UNITED STATES SECURITIES AND EXCHANGE COMMISSION

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, 2004

 

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)

 

 

(858) 385-7300

(Registrant’s telephone number, including area code)

 

N/A

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

 

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 2, 2004 was 36,787,732.

 

 

CYMER, INC.

 

FORM 10-Q

 

For the Quarterly Period Ended June 30, 2004

 

INDEX

 

PART I.	FINANCIAL INFORMATION
ITEM 1.	Consolidated Financial Statements (unaudited)
	Consolidated Balance Sheets as of December 31, 2003
	and June 30, 2004
	Consolidated Statements of Operations for the
	three and six months ended June 30, 2003 and 2004
	Consolidated Statements of Cash Flows for the
	six months ended June 30, 2003 and 2004
	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, Use of Proceeds, and Issuer Purchases of Equity Securities
ITEM 3.	Defaults Upon Senior Securities
ITEM 4.	Submission of Matters to a Vote of Security Holders
ITEM 5.	Other Information
ITEM 6.	Exhibits and Reports on Form 8-K
SIGNATURE PAGE

 

2

 

PART I.  FINANCIAL INFORMATION

 

 

ITEM 1.  Financial Statements

 

CYMER, INC.

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(In thousands, except share data)

 

		December 31, 2003			June 30, 2004
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	230,657		$	211,056
Short-term investments		93,474			107,544
Accounts receivable – net		62,819			88,828
Inventories		93,012			110,788
Deferred income taxes		1,407			1,692
Prepaid expenses and other assets		5,513			7,378
Total current assets		486,882			527,286
PROPERTY AND EQUIPMENT – NET		128,849			124,883
LONG-TERM INVESTMENTS		77,509			80,250
DEFERRED INCOME TAXES		80,711			81,680
GOODWILL –  NET		7,647			8,358
INTANGIBLE ASSETS – NET		12,925			11,659
OTHER ASSETS		8,698			8,324
TOTAL ASSETS		$	803,221		$	842,440
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable		$	19,099		$	22,565
Accrued warranty and installation		26,486			27,318
Accrued payroll and benefits		7,196			15,179
Accrued patents, royalties and other fees		8,436			3,824
Foreign currency forward exchange contracts		6,401			2,263
Income taxes payable		16,473			20,763
Accrued and other current liabilities		4,945			7,785
Total current liabilities		89,036			99,697
CONVERTIBLE SUBORDINATED NOTES		250,000			250,000
OTHER LIABILITIES		5,660			6,601
MINORITY INTEREST		5,195			5,813
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS’ EQUITY:
Preferred stock – authorized 5,000,000 shares; $.001 par value, no shares issued or outstanding		—			—
Common stock – $.001 par value per share; 100,000,000 shares authorized; 36,345,000 and 36,767,000 shares outstanding at December 31, 2003 and June 30, 2004, respectively		36			37
Additional paid-in capital		358,988			369,659
Unearned compensation		(146		)	(79		)
Accumulated other comprehensive loss		(5,734		)	(6,831		)
Retained earnings		100,186			117,543
Total stockholders’ equity		453,330			480,329
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	803,221		$	842,440

 

See Notes to Unaudited Consolidated Financial Statements.

 

3

 

 

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,
		2003			2004			2003			2004
REVENUES:
Product sales		$	62,177		$	94,722		$	129,513		$	182,593
Other		—			185			57			235
Total revenues		62,177			94,907			129,570			182,828
COSTS AND EXPENSES:
Cost of product sales		52,031			49,975			94,901			102,143
Research and development		16,072			14,832			33,390			27,202
Sales and marketing		4,461			5,879			8,555			11,702
General and administrative		6,547			8,154			12,320			14,769
Amortization of intangible assets		40			40			80			80
Total costs and expenses		79,151			78,880			149,246			155,896
OPERATING INCOME (LOSS)		(16,974		)	16,027			(19,676		)	26,932
OTHER INCOME (EXPENSE):
Foreign currency exchange loss – net		(57		)	(399		)	(417		)	(345		)
Interest and other income		2,397			1,603			4,886			3,499
Interest and other expense		(2,505		)	(2,511		)	(4,980		)	(5,067		)
Total other expense – net		(165		)	(1,307		)	(511		)	(1,913		)
INCOME (LOSS) BEFORE INCOME TAX  PROVISION (BENEFIT) AND MINORITY INTEREST		(17,139		)	14,720			(20,187		)	25,019
INCOME TAX PROVISION (BENEFIT)		(12,112		)	3,386			(12,112		)	5,754
MINORITY INTEREST		(166		)	(1,133		)	(480		)	(1,908		)
NET INCOME (LOSS)		$	(5,193	)	$	10,201		$	(8,555	)	$	17,357
EARNINGS (LOSS) PER SHARE:
Basic earnings (loss) per share		$	(0.15	)	$	0.28		$	(0.25	)	$	0.47
Weighted average common shares outstanding		34,577			36,735			34,443			36,661
Diluted earnings (loss) per share		$	(0.15	)	$	0.27		$	(0.25	)	$	0.46
Weighted average common and dilutive potential common shares outstanding		34,577			37,673			34,443			37,846

 

See Notes to Unaudited Consolidated Financial Statements.

