United States

Securities and Exchange Commission

Washington, D.C. 20549

 

Form 20-F

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)

OF THE SECURITIES EXCHANGE ACT OF 1934

for the fiscal year ended December 31, 2007

 

Commission file number 025566

 

 

ASML HOLDING N.V.

(Exact Name of Registrant as Specified in Its Charter)

 

THE NETHERLANDS

(Jurisdiction of Incorporation or Organization)

 

DE RUN 6501

5504 DR VELDHOVEN

THE NETHERLANDS

(Address of Principal Executive Offices)

 

Securities registered or to be registered pursuant to

Section 12(b) of the Act:

 

 

Securities registered or to be registered pursuant to

Section 12(g) of the Act:

None

(Title of Class)

 

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

None

(Title of Class)

 

Indicate the number of outstanding shares of each of the issuer’s classes of

capital or common stock as of the close of the period covered by the annual report.

 

435,625,934 Ordinary Shares

(nominal value EUR 0.09 per share)

 

Indicate by check mark if the registrant is a well-known seasoned issuer,

as defined in Rule 405 of the Securities Act.

Yes (ü) No ( )

 

If this report is an annual or transition report, indicate by check mark if the registrant

is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

Yes ( ) No (ü)

 

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 (ü) No ( )

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.

See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer (ü) Accelerated filer ( ) Non-accelerated filer ( )

 

Indicate by check mark which financial statement item the registrant has elected to follow

Item 17 ( ) Item 18 (ü)

 

If this is an annual report, indicate by check mark whether the registrant is a

shell company (as defined in Rule 12b-2 of the Exchange Act)

Yes ( ) No (ü)

 

Name and address of person authorized to receive notices and communications

from the Securities and Exchange Commission:

 

Richard A. Ely

Skadden, Arps, Slate, Meagher & Flom (UK) LLP

40 Bank Street, Canary Wharf

London E14 5DS England

 

ASML ANNUAL REPORT 2007

Contents

 

 

 

ASML ANNUAL REPORT 2007

 

ASML ANNUAL REPORT 2007

 

 

Special Note Regarding Forward-Looking Statements

In addition to historical information, this annual report on Form 20-F contains statements relating to our future business and/or results. These statements include certain projections and business trends that are “forward-looking” within the meaning of the Private Securities Litigation Reform Act of 1995. You can generally identify these statements by the use of words like “may”, “will”, “could”, “should”, “project”, “believe”, “anticipate”, “expect”, “plan”, “estimate”, “forecast”, “potential”, “intend”, “continue” and variations of these words or comparable words.

 

 

Forward-looking statements do not guarantee future performance and involve risks and uncertainties. Actual results may differ materially from projected results as a result of certain risks and uncertainties. These risks and uncertainties include, without limitation, those described under Item 3.D. “Risk Factors” and those detailed from time to time in our other filings with the United States Securities and Exchange Commission (the “Commission” or the “SEC”). These forward-looking statements are made only as of the date of this annual report on Form 20-F. We do not undertake to update or revise the forward-looking statements, whether as a result of new information, future events or otherwise.

 

 

Presentation of Financial and Operational Information

On December 18, 2002, we announced our decision to divest our Thermal business, including related customer support activities, and the termination of our manufacturing activities in the Track business. As a result of this decision our selected financial data for the years ended December 31, 2003, 2004 and 2005 presented in this annual report on Form 20-F present these businesses as discontinued operations, instead of as a separate segment as they had been reported prior to the divestiture announcement.

 

 

Not applicable.

 

 

Not applicable.

The following selected consolidated financial data should be read in conjunction with Item 5 “Operating and Financial Review and Prospects” and Item 18 “Financial Statements”.

 

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Five-Year Financial Summary

 

 

ASML ANNUAL REPORT 2007

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ASML ANNUAL REPORT 2007

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Exchange Rate Information

We publish our consolidated financial statements in euro. In this Annual Report, references to “€”, “EUR” or “euro” are to euro, and references to ‘‘$”, “dollars”, “U.S. dollars”, “U.S. dollar”, “USD” or “US$” are to United States dollars. Solely for the convenience of the reader, certain U.S. dollar amounts have been translated into euro amounts using an exchange rate in effect on December 31, 2007 of US $1.00 = EUR 0.67986.

 

 

A portion of our net sales and expenses is, and historically has been, denominated in currencies other than the euro. For a discussion of the impact of exchange rate fluctuations on our financial condition and results of operations, see Item 5.A. “Operating Results, Foreign Exchange Management” and Note 1 to our consolidated financial statements.

 

 

The following are the Noon Buying Rates certified by the Federal Reserve Bank of New York for customs purposes (the “Noon Buying Rate”) expressed in U.S. dollars per euro.

 

 

 

Not applicable.

Not applicable.

In conducting our business, we face many risks that may interfere with our business objectives. Some of these risks relate to our operational processes, while others relate to our business environment. It is important to understand the nature of these risks and the impact they may have on our business, financial condition and results of operations. Some of the more relevant risks are described below.

 

 

Risks Related to the Semiconductor Industry

 

The Semiconductor Industry is Highly Cyclical and We May Be Adversely Affected by Any Future Downturns

As a supplier to the global semiconductor industry, we are subject to the industry’s business cycles, the timing, duration and volatility of which are difficult to predict. The semiconductor industry has historically been cyclical. Sales of our photolithography systems depend in large part upon the level of capital expenditures by semiconductor manufacturers. These capital expenditures depend upon a range of competitive and market factors, including:

 

 

Changes in demand for our products as a result of these business cycles have been affected by the timing and amounts of customers’ capital equipment purchases and investments in new technology. Future reductions or delays in capital equipment purchases by our customers could have a material adverse effect on our business, financial condition and results of operations.

 

 

In anticipation of periods of increasing demand for semiconductor manufacturing equipment, we must maintain sufficient manufacturing capacity and inventory, and we must attract, hire, integrate and retain a sufficient number of qualified employees to

 

ASML ANNUAL REPORT 2007

4

meet customer demand. Our ability to predict the timing and magnitude of industry fluctuations is limited and our products require significant lead time to complete. Accordingly, we may not be able to effectively increase our production capacity to respond to an increase in customer demand in an industry upturn resulting in lost revenues and damage to customer relationships.

 

 

Conversely, in an industry downturn, our ability to maintain profitability will depend substantially on whether we are able to lower our costs and break-even level, which is the number of lithography systems we must sell in a year to achieve net income. If we are unable to lower costs in an industry downturn, our net income may decline significantly or we may suffer losses. As we need to keep certain levels of inventory on hand to meet anticipated product demand, we also incur increased costs related to inventory obsolescence in an industry downturn. In addition, industry downturns generally result in overcapacity, resulting in downward pressure on prices, which has had in the past, and could have in the future, a material adverse effect on our business, financial condition and results of operations.

 

 

Our Business Will Suffer If We Do Not Respond Rapidly to Commercial and Technological Changes in the Semiconductor Industry

The semiconductor manufacturing industry is subject to:

 

 

Our products could become obsolete sooner than anticipated because of a faster than anticipated change in one or more of the technologies related to our products or in market demand for products based on a particular technology. Our success in developing new products and in enhancing our existing products depends on a variety of factors, including the successful management of our research and development programs and timely completion of product development and design relative to competitors. If we do not develop and introduce new and enhanced systems at competitive prices and on a timely basis, our customers will not integrate our systems into the planning and design of new fabrication facilities and upgrades of existing facilities, which would have a material adverse effect on our business, financial condition and results of operations.

 

 

In addition, we may invest considerable financial and other resources to develop and introduce new products and product enhancements, such as Extreme Ultraviolet lithography (“EUV”), that our customers may not ultimately adopt. If our customers do not adopt these new technologies, products or product enhancements that we develop due to a preference for more established or alternative new technologies and products or for other reasons, we would not recoup any return on our investments in these technologies or products, which may result in charges to our statement of operations and materially and adversely affect the future growth of the Company.

 

 

We Face Intense Competition

The semiconductor equipment industry is highly competitive. The principal elements of competition in our market segments are:

 

 

Our competitiveness increasingly depends upon our ability to develop new and enhanced semiconductor equipment that is competitively priced and introduced on a timely basis, as well as our ability to protect and defend our intellectual property rights. See Item 4.B. “Business Overview, Intellectual Property” and Note 15 to our consolidated financial statements.

 

 

The costs to develop new systems, in particular photolithography systems, are extremely high and accordingly, the photolithography equipment industry is characterized by fierce competition among a few suppliers. ASML’s primary competitors are Nikon Corporation (“Nikon”) and Canon Kabushika Kaisha (“Canon”). Nikon and Canon are the leading suppliers in Japan, which accounts for a significant portion of worldwide semiconductor production. This region historically has been difficult for non-Japanese companies to penetrate.

 

 

Both Nikon and Canon have substantial financial resources and broad patent portfolios. Each continues to introduce new products with improved price and performance characteristics that compete directly with our products, and may cause a decline in our sales or loss of market acceptance for our photolithography systems. In addition, adverse market conditions, industry overcapacity or a decrease in the value of the Japanese yen in relation to the euro or the U.S. dollar could further intensify price-based competition in those regions that account for the majority of our sales, resulting in lower prices and margins and a material adverse effect on our business, financial condition and results of operations.

 

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Industry Alliances May Not Select our Equipment

Increasingly, our customers are entering into alliances or other forms of cooperation with one another to expedite the development of processes and other manufacturing technologies. One of the results of such a form of cooperation may be the definition of a system or particular tool set for a certain function or a series of process steps that use a specific set of manufacturing equipment. These decisions could work to our disadvantage if a competitor’s equipment becomes the standard equipment for such function or process. Even if ASML’s equipment was previously used by a customer, that equipment may be displaced in current and future applications by the equipment standardized by the form of cooperation. These forms of cooperation may have a material adverse effect on our business, financial condition and results of operations.

 

 

Risks Related to ASML

 

The Number of Systems We Can Produce Is Limited by Our Dependence on a Limited Number of Suppliers of Key Components

We rely on outside vendors for the components and subassemblies used in our systems, each of which is obtained from a single supplier or a limited number of suppliers. Our reliance on a limited group of suppliers involves several risks, including a potential inability to obtain an adequate supply of required components and the risk of untimely delivery of these components and subassemblies.

 

 

The number of photolithography systems we have been able to produce has occasionally been limited by the production capacity of Carl Zeiss SMT AG (“Zeiss”). Zeiss is our single supplier of lenses and other critical optical components. If Zeiss were unable to maintain and increase production levels or if we are unable to maintain our business relationship with Zeiss in the future we could be unable to fulfill orders, which could damage relationships with current and prospective customers and have a material adverse effect on our business, financial condition and results of operations. If Zeiss were to terminate its relationship with us or if Zeiss were unable to maintain production of lenses over a prolonged period, we would effectively cease to be able to conduct our business. See Item 4.B. “Business Overview, Manufacturing, Logistics and Suppliers”.

 

 

In addition to Zeiss’ current position as our single supplier of lenses, the excimer laser illumination systems that provide the ultraviolet light source, referred to as “deep UV”, used in our high resolution steppers and Step & Scan systems are available from only a limited number of suppliers. In particular, we rely both on Cymer, Inc., a United States based company, and Gigaphoton, Inc., a Japanese based company, to provide excimer laser illumination systems.

 

 

Although the timeliness, yield and quality of deliveries to date from our other subcontractors generally have been satisfactory, manufacturing of certain of these components and subassemblies that we use in our manufacturing processes is an extremely complex process and delays caused by suppliers may occur in the future. A prolonged inability to obtain adequate deliveries of components or subassemblies, or any other circumstance that requires us to seek alternative sources of supply, could significantly hinder our ability to deliver our products in a timely manner, which could damage relationships with current and prospective customers and have a material adverse effect on our business, financial condition and results of operations.

 

 

A High Percentage of Net Sales Is Derived from a Few Customers

Historically, we have sold a substantial number of lithography systems to a limited number of customers. While the identity of our largest customers may vary from year to year, we expect sales to remain concentrated among relatively few customers in any particular year. In 2007, sales to our largest customer accounted for EUR 833 million, or 21.9 percent of net sales, compared to EUR 730 million, or 20 percent of net sales, in 2006. The loss of any significant customer or any significant reduction in orders by a significant customer may have a material adverse effect on our business, financial condition and results of operations.

 

 

Additionally, as a result of the limited number of our customers, credit risk on our receivables is concentrated. Our three largest customers accounted for 40.1 percent of accounts receivable at December 31, 2007, compared to 35 percent at December 31, 2006. As a result, business failure or insolvency of one of our main customers may have a material adverse effect on our business, financial condition and results of operations.

 

 

The Pace of Introduction of Our New Products Is Accelerating and Is Accompanied by Potential Design and Production Delays and by Significant Costs

The development and initial production, installation and enhancement of the systems we produce is often accompanied by design and production delays and related costs of a nature typically associated with the introduction and transition to full-scale manufacturing of complex capital equipment. While we expect and plan for a corresponding learning curve effect in our product development cycle, we cannot predict with precision the time and expense required to overcome these initial problems and to ensure full performance to specifications. There is a risk that we may not be able to introduce or bring to full-scale production new products as quickly as we expected in our product introduction plans, which could have a material adverse effect on our business, financial condition and results of operations.

