** **

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM10-K**

 

**(Mark One)**
| **ý**                                                 | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                       |                                                                                          |
|------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------|
|                                                       |                                                                                                                                                                                                                            |                                                                                          |
| **For the Fiscal Year Ended December 31, 2004**  |                                                                                                                                                                                                                            |
|                                                       | ** **                                                                                                                                                                                                                      |
|                                                       | **OR**                                                                                                                                                                                                                          |
|                                                       |                                                                                                                                                                                                                            |                                                                                          |
|                                                       | **o**                                                                                                                                                                                                                           | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                       | ** **                                                                                                                                                                                                                      | ** **                                                                                    |
|                                                       | **FOR THE TRANSITION PERIOD FROM                   TO                 .** |
|                                                            |                                                                                                                                                                                                                                 |                                                                                               |  |

 

**Commission File Number 0-21321**

 

**CYMER,INC.**

(Exact name of registrant as specified in its charter)

 
| **Nevada**                                                       | ** ** | ** **                            | **33-0175463** |   |
|------------------------------------------------------------------|------------|---------------------------------------|----------------|--------|
| (State  or other jurisdiction of  incorporation or organization) |       | (I.R.S. Employer  Identification No.) |           |
|                                                             |       |                                  |           |
| **17075 Thornmint Court, San Diego, CA**                         | ** ** | **92127**                             |           |
| (Address  of principal executive offices)                        |       | (Zip Code)                            |           |
|                                                                  |            |                                       |                |        |  |  |  |

 

Registrant’s telephone number including area code: **(858) 385-7300**

 

Securities registered pursuant to Section 12(b) of the Act: **None**

 

Securities registered pursuant to Section 12(g) of the Act:

 

**Common Stock, $.001 par value**

(Titleof class)

 

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

 

Yes  ý  No  o

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained to the bestof registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K.   ý

 

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

 

Theaggregate market value of the voting stock held by non-affiliates of theregistrant, based upon the closing price of $37.44 for shares of the registrant’sCommon Stock on June 30, 2004 as reported on the Nasdaq National Market, wasapproximately $1,363,811,268. In calculating such aggregate market value,shares of Common Stock owned of record or beneficially by officers ordirectors, and persons known to the registrant to own more than ten percent ofthe registrant’s voting securities were excluded because such persons may bedeemed to be affiliates. The registrant disclaims the existence of control orany admission thereof for any other purpose.

 

Numberof shares of Common Stock outstanding as of March 10, 2005: 36,765,263.

 

DOCUMENTS INCORPORATED BY REFERENCE

Thefollowing document is incorporated by reference in Part III of this AnnualReport on Form 10-K: portions of registrant’s proxy statement for its annualmeeting of stockholders to be held on May 19, 2005.

 

 

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CYMER, INC.

 

2004 Annual Report on Form 10-K

 

TABLE OF CONTENTS

 
| PART I    |       |
|-----------|------------|
|      | Item 1.    | Business |   |
|      | Item 2.    | Properties |   |
|      | Item 3.    | Legal Proceedings |   |
|      | Item 4.    | Submission of Matters to a Vote of Security  Holders |   |
|      |       |   |   |
| PART II   |       |   |   |
|      | Item 5.    | Market for Registrant’s Common Equity,  Related Stockholder Matters and Issuer Purchases of Equity Securities |   |
|      | Item 6.    | Selected Financial Data |   |
|      | Item 7.    | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |   |
|      | Item 7A.   | Quantitative  and Qualitative Disclosures About Market Risk |   |
|      | Item  8.   | Financial  Statements and Supplementary Data |   |
|      | Item  9.   | Changes  in and Disagreements with Accountants on Accounting and Financial Disclosure |   |
|      | Item 9A.   | Controls and  Procedures |   |
|      | Item 9B.   | Other Information |   |
|      |       |   |   |
| PART  III |       |   |   |
|      | Item  10.  | Directors  and Executive Officers of the Registrant |   |
|      | Item 11.   | Executive Compensation |   |
|      | Item  12.  | Security  Ownership of Certain Beneficial Owners and Management |   |
|      | Item  13.  | Certain  Relationships and Related Transactions |   |
|      | Item  14.  | Principal  Accounting Fees and Services |   |
|      |       |   |   |
| PART IV   |       |   |   |
|      | Item  15.  | Exhibits  and Financial Statement Schedules |   |
|      |       |   |   |
|      | Signatures |   |
|           |            |  |  |  |

 

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**Forward-LookingStatements**

#### ** **

Statementsin this Annual Report on Form 10-K that are not strictly historical in natureare forward-looking statements. These statements include, but are not limitedto, references to expected domestic and international product sales anddevelopment; research and development activities and expenditures; adequacy ofcapital resources and investments; effects of business cycles in thesemiconductor business; competitive positioning; and relationships withcustomers and third-party manufacturers for product manufacturing, and maycontain words such as “believes,” “anticipates,” “expects,” and words ofsimilar meaning. These statements are only predictions based on currentinformation and expectations and involve a number of risks and uncertainties.The underlying information and expectations are likely to change over time.Actual events or results may differ materially from those projected in theforward-looking statements due to various factors, including, but not limitedto, those set forth under the caption “Risks and Uncertainties That May AffectResults” and elsewhere in this Annual Report on Form 10-K. Forward-lookingstatements herein speak only as of the date of this Annual Report on Form 10-K.

 

PARTI

 

### **Item 1****. Business**

### ** **

#### **Overview**

#### ** **

Weare the world’s leading supplier of excimer light sources, the essential lightsource for deep ultraviolet (“DUV”) photolithography systems. DUVphotolithography is a key enabling technology that has allowed thesemiconductor industry to meet the exacting specifications and manufacturingrequirements for volume production of today’s most advanced semiconductorchips. Our light source systems are incorporated into step-and-repeat (“steppers”)and step-and-scan (“scanners”) photolithography systems for use in themanufacture of semiconductors with critical feature sizes below 0.35 microns.One micron equals one millionth of a meter. Our excimer light source systemsconstitute a substantial majority of all excimer light sources incorporated inDUV photolithography tools. Our products consist of photolithography lightsource systems, replacement parts and service. We maintain a worldwide serviceorganization that supports our installed base of light sources. As of December31, 2004 this installed base totaled 2,496 light sources. Our customers includeall three manufacturers of DUV photolithography systems: ASM Lithography, Canonand Nikon. Photolithography systems incorporating our excimer lightsources have been purchased by many of the world’s largest semiconductormanufacturers including: AMD, Elpida, Hynix, IBM,  Infineon, Intel, Micron, Nanya/Inotera,Powerchip, Renesas Technology, Samsung, SMIC, Sony, ST Microelectronics, TexasInstruments, Toshiba, TSMC, and UMC.

 

#### **Other Information**

#### ** **

Weare a Nevada corporation, incorporated on July 12, 1996. We were originallyincorporated in California in 1986 and reincorporated in Nevada in 1996.

 

Ourwebsite address is http://www.cymer.com. Our filings with the Securities andExchange Commission (“SEC”) including our Annual Report on Form 10-K, quarterlyreports on Form 10-Q, current reports on Form 8-K and any amendments to thosereports are available free of charge through our website as soon as reasonablypracticable after being filed with or furnished to the SEC.

 

Youmay read and copy materials that we file with the SEC at the SEC’s PublicReference Room at 450 Fifth Street, NW, Washington DC 20549. Information on theoperation of the Public Reference Room is available by calling the SEC at1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxystatements and other information we file. The address of the SEC website ishttp://www.sec.gov.

 

1

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**Products and Services**

 

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

 

*Photolithography Light Sources*

* *

Ourphotolithography light sources produce narrow bandwidth pulses of shortwavelength light within the DUV spectrum. The three DUV wavelengths aremeasured in nanometers (“nm”). One nanometer equals one billionth of a meter.The light sources are referred to according to the gases mixed to produce thelight or by the wavelength. Krypton Fluoride (“KrF”) gases produce 248 nm lightand Argon Fluoride (“ArF”) gases produce 193 nm light. The light sources permitvery fine feature resolution for imaging the circuitry on the wafer and highthroughput in wafer processing. We have designed our light sources to be highlyreliable, easy to install and compatible with existing semiconductormanufacturing processes. Our light sources are used to pattern the integratedcircuits, which are also called semiconductors or “chips”, that power many oftoday’s advanced consumer and business electronics. In 2004, we sold 301 lightsource systems at an average selling price of $827,000.

 

***248 nm KrF Light Sources***

** **

**7000 Series** – The 7000 series product line offers a full range of products forboth KrF and ArF 4 kilohertz (“kHz”) excimer light sources so that customershave the flexibility to “mix and match” products within the same manufacturingenvironment. Advanced architecture and materials incorporated into the designof the 7000 Series significantly reduce the light source consumables costs.

 

•                  **ELS-7010******– The ELS-7010 meets the requirements of highvolume production of sub-0.10 micron devices on 248 nm exposure tools. TheELS-7010 offers a 4 kHz, 40 watt (“W”) optical output, plus ultra-narrowedbandwidth performance and high-speed wavelength control.

 

•                  **ELS-7000TM******–****Thetechnically-advanced ELS-7000 meets the requirements of high volume productionof sub-0.13 micron devices on 248 nm exposure tools. The ELS-7000 offers a 4kHz, 30 W optical output, plus ultra-low bandwidth performance and high speedwavelength control.

 

### **6000 Series******–****The6000 Series consists of light source models that are within our cutting-edge248 nm KrF portfolio and are designed for the production of semiconductordevices down to 130 nm (0.13 micron) design rules.

### ** **

•                  **ELS-6010******– The ELS-6010 enables semiconductormanufacturers to leverage their existing KrF experience during the transitionto 130 nm design rules. It provides a highly line-narrowed spectral bandwidthof < 0.5 picometer (“pm”), full width half maximum (“FWHM”) and <1.4 pm 95% energy integral. The ELS-6010 enables full image performance fromlithography steppers and scanners using lenses with numerical apertures (“NA”)> 0.75.

 

•                  **ELS-6000®TM******–****TheELS-6000 is a 2 kHz light source designed for advanced steppers and scanners forthe production of devices with 180 nm and below geometries. The 20 W ELS-6000is designed for the most advanced optical systems with up to 0.70 NA lensdesigns. Incorporating advances in the light source chamber, pulse power andoptics modules, the ELS-6000 enables significant improvements in throughputrates and critical dimension (“CD”) control through its ±0.4% energy dosestability, 0.6 pm bandwidth FWHM, and 2.0 pm bandwidth at 95% energy integral.

 

### **5000 Series******–****Witha repetition rate of 1 kHz, this solid-state pulse power light source series isengineered using modular construction. Enabling higher device yields bydelivering improved energy stability, this series is designed specifically foruse in the manufacture of semiconductors with 250 nm and smaller design rules.The 5000 series consists of the following models: ELS-5010, ELS-5005 upgrade,ELS-5000 and EX-5000.

###  

2

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***193 nm ArF Light Sources***

** **

Today’schipmakers seek light sources that make the critical transition in exposurewavelength from 248 nm using KrF to 193 nm using ArF while maintaining theperformance and volume demands of mainstream manufacturing.

 

**XL Series** – The XL Series can accommodate multiple generations of light sourceproducts operating at the excimer light source exposure wavelengths of KrF (248nm) and ArF (193 nm). The XL Series dual chamber design called MasterOscillator Power Amplifier (“MOPA”) is the technology that will enable theperformance and cost advantages required by the market. By utilizing the ArF(193 nm) exposure wavelength, the XL Series enables chip design rules toshrink, which leads to faster processing speeds and boosts memory capacity perchip.

 

•                  **XLA 200** – The XLA 200 is our third-generation,leading-edge ArF light source to feature the production-proven, dual-chamberMOPA platform—enabling both ultra line-narrowed bandwidth and 60 W of outputpower. Because the XLA 200 is built on the existing XL Series platform,customers will enjoy seamless integration into their existing processes andrapid time-to-yield. With an ultra line-narrowed spectral bandwidth of <0.12pm FWHM, the XLA 200 provides the light that enables high contrast imagingfor lithography tools with an NA up to > 1.0. The first unit of this model isexpected to ship sometime in mid - 2005.

 

•                  **XLA 105** – The XLA 105 is our second-generation,leading-edge ArF light source to feature the production-proven, dual-chamberMOPA platform—enabling both ultra line-narrowed bandwidth and 40 W of outputpower.  Because the XLA 105 is built on the existing XL Series platform,customers will enjoy seamless integration into their existing processes andrapid time-to-yield. With an ultra line-narrowed spectral bandwidth of <0.20 pm FWHM, the XLA 105 provides the light that enables high contrastimaging for lithography tools with an NA up to 0.93.

 

•                  **XLA 100** – The XLA 100 was the first, ultraline-narrowed, high power 4 kHz ArF production light source featuring the dualchamber MOPA design. The XLA 100 provides outstanding optical and powerperformance. MOPA enables the XLA 100 to produce 40 W of output power, which istwice the output power of our earlier single chamber-based ArF models. With anultra line-narrowed spectral bandwidth of 0.25 pm FWHM, the tightest spectralbandwidth performance of any DUV production light source, the XLA 100 produceshigh contrast imaging for lithography tools with an NA up to 0.9.

 

**NanoLithTM 7000******–****TheNanoLithTM 7000 is a single-chamber light source that, whenintroduced, provided the required output power and stability while providing ahighly line-narrowed bandwidth to meet the stringent requirements of highvolume production at that time. The NanoLith 7000 offers a bandwidth of <=0.5 pm FWHM and <= 1.3 pm 95% energy integral, which enables next-generationscanners with high NA lenses to produce the resolution for sub 100 nm devices.

 

**ELS-6010A******–****The ELS-6010A is a highly line-narrowed, 2kHz 10 W 193 nm production light source designed to meet resolution, imagecontrast, and wafer throughput requirements in semiconductor chip production atthe <130 nm node. With highly line-narrowed bandwidth, the ELS-6010A enableshigh contrast imaging from lithography scanners using high NA lenses. Built-inlaser metrology provides pulse-to-pulse data acquisition and feedback controlto minimize transient wavelength instabilities, thereby enhancing exposurelatitude and CD control. In life tests the ELS-6010A revealed a potential for70% cost of consumables reduction compared to the ELX-5000A predecessor. TheELS-6010A is built on our highly reliable ELS-6000® platform.

 

Revenuesgenerated from sales of light sources were approximately $203.1 million, $160.3million, and $244.8 million for 2002, 2003, and 2004, respectively.

 

3

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*Replacement Parts and Refurbishment Activities*

 

Certaincomponents and subassemblies included in our light sources require replacementor refurbishment following extended operation. For example, the dischargechamber of our light sources has an expected life of approximately three tosixteen billion pulses, depending on the model. We estimate that a light sourceused in a semiconductor production environment will require one to tworeplacement chambers per year, depending upon the level of usage. Similarly,certain optical components of the light source deteriorate with continuedexposure to DUV light and require periodic replacement. We provide these andother spare and replacement parts for our photolithography light sources asneeded by our customers.

 

Revenuesgenerated from sales of replacement parts, excluding the receipt of reusablematerial, were approximately $66.8 million, $83.2 million, and $123.2 millionfor 2002, 2003, and 2004, respectively. Revenues from replacement parts aredependent on both the utilization of our light source systems and the size ofour installed base of light sources. The size of our installed base increasedfrom 2,217 light sources as of December 31, 2003 to 2,496 light sources as ofDecember 31, 2004, and the utilization of our light source systems atchipmakers grew significantly in 2004 until we reached peak levels in August2004. However, in September 2004 we started to experience a slowdown in thesemiconductor industry, which resulted in decreased utilization of our lightsource systems in the third and fourth quarters of 2004 or about 12% below theAugust 2004 peak.

 

Aspart of our regular business activities, we conduct significant partsrefurbishment activities related to some of our core assemblies. Theseactivities involve arrangements with our customers where we sell new parts toour customers at a reduced sales price in exchange for these customers sendingback to us the consumed assembly that the new part replaced. These returnedcore assemblies contain a certain amount of material, primarily metalcomponents, that may be reused by us in future core assemblies. Since a portionof the consideration related to the original sale is related to the return ofconsumed parts, we record revenue when we receive the returned assemblies fromour customers.

 

Revenuesgenerated from the receipt of reusable material contained within consumedassemblies returned from our customers were approximately $28.5 million for2004. Revenues from such activities are dependent on the quantity of the coreassemblies returned from our customers and the value of the reusable parts thatwe expect to yield from the core assemblies received. See further discussion onchange in method of accounting for refurbishment activities under Item 7.Management’s Discussion and Analysis of Financial Condition and Results ofOperations and Item 8. Financial Statements and Supplementary Data Note 2 tothe consolidated financial statements.

 

*Service*

* *

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

 

Inaddition to service contracts, we provide an on-line diagnostic product,CymerOnLineTM. CymerOnLine is a diagnostic and performance softwareproduct, which delivers critical laser diagnostics and performance informationin near real-time directly to authorized users anywhere. The softwaresimplifies reporting and allows users to efficiently manage consumables usage.CymerOnLine features a user-friendly browser-based interface, which features arobust design and provides a secure data environment. Event-initiated messagessent to pagers, e-mail, mobile phones, or other handheld devices enableup-to-the minute communication and proactive management.

 

Revenuesgenerated from service and service contracts were approximately $15.8 million,$21.3 million, and $20.1 million for 2002, 2003, and 2004, respectively. Weexpect service and service

 

4

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contract revenues to remain at or near thesehigher levels as our installed base grows and the warranty period of thoselight source systems expire.

 

**Customers and End-Users**

 

Wesell our photolithography light source products to each of the threemanufacturers of DUV photolithography tools:

 
| ASM Lithography | Canon | Nikon |
|-----------------|-------|-------|

 

Webelieve that maintaining and strengthening customer relationships will play animportant role in maintaining our leading position in the photolithographymarket. We work closely with our customers to integrate our products into theirphotolithography tools. Sales to ASM Lithography, Canon, and Nikon accountedfor 34%, 11% and 22%, respectively, of total revenue in 2004.

 

Revenuesgenerated from customers within the United States were $27.8 million, $29.3million and $75.8 million for 2002, 2003 and 2004, respectively. Revenuesgenerated from customers outside of the United States were $261.1 million,$236.5 million and $342.2 million for 2002, 2003, and 2004, respectively.

 

Revenuesgenerated from customers located in Japan were $123.4 million, $116.5 millionand $132.8 million for 2002, 2003 and 2004, respectively. Revenues generatedfrom customers located in Europe were $102.1 million, $74.6 million and $154.7million for 2002, 2003, and 2004, respectively. These revenues can originatefrom any of our subsidiary locations to customers located in these countries.

 

End-usersof our light sources include many of the world’s largest semiconductormanufacturers, as listed in “Part I, Item 1. Business, Overview”. The followingsemiconductor manufacturers have purchased one or more DUV photolithographytools incorporating our light sources:

 
| **United States**        | ** ** | **Japan**               | ** ** | **Singapore**      | ** ** | **Taiwan/China** | ** ** | **Korea**              |
|--------------------------|------------|-------------------------|------------|--------------------|------------|------------------|------------|------------------------|
|                     |       |                    |       |               |       |             |       |                   |
| Agere  Systems           |       | CASMAT                  |       | 1st  Silicon       |       | ASMC             |       | ANAM  F1               |
| Agilent  Technologies    |       | Denso                   |       | Chartered  Silicon |       | ERSO             |       | Dongbu                 |
| Albany  Nanotech         |       | Elpida  Memory Inc.     |       | Partners           |       | GSMC             |       | Hynix  Semiconductor   |
| Applied  Materials       |       | Fuji  Film              |       | Peregrine          |       | Hejian           |       | Inc                    |
| Atmel                    |       | Fujitsu                 |       | Semiconductor      |       | Inotera          |       | Samsung                |
| Clariant  Corp.          |       | Gifu  Sanyo Electronics |       | Silterra           |       | Mosel            |       |                   |
| Cypress                  |       | Hitachi                 |       | SSMC               |       | MXIC             |       | **Europe**             |
| Freescale  Semiconductor |       | JSR                     |       | TECH               |       | Nan-ya           | ** ** | Altis  Semiconductor   |
| Headway  Technologies    |       | Kawasaki  Seitetsu      |       | UMCI  Pte Ltd.     |       | Promos           |       | C-NET                  |
| Honeywell                |       | Matsushita              |       |               |       | PSC              |       | IHP                    |
| HP                       |       | Mitsubishi              |       |               |       | SMIC             |       | IMEC  v.z.w †     |
| IBM                      |       | NEC                     |       |               |       | TSMC             |       | Infineon  Technologies |
| Integrated  Device       |       | OKI                     |       |               |       | UMC  Group       |       | AG                     |
| Technology               |       | Rohm                    |       |               |       | VISC             |       | LETI                   |
| Intel                    |       | Sanyo                   |       |               |       | Winbond  Group   |       | Micronas  GmbH         |
| Jazz  Semiconductor      |       | Seiko                   |       |               |       |             |       | Philips                |
| LSI  Logic Corp.         |       | SELETE  †          |       |               |       |             |       | RENESAS                |
| Lucent                   |       | Sharp                   |       |               |       |             |       | Semiconductor          |
| Maxim  Integrated        |       | Sony                    |       |               |       |             |       | ST  Microelectronics   |
| Products                 |       | Tokyo  Electron Ltd.    |       |               |       |             |       | Tower  Semiconductor   |
| Microchip  Technology    |       | Tokyo  Ohka Kougyo      |       |               |       |             |       |                   |
| Inc.                     |       | Co.                     |       |               |       |             |       |                   |
| Micron  Technology       |       | Toshiba                 |       |               |       |             |       |                   |
| National  Semiconductor  |       | Trecenti  Technologies  |       |               |       |             |       |                   |
| Rohm  & Haas         |       |                    |       |               |       |             |       |                   |
| SEMATECH  †         |       |                    |       |               |       |             |       |                   |
| Spansion                 |       |                    |       |               |       |             |       |                   |
| Texas  Instruments       |       |                    |       |               |       |             |       |                   |
| VLSI                     |       |                    |       |               |       |             |       |                   |
| Wafertech                |       |                    |       |               |       |             |       |                   |

 

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† A semiconductor industryconsortium.

 

5

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**Backlog**

 

Weschedule production of light sources based upon order backlog and informalcustomer forecasts. We include in backlog only those orders to which a purchaseorder number has been assigned by the customer and for which delivery has beenspecified within 12 months. Because customers may cancel or delay orders withlittle or no penalty, our backlog as of any particular date may not be areliable indicator of actual sales for any succeeding period. AtDecember 31, 2004, we had a backlog of approximately $79.1 millioncompared with a backlog of $103.9 million at December 31, 2003.

 

**Manufacturing**

 

Ourmanufacturing activities consist of material management, assembly, integrationand testing. These activities are performed in a 265,000 square foot facilityin San Diego, California that includes approximately 31,000 square feet ofClass 10,000 cleanroom manufacturing and test space. In order to focus our ownresources, capitalize on the expertise of our key suppliers and respond more efficientlyto customer demand, we have contracted the manufacture of many of oursubassemblies. Our manufacturing outsourcing strategy is exemplified by themodular design of our products. Substantially all manufacturing ofnonproprietary subassemblies has been contracted to third-party suppliers. As aresult, we are increasingly dependent upon these contract suppliers to meet ourmanufacturing schedules. The failure by one or more of these suppliers tosupply us on a timely basis with sufficient quantities of components orsubassemblies that perform to our specifications could affect our ability todeliver completed light sources to our customers on schedule. We believe thatthe highly outsourced content and manufacturable design of our products allowsfor reduced manufacturing cycle times and increased output per employee. Toimprove current production efficiencies, control costs, and manage overallmanufacturing capacity, we intend to continue to provide additional training tomanufacturing personnel, improve our assembly and test processes in order toreduce cycle time, invest in additional manufacturing tooling and furtherdevelop our supplier management and engineering capabilities.

 

Inaddition to the manufacturing capacity at our facilities in San Diego, California,we completed the construction of a manufacturing facility in Korea in late2002. This facility is used as a refurbishment facility and refurbishes one ofour core modules, our chamber, initially for light sources in Korea andultimately for the Asia-Pacific region. The refurbishment facility in Koreaincludes 6,550 square feet of Class 10,000 cleanroom manufacturing space. Allof the final qualification phases for this facility were completed during thefourth quarter of 2002 and the first chamber was shipped to a customer fromthis facility in January 2003. Throughout 2003 and 2004 chambers for several ofour light source models were refurbished in the Korea facility and successfullyshipped to customers.

 

Duringthe period from 1997 through March 2003, we also had additional manufacturingcapacity as a result of our contract manufacturing agreement with SeikoInstruments, Inc. (“Seiko”). Seiko was qualified as a contract manufacturer ofour light source systems and began production of our light sources in 1997.Although the original agreement could have been renewed for an additional twoyears, we and Seiko mutually consented to the termination of this contract. Asa result, Seiko ceased manufacturing light source systems for us effectiveMarch 31, 2003. The termination of this agreement has not impacted ourproduction of light source systems to date.

 

Alimited number of components and subassemblies included in our products areobtained from a single supplier or a small group of suppliers. For certainoptical components used in our light source systems, we currently utilize asingle supplier. Where possible, we work with secondary suppliers to qualifyadditional sources of supply. To reduce the risk associated with this singlesupplier, we carry significant strategic inventories of these components.Strategic inventories are managed as a percentage of future demand. We havealso negotiated to have vendor-managed inventory of critical components tofurther reduce the risk of a single supplier. To date we have been able toobtain adequate supplies of the components and subassemblies used in theproduction of our light source systems in a timely manner from existingsources. If in the future we are unable to obtain sufficient quantities ofrequired materials, components or subassemblies, or if such items do not meetour quality

 

6

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standards,delays or reductions in product shipments could occur which could have amaterial adverse effect on our business, financial condition and results ofoperations.

 

**Sales and Marketing**

 

Oursales and marketing efforts are designed to serve our customer base consistingof both the DUV photolithography tool providers such as ASM Lithography, Canonand Nikon as well as many of the world’s top 20 chipmakers. We market and sellour products through our own worldwide direct sales and marketing channels andwe have developed product and applications engineering teams to support theseefforts. We believe that in order for our sales and marketing organization tobe successful, we must work closely with and understand the requirements ofboth the photolithography systems solutions providers and the semiconductormanufacturers alike.

 

**Service and Support**

 

Webelieve our success in the semiconductor photolithography market is highlydependent upon after-sales support of both the direct customer and theend-user. We support our customers with field service, technical serviceengineers and training programs, and in some cases provide ongoing on-sitetechnical support at the customer’s manufacturing facility. Prior to shipment,our support personnel typically assist the customer in site preparation andinspection and provide customers with training at our facilities or at thecustomer’s location. We also provide direct customers and end-users with acomprehensive set of manuals, including operations, maintenance, service,diagnostic and safety manuals.

 

Ourfield engineers and technical support specialists provide field service andfront-line technical support capability from our San Diego headquarters, and atour field service offices located throughout the United States. Support inEurope, Japan, Korea, Singapore, the People’s Republic of China, Taiwan andSoutheast Asia is provided by our subsidiaries located within those regions. Aspart of our customer service, we maintain an inventory of spare parts at eachof our service facilities. As our installed base grows, replacement partsrequired to satisfy worldwide support requirements, as well as our ownlogistics support organization, will be subject to the fluctuating demands ofthe semiconductor industry. In order to meet these demands, we must continue toeffectively manage our production of component modules which are required fornew systems, as well as for support and warranty requirements for installedsystems.

 

Webelieve that the need to provide fast and responsive service to thesemiconductor manufacturers using our light sources is critical and that wecannot depend solely on our customers to provide this service. Therefore, webelieve it is essential to maintain, through our own personnel, a rapidresponse capability to service our customers and end-users throughout theworld. Accordingly, we have an ongoing effort to continuously develop ourdirect support infrastructure in Europe, Japan, Korea, Singapore, the People’sRepublic of China, Taiwan and Southeast Asia and the United States. This taskentails recruiting and training qualified field service personnel oridentifying qualified independent firms and maintaining effective and highlytrained organizations that can provide service to customers in variouscountries in their assigned regions.

 

Wegenerally warrant our new light source products against defects in design,materials, and workmanship. The warranty period and terms vary by light sourcemodel. In general, the light source system warranty period ranges from 17 to 26months after shipment. We also warrant consumables and spare parts sold to ourcustomers 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 warranty period for consumables and spare parts isapproximately six months from the date of shipment.

 

#### **Research and Development**

#### ** **

Thesemiconductor industry is subject to rapid technological change and new product

 

7

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introductions and enhancements. We believethat continued and timely development and introduction of new and enhancedlight source products are essential for us to maintain our competitiveposition. We intend to continue to develop our technology and innovativeproducts to meet customer demands. Current projects include enhancements to ourKrF and ArF light sources and the new MOPA platform. We have significantdevelopment efforts to address the technology and products that will be basedon the extreme ultraviolet (“EUV”) technology needed for future generationphotolithography illumination sources. While we are no longer making directinvestments in fluorine (“F2”) light sources development, previous investmentcombined with continued platform and core technology developments in our otherproducts are expected to enable us to acquire a leadership position should amarket for F2 light sources develop. We may also invest in other product andtechnology areas in order to expand our portfolio within the semiconductorcapital equipment market sector. In addition there are ongoing efforts toimprove existing products, reduce manufacturing costs, lower the cost of lightsource operation, enhance light source performance, develop new features forexisting light sources, and conduct research and development of non-lightsource products.

 

Wehave historically devoted a significant portion of our financial resources toresearch and development programs and expect to continue to allocatesignificant resources to these efforts. Research and development expenses for2002, 2003, and 2004 were approximately $72.4 million, $56.6 million, and $58.5million, respectively.

 

Inthe last three years, we have entered into several research and developmentagreements related to EUV technology both with customers and governmentagencies. The largest of these research and development agreements was withIntel Corporation (“Intel”) in January 2004. The total funding under thisagreement is $20.0 million and provides us with funding over three years toaccelerate the development of production-worthy EUV lithography light sources.The funding being received from Intel under this agreement is milestone basedand is netted against our total research and development expenses in the periodthe milestone is achieved. The total funding recorded under this agreement for2004 was $6.1 million.

 

Revenuesgenerated from research and development contracts amounted to approximately$871,000, $57,000, and $783,000 during 2002, 2003, and 2004, respectively. Forcertain of our research and development contracts, our research and developmentexpenses are offset by amounts earned associated with these contracts. Theamounts offset against research and development expenses were $1.3 million,$1.6 million, and $7.6 million during 2002, 2003, and 2004, respectively.

 

#### **Intellectual Property Rights**

#### ** **

Webelieve that the success of our business depends more on such factors as thetechnical expertise of our employees, as well as their innovative skills andmarketing and customer relations ability, than on patents, copyrights, tradesecrets and other intellectual property rights. Nevertheless, our success maydepend in part on patents. As of December 31, 2004, we owned 209 United Statespatents covering certain aspects of technology related to light sources andpiezo techniques. These patents will expire at various times during the periodfrom January 2008 through June 2022. As of December 31, 2004, we had appliedfor 83 additional patents in the United States. As of December 31, 2004, weowned 299 foreign patents and had 325 patent applications pending in variousforeign countries.

 

Ourpending patent applications and any future applications might not be approved.Our patents might not provide us with a competitive advantage and may bechallenged by third parties. In addition, third parties’ patents might have anadverse effect on our ability to do business. As a result of cost constraints,we did not begin filing in Japan and other countries our patents for inventionscovered by United States patents and patent applications until 1993. As aresult we do not have the right to seek foreign patent protection for some ofour early inventions. Additionally, laws of some foreign countries in which ourproducts are or may be developed, manufactured or sold, including variouscountries in Asia, may not protect our products or intellectual property rightsto the same extent as do the laws of the United States. Thus, protection of ourtechnology and products in these countries may not be

 

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adequate. Further, third parties might independentlydevelop similar products, duplicate our products, or design around patents thatare 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 appropriate proceedings in the courts or the patent offices in order todetermine the priority of inventions. These proceedings may determine thatthese third-party patent applications have priority over our patentapplications. Loss of priority in these interference proceedings could resultin substantial cost to us.

 

Wealso rely upon trade secret protection, employee and third-party nondisclosureagreements and other intellectual property protection methods to protect ourconfidential and proprietary information. Despite these efforts, third partiesmight independently develop substantially the same proprietary information andtechniques or otherwise gain access to our trade secrets or disclose ourtechnology. We might not be able to meaningfully protect our trade secrets.

 

Inthe past, funds from research and development arrangements with third partieshave been used to pay for a portion of our own research and developmentexpenses. We receive these funds from government-sponsored programs and customers,in connection with our designing and developing specific products. Currently,funds from lithography tool manufacturers and chipmakers are used to fund asmall portion of our development expenses. In providing these research anddevelopment services to these manufacturers, we try to make clear who owns theintellectual property that results from the research and development serviceswe perform. However, disputes over the ownership or rights to use or marketthis intellectual property may arise between the funding organizations and us.

 

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

 

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

 

Inthe future, patent litigation may result due to a claim of infringement by ourcompetitor or any other third party or may be necessary to enforce patentsissued to us. Any such litigation could result in substantial cost anddiversion of effort to us, which would have an adverse effect on our business,financial condition and operating results. Furthermore, our customers and theend-users of our products might assert other claims for indemnification thatarise from infringement claims against them. If these

 

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assertionsare successful, our business, financial condition and operating results may bematerially affected. Instead of litigation, or as a result thereof, we may seeka license from third parties to use their intellectual property. However, wemay not be able to obtain a license. In the alternative, we may design aroundthe third party’s intellectual property rights. Any adverse determination in alegal proceeding could result in loss of our proprietary rights, exposure tosignificant liabilities by other third parties, requirement that we get alicense from third parties on terms that are not favorable, or restriction frommanufacturing or selling our products, any of which could have a substantialadverse effect on our business, financial condition and operating results. Anyof these actions could be costly and would divert the efforts and attention ofour management and technical personnel, which would materially adversely affectour business, financial condition and results of operations.

 

EffectiveAugust 1, 1989 and lasting until the expiration of the licensed patentsduring 2004, we entered into an agreement for a nonexclusive worldwide licenseto use or sell certain patented light source technology with Patlex Corp., apatent holding company. Under the terms of the agreement, we are required topay royalties ranging from 0.25% to 5.0% of gross sales and leases of its lightsources, subject to an annual cap of $100,000 per year. During 2002, 2003 and2004, royalty fees totaled $100,000 per year.

 

Wehave granted Seiko a right of first refusal to fund our development of, andreceive a license to, new industrial light source technologies not developedwith funding from other parties. In exchange for these rights, we receivedup-front license fees of $3.0 million in aggregate during 1992 and 1993. Wewere also entitled to royalties of 5% on related product sales through September1999, after which the royalty rate was subject to renegotiation. To date norenegotiation of the royalty rate has occurred. Through 1999, we earned noroyalties under the agreement. The license agreement also provides that productsales between us and Seiko will be at a 15% discount from the respectivecompanies’ list prices. The agreement terminates in August 2012. There has beenno Seiko production or sales activity associated with this contract to date andthis contract does not apply to our current light source system products.

 

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

 

**Competition**

 

Webelieve that the principal elements of competition in our markets are thetechnical performance characteristics of the excimer light source products andthe operating efficiency of the system, which is based on availability,performance efficiency and rate of quality. We believe that we competefavorably with respect to these factors.

 

Wecurrently have one significant competitor, Gigaphoton, that sells light sourcesfor DUV photolithography applications. Gigaphoton is a joint venture betweentwo large companies, Komatsu and Ushio, which is headquartered in Japan. Webelieve that Gigaphoton is aggressively trying to gain larger marketpenetration in the excimer light source industry. We know that our customershave purchased products from this competitor and that our customers haveapproved this competitor’s light sources for use with their products. We knowthat Gigaphoton has been approved by chipmakers in Japan, the U.S. andelsewhere for producing excimer light sources. We could lose market share andour growth could slow or even decline if our competitor gains marketacceptance. Late in 2004, a former competitor, Coherent, announced that theirsubsidiary, Lambda-Physik, would no longer pursue the excimer light sourcesystems business for photolithography in the semiconductor industry.

