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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

(Mark One)

x

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

For the Quarterly Period Ended June 30, 2010

OR

 

¨

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

For the transition period from                      to                    

Commission file number 0-21321

CYMER, INC.

(Exact name of registrant as specified in its charter)

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

 

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

(858) 385-7300

(Registrant’s telephone number, including area code)

N/A

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x  No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer x		Accelerated filer ¨		Non-accelerated filer ¨ (Do not check if a smaller     reporting company)		Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨  No x

The total number of shares of Common Stock, with $0.001 par value, outstanding on July 23, 2010 was 42,951,000.

 

 

 

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CYMER, INC.

FORM 10-Q

Quarterly Period Ended June 30, 2010

INDEX

 

				Page
PART 1.		FINANCIAL INFORMATION
ITEM 1.		Financial Statements (unaudited)		3
		Consolidated Balance Sheets - June 30, 2010 and December 31, 2009		3
		Consolidated Statements of Operations - Three and Six Months Ended June 30, 2010 and 2009		4
		Consolidated Statements of Comprehensive Income (Loss) – Three and Six Months Ended June 30, 2010 and 2009		5
		Consolidated Statements of Equity – Six Months Ended June 30, 2010		6
		Consolidated Statements of Cash Flows - Six Months Ended June 30, 2010 and 2009		7
		Notes to Unaudited Consolidated Financial Statements		8
ITEM 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		23
ITEM 3.		Quantitative and Qualitative Disclosures About Market Risk		32
ITEM 4.		Controls and Procedures		33
PART II.		OTHER INFORMATION
ITEM 1.		Legal Proceedings		34
ITEM 1A.		Risk Factors		34
ITEM 2.		Unregistered Sales of Equity Securities and Use of Proceeds		48
ITEM 3.		Defaults Upon Senior Securities		49
ITEM 4.		(REMOVED AND RESERVED)		49
ITEM 5.		Other Information		49
ITEM 6.		Exhibits		49
SIGNATURES				49

 

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ITEM 1. Financial Statements

CYMER, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

(unaudited)

 

		June 30, 2010			December 31, 2009
ASSETS
Current assets:
Cash and cash equivalents		$	78,809		$	118,381
Restricted cash			4,984			1,200
Short-term investments			75,231			62,895
Accounts receivable - net of allowance for doubtful accounts of $796 and $2,297, respectively			114,380			76,792
Accounts receivable - related party			-			732
Inventories			202,966			185,077
Deferred and prepaid income taxes			48,035			45,689
Prepaid expenses and other assets			14,301			12,121
Total current assets			538,706			502,887
Property and equipment - net of accumulated depreciation of $180,326 and $179,686, respectively			102,066			106,755
Long-term investments			-			5,167
Deferred income taxes			29,652			26,998
Goodwill			8,833			8,833
Intangible assets - net of accumulated amortization of $19,147 and $18,806, respectively			7,986			8,327
Other assets			5,200			5,951
Total assets		$	692,443		$	664,918
LIABILITIES
Current liabilities:
Accounts payable		$	31,908		$	21,756
Accounts payable - related party			127			9,284
Accrued warranty			11,985			16,640
Accrued payroll and benefits			22,726			16,434
Deferred and accrued income taxes			5,191			12,363
Deferred revenue			20,810			22,339
Accrued and other current liabilities			11,527			4,807
Total current liabilities			104,274			103,623
Accrued income taxes			14,612			11,562
Deferred revenue			681			525
Other liabilities			6,324			7,570
Total liabilities		$	125,891		$	123,280
Commitments and contingencies - Note 9
EQUITY
Cymer, Inc. stockholders’ equity:
Preferred stock - authorized 5,000,000 shares; $.001 par value; no shares issued or outstanding		$	-		$	-
Common stock - authorized 100,000,000 shares; $.001 par value; 42,951,000 shares issued and 29,539,000 shares outstanding at June 30, 2010; 42,751,000 shares issued and 29,899,000 shares outstanding at December 31, 2009			43			43
Additional paid-in capital			607,788			598,314
Treasury stock at cost (13,412,000 and 12,852,000 common shares at June 30, 2010 and December 31, 2009, respectively)			(492,890)			(473,580)
Accumulated other comprehensive loss			(8,356)			(8,280)
Retained earnings			459,967			422,750
Total Cymer, Inc. stockholders’ equity			566,552			539,247
Noncontrolling interest			-			2,391
Total equity			566,552			541,638
Total liabilities and equity		$	692,443		$	664,918

See Notes to Unaudited Consolidated Financial Statements.

 

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CYMER, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2010			2009			2010			2009
Revenues:
Product sales		$	131,864		$	62,319		$	245,645		$	118,614
Product sales - related party			-			114			-			318
Total revenues			131,864			62,433			245,645			118,932
Cost of revenues			62,373			38,311			119,338			73,269
Gross profit			69,491			24,122			126,307			45,663
Operating expenses:
Research and development			21,617			14,285			41,502			32,728
Sales and marketing			6,332			3,947			11,466			7,910
General and administrative			10,346			6,430			19,557			13,674
Restructuring			-			-			-			8,407
Total operating expenses			38,295			24,662			72,525			62,719
Operating income (loss)			31,196			(540)			53,782			(17,056)
Other income (expense):
Foreign currency exchange gain (loss)			(160)			455			(56)			(1,478)
Interest and other income			173			418			313			1,021
Interest and other expense			(139)			(90)			(316)			(853)
Total other income (expense) - net			(126)			783			(59)			(1,310)
Income (loss) before income tax expense (benefit)			31,070			243			53,723			(18,366)
Income tax expense (benefit)			9,858			452			16,654			(6,061)
Net income (loss)		$	21,212		$	(209)		$	37,069		$	(12,305)
Net loss attributable to noncontrolling interest in subsidiary			-			734			148			1,343
Net income (loss) attributable to Cymer, Inc.		$	21,212		$	525		$	37,217		$	(10,962)
Earnings per share:
Basic earnings (loss) per share		$	0.71		$	0.02		$	1.25		$	(0.37)
Weighted average common shares outstanding - basic			29,716			29,680			29,856			29,664
Diluted earnings (loss) per share		$	0.70		$	0.02		$	1.23		$	(0.37)
Weighted average common shares outstanding - diluted			30,127			29,845			30,194			29,664

See Notes to Unaudited Consolidated Financial Statements.

 

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CYMER, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands)

(unaudited)

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2010			2009			2010			2009
Net income (loss)		$	21,212		$	(209)		$	37,069		$	(12,305)
Other comprehensive income (loss):
Foreign currency translation adjustments			1,108			4,627			220			(1,523)
Unrealized (losses) gains on available for sale investments, net of income tax (benefit) expense of $(5), $18, $(20) and $(11), respectively			(9)			30			(32)			(18)
Unrealized (losses) gains on foreign currency forward exchange contracts, net of income tax (benefit) expense of $(202), $(81), $(175) and $83, respectively			(297)			(119)			(257)			122
Unrealized pension (losses) gains			(7)			(3)			(7)			5
Total other comprehensive income (loss)			795			4,535			(76)			(1,414)
Comprehensive income (loss)		$	22,007		$	4,326		$	36,993		$	(13,719)
Comprehensive loss attributable to noncontrolling interest in subsidiary			-			734			148			1,343
Comprehensive income (loss) attributable to Cymer, Inc.		$	22,007		$	5,060		$	37,141		$	(12,376)

See Notes to Unaudited Consolidated Financial Statements.

 

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CYMER, INC.

CONSOLIDATED STATEMENTS OF EQUITY

(in thousands)

(unaudited)

 

 

															Accumulated
							Additional								Other
		Common Stock					Paid-in			Treasury Stock					Comprehensive			Retained						Noncontrolling
		Shares		Amount			Capital			Shares		Amount			Loss			Earnings			Total			Interest			Total
BALANCE, DECEMBER 31, 2009		42,751		$	43		$	598,314		(12,852)		$	(473,580)		$	(8,280)		$	422,750		$	539,247		$	2,391		$	541,638
Exercise of common stock options		83			-			2,634		-			-			-			-			2,634			-			2,634
Issuance of shares upon vesting of restricted stock unit awards		107			-			-		-			-			-			-			-			-			-
Issuance of employee stock purchase plan shares		10			-			302		-			-			-			-			302			-			302
Employee stock-based compensation		-			-			5,180		-			-			-			-			5,180			-			5,180
Income tax benefit from stock option exercises		-			-			1,301		-			-			-			-			1,301			-			1,301
Repurchases of common stock into treasury		-			-			-		(560)			(19,310)			-			-			(19,310)			-			(19,310)
Acquisition of noncontrolling interest in subsidiary		-			-			57		-			-			-			-			57			(2,243)			(2,186)
Net income		-			-			-		-			-			-			37,217			37,217			(148)			37,069
Other comprehensive income:
Foreign currency translation adjustments		-			-			-		-			-			220			-			220			-			220
Unrealized losses on available-for-sale investments, net of tax		-			-			-		-			-			(32)			-			(32)			-			(32)
Unrealized losses on foreign currency forward exchange contracts, net of tax		-			-			-		-			-			(257)			-			(257)			-			(257)
Unrealized pension losses, net of tax		-			-			-		-			-			(7)			-			(7)			-			(7)
BALANCE, JUNE 30, 2010		42,951		$	43		$	607,788		(13,412)		$	(492,890)		$	(8,356)		$	459,967		$	566,552		$	-		$	566,552

See Notes to Unaudited Consolidated Financial Statements.

 

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CYMER, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

		Six Months Ended June 30,
		2010			2009
Operating activities:
Net income (loss)		$	37,069		$	(12,305)
Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities:
Depreciation and amortization			9,789			11,672
Stock-based compensation			5,180			2,169
Bad debt expense			(696)			1,218
Excess tax benefits from stock option exercises			(1,370)			-
Provision for deferred income taxes			(3,669)			451
Loss on disposal and impairment of property and equipment			61			584
Change in assets and liabilities:
Restricted cash			(3,754)			-
Accounts receivable			(36,676)			16,637
Accounts receivable - related party			732			546
Inventories			(17,745)			17,505
Prepaid expenses and other assets			(1,434)			1,108
Income taxes receivable			-			(9,085)
Accounts payable			12,520			(4,071)
Accounts payable - related party			(9,157)			(763)
Accrued expenses and other liabilities			5,998			(20,959)
Deferred revenue			(1,362)			(1,173)
Income taxes payable and accrued income taxes			(3,895)			(2,146)
Net cash (used in) provided by operating activities			(8,409)			1,388
Investing activities:
Acquisition of property and equipment			(7,879)			(3,210)
Purchases of investments			(57,880)			(26,147)
Proceeds from sold or matured investments			50,659			22,329
Net cash used in investing activities			(15,100)			(7,028)
Financing activities:
Proceeds from issuance of common stock			3,017			1,360
Purchase of noncontrolling interest			(1,456)			-
Repayment of convertible subordinated notes			-			(140,722)
Excess tax benefits from stock option exercises			1,370			42
Repurchase of common stock into treasury			(19,310)			-
Net cash used in financing activities			(16,379)			(139,320)
Effect of exchange rate changes on cash and cash equivalents			316			(1,982)
Net decrease in cash and cash equivalents			(39,572)			(146,942)
Cash and cash equivalents at beginning of the period			118,381			252,391
Cash and cash equivalents at end of the period		$	78,809		$	105,449
Supplemental disclosure of cash flow information:
Interest paid		$	196		$	2,654
Income taxes paid		$	24,143		$	5,990
Supplemental disclosure of noncash operating, investing and finance activities:
Net (decrease) increase in acquisition of property and equipment included in accounts payable		$	(2,268)		$	330
Net (decrease) increase in in-transit proceeds from issuance of common stock		$	(81)		$	45

See Notes to Unaudited Consolidated Financial Statements.

 

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CYMER, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Quarterly Period Ended June 30, 2010

1. BASIS OF PRESENTATION

Nature of Operations

Cymer, Inc., together with its wholly-owned subsidiaries, is engaged primarily in the development, manufacturing and marketing of excimer light sources for sale to customers who manufacture photolithography tools in the semiconductor equipment industry. We sell replacement parts and support to our lithography tool manufacturer customers as well as directly to our chipmaker customers. Our TCZ reporting segment develops, integrates, markets, and supports silicon crystallization systems used in the manufacture of organic light emitting diode (“OLED”) flat panel displays.

We manufacture our products primarily at our San Diego headquarters, and we also conduct refurbishment manufacturing activities for replacement parts at our subsidiary office located in Korea. We sell our products to customers primarily in the United States, Europe, Japan, Taiwan, Korea and other Asian countries. We provide customer support from our San Diego headquarters, and from our field offices located throughout the United States, Europe, Japan, Korea, Singapore, China, and Taiwan.

Unaudited Interim Financial Statements

The accompanying unaudited consolidated financial information has been prepared by management, without audit, in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. The unaudited consolidated balance sheet at December 31, 2009 was derived from the audited consolidated financial statements at that date; however, it does not include all disclosures required by accounting principles generally accepted in the United States.

In the opinion of management, the unaudited consolidated financial statements for the interim period 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 unaudited consolidated financial statements and notes hereto should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2009. 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 year ending December 31, 2010.

Principles of Consolidation

The accompanying unaudited consolidated financial statements include the accounts of Cymer, Inc. and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. References to “Cymer”, “the Company,” “we,” “us,” “our” and other similar words refer to Cymer, Inc. and its consolidated subsidiaries, unless the context suggests otherwise.

On January 15, 2010, we purchased the remaining 40% ownership interest in TCZ, which increased our ownership in TCZ from 60% to 100%. Prior to January 15, 2010, we reflected the noncontrolling interest of TCZ in our unaudited consolidated financial statements with any earnings or losses distributed in accordance with the respective percentage interests of the joint owners.

Correction of Immaterial Error Related to Prior Periods

During the three months ended June 30, 2010, we corrected an immaterial error in our previously presented consolidated statement of cash flows for the six months ended June 30, 2009. The error related to the treatment of non-cash transfers between inventory and property and equipment during the six months ended June 30, 2009. The effect of the correction on our consolidated statement of cash flows for the six months ended June 30, 2009 was to decrease net cash provided by operating activities from $2.2 million to $1.4 million and to decrease net cash used in investing activities from $7.8 million to $7.0 million.

We will revise our historical consolidated statements of cash flows for the three months ended March 31, 2010, the nine months ended September 30, 2009 and the years ended December 31, 2009 and 2008 when the respective statements are presented in future filings. The effect of the correction for the three months ended March 31, 2010 is estimated to increase net cash used in operating activities and increase net cash provided by investing activities by approximately $1.7 million. The effect of the correction for the nine months ended September 30, 2009 is estimated to increase net cash provided by operating activities and increase net cash used in investing activities by approximately $0.8 million. The effect of the correction for the year ended December 31, 2009 is estimated to decrease net cash provided by operating activities and decrease net cash used in investing activities by approximately $5.1 million. The effect of the correction for the year ended December 31, 2008 is estimated to increase net cash used in operating activities and decrease net cash used in investing activities by approximately $2.1 million.

Use of Estimates

The unaudited consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. Applying these principles 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 unaudited consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results may differ from those estimates.

Recently Issued Accounting Standards

In January 2010, the Financial Accounting Standards Board (“FASB”) issued guidance to require additional disclosures for fair value measurements including the following: (1) amounts transferred in and out of Level 1 and 2 fair value measurements, which is effective for interim and annual reporting periods beginning after December 15, 2009 (“Part I”), and (2) activities in Level 3 fair value measurements including purchases, sales, issuances, and settlements, which is effective for interim and annual reporting periods beginning after December 15, 2010 (“Part II”). We adopted Part I of the revised guidance for fair value measurements disclosures on January 1, 2010, which did not have a significant effect on our unaudited consolidated financial statements. We do not expect adoption of Part II of the revised guidance to have a material effect on our consolidated financial statements.