 

4

 

CYMER, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In thousands)

 

		For the six months ended June 30,
		2003			2004
OPERATING ACTIVITIES:
Net income (loss)		$	(8,555	)	$	17,357
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization		16,617			13,949
Non-cash stock-based compensation		804			261
Amortization of unearned compensation		555			67
Minority interest		480			1,908
Provision for deferred income taxes		(21		)	(490		)
Loss on disposal and impairment of property and equipment		2,036			58
Change in assets and liabilities:
Accounts receivable – net		(6,778		)	(26,009		)
Income taxes receivable		(2,798		)	—
Foreign currency forward exchange contracts		212			(2,127		)
Inventories		4,634			(17,776		)
Prepaid expenses and other assets		1,216			(2,126		)
Accounts payable		(11,243		)	3,466
Accrued expenses and other liabilities		(1,965		)	13,998
Income taxes payable		(11,321		)	4,290
Net cash provided by (used in) operating activities		(16,127		)	6,826
INVESTING ACTIVITIES:
Acquisition of property and equipment		(42,415		)	(8,140		)
Purchases of investments		(53,101		)	(142,560		)
Proceeds from sold or matured investments		70,485			123,724
Acquisition of patents  (1)		—			(5,990		)
Acquisition of minority interest		(180		)	(2,000		)
Net cash used in investing activities		(25,211		)	(34,966		)
FINANCING ACTIVITIES:
Net borrowings under revolving loan and security agreements		(6,667		)	—
Proceeds from issuance of common stock		12,505			10,410
Payments on capital lease obligations		(26		)	(24		)
Net cash provided by financing activities		5,812			10,386
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS		(215		)	(1,847		)
NET DECREASE IN CASH AND CASH EQUIVALENTS		(35,741		)	(19,601		)
CASH AND CASH EQUIVALENTS AT BEGINNING  OF THE PERIOD		196,643			230,657
CASH AND CASH EQUIVALENTS AT END OF THE PERIOD		$	160,902		$	211,056
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid		$	4,509		$	4,482
Income taxes paid, net		$	2,194		$	2,159
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Reversal of unearned compensation related to cancelled stock options previously issued for the ACX acquisition		$	1,475		$	—

 

(1)  These patents were acquired in the fourth quarter of 2003 and the payment was accrued.  Payment for these patents was made in the first quarter of 2004.

 

 

See Notes to Unaudited Consolidated Financial Statements.

 

5

 

CYMER, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three and Six Months Ended June 30, 2004

(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, 2003.  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, Ltd, 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 81% of Cymer Korea.  In February 2004, Cymer acquired 6% of the remaining 25% minority interest in its majority-owned subsidiary, Cymer Korea.  Cymer paid a total of $2.0 million for this 6% interest and recorded $1.3 million of the $2.0 million as an additional investment in Cymer Korea and the remaining $711,000 as goodwill.  This transaction increased Cymer’s total interest in Cymer Korea from 75% to 81%.    Cymer Japan is currently the only subsidiary office of Cymer which sells excimer light source systems.  In addition, Cymer Japan provides field service to customers in the Japan region. Cymer SEA, Cymer PRC, Cymer Singapore and Cymer B.V. are field service offices for customers in those respective regions.  Cymer Korea provides refurbishment manufacturing, 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.

 

Accounting Pronouncements Adopted – In January 2003, the Financial Accounting Standards Board (“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 December 15, 2003.  The adoption of this interpretation did not have a material effect on the consolidated financial statements of Cymer as it does not have arrangements that meet the criteria of a VIE.

 

6

 

In December 2003, FASB issued Interpretation No. 46R, “Consolidation of Variable Interest Entities”, which supersedes FIN 46.  The application of the revised interpretation is required in the financial statements of companies that have interests in special purpose entities for periods after December 15, 2003.  The application of this interpretation did not have a material effect on the consolidated financial statements of Cymer's as it does not have any arrangements that meet the criteria of a special purpose entity.

 

In March 2004, the Emerging Issues Task Force (“EITF”) finalized its consensus on EITF Issue 03-6, “Participating Securities and the Two-Class Method Under FASB Statement No. 128, Earnings Per Share” (“EITF 03-6”). EITF 03-6 clarifies what constitutes a participating security and requires the use of the two-class method for computing basic earnings per share when participating convertible securities exists. EITF 03-6 is effective for fiscal periods beginning after March 31, 2004. The application of EITF 03-6 did not have an effect on Cymer's calculation of earnings per share.

