netcash provided by financing activities for the three months ended March 31, 2006reflects the proceeds received from the exercise of employee stock optionstotaling $54.1 million and excess tax benefits for the period from stockoptions exercises totaling $10.2 million. Net cash provided by financingactivities for the three months ended March 31, 2007 reflects the proceedsreceived from the exercise of employee stock options totaling $1.3 million andthe excess tax benefits for the period from stock options exercises totaling$313,000.

Werequire substantial working capital to fund our business, particularly tofinance inventories, including purchase orders with our vendors, accountsreceivable, and for capital expenditures. Our future capital requirements depend on many factors, including ourmanufacturing activity, the timing and extent of spending to support productdevelopment efforts, expansion of sales and marketing and field service andsupport, competitive labor market compensation requirements, the timing ofintroductions of new products and enhancements to existing products, and themarket acceptance of our products. We believe that cash generated fromoperations along with the liquidity provided by our existing cash balances andshort-term investments will be sufficient to sustain operations and provide forany potential future expansion of our business for at least the next 12 months.

**OFF BALANCE SHEET ARRANGEMENTSAND CONTRACTUAL OBLIGATIONS**

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

Wehave no significant contractual obligations that are not recorded on ourconsolidated financial statements or fully disclosed in the notes thereto.

**SUBSEQUENTEVENT**

On April 24, 2007, weannounced that our board of directors authorized us to repurchase up to $300million of our common stock. The purchases will be made from time to time inthe open market or in privately negotiated transactions. The program may bediscontinued at any time. Total purchases through May 4, 2007 were $54.9million or 1,334,500 shares under this program.

**RECENTACCOUNTING PRONOUNCEMENTS**

In September 2006,the FASB issued Statement of Financial Accounting Standards No. 157 (“SFAS No.157”), “Fair Value Measurements”. SFAS No. 157 defines fair value, establishesa framework for measuring fair value using generally accepted accountingprinciples, and expands disclosures related to fair value measurements. ThisStatement applies under other accounting pronouncements that require or permitfair value measurements, the FASB having previously concluded in thoseaccounting pronouncements that fair value is the relevant measurementattribute. Accordingly, SFAS No. 157 does not require any new fair valuemeasurements. However, for some entities, the application of this Statementwill change current practice. This Statement is effective for us on January 1,2008. We are currently evaluating the impact of this pronouncement on ourconsolidated financial statements.

In September 2006,FASB issued SFAS No. 158 (“SFAS No. 158”), “Employers’ Accounting for DefinedBenefit Pension and Other Postretirement Plans—an Amendment of FASB StatementsNo. 87, 88, 106, and 132(R)”.  Weadopted all provisions of SFAS No. 158 in December 2006 except for theprovision which will require us to measure the funded status of our pensionplans as of the date of our year-end statement of financial position.  This provision will be effective for us forthe fiscal year ending 

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December 31, 2008, and we do not expectits adoption to have a material impact on our consolidated financialstatements.

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

#### **Item 3.  Quantitative and Qualitative DisclosuresAbout Market Risk**

**Foreign Currency Risk**

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

Asof March 31, 2007, we had outstanding forward contracts to buy U.S. $38.0million for 5.1 billion yen under foreign currency exchange facilities withcontract rates ranging from 113.87 yen to 119.46****yenper U.S. dollar.  These contracts expireon various dates through December 2007.

Our forward contractsgenerally qualify for hedge accounting treatment per the provisions ofStatement of Financial Accounting Standards No. 133, “Accounting for DerivativeInstruments and Hedging Activities”. As a result, we defer changes in the fairvalue for the effective portion of these hedges and record the amount in othercomprehensive income and subsequently reclassify the gain or loss to cost ofproduct sales in the same period that the related sale is made to the thirdparty. The fair value of all of our forward contracts and the deferred gain,net of tax, for those that qualify for hedge accounting treatment totaled$55,000 and $23,000 respectively, as of March 31, 2007.

