WASHINGTON, D.C.  20549

 

FORM 10-Q

 

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

 

OR

 

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

 

Commission file number 0-21321

 

CYMER, INC.

(Exact name of registrant as specified in its charter)

 

 

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

 

The number of shares of Common Stock, with $0.001 par value, outstanding on August 7, 2003 was 35,188,131.

 

 

CYMER, INC.

 

FORM 10-Q

 

For the Quarter Ended June 30, 2003

 

INDEX

 

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

 

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PART I.  FINANCIAL INFORMATION

 

ITEM 1.  Financial Statements

 

CYMER, INC.

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(In thousands, except share data)

 

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

 

See Notes to Unaudited Consolidated Financial Statements.

 

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CYMER, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(In thousands, except per share data)

 

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

 

See Notes to Unaudited Consolidated Financial Statements.

 

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CYMER, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In thousands)

 

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

 

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

 

See Notes to Unaudited Consolidated Financial Statements.

 

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CYMER, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Three and Six Months Ended June 30, 2003

(Unaudited)

 

1.              BASIS OF PRESENTATION

 

Unaudited Interim Financial Data –The accompanying consolidated financial information has been prepared by Cymer, Inc., and its wholly-owned and majority-owned subsidiaries (collectively, “Cymer”), without audit, in accordance with the instructions to Form 10-Q.  In the opinion of management, the unaudited consolidated financial statements for the interim periods presented reflect all material adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial position and results of operations as of and for such periods indicated.  These consolidated financial statements and notes hereto should be read in conjunction with the consolidated financial statements and notes thereto included in Cymer’s Annual Report on Form 10-K for the year ended December 31, 2002.  Results for the interim periods presented herein are not necessarily indicative of results which may be reported for any other interim period or for the entire fiscal year.

 

Principles of Consolidation – The consolidated financial statements include the accounts of Cymer, Inc., its wholly-owned subsidiaries – Cymer Japan, Inc. (“Cymer Japan”), Cymer Singapore Pte Ltd. (“Cymer Singapore”), Cymer B.V. in the Netherlands (“Cymer B.V.”), Cymer Southeast Asia, Inc., in Taiwan (“Cymer SEA”),  Cymer Semiconductor Equipment Shanghai Co., Ltd, in the People’s Republic of China (“Cymer PRC”), and its majority-owned subsidiary, Cymer Korea, Inc. (“Cymer Korea”).  Cymer, Inc. owns 75% of Cymer Korea.  During 2002, Cymer Boston (formerly known as Active Control eXperts, Inc. or ACX) was a wholly-owned subsidiary of Cymer, Inc.  Effective January 1, 2003, Cymer Boston was merged with and into Cymer, Inc.  Cymer sells its excimer light sources in Japan primarily through Cymer Japan. Cymer SEA, Cymer PRC, Cymer Singapore and Cymer B.V. are field service offices for customers in those respective regions.  Cymer Korea provides manufacturing, refurbishment, field service, and administrative activities for that region.  All significant intercompany balances have been eliminated in consolidation.

 

Accounting Estimates – The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results may differ from those estimates.

 

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

 

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

 

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

 

Cymer adopted the provisions of Statement of Financial Accounting Standards No. 145 (“SFAS No. 145”), “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections” (“SFAS 145”) on January 1, 2003.  SFAS 145 provides guidance on the classification of gains and losses from the extinguishment of debt and on the accounting for certain specified lease transactions. Cymer reclassified the 2002 loss on extinguishment of debt from an extraordinary loss on debt extinguishment to operating expenses in the consolidated statement of operations.

 

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

 

Cymer adopted the initial recognition and measurement provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others”, on January 1, 2003, which apply on a prospective basis to guarantees issued or modified after December 31, 2002. We adopted the disclosure provisions of FIN 45 during the quarter ended December 31, 2002.  In the ordinary course of business, Cymer is not subject to potential obligations under guarantees that fall within the scope of FIN 45 except for warranty provisions, intellectual property indemnification clauses that are contained within many of our customer agreements and third-party bank guarantees that we had with one of our subsidiaries until June 2003.  All these provisions give rise only to the disclosure requirements prescribed by FIN 45.

 

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

 

2.              STOCK-BASED COMPENSATION

 

Cymer applies the intrinsic value-based method of accounting prescribed by Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations including Financial Accounting Standards Board (“FASB”) Interpretation No. 44, “Accounting for Certain Transactions involving Stock Compensation an interpretation of APB Opinion No. 25” to account for its stock option plans.  Under this method, employee-based stock compensation expense is measured on the date of grant only if the then current market price of the underlying stock exceeded the exercise price and is recorded on a straight-line basis over the applicable vesting period. FASB Statement of Financial Accounting Standards No. 123 (“SFAS No. 123”), “Accounting for Stock-Based Compensation”, established accounting and disclosure requirements using a fair value-based method of accounting for stock-based employee compensation plans.  As allowed by SFAS No. 123, Cymer has elected to continue to apply the intrinsic value-based method of accounting described above, and has adopted the disclosure requirements of SFAS No. 123, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure”.

 

All options granted under the plans had an exercise price equal to the market value of the underlying common stock on the date of grant.

 

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

 

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

 

3.              EARNINGS (LOSS) PER SHARE

 

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

 

The following table sets forth the computation of diluted weighted average common and potential common shares outstanding for the three and six months ended June 30, 2002 and 2003 (in thousands):

 

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

 

For the three months ended June 30, 2002 and 2003, weighted average options and warrants to purchase 453,000 and 3,893,000 shares of common stock, respectively, were

 

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

 

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

 

4.              INVENTORIES

 

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

 

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

 

5.              REPORTING COMPREHENSIVE INCOME (LOSS)

 

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

 

The following table summarizes the change in each component of accumulated other comprehensive loss for the six months ended June 30, 2003 (in thousands):

 

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

 

6.              GOODWILL AND INTANGIBLE ASSETS

 

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

 

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

 

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

 

The above table only includes intangible assets associated with prior purchase business combinations.  Also included in intangible assets – net on the accompanying balance sheets are amounts associated with patents which were acquired in 2001.  As of December 31, 2002 and June 30, 2003, the net carrying amount of these patents was $8.2 million and $7.6 million, respectively.