 

In March 2004, the EITF reached a consensus on EITF Issue No. 03-1 (“EITF 03-1”),  “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”. The EITF’s consensus applies to debt and equity securities accounted for under FASB Statement No. 115 (“SFAS 115”),  “Accounting for Certain Investments in Debt and Equity Securities”.  The guidance for evaluating whether an investment is other-than-temporarily impaired should be applied in other-than-temporary impairment evaluations made in reporting periods after June 15, 2004. The disclosures are effective in annual financial statements for fiscal years ending after June 15, 2004, for investments accounted for under SFAS 115. The adoption of  EITF 03-1 did not have a material impact on Cymer’s consolidated financial statements.

 

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

 

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 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.  Statement of Financial Accounting Standards Board 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.

 

Cymer accounts for options granted to non-employees under SFAS No. 123 and EITF Issue No. 96-18, “Accounting for Equity Instruments that are Issued to other than Employees for Acquiring or in Conjunction with Selling Goods or Services”.  Cymer measures the fair value of such options using the Black-Scholes option-pricing model at each financial reporting date.  Cymer accounts for changes in fair values between reporting dates in accordance with Financial Accounting Interpretation 28.  Stock-based compensation expense for options granted to non-employees and for those employees who changed status for the six months ended June 30, 2003 and 2004 was $792,000 and $252,000, respectively.

 

7

 

Under SFAS No. 123, the weighted average per share fair value of the options granted for the six months ended June 30, 2003 and 2004 was $17.75 and $25.50, respectively, on the date of grant.  Fair value under SFAS No. 123 is determined using the Black-Scholes option-pricing model with the assumptions noted below.  For risk free interest, Cymer uses the then currently available rate on zero coupon U.S. Government issues with a remaining life of five years for valuing options and one year for valuing Employee Stock Purchase Plan (“ESPP”) shares.

 

		Three months ended June 30,				Six months ended June 30,
		2003		2004		2003		2004
Dividend yield		None		None		None		None
Volatility rate		83	%	79	%	83	%	79	%
Weighted average risk free interest :
Options		3.40	%	3.72	%	3.13	%	3.31	%
ESPP		1.22	%	1.55	%	1.22	%	1.55	%
Assumed forfeiture rate		5	%	5	%	5	%	5	%
Expected life:
Options		6 years		6 years		6 years		6 years
ESPP		.5 years		.5 years		.5 years		.5 years

 

The following table compares earnings (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,
		2003			2004			2003			2004
Net income (loss), as reported		$	(5,193	)	$	10,201		$	(8,555	)	$	17,357
Add: Stock-based employee compensation expense included in reported net income (loss), net of related tax effects		(75		)	121			322			202
Deduct: Total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects		2,330			(4,825		)	(6,320		)	(9,008		)
Pro forma net income (loss)		$	(2,938	)	$	5,497		$	(14,553	)	$	8,551
Earnings (loss) per share:
Basic – as reported		$	(0.15	)	$	0.28		$	(0.25	)	$	0.47
Basic – pro forma		$	(0.08	)	$	0.15		$	(0.42	)	$	0.23
Diluted – as reported		$	(0.15	)	$	0.27		$	(0.25	)	$	0.46
Diluted – pro forma		$	(0.08	)	$	0.15		$	(0.42	)	$	0.23

 

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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, 2003 and 2004 (in thousands):

 

		Three months ended June 30,				Six months ended June 30,
		2003		2004		2003		2004
Basic weighted average common shares outstanding		34,577		36,735		34,443		36,661
Effect of dilutive securities:
Warrants		—		23		—		37
Options		—		915		—		1,148
Diluted weighted average common and potential common shares outstanding		34,577		37,673		34,443		37,846

 

For the three months ended June 30, 2003 and 2004, weighted average options and warrants to purchase 3,893,000 and 2,959,000 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 three months ended June 30, 2003 and 2004, weighted average common shares attributable to convertible subordinated notes of 5,000,000 were not included in the computation of diluted earnings per share as their effect was also anti-dilutive.

 

For the six months ended June 30, 2003 and 2004, weighted average options and warrants to purchase 3,825,000 and 1,425,000 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, 2003 and 2004, weighted average common shares attributable to convertible subordinated notes of 5,000,000 were not included in the computation of diluted earnings per share as their effect was also anti-dilutive.

