CYMER, INC.

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(In thousands, except share data)

	December 31, 2003			September 30, 2004
ASSETS

CURRENT ASSETS:
Cash and cash equivalents	$	230,657		$	217,202
Short-term investments	93,474			97,133
Accounts receivable – net	62,819			96,310
Foreign currency forward exchange contracts	—			162
Inventories	93,012			120,625
Deferred income taxes	1,407			1,653
Prepaid expenses and other assets	5,513			7,351
Total current assets	486,882			540,436

PROPERTY AND EQUIPMENT – NET	128,849			125,184
LONG-TERM INVESTMENTS	77,509			43,789
DEFERRED INCOME TAXES	80,711			80,888
GOODWILL – NET	7,647			8,358
INTANGIBLE ASSETS – NET	12,925			11,026
OTHER ASSETS	8,698			7,236

TOTAL ASSETS	$	803,221		$	816,917

LIABILITIES AND STOCKHOLDERS’ EQUITY

CURRENT LIABILITIES:
Accounts payable	$	19,099		$	22,934
Accrued warranty and installation	26,486			27,888
Accrued payroll and benefits	7,196			17,549
Accrued patents, royalties and other fees	8,436			5,143
Foreign currency forward exchange contracts	6,401			—
Income taxes payable	16,473			25,658
Accrued and other current liabilities	4,945			6,155
Total current liabilities	89,036			105,327

CONVERTIBLE SUBORDINATED NOTES	250,000			200,753
OTHER LIABILITIES	5,660			6,777
MINORITY INTEREST	5,195			5,843

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 36,822,000 shares outstanding at December 31, 2003 and September 30, 2004, respectively	36			37
Additional paid-in capital	358,988			370,559
Unearned compensation	(146		)	(48		)
Accumulated other comprehensive loss	(5,734		)	(5,295		)
Retained earnings	100,186			132,964
Total stockholders’ equity	453,330			498,217

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	803,221		$	816,917

See Notes to Unaudited Consolidated Financial Statements.

CYMER, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(In thousands, except per share data)

	For the three months ended September 30,						For the nine months ended September 30,
	2003			2004			2003			2004

REVENUES:
Product sales	$	63,873		$	106,751		$	193,386		$	289,344
Other	—			389			57			624
Total revenues	63,873			107,140			193,443			289,968

COSTS AND EXPENSES:
Cost of product sales	48,029			56,120			142,930			158,263
Research and development	11,470			15,796			44,860			42,998
Sales and marketing	3,873			5,784			12,428			17,486
General and administrative	20,621			8,218			32,941			22,987
Amortization of intangible assets	40			40			120			120
Gain on debt extinguishment	—			(911		)	—			(911		)

Total costs and expenses	84,033			85,047			233,279			240,943

OPERATING INCOME (LOSS)	(20,160		)	22,093			(39,836		)	49,025

OTHER INCOME (EXPENSE):
Foreign currency exchange gain (loss) – net	482			(928		)	65			(1,273		)
Interest and other income	2,078			2,401			6,964			5,900
Interest and other expense	(2,530		)	(2,299		)	(7,510		)	(7,366		)

Total other income (expense) – net	30			(826		)	(481		)	(2,739		)

INCOME (LOSS) BEFORE INCOME TAX PROVISION (BENEFIT) AND MINORITY INTEREST	(20,130		)	21,267			(40,317		)	46,286

INCOME TAX PROVISION (BENEFIT)	(12,078		)	5,818			(24,190		)	11,572
MINORITY INTEREST	(467		)	(28		)	(947		)	(1,936		)

NET INCOME (LOSS)	$	(8,519	)	$	15,421		$	(17,074	)	$	32,778

EARNINGS (LOSS) PER SHARE:
Basic earnings (loss) per share	$	(0.24	)	$	0.42		$	(0.49	)	$	0.89
Weighted average common shares outstanding	35,302			36,788			34,733			36,704

Diluted earnings (loss) per share	$	(0.24	)	$	0.41		$	(0.49	)	$	0.87
Weighted average common and dilutive potential common shares outstanding	35,302			37,266			34,733			37,639

See Notes to Unaudited Consolidated Financial Statements.

CYMER, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In thousands)

	For the nine months ended September 30,
	2003			2004

OPERATING ACTIVITIES:
Net income (loss)	$	(17,074	)	$	32,778
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Gain on debt extinguishment	—			(911		)
Depreciation and amortization	23,816			21,004
Non-cash stock-based compensation	1,115			141
Amortization of unearned compensation	665			98
Minority interest	947			1,936
Provision for deferred income taxes	(54		)	(727		)
Loss on disposal and impairment of property and equipment	17,635			61
Change in assets and liabilities: Accounts receivable – net	(14,303		)	(33,491		)
Income taxes receivable	(16,725		)	—
Foreign currency forward exchange contracts	1,925			(2,247		)
Inventories	11,209			(27,613		)
Prepaid expenses and other assets	786			(2,299		)
Accounts payable	(12,094		)	3,835
Accrued expenses and other liabilities	(3,627		)	16,892
Income taxes payable	(11,321		)	9,185

Net cash provided by (used in) operating activities	(17,100		)	18,642

INVESTING ACTIVITIES:
Acquisition of property and equipment	(55,509		)	(14,584		)
Purchases of investments	(84,006		)	(161,549		)
Proceeds from sold or matured investments	121,454			189,384
Acquisition of patents (1)	—			(5,990		)
Acquisition of minority interest	(180		)	(2,000		)

Net cash provided by (used in) investing activities	(18,241		)	5,261

FINANCING ACTIVITIES:
Net borrowings under revolving loan and security agreements	(6,667		)	—
Proceeds from issuance of common stock	31,288			11,430
Redemption of convertible subordinated notes	—			(47,407		)
Payments on capital lease obligations	(38		)	(36		)

Net cash provided by (used in) financing activities	24,583			(36,013		)

EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS	1,658			(1,345		)

NET DECREASE IN CASH AND CASH EQUIVALENTS	(9,100		)	(13,455		)
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE PERIOD	196,643			230,657

CASH AND CASH EQUIVALENTS AT END OF THE PERIOD	$	187,543		$	217,202

CYMER, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Three and Nine Months Ended September 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 that 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 that 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.

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 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. Cymer does not anticipate that the adoption of EITF 03-1 will 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 nine months ended September 30, 2003 and 2004 was $1.1 million and $126,000, respectively.

Under SFAS No. 123, the weighted average per share fair value of the options granted for the nine months ended September 30, 2003 and 2004 was $18.62 and $24.07, 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 September 30,				Nine months ended September 30,
	2003		2004		2003		2004

Dividend yield	None		None		None		None
Volatility rate	83	%	79	%	83	%	79	%
Weighted average risk free interest:
Options	2.91	%	3.51	%	2.87	%	3.38	%
ESPP	N/A		N/A		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 September 30,						Nine months ended September 30,
	2003			2004			2003			2004

Net income (loss), as reported	$	(8,519	)	$	15,421		$	(17,074	)	$	32,778
Add: Stock-based employee compensation expense included in reported net income (loss), net of related tax effects	124			(96		)	446			106
Deduct: Total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects	(2,417		)	(3,818		)	(8,737		)	(12,826		)

Pro forma net income (loss)	$	(10,812	)	$	11,507		$	(25,365	)	$	20,058

Earnings (loss) per share:
Basic – as reported	$	(0.24	)	$	0.42		$	(0.49	)	$	0.89
Basic – pro forma	$	(0.31	)	$	0.31		$	(0.73	)	$	0.55

Diluted – as reported	$	(0.24	)	$	0.41		$	(0.49	)	$	0.87
Diluted – pro forma	$	(0.31	)	$	0.31		$	(0.73	)	$	0.53

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 nine months ended September 30, 2003 and 2004 (in thousands):

	Three months ended September 30,		Nine months ended September 30,
	2003	2004	2003	2004

Basic weighted average common shares
outstanding	35,302	36,788	34,733	36,704

Effect of dilutive securities:
Warrants	—	—	—	21
Options	—	478	—	914

Diluted weighted average common and potential common shares outstanding	35,302	37,266	34,733	37,639

For the three months ended September 30, 2003 and 2004, weighted average options and warrants to purchase 2,858,000 and 4,922,000 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 September 30, 2003 and 2004, weighted average common shares attributable to convertible subordinated notes of 5,000,000 and 4,572,000, respectively, were not included in the computation of diluted earnings per share as their effect was also anti-dilutive.

For the nine months ended September 30, 2003 and 2004, weighted average options and warrants to purchase 4,311,000 and 2,978,000 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 nine months ended September 30, 2003 and 2004, weighted average common shares attributable to convertible subordinated notes of 5,000,000 and 4,856,000, respectively, were not included in the computation of diluted earnings per share as their effect was also anti-dilutive.

4. INVENTORIES

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

	December 31, 2003			September 30, 2004
INVENTORIES:
Raw materials	$	37,393		$	47,453
Work-in-progress	26,949			34,651
Finished goods	40,698			49,421
Allowance for excess and obsolete inventory	(12,028		)	(10,900		)
Total	$	93,012		$	120,625

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 nine months ended September 30, 2004 (in thousands):

		Translation adjustment, net of tax			Total unrealized gains on available-for-sale investments, net of tax			Total unrealized 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	(793		)	(1,313		)	2,545			439
September 30, 2004	Balance	$	(5,266	)	$	135		$	(164	)	$	(5,295	)

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

	Three months ended September 30,						Nine months ended September 30,
	2003			2004			2003			2004

Net income (loss)	$	(8,519	)	$	15,421		$	(17,074	)	$	32,778

Foreign currency translation adjustments, net of tax	1,104			296			977			(793		)
Unrealized losses on available for sale investments, net of tax	(495		)	(119		)	(456		)	(1,313		)
Unrealized gains (losses) on foreign currency forward exchange contracts, net of tax	(1,957		)	1,359			(1,633		)	2,545

Comprehensive income (loss)	$	(9,867	)	$	16,957		$	(18,186	)	$	33,217

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 nine months ended September 30, 2004 were $2.1 million and $4.5 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 September 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 for identifiable intangibles, excluding patents, was $120,000 for each of the nine months ended September 30, 2003 and 2004. As of September 30, 2004, future estimated amortization expense is expected to be as follows (in thousands):

	Future Amortization

Three months ending December 31, 2004	$	40
Year ending December 31, 2005	$	20

The following table summarizes the activity in the carrying amount of goodwill as of December 31, 2003 and September 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 September 30, 2004	$	8,358

Also included in intangible assets – net on the accompanying balance sheets are amounts associated with patents that were acquired in 2001 and 2003. As of December 31, 2003 and September 30, 2004, the net carrying amount of these patents was $12.7 million and $11.0 million, respectively. Amortization expense for these patents was $323,000 and $593,000 for the three months ended September 30, 2003 and 2004, respectively. Amortization expense was $968,000 and $1.8 million for the nine months ended September 30, 2003 and 2004, respectively.

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

	Future Amortization

Three months ending December 31, 2004	$	593
Year ending December 31, 2005	$	2,371
Year ending December 31, 2006	$	2,371
Year ending December 31, 2007	$	2,371
Year ending December 31, 2008	$	2,371
Year ending December 31, 2009	$	889

8. 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 over the light source system’s 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 nine months ended September 30, 2004 (in thousands):

	2004

Balance, January 1, 2004	$	26,200
Liabilities accrued for warranties issued during the nine month period,
net of adjustments and expirations	18,687
Warranty expenditures incurred during the nine month period	(17,337		)
Balance, September 30, 2004	$	27,550

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.

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 defaulted 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. CONVERTIBLE SUBORDINATED NOTES

In February 2002, Cymer issued $250.0 million principal amount of unsecured fixed rate 3.50% convertible subordinated notes due February 15, 2009 with interest payable on February 15 and August 15 of each year. These 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 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. In the third quarter of 2004, Cymer repurchased, at a discount to par, $49.2 million of these notes. As a result of this repurchase, Cymer recognized a gain on debt extinguishment of $911,000. As of September 30, 2004, Cymer had $200.8 million convertible subordinated notes outstanding.

10. STOCKHOLDERS’ EQUITY

Stockholder Rights Plan. On August 23, 2004, Cymer announced its amendment to its Preferred Shares Rights Agreement (the “Agreement”) changing the Agreement’s Final Expiration Date from February 13, 2008 to September 1, 2004. As a result of this amendment, the Agreement terminated on September 1, 2004. On September 2, 2004, Cymer filed with the Nevada Secretary of State to withdraw the Certificate of Designations of Rights, Preferences and Privileges of Series A Participating Preferred Stock and the elimination from Cymer’s Articles of Incorporation of the Series A Participating Preferred Stock that had been created in connection with the Agreement.

11. 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.

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 and Argon Fluoride (“ArF”) gases 193 nm light. The light sources permit very fine feature resolution for imaging the circuitry on the wafer and high throughput in wafer processing. We have designed our light sources to be highly reliable, easy to install and compatible with existing semiconductor manufacturing processes. Our light sources are used to pattern the integrated circuits,

which are also called semiconductors or “chips”, that power many of today’s advanced consumer and business electronics. In the first nine months of 2004, we sold 231 light source systems at an average selling price of $785,000.

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 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 usage. CymerOnLine features a user-friendly browser-based interface, which features a robust design and provides a secure data environment. Event-initiated messages sent to pagers, e-mail, mobile phones, or other handheld devices enable up-to-the minute communication and proactive management.

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 significant 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 us for the next upturn. During the downturn which occurred during 2001 through 2003, we made several such strategic investments including the completion of our new manufacturing facilities in San Diego and Korea, the development and introduction of our new 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. In addition to the positive industry indicators, which we saw at the end of 2003, we have experienced much higher revenue levels and revenue growth from quarter to quarter during the first nine months of 2004. From the end of 2003 to the end of the third quarter of 2004, our sequential quarter over

quarter revenue growth ranged from 8% to 20%. As a result of these positive activities and industry indicators over the last year, we concluded that we were an upturn.

As soon as this most recent upturn became apparent, there was controversy over its potential duration and magnitude. During the course of the third quarter of 2004, though our business remained strong and we had received no net order push outs, many semiconductor and equipment companies issued warnings about potential shortfalls in revenue and earnings. Starting in October 2004, the reported decline in chip fab utilization caused some chipmakers to begin holding off on equipment purchases, including the purchase of lithography tools. Recently, we also received notification of light source push outs from two of our direct customers and have begun to see a reduction in light source system utilizations at chipmakers. As a result of this uncertainty in the semiconductor industry, our visibility as to the forecastability of the industry cycle has become limited to less than one quarter. Under these circumstances, we have decided to take actions that will prepare Cymer to deal effectively with what, at this time, appears to be an industry slowdown that could persist potentially for a few quarters.

Since we cannot predict with any certainty the depth or duration of this apparent slowdown of the semiconductor industry, we have taken actions to align our cost structure accordingly with these uncertain conditions. In addition to taking a number of steps to reduce our overall expenses, early in the fourth quarter of 2004 we implemented a reduction in our workforce of approximately 14% on October 21, 2004. Since we were able to keep our headcount in line with the volume of our business during this most recent and brief upturn in 2004, this headcount adjustment primarily reflects the change in any volume production activities. In addition, since approximately one-third of the employees affected by this workforce reduction were temporary employees, we are preserving our ability to ramp up production again quickly in response to any potential re-acceleration of orders that may occur as we enter 2005.

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 and judgments associated with revenue recognition, inventory allowances, warranty provisions, income taxes, allowances for bad debts, long-lived assets valuation, intangible assets valuation, and contingencies and litigation. We base these estimates and judgments upon historical information and other facts and assumptions that we believe to be valid and/or reasonable under the circumstances. These assumptions and facts form the basis for making judgments and estimates and for determining the carrying values of our assets and liabilities that are not apparent from other sources. Actual results could vary from our estimates if we were to use different assumptions and conditions.

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

Revenue Recognition

Our revenues consist of product sales, which include sales of light source systems, consumable and spare parts, upgrades, service, service contracts and training. Our revenues also consist of other revenues, which include revenue from certain funded development activities performed for customers and under government contracts and license agreements. We do not recognize any revenue for light source systems prior to shipment. We test the systems in environments similar to those used by our customers prior to shipment to ensure that they meet the customers’ specifications and will interface with the customers’ software. Our installation obligations are perfunctory within the framework of Staff Accounting Bulletin 104. The shipping terms vary by customer for light source systems shipments. The majority of light source shipment terms are F.O.B. shipping point and revenue is recognized upon shipment. For those customers with F.O.B. destination shipping terms, revenue is recognized upon delivery of the light source system to the customer. One of our customers has an acceptance provision, which is satisfied by the issuance of an acceptance certificate following a visual inspection of the system by the customer. We do not recognize

revenue on systems shipped to that customer until we receive the acceptance certificate. 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 types of funded development contracts are derived from cost sharing contracts between certain customers and us. If milestones on these funded development contracts require that specific results be achieved or reported by us, revenue is not recognized until that milestone is completed. For some of the funded development contracts that we enter into with customers and government agencies, we evaluate certain criteria to determine whether recording the funds received as revenue is appropriate. If certain conditions are met, these funds are not recorded as revenue but rather offset against our own internal research and development expenses in the period that the milestone is achieved or per the terms of the contract.

Inventory Allowance

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

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 periods for our inventory are substantially different from our estimates, adjustments to our

inventory allowance may be required, which could have a material adverse effect on our financial condition and results of operations.

Warranty Provision

We maintain an accrual for the estimated cost of product warranties associated with our product sales. Warranty costs include the replacement parts and labor costs to repair our products during the warranty periods. At the time revenue is recognized, we record a warranty provision, which is included in cost of product sales in the accompanying consolidated statements of operations. The warranty coverage period and terms vary by light source 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 systems. 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 over the light source system’s life cycle. Due to the highly technical nature of our light source system products, the newer model light sources and the modules contained within them 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.

Income Taxes

We account for income taxes in accordance with Statement of Financial Accounting Standards No. 109 (“SFAS 109”), “Accounting for Income Taxes.” Pursuant to SFAS 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.

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 September 30,				Nine months ended September 30,
	2003		2004		2003		2004

Revenues:
Product sales	100.0	%	99.6	%	99.9	%	99.8	%
Other	—		.4		.1		.2
Total revenues	100.0	%	100.0	%	100.0	%	100.0	%

Cost and expenses:
Cost of product sales	75.2		52.4		73.9		54.6
Research and development	18.0		14.7		23.2		14.8
Sales and marketing	6.0		5.4		6.4		6.0
General and administrative	32.3		7.7		17.0		7.9
Amortization of intangible assets	.1		.1		.1		.1
Gain on debt extinguishment	—		(0.9	)	—		(0.3	)
Total costs and expenses	131.6		79.4		120.6		83.1

Operating income (loss)	(31.6	)	20.6		(20.6	)	16.9

Total other income (expense) – net	.1		(0.8	)	(.2	)	(0.9	)

Income (loss) before income tax provision (benefit) and minority interest	(31.5	)	19.8		(20.8	)	16.0

Income tax provision (benefit)	(18.9	)	5.4		(12.5	)	4.0
Minority interest	(0.7	)	—		(.5	)	(0.7	)

Net income (loss)	(13.3	)%	14.4	%	(8.8	)%	11.3	%
Gross margin on product sales	24.8	%	47.4	%	26.1	%	45.3	%

THREE MONTHS ENDED SEPTEMBER 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. We test the systems in environments similar to those used by our customers prior to shipment to ensure that they meet the customers’ specifications and will interface with the customers’ software. Our installation obligations are perfunctory within the framework of Staff Accounting Bulletin 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 that 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 certain customers and us. 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 that we enter into with customers and government agencies, we evaluate certain criteria to determine whether recording the funds received as revenue is appropriate. If certain conditions are met, these funds are not recorded as revenue 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 September 30,
	2003		2004

Light source systems:
Revenue	$	39,163	$	67,717	(1)
Units sold	34		86
Average selling price	$	1,152	$	798

Consumable and spare parts and service products	$	24,710	$	39,034
Other revenue	$	—	$	389

Total revenue	$	63,873	$	107,140

(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.

Product sales increased 67% from $63.9 million for the three months ended September 30, 2003 to $106.8 million for the three months ended September 30, 2004, primarily due to a 73% increase in light source system revenue from $39.2 million in the three months ended September 30, 2003 to $67.7 million in the three months ended September 30, 2004. A total of 34 light source systems were sold in the three months ended September 30, 2003 at an average selling price of $1.2 million, compared to 86 systems sold in the three months ended September 30, 2004 at an average selling price of $798,000. On a foreign currency adjusted basis, the average selling price for the three months ended September 30, 2003 was $1.1 million compared to $798,000 for the three months ended September 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 third quarter of 2004. Product sales were further increased from period to period due to a 58% increase in sales of consumable and spare parts and service products from $24.7 million in the three months ended September 30, 2003 to $39.0 million in the three months ended September 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 September 30, 2004. There were

no revenues from funded development contracts for the three months ended September 30, 2003, compared to revenues from funded development contracts of $389,000 for the three months ended September 30, 2004. As a result of the current market conditions, we expect our revenue to decrease approximately 10% in the fourth quarter of 2004 compared to the third quarter 2004 levels.

Our backlog at September 30, 2003 was $109.5 million compared to $104.6 million at September 30, 2004. Bookings for the three months ended September 30, 2003 and September 30, 2004 were $72.0 million and $104.0 million, respectively. The book-to-bill ratio for the three months ended September 30, 2003 was 1.14 compared to 0.97 for the three months ended September 30, 2004. The increase in overall bookings was primarily due to the short three quarter upturn in the semiconductor industry in 2004 that resulted in higher systems bookings and record bookings of consumable and spare parts in the third quarter of 2004.

We installed 48 light sources at chipmakers and other end-users during the quarter ended September 30, 2003 as compared to 76 light sources installed during the quarter ended September 30, 2004.

Sales to our three largest customers, ASM Lithography, Canon, and Nikon, amounted to 21%, 27% and 22%, respectively, of total revenue for the three months ended September 30, 2003, and 39%, 7% and 25%, respectively, of total revenue for the three months ended September 30, 2004.

Our sales are generated primarily by shipments to customers in Japan, Europe, and the United States. Approximately 90% and 87% of our sales for the three months ended September 30, 2003 and 2004, respectively, 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 48% and 31% of total revenues in the three months ended September 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 increased 17% from $48.0 million for the three months ended September 30, 2003 to $56.1 million for the three months ended September 30, 2004. This increase in the cost of product sales from period to period is primarily due to the overall increase in product sales from period to period. Both light source system sales and sales of consumables and spare parts and service products were higher in the three months ended September 30, 2004 compared to the same three-month period in 2003. This increase in the cost of product sales was partially offset by the product costs associated with the shift in the product mix to the lower costs Krf products and our overall material cost reduction targets on a variety of products.

The gross margin on product sales was 24.8% for the three months ended September 30, 2003 as compared to 47.4% 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. As a result of the apparent slowdown in the semiconductor industry and the related uncertainties, we do not anticipate being able to sustain the high level of gross margin that we experienced during the third quarter of 2004. In response to the current industry conditions, we have decided to reduce our inventory levels which will have a negative effect on our gross margin by several points due to reduced factory loading.

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. Research and development expenses increased 38% from $11.5 million for the three months ended September 30, 2003 to $15.8 million for the three months ended September 30, 2004, due primarily to costs associated with our EUV light source development, new business opportunity development and costs associated with the profit sharing and bonus plans, which were earned by employees in the third quarter of 2004. In addition to our development of EUV, we also continued to focus on next generation KrF and ArF products based on the XL platform. Total amounts recorded as offsets to our research and development costs from externally funded research and development contracts were $563,000 and $2.4 million for the three months ended September 30, 2003 and 2004, respectively. As a percentage of total revenues, research and development expenses decreased from 18.0% for the three months ended September 30, 2003 to 14.7% 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 about this dollar level during the next few quarters due to our spending on 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 49% from $3.9 million for the three months ended September 30, 2003 to $5.8 million for the three months ended September 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 earned by employees in the third quarter of 2004 and increased marketing expenses associated with our international subsidiaries recorded in the three months ended September 30, 2004. As a percentage of total revenues, such sales and marketing expenses decreased from 6.0% for the three months ended September 30, 2003 to 5.4% for the same three-month period in 2004. We anticipate sales and marketing expenses to remain relatively flat in dollar spending with the third quarter levels for the remainder of 2004.

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 decreased 60% from $20.6 million for the three months ended September 30, 2003 to $8.2 million for the three months ended September 30, 2004 due primarily to a $15.6 million tenant improvement write-off associated with the facilities which we vacated during the third quarter of 2003. General and administrative expenses in the three months ended September 30, 2004 included $1.4 million in costs associated with revisions of our estimates related to the timing and market rates for subleasing our San Diego and Boston facilities, which we exited in 2003, as well as expenses associated with our bonus and profit sharing plans, which were earned by employees in the third quarter of 2004. As a percentage of total revenues, such expenses decreased from 32% for the three months ended September 30, 2003 to 8% for the same three-month period in 2004. We anticipate general and administrative expenses in dollars to remain relatively flat in dollar spending with the third quarter levels for the remainder of 2004.

Amortization of Intangible Assets. Amortization of intangible assets totaled $40,000 for both three-month periods ended September 30, 2003 and 2004. This amortization of intangible assets expense is consistent from year to year and relates to the existing technology associated with the acquisition of Active Control eXperts, Inc., (“ACX”) which was completed in early 2001. With our adoption of SFAS No. 142 on January 1, 2002, we discontinued the amortization of goodwill with indefinite useful life associated with previous purchase business combinations. Amortization expense for patents which is included in research and development expenses and cost of product sales was $323,000 and $593,000 for the three months ended September 30, 2003 and 2004, respectively.

Gain on Debt Extinguishment. In February 2002, we issued $250.0 million principal amount of unsecured fixed rate 3.50% convertible subordinated to fund our operations. These notes are due February 15, 2009 with interest payable on February 15 and August 15 of each year. In the third quarter of 2004, we repurchased, at a discount to par, $49.2 million of these notes. As a result of this repurchase, we recognized a gain on debt extinguishment of $911,000 for the three months ended September 30, 2004.

Total 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 functional currencies of our foreign subsidiary offices against the United States dollar. Net

other income totaled $30,000 for the three months ended September 30, 2003 compared to net other expense of $826,000 million for the three months ended September 30, 2004. The change from net other income to net other expense was primarily due to foreign currency exchange losses recorded in the third quarter of 2004 compared to foreign currency exchange gains recorded in the third quarter of 2003. The foreign currency loss in the third quarter of 2004 reflects the loss of $1.1 million from our discontinuance of certain cash flow hedges. These other expenses in the third quarter of 2004 were offset by a $281,000 gain recorded for a sale of investments during the quarter and slightly reduced interest expense associated with our lower bond balances at the end of the third quarter of 2004. Foreign currency exchange gains totaled $482,000, interest income totaled $2.1 million and interest expense totaled $2.5 million for the three months ended September 30, 2003, compared to foreign currency exchange losses of $928,000, interest income and other income of $2.4 million and interest expense of $2.3 million for the three months ended September 30, 2004.

Income Tax Provision (Benefit). The tax benefit of $12.1 million and the tax provision of $5.8 million for the three months ended September 30, 2003 and 2004, respectively, reflect an annual effective rate of 60% and 25%, respectively. The change in the annual effective tax rate from a benefiting rate of 60% during the three months ended September 30, 2003 to a provision rate of 25% for the three months ended September 30, 2004 is primarily attributable to the increase in pre-tax earnings as well as tax benefits from U.S. export incentive programs and research and development and manufacturing investment credits. The annual effective tax rates for both periods are less than the U.S. statutory rate of 35% primarily as a result of permanent book/tax differences and tax credits. The effective tax rate is a function of current tax law and geographic location of pre-tax income. On October 22, 2004, the American Jobs Creation Act of 2004 was enacted in the United States. We are currently evaluating the impact of this new law on our operations and effective tax rate. At this time, we are unable to determine the effects of this new law and will continue to analyze its potential impact as guidance is made available.

NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2004

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

	Nine months ended September 30,
	2003		2004

Light source systems:
Revenue	$	118,544	$	179,097	(1)
Units sold	121		231
Average selling price	$	980	$	785

Consumable and spare parts and service products	$	74,842	$	110,247
Other revenue	$	57	$	624

Total revenue	$	193,443	$	289,968

(1) Net of deferred light source revenue of $2.2 million, 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.

Revenues. Product sales increased 50% from $193.4 million for the nine months ended September 30, 2003 to $289.3 million for the nine months ended September 30, 2004, primarily due to a 51% increase in light source systems revenue from $118.5 million in the nine months ended September 30, 2003 to $179.1 million in the nine months ended September 30, 2004. A total of 121 light source systems were sold in the nine months ended September 30, 2003 at an average selling price of $980,000, compared to 231 systems sold in the nine months ended September 30, 2004 at an average selling price of $785,000. On a foreign currency adjusted basis, the average selling price for the nine months ended

September 30, 2003 was $966,000 compared to $776,000 for the nine months ended September 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 first nine months of 2004. Product sales were further increased due to a 47% increase in sales of consumable and spare parts and service products from $74.8 million in the nine months ended September 30, 2003 to $110.2 million in the nine months ended September 30, 2004. The increase in this type of product sales was due to increased utilization of our DUV light sources by chipmakers and an increased installed base in the nine months ended September 30, 2004. Revenues from funded development contracts were $57,000 and $624,000 for the nine months ended September 30, 2003 and 2004, respectively.

Approximately 90% and 87% of our sales for the nine months ended September 30, 2003 and 2004, respectively, were derived from customers outside the United States. Revenues from Japanese customers, generated primarily by our wholly-owned Japanese subsidiary, accounted for 46% and 35% of total revenues in the nine months ended September 30, 2003 and 2004, respectively.

Sales to our three largest customers, ASM Lithography, Canon, and Nikon, amounted to 22%, 26% and 22%, respectively, of total revenue for the nine months ended September 30, 2003, and 35%, 14% and 21%, respectively, of total revenue for the nine months ended September 30, 2004.

Cost of Product Sales. The cost of product sales increased 11% from $142.9 million for the nine months ended September 30, 2003 to $158.3 million for the nine months ended September 30, 2004. This increase in the cost of product sales from period to period is primarily due to the overall increase in sales from period to period. Both light source system sales and sales of consumables and spare parts and service products were higher in the nine months period ended September 30, 2004 compared to the same nine-month period in 2003. Although our cost of product sales were higher in absolute dollars in the nine months ended September 30, 2004 compared to the same period in 2003, cost of product sales in 2004 included significant cost reduction achievements for our XL series products, from both a material cost and labor efficiency standpoint, and lower costs associated with our KrF light source systems, which were the majority of our system unit shipments in the nine months ended September 30, 2004.

The gross margin on product sales was 26.1% for the nine months ended September 30, 2003 as compared to 45.3% for the same nine-month period in 2004. This higher gross margin in 2004 reflects improved efficiencies associated with the XL series product, ongoing overall manufacturing cost reduction efforts and increased factory yield and utilization. As a result of the current slowdown in the semiconductor industry and our plans to reduce inventory levels, we do not anticipate that we will be able to sustain the high level of gross margin that we experienced during 2004.

Research and Development. Research and development expenses decreased 4% from $44.9 million for the nine months ended September 30, 2003 to $43.0 million for the nine months ended September 30, 2004. During the nine months of 2003, research and development spending was due primarily to the high costs associated with the final productization and introduction of the XLA 100 light source, which was shipped in the first quarter of 2003. For the nine months ended September 30, 2004, research and development spending represented costs associated with the profit sharing and bonus plans attributable to research and development personnel, which were earned by employees during the nine months ended September 30, 2004, and costs associated with our EUV light source development efforts and new business development investigations. We also continued to invest in next generation KrF and ArF products based on the XL platform. Amounts funded by external research and development contracts totaled $1.0 million and $6.0 million for the nine months ended September 30, 2003 and 2004, respectively. As a percentage of total revenues, research and development expenses decreased from 23.2% for the nine months ended September 30, 2003 to 14.8% for the same nine-month period in 2004 due to the combination of higher revenue and lower expenses from period to period.

Sales and Marketing. Sales and marketing expenses increased 41% from $12.4 million for the nine months ended September 30, 2003 to $17.5 million for the nine months ended September 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 earned by employees in all three quarters of 2004. This increase in expenses also reflects increases in marketing expenses associated with our international subsidiaries recorded in the nine months ended September 30, 2004. As a percentage of total revenues, such sales and marketing expenses decreased slightly from 6.4% for the nine months ended September 30, 2003 to 6.0% for the same nine-month period in 2004.

General and Administrative. General and administrative expenses decreased 30% from $32.9 million for the nine months ended September 30, 2003 to $23.0 million for the nine months ended September 30, 2004 due primarily to the $15.6 million tenant improvement write-off associated with the facilities vacated in the third quarter of 2003. This decrease in expenses from period to period was partially offset by expenses associated with the profit sharing and bonus plans, which were earned by employees in the nine months ended September 30, 2004 as well as increased consulting and advisory fees associated with the implementation of the Sarbanes-Oxley section 404 requirements. As a percentage of total revenues, such expenses decreased from 17.0% for the nine months ended September 30, 2003 to 7.9% for the same nine-month period in 2004 due to both higher revenues and lower expenses from period to period.

Amortization of Intangible Assets. Amortization of intangible assets totaled $120,000 for both nine-month periods ended September 30, 2003 and 2004. This amortization of intangible assets expense is consistent from year to year and relates to the existing technology associated with the acquisition of ACX, which was completed in early 2001. With our adoption of SFAS No. 142 on January 1, 2002, we discontinued the amortization of goodwill with indefinite useful life associated with previous purchase business combinations. Amortization expense for patents which is included in research and development expenses and cost of product sales was $968,000 and $1.8 million for the nine months ended September 30, 2003 and 2004, respectively.

Total Other Expense – Net. Net other expense totaled $481,000 and $2.7 million for the nine months ended September 30, 2003 and 2004, respectively. The increase in net other expense was primarily due to foreign currency exchange losses recorded in the nine months ended September 30, 2004 and decreases in interest income from period to period. The foreign currency loss in 2004 reflects the loss of $1.1 million from our discontinuance of certain cash flow hedges. The decreased interest income from period to period was primarily due to lower market interest rates for our short-term and long-term investments in the first nine months of 2004 as compared to the first nine months of 2003. This increase in expense from period to period was partially offset by a $281,000 gain on sale of investment recorded in the third quarter of 2004 and reduced interest expense associated with our lower bond balances at the end of the third quarter of 2004. Foreign currency exchange gains totaled $65,000, interest income totaled $7.0 million and interest expense totaled $7.5 million for the nine months ended September 30, 2003, compared to foreign currency exchange losses of $1.3 million, interest income of $5.9 million and interest expense of $7.4 million for the nine months ended September 30, 2004.

Income Tax Provision (Benefit). The tax benefit of $24.2 million and the tax provision of $11.6 million for the nine months ended September 30, 2003 and 2004, respectively, reflect an annual effective rate of 60% and 25%, respectively. The change in the annual effective tax rate from a benefiting rate of 60% during the nine months ended September 30, 2003 to a provision rate of 25% for the nine months ended June 30, 2004 is primarily attributable to the increase in pre-tax earnings as well as tax benefits from U.S. export incentive programs and research and development and manufacturing investment credits. The annual effective tax rates for both periods are less than the U.S. statutory rate of 35% primarily as a result of permanent book/tax differences and tax credits. The effective tax rate is a function of current tax law and geographic location of pre-tax income. On October 22, 2004, the American Jobs Creation Act of 2004 was enacted in the United States. We are currently evaluating the impact of this new law on our operations and effective tax rate. At this time, we are unable to determine the effects of this new law and will continue to analyze its potential impact as guidance is made available.

LIQUIDITY AND CAPITAL RESOURCES

As of September 30, 2004, we had approximately $217.2 million in cash and cash equivalents, $97.1 million in short-term investments, $43.8 million in long-term investments, and $435.1 million in working capital.

In February 2002, we issued $250.0 million in aggregate principal amount in a private placement of notes. These 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 our common stock at a conversion rate of 20 shares per $1,000 principal amount or an effective conversion price of $50.00 per share. We used a portion of the net proceeds from this private placement to redeem the convertible subordinated notes then outstanding. The remaining proceeds will be used for our future operating, investing and financing activities.

Net cash used in operating activities was approximately $17.1 million for the nine months ended September 30, 2003, compared to $18.6 million net cash provided by operating activities for the nine months ended September 30, 2004. Net cash used in operating activities for the nine months ended September 30, 2003 reflects the net loss for the period, higher accounts receivable balances, primarily due to the timing of sales and related customer invoicing late in the quarter, and decreases in accounts payable, accrued liabilities and income taxes for the period. This use of cash in the first nine months of 2003 was partially offset by a decrease in inventories. Net cash provided by operating activities for the nine months ended September 30, 2004 primarily reflects net income for the period and increases in accounts payable and other liabilities offset by increases in accounts receivable and inventories. The increase in accounts receivable is the result of an unusually large portion of product shipments being made in the final month of the quarter ended September 30, 2004. The increase in inventories was primarily due to our response to the growing light source utilizations that we saw throughout 2004 and our preparation from a spare parts standpoint for what we thought was a continued upturn in the semiconductor industry.

Net cash used in investing activities was approximately $18.2 million for the nine months ended September 30, 2003 compared to $5.3 million in cash provided by investing activities for the nine months ended September 30, 2004. Net cash used in investing activities for the nine months ended September 30, 2003 was due primarily to the construction costs associated with our new manufacturing and office facility in San Diego and purchases of required manufacturing equipment for the new facility. This capital expenditure during the first nine months of 2003 was offset by the timing of short-term and long-term investments that matured and were reinvested during the period. Net cash provided by investing activities for the nine months ended September 30, 2004 was due primarily to the timing of short-term and long-term investments maturing and being reinvested during the quarter, offset by a $6.0 million payment to acquire certain patents and a $2.0 million payment to acquire an additional 6% minority interest in our Cymer Korea subsidiary.

Net cash provided by financing activities was approximately $24.6 million for the nine months ended September 30, 2003 as compared to net cash used in financing activities of $36.0 million for the nine months ended September 30, 2004. Net cash provided by financing activities for the nine months ended September 30, 2003 was due primarily to proceeds received from the exercise of employee stock options totaling $31.3 million, offset by a $6.7 million payoff of our Japanese revolving loan that was made during the nine months ended September 30, 2003. Net cash used in financing activities for the nine months ended September 30, 2004 reflects the repurchase of approximately $49.2 million of our convertible subordinated notes during September 2004. This was offset by proceeds received from the exercise of stock options totaling $11.4 million during the first nine months of 2004.

During the nine months ended September 30, 2003, we had certain loan agreements with a commercial bank, 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, we were 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 us 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 our initial public offering and a secondary public offering, both in 1996, we have funded our operations primarily from cash generated from operations, the proceeds of the note offerings in August 1997 and February 2002, bank borrowings, and the proceeds from employee stock option exercises.

We require substantial working capital to fund our business, particularly to finance inventories, including purchase orders with our vendors, accounts receivable, and for capital expenditures. Our future capital requirements depend on many factors, including our 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 of our products. We believe that we have sufficient working capital to sustain operations and provide for the future expansion of our business for at least the next 12 months.

At September 30, 2004, we 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, we did not engage in trading activities involving non-exchange traded contracts. As a result, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships. We do not have relationships and transactions with persons and entities that derive benefits from their non-independent relationship with us or our related parties except as disclosed herein.

RECENT ACCOUNTING PRONOUNCEMENTS

On March 31, 2004, FASB issued a proposed statement, “Share-Based Payment - An Amendment to Statement Nos. 123 and 95,” that addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. The proposed statement would eliminate the ability to account for share-based compensation transactions using APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and generally would require instead that such transactions be accounted for using a fair-value-based method. While the final statement is subject to change, it is currently expected that it will become effective for periods beginning after June 15, 2005, which would be our third quarter in 2005. We will continue to monitor activity on this subject from the FASB in order to determine the impact on our consolidated financial statements.

Risks and Uncertainties That May Affect Results

The risks described below may not be the only risks we face. Additional risks that we do not currently think are material 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. 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 chipmakers take delivery of photolithography tools from lithography tool manufacturers (“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 chipmakers;

• 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;

• changes in market penetration by our competitors;

• 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 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.

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

The semiconductor industry is highly cyclical. We derive a substantial percentage of our revenues from lithography tool manufacturers within the semiconductor industry. Our customers depend in turn on the demand for their photolithography tool products from their customers, the chipmakers. The capital equipment expenditures of chipmakers 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 currently appears to be slowing after a short three quarter upturn that followed a significant and prolonged three-year 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.

We believe the industry has paused, particularly in regards to purchasing capacity driven semiconductor manufacturing equipment. Therefore, we are not able to predict with any certainty the depth or duration of the apparent slowdown of the semiconductor industry or the timing and order of magnitude of any future recovery. The previous downturn had a severe effect on the demand for semiconductor manufacturing equipment, including photolithography tools that our customers produce. If overall market conditions deteriorate in the near term, our current operating levels may negatively impact our profitability. We believe that downturns in the semiconductor 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 chipmakers 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 chipmakers. Market conditions in the industry and production efficiency of the lithography 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.

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, or 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:

	Nine months ended September 30,
	2003		2004

ASM Lithography	22	%	35	%
Canon	26	%	14	%
Nikon	22	%	21	%

Total	70	%	70	%

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

	December 31, 2003		September 30, 2004

ASM Lithography	38	%	45	%
Canon	14	%	3	%
Nikon	18	%	28	%

Total	70	%	76	%

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 lithography 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 KrF and ArF 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 chipmakers further adopt excimer light sources as the chosen light source for their photolithography tools. The rate with which chipmakers adopt excimer light sources may vary for a variety of reasons, including:

• inadequate performance of photoresists used in advanced DUV photolithography;

• potential shortages of specialized materials used in DUV optics;

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

• consolidation of chipmakers.

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 in which we participate;

• 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 — 248 nm, 193 nm and 157 nm. 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 lithography tool manufacturers and chipmakers, manufacturability and cost effectiveness of the new products and the development of a comparable product by our competitors.

We believe that chipmakers are currently developing a capability to produce devices that are measured at 90 nanometers or less, and these efforts are driving the current demand for our light source products for DUV photolithography systems. After chipmakers 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, EPL, and maskless lithography 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.

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.

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;

• 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.

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

We purchase a limited number of components and subassemblies included in our light source products from a single supplier or a small group of suppliers. For certain optical components used in our light source systems, we currently utilize a single supplier. To reduce the risk associated with this single supplier, we carry a significant strategic inventory of these components. Strategic inventories are managed as a percentage of future demand. We have also negotiated to have vendor-managed inventory of critical components to further reduce the risk of a single supplier. In addition, we contract 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 are susceptible to industry ups and downs and subject to the same risks and uncertainties regarding their ability to respond to changing market conditions. Because many of these suppliers reduce the size of their workforce in an industry downturn and increase it in an upturn, they may not be able to meet our

requirements or respond quickly enough as an upturn begins and gains momentum. 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, 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 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.

Decreased effectiveness of equity compensation could adversely affect our ability to attract and retain employees, and proposed changes in accounting for equity compensation could adversely affect earnings.

We have historically used stock options and other forms of equity-related incentives as a key component of our employee compensation packages. We believe that stock options and other long-term equity incentives directly motivate our employees to maximize long-term stockholder value and, through the use of long-term vesting, encourage employees to remain with us. FASB has issued a proposed statement, which is expected to be effective for periods after June 15, 2005, that would require us to record an expense to earnings for employee stock option grants and other equity incentives. Moreover, applicable stock exchange listing standards relating to obtaining stockholder approval of equity compensation plans could make it more difficult or expensive for us to grant options to employees in the future, which may result in changes in our equity compensation strategy. These and other developments in the provision of equity compensation to employees could make it more difficult to attract, retain and motivate employees, and such a change in accounting rules may adversely impact our future operating results, financial condition and cash flows.

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 chipmakers 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.

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, nondisclosure and other contractual agreements and technical measures to protect our proprietary rights.

As of September 30, 2004, we owned 207 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 June 2022. As of September 30, 2004, we had applied for 78 additional

patents in the United States. As of September 30, 2004, we owned 280 foreign patents and had 323 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, funds from research and development arrangements with third parties have been used to pay for a portion of our own research and development expenses. We receive these funds from government-sponsored programs and customers, in connection with our designing and developing specific products. Currently, funds from lithography tool manufacturers and chipmakers are used to fund a small portion of our development expenses. In providing these research and development services to these manufacturers, we try to make clear who owns the intellectual property that results from the research and development services we perform. However, disputes over the ownership or rights to use or market this intellectual property may arise between the manufacturers and us. 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 our former Japanese manufacturing partner, Seiko, or we may be infringing on some of Komatsu’s United States patents and a number of its additional Japanese patents. Komatsu has also notified one of our customers, Nikon, of its belief that our light sources infringe several of Komatsu’s Japanese and U.S. patents. As a result, we started proceedings in the Japanese Patent Office to oppose certain patents and patent applications of Komatsu. The Japanese Patent Office has dismissed some of our opposition claims. Thus, litigation may result in connection with Komatsu’s Japanese patents or U.S. patents. Also, Komatsu might claim that we infringe other or additional patents. Komatsu notified Seiko that it intends to enforce its rights against Seiko with respect to its Japanese patents if Seiko continued to engage in manufacturing activities for us. In connection with our former manufacturing agreement with Seiko, we agree to pay Seiko under certain conditions for damages associated with these types of claims. Seiko may not prevail in any litigation against Komatsu, and therefore, we may be required to pay Seiko for such damages.

We have notified our 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 (a subsidiary of Coherent, Inc.), 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;

• 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 trademarks ‘‘CYMER’’ and “INSIST ON CYMER” and others in the United States and in some other countries. We are also trying to register additional trademarks in the United

States and in other countries. We use these trademarks and many other marks in our advertisements and other business materials, which are distributed throughout the world. We may be subject to trademark infringement actions for using these marks and other marks on a worldwide basis and this would be costly to defend. If a trademark infringement action were successful, we would have to stop using the mark and possibly pay damages.

Compliance with changing regulations 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. In particular, the Section 404 internal control requirements under the Sarbanes-Oxley Act have added and will continue to add complexity and costs to our business and require a significant investment of our time to complete its initial implementation in 2004 and maintain going forward. We are taking this new requirement very seriously and making every effort to ensure that we receive a clean attestation on our internal controls from our outside auditors for 2004 and in the future, but we are unsure as to the final outcome of this effort at this time. To maintain high standards of corporate governance and public disclosure, we intend to invest all reasonably necessary resources to comply with all other evolving standards. These investments may result in increased general and administrative expenses and a diversion of management time and attention from strategic revenue generating and cost management activities.

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 chipmakers; 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.

When we sell products to our Japanese subsidiary, the sale is denominated in U.S. dollars. When 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.

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.

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

Over time, our light source products may not meet chipmakers’ production specifications or operating cost requirements after the light source is used for a long period in high volume production. If any chipmaker cannot successfully achieve or sustain their volume production using our light sources, our reputation could be damaged with the chipmakers and our customers who are the limited number of lithography 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;

• assumption of unknown liabilities or other unanticipated events or circumstances; and

• compliance with the Sarbanes-Oxley Act of 2002, new SEC regulations, Nasdaq Stock Market rules and new accounting pronouncements.

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.

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. 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 results from their use.

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.

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 our business, financial condition and results of operations.

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 U.S. 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 September 30, 2004, Cymer had outstanding foreign currency forward exchange contracts to buy U.S. $67.4 million for 7.4 billion yen under foreign currency exchange facilities with contract rates ranging from 104.3 yen to 116.2 yen per U.S. dollar. These contracts expire on various dates through June 2005.

Cymer’s foreign currency forward exchange contracts qualify for hedge accounting treatment per the provisions of Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities”. As a result, Cymer defers changes in the fair value for the effective portion of these hedges and records the amount in other comprehensive income (loss) and subsequently reclassifies the gain or loss to cost of product sales in the same period that the related sale is made to the third party. The fair value of these contracts and the deferred loss totaled $162,000 and $164,000, respectively, as of September 30, 2004. In the third quarter of 2004, Cymer recorded a loss of $1.1 million as a result of the discontinuance of certain cash flow hedges. This loss is included in foreign currency exchange gain (loss) on the accompanying statements of operations.

The fair value of these foreign currency forward exchange contracts as of September 30, 2004 would have changed by $6.8 million if the foreign currency exchange rate for the Japanese yen to the U.S. dollar on these forward contracts had changed by 10%.

Investment and Debt Risk

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. In September 2004 Cymer sold approximately $20.3 million of corporate debt securities that resulted in a $281,000 gain on the sale. 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. 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 2002 Notes are recorded at face value on the consolidated balance sheets. In the third quarter of 2004, Cymer repurchased, at a discount to par, approximately $49.2 million of these 2002 notes. As of September 30, 2004, $200.8 million principal amount of the 2002 Notes were outstanding. The fair value of such debt based on quoted market prices on September 30, 2004 was $194.3 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 September 30, 2004, 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 Cymer’s internal control over financial reporting during the fiscal quarter ended September 30, 2004 that has materially affected, or is reasonably likely to materially affect, Cymer’s internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1.	Legal Proceedings

	None.

ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds

	None.

ITEM 3.	Defaults Upon Senior Securities

	None.

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

	None.

ITEM 5.	Other Information

	None.

ITEM 6.	Exhibits

	(a)	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

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

	For the Quarterly Period Ended September 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

Nevada		33-0175463
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

17075 Thornmint Court, San Diego, CA		92127
(Address of principal executive offices)		(Zip Code)

	For the nine months ended September 30,
	2003		2004

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid	$	8,925	$	8,949
Income taxes paid, net	$	4,037	$	2,650

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	$	—

		CYMER, INC.


Date: November 5, 2004	By:	/s/ NANCY J. BAKER

		Nancy J. Baker
		Senior Vice President and
		Chief Financial Officer
		(Duly Authorized Officer and
		Principal Financial Officer)

PART I.	FINANCIAL INFORMATION

ITEM 1.	Financial Statements (unaudited)

	Consolidated Balance Sheets as of December 31, 2003 and September 30, 2004

	Consolidated Statements of Operations for the three and nine months ended September 30, 2003 and 2004

	Consolidated Statements of Cash Flows for the nine months ended September 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.	Unregistered Sales of Equity 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

SIGNATURE PAGE

Overview

Semiconductor Industry Status and Outlook

Critical Accounting Policies and Estimates

Warranty Provision

THREE MONTHS ENDED SEPTEMBER 30, 2003 AND 2004

NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2004

LIQUIDITY AND CAPITAL RESOURCES

Risks and Uncertainties That May Affect Results

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

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Foreign Currency Risk

Investment and Debt Risk

ITEM 1.

Legal Proceedings

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds

ITEM 3.

Defaults Upon Senior Securities

ITEM 4.

Submission of Matters to a Vote of Security Holders

ITEM 6.

Exhibits