 

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

 

 

7.              GUARANTEES

 

Cymer adopted the disclosure provisions of FIN 45 during the quarter ended December 31, 2002 and has adopted the recognition and measurement provisions as required after December 31, 2002.  FIN No. 45 provides expanded accounting guidance surrounding liability recognition and disclosure requirements related to guarantees, as defined by this interpretation.

 

In the ordinary course of business, Cymer is not subject to potential obligations under guarantees that fall within the scope of FIN No. 45, except for standard warranty provisions associated with product sales, indemnification provisions related to intellectual property that are contained within many of its customer agreements, and third-party bank guarantees for subsidiary office lines of credit.  All of these provisions give rise only to the disclosure requirements prescribed by FIN No. 45.

 

Product Warranties – Warranty provisions contained within Cymer’s customer agreements are generally consistent with those prevalent in the semiconductor equipment industry. 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.  Cymer also warrants consumables and spare parts sold to its 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 6 months from the date of shipment.  Cymer records a provision for warranty for all products, which is included in cost of product sales in the consolidated statements of operations and is recorded at the time that the related revenue is recognized. The warranty provision for light source systems is determined by using a financial model, which takes into consideration actual historical expenses, and potential risks associated with Cymer’s different light source system

 

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

 

The following table summarizes information related to Cymer’s warranty provision for the six months ended June 30, 2003 (in thousands):

 

 

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

 

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

 

An indemnification provision is 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 agreement even after its termination. Seiko and at least one Japanese customer have been notified that Cymer’s light source systems in Japan may infringe certain Japanese patents.  Cymer believes, based upon the advice of counsel, that Cymer’s products do not infringe any valid claim of the asserted patents or that it is entitled to prior use claims in Japan.

 

Guarantees on Subsidiary Debt – During the first quarter of 2003 and part of the second quarter of 2003, Cymer was party to a Parent Guarantee associated with a revolving Loan Agreement held by Cymer Japan. This guarantee was between a commercial bank in the United States and Cymer.  The Parent Guarantee was entered into in 2001 in order to establish a banking relationship between this commercial bank and Cymer Japan.  Per the terms of the Parent Guarantee, Cymer guaranteed payment of any obligations under the revolving loan agreement in the event that Cymer Japan could not make such payments due or defaults on the loan.  Cymer Japan made all payments per the terms of the Loan Agreement and thus, Cymer did not incur any guarantor obligations under the Parent Guarantee.  Since Cymer Japan is a wholly-owned subsidiary of Cymer and Cymer Japan records the revolving loan outstanding balance as a liability on its financial statements, the carrying amount of the liability is included in the consolidated balance sheets.  The Loan Agreement expired on June 16, 2003 and was paid in full by Cymer Japan. The Loan Agreement was not renewed on this expiration date.

 

8.              CONTINGENCIES AND COMMITMENTS

 

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

 

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

 

Cymer’s former Japanese manufacturing partner, Seiko, and one of Cymer’s Japanese customers have been notified that Cymer’s light source systems in Japan may infringe certain Japanese patents held by another Japanese company.  Cymer has agreed to indemnify its former Japanese manufacturing partner and its customers against patent infringement claims under certain circumstances, even after the termination date of the contract manufacturing agreement.  Cymer believes, based upon the advice of counsel, that Cymer’s products do not infringe any valid claim of the asserted patents or that Cymer is entitled to prior user rights in Japan.

 

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

 

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

 

Statements in this quarterly report on Form 10-Q that are not strictly historical in nature are forward-looking statements.  These statements include, but are not limited to, references to manufacturing activities; expected product sales and development; service and support; research and development expenditures; expected product development; expected international product sales, development and revenue; adequacy of capital resources and investments; effects of business cycles in the semiconductor business; competitive positioning; and continuing relationships with third-party manufacturers for product manufacturing, and may contain words such as “believes,” “anticipates,” “expects,” and words of similar import.  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 in this Item 2 and under the caption  “Risks and Uncertainties That May Affect Results”  and  elsewhere in this quarterly report on Form 10-Q.

 

The following discussion of the financial condition and results of operations of Cymer should be read in conjunction with Cymer’s consolidated financial statements and notes thereto included in this quarterly report on Form 10-Q and its consolidated financial statements and notes thereto included in Cymer’s annual report on Form 10-K for the year ended December 31, 2002.

 

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RESULTS OF OPERATIONS

 

The following table sets forth certain items in Cymer’s consolidated statements of operations as a percentage of total revenues for the periods indicated:

 

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

 

THREE MONTHS ENDED JUNE 30, 2002 AND 2003

 

Revenues.  Cymer’s revenues consist of product sales, which include sales of light source systems, consumable and spare parts, upgrades, service, service contracts, and training. Other revenues include revenue from funded development activities performed for customers and government contracts and license agreements.  Revenue from light source system sales is generally recognized at the time of shipment, unless customer agreements contain inspection, acceptance or other conditions, in which case revenue is recognized at the time such conditions are satisfied. 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 the Cymer facility.  Service and training revenue is generally recognized at the time that the services are rendered or the training class is completed.  Service contracts revenues are generally recorded as revenue ratably over the life of the contract or per the specific terms of the agreement. Funded development contracts are accounted for on the percentage-of-completion method based on the relationship of costs incurred to total estimated costs.  If milestones on funded development contracts require that specific results be achieved or reported by Cymer, revenue is not recognized until that milestone is completed.