 

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4.              INVENTORIES

 

Inventories consist of the following as of December 31, 2003 and June 30, 2004 (in thousands):

 

		December 31, 2003			June 30, 2004
INVENTORIES:
Raw materials		$	37,393		$	46,672
Work-in-progress		26,949			32,159
Finished goods		40,698			42,507
Allowance for excess and obsolete inventory		(12,028		)	(10,550		)
Total		$	93,012		$	110,788

 

5.              REPORTING COMPREHENSIVE INCOME (LOSS)

 

Comprehensive income (loss) 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, 2004 (in thousands):

 

				Translation adjustment, net of tax			Total unrealized gains (losses) 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, 2003		Balance		$	(4,473	)	$	1,448		$	(2,709	)	$	(5,734	)
		Period net change		(1,089		)	(1,194		)	1,186			(1,097		)
June 30, 2004		Balance		$	(5,562	)	$	254		$	(1,523	)	$	(6,831	)

 

Comprehensive income (loss) consists of the following components (in thousands):

 

		Three months ended June 30,						Six months ended June 30,
		2003			2004			2003			2004
Net income (loss)		$	(5,193	)	$	10,201		$	(8,555	)	$	17,357
Foreign currency translation adjustments, net of tax		491			(1,235		)	(127		)	(1,089		)
Unrealized gains (losses) on available for sale investments, net of tax		(143		)	(1,006		)	39			(1,194		)
Unrealized gains on foreign currency forward exchange contracts, net of tax		160			1,124			324			1,186
Comprehensive income (loss)		$	(4,685	)	$	9,084		$	(8,319	)	$	16,260

 

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6.              DEVELOPMENT AGREEMENT AND INTELLECTUAL PROPERTY LICENSE AGREEMENT

 

On January 23, 2004, Cymer entered into a research and development agreement with Intel Corporation (“Intel”).  Total funding under the agreement is $20.0 million and will provide Cymer with funding over the next three years to accelerate the development of production-worthy extreme ultraviolet (“EUV”) lithography light sources.  The funding to be received from Intel under this agreement is milestone based and will be netted against Cymer’s total research and development expenses in the period that the milestone is achieved.  Total funding amounts recorded under this agreement for the three and six months ended June 30, 2004 were $1.6 million and $2.4 million, respectively.

 

On February 4, 2004, Cymer entered into an intellectual property license agreement with Intel for the use of certain Intel patents and trade secrets related to EUV technology.  Under the terms of this agreement, Cymer will pay license fees to Intel if Cymer is successful in commercializing an EUV lithography light source capable of high volume manufacturing by the end of the second quarter of 2008.  The license payments under this agreement are triggered in the quarter in which Cymer successfully ships the first complete high volume manufacturing EUV source system.  Upon shipment of this first unit, Cymer is to pay Intel $1.25 million in license fees per quarter for a period of sixteen quarters.  The quarterly license amounts paid to Intel, if any, will be related to Cymer’s sale of EUV light source systems and, as a result, will be recorded as cost of sales.  The methodology and amounts that will be recorded to cost of sales will be determined when the high volume manufacturing production unit sales or a forecast of sales can be made.  No amounts have been earned under this arrangement as of June 30, 2004.

 

7.              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.

 

During the fourth quarter of 2003, Cymer completed its annual impairment test of goodwill and intangible assets, and concluded that no impairment of goodwill existed.

 

Aggregate amortization expense was $80,000 for each of the six months ended June 30, 2003 and 2004.  As of June 30, 2004, future estimated amortization expense is expected to be as follows (in thousands):

 

		Future Amortization
Six months ending December 31, 2004		$	80
Year ending December 31, 2005		$	20

 

The following table summarizes the activity in the carrying amount of goodwill as of December 31, 2003 and June 30, 2004 (in thousands):

 

Goodwill as of December 31, 2003		$	7,647
Goodwill acquired with acquisition of 6% minority interest of Cymer Korea		711
Goodwill as of June 30, 2004		$	8,358

 

Also included in intangible assets – net on the accompanying balance sheets are amounts associated with patents which were acquired in 2001 and 2003.  As of December 31, 2003 and June 30, 2004, the net carrying amount of these patents was $12.7 million and $11.6 million, respectively.  Amortization expense for these patents was $323,000 and $593,000 for the three months ended June 30, 2003 and 2004, respectively.  Amortization expense was $645,000 and $1.2 million for the six months ended June 30, 2003 and 2004, respectively.

 

As of June 30, 2004, future estimated amortization expense for these patents is expected to be as follows (in thousands):

 

 

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8.              GUARANTEES

 

Cymer adopted the disclosure provisions of Financial Accounting Standards Board Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others”, during the quarter ended December 31, 2002 and has adopted the recognition and measurement provisions as required after December 31, 2002.  FIN 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 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 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 six 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 reviewed monthly and determined using a financial model, which considers 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 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 using actual historical data. For both light source systems and consumables, 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, 2004 (in thousands):

 

		2004
Balance, January 1, 2004		$	26,200
Liabilities accrued for warranties issued during the six month period, net of adjustments and expirations		13,556
Warranty expenditures incurred during the six month period		(12,756		)
Balance, June 30, 2004		$	27,000

 

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 products.  Under the indemnification clauses, Cymer will pay all costs and damages, including attorney’s fees, associated with such settlements or defenses, provided that the customer follows specific procedures for notifying Cymer 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.