The fair value of theseforward contracts as of March 31, 2007 would have fluctuated by $3.4 million ifthe foreign currency exchange rate for the Japanese yen to the U.S. dollar onthese forward contracts had changed by 10%.

# **Investment and Debt Risk**

We maintain an investmentportfolio consisting primarily of government and corporate fixed incomesecurities, certificates of deposit and commercial paper.  While it is our general intent to hold suchsecurities until maturity, we will occasionally sell certain securities forcash flow purposes. Therefore, our investments are classified asavailable-for-sale and are carried on the balance sheet at fair value.  A change in market interest rates of 1% wouldhave impacted our net income from these investments by approximately $675,000for the three months ended March 31, 2007.

In February 2002, weissued $250.0 million principal amount of unsecured fixed rate 3.50%Convertible Subordinated Notes due February 15, 2009.  Interest on these notes is payable onFebruary 15 and August 15 of each year. The notes are convertible into sharesof our common stock at a conversion rate of 20 shares per $1,000 principalamount subject to adjustment under certain conditions. As of February 21, 2005,we may redeem the notes at certain redemption prices expressed as a percentageof the principal amount. The notes are subordinated to our existing and futuresenior 

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indebtedness and effectively subordinated to allindebtedness and other liabilities of our subsidiaries.  Because the interest rate is fixed, webelieve there is no risk of increased interest expense. These notes arerecorded at face value on the consolidated balance sheets. In the third quarterof 2004 and the second quarter of 2005, we repurchased, at a discount to par,$49.2 million and $60.0 million principal amount, respectively, of thesenotes.  As of March 31, 2007, $140.7million principal amount of the notes were outstanding.  The fair value of such debt based on quotedmarket prices on March 31, 2007 was $145.1 million.

**ITEM 4.  Controls andProcedures**

*Evaluationof disclosure controls and procedures*.  For the first quarter of 2007, our chiefexecutive officer and our chief financial officer, evaluated the effectivenessof our disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”))as of March 31, 2007, and concluded that as of such date, our disclosurecontrols and procedures were not effective in ensuring that informationrequired to be disclosed by us in the reports that we file under the ExchangeAct is recorded, processed, summarized and reported within the time periodspecified in the rules and forms of the Securities and Exchange Commission.

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

*Changes in internal control over financial reporting.*Therehas been no change in our internal control over financial reporting during thequarter ended March 31, 2007 that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reportingother than the steps taken by us to remediate the material weakness that was disclosedby us in our annual report on Form 10-K for the year ended December 31, 2006,relating to our accounting for income taxes.

As described in Part II, Item 9A of our annual report on Form 10-K for the year ended December 31, 2006, we have identified several steps we will take throughout 2007 with the goal of remediating this material weakness prior to December 31, 2007.  Per our remediation plan, we made the following improvements in our internal controls over our accounting for income taxes for the three months ended March 31, 2007:

·                  Improved thecommunications between our tax department and our accounting department, andincreased the level of involvement of our accounting department in the reviewsof income tax reconciliations;

·                  Redesigned andimplemented new review and approval procedures and processes associated withall income tax provision workpapers and the consolidated income taxreconciliation schedules; and

·                  Identifiedand started the implementation of an automated tax provision software tool thatwill reduce the number of manual spreadsheets that we use to calculate andreconcile all income tax accounts on a quarterly and annual basis.

Wehave additional steps in our remediation plan from those identified above thatwe intend to implement within the next two quarters and we will report ourprogress with this remediation plan in future quarterly reports on Form10-Q.  As each of the steps in ourremediation plan are completed and 

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implemented, weplan to test the internal control changes immediately to ensure that they areproperly designed and working effectively and will make any changes thatmanagement deems necessary based on the results of this testing.