 

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In order for the market to accept technology enhancements, our customers, in many cases, must upgrade their existing technology capabilities. Such upgrades from established technology may not be available to our customers to enable volume production using our new technology enhancements. This could result in our customers not purchasing, or pushing back or canceling orders for our technology enhancements, which could negatively impact our business, financial condition and results of operations.

 

 

We Derive Most of Our Revenues from the Sale of a Relatively Small Number of Products

We derive most of our revenues from the sale of a relatively small number of lithography equipment systems (260 units in 2007; 266 units in 2006), with an average selling price (“ASP”) in 2007 of EUR 13.0 million (EUR 14.0 million for new systems and EUR 3.9 million for used systems) and an ASP in 2006 of EUR 12.1 million (EUR 14.0 million for new systems and EUR 3.2 million for used systems). As a result, the timing of recognition of revenue from a small number of product sales may have a significant impact on our net sales and other operating results for a particular reporting period. Specifically, the failure to receive anticipated orders, or delays in shipments near the end of a particular reporting period, due, for example, to:

may cause net sales in a particular reporting period to fall significantly below net sales in previous periods or our expected net sales, and would have a material adverse effect on our operating results for that period.

 

 

In particular our published quarterly earnings have varied significantly from quarter to quarter and may vary in the future for the reasons discussed above.

 

 

Failure to Adequately Protect the Intellectual Property Rights Upon Which We Depend Could Harm Our Business

We rely on intellectual property rights such as patents, copyrights and trade secrets to protect our proprietary technology. However, we face the risk that such measures could prove to be inadequate because:

 

 

In addition, litigation may be necessary to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Any such litigation may result in substantial costs and diversion of resources, and, if decided unfavorably to us, could have a material adverse effect on our business, financial condition and results of operations.

 

 

Defending Against Intellectual Property Claims Brought by Others Could Harm Our Business

In the course of our business, we are subject to claims by third parties alleging that our products or processes infringe upon their intellectual property rights. If successful, such claims could limit or prohibit us from developing our technology and manufacturing our products, which could have a material adverse effect on our business, financial condition and results of operations.

 

 

In addition, our customers may be subject to claims of infringement from third parties, alleging that our products used by such customers in the manufacture of semiconductor products and/or the processes relating to the use of our products infringe one or more patents issued to such parties. If such claims were successful, we could be required to indemnify customers for some or all of any losses incurred or damages assessed against them as a result of such infringement, which could have a material adverse effect on our business, financial condition and results of operations.

 

 

We may also incur substantial licensing or settlement costs where doing so would strengthen or expand our intellectual property rights or limit our exposure to intellectual property claims brought by others, which may have a material adverse effect on our business, financial condition and results of operations.

 

 

We Are Subject to Risks in Our International Operations

The majority of our sales are made to customers outside Europe. There are a number of risks inherent in doing business in some of those regions, including the following:

 

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If we are unable to manage successfully the risks inherent in our international activities, our business, financial condition and results of operations could be materially and adversely affected.

 

 

In particular, approximately 21 percent of our 2007 revenues and approximately 20 percent of our 2006 revenues were derived from customers in Taiwan. Taiwan has a unique international political status. The People’s Republic of China asserts sovereignty over Taiwan and does not recognize the legitimacy of the Taiwan government. Changes in relations between Taiwan and the People’s Republic of China, Taiwanese government policies and other factors affecting Taiwan’s political, economic or social environment could have a material adverse effect on our business, financial condition and results of operations.

 

 

We Are Dependent on the Continued Operation of a Limited Number of Manufacturing Facilities

All of our manufacturing activities, including subassembly, final assembly and system testing, take place in one clean room facility located in Veldhoven, the Netherlands, and one clean room facility in Wilton, Connecticut, the United States. These facilities are subject to disruption for a variety of reasons, including work stoppages, fire, energy shortages, flooding or other natural disasters. We cannot ensure that alternative production capacity would be available if a major disruption were to occur or that, if it were available, it could be obtained on favorable terms. Such a disruption could have a material adverse effect on our business, financial condition and results of operations.

 

 

Because of Labor Laws and Practices, Any Workforce Reductions That We May Wish to Implement in Order to Reduce Costs Company-Wide May Be Delayed or Suspended

The semiconductor market is highly cyclical and as a consequence we may need to implement workforce reductions in case of a downturn, in order to adapt to such market changes. In accordance with labor laws and practices applicable in the jurisdictions in which we operate, a reduction of any significance may be subject to certain formal procedures, which can delay, or may result in the modification of our planned workforce reductions. For example, in the Netherlands, if our Works Council renders adverse advice in connection with a proposed workforce reduction in the Netherlands, but we nonetheless determine to proceed, we must temporarily suspend any action while the Works Council determines whether to appeal to the Enterprise Chamber of the Amsterdam Court of Appeal. This appeal process can cause a delay of several months and may require us to address any procedural inadequacies identified by the Court in the way we reached our decision. Such delays could impair our ability to reduce costs company-wide to levels comparable to those of our competitors. See Item 6.D. “Employees”.

 

 

Fluctuations in Foreign Exchange Rates Could Harm Our Results of Operations

We are exposed to currency risks. We are particularly exposed to fluctuations in the exchange rates between the U.S. dollar, Japanese yen and the euro as we incur manufacturing costs and price our systems predominantly in euro while a portion of our net sales and cost of sales is denominated in U.S. dollars and Japanese yen.

 

 

In addition, a substantial portion of our assets and liabilities and operating results are denominated in U.S. dollars, and a small portion of our assets, liabilities and operating results are denominated in currencies other than the euro and the U.S. dollar. Our consolidated financial statements are expressed in euro. Accordingly, our results of operations and assets and liabilities are exposed to fluctuations in various exchange rates.

 

 

Furthermore, a strengthening of the euro particularly against the Japanese yen could lead to intensified price-based competition in those regions that account for the majority of our sales, resulting in lower prices and margins and a material adverse effect on our business, financial condition and results of operations.

 

 

Also see Item 5.A. “Operating Results, Foreign Exchange Management”, Item 5.F. “Tabular Disclosure of Contractual Obligations”, Item 11 “Quantitative and Qualitative Disclosures About Market Risk” and Note 4 to our consolidated financial statements.

 

 

We May Be Unable to Make Desirable Acquisitions or to Integrate Successfully Any Businesses We Acquire

Our future success may depend in part on the acquisition of businesses or technologies intended to complement, enhance or expand our current business or products or that might otherwise offer us growth opportunities. Our ability to complete such transactions may be hindered by a number of factors, including potential difficulties in obtaining government approvals.

 

 

Any acquisition that we do make would pose risks related to the integration of the new business or technology with our business. We cannot be certain that we will be able to achieve the benefits we expect from a particular acquisition or investment. Acquisitions may also strain our managerial and operational resources, as the challenge of managing new operations may divert our staff from monitoring and improving operations in our existing business. Our business, financial condition and results of operations may be materially and adversely affected if we fail to coordinate our resources effectively to manage both our existing operations and any businesses we acquire.

 

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Our Business and Future Success Depend on Our Ability to Attract and Retain a Sufficient Number of Adequately Educated and Skilled Employees

Our business and future success significantly depends upon our employees, including a large number of highly qualified professionals, as well as our ability to attract and retain employees. Competition for such personnel is intense, and we may not be able to continue to attract and retain such personnel, which could adversely affect our business, financial condition and results of operations.

 

 

In addition, the increasing complexity of our products results in a longer learning curve for new and existing employees leading to an inability to decrease cycle times and incurring significant additional costs, which could adversely affect our business, financial condition and results of operations.

 

 

Risks Related to Our Ordinary Shares

 

The Price of Our Ordinary Shares is Volatile

The current market price of our ordinary shares may not be indicative of prices that will prevail in the future. In particular, the market price of our ordinary shares has in the past experienced significant fluctuation, including fluctuation that is unrelated to our performance. This fluctuation may continue in the future.

 

 

Restrictions on Shareholder Rights May Dilute Voting Power

Our Articles of Association provide that we are subject to the provisions of Netherlands law applicable to large corporations, called “structuurregime”. These provisions have the effect of concentrating control over certain corporate decisions and transactions in the hands of our Supervisory Board. As a result, holders of ordinary shares may have more difficulty in protecting their interests in the face of actions by members of our Supervisory Board than if we were incorporated in the United States or another jurisdiction.

 

 

Our authorized share capital also includes a class of cumulative preference shares and ASML has granted “Stichting Preferente Aandelen ASML”, a Netherlands foundation, an option to acquire, at their nominal value of EUR 0.02 per share, such cumulative preference shares. Exercise of the cumulative preference share option would effectively dilute the voting power of our outstanding ordinary shares by one-half, which may discourage or significantly impede a third party from acquiring a majority of our voting shares.

 

 

See further Item 6.C. “Board Practices” and Item 10.B. “Memorandum and Articles of Association”.

We commenced business operations in 1984. ASM Lithography Holding N.V. was incorporated in the Netherlands on October 3, 1994 to serve as the holding company for our worldwide operations, which include operating subsidiaries in the Netherlands, the United States, Italy, France, Germany, the United Kingdom, Ireland, Belgium, Korea, Taiwan, Singapore, China (including Hong Kong), Japan, Malaysia, Israel and India. In 2001, we changed our name from ASM Lithography Holding N.V. to ASML Holding N.V. Our registered office is located at De Run 6501, 5504 DR Veldhoven, the Netherlands, telephone +31 40 268 3000.

 

 

In May 2001, we merged with SVG (now part of ASML US, Inc.), a company that was active in the Lithography, Track and Thermal businesses. In December 2002, we announced the termination of our manufacturing activities in the Track business and the divestiture of our Thermal business. In October 2003, we substantially completed the divestiture of our Thermal business.

 

 

From time to time, ASML pursues acquisitions of smaller businesses that it believes will complement or enhance ASML’s core lithography business. Acquisitions have included the acquisition of MaskTools in July, 1999 and the acquisition of Brion Technologies, Inc. (“Brion”) in March 2007. See Item 4.B. “Business Overview, Market and Technology Overview”.

 

 

Capital Expenditures and Divestitures

Our capital expenditures for 2007, 2006 and 2005 amounted to EUR 232.2 million, EUR 99.4 million and EUR 79.8 million, respectively. The related cash outflows for 2007, 2006 and 2005 amounted to EUR 179.2 million, EUR 70.7 million and EUR 74.0 million, respectively. Our capital expenditures in these years generally related to the construction of new facilities in Veldhoven and Taiwan, purchases of machinery and equipment mainly from our own product portfolio (e.g. prototypes, demonstration and training systems), information technology investments, leasehold improvements to our facilities and licenses of patents related to lithography equipment. See Item 4.D. “Property, Plants and Equipment” for capital expenditures currently in progress.

 

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Divestitures within continued operations, principally comprising machinery and equipment (more specifically prototypes, demonstration and training systems), amounted to EUR 20.4 million for 2007, EUR 5.6 million for 2006 and EUR 30.3 million for 2005. See Note 10 to our consolidated financial statements.

We are one of the world’s leading providers of advanced technology systems for the semiconductor industry, based on revenue. We offer an integrated portfolio of lithography systems mainly for manufacturing complex integrated circuits (“semiconductors” or “ICs”). We supply lithography systems to IC manufacturers throughout the United States, Asia and Europe and also provide our customers with a full range of support from advanced process and product applications knowledge to complete round-the-clock service support.

 

 

Our Business Model

Our business model is derived from our “Value of Ownership” concept which is based on the following principles:

 

 

Market and Technology Overview

The worldwide electronics and computer industries have experienced significant growth since the commercialization of ICs in the 1960s, largely due to the continual reduction in the cost per function performed by ICs. Improvement in the design and manufacture of ICs with higher circuit or “packing” densities has resulted in smaller and lower cost ICs capable of performing a greater number of functions at faster speeds and with reduced power consumption. We believe that these long-term trends will continue for the foreseeable future and will be accompanied by a continuing demand, subject to ongoing cyclical variations, for production equipment that can accurately produce advanced ICs in high volumes at the lowest possible cost. Photolithography is used to print complex circuit patterns onto the wafers that are the primary raw material for ICs and is one of the most critical and expensive steps in their fabrication. It is therefore a significant focus of the IC industry’s demand for cost-efficient enhancements to production technology.

 

 

We primarily design, manufacture, market and service semiconductor processing equipment used in the fabrication of ICs. Our photolithography equipment includes Step & Scan systems, which combine stepper technology with a photoscanning method.

 

 

Our TWINSCAN product platform was introduced in July 2000 and applies the production-proven elements of our PAS 5500 product family to the industry shift toward larger (300 millimeter (“mm”)) wafers. In 2003, the TWINSCAN platform became the vehicle to introduce improved resolution products both for 300 mm and 200 mm wafer size factories. Our PAS 5500 product family, which supports a maximum wafer size of 200 mm in diameter, comprises advanced wafer steppers and Step & Scan systems suitable for i-line and deep UV (including 248 nanometer (“nm”) and 193 nm wavelengths) processing of wafers. In the fourth quarter of 2007, we shipped our 750th TWINSCAN system, demonstrating the acceptance of the TWINSCAN platform as the semiconductor industry’s standard for 300 mm lithography.

 

 

In 2005, we intensified our research and development in immersion lithography as we believed this was the most probable solution to reduce the manufacturing cost per wafer while increasing resolution. In 2007 we shipped over 35 immersion systems compared to 23 in 2006 and 13 in 2005.