 

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An indemnification provision was also included in the contract manufacturing agreement with Seiko, which was terminated effective March 31, 2003.  As with Cymer’s indemnification provisions on intellectual property, Cymer will continue to honor this indemnification clause within the 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 Cymer is entitled to prior use claims in Japan.

 

As part of the research and development agreement signed with Intel, Cymer also agreed to provide Intel with indemnity against any infringement of the intellectual property rights of any third party arising from Intel’s purchase and/or use of Cymer’s EUV source systems.  Details of such indemnity will be negotiated as part of a purchase agreement related to potential future products.

 

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 recorded the revolving loan outstanding balance as a liability on its financial statements, the carrying amount of the liability was 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 and has not since been renewed.

 

9.              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 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 use claims in Japan.

 

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

 

In this section, references to “we”, “us” or “our” are references to Cymer. The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and notes thereto included in this quarterly report on Form 10-Q and our consolidated financial statements and notes thereto included in our annual report on Form 10-K for the year ended December 31, 2003.

 

Forward Looking Statements

 

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 domestic and international product sales and development; service and support; research and development activities and expenditures; adequacy of capital resources and investments; effects of business cycles in the semiconductor business; competitive positioning; and relationships with customers and third-party manufacturers for product manufacturing, and may contain words such as “believes,” “anticipates,” “expects,” and words of similar meaning. These statements are only predictions based on current information and expectations and involve a number of risks and uncertainties. The underlying information and expectations are likely to change over time.  Actual events or results may differ materially from those projected in the forward-looking statements due to various factors, including, but not limited to, those set forth under the caption “Risks and Uncertainties That May Affect Results”  and  elsewhere in this quarterly report on Form 10-Q.  Forward-looking statements herein speak only as of the date of this quarterly report on Form 10-Q.

 

Overview

 

General

 

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

 

Products and Services

 

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

 

Our photolithography light sources produce narrow bandwidth pulses of short wavelength light within the DUV spectrum. The three DUV wavelengths are measured in nanometers (“nm”).  One nanometer equals one billionth of a meter.  The light sources are referred to according to the gases mixed to produce the light or by the wavelength.  Krypton Fluoride (“KrF”) gases produce 248 nm light, Argon Fluoride (“ArF”) gases 193 nm light, and Fluorine (“F2”) gas 157 nm light. The light sources permit very fine feature resolution for imaging the circuitry on the wafer and high throughput in wafer processing.  We have designed our light sources to be highly reliable, easy to install and compatible with existing semiconductor manufacturing processes.  Our light sources are used to pattern the integrated circuits, which are also called semiconductors or “chips”, that power many of today’s advanced consumer and business electronics. In the first six months of 2004, we sold 145 light source systems at an average selling price of $777,000.

 

Certain components and subassemblies included in our light sources require replacement or refurbishment following extended operation.  For example, the discharge chamber of our light sources has an expected life of approximately three to sixteen billion pulses, depending on the model. We estimate that a light source used in a semiconductor production environment will require one to two replacement

 

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chambers per year, depending upon the level of usage.  Similarly, certain optical components of the light source deteriorate with continued exposure to DUV light and require periodic replacement.  We provide these and other spare and replacement parts for our photolithography light sources as needed by our customers.

 

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

 

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

 

Semiconductor Industry Status and Outlook

 

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

 

In the latter half of 2003, there were several indicators that the extended downturn in the semiconductor industry which started in 2001 was coming to an end and that an upturn was in sight.  During the final months of 2003, we experienced strong order growth and our direct customers announced increasing orders and extended delivery times. In addition, the chipmakers’ utilization of our DUV light sources exceeded the levels achieved in 2000, the peak of the last upturn, and the mix of our light source models shipped shifted toward KrF products, reflecting the chipmakers’ need for more capacity expansion.

 

As we entered 2004, we continued to see many of the same positive industry trends that we saw at the end of 2003, and we also experienced revenue growth during both the first and second quarters of 2004 that is indicative of an upturn.  Revenue for the first quarter of 2004 grew 20% over fourth quarter 2003 levels and again by 8% from the first to second quarters of 2004.  This continued growth in overall revenue since the beginning of 2004 was due to increased light source shipments and strong demand for consumables and spares to support the record light source utilization levels.  In both the first and second quarters of 2004, the light source product mix was heavily weighted toward our KrF products, reflecting chipmakers’ need to expand capacity to meet current industry demands.  Based upon our revenue levels

 

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and growth thus far in 2004, and the current positive indicators in the semiconductor industry, we believe that we are currently in the growth period of the upturn.

