10-K 1 a05-1735_110k.htm 10-K

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-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

(Title of class)

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

Yes ý No o

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

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

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

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

DOCUMENTS INCORPORATED BY REFERENCE

The following document is incorporated by reference in Part III of this Annual Report on Form 10-K: portions of registrant’s proxy statement for its annual meeting of stockholders to be held on May 19, 2005.

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

Forward-Looking Statements

Statements in this Annual Report on Form 10-K that are not strictly historical in nature are forward-looking statements. These statements include, but are not limited to, references to expected domestic and international product sales and development; research and development activities and expenditures; adequacy of capital resources and investments; effects of business cycles in the semiconductor business; competitive positioning; and relationships with customers and third-party manufacturers for product manufacturing, and may contain words such as “believes,” “anticipates,” “expects,” and words of similar meaning. These statements are only predictions based on current information 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 the forward-looking statements due to various factors, including, but not limited to, those set forth under the caption “Risks and Uncertainties That May Affect Results” and elsewhere in this Annual Report on Form 10-K. Forward-looking statements herein speak only as of the date of this Annual Report on Form 10-K.

PART I

Item 1. Business

Overview

We are the world’s leading supplier of excimer light sources, the essential light source for deep ultraviolet (“DUV”) photolithography systems. DUV photolithography is a key enabling technology that has allowed the semiconductor industry to meet the exacting specifications and manufacturing requirements for volume production of today’s most advanced semiconductor chips. Our light source systems are incorporated into step-and-repeat (“steppers”) and step-and-scan (“scanners”) photolithography systems for use in the manufacture of semiconductors with critical feature sizes below 0.35 microns. One micron equals one millionth of a meter. Our excimer light source systems constitute a substantial majority of all excimer light sources incorporated in DUV photolithography tools. Our products consist of photolithography light source systems, replacement parts and service. We maintain a worldwide service organization that supports our installed base of light sources. As of December 31, 2004 this installed base totaled 2,496 light sources. Our customers include all three manufacturers of DUV photolithography systems: ASM Lithography, Canon and Nikon. Photolithography systems incorporating our excimer light sources have been purchased by many of the world’s largest semiconductor manufacturers including: AMD, Elpida, Hynix, IBM, Infineon, Intel, Micron, Nanya/Inotera, Powerchip, Renesas Technology, Samsung, SMIC, Sony, ST Microelectronics, Texas Instruments, Toshiba, TSMC, and UMC.

Other Information

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

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

You may read and copy materials that we file with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington DC 20549. Information on the operation of the Public Reference Room is available by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy statements and other information we file. The address of the SEC website is http://www.sec.gov.

Products and Services

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

Photolithography Light Sources

Our photolithography light sources produce narrow bandwidth pulses of short wavelength light within the DUV spectrum. The three DUV wavelengths are measured in nanometers (“nm”). One nanometer equals one billionth of a meter. The light sources are referred to according to the gases mixed to produce the light or by the wavelength. Krypton Fluoride (“KrF”) gases produce 248 nm light and Argon Fluoride (“ArF”) gases produce 193 nm light. The light sources permit very fine feature resolution for imaging the circuitry on the wafer and high throughput in wafer processing. We have designed our light sources to be highly reliable, easy to install and compatible with existing semiconductor manufacturing processes. Our light sources are used to pattern the integrated circuits, which are also called semiconductors or “chips”, that power many of today’s advanced consumer and business electronics. In 2004, we sold 301 light source 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 for both KrF and ArF 4 kilohertz (“kHz”) excimer light sources so that customers have the flexibility to “mix and match” products within the same manufacturing environment. Advanced architecture and materials incorporated into the design of the 7000 Series significantly reduce the light source consumables costs.

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

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

6000 Series – The 6000 Series consists of light source models that are within our cutting-edge 248 nm KrF portfolio and are designed for the production of semiconductor devices down to 130 nm (0.13 micron) design rules.

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

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

5000 Series – With a repetition rate of 1 kHz, this solid-state pulse power light source series is engineered using modular construction. Enabling higher device yields by delivering improved energy stability, this series is designed specifically for use 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.

193 nm ArF Light Sources

Today’s chipmakers seek light sources that make the critical transition in exposure wavelength from 248 nm using KrF to 193 nm using ArF while maintaining the performance and volume demands of mainstream manufacturing.

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

• XLA 200 – The XLA 200 is our third-generation, leading-edge ArF light source to feature the production-proven, dual-chamber MOPA platform—enabling both ultra line-narrowed bandwidth and 60 W of output power. Because the XLA 200 is built on the existing XL Series platform, customers will enjoy seamless integration into their existing processes and rapid time-to-yield. With an ultra line-narrowed spectral bandwidth of <0.12 pm FWHM, the XLA 200 provides the light that enables high contrast imaging for lithography tools with an NA up to > 1.0. The first unit of this model is expected 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-chamber MOPA platform—enabling both ultra line-narrowed bandwidth and 40 W of output power. Because the XLA 105 is built on the existing XL Series platform, customers will enjoy seamless integration into their existing processes and rapid time-to-yield. With an ultra line-narrowed spectral bandwidth of < 0.20 pm FWHM, the XLA 105 provides the light that enables high contrast imaging for lithography tools with an NA up to 0.93.