 

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Inthe future, we will likely experience competition from other technologies, suchas EUV and electron projection lithography (“EPL”). To remain competitive, webelieve that we will need to manufacture and deliver products to customers on atimely basis without significant defects and maintain a high level ofinvestment in research and development and sales and marketing. We might nothave sufficient resources to continue to make the investments necessary tomaintain our competitive position.

 

Largercompetitors with substantially greater resources, such as other manufacturersof industrial light sources for advanced lithography, may attempt to sellcompetitive products to our customers. Potential competitors may also beattracted to our growing installed base of light sources and may attempt tosupply consumable products and refurbished parts to that installed base.

 

**Employees**

 

OnDecember 31, 2004, we employed 770 persons worldwide. No employees arecurrently covered by collective bargaining agreements or are members of anylabor organization as far as we are aware. We have not experienced any workstoppages and believe that our employee relations are good.

 

### **Executive Officers**

### ** **

Setforth below is certain information regarding our executive officers and theirages as of March 10, 2005.

 
| **Name**        | ** **         | **Age** | ** ** | **Position**                                       |                                                            |
|-----------------|--------------------|---------|------------|----------------------------------------------------|-----------------------------------------------------------------|
|            |               |    |       |                                               |                                                            |
| Robert P. Akins |               | 53      |       | Chairman of the Board and  Chief Executive Officer |                                                            |
|            | Pascal Didier      |    | 46         |                                               | President and Chief  Operating Officer                          |
|            | Nancy J. Baker     |    | 42         |                                               | Senior Vice President,  Chief Financial Officer                 |
|            | Bill N. Alexander  |    | 48         |                                               | Executive Vice President,  Worldwide Customer Operations        |
|            | Edward P. Holtaway |    | 49         |                                               | Executive Vice President,  Lithography System Solutions         |
|            | Brian C. Klene     |    | 47         |                                               | Executive Vice President,  Emerging Technology and Applications |
|            | Takeshi Watanabe   |    | 50         |                                               | President, Cymer Japan                                          |
|            | Rae Ann Werner     |    | 40         |                                               | Vice President, Controller  and Chief Accounting Officer        |
|                 |                    |         |            |                                                    |                                                                 |  |  |  |  |  |

 

**Robert P. Akins**,****oneof our co-founders, has served as our chairman and chief executive officersince our inception in 1986, and served as president of the company as wellfrom our inception until May 2000. He currently serves on the boards ofdirectors of Semiconductor Equipment and Materials International (“SEMI”), andSEMI North America. He is also a member of the council of advisors to the Irwinand Joan Jacobs School of Engineering at the University of California, SanDiego (“UCSD”), and serves on the board of the UC San Diego Foundation. Mr.Akins received the Ernst & Young Entrepreneur of the Year Award for SanDiego County in 1997, and with fellow co-founder Rick Sandstrom, received theoutstanding alumnus award from UCSD, and the prestigious SEMI Award for NorthAmerica, the highest honor conferred by SEMI, in 1996 for contributions to thefield of DUV lithography. Mr. Akins received a bachelor’s degree in physics, abachelor’s degree in literature, and a doctorate in applied physics from theUniversity of California, San Diego.

 

**Pascal Didier** has served as president and chief operating officer since May 2000. Heserved as senior vice president, worldwide customer operations from November1997 until May 2000, and served as vice president of sales and marketing fromJuly 1997, when he joined the company, until November of that year. He servedas vice president of worldwide sales and field operations with GaSonicsInternational, a semiconductor capital equipment manufacturer, from June 1995to June 1997, and served in the additional capacity of vice president ofAsia/Pacific for that company from June 1995 to June 1996. Prior to that, Mr. Didierserved for two years as vice president of international operations for MegatestCorporation, a semiconductor test equipment manufacturer. Mr. Didier received

 

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a bachelor’s degree in business and administrationfrom the College de Paris VII and a bachelor’s degree in electronics from theInstitut Universitaire de Lyon.

 

**Nancy J. Baker** has served as senior vice president andchief financial officer since January 2002. Prior to that, she served as our vicepresident, finance and treasurer from June 1998 to December 2001. During 2000,she headed the company’s successful effort to implement a new EnterpriseResource Planning system, which was implemented in San Diego in only sixmonths, and globally in only nine months. From October 1996 to June 1998 sheserved as director, corporate finance and treasurer. She joined us as corporatecontroller for worldwide operations in August 1992. Ms. Baker’s professionalcareer spans more than 19 years, and prior to joining us, she held a variety offinancial management positions with an international manufacturer in the SanDiego area. Ms. Baker received a bachelor’s degree in accounting from theUniversity of Texas at Austin and completed the executive advanced managementprogram at Harvard Business School.

 

**Bill N. Alexander** has served as executive vice president ofworldwide customer operations since October 2004. He joined us in October 2002as our senior vice president of sales in the Lithography System Solutions group.Prior to joining us, Mr. Alexander served as the president of Europe operationsfor Novellus Systems, Inc. and before that, he worked as the vice president ofworldwide sales and field operations at GaSonics International, Inc. fromAugust 1997 to January 2001. Throughout his career, Mr. Alexander has heldvarious senior management positions throughout the semiconductor industryincluding vice president, Asia Pacific sales and support operations at TencorInstruments, vice president of international operations for Watkins-JohnsonCompany, senior manager of Asia Pacific regional divisional marketing forApplied Materials, CVD Division, and senior manager of Asia Pacific strategicsales for Lam Research Corporation. Mr. Alexander holds a bachelor’s degreefrom San Jose State University as well as a master’s degree in businessadministration from Golden Gate University.

 

**Edward P. (Ted) Holtaway** currently serves as executive vice presidentof corporate operations. Prior to that, he served as our executive vicepresident of the Lithography System Solutions group since October 2002.Previously, he served as senior vice president of operations and businessprocess management from May 2000 until October 2002. He joined us in July 1998as senior vice president of process quality. Prior to joining us, Mr. Holtawayspent 13 years developing processes for San Diego-based Brooktree Corp., afabless semiconductor company acquired by Rockwell Semiconductor Systems inSeptember 1996. During his tenure, Mr. Holtaway’s executive posts includeddirector of Rockwell’s San Diego operations from 1997 to 1998, vice presidentand managing director of Brooktree’s Singapore operations from 1995 to 1996,and vice president of corporate quality from 1989 to 1995. Mr. Holtaway holds abachelor’s degree in electrical engineering from the New Jersey Institute ofTechnology, a master’s degree in electrical engineering from the PolytechnicInstitute of New York, and a master’s degree in business administration fromSan Diego State University.

 

**Brian C. Klene** has served as executive vice president ofthe Emerging Technology and Applications business unit since October 2002.Previously, he served as senior vice president, marketing and businessdevelopment, which he had held since joining us in June 2000. Prior to joiningus, Mr. Klene spent two years as vice president, strategic planning andbusiness development at Chartered Semiconductor Manufacturing Ltd. inSingapore. From 1995 to 1997, he served as executive vice president, sales andmarketing at Micron Electronics, Inc., Nampa, Idaho. Before that, he served asdirector of North American sales with Micron Technology, Inc., Boise, Idaho,from 1989 to 1994. He also served in a variety of sales and marketing positionsof increasing responsibility with IBM Corp. Mr. Klene received a master’sdegree in business administration from the University of Southern California,and a bachelor’s degree from The Citadel, Charleston, South Carolina.

 

**Takeshi Watanabe** has served as president of Cymer Japan, Inc.since February 2005, and in this role is responsible for managing our overallbusiness in Japan, including the sales, service, and operations infrastructurefor our direct customers and lithography tool manufacturers. Prior to that, heserved as our account sales director for Canon from June 2001 to February 2005.Mr. Watanabe joined Cymer Japan, Inc. in October 2000 as finance director, andserved in that position until June 2001. Before joining us,

 

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Mr. Watanabe served as senior finance managerwith Guidant Japan, Ltd., where he was responsible for finance and planning andrestructured the unit’s financial operations. Over the twenty years prior tothis, Mr. Watanabe served in a series of finance positions of increasingresponsibility with such companies as Duracell Battery Japan Ltd., StrykerJapan, Ltd., Nihon Valid Logic System, Ltd., Kulicke and Soffa (Japan), Ltd.,Sony Music Entertainment, and Measurex Japan, Ltd. Mr. Watanabe holds abachelor’s degree in accounting from Chuo University.

 

**Rae Ann Werner**has served as vice president, controller, andchief accounting officer since January 2003. Prior to that, she served as ourcontroller from February 1999 to January 2003. From 1993 to 1999 she held avariety of finance positions with increasing responsibilities since joining usin November 1993.  Ms. Werner’s professional career spans more than 17years, and prior to joining us, she held a variety of financial positions withsemiconductor and communications companies in the San Diego area.  Ms.Werner received a bachelor’s degree in accounting from San Diego StateUniversity.

 

Executiveofficers serve at the discretion of the board of directors. There are no familyrelationships between any of the directors and our executive officers.

 

#### **Item 2****. Properties**

#### ** **

Ourcorporate headquarters is located in San Diego, California and includesadministrative, manufacturing, engineering, and research and developmentfacilities. In addition, we have field service offices located throughout theUnited States and internationally. We completed construction of a refurbishmentfacility in Korea at the end of 2002. This manufacturing facility is used torefurbish chamber assemblies and was qualified for production at the end of2002. We completed construction of a 265,000 square foot building adjacent toour corporate headquarters located in San Diego, California in the thirdquarter of 2003. Also in the third quarter of 2003, we transferred allmanufacturing activities and corporate services from two leased facilities inSan Diego to this company-owned manufacturing and office facility. As ofDecember 31, 2004 we had subleased both of the facilities we vacated in 2003.In addition to the leased facilities in San Diego, we also have a much smallerfacility in Charlestown, Massachusetts that is currently vacant. As of December31, 2004, we have not been able to sublease this property.

 

AtDecember 31, 2004, details on our leased and owned property were as follows:

 
| **Location**                   | ** **      | **Lease  Expiration** | ** **    | **Total  Square  Footage** | ** ** | **Primary  Usage / Status**                                               |
|--------------------------------|-----------------|-----------------------|---------------|----------------------------|------------|---------------------------------------------------------------------------|
|                           |            |                  |          |                       |       |                                                                      |
| San Diego, California (1)      |            | Owned                 |          | 135,000                    |       | Corporate headquarters, engineering, research and development  facilities |
| San Diego, California (1)      |            | Owned                 |          | 265,000                    |       | Manufacturing and administrative office                                   |
| San Diego, California          |            | January 2010          |          | 155,000                    |       | Facility subleased                                                        |
| San Diego, California          |            | January 2010          |          | 65,755                     |       | Facility subleased                                                        |
| Santa Clara, California        |            | February 2005         |          | 1,857                      |       | Property was vacated February 2005                                        |
| Austin, Texas                  |            | October 2005          |          | 1,627                      |       | Field service office                                                      |
| Portland, Oregon               |            | April 2006            |          | 1,857                      |       | Field service office                                                      |
| Charlestown, Massachusetts     |            | January 2008          |          | 21,262                     |       | Vacant                                                                    |
| Motoyata, Japan                |            | June 2005             |          | 13,831                     |       | Field service and sales office                                            |
| Osaka, Japan                   |            | December 2005         |          | 807                        |       | Field service and sales office                                            |
| Hsin-Chu, Taiwan               |            | June 2005             |          | 4,821                      |       | Field service and sales office                                            |
| United Square, Singapore       |            | May 2005              |          | 1,866                      |       | Field service and sales office                                            |
| Maarssen, Netherlands          |            | May 2009              |          | 3,715                      |       | Field service and sales office                                            |
| Veldhoven, Netherlands         |            | December 2008         |          | 2,605                      |       | Field service and sales office                                            |
| Pyongtaek-city, Kyonggi, Korea | – Land (2) |                  | December 2020 |                       |       |                                                                      |   |
|                           | – Building |                  | Owned         |                       | 26,000     |                                                                      | Manufacturing, sales and administrative |
| Pudong, Shanghai, China        |            | October 2005          |          | 4,746                      |       | Field service and sales office                                            |

 

(1) Land and building are ownedby us.

(2)Land leased through December 2020. Building is owned by us.

 

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#### **Item 3****.    Legal Proceedings**

#### ** **

None.

 

**Item 4****.    Submission of Matters to a Vote of Security Holders**

 

Nomatters were submitted to a vote of our security holders during the fourthquarter of the fiscal year ended December 31, 2004.

 

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##### PART II

#####  

**Item 5****.    Market for Registrant’s Common Equity and Related StockholderMatters**

 

OurCommon Stock is publicly traded on the Nasdaq National Market under the symbol “CYMI”.The following table sets forth, for the periods indicated, the high and lowprices of our Common Stock as reported by the Nasdaq National Market.

 
| **Year ended December 31, 2003** | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------------------------|------------|----------|------------|---------|------------|
| First quarter                    |       | $        | 40.00      |    | $          | 23.63 |   |
| Second quarter                   |       | $        | 36.75      |    | $          | 23.06 |   |
| Third quarter                    |       | $        | 49.09      |    | $          | 30.52 |   |
| Fourth quarter                   |       | $        | 49.89      |    | $          | 39.05 |   |

 
| **Year ended December 31, 2004** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------------------|------------|------------|------------|------------|------------|
| First quarter                    |       | $          | 50.44      |       | $          | 34.90 |   |
| Second quarter                   |       | $          | 41.99      |       | $          | 30.75 |   |
| Third quarter                    |       | $          | 37.40      |       | $          | 23.81 |   |
| Fourth quarter                   |       | $          | 35.17      |       | $          | 25.69 |   |

 

Theclosing sales price of our Common Stock on the Nasdaq National Market was $27.82on March 10, 2005 and there were 282 registered holders of record as of thatdate.

 

Wehave never declared or paid cash dividends on our Common Stock and currently donot anticipate paying cash dividends in the future.

 

Theinformation required to be disclosed by Item 201(d) of Regulation S-K *“Securities Authorized for Issuance Under EquityCompensation Plans”* is incorporated herein by reference to our ProxyStatement.

 

**Item 6****.    Selected Financial Data**

 

Thefollowing selected consolidated financial data should be read in conjunctionwith our consolidated financial statements and notes thereto and with “Management’sDiscussion and Analysis of Financial Condition and Results of Operations,”which are included elsewhere in this report.

 

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| ** **                                                                 | ** ** | **Years  ended December 31,**              | ** ** |
|----------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                 | ** ** | **2000**                                   | ** ** | **2001  (1)** | ** ** | **2002** | ** ** | **2003** | ** ** | **2004  (4)** | ** ** |
| ** **                                                                 | ** ** | **(in  thousands, except per share data)** | ** ** |
| **Consolidated Statements of Operations Data:**                            |       |                                       |       |   |   |   |   |   |   |   |   |
| Revenues:                                                                  |       |                                       |       |   |   |   |   |   |   |   |   |
| Product sales                                                              |       | $                                          | 366,280    |   | $ | 267,003 |   | $ | 287,995 |   | $ | 265,816 |   | $ | 417,296 |   |
| Other (2)                                                                  |       | —                                     |       | 1,948 |   | 871 |   | 57 |   | 783 |   |
| Total revenues                                                             |       | 366,280                                    |       | 268,951 |   | 288,866 |   | 265,873 |   | 418,079 |   |
|                                                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Costs and expenses:                                                        |       |                                       |       |   |   |   |   |   |   |   |   |
| Cost of product sales                                                      |       | 187,579                                    |       | 151,340 |   | 162,095 |   | 187,679 |   | 243,473 |   |
| Research and development (2)                                               |       | 44,253                                     |       | 57,875 |   | 72,420 |   | 56,608 |   | 58,452 |   |
| Sales and marketing                                                        |       | 20,098                                     |       | 19,617 |   | 17,153 |   | 16,966 |   | 23,369 |   |
| General and administrative                                                 |       | 22,510                                     |       | 18,990 |   | 18,212 |   | 39,094 |   | 31,630 |   |
| Amortization of goodwill and intangible assets                             |       | 108                                        |       | 3,148 |   | 160 |   | 160 |   | 160 |   |
| Purchased in-process research and development                              |       | —                                     |       | 5,050 |   | — |   | — |   | — |   |
| Loss (gain) on debt extinguishment (3)                                     |       | —                                     |       | (610 | ) | 163 |   | — |   | (911 | ) |
| Total costs and expenses                                                   |       | 274,548                                    |       | 255,410 |   | 270,203 |   | 300,507 |   | 356,173 |   |
| Operating income (loss)                                                    |       | 91,732                                     |       | 13,541 |   | 18,663 |   | (34,634 | ) | 61,906 |   |
| Other expense – net                                                   |       | (1,230                                     | )          | (1,447 | ) | (1,914 | ) | (1,139 | ) | (1,332 | ) |
| Income (loss) before income tax provision (benefit) and minority  interest |       | 90,502                                     |       | 12,094 |   | 16,749 |   | (35,773 | ) | 60,574 |   |
| Income tax provision (benefit)                                             |       | 26,246                                     |       | 2,871 |   | 2,706 |   | (21,464 | ) | 15,144 |   |
| Minority interest                                                          |       | (484                                       | )          | (368 | ) | (447 | ) | (1,091 | ) | (2,276 | ) |
|                                                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Income (loss) before cumulative change in accounting principle             |       | 63,772                                     |       | 8,855 |   | 13,596 |   | (15,400 | ) | 43,154 |   |
|                                                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Cumulative change in accounting principle, net of taxes                    |       | —                                     |       | (370 | ) | — |   | — |   | — |   |
|                                                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Net income (loss)                                                          |       | $                                          | 63,772     |   | $ | 8,485 |   | $ | 13,596 |   | $ | (15,400 | ) | $ | 43,154 |   |
|                                                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Basic earnings (loss) per share                                            |       | $                                          | 2.19       |   | $ | 0.28 |   | $ | 0.41 |   | $ | (0.44 | ) | $ | 1.17 |   |
| Weighted average common shares outstanding                                 |       | 29,113                                     |       | 30,474 |   | 33,317 |   | 35,065 |   | 36,758 |   |
|                                                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Diluted earnings (loss) per share                                          |       | $                                          | 2.07       |   | $ | 0.27 |   | $ | 0.39 |   | $ | (0.44 | ) | $ | 1.15 |   |
| Weighted average common and dilutive potential common shares  outstanding  |       | 30,758                                     |       | 31,108 |   | 34,712 |   | 35,065 |   | 37,584 |   |

 
| ** **                           | ** ** | **As of December 31,** | ** ** |
|--------------------------------------|------------|------------------------|------------|
| ** **                           | ** ** | **2000**               | ** ** | **2001** | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                           | ** ** | **(in  thousands)**    | ** ** |
| **Consolidated Balance Sheet Data:** |       |                   |       |   |   |   |   |   |   |   |   |
| Cash and cash equivalents            |       | $                      | 79,678     |   | $ | 111,195 |   | $ | 196,643 |   | $ | 230,657 |   | $ | 201,021 |   |
| Working capital                      |       | 278,546                |       | 257,851 |   | 351,127 |   | 397,790 |   | 436,007 |   |
| Total assets                         |       | 501,562                |       | 483,346 |   | 766,887 |   | 809,244 |   | 825,778 |   |
| Total long-term liabilities          |       | 175,510                |       | 151,772 |   | 255,154 |   | 261,627 |   | 214,272 |   |
| Treasury stock                       |       | (24,871                | )          | (24,871 | ) | — |   | — |   | — |   |
| Stockholders’ equity            |       | 212,968                |       | 254,814 |   | 412,334 |   | 453,330 |   | 517,320 |   |
|                                      |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)          Includesresults of operations of Active Control Experts, Inc. acquired on February 13, 2001for the periods subsequent to its acquisition.

 

(2)          In 2004 we reclassed funds recorded forcertain of our funded development contracts that we enter into with customersand government agencies. These funds are not recorded as revenue but offsetagainst our own internal research and development expenses. Certain prior yearamounts were reclassified to conform to the current period presentation.

 

(3)          The loss (gain) on extinguishment of debt wasreclassified in 2003 in accordance with the provisions of Statement ofFinancial Accounting Standards No. 145.

 

(4)**         **Includesadditional inventory, revenue and cost of product sales associated with ourrefurbishment activities. During the****fourth****quarter of 2004, we corrected ouraccounting treatment for such activities and all amounts associated with thiscorrection are included in 2004. See further discussion under Item 7.Management’s Discussion and Analysis of Financial Condition and Results ofOperations and Item 8. Financial Statements and Supplementary Data Note 2 tothe Consolidated Financial Statements.

 

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### **Item 7****.    Management’s Discussion and Analysis of Financial Condition andResults of Operations**

### ** **

*In this section, references to “we”, “us” or “our”are references to Cymer. The following discussion of our financial conditionand results of operations should be read in conjunction with our consolidatedfinancial statements and notes thereto included in this Annual Report on Form10-K.*

 

### **Overview**

### ** **

Weare the world’s leading supplier of light source solutions for thesemiconductor industry. Our products provide the essential light source for DUVphotolithography systems. Almost all consumer electronic devices manufacturedin the last several years contain a semiconductor manufactured using lightsources, such as ours. We currently supply light sources to all threelithography tool manufacturers, ASM Lithography, Canon, and Nikon, who in turnsupply their wafer steppers and scanners to chipmakers.  In addition, wesell replacement parts and services to the lithography tool manufacturers aswell as directly to the chipmakers. Our light source systems currentlyconstitute a substantial majority of all excimer light sources incorporated inlithography stepper and scanner tools. A large portion of our revenue isderived from customers located outside of the United States. In order tosupport our foreign customers and our installed base of light sources inforeign countries, we maintain a manufacturing and field service office inKorea and field service and support offices in Japan, Singapore, the People’sRepublic of China, the Netherlands and Taiwan. We also maintain field serviceoffices in the United States to service our installed base of light sourceslocated in the United States.

 

Sincewe derive a substantial portion of our revenues from lithography toolmanufacturers, we are subject to the volatile and unpredictable nature of thesemiconductor industry. The semiconductor industry is highly cyclical in natureand historically has experienced periodic ups and downs. Since 2000, the finalyear of the last significant and prolonged peak in the cycle, the semiconductorindustry experienced one of the longest downturns in its history from 2001through late 2003. Although this downturn negatively impacted our business andresults of operations during 2001, 2002 and 2003, we were able to maintain ourrevenues at a relatively constant level and remain profitable during most ofthis three-year period. We are very conscious of the volatile nature of thesemiconductor industry and make every effort to manage our business through thecycles such that we maintain our annual profitability during the downturn andtake the necessary steps during the downturns to be strategically positionedfor the next upturn. During the extended downturn which occurred during 2001through 2003, we made several such strategic investments including thecompletion of our new manufacturing facilities in San Diego and Korea, thedevelopment and introduction of our new MOPA technology and XL platform, onwhich all of our future DUV light sources are planned to reside, and theongoing work to improve business processes that leverage the overall efficiencyof our workforce.

 

Inthe latter half of 2003, there were several indicators that the extendeddownturn in the semiconductor industry, which started in 2001, was coming to anend and that an upturn was in sight. During the final months of 2003, weexperienced strong order growth and our direct customers announced increasingorders and extended delivery times. In addition, the chipmakers’ utilization ofour DUV light sources exceeded the levels achieved in 2000, the peak of thelast extended upturn, and the mix of our light source models shipped shiftedtoward KrF products, reflecting the chipmakers’ need for more capacityexpansion. In addition to the positive industry indicators, which we saw at theend of 2003, we experienced much higher revenue levels and revenue growth fromquarter to quarter during the first nine months of 2004. From the end of 2003to the end of the third quarter of 2004, our sequential quarter over quarterrevenue growth ranged from 8% to 20%. The combination of these four consecutivequarters of positive industry indicators, our own growing order momentum, andsequential quarterly record light source utilization levels across ourinstalled base led us to believe that we were in an upturn.

 

However,during the third quarter of 2004, though our business remained strong and wehad received no net order push outs, many semiconductor and equipment companiesissued warnings about potential shortfalls in revenue and earnings. InSeptember 2004, the utilization rates of our light sources experienced thelargest single monthly decline in our company’s history. Starting in October 2004,

 

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the reported decline in chip fab utilizationcaused some chipmakers to hold off on equipment purchases, including thepurchase of lithography tools, and we received notification of light sourcepush outs from our direct customers. Our light source system utilization ratesat chipmakers continued to decline through the end of 2004.

 

Withthe increasing uncertainty in the semiconductor industry, our ability toforecast the industry cycle became limited to less than one quarter. Due tothese circumstances, in October 2004, we took actions to deal effectively withwhat appeared to be a semiconductor industry slowdown the depth and duration ofwhich we could not predict.  We alignedour cost structure accordingly with these uncertain conditions by reducing ouroverall expenses, and implementing a reduction in our workforce ofapproximately 14% on October 21, 2004. Since we were able to keep our headcountin line with the volume of our business during this most recent and briefupturn in 2004, this headcount adjustment primarily reflected the change weanticipated in any volume production activities. In addition, sinceapproximately one-third of the employees affected by this workforce reductionwere temporary employees, we preserved our ability to ramp up production againquickly in response to any potential re-acceleration of orders that might occurearly in 2005.

 

As2004 ended, it seemed apparent that the long awaited upturn, although realized,had ended without reaching the full magnitude or duration of a normal upturn.In spite of this, we had a number of noteworthy achievements during the year,including:

 

•                  Record total revenue of $418.1 million forthe year;

•                  Record non-systems revenue of $172.5 millionfor the year;

•                  Growing recognition of the benefits of the XLSeries products, and increasing adoption of these products, leading to recordshipments in the fourth quarter of 2004, with XL Series products accounting for27% of shipments for the year;

•                  Average selling prices, on a foreign currencyadjusted basis, reaching $957,000 in the fourth quarter as a result of theproduct mix shifting toward ArF products;

•                  The continued growth of our installed basedof light source systems, which reached nearly 2,500 units by the end of 2004;

•                  The successful subleasing, in the second halfof 2004, of the two San Diego facilities we vacated in 2003, which will resultin reduced general and administrative expenses going forward; and

•                  The successful continuation of our efforts toreduce lead times and material costs for our XL Series of products.

 

Withvisibility limited as we enter 2005, the outlook for our industry cannot bepredicted with accuracy. We will continue to manage our expenses effectivelywhile working to increase our operating efficiency. We expect to introduce asignificant number of new products and product features in 2005 to enhance ourcompetitiveness, including two new ArF light sources, one of which will be the XLA200, our third generation MOPA product. Since we made significant investmentsin facilities and equipment during the last several years, we do not foresee aneed for a high level of capital expenditures for some time in the future.

 

In2005, we plan to increase our management focus on improved asset managementwith particular emphasis on improving inventory management and turn rate,increasing operating efficiency, and ensuring the competitiveness of ourproduct offerings. We will be focusing our efforts in 2005 on generating asignificant amount of cash and improving shareholder returns by achievinghigher returns on assets, which includes increasing our inventory turns andreturn on invested capital during the year.

 

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**RESULTS OFOPERATIONS**

 

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

 
| ** **                                                                 | ** ** | **Years  ended December 31,** | ** ** |
|----------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                 | ** ** | **2002**                      | ** ** | **2003** | ** ** | **2004** | ** ** |
| Revenues:                                                                  |       |                          |       |   |   |   |   |
| Product sales                                                              |       | 99.7                          | %          | 100.0 | % | 99.8 | % |
| Other                                                                      |       | 0.3                           |       | — |   | 0.2 |   |
| Total revenues                                                             |       | 100.0                         | %          | 100.0 | % | 100 | % |
|                                                                       |       |                          |       |   |   |   |   |
| Cost and expenses:                                                         |       |                          |       |   |   |   |   |
| Cost of product sales                                                      |       | 56.1                          |       | 70.6 |   | 58.2 |   |
| Research and development                                                   |       | 25.0                          |       | 21.3 |   | 14.0 |   |
| Sales and marketing                                                        |       | 5.9                           |       | 6.3 |   | 5.6 |   |
| General and administrative                                                 |       | 6.3                           |       | 14.7 |   | 7.5 |   |
| Amortization of intangible assets                                          |       | 0.1                           |       | 0.1 |   | 0.1 |   |
| (Gain) loss on debt extinguishment                                         |       | 0.1                           |       | — |   | (0.2 | ) |
| Total costs and expenses                                                   |       | 93.5                          |       | 113.0 |   | 85.2 |   |
|                                                                       |       |                          |       |   |   |   |   |
| Operating income (loss)                                                    |       | 6.5                           |       | (13.0 | ) | 14.8 |   |
|                                                                       |       |                          |       |   |   |   |   |
| Other expense – net                                                   |       | (0.7                          | )          | (0.5 | ) | (0.3 | ) |
|                                                                       |       |                          |       |   |   |   |   |
| Income (loss) before income tax provision (benefit) and minority  interest |       | 5.8                           |       | (13.5 | ) | 14.5 |   |
|                                                                       |       |                          |       |   |   |   |   |
| Income tax provision (benefit)                                             |       | 0.9                           |       | (8.1 | ) | 3.6 |   |
| Minority interest                                                          |       | (0.2                          | )          | (0.4 | ) | (0.6 | ) |
|                                                                       |       |                          |       |   |   |   |   |
| Net income (loss)                                                          |       | 4.7                           | %          | (5.8 | )% | 10.3 | % |
| Gross margin on product sales                                              |       | 43.7                          | %          | 29.4 | % | 41.7 | % |

 

**CRITICALACCOUNTING POLICIES AND ESTIMATES**

 

*General*

 

Thediscussion and analysis of our financial condition and results of operationsare based upon our consolidated financial statements, which have been preparedin accordance with accounting principles generally accepted in the UnitedStates of America. The preparation of these financial statements requires us tomake estimates and use judgment that may impact the reported amounts of assets,liabilities, revenues, expenses, and related disclosure of contingent assetsand liabilities. As a part of our ongoing internal processes, we regularlyevaluate our estimates and judgments associated with revenue recognition,valuation of parts used in our refurbishment manufacturing process, inventoryallowances, warranty provisions, income taxes, allowances for bad debts,long-lived assets valuation, intangible assets valuation, and contingencies andlitigation. We base these estimates and judgments upon historical informationand other facts and assumptions that we believe to be valid and/or reasonableunder the circumstances. These assumptions and facts form the basis for makingjudgments and estimates and for determining the carrying values of our assetsand liabilities that are not apparent from other sources. Actual results couldvary from our estimates if we were to use different assumptions and conditions.

 

Webelieve that revenue recognition, valuation of parts used in our refurbishmentmanufacturing process, inventory allowances, warranty provisions, and incometaxes require more significant 

 

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judgments and estimates in the preparation ofour consolidated financial statements than do other of our accounting estimatesand judgments.

 

*Revenue Recognition*

 

Ourrevenues consist of product sales, which include sales of light source systems,consumable and spare parts, upgrades, service, service contracts and training.For a significant portion of our spare parts sales, our customers return theconsumed assembly to us as part of the sale of a new part. We reuse some of thematerial within these core assemblies, mainly metal components, for the futurebuild of core assemblies. As a result, our revenue consists of both cash andthe value of the reusable parts received from our customers as considerationfor these spare part sales. Our revenues also consist of other revenues, whichinclude revenue from certain funded development activities performed forcustomers and under government contracts and license agreements. We do notrecognize any revenue for light source systems prior to shipment. We test thesystems in environments similar to those used by our customers prior toshipment to ensure that they meet the customers’ specifications and willinterface with the customers’ software. Our installation obligations areperfunctory within the framework of Staff Accounting Bulletin No. 104 (“SAB 104”).The shipping terms vary by customer for light source systems shipments. Themajority of light source shipment terms are F.O.B. shipping point and revenueis recognized upon shipment. For those customers with F.O.B. destinationshipping terms, revenue is recognized upon delivery of the light source systemto the customer. One of our customers has an acceptance provision, which issatisfied by the issuance of an acceptance certificate following a visualinspection of the system by the customer. We do not recognize revenue onsystems shipped to that customer until we receive the acceptance certificate.We have one arrangement where a portion of the light source system fee is notpayable until the system is successfully installed at the end-user. Inaccordance with SAB 104 given the installation is not essential to thefunctionality of the system, we defer this portion of the fee until the systemis installed. Revenue from consumables and spare parts sales is recognized atthe point that legal title passes to the customer, which is generally uponshipment from our facility. Revenue associated with our customers return ofcore assemblies is recognized upon receipt of the returned core assembly. Theamount of the revenue is determined based upon the value of the reusable partsthat we expect to yield from the returned core assembly returned. Service andtraining revenue is generally recognized at the time that the services arerendered or the training class is completed. Service contract revenues aregenerally recorded as revenue ratably over the life of the contract or per thespecific terms of the agreement. For funded development contracts, which areincluded in other revenue, funds received are accounted for on thepercentage-of-completion method based on the relationship of costs incurred tototal estimated costs. Revenues generated from these types of fundeddevelopment contracts are derived from cost sharing contracts between certaincustomers and us. If milestones on these funded development contracts requirethat specific results be achieved or reported by us, revenue is not recognizeduntil that milestone is completed. For some of the funded development contractsthat we enter into with customers and government agencies, we evaluate certaincriteria to determine whether recording the funds received as revenue isappropriate. If certain conditions are met, these funds are not recorded asrevenue but rather are offset against our own internal research and developmentexpenses in the period that the milestone is achieved or per the terms of thecontract.

 

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

 

Overthe last several years as part of our regular business activities, we haveconducted significant parts refurbishment activities related to some of ourcore assemblies, in particular our chamber assemblies. The volume of thisactivity significantly increased in 2004. These activities involve arrangementswith our customers where we sell a new part to the customer at a reduced salesprice if the customer returns the consumed assembly that the new part replaces.These returned core assemblies contain a certain amount of material, primarilymetal components, that may be reused by us in future core assemblies. Uponreceipt of these consumed assemblies from our customers, we record an entry torecognize the estimated value of the reusable components as inventory andrevenue. The value of the reusable parts contained within the consumed assemblyis determined based upon historical data on the value of the reusable partsthat we typically yield from a consumed assembly. The costs of refurbishmentare also capitalized as part of 

 

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ending inventory.  See further discussion under Item 8.Financial Statements and Supplementary Data Note 2 to the ConsolidatedFinancial Statements. The value that we assign to these core assemblies can beaffected by the current demand for the reusable parts in our manufacturingoperations and the actual yield rate achieved for parts within these consumedcore assemblies. We believe that our methodology for valuing the reusable partswithin these returned core assemblies is reasonable, but any changes in thedemand for the parts or the yield of the parts included in these coreassemblies could have a material adverse effect on our financial condition andresults of operations.

 

Historically, wehave recorded the value of this material as a reduction of our cost of productsales in the period that the returned assembly was disassembled by our manufacturingoperations and the value of the reusable parts could be determined.  Upon further review of United StatesGenerally Accepted Accounting Principles (“GAAP”) in the fourth quarter of2004, we determined that we should instead estimate the value and record theseconsumed assemblies as inventory at the time we receive the returned assemblyfrom our customer and concurrently record this amount as revenue rather than asa reduction of cost of product sales.