 

We believe we are well positioned to take advantage of this most recent upturn in the semiconductor industry due to the key investments that we made during the three year downturn and the significant cost reductions and efficiencies we have realized in the first six months of 2004.   As we continue into this latest upturn, we expect that we will experience sequential quarterly increases in our light source unit shipments for the remainder of 2004 and high light source system utilization levels at our chipmaker customers, which should  continue to drive our consumables and spares demand at these current high levels.  Based upon our first six month’s 2004 performance and the continued positive industry indicators, we expect that 2004 will be a record revenue year overall for Cymer.

 

Critical Accounting Policies and Estimates

 

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America.  The preparation of these financial statements requires us to make estimates and use judgment that may impact the reported amounts of assets, liabilities, revenues, expenses, and related disclosure of contingent assets and liabilities.  As a part of our ongoing internal processes, we regularly evaluate our estimates, including those related to inventory allowances, warranty provision, income taxes, allowances for bad debts, long-lived assets valuation, intangible assets valuation, and contingencies and litigation.  We base these estimates upon both historical information and other assumptions that we believe to be 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 our estimates if we were to use different assumptions and conditions.

 

We believe that inventory allowances, warranty provisions, and income taxes require more significant judgments and estimates in the preparation of our consolidated financial statements than do other of our accounting estimates.

 

Inventory Allowance

 

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

 

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Both methodologies for analyzing excess and obsolete inventory and determining the inventory allowance are significantly affected by future demand and usage of our products.  There are many factors that could potentially affect the future demand or usage of our products, including the following:

 

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

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

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

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

•                  Utilization rates of our light sources at chipmakers.

 

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

 

Warranty Provision

 

We maintain an accrual for the estimated cost of product warranties associated with our product sales.  Warranty costs include the replacement parts and labor costs to repair our products during the warranty periods.  At the time revenue is recognized, we record a warranty provision, which is included in cost of product sales in the accompanying consolidated statements of operations. The warranty coverage period and terms vary by light source model.  In general, the light source system warranty period ranges from 17 to 26 months after shipment.  We also warrant consumables and spare parts sold to our customers and the coverage period varies by spare part type as some types include time based warranty periods and others include usage based warranty periods.  On average, the warranty period for consumables and spare parts is approximately six months from the date of shipment. The warranty provision for light source systems is reviewed monthly and determined by using a financial model, which takes into consideration actual historical expenses, and potential risks associated with our different light source system models.  This financial model is then used to estimate future expenses related to warranty and the required warranty provision.  The risk levels used within this model are reviewed and updated as risk levels change by model over its product life cycle.  Due to the highly technical nature of our light source system products, the newer model light sources have higher inherent warranty risks and require higher warranty provisions. The warranty provision for consumables and spare parts is determined by using actual historical data.

 

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

 

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Income Taxes

 

We account for income taxes in accordance with Statement of Financial Accounting Standards  No. 109 (“SFAS No. 109”), “Accounting for Income Taxes.”  Pursuant to SFAS No. 109, a deferred tax asset or liability is generally recognized for the estimated future tax effects attributable to temporary differences, net operating loss carryforwards and tax credit carryforwards.  Deferred tax assets are to be reduced by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized within the carryback or carryforward periods.  Information about an enterprise’s current financial position and its results of operations for the current and preceding years, as well as all currently available information about future years should be considered.

 

We have considered our industry’s outlook for the future, our historical performance and estimated future taxable income, and ongoing tax planning strategies in assessing the need for a valuation allowance.  Using this information, we have prepared a model to forecast our expected taxable income in future years in order to estimate when the benefits of our deferred tax assets are likely to be realized.  Based upon the analysis, we believe that it is more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax assets within the period allowed by current applicable tax law and, as such, no valuation allowance against deferred tax assets is provided.

 

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

 

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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,
		2003		2004		2003		2004
Revenues:
Product sales		100.0	%	99.8	%	99.9	%	99.9	%
Other		—		.2		.1		.1
Total revenues		100.0	%	100.0	%	100.0	%	100.0	%
Cost and expenses:
Cost of product sales		83.7		52.6		73.2		55.9
Research and development		25.8		15.6		25.8		14.9
Sales and marketing		7.2		6.2		6.6		6.4
General and administrative		10.5		8.6		9.5		8.0
Amortization of intangible assets		.1		.1		.1		.1
Total costs and expenses		127.3		83.1		115.2		85.3
Operating income (loss)		(27.3	)	16.9		(15.2	)	14.7
Total other expense – net		(.3	)	(1.4	)	(.4	)	(1.0	)
Income (loss) before income tax
provision (benefit) and minority interest		(27.6	)	15.5		(15.6	)	13.7
Income tax provision (benefit)		(19.5	)	3.5		(9.4	)	3.2
Minority interest		(.2	)	(1.2	)	(.4	)	(1.0	)
Net income (loss)		(8.3	)%	10.8	%	(6.6	)%	9.5	%
Gross margin on product sales		16.3	%	47.2	%	26.7	%	44.1	%