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

NanoLith™ 7000 – The NanoLith^TM 7000 is a single-chamber light source that, when introduced, provided the required output power and stability while providing a highly line-narrowed bandwidth to meet the stringent requirements of high volume 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-generation scanners with high NA lenses to produce the resolution for sub 100 nm devices.

ELS-6010A – The ELS-6010A is a highly line-narrowed, 2 kHz 10 W 193 nm production light source designed to meet resolution, image contrast, and wafer throughput requirements in semiconductor chip production at the <130 nm node. With highly line-narrowed bandwidth, the ELS-6010A enables high contrast imaging from lithography scanners using high NA lenses. Built-in laser metrology provides pulse-to-pulse data acquisition and feedback control to minimize transient wavelength instabilities, thereby enhancing exposure latitude and CD control. In life tests the ELS-6010A revealed a potential for 70% cost of consumables reduction compared to the ELX-5000A predecessor. The ELS-6010A is built on our highly reliable ELS-6000^® platform.

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

Replacement Parts and Refurbishment Activities

Certain components and subassemblies included in our light sources require replacement or refurbishment following extended operation. For example, the discharge chamber of our light sources has an expected life of approximately three to sixteen billion pulses, depending on the model. We estimate that a light source used in a semiconductor production environment will require one to two replacement chambers per year, depending upon the level of usage. Similarly, certain optical components of the light source deteriorate with continued exposure to DUV light and require periodic replacement. We provide these and other spare and replacement parts for our photolithography light sources as needed by our customers.

Revenues generated from sales of replacement parts, excluding the receipt of reusable material, were approximately $66.8 million, $83.2 million, and $123.2 million for 2002, 2003, and 2004, respectively. Revenues from replacement parts are dependent on both the utilization of our light source systems and the size of our installed base of light sources. The size of our installed base increased from 2,217 light sources as of December 31, 2003 to 2,496 light sources as of December 31, 2004, and the utilization of our light source systems at chipmakers grew significantly in 2004 until we reached peak levels in August 2004. However, in September 2004 we started to experience a slowdown in the semiconductor industry, which resulted in decreased utilization of our light source systems in the third and fourth quarters of 2004 or about 12% below the August 2004 peak.

As part of our regular business activities, we conduct significant parts refurbishment activities related to some of our core assemblies. These activities involve arrangements with our customers where we sell new parts to our customers at a reduced sales price in exchange for these customers sending back to us the consumed assembly that the new part replaced. These returned core assemblies contain a certain amount of material, primarily metal components, that may be reused by us in future core assemblies. Since a portion of the consideration related to the original sale is related to the return of consumed parts, we record revenue when we receive the returned assemblies from our customers.

Revenues generated from the receipt of reusable material contained within consumed assemblies returned from our customers were approximately $28.5 million for 2004. Revenues from such activities are dependent on the quantity of the core assemblies returned from our customers and the value of the reusable parts that we expect to yield from the core assemblies received. See further discussion on change in method of accounting for refurbishment activities under Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 8. Financial Statements and Supplementary Data Note 2 to the consolidated financial statements.

Service

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

In addition to service contracts, we provide an on-line diagnostic product, CymerOnLine^TM.CymerOnLine is a diagnostic and performance software product, which delivers critical laser diagnostics and performance information in near real-time directly to authorized users anywhere. The software simplifies reporting and allows users to efficiently manage consumables usage. CymerOnLine features a user-friendly browser-based interface, which features a robust design and provides a secure data environment. Event-initiated messages sent to pagers, e-mail, mobile phones, or other handheld devices enable up-to-the minute communication and proactive management.

Revenues generated from service and service contracts were approximately $15.8 million, $21.3 million, and $20.1 million for 2002, 2003, and 2004, respectively. We expect service and service

contract revenues to remain at or near these higher levels as our installed base grows and the warranty period of those light source systems expire.

Customers and End-Users

We sell our photolithography light source products to each of the three manufacturers of DUV photolithography tools:

ASM Lithography

Canon

Nikon

We believe that maintaining and strengthening customer relationships will play an important role in maintaining our leading position in the photolithography market. We work closely with our customers to integrate our products into their photolithography tools. Sales to ASM Lithography, Canon, and Nikon accounted for 34%, 11% and 22%, respectively, of total revenue in 2004.

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

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

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

United States	Japan	Singapore	Taiwan/China	Korea

Agere Systems	CASMAT	1^st 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

† A semiconductor industry consortium.