 

**During the fourth quarter of 2004, wecorrected our accounting treatment for these refurbishment activities andanalyzed the financial impact that such an accounting correction would have on our2004 and prior year consolidated financial statements.  As a result of this analysis, we determinedthat although there is a financial impact due to this accounting correction,the amounts are not material to years prior to 2004 as well as to the fiscalyear ended December 31, 2004.  Upon makingthis determination, we recorded the cumulative impact of this accountingcorrection during the fourth quarter of 2004. Included in these corrections are increases to inventory, revenues, costof product sales and net income for the period, as well as reclassificationsfrom cost of product sales to revenues. As a result of this fourth quarter 2004 correction, our annual 2004consolidated financial statements were updated from those previously reportedin a press release issued by us on January 25, 2005.  The primary impacts of this correction fromthe previously released annual consolidated financial statements for 2004 areas follows:**

** **

**•**      $2.9 million increase in the inventory balance as of December31, 2004

**•**      $28.5 million increase in 2004 product revenues

**•**      $25.6 million increase in 2004 cost of product sales

**•**      $2.0 million increase in 2004 net income

 

*Inventory Allowance*

 

Weperform an analysis of our inventory allowances on at least a quarterly basisto determine the adequacy of this allowance on our financial statements. Theamount of the inventory allowance is determined by taking into considerationcertain assumptions related to market conditions and future demands for ourproducts, including changes to product mix, new product introductions, and/or productdiscontinuances, which may result in excess or obsolete inventory. We determinethe level of excess and obsolete inventory associated with our raw materialsand production inventory by comparing the on hand inventory balances andinventory on order to the next 12 months of forecasted demand. We then adjustthis calculation for inventory that has a high likelihood of use beyond oneyear or can be used in other products that may have lower demands. After thisadjustment, we arrive at our total exposure for excess and obsolete inventorywithin our raw materials and production inventory. As part of this analysis, wealso determine whether there are potential amounts owed to vendors as a resultof cancelled or modified raw material orders. We estimate and record a separateliability, which is included in accrued and other liabilities in theaccompanying balance sheets for such amounts owed.

 

Theinventory allowance totaled $12.0 million and $8.5 million at December 31, 2003and December 31, 2004, respectively. The decrease in this allowance from 2003to 2004 was primarily due to the mix of parts in inventory and the disposal ofobsolete inventory during 2004.

 

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

 

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

•                  Rate at which our customers take delivery ofour light source systems;

•                  Loss of any of our three major customers orsignificant change in demand from any of these three customers;

•                  Mix of light source system models and any changesto that mix required by our customers; and

•                  Utilization rates of our light sources atchipmakers.

 

Basedupon our experience, we believe that the estimates we use in calculating theinventory allowance are reasonable and properly reflect the risk of excess andobsolete inventory. If actual demand or the usage periods for our inventory aresubstantially different from our estimates, adjustments to our inventoryallowance may be required, which could have a material adverse effect on ourfinancial condition and results of operations.

 

*Warranty Provision*

 

Wemaintain an accrual for the estimated cost of product warranties associatedwith our product sales. Warranty costs include the replacement parts and laborcosts to repair our products during the warranty periods. At the time revenueis recognized, we record a warranty provision, which is included in cost ofproduct sales in the accompanying consolidated statements of operations. Thewarranty coverage period and terms vary by light source system model. Ingeneral, the light source system warranty period ranges from 17 to 26 monthsafter shipment. We also warrant consumables and spare parts sold to ourcustomers and the coverage period varies by spare part type as some typesinclude 

 

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time based warranty periods and othersinclude usage based warranty periods. On average, the warranty period forconsumables and spare parts is approximately six months from the date ofshipment. The warranty provision for light source systems is reviewed monthlyand determined by using a financial statistical model, which takes intoconsideration actual historical expenses, and potential risks associated withour different light source systems. This model is then used to estimate futureexpenses related to warranty and the required warranty provision. The risklevels and historical cost information used within this model are reviewedthroughout the year and updated as risk levels change over the light sourcesystem’s life cycle. Due to the highly technical nature of our light sourcesystem products, the newer model light sources and the modules contained withinthem have higher inherent warranty risks and require higher warrantyprovisions. The warranty provision for consumables and spare parts isdetermined by using actual historical data.

 

Thetotal balance in the warranty provision accrual as of December 31, 2003 andDecember 31, 2004 was $26.2 million and $28.2 million, respectively. Thisincrease from year to year is primarily due to an increase in the overallinstalled base of light source systems  under warranty, particularly in the XL Serieslight source which requires a higher level of warranty accruals due to theincreased number of modules included in its design.

 

Weactively engage in product improvement programs and processes to limit ourwarranty costs, but our warranty obligation is affected by the complexity ofour product, product failure rates and costs incurred to correct those productfailures at customer sites. The industry in which we operate is subject torapid technological change, and as a result, we periodically introduce newer,more complex light sources. Although we classify these newly released lightsource models as having a higher risk in our warranty model resulting in higherwarranty provisions, we are more likely to have differences between theestimated and actual warranty costs for these new products. This is due tolimited or no historical product performance data on which to base our future warrantycosts. Warranty provisions for our older and more established light sourcemodels are more predictable as we have more historical information available onthese products. If actual product failure rates or estimated costs to repairthose product failures were to differ from our estimates, revisions to ourestimated warranty provision would be required, which could have a materialadverse effect on our financial condition and results of operations.

 

*Income Taxes*

 

Weaccount for income taxes in accordance with Statement of Financial Accounting StandardsNo. 109 (“SFAS 109”), “Accounting for Income Taxes.” Pursuant to SFAS 109, adeferred tax asset or liability is generally recognized for the estimatedfuture tax effects attributable to temporary differences, net operating losscarryforwards and tax credit carryforwards. Deferred tax assets are to bereduced by a valuation allowance if, based on the weight of available evidence,it is more likely than not that some portion or all of the deferred tax assetswill not be realized within the carryback or carryforward periods. Informationabout an enterprise’s current financial position and its results of operationsfor the current and preceding years, as well as all currently availableinformation about future years should be considered.

 

Wehave considered our industry’s outlook for the future, our historicalperformance and estimated future taxable income, and ongoing tax planningstrategies in assessing the need for a valuation allowance. Using this information,we have prepared a model to forecast our expected taxable income in futureyears and to estimate when the benefits of our deferred tax assets are likelyto be realized. Based upon the analysis, we believe that it is more likely thannot that the results of future operations will generate sufficient taxableincome to realize the deferred tax assets within the period allowed by currentapplicable tax law and, as such, no valuation allowance against deferred taxassets is provided.

 

At December 31, 2004 we had federal tax netoperating loss (“NOL”) carryforwards of $51.1 million and federal tax creditsof $15.2 million, both of which begin to expire in 2018.  In order to realize the benefit associatedwith the federal NOL and credit carryforwards, we must earn cumulative taxableincome of at least $94.5 million prior to the expiration of thosecarryforwards.  At December 31, 2004 wehad state tax credit carryforwards of $13.2 million, of which $3.8 millionbegin to expire in 2009, and $9.4 million may be carried forwardindefinitely.  In order to realize thebenefit associated with the state tax credit carryforwards, we must earncumulative taxable income of at least $317.7 million prior to the expiration ofthose carryforwards.

 

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Amaterial adverse change in the outlook for worldwide lithography tool sales, inthe expected selling prices or profit margins for our products, or in ourexpected share of the global market for lithography light sources could causeus to determine that a valuation allowance is needed for some or all of ourdeferred tax assets, and would result in an increase to our income taxprovision in the period in which such determination is made.

 

Ourresults do not reflect the impact of the American Jobs Creation Act of 2004,which repealed the Extraterritorial Income Exclusion (“ETI”) subject to certaintransition rules. The ETI benefit is being replaced with a ManufacturingActivity deduction under Internal Revenue Code (“IRC”) Section 199. The benefitwill be available to us for tax years beginning in 2005, subject to certaintransition rules. We anticipate that the benefit available to us under bothregimes is comparable for years in which we have taxable income.  We have not provided for U.S. federal incomeand foreign withholding taxes on $43.0 million of undistributed earnings fromnon-U.S. operations as of December 31, 2004 as it is our intention to reinvestundistributed earnings of our foreign subsidiaries and thereby indefinitely postponetheir remittance.  Accordingly, noprovision has been made for foreign withholding taxes or United States incometaxes which may become payable if undistributed earnings of foreignsubsidiaries were paid as dividends to us.

 

Currently,we are not considering the repatriation of any foreign earnings and as such, noimpact is reported in the financial statements as of December 31, 2004.However, we are still evaluating the impact of repatriation of foreign earningsunder IRC Section 965. The American Jobs Creation Act of 2004, and IRC Section965 allow a temporary 85% dividends received deduction on repatriated foreignearnings if the funds are reinvested in the United States. Financial AccountingStandards Board (“FASB”) Staff Position No. 109-2 (“FSP No. 109-2”), allowscompanies additional time to evaluate whether foreign earnings will berepatriated under the provisions of the new law. We are awaiting the issuanceof further regulatory guidance prior to determining what amount, if any, willbe repatriated. As such, at this time, we have not determined a range ofpotential repatriated amounts, if any. We expect to complete our analysis anddetermine what amount, if any, to repatriate by September 30, 2005.

 

**YEARSENDED DECEMBER 31, 2003 AND 2004**

### ** **

*Revenues*. Our revenues consist of product sales, which include sales of lightsource systems, consumable and spare parts, upgrades, service, servicecontracts and training. For a significant portion of our spare parts sales, ourcustomers return the consumed assembly to us as part of the sale of a new part.We reuse some of the material within these core assemblies, mainly metalcomponents, for the future build of core assemblies. As a result, our revenueconsists of both cash and the value of reusable parts received from ourcustomers as consideration for these spare part sales. Our revenues alsoconsist of other revenues, which include revenue from certain fundeddevelopment activities performed for customers and under government contractsand license agreements. We do not recognize any revenue for light sourcesystems prior to shipment. We test the systems in environments similar to thoseused by our customers prior to shipment to ensure that they meet the customers’specifications and will interface with the customers’ software. Ourinstallation obligations are perfunctory within the framework of SAB 104. Oneof our customers has an acceptance provision, which is satisfied by theissuance of an acceptance certificate following a visual inspection of thesystem by the customer. We do not recognize revenue on systems shipped to thatcustomer until we receive the acceptance certificate. We have one arrangementwhere a portion of the light source system fee is not payable until the systemis successfully installed at the end-user. In accordance with SAB 104, giventhe installation is not essential to the functionality of the system, we deferthis portion of the fee until the system is installed. Revenue from consumablesand spare parts sales is recognized at the point that legal title passes to thecustomer, which is generally upon shipment from our facility. Revenueassociated with our customers’ return of core assemblies is recognized uponreceipt of the core assembly. The amount of the revenue is determined based uponthe value of the reusable parts that we expect to yield from the core assemblyreturned. Service and training revenue is generally recognized at the time thatthe services are rendered or the training class is completed. Service contractrevenues are generally recorded as revenue ratably over the life of thecontract or per the specific terms of the agreement. For funded developmentcontracts that are included in other revenue, funds received are accounted foron the percentage-of-completion method based on the relationship of costsincurred to total estimated costs. Revenues generated from these fundeddevelopment contracts are derived from cost sharing contracts between certaincustomers and us. The costs associated with these particular contracts areincluded in research and development expenses in the period incurred and arenot listed separately as other cost or expenses in the consolidated 

 

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statements of operations. If milestones onthese funded development contracts require that specific results be achieved orreported by us, revenue is not recognized until that milestone is completed.For some of the funded development contracts that we enter into with customersand government agencies, we evaluate certain criteria to determine whetherrecording the funds received as revenue is appropriate. If certain conditionsare met, these funds are not recorded as revenue and are rather offset againstour own internal research and development expenses in the period that themilestone is achieved or per the terms of the contract.

 

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

 
| ** **                                       | ** ** | **Years ended December 31,** | ** ** |
|--------------------------------------------------|------------|------------------------------|------------|
| ** **                                       | ** ** | **2002**                     | ** ** | **2003** | ** ** | **2004** | ** ** |
|                                             |       |                         |       |   |   |   |   |
| Light source systems:                            |       |                         |       |   |   |   |   |
| Revenue                                          |       | $                            | 203,106    |   | $ | 160,302 |   | $ | 244,840 | (1) |
| Units sold                                       |       | 282                          |       | 163 |   | 301 |   |
| Average selling price                            |       | $                            | 720        |   | $ | 983 |   | $ | 827 |   |
|                                             |       |                         |       |   |   |   |   |
| Consumable and spare parts and service  products |       | $                            | 84,889     |   | $ | 105,514 |   | $ | 172,456 |   |
| Other revenue                                    |       | $                            | 871        |   | $ | 57 |   | $ | 783 |   |
|                                             |       |                         |       |   |   |   |   |
| Total revenue                                    |       | $                            | 288,866    |   | $ | 265,873 |   | $ | 418,079 |   |

 

(1)  Net ofdeferred light source revenue of $4.2 million. We have one arrangement where aportion of the light source system fee is not payable until the system isinstalled successfully at the end-user.

 

Productsales increased 57% from $265.8****millionin 2003 to $417.3 million in 2004, primarily due to a 53% increase in lightsource system revenue from $160.3 million in 2003 to $244.8 million in 2004. Atotal of 163 light source systems were sold in 2003 at an average selling priceof $983,000, compared to 301 systems sold in 2004 at an average selling priceof $827,000. On a foreign currency adjusted basis, the average selling pricefor 2003 was $963,000 compared to $816,000 for 2004. The decrease in theaverage selling price from period to period reflects the shift in the productmix to capacity driven lower priced KrF products in 2004. Product sales werefurther increased from period to period due to a 63% increase in sales ofconsumable and spare parts and service products from $105.5 million in 2003 to$172.5 million in 2004. Included in the sales of consumable and spare parts andservice revenues are revenues associated with the receipt of reusable materialcontained within consumed core assemblies returned from our customers. Theserevenues totaled $28.5 million for 2004. See further discussion on change inaccounting method for refurbishment activities under Item 7. Management’sDiscussion and Analysis of Financial Condition and Results of Operations underCritical Accounting Policies and Item 8. Financial Statements and SupplementaryData Note 2 to the consolidated financial statements. The increase in this typeof product sales was due to increased utilization of our DUV light source bychipmakers during most of 2004 and an increased installed base in 2004.Revenues from funded development contracts were $57,000 in 2003, compared to$783,000 for 2004. As a result of the current market conditions and theindustry slowdown, we expect our revenue to decrease approximately 20% in thefirst quarter of 2005 compared to the fourth quarter of 2004.

 

Ourbacklog at December 31, 2003 was $103.9 million compared to $79.1 million atDecember 31, 2004. Bookings for the year ended December 31, 2003 and December31, 2004 were $270.4 million and $393.3 million, respectively. The book-to-billratio for the quarter ended December 31, 2003 was 0.92 compared to 0.80 for thequarter ended December 31, 2004. The increase in 2004 overall bookings wasprimarily due to the short three quarter upturn in the semiconductor industryin 2004 that resulted in higher systems bookings and record bookings ofconsumable and spare parts in 2004. The decrease in the book-to-bill ratio wasa result of the industry slowdown at the end of 2004. During the 

 

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industry cycles, we closely monitor ourbook-to-bills so that we achieve near unity on this ratio even during suchslowdowns.

 

 We installed 231 light sources at chipmakersand other end-users during 2003 as compared to 279 light sources installedduring 2004.

 

Salesto our three largest customers, ASM Lithography, Canon, and Nikon, amounted to24%, 24% and 21%, respectively, of total revenue for 2003, and 34%, 11% and22%, respectively, of total revenue for 2004.

 

Oursales are generated primarily by shipments to customers in Japan, Europe, andthe United States. Approximately 88% and 82% of our sales for 2003 and 2004,respectively, were derived from customers outside the United States. Wemaintain a wholly owned Japanese subsidiary, which sells to our Japanesecustomers. Revenues from Japanese customers, generated primarily by CymerJapan, accounted for 44% and 32% of total revenues for 2003 and 2004, respectively.The activities of our Japanese subsidiary are limited to sales and service ofproducts purchased by them from us as the parent corporation. We anticipatethat international sales will continue to account for a significant portion ofour net sales.

 

*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 (“forward contracts”), associated with purchases ofour products by our Japanese subsidiary for resale under firm third-party salescommitments. Shipping costs associated with our product sales are also includedin cost of product sales. We do not charge our customers for shipping fees andsuch costs are not significant.

 

Thecost of product sales increased 30% from $187.7 million for 2003 to $243.5million for 2004. This increase in the cost of product sales was primarily dueto the overall increase in product sales from year to year. Both light sourcesystem sales and sales of consumables and spare parts and service products werehigher in 2004 compared to 2003. The increase in costs of product sales alsoreflects the reduction in force activities which took place in October 2004 andmainly impacted manufacturing personnel. The increase in the cost of productsales was partially offset by the product costs associated with the shift inour product mix to lower cost KrF products and our overall material costreduction targets on a variety of products. This increase in the cost ofproduct sales was also offset by a $2.3 million Korean customs refund realizedin the fourth quarter of 2004.

 

Thegross margin on product sales was 29.4% for 2003 as compared to 41.7% for 2004.This higher gross margin was primarily due to the improved efficiencies andcosts associated with our XL Series light source and the shift to our lowercost and higher margin KrF products in 2004 as compared to 2003. The highergross margin in 2004 also reflects increased factory yield and utilization,increased and improved field utilization and efficiency and significant successin our material cost reduction efforts. In addition, gross margin was favorablyimpacted in 2004 by a couple of percentage points due to the Korean customsrefund of $2.3 million. As a result of the apparent slowdown in thesemiconductor industry and its related uncertainties, we do not anticipate thatwe will be able to sustain the high level of gross margin that we experiencedduring 2004. In response to the current industry conditions, we have decided toreduce our inventory level, including a reduction in our field sparesinventories. As a result, this reduction in inventory will have a negativeeffect on our gross margin by several percentage points over the next severalquarters due to reduced factory loading.

 

*Research and Development*. Research and development expenses includecosts of internally-funded and externally-funded projects as well as continuingproduct development support expenses, which consist primarily of employee andmaterial costs, depreciation of equipment and other engineering related costs.Our research and development expenses were offset by amounts associated withcertain of our externally funded research and development contracts. Researchand development expenses increased 3% from $56.6 million for 2003 to $58.5million for 2004, due primarily to costs associated with our EUV light sourcedevelopment, new business opportunity development and costs 

 

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associated with the profit sharing and bonusplans, which were earned by employees in 2004. Research and developmentexpenses were offset by amounts related to our externally funded research anddevelopment contracts of $1.6 million and $7.6 million for the years endedDecember 31, 2003 and 2004, respectively. In addition to our development ofEUV, we also continued to focus on next generation KrF and ArF products basedon the XL platform. As a percentage of total revenues, research and developmentexpenses decreased from 21.3% for 2003 to 14.0% for 2004 due primarily to lowerrevenues in 2003 compared to 2004. We expect research and development expensesto remain relatively flat or slightly increase in dollar spending next quarterdue to our spending on EUV development and other product developmentopportunity investigations.

 

*Sales and Marketing*. Sales and marketing expenses include theexpenses of the sales, marketing and customer support staff and other marketingexpenses. Sales and marketing expenses increased 38% from $17.0 million for2003 to $23.4 million for 2004. This increase in sales and marketing expensesfrom year to year primarily reflects the expenses associated with the profitsharing and bonus plans, which were earned by employees in 2004 and increasedmarketing expenses associated with our international subsidiaries in 2004. As apercentage of total revenues, such sales and marketing expenses decreased from 6.3%for 2003 to 5.6% for 2004. We anticipate sales and marketing expenses todecline in dollar spending in the first quarter of 2005.

 

*General and Administrative*. General and administrative expenses consistprimarily of management and administrative personnel costs, professionalservices and administrative operating costs. General and administrativeexpenses decreased 19% from $39.1 million for 2003 to $31.6 million for 2004due to a number of factors. First of all, we incurred a $15.6 million tenantimprovement write-off in 2003 associated with the facilities we vacated duringthe third quarter of that year. This tenant improvement write-off resulted in adecrease in depreciation expense in 2004, which is allocated among the variousexpense classifications. Although we were successful in subleasing our SanDiego facilities in 2004, we did incur a loss associated with one of thesubleases. General and administrative expenses in 2004 included $3.0 million incosts associated with such subleasing activities for our San Diego andCharlestown facilities (see Item 2. Properties). In addition, general andadministrative expenses were higher in 2004 as compared to 2003 due to theexpenses associated with our bonus and profit sharing plans, which were earnedby employees in 2004 and significant consulting and external audit feesassociated with our compliance with the new internal control reportingrequirements under Section 404 of the Sarbanes-Oxley Act. As a percentage oftotal revenues, such expenses decreased from 14.7% for 2003 to 7.5% for 2004.We anticipate general and administrative expenses to decrease in dollarspending in the first quarter of 2005.

 

*Amortization of Intangible Assets.*Amortization of intangible assets totaled$160,000 for both 2003 and 2004. This amortization of intangible assets expenseis consistent from year to year and relates to the existing technologyassociated with the acquisition of Active Control eXperts, Inc. (“ACX”), whichwas completed in early 2001. With our adoption of Statement of FinancialAccounting Standards No. 142 (“SFAS No. 142”), “Goodwill and Other IntangibleAssets” on January 1, 2002, we discontinued the amortization of goodwill withindefinite useful life associated with previous purchase business combinations.Amortization expense for patents which is included in research and developmentexpenses and cost of product sales was $1.5 million and $2.4 million for 2003and 2004, respectively.

 

*Gain on Debt Extinguishment.* In February 2002, we issued $250.0 millionprincipal amount of unsecured fixed rate 3.50% convertible subordinated notes(the “2002 notes”). These 2002 notes are due February 15, 2009 with interestpayable on February 15 and August 15 of each year. In the third quarter of2004, we repurchased, at a discount to par, $49.2 million of the 2002 notes. Asa result of this repurchase, we recognized a gain on debt extinguishment of$911,000 for 2004.

 

*Total Other Income (Expense) - Net.* Net other income (expense) consistsprimarily of interest income and expense and foreign currency exchange gainsand losses associated with fluctuations in the value of the functionalcurrencies of our foreign subsidiaries against the United States dollar. Netother expense totaled $1.1 million and $1.3 million for 2003 and 2004,respectively. The increase in net other expense was primarily due to a decreasein both interest income and interest expense from year 

 

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to year and a decrease in foreign currencyexchange gains recorded in 2004. The decrease in interest income reflects lowermarket interest rates for our short-term and long-term investments. Thedecrease in interest income from year to year was offset by a $281,000 gainrecorded for a sale of investments during 2004. Interest expense was reducedfrom year to year due to our lower debt balances as a result of the repurchaseof notes that we made in the third quarter of 2004. The foreign currency gainin 2004 was reduced by a net $1.1 million loss associated with thediscontinuance of certain cash flow hedges during the third quarter of 2004.Foreign currency exchange gains totaled $436,000, interest income totaled $8.9million and interest expense totaled $10.5 million for 2003, compared toforeign currency exchange gains of $82,000, interest income and other income of$8.1 million and interest expense of $9.5 million for 2004.

 

*Income Tax Provision (Benefit)*. The tax benefit of $21.5 million and thetax provision of $15.1 million for the years ended December 31, 2003 and 2004,respectively, reflects an annual effective rate of 60% and 25%, respectively.The change in the annual effective tax rate during the year ended December 31,2004 from a benefit rate of 60% to a provision rate of 25% was primarilyattributable to the increase in pre-tax earnings as well as tax benefits fromU.S. export incentive programs and research and development and manufacturinginvestment credits. The annual effective tax rates for both periods were lessthan the U.S. statutory rate of 35% primarily as a result of permanent book/taxdifferences and tax credits. The effective tax rate is a function of currenttax law and geographic location of pre-tax income. The Research andExperimentation Credit was extended under the Working Families Tax Relief Actfor amounts paid or incurred after June 30, 2004 and before 2006. The AmericanJobs Creation Act of 2004 repealed the ETI exclusion subject to certaintransition rules. The ETI exclusion is being replaced with a ManufacturingActivity deduction under IRC Section 199. The benefit will be available to usfor tax years beginning in 2005, subject to certain transition rules. Weanticipate that the benefit available to us under both regimes is comparablefor years in which we have taxable income.

 

### **YEARS ENDED DECEMBER 31, 2002 AND2003**

### ** **

*Revenues*. Product sales decreased 8% from $288.0****million in 2002 to $265.8****millionin 2003, primarily due to a 42% decrease in the number of light source systemssold offset by a 37% increase in the average selling price. A total of 282light source systems were sold in 2002 at an average selling price of $720,000,compared to 163 systems sold in 2003 at an average selling price of $983,000.On a foreign currency adjusted basis, the average selling price for 2002 was$716,000 compared to $963,000 for 2003. This increase in foreign currencyadjusted average selling price from period to period reflects the inclusion inthe product mix of the higher priced XLA 100 light source system which wasintroduced in the first quarter of 2003 and has a higher average selling price.Product sales were further increased due to a 24% increase in sales ofconsumable and spare parts and service products from $84.9 million in 2002 to$105.5 million in 2003. The increase in this type of product sales was due toincreased utilization of our DUV light source by chipmakers and an increasedinstalled base in 2003. Revenues from funded development projects were $871,000and $57,000 in 2002 and 2003, respectively.

 

Approximately90% and 88% of our sales for 2002 and 2003, respectively, were derived fromcustomers outside the United States. Revenues from Japanese customers,generated primarily by our wholly owned Japanese subsidiary, accounted for 43%and 44% of total revenues in 2002 and 2003, respectively.

 

Salesto our three largest customers, ASM Lithography, Canon, and Nikon, amounted to32%, 21% and 24%, respectively, of total revenue for 2002, and 24%, 24% and21%, respectively, of total revenue for 2003.

 

*Cost of Product Sales*. Although the number of light source systemsrecorded as revenue was significantly lower in 2003 as compared to 2002, inabsolute dollars, the cost of product sales increased 16% from $162.1 millionfor 2002 to $187.7 million for 2003. This increase in the cost of product salesfrom year to year is primarily due to the overall costs associated with our XLA100 light source systems 

 

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and its initial transition to manufacturingin the first quarter of 2003. These additional costs included infrastructurebuilding and facilities expenses as well as reduced efficiencies associatedwith the learning curve for the production of this new light source system. Inaddition, the increase in the cost of product sales reflects the costsassociated with the increase in sales of consumables and spare parts andservice products in 2003 compared to 2002.

 

Thegross margin on product sales was 43.7% for 2002 as compared to 29.4% in 2003.This lower gross margin in 2003 reflects the lower revenues with higher overallcosts associated with the introduction of our new XL series light sourcesystem. Gross margins were also negatively impacted by additional expenses ofapproximately $4.2 million recorded in the second quarter of 2003 for costsassociated with the April 2003 reduction in workforce and the write down ofmanufacturing assets. Gross margins were further reduced in 2003 as a result ofadditional Korean customs expenses associated with our Korean operationsincurred in the third quarter of 2003.

 

*Research and Development*. Research and development expenses decreased22% from $72.4 million for the year ended December 31, 2002 to $56.6 millionfor the year ended December 31, 2003, due primarily to the early stages of theMOPA common platform development effort in 2002 and its release to manufacturingwith the introduction of the XLA 100 in the first quarter of 2003. We shippedthe first light source system that utilizes the MOPA technology, the XLA 100,in February 2003. We also continued to invest in EUV, F2 and beam delivery unittechnology and to focus on next generation KrF and ArF products based on the XLplatform. Amounts funded by external research and development contracts totaled$1.3 million and $1.6 million for the years ended December 31, 2002 and 2003,respectively. As a percentage of total revenues, research and developmentexpenses decreased from 25.0% for 2002 to 21.3% for 2003, primarily due to thedifferent stages of the MOPA platform development effort.

 

*Sales and Marketing*. Sales and marketing expenses decreased 1%from $17.2 million for 2002 to $17.0 million for 2003, due to additionalexpenses associated with reductions in workforce in the second and fourthquarters of 2003 and asset write-offs in the second quarter of 2003. Theseadditional expenses were more than offset by lower expenses resulting from thetransfer of various senior members of the sales and marketing staff to generaland administrative functions as part of an organizational structure change madein the last quarter of 2002. As a percentage of total revenues, such sales andmarketing expenses increased from 5.9% for 2002 to 6.3% for 2003.

 

*General and Administrative*. General and administrative expensesincreased 115% from $18.2 million for 2002 to $39.1 million for 2003, dueprimarily to a $15.6 million tenant improvement write-off associated with theleased facilities vacated during the third quarter of 2003. This write-off waspartially offset by the cost savings realized in the third and fourth quartersof 2003 as a result of the cost reduction efforts implemented in the second quarterof 2003. In addition, general and administrative expenses in 2003 increasedfrom 2002 levels due to the transfer of various senior personnel from the salesand marketing staff to general and administrative functions in the last quarterof 2002. As a percentage of total revenues, such expenses increased from 6.3%for 2002 to 14.7% for 2003.

 

*Amortization of intangible assets.*Amortization of intangible assets totaled$160,000 for 2002 and 2003. This amortization of intangible assets expense isconsistent from year to year and relates to the existing technology associatedwith the acquisition of ACX, which was completed in early 2001. With ouradoption of SFAS No. 142 on January 1, 2002, we discontinued the amortizationof goodwill and intangible assets with indefinite useful lives associated withprevious purchase business combinations. Amortization expense for patents whichis included in research and development expenses and cost of product sales was$1.3 million and $1.5 million for 2002 and 2003, respectively.

 

*Total Other Expense - Net.*Net other expense totaled $1.9 million and$1.1 million for 2002 and 2003, respectively. The decrease in net other expensewas primarily due to foreign currency exchange gains in 2003 compared toforeign currency exchange losses recorded in 2002, and decreases in interestexpense and interest income from year to year. Also included in net otherexpenses for 2003 was a loss on disposal of assets of approximately $427,000 asa result of a fixed 

 

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asset audit conducted inthe fourth quarter of 2003.  Thedecreased interest expense from period to period was caused by the lowerinterest rate on the 2002 notes which was reflected in the interest expenseamounts for 2003 as compared to additional interest which was recorded in 2002as the result of the principal amounts of both our convertible subordinatednotes issued in 1997 (the “1997 notes”) and the 2002 notes being outstandingduring part of 2002. The decreased interest income in 2003 was primarily due tolower average cash and investment balances in 2003 as compared to 2002 as aresult of cash used during 2003 for the continued construction of our newmanufacturing and office facility in San Diego which was completed in the thirdquarter of 2003, and cash used in operating activities.  Foreign currency exchange losses totaled$723,000, interest income totaled $10.1 million and interest expense totaled$11.2 million for the year ended December 31, 2002, compared to a foreigncurrency exchange gain of $436,000, interest income of $8.9 million andinterest expense of $10.5 million for the year ended December 31, 2003.

 

*Income Tax Provision (Benefit)*.  The tax provision of $2.7million and the tax benefit of $21.5 million for the years ended December 31,2002 and 2003, respectively, reflects an annual effective rate of 16% and 60%,respectively.  The change in the annualeffective tax rate from a provision rate of 16% for the year ended December 31,2002 to a benefit rate of  60% for theyear ended December 31, 2003 was primarily attributable to tax benefitsfrom U.S. export incentive programs and research and development andmanufacturing investment credits. The annual effective tax rates for bothperiods were less than the U.S. statutory rate of 35% primarily as a result ofpermanent book/tax differences and tax credits. The tax benefit rate for 2003reflects the increased impact of our tax credits and foreign sales incentivesin a low income or loss environment.  Theeffective tax rate is a function of current tax law and geographic location ofpre-tax income.

 

#### **LIQUIDITY AND CAPITAL RESOURCES**

 

As of December 31, 2004, we had approximately$201.0 million in cash and cash equivalents, $89.1 million in short-terminvestments, $84.6 million in long-term investments, and $436.0 million inworking capital.

 

In August 1997, we issued$172.5 million in aggregate principal amount in a private placement of notes.These 31⁄2% / 71⁄4% step-upconvertible subordinated notes were due on August 6,2004 and were convertible at the option of the holder into shares of our commonstock. The conversion rate on the 1997 notes was 21.2766 shares per $1,000principal amount or an effective conversion price of $47.00 per share.  In 2001, we repurchased a total of $24.9million of the 1997 notes then outstanding. The 1997 notes were called for redemption on March 25, 2002.  Immediately prior to the March 25, 2002redemption date, holders of $113.0 million of the outstanding principal amountconverted their 1997 notes into shares of our common stock.  As a result of these conversions, 2,325,542shares of our common stock were issued to the note holders and the remaining$38.0 million of the outstanding principal amount of the 1997 notes was redeemed.

 

In February 2002, weissued $250.0 million in aggregate principal amount in a private placement ofnotes.  These 2002 notes are due on February 15,2009 with interest payable semi-annually on February 15 and August 15of each year at 3.50% per annum.  The2002 notes are convertible into shares of our common stock at a conversion rateof 20 shares per $1,000 principal amount or an effective conversion price of$50.00 per share.  We used a portion ofthe net proceeds from this private placement to redeem the 1997 notes thenoutstanding. The remaining proceeds are being used for our operating, investingand financing activities.

 

Net cash provided byoperating activities was approximately $25.8 million and $34.2 million for 2002and 2004, respectively, compared to $3.6 million used in operating activitiesfor 2003.  Net cash provided by operating activities during 2002primarily reflects increases in net income, accounts payable and otherliabilities which were offset by increases in inventory.  The increase in inventory was primarily dueto the increased bookings and overall business activities in the first threequarters and new raw materials requirements associated with the initialproduction of the XLA 100 in the fourth quarter of 2002. Cash was also usedduring 2002 to help fund our investment in research and development for our

 

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MOPA platform. Net cash used in operating activities during 2003 reflects the net lossfor the year due to the downturn in the semiconductor industry. This net lossfor the year also reflects additional overall costs associated with our new XLA100 light source system and its introduction to manufacturing in early2003.  Cash was further reduced byincreases in customer accounts receivable, decreases in accounts payable, andaccrued expenses and other liabilities offset by a decrease in inventory fromperiod to period.  Net cash provided byoperating activities during 2004 reflects net income for the year and increasesin accrued and other liabilities and income taxes offset by increases inaccounts receivable, inventories, and accounts payable. The increase inaccounts receivable was significant for 2004 and resulted from a higher numberof product shipments than normal taking place in the last month of the quarterended December 31, 2004. The increase in inventories was primarily due toour response to the growing light source utilizations that we experiencedduring the first three quarters of 2004 and higher spares inventories tosupport what we thought would be a continued upturn in the semiconductorindustry. When the industry started to slow down in the third and fourthquarters of 2004, we took action to reduce our spares and consumablesinventory.  As a result of these actions,our inventory decreased by $10.6 million in the fourth quarter of 2004.

 

Net cash used in investingactivities was approximately $166.5 million, $5.2 million, and $33.0 millionfor 2002, 2003, and 2004, respectively.  In 2002, the $166.5 millionused in investing activities primarily reflects short-term and long-terminvestments purchased using the net proceeds generated by the 2002 Notetransactions in February and March 2002, and $45.2 million in capitalequipment purchases. Included in these capital purchases for 2002 are costsassociated with our new spare parts refurbishment factory in Korea, which wascompleted in September 2002, and costs associated with the construction ofa new manufacturing and office facility adjacent to our corporate headquarterslocated in San Diego, California. In 2003, the cash used in investing activities was dueprimarily to the continued construction of the new manufacturing and officefacility in San Diego and purchases of required manufacturing equipment for thenew facility.  These capital acquisitionsduring the year were offset by the timing of short-term and long-terminvestments that matured and were reinvested. Cash used in investing activities during 2004 reflects the timing ofshort-term and long-term investments maturing and being reinvested during theyear, purchases of property and equipment, a $6.0 million payment to acquirecertain patents and a $2.0 million payment to acquire an additional 6% minorityinterest in our Cymer Korea subsidiary.