 

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THREE MONTHS ENDED JUNE 30, 2003 AND 2004

 

Revenues. Our revenues consist of product sales, which include sales of light source systems, consumable and spare parts, upgrades, service, service contracts and training. Our revenues also consist of other revenues, which include revenue from certain funded development activities performed for customers and under government contracts and license agreements.  We do not recognize any revenue for light source systems prior to shipment.  The systems are tested by us in environments similar to those used by our customers prior to shipment to ensure that they meet the customers’ specifications and will interface with the customers’ software.  Our installation obligations are perfunctory within the framework of Staff Accounting Bulletin 104.  One of our customers has an acceptance provision, which is satisfied by the issuance of an acceptance certificate following a visual inspection of the system by the customer. We do not recognize revenue on systems shipped to that customer until we receive the acceptance certificate.  There are no customer retentions with the exception of one customer where a small portion of our light source product revenue is delayed to align with the end-user acceptance of the integrated scanner containing our light source.  Revenue from consumables and spare parts sales is recognized at the point that legal title passes to the customer, which is generally upon shipment from our facility.  Service and training revenue is generally recognized at the time that the services are rendered or the training class is completed.  Service contract revenues are generally recorded as revenue ratably over the life of the contract or per the specific terms of the agreement. For funded development contracts which are included in other revenue, funds received are accounted for on the percentage-of-completion method based on the relationship of costs incurred to total estimated costs.  Revenues generated from these funded development contracts are derived from cost sharing contracts between us and certain customers.  The costs associated with these particular contracts are included in research and development expenses in the period incurred and are not listed separately as other cost or expenses in the consolidated statements of operations.  If milestones on these funded development contracts require that specific results be achieved or reported by us, revenue is not recognized until that milestone is completed.  For some of the funded development contracts which we enter into with customers and government agencies, we evaluate certain criteria to determine whether recording the funds received as revenue is appropriate.  If certain conditions are met, these funds are not recorded as revenue and are rather offset against our own internal research and development expenses in the period that the milestone is achieved or per the terms of the contract.

 

The following table summarizes the components of our revenue (in thousands, except units sold):

 

		Three months ended June 30,
		2003			2004
Light source systems:
Revenue		$	35,939		$	58,719	(1)
Units sold		31			81
Average selling price		$	1,159		$	737
Consumable and spare parts and service products		$	26,238		$	36,003
Other revenue		$	—		$	185
Total revenue		$	62,177		$	94,907

 

(1)  Net of deferred light source revenue of $943,000, which reflects one customer’s retention where light source revenue is delayed  to align with the end-user acceptance of the integrated scanner containing our light source.

 

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Product sales increased 52% from $62.2 million for the three months ended June 30, 2003 to $94.7 million for the three months ended June 30, 2004, primarily due to a 63% increase in light source system revenue from $35.9 million in the three months ended June 30, 2003 to $58.7 million in the three months ended June 30, 2004.  A total of 31 light source systems were sold in the three months ended June 30, 2003 at an average selling price of $1.2 million, compared to 81 systems sold in the three months ended June 30, 2004 at an average selling price of $737,000.  On a foreign currency adjusted basis, the average selling price for the three months ended June 30, 2003 was $1.1 million compared to $736,000 for the three months ended June 30, 2004. The decrease in the average selling price from period to period reflects the shift in the product mix to our lower priced KrF products in the second quarter of 2004.  Product sales were further increased from period to period due to a 37% increase in sales of consumable and spare parts and service products from $26.2 million in the three months ended June 30, 2003 to $36.0 million in the three months ended June 30, 2004.  The increase in this type of product sales was due to increased utilization of our DUV light source by chipmakers and an increased installed base in the three months ended June 30, 2004.  There were no revenues from funded development contracts for the three months ended June 30, 2003, compared to revenues from funded development contracts of $185,000 for the three months ended June 30, 2004.  We anticipate that our total revenues will increase sequentially for the remainder of 2004 as a result of the upturn in the semiconductor industry.

 

Our backlog at June 30, 2003 was $100.4 million compared to $107.7 million at June 30, 2004.  Bookings for the three months ended June 30, 2003 and June 30, 2004 were $65.5 million and $97.1 million, respectively.  The book-to-bill ratio for the three months ended June 30, 2003 was 1.05 compared to 1.02 for the three months ended June 30, 2004.  The increase in overall bookings was primarily due to the upturn in the semiconductor industry in 2004 which resulted in higher systems bookings and record bookings of consumable and spare parts in the second quarter of 2004.

 

We installed 50 light sources at chipmakers and other end-users during the quarter ended June 30, 2003 as compared to 73 light sources installed during the quarter ended June 30, 2004.

