** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C.  20549**

 

**FORM10-Q**

 
| **ý** |   | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|--------|----------------------------------------------------------------------------------------------|
|       |   | **For  the Quarterly Period Ended June 30, 2003**                                       |

 

**OR**

 
| **o**  |   | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE EXCHANGE ACT OF 1934**                                                                                                                                         |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   | **For  the Transition Period  from               to               ** |

 

**Commissionfile number 0-21321**

 

**CYMER,INC.**

(Exact name ofregistrant as specified in its charter)

 

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

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.

 

Yes  ý     No  o

 

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

 

The number of shares ofCommon Stock, with $0.001 par value, outstanding on August 7, 2003 was35,188,131.

 

 

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**CYMER,INC.**

 

**FORM10-Q**

 

**Forthe Quarter Ended June 30, 2003**

 

**INDEX**

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

 

2

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### **PART I.  FINANCIAL INFORMATION**

 

**ITEM1.  Financial Statements**

 

**CYMER,INC.**

**CONSOLIDATEDBALANCE SHEETS (UNAUDITED)**

**(Inthousands, except share data)**

 
|                                                                                                                                                                                         |   | **December 31,  2002** | ** ** | **June 30,  2003** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|------------|-------------------------|------------|
| **ASSETS**                                                                                                                                                                                   |   |                        | ** ** |                    | ** ** |
|                                                                                                                                                                                         |   |                        |       |                    |       |
| CURRENT  ASSETS:                                                                                                                                                                             |   |                        |       |                    |       |
| Cash  and cash equivalents                                                                                                                                                                   |   | $                           | 196,643    |                    | $          | 160,902 |   |
| Short-term  investments                                                                                                                                                                      |   | 71,249                      |       | 120,325                 |       |
| Accounts  receivable – net                                                                                                                                                              |   | 52,341                      |       | 59,119                  |       |
| Inventories                                                                                                                                                                                  |   | 100,119                     |       | 95,485                  |       |
| Deferred income taxes                                                                                                                                                                        |   | 20,041                      |       | 20,060                  |       |
| Income  taxes receivable                                                                                                                                                                     |   | —                      |       | 2,798                   |       |
| Prepaid  expenses and other assets                                                                                                                                                           |   | 6,029                       |       | 4,532                   |       |
| Total  current assets                                                                                                                                                                        |   | 446,422                     |       | 463,221                 |       |
|                                                                                                                                                                                         |   |                        |       |                    |       |
| PROPERTY  AND EQUIPMENT – NET                                                                                                                                                           |   | 112,209                     |       | 137,331                 |       |
| LONG-TERM  INVESTMENTS                                                                                                                                                                       |   | 159,029                     |       | 92,634                  |       |
| DEFERRED  INCOME TAXES                                                                                                                                                                       |   | 20,553                      |       | 20,390                  |       |
| GOODWILL  – NET                                                                                                                                                                         |   | 10,597                      |       | 10,597                  |       |
| INTANGIBLE  ASSETS – NET                                                                                                                                                                |   | 8,565                       |       | 7,840                   |       |
| OTHER  ASSETS                                                                                                                                                                                |   | 9,512                       |       | 9,158                   |       |
|                                                                                                                                                                                         |   |                        |       |                    |       |
| TOTAL  ASSETS                                                                                                                                                                                |   | $                           | 766,887    |                    | $          | 741,171 |   |
|                                                                                                                                                                                         |   |                        |       |                    |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                |   |                        |       |                    |       |
|                                                                                                                                                                                         |   |                        |       |                    |       |
| CURRENT  LIABILITIES:                                                                                                                                                                        |   |                        |       |                    |       |
| Accounts  payable                                                                                                                                                                            |   | $                           | 26,499     |                    | $          | 15,256 |   |
| Accrued  warranty and installation                                                                                                                                                           |   | 30,078                      |       | 26,166                  |       |
| Accrued  payroll and benefits                                                                                                                                                                |   | 7,334                       |       | 8,271                   |       |
| Foreign  currency forward exchange contracts                                                                                                                                                 |   | 907                         |       | 568                     |       |
| Accrued  interest                                                                                                                                                                            |   | 3,300                       |       | 3,260                   |       |
| Income  taxes payable                                                                                                                                                                        |   | 11,321                      |       | —                  |       |
| Revolving  loan                                                                                                                                                                              |   | 6,667                       |       | —                  |       |
| Accrued  and other current liabilities                                                                                                                                                       |   | 9,189                       |       | 9,739                   |       |
| Total  current liabilities                                                                                                                                                                   |   | 95,295                      |       | 63,260                  |       |
|                                                                                                                                                                                         |   |                        |       |                    |       |
| CONVERTIBLE SUBORDINATED NOTES                                                                                                                                                               |   | 250,000                     |       | 250,000                 |       |
| OTHER LIABILITIES                                                                                                                                                                            |   | 5,154                       |       | 5,448                   |       |
| MINORITY INTEREST                                                                                                                                                                            |   | 4,104                       |       | 4,584                   |       |
|                                                                                                                                                                                         |   |                        |       |                    |       |
| COMMITMENTS  AND CONTINGENCIES                                                                                                                                                               |   |                        |       |                    |       |
|                                                                                                                                                                                         |   |                        |       |                    |       |
| STOCKHOLDERS’  EQUITY:                                                                                                                                                                  |   |                        |       |                    |       |
| Preferred stock – authorized 5,000,000 shares; $.001  par value, no shares issued or outstanding                                                                                        |   | —                      |       | —                  |       |
| Common  stock – $.001 par value per share; 100,000,000 shares authorized; 34,227,000  and 34,863,000 shares outstanding at December 31, 2002 and June 30,  2003, respectively |   | 34                          |       | 35                      |       |
| Additional  paid-in capital                                                                                                                                                                  |   | 302,501                     |       | 314,334                 |       |
| Unearned  compensation                                                                                                                                                                       |   | (2,358                      | )          | (328                    | )          |
| Accumulated  other comprehensive loss                                                                                                                                                        |   | (3,429                      | )          | (3,193                  | )          |
| Retained  earnings                                                                                                                                                                           |   | 115,586                     |       | 107,031                 |       |
| Total  stockholders’ equity                                                                                                                                                             |   | 412,334                     |       | 417,879                 |       |
|                                                                                                                                                                                         |   |                        |       |                    |       |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                             |   | $                           | 766,887    |                    | $          | 741,171 |   |

 

See Notes toUnaudited Consolidated Financial Statements.

 

3

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**CYMER,INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS(UNAUDITED)**

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

 
|                                                                       |   | **For the  three months  ended June 30,** | ** ** | **For the  six months  ended June 30,** | ** ** |
|----------------------------------------------------------------------------|--------|------------------------------------------------|------------|----------------------------------------------|------------|
|                                                                       |   | **2002**                                       |       | **2003**                                     | ** ** | **2002** | ** ** | **2003** | ** ** |
| REVENUES:                                                                  |   |                                           |       |                                         |       |   |   |   |   |
| Product  sales                                                             |   | $                                              | 73,053     |                                         | $          | 62,177 |   | $ | 134,502 |   | $ | 129,513 |   |
| Other                                                                      |   | 616                                            |       | 239                                          |       | 1,150 |   | 502 |   |
| Total  revenues                                                            |   | 73,669                                         |       | 62,416                                       |       | 135,652 |   | 130,015 |   |
|                                                                       |   |                                           |       |                                         |       |   |   |   |   |
| COSTS  AND EXPENSES:                                                       |   |                                           |       |                                         |       |   |   |   |   |
| Cost  of product sales                                                     |   | 37,835                                         |       | 52,031                                       |       | 70,315 |   | 94,901 |   |
| Research  and development                                                  |   | 18,010                                         |       | 16,311                                       |       | 32,996 |   | 33,835 |   |
| Sales  and marketing                                                       |   | 4,158                                          |       | 4,461                                        |       | 7,842 |   | 8,555 |   |
| General  and administrative                                                |   | 4,361                                          |       | 6,547                                        |       | 8,047 |   | 12,320 |   |
| Amortization  of intangibles                                               |   | 40                                             |       | 40                                           |       | 80 |   | 80 |   |
| Loss  on debt extinguishment                                               |   | —                                         |       | —                                       |       | 163 |   | — |   |
|                                                                       |   |                                           |       |                                         |       |   |   |   |   |
| Total  costs and expenses                                                  |   | 64,404                                         |       | 79,390                                       |       | 119,443 |   | 149,691 |   |
|                                                                       |   |                                           |       |                                         |       |   |   |   |   |
| OPERATING  INCOME (LOSS)                                                   |   | 9,265                                          |       | (16,974                                      | )          | 16,209 |   | (19,676 | ) |
|                                                                       |   |                                           |       |                                         |       |   |   |   |   |
| OTHER  INCOME (EXPENSE):                                                   |   |                                           |       |                                         |       |   |   |   |   |
| Foreign  currency exchange gain (loss) – net                          |   | (37                                            | )          | (57                                          | )          | 120 |   | (417 | ) |
| Interest and other income                                                  |   | 2,655                                          |       | 2,397                                        |       | 4,611 |   | 4,886 |   |
| Interest  and other expense                                                |   | (2,588                                         | )          | (2,505                                       | )          | (5,941 | ) | (4,980 | ) |
|                                                                       |   |                                           |       |                                         |       |   |   |   |   |
| Total  other income (expense) – net                                   |   | 30                                             |       | (165                                         | )          | (1,210 | ) | (511 | ) |
|                                                                       |   |                                           |       |                                         |       |   |   |   |   |
| INCOME  (LOSS) BEFORE INCOME TAX PROVISION (BENEFIT) AND MINORITY INTEREST |   | 9,295                                          |       | (17,139                                      | )          | 14,999 |   | (20,187 | ) |
|                                                                       |   |                                           |       |                                         |       |   |   |   |   |
| INCOME  TAX PROVISION (BENEFIT)                                            |   | 2,509                                          |       | (12,112                                      | )          | 4,093 |   | (12,112 | ) |
| MINORITY  INTEREST                                                         |   | (236                                           | )          | (166                                         | )          | (268 | ) | (480 | ) |
|                                                                       |   |                                           |       |                                         |       |   |   |   |   |
| NET INCOME (LOSS)                                                          |   | $                                              | 6,550      |                                         | $          | (5,193 | ) | $ | 10,638 |   | $ | (8,555 | ) |
|                                                                       |   |                                           |       |                                         |       |   |   |   |   |
| EARNINGS  (LOSS) PER SHARE:                                                |   |                                           |       |                                         |       |   |   |   |   |
| Basic  earnings (loss) per share                                           |   | $                                              | 0.19       |                                         | $          | (0.15 | ) | $ | 0.33 |   | $ | (0.25 | ) |
| Weighted  average common shares outstanding - basic                        |   | 33,846                                         |       | 34,577                                       |       | 32,571 |   | 34,443 |   |
|                                                                       |   |                                           |       |                                         |       |   |   |   |   |
| Diluted  earnings (loss) per share                                         |   | $                                              | 0.18       |                                         | $          | (0.15 | ) | $ | 0.31 |   | $ | (0.25 | ) |
| Weighted  average common shares outstanding - diluted                      |   | 35,934                                         |       | 34,577                                       |       | 34,554 |   | 34,443 |   |

 

See Notes toUnaudited Consolidated Financial Statements.