 

 

In 2006, we shipped the industry’s first EUV Alpha Demo Tools to two research institutions, which work closely with most of the world’s major IC manufacturers in developing manufacturing processes and materials. EUV combines a wavelength of 13.5 nm and a lens system with a numerical aperture (“NA”) of 0.25 to provide imaging at a resolution of 32 nm. EUV will provide a large process window compared to current approaches and we expect it to be a multi-generation lithography solution. Through the end of 2007, ASML received four orders for a total of four next generation EUV systems, the first of which is scheduled for shipment in late 2009 and targeted for production of ICs down to 32 nm. In 2007, we significantly increased development resources to support the development of this product.

 

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In March 2007, we completed the acquisition of Brion, a manufacturer of computational lithography products used for the implementation of optical proximity correction “OPC” to design data and verification before mask (reticle) manufacture. The acquisition of Brion is expected to enable ASML to improve the implementation of OPC and resolution enhancement techniques such as Double Patterning in the masks to be used on ASML systems. These improvements in turn are expected to enable the extension of the practical resolution limits of ASML ArF immersion products. Use of Brion’s computational lithography capability is also expected to enable us to offer products to further improve the set-up and control of ASML lithography systems.

 

 

We are also performing research on maskless lithography (the mask contains the pattern which is imaged onto the wafer). Maskless lithography is one of the possible solutions for managing increasing mask costs or to increase the flexibility of the imaging. Designs resulting in small quantities of wafers, designs with many changes or designs that require a fast time-to-market will particularly benefit from maskless technology. In December 2004, Micronic Laser Systems AB (“Micronic”) and ASML agreed to a license agreement relating to the development of optical maskless lithography technology for semiconductor manufacturing.

 

 

Products

We develop lithography systems and related products for the semiconductor industry and related patterning applications. Our product development strategy focuses on the development of product families based on a modular, upgradeable design.

 

 

Our older PAS 2500 and PAS 5000 lithography systems, which we no longer manufacture but refurbish, are used for g-line and i-line processing of wafers up to 150 mm in diameter and are employed in manufacturing environments and in special applications for which design resolutions no more precise than 0.5 microns are required.

 

 

Our PAS 5500 product family comprises advanced wafer steppers and Step & Scan systems suitable for i-line and deep Ultra Violet (“UV”) processing of wafers up to 200 mm in diameter. In mid-1997, we introduced the PAS 5500 Step & Scan systems with improved resolution and overlay. Since then, we have further developed and expanded this Step & Scan product family. This modular upgradeable design philosophy has been further refined and applied in the design of our most advanced product family, the TWINSCAN platform, which is the basis for our current and next generation Step & Scan systems, producing wafers up to 300 mm in diameter and capable of extending shrink technology down to 40 nm.

 

 

The PAS 5500 series is the most suitable product range for processing of 200 mm wafers using step-and-scan technology. We offer PAS 5500 systems based on i-line (using light with a 365 nm wavelength), KrF (using light with a 248 nm wavelength) and ArF (using light with a 193 nm wavelength) technology. For high end 200 mm applications we also offer TWINSCAN ArF tools.

 

 

We are the leader in the innovation of immersion technologies and we were the world’s first producer of dual-stage design (TWINSCAN) systems. Wafer measurement, including focus and alignment, is completed on the dry stage, while the imaging process, using water applied between the wafer and the lens, is completed on the wet stage. The dual-stage advantage of TWINSCAN systems enables our customers to gain the process enhancements of immersion and to continue with familiar and proven metrology technology.

 

 

For processing of 300 mm wafers, we offer TWINSCAN systems based on i-line, KrF and ArF technology. In 2003, we introduced the second generation of TWINSCAN systems based on the XT body with a reduced footprint and a 50 percent reduction in the main production area occupied by our system. In 2004, we shipped our first lithography systems based on immersion technology. These shipments marked the delivery of the industry’s first high productivity immersion scanners for production applications.

 

 

In the second quarter of 2006, we started volume production of the TWINSCAN XT:1700i, a 193 nm immersion scanner capable of imaging at the 45 nm node in volume production environments. This system featured an NA of 1.2, substantially higher than the XT:1400’s NA of 0.93, exceeding the pre-immersion barrier of 1.0, which is enabled by a new catadioptric lens design. The XT:1700i has enabled chipmakers to improve resolution by 30 percent and has been employed in the development and manufacturing of the latest advanced generation of ICs.

 

 

In July 2006, we announced plans to introduce a next generation immersion system, the XT:1900i, with a new industry benchmark of 1.35 NA, which we believe is close to the practical limit for water-based immersion technology. In the third quarter of 2007, ASML began volume shipment of the XT:1900i. This new optical lithography system is capable of volume production of ICs down to 40 nm and below and has already been deployed by several of our advanced manufacturing customers. In 2007 we shipped over 18 XT:1900i systems.

 

 

In July 2007, ASML announced plans for a new product, the XT:1000, which will use the new catadioptric lens technology developed for the XT:1700i and XT:1900i to extend the maximum numerical aperture (NA) of the previous generation of 248 nm wavelength, KrF, systems to 0.93 NA from the previous maximum available of 0.8 NA. The XT:1000’s high NA of 0.93 can resolve 80 nm device features, far smaller than the 100 nm of today’s KrF systems. The XT:1000 also improves value to customers, with

 

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an increased throughput of 165-300 mm wafers per hour under volume manufacturing conditions while maintaining the same industry-leading 6 nm overlay as leading-edge ArF systems. ASML expects to ship XT:1000 systems from mid-2008.

 

 

We also continually develop and sell a range of product options and enhancements designed to increase productivity, imaging and overlay to optimize value of ownership over the entire life of our systems. The table below sets forth our current product portfolio of Steppers and Scan & Step Systems by resolution and wavelength.

 

 

Current ASML lithography product portfolio of Steppers and Step & Scan Systems¹

 

 

 

 

Sales and Customer Support

We market and sell our products principally through our direct sales staff.

 

 

We support our customers with a broad range of applications, services, and technical support products to maintain and maximize the performance of our systems at customer sites. We also offer refurbished and remanufactured tools, system upgrades and enhancements, and technical training.

 

 

Our field engineers and applications, service and technical support specialists are located throughout the United States, Europe and Asia.

 

 

In 2006, ASML started an initiative to establish the ASML Center of Excellence (“ACE”) in Asia. The primary goal of ACE is to serve as a supplementary engine to propel ASML’s long term growth. ACE will feature customer support, training, logistics, development and engineering, refurbishment and semiconductor application development. ACE will also enable sourcing of selected equipment modules, components and services in the region. Finally, ACE will be used as a training center to develop worldwide talent for ASML’s workforce. In the fourth quarter of 2007, we started construction of the building and facility that will house ACE near Taipei, Taiwan. Construction is expected to be finished at the end of 2008. See Item 4.D. “Property, Plants and Equipment”.

 

 

Customers and Geographic Regions

In 2007, sales to our largest customer accounted for EUR 833 million, or 21.9 percent of net sales, compared to EUR 730 million, or 20 percent of net sales, in 2006. We expect that sales to relatively few customers will continue to account for a high percentage of our net sales in any particular period for the foreseeable future. See Item 3.D. “Risk Factors – A High Percentage of Net Sales Is Derived from a Few Customers” and Note 17 to our consolidated financial statements for a breakdown of our sales by geographic location.

 

 

Manufacturing, Logistics and Suppliers

Our business model is based on outsourcing production of a significant part of the components and modules that comprise our lithography systems, working in partnership with suppliers from all over the world. Our manufacturing activities comprise the

 

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assembly, fine tuning and testing of a finished system from components and subassemblies that are manufactured to our specifications by third parties and by us, and which we test prior to assembly. All of our manufacturing activities (subassembly, final assembly and system testing) are performed in one clean room facility located in Veldhoven, the Netherlands, and one clean room facility in Wilton, Connecticut, United States. We procure stepper and scanner system components and subassemblies from a single supplier or a limited group of suppliers in order to ensure overall quality and timeliness of delivery. We jointly operate a formal strategy with suppliers known as “value sourcing” which is based on competitive performance in quality, logistics, technology and total cost. The essence of value sourcing is to maintain a supply base that is world class, globally competitive and globally present.

 

 

Our value sourcing strategy is based on the following strategic principles:

 

 

Value sourcing is intended to align the performance of our suppliers with our requirements on quality, logistics, technology and total costs.

 

 

Zeiss is our sole external supplier of main optical systems and one of the suppliers of other components. In 2007, approximately 40 percent of our aggregate cost of sales was purchased from Zeiss.

 

 

Zeiss is highly dependent on its manufacturing and testing facilities in Oberkochen and Wetzlar, Germany, and its suppliers. Moreover, Zeiss has a finite production capacity for production of lenses and optical components for our stepper and scanner systems. The expansion of this production capacity may require significant lead time. From time to time, the number of systems we have been able to produce has been limited by the capacity of Zeiss to provide us with lenses and optical components. During 2007, we were in some cases constrained by the number of lenses that Zeiss could produce.

 

 

If Zeiss is unable to maintain or increase production levels, we might not be able to respond to customer demand. As a result, our relationships with current and prospective customers could be harmed, which would have a material adverse effect on our business, financial condition and results of operations.

 

 

Our relationship with Zeiss is structured as a strategic alliance pursuant to several agreements executed in 1997 and later years. These agreements define an exclusive framework for cooperation in all areas of our joint business. The partnership between ASML and Zeiss is focused on continuous improvement of operational excellence.

 

 

Pursuant to these agreements, ASML and Zeiss will continue their strategic alliance until either party provides at least three years’ notice of its intent to terminate. Although we believe such an outcome is unlikely, if Zeiss were to terminate its relationship with us, or if Zeiss were unable to produce lenses and optical components over a prolonged period, we would effectively cease to be able to conduct our business.

 

 

In addition to Zeiss, we also rely on other outside vendors for the components and subassemblies used in our systems, each of which is obtained from a single supplier or a limited number of suppliers. Our reliance on a limited group of suppliers involves several risks, including a potential inability to obtain an adequate supply of required components and the risk of untimely delivery of these components and subassemblies.

 

 

See Item 3.D. “Risk Factors, The Number of Systems We Can Produce Is Limited by Our Dependence on a Limited Number of Suppliers of Key Components”.

 

 

Research and Development

The semiconductor manufacturing industry is subject to rapid technological changes and new product introductions and enhancements. We believe that continued and timely development and introduction of new and enhanced systems are essential for us to maintain our competitive position. As a result, we have historically devoted a significant portion of our financial resources to research and development programs and we expect to continue to allocate significant resources to these efforts. In addition, we have established and are currently establishing sophisticated development centers in the Netherlands, the United States and Taiwan, respectively. We also work jointly with independent research centers in nano-electronics and nano-technology. Those research centers focus on the next generations of chips and systems.

 

 

We apply for subsidy payments in connection with specific development projects under programs sponsored by the Netherlands government, the European Union, the United States and Taiwanese government. Amounts received under these programs

 

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generally are not required to be repaid. See our discussions of research and development in Item 5 “Operating and Financial Review and Prospects”, and Note 1 to our consolidated financial statements.

 

 

We invested EUR 511 million in research and development in continuing operations in 2007, compared to EUR 414 million in 2006 and EUR 348 million in 2005. The amount invested in 2007 includes a one-off charge related to the Brion acquisition of EUR 23 million (amortization of in-process research and development). We are also involved in joint research and development programs with both public and private partnerships and consortiums, involving independent research centers, leading chip manufacturers and governmental programs. We aim to own or license our jointly developed technology and designs of critical components.

 

 

In 2007, our research and development efforts drove further development of the TWINSCAN platform along with several leading-edge technologies, including 248 nm, 193 nm, immersion and EUV. The continuous drive by our customers for cost reductions has led us to significantly increase the commonality of components of the different models of the TWINSCAN platform. Our research and development activities in 2007 have also led to productivity and performance enhancements for our other product families. We also started developing technology to support applications of “double patterning”. Double patterning is a resolution enhancement technique that involves splitting a dense circuit pattern into multiple, less-dense patterns. These simplified patterns are then printed sequentially on a target wafer. Between the exposures, the wafer is removed from the exposure system for additional processing. Double patterning improves the achievable resolution and enables the printing of smaller features.

 

 

Intellectual Property

We rely on intellectual property rights such as patents, copyrights and trade secrets to protect our proprietary technology. We aim to obtain ownership rights on technology developed by or for us or, alternatively, to have license rights in place with respect to such technology. However, we face the risk that such measures will be inadequate. Intellectual property laws may not sufficiently support our proprietary rights, our patent applications may not be granted and our patents may not be construed as we expect. Also, competitors may be able to develop or protect similar technology earlier and independently.

 

 

Litigation may be necessary to enforce our intellectual property rights, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement. Any such litigation may result in substantial costs and diversion of management resources, and, if decided unfavorably to us, could have a material adverse effect on our business, financial condition and results of operations. We also may incur substantial licensing or settlement costs where doing so would strengthen or expand our intellectual property rights or limit our exposure to intellectual property claims of third parties.

 

 

Patent cross-license with Canon

In December 2007, we announced that ASML and Zeiss have signed an agreement with Canon for the global cross-license of patents in their respective fields of semiconductor lithography and optical components, used to manufacture integrated circuits, or chips. There will be no transfer of technology and no payment was made among the parties. The cross-license helps the three companies to compete more freely in the area relevant to their customers, which is technology expertise and implementation, rather than on intellectual property (IP) rights. ASML and Zeiss are strongly committed to investing in research and development and will continue their build-up of know-how and IP.