 

Sales to our three largest customers, ASM Lithography, Canon, and Nikon, amounted to 15%, 27% and 24%, respectively, of total revenue for the three months ended June 30, 2003, and 32%, 18% and 19%, respectively, of total revenue for the three months ended June 30, 2004.

 

Our sales are generated primarily by shipments to customers in Japan, Europe, and the United States.  Approximately 88% of our sales for both the three months ended June 30, 2003 and 2004 were derived from customers outside the United States.  We maintain a wholly-owned Japanese subsidiary, which sells to our Japanese customers.  Revenues from Japanese customers, generated primarily by this subsidiary, accounted for 50% and 35% of total revenues in the three months ended June 30, 2003 and 2004, respectively.  The activities of our Japanese subsidiary are limited to sales and service of products purchased by the subsidiary from the parent corporation.  We anticipate that international sales will continue to account for a significant portion of our net sales.

 

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 our products by our Japanese subsidiary for resale under firm third-party sales commitments.  Shipping costs associated with our product sales are also included in cost of product sales.  We do not charge our customers for shipping fees and such costs are not significant.

 

The cost of product sales decreased 4% from $52.0 million for the three months ended June 30, 2003 to $50.0 million for the three months ended June 30, 2004. This decrease in the cost of product sales is primarily due to a decrease in the overall costs associated with our XL series light source which was initially introduced to manufacturing and started shipping to customers in early 2003.  During its initial months of production in 2003, the inefficiencies and costs to manufacture the XL series light source were

 

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very high as is typically the case with new product introductions.  In addition, the cost of product sales were lower in the three months ended June 30, 2004 due to the shift in our product mix to the lower cost KrF products and achievement of our overall material cost reduction targets on a variety of products.

 

The gross margin on product sales was 16% for the three months ended June 30, 2003 as compared to 47% for the same three-month period in 2004.  This higher gross margin is primarily due to the improved efficiencies and costs associated with our XL series light source and the shift to our lower cost and higher margin KrF products in 2004 as compared to 2003.  This higher gross margin in 2004 also reflects increased factory yield and utilization, increased and improved field utilization and efficiency and significant success in our material cost control efforts.    We anticipate that we can maintain or achieve improvements in our gross margins over the next couple of quarters as we continue to reduce spending through ongoing process improvements, increase manufacturing yields and further reduce material costs.  We do not anticipate that system product mix will have a material impact on gross margins going forward.

 

Research and Development.  Research and development expenses include costs of internally-funded and externally-funded projects as well as continuing product development support expenses,  which consist primarily of employee and material costs, depreciation of equipment and other engineering related costs.  Our research and development expenses are offset by amounts associated with certain of our externally funded research and development contracts.  These amounts were $239,000 and $2.1 million for the three months ended June 30, 2003 and 2004, respectively.  Research and development expenses decreased 8% from $16.1 million for the three months ended June 30, 2003 to $14.8 million for the three months ended June 30, 2004, due primarily to the higher level of development efforts associated with the XL series light source product in 2003 compared to 2004.  These decreased expenses from period to period were offset by increased costs associated with the profit sharing and bonus plans funded in the second quarter of 2004.  We also continued to invest in EUV, F2 and beam delivery unit technology and to focus on next generation KrF and ArF products based on the XL platform.  As a percentage of total revenues, research and development expenses decreased from 25.8% for the three months ended June 30, 2003 to 15.6% for the same three-month period in 2004 due primarily to lower revenues in 2003 compared to 2004.  We expect research and development expenses to remain at this level of dollar spending or increase in the next few quarters due to increased spending in EUV development and other product development opportunity investigations.

 

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 32% from $4.5 million for the three months ended June 30, 2003 to $5.9 million for the three months ended June 30, 2004.  This increase in sales and marketing expenses from period to period primarily reflects the expenses associated with the profit sharing and bonus plans which were funded in the second quarter of 2004.  As a percentage of total revenues, such sales and marketing expenses decreased from 7.2% for the three months ended June 30, 2003 to 6.2% for the same three-month period in 2004.  We anticipate sales and marketing expenses to remain relatively flat in dollar spending over the next few quarters.

 

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 25% from $6.5 million for the three months ended June 30, 2003 to $8.2 million for the three months ended June 30, 2004 due primarily to profit sharing and bonus plans expenses associated with our increased profitability in the second quarter of 2004 and increased consulting and advisory fees associated with the implementation of the Sarbanes-Oxley section 404 internal controls reporting requirements.  As a percentage of total revenues, such expenses decreased from 10.5% for the three months ended June 30, 2003 to 8.6% for the same three-month period in 2004.  We anticipate general and administrative expenses over the next few quarters to continue to reflect costs for profit sharing and incentive bonuses associated with increased profitability, as well as continued costs related to the Sarbanes-Oxley section 404 requirements.

 

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