 

4

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**CYMER,INC.**

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

**(Inthousands)**

 
|                                                                                                 |   | **For the  six months ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------|--------|----------------------------------------------|------------|
|                                                                                                 |   | **2002**                                     |       | **2003** | ** ** |
|                                                                                                 |   |                                         |       |   |   |
| OPERATING  ACTIVITIES:                                                                               |   |                                         |       |   |   |
| Net  income (loss)                                                                                   |   | $                                            | 10,638     |   | $ | (8,555 | ) |
| Adjustments  to reconcile net income (loss) to net cash provided by (used in) operating  activities: |   |                                         |       |   |   |
| Loss  on debt extinguishment                                                                         |   | 163                                          |       | — |   |
| Depreciation  and amortization                                                                       |   | 12,254                                       |       | 16,617 |   |
| Non-cash  stock-based compensation                                                                   |   | —                                       |       | 804 |   |
| Amortization  of unearned compensation                                                               |   | 555                                          |       | 555 |   |
| Minority  interest                                                                                   |   | 268                                          |       | 480 |   |
| Provision  for deferred income taxes                                                                 |   | 39                                           |       | (21 | ) |
| Loss  on disposal or impairment of property and equipment                                            |   | 324                                          |       | 2,036 |   |
| Change  in assets and liabilities:                                                                   |   |                                         |       |   |   |
| Accounts  receivable – net                                                                      |   | (13,692                                      | )          | (6,778 | ) |
| Income  taxes receivable                                                                             |   | 3,039                                        |       | (2,798 | ) |
| Foreign  currency forward exchange contracts                                                         |   | 3,200                                        |       | 212 |   |
| Inventories                                                                                          |   | (23,016                                      | )          | 4,634 |   |
| Prepaid  expenses and other assets                                                                   |   | (1,231                                       | )          | 1,216 |   |
| Accounts  payable                                                                                    |   | 4,773                                        |       | (11,243 | ) |
| Accrued  and other liabilities                                                                       |   | 5,162                                        |       | (1,965 | ) |
| Income  taxes payable                                                                                |   | 1,927                                        |       | (11,321 | ) |
|                                                                                                 |   |                                         |       |   |   |
| Net  cash provided by (used in) operating activities                                                 |   | 4,403                                        |       | (16,127 | ) |
|                                                                                                 |   |                                         |       |   |   |
| INVESTING  ACTIVITIES:                                                                               |   |                                         |       |   |   |
| Acquisition  of property and equipment                                                               |   | (10,681                                      | )          | (42,415 | ) |
| Purchases  of investments                                                                            |   | (219,233                                     | )          | (53,101 | ) |
| Proceeds  from sold or matured investments                                                           |   | 55,382                                       |       | 70,485 |   |
| Acquisition  of minority interest                                                                    |   | (360                                         | )          | (180 | ) |
|                                                                                                 |   |                                         |       |   |   |
| Net  cash used in investing activities                                                               |   | (174,892                                     | )          | (25,211 | ) |
|                                                                                                 |   |                                         |       |   |   |
| FINANCING  ACTIVITIES:                                                                               |   |                                         |       |   |   |
| Net  repayments under revolving loan and security agreements                                         |   | (44                                          | )          | (6,667 | ) |
| Proceeds  from issuance of common stock                                                              |   | 17,958                                       |       | 12,505 |   |
| Redemption  of convertible subordinated notes                                                        |   | (39,598                                      | )          | — |   |
| Issuance  of convertible subordinated notes                                                          |   | 250,000                                      |       | — |   |
| Issuance  of convertible subordinated notes offering costs                                           |   | (7,870                                       | )          | — |   |
| Payments  on capital lease obligations                                                               |   | (16                                          | )          | (26 | ) |
|                                                                                                 |   |                                         |       |   |   |
| Net  cash provided by financing activities                                                           |   | 220,430                                      |       | 5,812 |   |
|                                                                                                 |   |                                         |       |   |   |
| EFFECT  OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS                                        |   | 579                                          |       | (215 | ) |
|                                                                                                 |   |                                         |       |   |   |
| NET  INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                                |   | 50,520                                       |       | (35,741 | ) |
| CASH  AND CASH EQUIVALENTS AT BEGINNING OF PERIOD                                                    |   | 111,195                                      |       | 196,643 |   |
|                                                                                                 |   |                                         |       |   |   |
| CASH  AND CASH EQUIVALENTS AT END OF PERIOD                                                          |   | $                                            | 161,715    |   | $ | 160,902 |   |

 

5

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|                                                                                                             |   | **For the six months ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------|------------|
|                                                                                                             |   | **2002**                                    |       | **2003** | ** ** |
|                                                                                                             |   |                                        |       |   |   |
| SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION:                                                               |   |                                        |       |   |   |
| Interest  paid                                                                                                   |   | $                                           | 5,854      |   | $ | 4,509 |   |
| Income  taxes paid (refunded), net                                                                               |   | $                                           | (903       | ) | $ | 2,194 |   |
|                                                                                                             |   |                                        |       |   |   |
| SUPPLEMENTAL  DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:                                         |   |                                        |       |   |   |
| Conversion  of subordinated notes to equity                                                                      |   | $                                           | 112,998    |   | $ | — |   |
| Reversal  of unearned compensation related to cancelled stock options previously issued  for the ACX acquisition |   | $                                           | —     |   | $ | 1,475 |   |

 

See Notes to Unaudited Consolidated Financial Statements.

 

6

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**CYMER,INC.**

 

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**Threeand Six Months Ended June 30, 2003**

**(Unaudited)**

 

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

 

*UnauditedInterim Financial Data* –The accompanying consolidatedfinancial information has been prepared by Cymer, Inc., and its wholly-ownedand majority-owned subsidiaries (collectively, “Cymer”), without audit, in accordancewith the instructions to Form 10-Q.  Inthe opinion of management, the unaudited consolidated financial statements forthe interim periods presented reflect all material adjustments, consisting onlyof normal recurring adjustments, necessary for a fair presentation of thefinancial position and results of operations as of and for such periodsindicated.  These consolidated financialstatements and notes hereto should be read in conjunction with the consolidatedfinancial statements and notes thereto included in Cymer’s Annual Report onForm 10-K for the year ended December 31, 2002.  Results for the interim periods presented herein are notnecessarily indicative of results which may be reported for any other interimperiod or for the entire fiscal year.

 

*Principlesof Consolidation* – The consolidated financial statementsinclude the accounts of Cymer, Inc., its wholly-owned subsidiaries – CymerJapan, Inc. (“Cymer Japan”), Cymer Singapore Pte Ltd. (“Cymer Singapore”),Cymer B.V. in the Netherlands (“Cymer B.V.”), Cymer Southeast Asia, Inc., inTaiwan (“Cymer SEA”),  CymerSemiconductor Equipment Shanghai Co., Ltd, in the People’s Republic of China(“Cymer PRC”), and its majority-owned subsidiary, Cymer Korea, Inc. (“CymerKorea”).  Cymer, Inc. owns 75% of CymerKorea.  During 2002, Cymer Boston(formerly known as Active Control eXperts, Inc. or ACX) was a wholly-ownedsubsidiary of Cymer, Inc.  EffectiveJanuary 1, 2003, Cymer Boston was merged with and into Cymer, Inc.  Cymer sells its excimer light sources inJapan primarily through Cymer Japan. Cymer SEA, Cymer PRC, Cymer Singapore andCymer B.V. are field service offices for customers in those respectiveregions.  Cymer Korea providesmanufacturing, refurbishment, field service, and administrative activities forthat region.  All significantintercompany balances have been eliminated in consolidation.

 

*Accounting Estimates*– The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting period. Actual results may differ from those estimates.

 

*Reclassifications–*Certain amounts in the prior year consolidated financialstatements have been reclassified to conform to current period presentation.

 

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

 

7

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normal use of the asset. This standard is effective for fiscal yearsbeginning after June 15, 2002. Cymer has determined that the adoption ofthis statement did not have an impact on its financial condition or results ofoperations.

 

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

 

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

 

Cymeradopted the initial recognition and measurement provisions of FinancialAccounting Standards Board (“FASB”) Interpretation No. 45 (“FIN 45”),“Guarantor’s Accounting and Disclosure Requirements for Guarantees, IncludingIndirect Guarantees of Indebtedness of Others”, on January 1, 2003, whichapply on a prospective basis to guarantees issued or modified afterDecember 31, 2002. We adopted the disclosure provisions of FIN 45 duringthe quarter ended December 31, 2002. In the ordinary course of business, Cymer is not subject to potentialobligations under guarantees that fall within the scope of FIN 45 except forwarranty provisions, intellectual property indemnification clauses that arecontained within many of our customer agreements and third-party bankguarantees that we had with one of our subsidiaries until June 2003.  All these provisions give rise only to thedisclosure requirements prescribed by FIN 45.

 

Cymer adopted theinterim disclosure provisions of Statement of Accounting Standards No. 148,“Accounting for Stock-Based Compensation - Transition and Disclosure”, duringthe quarter ended June 30, 2003. Related interim disclosures are included in footnote 2.

 

**2.****              STOCK-BASEDCOMPENSATION**

 

Cymer applies the intrinsic value-based method ofaccounting prescribed by Accounting Principles Board (“APB”) Opinion No. 25,“Accounting for Stock Issued to Employees”, and related interpretationsincluding Financial Accounting Standards Board (“FASB”) Interpretation No. 44,“Accounting for Certain Transactions involving Stock Compensation aninterpretation of APB Opinion No. 25”**toaccount for its stock option plans. Under this method, employee-based stock compensation expense is measuredon the date of grant only if the then current market price of the underlyingstock exceeded the exercise price and is recorded on a straight-line basis overthe applicable vesting period. FASB Statement of Financial Accounting StandardsNo. 123 (“SFAS No. 123”), “Accounting for Stock-Based Compensation”*,* established accounting and disclosure requirementsusing a fair value-based method of accounting for stock-based employeecompensation plans.  As allowedby SFAS No. 123, Cymer has elected to continue to apply the intrinsicvalue-based method of accounting described above, and has adopted the disclosurerequirements of SFAS No. 123, as amended by SFAS No. 148, “Accounting forStock-Based Compensation—Transition and Disclosure”*.*

 

All options granted under the plans had an exerciseprice equal to the market value of the underlying common stock on the date ofgrant.

 

8

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

 
|                                                                                                                                              |   | **Three  months ended  June 30,** | ** ** | **Six months  ended  June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------|------------|--------------------------------------|------------|
|                                                                                                                                              |   | **2002**                               |       | **2003**                             | ** ** | **2002** | ** ** | **2003** | ** ** |
|                                                                                                                                              |   |                                   |       |                                 |       |   |   |   |   |
| Net income (loss), as reported                                                                                                                    |   | $                                      | 6,550      |                                 | $          | (5,193 | ) | $ | 10,638 |   | $ | (8,555 | ) |
| Deduct: Total stock-based employee compensation  expense determined under the fair value based method for all awards, net of  related tax effects |   | (7,877                                 | )          | 2,255                                |       | (16,064 | ) | (5,998 | ) |
|                                                                                                                                              |   |                                   |       |                                 |       |   |   |   |   |
| Pro forma net loss                                                                                                                                |   | $                                      | (1,327     | )                                    | $          | (2,938 | ) | $ | (5,426 | ) | $ | (14,553 | ) |
|                                                                                                                                              |   |                                   |       |                                 |       |   |   |   |   |
| Earnings (loss) per share:                                                                                                                        |   |                                   |       |                                 |       |   |   |   |   |
| Basic – as reported                                                                                                                          |   | $                                      | 0.19       |                                 | $          | (0.15 | ) | $ | 0.33 |   | $ | (0.25 | ) |
| Basic – pro forma                                                                                                                            |   | $                                      | (0.04      | )                                    | $          | (0.08 | ) | $ | (0.17 | ) | $ | (0.42 | ) |
|                                                                                                                                              |   |                                   |       |                                 |       |   |   |   |   |
| Diluted – as reported                                                                                                                        |   | $                                      | 0.18       |                                 | $          | (0.15 | ) | $ | 0.31 |   | $ | (0.25 | ) |
| Diluted – pro forma                                                                                                                          |   | $                                      | (0.04      | )                                    | $          | (0.08 | ) | $ | (0.17 | ) | $ | (0.42 | ) |

 

**3.****              EARNINGS (LOSS) PERSHARE**

 

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

 

The followingtable sets forth the computation of diluted weighted average common andpotential common shares outstanding for the three and six months endedJune 30, 2002 and 2003 (in thousands):

 
|                                                 |   | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|------------------------------------------------------|--------|---------------------------------------|------------|-------------------------------------|------------|
|                                                 |   | **2002**                              |       | **2003**                            | ** ** | **2002** | ** ** | **2003** | ** ** |
|                                                 |   |                                  | ** ** |                                | ** ** |   | ** ** |   | ** ** |
| Weighted average common shares outstanding - basic   |   | 33,846                                |       | 34,577                              |       | 32,571 |   | 34,443 |   |
|                                                 |   |                                  |       |                                |       |   |   |   |   |
| Effect of dilutive securities:                       |   |                                  |       |                                |       |   |   |   |   |
| Warrants                                             |   | 60                                    |       | —                              |       | 51 |   | — |   |
| Options                                              |   | 2,028                                 |       | —                              |       | 1,932 |   | — |   |
|                                                 |   |                                  |       |                                |       |   |   |   |   |
| Weighted average common shares outstanding - diluted |   | 35,934                                |       | 34,577                              |       | 34,554 |   | 34,443 |   |

 

For the threemonths ended June 30, 2002 and 2003, weighted average options and warrantsto purchase 453,000 and 3,893,000 shares of common stock, respectively, were

 

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outstanding but not included in the computation of diluted earnings pershare as their effect was anti-dilutive. In addition, for the three months ended June 30, 2002 and 2003,weighted average common shares attributable to convertible subordinated notesof 5,000,000 were not included in the calculation of diluted earnings per shareas their effect was also anti-dilutive.