 

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In January 2010, the FASB issued additional guidance to clarify the scope of the decrease in ownership provisions in the existing guidance for consolidations. The new guidance is effective in the first annual or interim reporting period ending on or after December 15, 2009 for an entity that previously adopted the FASB authoritative guidance for consolidations. We adopted the guidance as of January 1, 2010, which did not have a significant effect on our unaudited consolidated financial statements.

In April 2010, the FASB issued additional guidance for revenue recognition to provide criteria that should be met for determining whether the milestone method of revenue recognition is appropriate. A vendor can recognize as revenue, in its entirety, consideration that is contingent upon achievement of a milestone in the period in which the milestone is achieved only if the milestone meets all criteria to be considered substantive. The guidance for milestone method of revenue recognition is effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010. We do not expect adoption of this guidance to have a significant effect on our unaudited consolidated financial statements.

2. INVENTORIES

Inventories consisted of the following (in thousands):

 

		June 30, 2010			December 31, 2009
Raw materials		$	67,740		$	59,189
Work-in-progress			53,283			41,014
Finished goods			81,943			84,874
		$	202,966		$	185,077

3. FAIR VALUE MEASUREMENTS

Per the authoritative guidance for fair value instruments, assets and liabilities recorded at fair value in our unaudited consolidated balance sheets are categorized based upon the level of judgment associated with the inputs used to measure their fair value. The levels as defined by the fair value hierarchy in the authoritative guidance for fair value instruments are as follows:

 

Level 1		—		Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.
Level 2		—		Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly at the measurement date.
Level 3		—		Inputs are unobservable for the asset or liability and usually reflect the reporting entity’s best estimate of what market participants would use in pricing the asset or liability at the measurement date.

Financial Assets and Liabilities

We analyze our financial assets and liabilities measured at fair value and categorize them within the fair value hierarchy based on the level of judgment associated with the inputs used to measure their fair value in accordance with the authoritative guidance for fair value instruments and the fair value option for financial assets and financial liabilities.

The majority of our available-for-sale securities and our foreign currency forward exchange contracts are priced via independent providers. In obtaining such valuation information from third parties, we have evaluated the valuation methodologies used to develop the fair values in order to determine whether such valuations are representative of an exit price in our principal markets.

Available-for-Sale Securities. The fair values of our available-for-sale securities are determined by a matrix pricing, which is a mathematical technique widely used to value securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark-quoted securities. Such assets are classified as Level 2 inputs in the fair value hierarchy and typically include commercial paper and government and corporate fixed income securities included in our investment portfolio.

 

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Preferred Stock. We hold preferred stock which is valued at zero, as we believe it is unlikely we will receive any future cash flow from this preferred stock.

Derivative Instruments. Our foreign currency forward exchange contracts are valued using an income approach which includes observable Level 2 market inputs at the measurement date and uses a standard valuation technique to convert future foreign currency amounts to a single discounted present amount assuming participants are motivated, but not compelled, to transact. Level 2 inputs are limited to quoted prices for similar assets or liabilities in active markets and inputs other than quoted prices that are observable for the asset or liability. Key inputs in this discounted calculation include spot currency exchange rates at the measurement date, interest rates, and credit default swap rates at standard quoted intervals. Credit default swaps on us are not available, so we estimated our credit risk premium based on a financing arrangement that was offered to us during the three months ended June 30, 2010 by a third party. The principal market in which we execute our foreign currency forward exchange contracts is the retail market. Mid-market pricing is used as a practical expedient for fair value measurements. Since significant inputs in the valuation of our foreign currency forward exchange contracts are observable in the active market, they are classified as Level 2 in the fair value hierarchy.

We did not have any transfers in or transfers out of Level 1 or Level 2 fair value measurements during the six months ended June 30, 2010. Our financial assets and financial liabilities measured at fair value on a recurring basis are as follows (in thousands):

 

					June 30, 2010			Fair Value Measurements at Reporting Date Using:
								Level 1			Level 2			Level 3
Assets:
Investment securities:
Cash and cash equivalents					$	78,809		$	78,809		$	-		$	-
Restricted cash						4,984			4,984			-			-
Short-term investments:
Corporate debt securities						39,402			-			39,402			-
U.S. government securities						35,829			-			35,829			-
Foreign currency forward exchange contracts		(1	)			134			-			134			-
Total assets					$	159,158		$	83,793		$	75,365		$	-
Liabilities:
Foreign currency forward exchange contracts		(2	)		$	2,065		$	-		$	2,065		$	-
Total liabilities					$	2,065		$	-		$	2,065		$	-
					December 31, 2009			Fair Value Measurements at Reporting Date Using:
								Level 1			Level 2			Level 3
Assets:
Investment securities:
Cash and cash equivalents					$	118,381		$	112,751		$	5,630		$	-
Restricted cash						1,200			1,200			-			-
Short-term investments:
Corporate debt securities						30,465			-			30,465			-
U.S. government securities						32,430			-			32,430			-
Long-term investments - corporate debt securities						5,167			-			5,167			-
Foreign currency forward exchange contracts		(1	)			208			-			208			-
Total assets					$	187,851		$	113,951		$	73,900		$	-
Liabilities:
Foreign currency forward exchange contracts		(2	)		$	182		$	-		$	182		$	-
Total liabilities					$	182		$	-		$	182		$	-

 

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(1)	Included in prepaid expenses and other assets on the accompanying unaudited consolidated balance sheets.

 

(2)	Included in accrued and other current liabilities on the accompanying unaudited consolidated balance sheets.

Non-Financial Assets and Liabilities

We apply fair value techniques on a non-recurring basis associated with: (1) valuing potential impairment losses related to goodwill which are accounted for pursuant to the authoritative guidance for intangibles—goodwill and other; and (2) valuing potential impairment losses related to long-lived assets which are accounted for pursuant to the authoritative guidance for property, plant and equipment.

We currently have two separate reporting units: (1) our primary business to design, manufacture and sell excimer light source systems and installed base products for use in lithography systems used in the manufacture of semiconductors; and (2) TCZ, which is currently developing and producing a system for use in the manufacture of OLED flat panel displays. We test for goodwill impairment at the reporting unit level. All of our goodwill is associated with our primary business unit, and we determine the fair value of this reporting unit based on a combination of inputs including the market capitalization of the company, as well as Level 3 inputs such as discounted cash flows which are not observable from the market, directly or indirectly. We conduct our goodwill impairment analysis annually as of November 30 each year, or upon the occurrence of certain triggering events. No such triggering events occurred during the six months ended June 30, 2010. Historically, the fair value of our primary business reporting unit has significantly exceeded its carrying value.

We test for the impairment of our long-lived assets when triggering events occur and such impairment, if any, is measured at fair value. The inputs for fair value of our long lived assets would be based on Level 3 inputs as data used for such fair value calculations would be based on discounted cash flows which are not observable from the market, directly or indirectly. During the six months ended June 30, 2010, there have been no triggering events associated with our long-lived assets; therefore, no impairment analysis was conducted during the period.

4. INVESTMENTS

Investments at June 30, 2010 consisted of the following (in thousands):

 

		Amortized Cost			Gross Unrealized Gains			Gross Unrealized Losses			Market Value
Short-term:
Corporate debt securities		$	39,439		$	-		$	37		$	39,402
U.S. government agencies			35,814			15			-			35,829
Total		$	75,253		$	15		$	37		$	75,231

Investments at December 31, 2009 consisted of the following (in thousands):

 

		Amortized Cost			Gross Unrealized Gains			Gross Unrealized Losses			Market Value
Short-term:
Corporate debt securities		$	30,404		$	63		$	2		$	30,465
U.S. government agencies			32,443			1			14			32,430
Total		$	62,847		$	64		$	16		$	62,895
Long-term:
Corporate debt securities		$	5,181		$	-		$	14		$	5,167
Total		$	5,181		$	-		$	14		$	5,167

As of June 30, 2010, the contractual maturities of our investments were all less than one year and classified as short-term. We did not have any investments in individual securities that have been in a continuous unrealized loss position deemed to be temporary for more than 12 months at June 30, 2010.

 

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5. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

We conduct business in several currencies through our global operations and, as a result, are exposed to foreign currency risks associated with our international subsidiary offices, particularly those located in Japan, Korea, the Netherlands and Taiwan. Our foreign currency risk falls into two primary categories.

First, our gross profit margins are subject to change when we sell our products in one currency and the product costs are denominated in a different currency. To mitigate this risk, we enter into derivative financial instruments, principally forward contracts, which we designate as cash flow hedges to mitigate fluctuations in the gross profit margins of these forecasted transactions. Designated hedging instruments qualify for cash flow hedge accounting treatment if certain criteria are met. For example, at the inception of the hedge, we must have formal documentation of the hedging relationship and our management objective and strategy for undertaking the hedge, including identification of the hedging instrument, the hedged transaction, the nature of the risk being hedged, and how the hedging instrument’s effectiveness will be assessed. The hedging relationship must be highly effective in achieving offsetting cash flows attributable to the hedged risk during the term of the hedge. We record changes in the fair value of the effective portion of these hedges in accumulated other comprehensive income (loss), and subsequently reclassify the gain or loss to cost of revenues in the same period that the related sale is made to the third party. Interest charges or “forward points” on our forward contracts are excluded from the assessment of hedge effectiveness and are recorded in cost of revenues in the unaudited consolidated statements of operations.

As mentioned above, gains and losses on cash flow hedges are recorded in accumulated other comprehensive income (loss) until the hedged transaction is recorded in the unaudited consolidated financial statements. Once the underlying transaction is recorded in the unaudited consolidated financial statements, we de-designate the derivative, reclassify the accumulated gain or loss on the derivative into cost of revenues and cease to apply hedge accounting treatment. Once the derivative has been de-designated, any further gains or losses are recorded to other income (expense). If all or a portion of the forecasted transaction were cancelled, this would render all or a portion of the cash flow hedge ineffective, and we would reclassify the ineffective portion of the hedge into other income (expense). We generally do not experience ineffectiveness of our cash flow hedges as a result of cancelled transactions, and the accompanying unaudited consolidated financial statements do not include such gains or losses.

The second category of foreign currency risk occurs when transactions are recorded in our unaudited consolidated financial statements in a currency other than the applicable subsidiary’s functional currency and the cash settlement of the transaction occurs at some point in the future. When transactions in non-functional currency are recorded to our unaudited consolidated financial statements, changes in the recorded amounts resulting from fluctuations in the value of that currency are recorded to other income (expense). In order to mitigate these remeasurement gains and losses, we enter into derivative financial instruments, principally forward contracts. The forward contracts that hedge these transactions that have been recorded to our unaudited consolidated financial statements are not designated as hedges and, therefore, we record changes in their fair value to other income (expense). See Note 3, “Fair Value Measurements” for further discussion of our derivative instruments during the six months ended June 30, 2010.

The derivatives that we enter into generally have maturity dates of no more than twelve months. We adjust the level and use of derivatives as soon as practicable after learning that an exposure has changed, and we review all exposures and derivative positions on a regular basis.

At June 30, 2010, we had outstanding forward contracts to buy $31.8 million in exchange for Japanese Yen, $8.0 million in exchange for Korean Won, $3.5 million in exchange for Taiwanese Dollars, and to sell $7.6 million in exchange for Euros. The fair value of all of our forward contracts totaled to a liability of $1.9 million at June 30, 2010. The deferred loss, net of tax, for those that qualified for hedge accounting treatment was $195,000 as of June 30, 2010. We expect that this unrealized loss will be reclassified from accumulated other comprehensive income into earnings at the then-current values over the next twelve months as the underlying hedged transactions occur.

We do not enter into derivative instruments for speculative purposes.

 

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The derivative instruments that we enter into are subject to master netting arrangements and qualify for net presentation on the balance sheet. The gross fair value of derivative instruments in our unaudited consolidated balance sheet was as follows (in thousands):

 

		Asset Derivatives (1)
		June 30, 2010					December 31, 2009
		Balance Sheet Location		Fair Value			Balance Sheet Location		Fair Value
Derivatives designated as hedging instruments: Foreign exchange contracts		Prepaid expenses and other assets		$	-		Prepaid expenses and other assets		$	103
Derivatives not designated as hedging instruments: Foreign exchange contracts		Prepaid expenses and other assets		$	134		Prepaid expenses and other assets		$	444
Total derivatives				$	134				$	547
		Liabilities Derivatives (1)
		June 30, 2010					December 31, 2009
		Balance Sheet Location		Fair Value			Balance Sheet Location		Fair Value
Derivatives designated as hedging instruments: Foreign exchange contracts		Accrued and other current liabilities		$	328		Accrued and other current liabilities		$	-
Derivatives not designated as hedging instruments: Foreign exchange contracts		Accrued and other current liabilities		$	1,737		Accrued and other current liabilities		$	521
Total derivatives				$	2,065				$	521

 

(1)	There were no asset derivatives designated as derivative hedging instruments at June 30, 2010, and there were no liabilities derivatives designated as derivative hedging instruments at December 31, 2009.

 

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The effect of derivative instruments on our unaudited consolidated statement of operations was as follows (in thousands):

 

		Three Months Ended June 30, 2010
Derivatives in cash flow hedging relationships		Gain (loss) recognized in other comprehensive income (“OCI”) on derivatives (effective portion)				Location of gain (loss) reclassified from accumulated OCI into income (effective portion)		Gain (loss) reclassified from accumulated OCI into income (effective portion)			Location of gain (loss) recognized in income on derivatives (ineffective portions and amount excluded from effectiveness testing)		Gain (loss) recognized in income on derivatives (ineffective portion and amount excluded from effectiveness testing)(1)
Foreign exchange contracts		$	(515	)		Cost of revenues		$	145		Cost of revenues		$	(3	)
Total		$	(515	)				$	145				$	(3	)
		Three Months Ended June 30, 2009
Derivatives in cash flow hedging relationships		Gain (loss) recognized in OCI on derivatives (effective portion)				Location of gain (loss) reclassified from accumulated OCI into income (effective portion)		Gain (loss) reclassified from accumulated OCI into income (effective portion)			Location of gain (loss) recognized in income on derivatives (ineffective portions and amount excluded from effectiveness testing)		Gain (loss) recognized in income on derivatives (ineffective portion and amount excluded from effectiveness testing)(1)
Foreign exchange contracts		$	(201	)		Cost of revenues		$	160		Cost of revenues		$	13
Total		$	(201	)				$	160				$	13

 

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		Six Months Ended June 30, 2010
Derivatives in Cash Flow Hedging Relationships		Gain (loss) recognized in OCI on derivatives (effective portion)				Location of gain (loss) reclassified from accumulated OCI into income (effective portion)		Gain (loss) reclassified from accumulated OCI into income (effective portion)				Location of gain (loss) recognized in income on derivatives (ineffective portions and amount excluded from effectiveness testing)		Gain (loss) recognized in income on derivatives (ineffective portion and amount excluded from effectiveness testing)(1)
Foreign exchange contracts		$	(447	)		Cost of revenues		$	101			Cost of Revenues		$	(1	)
Total		$	(447	)				$	101					$	(1	)
		Six Months Ended June 30, 2009
Derivatives in Cash Flow Hedging Relationships		Gain (loss) recognized in OCI on derivatives (effective portion)				Location of gain (loss) reclassified from accumulated OCI into income (effective portion)		Gain (loss) reclassified from accumulated OCI into income (effective portion)				Location of gain (loss) recognized in income on derivatives (ineffective portions and amount excluded from effectiveness testing)		Gain (loss) recognized in income on derivatives (ineffective portion and amount excluded from effectiveness testing)(1)
Foreign exchange contracts		$	184			Cost of revenues		($	62	)		Cost of revenues		$	32
Total		$	184					($	62	)				$	32

 

(1)	The amount represents the gain (loss) recognized in income on the amount of the hedging relationship excluded from effectiveness testing. There was no gain (loss) recognized in income related to an ineffective portion of the hedging relationship.