 

Net cash provided by financing activities was approximately$225.2 million and $41.4 million for 2002 and 2003, respectively, compared tonet cash used in financing activities of $32.0 million in 2004.   In 2002, the $225.2 million provided byfinancing activities was primarily due to the activity during the first quarterof 2002 related to our 2002 Notes. The private placement of notes that wecompleted in February 2002 resulted in net proceeds of approximately$242.1 million. Of these proceeds, we used $39.6 million to redeem a portion ofour outstanding 1997 Notes and pay accrued interest and premiums on thosenotes. In addition, during 2002 we received proceeds of $22.5 million from theexercise of employee stock options.  In2003, the cash provided by financing activities was primarily due to proceeds fromthe exercise of employee stock options of $48.2 million offset by a $6.7million payment on our Japanese revolving loan, which occurred in June 2003.  In 2004, net cash used in financingactivities reflects the purchase of approximately $49.2 million of ourconvertible subordinated notes in the third quarter of 2004.  This was offset by proceeds received from theexercise of stock options totaling $15.4 million during 2004.

 

During 2003, we hadcertain loan agreements with a commercial bank, which provided for unsecuredrevolving loan facilities allowing for borrowings of $10.0 million and $20.0million under a U.S. line of credit and Japanese line of credit,respectively.  Under the loan agreements,we were able to borrow in U.S. dollars or Japanese yen, and interest accrued onoutstanding borrowings at LIBOR plus 1.75% on U.S. dollar-denominatedborrowings and at the yen cost of funds rate plus 1.5% on yen-denominatedborrowings. The loan agreements required us to maintain compliance with certainfinancial and other covenants, including tangible net worth, quick ratio andprofitability requirements.  The loanagreements expired on June 16, 2003 and have not been renewed to date.

 

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Since our initial****publicoffering and a secondary public offering, both in 1996, we have funded ouroperations primarily from cash generated from operations, the proceeds of thenote offerings in August 1997 and February 2002, bank borrowings, andthe proceeds from employee stock option exercises.

 

We require substantial working capital to fund ourbusiness, particularly to finance inventories, including purchase orders withour vendors, accounts receivable, and for capital expenditures. Our futurecapital requirements depend on many factors, including our manufacturingactivity, the timing and extent of spending to support product developmentefforts, expansion of sales and marketing and field service and support,competitive labor market compensation requirements, the timing of introductionsof new products and enhancements to existing products, and the marketacceptance of our products. We believe that cash generated from operationsalong with the liquidity provided by our existing cash balances and short-terminvestments will be sufficient to sustain operations and provide for anypotential future expansion of our business for at least the next 12 months.

 

The following summarizes our contractual obligationsand other commitments as of December 31, 2004, and the impact such obligationscould have on our liquidity and cash flow in future periods (in thousands):

 
| ** **                                 | ** ** | **Amount of Commitment Expiring  by Period** | ** ** |
|--------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                 | ** ** | **Total**                                    | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **More than  5 years** | ** ** |
|                                       |       |                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Capital lease obligations                  |       | $                                            | 12         |   | $ | 12 |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Operating lease obligations (1)            |       | 19,101                                       |       | 4,727 |   | 3,883 |   | 3,845 |   | 3,328 |   | 3,256 |   | 62 |   |
| Convertible subordinated notes             |       | 200,753                                      |       | — |   | — |   | — |   | — |   | 200,753 |   | — |   |
| Interest on convertible subordinated notes |       | 31,616                                       |       | 7,026 |   | 7,026 |   | 7,026 |   | 7,026 |   | 3,512 |   | — |   |
| Purchase orders (2)                        |       | 74,362                                       |       | 74,362 |   | — |   | — |   | — |   | — |   | — |   |
|                                       |       |                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total commitments                          |       | $                                            | 325,844    |   | $ | 86,127 |   | $ | 10,909 |   | $ | 10,871 |   | $ | 10,354 |   | $ | 207,521 |   | $ | 62 |   |

 

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(1)          Wecurrently sublease three of our leased facilities, and the payments receivedunder these are direct offsets to our operating lease obligations. The amountsin the table above represent the gross lease amounts and the following tablesummarizes amounts to be received under these non-cancelable subleaseagreements (in thousands):

 
| ** **                | ** ** | **Future Sublease Payments** | ** ** |
|---------------------------|------------|------------------------------|------------|
| ** **                | ** ** | **Total**                    | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **More than  5 years** | ** ** |
|                      |       |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total sublease agreements |       | $                            | 12,579     |   | $ | 2,895 |   | $ | 3,380 |   | $ | 3,503 |   | $ | 1,677 |   | $ | 1,124 |   | $ | — |   |
|                           |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(2)          Thisbalance reflects purchase orders outstanding as of January 3, 2005.

 

At December 31,2003 and 2004, we 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, we did not engage in trading activities involving non-exchangetraded contracts.  As a result, we arenot exposed to any financing, liquidity, market or credit risk that could ariseif we had engaged in such relationships. We do not have relationships and transactions with persons and entitiesthat derive benefits from their non-independent relationship with us or ourrelated parties except as disclosed herein.

 

# **SUBSEQUENTEVENTS**

 

On January 27,2005, we announced that our board of directors had authorized us to repurchaseup to $50,000,000 of our common stock. The purchases will be made from time to time in the open

 

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marketor in privately negotiated transactions. The program may be discontinued at any time. Total purchases through February 17,2005 were $8.3 million or 292,841 shares under this program.

 

On February 17, 2005,our board of directors approved the acceleration of the vesting of stockoptions that have exercise prices of $30.50 per share or higher held byemployees. This acceleration of stock options excludes directors, executiveofficers and certain vice presidents. The purpose of this acceleration ofvesting is to enable us to eliminate recognizing in our statement of operationsthe compensation expense associated with these “out of the money” stock optionsin future periods, upon adoption of the FASB Statement of Financial AccountingStandards No. 123R (“SFAS 123R”), which will be effective in the third quarterof 2005. The charge to the statement of operations that will be eliminated isapproximately $7.1 million over the original vesting period of these stockoptions, of which $2.5 million in the aggregate would have occurred in thethird and fourth quarters of 2005.

 

OnFebruary 17, 2005, the board of directors approved an amendment to our1996 Employee Stock Purchase Plan (“ESPP”). Effective May 1, 2005, theamendment: a) changes duration of offering periods under the plan from 24months to 6 months, b) reduces the discount to market price used to determinepurchase price for shares of our common stock under the plan from 15% to 5%,and c) eliminates the “lookback” feature that allows the purchase price to bedetermined as of the beginning of an offering period, or enrollment date, ifthe market price as of the enrollment date was lower than the market price atthe end of the offering period. The purpose of this amendment to our ESPP is toqualify the plan as a non-compensatory plan and, therefore, eliminaterecognizing compensation expense in our statements of operations upon ouradoption of FASB No. 123R in the third quarter of 2005.

 

# **RECENTACCOUNTING PRONOUNCEMENTS**

 

InDecember 2004, FASB issued SFAS No. 123R, “Share-Based Payment - AnAmendment to Statement Nos. 123 and 95,” that addresses the accounting forshare-based payment transactions in which an enterprise receives employeeservices in exchange for (a) equity instruments of the enterprise or (b)liabilities that are based on the fair value of the enterprise’s equityinstruments or that may be settled by the issuance of such equity instruments.This statement will eliminate the ability to account for share-basedcompensation transactions using Accounting Principles Board (“APB”) Opinion No.25, “Accounting for Stock Issued to Employees,” and will require instead thatsuch transactions be accounted for using a fair-value-based method. SFAS123R is effective for public companies for interim or annual periods beginningafter June 15, 2005. We are currently evaluating the impact andimplementation of SFAS No.123R and how this new pronouncement will effect ourconsolidated financial statements. Our evaluation includes a determination onhow future stock awards will be valued based on an appropriate fair value modelupon adoption of SFAS No. 123R as well as the impact of stock compensation expenseassociated with unvested stock options which are outstanding as of July 1,2005. To date we estimate that approximately $12.0 million in compensationexpense for unvested stock options will be recognized over the remainingvesting periods. Of this amount, approximately $4.5 million will be recorded inthe third and fourth quarters of 2005 combined. In addition, as a result of the amendment to our ESPP, effective May 1,2005, our ESPP will be a non-compensatory plan, and, therefore, no stockcompensation expense will be recorded under the ESPP upon the adoption of SFASNo. 123R.  We are also required to electthe transition method that we will use as part of the adoption of SFAS No.123R. The allowed transition methods include prospective and retroactiveadoption alternatives. The prospective method requires that compensationexpense be recorded for all unvested stock options and awards at the beginningof the first quarter of adoption of SFAS No. 123R, while the retroactive methodwould require us to record compensation expense for all unvested stock optionsand awards beginning with the first period restated. We have elected to use theprospective transition method in our adoption of SFAS No. 123R and to adopteffective July 1, 2005.

 

In November 2004, the FASB issued Statement of Financial Accounting Standards No. 151 (“SFAS No. 151),  “Inventory Costs, an amendment of AB 43, Chapter 4”.  This statement amends ARB 43, Chapter 4, to clarify accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material.  SFAS No. 151 requires that those items be recognized as current-period

 

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charges in all circumstances.  SFAS No. 151 is effective for fiscal years beginning after June 15, 2005.  We are still assessing the impact that the adoption of SFAS No. 151 will have on our consolidated financial statements.

 

In December 2004, the FASB issued Statement ofFinancial Accounting Standards No. 153 (“SFAS No. 153), “Exchange of NonmonetaryAssets”, an amendment of APB Opinion No. 29. SFAS No. 153 replaces theexception from fair value measurement in APB No. 29, with a general exceptionfrom fair value measurement for exchanges of nonmonetary assets that do nothave commercial substance.  The statementis to be applied prospectively and is effective for nonmonetary asset exchangesoccurring in fiscal periods beginning after June 15, 2005.  We do not believe that SFAS No. 153 will havea material impact on our results of operations or cash flows.

 

FASB Staff Position No.109-1 (“FSP No. 109-1”), Application of FASB Statement No. 109, Accounting forIncome Taxes, to the Tax Deduction on Qualified Production Activities Providedby the American Jobs Creation Act of 2004, December 21, 2004, clarifiesFASB Statement No. 109’s guidance that applies to the new deduction forqualified domestic production activities. Specifically, the FSP No. 109-1 clarifies that the deduction should beaccounted for as a special deduction under FASB Statement No. 109, not as atax-rate reduction.  The first year inwhich the benefit is potentially applicable is 2005 and at such time, we willcomply with the accounting procedures.

 

FASB Staff Position No.109-2 (“FSP No. 109-2”), Accounting and Disclosure Guidance for the ForeignEarnings Repatriation Provision within the American Jobs Creation Act of 2004(the Act), December 21, 2004, provides accounting and disclosure guidancefor the repatriation provision under the American Jobs Creation Act.  Congress and the Treasury Department have yetto issue clarifying language on key elements of the provision, which couldimpact our decision for repatriation of foreign earnings.  FSP No. 109-2 allows corporations additionaltime beyond the financial reporting period of enactment to evaluate the effectof the Act on its plan for reinvestment or repatriation of foreign earnings forpurposes of applying FASB Statement No. 109. As provided for in FSP No. 109-2, we have not made any adjustments toour tax expense or deferred tax liability related to the repatriationprovisions of the Act.

 

PCAOB Release No.2004-015, Proposed Ethics and Independence Rules Concerning Independence, TaxServices, and Contingent Fees, December 4, 2004, proposes rules to promotethe ethics and independence of registered public accounting firms that auditand review financial statements of U.S. public companies.  The rules would limit the tax servicesindependent auditors could provide to their public company audit clients.  Specifically, the rules would prohibitcontingent fee or commission arrangements; treat the firm as not independent ifthe firm provided assistance in planning or provided tax advice on potentiallyabusive tax transactions or provided tax services to certain senior officers ofthe audit client; and would require accounting firms to provide certaininformation to the audit committee of an audit client in connection withseeking pre-approval to provide non-prohibited tax services to the auditclient. Our auditor does not currently provide services to us, which areconsidered prohibited under the proposed guidelines. Based on initial analysisof the above requirements, we are currently in compliance with the proposedguidelines.

 

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

 

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

 

Our revenues and operatingresults from quarter-to-quarter have varied in the past and our futureoperating results may continue to fluctuate significantly due to many factorsincluding those listed in this section and throughout this Annual Reporton Form 10-K for the period ended December 31, 2004. These factorsinclude:

 

•                  demand for semiconductorsin general and, in particular, for leading edge devices with smaller circuitgeometries;

•                  cyclicality in themarket for semiconductor manufacturing equipment;

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

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

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

•                  product lead timedemands from our customers and the chipmakers;

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

•                  changes in the price andprofitability of our products;

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

•                  changes in market penetrationby our competitor;

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

•                  our ability to manageour manufacturing requirements;

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

•                  worldwide politicalinstability;

•                  changing global economicconditions; and

•                  intellectual propertyprotection.

 

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

 

We manage our expense levelsbased, in large part, on expected future revenues. As a result, our expensesare relatively fixed for the short term, and if our actual revenue decreasesbelow the level we expect, our operating results will be adverselyaffected.  As a result of these or otherfactors, we could fail to achieve our expectations as to future revenue, grossprofit and operating income.  Our failureto meet the performance expectations set and published by external sourcescould result in a sudden and significant drop in the price of our stock,particularly on a short-term basis, and could negatively affect the value ofany investment in our stock.

 

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

 

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

 

The semiconductor industry iscyclical in nature and historically has experienced periodic ups and downs andcurrently appears to be slowing after a short three quarter upturn thatfollowed a significant and prolonged three-year downturn. This cyclical natureof the industry in which we operate affects our ability to accurately predictfuture revenue and thus, future expense levels. When cyclical fluctuationsresult in lower than expected revenue levels, operating results may beadversely affected and cost reduction measures may be necessary in order for usto remain competitive and financially sound. During a down cycle or an industry slowdown, we must be in a position toadjust our cost and expense structure to prevailing market conditions and tocontinue 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.

 

We believe the industry haspaused, particularly in regards to purchasing capacity driven semiconductormanufacturing equipment.  Therefore, weare not able to predict with any certainty the depth or duration of theapparent slowdown of the semiconductor industry or the timing and order ofmagnitude of any future recovery.  Theprevious downturn had a severe effect on the demand for semiconductormanufacturing equipment, including photolithography tools that our customersproduce.  If overall market conditionsdeteriorate in the near term, our current operating levels may negativelyimpact our profitability. We believe that downturns in the semiconductorindustry will occur periodically, and result in periodic decreases in demandfor all semiconductor manufacturing equipment, including photolithography toolsour customers manufacture. As a result, fluctuating levels of investment bychipmakers and pricing volatility will continue to materially affect ouraggregate bookings, revenues and operating results. Also, even during periodsof reduced revenues we believe we must continue to invest in research anddevelopment and to maintain extensive ongoing worldwide customer service andsupport capabilities to remain competitive, which may temporarily harm ourfinancial results.  Accordingly, thesedownturns and industry slowdowns are likely to continue to adversely affect ourbusiness, financial condition and operating results and our operating resultsmay fall below the expectations of public market analysts or investors in somefuture quarter or quarters. Such failure to meet operating result expectationswould materially adversely affect the price of our common stock.

 

Our customers try to managetheir inventories and production requirements to appropriate levels that bestreflect their expected sales to chipmakers. Market conditions in the industryand production efficiency of the lithography tool manufacturers can cause ourcustomers to expand or reduce their orders for new light source systems as theytry to manage 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 ourrevenue is derived from sales to a few large customers, and if we are not ableto retain these customers, or they reschedule, reduce or cancel orders, ordelay or default on payments, our revenues would be reduced and our financialcondition and cash flows would suffer.**

 

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

 
| ** **      | ** ** | **Years  ended December 31,** | ** ** |
|-----------------|------------|------------------------------------|------------|
| ** **      | ** ** | **2002**                           | ** ** | **2003** | ** ** | **2004** | ** ** |
|            |       |                               |       |   |   |   |   |
| ASM Lithography |       | 32                                 | %          | 24 | % | 34 | % |
| Canon           |       | 21                                 | %          | 24 | % | 11 | % |
| Nikon           |       | 24                                 | %          | 21 | % | 22 | % |
|            |       |                               |       |   |   |   |   |
| Total           |       | 77                                 | %          | 69 | % | 67 | % |

 

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

 
| ** **      | ** ** | **December 31,** | ** ** |
|-----------------|------------|-----------------------|------------|
| ** **      | ** ** | **2003**              | ** ** | **2004** | ** ** |
|            |       |                  |       |   |   |
| ASM Lithography |       | 38                    | %          | 46 | % |
| Canon           |       | 14                    | %          | 5 | % |
| Nikon           |       | 18                    | %          | 31 | % |
|            |       |                  |       |   |   |
| Total           |       | 70                    | %          | 82 | % |

 

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

 

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

•                  a customer experiencinglithography tool production problems;

•                  a decision to purchaselight sources from other suppliers;

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

•                  a decline in a customer’sfinancial condition.

 

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

 

Our only product line is excimerlight source systems, including KrF and ArF systems, and support, includingconsumables and service support.  Weexpect these light source systems and support to continue to account for alarge percentage of our revenues in the near term. Continued market acceptanceof our light source system products is, therefore, critical to our futuresuccess. The primary market for excimer light sources is in the use of DUVphotolithography equipment for manufacturing deep-submicron semiconductordevices using smaller circuit geometries. The demand for our products dependsin part on the rate at which chipmakers further adopt excimer light sources asthe chosen light source for their photolithography tools.

 

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

 

•                  inadequate performanceof photoresists used in advanced DUV photolithography;

•                  potential shortages ofspecialized materials used in DUV optics;

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

•                  consolidation ofchipmakers.

 

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

 

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

•                  a failure to achievecontinued market acceptance of our products;

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

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

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

 

**We depend on theintroduction of new products for our success, and we are subject to risksassociated with rapid technological change.**

 

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

 

Our most significant productintroduction in recent years consisted of a technology change from asingle-discharge-chamber excimer light source to a dual-discharge-chamberdesign called MOPA.  The MOPA designrepresented a paradigm shift from previously accepted lithography technologyand offered chipmakers higher power, tighter bandwidth and lower cost ofoperation for their current – and is expected to offer the same benefits fortheir future – optical lithography applications.  As originally designed, the MOPA architecturewas projected to provide its benefits across all three DUV wavelengths – 248nm, 193 nm, and 157 nm – but at this time, the semiconductor industry has onlyadopted MOPA at the 193 nm wavelength, due to the successful extension of 248nm single chamber technology, and the omission of 157 nm lithography from theroadmap.  There are risks inherent in theongoing transition to the MOPA technology, including effective execution of ourproduct development roadmap, continuing adoption of the product by lithographytool manufacturers and chipmakers, manufacturability and cost effectiveness ofthe new products and the development of a comparable product by our competitor.

 

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

 

Future technologies such asEUV, EPL, and maskless lithography may render our excimer light source productsobsolete. We must manage product transitions, as introduction of new productscould adversely affect our sales of existing products. If new products are notintroduced on time, or have

 

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reliability or quality problems, our performance may beimpacted by reduced orders, higher manufacturing costs, delays in acceptance ofand payment for new products, and additional service and warranty expenses. Wemay not be able to develop and introduce new products or enhancements to ourexisting products and processes in a timely or cost effective manner thatsatisfies customer needs or achieves market acceptance. Failure to develop and introducethese new products and enhancements could materially adversely affect ouroperating results, financial condition and cash flows.

 

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

 

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

 

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

 

•                  closely manage ourglobal operations;

•                  improve our process andother internal management systems;

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

•                  quickly adapt tochanging sales and marketing channels;

•                  effectively manage ourinventory levels; and

•                  attract, train, retainand manage key personnel.

 

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

 

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

 

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

 

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

 

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

 

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

 

Larger companies withsubstantially greater resources, such as other manufacturers of industriallight sources for advanced lithography, may attempt to sell competitiveproducts to our customers. Potential competitors may also be attracted to ourgrowing installed base of light sources and may attempt to supply consumableproducts and refurbished parts to that installed base. If any existing orfuture competitors gain market acceptance we could lose market share and ourgrowth could slow or decline, which could have a material adverse effect on ouroperating results, financial condition and cash flows.

 

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

** **

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

 

•                  research anddevelopment;

•                  engineering;

•                  sales and marketing;

•                  field service;

•                  manufacturing; and

•                  management.

 

In particular, there are alimited number of experts in excimer light source technology, and we requirehighly skilled hardware and software engineers. Competition for qualifiedpersonnel is intense and we cannot guarantee that we will be able to continueto attract and retain qualified personnel as needed.  We do not have employment agreements withmost of our employees. We believe that our future growth and operating resultswill depend on:

 

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

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

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

 

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

 

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

 

We serve an increasingly globalmarket.  A large portion of our totalrevenues is derived from customers located outside of the United States,particularly in Asian countries.  Weexpect our international sales to continue to account for a very large portionof our total revenues.  In order tosupport our foreign customers, we maintain a manufacturing and field servicesubsidiary in Korea as well as field service and support subsidiaries in Japan,the Netherlands, the People’s Republic of China, Singapore and Taiwan.

 

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

 

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

 

•                  unexpected changes inregulatory requirements;

•                  fluctuations in exchangerates and currency controls;

•                  political and economicconditions and instability;

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

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

•                  difficulties in staffingand managing foreign subsidiary and branch operations;

•                  limited intellectualproperty protection in some countries;

•                  potentially adverse taxconsequences in some countries;

•                  the possibility ofaccounts receivable collection difficulties;

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

•                  the effect of acts ofterrorism and war; and

•                  the burdens of complyingwith a variety of foreign laws.

 

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

 

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

 

Wehave historically used broad based stock option programs and other forms ofequity-related incentives as a key component of our employee compensationpackages. We believe that stock options and other long-term equity incentivesdirectly motivate a broader base of employees to maximize long-term stockholdervalue and, through the use of long-term vesting, encourage employees to remainwith us.  The FASB has issued SFAS 123R,which will be effective for interim or annual periods beginning after June 15,2005, that will require us to record an expense to earnings for employee stockoption grants and other equity incentives. Moreover, applicable stock exchangelisting standards relating to obtaining stockholder approval of equitycompensation plans could make it more difficult or expensive for us to grantoptions to employees in the future, which may result in changes in our equitycompensation strategy. These and other developments in the provision of equitycompensation to employees could make it more difficult to attract, retain andmotivate employees, and such a change in accounting rules may adversely impactour future operating results, financial condition and cash flows.

 

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

 

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

 

•                  recruit and trainqualified field service personnel;

•                  identify qualifiedindependent firms; and

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

 

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

 

**Compliance withchanging regulations of corporate governance and public disclosure may resultin additional expenses***.*

 

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

 

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

 

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

 

As of December 31, 2004,we owned 209 United States patents covering certain aspects of technologyrelated to light sources and piezo techniques. These patents will expire atvarious times during the period from January 2008 to June 2022.  As of December 31, 2004, we had appliedfor 83 additional patents in the United States. As of December 31, 2004, we owned 299 foreign patents and had 325patent applications pending in various foreign countries.

 

Our pending patent applicationsand any future applications might not be approved. Our patents might notprovide us with a competitive advantage and may be challenged by third parties.In addition, third parties’ patents might have an adverse effect on our abilityto do business. As a result of cost

 

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constraints, we did not begin filing in Japan and othercountries our patents for inventions covered by United States patents andpatent applications until 1993.  As aresult we do not have the right to seek foreign patent protection for some ofour 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.

 

Other companies or persons mayhave filed or may file in the future patent applications that are similar oridentical to ours. We may have to participate in interference proceedingsdeclared by the USPTO in order for the patent office to determine the priorityof inventions. The patent office may determine that these third-party patentapplications have priority over our patent applications. Loss of priority inthese interference proceedings could result in substantial cost to us.

 

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

 

•                  trade secret protection;

•                  employee nondisclosureagreements;

•                  third-partynondisclosure agreements; and

•                  other intellectualproperty protection methods.

 

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

 

•                  independently developsubstantially the same proprietary information and techniques;

•                  gain access to our tradesecrets; or

•                  disclose our technology.

 

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

 

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

 

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

 

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

 

Specifically, Komatsu hasnotified us that we may be infringing some of its Japanese patents. During ourdiscussions with Komatsu, they also asserted that our former Japanesemanufacturing partner, Seiko, or we may be infringing on some of Komatsu’sUnited States patents and a number of its additional Japanese patents. Komatsuhas also notified one of our customers, Nikon, of its belief that

 

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our light sources infringe several of Komatsu’s Japaneseand U.S. patents. As a result, we started proceedings in the Japanese PatentOffice to oppose certain patents and patent applications of Komatsu. TheJapanese Patent Office has dismissed some of our opposition claims. Thus,litigation may result in connection with Komatsu’s Japanese patents or U.S.patents. Also, Komatsu might claim that we infringe other or additionalpatents. Komatsu notified Seiko that it intends to enforce its rights againstSeiko with respect to its Japanese patents if Seiko continued to engage inmanufacturing activities for us. In connection with our former manufacturingagreement with Seiko, we agree to pay Seiko under certain conditions fordamages associated with these types of claims. Seiko may not prevail in anylitigation against Komatsu, and therefore, we may be required to pay Seiko forsuch damages.

 

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

 

In the future, patentlitigation may result due to a claim of infringement by our competitor or anyother third party or may be necessary to enforce patents issued to us.  Any such litigation could result insubstantial cost and diversion of effort by us, which would have an adverseeffect on our business, financial condition and operating results. Furthermore,our customers and the end-users of our products might assert other claims forindemnification that arise from infringement claims against them. If theseassertions are successful, our business, financial condition and operatingresults may be materially affected. Instead of litigation, we may seek alicense from third parties to use their intellectual property. However, we maynot be able to obtain a license on reasonable terms. In the alternative, we maydesign 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:

 

•                  loss of our proprietaryrights;

•                  exposure to significantliabilities by other third parties;

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

•                  restriction from manufacturingor selling our products.

 

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

 

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

 

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

 

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**We have in the past andmay in the future acquire a business or enter a new market that will involvenumerous risks. We may not be able to address these risks successfully withoutsubstantial expense, delay or other operational and financial problems.**

 

The risks involved withacquiring a new company or entering a new market include the following:

 

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

•                  failure to retain keypersonnel;

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

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

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

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

•                  failure to commercializepurchased technologies;

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

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

•                  compliance with theSarbanes-Oxley Act of 2002, new SEC regulations, Nasdaq Stock Market rules andnew accounting pronouncements.

 

Mergers and acquisitions aswell as entering new markets are inherently subject to multiple significantrisks, and the inability to effectively manage these risks could have amaterial adverse effect on our business. Any of these risks could materially harm our business, financialcondition and operating results. Further, any business that we acquire or newmarket we may enter may not achieve anticipated revenues or operating results.

 

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

 

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

 

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

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

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

•                  our sales and marketingefforts may be disrupted.

 

**We are exposed to risks relatedto the fluctuations in the currency exchange rates for the Japanese yen.**

 

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

 

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

 

Many foreign governmentstandards and regulations apply to our products. These standards andregulations are always being amended. Although we intend to meet all foreignstandards and regulations, our products may not comply with these foreigngovernment standards and regulations. Further, it might not be cost effectivefor us to redesign our products to comply with these foreign governmentstandards and regulations. Our inability to design or redesign products tocomply with foreign standards therefore could have a material adverse effect onour business.

 

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

 

Over time, our light sourceproducts may not meet chipmakers’ production specifications or operating costrequirements after the light source is used for a long period in high volumeproduction. If any chipmaker cannot successfully achieve or sustain theirvolume production using our light sources, our reputation could be damaged withthe chipmakers and our customers who are the limited number of lithography toolmanufacturers. This would have a material adverse effect on our business.

 

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

 

To continue to grow ourbusiness, our existing light source products and their process capabilitiesmust be enhanced, and we must develop and manufacture new products to serveother semiconductor applications. We cannot guarantee that we will be able tomanage our growth effectively. Nor can we guarantee that we will be able toaccelerate the development of new enhancements to our existing products andcreate new products. Further, we may not be able to effectively integrate newproducts and applications into our current operations. Any of these risks couldmaterially harm our business, financial condition and results of operations.

 

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

 

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

 

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

 

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

 

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environmental and land use regulations, or restrictionson our ability to discharge hazardous substances, could subject us to futureliability or cause our manufacturing operations to be reduced or stopped.

 

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

 

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

 

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

 

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

 

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

 

•                  the cyclical nature ofthe semiconductor industry;

•                  actual or anticipatedfluctuations in our operating results;

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

•                  announcements ofinnovations in technology;

•                  new products offered byus or our competitor;

•                  developments of patentsor proprietary rights;

•                  changes in financialestimates by securities analysts;

•                  general worldwidepolitical, economic, and market conditions;

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

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

 

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

 

#### **Item 7A**.  Quantitative and Qualitative DisclosuresAbout Market Risk

 

# **Foreign Currency Risk**

 

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

 

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Asof December 31, 2004, we had outstanding forward contracts to buy U.S.$49.1 million for 5.2 billion yen under foreign currency exchange facilitieswith contract rates ranging from 101.2 yen to 113.2****yenper U.S. dollar.  These contracts expireon various dates through September 2005.

 

Our forward contractsqualify for hedge accounting treatment per the provisions of Statement ofFinancial Accounting Standards No. 133, “Accounting for Derivative Instrumentsand Hedging Activities”. As a result, we defer changes in the fair value forthe effective portion of these hedges and record the amount in othercomprehensive income (loss) and subsequently reclassify the gain or loss tocost of product sales in the same period that the related sale is made to thethird party. The fair value of these contracts and the deferred loss totaled$1.9 million and $455,000, respectively, as of December 31, 2004.  In the third quarter of 2004, we recorded aloss of $1.1 million as a result of the discontinuance of certain cash flow hedges.This loss is included in foreign currency exchange gain (loss) on theaccompanying statements of operations.

 

The fair value of theseforward contracts as of December 31, 2004 would have changed by $6.3million if the foreign currency exchange rate for the Japanese yen to the U.S.dollar on these forward contracts had changed by 10%.

 

# **Investment and Debt Risk**

 

Wemaintain an investment portfolio consisting primarily of government andcorporate fixed income securities, certificates of deposit and commercialpaper.  While it is our general intent tohold such securities until maturity, we will occasionally sell certainsecurities for cash flow purposes. Therefore, our investments are classified asavailable-for-sale and are carried on the balance sheet at fair value. In 2004,we sold approximately $20.3 million of corporate debt securities that resultedin a $281,000 gain on the sale.  Due tothe conservative 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,we issued $250.0 million principal amount of unsecured fixed rate 3.50%Convertible Subordinated Notes due February 15, 2009.  Interest on these 2002 notes is payable on February 15and August 15 of each year.  The2002 notes are convertible into shares of our common stock at a conversion rateof 20 shares per $1,000 principal amount subject to adjustment under certainconditions. We may redeem the 2002 notes on or after February 20, 2005, orearlier if the price of our common stock reaches certain levels. The 2002 notesare subordinated to our existing and future senior indebtedness and effectivelysubordinated to all indebtedness and other liabilities of our subsidiaries.  Because the interest rate is fixed, webelieve there is no risk of increased interest expense. These 2002 notes arerecorded at face value on the consolidated balance sheets. In the third quarterof 2004, we repurchased, at a discount to par, approximately $49.2 million ofthese 2002 notes.  As of December 31,2004, $200.8 million principal amount of the 2002 notes were outstanding.  The fair value of such debt based on quotedmarket prices on December 31, 2004 was $199.7 million.

 

#### **Item8.  Financial Statements andSupplementary Data**

 

The information required by this Item is included inPart IV Items 15(a)(1) and (2) of this Annual Report on Form 10-K.

 

**Item 9.  Changes in and Disagreements with Accountantson Accounting and Financial Disclosure**

 

None.

 

#### **Item9A.  Controls and Procedures**

 

*Evaluation of disclosure controls and procedures*.  Our chief executive officer and our chieffinancial officer, after evaluating the effectiveness of our disclosurecontrols and procedures (as defined in Exchange Act Rule 13a-15(e) and15d-15(e)) as of December 31, 2004, have concluded that as of

 

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such date, our disclosurecontrols and procedures were adequate and sufficient to ensure that informationrequired to be disclosed by us in the reports that we file under the SecuritiesExchange Act of 1934 is recorded, processed, summarized and reported within thetime period specified in the Commission’s rules and forms.

 

*Changes in internal controls*. There hasbeen no change in our internal control over financial reporting during thefiscal year ended December 31, 2004 that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

 

*Management’sreport on internal control over financial reporting.* The management of Cymer, Inc. isresponsible for establishing and maintaining adequate internal control over thecompany’s financial reporting.  There areinherent limitations in the effectiveness of any internal control, includingthe possibility of human error and the circumvention or overriding ofcontrols.  Accordingly, even effectiveinternal controls can provide only reasonable assurances with respect tofinancial statement preparation. Further, because of changes in conditions, the effectiveness of internalcontrols may vary over time.

 

We assessed the effectiveness of the company’sinternal control over financial reporting as of December 31, 2004 usingthe criteria and framework set forth by the Committee of SponsoringOrganizations of the Treadway Commission (COSO).  Based on our assessment, we believe that, asof December 31, 2004, Cymer, Inc.’s internal control over financialreporting is effective.

 

Management’sassessment of the effectiveness of Cymer’s internal controls over financialreporting as of December 31, 2004, has been audited by our externalauditors, KPMG LLP, an independent registered public accounting firm.  Their report appears on page F-2 of thisAnnual Report on Form 10-K.

 

#### **Item 9B.  Other Information**

 

None.

 

##### PARTIII

 

**Item10.  Directors and Executive Officers ofthe Registrant.**

 

The information regarding the identification andbusiness experience of our directors under the caption “Proposal 1 - Electionof Directors” in our Proxy Statement for the annual meeting of stockholders tobe held on May 19, 2005 to be filed with the Securities and Exchange Commissionwithin 120 days after the end of our fiscal year ended December 31, 2004,is incorporated herein by reference. For information regarding theidentification and business experience of our executive officers, see “ExecutiveOfficers” at the end of Item 1 in Part I of this Annual Report on Form 10-K.Information concerning filing requirements applicable to our executive officersand directors under the caption “Section 16(a) Beneficial OwnershipReporting Compliance” in our Proxy Statement is incorporated herein byreference.

 

In 2003, we adopted a code ofethics that applies to our principal executive officer, principal financialofficer, principal accounting officer or controller, or persons performingsimilar functions.  We have posted thetext of the code of ethics on our website which can be accessed athttp://www.cymer.com under “Investor Relations.”  In addition, we will promptly disclose on ourwebsite (1) the nature of any amendment to the code of ethics that applies toour principal executive officer, principal financial officer, principalaccounting officer or controller, or persons performing similar functions and(2) the nature of any waiver, including an implicit waiver, from a provision ofthe code of ethics that is granted to one of these specified officers, and thename of such person who is granted the waiver on our website in the future.

 

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**Item11.  Executive Compensation**

 

The information under the caption “ExecutiveCompensation” in our Proxy Statement is incorporated herein by reference.

 

**Item 12. SecurityOwnership of Certain Beneficial Owners and Management**

 

The information under the caption “Security Ownershipof Certain Beneficial Owners and Management” in our Proxy Statement isincorporated herein by this reference. The remaining information called for bythis item relating to “Securities Authorized for Issuance under EquityCompensation Plans” is incorporated herein by reference to our Proxy Statement.

 

### **Item 13.  Certain Relationships and RelatedTransactions**

 

The information under the caption “CertainTransactions” in our Proxy Statement is incorporated herein by reference.

 

With the exception of the information specificallyincorporated by reference from our Proxy Statement in this Annual Report onForm 10-K, our Proxy Statement shall not be deemed to be filed as part of thisReport.  Without limiting the foregoing,the information under the captions “Report of the Audit Committee of the Boardof Directors,”  “Report of theCompensation Committee of the Board of Directors” and “Performance MeasurementComparison” in our Proxy Statement is not incorporated by reference in thisAnnual Report on Form 10-K.

 

#### **Item 14.  Principal Accounting Fees and Services**

 

The information under the caption “PrincipalAccounting Fees and Services” in our Proxy Statement is incorporated herein byreference.