 

For the six monthsended June 30, 2002 and 2003, weighted average options and warrants topurchase 450,000 and 3,825,000 shares of common stock, respectively, wereoutstanding but not included in the computation of diluted earnings per shareas their effect was anti-dilutive.  Inaddition, for the six months ended June 30, 2002 and 2003, weightedaverage common shares attributable to convertible subordinated notes of5,155,860 and 5,000,000, respectively, were not included in the calculation ofdiluted earnings per share as their effect was also anti-dilutive.

 

**4.****              INVENTORIES**

 

Inventoriesconsist of the following as of December 31, 2002 and June 30, 2003(in thousands):

 
|                                         |   | **December 31,  2002** |    | **June 30,  2003** | ** ** |
|----------------------------------------------|--------|-----------------------------|---------|-------------------------|------------|
| INVENTORIES:                                 |   |                        |    |                    |       |
| Raw  materials                               |   | $                           | 44,252  |                    | $          | 42,062 |   |
| Work-in-progress                             |   | 32,718                      |    | 27,922                  |       |
| Finished  goods                              |   | 37,849                      |    | 39,594                  |       |
| Allowance  for excess and obsolete inventory |   | (14,700                     | )       | (14,093                 | )          |
| Total                                        |   | $                           | 100,119 |                    | $          | 95,485 |   |

 

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

 

Comprehensive incomeincludes net income (loss), effective unrealized gains and losses on foreigncurrency forward exchange contracts, foreign currency translation adjustments,and unrealized gains and losses on available-for-sale securities, which arerecorded as short-term and long-term investments in the accompanyingconsolidated balance sheets.

 

Thefollowing table summarizes the change in each component of accumulated othercomprehensive loss for the six months ended June 30, 2003 (in thousands):

 
|                   |   |              |       | **Translation  adjustment,  net of tax** |       | **Total  unrealized  gains on  available-for-sale  investments,  net of tax** | ** ** | **Total  unrealized  gains (losses on)  foreign currency  forward exchange  contracts, net of tax** | ** ** | **Accumulated  other  comprehensive  loss** | ** ** |
|------------------------|--------|-------------------|------------|------------------------------------------|------------|-------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
|                   |   |              | ** ** |                                     | ** ** |                                                                          | ** ** |                                                                                                | ** ** |                                        | ** ** |
| December 31, 2002 |   | Balance           |       | $                                        | (5,272     | )                                                                             | $          | 2,342                                                                                               |       | $                                           | (499       | ) | $ | (3,429 | ) |
|                   |   | Period net change |       | (127                                     | )          | 39                                                                            |       | 324                                                                                                 |       | 236                                         |       |
| June 30, 2003     |   | Balance           |       | $                                        | (5,399     | )                                                                             | $          | 2,381                                                                                               |       | $                                           | (175       | ) | $ | (3,193 | ) |

 

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

 

As ofthe date of adoption of Statement of Financial Accounting Standards No. 142(“SFAS No. 142”), “Goodwill and Other Intangible Assets” on January 1,2002, Cymer had unamortized goodwill in the amount of $9.8 million andunamortized identifiable intangible assets, excluding acquired patents, in theamount of $1.1 million, all of which were subject to the transition provisionsof SFAS No. 142.

 

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As of December 31, 2002 and June 30, 2003, the components ofintangible assets acquired in prior purchase business combinations were asfollows (in thousands):

 
|                                  |   | **December 31,  2002** |       | **June 30,  2003**       |       |
|---------------------------------------|--------|-----------------------------|------------|-------------------------------|------------|
|                                  |   | **Gross  Carrying  Amount** |       | **Accumulated  Amortization** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
|                                  |   |                        | ** ** |                          | ** ** |   | ** ** |   | ** ** |
| Amortized intangible assets:          |   |                        |       |                          |       |   |   |   |   |
| Existing technology - ACX acquisition |   | $640                        |       | $300                          |       | $640 |   | $380 |   |
|                                  |   |                        |       |                          |       |   |   |   |   |
| Unamortized intangible  assets:       |   |                        |       |                          |       |   |   |   |   |
| Goodwill                              |   | $13,713                     |       | $3,116                        |       | $13,713 |   | $3,116 |   |

 

The above table only includes intangible assets associated with priorpurchase business combinations.  Alsoincluded in intangible assets – net on the accompanying balance sheets areamounts associated with patents which were acquired in 2001.  As of December 31, 2002 andJune 30, 2003, the net carrying amount of these patents was $8.2 millionand $7.6 million, respectively.

 

Aggregate amortizationexpense was $80,000 for each of  the sixmonths ended June 30, 2002 and 2003. As of June 30, 2003, future estimated amortization expense isexpected to be as follows (in thousands):

 

|                                     |   | **Future  Amortization** |       |
|------------------------------------------|--------|--------------------------|------------|
|                                     |   |                     | ** ** |
| Six months ended  December 31, 2003 |   | $                        | 80         |   |
| Year ended  December 31, 2004       |   | $                        | 160        |   |
| Year ended  December 31, 2005       |   | $                        | 20         |   |

 

**7.****              GUARANTEES**

 

Cymeradopted the disclosure provisions of FIN 45 during the quarter endedDecember 31, 2002 and has adopted the recognition and measurementprovisions as required after December 31, 2002.  FIN No. 45 provides expanded accounting guidance surroundingliability recognition and disclosure requirements related to guarantees, asdefined by this interpretation.

 

In theordinary course of business, Cymer is not subject to potential obligationsunder guarantees that fall within the scope of FIN No. 45, except forstandard warranty provisions associated with product sales, indemnificationprovisions related to intellectual property that are contained within many ofits customer agreements, and third-party bank guarantees for subsidiary officelines of credit.  All of theseprovisions give rise only to the disclosure requirements prescribed by FIN No.45.

 

*Product Warranties*– Warranty provisions contained within Cymer’s customer agreements aregenerally consistent with those prevalent in the semiconductor equipmentindustry. The warranty period and terms vary by light source model.  In general, the light source system warrantyperiod ranges from 17 to 26 months after shipment.  Cymer also warrants consumables and spare parts sold to itscustomers and the coverage period varies by spare part type as some typesinclude time-based warranty periods and others include usage-based warrantyperiods.  On average, the warrantyperiod for consumables and spare parts is approximately 6 months from the dateof shipment.  Cymer records a provisionfor warranty for all products, which is included in cost of product sales inthe consolidated statements of operations and is recorded at the time that therelated revenue is recognized. The warranty provision for light source systemsis determined by using a financial model, which takes into consideration actualhistorical expenses, and potential risks associated with Cymer’s differentlight source system

 

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models. This financial model is then used to calculate the futureprobable expenses related to warranty and the required level of the warrantyprovision.  The risk levels used withinthis model are reviewed and updated as risk levels change by model over itsproduct life cycle. The warranty provision for consumables and spares isdetermined by using actual historical data. For both light source systems and spares, if actual warrantyexpenditures differ substantially from Cymer’s estimates, revisions to thewarranty provision would be required. Actual warranty expenditures are recorded against the warranty provisionas they are incurred.

 

Thefollowing table summarizes information related to Cymer’s warranty provisionfor the six months ended June 30, 2003 (in thousands):

 

| Balance,  January 1, 2003                                                                    |   | $      | 29,600 |   |
|---------------------------------------------------------------------------------------------------|--------|--------|--------|--------|
| Liabilities  accrued for warranties issued during the period, net of adjustments and  expirations |   | 4,310  | (1)    |
| Warranty  expenditures incurred during the period                                                 |   | (8,160 | )      |
| Balance,  June 30, 2003                                                                      |   | $      | 25,750 |   |

 

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(1)  Included in this amount are adjustments toexisting warranty reserves as a result of normal recurring updates made to therisk factors used in the warranty model during the first quarter of 2003.

 

*Intellectual Property Indemnifications* –Cymer includes intellectual property indemnification clauses within its generalterms and conditions with its customers and the general purchase agreementswith its three major customers, ASM Lithography, Canon, and Nikon.  In general, these indemnification provisionsprovide that Cymer will defend its customers against any infringement claimsthat arise related to Cymer’s patents. Under the indemnification clauses, Cymer will pay all costs and damages,including attorney’s fees, associated with such settlements or defenses,provided that the customer follows specific procedures for notifying Cymer ofsuch claims and allows Cymer to manage the settlement proceedings. Due to thenature of these indemnification provisions, they are indefinite and extendbeyond the term of the actual customer agreements.

 

An indemnificationprovision is also included in the contract manufacturing agreement with Seiko,which was terminated effective March 31, 2003.  As with Cymer’s indemnification provisions on intellectualproperty, Cymer will continue to honor this indemnification clause within theagreement even after its termination. Seiko and at least one Japanese customerhave been notified that Cymer’s light source systems in Japan may infringecertain Japanese patents.  Cymerbelieves, based upon the advice of counsel, that Cymer’s products do notinfringe any valid claim of the asserted patents or that it is entitled toprior use claims in Japan.

 

*Guaranteeson Subsidiary Debt*– During the first quarter of 2003 andpart of the second quarter of 2003, Cymer was party to a Parent Guaranteeassociated with a revolving Loan Agreement held by Cymer Japan. This guaranteewas between a commercial bank in the United States and Cymer.  The Parent Guarantee was entered into in2001 in order to establish a banking relationship between this commercial bankand Cymer Japan.  Per the terms of theParent Guarantee, Cymer guaranteed payment of any obligations under therevolving loan agreement in the event that Cymer Japan could not make suchpayments due or defaults on the loan. Cymer Japan made all payments per the terms of the Loan Agreement andthus, Cymer did not incur any guarantor obligations under the ParentGuarantee.  Since Cymer Japan is awholly-owned subsidiary of Cymer and Cymer Japan records the revolving loanoutstanding balance as a liability on its financial statements, the carryingamount of the liability is included in the consolidated balance sheets.  The Loan Agreement expired on June 16,2003 and was paid in full by Cymer Japan. The Loan Agreement was not renewed onthis expiration date.

 

**8.****              CONTINGENCIES ANDCOMMITMENTS**

 

Cymer is party to legal actions in the normal courseof business.  Based in part on theadvice of legal counsel, management does not expect the outcome of legal actionin the normal

 

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course of business to have a material impact on the financial positionor results of operations of Cymer.

 

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

 

In July 2002, Cymerentered into an agreement with a contractor for the construction of a 265,000square foot building adjacent to its corporate headquarters located in SanDiego, California. The construction of the manufacturing and office facilitywill be completed in multiple phases; currently scheduled to be completed bythe end of the third quarter of 2003. Cymer will finance the cost of the construction project, which isestimated to be approximately $50 million, using existing capital.  Total capital expenditures for thisconstruction project to date total approximately $44.7 million.