 

 

Patent litigation with Nikon

From 2001 through late 2004, we were a party to a series of civil litigations and administrative proceedings in which Nikon alleged ASML’s infringement of Nikon patents relating to photolithography. ASML in turn filed claims against Nikon.

 

 

Pursuant to agreements executed on December 10, 2004 (effective November 12, 2004), ASML, Zeiss and Nikon agreed to settle all pending worldwide patent litigation between the companies. The settlement included an agreement to dismiss all pending patent litigation between the companies, an exchange of releases, a cross-license of patents related to lithography equipment used to manufacture semiconductor devices and payments to Nikon by ASML and Zeiss. In connection with the settlement, ASML made an initial payment to Nikon of US$ 60 million in 2004 and further payments of US$ 9 million in 2005, 2006 and 2007. Zeiss also made settlement payments to Nikon from 2004 to 2007. See Item 18 “Financial Statements” for a description of the accounting treatment.

 

 

Patent litigation with Ultratech Stepper, Inc

In May 2000, Ultratech Stepper, Inc. (“Ultratech”) filed a lawsuit against ASML. Ultratech alleged that ASML infringed Ultratech’s rights under a United States patent in connection with its manufacture and commercialization in the United States of advanced photolithography equipment embodying technology that, in particular, is used in Step & Scan equipment.

 

 

Ultratech’s patent infringement claims were tried before a jury in Oakland, California, in May and June of 2005. On June 21, 2005 the jury unanimously determined that each of the patent claims that Ultratech had asserted against ASML was invalid, and thus

 

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that ASML was not liable for patent infringement, notwithstanding the jury’s finding that each of these claims was infringed by ASML and certain of its customers. The court entered judgment in favor of ASML following receipt of the jury verdict.

 

 

Ultratech filed motions with the court seeking to overturn the jury’s finding that its asserted patent claims are invalid or, in the alternative, seeking a new trial. The court denied each of Ultratech’s motions. Ultratech then filed an appeal with the United States Court of Appeals for the Federal Circuit challenging the finding that its asserted patent claims are invalid. On May 14, 2007, the Federal Circuit rejected Ultratech’s arguments on appeal, affirming the lower court’s order that Ultratech’s asserted patent claims are invalid. The time for Ultratech to file an appeal with the United States Supreme Court has lapsed.

 

 

Arbitration with Aviza Technology

On December 1, 2006, Aviza Technology (“Aviza”) initiated arbitration proceedings against ASML Holding N.V., ASML U.S., Inc. and certain of its affiliates and subsidiaries (collectively, the “ASML parties”). Aviza’s arbitration demand alleges that the ASML parties engaged in fraud and made negligent misrepresentations or omissions in connection with a 2002 License Agreement between ASML and IPS, Ltd. That agreement was assigned to Aviza in connection with the 2003 divestiture of ASML’s Thermal Division.

 

 

We believe that there are meritorious defenses to Aviza’s allegations.

 

 

Although we believe the ultimate outcome of the dispute with Aviza will not have a material adverse effect on our business, financial condition or result of operations (taking into account the defenses available to ASML), given the inherently uncertain nature of arbitration, our defenses may not succeed. If Aviza were to prevail, it could have a material adverse effect on ASML’s business, financial condition or results of operations.

 

 

Dividend withholding tax

In May and June 2006 ASML entered into forward purchase agreements with a broker acting as principal to effect the share repurchases under its share buyback program.

 

 

The aggregate number of shares bought back up to and including July 13, 2006 was 25,450,296 and represented 100 percent of the announced objective of maximum EUR 400 million to be repurchased during the term of the program.

 

 

The Netherlands tax authorities have challenged the fiscal interpretation of the share program and are seeking to recast the repurchase as a dividend payment to unidentifiable shareholders. As a result the Netherlands tax authorities have issued a dividend withholding tax assessment of approximately EUR 24 million, payable by ASML. ASML management is of the opinion that the case of the Netherlands tax authorities is without merit and will contest the position of the Netherlands tax authorities in court. Based on this, ASML management believes that there is no reason to set up a liability for this dividend withholding tax assessment.

 

 

Competition

The semiconductor equipment industry is highly competitive. The principal elements of competition in our market segments are the technical performance characteristics of a photolithography system and the value of ownership of that system based on its purchase price, maintenance costs, productivity and customer service and support. In addition, we believe that an increasingly important factor affecting our ability to compete is the strength and breadth of our portfolio of patent and other intellectual property rights. We believe that the market segment for photolithography systems and the investments required to be a significant competitor in this market segment have resulted in increased competition for market share through the aggressive prosecution of patents. Our competitiveness will increasingly depend upon our ability to protect and defend our patents, as well as our ability to develop new and enhanced semiconductor equipment that is competitively priced and introduced on a timely basis. See Item 3.D. “Risk Factors, We Face Intense Competition”.

 

 

Government Regulation

Our business is subject to direct and indirect regulation in each of the countries in which our customers or we do business. As a result, changes in various types of regulations could affect our business adversely. The implementation of new technological or legal requirements could impact our products, or our manufacturing or distribution processes, and could affect the timing of product introductions, the cost of our production, and products as well as their commercial success. Moreover, environmental and other regulations that adversely affect the pricing of our products could adversely affect our results of operation. The impact of these changes in regulation could adversely affect our business even where the specific regulations do not directly apply to us or to our products.

ASML Holding N.V. is a holding company that operates through its subsidiaries. Our major operating subsidiaries, each of which is a wholly-owned subsidiary, are as follows:

 

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See Exhibit 8.1 for a list of our material subsidiaries.

We principally obtain and operate our facilities under operating leases. However, we also own a limited number of buildings. We are currently constructing new facilities as part of the expansion of our worldwide capacity. The book value of the buildings used in our continuing operations and owned by us amounted to EUR 136 million as of December 31, 2007 compared to EUR 59 million as of December 31, 2006.

 

 

During 2007, our facilities were generally utilized at and in some cases above normal capacity.

 

 

Subject to market developments we expect that our capital expenditures in 2008 could be up to approximately EUR 250 million, an increase of EUR 18 million compared to 2007. We expect that a significant part of 2008 expenditures will be allocated to construction and upgrades of production facilities in the Netherlands and Taiwan. This expansion would offer the additional space and facilities necessary to accommodate our current production levels as well as support continued growth in the long term. We intend to fund the related capital expenditures primarily with cash on hand and/or cash generated through operations.

 

 

See also Item 4.A. “History and Development of the Company, Capital Expenditures and Divestitures” and Item 5.B. “Liquidity and Capital Resources” and Note 10 to our consolidated financial statements.

 

 

Facilities in Europe

Our headquarters, applications laboratory and research and development facilities are located in a 120 thousand square meter state-of-the-art facility in the Netherlands, of which 65 thousand square meters is used as office space and 55 thousand square meters is used for manufacturing and research and development activities. We lease the majority of these facilities through long-term operating leases that contain purchase options. Some of our office facilities at our headquarters in Veldhoven are financed through a special purpose vehicle that is a variable interest entity. See Item 5.E. “Off-Balance Sheet Arrangements” and Note 13 to our consolidated financial statements. We also lease several sales and service facilities at locations across Europe.

 

 

Facilities in the United States

Our American headquarters and American training facilities are located in two buildings, comprising a nine thousand square meter office building space and a ten thousand square meter training space in Tempe, Arizona. We maintain lithography research, development and manufacturing operations in a 27 thousand square meter facility in Wilton, Connecticut and a six thousand square meter facility in Santa Clara, California. We also lease several sales and service facilities at locations across the United States.

 

 

Facilities in Asia

Our Asian headquarters is located in a 425 square meter office space in Hong Kong. We also lease and own several sales and service / training facilities at locations across Asia.

 

 

During 2007 we started the construction of our new ACE facility located in Linkou, Taiwan. This project comprises both clean room (approximately two thousand square meters) and office space (approximately six thousand square meters) in order to support customers in the Asia-Pacific region by focusing on technology and applications development, equipment support, training, logistics and refurbishment. ACE will also enable local sourcing of equipment models, components and services.

 

 

Not applicable.

 

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Executive Summary

 

 

Introduction

ASML is the world’s leading provider of lithography systems that are critical to the production of ICs or chips. Headquartered in Veldhoven, the Netherlands, ASML operates globally, with activities in Europe, the United States and Asia.

 

 

In 2007, we generated net sales of EUR 3,809 million and income from operations of EUR 825 million or 21.7 percent of net sales. Net income in 2007 amounted to EUR 688 million or 18.1 percent of net sales, representing EUR 1.49 per share.

 

 

As of December 31, 2007 we employed approximately 6,500 employees and operated in 16 countries through over 63 sales and service locations.

 

 

In the executive summary below we provide an update of the semiconductor equipment industry, followed by our business strategy and a discussion of our key performance indicators.

 

 

Semiconductor equipment industry update

Historically the semiconductor industry has experienced significant growth largely due to the continual reduction of cost per function performed by ICs. Improvement in the design and manufacture of ICs with higher circuit densities has resulted in smaller and cheaper ICs capable of performing a larger number of functions at higher speeds with lower power consumption. We believe that these long term trends will continue for the foreseeable future and will be accompanied by a continuing demand for production equipment that is capable of accurate production of advanced ICs in high volumes at the lowest possible cost.

 

 

Lithography equipment is used to print complex circuit patterns onto silicon wafers, which are the primary raw materials for ICs. The printing process is one of the most critical and expensive steps in wafer fabrication. Lithography equipment is therefore a significant focus of the IC industry’s demand for cost efficient enhancements to production technology.

 

 

The costs to develop new lithography equipment are high. Accordingly, the lithography equipment industry is characterized by the presence of only a few primary suppliers: ASML, Nikon and Canon. ASML is the world’s leading provider of lithography equipment with a market share based on revenue of 65 percent in 2007 up from 63 percent in 2006 according to the latest available data up to and including November 2007 as reported by SEMI, an independent semiconductor industry organization.

 

 

Nikon and Canon are the leading suppliers in Japan, which accounts for a significant portion of worldwide semiconductor production. This region historically has been difficult for non-Japanese companies to penetrate. Since 2004, we have been increasing our service, sales and marketing operations in Japan to serve our growing customer base. In 2007, we further strengthened our long term market development strategy in Japan, and our net system sales there grew from EUR 139 million in 2006 to EUR 269 million.

 

 

Total lithography equipment shipped by the industry as a whole in the five years ended December 31, 2006 is set forth in the following table:

 

 

(Source: Gartner Dataquest)

 

 

 

In 2007, the semiconductor industry experienced another year of growth due to growth in semiconductor units by 11 percent and the continuing technology drive of our customers among other things resulting in continued strong capacity build-up by our customers, especially in memory. During this period, our customers began ramp-up of volume manufacturing for 45 nm Flash and 55 nm DRAM with our advanced immersion systems.

 

 

Business strategy

Our business strategy is based on achieving and reinforcing technological leadership in semiconductor lithography, resulting in the delivery of superior value of ownership for our customers while achieving top financial performance in our segment. We implement this strategy through customer focus, aggressive investment in research and development, and operational excellence.

 

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Customer focus

We serve different types of chipmakers by ensuring that our products provide premium value for the various semiconductor market segments, including memory, integrated device manufacturers, and foundries or made-to-order chip contractors.

 

 

Of the top 20 chipmakers worldwide, in terms of semiconductor capital expenditure, 18 are our customers. We also have a significant market share of customers below the top 20. We strive for continued growth in both segments.

 

 

In 2007, we achieved top customer satisfaction ratings among large suppliers of semiconductor wafer processing equipment, according to VLSI Research, an independent industry research firm that surveyed customers representing 95 percent of the world’s total semiconductor market. Our satisfaction ratings by customers surpassed every lithography competitor for the fifth year in a row.

 

 

In July 2007, we announced a new KrF lithography system that significantly reduces operating costs for our customers. The ASML TWINSCAN XT:1000 scanner extends cost efficient KrF technology to resolutions that previously required more expensive ArF technology. Customers can realize savings of 30 percent or more per layer as a result of the lower operating costs for KrF technology, particularly its use of less expensive lasers and lower material costs for KrF resists and other materials.

 

 

We are making additional investments in Japan, where historically the leading positions have been held by our competitors and where ASML is increasing sales and customers.

 

 

From time to time, we seek to expand our business scope as ASML pursues hardware technologies and new product opportunities in fields adjacent or complementary to our core semiconductor lithography competence. In March 2007, ASML completed the acquisition of Brion Technologies, Inc., a leading provider of semiconductor design and wafer manufacturing optimization solutions for advanced lithography.

 

 

Aggressive investment in research and development

Our product range for steppers and advanced Step & Scan systems spans all the industry’s current wavelengths for both 200- and 300-mm wafers.

 

 

Supported by our financial performance, research and development expenses in 2007 increased by 25.8 percent compared with 2006 (which excludes a one-off charge of EUR 23 million in 2007 of in-process research and development relating to the Brion acquisition), as we accelerated new developments and advanced our development of immersion and EUV technologies. This operating decision was made possible by leveraging our outsourcing strategy, which continues to enable us to rapidly and efficiently adjust our cost structure throughout a cycle while making use of leading-edge capabilities in our supply chain.