Backlog

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

Manufacturing

Our manufacturing activities consist of material management, assembly, integration and testing. These activities are performed in a 265,000 square foot facility in San Diego, California that includes approximately 31,000 square feet of Class 10,000 cleanroom manufacturing and test space. In order to focus our own resources, capitalize on the expertise of our key suppliers and respond more efficiently to customer demand, we have contracted the manufacture of many of our subassemblies. Our manufacturing outsourcing strategy is exemplified by the modular design of our products. Substantially all manufacturing of nonproprietary subassemblies has been contracted to third-party suppliers. As a result, we are increasingly dependent upon these contract suppliers to meet our manufacturing schedules. The failure by one or more of these suppliers to supply us on a timely basis with sufficient quantities of components or subassemblies that perform to our specifications could affect our ability to deliver completed light sources to our customers on schedule. We believe that the highly outsourced content and manufacturable design of our products allows for reduced manufacturing cycle times and increased output per employee. To improve current production efficiencies, control costs, and manage overall manufacturing capacity, we intend to continue to provide additional training to manufacturing personnel, improve our assembly and test processes in order to reduce cycle time, invest in additional manufacturing tooling and further develop our supplier management and engineering capabilities.

In addition to the manufacturing capacity at our facilities in San Diego, California, we completed the construction of a manufacturing facility in Korea in late 2002. This facility is used as a refurbishment facility and refurbishes one of our core modules, our chamber, initially for light sources in Korea and ultimately for the Asia-Pacific region. The refurbishment facility in Korea includes 6,550 square feet of Class 10,000 cleanroom manufacturing space. All of the final qualification phases for this facility were completed during the fourth quarter of 2002 and the first chamber was shipped to a customer from this facility in January 2003. Throughout 2003 and 2004 chambers for several of our light source models were refurbished in the Korea facility and successfully shipped to customers.

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

A limited number of components and subassemblies included in our products are obtained from a single supplier or a small group of suppliers. For certain optical components used in our light source systems, we currently utilize a single supplier. Where possible, we work with secondary suppliers to qualify additional sources of supply. To reduce the risk associated with this single supplier, we carry significant strategic inventories of these components. Strategic inventories are managed as a percentage of future demand. We have also negotiated to have vendor-managed inventory of critical components to further reduce the risk of a single supplier. To date we have been able to obtain adequate supplies of the components and subassemblies used in the production of our light source systems in a timely manner from existing sources. If in the future we are unable to obtain sufficient quantities of required materials, components or subassemblies, or if such items do not meet our quality

standards, delays or reductions in product shipments could occur which could have a material adverse effect on our business, financial condition and results of operations.

Sales and Marketing

Our sales and marketing efforts are designed to serve our customer base consisting of both the DUV photolithography tool providers such as ASM Lithography, Canon and Nikon as well as many of the world’s top 20 chipmakers. We market and sell our products through our own worldwide direct sales and marketing channels and we have developed product and applications engineering teams to support these efforts. We believe that in order for our sales and marketing organization to be successful, we must work closely with and understand the requirements of both the photolithography systems solutions providers and the semiconductor manufacturers alike.

Service and Support

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

Our field engineers and technical support specialists provide field service and front-line technical support capability from our San Diego headquarters, and at our field service offices located throughout the United States. Support in Europe, Japan, Korea, Singapore, the People’s Republic of China, Taiwan and Southeast Asia is provided by our subsidiaries located within those regions. As part of our customer service, we maintain an inventory of spare parts at each of our service facilities. As our installed base grows, replacement parts required to satisfy worldwide support requirements, as well as our own logistics support organization, will be subject to the fluctuating demands of the semiconductor industry. In order to meet these demands, we must continue to effectively manage our production of component modules which are required for new systems, as well as for support and warranty requirements for installed systems.

We believe that the need to provide fast and responsive service to the semiconductor manufacturers using our light sources is critical and that we cannot depend solely on our customers to provide this service. Therefore, we believe it is essential to maintain, through our own personnel, a rapid response capability to service our customers and end-users throughout the world. Accordingly, we have an ongoing effort to continuously develop our direct support infrastructure in Europe, Japan, Korea, Singapore, the People’s Republic of China, Taiwan and Southeast Asia and the United States. This task entails recruiting and training qualified field service personnel or identifying qualified independent firms and maintaining effective and highly trained organizations that can provide service to customers in various countries in their assigned regions.

We generally warrant our new light source products against defects in design, materials, and workmanship. The warranty period and terms vary by light source model. In general, the light source system warranty period ranges from 17 to 26 months after shipment. We also warrant consumables and spare parts sold to our customers and the coverage period varies by spare part type as some types include time-based warranty periods and others include usage-based warranty periods. On average, the warranty period for consumables and spare parts is approximately six months from the date of shipment.