 

**ITEM 2.****     Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

 

*Statementsin this quarterly report on Form 10-Q that are not strictly historical innature are forward-looking statements. These statements include, but are not limited to, references tomanufacturing activities; expected product sales and development; service andsupport; research and development expenditures; expected product development;expected international product sales, development and revenue; adequacy ofcapital resources and investments; effects of business cycles in thesemiconductor business; competitive positioning; and continuing relationshipswith third-party manufacturers for product manufacturing, and may contain wordssuch as “believes,” “anticipates,” “expects,” and words of similar import.  These statements are only predictions basedon current information and expectations and involve a number of risks anduncertainties.  The underlyinginformation and expectations are likely to change over time.  Actual events or results may differ materiallyfrom those projected in the forward-looking statements due to various factors,including, but not limited to, those set forth in this Item 2 and under thecaption  “Risks and Uncertainties ThatMay Affect Results”  and  elsewhere in this quarterly report on Form10-Q.*

 

*Thefollowing discussion of the financial condition and results of operations ofCymer should be read in conjunction with Cymer’s consolidated financialstatements and notes thereto included in this quarterly report on Form 10-Q andits consolidated financial statements and notes thereto included in Cymer’sannual report on Form 10-K for the year ended December 31, 2002.*

 

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**RESULTSOF OPERATIONS**

 

The following table sets forth certain items inCymer’s consolidated statements of operations as a percentage of total revenuesfor the periods indicated:

 
|                                                             |   | **Three  months ended  June 30,** | ** ** | **Six months  ended  June 30,** | ** ** |
|------------------------------------------------------------------|--------|----------------------------------------|------------|--------------------------------------|------------|
|                                                             |   | **2002**                               |       | **2003**                             | ** ** | **2002** | ** ** | **2003** | ** ** |
|                                                             |   |                                   | ** ** |                                 | ** ** |   | ** ** |   | ** ** |
| Revenues:                                                        |   |                                   |       |                                 |       |   |   |   |   |
| Product sales                                                    |   | 99.2                                   | %          | 99.6                                 | %          | 99.1 | % | 99.6 | % |
| Other                                                            |   | .8                                     |       | .4                                   |       | .9 |   | .4 |   |
| Total revenues                                                   |   | 100.0                                  | %          | 100.0                                | %          | 100.0 | % | 100.0 | % |
|                                                             |   |                                   |       |                                 |       |   |   |   |   |
| Cost  and expenses:                                              |   |                                   |       |                                 |       |   |   |   |   |
| Cost  of product sales                                           |   | 51.4                                   |       | 83.4                                 |       | 51.8 |   | 73.0 |   |
| Research  and development                                        |   | 24.5                                   |       | 26.1                                 |       | 24.3 |   | 26.0 |   |
| Sales  and marketing                                             |   | 5.6                                    |       | 7.1                                  |       | 5.8 |   | 6.6 |   |
| General  and administrative                                      |   | 5.9                                    |       | 10.5                                 |       | 5.9 |   | 9.4 |   |
| Amortization  of goodwill and intangible assets                  |   | —                                 |       | .1                                   |       | .1 |   | .1 |   |
| Loss  on debt extinguishment                                     |   | —                                 |       | —                               |       | .2 |   | — |   |
| Total  costs and expenses                                        |   | 87.4                                   |       | 127.2                                |       | 88.1 |   | 115.1 |   |
|                                                             |   |                                   |       |                                 |       |   |   |   |   |
| Operating  income (loss)                                         |   | 12.6                                   |       | (27.2                                | )          | 11.9 |   | (15.1 | ) |
| Other  expense – net                                        |   | —                                 |       | (.3                                  | )          | (.9 | ) | (.4 | ) |
|                                                             |   |                                   |       |                                 |       |   |   |   |   |
| Income  (loss) before income tax provision and minority interest |   | 12.6                                   |       | (27.5                                | )          | 11.0 |   | (15.5 | ) |
|                                                             |   |                                   |       |                                 |       |   |   |   |   |
| Income  tax provision (benefit)                                  |   | 3.4                                    |       | (19.4                                | )          | 3.0 |   | (9.3 | ) |
| Minority  interest                                               |   | (.3                                    | )          | (.2                                  | )          | (.2 | ) | (.4 | ) |
|                                                             |   |                                   |       |                                 |       |   |   |   |   |
| Net  income (loss)                                               |   | 8.9                                    | %          | (8.3                                 | )%         | 7.8 | % | (6.6 | )% |
| Gross  margin on product sales                                   |   | 48.2                                   | %          | 16.3                                 | %          | 47.7 | % | 26.7 | % |

 

**THREE MONTHS ENDED JUNE 30, 2002AND 2003**

 

*Revenues*.  Cymer’s revenues consist of product sales,which include sales of light source systems, consumable and spare parts,upgrades, service, service contracts, and training. Other revenues includerevenue from funded development activities performed for customers andgovernment contracts and license agreements. Revenue from light source system sales is generally recognized at thetime of shipment, unless customer agreements contain inspection, acceptance orother conditions, in which case revenue is recognized at the time suchconditions are satisfied. Revenue from consumables and spare parts sales isrecognized at the point that legal title passes to the customer, which isgenerally upon shipment from the Cymer facility.  Service and training revenue is generally recognized at the timethat the services are rendered or the training class is completed.  Service contracts revenues are generallyrecorded as revenue ratably over the life of the contract or per the specificterms of the agreement. Funded development contracts are accounted for on thepercentage-of-completion method based on the relationship of costs incurred tototal estimated costs.  If milestones onfunded development contracts require that specific results be achieved orreported by Cymer, revenue is not recognized until that milestone is completed.

 

Product sales decreased 15% from $73.1****million for the three months endedJune 30, 2002 to $62.2 million for the three months ended June 30,2003, primarily due to a 30%, or a

 

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$15.1 million decrease in light source system revenue offset by a 19%,or a $4.2 million increase in consumable and spare parts, service revenue andother non-system product revenue from period to period.  This total non-system revenue was $22.0million or 30% of revenue for the three months ended June 30, 2002 ascompared to $26.2 million or 42% of revenue for the three months endedJune 30, 2003.  The increase innon-system revenue was due to increased utilization of Cymer’s deep ultraviolet(“DUV”) light sources by chipmakers and an increased installed base in thethree months ended June 30, 2003. The decrease in light source systemrevenue was primarily due to a 56% decrease in the number of light sourcesystem units sold offset by an increase in the average selling price (“ASP”)for light source systems sold.  A totalof 70 light source systems were sold in the three months ended June 30,2002 at an ASP of $729,000, compared to 31 systems sold in the three monthsended June 30, 2003 at an ASP of $1.2 million.  On a foreign currency adjusted basis, the ASP for the threemonths ended June 30, 2002 was $732,000 as compared to $1.1 million forthe three months ended June 30, 2003. This increase in ASPs from period to period primarily reflects the shiftin the product mix in the second quarter of 2003 to Cymer’s most advanced,higher priced XLA 100 light source system, the dual-discharge chamber MasterOscillator Power Amplifier (“MOPA”) design product.  The XLA 100 accounted for 65% of light source systems sold in thethree months ended June 30, 2003. Revenues from funded development projects were $616,000 and $239,000 forthe three months ended June 30, 2002 and 2003, respectively.

 

Cymer’s backlog atJune 30, 2002 was $107.9 million compared to $100.4 million atJune 30, 2003.  Bookings for thethree months ended June 30, 2002 and June 30, 2003 were $73.8 millionand $59.7 million, respectively.  Thebook-to-bill ratio for the three months ended June 30, 2002 was 1.08compared to 1.06 for the three months ended June 30, 2003.  This decrease in bookings and book-to-billratio was primarily due to reduced orders of light source systems in the secondquarter of 2003 compared to the second quarter of 2002.  

 

Cymer installed 80 lightsources at chipmakers and other end-users during the second quarter of 2002 ascompared to 50 light sources installed during the second quarter of 2003.

 

Cymer’s sales are generated primarily by shipments tocustomers in Japan, the Netherlands, and the United States.  Approximately 92% and 88% of Cymer’s salesfor the three months ended June 30, 2002 and 2003, respectively, werederived from customers outside the United States.  Cymer maintains a wholly-owned Japanese subsidiary, which sellsto Cymer’s Japanese customers.  Revenuesfrom Japanese customers, generated primarily by this subsidiary, accounted for50% of revenues for each of the three months ended June 30, 2002 and 2003.  The activities of Cymer’s Japanese subsidiaryare limited to sales and service of products purchased by the subsidiary fromthe parent corporation.  Cymeranticipates that international sales will continue to account for a significantportion of its net sales.

 

In April 2003, Cymer implemented cost reductionefforts in response to the continued downturn in the semiconductorindustry.  Included in these costreduction activities were a reduction in work force and the write down ofcertain corporate assets. These asset write downs totaled approximately $1.8million.  These activities impacted allareas of the company, and resulted in additional expenses during the secondquarter of 2003.  Cymer expects torealize the benefit from these cost reduction efforts starting in the thirdquarter of 2003.

 

*Cost of Product Sales*.  Cost of product sales includes directmaterial and labor, warranty expenses, license fees, and manufacturing andservice overhead, and foreign exchange gains and losses on foreign currencyforward exchange contracts associated with purchases of Cymer’s products by itsJapanese subsidiary for resale under firm third-party sales commitments.  Although the number of light source systemsrecorded as revenue was lower in the second quarter of 2003 as compared to thesecond quarter of 2002, the cost of product sales increased 38% from $37.8million for the three months ended June 30, 2002 to $52.0 million for thethree months ended June 30, 2003. This increase from period to period is primarily due to the higheroverall costs associated with the introduction of Cymer’s new XL series lightsource system and 

 

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its initial transition to manufacturing in 2003. Also included in thesehigher XL series costs are initial product costs, warranty accruals, andoverall infrastructure building expenses. As a result of these higher product costs, the gross margin on productsales was 16% for the three months ended June 30, 2003 as compared to 48%for the same three-month period in 2002. These lower margins in the second quarter of 2003 also reflectadditional expenses associated with cost reduction efforts which were completedduring the second quarter of 2003. These expenses totaled approximately $4.2million in the manufacturing area and includes increased costs associated withthe reduction in work force and write offs of impaired assets. We anticipatethat the gross margins will moderately increase in the next couple of quartersas a result of improved efficiencies associated with the production of the XLseries light source and the benefits resulting from the cost savings measurestaken in the second quarter of 2003.

 

*Researchand Development*. Research and development expenses include costs of internally-funded andexternally-funded projects as well as continuing research support expenses,which primarily include employee and material costs, depreciation of equipmentand other engineering related costs. Research and development expensesdecreased 9% from $18.0 million for the three months ended June 30, 2002to $16.3 million for the three months ended June 30, 2003, due primarilyto Cymer’s product development efforts associated with the XL series lightsource which uses the MOPA platform. Cymer’s investment in this product washigh in 2002 due to its initial development. This investment has decreased in2003 as the XL series light source transitioned to manufacturing.  Cymer shipped the first light source systemthat utilizes the MOPA platform, the XLA 100, in February 2003.  Cymer also continued to invest in extremeultra violet (“EUV”), Fluorine (“F2”) and Beam Delivery  ("BDU") Unit technology and tofocus on next generation Krypton fluoride (“KrF”) and argon fluoride (“ArF”)products.  As a percentage of totalrevenues, such expenses increased from 24.5% to 26.1%, primarily due to lowerrevenue levels in 2003 compared to 2002. We anticipate R&D spending in absolute dollars and as a percentageof total revenues, will decrease as the XLA 100 completes the final phase oftransition to manufacturing.

 

*Salesand Marketing*. Sales and marketing expenses include theexpenses of the sales, marketing and customer support staff and other marketingexpenses.  Sales and marketing expensesincreased 7% from $4.2 million for the three months ended June 30, 2002 to$4.5 million for the three months ended June 30, 2003, due primarily toincreased costs associated with the reduction in work force and asset writedown which occurred during the second quarter of 2003.  These increased expenses were offset bylower expenses resulting from the movement of various senior members of salesand marketing to general and administrative functions in the last quarter of2002.  As a percentage of totalrevenues, such expenses increased from 5.6% to 7.1% primarily due to the lower revenuelevels in 2003 compared to 2002.

 

*Generaland Administrative*. General and administrative expensesconsist primarily of management and administrative personnel costs,professional services and administrative operating costs.  General and administrative expensesincreased 50% from $4.4 million for the three months ended June 30, 2002to $6.5 million for the three months ended June 30, 2003. During the second quarter of 2003, general andadministrative expenses were significantly increased from the 2002 levels dueto the movement of various senior personnel from sales and marketing to generaland administrative functions in the last quarter of 2002 and increased costsassociated with the headcount reduction and asset write down completed in thesecond quarter of 2003. As a percentage of total revenues, such expensesincreased from 5.9% to 10.5% primarily due to the activities explained aboveand the lower revenue levels in 2003 compared to 2002.