**PART II. OTHER INFORMATION**

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

# **                **                                                None.

# **ITEM 1A****                                               RiskFactors**

*The risks described below may notbe the only risks we face. Additional risks that we do not currently think arematerial may also impair our business operations. The risk factors set forthbelow with an asterisk (*) next to the title contain changes to the descriptionof the risk factors associated with our business as previously disclosed inItem 1A to our Annual Report on Form 10-K for the fiscal year ended December31, 2006.  If any of the events 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 operating results from quarter-to-quarter have variedin the past and our future operating results may continue to fluctuatesignificantly.**

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

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

·      cyclicalityin the market for semiconductor manufacturing equipment;

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

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

·      timingand size of orders from our customers;

·      changesin market penetration by our competitor;

·                  product lead time demands from our customers;

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

·      changesin the price and profitability of our products;

·      ourability to develop and implement new technologies and introduce new products;

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

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

·      ourability to manage our manufacturing requirements;

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

·      worldwidepolitical instability;

·      changingglobal economic conditions, including rising energy prices; and

·      intellectual propertyprotection.

We have historically derived a large portion of ourquarterly and annual revenues from selling a small number of light sourcesystems. Because we sell a small number of products, the precise time that werecognize revenue from an order may have a significant impact on our totalrevenue for a particular 

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period. Our customers may cancel or reschedule orders with little or nopenalty. Orders expected in one quarter could shift to another period due tochanges in the anticipated timing of our customers’ purchase decisions orrescheduled delivery dates requested by our customers. Our operating resultsfor a particular quarter or year may be adversely affected if our customers,particularly our three largest customers, cancel or reschedule orders, or if wecannot fill orders in time due to unexpected delays in manufacturing, testing,shipping, and product acceptance.

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

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

We derive a substantial portion of our revenues fromlithography tool manufacturers who, as original equipment manufacturers (“OEMs”),incorporate our light source systems in photolithography tools that they sellto semiconductor manufacturers, or chipmakers, and from chipmakers who purchaseconsumables, spare parts, upgrades and service directly from us in support ofthe light source products. Like us, our OEM customers depend on demand fortheir products from the chipmakers. The capital equipment and related operatingexpenditures of chipmakers depend on a number of factors, including the currentand anticipated market demand for semiconductors and the many products usingsemiconductors.  That demand is highlyvolatile and unpredictable.

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

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

Our OEM customers try to manage their inventories andproduction requirements to appropriate levels that reflect their expected salesto chipmakers. Market conditions in the semiconductor industry and 

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our OEM customers’ production efficiency can cause them to expand orreduce their orders for new light source systems as they try to manage theirinventories and production requirements. We continue to work with our OEMcustomers to better understand these issues. However, we cannot guarantee that wewill be successful in understanding our OEM customers’ inventory management andproduction requirements or that our OEM customers will not build up an excessinventory of light source systems. If our OEM customers retain an excessinventory of light source systems, our revenue could be reduced in futureperiods as the excess inventory is utilized, which could adversely affect ouroperating results, financial condition and cash flows.  If our OEM customers demand shorter productlead times to improve their inventory and cash positions, our inventorymanagement and cash position may be negatively impacted, which may adverselyaffect our operating results, financial condition and cash flows.

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

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

|            | ** ** | **Three months ended** | ** ** |
|------------|------------|----------------------------------|------------|
| ** ** | ** ** | **March 31,**               | ** ** |
| ** ** | ** ** | **2006**                         | ** ** | **2007** | ** ** |
| ASML       |       | 35                               | %          | 38 | % |
| Canon      |       | 8                                | %          | 6 | % |
| Nikon      |       | 17                               | %          | 14 | % |
|       |       |                             |       |   |   |
| Total      |       | 60                               | %          | 58 | % |

 