 

		Three Months Ended June 30, 2010
Derivatives Not Designated as Hedging Instruments		Location of gain (loss) recognized in income on derivatives		Gain (loss) recognized in income on derivatives
Foreign exchange contracts		Foreign currency exchange loss		$	(1,638	)
Total				$	(1,638	)
		Three Months Ended June 30, 2009
Derivatives Not Designated as Hedging Instruments		Location of gain (loss) recognized in income on derivatives		Gain (loss) recognized in income on derivatives
Foreign exchange contracts		Foreign currency exchange loss		$	(429	)
Total				$	(429	)

 

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		Six Months Ended June 30, 2010
Derivatives Not Designated as Hedging Instruments		Location of gain (loss) recognized in income on derivatives		Gain (loss) recognized in income on derivatives
Foreign exchange contracts		Foreign currency exchange loss		$	(2,573	)
Total				$	(2,573	)
		Six Months Ended June 30, 2009
Derivatives Not Designated as Hedging Instruments		Location of gain (loss) recognized in income on derivatives		Gain (loss) recognized in income on derivatives
Foreign exchange contracts		Foreign currency exchange gain		$	345
Total				$	345

We are exposed to credit losses in the event of nonperformance by the banks with which we transact foreign currency hedges. We manage this credit risk by transacting foreign currency hedging with more than one institution, only executing hedges with counterparties that meet our minimum requirements, monitoring the credit ratings of our counterparties on a regular basis and negotiating contractual master netting provisions that allow us to record and offset liabilities to a counterparty against amounts due from that counterparty in an event of default. We do not receive collateral from our hedging counterparties. As of June 30, 2010, we did not have any credit exposure from nonperformance of foreign exchange hedging counterparties as we were in a net liability position.

6. EQUITY

Equity Awards

We grant equity awards from our 2005 Equity Incentive Plan (the “Incentive Plan”), which provides for the issuance of incentive stock options, non-statutory stock options, stock appreciation rights, stock bonus awards, stock purchase awards, stock unit awards and other stock awards to our employees, non-employee directors and consultants. Stock options issued under the Incentive Plan expire ten years after the options are granted and generally vest and become exercisable ratably over a four-year period following the date of grant. Stock unit awards issued under the Incentive Plan generally vest one to four years from the date granted.

Stock Options, Restricted Stock Unit Awards (“RSUs”) and Performance-Based Restricted Stock Unit Awards (“PRSUs”).

The majority of our equity awards are granted annually to our executive officers and certain key management under our long-term incentive program (“LTIP”) pursuant to our Incentive Plan.

 

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The table below summarizes the total number of shares granted:

 

		Three Months Ended June 30,				Six Months Ended June 30,
		2010		2009		2010		2009
Stock options (1)		20,000		-		40,000		5,000
Restricted stock unit awards (2)		11,180		2,030		223,599		232,148
Performance restricted stock unit awards (3)(4)		21,000		-		273,100		108,110
		52,180		2,030		536,699		345,258

 

(1)

Stock options vest over a four-year period with 25% of the shares vesting on the one-year anniversary of the participant’s date of hire, and the balance vesting in 36 equal monthly installments thereafter, subject to the participant’s continued service through the applicable vesting dates.

 

(2)

RSUs vest over a three-year period with 33% of the shares vesting on or about the first business day of each of the next three years following the date of grant, subject to the participant’s continued service through the applicable vesting dates.

 

(3)

The number of shares subject to PRSUs granted in 2010 represents the aggregate target awards for such PRSUs. The number of shares ultimately issued will be determined based on our relative performance related to market share, revenue, and net income compared to a specified company or group of peer companies over a one-year performance period. The shares, if any, will be issued following the end of the one-year performance period. The shares issued will vest over a three-year period, with 33% of the shares vesting on or about the first business day of each of the next three years following the date of grant, subject to the participant’s continued service through the applicable vesting dates. A participant must be employed on the last day of the performance period in order to be eligible for any shares subject to the PRSU award to vest and become issuable to the participant.

 

(4)

The number of shares subject to PRSUs granted in 2009 represents the aggregate target awards for such PRSUs. The number of shares ultimately issued will be determined based on our relative performance related to revenue and net income compared to a specified group of peer companies over a three-year performance period and the eligible individual’s management by objectives achievement during the same three-year performance period. The shares, if any, will be issued and fully vested following the end of the three-year performance period. A participant must be employed on the last day of the performance period in order to be eligible for any shares subject to the PRSU award to become issuable to the participant.

We measure the fair value of stock-based awards at the grant date as determined by a Black-Scholes option pricing model. The fair value is recognized as expense over the requisite service period. We value the stock unit awards which are issued to our non-employee directors, executive officers and certain key employees based on the fair value of our common stock on the date that the stock unit award is granted. Compensation expense related to RSUs is recognized over the service period. We adjust compensation expense related to PRSUs throughout the service period based upon the expected achievement of the underlying performance conditions. An estimated forfeiture rate is applied and included in the calculation of stock-based compensation at the time that the stock option or stock unit awards are granted and revised if necessary in subsequent periods, if actual forfeiture rates differ from those estimates.

 

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The following weighted average assumptions were used for stock options granted during the periods:

 

		Three Months Ended June 30,					Six Months Ended June 30,
		2010			2009(1)		2010			2009
Dividend yield		None			-		None			None
Volatility rate		46	%		-		44	%		53	%
Risk free interest rate		2.04	%		-		2.17	%		1.89	%
Expected life		3.1 years			-		3.0 years			3.1 years

 

(1)

No stock options were granted in the three months ended June 30, 2009.

Share-Based Compensation

The components of share-based compensation expense were as follows (in thousands):

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2010			2009			2010			2009
Stock options		$	367		$	440		$	758		$	1,223
RSUs			1,035			643			1,900			1,180
PRSUs			1,474			249			2,522			(234)
Total share-based compensation		$	2,876		$	1,332		$	5,180		$	2,169

Stock Repurchase Program

In April 2008, our board of directors authorized us to repurchase up to $100 million of our common stock. The program does not have a fixed expiration date and may be discontinued at any time. During the three months ended June 30, 2010, we purchased 560,000 shares for $19.3 million under this program. As of June 30, 2010, $57.8 million remain available under this program for repurchases.

Comprehensive Income (Loss)

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

The components of accumulated other comprehensive loss are as follows (in thousands):

 

		June 30, 2010			December 31, 2009
Foreign currency translation adjustments		$	(7,962)		$	(8,182)
Unrealized gains (losses) on available-for-sale investments, net of tax			(30)			2
Net unrealized gains (losses) on foreign currency forward exchange contracts, net of tax			(195)			62
Unrealized pension losses, net of tax			(169)			(162)
Accumulated other comprehensive loss		$	(8,356)		$	(8,280)

7. EARNINGS (LOSS) PER SHARE

Basic earnings (loss) per share (“EPS”) is computed by dividing net income or loss attributable to common stockholders by the weighted-average number 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 were exercised or converted into common stock. Potential dilutive securities include our stock options, RSUs, and PRSUs. Potential dilutive securities are excluded from the diluted EPS computation in loss periods as their effect would be anti-dilutive.

 

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The following table sets forth the basic and diluted EPS (in thousands, except per share information):

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2010			2009			2010			2009
Numerator:
Net income (loss) attributable to Cymer, Inc.		$	21,212		$	525		$	37,217		$	(10,962)
Denominator:
Weighted average shares used to compute basic EPS			29,716			29,680			29,856			29,664
Effect of dilutive options and stock unit awards			411			165			338			-
Diluted weighted average common shares outstanding			30,127			29,845			30,194			29,664
Earnings (loss) per share:
Basic		$	0.71		$	0.02		$	1.25		$	(0.37)
Diluted		$	0.70		$	0.02		$	1.23		$	(0.37)

For the three months ended June 30, 2010 and 2009, weighted average options, RSUs, and PRSUs totaling 961,000 shares and 2.4 million shares, respectively, were not included in the computation of diluted earnings per share as their effect was anti-dilutive.

For the six months ended June 30, 2010 and 2009, weighted average options, RSUs, and PRSUs totaling 1.0 million shares and 2.8 million shares, respectively, were not included in the computation of diluted earnings per share as their effect was anti-dilutive. Additionally, for the six months ended June 30, 2009, 746,000 shares of weighted average common stock attributable to our convertible subordinated notes, which were repaid at maturity in February 2009, were not included in the computation of diluted earnings per share as their effect was anti-dilutive.

8. INCOME TAXES

We calculate our interim tax provision in accordance with the guidance for accounting for income taxes in interim periods. At the end of each interim period, we estimate the annual effective tax rate and apply that tax rate to our ordinary year-to-date pre-tax income. The tax expense or benefit related to significant, unusual or extraordinary discrete events during the interim period is recognized in the interim period in which those events occurred. In addition, the effect of changes in enacted tax laws or rates or tax status is recognized in the interim period in which the change occurs.

Income tax expense of $9.9 million and $16.7 million reflect effective tax rates of 31.7% and 31.0% for the three and six months ended June 30, 2010, respectively. Our effective tax rate for the three months ended June 30, 2010 was less than the United States federal statutory rate of 35% due primarily to a benefit from the U.S. manufacturing deduction, offset partially by state income taxes net of federal benefit. Additionally, we recorded a net tax benefit in the United States of $324,000 as a discrete item during the three months ended June 30, 2010, which represents our estimate of TCZ net operating loss carryforwards we expect to utilize in the future given the retroactive revocation of TCZ’s tax holiday in Singapore. The $324,000 net tax benefit represents the establishment of a $1.2 million deferred tax asset, offset by a valuation allowance of $917,000. Our effective tax rate for the six months ended June 30, 2010 was less than the United States federal statutory rate of 35% due primarily to a benefit from the U.S. manufacturing deduction, a $324,000 net tax benefit discussed above, and a net tax benefit in the United States of $1.2 million recorded as a discrete item during the three months ended March 31, 2010 based on our estimate of the outcome of a foreign tax audit, offset partially by state income taxes net of federal benefit. We are currently negotiating settlement of this audit with the foreign tax authority and the United States Treasury Department, and our estimated benefit could change as negotiations evolve. Final resolution of this audit may not be known for several years. .

Income tax expense of $452,000 and income tax benefit of $6.1 million reflect effective tax rates of 186.0% and 33.0% for the three and six months ended June 30, 2009, respectively. Given the difficulty in forecasting annual results during the quarterly periods of 2009, we calculated our quarterly income tax expense (benefit) using the year-to-date actual results. Therefore, the income tax expense for the three months ended June 30, 2009 reflects the difference between the income tax benefit recorded for the six months ended June 30, 2009 and the income tax benefit recorded for the three months ended March 31, 2009. Our effective tax rate for the six months ended June 30, 2009 was lower than the United States federal statutory rate of 35% due primarily to foreign losses that could not be benefited, offset by state income taxes net of federal benefit.

 

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As of June 30, 2010, the balance of our net unrecognized tax benefits is $15.6 million, a decrease of $5.0 million from December 31, 2009. This decrease is due primarily to a settlement made to the Internal Revenue Service (IRS) related to an audit and a decrease in reserves relating to the foreign tax audit noted above.

We are subject to taxation in the United States and in various states and foreign jurisdictions. Our tax years 2007 and forward are subject to examination by the IRS, our tax years 2000 and forward are subject to examination by material state jurisdictions, and our tax years 2003 and forward are subject to examination by material foreign jurisdictions.

Several of our subsidiaries are currently under audit or appeal. It is reasonably possible that the examination phase of these audits or appeals may conclude in the next 12 months, and that the related tax reserves or unrecognized tax benefits for uncertain tax positions may change, potentially having a material effect on our effective tax rate. However, based on the status of the various examinations or appeals in multiple jurisdictions, an estimate of the range of reasonably possible outcomes cannot be made at this time.

9. COMMITMENTS AND CONTINGENCIES

TCZ

Due to the acquisition of the remaining 40% interest in TCZ effective January 15, 2010, we are obligated to pay our former partner in TCZ approximately $2.2 million, in three equal installments, by September 30, 2010. As of June 30, 2010, approximately $730,000 is still payable and is included in accrued and other current liabilities within the accompanying consolidated balance sheet.

Guarantees and Warranties

In the ordinary course of business, we are not subject to potential obligations under guarantees that fall within the scope of the authoritative guidance for guarantees with the exception of our standard warranty provisions associated with product sales and indemnification provisions related to intellectual property that are contained within many of our lithography tool manufacturer agreements.

We record a provision for warranty, which is included in cost of revenues and is recorded at the time that the related revenue is recognized. The warranty period and terms for light source systems and replacement parts varies by light source system model. We review our warranty provision using a statistical financial model which calculates actual historical expenses, product failure rates, and potential risks associated with our different product models. We then use this financial model to calculate the future probable expenses related to warranty and the required level of the warranty provision. Throughout the year, we review the risk levels, historical cost information and failure rates used within this model and update them as information changes over the product’s life cycle. If actual warranty expenditures differ substantially from our estimates, revisions to the warranty provision would be required. Actual warranty expenditures are recorded against the warranty provision as they are incurred. Consumed parts under warranty, when returned, are recorded as reductions to warranty expenditures during the period at their estimated fair value. We do not include the return of consumed parts in our statistical financial model used to estimate our provision for warranty because the specific parts and their estimated future fair value when returned, if any, can not be reasonably estimated at the time revenue is recorded. The following table provides the changes in the product warranty accrual (in thousands):

 

		Six Months Ended June 30, 2010
Balance as of January 1		$	16,640
Accruals for warranties issued during the period			8,445
Changes in liability related to pre-existing warranties			(8,701)
Warranty expenditures during the period, net of consumed parts returned			(4,399)
Balance as of June 30		$	11,985

Intellectual Property Indemnifications

We agree to indemnify certain of our customers in the general purchase agreements with our three lithography tool manufacturer customers, ASML, Canon and Nikon, and under certain of our development and supply agreements. These indemnifications generally include both general and intellectual property indemnification provisions that provide we defend these parties against certain infringement claims directed against our products. Under the indemnification provisions, we would pay costs and damages attributable to the infringement claims, including attorney’s fees associated with settlements or defenses in respect of such claims, provided that certain conditions are satisfied. As of June 30, 2010, we were not subject to any pending general or intellectual property-related litigation. We have not received any requests for nor have we been required to make any payments under these indemnification provisions.

 

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Contingencies Related to Third-Party Review and Legal Actions

From time to time, we are subject to potential claims and assessments from third parties. We are also subject to various governmental audits and reviews. We continually assess whether or not such claims have merit and warrant accrual. Where appropriate, we accrue estimates of anticipated liabilities in the unaudited consolidated financial statements. Such estimates are subject to change and may affect our operating results, financial condition and cash flows.

We are from time to time party to legal actions in the normal course of business. Management does not expect the outcome of legal action in the normal course of business to have a material effect on our operating results, financial condition and cash flows.