 

*Amortizationof intangible assets. *Amortizationof intangible assets totaled $40,000 for each of the three months endedJune 30, 2002 and 2003.  Thisamortization of intangible assets expense is consistent from period to periodand relates to the existing technology associated with the ACX acquisition,which was completed in early 2001.  Withthe adoption of SFAS 142 on January 1, 2002, Cymer discontinued theamortization of goodwill and intangible assets with indefinite useful livesassociated with previous purchase business combinations.

 

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*OtherIncome (Expense) – Net.* Net other income (expense) consists primarily of interest income andexpense and foreign currency exchange gains and losses associated withfluctuations in the value of the Japanese yen against the United Statesdollar.  Net other income totaled$30,000 for the three months ended June 30, 2002 as compared to a netother expense of $165,000 for the three months ended June 30, 2003.  The change from net other income to netother expense was primarily due to decreased interest income offset by a slightdecrease in interest expense from period to period. The decreased interestincome in the second quarter of 2003 was primarily due to lower average cashand investment balances in the second quarter of 2003 as compared to 2002 as aresult of cash used during 2003 for the continued construction of Cymer’s newmanufacturing and office facility in San Diego.  The decreased interest expense from period to period reflectscapitalization of interest expense associated with the construction of the newfacility recorded in the second quarter of 2003.  Foreign currency exchange losses totaled $37,000, interest incometotaled $2.7 million and interest expense totaled $2.6 million for the threemonths ended June 30, 2002, compared to foreign currency exchange lossesof $57,000, interest income of $2.4 million and interest expense of $2.5million for the three months ended June 30, 2003.

 

*IncomeTax Provision (Benefit)*. The tax provision of $2.5 million and the tax benefit of $12.1 millionfor the three months ended June 30, 2002 and 2003, respectively, reflectan annual effective rate of 27% and 60%, respectively.  Due to the pre-tax loss recorded in thefirst half of 2003, and the company's expectation that there will be nosignificant industry recovery during the remainder of 2003, Cymer currentlyestimates the 2003 annual effective tax benefit rate to be approximately 60percent.  Due to the 0% annual effectivetax rate estimated for the first quarter of 2003, a year-to-date change in thetax provision was made in the second quarter of 2003. This resulted in aquarterly tax benefit of 71% for the three months ended June 30,2003.  The annual effective tax ratesfor both periods differ from the U.S. statutory rate of 35% primarily as aresult of permanent book/tax differences and tax credits.  The tax benefit rate for 2003 reflects theincreased impact of Cymer’s tax credits and foreign sales incentives in a lowincome or loss environment.

 

**SIXMONTHS ENDED JUNE 30, 2002 AND 2003**

 

*Revenues.*Product sales decreased 4% from $134.5****millionfor the six months ended June 30, 2002 to $129.5 million for the sixmonths ended June 30, 2003, primarily due to a 17%, or a $16.0 milliondecrease in light source system revenue offset by a 28%, or a $11.0 millionincrease in consumable and spare parts, service revenue and other non-systemproduct revenue.  Total non-systemrevenue totaled $39.1 million or 29% of revenue and $50.1 million or 39% ofrevenue for the six months ended June 30, 2002 and 2003,respectively.  The increase innon-system revenue was due to slightly increased utilization of Cymer’s DUVlight sources by chipmakers and an increased installed base in the six monthsended June 30, 2003, which resulted in increased demand for consumablesand spare parts.  The decrease in lightsource system revenue was primarily due to a 34% decrease in the number oflight source system units sold offset by an increase in the ASP for light sourcesystems sold from period to period. A total of 132 light source systems weresold in the six months ended June 30, 2002 at an ASP of $722,000, comparedto 87 systems sold in the six months ended June 30, 2003 at an ASP of$912,000.  On a foreign currencyadjusted basis, the ASP for the six months ended June 30, 2002 was$737,000 compared to $896,000 for the six months ended June 30, 2003.  This increase in ASPs from period to periodprimarily reflects the increased participation in the product mix of the higherpriced XLA 100 light source system, the dual-discharge chamber MOPA designproduct in the first six months of 2003. Sales of the XLA 100 light source system accounted for 31% of lightsource systems sold in the six months ended June 30, 2003.  Revenues from funded development projectswere $1.2 million and $502,000 for the six months ended June 30, 2002 and2003, respectively.

 

Approximately 88% of Cymer’s sales for each of the sixmonths ended June 30, 2002 and 2003 were derived from customers outsidethe United States.  Revenues from Japanesecustomers, generated primarily by Cymer Japan, accounted for 42% and 45% ofrevenues for the six months ended June 30, 2002 and 2003, respectively.

 

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Sales to Cymer’s three largest customers, ASM Lithography,Canon, and Nikon, amounted to 31%, 22% and 23%, respectively, of total revenuefor six months ended June 30, 2002, and 23%, 25% and 21%, respectively, oftotal revenue for the six months ended June 30, 2003.

 

*Cost of Product Sales*.  Although the number of light source systemsrecorded as revenue was lower in the first six months of 2003 as compared tothe first six months of 2002, the cost of product sales increased 35% from$70.3 million for the six months ended June 30, 2002 to $94.9 million forthe six months ended June 30, 2003. This increase from period to period is primarily due to the higheroverall costs associated with the introduction of Cymer’s new XL series lightsource system and its initial transition to manufacturing during the firstquarter of 2003.  These cost of productsales were partially offset by a decrease in warranty expenses on more matureproduct models during the first quarter of 2003.  As a result of these higher XL series product costs, the grossmargin on product sales was 27% for the six months ended June 30, 2003 ascompared to 48% for the same six-month period in 2002.  Gross margin was further reduced byadditional expense associated with the cost reduction efforts, which totaledapproximately $4.2 million in the manufacturing areas, and includes increasedcosts associated with the reduction in work force and the write down of certainmanufacturing assets.  We anticipatethat the gross margins will increase in the next couple of quarters as a resultof improved efficiencies associated with the production of the XL series lightsource and the benefit of cost savings measures taken in the second quarter of2003.

 

*Researchand Development*. Research and development expenses increased 2% from $33.0 million forthe six months ended June 30, 2002 to $33.8 million for the six monthsended June 30, 2003, due primarily to Cymer’s most recent productdevelopment effort, the XL series which uses the MOPA platform.  Cymer shipped the first light source systemthat utilizes the MOPA platform, the XLA 100, in February 2003.  Cymer also continued to invest in EUV, F2and BDU technology and a focus on next generation KrF and ArF products.  As a percentage of total revenues, suchexpenses increased from 24.3% to 26.0%, primarily due to the lower revenuelevels in 2003 as compared to 2002.  Weanticipate R&D spending in absolute dollars and as a percentage of totalrevenues, will decrease as the XLA 100 productization and the transition to manufacturingis completed.

 

*Salesand Marketing*.  Salesand marketing expenses increased 10% from $7.8 million for the six months endedJune 30, 2002 to $8.6 million for the six months ended June 30,2003.  During the first six months of2003, sales and marketing expenses were higher than the 2002 levels due toadditional expenses associated with the reduction in work force and asset writeoffs which occurred during the second quarter of 2003.  These increased expenses in 2003 were offsetby lower expenses resulting from the movement of various senior members ofsales and marketing to general and administrative functions in the last quarterof 2002.  The lower expense levels inthe first six months of 2002 were due primarily to cost savings measures,including salary reductions that were initiated in the latter part of 2001 andwere reflected in expenses for the first six months of 2002. As a percentage oftotal revenues, such expenses increased from 5.8% to 6.6% primarily due tolower revenue levels in 2003 compared to 2002.

 

*Generaland Administrative*.  General and administrative expenses increased 54% from $8.0million for the six months ended June 30, 2002 to $12.3 million for thesix months ended June 30, 2003, due to a number of factors.  In the first six months of 2002, overallgeneral and administrative expenses were lower due to cost savings measures,including salary reductions that were initiated in the latter part of2001.  During the first six months of2003, general and administrative expenses were significantly increased from the2002 levels due to the reinstatement of the 2001 salary reductions, themovement of various senior personnel from sales and marketing to general andadministrative functions in the last quarter of 2002 and increased costsassociated with the reduction in work force conducted in the second quarter of2003.  As a percentage of totalrevenues, such expenses increased from 5.9% to 9.4% as a result of the increasein expenses and lower revenue levels in 2003 as compared to 2002.

 

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*Amortizationof intangible assets. *Amortizationof intangible assets totaled $80,000 for each of the six month periods endedJune 30, 2002 and 2003.  Thisamortization of intangible assets expense is consistent from period to periodand relates to the existing technology associated with the ACX acquisition,which was completed in early 2001.  Withthe adoption of SFAS 142 on January 1, 2002 Cymer discontinued theamortization of goodwill and intangible assets with indefinite useful livesassociated with previous purchase business combinations.

 

*OtherIncome (Expense) – Net.  *Net other expense totaled$1.2 million and $511,000 for the six months ended June 30, 2002 and 2003,respectively.  The decrease in net otherexpense was primarily due to decreased interest expense and increased interestincome which were offset by foreign currency exchange losses during the period.The decreased interest expense from period to period was caused by the lowerinterest rate on the 2002 bonds which is reflected in the interest expenseamounts for the first six months of 2003 as compared to additional interestwhich was recorded in the first six months of 2002 as the result of both the1997 Notes and 2002 Notes being outstanding during part of that six monthperiod. The increased interest income in the first six months of 2003 wasprimarily due to higher average cash and investment balances during the firstquarter of 2003 compared to 2002 as a result of the bond transactions, whichoccurred in the first quarter of 2002. These transactions included the privateplacement of the 2002 Notes in February 2002 and the redemption of the1997 Notes that were not converted to common stock prior to the March 25,2002 redemption date. Foreign currency exchange gains totaled $120,000,interest income totaled $4.6 million and interest expense totaled $5.9 millionfor the six months ended June 30, 2002, compared to foreign currencyexchange losses of $417,000, interest income of $4.9 million and interestexpense of $5.0 million for the six months ended June 30, 2003.

 

*IncomeTax Provision (Benefit)*. The tax provision of $4.1 million and the tax benefit of $12.1 millionfor the six months ended June 30, 2002 and 2003, respectively, reflect anannual effective rate of 27% and 60%, respectively.  The annual effective tax rates for both periods differ from theU.S. statutory rate of 35% primarily as a result of permanent book/taxdifferences and tax credits.  The taxbenefit rate for 2003 reflects the increased impact of Cymer’s tax credits andforeign sales incentives in a low income or loss environment.

 

# **LIQUIDITYAND CAPITAL RESOURCES**

# ** **

As of June 30, 2003,Cymer had approximately $160.9 million in cash and cash equivalents, $120.3million in short-term investments, $92.6 million in long-term investments,and  $400.0 million in working capital.

 

InAugust 1997, Cymer issued $172.5 million in aggregate principal amount ina private placement of notes. The 31⁄2% / 71⁄4% Step-Up ConvertibleSubordinated Notes were due onAugust 6, 2004 and were convertible at the option of the holder intoshares of common stock of Cymer. The conversion rate on the 1997 Notes was21.2766 shares per $1,000 principal amount or an effective conversion price of$47.00 per share.  In 2001, Cymerrepurchased a total of $24.9 million of convertible subordinated notesoutstanding.  The 1997 Notes were calledfor redemption on March 25, 2002. Immediately prior to the March 25, 2002 redemption date, holders of$113.0 million of the outstanding principal amount converted their 1997 Notesinto shares of Cymer’s common stock.  Asa result of these conversions, 2,325,542 shares of Cymer common stock wereissued to the note holders and the remaining $38.0 million of the outstandingprincipal amount of the 1997 Notes was redeemed.

 

InFebruary 2002, Cymer issued $250.0 million in aggregate principal amountin a private placement of notes.  The2002 Notes are due on February 15, 2009 with interest payablesemi-annually on February 15 and August 15 of each year at 31⁄2% perannum.  The 2002 Notes are convertibleinto shares of Cymer common stock at a conversion rate of 20 shares per $1,000principal amount or an effective conversion price of $50.00 per share.  Cymer used a portion of 

 

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the net proceeds from this private placement toredeem the 1997 Notes. The remaining proceeds will be used for Cymer’s futureoperating, investing and financing activities.