Collectively, these three companies accounted for thefollowing percentage of our total accounts receivable at the dates indicated:

|            | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
|------------|------------|-----------------------|------------|--------------------|------------|
| ** ** | ** ** | **2006**              | ** ** | **2007**           | ** ** |
| ASML       |       | 48                    | %          | 45                 | %          |
| Cano       |       | 3                     | %          | 4                  | %          |
| Nikon      |       | 19                    | %          | 18                 | %          |
|       |       |                  |       |               |       |
| Total      |       | 70                    | %          | 67                 | %          |

 

We expect that sales of our light source products tothese three customers will continue to account for a substantial portion of ourrevenue in the foreseeable future. None of our customers are obligated topurchase a minimum number of our products in the aggregate or during anyparticular period.  We can provide noassurance that any of our customers will continue to purchase our products atpast or current levels.  Sales to any ofthese customers may be affected by many factors, some of which are beyond ourcontrol. These factors include:

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

·      a customer experiencinglithography tool production problems;

·      a decision to purchase lightsources from other suppliers;

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

·                  a decline in a customer’s financial condition.

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

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

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

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

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

·      potential shortages ofspecialized materials used in DUV optics;

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

·      consolidationof chipmakers.

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

·      a decline in demand for ourcustomers’ DUV photolithography tools;

·      a failure to achieve continuedmarket acceptance of our products;

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

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

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

·      afailure to release new enhanced versions of our products on a timely basis.

**We depend on the introduction ofnew products for our success, and we are subject to risks associated with rapidtechnological change. ***

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

Our most significant product introduction in recentyears consisted of a technology change from a single-discharge-chamber excimerlight source to a dual-discharge-chamber design called MOPA.  The MOPA design represents a paradigm shiftfrom previously accepted lithography technology and offers chipmakers higherpower, tighter bandwidth and lower cost of operation for their current – and weexpect for their future – optical lithography applications. There are risksinherent in the MOPA technology, including effective execution of our productdevelopment roadmap, continuing adoption of the product by lithography toolmanufacturers and chipmakers, manufacturability, cost effectiveness, andproduct performance in the field of the new products and the development of acomparable product by our competitor.

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

Future technologies such as EUV, nano-imprintlithography, and certain maskless lithography techniques may render our excimerlight source products obsolete. We must manage product transitions, 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 andintroduce new products or enhancements to our existing products and processesin a timely or cost effective manner that satisfies customer needs or achievesmarket acceptance. Failure to develop and introduce these new products andenhancements could materially adversely affect our operating results, financialcondition and cash flows.

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

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

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

·      recruit and train qualifiedfield service personnel;

·      identify qualified independentfirms; and

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

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

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

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

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

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

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

·      closely manage our globaloperations;

·      improve our process and otherinternal management systems;

·      quickly adapt to changingsales and marketing channels;

·      effectively manage ourinventory levels; and

·      attract,train, retain and manage key personnel.

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

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

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

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

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

We purchase a limited number of components andsubassemblies included in our light source products from a single supplier or asmall group of suppliers.  Forcertain optical, control system and pulse power components and subassembliesused in our light source systems, we currently utilize a single supplier.  To reduce the risk associated with thissingle supplier, we carry a significant strategic inventory of thesecomponents.  Strategic inventories aremanaged as a percentage of future demand. We have also negotiated to have vendor-managed inventory of criticalcomponents to further reduce the risk of a single supplier.  Inaddition, we contract the manufacture of various subassemblies of our productsand depend on our contract manufacturers to deliver to our requiredspecifications, schedule, and quality standards. Further, some of our suppliershave specialized in supplying equipment or manufacturing 

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services to semiconductor equipment manufacturers and therefore aresusceptible to industry ups and downs and subject to the same risks anduncertainties regarding their ability to respond to changing marketconditions.  Because many of  these suppliers reduce the size of theirworkforce in an industry downturn and increase it in an upturn, they may not beable to meet our requirements or respond quickly enough as an upturn begins andgains momentum.  Due to the nature of ourproduct development requirements, these key suppliers must rapidly advancetheir own technologies and production capabilities in order to support theintroduction schedule of our new products. These suppliers may not be able toprovide new modules and subassemblies when they are needed to satisfy ourproduct schedule requirements. If we cannot purchase enough of these materials,components or subassemblies, or if these items do not meet our qualitystandards, there could be delays or reductions in our product shipments, whichwould harm our operating results, financial condition and cash flows.