Research and Development

The semiconductor industry is subject to rapid technological change and new product

introductions and enhancements. We believe that continued and timely development and introduction of new and enhanced light source products are essential for us to maintain our competitive position. We intend to continue to develop our technology and innovative products to meet customer demands. Current projects include enhancements to our KrF and ArF light sources and the new MOPA platform. We have significant development efforts to address the technology and products that will be based on the extreme ultraviolet (“EUV”) technology needed for future generation photolithography illumination sources. While we are no longer making direct investments in fluorine (“F2”) light sources development, previous investment combined with continued platform and core technology developments in our other products are expected to enable us to acquire a leadership position should a market for F2 light sources develop. We may also invest in other product and technology areas in order to expand our portfolio within the semiconductor capital equipment market sector. In addition there are ongoing efforts to improve existing products, reduce manufacturing costs, lower the cost of light source operation, enhance light source performance, develop new features for existing light sources, and conduct research and development of non-light source products.

We have historically devoted a significant portion of our financial resources to research and development programs and expect to continue to allocate significant resources to these efforts. Research and development expenses for 2002, 2003, and 2004 were approximately $72.4 million, $56.6 million, and $58.5 million, respectively.

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

Revenues generated from research and development contracts amounted to approximately $871,000, $57,000, and $783,000 during 2002, 2003, and 2004, respectively. For certain of our research and development contracts, our research and development expenses are offset by amounts earned associated with these contracts. The amounts 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

We believe that the success of our business depends more on such factors as the technical expertise of our employees, as well as their innovative skills and marketing and customer relations ability, than on patents, copyrights, trade secrets and other intellectual property rights. Nevertheless, our success may depend in part on patents. As of December 31, 2004, we owned 209 United States patents covering certain aspects of technology related to light sources and piezo techniques. These patents will expire at various times during the period from January 2008 through June 2022. As of December 31, 2004, we had applied for 83 additional patents in the United States. As of December 31, 2004, we owned 299 foreign patents and had 325 patent applications pending in various foreign countries.

Our pending patent applications and any future applications might not be approved. Our patents might not provide us with a competitive advantage and may be challenged by third parties. In addition, third parties’ patents might have an adverse 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 inventions covered by United States patents and patent applications until 1993. As a result we do not have the right to seek foreign patent protection for some of our early inventions. Additionally, laws of some foreign countries in which our products are or may be developed, manufactured or sold, including various countries in Asia, may not protect our products or intellectual property rights to the same extent as do the laws of the United States. Thus, protection of our technology and products in these countries may not be

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

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

We also rely upon trade secret protection, employee and third-party nondisclosure agreements and other intellectual property protection methods to protect our confidential and proprietary information. Despite these efforts, third parties might independently develop substantially the same proprietary information and techniques or otherwise gain access to our trade secrets or disclose our technology. We might not be able to meaningfully protect our trade secrets.

In the past, funds from research and development arrangements with third parties have been used to pay for a portion of our own research and development expenses. 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 a small portion of our development expenses. In providing these research and development services to these manufacturers, we try to make clear who owns the intellectual property that results from the research and development services we perform. However, disputes over the ownership or rights to use or market this intellectual property may arise between the funding organizations and us.

Third parties have notified us in the past, and may notify us in the future, that we are infringing their intellectual property rights. Also, we have notified third parties in the past, and may notify them in the future, that they may be infringing 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 former Japanese manufacturing partner, Seiko, or we may be infringing on some of Komatsu’s United States patents and a number of its additional Japanese patents. Komatsu has also notified one of our customers, Nikon, of its belief that 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 oppose certain patents and patent applications of Komatsu. The Japanese 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 additional patents. Komatsu notified Seiko that it intends to enforce its rights against Seiko with respect to its Japanese patents if Seiko continued to engage in manufacturing activities for us. In connection with our former manufacturing agreement with Seiko, we agree to pay Seiko under certain conditions for damages associated with these types of claims. Seiko may not prevail in any litigation against Komatsu, and therefore, we may be required to pay Seiko for such damages.

We have notified our competitor and others of our United States patent portfolio. Specifically, we have notified Komatsu that they may be infringing on some of our 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 and Trademark Office (“USPTO”) but it was subsequently re-issued by the USPTO. Also, Komatsu transferred its lithography light source business to our competitor, Gigaphoton. We also have had discussions with Lambda-Physik (a subsidiary of Coherent, Inc.), one of our former competitors, regarding allegations by each party against the other for possible patent infringement. Any of these discussions may not be successful and litigation could result.

In the future, patent litigation may result due to a claim of infringement by our competitor or any other third party or may be necessary to enforce patents issued to us. Any such litigation could result in substantial cost and diversion of effort to us, which would have an adverse effect on our business, financial condition and operating results. Furthermore, our customers and the end-users of our products might assert other claims for indemnification that arise from infringement claims against them. If these

assertions are successful, our business, financial condition and operating results may be materially affected. Instead of litigation, or as a result thereof, we may seek a license from third parties to use their intellectual property. However, we may not be able to obtain a license. In the alternative, we may design around the third party’s intellectual property rights. Any adverse determination in a legal proceeding could result in loss of our proprietary rights, exposure to significant liabilities by other third parties, requirement that we get a license from third parties on terms that are not favorable, or restriction from manufacturing or selling our products, any of which could have a substantial adverse effect on our business, financial condition and operating results. Any of these actions could be costly and would divert the efforts and attention of our management and technical personnel, which would materially adversely affect our business, financial condition and results of operations.