 

Net cash provided byoperating activities was approximately $4.4 million for the six months endedJune 30, 2002 as compared to $16.1 million net cash used in operatingactivities for the six months ended June 30, 2003.  The net cash provided by operatingactivities for the six months ended June 30, 2002 was primarilyattributable to net income and increases in accounts payable, and accrued andother liabilities offset by increases in accounts receivable andinventories.  Due to the continueddownturn in the semiconductor industry, net cash was used in operatingactivities during the six months ended June 30, 2003. This use of cash in2003 primarily reflects the net loss for the period, increases in accountsreceivable and decreases in accounts payable, accrued liabilities and incometaxes payable for the period. This use of cash in 2003 was partially offset bya decrease in inventories from period to period.

 

Net cash used ininvesting activities was approximately $174.9 million and $25.2 million for thesix months ended June 30, 2002 and 2003, respectively.  The decrease in cash used in investingactivities from period to period was primarily attributable to the timing ofshort-term and long-term investments maturing and being invested offset by cashused for capital expenditures in 2003. During the first six months of 2002,capital expenditures totaled $10.7 million as compared to capital expendituresof $42.4 million for the first six months of 2003.  This increased level of capital expenditures was primarily due tothe continued construction of the new manufacturing and office facility locatedin San Diego, California and purchases of required manufacturing equipment forthis new facility.

 

Net cash provided byfinancing activities was approximately $220.4 million and $5.8 million for thesix months ended June 30, 2002 and 2003, respectively.  The decrease in cash provided by financingactivities was primarily attributable to the activity on Cymer’s convertiblesubordinated notes and higher proceeds from employee stock option exercisesduring the first six months of 2002. The private placement of the 2002 Notes resulted in net proceeds ofapproximately $242.2 million, offset by a use of $39.6 million to redeem aportion of its 1997 Notes.  Proceedsfrom employee stock option exercises during the six months ended June 30,2002 totaled $18.0 million.  In the sixmonths ended June 30, 2003, financing activities from the exercise ofemployee stock options provided $12.5 million in cash offset by a $6.7 millionpayoff of Cymer’s Japanese revolving loan.

 

Cymer had certain loan agreements with a commercialbank (the “Loan Agreements”) which provided for unsecured revolving loanfacilities allowing for borrowings of $10.0 million and $20.0 million under aU.S. line of credit and Japanese line of credit, respectively.  Under the loan agreements, Cymer was able toborrow in U.S. dollars or Japanese yen, and interest accrued on outstandingborrowings at LIBOR plus 1.75% on U.S. dollar-denominated borrowings and at theyen Cost of Funds rate plus 1.5% on yen-denominated borrowings. The loanagreements required Cymer to maintain compliance with certain financial andother covenants, including tangible net worth, quick ratio and profitabilityrequirements.  The loan agreementsexpired on June 16, 2003 and were not renewed.

 

Since its initial****public offering and a secondary publicoffering, both in 1996, Cymer has funded its operations primarily from cashgenerated from operations, the proceeds of convertible subordinated noteofferings in August 1997 and February 2002, bank borrowings, and theproceeds from employee stock option exercises.

 

Cymer requiressubstantial working capital to fund its business, particularly to financeinventories and accounts receivable and for capital expenditures. Cymer’sfuture capital requirements depend on many factors, including Cymer’smanufacturing 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 

 

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of Cymer’s products. Cymer believes that it has sufficient workingcapital and available banking arrangements to sustain operations and providefor the future expansion of its business for at least the next 12 months.

 

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

 

# **CRITICALACCOUNTING POLICIES AND ESTIMATES**

# ** **

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

 

Cymer believes thatinventory allowances and warranty provisions require more significant judgmentsand estimates in the preparation of its consolidated financial statements thanother accounting estimates.

 

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

 

Cymer provides for theestimated cost of product warranties at the time the related revenue isrecognized. The warranty coverage period and terms vary by light sourcemodel.  In general, the light sourcesystem warranty period ranges from 17 to 26 months after shipment.  Cymer also warrants consumables and spareparts sold to its customers and the coverage period varies by spare part typeas some types include time based warranty periods and others include usagebased warranty periods.  On average, thewarranty period for consumables and spare parts is approximately 6 months fromthe date of shipment.  Cymer records aprovision for warranty for all products, which is included in cost of productsales in the consolidated statements of operations and is recorded at the timethat the related revenue is recognized. The warranty provision for light source systems is determined by using afinancial model, which takes into consideration actual historical expenses, andpotential risks associated with Cymer’s different light source system models.This financial model is then used to calculate the future probable expensesrelated to warranty and the required level of the warranty provision.  The risk levels 

 

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used within this model are reviewed and updated as risk levels changeby model over its product life cycle. The warranty provision for consumables and spares is determined by usingactual historical data.  Although Cymerengages in product improvement programs and processes, its warranty obligationis affected by product failure rates and costs incurred to correct thoseproduct failures at customer sites. Should actual product failure rates or estimated costs to repair thoseproduct failures differ from Cymer’s estimates, revisions to its estimatedwarranty provision would be required.

 

# **RECENT ACCOUNTING PRONOUNCEMENTS**

# ** **

InJanuary 2003, the FASB issued Interpretation No. 46 (“FIN 46”),“Consolidation of Variable Interest Entities”. FIN 46 provides guidance on how to identify a variable interest entity(VIE) and determines when the assets, liabilities, and results of operations ofa VIE need to be included in a company’s consolidated financial statements.  FIN 46 also requires additional disclosuresby primary beneficiaries and other significant variable interest holders in aVIE.  The provisions of FIN 46 areeffective immediately for all VIEs created after January 31, 2003.  For VIEs created before February 1,2003, the provisions of FIN 46 must be adopted at the beginning of the firstinterim or annual reporting period beginning after June 15, 2003.  While Cymer is currently evaluating thepotential impact of the adoption of FIN 46, Cymer believes that it will not besubject to the consolidation or disclosure requirements of FIN 46.

 

In November 2002,the Emerging Issues Task Force (“EITF”) issued EITF Issue No. 00-21,“Accounting for Revenue Arrangements with Multiple Deliverables.” EITF IssueNo. 00-21 addresses how to determine whether a revenue arrangementinvolving multiple deliverables contains more than one unit of accounting forthe purposes of revenue recognition and how the revenue arrangementconsideration should be measured and allocated to the separate units ofaccounting. EITF Issue No. 00-21 applies to revenue arrangements enteredinto after June 27, 2003. The adoption of this statement is not currentlyanticipated to have a material impact on Cymer’s financial condition or resultsof operations.

 

In April 2003, theFASB issued Statement of Financial Accounting Standards No. 149 (“SFAS No.149”), “Amendment of Statement 133 on Derivative Instruments and HedgingActivities”.  SFAS No. 149 amends andclarifies financial accounting and reporting for derivative instruments, includingcertain derivative instruments embedded in other contracts and for hedgingactivities under FASB Statement No. 133. This statement is effective for contracts entered into or modified afterJune 30, 2003 and for hedging relationships designated after June 30,2003. The adoption of this statement is not currently anticipated to have amaterial impact on Cymer’s financial condition or results of operations.

 

In May 2003, theFASB issued Statement of Financial Accounting Standards No.150 (“SFAS” No.150), “Accounting for Certain Instruments with Characteristics of BothLiabilities and Equity”. The standard establishes how an issuer classifies andmeasures certain freestanding financial instruments with characteristics ofliabilities and equity and requires that such instruments be classified asliabilities. The standard is effective for financial instruments entered intoor modified after May 31, 2003 and is otherwise effective at the beginningof the first interim period beginning after June 15, 2003.  The adoption of the standard is not expectedto have a material impact on Cymer’s consolidated financial statements.

 

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#### **Risks and Uncertainties That May Affect Results**

#### ** **

*In this section, references to “we”, “us” or “our” arereferences to Cymer.  Our business facessignificant risks. The risks described below may not be the only risks we face.Additional risks that we do not yet know of or that we currently think are immaterialmay also impair our business operations. If any of the events or circumstances described in the following risksactually occur, our business, financial condition or results of operationscould suffer, and the trading price of our common stock could decline.*

 

Ourrevenues and operating results from quarter-to-quarter have varied in the pastand our future operating results may continue to fluctuate significantly due tomany factors including those listed in this section and throughout thisquarterly report on Form 10-Q for the period ended June 30, 2003. Thesefactors include:

 

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

•                  cyclicality in the market for semiconductormanufacturing equipment;

•                  rates at which semiconductor device manufacturerstake delivery of photolithography tools from photolithography tool manufactures(“our customers”);

•                  rates at which our customers take delivery oflight source systems from us;

•                  timing and size of orders from our small base ofcustomers;

•                  product lead time demands from our customers andthe semiconductor manufacturers;

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

•                  changes in the price and profitability of ourproducts;

•                  our ability to develop and implement newtechnologies and introduce new products;

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

•                  our ability to manage our manufacturingrequirements;

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

•                  worldwide political instability;

•                  changing global economic conditions; and

•                  intellectual property protection.

 

Wealso have historically derived a large portion of our quarterly and annualrevenues from selling a small number of light source systems. Because we sell asmall number of products, the precise time that we recognize revenue from anorder may have a significant impact on our total revenue for a particularperiod. 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 customers’ purchase decisions or rescheduleddelivery dates requested by our customers. Our operating results for aparticular 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.

 

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

 

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**Our business depends on the semiconductor equipment industry, which ishighly volatile and unpredictable.**

** **

Thesemiconductor equipment industry is highly cyclical. We derive a substantialpercentage of our revenues from our customers. Our customers depend in turn onthe demand for their photolithography tool products from their customers, thesemiconductor device manufacturers. The capital equipment expenditures ofsemiconductor manufacturers depend on a number of factors, including thecurrent and anticipated market demand for semiconductors and products usingsemiconductors.

 

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

 

Thecurrent downturn has had a severe effect on the demand for semiconductormanufacturing equipment, including photolithography tools that our customersproduce. We are not able to predict when the semiconductor industry willrecover. If overall market conditions continue to deteriorate in the near term,our current operating levels may negatively impact our profitability. Webelieve that downturns in the semiconductor manufacturing industry will occurperiodically, and result in periodic decreases in demand for all semiconductormanufacturing equipment, including photolithography tools our customersmanufacture. As a result, fluctuating levels of investment by semiconductordevice manufacturers and pricing volatility will continue to materially affectour aggregate bookings, revenues and operating results. Also, even duringperiods of reduced revenues we believe we must continue to invest in researchand development and to maintain extensive ongoing worldwide customer serviceand support capabilities to remain competitive, which may temporarily harm ourfinancial results.  Accordingly, thesedownturns are likely to continue to adversely affect our business, financialcondition and operating results and our operating results may fall below theexpectations of public market analysts or investors in some future quarter orquarters. Such failure to meet operating result expectations would materiallyadversely affect the price of our common stock.

 

Ourcustomers try to manage their inventories and production requirements toappropriate levels that best reflect their expected sales to semiconductordevice manufacturers. Market conditions in the industry and productionefficiency of the photolithography tool manufacturers can cause our customersto expand or reduce their orders for new light source systems as they try tomanage their inventories and production requirements to these levels. Wecontinue to work with our customers to better understand these issues. However,we cannot guarantee that we will be successful in understanding our customers’inventory management and production requirements or that our customers will notbuild up an excess inventory of light source products. If our customers retainan excess inventory of light source products, our revenue could be reduced infuture periods as the excess inventory is utilized, which could adverselyaffect our operating results, financial condition and cash flows.  In addition, if our customers demand shorterproduct lead times as a solution to improve their inventory and cash positions,our inventory management and cash position may be impacted, which may adverselyaffect our operating results, financial condition and cash flows.

 

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**A significant percentage of our revenue is derived from salesto a few large customers, and if we are not able to retain these customers, orthey reschedule, reduce or cancel orders, delay or default on payments, ourrevenues would be reduced and our financial condition and cash flows wouldsuffer.**

 

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

 

|            |   | **Six months ended  June 30,** |   |
|-----------------|--------|-------------------------------------|--------|
|            |   | **2002**                            |   | **2003** | ** ** |
| ASM Lithography |   | 31                                  | %      | 23 | % |
| Canon           |   | 22                                  | %      | 25 | % |
| Nikon           |   | 23                                  | %      | 21 | % |
|            |   |                                |   |   |   |
| Total           |   | 76                                  | %      | 69 | % |

 

Collectively, these threecompanies account for the following percentage of our total accounts receivablefor the periods indicated:

 

|            |   | **December 31,  2002** |   | **June 30,  2003** |   |
|-----------------|--------|-----------------------------|--------|-------------------------|--------|
| ASM Lithography |   | 40                          | %      | 15                      | %      |
| Canon           |   | 12                          | %      | 18                      | %      |
| Nikon           |   | 18                          | %      | 33                      | %      |
|            |   |                        |   |                    |   |
| Total           |   | 70                          | %      | 66                      | %      |

 

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

 

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

•      acustomer experiencing DUV photolithography tool production problems;

•      adecision to purchase light sources from other suppliers;

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

•                  a decline in a customer’s financial condition.