10 . SEGMENT OPERATIONS

We develop, manufacture and market our products within two reportable business segments, Cymer and TCZ. Cymer’s primary business is to design, manufacture and sell excimer light source systems and installed base products for use in photolithography systems used in the manufacture of semiconductors. TCZ is manufacturing and marketing a system for use in the manufacture of OLED flat panel displays.

 

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Our chief operating decision maker is our chief operating officer, who uses this information in order to make decisions on resources needed for our light source systems and the OLED flat panel display systems businesses and to assess the overall performance of these components of our business. The accounting policies to derive our consolidated financial results are substantially the same as those used for our segment reporting. Information related to our Cymer and TCZ operating segments is as follows (in thousands):

 

		Three Months Ended June 30, 2010
		Cymer			TCZ			Consolidation Adjustments			Total
Revenue		$	127,414		$	4,563		$	(113)		$	131,864
Operating income (loss)		$	32,221		$	(1,025)		$	-		$	31,196
		Three Months Ended June 30, 2009 (1)
		Cymer			TCZ			Consolidation Adjustments			Total
Revenue		$	62,433		$	-		$	-		$	62,433
Operating income (loss)		$	404		$	(1,007)		$	63		$	(540)
		Six Months Ended June 30, 2010 (1)
		Cymer			TCZ			Consolidation Adjustments			Total
Revenue		$	241,287		$	4,563		$	(205)		$	245,645
Operating income (loss)		$	58,771		$	(5,015)		$	26		$	53,782
		Six Months Ended June 30, 2009 (1)
		Cymer			TCZ			Consolidation Adjustments			Total
Revenue		$	118,932		$	-		$	-		$	118,932
Operating income (loss)		$	(15,106)		$	(2,076)		$	126		$	(17,056)

 

(1)	TCZ operating income (loss) is presented excluding noncontrolling interest.

 

		June 30, 2010
		Cymer			TCZ			Consolidation Adjustments			Total
Total assets		$	672,117		$	20,600		$	(274)		$	692,443
		December 31, 2009
		Cymer			TCZ			Consolidation Adjustments			Total
Total assets		$	648,911		$	18,157		$	(2,150)		$	664,918

 

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11. RELATED PARTY TRANSACTION

During the three months ended June 30, 2010, we engaged Exponent, Inc., to perform a one-time component reliability analysis for a fee of approximately $200,000, of which $127,000 had been incurred through June 30, 2010. Mr. Michael R. Gaulke, a member of our board of directors and member of Exponent’s board of directors, served as an executive officer of Exponent until he retired from his executive chairman role on June 3, 2010.

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

The following discussion of our financial condition and results of operations should be read in conjunction with our unaudited consolidated financial statements and notes thereto included in “Item 1. Financial Statements” of this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto and the section titled “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2009, filed with the Securities Exchange Commission on February 26, 2010.

FORWARD-LOOKING STATEMENTS

Statements in this Quarterly Report on Form 10-Q that are not strictly historical in nature are “forward-looking statements”, within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements include, but are not limited to, references to the outlook for the semiconductor industry and us; expected timeline for the adoption of new photolithography and flat panel display technologies by customers; expected domestic and international product sales and development; our research and development activities and expenditures; adequacy of our capital resources and investments; effects of business cycles in the semiconductor business; our competitive position; and our relationships with customers and third-party manufacturers of our products, and may contain words such as “believes,” “anticipates,” “expects,” “plans,” “intends” and words of similar meaning. In addition, statements regarding backlog and book-to-bill ratios should not be read as predictions or projections of future performance. These forward-looking statements are predictions based on current information and our expectations and involve a number of risks and uncertainties. The underlying information and our expectations involve a number of risks and uncertainties and our 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 contained under the caption “Risk Factors” 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. Unless required by law, we undertake no obligation to update or revise any forward-looking statements to reflect new information or future events or developments. Thus, you should not assume that our silence over time means that actual events are bearing out as expressed or implied in such forward-looking statements.

OVERVIEW

We are the world’s leading supplier of light sources used in the photolithography process for semiconductor, or chip, manufacturing. We provide state-of-the-art light sources designed to help enable the performance of leading edge wafer steppers and wafer scanners built by our lithography tool manufacturers. Additionally, we provide installed base products in support of chipmaker customers who use our light sources in their advanced wafer patterning production processes. We currently supply deep ultraviolet (“DUV”) light sources to our lithography tool manufacturer customers ASML, Canon and Nikon, who integrate the light source into their wafer steppers and scanners which they then provide to chipmakers. In addition, we sell replacement parts and support to lithography tool manufacturers as well as directly to chipmakers, who include all of the world’s largest semiconductor manufacturers. Our light source systems constitute a substantial majority of all DUV light sources incorporated in lithography stepper and scanner tools at chipmakers worldwide. As the leading supplier of these light sources, the majority of consumer electronics devices manufactured in the last several years contain a semiconductor manufactured using our light sources. We are currently developing extreme ultraviolet (“EUV”) source technology for chip manufacturing, and we anticipate recording our first sale of an EUV pilot source system in 2010. Our TCZ reporting segment develops, integrates, markets, and supports silicon crystallization tools used in the manufacture of organic light emitting diode (“OLED”) flat panel displays. We recorded our first sale of a TCZ silicon crystallization tool during the second quarter of 2010.

Revenue of $131.8 million in the second quarter of 2010 represented a 111% increase over the second quarter of 2009 and a 16% increase over the first quarter of 2010. The increases over prior year and last quarter are due to growth in both installed base products and light source revenues during the quarter. During the quarter, the majority of our light source shipments continued to be ArF sources in support of 45nm and below immersion lithography, and we also delivered several KrF sources to support increased semiconductor manufacturing (also referred to as “fabs”). Semiconductor fabs continue to increase their pulse utilization levels, and we estimate that by the end of the second quarter, gross pulses were approximately 98% of the June 2008 peak. Driven by strong end user demand for smart phones, tablet computers, cell phones, and other electronic products, we expect semiconductor fab utilization will continue to remain high and pulse utilization will exceed prior peak levels in the second half of this year.

 

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Gross margin was 52.7% in the second quarter of 2010, an increase over gross margin of 38.6% in the second quarter of 2009 and 50.0% in the first quarter of 2010. Increases in gross margin have been driven by our continued focus on operational execution, coupled with previously implemented cost structure improvements, improved manufacturing absorption and lower write downs of inventory. During the second quarter of 2010, we also realized decreases in warranty expenses due to light source reliability improvements, which decreased our estimated future warranty liability.

Operating expenses of $38.3 million in the second quarter of 2010 represents a 55.3% increase over the second quarter of 2009 and a 11.8% increase over the first quarter of 2010. We continued to raise our investment in EUV source development and commercialization, and we are funding variable compensation programs that are closely linked to improvements in business levels and company performance. Operating expenses as a percentage of net sales decreased to 29.0% in the second quarter of 2010, compared to 39.5% in the second quarter of 2009 and 30.1% in the first quarter of 2010.

Our company has delivered strong growth in net income as compared to a year ago and last quarter. Our second quarter 2010 net income was $21.2 million, compared to $525,000 net income in the second quarter of 2009, and represented a 32.5% increase over the $16.0 million of net income generated in the first quarter of 2010.

We are encouraged by the outlook for our business in the second half of 2010. Chipmakers in all three sectors are increasing their investment in ArF immersion lithography technology in support of 45nm and below development and manufacturing. The depth of investment has broadened to a larger number of chipmakers and includes increased KrF purchases. We believe our installed base products and DUV light sources are well positioned to support our customers’ business needs. Customer adoption of OnPulse has increased over the last two years, representing a sizeable, scalable, and predictable contributor to our revenues and net income. Our investment in EUV commercialization and TCZ market penetration positions us strategically for additional growth and continued market leadership.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

General

The discussion and analysis of our financial condition and results of operations are based upon our unaudited consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. For a summary of significant accounting policies, see Note 1 to the Consolidated Financial Statements in Part II, Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2009. 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. 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. As future events and their effects cannot be determined with precision, particularly those related to the condition of the economy, actual results could differ significantly from these estimates.

There have been no changes to the items disclosed as critical accounting policies and estimates in “Management Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2009.

 

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RESULTS OF OPERATIONS

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

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2010			2009			2010			2009
Revenues:
Product sales		100.0	%		99.8	%		100.0	%		99.7	%
Product sales - related party		-			0.2			-			0.3
Total revenues		100.0			100.0			100.0			100.0
Cost of revenues		47.3			61.4			48.6			61.6
Gross profit		52.7			38.6			51.4			38.4
Operating expenses:
Research and development		16.4			22.9			16.8			27.5
Sales and marketing		4.8			6.3			4.7			6.6
General and administrative		7.8			10.3			8.0			11.5
Restructuring		-			-			-			7.1
Total operating expenses		29.0			39.5			29.5			52.7
Operating income (loss)		23.7			(0.9)			21.9			(14.3)
Total other income (expense) - net		(0.1)			1.3			-			(1.1)
Income (loss) before income tax expense (benefit)		23.6			0.4			21.9			(15.4)
Income tax expense (benefit)		7.5			0.7			6.8			(5.1)
Net income (loss)		16.1			(0.3)			15.1			(10.3)
Net loss attributable to noncontrolling interest in subsidiary		-			1.2			0.1			1.2
Net income (loss) attributable to Cymer, Inc.		16.1	%		0.9	%		15.2	%		(9.1)	%

We currently operate within two reportable segments, Cymer and TCZ. The Cymer segment of our business consists of products including lithography light sources and installed base products. The TCZ segment is targeting the growing market for low-temperature poly-silicon (“LTPS”) processing used in the manufacture of OLED flat panel displays. The discussion which follows for revenues, cost of revenues and operating expenses includes our consolidated results and identifies those amounts associated with the TCZ segment, which are included in the consolidated amounts, for the three and six months ended June 30, 2010 and 2009. Additional information regarding our reporting segments is contained in Note 10 to our unaudited consolidated financial statements in Part I, Item 1 of this report.

Three Months Ended June 30, 2010 and 2009

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

 

		Three Months Ended June 30,
		2010			2009			Increase (Decrease)			% Change
Light source systems:
Revenue		$	44,751		$	8,375		$	36,376		436	%
Units sold			30			4			26		650	%
Average selling price (1)		$	1,496		$	1,990		$	(494)		(25	%)
Installed base product revenue		$	82,550		$	54,058		$	28,492		53	%
TCZ flat panel display systems		$	4,563			-		$	4,563
Total revenue		$	131,864		$	62,433		$	69,431		111	%

 

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(1)

For purposes of calculating the average selling price, we have excluded the effect of deferred light source system revenue between periods in order to present the actual average selling price per light source system sold.

Total revenue increased period over period primarily due to improved demand for light source systems and installed base products as a result of improved market conditions where we do business as compared to the same period in the prior year. The increase in light source revenues was primarily due to a higher level of investment in ArF light sources in support of 45nm and below immersion lithography and an increase in KrF source purchases. The average selling price of our light source systems decreased 25% due to a change in the product mix of light source systems sold period over period. Our installed base product revenue increased from period to period due to the continued customer adoption of our OnPulse contracts and a rise in pulse utilization of our light source systems by chipmaker customers. We also recorded our first TCZ segment revenue during the three months ended June 30, 2010 for the relocation, installation and final acceptance of a flat panel display system by a large Korean display manufacturer.

Our sales to external customers consist of sales generated from each of the following geographic locations in which we do business (in thousands):

 

		Three Months Ended June 30,
		2010			2009			$ Change			% Change
U.S.		$	52,850		$	16,053		$	36,797		229	%
Japan			22,772			14,073			8,699		62	%
Korea			22,530			15,330			7,200		47	%
Other Asia (Taiwan, Singapore, China)			24,733			11,886			12,847		108	%
Europe			8,979			5,091			3,888		76	%
Total		$	131,864		$	62,433		$	69,431

Revenues in regions outside of the United States increased $32.6 million to $79.0 million during the quarter ended June 30, 2010 due to improved economic conditions in certain regions where we conduct business when compared to the same period in the prior year. We anticipate that international sales will continue to account for a significant portion of our sales.

Sales to ASML and Nikon, two of our three lithography tool manufacturing customers, and Samsung, who purchased installed base products and a flat panel display system from us, amounted to 30%, 11% and 12%, respectively, of total revenue for the three months ended June 30, 2010, and 8%, 16% and 18%, respectively, of total revenue for the same period in 2009.

Backlog. Our backlog includes only those orders for DUV light source systems and replacement parts for which we have accepted a purchase order from a customer, and that will be delivered to the customer within the following twelve months. In addition, our backlog does not include services or support which will be provided to our customers in the future or under service contracts. Although we have purchase orders for several EUV source systems and a TCZ flat panel display system, we have not included these purchase orders in our backlog as these systems are still in development or in evaluation stages and we can not be certain revenue will be recognized within the next twelve months. Timing of delivery can be affected by many factors, including factors that can not be easily predicted or controlled. Because it is the practice in our industry that customers may cancel or delay orders with little or no penalty, our backlog as of any particular date may not be a reliable indicator of actual sales for any succeeding period.

At June 30, 2010, we had a DUV backlog of $55.5 million compared with a DUV backlog of $34.5 million at June 30, 2009. DUV bookings at June 30, 2010 and 2009 were $139.6 million and $71.4 million, respectively. The DUV book-to-bill ratio at June 30, 2010 was 1.09 compared to 0.79 for the same period in 2009. The increase in DUV bookings, backlog and book-to-bill ratio reflects an increase in demand for our light source systems in the second quarter of 2010.

Cost of revenues. Cost of revenues includes direct material and labor, warranty expenses, license fees, manufacturing and service overhead. Cost of revenues also includes foreign exchange gains and losses on foreign currency forward exchange contracts (“forward contracts”) associated with purchases of our products by Cymer Japan for resale under firm third-party sales commitments. Costs incurred for shipping and handling are included in cost of revenues at the time the related revenue is recognized. Amounts billed to a customer, if any, for shipping and handling are reported as revenue.

The cost of revenues increased 62.8% to $62.4 million for the quarter ended June 30, 2010 from $38.3 million for the quarter ended June 30, 2009. Gross profit increased to $69.5 million with a 52.7% gross margin for the quarter ended June 30, 2010 from $24.1 million with a 38.6% gross margin for the quarter ended June 30, 2009. The increase in gross profit and gross margin from period to period was primarily due to the higher level of light source system sales along with the realized benefits of previously implemented cost structure improvements, improved manufacturing absorption, and lower write-downs of inventory. During the quarter ended June 30, 2010, we also realized decreases in warranty expenses due to light source reliability improvements, which decreased our estimated future warranty liability.

 

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Included in cost of revenues for the quarter ended June 30, 2010 was $4.0 million related to the relocation, installation and final acceptance of a TCZ flat panel display system. There were no costs of revenues associated with the TCZ segment for the quarter ended June 30, 2009.

Research and development. Research and development expenses include costs of continuing product development projects, which consist primarily of employee and material costs, depreciation of equipment and other engineering related costs. Research and development expenses increased 51.3% to $21.6 million for the quarter ended June 30, 2010 from $14.3 million for the quarter ended June 30, 2009. In the quarter ended June 30, 2010, research and development spending increased as we continued to raise our level of investment in EUV source development, and an increase in costs associated with funding variable compensation programs that are closely linked to improvements in business levels and company performance. In the quarter ended June 30, 2009, research and development expenses reflect the impact of reductions in workforce including a reduction in variable compensation costs and adjusted spending on our DUV product portfolio. In addition, research and development expenses included $831,000 and $1.0 million for the quarters ended June 30, 2010 and 2009, respectively, for our TCZ segment. As a percentage of total revenues, research and development expenses decreased to 16.4% for the quarter ended June 30, 2010 from 22.9% for the quarter ended June 30, 2009.