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

We have granted Seiko a right of first refusal to fund our development of, and receive a license to, new industrial light source technologies not developed with funding from other parties. In exchange for these rights, we received up-front license fees of $3.0 million in aggregate during 1992 and 1993. We were also entitled to royalties of 5% on related product sales through September 1999, after which the royalty rate was subject to renegotiation. To date no renegotiation of the royalty rate has occurred. Through 1999, we earned no royalties under the agreement. The license agreement also provides that product sales between us and Seiko will be at a 15% discount from the respective companies’ list prices. The agreement terminates in August 2012. There has been no Seiko production or sales activity associated with this contract to date and this contract does not apply to our current light source system products.

We have registered the trademarks ‘‘CYMER’’ and “INSIST ON CYMER” and others in the United States and in some other countries. We are also trying to register additional trademarks in the United States and in other countries. We use these trademarks and many other marks in our advertisements and other business materials, which are distributed throughout the world. We may be subject to trademark infringement actions for using these marks and other marks on a worldwide basis and this would be costly to defend. If a trademark infringement action were successful, we would have to stop using the mark and possibly pay damages.

Competition

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

We currently have one significant competitor, Gigaphoton, that sells light sources for DUV photolithography applications. Gigaphoton is a joint venture between two large companies, Komatsu and Ushio, which is headquartered in Japan. We believe that Gigaphoton is aggressively trying to gain larger market penetration in the excimer light source industry. We know that our customers have purchased products from this competitor and that our customers have approved this competitor’s light sources for use with their products. We know that Gigaphoton has been approved by chipmakers in Japan, the U.S. and elsewhere for producing excimer light sources. We could lose market share and our growth could slow or even decline if our competitor gains market acceptance. Late in 2004, a former competitor, Coherent, announced that their subsidiary, Lambda-Physik, would no longer pursue the excimer light source systems business for photolithography in the semiconductor industry.

In the future, we will likely experience competition from other technologies, such as EUV and electron projection lithography (“EPL”). To remain competitive, we believe that we will need to manufacture and deliver products to customers on a timely basis without significant defects and maintain a high level of investment in research and development and sales and marketing. We might not have sufficient resources to continue to make the investments necessary to maintain our competitive position.

Larger competitors with substantially greater resources, such as other manufacturers of industrial light sources for advanced lithography, may attempt to sell competitive products to our customers. Potential competitors may also be attracted to our growing installed base of light sources and may attempt to supply consumable products and refurbished parts to that installed base.

Employees

On December 31, 2004, we employed 770 persons worldwide. No employees are currently covered by collective bargaining agreements or are members of any labor organization as far as we are aware. We have not experienced any work stoppages and believe that our employee relations are good.

Executive Officers

Set forth below is certain information regarding our executive officers and their ages 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, one of our co-founders, has served as our chairman and chief executive officer since our inception in 1986, and served as president of the company as well from our inception until May 2000. He currently serves on the boards of directors of Semiconductor Equipment and Materials International (“SEMI”), and SEMI North America. He is also a member of the council of advisors to the Irwin and Joan Jacobs School of Engineering at the University of California, San Diego (“UCSD”), and serves on the board of the UC San Diego Foundation. Mr. Akins received the Ernst & Young Entrepreneur of the Year Award for San Diego County in 1997, and with fellow co-founder Rick Sandstrom, received the outstanding alumnus award from UCSD, and the prestigious SEMI Award for North America, the highest honor conferred by SEMI, in 1996 for contributions to the field of DUV lithography. Mr. Akins received a bachelor’s degree in physics, a bachelor’s degree in literature, and a doctorate in applied physics from the University of California, San Diego.

Pascal Didier has served as president and chief operating officer since May 2000. He served as senior vice president, worldwide customer operations from November 1997 until May 2000, and served as vice president of sales and marketing from July 1997, when he joined the company, until November of that year. He served as vice president of worldwide sales and field operations with GaSonics International, a semiconductor capital equipment manufacturer, from June 1995 to June 1997, and served in the additional capacity of vice president of Asia/Pacific for that company from June 1995 to June 1996. Prior to that, Mr. Didier served for two years as vice president of international operations for Megatest Corporation, a semiconductor test equipment manufacturer. Mr. Didier received

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

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

Bill N. Alexander has served as executive vice president of worldwide customer operations since October 2004. He joined us in October 2002 as our senior vice president of sales in the Lithography System Solutions group. Prior to joining us, Mr. Alexander served as the president of Europe operations for Novellus Systems, Inc. and before that, he worked as the vice president of worldwide sales and field operations at GaSonics International, Inc. from August 1997 to January 2001. Throughout his career, Mr. Alexander has held various senior management positions throughout the semiconductor industry including vice president, Asia Pacific sales and support operations at Tencor Instruments, vice president of international operations for Watkins-Johnson Company, senior manager of Asia Pacific regional divisional marketing for Applied Materials, CVD Division, and senior manager of Asia Pacific strategic sales for Lam Research Corporation. Mr. Alexander holds a bachelor’s degree from San Jose State University as well as a master’s degree in business administration from Golden Gate University.