 

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

 

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

 

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

 

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

 

Cymer’s sales are generated primarily by shipments to customers in Japan, the Netherlands, and the United States.  Approximately 92% and 88% of Cymer’s sales for the three months ended June 30, 2002 and 2003, respectively, were derived from customers outside the United States.  Cymer maintains a wholly-owned Japanese subsidiary, which sells to Cymer’s Japanese customers.  Revenues from Japanese customers, generated primarily by this subsidiary, accounted for 50% of revenues for each of the three months ended June 30, 2002 and 2003.  The activities of Cymer’s Japanese subsidiary are limited to sales and service of products purchased by the subsidiary from the parent corporation.  Cymer anticipates that international sales will continue to account for a significant portion of its net sales.

 

In April 2003, Cymer implemented cost reduction efforts in response to the continued downturn in the semiconductor industry.  Included in these cost reduction activities were a reduction in work force and the write down of certain corporate assets. These asset write downs totaled approximately $1.8 million.  These activities impacted all areas of the company, and resulted in additional expenses during the second quarter of 2003.  Cymer expects to realize the benefit from these cost reduction efforts starting in the third quarter of 2003.

 

Cost of Product Sales.  Cost of product sales includes direct material and labor, warranty expenses, license fees, and manufacturing and service overhead, and foreign exchange gains and losses on foreign currency forward exchange contracts associated with purchases of Cymer’s products by its Japanese subsidiary for resale under firm third-party sales commitments.  Although the number of light source systems recorded as revenue was lower in the second quarter of 2003 as compared to the second quarter of 2002, the cost of product sales increased 38% from $37.8 million for the three months ended June 30, 2002 to $52.0 million for the three months ended June 30, 2003.  This increase from period to period is primarily due to the higher overall costs associated with the introduction of Cymer’s new XL series light source system and

 

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

 

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

 

Sales and Marketing. Sales and marketing expenses include the expenses of the sales, marketing and customer support staff and other marketing expenses.  Sales and marketing expenses increased 7% from $4.2 million for the three months ended June 30, 2002 to $4.5 million for the three months ended June 30, 2003, due primarily to increased costs associated with the reduction in work force and asset write down which occurred during the second quarter of 2003.  These increased expenses were offset by lower expenses resulting from the movement of various senior members of sales and marketing to general and administrative functions in the last quarter of 2002.  As a percentage of total revenues, such expenses increased from 5.6% to 7.1% primarily due to the lower revenue levels in 2003 compared to 2002.

 

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

 

Amortization of intangible assets.  Amortization of intangible assets totaled $40,000 for each of the three months ended June 30, 2002 and 2003.  This amortization of intangible assets expense is consistent from period to period and relates to the existing technology associated with the ACX acquisition, which was completed in early 2001.  With the adoption of SFAS 142 on January 1, 2002, Cymer discontinued the amortization of goodwill and intangible assets with indefinite useful lives associated with previous purchase business combinations.

 

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Other Income (Expense) – Net.  Net other income (expense) consists primarily of interest income and expense and foreign currency exchange gains and losses associated with fluctuations in the value of the Japanese yen against the United States dollar.  Net other income totaled $30,000 for the three months ended June 30, 2002 as compared to a net other expense of $165,000 for the three months ended June 30, 2003.  The change from net other income to net other expense was primarily due to decreased interest income offset by a slight decrease in interest expense from period to period. The decreased interest income in the second quarter of 2003 was primarily due to lower average cash and investment balances in the second quarter of 2003 as compared to 2002 as a result of cash used during 2003 for the continued construction of Cymer’s new manufacturing and office facility in San Diego.  The decreased interest expense from period to period reflects capitalization of interest expense associated with the construction of the new facility recorded in the second quarter of 2003.  Foreign currency exchange losses totaled $37,000, interest income totaled $2.7 million and interest expense totaled $2.6 million for the three months ended June 30, 2002, compared to foreign currency exchange losses of $57,000, interest income of $2.4 million and interest expense of $2.5 million for the three months ended June 30, 2003.

 

Income Tax Provision (Benefit).  The tax provision of $2.5 million and the tax benefit of $12.1 million for the three months ended June 30, 2002 and 2003, respectively, reflect an annual effective rate of 27% and 60%, respectively.  Due to the pre-tax loss recorded in the first half of 2003, and the company's expectation that there will be no significant industry recovery during the remainder of 2003, Cymer currently estimates the 2003 annual effective tax benefit rate to be approximately 60 percent.  Due to the 0% annual effective tax rate estimated for the first quarter of 2003, a year-to-date change in the tax provision was made in the second quarter of 2003. This resulted in a quarterly tax benefit of 71% for the three months ended June 30, 2003.  The annual effective tax rates for both periods differ from the U.S. statutory rate of 35% primarily as a result of permanent book/tax differences and tax credits.  The tax benefit rate for 2003 reflects the increased impact of Cymer’s tax credits and foreign sales incentives in a low income or loss environment.

 

SIX MONTHS ENDED JUNE 30, 2002 AND 2003

 

Revenues. Product sales decreased 4% from $134.5 million for the six months ended June 30, 2002 to $129.5 million for the six months ended June 30, 2003, primarily due to a 17%, or a $16.0 million decrease in light source system revenue offset by a 28%, or a $11.0 million increase in consumable and spare parts, service revenue and other non-system product revenue.  Total non-system revenue totaled $39.1 million or 29% of revenue and $50.1 million or 39% of revenue for the six months ended June 30, 2002 and 2003, respectively.  The increase in non-system revenue was due to slightly increased utilization of Cymer’s DUV light sources by chipmakers and an increased installed base in the six months ended June 30, 2003, which resulted in increased demand for consumables and spare parts.  The decrease in light source system revenue was primarily due to a 34% decrease in the number of light source system units sold offset by an increase in the ASP for light source systems sold from period to period. A total of 132 light source systems were sold in the six months ended June 30, 2002 at an ASP of $722,000, compared to 87 systems sold in the six months ended June 30, 2003 at an ASP of $912,000.  On a foreign currency adjusted basis, the ASP for the six months ended June 30, 2002 was $737,000 compared to $896,000 for the six months ended June 30, 2003.  This increase in ASPs from period to period primarily reflects the increased participation in the product mix of the higher priced XLA 100 light source system, the dual-discharge chamber MOPA design product in the first six months of 2003.  Sales of the XLA 100 light source system accounted for 31% of light source systems sold in the six months ended June 30, 2003.  Revenues from funded development projects were $1.2 million and $502,000 for the six months ended June 30, 2002 and 2003, respectively.