 

PART IV

 

### **Item 15.  Exhibits, Financial Statement Schedules**

 

(a)                                  The following documents are filed as part of,or incorporated by reference into, this Annual Report on Form 10-K:

 

(1)(2)                    Financial Statements and Reports of Financial Statement Schedule. The following Consolidated FinancialStatements of Cymer, Inc., Financial Statement Schedule and Reports of IndependentRegistered Public Accounting Firm are included in a separate section ofthis Annual Report on Form 10-K beginning on page F-1:

 
| Description                                                                                                      |   |
|------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                             |   |
| Report  of Independent Registered Public Accounting Firm                                                         |   |
| Report  of Independent Registered Public Accounting Firm                                                         |   |
| Consolidated Balance Sheets  as of December 31, 2003 and 2004                                               |   |
| Consolidated  Statements of Operations for the Years Ended December 31, 2002, 2003 and  2004                |   |
| Consolidated  Statements of Stockholders’ Equity for the Years Ended December 31,  2002, 2003 and 2004 |   |
| Consolidated  Statements of Cash Flows for the Years Ended December 31, 2002, 2003 and  2004                |   |
| Notes to  Consolidated Financial Statements                                                                      |   |
| Financial  Statement Schedule:                                                                                   |   |
| Schedule II  – Valuation and Qualifying Accounts and Reserves                                          |   |

 

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All other financial statement schedules have beenomitted because the required information is not applicable or not present inamounts sufficient to require submission of the schedule, or because theinformation required is included in the consolidated financial statements orthe notes thereto.

 

(3)                              Exhibits.  The exhibits listed under Item15(c) hereof are filed with, or incorporated by reference into, this AnnualReport on Form 10-K.  Each managementcontract or compensatory plan or arrangement is identified separately in item15(c) hereof.

 

(b)                                                                             Exhibits.  The following exhibits arefiled as part of, or incorporated by reference into, this Annual Report on Form10-K:

 
| 3.1    |   |   | Amended  and Restated Articles of Incorporation of Cymer, Inc. (incorporated herein by  reference to Exhibit 3.1 to Cymer’s Registration Statement on Form S-1, Reg.  No. 333-08383).                                                                                                                                                    |
|--------|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                                                                                                                                                                          |
| 3.2    |   |   | Amendment of  Articles of Incorporation of Cymer, Inc. (incorporated herein by reference to  Exhibit 3.1 to Cymer’s Quarterly Report on Form 10-Q for the quarter ended June 30,  2002).                                                                                                                                            |
|   |   |   |                                                                                                                                                                                                                                                                                                                                          |
| 3.3    |   |   | Amended and  restated Bylaws of Cymer, as amended and restated (incorporated herein by  reference to Exhibit 3.1 to Cymer’s Form 8-K filed on August 23, 2004).                                                                                                                                                                     |
|   |   |   |                                                                                                                                                                                                                                                                                                                                          |
| 4.1    |   |   | Purchase  Agreement, dated as of February 12, 2002, among Cymer, Credit Suisse  First Boston Corporation and Merrill Lynch Pierce Fenner and Smith  Incorporated (incorporated herein by reference to Exhibit 4.1 to Cymer’s  Quarterly Report on Form 10-Q for the quarter ended March 31, 2002).                             |
|   |   |   |                                                                                                                                                                                                                                                                                                                                          |
| 4.2    |   |   | Indenture,  dated as of February 15, 2002, between Cymer and State Street Bank and  Trust Company of California, N.A., as Trustee (incorporated herein by  reference to Exhibit 4.2 to Cymer’s Quarterly Report on Form 10-Q for the  quarter ended March 31, 2002).                                                           |
|   |   |   |                                                                                                                                                                                                                                                                                                                                          |
| 4.3    |   |   | Registration  Rights Agreement, dated as of February 15, 2002, among Cymer, Credit  Suisse First Boston Corporation and Merrill Lynch Pierce Fenner and Smith  Incorporated (incorporated herein by reference to Exhibit 4.3 to Cymer’s  Quarterly Report on Form 10-Q for the quarter ended March 31, 2002).                  |
|   |   |   |                                                                                                                                                                                                                                                                                                                                          |
| 10.1   | #      |   | Form of  Indemnification Agreement with Directors and Officers (incorporated herein by  reference to Exhibit 10.1 to Cymer’s Annual Report on Form 10-K for the year  ended December 31, 2004).                                                                                                                                     |
|   |   |   |                                                                                                                                                                                                                                                                                                                                          |
| 10.2   |   |   | Standard  Industrial Lease – Multi-Tenant, dated August 19, 1991, by and between  Lepercq Corporate Income Fund L.P. and Cymer** **(originally  between Frankris** **Corporation  and Cymer) (incorporated herein by reference to Exhibit 10.15 to Cymer’s  Registration Statement on Form S-1, Reg. No. 333-08383). |
|   |   |   |                                                                                                                                                                                                                                                                                                                                          |
| 10.3   |   |   | Single-Tenant  Industrial Lease, dated December 19, 1996, by and between Arden Realty  Finance III, LLC (originally AEW/LBA Acquisition Co. II, LLC) and Cymer, as  amended.                                                                                                                                                             |
|   |   |   |                                                                                                                                                                                                                                                                                                                                          |
| 10.4   |   |   | Sublease  Agreement, dated December 22, 2004, by and between Northrop Grumman  Systems Corporation and Cymer.                                                                                                                                                                                                                            |

 

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| 10.5    |   | Contract  Manufacturing Agreement - Lithography Laser, dated August 28, 1992, by  and between Cymer and Seiko Instruments Inc. (the “Seiko Agreement”)  (incorporated herein by reference to Exhibit 10.16 to Cymer’s Registration  Statement on Form S-1, Reg. No. 333-08383). |
|---------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |   |                                                                                                                                                                                                                                                                                                |
|    |   | Addendum No. 2  to the Seiko Agreement, dated February 21, 2000 (incorporated herein by  reference to Exhibit 10.5 to Cymer’s Annual Report on Form 10-K for the year  ended December 31, 1999).                                                                                     |
|    |   |                                                                                                                                                                                                                                                                                                |
|    |   | Termination of Seiko Contract Manufacturing Agreement - Lithography  Laser, dated March 31, 2003 (incorporated herein by reference to Exhibit  10.5 to Cymer’s Annual Report on Form 10-K for the year ended December 31,  2002).                                                    |
|    |   |                                                                                                                                                                                                                                                                                                |
| 10.6#   |   | 1996 Stock  Option Plan, as amended (incorporated herein by reference to Exhibit 99.1 to  Cymer’s Registration Statement on Form S-8, Registration No. 333-69736).                                                                                                                             |
|    |   |                                                                                                                                                                                                                                                                                                |
| 10.7#   |   | Form of Stock  Option Agreement used in connection with the 1996 Stock Option Plan, as  amended (incorporated herein by reference to Exhibit 4.1 to Cymer’s  Registration Statement on Form S-8, Registration No. 333-48242).                                                                  |
|    |   |                                                                                                                                                                                                                                                                                                |
| 10.8#   |   | 1996 Employee  Stock Purchase Plan, as amended (incorporated herein by reference to Exhibit  99.2 to Cymer’s Current Report on Form 8-K filed on February 23, 2005).                                                                                                                      |
|    |   |                                                                                                                                                                                                                                                                                                |
| 10.9#   |   | 1996 Director  Option Plan (incorporated herein by reference to Exhibit 10.5 to Cymer’s  Registration Statement on Form S-1, Reg. No. 333-08383).                                                                                                                                              |
|    |   |                                                                                                                                                                                                                                                                                                |
| 10.10 # |   | 2000 Equity  Incentive Plan (formerly known as the 2000 Nonstatutory Stock Option Plan and  incorporated herein by reference to Exhibit 99.4 to Cymer’s Registration  Statement on Form S-8, Registration No. 333-69736).                                                                      |
|    |   |                                                                                                                                                                                                                                                                                                |
| 10.11#  |   | Form of Stock  Option Agreement used in connection with the 2000 Equity Incentive Plan  (incorporated herein by reference to Exhibit 99.5 to Cymer’s Registration  Statement on Form S-8, Registration No. 333-69736).                                                                         |
|    |   |                                                                                                                                                                                                                                                                                                |
| 10.12#  |   | Employment  Agreement, effective as of April 1, 2002, by and between Robert P. Akins  and Cymer (incorporated herein by reference to Exhibit 10.1 to Cymer’s  Quarterly Report on Form 10-Q for the quarter ended March 31, 2002).                                                   |
|    |   |                                                                                                                                                                                                                                                                                                |
| 10.13#  |   | Employment  Agreement, effective as of March 1, 2004, by and between Nancy J. Baker  and Cymer (incorporated herein by reference to Exhibit 10.13 to Cymer’s  Annual Report on 10-K for the year ended December 31, 2004).                                                           |
|    |   |                                                                                                                                                                                                                                                                                                |
| 10.14#  |   | Employment  Agreement, effective as of June 1, 2003, by and between Pascal Didier  and Cymer (incorporated herein by reference to Exhibit 10.1 to Cymer’s Quarterly  Report on Form 10-Q for the quarter ended June 30, 2003).                                                       |
|    |   |                                                                                                                                                                                                                                                                                                |
| 10.15#  |   | Employment  Agreement, effective as of May 1, 2003, by and between Edward P. Holtaway and  Cymer (incorporated herein by reference to                                                                                                                                                               |

 

51

----

 
|   |   | Exhibit 10.4 to  Cymer’s Quarterly report on Form 10-Q for the quarter ended June 30,  2003).                                                                                                                                                                                         |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                            |
| 10.16# |   | Employment  Agreement, effective as of May 1, 2003, by and between Brian C. Klene and  Cymer (incorporated herein by reference to Exhibit 10.5 to Cymer’s Quarterly Report  on Form 10-Q for the quarter ended June 30, 2003).                                                        |
|   |   |                                                                                                                                                                                                                                                                                            |
| 10.17  |   | Employment  Agreement, effective as of May 1, 2003, by and between Jung Ho (John) Shin  and Cymer (incorporated herein by reference to Exhibit 10.6 to Cymer’s  Quarterly Report on Form 10-Q for the quarter ended June 30, 2003).                                                   |
|   |   |                                                                                                                                                                                                                                                                                            |
|   |   | Separation  Agreement, dated February 28, 2005, by and between John Shin and Cymer  (incorporated herein by reference to Exhibit 99.1 to Cymer’s Current Report  on Form 8-K filed on March 3, 2005).                                                                            |
|   |   |                                                                                                                                                                                                                                                                                            |
|   |   | Consulting  Services Agreement, dated February 28, 2005, Current Report on Form by  and between John Shin and Cymer (incorporated herein by reference to Exhibit  99.2 to Cymer’s Current Report on Form 8-K filed on March 3, 2005).                                            |
|   |   |                                                                                                                                                                                                                                                                                            |
| 10.18# |   | Description of  Cymer Incentive Bonus Program (incorporated herein by reference to Exhibit  99.1 to Cymer’s Current Report on Form 8-K filed on February 23, 2005).                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                            |
| 10.19# |   | Cymer Deferred  Compensation Plan, as amended and restated (incorporated herein by reference  to Exhibit 10.1 to Cymer’s Quarterly Report on Form 10-Q for the quarter  ended March 31, 2000).                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                            |
| 10.20* |   | Patent License  Agreement, dated May 14, 2001, by and among Cymer, Inc., Linda B. Jacob,  Joseph A. Mangano, and Science Research Laboratory, Inc. (incorporated herein  by reference to Exhibit 10.2 to Cymer’s Quarterly Report on Form 10-Q for the  quarter ended June 30, 2001). |
|   |   |                                                                                                                                                                                                                                                                                            |
|   |   | Patent  Sublicense Agreement, dated May 14, 2001, by and between Science Research  Laboratory, Inc. and Cymer, Inc. (incorporated herein by reference to Exhibit  10.2 to Cymer’s Quarterly Report on Form 10-Q for the quarter ended June 30,  2001).                                |
|   |   |                                                                                                                                                                                                                                                                                            |
| 10.21  |   | Patent  Sublicense Agreement, dated November 7, 2003, by and between SRL-EUV,  LLC and Cymer, Inc. (incorporated herein by reference to Exhibit 10.27 to  Cymer’s Annual Report on Form 10-K for the year ended December 31,  2003).                                             |
|   |   |                                                                                                                                                                                                                                                                                            |
| 10.22  |   | Patent  Sublicense Agreement, dated November 7, 2003, by and between Science  Research Laboratory, Inc. and Cymer, Inc. (incorporated herein by reference  to Exhibit 10.28 to Cymer’s Annual Report on Form 10-K for the year ended December 31,  2003).                        |
|   |   |                                                                                                                                                                                                                                                                                            |
| 10.23# |   | Reduction in  Force Benefits Plan, as amended (incorporated herein by reference to Exhibit  10.1 to Cymer’s Quarterly Report on Form 10-Q for the quarter ended March 31,  2003).                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                            |
| 10.24# |   | Executive Option  and Group Health Coverage Extension Program (incorporated herein by reference  to Exhibit 10.22 to Cymer’s Annual Report on Form 10-K for the year ended December 31,  2001).                                                                                       |

 

52

----

 
| 10.25* |   | Development  Agreement dated January 23, 2004, by and between Cymer, Inc. and Intel  Corporation (incorporated herein by reference to Exhibit 10.1 to Cymer’s  Quarterly Report on Form 10-Q for the quarter ended March 31, 2004).                    |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                  |
| 10.26* |   | Intellectual  Property License Agreement dated February 4, 2004, by and between Cymer,  Inc. and Intel Corporation (incorporated herein by reference to Exhibit 10.2  to Cymer’s Quarterly Report on Form 10-Q for the quarter ended March 31,  2004). |
|   |   |                                                                                                                                                                                                                                                                  |
| 14.1   |   | Code of Ethics  for Chief Executive, Chief Financial and Chief Accounting Officers  (incorporated herein by reference to Exhibit 14.1 to Cymer’s Annual Report on  Form 10-K for the year ended December 31, 2003).                                         |
|   |   |                                                                                                                                                                                                                                                                  |
| 21.1   |   | Subsidiaries of  Cymer.                                                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                  |
| 23.1   |   | Consent of KPMG  LLP, Independent Registered Public Accounting Firm.                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                  |
| 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.                                                                                                                                                                |

 

----

|   |   | #                 Indicates  management contract or compensatory plan or arrangement.                                                                                                                            |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                             |
|   |   | *                 Confidential  treatment was requested with respect to certain portions of    this exhibit. Omitted portions were filed  separately with the Securities and Exchange Commission. |

 

(d)                                                         FinancialStatement Schedules.  See item 15,paragraph (a) (2), above.

 

53

----

 

SIGNATURES

 
|                  |   |    CYMER, INC.                       |
|-----------------------|--------|-----------------------------------------------------|
|                  |   |                                                |
|                  |   |                                                |
| Dated: March 14, 2005 | By:    | /s/   ROBERT P. AKINS                |   |
|                  |   | Robert P. Akins,                                    |
|                  |   | Chief Executive Officer,  and Chairman of the Board |

 

KNOWALL PERSONS BY THESE PRESENTS, that each person whose signature appears belowconstitutes and appoints Nancy J. Baker and Rae Ann Werner, and each of them,as his true and lawful attorneys-in-fact and agents, with full power ofsubstitution and resubstitution, for him and in his name, place, and stead, inany and all capacities, to sign any and all amendments to this Report, and tofile the same, with all exhibits thereto, and other documents in connectiontherewith, with the Securities and Exchange Commission, granting unto saidattorneys-in-fact and agents, and each of them, full power and authority to doand perform each and every act and thing requisite and necessary to be done inconnection therewith, as fully to all intents and purposes as he might or coulddo in person, hereby ratifying and confirming that all said attorneys-in-factand agents, or any of them or their or his substitute or substituted, maylawfully do or cause to be done by virtue hereof.

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, this report has been signed below by the followingpersons on behalf of the registrant and in the capacities and on the dateindicated.

 

 
|   | /s/   ROBERT P. AKINS        |   | Chief Executive Officer,         |   |                 |
|--------|---------------------------------------------|--------|----------------------------------|--------|----------------------|
|   | Robert P. Akins                             |   | and Chairman of the Board        |   |                 |
|   |                                        |   | (*Principal Executive  Officer*) |   |  March 14, 2005 |
|   |                                        |   |                             |   |                 |
|   | /s/   NANCY J. BAKER         |   | Senior Vice President            |   |                 |
|   | Nancy J. Baker                              |   | and Chief Financial Officer      |   |                 |
|   |                                        |   | (*Principal Financial  Officer*) |   |  March 14, 2005 |
|   |                                        |   |                             |   |                 |
|   | /s/   RAE  ANN WERNER        |   | Vice President, Controller       |   |                 |
|   | Rae  Ann Werner                             |   | and Chief Accounting Officer     |   |                 |
|   |                                        |   | (*Principal Accounting Officer*) |   |  March 14, 2005 |
|   |                                        |   |                             |   |                 |
|   | /s/   CHARLES  J. ABBE       |   | Director                         |   |  March 14, 2005 |
|   | Charles  J. Abbe                            |   |                             |   |                 |
|   |                                        |   |                             |   |                 |
|   | /s/   EDWARD  H. BRAUN       |   | Director                         |   |  March 14, 2005 |
|   | Edward  H. Braun                            |   |                             |   |                 |
|   |                                        |   |                             |   |                 |
|   | /s/   MICHAEL  R. GAULKE     |   | Director                         |   |  March 14, 2005 |
|   | Michael  R. Gaulke                          |   |                             |   |                 |
|   |                                        |   |                             |   |                 |
|   | /s/   WILLIAM  G. OLDHAM     |   | Director                         |   |  March 14, 2005 |
|   | William  G. Oldham                          |   |                             |   |                 |
|   |                                        |   |                             |   |                 |
|   | /s/    PETER  J. SIMONE |   | Director                         |   |  March 14, 2005 |
|   | Peter  J. Simone                            |   |                             |   |                 |
|   |                                        |   |                             |   |                 |
|   | /s/    YOUNG  K. SOHN   |   | Director                         |   |  March 14, 2005 |
|   | Young  K. Sohn                              |   |                             |   |                 |
|   |                                        |   |                             |   |                 |
|   | /s/    JON  D. TOMPKINS |   | Director                         |   |  March 14, 2005 |
|   | Jon  D. Tompkins                            |   |                             |   |                 |

 

54

----

 

#### **Report of Independent Registered Public AccountingFirm**

 

 

The Board of Directorsand StockholdersCymer, Inc.

 

 

Wehave audited the accompanying consolidated balance sheets of Cymer, Inc. andsubsidiaries as of December 31, 2004 and 2003, and the related consolidatedstatements of operations, stockholders’ equity, and cash flows for each of theyears in the three-year period ended December 31, 2004. In connection withour audits of the consolidated financial statements, we also have auditedfinancial statement Schedule II. These consolidated financial statements andfinancial statement schedule are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these consolidatedfinancial statements based on our audits.

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the financial statements arefree of material misstatement. An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

 

In ouropinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of Cymer, Inc. andsubsidiaries as of December 31, 2004 and 2003, and the results of theiroperations and their cash flows for each of the years in the three-year periodended December 31, 2004, in conformity with U.S. generally acceptedaccounting principles.  Also, in ouropinion, the related financial statement Schedule II, when considered inrelation to the basic consolidated financial statements taken as a whole,presents fairly, in all material respects, the information set forth therein.

 

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the effectiveness of the Company’sinternal control over financial reporting as of December 31, 2004, basedon criteria established in Internal Control–Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO), andour report dated March 15, 2005 expressed an unqualified opinion on management’sassessment of, and the effective operation of, internal control over financialreporting.

 

 
|   | /s/ KPMG LLP |   |
|--------|--------------|--------|

 

 

**SanDiego, California**

**March15, 2005**

 

F-1

----

 

**Report of Independent Registered PublicAccounting Firm**

 

The Board of Directorsand StockholdersCymer, Inc.

 

We have audited Management’sassessment, included in the accompanying management’s report on internalcontrol over financial reporting, as of December 31, 2004, that Cymer,Inc. and subsidiaries (Cymer) maintained effective internal control overfinancial reporting as of December 31, 2004, based on criteria establishedin Internal Control–Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO). Cymer’s management isresponsible for maintaining effective internal control over financial reportingand for its assessment of the effectiveness of internal control over financialreporting. Our responsibility is to express an opinion on management’sassessment and an opinion on the effectiveness of the Company’s internalcontrol over financial reporting based on our audit.

 

We conducted our audit inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether effective internal control overfinancial reporting was maintained in all material respects. Our audit includedobtaining an understanding of internal control over financial reporting,evaluating management’s assessment, testing and evaluating the design andoperating effectiveness of internal control, and performing such otherprocedures as we considered necessary in the circumstances. We believe that ouraudit provides a reasonable basis for our opinion.

 

A company’s internalcontrol over financial reporting is a process designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with generallyaccepted accounting principles. A company’s internal control over financialreporting includes those policies and procedures that (1) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2)provide reasonable assurance that transactions are recorded as necessary topermit preparation of financial statements in accordance with generallyaccepted accounting principles, and that receipts and expenditures of thecompany are being made only in accordance with authorizations of management anddirectors of the company; and (3) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use, or dispositionof the company’s assets that could have a material effect on the financialstatements.

 

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Also, projections of any evaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

 

In ouropinion, management’s assessment that Cymer maintained effective internalcontrol over financial reporting as of December 31, 2004, is fairlystated, in all material respects, based on criteria established in InternalControl–Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission. Also, in our opinion, Cymermaintained, in all material respects, effective internal control over financialreporting as of December 31, 2004, based on criteria established inInternal Control–Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission.

 

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the consolidated balance sheets ofCymer, Inc. and subsidiaries as of December 31, 2004 and 2003, and therelated consolidated statements of operations, stockholders’ equity, and cashflows for each of the years in the three-year period ended December 31,2004, and our report dated March 15, 2005 expressed an unqualified opinion onthose consolidated financial statements.

 
|   | /s/ KPMG LLP |   |
|--------|--------------|--------|

 

San Diego, California

March 15, 2005

 

F-2

----

 

**CYMER,INC.**

**CONSOLIDATEDBALANCE SHEETS**

**(Inthousands, except share data)**

 
| ** **                                                                                                                                                               | ** ** | **December 31,  2003** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| **ASSETS**                                                                                                                                                               |       |                   |       |                   |       |
|                                                                                                                                                                     |       |                   |       |                   |       |
| CURRENT ASSETS:                                                                                                                                                          |       |                   |       |                   |       |
| Cash and cash  equivalents                                                                                                                                               |       | $                      | 230,657    |                   | $          | 201,021 |   |
| Short-term  investments                                                                                                                                                  |       | 93,474                 |       | 89,091                 |       |
| Accounts  receivable – net                                                                                                                                          |       | 62,819                 |       | 110,680                |       |
| Inventories                                                                                                                                                              |       | 93,012                 |       | 110,022                |       |
| Deferred income  taxes                                                                                                                                                   |       | 1,407                  |       | 7,470                  |       |
| Prepaid expenses  and other assets                                                                                                                                       |       | 5,513                  |       | 5,726                  |       |
| Total current  assets                                                                                                                                                    |       | 486,882                |       | 524,010                |       |
|                                                                                                                                                                     |       |                   |       |                   |       |
| PROPERTY AND  EQUIPMENT – NET                                                                                                                                       |       | 128,849                |       | 123,548                |       |
| LONG-TERM  INVESTMENTS                                                                                                                                                   |       | 77,509                 |       | 84,561                 |       |
| DEFERRED INCOME  TAXES                                                                                                                                                   |       | 86,734                 |       | 67,722                 |       |
| GOODWILL – NET                                                                                                                                                      |       | 7,647                  |       | 8,358                  |       |
| INTANGIBLE  ASSETS – NET                                                                                                                                            |       | 12,925                 |       | 10,394                 |       |
| OTHER ASSETS                                                                                                                                                             |       | 8,698                  |       | 7,185                  |       |
|                                                                                                                                                                     |       |                   |       |                   |       |
| TOTAL ASSETS                                                                                                                                                             |       | $                      | 809,244    |                   | $          | 825,778 |   |
|                                                                                                                                                                     |       |                   |       |                   |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                           |       |                   |       |                   |       |
|                                                                                                                                                                     |       |                   |       |                   |       |
| CURRENT  LIABILITIES:                                                                                                                                                    |       |                   |       |                   |       |
| Accounts payable                                                                                                                                                         |       | $                      | 19,099     |                   | $          | 13,949 |   |
| Accrued warranty  and installation                                                                                                                                       |       | 26,486                 |       | 28,546                 |       |
| Accrued payroll  and benefits                                                                                                                                            |       | 7,196                  |       | 16,284                 |       |
| Accrued patents,  royalties and other fees                                                                                                                               |       | 8,436                  |       | 6,318                  |       |
| Foreign currency  forward exchange contracts                                                                                                                             |       | 6,401                  |       | 1,901                  |       |
| Income taxes  payable                                                                                                                                                    |       | 16,473                 |       | 10,397                 |       |
| Unearned income                                                                                                                                                          |       | 753                    |       | 6,152                  |       |
| Accrued and  other current liabilities                                                                                                                                   |       | 4,248                  |       | 4,456                  |       |
| Total current  liabilities                                                                                                                                               |       | 89,092                 |       | 88,003                 |       |
|                                                                                                                                                                     |       |                   |       |                   |       |
| CONVERTIBLE  SUBORDINATED NOTES                                                                                                                                          |       | 250,000                |       | 200,753                |       |
| DEFERRED INCOME  TAXES                                                                                                                                                   |       | 5,967                  |       | 6,237                  |       |
| OTHER  LIABILITIES                                                                                                                                                       |       | 5,660                  |       | 7,282                  |       |
|                                                                                                                                                                     |       |                   |       |                   |       |
| Total  liabilities                                                                                                                                                       |       | 350,719                |       | 302,275                |       |
|                                                                                                                                                                     |       |                   |       |                   |       |
| MINORITY  INTEREST                                                                                                                                                       |       | 5,195                  |       | 6,183                  |       |
|                                                                                                                                                                     |       |                   |       |                   |       |
| COMMITMENTS AND  CONTINGENCIES                                                                                                                                           |       |                   |       |                   |       |
|                                                                                                                                                                     |       |                   |       |                   |       |
| STOCKHOLDERS’  EQUITY:                                                                                                                                              |       |                   |       |                   |       |
| Preferred stock –  authorized 5,000,000 shares; $.001 par value, no shares issued or outstanding                                                                    |       | —                 |       | —                 |       |
| Common stock –  $.001 par value per share; 100,000,000 shares authorized; 36,345,000 and  36,993,000 shares outstanding at December 31, 2003 and 2004, respectively |       | 36                     |       | 37                     |       |
| Additional  paid-in capital                                                                                                                                              |       | 358,988                |       | 378,414                |       |
| Unearned  compensation                                                                                                                                                   |       | (146                   | )          | (16                    | )          |
| Accumulated  other comprehensive loss                                                                                                                                    |       | (5,734                 | )          | (4,455                 | )          |
| Retained  earnings                                                                                                                                                       |       | 100,186                |       | 143,340                |       |
| Total  stockholders’ equity                                                                                                                                         |       | 453,330                |       | 517,320                |       |
|                                                                                                                                                                     |       |                   |       |                   |       |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                         |       | $                      | 809,244    |                   | $          | 825,778 |   |

 

See Notes toConsolidated Financial Statements.

 

F-3

----

 

### **CYMER, INC.**

### **CONSOLIDATEDSTATEMENTS OF OPERATIONS**

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

 
| ** **                                                                 | ** ** | **Years ended December 31,** | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                 | ** ** | **2002**                     | ** ** | **2003** | ** ** | **2004** | ** ** |
|                                                                       |       |                         |       |   |   |   |   |
| REVENUES:                                                                  |       |                         |       |   |   |   |   |
| Product sales                                                              |       | $                            | 287,995    |   | $ | 265,816 |   | $ | 417,296 |   |
| Other                                                                      |       | 871                          |       | 57 |   | 783 |   |
| Total revenues                                                             |       | 288,866                      |       | 265,873 |   | 418,079 |   |
|                                                                       |       |                         |       |   |   |   |   |
| COSTS AND  EXPENSES:                                                       |       |                         |       |   |   |   |   |
| Cost of product  sales                                                     |       | 162,095                      |       | 187,679 |   | 243,473 |   |
| Research and  development                                                  |       | 72,420                       |       | 56,608 |   | 58,452 |   |
| Sales and  marketing                                                       |       | 17,153                       |       | 16,966 |   | 23,369 |   |
| General and  administrative                                                |       | 18,212                       |       | 39,094 |   | 31,630 |   |
| Amortization of  intangible assets                                         |       | 160                          |       | 160 |   | 160 |   |
| (Gain) loss on  debt extinguishment                                        |       | 163                          |       | — |   | (911 | ) |
|                                                                       |       |                         |       |   |   |   |   |
| Total costs and  expenses                                                  |       | 270,203                      |       | 300,507 |   | 356,173 |   |
|                                                                       |       |                         |       |   |   |   |   |
| OPERATING INCOME  (LOSS)                                                   |       | 18,663                       |       | (34,634 | ) | 61,906 |   |
|                                                                       |       |                         |       |   |   |   |   |
| OTHER INCOME  (EXPENSE):                                                   |       |                         |       |   |   |   |   |
| Foreign currency  exchange gain (loss) – net                          |       | (723                         | )          | 436 |   | 82 |   |
| Interest and  other income                                                 |       | 10,055                       |       | 8,928 |   | 8,079 |   |
| Interest and  other expense                                                |       | (11,246                      | )          | (10,503 | ) | (9,493 | ) |
|                                                                       |       |                         |       |   |   |   |   |
| Total other  expense – net                                            |       | (1,914                       | )          | (1,139 | ) | (1,332 | ) |
|                                                                       |       |                         |       |   |   |   |   |
| INCOME (LOSS)  BEFORE INCOME TAX PROVISION (BENEFIT) AND MINORITY INTEREST |       | 16,749                       |       | (35,773 | ) | 60,574 |   |
|                                                                       |       |                         |       |   |   |   |   |
| INCOME TAX  PROVISION (BENEFIT)                                            |       | 2,706                        |       | (21,464 | ) | 15,144 |   |
| MINORITY  INTEREST                                                         |       | (447                         | )          | (1,091 | ) | (2,276 | ) |
|                                                                       |       |                         |       |   |   |   |   |
| NET INCOME  (LOSS)                                                         |       | $                            | 13,596     |   | $ | (15,400 | ) | $ | 43,154 |   |
|                                                                       |       |                         |       |   |   |   |   |
| EARNINGS (LOSS)  PER SHARE:                                                |       |                         |       |   |   |   |   |
| Basic earnings  (loss) per share                                           |       | $                            | 0.41       |   | $ | (0.44 | ) | $ | 1.17 |   |
| Weighted average  common shares outstanding                                |       | 33,317                       |       | 35,065 |   | 36,758 |   |
|                                                                       |       |                         |       |   |   |   |   |
| Diluted earnings  (loss) per share                                         |       | $                            | 0.39       |   | $ | (0.44 | ) | $ | 1.15 |   |
| Weighted average  common and dilutive potential common shares outstanding  |       | 34,712                       |       | 35,065 |   | 37,584 |   |

 

See Notes to Consolidated Financial Statements.

 

F-4

----

 

**CYMER, INC.**

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

**(In thousands)**

 
| ** **                                                         | ** ** | ** **        | ** ** | ** **  | ** ** | ** **     | ** ** | ** **   | ** ** | ** **        | ** **  | **Accumulated** | ** ** | ** **             | ** ** | ** **        | ** ** | ** **         | ** **  |
|--------------------------------------------------------------------|------------|-------------------|------------|-------------|------------|----------------|------------|--------------|------------|-------------------|-------------|-----------------|------------|------------------------|------------|-------------------|------------|--------------------|-------------|
| ** **                                                         | ** ** | ** **        | ** ** | ** **  | ** ** | **Additional** | ** ** | ** **   | ** ** | ** **        | ** **  | **Other**       | ** ** | ** **             | ** ** | **Total**         | ** ** | **Total**          | ** **  |
| ** **                                                         | ** ** | **Common  Stock** | ** ** | **Paid-in** | ** ** | **Treasury**   | ** ** | **Unearned** | ** ** | **Comprehensive** | ** **  | **Retained**    | ** ** | **Stockholders’** | ** ** | **Comprehensive** | ** ** |
| ** **                                                         | ** ** | **Shares**        | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **Stock**    | ** ** | **Compensation**  | ** **  | **Loss**        | ** ** | **Earnings**           | ** ** | **Equity**        | ** ** | **Income  (Loss)** | ** **  |
|                                                               |       |              |       |        |       |           |       |         |       |              |        |            |       |                   |       |              |       |               |        |
| **BALANCE,  JANUARY 1, 2002**                                      | ** ** | **30,848**        | ** ** | **$**       | **31**     | ** **     | **$**      | **184,794**  | ** ** | **$**             | **(24,871** | **)**           | **$**      | **(3,468**             | **)**      | **$**             | **(3,662** | **)**              | **$**       | **101,990** | ** ** | **$** | **254,814** | ** ** | ** ** | ** ** |
|                                                               |       |              |       |        |       |           |       |         |       |              |        |            |       |                   |       |              |       |               |        |
| Exercise of  common stock options and warrants                     |       | 900               |       | 1           |       | 19,748         |       |         |       |              |        |            |       |                   |       | 19,749            |       |               |        |
| Issuance of  employee stock purchase plan shares                   |       | 154               |       |        |       | 2,798          |       |         |       |              |        |            |       |                   |       | 2,798             |       |               |        |
| Amortization of  unearned compensation                             |       |              |       |        |       |           |       |         |       | 1,110             |        |            |       |                   |       | 1,110             |       |               |        |
| Conversion of  1997 Notes to common stock                          |       | 2,325             |       | 2           |       | 88,125         |       | 24,871       |       |              |        |            |       |                   |       | 112,998           |       |               |        |
| Non-employee  stock options granted                                |       |              |       |        |       | 75             |       |         |       |              |        |            |       |                   |       | 75                |       |               |        |
| Employee stock  options – change in status                    |       |              |       |        |       | 86             |       |         |       |              |        |            |       |                   |       | 86                |       |               |        |
| Employee stock  awards                                             |       |              |       |        |       | 22             |       |         |       |              |        |            |       |                   |       | 22                |       |               |        |
| Income tax  benefit from stock options exercised                   |       |              |       |        |       | 6,853          |       |         |       |              |        |            |       |                   |       | 6,853             |       |               |        |
| Net income                                                         |       |              |       |        |       |           |       |         |       |              |        |            |       | 13,596                 |       | 13,596            |       | $                  | 13,596      |   |
| Other  comprehensive income:                                       |       |              |       |        |       |           |       |         |       |              |        |            |       |                   |       |              |       |               |        |
| Translation  adjustment, net of tax                                |       |              |       |        |       |           |       |         |       |              |        | 135             |       |                   |       | 135               | ** ** | **135**            | ** **  |
| Net unrealized  gain on available-for-sale investments, net of tax | ** ** | ** **        | ** ** | ** **  | ** ** | ** **     | ** ** | ** **   | ** ** | ** **        |        | 1,966           |       |                   |       | 1,966             |       | 1,966              |        |
| Net unrealized  loss on derivatives, net of tax                    |       |              |       |        |       |           |       |         |       |              |        | (1,868          | )          |                   |       | (1,868            | )          | (1,868             | )           |
| Total  comprehensive income                                        |       |              |       |        |       |           |       |         |       |              |        |            |       |                   |       |              | ** ** | **$**              | **13,829**  | ** ** |
|                                                               |       |              |       |        |       |           |       |         |       |              |        |            |       |                   |       |              |       |               |        |
| **BALANCE,  DECEMBER 31, 2002**                                    | ** ** | **34,227**        | ** ** | **34**      | ** ** | **302,501**    | ** ** | **—**   | ** ** | **(2,358**        | **)**       | **(3,429**      | **)**      | **115,586**            | ** ** | **412,334**       | ** ** | ** **         | ** **  |
|                                                               |       |              |       |        |       |           |       |         |       |              |        |            |       |                   |       |              |       |               |        |
| Exercise of  common stock options and warrants                     |       | 1,899             |       | 2           |       | 44,083         |       |         |       |              |        |            |       |                   |       | 44,085            |       |               |        |
| Issuance of  employee stock purchase plan shares                   |       | 217               |       |        |       | 4,072          |       |         |       |              |        |            |       |                   |       | 4,072             |       |               |        |
| Amortization of  unearned compensation                             |       |              |       |        |       |           |       |         |       | 737               |        |            |       |                   |       | 737               |       |               |        |
| Reversal of  unearned compensation                                 |       |              |       |        |       | (1,475         | )          |         |       | 1,475             |        |            |       |                   | ** ** | **—**        |       |               |        |
| Non-employee  stock options granted                                |       |              |       |        |       | 235            |       |         |       |              |        |            |       |                   |       | 235               |       |               |        |
| Employee stock  options – change in status                    |       |              |       |        |       | 1,102          |       |         |       |              |        |            |       |                   |       | 1,102             | ** ** | ** **         | ** **  |
| Employee stock  awards                                             |       | 2                 |       |        |       | 22             |       |         |       |              |        |            |       |                   |       | 22                |       |               |        |
| Income tax  benefit from stock options exercised                   |       |              |       |        |       | 8,448          |       |         |       |              |        |            |       |                   |       | 8,448             |       |               |        |
| Net loss                                                           |       |              |       |        |       |           |       |         |       |              |        |            |       | (15,400                | )          | (15,400           | )          | $                  | (15,400     | ) |
| Other  comprehensive income:                                       | ** ** | ** **        | ** ** | ** **  | ** ** | ** **     | ** ** | ** **   | ** ** | ** **        |        |            |       |                   |       |              |       |               |        |
| Translation  adjustment, net of tax                                |       |              |       |        |       |           |       |         |       |              |        | 799             |       |                   |       | 799               |       | 799                |        |
| Net unrealized loss  on available-for-sale investments, net of tax |       |              |       |        |       |           |       |         |       |              |        | (894            | )          |                   |       | (894              | )          | (894               | )           |
| Net unrealized  loss on derivatives, net of tax                    | ** ** | ** **        | ** ** | ** **  | ** ** | ** **     | ** ** | ** **   | ** ** | ** **        |        | (2,210          | )          |                   |       | (2,210            | )          | (2,210             | )           |
| Total  comprehensive loss                                          |       |              |       |        |       |           |       |         |       |              |        |            |       |                   |       |              | ** ** | **$**              | **(17,705** | **)** |
|                                                               |       |              |       |        |       |           |       |         |       |              |        |            |       |                   | ** ** | ** **        | ** ** | ** **         | ** **  |
| **BALANCE,  DECEMBER 31, 2003**                                    | ** ** | **36,345**        | ** ** | **36**      | ** ** | **358,988**    | ** ** | **—**   | ** ** | **(146**          | **)**       | **(5,734**      | **)**      | **100,186**            | ** ** | **453,330**       |       |               |        |
|                                                               |       |              |       |        |       |           |       |         |       |              |        |            |       |                   |       |              |       |               |        |
| Exercise of  common stock options and warrants                     |       | 502               |       | 1           |       | 11,721         |       |         |       |              |        |            |       |                   |       | 11,722            |       |               |        |
| Issuance of employee  stock purchase plan shares                   |       | 145               |       |        |       | 3,724          |       |         |       |              |        |            |       |                   |       | 3,724             |       |               |        |
| Amortization of  unearned compensation                             |       |              |       |        |       |           |       |         |       | 130               |        |            |       |                   |       | 130               |       |               |        |
| Non-employee  stock options granted                                |       |              |       |        |       | 29             |       |         |       |              |        |            |       |                   |       | 29                |       |               |        |
| Employee stock  options – change in status                    |       |              |       |        |       | 297            |       |         |       |              |        |            |       |                   |       | 297               |       |               |        |
| Employee stock  awards                                             |       | 1                 |       |        |       | 19             |       |         |       |              |        |            |       |                   |       | 19                |       |               |        |
| Income tax  benefit from stock options exercised                   | ** ** | ** **        | ** ** | ** **  | ** ** | **3,636**      | ** ** | ** **   | ** ** | ** **        |        |            |       |                   |       | 3,636             |       |               |        |
| Net income                                                         |       |              |       |        |       |           |       |         |       |              |        |            |       | 43,154                 |       | 43,154            |       | $                  | 43,154      |   |
| Other  comprehensive income:                                       |       |              |       |        |       |           |       |         |       |              |        |            |       |                   |       |              |       |               |        |
| Translation  adjustment, net of tax                                |       |              |       |        |       |           |       |         |       |              |        | 697             |       |                   |       | 697               |       | 697                |        |
| Net unrealized  loss on available-for-sale investments, net of tax | ** ** | ** **        | ** ** | ** **  | ** ** | ** **     | ** ** | ** **   | ** ** | ** **        |        | (1,672          | )          |                   |       | (1,672            | )          | (1,672             | )           |
| Net unrealized  loss on derivatives, net of tax                    |       |              |       |        |       |           |       |         |       |              |        | 2,254           |       |                   |       | 2,254             | ** ** | **2,254**          | ** **  |
| Total  comprehensive income                                        |       |              |       |        |       |           |       |         |       |              |        |            |       |                   |       |              | ** ** | **$**              | **44,433**  | ** ** |
| **BALANCE,  DECEMBER 31, 2004**                                    | ** ** | **36,993**        | ** ** | **$**       | **37**     | ** **     | **$**      | **378,414**  | ** ** | **$**             | **—**  | ** **      | **$**      | **(16**                | **)**      | **$**             | **(4,455** | **)**              | **$**       | **143,340** | ** ** | **$** | **517,320** |   | ** ** |   |

 

See Notes to Consolidated FinancialStatements.

 

F-5

----

 

**CYMER, INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(In thousands)**

 
| ** **                                                                                                       | ** ** | **Years ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                                                       | ** ** | **2002**                     | ** ** | **2003** | ** ** | **2004** | ** ** |
|                                                                                                             |       |                         |       |   |   |   |   |
| OPERATING  ACTIVITIES:                                                                                           |       |                         |       |   |   |   |   |
| Net income (loss)                                                                                                |       | $                            | 13,596     |   | $ | (15,400 | ) | $ | 43,154 |   |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating  activities:             |       |                         |       |   |   |   |   |
| (Gain) loss on  debt extinguishment                                                                              |       | 163                          |       | — |   | (911 | ) |
| Depreciation and  amortization                                                                                   |       | 25,492                       |       | 30,938 |   | 28,364 |   |
| Non-cash  stock-based compensation                                                                               |       | 183                          |       | 1,359 |   | 345 |   |
| Amortization of  unearned compensation                                                                           |       | 1,110                        |       | 737 |   | 130 |   |
| Minority  interest                                                                                               |       | 447                          |       | 1,091 |   | 2,276 |   |
| Provision for  deferred income taxes                                                                             |       | (31                          | )          | (1,361 | ) | (1,117 | ) |
| Loss on disposal  and impairment of property and equipment                                                       |       | 675                          |       | 18,106 |   | 131 |   |
| Change in assets  and liabilities:                                                                               |       |                         |       |   |   |   |   |
| Accounts  receivable – net                                                                                  |       | (2,285                       | )          | (10,478 | ) | (47,861 | ) |
| Income taxes  receivable                                                                                         |       | 3,153                        |       | — |   | — |   |
| Foreign currency  forward exchange contracts                                                                     |       | 939                          |       | 1,749 |   | (679 | ) |
| Inventories                                                                                                      |       | (38,335                      | )          | 7,107 |   | (17,010 | ) |
| Prepaid expenses  and other assets                                                                               |       | (2,538                       | )          | 59 |   | (884 | ) |
| Accounts payable                                                                                                 |       | 10,770                       |       | (7,400 | ) | (5,150 | ) |
| Accrued expenses  and other liabilities                                                                          |       | 5,813                        |       | (8,036 | ) | 22,374 |   |
| Income taxes  payable                                                                                            |       | 6,651                        |       | (22,066 | ) | 11,008 |   |
|                                                                                                             |       |                         |       |   |   |   |   |
| Net cash  provided by (used in) operating activities                                                             |       | 25,803                       |       | (3,595 | ) | 34,170 |   |
|                                                                                                             |       |                         |       |   |   |   |   |
| INVESTING  ACTIVITIES:                                                                                           |       |                         |       |   |   |   |   |
| Acquisition of  property and equipment                                                                           |       | (45,217                      | )          | (62,783 | ) | (19,485 | ) |
| Purchases of  investments                                                                                        |       | (284,352                     | )          | (107,749 | ) | (215,365 | ) |
| Proceeds from  sold or matured investments                                                                       |       | 163,410                      |       | 165,527 |   | 209,862 |   |
| Acquisition of  patents                                                                                          |       | —                       |       | — |   | (5,990 | ) |
| Acquisition of  minority interest                                                                                |       | (360                         | )          | (180 | ) | (2,000 | ) |
|                                                                                                             |       |                         |       |   |   |   |   |
| Net cash used in  investing activities                                                                           |       | (166,519                     | )          | (5,185 | ) | (32,978 | ) |
|                                                                                                             |       |                         |       |   |   |   |   |
| FINANCING  ACTIVITIES:                                                                                           |       |                         |       |   |   |   |   |
| Net borrowings  under revolving loan and security agreements                                                     |       | (1,672                       | )          | (6,667 | ) | — |   |
| Proceeds from  issuance of common stock                                                                          |       | 22,547                       |       | 48,157 |   | 15,446 |   |
| Redemption of  convertible subordinated notes                                                                    |       | (39,598                      | )          | — |   | (47,407 | ) |
| Issuance of  convertible subordinated notes                                                                      |       | 250,000                      |       | — |   | — |   |
| Issuance of  convertible subordinated notes offering costs                                                       |       | (7,873                       | )          | — |   | — |   |
| Minority  interest investments in subsidiary                                                                     |       | 1,900                        |       | — |   | — |   |
| Payments on  capital lease obligations                                                                           |       | (56                          | )          | (50 | ) | (48 | ) |
|                                                                                                             |       |                         |       |   |   |   |   |
| Net cash  provided by (used in) financing activities                                                             |       | 225,248                      |       | 41,440 |   | (32,009 | ) |
|                                                                                                             |       |                         |       |   |   |   |   |
| EFFECT OF  EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS                                                    |       | 916                          |       | 1,354 |   | 1,181 |   |
|                                                                                                             |       |                         |       |   |   |   |   |
| NET INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS                                                            |       | 85,448                       |       | 34,014 |   | (29,636 | ) |
| CASH AND CASH  EQUIVALENTS AT BEGINNING OF THE YEAR                                                              |       | 111,195                      |       | 196,643 |   | 230,657 |   |
|                                                                                                             |       |                         |       |   |   |   |   |
| CASH AND CASH  EQUIVALENTS AT END OF THE YEAR                                                                    |       | $                            | 196,643    |   | $ | 230,657 |   | $ | 201,021 |   |
|                                                                                                             |       |                         |       |   |   |   |   |
| SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION:                                                               |       |                         |       |   |   |   |   |
| Interest paid                                                                                                    |       | $                            | 10,473     |   | $ | 9,004 |   | $ | 9,033 |   |
| Income taxes  paid, net                                                                                          |       | $                            | (7,821     | ) | $ | 1,325 |   | $ | 3,515 |   |
|                                                                                                             |       |                         |       |   |   |   |   |
| 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 |   | $ | — |   |
| Intangible  assets included in accrued liabilities                                                               |       | $                            | —     |   | $ | 5,990 |   | $ | — |   |
| Reversal of  deferred tax asset valuation allowance against goodwill                                             |       | $                            | —     |   | $ | 2,950 |   | $ | — |   |
|                                                                                                                  |            |                              |            |  |  |  |  |  |  |  |  |  |

 

See Notes to Consolidated Financial Statements.

 

F-6

----

 

**CYMER, INC.**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**1.**                      SUMMARY OF SIGNIFICANTACCOUNTING POLICIES

 

***Nature of Operations*** – Cymer, Inc.and its wholly owned and majority-owned subsidiaries (collectively, “Cymer” orthe Company), are engaged primarily in the development, manufacturing andmarketing of excimer light sources for sale to manufacturers ofphotolithography tools in the semiconductor equipment industry.  Cymer sells its product to customersprimarily in Japan, Asia, Europe and the United States.

 

***Principles of 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, Ltd, inTaiwan (“Cymer SEA”), Cymer Semiconductor Equipment Shanghai Co., Ltd, in thePeople’s Republic of China (“Cymer PRC”), and its majority-owned subsidiary,Cymer Korea, Inc. (“Cymer Korea”). Cymer, Inc. owns 81% of Cymer Korea. In February 2004, Cymer acquired 6% of the remaining 25% minorityinterest in its majority-owned subsidiary, Cymer Korea.  Cymer paid a total of $2.0 million for this6% interest and recorded $1.3 million of the $2.0 million as an additionalinvestment in Cymer Korea and the remaining $711,000 as goodwill.  This transaction increased Cymer’s totalownership interest in Cymer Korea from 75% to 81%.  Cymer Japan is currently the only subsidiaryoffice of Cymer that sells excimer light source systems.  In addition, Cymer Japan provides fieldservice to customers in the Japan region. Cymer Singapore, Cymer B.V., CymerSEA, and Cymer PRC are field service offices for customers in those respectiveregions.  Cymer Korea providesrefurbishment manufacturing, field service, and administrative activities for thatregion. All significant intercompany balances have been eliminated inconsolidation.

 

***Accounting Estimates*** – Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period.  Actualresults may differ from those estimates.

 

***CashEquivalents***– Cash equivalents consist of money marketinstruments, commercial paper and other highly liquid investments purchasedwith an original maturity of three months or less.

 

***Investments***–Cymer maintains an investment portfolio consisting primarily of government andcorporate fixed income securities, certificates of deposit and commercialpaper.  While it is Cymer’s generalintent to hold such securities until maturity, Cymer will occasionally sellcertain securities for cash flow purposes. Therefore, Cymer’s investments areclassified as available-for-sale and are carried on the balance sheet at fairvalue. In September 2004 Cymer sold approximately $20.3 million of corporate debtsecurities that resulted in a $281,000 gain on the sale. The cost of securitiessold was determined by a specific identification method.

 

***Inventories*** – Inventoriesare carried at the lower of standard cost, which approximates the first-in,first-out method, or market.  Costincludes material, labor and manufacturing overhead costs. Cymer reviews thecomponents of its inventory on a regular basis for excess or obsolete inventoryand makes appropriate allowances and dispositions in the period that such inventoryis identified.

 

Cymer’sinventories include reusable parts that Cymer receives from its customers aspart of consumed assemblies. These parts, consisting primarily of metalcomponents, are refurbished by Cymer and used in future core assemblies.  The value of these parts is determined basedupon the

 

F-7

----

 

estimatedyield of reusable parts contained within the consumed core assembly.  Refurbishment costs are capitalized asincurred.

 

***Property and Equipment*** – Property and equipment are stated at costless accumulated depreciation.  Equipment acquired under capital leases is stated atthe present value of the future minimum lease payments. Additions andimprovements are capitalized and maintenance and repairs are expensed whenincurred.  Depreciation is provided using the straight-line method over theestimated useful lives of the assets (generally one to five years).  The Cymer owned buildings are depreciatedover a useful life of twenty years. Leasehold improvements and equipment heldunder capital leases are amortized using the straight-line method over theshorter of the life of the asset or the remaining lease term. Amortization ofequipment obtained under capital leases is included in depreciation expense inthe accompanying consolidated financial statements.  Light source systems built for internal useare capitalized and depreciated using the straight-line method over threeyears.

 

***Goodwill****/**Intangible Assets** –*Cymer adopted Statement of Financial AccountingStandards No. 142 (“SFAS 142”), “Goodwill and Other Intangible Assets*”* on January 1, 2002. SFAS 142 supercededAccounting Principles Board Opinion No. 17, “Intangible Assets”, anddiscontinued the amortization of goodwill and intangible assets with indefiniteuseful lives associated with purchase business combinations. In addition,SFAS 142 includes provisions regarding the reclassification betweengoodwill and identifiable intangible assets in accordance with the newdefinition of intangible assets set forth in Statement of Financial AccountingStandards No. 141 (“SFAS 141”), “Business Combinations”, thereassessment of the useful lives of existing intangible assets, and the annualtesting for impairment of existing goodwill and other intangible assets withindefinite lives. In accordance with the adoption of SFAS 142 onJanuary 1, 2002, Cymer ceased the amortization of goodwill and intangibleassets with indefinite lives, and completed the required transitionalimpairment test, which resulted in no indication of impairment. Cymer also re-evaluated the classifications of its existingintangible assets and goodwill in accordance with SFAS No. 141.  As a result, Cymer reclassified assembledworkforce net of amortization of $617,000 from intangible assets to goodwill,as assembled workforce no longer meets the definition of an identifiableintangible asset under the provisions of SFAS No. 141. Inaccordance with SFAS 142, Cymer conducts an annual impairment test ofgoodwill.  This test is conducted in the fourthquarter of each fiscal year, or whenever events or circumstances occurindicating potential impairment.

 

Intangible assets consist primarily of acquired patents and purchasedtechnology. Intangible assets with definite lives are recorded at cost and areamortized using the straight-line method over their expected useful lives fromfour to eight years. Cymer reviews the carrying value and remaining useful lifeof intangibles for impairment whenever events or circumstances indicate thatthe carrying amount may not be recoverable. The amount of impairment, if any,is measured based on the projected discounted future operating cash flows usinga discount rate reflecting Cymer’s average cost of funds.  The assessment of the recoverability ofintangible assets will be impacted if estimated future operating cash flows arenot achieved.

 

***Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of***– On January 1, 2002, Cymer adopted Statement of Financial Accounting Standards No. 144 (“SFAS144”), “Accounting for**the Impairment orDisposal of Long-Lived Assets”, which addresses financial accounting andreporting for the impairment or disposal of long-lived assets.  While SFAS 144 supersedes SFAS 121, itretains many of the fundamental provisions of SFAS 121, including therecognition and measurement of the impairment of long-lived assets to be heldand used, and the measurement of long-lived assets to be disposed of by sale. Long-livedassets and certain identifiable intangibles are reviewed for impairmentwhenever events or changes in circumstances indicate that the carrying amountof an asset may not be recoverable. Recoverability of assets to be

 

F-8

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heldand used is measured by a comparison of the carrying amount of the assets tofuture net cash flows (undiscounted and without interest) expected to begenerated by the asset.  If such assetsare considered to be impaired, the impairment to be recognized is measured bythe amount by which the carrying amount of the assets exceeds the fair value ofthe assets.  Assets to be disposed of arereported at the lower of the carrying amount or fair value less costs to sell.

 

***Fair Value of Financial Instruments***– The following methods and assumptions were used to estimate the fair value ofeach class of financial instruments for which it is practicable to estimatethat value:

 

Cash and cashequivalents, accounts receivable, accounts payable, accrued warranty andinstallation, accrued payroll and benefits, accrued patents, royalties andother fees, income tax payable, unearned income, and accrued and other currentliabilities – The carrying amount reported in the consolidated balance sheetsfor cash and cash equivalents, accounts receivable, income taxes receivable,accounts payable, accrued warranty and installation, accrued payroll andbenefits, accrued patents, royalties and other fees, accrued interest, incometax payable, unearned income, and accrued and other current liabilitiesapproximates fair value because of the short maturity of these instruments.

 

Investments –Investments are carried at fair value, which is based on quoted market pricesfor such securities.

 

ForwardContracts – The fair value of  forwardcontracts is determined using the quoted exchange rate (see “DerivativeInstruments” below).

 

ConvertibleSubordinated Notes – Convertible Subordinated Notes are recorded at face valueof $250.0 million and $200.8 million at December 31, 2003 and 2004,respectively. The fair value of such debt, based on quoted market prices atDecember 31, 2003 and 2004, was $276.0 million and $199.7 million,respectively.

 

***Lease Loss Accrual*****–**Cymer adopted Statement of FinancialAccounting Standards No. 146 (“SFAS No. 146”), “Accounting for Costs Associatedwith Exit or Disposal Activities”, for exit or disposal activities initiatedafter December 31, 2002.  In accordancewith SFAS No. 146, all costs associated with exit or disposal activities arerecognized when they are incurred or when Cymer ceases using a property.  To date, Cymer’s exit or disposal activitiesconsist of lease obligations net of expected sublease income for Cymer’s SanDiego and Charlestown facilities which were vacated.  The total accrued liability was $2.2 millionat December 31, 2004 and is included within Accrued and Other CurrentLiabilities on the accompanying consolidated balance sheet.  There was no accrual as of December 31, 2003.

 

***Guarantees***–******Cymer adopted thedisclosure provisions of Financial Accounting Standards Board InterpretationNo. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements forGuarantees, Including Indirect Guarantees of Indebtedness to Others”, duringthe quarter ended December 31, 2002 and adopted the recognition and measurementprovisions as required after December 31, 2002. FIN 45 provides expanded accounting guidance surrounding liabilityrecognition and disclosure requirements related to guarantees, as defined bythis interpretation.

 

In the ordinary course of business, Cymer is not subject topotential obligations under guarantees that fall within the scope of FIN 45,except for standard warranty provisions associated with product sales,indemnification provisions related to intellectual property that are containedwithin many of its

 

F-9

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customer agreements, and third-party bank guarantees forsubsidiary lines of credit.  All of theseprovisions give rise only to the disclosure requirements prescribed by FIN 45.

 

Product Warranties – Warranty provisions contained withinCymer’s customer agreements are generally consistent with those prevalent inthe semiconductor equipment industry. The warranty period and terms vary bylight source system model.  In general,the light source system warranty period ranges from 17 to 26 months aftershipment. Cymer also warrants consumables and spare parts sold to its customersand the coverage period varies by spare part type as some types includetime-based warranty periods and others include usage-based warranty periods. Onaverage, the warranty period for consumables and spare parts is approximatelysix months from the date of shipment. Cymer records a provision for warranty for all products, which isincluded in cost of product sales in the consolidated statements of operationsand is recorded at the time that the related revenue is recognized. Thewarranty provision for light source systems is reviewed monthly and determinedusing a financial statistical model, which considers actual historicalexpenses, and potential risks associated with Cymer’s different light sourcesystem models. This model is then used to calculate the future probableexpenses related to warranty and the required level of the warrantyprovision.  The risk levels andhistorical cost information used within this model are reviewed throughout theyear and updated as risk levels change over the light source system’s lifecycle. The warranty provision for consumables and spares is determined usingactual historical data. For both light source systems and consumables, ifactual warranty expenditures differ substantially from Cymer’s estimates,revisions to the warranty provision would be required.  Actual warranty expenditures are recordedagainst the warranty provision as they are incurred.

 

The following table summarizes information related to Cymer’swarranty provision for the years ended December 31, 2003 and 2004 (inthousands):

 
| ** **                                                                                      | ** ** | **2003** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                                            |       |     |       |     |       |
| Balance, January  1                                                                             |       | $        | 29,600     |     | $          | 26,200 |   |
| Liabilities  accrued for warranties issued during the year, net of adjustments and  expirations |       | 15,505   |       | 23,595   |       |
| Warranty  expenditures incurred during the year                                                 |       | (18,905  | )          | (21,595  | )          |
| Balance,  December 31                                                                           |       | $        | 26,200     |     | $          | 28,200 |   |
|                                                                                                 |            |          |            |          |            |  |  |  |

 

Intellectual Property Indemnifications – Cymer includesintellectual property indemnification clauses within its general terms andconditions with its customers and the general purchase agreements with itsthree 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 products. Under the indemnification clauses, Cymer will pay all costs and damages,including attorney’s fees, associated with such settlements or defenses,provided that the customer follows specific procedures for notifying Cymer ofsuch claims and allows Cymer to manage the settlement proceedings. Due to thenature of these indemnification provisions, they are indefinite and extendbeyond the term of the actual customer agreements.

 

An indemnificationprovision was also included in the contract manufacturing agreement with Seiko,which was terminated effective March 31, 2003. As with Cymer’s indemnification provisions on intellectual property,Cymer will continue to honor this indemnification clause within the agreementeven after its termination. Seiko and at least one Japanese customer

 

F-10

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have been notifiedthat Cymer’s light source systems in Japan may infringe certain Japanesepatents.  Cymer believes, based upon theadvice of counsel, that Cymer’s products do not infringe any valid claim of theasserted patents or that Cymer is entitled to prior use claims in Japan.

 

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

 

Guarantees on SubsidiaryDebt – Through part of the second quarter of 2003, Cymer was party to a ParentGuarantee associated with a revolving Loan Agreement held by Cymer Japan. Thisguarantee was between a commercial bank in the United States and Cymer.  The Parent Guarantee was entered into in 2001in order to establish a banking relationship between this commercial bank andCymer Japan.  Per the terms of the ParentGuarantee, Cymer guaranteed payment of any obligations under the revolving loanagreement in the event that Cymer Japan could not make such payments due ordefaulted on the loan.  Cymer Japan madeall payments per the terms of the Loan Agreement and thus, Cymer did not incurany guarantor obligations under the Parent Guarantee.  Since Cymer Japan is a wholly ownedsubsidiary of Cymer and Cymer Japan recorded the revolving loan outstandingbalance as a liability on its financial statements, the carrying amount of theliability was included in the consolidated balance sheets.  The Loan Agreement expired on June 16, 2003and was paid in full by Cymer Japan. The Loan Agreement was not renewed on thisexpiration date and has not since been renewed.

 

***Comprehensive Income –***Comprehensiveincome (loss) includes net income (loss), effective unrealized gains and losseson forward contracts, foreign currency translation adjustments, and unrealizedgains and losses on available-for-sale securities,  net of tax, which are recorded as short-termand long-term investments in the accompanying consolidated balance sheets.

 

***Revenue Recognition*** – Cymerrecognizes revenue when all four revenue recognition criteria have beenmet.  These four criteria are as follows:persuasive evidence of an arrangement exists; delivery has occurred or serviceshave been rendered; seller’s price to buyer is fixed or determinable; andcollectibility is reasonably assured. Cymer’s revenue is generated from productsales, which includes light source systems, consumables and spare parts,upgrades, service, service contracts and training. For a significant portion of its spare parts sales, Cymer’s customersreturn a consumed assembly as part of the sale of a new part.  Cymer reuses some of the material withinthese core assemblies, mainly metal components, for the future build of coreassemblies.  As a result, Cymer’s revenueconsists of both cash and the value of the reusable parts received from itscustomers as consideration for these spare part sales. In addition, Cymergenerates other revenue, which primarily represents revenue earned from fundeddevelopment activities and license fees.

 

Cymer’s revenuerecognition policy results in revenue being recognized as follows for productsales 1) For light source systems that have proven to meet specifications priorto shipment and do not have acceptance provisions, the revenue is recognizedonce legal title passes to the customer. The systems are tested by Cymer in environments similar to those used bythe customers prior to shipment to ensure that they meet the customer’sspecifications and will interface with the customer’s software.  As the shipping terms vary by customer, titlewill transfer based upon the shipping terms specific to that customer.  For light source systems, which are shippedto customers

 

F-11

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requiring acceptanceprovisions, the revenue is recognized at such time that the acceptanceconditions are satisfied.  We have onearrangement where a portion of the light source system fee is not payable untilthe system is successfully installed at the end-user.  In accordance with Staff Accounting Bulletin No.104 given the installation is not essential to the functionality of the system,we defer this portion of the fee until the system is installed.  Until these obligations are met, the revenueis deferred and recorded in unearned income in the accompanying consolidatedbalance sheets.  2) For consumables andspare parts sales, revenue is recognized at the point that legal title passesto the customer.  For consumables andspare parts sales, legal title generally passes to the customer upon shipmentfrom the Cymer facility.  3) Revenueassociated with Cymer’s customers’ return of core assemblies is recognized uponreceipt of the returned core assembly. The amount of the revenue is determined based upon the value of thereusable parts that Cymer expects to yield from the returned core assembly.  (4) For service and training sales, which aregenerated from a billable service call or a training class, revenue isrecognized when the services or training have been rendered to the customer. 5)For service contract sales, revenue is generally recognized ratably over thelife of the contract or per the specific terms of the agreement. 6) Revenueclassified as “other revenue” in Cymer’s consolidated statements of operationsis recorded as revenue on a basis consistent with the performance requirementof the funded development or license agreement. Revenue from funded developmentcontracts is generally recognized on the percentage-of-completion method basedon the relationship of costs incurred to total estimated costs.  Revenues generated from funded developmentcontracts are derived from cost sharing contracts between Cymer and certaincustomers.  The costs associated withthese contracts are included in research and development expenses in the periodincurred and are not listed separately as other cost or expenses in theconsolidated statements of operations. If milestones on funded development contracts require that specificresults be achieved or reported by Cymer, revenue is not recognized until thatmilestone is completed.  Paymentsreceived in advance of performance are recorded as deferred revenue.  For some of the funded development contractsthat Cymer enters into with customers and government agencies, Cymer evaluatescertain criteria to determine whether recording the funds as revenue isappropriate.  If certain conditions aremet, these funds are not recorded as revenue but rather offset against Cymer’sinternal research and development expenses in the period that the milestone isachieved or per the terms of the contract.

 

***Research and Development*****– Research and development costs are expensed in the periodincurred and include costs associated with funded development contracts.  The funded development contracts aregenerally cost sharing contracts between Cymer and a customer where each partypays near equivalent portions of the total development costs.  As a result, costs for the funded developmentcontracts approximate the revenue recorded for these contracts in other revenuein the accompanying statements of operations. The services performed under thefunded development contracts are provided on a best efforts basis.  Cymer’s research and development expensesalso include offsets for amounts received from certain of its externally fundedresearch and development contracts.

 

***Income Taxes*** – Income taxes are accountedfor under the asset and liability method. Deferred tax assets and liabilities are recognized for the future taxconsequences attributable to differences between the financial statementcarrying amounts of existing assets and liabilities and their respective taxbases.  Deferred tax assets andliabilities are measured using enacted tax rates that are expected to apply inthe periods in which the deferred tax asset or liability is expected to berealized or settled.  The effect ondeferred tax assets and liabilities of a change in tax rates is recognized inincome in the period that includes the enactment date.

 

F-12

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

 

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

 

Cymer accounts for options granted to non-employeesunder SFAS No. 123 and EITF Issue No. 96-18, “Accounting for Equity Instrumentsthat are Issued to other than Employees for Acquiring or in Conjunction withSelling Goods or Services”.  Cymermeasures the fair value of such options using the Black-Scholes option-pricingmodel at each financial reporting date. Cymer accounts for changes in fair values between reporting dates inaccordance with Financial Accounting Interpretation 28.  Stock-based compensation expense for optionsgranted to non-employees and for those employees who changed status for theyears ended December 31, 2002, 2003 and 2004 was $161,000, $1.3 million and$326,000, respectively.

 

UnderSFAS No. 123, the weighted average per share fair value of the options grantedfor the years ended December 31, 2002, 2003, and 2004 was $17.45, $19.20, and$21.76, respectively, on the date of grant. Fair value under SFAS No. 123 is determined using the Black-Scholesoption-pricing model with the assumptions noted below.  For the risk free interest rate, Cymer usesthe then currently available rate on zero coupon U.S. Government issues with aremaining life of five years for valuing options and one year for valuingEmployee Stock Purchase Plan (“ESPP”) shares.

 
| ** **                                  | ** ** | **Years ended December 31,** | ** ** |
|---------------------------------------------|------------|------------------------------|------------|
| ** **                                  | ** ** | **2002**                     | ** ** | **2003** | ** ** | **2004** | ** ** |
|                                        |       |                         |       |   |   |   |   |
| Dividend yield                              |       | None                         |       | None |   | None |   |
| Volatility rate                             |       | 83                           | %          | 79 | % | 75 | % |
| Weighted average  risk free interest rate : |       |                         |       |   |   |   |   |
| Options                                     |       | 3.34                         | %          | 3.16 | % | 3.40 | % |
| ESPP                                        |       | 1.88                         | %          | 1.26 | % | 2.3 | % |
| Expected life:                              |       |                         |       |   |   |   |   |
| Options                                     |       | 6 years                      |       | 6 years |   | 6 years |   |
| ESPP                                        |       | .5 years                     |       | .5 years |   | .5 years |   |

 

F-13

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The following table compares earnings (loss) per share asreported by Cymer to the pro forma amounts that would be reported had compensationexpense been recognized for Cymer’s stock-based compensation plans inaccordance with SFAS No. 123 (in thousands, except per share amounts):

 
| ** **                                                                                                                                        | ** ** | **Years ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                                                                                        | ** ** | **2002**                     | ** ** | **2003** | ** ** | **2004** | ** ** |
|                                                                                                                                              |       |                         |       |   |   |   |   |
| Net income  (loss), as reported                                                                                                                   |       | $                            | 13,596     |   | $ | (15,400 | ) | $ | 43,154 |   |
| Add: Stock-based  employee compensation expense included in reported net income (loss), net of  related tax effects                               |       | 154                          |       | 544 |   | 259 |   |
| Deduct: Total  stock-based employee compensation expense determined under the fair value  based method for all awards, net of related tax effects |       | (33,739                      | )          | $ | (10,933 | ) | $ | (17,112 | ) |
|                                                                                                                                              |       |                         |       |   |   |   |   |
| Pro forma net  income (loss)                                                                                                                      |       | $                            | (19,989    | ) | $ | (25,789 | ) | $ | 26,301 |   |
|                                                                                                                                              |       |                         |       |   |   |   |   |
| Earnings (loss)  per share:                                                                                                                       |       |                         |       |   |   |   |   |
| Basic – as  reported                                                                                                                         |       | $                            | 0.41       |   | $ | (0.44 | ) | $ | 1.17 |   |
| Basic – pro  forma                                                                                                                           |       | $                            | (0.60      | ) | $ | (0.74 | ) | $ | 0.72 |   |
|                                                                                                                                              |       |                         |       |   |   |   |   |
| Diluted – as  reported                                                                                                                       |       | $                            | 0.39       |   | $ | (0.44 | ) | $ | 1.15 |   |
| Diluted – pro  forma                                                                                                                         |       | $                            | (0.60      | ) | $ | (0.74 | ) | $ | 0.70 |   |

 

***Foreign CurrencyTranslation*** – The financial statements of Cymer’s foreignsubsidiaries where the functional currency has been determined to be the localcurrency are translated into United States dollars using current rates ofexchange for assets and liabilities and rates of exchange that approximate therates in effect at the transaction date for revenues, expenses, gains andlosses. Gains and losses resulting from foreign currency translation areaccumulated as a separate component of consolidated stockholders’ equity asaccumulated other comprehensive income (loss). Gains and losses resulting fromforeign currency transactions are included in the consolidated statements ofoperations.  The net loss fromforeign currency transactions was $723,000 for the year ended December 31,2002, and the net gains from foreign currency transactions were $436,000 and$82,000 for the years ended December 31, 2003 and 2004, respectively.  Such amounts are recorded in other income(expense) in the accompanying consolidated statements of operations.

 

***Derivative Instruments*****– Cymer conducts business in severalinternational currencies through its global operations. Due to the large volumeof Cymer’s business that is conducted in Japan, the Japanese operation posesthe greatest foreign currency risk. Cymer maintains a foreign exchange risk management policy with the goalsof protecting product margins and minimizing the volatility of reportedearnings due to foreign currency exposure. In accordance with its policy, Cymer uses financial instruments,principally foreign currency forward exchange contracts (“forward contracts”),to manage its foreign currency exposures. Cymer enters into forward contractsin order to reduce the impact of currency fluctuations related to purchases ofCymer’s products by Cymer Japan in U.S. dollars for resale under firmthird-party sales commitments denominated in Japanese yen.  The maximum length of time over which Cymerhedges its foreign currency exposure is 12 months.  Cymer does not enter into forward contractsfor speculative purposes.