 

**A substantial percentage of our revenue is derived from thesale of a limited number of primary products.**

 

Ouronly product line is excimer light source systems, which include kryptonfluoride, argon fluoride and fluorine systems, and we expect these primaryproducts to continue to account for a large percentage of our revenues in thenear term. Continued market acceptance of our primary products is, therefore,critical to our future success. The primary market for excimer light sources isin the use 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 semiconductor devicemanufacturers further adopt excimer light sources as the chosen light sourcefor their photolithography tools. Semiconductor manufacturers may choose not toadopt excimer light sources for a variety of reasons, including:

 

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•                  inadequate performance of photoresists used inadvanced DUV photolithography; and

•      potentialshortages of specialized materials used in DUV optics.

 

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

 

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

•      afailure to achieve continued market acceptance of our products;

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

•      technological change that we are unable toaddress with our products; and

•      a failure to release new enhanced versionsof our products on a timely basis.

 

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

** **

Rapidtechnological changes in semiconductor manufacturing processes subject us toincreased pressure to develop technological advances enabling such processes.We believe that our future success depends in part upon our ability to develop,manufacture and timely introduce new light source products with improvedcapabilities and to continue to enhance our existing light source systems andprocess capabilities.  Due to the risksinherent in transitioning to new products, we must forecast accurate demand fornew products while managing the transition from older products.

 

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

 

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

 

Futuretechnologies, such as EUV and electron projection lithography (“EPL”), mayrender our excimer light source products obsolete. We must manage producttransitions, as introduction of new products could adversely affect our salesof existing products. If new products are not introduced on time, or havereliability or quality problems, our performance may be impacted by reducedorders, higher manufacturing costs, delays in acceptance of and payment for newproducts, and additional service and warranty expenses. We may not be able todevelop and introduce new products or enhancements to our existing products andprocesses in a timely or cost effective manner that satisfies customer needs orachieves market acceptance. Failure to develop and introduce these new productsand enhancements could materially adversely affect our operating results,financial condition and cash flows.

 

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

 

**Economic, political, regulatory and other events in geographic areaswhere we have significant sales or operations could interfere with ourbusiness.**

** **

Weserve an increasingly global market.  Alarge portion of our total revenues is derived from customers located outsideof the United States, particularly in Asian countries.  We expect our international sales tocontinue to account for a very large portion of our total revenues. In order tosupport our foreign customers, we maintain a manufacturing and field servicesubsidiary in Korea as well as field service and support subsidiaries in Japan,Taiwan, Singapore, the People’s Republic of China and the Netherlands.

 

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

 

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

 

•      unexpectedchanges in regulatory requirements,

•      fluctuationsin exchange rates and currency controls,

•      politicaland economic conditions and instability,

•                  imposition of 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,

•      difficultiesin staffing and managing foreign subsidiary and branch operations,

•      limitedintellectual property protection in some countries,

•      potentiallyadverse tax consequences in some countries,

•      thepossibility of accounts receivable collection difficulties,

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

•      theeffect of acts of terrorism and war; and

•      theburdens of complying with a variety of foreign laws.

 

Many of our major customers and many of the semiconductor devicemanufacturers who use our light source products in their photolithographysystems are located in Asia. Economic problems and currency fluctuationsaffecting these regions in Asia could create a larger risk for us. Further,even though it has not been difficult for us to comply with United Statesexport 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.

 

**We must effectively manage changes in our business.**

 

In order to respond to thebusiness cycles of the semiconductor industry, in the past few years we havesharply expanded and contracted the scope of our operations and the number ofemployees in many of our departments. As the semiconductor industry grows andcontracts we will need to:

 

•      closelymanage our global operations;

•      improveour process and other internal management systems;

 

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

•      quicklyadapt to changing sales and marketing channels;

•      effectivelymanage our inventory levels; and

•      attract,train, retain and manage key personnel.

 

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

 

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

 

Wepurchase some of the components and subassemblies included in our light sourceproducts from a single supplier or a limited group of suppliers.  For certain optical components usedin our light source systems, we currently utilize a single supplier.  Although we have not aggressively pursuedother vendors for these optical components, we have attempted to qualify one othervendor. To date, this vendor has been unsuccessful in producing these opticalcomponents and has not been qualified by us. To reduce the risk associated withthis single supplier, we carry a two year supply of these optical components.  This two year supply is based upon currentbusiness activities, so any significant increase in production would likelyresult in a quicker consumption of these optical components. In addition, we outsource the manufacture ofvarious subassemblies more often than in the past. Further, some of oursuppliers have specialized in supplying equipment or manufacturing services tosemiconductor equipment manufacturers and therefore have been adverselyaffected by the current industry downturn. If the current downturn continues foran extended period of time, these suppliers may not be able to continue to meetour requirements or respond quickly enough. Due to the nature of our product development requirements, these keysuppliers must rapidly advance their own technologies and productioncapabilities in order to support the introduction schedule of our new products.These suppliers may not be able to provide new modules and subassemblies whenthey are needed to satisfy our product schedule requirements. If we cannotpurchase enough of these materials, components or subassemblies, or if theseitems do not meet our quality standards, there could be delays or reductions inour product shipments, which would have a material adverse effect on ouroperating results, financial condition and cash flows.

 

**We face competition from two companies and may face competition fromadditional competitors who enter the market.**

** **

Weare currently aware of two significant competitors that sell light sources forDUV photolithography applications. These competitors are:

 

•                  Gigaphoton, a joint venture between two largecompanies, Komatsu and Ushio, which is headquartered in Japan; and

•                  Lambda-Physik, a company headquartered inGermany, majority owned by Coherent, Inc., a U.S. company.

 

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

 

Themarket for excimer light sources is still small and immature. Largercompetitors with substantially greater resources, such as other manufacturersof industrial light sources for advanced lithography, may attempt to sellcompetitive products to our customers. Potential 

 

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competitors may also be attracted to our growinginstalled base of light sources and may attempt to supply consumable productsand refurbished parts to that installed base. If any existing or futurecompetitors gain market acceptance we could lose market share and our growthcould slow or decline, which could have a material adverse effect on ouroperating results, financial condition and cash flows.

 

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

** **

We are highly dependent on theservices of many key employees in various areas, including:

 

•      engineering;

•      researchand development;

•      salesand marketing;

•      fieldservice;

•      manufacturing;and

•      management.

 

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

 

•                  the continued services of our engineering,research and development, sales and marketing, manufacturing and field service,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.

 

Ifwe are unable to hire, train and retain key personnel as required, ouroperating results,  financial conditionand cash flows could be adversely affected.

 

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

 

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

 

•      recruitand train qualified field service personnel;

•      identifyqualified independent firms; and

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

 

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

 

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**Our ability to compete could be jeopardized if we are unableto protect our intellectual property rights. These types of claims couldseriously harm our business or require us to incur significant costs.**

 

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

 

Asof June 30, 2003, we owned 187 United States patents covering certainaspects of technology related to light sources and piezo techniques. Thesepatents will expire at various times during the period from January 2008to November 2021.  As ofJune 30, 2003, we also had applied for 74 additional patents in the UnitedStates.  As of June 30, 2003, weowned 169 foreign patents and had filed 295 patent applications pending invarious foreign countries.

 

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

 

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

 

Wealso rely on the following to protect our confidential information and ourother intellectual property:

 

•      tradesecret protection,

•      employeenondisclosure agreements,

•      third-partynondisclosure agreements; and

•      otherintellectual property protection methods.

 

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

 

•      independentlydevelop substantially the same proprietary information and techniques,

•      gainaccess to our trade secrets, or

•      discloseour technology.

 

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

** **

Inthe past, revenues from research and development arrangements with thirdparties have been used to pay for a portion of our own research and developmentexpenses. We receive these revenues from government-sponsored programs,customers and from SEMATECH, a 

 

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

 

**In the future, we may be subject to patent litigation to enforce patentsissued to us and defend ourselves against claimed infringement by ourcompetitors or any other third party.**

** **

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

 

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

 

Wehave notified our competitors and others of our United States patent portfolio.Specifically, we have notified Komatsu that they may be infringing on some ofour U.S. patents. We have discussed with Komatsu our claims against each other.  Komatsu challenged one of our U.S. patentsin the USPTO but it was subsequently re-issued by the USPTO.  Also, Komatsu transferred its lithographylight source business to one of our competitors, Gigaphoton.  We also have had discussions withLambda-Physik, another competitor, regarding allegations by each party againstthe other for possible patent infringement. Any of these discussions with ourcompetitors may not be successful and litigation could result.

 

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

 

•      lossof our proprietary rights,

•      exposureto significant liabilities by other third parties,

 

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

•      restrictionfrom manufacturing or selling our products.

 

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

 

**Trademark infringement claims against our registered andunregistered trademarks would be expensive and we may have to stop using suchtrademarks and pay damages.**

 

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

 

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

 

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

 

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

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

•                  we may not be able to provide timely support ofinstalled light sources for semiconductor device manufacturers; and

•      oursales and marketing efforts may be disrupted.

 

**We are exposed to risks related to the fluctuations in thecurrency exchange rates for the Japanese yen.**

 

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

 

**Compliancewith changing regulation 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,Nasdaq Stock Market rules, and new accounting pronouncements are creatinguncertainty and additional complexities for companies such as ours. To maintainhigh standards of corporate governance and public disclosure, we intend toinvest all reasonable necessary resources to comply with 

 

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evolving standards. This investment may result in increased general andadministrative expenses and a diversion of management time and attention fromstrategic revenue-generating and cost management activities.

 

**Newaccounting rules may impact our operating results.**

 

Recently,the Financial Accounting Standards Board (“FASB”) announced plans to requireall companies to expense the value of employee stock options measured accordingto the fair value of the options.  Sucha change in accounting rules may adversely impact our future financialcondition and operating results.

 

**We are subject to many standards and regulations of foreign governmentsand, even though we intend to comply, we may not always be in compliance withthese rules, or we may be unable to design or redesign our products to complywith these rules.**

** **

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

 

**Semiconductor device manufacturers’ prolonged use of our products in highvolume productions may not produce the results they desire and, as a result,our reputation and that of our customers who supply photolithography tools tothe semiconductor manufacturers could be damaged in the semiconductor industry.**

** **

Overtime, our light source products may not meet semiconductor devicemanufacturers’ production specifications or operating cost requirements afterthe light source is used for a long period in high volume production. If any semiconductordevice manufacturer cannot successfully achieve or sustain their volumeproduction using our light sources, our reputation could be damaged with thesemiconductor device manufacturers and our customers who are the limited numberof photolithography tool manufacturers. This would have a material adverseeffect on our business.

 

**We have in the past and may in the future acquire a business that willinvolve numerous risks. We may not be able to address these risks successfullywithout substantial expense, delay or other operational and financial problems.**

** **

Therisks involved with acquiring a new company include the following:

 

•                  diversion of management’s attention and resourcesto integrate the new company,

•                  failure to retain key personnel,

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

•      clientdissatisfaction or performance problems with the acquired company,

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

•      failureto commercialize purchased technologies,

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

•      assumptionof unknown liabilities or other unanticipated events or circumstances.

 

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

 

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**We must develop and manufacture enhancements to our existing products andintroduce new products in order to continue to grow our business. We may noteffectively manage our growth and integrate these new enhancements andproducts, which could materially harm our business.**

** **

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

 

## **We are dependent on our manufacturing facilities andsubcontractors to assemble and test our products.**

## ** **

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

 

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

 

Weare subject to federal, state and local regulations, such as regulationsrelated to the environment, land use, public utility utilization and the firecode, in connection with the storage, handling, discharge and disposal ofsubstances that we use in our manufacturing process and on our facilities thatwe lease. We believe that our activities comply with current governmentregulations that are applicable to our operations and current facilities. Wemay be required to purchase additional capital equipment or other requirementsfor our processes to comply with these government regulations in the future ifthey change. Further, these government regulations may restrict us fromexpanding our operations. Adopting measures to comply with changes in thegovernment regulations, our failure to comply with environmental and land useregulations, or restrictions on our ability to discharge hazardous substances,could subject us to future liability or cause our manufacturing operations tobe reduced or stopped.