 

 

Since 2000, we have offered a dual-stage wafer imaging platform – the TWINSCAN system – which allows exposure of one wafer while simultaneously measuring the wafer that will be exposed next. ASML’s strong leadership in this capability has allowed it to achieve the industry’s highest throughput, enabling reduced cost-per-exposure per wafer. ASML is the only lithography manufacturer that has volume production based on dual stage systems.

 

 

In the third quarter of 2007, we shipped our first new TWINSCAN XT:1900i system, the only immersion lithography machine in the world capable of imaging chip features down to 40 nm. Our innovative immersion lithography replaces air over the wafer with fluid, enhancing focus on enabling circuit line-width to shrink to even smaller dimensions. ASML experienced strong demand for this machine, driven initially by memory chip makers that need more cost effective technology transitions to the 4x and 5x nm nodes that are enabled by immersion systems. With more than 70 immersion systems shipped to date, our immersion technology is now widely accepted as the standard for critical layer high volume chip manufacturing, solidifying our technology leadership position worldwide and supporting our significant growth in Japan.

 

 

In parallel, we are developing EUV technology. We received four orders for preproduction tools during 2007, the first of which is scheduled for shipment in late 2009. We have two Alpha Demo Tools at research and development institutions located in Albany, New York (United States) and Leuven (Belgium), where potential customers can conduct early stage research and development, and where the first 30 nm images with a Sn light source were produced.

 

 

Operational excellence

We strive to sustain our business success based on our technological leadership by continuing to execute our fundamental operating strategy well, including reducting in lead time while improving our cost competitiveness. Lead time is the time from a customer’s order to a tool’s delivery.

 

 

Our business strategy includes outsourcing the majority of components and subassemblies that make up our products. We work in partnership with suppliers, collaborating on quality, logistics, technology and total cost. By operating our strategy of value

 

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sourcing, we strive to attain flexibility and cost efficiencies from our suppliers through mutual commitment and shared risk and reward. Value sourcing also allows the necessary flexibility to adapt to the cyclicality of the world market for semiconductor lithography systems.

 

 

ASML has a flexible labor model in its manufacturing facilities located in Veldhoven which reinforces our ability to adapt more quickly to semiconductor market cycles, including support for potential 24-hour, seven days-a-week production activities. By maximizing the flexibility of our high tech work force, we can shorten lead time: a key driver of added value for customers. Flexibility also reduces our working capital requirements.

 

 

We continuously strive to improve efficiencies in our operations: addressing our cost structure and strengthening our capability to generate cash. We have been successful at progressively enhancing the value of ownership of our products while increasing margins and boosting cash generation through gains in manufacturing productivity and reductions in cycle time.

 

 

ASML operations update on key performance indicators

The following table presents the key performance indicators used by our Board of Management and senior management to measure performance in our monthly operational review meetings.

 

 

 

 

Growth

We are seeking to grow to a net sales level of EUR 5 billion in 2010, based on three growth drivers: market growth, market share growth and a broadening of our product and services scope.

 

 

In 2007, we achieved growth in net sales of 5.9 percent to EUR 3,809 million from EUR 3,597 million in 2006. The increase in net sales mainly resulted from a continued high demand for lithography equipment with higher ASPs in 2007 ultimately driven by a continuing increase in unit demand for semiconductors of 11 percent (2006: 9 percent; 2005: 9 percent). In addition we achieved market share growth from 63 percent in 2006 to 65 percent in 2007 (according to the latest available data up to and including November 2007 as reported by SEMI, an independent semiconductor industry organization) as a result of our sustained technological leadership.

 

 

The ASP of our systems increased by 7.4 percent from EUR 12.1 million in 2006 to EUR 13.0 million in 2007. This increase was mainly driven by a change in the product mix reflecting the continued shift in market demand to our leading-edge technology systems with higher ASPs driven by the shrink roadmaps of our customers. This increase was partly offset by a growing number of i-line systems, with relatively low ASPs, sold in 2007, reflecting our market share gains in this segment of the market.

 

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As of December 31, 2007, our order backlog was valued at EUR 1,697 million and included 89 systems with an ASP of EUR 19.1 million. As of December 31, 2006, the order backlog was valued at EUR 2,146 million and included 163 systems with an ASP of EUR 13.2 million. The increase in ASP of 44.8 percent was mainly due to a high number of leading-edge ArF-immersion systems in the backlog of 2007 pursuant to the continued ramp-up of volume manufacturing with our leading-edge immersion systems in 2008. The decrease in the total value of backlog was primarily the result of increased uncertainty about future global economic market conditions and the impact on the semiconductor industry.

 

 

Profitability

We seek to achieve an average income from operations to net sales of 17 percent over the industry’s business cycle with 10-15 percent at the downturn point and 20-25 percent at the upturn point.

 

 

Operating income decreased by 5.2 percent from EUR 871 million or 24.2 percent of sales in 2006 to 825 million or 21.7 percent of sales in 2007. This EUR 46 million decrease was substantially the result of the increase in operating expenses of EUR 144 million or 24.3 percent which was partially offset by an increase of gross profit of EUR 98 million or 6.7 percent.

 

 

Gross profit on sales increased compared to 2006, showing a growth of 6.7 percent from EUR 1,462 million or 40.6 percent of net sales in 2006 to 1,560 million or 41.0 percent of net sales in 2007. The higher gross profit was principally attributable to an increase in net sales (see above) and a decrease in the cost of sales as a percentage of net sales.

 

 

Operating expenses were EUR 144 million higher in 2007 compared to 2006 due to an increase of both research and development costs by 123 million, or 31.7 percent and selling, general and administrative costs by EUR 21 million, or 10.2 percent. The increase in research and development costs included a one-off charge of EUR 23 million related to the Brion acquisition (in-process research and development). The remaining increase in research and development costs by EUR 100 million, or 25.8 percent was mainly related to our decision to further accelerate investments in our technological leadership in a time of strong financial performance. For further details regarding research and development see Item 4.B “Business Overview” and Item 5 “Operating and Financial Review and Prospects, Business Strategy”.

 

 

Net income in 2007 amounted to EUR 688 million, representing EUR 1.49 per share compared with net income of EUR 625 million or EUR 1.32 per share in 2006.

 

 

Liquidity

We seek to maintain our strategic target level of cash and cash equivalents between EUR 1.0 and 1.5 billion. To the extent that our cash and cash equivalents exceeds this target and there are no investment opportunities that we wish to pursue, we intend to return excess cash to our shareholders. As of December 31, 2007 our cash and cash equivalents amounted to EUR 1.3 billion.

 

 

Our cash and cash equivalents decreased from EUR 1,656 million as of December 31, 2006 to EUR 1,272 million as of December 31, 2007. We generated cash from operations of EUR 670 million in 2007, which was offset by a cash outflow of EUR 699 million from financing activities, mainly as a result of our 2007 share buyback programs (EUR 1,372 million) which was offset by the net proceeds from issuance of a Eurobond in June 2007 (EUR 594 million), and EUR 348 million cash used in investing activities mainly related to the acquisition of Brion (EUR 188 million), production facilities in Veldhoven and, to a lesser extent, equipment and information technology.

 

 

In an ongoing commitment to return excess cash to shareholders, ASML returned EUR 1,372 million in cash to its shareholders in 2007. The cumulative amount returned to shareholders between May 2006 and December 2007 was EUR 2,050 million.

 

 

Critical accounting policies using significant estimates

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of our financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, net sales and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, warranty, long-lived assets, inventories, accounts receivable, contingencies and litigation, income tax and share-based compensation expenses. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. While we regularly evaluate our estimates and assumptions, actual results may differ from these estimates if these assumptions prove incorrect. To the extent there are material differences between actual results and these estimates, our future results of operations could be materially and adversely affected. We believe that the accounting policies described below require us to make significant judgments and estimates in the preparation of our consolidated financial statements.

 

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Revenue recognition

In general, we recognize the revenue from the sale of a system upon shipment and the revenue from the installation of a system upon completion of that installation at the customer site. Each system undergoes, prior to shipment, a “Factory Acceptance Test” in our clean room facilities, effectively replicating the operating conditions that will be present on the customer’s site, in order to verify whether the system will meet its standard specifications and any additional technical and performance criteria agreed with the customer. A system is shipped, and revenue is recognized, only after all specifications are met and customer sign-off is received or waived. Although each system’s performance is re-tested upon installation at the customer’s site, we have never failed to successfully complete installation of a system at a customer’s premises.

 

 

We anticipate that, in connection with future introductions of new technology, we will initially defer revenue recognition until completion of installation and acceptance of the new technology at customer premises. This deferral would continue until we are able to conclude that installation of the technology in question would occur consistently within a predetermined time period and that the performance of the new technology would not reasonably be different from that exhibited in the pre-shipment Factory Acceptance Test. Any such deferral of revenues, however, could have a material effect on our results of operations for the fiscal period in which the deferral occurred and on the succeeding fiscal period. At December 31, 2007 and 2006, we had no deferred revenue from shipments of new technology. During the three years ended December 31, 2007, no revenue from new technology was recorded that had been previously deferred. As our systems are based largely on two product platforms that permit incremental, modular upgrades, the introduction of genuinely “new” technology occurs infrequently, and has occurred on only one occasion since 1999.

 

 

A portion of our revenue is derived from contractual arrangements with our customers that have multiple deliverables, such as installation and training services, prepaid service contracts and prepaid extended optic warranty contracts. The revenue relating to the undelivered elements of the arrangements is deferred at fair value until delivery of these elements. The fair value is determined by vendor specific objective evidence (“VSOE”). VSOE is determined based upon the prices that we charge for installation and comparable services (such as relocating a system to another customer site) on a stand-alone basis, which are subject to normal price negotiations. Revenue from installation and training services is recognized when the services are completed. Revenue from prepaid service contracts and prepaid extended optic warranty contracts is recognized over the term of the contract.

 

 

The deferred revenue balance from installation and training services amounted to approximately EUR 9 million and EUR 28 million, respectively, as of December 31, 2007.

 

 

The deferred revenue balance from prepaid service contracts and prepaid extended optic warranty contracts amounted to approximately EUR 149 million and EUR 38 million, respectively, as of December 31, 2007.

 

 

We offer customers discounts in the normal course of sales negotiations. These discounts are directly deducted from the gross sales price at the moment of revenue recognition. From time to time, we offer volume discounts to a limited number of customers. In some instances these volume discounts can be used to purchase field options (system enhancements). The related amount is recorded as a reduction in revenue at time of shipment. Generally, there are no other credits or adjustments recognized at shipment. From time to time, we offer free products or services in connection with the sale of a system, which are earned by the customer at a future date only if the customer completes a specified cumulative level of revenue transactions. As the value of these free products or services is insignificant in relation to the value of the transactions necessary to earn these free products or services, a liability is recorded for the cost of these free products or services at the time of revenue recognition.

 

 

Warranty

We provide standard warranty coverage on our systems for 12 months and on certain optic parts for 60 months, providing labor and parts necessary to repair systems and optic parts during the warranty period. The estimated warranty costs are accounted for by accruing these costs for each system upon recognition of the system sale. The estimated warranty costs are based on historical product performance and field expenses. Based upon historical service records, we calculate the charge of average service hours and parts per system to determine the estimated warranty charge. We update these estimated charges periodically. The actual product performance and/or field expense profiles may differ, and in those cases we adjust our warranty reserves accordingly. Future warranty expenses may exceed our estimates, which could lead to an increase in our cost of sales.

 

 

Business combinations

Acquisitions of subsidiaries are accounted for using the ‘purchase accounting’ method. The costs of an acquired subsidiary are assigned to the assets and the liabilities assumed on the basis of their fair values at the date of acquisition. The determination of fair values of assets and liabilities acquired requires us to make estimates and use valuation techniques when market value is not readily available. The excess of the costs of an acquired subsidiary over the net of the amounts assigned to assets acquired and liabilities assumed is capitalized as goodwill.

 

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Evaluation of long-lived assets for impairment and costs associated with exit or disposal activities

Long-lived assets include goodwill, other intangible assets and property, plant and equipment.

 

 

Goodwill is tested at least annually for impairment. Goodwill is considered to be impaired if the fair value based on discounted future cash flows expected to be generated by the reporting unit is less than the carrying amount. The impairment to be recognized is measured as the excess of the carrying amount of goodwill over its implied fair value.

 

 

Other intangible assets and property, plant and equipment are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of those assets may not be recoverable. Recoverability of these assets is measured by a comparison of the carrying amount of the asset to future undiscounted net cash flows expected to be generated by the asset. If those assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the asset. Assets held for sale are reported at the lower of the carrying amount or fair value less the costs to sell.

 

 

In determining the fair value of a reporting unit or the recoverable amount of an asset, the Company makes estimates about future cash flows. These estimates are based on the financial plan updated with the latest available projection of the semiconductor market conditions and our sales and cost expectations which are consistent with the plans and estimates that we use to manage our business. We also make estimates and assumptions concerning Weighted Average Cost of Capital (WACC) and future inflation rates. It is possible that the outcome of the plans, estimates and assumptions used may differ from our estimates, which may require impairment of certain long-lived assets. Future adverse changes in market conditions may also require impairment of certain long-lived assets.