 

F-14

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Cymer’s forward contracts generally qualify for hedgeaccounting treatment as “cash flow hedges” per the provisions of Statement ofFinancial Accounting Standards No. 133, “Accounting for Derivative Instrumentsand Hedging Activities” (“SFAS 133”). Pursuant to SFAS 133, designated hedging instruments and hedged items ortransactions qualify for cash flow hedge accounting treatment if certaincriteria are met.  For example, at theinception of the hedge, Cymer must have formal documentation of the hedgingrelationship and Cymer’s risk management objective and strategy for undertakingthe hedge, including identification of the hedging instrument, the hedgedtransaction, the nature of the risk being hedged, and how the hedginginstrument’s effectiveness will be assessed. Furthermore, the hedging relationship must be highly effective inachieving offsetting cash flows attributable to the hedged risk during the termof the hedge.

 

In accordance with the provisions of SFAS 133, Cymerdefers changes in the fair value for the effective portion of these hedges andrecords the amount in other comprehensive income (loss), and subsequentlyreclassifies the gain or loss to cost of product sales in the same period thatthe related sale is made to the third party.  For forward contracts entered into after May1, 2004, interest charges or “forward points” on Cymer’s forward contracts areexcluded from the assessment of hedge effectiveness, and are recorded currentlyin foreign currency exchange gain (loss) in the consolidated statements ofoperations. In the event that an anticipated, hedged transaction is no longerlikely to occur within a certain time period, the derivative gain or lossreported in accumulated other comprehensive income is immediately reclassifiedinto foreign currency exchange gain (loss).

 

The fair value of all forward contracts and theassociated deferred loss in other comprehensive income (loss) totaled $1.9million and $455,000, respectively, as of December 31, 2004.  It is expected that 100% of the deferred losswill be reclassified into earnings within the next 12 months.  In the third quarter of 2004, Cymer recordeda loss of $1.1 million as a result of the discontinuance of certain cash flowhedges. This loss is included in foreign currency exchange gain (loss) on theconsolidated statements of operations.

 

At December 31, 2004, Cymer had outstanding forwardcontracts to buy U.S. $49.1 million for 5.2 billion yen under foreign currencyexchange facilities with contract rates ranging from 101.2 yen to 113.2****yen per U.S. dollar.  These contracts expire on various datesthrough September 2005. Cymer recognized a net loss through cost of productsales from the forward contracts of $992,000, $2,484,000 and $2,317,000 for theyears ended December 31, 2002, 2003 and 2004, respectively.

 

***Concentration of Credit Risk***– Financial instruments, which potentiallysubject Cymer to concentrations of credit risk, consist principally of cash andaccounts receivable.

 

*Cashand cash equivalents* – Cymer investsits excess cash in an effort to preserve capital, provide liquidity, maintaindiversification and generate returns relative to Cymer’s corporate investmentpolicy and prevailing market conditions. Cymer has not experienced any material losses on its cash and investmentaccounts.  At times, cash balances held in financial institutions are in excess offederally insured limits. Cymer performs periodic evaluations of the relativecredit standing of financial institutions and limits the amount of risk byselecting financial institutions with a strong relative credit standing.  At December 31, 2003 and 2004, Cymer had$230.4 million and $200.6 million respectively, in deposits with majorfinancial institutions that exceeded the federally insured limit of $100,000.

 

*Accountsreceivable* – Cymermaintains an allowance for doubtful accounts for estimated losses resultingfrom the inability of its customers to make required payments, which results inbad debt expense.  Managementperiodically determines the adequacy of this allowance by continually

 

F-15

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evaluatingindividual customer receivables considering the customer’s financial condition,security deposits, and current economic conditions.   Credit losses to date have been minimal.

 

***Concentration of Supplier Risk***- Alimited number of components and subassemblies included in Cymer’s products areobtained from a single supplier or a small group of suppliers.  For certain optical components used in itslight source systems, Cymer currently utilizes a single supplier.  Where possible, Cymer works with secondarysuppliers to qualify additional sources of supply.  To reduce the risk associated with thissingle supplier, Cymer carries significant strategic inventories of thesecomponents.  Strategic inventories aremanaged as a percentage of future demand. Cymer has also negotiated to have vendor-managed inventory of criticalcomponents to further reduce the risk of a single supplier.  To date Cymer has been able to obtain adequatesupplies of the components and subassemblies used in the production of itslight source systems in a timely manner from existing sources.

 

***Major Customers*** – Revenues from major customers are detailedas follows:

 
| ** **      | ** ** | **Years ended December 31,** | ** ** |
|-----------------|------------|------------------------------|------------|
| ** **      | ** ** | **2002**                     | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **      | ** ** | **(in thousands)**           | ** ** |
| **Customer**    |       |                         |       |   |   |   |   |
| ASM Lithography |       | $                            | 92,286     |   | $ | 63,793 |   | $ | 140,828 |   |
| Canon           |       | 61,709                       |       | 64,459 |   | 45,597 |   |
| Nikon           |       | 68,358                       |       | 55,107 |   | 90,972 |   |
|                 |            |                              |            |  |  |  |  |  |  |  |

 

Accountsreceivable balances for these same major customers are detailed as follows:

 
| ** **      | ** ** | **December 31,**   | ** ** |
|-----------------|------------|--------------------|------------|
| ** **      | ** ** | **2003**           | ** ** | **2004** | ** ** |
| ** **      | ** ** | **(in thousands)** | ** ** |
| **Customer**    |       |               |       |   |   |
| ASM Lithography |       | $                  | 22,033     |   | $ | 48,946 |   |
| Canon           |       | 8,041              |       | 4,812 |   |
| Nikon           |       | 10,550             |       | 33,173 |   |
|                 |            |                    |            |  |  |  |  |

 

Revenuesfrom Japanese customers, generated primarily by Cymer Japan,  amounted to 43%, 44% and 32% of total revenuefor the years ended December 31, 2002, 2003, and 2004, respectively.Revenues from ASM Lithography in the Netherlands accounted for 32%, 24% and 34%of revenues for the years ended December 31, 2002, 2003, and 2004, respectively.

 

Theloss of business of any of these major customers would have a material adverseeffect on our operating results, financial condition, and cash flows.

 

***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 loss periodsas their effect would be anti-dilutive.

 

F-16

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Thefollowing table sets forth the computation of diluted weighted average commonand potential common shares outstanding for the years ended December 31, 2002,2003, and 2004 (in thousands):

 
| ** **                                                               | ** ** | **Years ended December 31,** | ** ** |
|--------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                               | ** ** | **2002**                     | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                                                               | ** ** | **(in thousands)**           | ** ** |
| Basic weighted  average common shares outstanding                        |       | 33,317                       |       | 35,065 |   | 36,758 |   |
|                                                                     |       |                         |       |   |   |   |   |
| Effect of  dilutive securities:                                          |       |                         |       |   |   |   |   |
| Warrants                                                                 |       | 19                           |       | — |   | 14 |   |
| Options                                                                  |       | 1,376                        |       | — |   | 812 |   |
|                                                                     |       |                         |       |   |   |   |   |
| Diluted weighted  average common and potential common shares outstanding |       | 34,712                       |       | 35,065 |   | 37,584 |   |

 

For the years ended December 31, 2002, 2003, and2004, weighted average options and warrants to purchase 2,489,000, 3,943,000,and 3,326,000 shares of common stock, respectively, were outstanding but notincluded in the computation of diluted earnings per share as their effect wasanti-dilutive.  In addition, for the yearsended December 31, 2002, 2003, and 2004, weighted average common sharesattributable to convertible subordinated notes of 5,077,000, 5,000,000, and4,645,000, respectively, were not included in the computation of dilutedearnings per share as their effect was also anti-dilutive.

 

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

 

***Accounting Pronouncements Adopted***

 

In January 2003, the Financial AccountingStandards Board (“FASB”) issued Interpretation No. 46 (“FIN 46”), “Consolidationof Variable Interest Entities”.  FIN 46provides guidance on how to identify a variable interest entity (“VIE”) anddetermine when the assets, liabilities, and results of operations of a VIE needto 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 are effective immediately for all VIEs createdafter January 31, 2003.  For VIEs createdbefore February 1, 2003, the provisions of FIN 46 must be adopted at thebeginning of the first interim or annual reporting period beginning afterDecember 15, 2003.  The adoption of thisinterpretation did not have any effect on the consolidated financial statementsof Cymer as it does not have arrangements that meet the criteria of a VIE.

 

In December 2003, FASB issued Interpretation No.46R, “Consolidation of Variable Interest Entities”, which supersedes FIN46.  The application of the revisedinterpretation is required in the financial statements of companies that haveinterests in special purpose entities for periods after December 15, 2003.  The application of this interpretation didnot have any effect on the consolidated financial statements of Cymer as itdoes not currently have any arrangements that meet the criteria of a specialpurpose entity.

 

In March 2004, theEmerging Issues Task Force (“EITF”) finalized its consensus on EITF Issue 03-6,“Participating Securities and the Two-Class Method Under FASB Statement No.128, Earnings Per Share” (“EITF 03-6”). EITF 03-6 clarifies what constitutes aparticipating security and requires the

 

F-17

----

 

use of thetwo-class method for computing basic earnings per share when participatingconvertible securities exists. EITF 03-6 is effective for fiscal periodsbeginning after March 31, 2004. The application of EITF 03-6 did not have aneffect on Cymer’s calculation of earnings per share.

 

In March 2004, the EITFreached a consensus on EITF Issue No. 03-1 (“EITF 03-1”),  “The Meaning of Other-Than-TemporaryImpairment and Its Application to Certain Investments”. The EITF’s consensusapplies to debt and equity securities accounted for under FASB Statement No.115 (“SFAS 115”),  “Accounting forCertain Investments in Debt and Equity Securities”.  The objective of EITF 03-1 is to provideguidance for identifying other-than-temporary impaired investments. EITF 03-1also provides new disclosure requires for investments that are deemed to betemporarily impaired. In September 2004, the FASB issued a FASB Staff PositionEITF 03-1-1 that delays the effective date of the measurement and recognitionguidance in EITF 03-1 until further deliberations are completed by the FASB. The disclosure requirements areeffective in annual financial statements for fiscal years ending after June 15,2004, for investments accounted for under SFAS 115. Accordingly, the additionaldisclosures as required by EITF 03-1 are included in Note 4 of the Notes to theConsolidated Financial Statements. Cymer does not anticipate that the adoptionof the measurement and recognition guidance of EITF 03-1 will have a materialimpact on Cymer’s consolidated financial statements.

 

***RecentAccounting Pronouncements***

 

In December 2004, FASBissued Statement of Financial Accounting Standards No. 123R (“SFAS No. 123R”), “Share-BasedPayment - An Amendment to Statement Nos. 123 and 95,” that addresses theaccounting for share-based payment transactions in which an enterprise receivesemployee services in exchange for (a) equity instruments of the enterprise or(b) liabilities that are based on the fair value of the enterprise’s equityinstruments or that may be settled by the issuance of such equity instruments.This statement will eliminate the ability to account for share-basedcompensation transactions using Accounting Principles Board (“APB”) Opinion No.25, “Accounting for Stock Issued to Employees,” and will require instead thatsuch transactions be accounted for using a fair-value-based method. SFAS 123Ris effective for public companies for interim or annual periods beginning afterJune 15, 2005.

 

**2.****                      CORRECTION OFTHE METHOD OF ACCOUNTING FOR REFURBISHMENT ACTIVITIES**

 

As part of Cymer’sregular business activities, it conducts significant refurbishment activitiesrelated to certain of its consumable assemblies that wear out with use.  These activities include arrangements withCymer’s customers to sell new, or refurbished as new, assemblies at a reducedsales price in exchange for the return of the consumed core assemblies from thecustomer.  The returned core assembliescontain a certain amount of material, primarily metal components, that may bereusable by Cymer in future builds of core assemblies. Historically, Cymer hasrecorded the value of this material as a reduction of its cost of product salesin the period that the returned assembly was disassembled by its manufacturingoperations and the value of the reusable parts could be determined.  Upon further review of United StatesGenerally Accepted Accounting Principles (“GAAP”) in the fourth quarter of2004, Cymer determined that it should instead estimate the value and recordthese consumed assemblies as inventory at the time that it receives thereturned assembly from its customer and concurrently record this amount asrevenue rather than as a reduction of cost of product sales.

 

**During the fourth quarter of2004, Cymer corrected its accounting treatment for these refurbishment activitiesand analyzed the financial impact that such an accounting correction would haveon its 2004 and prior year consolidated financial statements.  As a result of this analysis, Cymerdetermined that although there is a financial impact due to this accountingcorrection, the amounts are not material to years prior to 2004 as well as tothe fiscal year ended December 31, 2004. Upon making this determination, Cymer recorded the cumulative impact ofthis accounting correction during the fourth quarter of 2004.  Included in these corrections are increasesto inventory, revenues, cost of product sales, and net income for the period,as well as reclassifications from cost of product sales to revenues.**

 

F-18

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**The following adjustments toeffect the change in method of accounting for refurbishment activities wererecorded in the fourth quarter of 2004:**

** **

**•**                  $2.9 million increase in the inventorybalance as of December 31, 2004

**•**                  $28.5 million increase in 2004 productrevenues

**•**                  $25.6 million increase in 2004 cost ofproduct sales

**•**                  $2.0 million increase in 2004 net income

 

**3.****                     ****BALANCE SHEET DETAILS**

 

Theconsolidated balance sheets detail is as follows as of December 31, 2003and 2004 (in thousands):

 
| ** **                                      | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|------------------|------------|
| ** **                                      | ** ** | **2003**         | ** ** | **2004** | ** ** |
| ACCOUNTS  RECEIVABLE:                           |       |             |       |   |   |
| Trade                                           |       | $                | 58,514     |   | $ | 105,662 |   |
| Notes and other                                 |       | 6,269            |       | 5,638 |   |
|                                            |       | 64,783           |       | 111,300 |   |
| Less allowance  for doubtful accounts and notes |       | (1,964           | )          | (620 | ) |
| Total                                           |       | $                | 62,819     |   | $ | 110,680 |   |
|                                            |       |             |       |   |   |
| INVENTORIES:                                    |       |             |       |   |   |
| Raw materials                                   |       | $                | 37,393     |   | $ | 48,131 |   |
| Work-in-progress                                |       | 26,949           |       | 24,344 |   |
| Finished goods                                  |       | 40,698           |       | 46,093 |   |
| Allowance for  excess and obsolete inventory    |       | (12,028          | )          | (8,546 | ) |
| Total                                           |       | $                | 93,012     |   | $ | 110,022 |   |
|                                            |       |             |       |   |   |
| PROPERTY AND  EQUIPMENT:                        |       |             |       |   |   |
| Land                                            |       | $                | 9,080      |   | $ | 9,080 |   |
| Building                                        |       | 88,547           |       | 89,546 |   |
| Building  improvements                          |       | 4,280            |       | 5,498 |   |
| Furniture and  equipment                        |       | 72,287           |       | 83,587 |   |
| Capitalized  light sources                      |       | 33,069           |       | 37,041 |   |
| Leasehold  improvements                         |       | 2,860            |       | 3,024 |   |
| Construction in  process                        |       | 1,521            |       | 2,546 |   |
|                                            |       | 211,644          |       | 230,322 |   |
| Less accumulated  depreciation and amortization |       | (82,795          | )          | (106,774 | ) |
| Total                                           |       | $                | 128,849    |   | $ | 123,548 |   |

 

**Depreciation expense totaled $22.8 million, $28.0 million, and $24.7million for the years ended December 31, 2002, 2003, and 2004, respectively.**

 

F-19

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Unearned income for theyears ended December 31, 2003 and 2004 consists of the following (inthousands):

 
| ** **                    | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|------------------|------------|
| ** **                    | ** ** | **2003**         | ** ** | **2004** | ** ** |
|                          |       |             |       |   |   |
| Light source  systems         |       | $                | —     |   | $ | 4,169 |   |
| Funded  development contracts |       | 158              |       | 1,699 |   |
| Service  contracts            |       | 283              |       | 221 |   |
| License  agreement            |       | 312              |       | 63 |   |
|                          |       |             |       |   |   |
| Total                         |       | $                | 753        |   | $ | 6,152 |   |

 

**4.**                      INVESTMENTS

 

Investments at December 31, 2003 consist of the following (inthousands):

 
| ** **                 | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Market  Value** | ** ** |
|----------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|-------------------|------------|
| Short-term:                |       |                |       |                         |       |                          |       |              |       |
| Corporate debt  securities |       | $                   | 66,526     |                         | $          | 454                           |       | $                 | —     |   | $ | 66,980 |   |
| Commercial paper           |       | 8,438               |       | —                       |       | —                        |       | 8,438             |       |
| U.S. government  agencies  |       | 16,000              |       | 59                           |       | (9                            | )          | 16,050            |       |
| Other                      |       | 2,003               |       | 3                            |       | —                        |       | 2,006             |       |
| Total                      |       | $                   | 92,967     |                         | $          | 516                           |       | $                 | (9         | ) | $ | 93,474 |   |
|                       |       |                |       |                         |       |                          |       |              |       |
| Long-term:                 |       |                |       |                         |       |                          |       |              |       |
| Corporate debt  securities |       | 65,337              |       | 1,488                        |       | —                        |       | 66,825            |       |
| U.S. government  agencies  |       | 3,154               |       | 89                           |       | —                        |       | 3,243             |       |
| Other                      |       | 7,234               |       | 207                          |       | —                        |       | 7,441             |       |
| Total                      |       | $                   | 75,725     |                         | $          | 1,784                         |       | $                 | —     |   | $ | 77,509 |   |

 

Investments at December 31, 2004 consist of the following (inthousands):

 
| ** **                 | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Market  Value** | ** ** |
|----------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|-------------------|------------|
|                       |       |                |       |                         |       |                          |       |              |       |
| Short-term:                |       |                |       |                         |       |                          |       |              |       |
| Corporate debt  securities |       | $                   | 49,972     |                         | $          | 80                            |       | $                 | (7         | ) | $ | 50,045 |   |
| U.S. government  agencies  |       | 33,124              |       | 25                           |       | (98                           | )          | 33,051            |       |
| Commercial paper           |       | 1,997               |       | —                       |       | (2                            | )          | 1,995             |       |
| Auction rate  securities   |       | 4,000               |       | —                       |       | —                        |       | 4,000             |       |
| Total                      |       | $                   | 89,093     |                         | $          | 105                           |       | $                 | (107       | ) | $ | 89,091 |   |
|                       |       |                |       |                         |       |                          |       |              |       |
| Long-term:                 |       |                |       |                         |       |                          |       |              |       |
| Corporate debt  securities |       | 14,726              |       | —                       |       | (158                          | )          | 14,568            |       |
| U.S. government  agencies  |       | 67,680              |       | —                       |       | (387                          | )          | 67,293            |       |
| Other                      |       | 2,700               |       | —                       |       | —                        |       | 2,700             |       |
| Total                      |       | $                   | 85,106     |                         | $          | —                        |       | $                 | (545       | ) | $ | 84,561 |   |

 

F-20

----

 

As of December 31, 2004,the contractual maturities of debt securities were as follows (in thousands):

 
| ** **  | ** ** | **Less than** | ** ** | **One to**      | ** ** | ** ** | ** ** |
|-------------|------------|---------------|------------|-----------------|------------|------------|------------|
| ** **  | ** ** | **One Year**  | ** ** | **Three Years** | ** ** | **Total**  | ** ** |
|        |       |          |       |            |       |       |       |
| Short-term: |       | 89,091        |       | —          |       | 89,091     |       |
| Long-term:  |       | —        |       | 84,561          |       | 84,561     |       |
|        |       |          |       |            |       |       |       |
| Total       |       | 89,091        |       | 84,561          |       | 173,652    |       |

 

The followingtable shows the gross unrealized losses and fair value of Cymer’s investmentsthat are not deemed to be other-than-temporarily impaired aggregated byinvestment category at December 31, 2004.

 
| ** **                      | ** ** | **Market  Value** | ** ** | **Gross  Unrealized  Loss** | ** ** |
|---------------------------------|------------|-------------------|------------|-----------------------------|------------|
|                            |       |              |       |                        |       |
| Corporate debt  securities      |       | $                 | 31,289     |                        | $          | (165 | ) |
| U.S. government  & agencies |       | 92,176            |       | (485                        | )          |
| Commercial paper                |       | 1,995             |       | (2                          | )          |
| Total                           |       | $                 | 125,460    |                        | $          | (652 | ) |

 

At December 31, 2004,Cymer did not have any investments in individual securities that have been in acontinuous unrealized loss position deemed to be temporary for more than 12months. The unrealized losses are the result of market conditions affectingfixed-income securities. Because Cymer’s general intent is to hold itsinvestment securities to maturity, and considering the high quality of theinvestment securities, Cymer is confident that the unrealized losses atDecember 31, 2004 represent a temporary condition and will not result inrealized losses on sale or maturity of the securities.

 

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

 

Comprehensiveincome (loss) includes net income (loss), effective unrealized gains and losseson  forward contracts, foreign currencytranslation adjustments, and unrealized gains and losses on available-for-salesecurities, which are recorded as short-term and long-term investments in theaccompanying consolidated balance sheets.

 

Seethe Consolidated Statements of Stockholders’ Equity for the impact of thecomponents of comprehensive income (loss) to Cymer’s net income (loss).

 

F-21

----

 

The followingtable summarizes the change in each component of accumulated othercomprehensive loss for the year ended December 31, 2004 (in thousands):

 
| ** **        | ** ** | ** **        | ** ** | **Translation  adjustment,  net of tax** | ** ** | **Total unrealized  gains (losses) on  available-for-sale  investments,  net of tax** | ** ** | **Total unrealized  losses on  foreign currency  forward exchange  contracts, net of tax** | ** ** | **Accumulated  other  comprehensive  loss** | ** ** |
|-------------------|------------|-------------------|------------|------------------------------------------|------------|---------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
|              |       |              |       |                                     |       |                                                                                  |       |                                                                                       |       |                                        |       |
| January 1, 2002   |       | Balance           |       | (5,407                                   | )          | 376                                                                                   |       | 1,369                                                                                      |       | (3,662                                      | )          |
|              |       | Period net change |       | 135                                      |       | 1,966                                                                                 |       | (1,868                                                                                     | )          | 233                                         |       |
| December 31, 2002 |       | Balance           |       | (5,272                                   | )          | 2,342                                                                                 |       | (499                                                                                       | )          | (3,429                                      | )          |
|              |       | Period net change |       | 799                                      |       | (894                                                                                  | )          | (2,210                                                                                     | )          | (2,305                                      | )          |
| December 31, 2003 |       | Balance           |       | $                                        | (4,473     | )                                                                                     | $          | 1,448                                                                                      |       | $                                           | (2,709     | ) | $ | (5,734 | ) |
|              |       | Period net change |       | 697                                      |       | (1,672                                                                                | )          | 2,254                                                                                      |       | 1,279                                       |       |
| December 31, 2004 |       | Balance           |       | $                                        | (3,776     | )                                                                                     | $          | (224                                                                                       | )          | $                                           | (455       | ) | $ | (4,455 | ) |

 

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

 

In January 2004,Cymer entered into a research and development agreement with Intel. Totalfunding under the agreement is $20.0 million and is providing Cymer withfunding over a three- year period to accelerate the development ofproduction-worthy EUV lithography light sources.  The funding, which is being received fromIntel under this agreement is milestone based and is being netted against Cymer’stotal research and development expenses in the period that the milestone isachieved.  The total funding amountrecorded under this agreement for the year ended December 31, 2004 was $6.1million.

 

In February 2004, Cymerentered into an intellectual property license agreement with Intel for the useof certain Intel patents and trade secrets related to EUV technology. Under theterms of this agreement, Cymer will pay license fees to Intel if Cymer issuccessful in commercializing an EUV lithography light source capable of highvolume manufacturing by the end of the second quarter of 2008. The licensepayments under this agreement are triggered in the quarter in which Cymersuccessfully ships the first complete high volume manufacturing EUV sourcesystem.  Upon shipment of this firstunit, Cymer is to pay Intel $1.25 million in license fees per quarter for aperiod of sixteen quarters.  Thequarterly license amounts paid to Intel, if any, will be related to Cymer’ssale of EUV light source systems and, as a result, will be recorded as cost ofsales.  The methodology and amounts thatwill be recorded to cost of sales will be determined when the high volumemanufacturing production unit sales or a forecast of sales can be made.  No amounts have been earned under thisarrangement as of December 31, 2004.

 

**7.****                     ****GOODWILL AND INTANGIBLE ASSETS**

 

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

 

During the fourthquarter of 2004, Cymer completed its annual impairment test of goodwill andintangible assets, and concluded that no impairment of goodwill existed.

 

F-22

----

 

Aggregate amortizationexpense for identifiable intangibles, excluding patents, was $160,000 for eachof the years ended December 31, 2002, 2003, and 2004, respectively.  As of December 31, 2004, future estimatedamortization expense is expected to be as follows (in thousands):

 
| ** **                     | ** ** | **Future  Amortization** | ** ** |
|--------------------------------|------------|--------------------------|------------|
|                           |       |                     |       |
| Year ending  December 31, 2005 |       | $                        | 20         |   |
|                                |            |                          |            |  |

 

The following tablesummarizes the activity in the carrying amount of goodwill as of December 31,2003 and 2004 (in thousands):

 
| Goodwill as of  December 31, 2002                                          |   | $      | 10,597 |   |
|----------------------------------------------------------------------------|--------|--------|--------|--------|
| Reversal of  deferred tax asset valuation allowance against goodwill       |   | (2,950 | )      |
| Goodwill as of  December 31, 2003                                          |   | 7,647  |   |
| Goodwill  acquired with acquisition of 6% minority interest in Cymer Korea |   | 711    |   |
|                                                                       |   |   |   |
| Goodwill as of  December 31, 2004                                          |   | $      | 8,358  |   |

 

Also included inintangible assets – net on the accompanying balance sheets are amountsassociated with patents that were acquired in 2001 and 2003.  As of December 31, 2003 and 2004, the netcarrying amount of these patents was $12.7 million and $10.4 million,respectively.  Amortization expense forthese patents was $1.3 million, $1.5 million and $2.4 million for the yearsended December 31, 2002, 2003 and 2004, respectively.

 

As of December 31,2004, future estimated amortization expense for these patents is expected to beas follows (in thousands):

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

 

**8.**                      CREDIT FACILITIES

 

***Revolving Loan Agreements*** – During part of 2003, Cymer had certain loan agreements with acommercial bank, which provided for unsecured revolving loan facilitiesallowing for borrowings of $10.0 million and $20.0 million under a U.S. line ofcredit 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 and othercovenants, including tangible net worth, quick ratio and profitabilityrequirements.  The loan agreementsexpired on June 16, 2003 and have not since been renewed.

 

F-23

----

 

***Foreign Exchange Facilities*** – During 2003 and 2004, Cymer maintainedforeign exchange facilities with five financial institutions in the UnitedStates.  See also “Derivative Instruments”in Note 1.  The foreign exchangefacilities provided up to $100 million in 2003 and 2004 to be utilized for spotand futures foreign exchange contracts for periods of up to one year. As ofDecember 31, 2003 and 2004, $81.0 million and $49.1 million was utilized underthe foreign exchange facilities, respectively. One of these facilities wasassociated with the Revolving Loan Agreements discussed above and was subjectto the same covenants through June 16, 2003.

 

**9.**                      IMPAIRMENT OR DISPOSAL OFLONG-LIVED ASSETS

 

Thetotal amount of impairment losses incurred in the years ended December 31,2002, 2003, and 2004 was approximately $574,000, $17.7 million, and $6,000,respectively. For the year ended December 31, 2002, theimpairment loss of $574,000 included write-offs associated with tenantimprovements in Cymer’s San Diego facility and test equipment used withinresearch and development.  The loss of$574,000 was recorded in the research and development and general andadministrative expenses, as appropriate, in the accompanying consolidatedstatements of operations.  For the yearended December 31, 2003 the impairment loss of $17.7 million includedwrite-offs associated with tenant improvements, $15.6 million of which resultedfrom the two leased facilities in San Diego, which were vacated in the thirdquarter of 2003.  In addition, there wereimpairment losses associated with test equipment used within manufacturing andresearch and development.  The loss of$17.7 million was recorded in general and administrative, cost of product salesand research and development expenses, as appropriate, in the accompanying consolidatedstatements of operations.  For the yearended December 31, 2004, the impairment of $6,000 includes the write-off ofcertain equipment used by the general and administrative and manufacturingareas and the related impairment expense was recorded accordingly in these twoclassifications on the accompanying consolidated statements of operations.

 

**10.**               CONVERTIBLE SUBORDINATED NOTES

 

In August 1997, Cymer issued $172.5 million inaggregate principal amount in a private placement of notes.  These Notes were called for redemption onMarch 25, 2002.  Immediately prior to theMarch 25, 2002 redemption date, holders of $113.0 million of the outstandingprincipal amount converted their 1997 notes into shares of Cymer’s commonstock.  As a result of these conversions,2,325,542 shares of Cymer common stock were issued to the note holders and theremaining $38.0 million of the outstanding principal amount of the 1997 noteswas redeemed.  Cymer used its 2,000,000shares of treasury stock as part of the total 2,325,542 shares issued in theconversion.  The redemption resulted in aloss on debt extinguishment of $163,000.

 

In February 2002, Cymer issued $250.0 million principal amount ofunsecured fixed rate 3.50% convertible subordinated notes due February 15, 2009with interest payable on February 15 and August 15 of each year. These notesare convertible into shares of Cymer common stock at a conversion rate of 20shares per $1,000 principal amount or an effective conversion price of $50.00per share. Cymer may redeem the 2002 notes on or after February 20,2005, or earlier if the price of its common stock reaches certain levels.  The 2002 notes are subordinated to Cymer’sexisting and future senior indebtedness and effectively subordinated to allindebtedness and other liabilities of Cymer’s subsidiaries. In the third quarter of 2004, Cymerrepurchased, at a discount to par, $49.2 million of these notes. As a result ofthis repurchase, Cymer recognized a gain on debt extinguishment of $911,000. Asof December 31, 2004, Cymer had $200.8 million convertible subordinated notesoutstanding.

 

F-24

----

 

**11.****              ****STOCKHOLDERS’ EQUITY**

 

***Common Stock Warrants*** – During fiscal 2001, Cymer issuedwarrants to purchase 200,000 shares of its common stock at a weighted averagepurchase price of $31.43 per share in conjunction with the acquisition ofcertain patents (See Note 14).  During fiscal 2002, 2003 and 2004, no warrantswere granted and no warrants were exercised. The warrants expire in May 2006.

 

***Stockholder Rights Plan***– On February 13, 1998, Cymer’s board of directors adopted a stockholder rights plan.  The stockholder rights plan was intended to assure that all Cymer stockholders would receive fair and equal treatment in the event of any proposed takeover of Cymer and to guard against partial tender offers and other abusive tactics to gain control of Cymer without paying all stockholders the fair value of their shares, including a control premium.

 

On August 23, 2004, Cymer announced that it had amended the stockholderrights plan to change the final expiration date from February 13, 2008 toSeptember 1, 2004.  As a result of thisamendment, the stockholder rights plan terminated on September 1, 2004.  On September 2, 2004, Cymer filed with theNevada Secretary of State to withdraw the Certificate of Designations ofRights, Preferences and Privileges of Series A Participating Preferred Stockand eliminate from Cymer’s Articles of Incorporation the Series A ParticipatingPreferred Stock that had been created in connection with the stockholder rightsplan.

 

***StockOption and Purchase Plans***– Cymer hasthe following stock option and stock purchase plans:

 

*1996 Stock Option Plan (the “1996Plan”)* – The 1996 Plan provides for the grant of incentive stock options  to employees and nonqualified stock optionsto employees, directors and consultants of Cymer.  The exercise price of stock options grantedunder the 1996 Plan must be at least equal to the fair market value of Cymer’scommon stock on the date of grant. Options issued under the 1996 Plan expirefive to ten years after the options are granted and generally vest and becomeexercisable ratably over a four-year period following the date of grant.  A total of 7,900,000 shares of common stockwere reserved for issuance under the 1996 Stock Plan.  Of these shares, options to purchase4,343,657 shares are outstanding and 155,325 shares remain available for grantsas of December 31, 2004.

 

*1996 Employee Stock Purchase Plan(the “ESPP”)*– The ESPP is intended to qualify under Section 423of the Code.  Under the ESPP, eligibleemployees may purchase shares of common stock from Cymer through payrolldeductions of up to 15% of his or her compensation (as defined in the plan), ata price per share equal to 85% of the lower of (i) the fair market value ofCymer’s common stock as of the first day of each offering period under the ESPPor (ii) the fair market value of the common stock at the end of the purchaseperiod.  This plan was amended in 2001 bythe shareholders to establish two year offering periods with six-month purchaseperiods and to increase the plan shares issuable from 500,000 to 800,000.  This plan was amended in 2004 to increase theplan shares issuable to 1.2 million shares. The amount of shares issuable under this plan as of December 31, 2004was 209,382, and 990,618 shares have been previously issued.

 

*2000Equity Incentive Plan (the “2000 Plan”)*– On August 16, 2000, Cymer adopted the 2000 Plan which provides for the grantof options to employees or consultants who are neither directors nor officers.The exercise price of the options granted under the 2000 Plan will equal thequoted market value of the common stock at the date of grant.  Options issued under the 2000 Plan expire

 

F-25

----

 

tenyears after the options are granted and generally vest and become exercisableratably over a four year period following the date of grant.  This plan was amended in 2002 to increase theshares reserved for issuance under the plan from 1,850,000 to 4,950,000.  Of these shares, options to purchase3,061,566 shares are outstanding and 696,773 shares remain available for grantsas of December 31, 2004.

 

*ACX1993 Stock Option Plan**(the“ACX Plan”)*– Cymer assumedthe ACX Stock Option Plan upon completion of the acquisition of ACX in February2001.  Outstanding options may beexercised solely for shares of Cymer common stock, according to the conversionratio established in the terms of the acquisition.  The outstanding ACX options were converted tooptions to purchase 336,109 Cymer shares, at exercise prices ranging from $2.08to $38.71 per share.  The ACX Planprovides for the grant of incentive and nonstatutory options to purchase sharesof common stock to employees, directors and consultants at prices not less than100% of the fair market value of common stock on the date the options aregranted.  Options issued under the ACXPlan expire five to ten years after the options were granted and generally vestand become exercisable ratably over a four-year period following the date ofgrant.  No further options will be issuedunder the ACX Stock Option Plan.  As ofDecember 31, 2004, 36,277 shares are outstanding under the ACX Stock OptionPlan.

 

In 1996, Cymer adopted a *1996Director Option Plan (the “Director Option Plan”)* whereby 200,000shares were reserved for Board of Director option grants.  There were 80,000 options issued under theDirector Option Plan in 1997.  TheDirector Option Plan was dissolved in October 1997; however, 20,000 of theseoptions remain outstanding as of December 31, 2004.