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

Operations at our primary manufacturing facility and oursubcontractors are subject to disruption for a variety of reasons, includingwork stoppages, terrorism, fire, earthquake, energy shortages, flooding orother natural disasters.  Suchdisruptions could cause delays in shipments of our products to our customers.  We provide no assurance that alternateproduction capacity would be available if a major disruption were to occur orthat, if it were available, it could be obtained on favorable terms.  Such disruption could result in cancellationof orders or loss of customers, which would have a material adverse effect onour operating results, financial condition and cash flows.

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

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

·      research and development;

·      engineering;

·      sales and marketing;

·      field service and support;

·      manufacturing; and

·      management.

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

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

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

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

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

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

We serve an increasingly global market.  A large portion of our total revenues isderived from customers located outside of the U.S.  We expect our international sales to continueto account for a very 

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large portion of our total revenues. In order to support our foreign customers, we maintain a manufacturingand field service subsidiary in Korea as well as field service and supportsubsidiaries in Japan, the Netherlands, the People’s Republic of China,Singapore and Taiwan.

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

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

·      unexpected changes inregulatory requirements;

·      fluctuations in exchange ratesand currency controls;

·      political and economicconditions and instability;

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

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

·      difficulties in staffing andmanaging foreign subsidiary and branch operations;

·      limited intellectual propertyprotection in some countries;

·      potentially adverse taxconsequences in some countries;

·      the possibility of accountsreceivable collection difficulties;

·      in the case of Asia, the riskof business interruption and damage from earthquakes;

·      the effect of acts ofterrorism and war; and

·      theburdens of complying with 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 U.S.export controls, these export rules could change in the future and make it moredifficult or impossible for us to export our products to many countries.  Any of these vulnerabilities could have amaterial adverse effect on our business, financial condition and results ofoperations.

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

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

As of March 31, 2007, we owned 265 U.S. patents coveringcertain aspects of technology related to light sources and piezo techniques.These patents will expire at various times during the period from January 2008to September 2025.  As of March 31, 2007,we had applied for 134 additional patents in the U.S.  As of March 31, 2007, we owned 404 foreignpatents and had 382 patent applications pending in various foreign countries.

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

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Further, third parties might independently develop similar products,duplicate our products, or design around patents that are granted to us.

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

We also rely on the following to protect ourconfidential information and our other intellectual property:

·      trade secret protection;

·      employee nondisclosureagreements;

·      third-party nondisclosureagreements; and

·      otherintellectual property protection methods.

However, we may not be successful in protecting ourconfidential information and intellectual property, particularly our tradesecrets, because third parties may:

·      independently developsubstantially the same proprietary information and techniques;

·      gain access to our tradesecrets; or

·      discloseour technology.

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

In the past, funds from research and developmentarrangements with third parties have been used to pay for a portion of our ownresearch and development expenses. We receive these funds fromgovernment-sponsored programs and customers, in connection with our designingand developing specific products. Periodically, funds from lithography toolmanufacturers and chipmakers are used to fund a small portion of our researchand development expenses. In providing these research and development servicesto these manufacturers, we try to make 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 be subject to patent litigation toenforce patents issued to us and defend ourselves against claimed infringementby our competitor or any other third party.**