 

 

During 2007, we recorded impairment charges of EUR 8.0 million in property, plant and equipment and EUR 1.0 million in other intangible assets of which we recorded EUR 8.6 million in cost of sales, EUR 0.2 million in research and development costs and EUR 0.2 million in selling, general and administrative costs. The impairment charges mainly relate to buildings and constructions and machinery and equipment. The impairment charges with respect to buildings and constructions mainly relate to a building in Veldhoven that was abandoned in 2007 and will be demolished in 2008 to create space for the clean room and central utilities which are currently under construction. The impairment was determined based on the difference between the building’s estimated fair value (being EUR 0.0) and its carrying amount. The impairment charges with respect to machinery and equipment mainly relate to development, production and field service tooling, which were no longer used because the tools no longer met current technology requirements. The impairment charges were determined based on the difference between the assets’ estimated fair value (being EUR 0.0) and their carrying amount. See Notes 9 and 10 to our consolidated financial statements.

 

 

Inventories

Inventories are stated at the lower of cost (first-in, first-out method) or market value. Costs include net prices paid for materials purchased, charges for freight and customs duties, production labor cost and factory overhead. Inventory provisions are made for slow moving, obsolete or unsaleable inventory and are reviewed on a quarterly basis. Our methodology involves matching our on-hand and on-order inventory with our manufacturing forecast. In determining inventory provisions, we evaluate inventory in excess of our forecasted needs on both technological and economical criteria and make appropriate provisions to reflect the risk of obsolescence. This methodology is significantly affected by our forecasted needs for inventory. If actual demand or usage were to be lower than estimated, additional inventory provisions for excess or obsolete inventory may be required, which could have a material adverse effect on our business, financial condition and results of operations. See Note 6 to our consolidated financial statements.

 

 

Accounts receivable

A majority of our accounts receivable are derived from sales to large multinational semiconductor manufacturers throughout the world. In order to monitor potential credit losses, we perform ongoing credit evaluations of our customers’ financial condition. An allowance for doubtful accounts is maintained for potential credit losses based upon management’s assessment of the expected collectability of all accounts receivable. The allowance for doubtful accounts is reviewed periodically to assess the adequacy of the allowance. In making this assessment, we take into consideration (i) any circumstances of which we are aware regarding a customer’s inability to meet its financial obligations; and (ii) our judgments as to potential prevailing economic conditions in the industry and their potential impact on the Company’s customers. Where we deem it prudent to do so, we may require some form of credit enhancement, such as a letter of credit or bank guarantee, before shipping systems to certain customers. We have not incurred any material accounts receivable credit losses during the past three years. However, we sell a substantial number of systems to a limited number of customers. Our three largest customers accounted for 40.1 percent of accounts receivable at December 31, 2007, compared to 35.0 percent at December 31, 2006. An unanticipated business failure of one of our main customers could result in a substantial credit loss in respect to amounts owed to the Company by that customer, which could adversely affect our results of operations and financial condition. See Note 5 and 20 to our consolidated financial statements.

 

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Contingencies and litigation

We are party to various legal proceedings generally incidental to our business, as disclosed in Note 15 to the consolidated statements. In connection with these proceedings and claims, our management evaluates, based on the relevant facts and legal principles, the likelihood of an unfavorable outcome and whether the amount of the loss could be reasonably estimated. In each case, management has determined that either a loss was not probable or was not reasonably estimable and, as a result, no estimated losses were recorded as a charge to our statement of operations in 2005, 2006 and 2007. Significant subjective judgments were required in these evaluations, including judgments regarding the validity of asserted claims and the likely outcome of legal and administrative proceedings. The outcome of these proceedings, however, is subject to a number of factors beyond our control, most notably the uncertainty associated with predicting decisions by courts and administrative agencies. In addition, estimates of the potential costs associated with legal and administrative proceedings frequently cannot be subjected to any sensitivity analysis, as damage estimates or settlement offers by claimants may bear little or no relation to the eventual outcome. Finally, in any particular proceeding, even where we believe that we would ultimately prevail, we may agree to settle or to terminate a claim or proceeding where we believe that doing so, when taken together with other relevant commercial considerations, is more cost-effective than engaging in an expensive and protracted litigation, the outcome of which is otherwise uncertain. Such a decision occurred when we determined to enter into a cross-license agreement as an alternative to continuing our intellectual property dispute with Nikon.

 

 

We accrue for legal costs related to litigation in our statement of operations at the time when the related legal services are actually provided to us.

 

 

Share-based compensation expenses

Prior to January 1, 2006, we measured compensation expenses for our stock option plans using the intrinsic value method under APB 25 “Accounting for Stock Issued to Employees” and related interpretations. As the exercise price of all stock options granted under these plans was at or above the fair market price of the underlying ordinary shares on the grant date, no compensation expenses were recognized.

 

 

As of January 1, 2006, we implemented the provisions of SFAS No. 123(R), “Share-Based Payment”, using the modified prospective transition method. Under the modified prospective transition method, no restatement of prior interim periods and fiscal years has been made. SFAS No. 123(R) requires companies to recognize the cost of employee services received in exchange for equity-based awards based upon the grant-date fair value of those awards. The grant-date fair value of these awards was estimated using a Black-Scholes option valuation model. This Black-Scholes valuation model requires the use of assumptions, including the risk-free interest rate, the expected stock price volatility and the estimated life of each award. The risk-free interest rate used in the model is determined, based on a Euro government bond with a life equal to the expected life of the equity-settled share-based payments.

 

 

Using the modified prospective transition method, we began recognizing compensation expenses for equity-based awards granted, modified, repurchased, or cancelled after the required effective date of January 1, 2006. Additionally, we began recognizing compensation expenses for equity-based awards granted before the effective date of January 1, 2006 that were outstanding as of January 1, 2006 and for which the requisite service period has not been rendered. Compensation expenses are recognized on a straight-line basis over the requisite service period of the awards, which is generally the vesting period. The total gross amount of expenses associated with share based payments recognized in 2007 was EUR 16.5 million.

 

 

The grant-date fair value for awards for which the requisite service has not been rendered and that are outstanding as of January 1, 2006 was based on the grant-date fair value of those awards as calculated under SFAS No. 123, “Accounting for Stock-Based Compensation” for pro forma disclosures under the assumption of historical volatility. We changed our method of estimating expected volatility for all stock options granted after January 1, 2006 from the exclusive use of historical volatility to the exclusive use of implied volatility. The primary reason for this change is that historical volatility had showed a significant and consistent downward trend over the five years ended December 31, 2006, which we believe is the result of the semiconductor industry becoming more mature and less cyclical. Within this period, historical share price volatility decreased from 89 percent in 2002 to 28 percent in 2006. The implied volatility as applied by ASML in 2006 was approximately 30 percent, which is significantly lower than historical share price volatility of 55 percent over the five year period then ended, and was much closer to the actual volatility of ASML’s share price over fiscal year 2006 of 28 percent. Consequently, we no longer believe that an average historical volatility over a period commensurate with the expected term of the employee stock options (4-5 years) is likely to be indicative of future stock price behavior. Instead, we believe that the exclusive use of implied volatility results in a more accurate estimate of the expected stock price volatility because it more appropriately reflects market expectations of future stock price volatility. Our stock options are actively traded on Euronext Amsterdam. For this purpose, we use implied volatility as calculated by Bloomberg, which is based on an average of traded stock options:

 

ASML ANNUAL REPORT 2007

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We make quarterly assessments of the adequacy of the (hypothetical) tax pool to determine whether there are tax deficiencies that require recognition in the consolidated statements of operations. We have selected the alternative transition method (under FSP FAS 123(R)-3) in order to calculate the tax pool.

 

 

We did not modify outstanding stock option plans in anticipation of the adoption of SFAS No. 123(R). Our current stock option plans do not provide for cash settlement of options. See Note 1 and 14 to our consolidated financial statements.

 

 

Income tax

We operate in various tax jurisdictions in Europe, Asia and the United States and must comply with the tax laws and regulations of each of these jurisdictions.

 

 

We use the asset and liability method in accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for tax consequences attributable to differences between the balance sheet carrying amounts of existing assets and liabilities and their respective tax bases. Furthermore tax assets are recognized for the tax effect of incurred net operating losses. If it is more likely than not that the carrying amounts of deferred tax assets will not be realized, a valuation allowance will be recorded to reduce the carrying amounts of those assets.

 

 

We continuously assess our ability to realize our deferred tax assets resulting from net operating loss carry-forwards. The total amount of loss carry-forwards as of December 31, 2007 was EUR 209 million, which resides completely with ASML US, Inc. We believe that all losses will be offset by future taxable income before our ability to utilize those losses expires. This analysis takes into account our projected future taxable income from operations, possible tax planning alternatives available to us, and a realignment of group assets that we effected during the period 2001 through 2003 that included the transfer of certain tangible and intangible assets of ASML US, Inc. to ASML Netherlands B.V. The value of the assets transferred has resulted and will result in income recognized and to be recognized by ASML US, Inc., which we believe, together with projected future taxable income from operations will be sufficient to absorb the net operating losses that ASML US, Inc. has incurred, prior to the expiry of those losses. In order to determine with certainty the tax consequences and value of the asset transfer and the routine remuneration of ASML US, Inc. for intercompany services rendered, in 2002 we requested a bilateral advance pricing agreement (“APA”) from the United States and Netherlands tax authorities which resulted in September 2007 in two duly signed APAs between certain ASML subsidiaries and the tax authorities of the United States and the Netherlands. The APAs will be valid through 2009 with the possibility of extension (see also Note 16 to our consolidated financial statements).

 

 

Until December 31, 2006, we accounted for income tax contingencies in accordance with SFAS No. 5, “Accounting for Contingencies”. The tax contingencies mainly related to transfer pricing positions, operational activities in countries where we are not tax registered and tax deductible costs. We provided for these tax contingencies for the duration of the statute of limitation which differs per tax jurisdiction and generally ranges up to seven years. As of December 31, 2006, the tax contingencies amount to EUR 130.7 million and are included in deferred tax and other liabilities in the consolidated balance sheet.

 

 

On January 1, 2007, we adopted the provisions of FIN 48 “Accounting for Uncertainty in Income Taxes”. FIN 48 clarifies the accounting for income taxes, by prescribing a minimum recognition threshold a tax position is required to meet, before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods and disclosure regarding income taxes. The cumulative effect of adopting FIN 48 was an increase in the liability for unrecognized tax benefits and a decrease in retained earnings of EUR 7.6 million at January 1, 2007. Upon adoption, the liability for unrecognized tax benefits amounted to EUR 138.3 million. The amount of unrecognized tax benefits, if recognized, would have a favorable effect on the Company’s effective tax rate.

 

 

In addition, consistent with the provisions of FIN 48, we classified EUR 138.3 million as non-current liabilities because payment of cash was not anticipated within one year of the balance sheet date. These non-current income tax liabilities are recorded in deferred tax and other liabilities in the consolidated balance sheet.

 

 

Expected interest and penalties related to income tax liabilities have been accrued for and are included in the liability for unrecognized tax benefits and in the provision for income taxes. The balance of accrued interest and penalties recorded in the consolidated balance sheet of January 1, 2007 amounted to EUR 10.5 million and as of December 31, 2007 amounted to EUR 32.0 million; these amounts were also classified as non-current liabilities consistent with the provisions of FIN 48.

 

 

A reconciliation of the beginning and ending balance of the liability for unrecognized tax benefits is as follows:

 

 

ASML ANNUAL REPORT 2007

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For the 12 month period ending December 31, 2007, there were material changes related to the liability for unrecognized tax benefits that impacted the Company’s effective tax rate. This was due to the settlement of a number of unrecognized tax benefits recorded in prior years in the various jurisdictions. The settlement of the unrecognized tax benefits in the Netherlands jurisdiction was the result of discussions held with the Netherlands tax authorities. As a result of these discussions clarity was obtained on substantially all uncertain tax positions relating to the Netherlands unrecognized tax benefits through fiscal year 2006. The total tax liability related to resolved uncertain tax positions in 2007 amounted to EUR 72.3 million of which EUR 36.8 million was released to the tax provision and EUR 35.5 million was reclassified from deferred tax and other liabilities to current tax liabilities.

 

 

The Company estimates that the total liability of unrecognized tax benefits will change with EUR 15.8 million within the next 12 months. The estimated changes to the liability for unrecognized tax benefits within the next 12 months are mainly due to expected settlements and expiration of statute of limitations which are expected to have a favorable effect on the Company’s effective tax rate.

 

 

On December 5, 2007, ASML Holding entered into a Supervision Agreement, or ‘Handhavingsconvenant’ with the Netherlands tax authorities, which provides for cooperation between ASML and the Netherlands tax authorities. The purpose of this agreement is that parties base their mutual relationship on transparency, understanding and trust. This should result in accelerated settlement of uncertain tax positions for ASML in the Netherlands, where ASML reports the vast majority of its taxable income.

 

 

Results of Operations

The following discussion and analysis of results of operations should be viewed in the context of the risks affecting our business strategy, described in Item 3.D. “Risk Factors”.

 

 

Set forth below are our consolidated statements of operations data for the three years ended December 31, 2007:

 

 

 

Set forth below are our consolidated statements of operations from continuing operations data for the three years ended December 31, 2007, expressed as a percentage of our total net sales:

 

 

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Results of operations from continuing operations 2007 compared with 2006

 

Consolidated sales and gross profit

The following table shows a summary of sales (revenue and units sold), gross profit on sales and ASP data on an annual and semi-annual basis for the years ended December 31, 2007 and 2006.