 

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

 

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

 

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

 

Research and Development.  Research and development expenses increased 2% from $33.0 million for the six months ended June 30, 2002 to $33.8 million for the six months ended June 30, 2003, due primarily to Cymer’s most recent product development effort, the XL series which uses the MOPA platform.  Cymer shipped the first light source system that utilizes the MOPA platform, the XLA 100, in February 2003.  Cymer also continued to invest in EUV, F2 and BDU technology and a focus on next generation KrF and ArF products.  As a percentage of total revenues, such expenses increased from 24.3% to 26.0%, primarily due to the lower revenue levels in 2003 as compared to 2002.  We anticipate R&D spending in absolute dollars and as a percentage of total revenues, will decrease as the XLA 100 productization and the transition to manufacturing is completed.

 

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

 

General and Administrative.  General and administrative expenses increased 54% from $8.0 million for the six months ended June 30, 2002 to $12.3 million for the six months ended June 30, 2003, due to a number of factors.  In the first six months of 2002, overall general and administrative expenses were lower due to cost savings measures, including salary reductions that were initiated in the latter part of 2001.  During the first six months of 2003, general and administrative expenses were significantly increased from the 2002 levels due to the reinstatement of the 2001 salary reductions, the movement of various senior personnel from sales and marketing to general and administrative functions in the last quarter of 2002 and increased costs associated with the reduction in work force conducted in the second quarter of 2003.  As a percentage of total revenues, such expenses increased from 5.9% to 9.4% as a result of the increase in expenses and lower revenue levels in 2003 as compared to 2002.

 

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Amortization of intangible assets.  Amortization of intangible assets totaled $80,000 for each of the six month periods ended June 30, 2002 and 2003.  This amortization of intangible assets expense is consistent from period to period and relates to the existing technology associated with the ACX acquisition, which was completed in early 2001.  With the adoption of SFAS 142 on January 1, 2002 Cymer discontinued the amortization of goodwill and intangible assets with indefinite useful lives associated with previous purchase business combinations.

 

Other Income (Expense) – Net.  Net other expense totaled $1.2 million and $511,000 for the six months ended June 30, 2002 and 2003, respectively.  The decrease in net other expense was primarily due to decreased interest expense and increased interest income which were offset by foreign currency exchange losses during the period. The decreased interest expense from period to period was caused by the lower interest rate on the 2002 bonds which is reflected in the interest expense amounts for the first six months of 2003 as compared to additional interest which was recorded in the first six months of 2002 as the result of both the 1997 Notes and 2002 Notes being outstanding during part of that six month period. The increased interest income in the first six months of 2003 was primarily due to higher average cash and investment balances during the first quarter of 2003 compared to 2002 as a result of the bond transactions, which occurred in the first quarter of 2002. These transactions included the private placement of the 2002 Notes in February 2002 and the redemption of the 1997 Notes that were not converted to common stock prior to the March 25, 2002 redemption date. Foreign currency exchange gains totaled $120,000, interest income totaled $4.6 million and interest expense totaled $5.9 million for the six months ended June 30, 2002, compared to foreign currency exchange losses of $417,000, interest income of $4.9 million and interest expense of $5.0 million for the six months ended June 30, 2003.

 

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

 

LIQUIDITY AND CAPITAL RESOURCES

 

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

 

In August 1997, Cymer issued $172.5 million in aggregate principal amount in a private placement of notes. The 3½% / 7¼% Step-Up Convertible Subordinated Notes were due on August 6, 2004 and were convertible at the option of the holder into shares of common stock of Cymer. The conversion rate on the 1997 Notes was 21.2766 shares per $1,000 principal amount or an effective conversion price of $47.00 per share.  In 2001, Cymer repurchased a total of $24.9 million of convertible subordinated notes outstanding.  The 1997 Notes were called for redemption on March 25, 2002.  Immediately prior to the March 25, 2002 redemption date, holders of $113.0 million of the outstanding principal amount converted their 1997 Notes into shares of Cymer’s common stock.  As a result of these conversions, 2,325,542 shares of Cymer 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, Cymer issued $250.0 million in aggregate principal amount in a private placement of notes.  The 2002 Notes are due on February 15, 2009 with interest payable semi-annually on February 15 and August 15 of each year at 3½% per annum.  The 2002 Notes are convertible into shares of Cymer common stock at a conversion rate of 20 shares per $1,000 principal amount or an effective conversion price of $50.00 per share.  Cymer used a portion of

 

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

 

Net cash provided by operating activities was approximately $4.4 million for the six months ended June 30, 2002 as compared to $16.1 million net cash used in operating activities for the six months ended June 30, 2003.  The net cash provided by operating activities for the six months ended June 30, 2002 was primarily attributable to net income and increases in accounts payable, and accrued and other liabilities offset by increases in accounts receivable and inventories.  Due to the continued downturn in the semiconductor industry, net cash was used in operating activities during the six months ended June 30, 2003. This use of cash in 2003 primarily reflects the net loss for the period, increases in accounts receivable and decreases in accounts payable, accrued liabilities and income taxes payable for the period. This use of cash in 2003 was partially offset by a decrease in inventories from period to period.

 

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

 

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

 

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

 

Since its initial public offering and a secondary public offering, both in 1996, Cymer has funded its operations primarily from cash generated from operations, the proceeds of convertible subordinated note offerings in August 1997 and February 2002, bank borrowings, and the proceeds from employee stock option exercises.