Sales and marketing. Sales and marketing expenses include sales, marketing, customer support staff and other marketing expenses. Sales and marketing expenses increased 60.4% to $6.3 million for the quarter ended June 30, 2010 from $3.9 million for the quarter ended June 30, 2009. Included in sales and marketing expenses were $563,000 and $454,000 for the quarters ended June 30, 2010 and 2009, respectively, for our TCZ segment. The increase in sales and marketing expenses primarily reflects an increase in costs associated with funding variable compensation programs that are closely linked to improvements in business levels and company performance. As a percentage of total revenues, sales and marketing decreased to 4.8% for the quarter ended June 30, 2010 compared to 6.3% for the quarter ended June 30, 2009.

General and administrative. General and administrative expenses consist primarily of management and administrative personnel costs, professional services including external audit and consultant fees, and administrative operating costs. General and administrative expenses increased 60.9% to $10.3 million for the quarter ended June 30, 2010 from $6.4 million for the quarter ended June 30, 2009 primarily due to an increase in costs associated with funding variable compensation programs that are closely linked to improvements in business levels and company performance. Included in general and administrative expenses were $221,000 and $257,000 for the quarters ended June 30, 2010 and 2009, respectively, for our TCZ segment. As a percentage of total revenues, general and administrative expenses decreased to 7.8% for the quarter ended June 30, 2010 compared to 10.3% for the quarter ended June 30, 2009.

Total other income (expense)—net. Net other income (expense) consists primarily of interest income earned on our investment and cash portfolio, foreign currency exchange gains or losses associated with fluctuations in the value of the functional currencies of our foreign subsidiaries against the U.S. Dollar and other items that may be specific to a reporting period. Other expense, net was $126,000 for the quarter ended June 30, 2010 compared to other income, net of $783,000 for the quarter ended June 30, 2009. Other expense, net for the quarter ended June 30, 2010 relates primarily to foreign currency losses as a result of the negative impact due to the depreciation of the Korean Won and Euro against the U.S. Dollar and reduced interest income due to lower investments when compared to the quarter ended June 30, 2009.

Income tax expense. Income tax expense of $9.9 million and $452,000 reflect effective tax rates of 31.7% and 186.0% for the three months ended June 30, 2010 and 2009, respectively. Given the difficulty in forecasting annual results during the quarterly periods of 2009, we calculated our quarterly income tax expense (benefit) using the year-to-date actual results. Therefore, the income tax expense for the three months ended June 30, 2009 reflects the difference between the income tax benefit recorded for the six months ended June 30, 2009 and the income tax benefit recorded for the three months ended March 31, 2009. The decrease in the effective tax rate for the three months ended June 30, 2010 was also due to an increase in our ability to realize the U.S manufacturing benefit given increased profitability in 2010. Additionally, we recorded a net tax benefit in the United States of $324,000 as a discrete item during the three months ended June 30, 2010, which represents our estimate of TCZ net operating loss carryforwards we expect to utilize in the future given the retroactive revocation of TCZ’s tax holiday in Singapore.

Our future effective tax rate depends on various factors, such as tax legislation and credits and the geographic compositions of our pre-tax income. The currently expired United States research and development tax credit is expected to be reinstated; however, it is unknown when this event will take place. In the quarter in which this occurs, the tax benefit from the credit will be recognized. Additionally, several of our subsidiaries are under audit or appeal. It is reasonably possible that the examination phase of these audits or appeals may conclude in the next 12 months, and that the related tax reserves or unrecognized tax benefits for uncertain tax positions may change, potentially having a material effect on our effective tax rate.

 

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Six Months Ended June 30, 2010 and 2009

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

 

		Six Months Ended June 30,
		2010			2009			Increase (Decrease)			% Change
Light source systems:
Revenue		$	79,936		$	23,955		$	55,981		234	%
Units sold			54			13			41		315	%
Average selling price (1)		$	1,509		$	1,776		$	(267)		(15	%)
Installed base product revenue		$	161,146		$	94,977		$	66,169		70	%
TCZ flat panel display systems		$	4,563			-		$	4,563
Total revenue		$	245,645		$	118,932		$	126,713		107	%

 

(1)

For purposes of calculating the average light source system selling price, we have excluded the effect of deferred light source system revenue between periods in order to present the actual average selling price per light source system sold.

Total revenue for the six months ended June 30, 2010 increased due to greater demand for light source systems and installed base products as a result of overall improved market conditions when compared to the same period in the prior year. The increase in light source revenues was primarily due to a higher level of investment in ArF light sources in support of 45nm and below immersion lithography and an increase in KrF source purchases. The average selling price of our light source systems decreased 15% due to a change in the product mix of light source systems sold period over period. Our installed base product revenue increased from period to period due to the increased adoption of OnPulse contracts and a rise in pulse utilization of our light source systems by chipmaker customers.

We also recorded our first TCZ segment revenue during the six months ended June 30, 2010 for the relocation, installation and final acceptance of a flat panel display system by a large Korean display manufacturer. There were no revenues associated with our TCZ segment for the six months ended June 30, 2009.

Our sales to external customers consist of sales generated from each of the following geographic locations in which we do business (in thousands):

 

		Six Months Ended June 30,
		2010			2009			$ Change			% Change
U.S.		$	97,728		$	29,422		$	68,306		232	%
Japan			45,697			34,110			11,587		34	%
Korea			41,062			25,192			15,870		63	%
Other Asia (Taiwan, Singapore, China)			44,142			21,052			23,090		110	%
Europe			17,016			9,156			7,860		86	%
Total		$	245,645		$	118,932		$	126,713

Revenues in regions outside of the United States increased $58.4 million to $147.9 million during the six months ended June 30, 2010 due to improved economic conditions in certain regions where we conduct business when compared to the same period in the prior year. We anticipate that international sales will continue to account for a significant portion of our sales.

 

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Sales to ASML and Nikon, two of our three lithography tool manufacturing customers, and Samsung, who purchased installed base products and a flat panel display system from us, amounted to 29%, 13% and 11%, respectively, of total revenue for the six months ended June 30, 2010, and 8%, 23% and 14%, respectively, of total revenue for the same period in 2009.

Cost of revenues. The cost of revenues increased 62.9% to $119.3 million for the six months ended June 30, 2010 from $73.3 million for the same period in 2009. Gross profit increased to $126.3 million with a 51.4% gross margin for the six months ended June 30, 2010 from $45.7 million with a 38.4% gross margin for the same period in 2009. The increase in gross profit and gross margin from period to period was primarily due to the higher level of sales, the realized benefits of previously implemented cost structure improvements, improved manufacturing absorption, and lower write downs of inventory. These increases were offset partially by increases in warranty expenses due to an increase in laser shipments during the six months ended June 30, 2010 compared to the same period in 2009, offset partially by decreases in warranty expenses due to light source reliability improvements, which decreased our estimated future warranty liability.

Included in cost of revenues for the six months ended June 30, 2010 was $4.0 million related to the relocation, installation and final acceptance of a TCZ flat panel display system. There were no costs of revenues associated with the TCZ segment for the six months ended June 30, 2009.

Research and development. Research and development expenses increased 26.8% to $41.5 million for the six months ended June 30, 2010 from $32.7 million for the same period in 2009. Research and development spending increased in the six months ended June 30, 2010 as we raised our level of investment in EUV source development, and reinstated variable compensation programs that are closely linked to improvements in business levels and company performance. In the six months ended June 30, 2009, research and development expenses were negatively impacted by the reductions in workforce conducted during the period, including a reduction in variable compensation costs. Research and development expenses included $3.7 million and $2.0 million for the six months ended June 30, 2010 and 2009, respectively, for our TCZ segment. The increase in research and development expenses for TCZ is due primarily to assuming full ownership of the joint venture in January 2010. As a percentage of total revenues, research and development expenses decreased to 16.8% for the six months ended June 30, 2010 from 27.5% for the same period in 2009.

Sales and marketing. Sales and marketing expenses increased 45.0% to $11.5 million for the six months ended June 30, 2010 from $7.9 million for the same period in 2009. Included in sales and marketing expenses were $1.1 million and $917,000 for of the six months ended June 30, 2010 and 2009, respectively, for our TCZ segment. The increase in sales and marketing expenses primarily reflects an increase in costs associated with funding variable compensation programs that are closely linked to improvements in business levels and company performance, and advertising costs during the period. As a percentage of total revenues, sales and marketing decreased to 4.7% for the six months ended June 30, 2010 compared to 6.6% for the six months ended June 30, 2009.

General and administrative. General and administrative expenses increased 43.0% to $19.6 million for the six months ended June 30, 2010 from $13.7 million for the same period in 2009, primarily due to an increase in costs associated with funding variable compensation programs that are closely linked to improvements in business levels and company performance. These increases were partially offset by a decline in bad debt expense as a result of improved risk profiles and payment histories of certain of our customers compared to the same period in 2009. Included in general and administrative expenses were $740,000 and $496,000 for of the six months ended June 30, 2010 and 2009, respectively, for our TCZ segment. As a percentage of total revenues, general and administrative expenses decreased to 8.0% for the six months ended June 30, 2010 compared to 11.5% for the six months ended June 30, 2009.

Restructuring. There were no restructuring expenses during the six months ended June 30, 2010. During the six months ended June 30, 2009, we reduced our worldwide workforce by approximately 26 percent or a total of 230 employees, as part of our cost reduction efforts in response to the deterioration in the lithography sector of the semiconductor capital equipment market at the time. These reductions in workforce affected only employees at our Cymer segment. As a result of these reductions in our workforce, we recorded restructuring expense of approximately $8.4 million during the six months ended June 30, 2009.

Total other income (expense)—net. Other expense, net was $59,000 for the six months ended June 30, 2010 compared to $1.3 million for the six months ended June 30, 2009. Other expense, net for the six months ended June 30, 2010 relates primarily to foreign currency losses as a result of the negative impact due to the depreciation of the Korean Won and Euro against the U.S. Dollar, reduced interest income due to lower investments and reduced interest expense due to the repayment of our convertible subordinated notes in February 2009 when compared to the same period in 2009. Other expense, net of $1.3 million for the six months ended June 30, 2009 was primarily due to foreign currency losses of $1.5 million as a result of the negative impact due to the depreciation of the Korean Won against the U.S. Dollar.

 

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Income tax expense (benefit). Income tax expense of $16.7 million and income tax benefit of $6.1 million reflect effective tax rates of 31.0% and 33.0% for the six months ended June 30, 2010 and 2009, respectively. The decrease in the effective rate is due primarily to an increase in our ability to utilize the U.S. manufacturing benefit due to increased profitability in 2010. Additionally, we recorded a net tax benefit in the United States of $324,000 as a discrete item during the three months ended June 30, 2010, which represents our estimate of TCZ net operating loss carryforwards we expect to utilize in the future given the retroactive revocation of TCZ’s tax holiday in Singapore. We also recorded a net tax benefit in the United States of $1.2 million as a discrete item during the three months ended March 31, 2010 based on our estimate of the outcome of a foreign tax audit. We are currently negotiating settlement of this audit with the foreign tax authority and the United States Treasury Department, and our estimated benefit could change as negotiations evolve. Final resolution of this audit may not be known for several years.

Our future effective tax rate depends on various factors, such as tax legislation and credits and the geographic compositions of our pre-tax income. The currently expired United States research and development tax credit is expected to be reinstated; however, it is unknown when this event will take place. In the quarter which this occurs, the tax benefit from the credit will be recognized. Additionally, several of our subsidiaries are under audit or appeal. It is reasonably possible that the examination phase of these audits or appeals may conclude in the next 12 months, and that the related tax reserves or unrecognized tax benefits for uncertain tax positions may change, potentially having a material effect on our effective tax rate.

LIQUIDITY AND CAPITAL RESOURCES

In recent years, we have funded our operations primarily from cash generated from operations, the proceeds from note offerings, and proceeds from employee stock option exercises. We have also from time to time utilized cash to repurchase shares of our common stock. In summary, our cash flows were as follows:

 

		Six Months Ended June 30,
		2010			2009
Net cash (used in) provided by operating activities		$	(8,409)		$	1,388
Net cash used in investing activities			(15,100)			(7,028)
Net cash used in financing activities			(16,379)			(139,320)
Effect of exchange rate changes on cash and cash equivalents			316			(1,982)
Net decrease in cash and cash equivalents		$	(39,572)		$	(146,942)

Operating Activities

Net cash used in operating activities for the six months ended June 30, 2010 primarily reflects changes in working capital, including a $36.7 million increase in accounts receivable and a $17.7 million increase in inventory, offset partially by net earnings for the period before depreciation, amortization, and stock-based compensation. The accounts receivable increase results primarily from the increase in revenue and an increase in days sales outstanding to 79 days in the six months ended June 30, 2010 from 72 days in the six months ended June 30, 2009. The increase in inventory is due primarily to the build of EUV source pilot systems.

Net cash provided by operating activities for the six months ended June 30, 2009 primarily reflects decreases in inventory and accounts receivable and the effect of non-cash charges including depreciation and amortization, stock-based compensation and bad debt expense. These sources of cash were partially offset by the net loss for the period, decreases in accrued expenses and other liabilities, accounts payable and changes in income taxes receivable and payable. The decrease in inventory was due primarily to decreases in our spares inventory and work-in-progress inventory during the six months ended June 30, 2009, as we focused on optimizing our inventory levels. The decrease in accounts receivable was due to lower sales and ongoing collection efforts, and the changes in the income tax accounts were primarily due to the tax benefit recorded for the first six months of 2009 and tax payments that were made during the period. The decrease in accrued expenses and other liabilities primarily reflects the decrease in warranty provision as a result of reduced sales and a lower number of light source systems under warranty at June 30, 2009.

 

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Investing Activities

Net cash used in investing activities for the six months ended June 30, 2010 was due primarily to the timing of short-term and long-term investments that matured and were reinvested during the period as well as capital expenditures of $7.9 million primarily related to our investment in EUV. Net cash used in investing activities for the six months ended June 30, 2009 was due primarily to the timing of short-term and long-term investments that matured and were reinvested during the period. A portion of the proceeds from matured investments were used to redeem our convertible subordinated notes in February 2009. Our capital expenditures were reduced to approximately $3.2 million for the first six months of 2009, in support of our cost reduction efforts in 2009.

Financing Activities

Net cash used in financing activities for the six months ended June 30, 2010 primarily reflects $19.3 million of treasury stock purchases as well as the first and second installment paid to our former partner in TCZ. These uses of cash were partially offset by proceeds from the issuance of common stock and excess tax benefits related to stock option exercises. Net cash used in financing activities for the six months ended June 30, 2009 primarily reflects the payment of $140.7 million for the redemption of our outstanding convertible subordinate notes that matured on February 15, 2009. This payment was partially offset by proceeds from the issuance of common stock and excess tax benefits related to stock option exercises.

Effect of Exchange Rate Changes

Most of our foreign subsidiaries operate in currencies other than the U.S. Dollar, and the majority of their cash balances are denominated in these foreign currencies. As a result, our cash and cash equivalent balances are subject to the effects of the fluctuations in these currencies against the U.S. Dollar at the end of each reporting period. The net effect of exchange rate changes on cash and cash equivalents, when expressed in U.S. Dollar terms, was an increase in cash and cash equivalents of $316,000 for the six months ended June 30, 2010 and a reduction of $2.0 million for the same period in the prior year. For the six months ended June 30, 2010, the increase in cash was primarily driven by a strengthening of the Japanese Yen, partially offset by a weakening of the Euro and Korean Won against the U.S. Dollar. For the six months ended June 30, 2009, the reduction in cash was primarily driven by a weakening of the Japanese Yen and to a lesser extent the volatility of the Korean Won against the U.S. Dollar.