 

A summary of the stockoption activity under all stock option plans is as follows (in thousands,except per share data):

 
| ** **                      | ** ** | ** **                              | ** ** | **Options Outstanding** | ** ** |
|---------------------------------|------------|-----------------------------------------|------------|-------------------------|------------|
| ** **                      | ** ** | **Stock Options  Available  for Grant** | ** ** | **Number of  Shares**   | ** ** | **Weighted Average  Exercise Price  Per Share** | ** ** |
|                            |       |                                    |       |                    |       |   |   |
| Balance at  January 1, 2002     |       | 4,161                                   |       | 7,545                   |       | $ | 27.75 |   |
| Granted                         |       | (1,803                                  | )          | 1,803                   |       | 28.20 |   |
| Exercised                       |       | —                                  |       | (900                    | )          | 21.94 |   |
| Cancelled                       |       | 326                                     |       | (326                    | )          | 34.81 |   |
| Expired                         |       | (34                                     | )          | —                  |       | — |   |
|                            |       |                                    |       |                    |       |   |   |
| Balance at  December 31, 2002   |       | 2,650                                   |       | 8,122                   |       | 28.20 |   |
| Granted                         |       | (1,496                                  | )          | 1,496                   |       | 32.01 |   |
| Exercised                       |       | —                                  |       | (1,899                  | )          | 23.22 |   |
| Cancelled                       |       | 493                                     |       | (493                    | )          | 27.38 |   |
| Expired                         |       | (53                                     | )          | —                  |       | — |   |
|                            |       |                                    |       |                    |       |   |   |
| Balance at  December 31, 2003   |       | 1,594                                   |       | 7,226                   |       | 30.36 |   |
| Granted                         |       | (1,053                                  | )          | 1,053                   |       | 36.73 |   |
| Exercised                       |       | —                                  |       | (502                    | )          | 23.34 |   |
| Cancelled                       |       | 315                                     |       | (315                    | )          | 32.97 |   |
| Expired                         |       | (4                                      | )          | —                  |       | — |   |
|                            |       |                                    |       |                    |       |   |   |
| Balance at  December 31, 2004   |       | 852                                     |       | 7,462                   |       | $ | 31.62 |   |
|                            |       |                                    |       |                    |       |   |   |
| Exercisable,  December 31, 2004 |       |                                    |       | 5,255                   |       | $ | 31.21 |   |
|                                 |            |                                         |            |                         |            |  |  |  |  |

 

F-26

----

 

Thefollowing table summarizes information as of December 31, 2004 concerningcurrently outstanding and exercisable options (number of shares in thousands):

 
| **Options Outstanding**                | ** ** | **Options Exercisable** | ** ** |
|----------------------------------------|------------|-------------------------|------------|
| ** **                             | ** ** | ** **              | ** ** | **Weighted  Average** | ** ** | **Weighted** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                             | ** ** | ** **              | ** ** | **Remaining** | ** ** | **Average** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| **Range of**                           | ** ** | **Number**              | ** ** | **Contractual Life** | ** ** | **Exercise** | ** ** | **Number** | ** ** | **Average** | ** ** |
| **Exercise Prices**                    | ** ** | **Outstanding**         | ** ** | **(years)** | ** ** | **Price** | ** ** | **Exercisable** | ** ** | **Exercise Price** | ** ** |
|                                   |       |                    |       |   |   |   |   |   |   |   |   |
| $  2.08  - $  2.08 |       | 2                       |       | 1.18 |   | $ | 2.08 |   | 2 |   | $ | 2.08 |   |
| $10.41 - $15.50                        |       | 47                      |       | 2.38 |   | $ | 12.22 |   | 47 |   | $ | 12.22 |   |
| $16.32 - $23.25                        |       | 1,536                   |       | 5.45 |   | $ | 20.08 |   | 1,273 |   | $ | 20.16 |   |
| $23.38 - $34.87                        |       | 2,889                   |       | 7.38 |   | $ | 29.10 |   | 1,797 |   | $ | 28.75 |   |
| $34.94 - $52.31                        |       | 2,  957                 |       | 6.61 |   | $ | 40.12 |   | 2,105 |   | $ | 40.05 |   |
| $54.00 - $60.00                        |       | 31                      |       | 5.22 |   | $ | 56.19 |   | 31 |   | $ | 56.19 |   |
| $  2.08  - $60.00            |       | 7,462                   |       | 6.64 |   | $ | 31.62 |   | 5,255 |   | $ | 31.21 |   |

 

As the result of theaccelerated vesting of certain stock options described in Note 18, SubsequentEvents, approximately 1.0 million shares of Cymer’s common stock, at exerciseprices of $30.50 or higher became immediately exercisable as of February 17,2005.

 

**12.**               INCOME TAXES

 

Total income taxes forthe years ended December 31, 2002, 2003 and 2004 were allocated as follows (inthousands):

 
| ** **                                 | ** ** | **Years ended December 31,** | ** ** |
|--------------------------------------------|------------|------------------------------|------------|
| ** **                                 | ** ** | **2002**                     | ** ** | **2003** | ** ** | **2004** | ** ** |
|                                       |       |                         |       |   |   |   |   |
| To income on  continuing operations        |       | $                            | 2,706      |   | $ | (21,464 | ) | $ | 15,144 |   |
| To stockholder’s  equity and goodwill |       | (6,683                       | )          | (13,005 | ) | (2,748 | ) |
| Total income  taxes                        |       | $                            | (3,977     | ) | $ | (34,469 | ) | $ | 12,396 |   |

 

Thebreakdown of income (loss) before income tax provision (benefit) and minorityinterest and the components of the provision (benefit) for income taxes oncontinuing operations on U.S. and foreign pre-tax income are summarized as follows:

 
| ** **              | ** ** | **Years ended December 31,** | ** ** |
|-------------------------|------------|------------------------------|------------|
| ** **              | ** ** | **2002**                     | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **              | ** ** | **(in thousands)**           | ** ** |
|                    |       |                         |       |   |   |   |   |
| U.S. pre-tax  income    |       | $                            | 16,485     |   | $ | (46,536 | ) | $ | 48,369 |   |
| Foreign pre-tax  income |       | 264                          |       | 10,763 |   | 12,205 |   |
|                    |       |                         |       |   |   |   |   |
| Total                   |       | $                            | 16,749     |   | $ | (35,773 | ) | $ | 60,574 |   |
|                    |       |                         |       |   |   |   |   |
| Current income  taxes:  |       |                         |       |   |   |   |   |
| Federal                 |       | $                            | 8,320      |   | $ | (4,082 | ) | $ | (794 | ) |
| State                   |       | 371                          |       | (714 | ) | 78 |   |
| Foreign                 |       | 4,262                        |       | 3,989 |   | 1,838 |   |
|                    |       |                         |       |   |   |   |   |
| Total                   |       | 12,953                       |       | (807 | ) | 1,122 |   |

 

F-27

----

 
| ** **                      | ** ** | **Years ended December 31,** | ** ** |
|---------------------------------|------------|------------------------------|------------|
| ** **                      | ** ** | **2002**                     | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                      | ** ** | **(in thousands)**           | ** ** |
|                            |       |                         |       |   |   |   |   |
| Deferred income  taxes:         |       |                         |       |   |   |   |   |
| Federal                         |       | (6,874                       | )          | (14,904 | ) | 16,455 |   |
| State                           |       | (3,373                       | )          | (4,418 | ) | (1,226 | ) |
| Foreign                         |       | —                       |       | (1,335 | ) | (1,207 | ) |
|                            |       |                         |       |   |   |   |   |
| Total                           |       | (10,247                      | )          | (20,657 | ) | 14,022 |   |
|                            |       |                         |       |   |   |   |   |
| Income tax  provision (benefit) |       | $                            | 2,706      |   | $ | (21,464 | ) | $ | 15,144 |   |
|                                 |            |                              |            |  |  |  |  |  |  |  |

 

Theincome tax provision (benefit) is different from that which would be obtainedby applying the statutory Federal income tax rate (35%) to income before incometax expense.  The items causing thisdifference for the period are as follows:

 
| ** **                                                                       | ** ** | **Years ended December 31,** | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                       | ** ** | **2002**                     | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                                                                       | ** ** | **(in thousands)**           | ** ** |
|                                                                             |       |                         |       |   |   |   |   |
| Provision at  statutory rate                                                     |       | $                            | 5,919      |   | $ | (12,520 | ) | $ | 21,201 |   |
| Foreign  provision in excess of federal statutory rate                           |       | 1,756                        |       | 312 |   | 2,958 |   |
| State income  taxes, net of federal benefit                                      |       | (730                         | )          | (2,903 | ) | (135 | ) |
| Extraterritorial  income exclusion benefit                                       |       | (2,848                       | )          | (4,108 | ) | (7,305 | ) |
| Federal tax  credits                                                             |       | (1,990                       | )          | (2,123 | ) | (1,139 | ) |
| Non-deductible  amortization of goodwill and in-process research and development |       | 56                           |       | 56 |   | 56 |   |
| Other                                                                            |       | 543                          |       | (178 | ) | (492 | ) |
|                                                                             |       |                         |       |   |   |   |   |
| Provision  (benefit) at effective tax rate                                       |       | $                            | 2,706      |   | $ | (21,464 | ) | $ | 15,144 |   |
|                                                                                  |            |                              |            |  |  |  |  |  |  |  |  |

 

Deferred income taxesreflect the net tax effects of temporary differences between the carryingamounts of assets and liabilities for financial reporting purposes and theamounts used for income tax purposes. Significant components of Cymer’s net deferred tax assets are asfollows:

 
| ** **                                                       | ** ** | **December 31,**   | ** ** |
|------------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                       | ** ** | **2003**           | ** ** | **2004** | ** ** |
| ** **                                                       | ** ** | **(in thousands)** | ** ** |
|                                                             |       |               |       |   |   |
| Deferred tax  assets:                                            |       |               |       |   |   |
| Reserves and  accruals not currently deductible                  |       | $                  | 15,250     |   | $ | 20,045 |   |
| Difference  between book and tax basis of inventory              |       | 4,606              |       | 3,390 |   |
| Tax  carryforwards                                               |       | 59,049             |       | 46,175 |   |
| Tax effect of  foreign transactions                              |       | 7,169              |       | 2,138 |   |
| Foreign deferred  tax assets                                     |       | 2,067              |       | 3,444 |   |
| Total gross  deferred tax assets                                 |       | 88,141             |       | 75,192 |   |
| Valuation  allowance                                             |       | —             |       | — |   |
| Net deferred tax  assets                                         |       | 88,141             |       | 75,192 |   |
| Deferred tax  liabilities:                                       |       |               |       |   |   |
| Difference  between book and tax basis of property and equipment |       | (5,499             | )          | (6,237 | ) |
| Reserves and  accruals not currently taxable                     |       | (524               | )          | (706 | ) |
| Net deferred tax  assets                                         |       | $                  | 82,118     |   | $ | 68,249 |   |

 

F-28

----

 

In assessing therealizability of deferred tax assets, we consider whether it is more likelythan not that some portion or all of the deferred tax assets will not berealized.  Webelieve that it is more likely than not that the results of future operationswill generate sufficient taxable income to realize the deferred tax assets forwhich a valuation allowance has not been provided.

 

At December 31, 2004 Cymer had federal tax netoperating loss (“NOL”) carryforwards of $51.1 million and federal tax creditsof $15.2 million, both of which begin to expire in 2018.  In order to realize the benefit associatedwith the federal NOL and credit carryforwards, Cymer must earn cumulativetaxable income of at least $94.5 million prior to the expiration of thosecarryforwards.  At December 31, 2004Cymer had state tax credit carryforwards of $13.2 million, of which $3.8million begin to expire in 2009, and $9.4 million may be carried forwardindefinitely.  In order to realize thebenefit associated with the state tax credit carryforwards, Cymer must earncumulative taxable income of at least $317.7 million prior to the expiration ofthose carryforwards.

 

Cymerbenefits from a tax holiday in Korea where it manufactures certainproducts.  The tax holiday is scheduledto expire in eight years.  The effect ofthe tax holiday for the year ended December 31, 2004 is a benefit to the taxrate of approximately 2.7%.

 

Cymerhas not provided for U.S. federal income and foreign withholding taxes on $43.0million of undistributed earnings from non-U.S. operations as of December 31,2004 as it is Cymer’s intention to reinvest undistributed earnings of itsforeign subsidiaries and thereby indefinitely postpone their remittance.  Accordingly, no provision has been made forforeign withholding taxes or United States income taxes which may becomepayable if undistributed earnings of foreign subsidiaries were paid asdividends to Cymer.

 

Currently,Cymer is not considering the repatriation of any foreign earnings and as such,no impact is reported in the financial statements as of December 31, 2004.  However, Cymer is still evaluating the impactof repatriation of foreign earnings under Internal Revenue Code (“IRC”) Section965.  The American Jobs Creation Act of2004, and IRC Section 965 allow a temporary 85% dividends received deduction onrepatriated foreign earnings if the funds are reinvested in the UnitedStates.  FASB Staff Position No. 109-2 (“FSPNo. 109-2”), allows companies additional time to evaluate whether foreignearnings will be repatriated under the provisions of the new law.  Cymer is awaiting the issuance of furtherregulatory guidance prior to determining what amount, if any, will berepatriated.  As such, at this time,Cymer has not determined a range of potential repatriated amounts, if any.Cymer expects to complete its analysis and determine what amount, if any, torepatriate by September 30, 2005.

 

**13.**               CONTINGENCIES AND COMMITMENTS

 

***Leases*** – Cymer leasescertain facilities under non-cancelable operating leases.  The lease terms on these facilities arethrough January 1, 2010 and provide for certain rent abatements and minimumannual increases and options to extend the terms.  In addition, Cymer has a land lease in Koreawith a lease term through December 2020. This land lease is currently exemptfrom lease payments because the building meets certain investment andoperational criteria of the Korean government. Cymer also leases certain equipment under capital and short-termoperating lease agreements.  The capitalleases will expire in 2005.

 

Rentexpense under operating leases net of sublease rental income is recognized on astraight-line basis over the life of the related leases, and totaledapproximately $4,545,000, $4,773,000 and $6,495,000 for the years endedDecember 31, 2002, 2003 and 2004, respectively.  Rent expenses for 2004 includes $3.0 millionin costs recorded for lease losses associated with our subleasing activitiesfor our San Diego and Charlestown facilities.

 

F-29

----

 

Thenet book value of assets under capital leases at December 31, 2003 and2004 was approximately $61,000 and $12,000, which are net of accumulatedamortization of approximately $86,000 and $135,000, respectively.

 

Totalfuture minimum lease commitments under operating and capital leases are as follows(in thousands):

 
| **Years ending December 31,**               | ** ** | **Operating** | ** ** | **Capital** | ** ** |
|---------------------------------------------|------------|---------------|------------|-------------|------------|
|                                        |       |          |       |        |       |
| 2005                                        |       | 4,727         |       | $           | 12         |   |
| 2006                                        |       | 3,883         |       | —      |       |
| 2007                                        |       | 3,845         |       | —      |       |
| 2008                                        |       | 3,328         |       | —      |       |
| 2009                                        |       | 3,256         |       |        |       |
| Thereafter                                  |       | 62            |       | —      |       |
| Total                                       |       | $             | 19,101     |        | 12         |   |
|                                        |       |          |       |        |       |
| Less amount  representing interest          |       |          |       | —      |       |
|                                        |       |          |       |        |       |
| Present value of  minimum lease payments    |       |          |       | 12          |       |
| Less current  portion                       |       |          |       | (12         | )          |
|                                        |       |          |       |        |       |
| Long-term  obligations under capital leases |       |          |       | $           | —     |   |
|                                             |            |               |            |             |            |  |  |

 

The following represents future minimum rentals to beearned under Cymer’s noncancelable subleases (in thousands). These amounts aredirectly offset to the operating lease amounts above.

 
| **Years ending December 31,** | ** ** | **Sublease  Payments** | ** ** |
|-------------------------------|------------|------------------------|------------|
|                          |       |                   |       |
| 2005                          |       | $                      | 2,895      |   |
| 2006                          |       | 3,380                  |       |
| 2007                          |       | 3,503                  |       |
| 2008                          |       | 1,677                  |       |
| 2009                          |       | 1,124                  |       |
| Thereafter                    |       | —                 |       |
| Total                         |       | $                      | 12,579     |   |

 

***Patent License Agreement***– Cymer has a patent license agreement for a non-exclusive worldwide license tocertain patented light source technology. Under the terms of the agreement, Cymer is required to pay royaltiesranging from 0.25% to 5.0% of gross sales and leases as defined depending onthe total amounts attained subject to an annual maximum of $100,000. Royaltyfees totaled $100,000 in each of the years ended December 31, 2002, 2003and 2004.  The licensed patents expiredin 2004, and no additional royalty fees will be paid under this agreement.

 

***Employee Savings Plan*** – Cymer has a401(k) plan that allows participating employees to contribute a percentage oftheir salary, subject to annual limits. The Plan is available to substantially all full-time United Statesemployees.  Effective January 1, 1997through December 31, 1999, Cymer matched 100% of each eligible employee’scontributions, up to $500 per year.  ThePlan was amended effective January 1, 2000 to include a matching contributionof up to 4% of each participating employee’s compensation, not to exceed $4,000per year.  Effective January 1, 2004,

 

F-30

----

 

the401(k) plan was amended to increase the employer matching contribution of up to5% of each participating employee’s compensation, not to exceed $5,000 peryear. Under the Plan, Cymer contributed $1,438,000, $1,558,000, and $2,811,000for the years ended December 31, 2002, 2003, and 2004, respectively.

 

***Executive Deferred Compensation Plan***– Cymer has an executive deferred compensation plan for certain officers andkey executives.  Beginning in 2001, Cymerused corporate owned life insurance to finance the plan.  Compensation expense under this plan totaled$367,000, $310,000 and $182,000 for the years ended December 31, 2002, 2003 and2004, respectively.  Cymer’s liabilityfor deferred compensation totaled $2,250,000 and $2,958,000 as of December 31,2003 and December 31, 2004, respectively, and is included in otherliabilities.  The cash surrender value ofthe life insurance policies totaled $869,000 and $1,455,000 as of December 31,2003 and 2004, respectively, and is included in other assets.

 

***Executive Option and Group Health CoverageExtension Program***– Cymer has an executive option and health coverage extension program foreligible executives who meet certain minimum service and age requirements.  This program is designed to provide extendedbenefits to eligible executives who retire and cease to serve Cymer on afull-time basis.  Under the terms of theplan, the executive acts as a consultant to Cymer for a term of fouryears.  In return for these services, theprogram allows the executive to continue vesting in his or her stock optionsafter the retirement separation date. The program also provides the executiveswith specified health insurance continuation benefits. One former executiveparticipated in this program. The cost for this program was not material in2003 and 2004.

 

***Retirement Plans*** – Cymer Japan has aRetirement Allowance and Pension Plan (“pension plan”) for all Cymer Japanemployees and as well as a retirement allowance for Japanese directors (“directors’plan’).  Expense under these planstotaled approximately $247,000, $526,000, and $536,000 for the years ended December31, 2002, 2003 and 2004, respectively.  The expenses for the pension plan are in accordance with the November2004 actuarial valuation report pursuant to the accounting requirements underStatements of Financial Standards No. 87, 88 and 132R. Cymer’s liability forboth plans totaled approximately $1.1 million and $1.5 million as of December31, 2003 and 2004, respectively. Although the total expenses and liabilitybalances provided above include both plans, the directors plan is immaterial toall amounts and years provided.  The projectedbenefit obligation at December 31, 2004 was approximately $1.3 million.  The accumulated benefit obligation atDecember 31, 2004 was approximately $928,000.

 

The pension planis an unfunded plan and includes no plan assets. The net periodic pension costsfor the year 2005 are estimated at $250,000, and the projected benefitobligation is $1.5 million as of December 31, 2005. Estimated future benefitexpected payments under the pension plan from 2005 through 2009 and thereafterare $77,000, $90,000, $102,000, $112,000, $175,000 and $747,000,respectively.  The following assumptionswere used in the actuarial calculation for 2004: discount rate 1.25%, salaryincreases 4.0% per year, and mortality rates using the Japanese 19thLife Table.

 

***Korea Customs Investigation*****–**The****customsagency in Korea had asserted that parts being imported into Korea from Cymer’scorporate office in San Diego were classified improperly for customs and dutiespurposes and some used items, which were returned to San Diego, were valuedimproperly during the period from 1997 through July 2003.  Although Cymer did not agree with theseassertions, Korean customs assessed and required payment from Cymer on additionalduties related to shipments during this time period.  As a result of these assertions anddiscussions that Cymer had with the customs agencies in Korea, Cymer accrued aliability of $4.7 million through December 31,

 

F-31

----

 

2003.

 

The expense resultingfrom this recorded liability was included in cost of product sales in theaccompanying consolidated statements of operations. Payments made to thecustoms agency in Korea were $2.5 million and $1.9 million during 2003 and2004, respectively. The 2004 payment is net of a $289,000 refund received fromthe Korea customs office.  In 2004, Cymerreceived notification from the Korean customs office that Cymer would receive arefund of a portion of duties previously paid. As a result, Cymer recorded a$2.3 million reduction to cost of product sales and $100,000 to interest incomein the accompanying consolidated statements of operations for the year endedDecember 31, 2004 related to this refund. The accrual for this refund wasrecorded in accounts receivable-net in the accompanying consolidated balancesheet as of December 31, 2004.

 

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

 

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

 

**14.****              ****PATENT LICENSE AGREEMENTS**

 

In May 2001, Cymeracquired certain patents for use in its DUV light source applications.  The total consideration for this transactionwas $10.3 million, which included a $6.0 million cash payment and the issuanceof 200,000 warrants valued at $4.3 million. The warrants were valued on thedate of issuance using the Black-Scholes pricing model using the followingassumptions: 87% volatility, 5.0% risk-free interest rate and 4.6 yearsexpected life.  The total value of thesepatents are being amortized over eight years which represents the remaininglife of the patents purchased under the agreement. The amortization of thesepatents is included in cost of product sales on the accompanying statements ofoperations since they are used in products, which are currently being shippedto customers.

 

In November 2003,Cymer acquired the rights to the same list of patents as in the May 2001agreement but for a different field of use, for a total amount of $6.0 millionin cash.  Instead of DUV light sourceapplications for the patents, this license agreement allows Cymer to use thepatents for EUV and other future applications. The total value of these patents are being amortized over a period of5.5 years which represents the remaining life of the patents purchased underthe agreement. The amortization of these patents is included in research anddevelopment expenses on the accompanying statements of operations since thefield of use involves applications, which are still in the research anddevelopment stages.

 

As of December 31,2003 and 2004, the net carrying amount related to both of these patent licenseagreements was $12.7 million and $10.4 million, respectively.

 

F-32

----

 

**15.**               RELATED PARTY TRANSACTIONS

 

***Collaborative Arrangement****–* Cymer has a collaborative arrangementwith a Japanese company that was also a stockholder of Cymer until 2000.  The arrangement, entered into in August 1992,includes a product license agreement and contract manufacturing agreement.  The general provisions of these agreementsare as follows:

 

*Product License Agreement**–* Cymer granted to the stockholder the exclusive right inJapan and the non-exclusive right outside Japan to manufacture and sell one ofCymer’s products and subsequent enhancements thereto. Cymer also granted thestockholder the right of first refusal to license and fund the development ofnew technologies not developed with funding from other parties.  In exchange for these rights, Cymer receivedup-front license fees and was entitled to royalties of 5% on related productsales through September 1999, after which the royalty rate was subject torenegotiation.  To date no renegotiationof the royalty rate has occurred.  Thelicense agreement also provides that product sales between Cymer and thestockholder will be at a 15% discount from the respective companies’ listprice. The agreement terminates in August 2012. There was no activity under this agreement in 2002, 2003 and 2004.

 

*Contract Manufacturing Agreement**–* The stockholder agreed to manufacture for Cymer certainproducts and Cymer was required to purchase a specified percentage of its totalannual product, as defined, from the stockholder.  Cymer and this stockholder mutually agreed tothe termination of this contract effective March 31, 2003.

 

Cymer made $2.0 million and$351,000 in purchases under this agreement in 2002 and 2003. No purchases weremade in 2004.  In addition, Cymer had nopayables due at December 31, 2003 and  atDecember 31, 2004.

 

**16.****              ****SEGMENTINFORMATION**

 

Cymerdesigns, manufactures and sells excimer light source systems, replacementparts, and support services for use in photolithography systems used in themanufacture of semiconductors with critical features sizes.  In accordance with Statement of FinancialAccounting Standards No. 131, “Disclosure about Segments of an Enterprise andRelated Information”, Cymer currently considers its business to consist of onereportable operating segment.

 

**GeographicInformation**

 

Presentedbelow is information regarding sales to unaffiliated customers, operatingincome (loss) from operations, long-lived assets, all other identifiable assetsand total identifiable assets, classified by operations located in the UnitedStates, Japan, Korea, Taiwan, Singapore, the People’s Republic of China (“China”),and the Netherlands.  Long-lived assetsinclude net property, plant and equipment attributed to the geographic locationin which they are located. Cymer sells its excimer light sources in Japanthrough Cymer Japan. Intercompany sales to the subsidiaries are generallypriced between 90% to 95% of the price of products sold to outside customers.Sales to unaffiliated customers consist of sales generated from each of thegeographic locations as detailed below. These sales exclude export sales toother geographic locations. All significant intercompany balances areeliminated in consolidation.  Themajority of corporate costs and expenses are incurred in the United States andare reflected in the operating loss from the United States operations.

 

F-33

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| ** **                       | ** ** | **Year ended December 31, 2002** | ** ** |
|----------------------------------|------------|----------------------------------|------------|
| ** **                       | ** ** | **(in thousands)**               | ** ** |
| ** **                       | ** ** | **United States**                | ** ** | **Japan** | ** ** | **Korea, Taiwan,  Singapore, China,  and the Netherlands** | ** ** | **Consolidated** | ** ** |
|                             |       |                             |       |   |   |   |   |   |   |
| Sales to  unaffiliated customers |       | $                                | 118,415    |   | $ | 122,916 |   | $ | 47,535 |   | $ | 288,866 |   |
|                             |       |                             |       |   |   |   |   |   |   |
| Operating income  (loss)         |       | (62,033                          | )          | 61,990 |   | 18,706 |   | 18,663 |   |
|                             |       |                             |       |   |   |   |   |   |   |
| Long-lived  assets               |       | 102,695                          |       | 3,231 |   | 6,283 |   | 112,209 |   |
| All other  identifiable assets   |       | 585,539                          |       | 36,312 |   | 32,827 |   | 654,678 |   |
|                             |       |                             |       |   |   |   |   |   |   |
| Total  identifiable assets       |       | $                                | 688,234    |   | $ | 39,543 |   | $ | 39,110 |   | $ | 766,887 |   |

 
| ** **                       | ** ** | **Year ended December 31, 2003** | ** ** |
|----------------------------------|------------|----------------------------------|------------|
| ** **                       | ** ** | **(in thousands)**               | ** ** |
| ** **                       | ** ** | **United States**                | ** ** | **Japan** | ** ** | **Korea, Taiwan,  Singapore, China,  and the Netherlands** | ** ** | **Consolidated** | ** ** |
|                             |       |                             |       |   |   |   |   |   |   |
| Sales to  unaffiliated customers |       | $                                | 90,986     |   | $ | 116,530 |   | $ | 58,357 |   | $ | 265,873 |   |
|                             |       |                             |       |   |   |   |   |   |   |
| Operating income  (loss)         |       | (109,800                         | )          | 46,831 |   | 28,335 |   | (34,634 | ) |
|                             |       |                             |       |   |   |   |   |   |   |
| Long-lived  assets               |       | 120,452                          |       | 1,918 |   | 6,479 |   | 128,849 |   |
| All other  identifiable assets   |       | 587,953                          |       | 46,649 |   | 45,793 |   | 680,395 |   |
|                             |       |                             |       |   |   |   |   |   |   |
| Total  identifiable assets       |       | $                                | 708,405    |   | $ | 48,567 |   | $ | 52,272 |   | $ | 809,244 |   |

 
| ** **                       | ** ** | **Year ended December 31, 2004** | ** ** |
|----------------------------------|------------|----------------------------------|------------|
| ** **                       | ** ** | **(in thousands)**               | ** ** |
| ** **                       | ** ** | **United States**                | ** ** | **Japan** | ** ** | **Korea, Taiwan,  Singapore, China,  and the Netherlands** | ** ** | **Consolidated** | ** ** |
|                             |       |                             |       |   |   |   |   |   |   |
| Sales to  unaffiliated customers |       | $                                | 212,283    |   | $ | 132,512 |   | $ | 73,284 |   | $ | 418,079 |   |
|                             |       |                             |       |   |   |   |   |   |   |
| Operating income  (loss)         |       | (32,867                          | )          | 60,265 |   | 34,508 |   | 61,906 |   |
|                             |       |                             |       |   |   |   |   |   |   |
| Long-lived  assets               |       | 114,134                          |       | 3,115 |   | 6,299 |   | 123,548 |   |
| All other  identifiable assets   |       | 582,638                          |       | 52,470 |   | 67,122 |   | 702,230 |   |
|                             |       |                             |       |   |   |   |   |   |   |
| Total  identifiable assets       |       | $                                | 696,772    |   | $ | 55,585 |   | $ | 73,421 |   | $ | 825,778 |   |

 

F-34

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**17.****              ****SELECTEDQUARTERLY FINANCIAL DATA (UNAUDITED)**

 
| ** ** | ** ** | **QUARTERLY RESULTS OF OPERATIONS**           | ** ** |
|------------|------------|-----------------------------------------------|------------|
| ** ** | ** ** | **(in thousands, except for per share data)** | ** ** |

 
|                                   |   | **Years ended December 31, 2003** |       |
|----------------------------------------|--------|-----------------------------------|------------|
|                                   |   | **1st**                           | ** ** | **2nd** | ** ** | **3rd** | ** ** | **4th** |   |
|                                   |   |                              |       |   |   |   |   |   |   |
| Revenues                               |   | $                                 | 67,393     |   | $ | 62,177 |   | $ | 63,873 |   | $ | 72,430 |   |
|                                   |   |                              |       |   |   |   |   |   |   |
| Operating income  (loss)               |   | $                                 | (2,702     | ) | $ | (16,974 | ) | $ | (20,160 | ) | $ | 5,202 |   |
|                                   |   |                              |       |   |   |   |   |   |   |
| Net income  (loss)                     |   | $                                 | (3,362     | ) | $ | (5,193 | ) | $ | (8,519 | ) | $ | 1,674 |   |
|                                   |   |                              |       |   |   |   |   |   |   |
| Basic earnings  (loss) per share (1)   |   | $                                 | (0.10      | ) | $ | (0.15 | ) | $ | (0.24 | ) | $ | 0.05 |   |
|                                   |   |                              |       |   |   |   |   |   |   |
| Diluted earnings  (loss) per share (1) |   | $                                 | (0.10      | ) | $ | (0.15 | ) | $ | (0.24 | ) | $ | 0.04 |   |

 
| ** **                      | ** ** | **QUARTERLY RESULTS OF OPERATIONS**           | ** ** |
|---------------------------------|------------|-----------------------------------------------|------------|
| ** **                      | ** ** | **(in thousands, except for per share data)** | ** ** |
| ** **                      | ** ** | ** **                                    | ** ** |
| ** **                      | ** ** | **Years ended December 31, 2004**             | ** ** |
| ** **                      | ** ** | **1st**                                       | ** ** | **2nd** | ** ** | **3rd** | ** ** | **4th (2)** | ** ** |
|                            |       |                                          |       |   |   |   |   |   |   |
| Revenues                        |       | $                                             | 87,921     |   | $ | 94,907 |   | $ | 107,140 |   | $ | 128,111 |   |
|                            |       |                                          |       |   |   |   |   |   |   |
| Operating income                |       | $                                             | 10,905     |   | $ | 16,027 |   | $ | 22,093 |   | $ | 12,881 |   |
|                            |       |                                          |       |   |   |   |   |   |   |
| Net income                      |       | $                                             | 7,156      |   | $ | 10,201 |   | $ | 15,421 |   | $ | 10,376 |   |
|                            |       |                                          |       |   |   |   |   |   |   |
| Basic earnings  per share (1)   |       | $                                             | 0.20       |   | $ | 0.28 |   | $ | 0.42 |   | $ | 0.28 |   |
|                            |       |                                          |       |   |   |   |   |   |   |
| Diluted earnings  per share (1) |       | $                                             | 0.19       |   | $ | 0.27 |   | $ | 0.41 |   | $ | 0.28 |   |

 

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(1)          Earnings pershare are computed separately for each quarter and the full year using therespective weighted average shares. Therefore, the sum of the quarterly earnings per share amounts may notequal the annual amounts reported.

 

(2)          Includesadditional revenues and cost of product sales associated with Cymer’srefurbishment activities.  During thefourth quarter of 2004, Cymer corrected its accounting treatment for suchactivities and all amounts associated with this correction were recorded in thequarter ended December 31, 2004.  Seefurther discussion in Note 2.

 

**18.****              ****SUBSEQUENTEVENTS**

 

On January 27, 2005, Cymer announced that itsboard of directors had authorized Cymer to repurchase up to $50,000,000 ofCymer’s common stock.  The purchases willbe made from time to time in the open market or in privately negotiatedtransactions.  The program may be discontinuedat any time. Total purchases through February 17, 2005 were $8.3 million or292,841 shares under this program.

 

F-35

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OnFebruary 17, 2005, Cymer’s board of directors approved the acceleration of thevesting of stock options that have exercise prices of $30.50 per share orhigher held by employees. This acceleration of stock options excludesdirectors, executive officers and certain vice presidents. The purpose of thisacceleration of vesting is to enable Cymer to eliminate recognizing in itsstatement of operations the compensation expense associated with these stockoptions in future periods, upon adoption of FASB SFAS 123R which will beeffective in the third quarter of 2005.

 

OnFebruary 17, 2005, the board of directors approved an amendment to Cymer’s 1996ESPP. Effective May 1, 2005, the amendment: a) changes duration of offeringperiods under the plan from 24 months to 6 months, b) reduces the discount tomarket price used to determine purchase price for shares of Cymer’s commonstock under the plan from 15% to 5%, and c) eliminates the “lookback” featurethat allows the purchase price to be determined as of the beginning of anoffering period, or enrollment date, if the market price as of the enrollmentdate was lower than the market price at the end of the offering period.

 

F-36

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**CYMER, INC.**

**SCHEDULE II**

**VALUATIONAND QUALIFYING ACCOUNTS**

**Years EndedDecember 31, 2002, 2003 and 2004**

**(inthousands)**

 
| ** **                                     | ** ** | **Balance at**        | ** ** | **Additions (net)** | ** ** | ** **     | ** ** | **Balance at**  | ** ** |
|------------------------------------------------|------------|-----------------------|------------|---------------------|------------|----------------|------------|-----------------|------------|
| ** **                                     | ** ** | **Beginning of Year** | ** ** | **(1)**             | ** ** | **Deductions** | ** ** | **End of Year** | ** ** |
|                                           |       |                  |       |                |       |           |       |            |       |
| **Allowance for Doubtful Accounts  and Notes** |       |                  |       |                |       |           |       |            |       |
|                                           |       |                  |       |                |       |           |       |            |       |
| Year ended  December 31, 2002                  |       | $                     | 2,197      |                | $          | (399           | )          | $               | (42        | ) | $ | 1,756 |   |
| Year ended  December 31, 2003                  |       | $                     | 1,756      |                | 250        |           | $          | (42             | )          | $ | 1,964 |   |
| Year ended  December 31, 2004                  |       | $                     | 1,964      |                | $          | 199            |       | $               | (1,543     | )(2) | $ | 620 |   |
|                                           |       |                  |       |                |       |           |       |            |       |
| **Inventory  Allowance**                       |       |                  |       |                |       |           |       |            |       |
|                                           |       |                  |       |                |       |           |       |            |       |
| Year ended  December 31, 2002                  |       | $                     | 13,528     |                | $          | 6,658          |       | $               | (5,486     | ) | $ | 14,700 |   |
| Year ended  December 31, 2003                  |       | $                     | 14,700     |                | $          | 4,324          |       | $               | (6,996     | ) | $ | 12,028 |   |
| Year ended  December 31, 2004                  |       | $                     | 12,028     |                | $          | 5,360          |       | $               | (8,842     | ) | $ | 8,546 |   |

 

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(1)   Includes reversals of allowance amounts asdeemed necessary.

(2)   Represents write-off of note receivable andaccrued interest.

 

See accompanying report of independent registered public accountingfirm.

 

S-1

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