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

Brian C. Klene has served as executive vice president of the Emerging Technology and Applications business unit since October 2002. Previously, he served as senior vice president, marketing and business development, which he had held since joining us in June 2000. Prior to joining us, Mr. Klene spent two years as vice president, strategic planning and business development at Chartered Semiconductor Manufacturing Ltd. in Singapore. From 1995 to 1997, he served as executive vice president, sales and marketing at Micron Electronics, Inc., Nampa, Idaho. Before that, he served as director of North American sales with Micron Technology, Inc., Boise, Idaho, from 1989 to 1994. He also served in a variety of sales and marketing positions of increasing responsibility with IBM Corp. Mr. Klene received a master’s degree 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 overall business in Japan, including the sales, service, and operations infrastructure for our direct customers and lithography tool manufacturers. Prior to that, he served 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, and served in that position until June 2001. Before joining us,

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

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

Executive officers serve at the discretion of the board of directors. There are no family relationships between any of the directors and our executive officers.

Item 2. Properties

Our corporate headquarters is located in San Diego, California and includes administrative, manufacturing, engineering, and research and development facilities. In addition, we have field service offices located throughout the United States and internationally. We completed construction of a refurbishment facility in Korea at the end of 2002. This manufacturing facility is used to refurbish chamber assemblies and was qualified for production at the end of 2002. We completed construction of a 265,000 square foot building adjacent to our corporate headquarters located in San Diego, California in the third quarter of 2003. Also in the third quarter of 2003, we transferred all manufacturing activities and corporate services from two leased facilities in San Diego to this company-owned manufacturing and office facility. As of December 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 smaller facility in Charlestown, Massachusetts that is currently vacant. As of December 31, 2004, we have not been able to sublease this property.

At December 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 owned by us.

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

Item 3. Legal Proceedings

None.

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

No matters were submitted to a vote of our security holders during the fourth quarter of the fiscal year ended December 31, 2004.

PART II

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters

Our Common 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 low prices 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

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

We have never declared or paid cash dividends on our Common Stock and currently do not anticipate paying cash dividends in the future.

The information required to be disclosed by Item 201(d) of Regulation S-K “Securities Authorized for Issuance Under Equity Compensation Plans” is incorporated herein by reference to our Proxy Statement.

Item 6. Selected Financial Data

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

	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

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

(2) In 2004 we reclassed funds recorded for certain of our funded development contracts that we enter into with customers and government agencies. These funds are not recorded as revenue but offset against our own internal research and development expenses. Certain prior year amounts were reclassified to conform to the current period presentation.

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

(4) Includes additional inventory, revenue and cost of product sales associated with our refurbishment activities. During the fourth quarter of 2004, we corrected our accounting treatment for such activities and all amounts associated with this correction are included in 2004. See further discussion under Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 8. Financial Statements and Supplementary Data Note 2 to the Consolidated Financial Statements.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

In this section, references to “we”, “us” or “our” are references to Cymer. The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and notes thereto included in this Annual Report on Form 10-K.

Overview

We are the world’s leading supplier of light source solutions for the semiconductor industry. Our products provide the essential light source for DUV photolithography systems. Almost all consumer electronic devices manufactured in the last several years contain a semiconductor manufactured using light sources, such as ours. We currently supply light sources to all three lithography tool manufacturers, ASM Lithography, Canon, and Nikon, who in turn supply their wafer steppers and scanners to chipmakers. In addition, we sell replacement parts and services to the lithography tool manufacturers as well as directly to the chipmakers. Our light source systems currently constitute a substantial majority of all excimer light sources incorporated in lithography stepper and scanner tools. A large portion of our revenue is derived from customers located outside of the United States. In order to support our foreign customers and our installed base of light sources in foreign countries, we maintain a manufacturing and field service office in Korea and field service and support offices in Japan, Singapore, the People’s Republic of China, the Netherlands and Taiwan. We also maintain field service offices in the United States to service our installed base of light sources located in the United States.

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

In the latter half of 2003, there were several indicators that the extended downturn in the semiconductor industry, which started in 2001, was coming to an end and that an upturn was in sight. During the final months of 2003, we experienced strong order growth and our direct customers announced increasing orders and extended delivery times. In addition, the chipmakers’ utilization of our DUV light sources exceeded the levels achieved in 2000, the peak of the last extended upturn, and the mix of our light source models shipped shifted toward KrF products, reflecting the chipmakers’ need for more capacity expansion. In addition to the positive industry indicators, which we saw at the end of 2003, we experienced much higher revenue levels and revenue growth from quarter to quarter during the first nine months of 2004. From the end of 2003 to the end of the third quarter of 2004, our sequential quarter over quarter revenue growth ranged from 8% to 20%. The combination of these four consecutive quarters of positive industry indicators, our own growing order momentum, and sequential quarterly record light source utilization levels across our installed base led us to believe that we were in an upturn.

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

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

With the increasing uncertainty in the semiconductor industry, our ability to forecast the industry cycle became limited to less than one quarter. Due to these circumstances, in October 2004, we took actions to deal effectively with what appeared to be a semiconductor industry slowdown the depth and duration of which we could not predict. We aligned our cost structure accordingly with these uncertain conditions by reducing our overall expenses, and implementing a reduction in our workforce of approximately 14% on October 21, 2004. Since we were able to keep our headcount in line with the volume of our business during this most recent and brief upturn in 2004, this headcount adjustment primarily reflected the change we anticipated in any volume production activities. In addition, since approximately one-third of the employees affected by this workforce reduction were temporary employees, we preserved our ability to ramp up production again quickly in response to any potential re-acceleration of orders that might occur early in 2005.

As 2004 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 for the year;

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

• Growing recognition of the benefits of the XL Series products, and increasing adoption of these products, leading to record shipments in the fourth quarter of 2004, with XL Series products accounting for 27% of shipments for the year;

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

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

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

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

With visibility limited as we enter 2005, the outlook for our industry cannot be predicted with accuracy. We will continue to manage our expenses effectively while working to increase our operating efficiency. We expect to introduce a significant number of new products and product features in 2005 to enhance our competitiveness, including two new ArF light sources, one of which will be the XLA 200, our third generation MOPA product. Since we made significant investments in facilities and equipment during the last several years, we do not foresee a need for a high level of capital expenditures for some time in the future.

In 2005, we plan to increase our management focus on improved asset management with particular emphasis on improving inventory management and turn rate, increasing operating efficiency, and ensuring the competitiveness of our product offerings. We will be focusing our efforts in 2005 on generating a significant amount of cash and improving shareholder returns by achieving higher returns on assets, which includes increasing our inventory turns and return on invested capital during the year.

RESULTS OF OPERATIONS

The following table sets forth certain items in our consolidated statements of operations 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	%

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

General

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and use judgment that may impact the reported amounts of assets, liabilities, revenues, expenses, and related disclosure of contingent assets and liabilities. As a part of our ongoing internal processes, we regularly evaluate our estimates and judgments associated with revenue recognition, valuation of parts used in our refurbishment manufacturing process, inventory allowances, warranty provisions, income taxes, allowances for bad debts, long-lived assets valuation, intangible assets valuation, and contingencies and litigation. We base these estimates and judgments upon historical information and other facts and assumptions that we believe to be valid and/or reasonable under the circumstances. These assumptions and facts form the basis for making judgments and estimates and for determining the carrying values of our assets and liabilities that are not apparent from other sources. Actual results could vary from our estimates if we were to use different assumptions and conditions.

We believe that revenue recognition, valuation of parts used in our refurbishment manufacturing process, inventory allowances, warranty provisions, and income taxes require more significant

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

Revenue Recognition

Our revenues 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 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 metal components, for the future build of core assemblies. As a result, our revenue consists of both cash and the value of the reusable parts received from our customers as consideration for these spare part sales. Our revenues also consist of other revenues, which include revenue from certain funded development activities performed for customers and under government contracts and license agreements. We do not recognize any revenue for light source systems prior to shipment. We test the systems in environments similar to those used by our customers prior to shipment to ensure that they meet the customers’ specifications and will interface with the customers’ software. Our installation obligations are perfunctory within the framework of Staff Accounting Bulletin No. 104 (“SAB 104”). The shipping terms vary by customer for light source systems shipments. The majority of light source shipment terms are F.O.B. shipping point and revenue is recognized upon shipment. For those customers with F.O.B. destination shipping terms, revenue is recognized upon delivery of the light source system to the customer. One of our customers has an acceptance provision, which is satisfied by the issuance of an acceptance certificate following a visual inspection of the system by the customer. We do not recognize revenue on systems shipped to that customer until we receive the acceptance certificate. We have one arrangement where a portion of the light source system fee is not payable until the system is successfully installed at the end-user. In accordance with SAB 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. Revenue from consumables and spare parts sales is recognized at the point that legal title passes to the customer, which is generally upon shipment from our facility. Revenue associated with our customers return of core assemblies is recognized upon receipt of the returned core assembly. The amount of the revenue is determined based upon the value of the reusable parts that we expect to yield from the returned core assembly returned. Service and training revenue is generally recognized at the time that the services are rendered or the training class is completed. Service contract revenues are generally recorded as revenue ratably over the life of the contract or per the specific terms of the agreement. For funded development contracts, which are included in other revenue, funds received are accounted for on the percentage-of-completion method based on the relationship of costs incurred to total estimated costs. Revenues generated from these types of funded development contracts are derived from cost sharing contracts between certain customers and us. If milestones on these funded development contracts require that specific results be achieved or reported by us, revenue is not recognized until that milestone is completed. For some of the funded development contracts that we enter into with customers and government agencies, we evaluate certain criteria to determine whether recording the funds received as revenue is appropriate. If certain conditions are met, these funds are not recorded as revenue but rather are offset against our own internal research and development expenses in the period that the milestone is achieved or per the terms of the contract.