 

 

 

We achieved growth in net sales of EUR 212 million or 5.9 percent from EUR 3,597 million in 2006 to EUR 3,809 million in 2007. The increase in net sales mainly relates to an increase in net system sales of EUR 163 million or 5.0 percent, from EUR 3,229 million in 2006 to EUR 3,392 million in 2007 mainly attributable to increased ASPs partly offset by a lower number of systems shipped and to an increase in net service and field option sales of EUR 49 million or 13.3 percent from EUR 368 million in 2006 to EUR 417 million in 2007.

 

 

The number of systems shipped decreased by 2.3 percent from 266 systems in 2006 to 260 systems in 2007, following a year of significant growth of systems shipped (35.7 percent) in 2006. The continued high market demand for lithography equipment was driven by a continuing increased market demand for semiconductor revenue by 11 percent in 2007 following two years of semiconductor unit growth by 9 percent in 2005 and 2006. Furthermore the 2007 strong market demand was related to the continued drive from our customers to follow or accelerate their technology shrink roadmaps.

 

 

The ASP of our systems increased by 7.4 percent from EUR 12.1 million in 2006 to EUR 13.0 million in 2007. This increase was mainly driven by a change in product mix reflecting the continued shift in market demand to our leading-edge technology systems (as customers commenced their ramp-up of volume manufacturing with our leading-edge immersion systems for 45 nm Flash and 55 nm DRAM) with higher ASPs driven by the shrink roadmaps of our customers. This increase was partly offset by a growing number of i-line systems sold, with relatively low ASPs, in 2007 reflecting our market share gains in this segment of the market.

 

 

From time to time, ASML repurchases systems that it has manufactured and sold and, following factory-rebuild or refurbishment, resells those systems to other customers. This repurchase decision is mainly driven by market demand for capacity expressed by other customers and not by explicit or implicit contractual arrangements relating to the initial sale. The number of used systems sold in 2007 decreased to 25 from 46 in 2006, reflecting decreased demand for older systems to produce less complex ICs following two years of significant capacity growth. The ASP for used systems increased from EUR 3.2 million in 2006 to

 

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EUR 3.9 million in 2007, reflecting a further shift from our older PAS 2500 towards our newer PAS 5500 family and TWINSCAN family.

 

 

Net service and field option sales showed a 13.3 percent increase from EUR 368 million in 2006 to EUR 417 million in 2007, resulting from increased service as well as field option sales. The increase in service sales was mainly driven by the growth of our system installed base at customers. The growth of field option sales is positively impacted by the customer demand for system upgrade packages that further enhance system performance.

 

 

Of the top 20 chipmakers worldwide, in terms of semiconductor capital expenditures, 18 are customers of ASML. In 2007, sales to the largest customer accounted for EUR 833 million, or 21.9 percent of our net sales. In 2006, sales to the largest customer accounted for EUR 730 million, or 20 percent of our net sales.

 

 

Gross profit increased 6.7 percent from EUR 1,462 million or 40.6 percent of net sales in 2006 to 1,560 million or 41.0 percent of net sales in 2007. The gross margin was positively impacted by a changed product mix (0.2 percent) and, more important, by decreased cost of sales (2.4 percent) reflecting the results of our continuous cost of sales reduction programs. Gross margin was negatively impacted by decreased ASPs of mature technology (−2.4 percent). In addition gross margin was positively impacted by currency effects (0.4 percent) partly offset by various other items including lower service gross margin as a result of investments in spare parts related to the introduction of immersion systems for volume manufacturing as well as investments in our ASML Center of Excellence (ACE) in Asia.

 

 

We started 2006 with an order backlog of 163 systems. In 2007, we booked orders for 203 systems, received order cancellations or push-outs beyond 12 months of 17 systems and recognized sales for 260 systems. This resulted in an order backlog of 89 systems as of December 31, 2007. The total value of our backlog as of December 31, 2007 amounted to EUR 1,697 million with an ASP of EUR 19.1 million, compared with a backlog of EUR 2,146 million with an ASP of EUR 13.2 million as of December 31, 2006. See also Item 5.D. “Trend Information”.

 

 

Research and development

Research and development costs increased by EUR 97 million or 23.4 percent from EUR 414 million in 2006 to EUR 511 million in 2007. The increase reflected further investment in technology leadership in 2007 through investments in the development of the newest versions of our high resolution TWINSCAN systems and enhancements of the next generation TWINSCAN systems based on immersion, double patterning and EUV. In the third quarter of 2007 we shipped the first XT:1900i, capable of imaging features down to 40 nm.

 

 

Amortization of in-process research and development costs of EUR 23 million in 2007 relates to a one-off charge related to the Brion acquisition.

 

 

Research and development credits are EUR 24 million in 2007 compared to EUR 27 million in 2006.

 

 

Selling, general and administrative costs

Selling, general and administrative costs increased by 10.2 percent from EUR 205 million in 2006 to EUR 226 million in 2007 reflecting the increased activity level to support sales growth. Over the past two years selling, general and administrative costs increased by 12.2 percent, while net sales grew by 50.6 percent. Continuing cost reduction and efficiency programs contributed to maintaining a relatively low increase in the level of selling, general and administrative costs compared to the increase in net sales and related activity over the two year period ended December 31, 2007.

 

 

Net interest expense

Net interest changed from EUR 1 million net interest expense in 2006 to EUR 33 million net interest income in 2007. Our interest income relates to interest earned on our cash and cash equivalents. In 2007 interest income increased mainly as a result of higher short-term interest rates and a higher average cash balance. The average cash balance was higher as a result of the cash provided by operating activities and the issuance of a EUR 600 million Eurobond. Interest expense in 2007 was lower due to the conversion of substantially all the U.S. dollar 575 million 5.75 percent Convertible Subordinated Notes in October 2006 (with the unconverted notes redeemed) and the conversion of substantially all the EUR 380 million 5.50 percent Convertible Subordinated Notes, in October 2007 (with the unconverted notes redeemed). This was partly offset by the issuance of a EUR 600 million Eurobond in June 2007.

 

 

Income taxes

Income taxes represented 19.9 percent of income before taxes in 2007, compared to 28.2 percent in 2006. The decrease in income taxes in 2007 is mainly related to a favorable settlement of unrecognized tax benefits. In addition a corporate tax rate reduction in the Netherlands also contributed to a decrease in income taxes. As of January 1, 2007, we implemented FIN 48

 

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“Accounting for uncertainty in income taxes”. The cumulative effect of implementing FIN 48 was an increase in the tax liability for uncertain tax positions against retained earnings of EUR 7.6 million at January 1, 2007.

 

 

Results of operations from continuing operations 2006 compared with 2005

 

Consolidated sales and gross profit

The following table sets forth a summary of sales (by revenue and units sold), gross profit on sales and ASP data on an annual and semi-annual basis for the years ended December 31, 2006 and 2005.

 

 

 

We achieved a significant growth in net sales of 42 percent from EUR 2,529 million in 2005 to EUR 3,597 million in 2006. The increase in net sales was driven by a combination of ASP increases and an increased market demand for lithography equipment in 2006 by 34 percent (2005: −3 percent). The increase in net sales mainly relates to an increase in net system sales of 44.9 percent, from EUR 2,228 million in 2005 to EUR 3,229 million in 2006 and to a lesser degree to an increase in net service and field option sales of 22.3 percent from EUR 301 million in 2005 to EUR 368 million in 2006.

 

 

The number of systems shipped increased by 35.7 percent from 196 systems in 2005 to 266 systems in 2006. This increase in the number of systems shipped reflects the increased market demand for lithography equipment in 2006 as well as the growth of our market share which is the result of our sustained technological leadership.

 

 

The ASP of our systems increased slightly by 6.1 percent from EUR 11.4 million in 2005 to EUR 12.1 million in 2006. This increase is mainly driven by a change in product mix reflecting the continuous shift in market demand to our leading-edge technology systems (65 nm ramp and immersion start up) with higher ASPs driven by the shrink roadmaps of our customers, partly offset by a growing number of i-line and KrF systems in 2006 reflecting capacity investments by our customers.

 

 

The number of used systems sold in 2006 increased to 46 from 40 in 2005, reflecting increased demand for older systems to produce less complex ICs. The ASP for used systems increased from EUR 2.9 million in 2005 to EUR 3.2 million in 2006, reflecting a further shift from our older PAS 2500 towards our newer PAS 5500 family and TWINSCAN family.

 

 

Net service and field option sales showed a 22.3 percent increase from EUR 301 million in 2005 to EUR 368 million in 2006, resulting from increased service as well as field option sales. The increase in service sales was mainly driven by the growth of our system installed base at customers. The growth of field option sales is positively impacted by the availability and customer demand for system upgrade packages that further enhance system performance.

 

 

Of the top 20 chipmakers worldwide, in terms of semiconductor capital expenditures, 16 were customers of ASML. In 2006, sales to the largest customer accounted for EUR 730 million, or 20 percent of our net sales. In 2005, sales to the largest customer accounted for EUR 609 million, or 24 percent of our net sales.

 

 

Gross profit increased compared to 2005, increasing by 50.1 percent from EUR 974 million or 38.5 percent of net sales in 2005 to 1,462 million or 40.6 percent of net sales in 2006. The increased gross margin was positively impacted by decreased cost of sales as a percentage of net sales (5.2 percent positive impact on gross profit) reflecting the results of our continuous cost of sales reduction program, partly offset by a change in the product mix (2.1 percent negative impact on gross profit) and slightly decreased prices (0.8 percent negative impact on gross profit). The positive impact on gross profit of the higher production volumes (0.6 percent) and currency effects (0.4 percent) was offset by the negative impact on gross profit of the higher cost for obsolete inventories (0.4 percent) and the higher costs for lens swaps (0.9 percent).

 

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We started 2005 with an order backlog of 95 systems. In 2006, we booked orders for 347 systems, received order cancellations or push-outs beyond 12 months of 13 systems and recognized sales for 266 systems. This resulted in an order backlog of 163 systems as of December 31, 2006. The total value of our backlog as of December 31, 2006 amounted to EUR 2.1 billion, compared with a backlog of approximately EUR 1.4 billion as of December 31, 2005.

 

 

Research and development

Research and development costs increased by 19.0 percent from EUR 348 million in 2005 to EUR 414 million in 2006. We further accelerated our investment in technology leadership in 2006 through the investments in the newest versions of our high resolution TWINSCAN systems and enhancements of the next generation TWINSCAN systems based on immersion, double patterning, EUV and the development of optical maskless lithography. In the second quarter of 2006 we shipped the first XT:1700i and the third quarter we introduced the XT:1900i, both enhanced immersion systems. Also in the second quarter of 2006, we shipped the industry’s first EUV Alpha Demo Tools to two research and development institutions.

 

 

Research and development credits increased from EUR 24 million in 2005 to EUR 27 million in 2006 due to an increased volume of research and development projects that qualified for credits under governmental funding programs.

 

 

Selling, general and administrative costs

Selling, general and administrative costs increased by only 2 percent from EUR 201 million in 2005 to EUR 205 million in 2006 while sales grew by 42 percent. Cost reduction and efficiency programs contributed to maintaining a near constant level of selling, general and administrative costs.

 

 

Net interest expense

Net interest expense decreased from EUR 14 million in 2005 to EUR 1 million in 2006 due to decreased interest expenses and increased interest income. Interest expense mainly relate to our convertible subordinated notes, which had lower average balances in 2006 mainly due to the conversion of the USD 575 million 5.75 percent convertible notes which were due October 15, 2006. Our interest income relates primarily to interest earned on our cash and cash equivalents. Our interest income increased in 2006 mainly as a result of higher short term interest rates.

 

 

Income taxes

Income taxes represented 28.2 percent of income before taxes in 2006, compared to 28.4 percent in 2005. The decrease in income taxes in 2006 is mainly related to a corporate tax rate reduction in the Netherlands.

 

 

Foreign Exchange Management

See Item 3.D. “Risk Factors, Fluctuations in Foreign Exchange Rates Could Harm Our Results of Operations”, Item 11 “Quantitative and Qualitative Disclosures About Market Risk” and Note 4 to our consolidated financial statements.

 

 

New U.S. GAAP Accounting Pronouncements

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments”. This Statement amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” and SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” and permits, among other things, fair value re-measurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation. SFAS No. 155 had to be adopted for all financial instruments acquired, issued, or subject to a re-measurement (new basis) event occurring after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The adoption of SFAS No. 155 did not have a material impact on our consolidated financial statements.

 

 

In June 2006, the FASB issued Interpretation 48, “Accounting for Uncertainty in Income Taxes”. FIN 48 clarifies the accounting for income taxes, by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. On January 1, 2007 we adopted FIN 48. See Note 16 to the consolidated financial statements for additional information, including the effect of adoption on the Company’s consolidated financial statements.

 

 

In June 2006, the FASB ratified the consensus reached by the FASB’s Emerging Issues Task Force (“EITF”) on Issue No. 06-03, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That is, Gross versus Net Presentation)” (“EITF No. 06-03”). EITF No. 06-03 permits registrants to elect to present vendor taxes imposed concurrently on a specific revenue-producing transaction between a seller and a customer on either a gross or net basis. The scope of EITF No. 06-03 includes government assessed taxes that are directly imposed on revenue-producing transactions between a seller and a customer and may include, but is not limited to, sales, use, value added and some excise taxes. Registrants are to be required to disclose their policies for presenting the taxes and would disclose any amounts presented on a gross basis. EITF No. 06-03 is effective for interim and annual financial statements issued for periods beginning after

 

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December 15, 2006. The adoption of EITF No. 06-03 did not have a material impact on our consolidated financial statements. ASML continues to recognize revenues excluding the taxes levied on revenues (net basis).