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

Specifically, Komatsu notified us in 1996 that we may beinfringing some of its Japanese patents. During our subsequent discussions,Komatsu also asserted that our former Japanese manufacturing partner, Seiko, orwe may be infringing on some of Komatsu’s U.S. patents and a number of itsadditional Japanese patents. Komatsu has also notified one of our customers,Nikon, of its belief that our light sources infringe several of Komatsu’sJapanese and U.S. patents. As a result, we started proceedings in the JapanesePatent Office to oppose certain patents and patent applications of Komatsu. TheJapanese Patent Office has dismissed our opposition claims. Thus, litigationmay result in connection with Komatsu’s Japanese patents or U.S. patents. Also,Komatsu might claim that we infringe other or additional patents. Komatsunotified Seiko that it intends to enforce its rights against Seiko with respectto its Japanese patents if Seiko continued to engage in manufacturingactivities for us. In connection with our former manufacturing agreement withSeiko, we agreed to pay Seiko under certain conditions for 

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damages associated with these types of claims. Seiko may not prevail inany litigation against Komatsu, and therefore, we may be required to pay Seikofor such damages.

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

In the future, patent litigation may result due to aclaim of infringement by our competitor or any other third party or may benecessary to enforce patents issued to us. Any such litigation could result in substantial cost to us and diversionof our effort,  which would have anadverse effect on our business, financial condition and operating results.Furthermore, our customers and the end-users of our products might assert otherclaims for indemnification that arise from infringement claims against them. Ifthese assertions are successful, our business, financial condition andoperating results may be materially affected. Instead of litigation, or as aresult thereof, we may seek a license from third parties to use theirintellectual property. However, we may not be able to obtain a license.  Alternatively, we may design around the thirdparty’s intellectual property rights or we may challenge these claims in legalproceedings.  Any adverse determinationin a legal proceeding could result in one or more of the following, any ofwhich could harm our business, financial condition and operating results:

·      loss of our proprietaryrights;

·      exposure to significantliabilities by other third parties;

·      requirement that we get alicense from third parties on terms that are not favorable to us; or

·      restrictionfrom manufacturing or selling our products.

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

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

The risks involved with acquiring a new company, forminga joint venture, or entering a new market include the following:

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

·                  failure to retain key personnel;

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

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

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

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

·      failure to commercializepurchased technologies;

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

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

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

Mergers, acquisitions and joint ventures, as well asentry into new markets, are inherently subject to multiple significant risks,and the inability to effectively manage these risks could have a materialadverse effect on our business.  In July2005, we formed our TCZ joint venture with Zeiss to produce tools for the manufactureof flat panel displays.  This is a newmarket for both Cymer and Zeiss and may involve numerous risks. Any of theserisks could materially harm our business, financial condition and operatingresults. Further, any business that we acquire, joint venture that we form ornew market we may enter may not achieve anticipated revenues or operatingresults.

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

Changinglaws, regulations and standards relating to corporate governance and publicdisclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations,including accelerated SEC filing timelines and new Proxy rules, new NASDAQStock Market rules, and new accounting pronouncements are creating uncertaintyand additional complexities for companies such as ours. In particular, theSection 404 internal control evaluation requirements under the Sarbanes-OxleyAct have added and will continue to add complexity and costs to our businessand require a significant investment of our time and resources to complete eachyear.  We take these  requirements seriously and expect to continueto make every effort to ensure that we receive clean attestations on ourinternal controls each year from our outside auditors. To maintain high standardsof corporate governance and public disclosure, we intend to invest allreasonably necessary resources to comply with all other evolving standards.These investments may result in increased general and administrative expensesand a diversion of management time and attention from strategic revenuegenerating and cost management activities.