Prospective Capital Needs

We require substantial resources to fund the operations of our business, particularly to fund our investment in new technologies, including inventory and capital in support of these technologies. We expect purchases of property and equipment in 2010 to be approximately $20.0 million, a significant portion of which will relate to purchases of equipment associated with EUV development and commercialization, as well as purchases of software and equipment. In addition, we require resources to fund our normal operations. Due to the acquisition of the remaining 40% interest in TCZ, effective January 15, 2010, we are obligated to pay our former partner in TCZ approximately $2.2 million, in three equal installments by September 30, 2010. As of June 30, 2010, approximately $730,000 is still payable and included in accrued and other current liabilities within the accompanying consolidated balance sheet.

We believe that our current cash, cash equivalents and marketable securities and, to a lesser extent, cash from the exercise of employee stock options and the purchase by our employees of common stock through our employee stock purchase plan, will be sufficient to cover our working capital needs for our normal operations, and our investments in our new technologies, including EUV and OLED display manufacturing, for at least the next 12 months. It is possible that we may need to raise additional funds to finance our activities or to acquire assets, products or new technologies beyond the next 12 months. We may also decide that it is prudent in the current business and economic environment to secure commitments to access additional capital, including equity or debt securities, to protect our long term liquidity position. In April 2008, our board of directors authorized us to repurchase up to $100.0 million of our common stock. During the quarter ended June 30, 2010, we purchased 560,000 shares for $19.3 million under this program. As of June 30, 2010, $57.8 million remain available under this program for repurchases.

Our future capital requirements may vary materially from those currently planned. We anticipate that the amount of capital we will need in the future will depend on many factors, including:

 

•

the required investments in our new technologies such as EUV and OLED display manufacturing;

 

•

the market acceptance of our products;

 

•

the overall levels of sales of our products and gross profit margins;

 

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•

general economic and political conditions and specific conditions in the markets in which we operate, including the volatility in the semiconductor industry, and trends in the semiconductor markets in various geographic regions, including seasonality in sales of consumer products into which semiconductors are incorporated;

 

•

the timing and requirements of spending to support product development efforts for our current technologies and other operating costs;

 

•

our competitors’ responses to our products and our anticipation of and responses to their products;

 

•

our manufacturing activity;

 

•

the levels of inventory and accounts receivable that we maintain;

 

•

the inability of certain of our customers who depend on credit to have access to their traditional sources of credit to finance the purchase of products from us, particularly during changing or adverse global economic conditions, which may lead them to reduce their level of purchases or to seek credit or other accommodations from us;

 

•

competitive labor market compensation requirements;

 

•

acquisitions of assets, products or new technologies;

 

•

repurchases of our common stock;

 

•

capital improvements for new and existing facilities;

 

•

our relationships with suppliers and customers; and

 

•

the level of exercises of stock options and stock purchases by our employees under our employee stock purchase plan.

OFF BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS

As of June 30, 2010, we did not have any relationships 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.

There have been no material changes to our contractual obligations from the information provided in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included in our Annual Report on Form 10-K for the year ended December 31, 2009.

RECENTLY ISSUED ACCOUNTING STANDARDS

See Note 1 to our unaudited consolidated financial statements in Part I, Item 1 of this report for a description of recently issued accounting standards, including our expected dates of adoption and estimated effects on our results of operations and financial condition.

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

FOREIGN CURRENCY RISK

We conduct business in several international currencies through our global operations. Our foreign currency hedging program manages fluctuations in the value of the Japanese Yen, the Korean Won, the Euro and the Taiwanese Dollar. Our foreign currency risk falls into two primary categories.

First, we are subject to uncertain gross profit margins when we forecast selling products in one currency and the product costs are denominated in a different currency. In this instance we enter into derivative financial instruments, principally forward contracts, which we designate as cash flow hedges in order to mitigate fluctuations in the gross profit margins of these forecasted transactions.

 

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Forward contracts on forecasted transactions that hedge uncertain gross profit margins generally qualify for cash flow hedge accounting treatment. Gains and losses on cash flow hedges are recorded in accumulated other comprehensive income (loss) until the hedged transaction is recorded in the financial statements. Once the underlying transaction is recorded in the financial statements, we de-designate the derivative, reclassify the accumulated gain or loss on the derivative into cost of revenues and cease to apply hedge accounting treatment. Once the derivative has been de-designated, any further gains or losses are recorded to other income (expense). If all or a portion of the forecasted transaction were cancelled, this would render all or a portion of the cash flow hedge ineffective and we would reclassify the ineffective portion of the hedge into other income (expense). We generally have not experienced ineffectiveness of cash flow hedges from cancelled transactions. The fair value of all our forward contracts totaled to a liability of $1.9 million at June 30, 2010. The deferred loss, net of tax, for those that qualified for hedge accounting treatment was $195,000 as of June 30, 2010.

At June 30, 2010, we had outstanding forward contracts to buy $31.8 million in exchange for Japanese Yen, $8.0 million in exchange for Korean Won, $3.5 million in exchange for Taiwanese Dollars and to sell $7.6 million in exchange for Euros. These contracts expire on various dates through December 2010.

The second category of foreign currency risk occurs when transactions are recorded to our consolidated financial statements in a currency other than the applicable entity’s functional currency and the cash settlement of the transaction occurs at some point in the future. When transactions in non-functional currency are recorded to our consolidated financial statements, any changes in the recorded amounts resulting from fluctuations in the value of that currency will be recorded to other income (expense). In order to mitigate these revaluation gains and losses, we enter into derivative financial instruments, principally forward contracts. The forward contracts that hedge transactions that have been recorded to our consolidated financial statements are not designated as hedges and we record changes in their fair value to other income (expense) in order to attempt to offset gains and losses on the underlying transactions.

We considered the historical trends in currency exchange rates and determined that it was reasonably possible that adverse changes in exchange rates of 20% for all currencies could be experienced in the near term. These changes would have resulted in an adverse impact on income before income taxes of approximately $2.8 million and $1.4 million at June 30, 2010 and 2009, respectively. The adverse impact at June 30, 2010 and 2009 is after consideration of the offsetting effect of approximately $7.0 million and $4.7 million from forward exchange contracts in place for June 30, 2010 and 2009, respectively. These reasonably possible adverse changes in foreign currency exchange rates of 20% were applied to net assets and liabilities denominated in currencies other than the functional currencies at the balance sheet dates to compute the adverse impact these changes would have had on our income before taxes in the near term.

INVESTMENT AND DEBT RISK

We maintain an investment portfolio consisting primarily of government and corporate fixed income securities, commercial paper and money market funds. While it is our general intent to hold such securities until maturity, we will occasionally sell certain securities for cash flow purposes. Therefore, our investments are classified as available-for-sale and are carried on the balance sheet at fair value. If interest rates were to increase instantaneously and uniformly by 100 basis points, the fair market value of our investment portfolio as of June 30, 2010 would decrease by an immaterial amount.

ITEM 4. Controls and Procedures

Evaluation of disclosure controls and procedures. Our chief executive officer and our chief financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of June 30, 2010, have concluded that as of such date, our disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in the reports that we file under the Exchange Act is recorded, processed, summarized and reported within the time period specified in the rules and forms of the Securities and Exchange Commission and that such information is accumulated and communicated to management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in internal control over financial reporting. There has been no change in our internal control over financial reporting during the quarter ended June 30, 2010 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations on the Effectiveness of Internal Control. There are inherent limitations in the effectiveness of any internal control, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even effective internal controls can provide only reasonable assurances with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of internal controls may vary over time.

 

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PART II. OTHER INFORMATION

ITEM 1. Legal Proceedings

None.

ITEM 1A. Risk Factors

The risks described below may not be the only risks we face. Additional risks that we do not currently believe are material may also impair our business operations. The risk factors set forth below with an asterisk (*) next to the title contain changes to the description of the risk factors associated with our business as previously disclosed in Item 1A to our Annual Report on Form 10-K for the fiscal year ended December 31, 2009. If any of the events or circumstances described in the following risks occur, our business, financial condition, results of operations or cash flows could suffer, and the trading price of our common stock and our market capitalization could decline.

Our revenues and operating results from quarter to quarter and year to year have varied in the past and our future operating results may continue to fluctuate significantly.*

Factors that contribute to fluctuations in our revenues and operating results include:

 

•

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

 

•

utilization rates of light sources by our chipmaker customers and pulse usage which affect our installed base products revenues and costs;

 

•

cyclicality in the market for semiconductor manufacturing equipment;

 

•

rates at which our chipmaker customers take delivery of photolithography tools from our lithography tool manufacturer customers;

 

•

rates at which lithography tool manufacturer customers take delivery of light source systems from us;

 

•

timing and size of orders from our customers;

 

•

the ability of our customers to pay for products purchased from us;

 

•

our abilities to manage customer satisfaction and product reliability, and to provide effective field support to our customers;

 

•

variability in the amount and timing of parts replacement costs under our OnPulse contracts;

 

•

changing or adverse global economic conditions, including their potential effects on our customers, suppliers, ability to sell products, and investments, and on energy prices, inflation, deflation, recession, unemployment, consumer confidence and demand, turmoil in the credit markets and financial services industry, and credit availability;

 

•

improved or reduced market penetration by our competitors;

 

•

demand for reduced product lead time from our customers;

 

•

the mix of light source models, and the level of installed base products 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 that meet our customers’ needs, in particular, extreme ultraviolet (“EUV”) lithography;

 

•

research and development costs incurred to develop new technologies;

 

•

global demand for flat panel displays, in particular, for organic light emitting diode (“OLED”) displays;

 

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•

demand for TCZ’s production system for low-temperature poly-silicon processing in the manufacture of OLED flat panel displays;

 

•

our ability to manage our manufacturing and inventory requirements, including our inventory levels and controls at our widely dispersed operations;

 

•

the financial condition of our suppliers which, if negative, could affect their ability to supply us with the parts that we need to manufacture our products;

 

•

foreign currency exchange rate fluctuations and possible protectionist measures in the countries in which we do business;

 

•

our investments in marketable securities;

 

•

changes in our effective tax rate;

 

•

worldwide political instability;

 

•

intellectual property protection; and

 

•

potential impairments to our goodwill or long-lived assets.

Prior to 2007, we derived the majority of our revenues from selling light source systems used in semiconductor manufacturing. In 2007, 2008 and 2009, our light source systems revenue represented 47%, 34% and 22% of total revenue, respectively. In recent years, chipmakers have been controlling the number of new tools they need to purchase by improving their manufacturing efficiency, utilization and repurposing of existing tools. As a result, installed base products represent a greater percentage of our total revenue. The revenues from the operation of our installed base of light source systems depend on the rate at which our customers use these light source systems, the rate of growth of our installed base, and the mix of pulses from KrF, ArF dry and ArF immersion light sources. Our operating results for a particular period may be adversely affected if our customers reduce usage rates, or change their buying patterns, or if we incur higher parts replacement costs.

Because we sell a limited number of light source system products, the precise timing for recognizing revenue from an order may have a significant effect on our total revenue for a particular period. As is the practice in our industry, 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 our 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 cancel or reschedule orders, or if we cannot fill orders in time due to unexpected delays in manufacturing, testing, shipping, or product acceptance. Our light source systems used in a production environment generate product revenues based on system usage, which may also vary period to period. Additionally, accounting guidance may require us to defer revenue associated with contracts that contain multiple deliverables.

We manage our expense levels based, in large part, on expected future revenues. As a result, if our actual revenue decreases below the level we expect, or we are not successful in aligning our manufacturing cost structure with decreasing production levels, 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 gross margin, operating income, net income, earnings per share, and cash flows. 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 and the semiconductor capital equipment industries, which are volatile and unpredictable.

We derive the majority of our revenues from our lithography tool manufacturer customers who, as original equipment manufacturers (“OEMs”), incorporate our light source systems in photolithography tools that they sell to semiconductor manufacturers, or chipmakers, and from our chipmaker customers who purchase installed base products directly from us in support of their light source systems. Like us, our OEM customers depend on market demand for their products from the chipmakers who supply the many products using semiconductors. This market demand can be volatile and unpredictable and can affect our ability to accurately predict future revenue and, therefore, our ability to manage our future expense levels. When cyclical fluctuations result in lower than expected revenue levels, operating results may be adversely affected and cost reduction actions may be necessary in order for us to remain competitive and financially stable. During a down cycle or slowdown, we must adjust our cost and expense structure to prevailing market conditions while maintaining our longer term strategies and motivating and retaining our key employees. In contrast, during periods of rapid growth, we must quickly increase manufacturing capacity and personnel to meet our customers’ needs. We can provide no assurance that these objectives can be met in a timely manner in response to industry cycles. We are not able to predict with any certainty the duration of any industry cycle or the timing or order of magnitude of any recovery from a down cycle or slowdown.

 

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Downturns in the semiconductor industry often result in decreases in demand for semiconductor manufacturing equipment, including the photolithography tools that our OEM customers produce. Downturns in the semiconductor industry have generally had severe effects on the demand for semiconductor manufacturing equipment and to a lesser extent, the associated installed base products. Fluctuating levels of investment by chipmakers and resulting pricing volatility will continue to materially affect our aggregate bookings, revenues and operating results. Even during periods of reduced revenues, we believe we must continue to invest in research and development and maintain extensive ongoing worldwide customer support capabilities to meet our customers’ needs and to remain competitive. Continued spending to further these objectives may temporarily harm our financial results. Semiconductor industry downturns and slowdowns will likely continue to adversely affect our business, financial condition and operating results.

Market conditions in the semiconductor industry and our OEM customers’ production efficiency can cause them to expand or reduce their orders for new light source systems as they try to manage their inventories and production requirements. We continue to work closely with our OEM customers to better understand these issues. However, we cannot guarantee that we will be successful in understanding our OEM customers’ inventory management or production requirements or that our OEM customers will not build up an excess inventory of light source systems. If our OEM customers retain an excess inventory of light source systems, 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. If our OEM customers demand shorter product lead times to improve their inventory and cash positions, our inventory management and cash position may be negatively affected, which may adversely affect our operating results, financial condition and cash flows.

A significant percentage of our revenue is derived from sales to a limited number of customers, and if we are not able to retain these customers, or they reschedule, reduce or cancel orders, or delay or default on payments, we may experience material adverse effects on our operating results, financial condition and cash flows.*

Two large companies, ASML and Nikon, dominate the photolithography tool business. ASML, Nikon and Samsung, one of our chipmaker customers that purchase our installed base products, accounted for the following percentages of our revenues during the periods indicated:

 

		Six Months Ended June,
		2010		2009
ASML		29%		8%
Nikon		13%		23%
Samsung		11%		14%
Total		53%		45%

We expect that sales to these customers will continue to account for a substantial portion 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. We can provide no assurance that any of our customers will continue to purchase our products at past or current levels. Sales to any of these customers may be affected by many factors, some of which are beyond our control. These factors include:

 

•

changes in global economic or market conditions affecting the semiconductor or the photolithography tool industries;

 

•

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

 

•

a customer experiencing production problems;

 

•

a decision to purchase light sources or related products from other suppliers;

 

•

a change in a customer’s production or utilization rate; and

 

•

a decline in a customer’s financial condition.

 

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These companies accounted for the following percentages of our total accounts receivable at the dates indicated:

 

		June 30, 2010		December 31, 2009
ASML		34%		14%
Nikon		6%		12%
Samsung		2%		6%
Total		42%		32%

We believe there is limited credit risk exposure for us with these companies who continue to demonstrate sound creditworthiness. However, our ability to generate future revenue and collect accounts receivable from them is dependent on their ongoing financial condition and liquidity.

The loss of any significant business from, or production problems for, any one of these customers may have a material adverse effect on our operating results, financial condition and cash flows.

The majority of our revenue is derived from selling our light source systems and supporting the installed base of light source systems being used in production.*

We expect sales of our excimer light source systems, including KrF and ArF systems, and the products in support of the installed base of light source systems to continue to account for a majority of our revenues in the near term. Continued market acceptance of our light source systems and installed base products is, therefore, critical to our future success. The rate at which chipmakers adopt excimer light sources may vary, for reasons including:

 

•

performance of ArF immersion-specific resists;

 

•

potential shortages of specialized materials used in deep ultraviolet (“DUV”) optics;

 

•

the productivity of double-patterning ArF lithography tools;

 

•

consolidation of chipmakers; and

 

•

the level of demand for chips with ever-smaller feature sizes.

We cannot guarantee that these factors can or will be overcome or that the demand for our excimer light source systems and installed base products will not be materially reduced. The demand for our light source systems and installed base 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 decline in chipmaker light source utilization rates or retirement of light sources in our installed base;

 

•

a failure to achieve continued market acceptance of our products;

 

•

a failure to manage customer satisfaction, product reliability, or maintain the effectiveness of direct field support;

 

•

a failure to release enhanced versions of our products on a timely basis;

 

•

a deterioration in global economic conditions;

 

•

the introduction of one or more improved versions of DUV light sources by our one competitor; and

 

•

technological changes that we are unable to address with our products.

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 systems and installed base products from a single supplier or a small group of suppliers. For certain optical, control system and pulse power components and subassemblies used in our light source systems and installed base products, we currently utilize a single supplier. To reduce the risk associated with this single supplier, we have supply agreements in place and carry a strategic inventory of these components. Strategic inventories are managed as a percentage of future demand. We also have vendor-managed inventory of critical components to further reduce the risk of a single supplier. In addition, we contract for the manufacture of various subassemblies of our products and depend on our contract manufacturers to deliver to our required specifications, schedule, and quality standards. Further, some of our suppliers have specialized in supplying equipment or manufacturing services to semiconductor equipment manufacturers and, therefore, are susceptible to industry fluctuations and subject to the same risks and uncertainties regarding their ability to respond to changing market and global economic conditions.

 

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Because many of these suppliers reduce their workforce in an industry downturn and rehire 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 manufacturing and delivery schedules. These suppliers may also be adversely affected by economic conditions, which could result in a lack of available capital and limit their ability to access such capital, if needed, to fund their operations. In addition, 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 may have a material adverse effect on our business, operating results, financial condition and cash flows.

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

The development, introduction and support of new products in a competitive business environment are complex processes and could be expensive. New or improved products may lead to higher costs and perhaps reduced profits. Rapid technological changes in semiconductor manufacturing processes subject us to increased pressure to develop technological advances which enable such processes. We believe that our future success depends in part upon our ability to develop, manufacture, and support new light source products with improved capabilities on a timely basis and to continue to enhance our existing product 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 established products. After our chipmaker customers have built their capacity to levels appropriate to meet existing demand, their demand for our light source products will depend, in part, on their sales forecasts, their estimates regarding the duration and magnitude of the current industry cycle and whether their projected manufacturing process yields will enable ongoing investments at a suitable level of capacity.

To provide our customers with more productive and lower cost of operation systems, 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 and to continue to grow our business. We cannot guarantee that we will be able to manage our business growth effectively. 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. Development of new products and enhancements to existing products represent significant investments of our resources, and there is no guarantee that we will realize a return on these investments. Further, we may not be able to effectively integrate new products and applications into our current operations. Any of these risks could have a material adverse effect on our operating results, financial condition and cash flows.

Current technologies that are still being developed and commercialized, such as EUV, and future technologies such as nano-imprint lithography and certain maskless lithography techniques may render our KrF and ArF excimer light source products obsolete. We must manage product transitions, as the introduction of new products could have a negative adverse affect on our sales of existing products.

EUV sources could fail to meet customer specifications or not be delivered on time.*

We are investing significant financial and other resources to develop EUV source technology for chip manufacturing. In the second quarter of 2010, we shipped the first pilot EUV system to ASML, and we are planning to deliver additional pilot sources for EUV lithography process development over the course of this year. If we are not able to meet customer specifications, or have reliability or quality problems, or if the pilot sources and eventually commercial systems do not meet customer specifications or are not introduced on time, or if a competitor’s source is selected over our source, we may experience the recording of impairment charges, reduced orders, higher manufacturing costs, delays in acceptance of and payment for new products, and additional service and warranty expenses. These risks could also damage our reputation among the initial adopters of EUV source technology and limit our ability to penetrate the market. Any of these risks could have a material adverse effect on our operating results, financial condition and cash flows.

 

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We could fail to penetrate the flat panel display market and may not achieve profitability in our TCZ operating segment.*

Effective January 15, 2010, we acquired full ownership of TCZ. TCZ offers a silicon crystallization system which can be used in the manufacture of OLED flat panel display systems. The manufacture of flat panel display systems is a new market for us and involves numerous risks. The global flat panel display industry historically has experienced considerable volatility in capital equipment investment levels, due in part to the limited number of liquid crystal displays (“LCD”) and OLED manufacturers and the concentrated nature of LCD and OLED end-use applications. We face strong competition in the flat panel display market from a number of major competitors. TCZ’s laser crystallization system is applicable only to manufacturing low temperature poly-silicon OLED displays, but low-temperature poly-silicon OLED display technology must compete for market share with other technologies for producing flat panel displays.

In addition to industry risks, we may not experience sufficient demand for TCZ’s production system for low-temperature poly-silicon processing in the manufacture of OLED flat panel displays. We have shipped, installed, and received customer acceptance of our first TCZ production system for OLED flat panel display fabrication. If future systems do not meet customer specifications or the customer decides not to place follow-on orders for additional systems, we may experience damage to our reputation among manufacturers of OLED fabrication systems and there is no guarantee that we will be able to materially penetrate this market or ever achieve profitability in our TCZ operating segment. To the extent TCZ is unable to achieve profitability, or we are obligated to provide increasing financial resources to support our flat panel display operations, our business, operating results, financial condition and cash flows could be materially adversely affected.

Global economic conditions could affect our revenues and operating results.

A general weakening of, or declining corporate or consumer confidence in, the global economy, or a reduction in corporate or consumer spending, could delay or significantly decrease purchases of our products by our customers, which are driven in part by indirect consumer demand for the electronic devices that contain semiconductor chips. It could also decrease revenues from our installed base products by causing our chipmaker customers to reduce their usage rates. Our revenues and operating results will be affected by uncertain or changing economic and market conditions including inflation, deflation, prolonged weak consumer demand or other changes which may affect the principal markets in which we conduct business. If economic or market conditions in the United States or other key global markets deteriorate, we may experience material adverse effects on our business, operating results, financial condition and cash flows.

Adverse economic and market conditions could also harm our business by negatively affecting the parties with whom we do business, including our business partners, our customers and our suppliers. These conditions could impair the ability of our customers to pay for products they have purchased from us. As a result, allowances for doubtful accounts and write-offs of accounts receivable from our customers may increase. In addition, our suppliers may experience financial difficulties that could negatively affect their operations and their ability to supply us with the parts we need to manufacture our products.

We face competition from one company in the DUV photolithography tool market and may face competition from additional competitors who enter the market.

Our future performance depends, in part, upon our ability to continue to compete successfully worldwide. The principal elements of competition in our markets are the technical performance characteristics of light source products and the operating efficiency of the system, which is based on availability, reliability, performance efficiency, cost of ownership, and overall quality.

We currently have one competitor, Gigaphoton, that sells light sources for DUV photolithography applications. Gigaphoton is a joint venture between two large companies, Komatsu and Ushio, and is headquartered in Japan. Our customers have purchased products from Gigaphoton and have qualified Gigaphoton’s light sources for use with their products. Additionally, Gigaphoton has been qualified by a number of chipmakers in Europe, Japan, other regions in Asia, and the United States, and has an installed base of light sources at chipmakers in these regions.

Future competitors may develop systems and products that are competitive to our products. This competition may affect our ability to sell our products. Larger companies 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 which represents a significant revenue stream for us, and they may attempt to supply replacement parts to our customer 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 business, operating results, financial condition and cash flows.

 

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We must effectively manage changes in our business. *

In order to respond to the business cycles of the semiconductor industry and overall economic conditions, we must constantly adjust our business plans and cost structure. As the semiconductor equipment industry cycle moves between contraction and growth and the condition of the global economy changes, we need to:

 

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quickly adapt to changing sales and marketing channels;

 

•

effectively manage our inventory levels;

 

•

closely manage our global operations and cost structure;

 

•

accurately forecast demand and meet production schedules for our products;

 

•

differentiate our products from those of competitors, meet customer performance specifications, and drive efficiencies;

 

•

allocate resources including key personnel between the development of new products and the enhancement of existing products, as most appropriate and effective for future growth;

 

•

improve our product reliability through quality control, order fulfillment and customer support capabilities;

 

•

attract, train, retain and motivate key personnel; and

 

•

improve our processes and other internal management systems.

If we fail to effectively manage changes in our business, we may experience a material adverse effect on our operating results, financial condition and cash flows.

Any failure to manage our inventory levels and our inventory controls at our widely dispersed operations could adversely affect our business, operating results, financial condition and cash flows.*

We need to continually evaluate and monitor the adequacy of our inventory levels. We also need to closely manage the levels of obsolete and excess parts. We have inventory located at warehouses at our corporate office in the United States and at bonded warehouses and customer locations throughout Asia, Europe and North America. The success of our business depends to a significant degree on our ability to maintain or increase the sales of our products in the markets in which we do business. If we overestimate demand for our products or the overall condition of the global economy, we could experience excess inventory levels and use unnecessary cash. As a result of such excess inventory, we may be required to significantly write down the value of our inventory, which would negatively affect our operating results and financial condition.

We could also sustain a loss in the event of a catastrophe in any of the locations where we maintain our inventory if our insurance is inadequate to cover such losses. We will be required to continually analyze the sufficiency of our inventory distribution systems in order to support our operations. We may not adequately anticipate all of the changing demands that will be imposed on these systems. An inability or failure to update our internal inventory distribution systems or procedures, as required, could have a material adverse effect on our business, operating results and financial condition.

International operations expose us to foreign currency exchange rate fluctuations for all foreign currencies in which we do business, and we may be materially adversely affected by these fluctuations.*

We have international subsidiaries that operate in foreign currencies. All of our international subsidiaries purchase inventory in U.S. Dollars from either our manufacturing facility in San Diego or from our Korean subsidiary and, in many cases, resell these products to their customers in their local currency. In addition, our TCZ subsidiary purchases certain inventory in Euros. We hedge the foreign currency risks associated with these intercompany transactions by entering into forward contracts. Although we enter into such forward contracts, they may not be adequate to eliminate the risk of foreign currency exchange rate exposures.

We have taken steps to mitigate our foreign currency exchange risks; however, these steps may fail to sufficiently hedge or otherwise manage our foreign currency risks properly and could have a material adverse effect on our operating results and financial condition.

International operations also expose us to currency fluctuations as we translate the financial statements of our international subsidiaries to U.S. Dollars.

 

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

We believe it is critical for us to provide quick and responsive support directly to our chipmaker and direct customers who use our light source products in their photolithography systems as well as to display manufacturers that purchase our TCZ laser crystallization system. It is also essential to have well trained field service engineers to provide the high level of support that our customers have come to expect. Accordingly, we have an ongoing effort to develop our direct support system with service locations in Europe, Korea, Japan, China, Singapore, Taiwan and the United States. This requires us to do the following:

 

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recruit and train qualified support service personnel; and

 

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maintain effective and highly trained resources who can provide support to our customers in various countries.

We may not be able to attract and train qualified personnel to maintain our direct support operations successfully. Further, we may incur significant costs in providing this support. Failure to implement our direct support operation effectively could harm our operating results, financial condition and cash flows.

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

Operations at our primary manufacturing facility in San Diego and our refurbishment facility in Korea and operations at our suppliers are subject to disruption for a variety of reasons, including but not limited to, work stoppages, terrorism, political turmoil, fire, earthquake, energy shortages, flooding or other natural disasters. Such disruptions could cause delays in shipments of our products to our customers. Our San Diego facility, where we build our light source systems and replacement parts, poses the greatest risk. We provide no assurance 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, or at all. 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.

We depend on key personnel, particularly 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:

 

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research and development;

 

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engineering;

 

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sales and marketing;

 

•

direct service support;

 

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manufacturing; and

 

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management or leadership roles.

In particular, there are a limited number of experts in excimer light source technology, EUV lithography, and the laser crystallization process for flat panel display fabrication, 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. We believe that our future growth and operating results will depend on:

 

•

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

 

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

 

•

the ability of key management to continue to expand, motivate and manage our employee base.

Stock option grants may not be viewed by key employees as a financial incentive during periods when stock price volatility could cause our stock price to fall below the option’s exercise price, reducing the effectiveness of stock options as a means to retain and incentivize these employees. Grants to our key employees have an exercise price per share at least equal to the fair market value of our common stock on the date of grant.

 

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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.

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

We serve a global market and a large portion of our revenue is derived from customers outside of the United States. We expect our international sales to continue to account for the majority of our total revenues. In order to support our foreign customers, we maintain a refurbishment facility in Korea as well as field support facilities in Japan, the Netherlands, China, Singapore and Taiwan.

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 be viably competitive in the global market, or we may not be able to meet the support or manufacturing levels required by our global customers. Additionally, we are subject to risks inherent in doing business globally, including but not limited to:

 

•

fluctuations in exchange rates and currency controls;

 

•

political and economic conditions and instability, including economic turmoil in many parts of the world;

 

•

imposition of trade barriers and restrictions, such as the Foreign Corrupt Practices Act, including changes in tariff and freight rates, foreign customs and duties;

 

•

difficulty in coordinating our management and operations in 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 challenging accounts receivable collections;

 

•

the risk of business interruption as a result of natural disasters or supply chain disruptions;

 

•

the effect of acts of terrorism and war;

 

•

the burdens of complying with foreign laws, including regulatory structures and unexpected changes in regulatory environments; and

 

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distribution costs, disruptions in shipping or reduced availability of freight transportation.

A significant portion of our customers are located in Asia. Political turmoil, economic problems and currency fluctuations affecting Asia could increase our risk in that region. It has not been difficult for us to comply with United States export controls; however, changes to these controls in the future could make it more difficult or impossible for us to export our products to many countries. There are certain risks for which we purchase limited or no insurance, including earthquake risk. Any of these vulnerabilities could have a material adverse effect on our business, operating results, financial condition and cash flows. Currently, none of our United States or international employees are members of a labor union; however if such employees decide to join a union, our cost of doing business could increase, and we could experience contract delays, difficulty in adapting to a changing regulatory and economic environment, cultural conflicts between unionized and non-unionized employees, strikes and work stoppages, any of which could have a material adverse effect on our business, financial condition and operating results.

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 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. We own and have numerous patents pending in the United States and various foreign countries covering certain aspects of technology related to our light source and TCZ laser crystallization system. These patents will expire at various times through 2029.

 

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Our pending patent applications and any future applications might not be approved. Our patents may not provide us with a competitive advantage and may be successfully challenged by third parties. In addition, third parties’ patents might have an adverse effect on our ability to do business. Due to cost constraints, we do not seek international patent protection for all inventions that are covered by United States patents and patent applications. As a result, we do not have foreign patent protection for some of our 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 Therefore, the likelihood of piracy of our technology and products is greater 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 file or have filed patent applications that are similar or identical to ours. As a result, we may have to participate in appropriate proceedings in the courts or the patent offices to determine the priority of inventions. These proceedings may determine that these third-party patent applications have priority over our patent applications. Loss of priority in these interference proceedings could result in substantial cost to us and loss of rights.

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

 

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trade secret protection;

 

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employee nondisclosure agreements;

 

•

third-party nondisclosure agreements; and

 

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other intellectual property protection methods.

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

 

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develop substantially the same proprietary information or techniques independently;

 

•

gain access to our trade secrets from unrelated third parties and/or without obligation of confidentiality; or

 

•

disclose our technology following expiration of their confidentiality obligation.

We may be subject to patent litigation to enforce patents issued to us or defend ourselves against claimed infringement by our competitor 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.

In the future, patent litigation may result due to a claim of infringement by our competitor or any other third party or may be necessary to enforce patents issued to us. Any such litigation could result in substantial cost to us and diversion from our primary business efforts, 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, it may have a material adverse effect on our business, operating results, financial condition and cash flows. Instead of litigation, or as a result thereof, we may seek a license from third parties to use their intellectual property. However, we may not be able to obtain a license. Alternatively, 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:

 

•

loss of our proprietary rights;

 

•

exposure to significant liabilities by other third parties;

 

•

a requirement that we get a license from third parties on terms that are not favorable to us or not available at all; or

 

•

an injunction that prohibits us from manufacturing or selling our products.

Any of these actions could be costly and would divert the efforts and attention of our management and technical personnel, which could have a material adverse effect on our business, operating results, financial condition and cash flows.

 

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Disputes may arise over the ownership of intellectual property resulting from our research and development activities that are partially funded by other parties.

Funds from research and development arrangements with third parties have been used to pay for a portion of our research and development costs associated with the design and development of specific products. Additionally, funds from lithography tool manufacturers and chipmaker customers have been used to fund a portion of our light source research and development efforts. In connection with providing these research and development services, we try to make contractually clear who owns the intellectual property that results from such activities. Disputes over the ownership or rights to use or market the resulting intellectual property could arise between the funding organizations 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.

If our goodwill, definite lived intangible assets or our property, plant and equipment become impaired, we may be required to record a significant charge to earnings.

We review our amortizable intangible assets, which are primarily patents, and our property, plant and equipment, for impairment when events or changes in circumstances indicate that their carrying value may not be recoverable. Goodwill is also tested for impairment at least annually and more often if certain triggering events or circumstances occur. Factors that may be considered to be a change in circumstances that would indicate the carrying value of our goodwill, amortizable intangible assets or our property, plant and equipment may not be recoverable include reduced future cash flow estimates for our company, a decline in our stock price and market capitalization, slower growth rates in our industry and adverse global economic conditions. If, as a result of our impairment test, it is determined that our goodwill, amortizable intangible assets or property plant and equipment is impaired, we may be required to record a significant charge in our financial statements during the period in which such impairment is determined, which may have a material adverse affect on our operating results.

Our investments in marketable securities are subject to market, interest and credit risk that may reduce their value.

The value of our investments in marketable securities may be adversely affected by changes in interest rates, downgrades in the creditworthiness of bonds we hold, turmoil in the credit markets and financial services industry and by other factors which may result in other than temporary declines in the value of our investments. Each of these events may cause us to record charges to reduce the carrying value of our investment portfolio, which could have a material adverse effect on our operating results and financial position.

Changes in our effective tax rate may have a material adverse effect on our operating results, financial position and cash flows.

Our future effective tax rate may be adversely affected by a number of factors including:

 

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changes in available tax credits, particularly the federal research and development tax credit, which expired at the end of 2009 and has yet to be reinstated for 2010 and later years;

 

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the resolution of issues arising from tax audits with various tax authorities;

 

•

the jurisdictions in which profits are determined to be earned and taxed;

 

•

changes in the valuation of our deferred tax assets and liabilities;

 

•

adjustments to estimated taxes upon finalization of various tax returns;

 

•

increases in expenses not deductible for tax purposes;

 

•

changes in tax laws or the interpretation of such tax laws, such as the Internal Revenue Service (“IRS”) Code Section 199 manufacturing deduction which currently provides a tax benefit; and

 

•

the repatriation of non-U.S. earnings for which we have not previously provided for United States taxes.

An adverse change in our future effective tax rate could in turn, adversely affect our operating results, financial position and cash flows.

We may not have sufficient cash to fund our current operations and future growth plans.

We believe that our cash resources remain sufficient for our planned operations; however, if global economic conditions deteriorate, our business conditions worsen, our plans change or other unanticipated events occur, we may need to raise additional cash through the establishment of financing facilities or the sale of equity or debt securities to fund our operations. Depending on market conditions, it could be difficult for us to raise the additional cash needed without incurring significant dilution of our existing stockholders or agreeing to significant restrictions on our ability to operate as currently planned. If we were unable to raise additional cash in such circumstances, we could be required to reduce costs further through the delay, reduction or curtailment of our operating plan, including further reductions in our global workforce or other cost reduction actions, any of which could have a material adverse effect on our operating results, financial condition or cash flows.

 

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We may acquire a business or enter a new market that will involve numerous risks. We may not be able to address these risks successfully without substantial expense, delay or other operational and financial challenges.

The risks involved with mergers, acquisitions and joint ventures or entering a new market include the following:

 

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diversion of management’s attention and resources to integrate the new business opportunity;

 

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failure to retain key personnel;

 

•

customer dissatisfaction or performance problems with the acquired company or new product in a new market;

 

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costs associated with acquisitions and joint ventures and the integration of acquired operations;

 

•

costs associated with developing, marketing, introducing and supporting a new product in a new market;

 

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failure to commercialize purchased technologies;

 

•

ability of the acquired companies, joint ventures or new markets to meet their financial projections;

 

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

 

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compliance with the Sarbanes-Oxley Act of 2002, new SEC regulations, NASDAQ Stock Market rules and new accounting standards as they relate to the new company or joint venture.

Mergers, acquisitions and joint ventures, as well as entry into new markets, are inherently subject to multiple significant risks, and the inability to effectively manage these risks could have a material adverse effect on our business. Further, any business that we acquire, any joint venture that we form or new market we may enter may not achieve anticipated revenues or operating results.

We may experience difficulties with our enterprise resource planning (“ERP”) system or other critical information systems that we use for the daily operations of our business. System failure or malfunction or loss of data contained in these information systems may result in disruption of our operations and result in our inability to process transactions, and this could adversely affect our financial results.

System failure, malfunction or loss of data which is housed in our critical information systems could disrupt our ability to timely and accurately process transactions and produce key financial reports, including information on our operating results, financial position and cash flows. Any disruptions or difficulties that may occur in connection with our ERP system or other critical systems could also adversely affect our ability to complete important business processes such as the evaluation of our internal controls and attestation activities pursuant to Section 404 of the Sarbanes-Oxley Act of 2002. We also regularly upgrade our information systems hardware and software to better meet the information requirements needed to effectively manage our business. If we encounter unforeseen problems with regard to our ERP system or other critical information systems, including those encountered during system upgrades, our business could be adversely affected.

Compliance with changing regulations and standards for accounting, corporate governance and public disclosure may result in additional expenses.

Changing laws, regulations and standards relating to corporate governance and public disclosure, including new SEC regulations, new NASDAQ Stock Market rules, new accounting requirements and the expected future requirement to transition to international financial reporting standards are creating uncertainty and additional complexities for companies such as ours. For example, the Section 404 internal control evaluation requirements under the Sarbanes-Oxley Act of 2002 have added complexity and costs to our business and require a significant investment of our time and resources to complete each year. We take these requirements seriously and expect to continue to make every effort to ensure that we receive clean attestations on our internal controls each year from our outside auditors, but there is no guarantee that our efforts to do so will be successful. Financial reform legislation, and the regulations enacted under such legislation, could add costs to our business by requiring advisory votes on executive compensation and severance packages and increasing access to, and the number of proposals in, our proxy statement. 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.

 

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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, regulatory compliance issues 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 service of or support for installed light sources for chipmakers; and

 

•

our sales and marketing efforts may be disrupted.

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 and these standards and regulations are frequently being amended. Although we intend to meet all foreign standards and regulations, our products may not comply with all of them. 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 products to fully comply with foreign standards, therefore, could have a material adverse effect on our business.

Our chipmaker customers’ 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 our chipmaker customers’ production specifications or operating cost requirements after the light source has been 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 them and with lithography tool manufacturers. This would have a negative effect on our business.

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 in 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 meet other requirements 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. This could have a material adverse effect on our business, operating results, financial condition and cash flows.

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 are acceptable to us. 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, operating results, financial condition and cash flows.

 

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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 have registered a number of trademarks including “CYMER” in the United States and in some other countries. We are also trying to register additional trademarks in the United States and in other countries. These registrations in other countries, or any new registrations we may undertake in the United States, could be unsuccessful.

We use these trademarks in the course of our business and in advertising materials, which are distributed throughout the world. While we take precautions against trademark infringement before using our trademarks in new markets, we may be subject to claims of trademark infringement. The process of negotiating a settlement or coexistence agreement to allow us to continue using our trademarks in a particular market could be expensive or distract us from our primary business efforts, potentially adversely affecting our financial condition or operations. Furthermore, if we must undertake negotiations, and the negotiations are ultimately unsuccessful, we would either need to discontinue using the trademarks in the new market, risk facing litigation or potentially pay damages. Even if we ultimately prevail, litigation could be expensive or distract us from our primary business efforts.

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

The price of our common stock has historically been subject to significant fluctuations and could continue to fluctuate significantly in response to a variety of factors, including the risk factors contained in this report.

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

 

•

the cyclical nature of the semiconductor industry;

 

•

actual or anticipated fluctuations in our operating results, including our net income, revenue and product gross margins;

 

•

conditions and trends in the light source device and other technology industries;

 

•

announcements of innovations in technology;

 

•

new products offered by us or our competitor;

 

•

developments of patents or proprietary rights;

 

•

changes in financial estimates by securities analysts;

 

•

global political, economic, and market conditions, including a recession or economic deterioration; and

 

•

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

Stock markets in the United States can experience extraordinary volatility. Severe price fluctuations in a company’s stock have frequently been followed by securities litigation. If such litigation were initiated against us, it may result in substantial costs and a diversion of management’s attention and resources and, therefore, could have a material adverse effect on our business, operating results, financial condition and cash flows.

Some anti-takeover provisions contained in our articles of incorporation and bylaws, as well as provisions of Nevada law and our executive employment contracts, could impair a takeover attempt.

Our articles of incorporation and bylaws contain provisions which could have the effect (separately, or in combination) of rendering more difficult or discouraging a merger, acquisition or other change of control deemed undesirable by our Board of Directors. These include provisions:

 

•

authorizing blank check preferred stock, which could be issued with voting, liquidation, dividend and other rights superior to our common stock;

 

•

limiting the liability of, and providing indemnification to, our directors and officers;

 

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•

requiring advance notice of stockholder proposals for business to be conducted at meetings of our stockholders and for nominations of candidates for election to our Board of Directors;

 

•

controlling the procedures for conduct of stockholder meetings and election and removal of directors; and

 

•

specifying that stockholders may not take action by written consent.

These provisions, alone or together, could deter or delay hostile takeovers, proxy contests and changes in control or management.

As a Nevada corporation, we are subject to Nevada law. Nevada law does not grant stockholders the authority to call a special meeting unless the corporation’s articles of incorporation or bylaws otherwise provide; neither our articles of incorporation nor our bylaws contain such a provision. Nevada law may also limit the ability of certain stockholders to engage in certain business combinations with us and may limit the voting rights of stockholders who acquire 20% or more of our outstanding shares. Either limitation could discourage or increase the difficulty of an attempted merger, acquisition or other change of control.

Additionally, we have employment agreements with certain officers under which severance payments would become payable in the event of specified terminations without cause or terminations under certain circumstances after a change in control. If such persons were terminated without cause or under certain circumstances after a change of control, and the severance payments under the current employment agreements were to become payable, the officers would receive certain payments and other benefits which depend on the individual officer’s employment agreement but generally include continued base salary and health insurance payments for a period of time, lump sum bonus payments and accelerated vesting of equity awards.

Any provision of our articles of incorporation, bylaws, employment agreements or Nevada law that has the effect of delaying or deterring a change in control could limit the opportunity for our stockholders to receive a premium for their shares of our common stock in connection with such a transaction and also could affect the price that some investors are willing to pay for our common stock.

Sales of additional common stock and securities convertible into our common stock may dilute the voting power of current holders.

We may issue equity securities in the future the terms and rights of which are superior to those of our common stock. Our articles of incorporation authorize the issuance of up to 5,000,000 shares of preferred stock. These are “blank check” preferred shares, meaning that our Board of Directors is authorized, from time to time, to issue the shares and designate their voting, conversion and other rights, including rights superior, or preferential, to rights of already outstanding shares, all without stockholder consent. No preferred shares are outstanding, and we currently do not intend to issue any shares of preferred stock. Any shares of preferred stock that may be issued in the future could be given voting and conversion rights that could dilute the voting power and equity of existing holders of shares of common stock and have preferences over shares of common stock with respect to dividends and liquidation rights.

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

 

(a)

Not applicable

 

(b)

Not applicable

 

(c)

On April 21, 2008, we announced that our board of directors authorized us to repurchase up to $100 million of our common stock. The purchases have been made from time to time in the open market or in privately negotiated transactions. The program does not have a fixed expiration date and may be discontinued at any time.

 

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Table of Contents

The following table provides information with respect to the shares of common stock repurchased by us during the three months ended June 30, 2010:

 

Period		Total number of shares purchased		Average price paid per share			Total number of shares purchased as part  of publicly announced plans or programs		Approximate dollar value of shares that may yet be purchased  under the plans or programs
April 1, 2010 to April 30, 2010		292,500		$	35.40		292,500		$	66.8 million
May 1, 2010 to May 31, 2010		267,500			33.28		267,500		$	57.8 million
June 1, 2010 to June 30, 2010		-			-		-		$	57.8 million
Total		560,000		$	34.46		560,000

ITEM 3. Defaults Upon Senior Securities

None.

ITEM 4. (Removed and Reserved)

ITEM 5. Other Information

 

(a)

None.

(b)

There were no material changes to the procedures by which security holders may recommend nominees to our board of directors.

ITEM 6. Exhibits

 

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.
101		The following financial information from Cymer, Inc.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets as of June 30, 2010 and December 31, 2009, (ii) the Consolidated Statements of Operations for the three and six months ended June 30, 2010 and 2009, (iii) the Consolidated Statements of Comprehensive Income (Loss) for the three and six months ended June 30, 2010 and 2009, (iv) the Consolidated Statements of Equity for the six months ended June 30, 2010, (v) the Consolidated Statements of Cash Flows for the six months ended June 30, 2010 and 2009 and (vi) the Notes to Unaudited Consolidated Financial Statements, tagged as blocks of text.

SIGNATURES

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

 

		CYMER, INC.
Date: July 29, 2010		By:		/S/ PAUL B. BOWMAN
				Paul B. Bowman
				Senior Vice President and Chief Financial Officer
				(Principal Financial Officer)

 

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