 

Cymer requires substantial working capital to fund its business, particularly to finance inventories and accounts receivable and for capital expenditures. Cymer’s future capital requirements depend on many factors, including Cymer’s manufacturing activity, the timing and extent of spending to support product development efforts, expansion of sales and marketing and field service and support, competitive labor market compensation requirements, the timing of introductions of new products and enhancements to existing products, and the market acceptance

 

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

 

At June 30, 2002 and 2003, Cymer did not have any relationship with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance, variable interest, or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.  In addition, Cymer did not engage in trading activities involving non-exchange traded contracts.  As a result, Cymer is not exposed to any financing, liquidity, market or credit risk that could arise if it had engaged in such relationships.  Cymer does not have relationships and transactions with persons and entities that derive benefits from their non-independent relationship with Cymer or its related parties except as disclosed herein.

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

Cymer’s discussion and analysis of its financial condition and results of operations are based upon Cymer’s 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 Cymer 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 its on-going internal processes, Cymer evaluates its estimates, including those related to inventory allowances, warranty provisions, revenue recognition, allowances for bad debt, long-lived assets valuation, intangible assets valuation, income taxes, and contingencies and litigation.  Cymer bases these estimates upon both historical information and other assumptions that it believes valid and reasonable under the circumstances.  These assumptions form the basis for making judgments and determining the carrying values of assets and liabilities that are not apparent from other sources.  Actual results could vary from those estimates under different assumptions and conditions.

 

Cymer believes that inventory allowances and warranty provisions require more significant judgments and estimates in the preparation of its consolidated financial statements than other accounting estimates.

 

Cymer maintains an inventory allowance to record inventory at net realizable value.  The value of this allowance is determined by taking into consideration certain assumptions related to market conditions and future demands for its products, which may result in excess or obsolete inventory.  In addition to estimating excess and obsolete inventory, Cymer estimates and records a separate liability which is included in accrued and other liabilities in the accompanying balance sheets for any vendor amounts owed by Cymer as a result of cancelled or modified orders.  If actual market conditions are more or less favorable than projected by management, adjustments to this inventory allowance or these liabilities may be required.

 

Cymer provides for the estimated cost of product warranties at the time the related revenue is recognized. The warranty coverage period and terms vary by light source model.  In general, the light source system warranty period ranges from 17 to 26 months after shipment.  Cymer also warrants consumables and spare parts sold to its 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 6 months from the date of shipment.  Cymer records a provision for warranty for all products, which is included in cost of product sales in the consolidated statements of operations and is recorded at the time that the related revenue is recognized.  The warranty provision for light source systems is determined by using a financial model, which takes into consideration actual historical expenses, and potential risks associated with Cymer’s different light source system models. This financial model is then used to calculate the future probable expenses related to warranty and the required level of the warranty provision.  The risk levels

 

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

 

RECENT ACCOUNTING PRONOUNCEMENTS

 

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

 

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

 

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

 

In May 2003, the FASB issued Statement of Financial Accounting Standards No.150 (“SFAS” No. 150), “Accounting for Certain Instruments with Characteristics of Both Liabilities and Equity”. The standard establishes how an issuer classifies and measures certain freestanding financial instruments with characteristics of liabilities and equity and requires that such instruments be classified as liabilities. The standard is effective for financial instruments entered into or modified after May 31, 2003 and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003.  The adoption of the standard is not expected to have a material impact on Cymer’s consolidated financial statements.

 

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Risks and Uncertainties That May Affect Results

 

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

 

Our revenues and operating results from quarter-to-quarter have varied in the past and our future operating results may continue to fluctuate significantly due to many factors including those listed in this section and throughout this quarterly report on Form 10-Q for the period ended June 30, 2003. These factors include:

 

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

•                  cyclicality in the market for semiconductor manufacturing equipment;

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

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

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

•                  product lead time demands from our customers and the semiconductor manufacturers;

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

•                  changes in the price and profitability of our products;

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

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

•                  our ability to manage our manufacturing requirements;

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

•                  worldwide political instability;

•                  changing global economic conditions; and

•                  intellectual property protection.

 

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

 

We manage our expense levels based, in large part, on expected future revenues. As a result, our expenses are relatively fixed for the short term, and if our actual revenue decreases below the level we expect, our operating results will be adversely affected.  As a result of these or other factors, we could fail to achieve our expectations as to future revenue, gross profit and operating income.  Our failure to meet the performance expectations set and published by external sources could 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 of any investment in our stock.

 

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Our business depends on the semiconductor equipment industry, which is highly volatile and unpredictable.

 

The semiconductor equipment industry is highly cyclical. We derive a substantial percentage of our revenues from our customers. Our customers depend in turn on the demand for their photolithography tool products from their customers, the semiconductor device manufacturers. The capital equipment expenditures of semiconductor manufacturers depend on a number of factors, including the current and anticipated market demand for semiconductors and products using semiconductors.

 

The semiconductor industry is cyclical in nature and historically has experienced periodic ups and downs and is currently in a significant and prolonged downturn. This cyclical nature of the industry in which we operate affects our ability to accurately predict future revenue and thus, future expense levels. When cyclical fluctuations result in lower than expected revenue levels, operating results may be adversely affected and cost reduction measures may be necessary in order for us to remain competitive and financially sound.  During a down cycle, we must be in a position to adjust our cost and expense structure to prevailing market conditions and to continue to motivate and retain our key employees.  In addition, during periods of rapid growth, we must be able to increase manufacturing capacity and personnel to meet customer demand.  We can provide no assurance that these objectives can be met in a timely manner in response to industry cycles.

 

The current downturn has had a severe effect on the demand for semiconductor manufacturing equipment, including photolithography tools that our customers produce. We are not able to predict when the semiconductor industry will recover. If overall market conditions continue to deteriorate in the near term, our current operating levels may negatively impact our profitability. We believe that downturns in the semiconductor manufacturing industry will occur periodically, and result in periodic decreases in demand for all semiconductor manufacturing equipment, including photolithography tools our customers manufacture. As a result, fluctuating levels of investment by semiconductor device manufacturers and pricing volatility will continue to materially affect our aggregate bookings, revenues and operating results. Also, even during periods of reduced revenues we believe we must continue to invest in research and development and to maintain extensive ongoing worldwide customer service and support capabilities to remain competitive, which may temporarily harm our financial results.  Accordingly, these downturns are likely to continue to adversely affect our business, financial condition and operating results and our operating results may fall below the expectations of public market analysts or investors in some future quarter or quarters. Such failure to meet operating result expectations would materially adversely affect the price of our common stock.

 

Our customers try to manage their inventories and production requirements to appropriate levels that best reflect their expected sales to semiconductor device manufacturers. Market conditions in the industry and production efficiency of the photolithography tool manufacturers can cause our customers to expand or reduce their orders for new light source systems as they try to manage their inventories and production requirements to these levels. We continue 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 not build up an excess inventory of light source products. If our customers retain an excess inventory of light source products, our revenue could be reduced in future periods as the excess inventory is utilized, which could adversely affect our operating results, financial condition and cash flows.  In addition, if our customers demand shorter product lead times as a solution to improve their inventory and cash positions, our inventory management and cash position may be impacted, which may adversely affect our operating results, financial condition and cash flows.

 

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

 

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

 

 

Collectively, these three companies account for the following percentage of our total accounts receivable for the periods indicated:

 

 

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

 

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

•      a customer experiencing DUV photolithography tool production problems;

•      a decision to purchase light sources from other suppliers;

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

•                  a decline in a customer’s financial condition.

 

A substantial percentage of our revenue is derived from the sale of a limited number of primary products.

 

Our only product line is excimer light source systems, which include krypton fluoride, argon fluoride and fluorine systems, and we expect these primary products to continue to account for a large percentage of our revenues in the near term. Continued market acceptance of our primary products is, therefore, critical to our future success. The primary market for excimer light sources is in the use of DUV photolithography equipment for manufacturing deep-submicron semiconductor devices using smaller circuit geometries. The demand for our products depends in part on the rate at which semiconductor device manufacturers further adopt excimer light sources as the chosen light source for their photolithography tools. Semiconductor manufacturers may choose not to adopt excimer light sources for a variety of reasons, including:

 

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•                  inadequate performance of photoresists used in advanced DUV photolithography; and

•      potential shortages of specialized materials used in DUV optics.

 

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

 

•      a decline in demand for our customers’ DUV photolithography tools;

•      a failure to achieve continued market acceptance of our products;

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

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

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

 

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

 

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

 

Our newest product introduction project consists of a technology change from a single- discharge-chamber designed excimer light source to a dual-discharge-chamber design called MOPA.  This MOPA design represents a paradigm shift from current lithography technology and is projected to enable higher power, tighter bandwidth and lower cost of operation for future optical lithography applications across all three DUV wavelengths – 248nm, 193nm and 157nm.  There are risks inherent in transitioning to this new technology.  These risks include effective execution of the product development plan, adoption of the product by photolithography tool manufacturers and semiconductor manufacturers, manufacturability and cost effectiveness of the new products and the development of a comparable product by our competitors.

 

We believe that semiconductor device manufacturers are currently developing a capability to produce devices that are measured at 0.13 micron or less, and these efforts are driving the current demand for our light source products for DUV photolithography systems. After semiconductor device manufacturers have this capability, their demand for our light source products will depend, in part, on whether they want to expand their capacity to manufacture these devices. This will in turn depend on whether their sales forecasts and projected manufacturing process yields justify the necessary investments.

 

Future technologies, such as EUV and electron projection lithography (“EPL”), may render our excimer light source products obsolete. We must manage product transitions, as introduction of new products could adversely affect our sales of existing products. If new products are not introduced on time, or have reliability or quality problems, our performance may be impacted by reduced orders, higher manufacturing costs, delays in acceptance of and payment for new products, and additional service and warranty expenses. We may not be able to develop and introduce new products or enhancements to our existing products and processes in a timely or cost effective manner that satisfies customer needs or achieves market acceptance. Failure to develop and introduce these new products and enhancements could materially adversely affect our operating results, financial condition and cash flows.

 

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

 

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

 

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

 

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

 

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

 

•      unexpected changes in regulatory requirements,

•      fluctuations in exchange rates and currency controls,

•      political and economic conditions and instability,

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

•                  difficulty in coordinating our management and operations in several different countries,

•      difficulties in staffing and managing foreign subsidiary and branch operations,

•      limited intellectual property protection in some countries,

•      potentially adverse tax consequences in some countries,

•      the possibility of accounts receivable collection difficulties,

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

•      the effect of acts of terrorism and war; and

•      the burdens of complying with a variety of foreign laws.

 

Many of our major customers and many of the semiconductor device manufacturers who use our light source products in their photolithography systems are located in Asia. Economic problems and currency fluctuations 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 United States export controls, these export rules could change in the future and make it more difficult or impossible for us to export our products to many countries.  Any of these vulnerabilities could have a material adverse effect on our business, financial condition and results of operations.

 

We must effectively manage changes in our business.

 

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

 

•      closely manage our global operations;

•      improve our process and other internal management systems;

 

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

•      quickly adapt to changing sales and marketing channels;

•      effectively manage our inventory levels; and

•      attract, train, retain and manage key personnel.

 

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

 

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

 

We purchase some of the components and subassemblies included in our light source products from a single supplier or a limited group of suppliers.  For certain optical components used in our light source systems, we currently utilize a single supplier.  Although we have not aggressively pursued other vendors for these optical components, we have attempted to qualify one other vendor. To date, this vendor has been unsuccessful in producing these optical components and has not been qualified by us. To reduce the risk associated with this single supplier, we carry a two year supply of these optical components.  This two year supply is based upon current business activities, so any significant increase in production would likely result in a quicker consumption of these optical components. In addition, we outsource the manufacture of various subassemblies more often than in the past. Further, some of our suppliers have specialized in supplying equipment or manufacturing services to semiconductor equipment manufacturers and therefore have been adversely affected by the current industry downturn. If the current downturn continues for an extended period of time, these suppliers may not be able to continue to meet our requirements or respond quickly enough.  Due to the nature of our product development requirements, these key suppliers must rapidly advance their own technologies and production capabilities in order to support the introduction schedule of our new products. These suppliers may not be able to provide new modules and subassemblies when they are needed to satisfy our product schedule requirements. If we cannot purchase enough of these materials, components or subassemblies, or if these items do not meet our quality standards, there could be delays or reductions in our product shipments, which would have a material adverse effect on our operating results, financial condition and cash flows.

 

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

 

We are currently aware of two significant competitors that sell light sources for DUV photolithography applications. These competitors are:

 

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

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

 

We believe that Gigaphoton and Lambda-Physik are aggressively trying to gain larger market penetration in the excimer light source industry. We know that our customers have purchased products from these two competitors and that our customers have approved these competitors’ light sources for use with their products.  We know that Gigaphoton, in particular, has been approved by chipmakers in Japan, the U.S. and elsewhere for producing excimer light sources.  Also, we believe that Lambda-Physik has been approved by chipmakers in the U.S. and Europe for producing excimer light source products.

 

The market for excimer light sources is still small and immature. 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

 

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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. If any existing or future competitors gain market acceptance we could lose market share and our growth could slow or decline, which could have a material adverse effect on our operating results, financial condition and cash flows.

 

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

 

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

 

•      engineering;

•      research and development;

•      sales and marketing;

•      field service;

•      manufacturing; and

•      management.

 

In particular, there are a limited number of experts in excimer light source technology, and we require highly-skilled hardware and software engineers. Competition for qualified personnel is intense and we cannot guarantee that we will be able to continue to attract and retain qualified personnel as needed.  We do not have employment agreements with most of our employees. We believe that our future growth and operating results will depend on:

 

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

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

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

 

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

 

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

 

We believe it is critical for us to provide quick and responsive service directly to the semiconductor device manufacturers throughout the world that use our light source products in their photolithography systems, and that it is essential to maintain our own personnel or trained third-party resources to provide these services.  Accordingly, we have an ongoing effort to develop our direct support system with locations in the United States, Japan, Europe, Korea, Singapore, Taiwan and the People’s Republic of China. This requires us to do the following:

 

•      recruit and train qualified field service personnel;

•      identify qualified independent firms; and

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

 

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

 

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

 

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

 

As of June 30, 2003, we owned 187 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 to November 2021.  As of June 30, 2003, we also had applied for 74 additional patents in the United States.  As of June 30, 2003, we owned 169 foreign patents and had filed 295 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, the possibility of piracy of our technology and products are more likely in these countries. 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 interference proceedings declared by the United States Patent and Trademark Office (“USPTO”) in order for the patent office to determine the priority of inventions. The patent office 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 on the following to protect our confidential information and our other intellectual property:

 

•      trade secret protection,

•      employee nondisclosure agreements,

•      third-party nondisclosure agreements; and

•      other intellectual property protection methods.

 

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

 

•      independently develop substantially the same proprietary information and techniques,

•      gain access to our trade secrets, or

•      disclose our technology.

 

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

 

In the past, revenues 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 revenues from government-sponsored programs, customers and from SEMATECH, a

 

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research consortium, in connection with our designing and developing specific products. Currently, revenues from SEMATECH, photolithography tool manufacturers and semiconductor manufacturers are used to fund a small portion of our development expenses. In providing these research and development services to these manufacturers and SEMATECH, 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 us and the photolithography tool manufacturers and SEMATECH. Any dispute over ownership of the intellectual property we develop could restrict our ability to market our products and have a material adverse effect on our business.

 

In the future, we may be subject to patent litigation to enforce patents issued to us and defend ourselves against claimed infringement by our competitors or any other third party.

 

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 we or our former Japanese manufacturing partner, Seiko, 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 competitors 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 USPTO but it was subsequently re-issued by the USPTO.  Also, Komatsu transferred its lithography light source business to one of our competitors, Gigaphoton.  We also have had discussions with Lambda-Physik, another competitor, regarding allegations by each party against the other for possible patent infringement. Any of these discussions with our competitors may not be successful and litigation could result.

 

In the future, patent litigation may result due to a claim of infringement by our competitors 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 by 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, we may seek a license from third parties to use their intellectual property. However, we may not be able to obtain a license on reasonable terms. In the alternative, we may design around the third party’s intellectual property rights or we may challenge these claims in legal proceedings. Any adverse determination in a legal proceeding could result in one or more of the following, any of which could have a substantial adverse effect on our business, financial condition and operating results:

 

•      loss of our proprietary rights,

•      exposure to significant liabilities by other third parties,

 

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

 

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

 

We registered the trademark ‘‘CYMER’’ & “INSIST ON CYMER” 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 was successful, we would have to stop using the mark and possibly pay damages.

 

We are dependent on air transport to conduct our business and disruption of domestic and international air transport systems could adversely affect our business.

 

We depend on regular and reliable air transportation on a worldwide basis for many of our routine business functions. If civil aviation in the United States or abroad is disrupted by terrorist activities or security responses to the threat of terrorism or for any other reason, our business could be adversely affected in the following ways:

 

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

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

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

•      our sales and marketing efforts may be disrupted.

 

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

 

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

 

Compliance with changing regulation of corporate governance and public disclosure may result in additional expenses.

 

Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations, Nasdaq Stock Market rules, and new accounting pronouncements are creating uncertainty and additional complexities for companies such as ours. To maintain high standards of corporate governance and public disclosure, we intend to invest all reasonable necessary resources to comply with

 

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

 

New accounting rules may impact our operating results.

 

Recently, the Financial Accounting Standards Board (“FASB”) announced plans to require all companies to expense the value of employee stock options measured according to the fair value of the options.  Such a change in accounting rules may adversely impact our future financial condition and operating results.

 

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

 

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

 

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

 

Over time, our light source products may not meet semiconductor device manufacturers’ production specifications or operating cost requirements after the light source is used for a long period in high volume production. If any semiconductor device manufacturer cannot successfully achieve or sustain their volume production using our light sources, our reputation could be damaged with the semiconductor device manufacturers and our customers who are the limited number of photolithography tool manufacturers. This would have a material adverse effect on our business.

 

We have in the past and may in the future acquire a business that will involve numerous risks. We may not be able to address these risks successfully without substantial expense, delay or other operational and financial problems.

 

The risks involved with acquiring a new company include the following:

 

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

•                  failure to retain key personnel,

•      amortization of acquired definite-lived intangible assets and deferred compensation,

•      client dissatisfaction or performance problems with the acquired company,

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

•      failure to commercialize purchased technologies,

•      ability of the acquired companies to meet their financial projections; and

•      assumption of unknown liabilities or other unanticipated events or circumstances.

 

Mergers and acquisitions are inherently subject to multiple significant risks, and the inability to effectively manage these risks could have a material adverse effect on our business.  Any of these risks could materially harm our business, financial condition and operating results. Further, any business that we acquire may not achieve anticipated revenues or operating results.

 

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

 

To continue to grow our business, our existing light source products and their process capabilities must be enhanced, and we must develop and manufacture new products to serve other semiconductor applications. We cannot guarantee that we will be able to manage our growth effectively. Nor can we guarantee that we will be able to accelerate the development of new enhancements to our existing products and create new products. Further, we may not be able to effectively integrate new products and applications into our current operations. Any of these risks could materially harm our business, financial condition and results of operations.

 

We are dependent on our manufacturing facilities and subcontractors to assemble and test our products.

 

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

 

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

 

We are subject to federal, state and local regulations, such as regulations related to the environment, land use, public utility utilization and the fire code, in connection with the storage, handling, discharge and disposal of substances that we use in our manufacturing process and on our facilities that we lease. We believe that our activities comply with current government regulations that are applicable to our operations and current facilities. We may be required to purchase additional capital equipment or other requirements for our processes to comply with these government regulations in the future if they change. Further, these government regulations may restrict us from expanding our operations. Adopting measures to comply with changes in the government regulations, our failure to comply with environmental and land use regulations, or restrictions on our ability to discharge hazardous substances, could subject us to future liability or cause our manufacturing operations to be reduced or stopped.

 

Our products are subject to potential product liability claims if personal injury or death result.

 

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

 

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The price of our common stock has fluctuated and may continue to fluctuate widely.

 

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

 

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

 

•      the cyclical nature of the semiconductor industry,

•      actual or anticipated fluctuations in our operating results,

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

•      announcements of innovations in technology,

•      new products offered by us or our competitors,

•      developments of patents or proprietary rights,

•      changes in financial estimates by securities analysts,

•      general worldwide political, economic, and market conditions,

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

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

 

In addition, the stock market has experienced extreme price and volume fluctuations that have particularly affected the market price for many high technology companies. Such fluctuations have in some cases been unrelated to the operating performance of these companies. Severe price fluctuations in a company’s stock have frequently been followed by securities litigation.  Any such litigation can result in substantial costs and a diversion of management’s attention and resources and therefore could have a material adverse effect on Cymer’s business, financial condition and results of operations.

 

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

 

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

 

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

 

Foreign Currency Risk

 

Cymer conducts business in several international currencies through its global operations. Due to the large volume of Cymer’s business that is conducted in Japan, the Japanese operation poses the greatest foreign currency risk.  Cymer uses financial instruments, principally foreign currency forward exchange contracts, in Japan to manage its foreign currency exposures. Cymer enters into foreign currency forward exchange contracts in order to reduce the impact of currency fluctuations related to purchases of Cymer’s inventories by Cymer Japan in US dollars for resale under firm third-party sales commitments denominated in Japanese Yen.  Cymer does not enter into foreign currency forward exchange contracts for trading purposes.

 

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

 

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

 

Investment and Debt Risk

 

Cymer maintains an investment portfolio consisting primarily of government and corporate fixed income securities, certificates of deposit and commercial paper.  While it is Cymer’s general intent to hold such securities until maturity, Cymer will occasionally sell certain securities for cash flow purposes. Therefore, Cymer’s investments are classified as available-for-sale and are carried on the balance sheet at fair value.  Due to the conservative nature of the investment portfolio, a sudden change in interest rates would not have a material effect on the value of the portfolio.

 

In February 2002, Cymer issued $250.0 million principal amount of unsecured fixed rate 3½% Convertible Subordinated Notes due February 15, 2009.  Interest on these 2002 Notes is payable on February 15 and August 15 of each year, commencing August 15, 2002.  The 2002 Notes are convertible into shares of Cymer’s common stock at a conversion rate of 20 shares per $1,000 principal amount subject to adjustment under certain conditions. 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’s existing and future senior indebtedness and effectively subordinated to all indebtedness and other liabilities of Cymer’s subsidiaries.  Because the interest rate is fixed, we believe there is no risk of increased interest expense.  These Notes are recorded at face value on the consolidated balance sheets.  The fair value of such debt based on quoted market prices on June 30, 2003 was $260.9 million.

 

ITEM 4.  Controls and Procedures

 

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

 

Changes in internal controls. There has been no change in our internal control over financial reporting during the fiscal quarter ended June 30, 2003 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

PART II.  OTHER INFORMATION

 

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

 

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

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

 

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SIGNATURES

 

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

 

 

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

 

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