Valuation of Parts Used in Refurbishment Manufacturing Process and Corrected Accounting Method

Over the last several years as part of our regular business activities, we have conducted significant parts refurbishment activities related to some of our core assemblies, in particular our chamber assemblies. The volume of this activity significantly increased in 2004. These activities involve arrangements with our customers where we sell a new part to the customer at a reduced sales price if the customer returns the consumed assembly that the new part replaces. These returned core assemblies contain a certain amount of material, primarily metal components, that may be reused by us in future core assemblies. Upon receipt of these consumed assemblies from our customers, we record an entry to recognize the estimated value of the reusable components as inventory and revenue. The value of the reusable parts contained within the consumed assembly is determined based upon historical data on the value of the reusable parts that we typically yield from a consumed assembly. The costs of refurbishment are also capitalized as part of

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

Historically, we have recorded the value of this material as a reduction of our cost of product sales in the period that the returned assembly was disassembled by our manufacturing operations and the value of the reusable parts could be determined. Upon further review of United States Generally Accepted Accounting Principles (“GAAP”) in the fourth quarter of 2004, we determined that we should instead estimate the value and record these consumed assemblies as inventory at the time we receive the returned assembly from our customer and concurrently record this amount as revenue rather than as a reduction of cost of product sales.

During the fourth quarter of 2004, we corrected our accounting treatment for these refurbishment activities and analyzed the financial impact that such an accounting correction would have on our 2004 and prior year consolidated financial statements. As a result of this analysis, we determined that 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 fiscal year ended December 31, 2004. Upon making this determination, we recorded the cumulative impact of this accounting correction during the fourth quarter of 2004. Included in these corrections are increases to inventory, revenues, cost of product sales and net income for the period, as well as reclassifications from cost of product sales to revenues. As a result of this fourth quarter 2004 correction, our annual 2004 consolidated financial statements were updated from those previously reported in a press release issued by us on January 25, 2005. The primary impacts of this correction from the previously released annual consolidated financial statements for 2004 are as follows:

• $2.9 million increase in the inventory balance as of December 31, 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

We perform an analysis of our inventory allowances on at least a quarterly basis to determine the adequacy of this allowance on our financial statements. The amount of the inventory allowance is determined by taking into consideration certain assumptions related to market conditions and future demands for our products, including changes to product mix, new product introductions, and/or product discontinuances, which may result in excess or obsolete inventory. We determine the level of excess and obsolete inventory associated with our raw materials and production inventory by comparing the on hand inventory balances and inventory on order to the next 12 months of forecasted demand. We then adjust this calculation for inventory that has a high likelihood of use beyond one year or can be used in other products that may have lower demands. After this adjustment, we arrive at our total exposure for excess and obsolete inventory within our raw materials and production inventory. As part of this analysis, we also determine whether there are potential amounts owed to vendors as a result of cancelled or modified raw material orders. We estimate and record a separate liability, which is included in accrued and other liabilities in the accompanying balance sheets for such amounts owed.

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

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

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

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

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

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

• Utilization rates of our light sources at chipmakers.

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

Warranty Provision

We maintain an accrual for the estimated cost of product warranties associated with our product sales. Warranty costs include the replacement parts and labor costs to repair our products during the warranty periods. At the time revenue is recognized, we record a warranty provision, which is included in cost of product sales in the accompanying consolidated statements of operations. The warranty coverage period and terms vary by light source system model. In general, the light source system warranty period ranges from 17 to 26 months after shipment. We also warrant consumables and spare parts sold to our customers and the coverage period varies by spare part type as some types include

time based warranty periods and others include usage based warranty periods. On average, the warranty period for consumables and spare parts is approximately six months from the date of shipment. The warranty provision for light source systems is reviewed monthly and determined by using a financial statistical model, which takes into consideration actual historical expenses, and potential risks associated with our different light source systems. This model is then used to estimate future expenses related to warranty and the required warranty provision. The risk levels and historical cost information used within this model are reviewed throughout the year and updated as risk levels change over the light source system’s life cycle. Due to the highly technical nature of our light source system products, the newer model light sources and the modules contained within t