**Decreased effectiveness of equitycompensation could adversely affect our ability to attract and retainemployees, and changes in accounting for equity compensation could adverselyaffect earnings. ***

Wehave historically used broad based stock option programs and other forms ofequity-related incentives as a key component of our employee compensationpackages. We believe that stock options and other long-term equity incentivesdirectly motivate a broader base of employees to maximize long-term stockholdervalue and, through the use of long-term vesting, encourage employees to remainwith us.  In December 2004, the FinancialAccounting Standards Board (“FASB”) issued Statement of Financial AccountingStandards No. 123R (“SFAS No. 123R”), “Share-Based Payment — An Amendment toStatement Nos. 123 and 95,” which we adopted on January 1, 2006.  This rule requires us to record an expense toearnings for employee stock option grants and other equity incentives.Moreover, applicable stock exchange listing standards relating to obtainingstockholder approval of equity compensation plans has made it more difficultand expensive for us to grant options to employees, which has resulted inchanges to our equity compensation strategy, including a significant reductionin the number of stock options granted to employees. We have developedalternative cash and restricted stock unit compensation arrangements for ouremployees to replace the majority of these stock option program. These andother developments in the provision of equity compensation to employees couldmake it more difficult to attract, retain and motivate employees, and such achange in accounting rules and alternative compensation programs may adversely impact our future operating results,financial condition and cash flows.

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

We depend on regular and reliable air transportation ona worldwide basis for many of our routine business functions. If civil aviationin the U.S. or abroad is disrupted by terrorist activities or security 

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responses to the threat of terrorism or for any other reason, ourbusiness could be adversely affected in the following ways:

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

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

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

·      oursales and marketing efforts may be disrupted.

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

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

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

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

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

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

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

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

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changes in the government regulations, our failure to comply withenvironmental and land use regulations, or restrictions on our ability todischarge hazardous substances, could subject us to future liability or causeour manufacturing operations to be reduced or stopped.

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

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

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

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

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

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

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

·      the cyclical nature of thesemiconductor industry;

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

·      conditions and trends in thelight source device and other technology industries;

·      announcements of innovationsin technology;

·      new products offered by us orour competitor;

·      developments of patents orproprietary rights;

·      changes in financial estimatesby securities analysts;

·      general worldwide political,economic, and market conditions;

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

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

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

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

None.

# **ITEM 3.      Defaults Upon Senior Securities**

# None.

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

None.

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

(a)          None.

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

# **ITEM 6.      Exhibits**

| 10.1   |   | Amended and Restated Employment Agreement, effective  as of January 2, 2007, by and between Rae Ann Werner and Cymer.                                                                                            |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                             |
| 10.2   |   | Summary description of Cymer, Inc. Short-Term  Incentive Bonus Plan, as amended (incorporated herein by reference to Exhibit  99.1 to Cymer’s Current Report on Form 8-K filed on April 20, 2007).          |
|   |   |                                                                                                                                                                                                             |
| 10.3   |   | Summary description of Cymer, Inc. Long-Term  Incentive Bonus Plan for 2007, as amended (incorporated herein by reference  to Exhibit 99.2 to Cymer’s Current Report on Form 8-K filed on April 20,  2007). |
|   |   |                                                                                                                                                                                                             |
| 31.1   |   | Certification of Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act.                                                                                                                     |
|   |   |                                                                                                                                                                                                             |
| 31.2   |   | Certification of Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act.                                                                                                                     |
|   |   |                                                                                                                                                                                                             |
| 32.1   |   | Certification of Chief Executive Officer pursuant to  Section 906 of the Sarbanes-Oxley Act.                                                                                                                     |
|   |   |                                                                                                                                                                                                             |
| 32.2   |   | Certification of Chief Financial Officer pursuant to  Section 906 of the Sarbanes-Oxley Act.                                                                                                                     |

 

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this quarterly report on Form 10-Q to be signed on its behalf bythe undersigned thereunto duly authorized.
|                    | CYMER, INC.                  |
|--------------------|------------------------------|
|               |                         |   |
|               |                         |   |
|               |                         |   |
| Date: May 8,  2007 | By:                          | /s/ Nancy J. Baker |   |
|               |                         |   |
|               | Nancy J. Baker               |
|               | Senior Vice President and    |
|               | Chief Financial Officer      |
|               | (Duly Authorized Officer and |
|               | Principal Financial Officer) |

 

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