 

**Our products are subject to potential product liability claims ifpersonal injury or death result.**

** **

Weare exposed to significant risks for product liability claims if personalinjury or death results from the use of our products. We may experiencematerial product liability losses in the future. We maintain insurance againstproduct liability claims. However, our insurance coverage may not continue tobe available on terms that we accept. This insurance coverage also may notadequately cover liabilities that we incur. Further, if our products aredefective, we may be required to recall or redesign these products. Asuccessful claim against us that exceeds our insurance coverage level, or anyclaim or product recall that results in adverse publicity against us, couldhave a material adverse effect on our business, financial condition and resultsof operations.

 

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

 

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

 

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

 

•      thecyclical nature of the semiconductor industry,

•      actualor anticipated fluctuations in our operating results,

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

•      announcementsof innovations in technology,

•      newproducts offered by us or our competitors,

•      developmentsof patents or proprietary rights,

•      changesin financial estimates by securities analysts,

•      generalworldwide political, economic, and market conditions,

•      UnitedStates political, economic, and market conditions; and

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

 

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

 

**We have implemented steps to protect our company from hostile takeovers.**

** **

Nevada law and our articles of incorporation contain provisions thatdiscourage a proxy contest and provisions that make an acquisition of asubstantial block of our common stock more difficult. In addition, our board ofdirectors is authorized to issue, without stockholder approval, shares ofpreferred stock. Such shares of preferred stock may have voting, conversion andother rights and preferences that may be superior to those of the common stockand this could adversely affect the voting power or other rights of holders ofcommon stock. Our board can use the issuance of the preferred stock or rightsto purchase the preferred stock to discourage any unsolicited acquisitionproposal or attempt.

 

#### **Item 3.  Quantitative and QualitativeDisclosures About Market Risk**

#### ** **

# **ForeignCurrency Risk**

# ** **

Cymer conducts business in several internationalcurrencies through its global operations. Due to the large volume of Cymer’sbusiness that is conducted in Japan, the Japanese operation poses the greatestforeign currency risk.  Cymer usesfinancial instruments, principally foreign currency forward exchange contracts,in Japan to manage its foreign currency exposures. Cymer enters into foreigncurrency forward exchange contracts in order to reduce the impact of currencyfluctuations related to purchases of Cymer’s inventories by Cymer Japan in USdollars for resale under firm third-party sales commitments denominated inJapanese Yen.  Cymer does not enter intoforeign currency forward exchange contracts for trading purposes.

 

As of June 30, 2003, Cymer had outstandingforeign currency forward exchange contracts to buy US $61.4 million for 7.4billion yen under foreign currency exchange facilities with 

 

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contract rates ranging from 117.30 yen to 132.60****yen per U.S. dollar.  These contracts expire on various datesthrough March 2004.

 

# **Investmentand Debt Risk**

# ** **

Cymer maintains an investment portfolio consistingprimarily of government and corporate fixed income securities, certificates ofdeposit and commercial paper.  While itis Cymer’s general intent to hold such securities until maturity, Cymer willoccasionally sell certain securities for cash flow purposes. Therefore, Cymer’sinvestments are classified as available-for-sale and are carried on the balancesheet at fair value.  Due to theconservative nature of the investment portfolio, a sudden change in interestrates would not have a material effect on the value of the portfolio.

 

In February 2002,Cymer issued $250.0 million principal amount of unsecured fixed rate 31⁄2%Convertible Subordinated Notes due February 15, 2009.  Interest on these 2002 Notes is payable onFebruary 15 and August 15 of each year, commencing August 15,2002.  The 2002 Notes are convertibleinto shares of Cymer’s common stock at a conversion rate of 20 shares per$1,000 principal amount subject to adjustment under certain conditions. Cymermay redeem the 2002 Notes on or after February 20, 2005, or earlier if theprice of its common stock reaches certain levels.  The 2002 Notes are subordinated to Cymer’s existing and futuresenior indebtedness and effectively subordinated to all indebtedness and otherliabilities of Cymer’s subsidiaries. Because the interest rate is fixed, we believe there is no risk ofincreased interest expense.  These Notesare recorded at face value on the consolidated balance sheets.  The fair value of such debt based on quotedmarket prices on June 30, 2003 was $260.9 million.

 

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

#### ** **

*Evaluationof disclosure controls and procedures*.  Cymer’s chief executive officer and itschief financial officer, after evaluating the effectiveness of Cymer’sdisclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)and 15d-15(e)) as of June 30, 2003, have concluded that as of such date,Cymer’s disclosure controls and procedures were adequate and sufficient toensure that information required to be disclosed by Cymer in the reports thatit files under the Securities Exchange Act of 1934 is recorded, processed,summarized and reported within the time period specified in the Commission’srules and forms.

 

*Changesin internal controls*. There has been no change in ourinternal control over financial reporting during the fiscal quarter endedJune 30, 2003 that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

 

**PARTII.  OTHER INFORMATION**

 
| **ITEM 1.**     | **Legal Proceedings**                          |
|-----------------|------------------------------------------------|
|            |                                           |
|            | None.                                          |
|            |                                           |
| **ITEM 2.**     | **Changes in Securities and Use of  Proceeds** |
|            |                                           |
|            | None.                                          |
|            |                                           |
| **ITEM 3****.** | **Defaults upon Senior Securities**            |
|            |                                           |
|            | None.                                          |

 

36

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| **ITEM 4.** | **Submission of Matters to a Vote of  Security Holders**                                                                                                                                                                                                                                                                                |
|-------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |                                                                                                                                                                                                                                                                                                                                    |
|        | Cymer held its Annual Meeting of Stockholders on  May 22, 2003. Out of 34,398,929 shares of common stock entitled to vote  at such meeting, there were present in person or by proxy 32,112,733 shares.  At the Annual Meeting, the stockholders of Cymer approved the following  matters:                                         |
|        |                                                                                                                                                                                                                                                                                                                                    |
|        | Proposal 1. The Election of the following eight  directors to serve for one year. The votes for the nominated directors was as  follows:                                                                                                                                                                                                |
|        |                                                                                                                                                                                                                                                                                                                                    |
|        | **Director’s Name**                                                                                                                                                                                                                                                                                                                |   | **Votes For** |   | **Votes  Withheld** |   |   |
|        |                                                                                                                                                                                                                                                                                                                                    |   |   |   |   |   |   |
|        | Charles  J. Abbe                                                                                                                                                                                                                                                                                                                        |   | 29,698,740 |   | 2,413,993 |   |   |
|        | Robert  P. Akins                                                                                                                                                                                                                                                                                                                        |   | 29,704,143 |   | 2,408,590 |   |   |
|        | Edward  H. Braun                                                                                                                                                                                                                                                                                                                        |   | 29,725,919 |   | 2,386,814 |   |   |
|        | Michael  R. Gaulke                                                                                                                                                                                                                                                                                                                      |   | 29,688,722 |   | 2,424,011 |   |   |
|        | William  G. Oldham                                                                                                                                                                                                                                                                                                                      |   | 29,704,143 |   | 2,408,590 |   |   |
|        | Peter  J. Simone                                                                                                                                                                                                                                                                                                                        |   | 29,704,143 |   | 2,408,590 |   |   |
|        | Young  K. Sohn                                                                                                                                                                                                                                                                                                                          |   | 31,781,584 |   | 331,149 |   |   |
|        | Jon  D. Tompkins                                                                                                                                                                                                                                                                                                                        |   | 29,704,043 |   | 2,408,690 |   |   |
|        |                                                                                                                                                                                                                                                                                                                                    |
|        | Proposal 2. Approval of an amendment to Cymer’s 1996  Employee Stock Purchase Plan to increase the aggregate number of shares  reserved for issuance under the plan by 200,000 shares. 31,442,787 votes were  cast for approval, 646,345 votes were cast against, 23,601 votes were abstained  and there were no broker non-votes. |
|        |                                                                                                                                                                                                                                                                                                                                    |
|        | Proposal 3. Ratification of the appointment of KPMG  LLP as the independent auditors of Cymer for the year ending  December 31, 2003. 23,645,697 votes were cast for approval, 8,322,018  votes were cast against, 145,018 votes were abstained and there were no  broker non-votes.                                               |
|        |                                                                                                                                                                                                                                                                                                                                    |
| **ITEM 5.** | **Other Information**                                                                                                                                                                                                                                                                                                                   |
|        |                                                                                                                                                                                                                                                                                                                                    |
|        | None.                                                                                                                                                                                                                                                                                                                                   |
|        |                                                                                                                                                                                                                                                                                                                                    |
| **ITEM 6.** | **Exhibits and Reports on Form 8-K**                                                                                                                                                                                                                                                                                                    |
|        |                                                                                                                                                                                                                                                                                                                                    |
|        | **(a)**                                                                                                                                                                                                                                                                                                                                 | 10.1 | Employment Agreement,  effective as of June 1, 2003, by and between Pascal Didier and Cymer. |
|        |                                                                                                                                                                                                                                                                                                                                    |   |   |
|        |                                                                                                                                                                                                                                                                                                                                    | 10.2 | Employment Agreement,  effective as of June 1, 2003, by and between Nancy J. Baker and Cymer. |
|        |                                                                                                                                                                                                                                                                                                                                    |   |   |
|        |                                                                                                                                                                                                                                                                                                                                    | 10.3 | Employment Agreement,  effective as of June 1, 2003, by and between Hugh R. Grinolds and Cymer. |
|        |                                                                                                                                                                                                                                                                                                                                    |   |   |
|        |                                                                                                                                                                                                                                                                                                                                    | 10.4 | Employment Agreement,  effective as of June 1, 2003, by and between Edward P. Holtaway and  Cymer. |
|        |                                                                                                                                                                                                                                                                                                                                    |   |   |
|        |                                                                                                                                                                                                                                                                                                                                    | 10.5 | Employment Agreement,  effective as of June 1, 2003, by and between Brian C. Klene and Cymer. |
|        |                                                                                                                                                                                                                                                                                                                                    |   |   |
|        |                                                                                                                                                                                                                                                                                                                                    | 10.6 | Employment Agreement,  effective as of June 1, 2003, by and between Jung Ho (John) Shin and  Cymer. |
|             |                                                                                                                                                                                                                                                                                                                                         |  |  |  |  |  |  |  |  |

37

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|   |    | 10.7                                                                                                 | Employment Agreement,  effective as of June 1, 2003, by and between Rae Ann Werner and Cymer. |
|--------|---------|------------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------|
|   |    |                                                                                                 |                                                                                               |
|   |    | 31.1                                                                                                 | Certification of Chief  Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act.       |
|   |    |                                                                                                 |                                                                                               |
|   |    | 31.2                                                                                                 | Certification of Chief  Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act.       |
|   |    |                                                                                                 |                                                                                               |
|   |    | 32.1                                                                                                 | Certification of Chief  Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act.       |
|   |    |                                                                                                 |                                                                                               |
|   |    | 32.2                                                                                                 | Certification of Chief  Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act.       |
|   |    |                                                                                                 |                                                                                               |
|   | **(b)** | **Reports  on Form 8-K**                                                                             |
|   |    |                                                                                                 |                                                                                               |
|   |    | On April 22, 2003,  Cymer filed a Form 8-K announcing its first quarter 2003 financial results. |

 

38

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this quarterly report onForm 10-Q to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
|                             |   | CYMER, INC.                                                                                                     |
|----------------------------------|--------|-----------------------------------------------------------------------------------------------------------------|
|                             |   | (Registrant)                                                                                                    |
|                             |   |                                                                                                            |
|                             |   |                                                                                                            |
| Date:  August 11, 2003 | By:    | /s/ NANCY J. BAKER                                                                                              |   |
|                             |   | Nancy J. Baker                                                                                                  |
|                             |   | Senior Vice President  and  Chief Financial Officer  (Duly Authorized Officer and  Principal Financial Officer) |

 

39

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