 

 

The FASB issued SFAS No. 157, “Fair Value Measurements” on September 15, 2006. The Statement defines fair value, provides guidance on how to measure assets and liabilities using fair value and expands disclosures about fair value measurements. The Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007 and should be applied prospectively (with a limited form of retrospective application) as of the beginning of the fiscal year in which this Statement is initially applied. We believe that the adoption of SFAS No. 157 will have no material impact on our consolidated financial statements.

 

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115” (“SFAS 159”). SFAS 159 is expected to expand the use of fair value accounting but does not affect existing standards which require certain assets or liabilities to be carried at fair value. The objective of SFAS 159 is to improve financial reporting by providing companies with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. Under SFAS 159, a company may choose, at specified election dates, to measure eligible items at fair value and report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. SFAS 159 is effective for interim and annual financial statements issued for fiscal years beginning after November 15, 2007. We are currently assessing the impact that SFAS 159 may have on our consolidated financial statements.

 

 

In June 2007, the FASB ratified the consensus reached by the EITF on Issue No. 06-11, “Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards”. EITF No. 06-11 requires that a realized income tax benefit from dividends or dividend equivalents that are charged to retained earnings and are paid to employees for equity classified nonvested equity shares, nonvested equity share units, and outstanding equity share options should be recognized as an increase to additional paid-in capital. The amount recognized in additional paid-in capital for the realized income tax benefit from dividends on those awards should be included in the pool of excess tax benefits available to absorb tax deficiencies on share-based payment awards. EITF No. 06-11 is effective for interim and annual financial statements issued for periods beginning after December 15, 2007. We believe that the adoption of EITF 06-11 will have no material impact on our consolidated financial statements.

 

 

In December 2007, the FASB issued SFAS 141(R), “Business Combinations”. This statement replaces FASB Statement No. 141 “Business Combinations”. SFAS 141(R) improves the relevance, representational faithfulness and comparability of the information that a reporting entity provides in its financial reports about a business combination and its effects. This FASB statement applies prospectively to business combination for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. We are currently assessing the impact that SFAS 141(R) may have on our consolidated financial statements.

 

 

In December 2007, the FASB issued SFAS 160, “Noncontrolling Interests in Consolidated Financial Statements”. This statement amends ARB No. 51 “Consolidated Financial Statement”. This Statement establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. This Statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Adoption of SFAS 160 will have no impact on our consolidated financial statements since all subsidiaries are wholly owned and no subsidiaries are deconsolidated.

 

 

In December 2007, the SEC issued Staff Accounting Bulletin No. 110 (“SAB 110”) regarding the use of a “simplified” method in developing an estimate of expected term of “plain vanilla” share options. In particular, the staff indicated in SAB 107 that it will accept a company’s election to use the simplified method, regardless of whether the company has sufficient information to make more refined estimates of expected term. At the time SAB 107 was issued, the SEC staff believed that more detailed external information about employee exercise behavior (e.g. employee exercise patterns by industry and/or other categories of companies) would, over time, become readily available to companies. Therefore, the SEC staff stated in SAB 107 that it would not expect a company to use the simplified method for share option grants after December 31, 2007. The SEC staff stated that it understands that such detailed information about employee exercise behavior may not be widely available by December 31, 2007. Accordingly, the SEC staff stated that it will continue to accept, under certain circumstances, the use of the simplified method beyond December 31, 2007. We believe that the adoption of SAB 110 will have no material adverse effect on our consolidated financial statements.

The following discussion and analysis of financial condition should be viewed in the context of the risks affecting our business, described in Item 3.D. “Risk Factors”.

 

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Our balance of cash and cash equivalents amounted to EUR 1,656 million and EUR 1,272 million as of December 31, 2006 and 2007, respectively.

 

 

We generated cash from operating activities of EUR 478 million and EUR 670 million in 2006 and 2007, respectively. The primary components of cash provided by operating activities in 2007 were net income (EUR 688 million) plus non-cash expenses (EUR 215 million) mainly related to depreciation, impairment charges and inventory obsolescence partially offset by a cash outflow of EUR 233 million due to investments in working capital. The investments in working capital mainly relate to higher inventories of EUR 439 million and higher other assets of EUR 86 million, partly offset by higher accrued liabilities of EUR 263 million. The higher inventories relate to the increased complexity of our systems resulting in higher costs of components for our systems and higher ASPs.

 

 

We used EUR 66 million for investing activities in 2006 and EUR 348 million in 2007. The majority of the 2007 expenditures was spent on the ongoing construction of a new production facility, the acquisition of Brion and, to a lesser extent, machinery and equipment and information technology investments.

 

 

Net cash used by financing activities was EUR 648 million in 2006 compared to EUR 699 million in 2007. In 2007, cash provided by financing activities mainly included EUR 594 million net proceeds from the issuance in June 2007 of a Eurobond, EUR 80 million from the issuance of shares in connection with the exercise of employee stock options. In 2007, cash used by financing activities mainly included EUR 1,372 million for share buyback programs (including the synthetic share buyback) and EUR 10 million for the redemption of debt. See also Item 16.E. “Purchases of Equity Securities by the Issuer and Affiliated Purchasers”.

 

 

Our principal sources of liquidity consist of EUR 1,272 million of cash and cash equivalents as of December 31, 2007, EUR 500 million of available credit facilities as of December 31, 2007 and cash flows from operations. For further details of our credit facilities, see Note 12 to our consolidated financial statements. In addition to cash and available credit facilities, from time to time we raise additional capital in debt and equity markets. Our liquidity needs are affected by many factors, some of which are based on the normal ongoing operations of the business, and others that relate to the uncertainties of global economies and the semiconductor industries. Although our cash requirements fluctuate based on the timing and extent of these factors, we believe that cash generated from operations, together with the liquidity provided by existing cash balances, are sufficient to satisfy our present requirements.

 

 

We expect substantial cash outflow from investing activities in 2008 due to our planned capital expenditures. Subject to market developments we expect that our capital expenditures in 2008 could be up to approximately EUR 250 million, an increase of EUR 18 million compared to 2007. We expect that a significant part of the 2008 expenditures will be allocated to construction and upgrades of production facilities in the Netherlands and Taiwan. See also Item 4.D. “Property, Plants and Equipment”. We expect to finance 2008 capital expenditures out of our cashflow from operations and available cash and cash equivalents.

 

 

We reiterate our commitment to return excess cash to our shareholders and will consider all available opportunities to return this cash to shareholders, including share buybacks, dividend and capital repayment. Accordingly, we intend to seek authorization for additional share buyback programs at the Annual General Meeting of Shareholders on April 3, 2008.

 

 

We have repayment obligations in 2017, amounting to EUR 600 million, on our 5.75 percent senior notes due 2017. We currently intend to fund any future repayment obligations primarily with cash on hand and cash generated through operations. A description of our senior bond, lines of credit and other borrowing arrangements is provided in Note 12 to our consolidated financial statements.

 

 

Our contractual obligations and commercial commitments are disclosed in further detail in Item 5.F. “Tabular Disclosure of Contractual Obligations” and Note 13 to our consolidated financial statements.

 

 

See Notes 4 and 12 to our consolidated financial statements for discussion of our funding, treasury policies and currencies in which cash and cash equivalents are held and convertible notes, senior bonds and other borrowing arrangements.

 

 

Research and Development

See Item 4.B. “Business Overview, Research and Development” and Item 5.A. “Operating Results”.

 

 

Intellectual Property Matters

See Item 3.D. “Risk Factors, Defending Against Intellectual Property Claims by Others Could Harm Our Business” and Item 4.B. “Business Overview, Intellectual Property”.

 

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Within the current sentiment of global economic weakness and an overall 2008 semiconductor capital investment slowdown forecast by some analysts and customers, ASML believes that it is nonetheless well positioned for robust revenues in the first half of 2008. With 60 percent of our EUR 1,697 million backlog covered by immersion technology tools, and 26 percent of the backlog ordered by manufacturers of logic ICs, we have a relatively low exposure to the currently more volatile capital spend at second tier memory manufacturers. Our immersion products are designed to enable rapid technology transfers down to 4x nm nodes, which are being executed by our customers to reach appropriate integration and cost targets that are needed in the current environment. We expect to almost double our net sales from immersion systems in 2008 from 2007. Although independent market researchers still expect a double digit increase in demand for integrated circuit units in 2008, which we expect will translate into lithography market expansion in 2008, we are awaiting confirmation of this potential growth through the level of first and second quarter bookings. We remain optimistic, in view of our customers’ large immersion technology needs, their high level of capacity utilization, and the current IC inventory levels in the market.

 

 

The trends discussed in this Item 5.D. are subject to risks and uncertainties. See “Part I — Special Note Regarding Forward Looking Statements”.

 

 

The following table sets forth our backlog of systems as of December 31, 2006 and 2007.

 

 

 

Our backlog includes only system orders for which written authorizations have been accepted and shipment dates within 12 months have been assigned. Historically, orders have been subject to cancellation or delay by the customer. Due to possible customer changes in delivery schedules and to cancellation of orders, our backlog at any particular date is not necessarily indicative of actual sales for any succeeding period.

 

 

ASML expects to ship 50 systems in the first quarter of 2008 with an average selling price of EUR 18.9 million for new systems and an average selling price for all systems of EUR 16.3 million. We expect a gross profit margin in the first quarter of 2008 of between 40 to 41 percent, research and development costs of EUR 127 million net of credits and selling, general and administrative costs of EUR 58 million.

We have various contractual obligations, some of which are required to be recorded as liabilities in our consolidated financial statements, including long- and short-term debt. Other contractual arrangements, namely operating lease commitments and purchase obligations, are not generally required to be recognized as liabilities on our balance sheet but are required to be disclosed.

 

 

Variable Interest Entities

In December 2003, the FASB issued FIN 46(R) “Consolidation of Variable Interest Entities”. Under FIN 46(R), an enterprise must consolidate a variable interest entity if that enterprise has a variable interest (or combination of variable interests) that will absorb a majority of the entity’s expected losses if they occur, receive a majority of the entity’s expected residual returns if they occur, or both.

 

 

In 2003, ASML moved to its current Veldhoven headquarters. We lease these headquarters for a period of 15 years from an entity (the “lessor”) that was incorporated by a syndicate of three banks (“shareholders”) solely for the purpose of leasing this building. The shareholders equity in the lessor amounts to EUR 1.9 million. The shareholders each granted a loan of EUR 11.6 million and a fourth bank granted a loan of EUR 12.3 million to the lessor. ASML provided the lessor with a subordinated loan of EUR 5.4 million and has a purchase option that is exercisable either at the end of the lease in 2018, at a pre-determined price of EUR 24.5 million, or during the lease at the book value of the assets. The total assets of the lessor entity amounted to approximately EUR 54 million at inception of the lease.

 

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ASML believes that it holds a variable interest in this entity and that the entity is a variable interest entity (“VIE”) because it is subject to consolidation in accordance with the provisions of paragraph 5 of FIN 46(R). The total equity investment at risk is approximately 3.6 percent of the lessor’s total assets and is not considered and cannot be demonstrated, qualitatively or quantitatively, to be sufficient to permit the lessor to finance its activities without additional subordinated financial support provided by any parties, including the shareholders.

 

 

ASML has determined that it is not appropriate to consolidate the VIE as it is not the primary beneficiary. To make this determination, the expected losses and expected residual returns of the lessor were allocated to each variable interest holder based on their contractual right to absorb expected losses and residual returns. The analysis of expected losses and expected residual returns involved determining the expected negative and positive variability in the fair value of the lessor’s net assets exclusive of variable interests through various cash flow scenarios based upon the expected market value of the lessor’s net assets. Based on this analysis, ASML determined that other variable interest holders will absorb the majority of the lessor’s expected losses, and as a result, ASML is not the primary beneficiary.

 

 

ASML’s maximum exposure to the lessor’s expected losses is estimated to be approximately EUR 5.4 million.

 

 

Purchase Obligations

We enter into purchase commitments with vendors in the ordinary course of business to ensure a smooth and continuous supply chain for key components. Purchase obligations include medium to long-term purchase agreements. These contracts differ and may include certain restrictive clauses. Any identified losses that result from purchase commitments that are forfeited are provided for in our financial statements. As of December 31, 2007, we had purchase commitments for a total amount of approximately EUR 1,405 million, compared to EUR 995 million as of December 31, 2006. This increase is mainly due to costs of components for our systems as ASPs have increased. In our negotiations with suppliers we continuously seek to align our purchase commitments with our business objectives. See also Item 5.F. “Tabular Disclosure of Contractual Obligations”.

 

 

Other Off-Balance Sheet Arrangements

We have certain additional commitments and contingencies that are not recorded on our balance sheet but may result in future cash requirements.

 

 

We provide guarantees to third parties in connection with transactions entered into in the ordinary course of business from time to time.

Our contractual obligations as of December 31, 2007 can be summarized as follows:

 

 

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Several operating leases for our buildings contain purchase options, exercisable at the option of the Company at the end of the lease, and in some cases, during the term of the lease. The amounts to be paid if ASML should exercise these purchase options at the end of the lease can be summarized as of December 31, 2007 as follows:

 

 

 

G. Safe Harbor

See “Special Note regarding Forward-Looking Statements”.

 

 

Item 6 Directors, Senior Management and Employees

 

 

A. Directors and Senior Management

The members of our Supervisory Board and our Board of Management are as follows: