20-F 1 u51076e20vf.htm FORM 20-F 20-F
Table of Contents

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, 2006
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:
     
Title of each class   Name of each exchange on which registered
     
Ordinary Shares
  Nasdaq Global Select Market
(nominal value EUR 0.02 per share)
  Euronext Amsterdam N.V.
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.
477,099,245 Ordinary Shares
(nominal value EUR 0.02 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


Table of Contents

Contents
         
       
 
       
 
       
 
       
         A. Selected Financial Data
       
       
       
         D. Risk Factors
       
 
       
       
         B. Business Overview
       
         C. Organizational Structure
       
       
 
       
 
       
         A. Operating Results
       
       
       
         D. Trend Information
       
       
       
         G. Safe Harbor
       
 
       
       
         B. Compensation
       
         C. Board Practices
       
         D. Employees
       
         E. Share Ownership
       
 
       
         A. Major Shareholders
       
         B. Related Party Transactions
       
       
 
       
       
         B. Significant Changes
       
ASML ANNUAL REPORT 2006
2


Table of Contents

         
       
         A. Listing Details
       
         B. Plan of Distribution
       
         C. Markets
       
         D. Selling Shareholders
       
         E. Dilution
       
         F. Expenses of the Issue
       
 
       
         A. Share Capital
       
       
         C. Material Contracts
       
         D. Exchange Controls
       
         E. Taxation
       
       
         G. Statement by Experts
       
         H. Documents on Display
       
         I.  Subsidiary Information
       
 
       
 
       
 
       
 
       
 
       
 
       
 
       
       
         B. Code of Ethics
       
       
       
       
 
       
 
       
 
       
 
       
 EXHIBIT 8.1
 EXHIBIT 12.1
 EXHIBIT 13.1
 EXHIBIT 15.1
ASML ANNUAL REPORT 2006
3


Table of Contents

Part I
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 consolidated financial statements for each of the three years ended December 31, 2006, our selected financial data for each of the five years ended December 31, 2006 and the financial and operational information 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.
Item 1 Identity of Directors, Senior Management and Advisors
Not applicable.
Item 2 Offer Statistics and Expected Timetable
Not applicable.
Item 3 Key Information
A. Selected Financial Data
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.”
ASML ANNUAL REPORT 2006
4


Table of Contents

Five-Year Financial Summary
                                             
 
Year ended December 31   2002   2003   2004   2005   2006    
(in thousands, except per share data)1   EUR   EUR   EUR   EUR   EUR    
 
Consolidated statements of operations data
                                           
Net sales
    1,958,672       1,542,737       2,465,377       2,528,967       3,597,104      
Cost of sales
    1,491,068       1,173,955       1,559,738       1,554,772       2,135,086      
 
 
Gross profit on sales
    467,604       368,782       905,639       974,195       1,462,018      
Research and development costs
    324,419       305,839       352,920       347,901       413,708      
Research and development credits
    (26,015 )     (19,119 )     (21,961 )     (24,027 )     (27,141 )    
Selling, general and administrative expenses
    263,243       212,609       201,629       201,204       204,799      
Restructuring and merger and acquisition costs (credits)
    0       24,485       (5,862 )     0       0      
 
 
Income (loss) from operations
    (94,043 )     (155,032 )     378,913       449,117       870,652      
Interest income (expense), net
    (36,781 )     (29,149 )     (16,073 )     (14,094 )     (854 )    
 
 
Income (loss) from continuing
operations before income taxes
    (130,824 )     (184,181 )     362,840       435,023       869,798      
(Provision for) benefit from income taxes
    42,779       59,675       (127,380 )     (123,559 )     (245,109 )    
 
 
Income (loss) from continuing operations
    (88,045 )     (124,506 )     235,460       311,464       624,689      
Loss from discontinued operations before income taxes
    (183,624 )     (59,026 )     0       0       0      
Benefit from income taxes
    63,846       23,316       0       0       0      
 
 
Loss from discontinued operations
    (119,778 )     (35,710 )     0       0       0      
 
 
Net income (loss)
    (207,823 )     (160,216 )     235,460       311,464       624,689      
 
 
 
 
 
 
Earnings per share data2
                                           
Basic net income (loss) from continuing
operations per ordinary share
    (0.18 )     (0.26 )     0.49       0.64       1.32      
Basic net loss from discontinued
operations per ordinary share
    (0.26 )     (0.07 )     0.00       0.00       0.00      
Basic net income (loss) per ordinary share
    (0.44 )     (0.33 )     0.49       0.64       1.32      
Diluted net income (loss) per ordinary share
    (0.44 )     (0.33 )     0.49       0.64       1.27      
 
Number of ordinary shares used in
computing per share amounts (in thousands)
                                           
Basic
    476,866       482,240       483,380       484,103       474,860      
Diluted
    476,866       482,240       484,661       542,979       503,983      
 
 
The selected consolidated data for all periods reflect the effects of our decision in December 2002 to discontinue our Track business and divest our Thermal business which we substantially divested in October 2003.
The calculation of the number of ordinary shares used in computing diluted net income per ordinary share (i) in 2002, 2003 and 2004 does not assume conversion of ASML’s outstanding Convertible Subordinated Notes and (ii) in 2002 and 2003 does not assume the exercise of options issued under ASML’s stock option plans, as such conversions and exercises would have an anti-dilutive effect.
ASML ANNUAL REPORT 2006
5


Table of Contents

                                             
 
As of December 31   2002   2003   2004   2005   2006    
(in thousands)   EUR   EUR   EUR   EUR   EUR    
 
Consolidated balance sheets data
                                           
Cash and cash equivalents
    668,760       1,027,806       1,228,130       1,904,609       1,655,857      
Working capital3
    1,662,570       1,463,308       1,868,871       1,785,836       2,244,625      
Total assets
    3,301,688       2,868,282       3,243,766       3,756,023       3,951,035      
Long-term liabilities
    1,233,398       1,040,556       1,039,023       624,203       613,167      
Total shareholders’ equity
    1,315,516       1,141,207       1,391,602       1,711,837       2,156,455      
Capital stock
    9,644       9,651       9,675       9,694       10,051      
 
Consolidated statements of cash flows data
                                           
Purchases of property, plant and equipment
    (89,282 )     (48,567 )     (74,979 )     (72,660 )     (70,619 )    
Depreciation, amortization and impairment
    186,686       156,900       93,144       98,881       104,446      
Net cash provided by (used in) continuing operating activities
    (61,127 )     532,659       257,147       713,511       477,507      
Net cash provided by (used in) discontinued operating activities
    (121,039 )     12,736       (5,880 )     (2,018 )     0      
Net cash provided by (used in) total operating activities
    (182,166 )     545,395       251,267       711,493       477,507      
Net cash used in continuing investing activities
    (72,876 )     (49,028 )     (60,398 )     (60,803 )     (65,523 )    
Net cash used in discontinued investing activities
    (6,434 )     0       0       0       0      
Net cash used in total investing activities
    (79,310 )     (49,028 )     (60,398 )     (60,803 )     (65,523 )    
Net cash provided by (used in) continuing financing activities
    21,427       (68,156 )     18,871       2,879       (647,957 ) 6    
Net cash provided by (used in)
discontinued financing activities
    0       0       0       0       0      
Net cash provided by (used in) total financing activities
    21,427       (68,156 )     18,871       2,879       (647,957 ) 6    
Net increase (decrease) in cash and cash equivalents
    (241,918 )     359,046       200,324       676,479       (248,752 )    
 
Ratios and other data
                                           
Increase (decrease) net sales (in percent)
    23.2       (21.2 )     59.8       2.6       42.2      
Gross profit as a percentage of net sales
    23.9       23.9       36.7       38.5       40.6      
Income (loss) from operations as a percentage of net sales
    (4.8 )     (10.0 )     15.4       17.8       24.2      
Net income (loss) as a percentage of net sales
    (4.5 )     (8.1 )     9.6       12.3       17.4      
Shareholders’ equity as a percentage of total assets
    39.8       39.8       42.9       45.6       54.6      
Backlog of new systems (in units) at year end
    103       103       119       86       153      
Backlog of used systems (in units) at year end
    7       21       12       9       10      
Backlog of systems (in units) at year end
    110       124       131       95       163      
Sales of systems (in units)
    205       169       282       196       266      
Number of employees at year end for continuing operations
    5,971       5,059       5,071       5,055       5,594      
Number of ordinary shares
outstanding (in thousands) at year end
    482,182       482,514       483,676       484,670       477,099      
Share price ASML at year end4
    7.96       15.72       11.81       16.90       18.84      
Volatility % ASML shares (260 days)5
    89.0       60.9       37.4       26.0       28.08      
 
 
Working Capital is calculated as the difference between total current assets, including cash and cash equivalents, and total current liabilities.
Closing price of ASML’s ordinary shares listed on the Official Segment of the stock market of Euronext Amsterdam N.V. (Source: Bloomberg)
Volatility represents the variability in our share price on the Official Segment of the stock market of Euronext Amsterdam N.V. as measured over the last 260 business days of each year presented (Source: Bloomberg).
Net cash used in financing activities includes an amount of EUR 678 million with respect to 2006 share buyback programs.
ASML ANNUAL REPORT 2006
6


Table of Contents

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, 2006 of US$ 1.00 = EUR 0.75930.
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.
                                                 
 
    January 24
Calendar period   2002   2003   2004   2005   2006   2007
 
Period End
    1.05       1.26       1.35       1.18       1.32       1.30  
Average1
    0.95       1.13       1.24       1.24       1.26       1.30  
High
    1.05       1.26       1.36       1.35       1.33       1.33  
Low
    0.86       1.04       1.18       1.17       1.19       1.29  
 
The average of the Noon Buying Rates on the last business day of each month during the period presented.
                                                         
 
    July   August   September   October   November   December   January 24
Months of   2006   2006   2006   2006   2006   2006   2007
 
High
    1.28       1.29       1.28       1.28       1.33       1.33       1.33  
Low
    1.25       1.27       1.26       1.25       1.27       1.31       1.29  
 
B. Capitalization and Indebtedness
Not applicable.
C. Reasons for the Offer and Use of Proceeds
Not applicable.
D. Risk Factors
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:
•  the current and anticipated market demand for semiconductors and for products utilizing semiconductors;
•  semiconductor prices;
•  semiconductor production costs; and
•  general economic conditions.
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 meet customer demand. Our ability to predict the timing and magnitude of industry fluctuations is limited and our products
ASML ANNUAL REPORT 2006
7


Table of Contents

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. 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:
•  rapid change towards more complex technologies;
•  frequent new product introductions and enhancements;
•  evolving industry standards;
•  changes in customer requirements; and
•  continued shortening of product life cycles.
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 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 markets are:
•  the technical performance characteristics of a photolithography system;
•  the value of ownership of that system based on its purchase price, maintenance costs, productivity and customer service and support; and
•  the strength and breadth of our portfolio of patents and other intellectual property rights.
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 14 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 dominant suppliers in the Japanese market, which accounts for a significant portion of worldwide semiconductor production. This market 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 markets 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.
ASML ANNUAL REPORT 2006
8


Table of Contents

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 heavily on Cymer, Inc., a United States 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 2006, sales to one customer accounted for EUR 730 million, or 20 percent of net sales, compared to EUR 609 million, or 24 percent of net sales, in 2005. The loss of any significant customer or any 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 35 percent of accounts receivable at December 31, 2006, compared to 49 percent at December 31, 2005. 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 precisely predict 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.
ASML ANNUAL REPORT 2006
9


Table of Contents

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 (266 units in 2006; 196 units in 2005), with an average selling price (“ASP”) in 2006 of EUR 12.1 million (EUR 14.0 million for new systems and EUR 3.2 million for used systems) and ASP in 2005 of EUR 11.4 million (EUR 13.5 million for new systems and EUR 2.9 million for used systems). As a result, the timing of recognition of revenue from a small number of transactions 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:
•  the highly cyclical semiconductor business industry;
•  unanticipated shipment rescheduling;
•  cancellation or order push back by customers;
•  unexpected manufacturing difficulties; and
•  delays in deliveries by suppliers,
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 these measures will be inadequate:
•  intellectual property laws may not sufficiently support our proprietary rights or may adversely change in the future;
•  patent rights may not be granted or construed as intended;
•  patent rights will expire;
•  the steps we take to prevent misappropriation or infringement of our proprietary rights may not be successful; and
•  third parties may be able to develop or obtain patents for similar competing technology.
In addition, litigation may be necessary in order 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 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 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 markets, including the following:
•  potentially adverse tax consequences;
•  unfavorable political or economic environments;
•  unexpected legal or regulatory changes; and
•  an inability to effectively protect intellectual property.
ASML ANNUAL REPORT 2006
10


Table of Contents

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 20 percent of our 2006 revenues and approximately 18 percent of our 2005 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, 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 does not agree 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 Netherlands Court. 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.”
Non-compliance with or a Change in Environmental Laws and Regulations Could Harm Our Results of Operations
We are subject to Netherlands and foreign environmental regulations in areas such as energy resource management, use, storage, discharge and disposal of hazardous substances, recycling, clean air, water protection and waste disposal. Although we believe that we are in general compliance with these regulations and do not use large quantities of hazardous substances in our manufacturing processes, if we do not take adequate measures to comply with these regulations in the course of our ordinary business operations, or if there is a significant change in the environmental laws or regulations that affect our business, there could be a material adverse effect on our business, financial condition and results of operations.
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. dollar, 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 markets 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.
ASML ANNUAL REPORT 2006
11


Table of Contents

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.
Our Business and Future Success Depend on Our Ability to Attract and Retain Sufficient, 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.
Risks Related to Our Ordinary Shares
The Price of Our Ordinary Shares is Very 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.
We also have a class of protective cumulative preference shares (the “Preference Shares”) and have granted to “Stichting Preferente Aandelen ASML”, a Netherlands foundation, an option to acquire from us, at their nominal value of EUR 0.02 per share, a number of preference shares equal to the number of ordinary shares outstanding at the time of option exercise. This effectively would dilute by one half the voting power of our outstanding ordinary shares, 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”.
Item 4 Information on the Company
A. History and Development of the Company
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 and Israel. 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.
Capital Expenditures and Divestitures
Our capital expenditures for 2006, 2005 and 2004 amounted to EUR 99.4 million, EUR 79.8 million and EUR 111.3 million, respectively. The related cash outflows for 2006, 2005 and 2004 amounted to EUR 70.7 million, EUR 74.0 million and EUR 75.5 million, respectively. Our capital expenditures consist of purchases of machinery and equipment (e.g. prototypes, demonstration systems and training systems), information technology investments, leasehold improvements to our facilities and licenses of patents related to lithography equipment. Substantially all capital expenditures in these periods have been made in The Netherlands.
ASML ANNUAL REPORT 2006
12


Table of Contents

Our Veldhoven headquarters is financed through a special purpose vehicle that is a variable interest entity. See Item 5.E. “Off-Balance Sheet Arrangements” and Note 12 to our consolidated financial statements. All other current capital expenditures are financed internally.
Divestitures within continued operations, principally comprising machinery and equipment (more specifically, demonstration systems and training systems), amounted to EUR 5.6 million for 2006, EUR 30.3 million for 2005 and EUR 36.2 million for 2004. See Note 9 to our consolidated financial statements.
B. Business Overview
We are one of the world’s leading providers of advanced technology systems for the semiconductor industry, based on revenue and market share. 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:
•  offering ongoing improvements in productivity, imaging and overlay by introducing advanced technology based on modular platforms;
•  providing customer services that ensure rapid, efficient installation and superior on-site support and training to optimize manufacturing processes and improve productivity;
•  maintaining appropriate levels of research and development to offer the most advanced technology suitable for high-throughput and low-cost volume production at the earliest possible date;
•  enhancing the capabilities of the installed base through ongoing field upgrades of key value drivers (productivity, imaging and overlay) based on further technology developments;
•  reducing the cycle time between customer order of a system and the use of that system in volume production on-site;
•  expanding operational flexibility in research and manufacturing by reinforcing strategic alliances with world-class partners;
•  improving the reliability and uptime of our installed system base; and
•  providing re-marketing services that effectively increase residual value by extending the life of equipment.
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 higher speeds and 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, 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 integrated circuits. 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) wafers. In 2003, the TWINSCAN platform became the vehicle to introduce improved resolution products both for 300 millimeter and 200 millimeter wafer size factories. Our PAS 5500 product family, which supports a maximum wafer size of 200 millimeters in diameter, comprises advanced wafer steppers and Step & Scan systems suitable for i-line and deep UV (including 248 nm and 193 nm wavelengths) processing of wafers. In the third quarter of 2006, we shipped our 500th TWINSCAN system, demonstrating the acceptance of the TWINSCAN platform as the semiconductor industry’s standard for 300-millimeter lithography. In 2006 we gained 7 new customers with orders for 200 and 300 millimeter systems.
In 2005, we intensified our research and development on immersion lithography as we believed this was the most probable solution to lower the manufacturing cost per wafer while increasing resolution. In 2006 we shipped an additional 23 immersion systems bringing the total of immersion systems shipped at 36.
In 2006, we reached a milestone in our EUV program. EUV combines a wavelength of 13.5 nm and a lens system with an initial numerical aperture (“NA”) of 0.25 to provide imaging at a resolution of 40 nm. EUV will provide a large process window compared to today’s approaches and we expect it to be a multi-generation lithography solution. In the third quarter of 2006,
ASML ANNUAL REPORT 2006
13


Table of Contents

ASML shipped the industry’s first EUV Alpha Demo Tools to research and development institutions located in Albany, New York (United States of America) and Leuven (Belgium), where potential customers can conduct early research and development. The launch of systems for volume applications is planned for 2009.
We are also performing research and development 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 cost, which is becoming a dominant factor in bringing new semiconductor designs to market for advanced technology nodes. Designs resulting in small quantities of wafers produced, designs with many changes or designs that require a fast time-to-market will particularly benefit from this 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 for the semiconductor industry and related technologies. Our product development strategy focuses on the development of product families based on a modular, upgradeable design.
Our older PAS 2500 and PAS 5000 systems, which we no longer manufacture but refurbish, are used for g-line and i-line processing of wafers up to 150 millimeters (“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 beyond 45 nm.
For processing of 200 mm wafers using step-and-scan technology, the PAS 5500 series is the most suitable product range. 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 200 mm high end applications we also offer TWINSCAN ArF tools.
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. 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.
In July 2005, we announced the TWINSCAN XT:1700i, a 193-nm immersion scanner capable of imaging at the 45-nm node in volume production environments. This new system has an NA of 1.2, which is substantially higher than the XT:1400 with an NA of 0.93, exceeding the previously perceived, pre-immersion barrier of 1.0. We started volume production of this system in the second quarter of 2006. The XT:1700i allows chipmakers to improve resolution by 30 percent. We believe this new system increases the value of each wafer since better resolution will likely result in more chips being produced per wafer or more functionality per chip. Additionally, we believe the XT:1700i has the highest throughput currently available, 122 wafers per hour, for the 45-nm node.
In July 2006, we announced plans to introduce a next generation immersion system the XT:1900i which set a new industry benchmark of 1.35 NA, which we believe is close to the practical limit for water-based immersion technology. This new system extends optical lithography for volume production to 40 nm and below. ASML expects to begin shipping the XT:1900i by mid 2007.
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.
ASML ANNUAL REPORT 2006
14


Table of Contents

Current ASML Lithography product portfolio of Steppers and Step & Scan Systems1
                             
 
Res.2   365 nm (i-line)   Res.2   248 nm (KrF)   Res.2   193 nm (ArF)   Res.2   193 nm (ArFi)
 
700
  PAS 5500/22   150   PAS 5500/350   100   PAS 5500/1100 and AT:1100    45   XT:1700i
350
  PAS 5500/125 and XT:400   130   PAS 5500/750    90   PAS 5500/1150 and AT:1150    40   XT:1900i
280
  PAS 5500/275   130   AT:750 and XT:760    80   AT:1200        
280
  PAS 5500/400   120   PAS 5500/800    70   XT:1250        
280
  AT:400   110   PAS 5500/850 and AT:850    65   XT:1400 and XT:1450        
220
  PAS 5500/450 and XT:450   100   XT:860                
         90   XT:875                
 
This table does not include the older products sold on the PAS 2500 and PAS 5000 platforms
Resolution (“Res.”) refers to the size of line width in nanometers
 
–  PAS 5500/22/125/250/350 are Stepper systems for wafer sizes of up to 200 mm
–  PAS 5500/400 and up are Step & Scan systems for wafer sizes of up to 200 mm
–  AT and XT are TWINSCAN systems for wafer sizes of up to 200 and 300 mm
–  “i” denotes a system using immersion technology
–  Wavelength refers to the length of light going through projection lens; the shorter the wavelength, the smaller the line width and the finer the pattern on the IC
–  1 nanometer is equal to one billionth of a meter
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 based throughout the United States, Europe and Asia.
ASML is currently in the process of establishing 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.
Customers and Geographic Markets
In 2006, sales to one customer accounted for EUR 730 million, or 20 percent of net sales, compared to EUR 609 million, or 24 percent of net sales, in 2005. 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 16 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 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. 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:
•  maintaining long-term relationships with our suppliers;
•  sharing risks and rewards with our suppliers;
•  dual sourcing of knowledge, globally, together with our suppliers; and
•  single, dual or multiple sourcing of products, where possible or required.
ASML ANNUAL REPORT 2006
15


Table of Contents

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. Total purchased value from Zeiss accounted for between 20 percent and 50 percent of our cost of goods sold, depending on product type. In 2006 approximately 34 percent of our aggregate cost of goods sold was purchased from Zeiss.
Zeiss currently is capable of manufacturing a limited number of lenses and optical components for our stepper and scanner systems and is highly dependent on its manufacturing and testing facilities in Oberkochen and Wetzlar, Germany, and its suppliers. 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 2006, 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. During 2006, we were in some cases constrained by the number of excimer laser illumination systems that we could obtain from Cymer.
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. To meet this ongoing requirement, 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 and the United States of America 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 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 414 million on research and development in continuing operations in 2006, compared to EUR 348 million in 2005 and EUR 353 million in 2004 (including a charge of EUR 49 million with respect to a cross-license agreement entered into between ASML and Nikon). 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 2006, our research and development efforts propelled further development of the TWINSCAN platform along with several leading edge technologies, including 248 nm, 193 nm, immersion and EUV. These efforts enabled us to ship the first EUV system to research and development institutions in 2006, a milestone achievement. 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 2006 have also led to productivity and performance enhancements for our other product families. Moreover, we have continued our research into the feasibility of maskless technology and started
ASML ANNUAL REPORT 2006
16


Table of Contents

research on extension of ArF immersion with higher index fluid and optical materials. 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. In 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 appropriate licensing 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 intended. Also, competitors may be able to develop or protect similar technology earlier and independently.
Litigation may be necessary in order 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 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 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 (approximately EUR 49 million) in 2004, further made payments of US$ 9 million (approximately EUR 8 million) in both 2005 and 2006, and is obligated to make an additional payment to Nikon of US$ 9 million in 2007. Zeiss made an initial payment to Nikon of US$ 40 million (approximately EUR 32 million) in 2004, further made required payments of US$ 6 million (approximately EUR 4 million) in both 2005 and 2006, and is required to make an additional payment to Nikon of US$ 6 million in 2007. See Item 18 “Financial Statements” for a description of the accounting treatment and Item 10.C. “Material Contracts” for a summary of the ASML-Nikon patent Cross-License Agreement and the ASML-Zeiss Sublicense Agreement.
Patent litigation with Ultratech Stepper, Inc
In May 2000, Ultratech Stepper, Inc. (“Ultratech”) filed a lawsuit against ASML. Ultratech alleges that ASML is infringing 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 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 the asserted claims of its patent 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 the asserted claims of Ultratech’s patent are invalid. Briefing is ongoing in connection with this appeal, and no hearing date has been set yet. In the event the appeals court overturns the jury’s finding that the asserted claims of Ultratech’s patent are invalid and ASML is held to infringe any valid claims of Ultratech’s patent, it could result in a substantial damages award and an injunction that could substantially restrict or prohibit ASML’s sales in the United States, either of which could have a material adverse effect on the Company’s financial position and results of operations.
Arbitration with Aviza Technology
On December 1, 2006, Aviza Technology (“Aviza”) initiated arbitration proceedings against ASML Holding N.V., ASML U.S., Inc. and various other 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 was assigned to Aviza in connection with the 2003 divestiture of ASML’s Thermal Division.
ASML ANNUAL REPORT 2006
17


Table of Contents

We believe that there are meritorious defenses to Aviza’s allegations, and we intend to vigorously defend ourself in the arbitration proceeding, and accordingly, that the outcome of the proceeding will not have a material adverse effect on our financial position or results of operations. However, there can be no assurance that ASML will prevail, given the inherently uncertain nature of arbitration proceedings. If Aviza were to prevail, it could result in a substantial damages award and have a material adverse effect on our financial position and results of operations.
Competition
The semiconductor equipment industry is highly competitive. The principal elements of competition in our markets 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 for photolithography systems and the investments required to be a significant competitor in this market 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.
Share Purchase Agreement Brion Technologies, Inc.
On December 19, 2006 we announced the intended acquisition of 100 percent of the outstanding shares of Brion Technologies, Inc. (“Brion”). Subject to approval by regulatory authorities, closing is expected in the first quarter of 2007. Pursuant to the sale and purchase agreement, Brion shareholders will receive total consideration of USD 270 million (approximately EUR 203 million) in cash.
Brion was incorporated in 2002 and is a leader in the field of computational lithography which encompasses design verification, reticle enhancement technologies and optical proximity correction. Brion designs, develops and markets computational lithography technology enabling semiconductor manufacturers to simulate the realized pattern of integrated circuits and to correct the mask pattern that could compromise the manufacturing process and reduce yield. The software technology behind its products is a hardware accelerated, image-based data and simulation engine which has been designed for the tasks of lithography modeling and database handling.
Brion’s largest customers are principally semiconductor manufacturers in Asia, Europe and North America. Brion currently employs approximately 130 employees worldwide which are mainly located in the United States and China.
Brion has its headquarter in Santa Clara, California (United States) with subsidiaries in Cayman Islands, Japan and China.
C. Organizational Structure
ASML Holding N.V. is a holding company that operates through its subsidiaries. Our major operating subsidiaries, each of which is a direct wholly-owned subsidiary, are as follows:
(CHART)
See Exhibit 8.1 for a list of our material subsidiaries.
ASML ANNUAL REPORT 2006
18


Table of Contents

D. Property, Plants and Equipment
We principally obtain and operate our facilities under operating leases. However, we also own a limited number of buildings. The book value of the buildings used in our continuing operations and owned by us amounted to EUR 59 million as of December 31, 2006 compared to EUR 76 million as of December 31, 2005.
In support of our expected growth, we plan to invest an additional EUR 150 million in capital expenditures in 2007 to expand our capacity worldwide, bringing the total amount of planned capital expenditures for the year to EUR 250 million. A substantial part of these expenditures is allocated to expanding our facilities in Veldhoven, the Netherlands with 6,000 square meters of clean room and office space. This expansion will offer the extra space and facilities necessary to accommodate our current production levels as well as support continued growth in the long term. The completion of the additional clean room facilities and central utilities is expected before the end of 2007; whereas, the complete building (including office space) is expected to be completed in the first half of 2008. 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 9 to our consolidated financial statements.
During 2006 our facilities were generally utilized above normal capacity.
Facilities in Europe
Our headquarters, applications laboratory and research and development facilities are located in a 120,000 square meter state-of-the-art facility in the Netherlands, of which 65,000 square meters is used as office space and 55,000 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 12 to our consolidated financial statements. We also lease several sales and service locations across Europe.
Facilities in the United States
We maintain lithography research, development and manufacturing operations in a 27,142 square meter facility in Wilton, Connecticut. Our American headquarters and American training facilities are located in two buildings, comprising an 8,840 square meter office building space and a 10,485 square meter training space in Tempe, Arizona. We also lease several sales and service locations across the United States.
Facilities in Asia
Our Asian headquarters are located in a 250 square meter office space in Hong Kong. We also lease and own several sales and service/training locations across Asia.
Item 4A Unresolved Staff Comments
Not applicable.
Item 5 Operating and Financial Review and Prospects
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 2006, we generated net sales of EUR 3,597 million and income from operations of EUR 871 million or 24.2 percent of net sales. Net income in 2006 amounted to EUR 625 million or 17.4 percent of net sales, representing EUR 1.32 per share.
We employed approximately 5,600 employees and operated in 14 countries through over 60 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.
ASML ANNUAL REPORT 2006
19


Table of Contents

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 imprint complex circuit patterns onto silicon wafers, which are the primary raw materials for ICs. The imprinting 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 61 percent in 2006 up from 57 percent in 2005 according to the latest available data up to and including November 2006 as reported by SEMI, an independent semiconductor industry organization.
Nikon and Canon are the dominant suppliers in the Japanese market-segment, which accounts for a significant portion of worldwide semiconductor production. This market-segment 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 2006, we further strengthened our long term market development strategy in Japan. Our customer base there grew from 6 customers in 2005 to 8 customers in 2006. In 2006, 7 percent of our net system sales was generated by Japanese customers.
Total lithography equipment shipped by the industry as a whole in the five years ended December 31, 2005 is set forth in the following table:
                     
 
Year ended December 31   2001   2002   2003   2004   2005
 
Total units shipped
  789   413   456   694   536
Total value (in millions USD)
  3,792   2,817   3,229   5,268   4,988
 
(Source: Gartner Dataquest)
In 2006, the semiconductor industry experienced significant growth, as it had in 2005, due to significant growth in semiconductor unit demand among other things resulting in a strong capacity build-up by our customers, especially in flash memory. During this period, our customers increased both high-volume production and leading-edge for respectively 65nm and 45nm IC manufacturing.
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.
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, 16 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 2006, 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 fourth year in a row.
We plan to expand our market share by increasing our investments in Japan, which is a market that historically has been dominated by our competitors. In 2006, we continued our long-term market development strategy in Japan, and we now have eight customers there.
ASML ANNUAL REPORT 2006
20


Table of Contents

We also intend to expand our business scope as ASML pursues hardware technologies and new product opportunities in fields adjacent to and complementary with our core semiconductor lithography competence.
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-millimeter wafers.
Supported by our financial performance, research and development expenses in 2006 increased by 19 percent compared with 2005, 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 the industry’s only dual-stage wafer imaging platform — the TWINSCANtm system — which allows exposure of one wafer while simultaneously measuring the wafer that will be exposed next. This unique capability translates into the industry’s highest throughput, enabling reduced cost-per-exposure per wafer. In the third quarter of 2006, we shipped our 500th TWINSCAN system, demonstrating the acceptance of the TWINSCAN platform as the semiconductor industry’s standard for 300 mm lithography.
In 2006, we expanded our immersion product suite by introducing the industry’s most advanced lithography system, the ASML TWINSCAN XT:1900i. Our innovative immersion lithography replaces the air over the wafer with fluid, enhancing focus and enabling circuit line-width to shrink to even smaller dimensions. The new XT:1900i system extends optical lithography for volume production to 40nm and below. Since the fourth quarter of 2004, we have shipped 36 immersion systems to customers in three continents, marking our continued immersion technological leadership.
In December 2006, we announced ASML’s newest TWINSCAN system, the XT:1450, an advanced 193-nm exposure tool targeted for high volume manufacturing that extends dry 193-nm technology to sub-60-nm. It can also be used by customers to support development of 32-nm node processes using double patterning techniques. Double patterning represents a bridge between current lithography technology and next generation extreme ultra violet (EUV) technology.
In parallel, we are developing EUV technology. In the third quarter of 2006, we shipped the industry’s first EUV Alpha Demo Tools to research and development institutions located in Albany, New York (United States) and Leuven (Belgium) where potential customers can conduct early stage research and development.
Operational excellence
We strive to sustain our business success based on our technological leadership by continuing to execute well on our fundamental operating strategy, including reduction 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 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.
We strive to improve efficiencies in our own operations on an ongoing basis: 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.
In the first quarter of 2006, we expanded our capability to manufacture lithography systems in Veldhoven, the Netherlands, by introducing a flexible labor model. It 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 in manufacturing facilities located in Veldhoven, we can shorten lead time: a key driver of added value for customers. It also reduces our working capital requirements.
ASML ANNUAL REPORT 2006
21


Table of Contents

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.
                                                 
 
Year ended December 31    
(in millions, except market   2004       2005       2006    
share and systems)   EUR       EUR       EUR    
 
Growth
                                               
Market share (based on revenue)
    53%               57%               61%3          
Net sales
    2,465               2,529               3,597          
Systems shipped (value)
    2,175               2,228               3,229          
Systems shipped (number)
    282               196               266          
Average selling price
    7.7               11.4               12.1          
Systems backlog (value)
    1,691               1,434               2,146          
Systems backlog (number)
    131               95               163          
Average selling price
    12.9               15.1               13.2          
Technical achievement:
                                               
Immersion systems shipped
    3               10               23          
 
Profitability
                                               
Gross profit
    906       36.7%       974       38.5%       1,462       40.6%  
Income from operations1
    379       15.4%       449       17.8%       871       24.2%  
Net income (loss)1
    235       9.6%       311       12.3%       625       17.4%  
 
Liquidity
                                               
Cash and cash equivalents
    1,228               1,905               1,656          
Net cash2
    425               1,037               1,276          
Operating cash flow
    251               711               478          
 
In 2004 ASML, Nikon Corporation and Carl Zeiss SMT AG agreed to a comprehensive settlement of legal proceedings and cross-license of patents related to lithography equipment. This agreement had the following effects on ASML’s results for the twelve months ended December 31, 2004 (i) an increase of EUR 49 million in our Research and Development costs and consequently a decrease in income from operations; (ii) a decrease of EUR 33 million in net income.
Net cash is calculated as the difference between cash and cash equivalents and convertible subordinated notes. Balances of the convertible subordinated notes as of December 31, 2004, 2005 and 2006 are EUR 802.8 million, EUR 867.7 million and EUR 380 million respectively.
According to the latest available data up to and including November 2006 as reported by SEMI, an independent semiconductor industry organization.
Growth
We strive 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.
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 mainly resulting from an increased demand for lithography equipment in 2006 by 34 percent (2005: -3 percent), which was ultimately driven by an increased demand for semiconductors in 2006 by 9 percent (2005: 9 percent). In addition we achieved market share growth from 57 percent in 2005 to 61 percent in 2006 (according to the latest available data up to and including November 2006 as reported by SEMI, an independent semiconductor industry organization) as a result of our sustained technological leadership.
The average selling price of our systems increased by 6.1 percent from EUR 11.4 million in 2005 to EUR 12.1 million in 2006. This increase was mainly driven by a change in the 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.
As of December 31, 2006, our order backlog was valued at EUR 2,146 million and included 163 systems with an ASP of EUR 13.2 million. As of December 31, 2005 the order backlog was valued at EUR 1,434 million, which included 95 systems with an ASP of EUR 15.1 Million. The decrease in ASP of 14 percent was mainly due to a high number of I-line and KrF systems in the backlog of 2006 pursuant to the shift from leading edge investments in 2005 to both capacity and leading edge investments in 2006 by our customers.
Profitability
We strive to achieve an average income from operations to sales of 15 percent over the industry’s business cycle with 5-10 percent at the downturn point and 20-25 percent at the upturn point.
ASML ANNUAL REPORT 2006
22


Table of Contents

Operating income grew by 94.0 percent from EUR 449 million or 17.8 percent of sales in 2005 to 871 million or 24.2 percent of sales in 2006. This EUR 422 million growth was substantially the result of the increase of gross profit of EUR 488 million or 50.1 percent which was partially offset by an increase in operating expenses of EUR 67 million or 12.6 percent.
Gross profit increased compared to 2005, showing a growth of 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 higher gross profit was principally attributable to an increased market demand for lithography equipment with higher ASPs, decreased product costs resulting from our continuous cost of goods reduction programs and increased manufacturing volumes and related absorption partially offset by a change in product mix.
Operating expenses were EUR 67 million higher in 2006 compared to 2005 due to an increase of both R&D expenses by 63 million and SG&A expenses by EUR 4 million. The increase in R&D expenses by EUR 63 million or 19.4 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 also Item 4.B “Business Overview” and Item 5 “Operating and Financial Review and Prospects, Business Strategy”.
Net income in 2006 amounted to EUR 625 million, representing EUR 1.32 per share compared with net income of EUR 311 million or EUR 0.64 per share in 2005.
Liquidity
We strive to maintain our strategic target level of EUR 1 billion in net cash, which is comprised of total cash and cash equivalents minus convertible subordinated bonds. To the extent that our net cash exceeds EUR 1 billion and there are no alternative investment opportunities, we intend to return excess cash to our shareholders. As of December 31, 2006 our net cash amounted to EUR 1.3 billion.
Our net cash decreased from EUR 1,905 million as of December 31, 2005 to EUR 1,656 million as of December 31, 2006. We generated cash from operations of EUR 478 million in 2006 offset by a negative cash flow of EUR 648 million from financing activities mainly as result of our 2006 share buy back programs (EUR 678 million) and EUR 66 million cash used in investing activities mainly related to production facilities, equipment and information technology.
A. Operating Results
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, restructuring, 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.
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, 2006 and 2005 we had no deferred revenue from shipments of new technology. During the three years ended December 31, 2006, no revenue from new technology
ASML ANNUAL REPORT 2006
23


Table of Contents

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 and prepaid service 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 is recognized over the term of the contract.
The deferred revenue balance from installation and training services amounted to approximately EUR 13 million and EUR 27 million, respectively, at December 31, 2006. The deferred revenue balance from prepaid service contracts amounted to approximately EUR 121 million as of December 31, 2006.
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. These discounts do not relate to future purchases or trade-ins with the exception of volume discounts. 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. 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 or discounted products or services in connection with a current revenue transaction, 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.
Warranty
We provide standard warranty coverage on our systems for 12 months, providing labor and parts necessary to repair systems 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.
Evaluation of long-lived assets for impairment and costs associated with exit or disposal activities
We evaluate our long-lived assets, including intellectual property, for impairment whenever events or changes in circumstances indicate that the carrying amount of those assets may not be recoverable. If an impairment test is warranted, we assess whether the undiscounted cash flows expected to be generated by our long-lived assets exceed their carrying value. If this assessment indicates that the long-lived assets are impaired, the assets are written down to their fair value. These assessments are based on our judgment, which includes the estimate of future cash flows from long-lived assets and the estimate of the fair value of an asset if it is impaired. In determining impairments of long-lived assets, we must make judgments and estimates to determine whether the cash flows generated by those assets are less than their carrying value. These estimates are based on financial plans updated with the latest available projections of the semiconductor market evolution, our sales expectations and our costs evaluation, and are consistent with the plans and estimates that we use to manage our business. It is possible, however, that the outcome of the plans and estimates used may differ, and future adverse changes in market conditions, may require impairment of certain long-lived assets.
During 2006 we recorded impairment charges of EUR 17.4 million of which we recorded EUR 14.1 million in cost of sales, EUR 2.0 million in research and development expenses and EUR 1.3 million in selling, general and administrative costs. The impairment charges recorded in 2006 mainly relate to buildings and construction (EUR 10.2 million) and machinery and equipment (EUR 7.1 million). The impairment charges with respect to buildings and construction mainly relate to a subleased building in Japan for which there are insufficient cash flows to support its carrying amount, mainly as a result of a drop in rental income. This drop is caused by a cancellation of one of the subleases and unfavorable real estate market conditions at the location of our Japan building. The impairment was determined based on the difference between the building’s estimated fair value 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 meet the today’s technology requirements. The impairment charges were determined based on the difference between the assets’ estimated fair value and their carrying amount.
See Notes 2, 3 and 9 to our consolidated financial statements.
ASML ANNUAL REPORT 2006
24


Table of Contents

Inventories
Inventories are stated at the lower of cost (first-in, first-out method) or market value. Cost includes 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 collectibility 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 a customer that presents a credit risk. 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 35 percent of accounts receivable at December 31, 2006, compared to 49 percent at December 31, 2005. 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 19 to our consolidated financial statements.
Restructuring
We apply the criteria defined in SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” and SFAS No. 112, “Employers’ Accounting for Postemployment Benefits,” in order to determine when a liability for restructuring or exit costs should be recognized.
With respect to employee termination costs, we apply SFAS No. 146 in the case of benefit arrangements that, in substance, do not constitute an ongoing benefit arrangement. We apply SFAS No. 112 for termination benefits that are provided under an ongoing benefit arrangement. SFAS No. 146 provides that a liability for a cost associated with an exit or disposal activity that does not constitute an ongoing benefit arrangement shall be recognized and measured initially at its fair value in the period in which the liability is incurred; that is when a detailed exit or disposal plan exists, has been committed to by management and has been communicated to the employees. SFAS No. 112 provides that a liability for termination benefits provided under an ongoing benefit arrangement covered by SFAS No. 112 shall be recognized when the likelihood of future settlement is probable and can be reasonably estimated. As a result, whether an employee termination plan constitutes an ongoing benefit arrangement or not, and accordingly, whether SFAS No. 146 or SFAS No. 112 is applied, will affect the timing of recognition of employee termination costs, as well as the amounts recognized. In 2003, we announced workforce reductions of approximately 550 positions worldwide due to the continuing downturn in the semiconductor equipment industry. During 2003, we recorded a provision of EUR 15.3 million as an ongoing benefit arrangement. The amount of the provision was based upon severance arrangements agreed with our Works Council in the Netherlands for the previous workforce reductions announced in December 2002. Our Board of Management and our Works Council then commenced a joint study on implementing these workforce reductions in the Netherlands, which delayed the workforce reductions until the beginning of 2004. Thereafter, in response to a sharp improvement in market conditions during 2004, we decreased the reductions to approximately 300 positions worldwide, of which 150 were contract employees with limited rights upon termination. As a result, in 2004 we recorded a restructuring credit of EUR 12.1 million, EUR 3.8 million of which was recorded in cost of sales and EUR 8.3 million of which was recorded under restructuring expenses.
Other exit costs include purchase and other commitments to be settled or fulfilled. These costs are estimated based on expected settlement fees and committed payments, taking into account future potential benefits, if any, from those commitments. We apply the criteria defined in SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” and SFAS No. 112, “Employers’ Accounting for Postemployment Benefits,” in order to determine when a liability for restructuring or exit costs should be recognized.
Contingencies and litigation
We are party to various legal proceedings generally incidental to our business, as disclosed in Note 14 to the consolidated statements. In connection with these proceedings and claims, our management evaluated, based on the relevant facts and legal
ASML ANNUAL REPORT 2006
25


Table of Contents

principles, the likelihood of an unfavorable outcome and whether the amount of the loss could be reasonably estimated. In each case, management determined that either a loss was not probable or was not reasonably estimable. As a result, no estimated losses were recorded as a charge to our statement of operations in 2004, 2005 and 2006. 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, we may agree to settle or to terminate a claim or proceeding in which it believes it would ultimately prevail 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 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. See Item 10.C. “Material Contracts” for a summary of the Nikon-ASML Cross License Agreement and the ASML/ Zeiss Sublicense Agreement and Item 18 “Financial Statements”.
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
On January 1, 2006, we implemented the provisions of SFAS No. 123(R), “Share-Based Payment”, using the modified prospective transition method. SFAS No.123(R) requires companies to recognize the cost of employee services received (compensation expenses) in exchange for awards of equity instruments based upon the grant-date fair value of those instruments. The grant-date fair value of these instruments was estimated using a Black-Scholes option valuation model. This Black-Scholes pricing model requires the use of assumptions, including 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. Our income before income taxes and net income was negatively impacted with EUR 8.8 million and EUR 7.4 million respectively due to the adoption of SFAS No. 123(R).
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, compensation expenses for the portion of equity-based awards for which the requisite service has not been rendered and that are outstanding as of January 1, 2006 are also recognized as the requisite service is rendered on or after that date. Compensation expenses are then amortized on a straight-line basis over the requisite service period of the awards, which is generally the vesting period. The total gross amount of recognized expenses associated with share based payments was EUR 9.7 million in 2006.
Under the modified prospective transition method, no restatement of prior interim periods and fiscal years has been made. 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 not below the fair market price of the underlying common stock on the grant date, no compensation expenses were recognized in the consolidated statements of operations.
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 is 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. Since January 1, 2006 we are adopting implied volatility of our actively-traded options for new issued stock options as one of the assumptions in the Black-Scholes pricing model. As the semiconductor industry is becoming more mature, resulting in a decreasing cyclicality, we believe that implied volatility is currently a better assumption for the valuation model than historical volatility.
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 to our consolidated financial statements.
Income tax
We operate in various tax jurisdictions in the United States, Europe and Asia and must comply with the tax laws of each of these jurisdictions.
ASML ANNUAL REPORT 2006
26


Table of Contents

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 assess our ability to realize our deferred tax assets resulting from net operating loss carry-forwards on an ongoing basis. The total amount of loss carry-forwards as of December 31, 2006 was EUR 276 million, which resides completely with ASML US, Inc. We believe that it is more likely than not 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 affected 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 is expected to result in additional income to ASML US, Inc., which we believe, together with projected future taxable income from operations, will, more likely than not, 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 this asset transfer, in 2002 we requested a bilateral advance pricing agreement (“APA”) from the United States and Netherlands tax authorities. Since December 2002, management has held numerous meetings with representatives of those authorities. The most recent meetings with the United States and Netherlands tax authorities took place in June and July 2006. Based on these meetings, and feedback from both authorities, we are confident that our APA request will be successful. The specific timing for completion of the APA however remains in the control of those tax authorities. See Note 15 to our consolidated financial statements.
The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws. Our estimate for the potential outcome of any uncertain tax issue is highly judgmental. However, we believe that we have adequately reserved for tax contingencies. Settlement of these uncertainties in a manner inconsistent with our expectations could have a material impact on our results of operations, financial condition and cash flows. We account for the income tax contingencies in accordance with SFAS No. 5, “Accounting for Contingencies”. The tax contingencies mainly relate to transfer pricing positions, operational activities in countries where we are not tax registered and tax deductible costs. We provide for these tax contingencies for the duration of the statue of limitation which differs per tax jurisdiction and generally ranges up to 7 years. As of December 31, 2006 the tax contingencies amount to EUR 130.7 million (December 31, 2005: EUR 127.9 million) and are included in Deferred tax and other liabilities on the consolidated balance sheets.
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, 2006 (in thousands):
                         
 
Year ended December 31   2004   2005   2006
(in millions)   EUR   EUR   EUR
 
Total net sales
    2,465       2,529       3,597  
Cost of sales
    1,559 1     1,555       2,135  
Gross profit on sales
    906       974       1,462  
Research and development costs
    353 2     348       414  
Research and development credits
    (22 )     (24 )     (28 )
Selling, general and administrative costs
    202       201       205  
Restructuring (credits)
    (6 )     0       0  
Income from operations
    379       449       871  
Interest expense, net
    16       14       1  
Income from operations before income taxes
    363       435       870  
Provision for income taxes
    128       124       245  
Net income
    235 2     311       625  
 
Includes reversal of restructuring charges of EUR 3 million.
In 2004, ASML, Nikon Corporation and Carl Zeiss SMT AG agreed to a comprehensive settlement of legal proceedings and cross-license of patents related to lithography equipment. This agreement had the following effects on ASML’s results for the year ended December 31, 2004 (i) an increase of EUR 49 million in our Research and Development costs and consequently a decrease in income from operations and (ii) a decrease of EUR 33 million in net income.
ASML ANNUAL REPORT 2006
27


Table of Contents

Set forth below are our consolidated statements of operations from continuing operations data for the three years ended December 31, 2006, expressed as a percentage of our total net sales:
                         
 
Year ended December 31   2004   2005   2006
 
Total net sales
    100.0 %     100.0 %     100.0 %
Cost of sales
    63.3 1     61.5       59.4  
Gross profit on sales
    36.7       38.5       40.6  
Research and development costs
    14.3 2     13.8       11.5  
Research and development credits
    (0.9 )     (1.0 )     (0.8 )
Selling, general and administrative costs
    8.1       8.0       5.7  
Restructuring credits
    (0.2 )     0.0       0.0  
Income from operations
    15.4       17.8       24.2  
Interest expense, net
    0.7       0.6       0.0  
Income from operations before income taxes
    14.7       17.2       24.2  
Provision for income taxes
    5.2       4.9       6.8  
Net income
    9.6 2     12.3       17.4  
 
Includes reversal of restructuring charges of 0.1 percent.
In 2004, ASML, Nikon Corporation and Carl Zeiss SMT AG agreed to a comprehensive settlement of legal proceedings and cross-license of patents related to lithography equipment. This agreement had the following effects on ASML’s results for year ended December 31, 2004 expressed as a percentage of net sales (i) an increase of 2.0 percent in our Research and Development costs and consequently a decrease in income from operations; (ii) a decrease of 1.3 percent in net income.
Results of operations from continuing operations 2006 compared with 2005
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, 2006 and 2005.
                                                 
 
    2005       2006
    First   Second   Full   First   Second   Full
Year ended December 31   half year   half year   year   half year   half year   year
 
Net sales (EUR million)
    1,448       1,081       2,529       1,571       2,026       3,597  
Net system sales (EUR million)
    1,313       915       2,228       1,394       1,835       3,229  
Net service and field option sales (EUR million)
    135       166       301       177       191       368  
Total systems recognized
    110       86       196       123       143       266  
Total new systems recognized
    94       62       156       97       123       220  
Total used systems recognized
    16       24       40       26       20       46  
Gross profit on sales (% of sales)
    39.6       37.1       38.5       40.3       40.9       40.6  
ASP for systems (EUR million)
    11.9       10.6       11.4       11.3       12.8       12.1  
ASP for new systems (EUR million)
    13.5       13.6       13.5       13.6       14.3       14.0  
ASP for used systems (EUR million)
    2.8       2.9       2.9       2.8       3.7       3.2  
 
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.
ASML ANNUAL REPORT 2006
28


Table of Contents

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 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 are customers of ASML. In 2006, sales to one customer accounted for EUR 730 million, or 20 percent of our net sales. In 2005, sales to one customer accounted for EUR 609 million, or 24 percent of our net sales.
Gross profit increased compared to 2005, showing a growth of 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 goods (5.2 percent positive impact on gross profit) reflecting the results of our continuous cost of goods 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).
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. See also Item 5.D. “Trend Information.”
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 mask less 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 28 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.
ASML ANNUAL REPORT 2006
29


Table of Contents

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.
Results of operations from continuing operations 2005 compared with 2004
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, 2005 and 2004.
                                                 
 
    2004       2005    
    First   Second   Full   First   Second   Full
Year ended December 31   half year   half year   year   half year   half year   year
 
Net sales (EUR million)
    1,070       1,395       2,465       1,448       1,081       2,529  
Net system sales (EUR million)
    933       1,242       2,175       1,313       915       2,228  
Net service and field option sales (EUR million)
    137       153       290       135       166       301  
Total systems recognized
    130       152       282       110       86       196  
Total new systems recognized
    99       117       216       94       62       156  
Total used systems recognized
    31       35       66       16       24       40  
Gross profit on sales (% of sales)
    34.2       38.7       36.7       39.6       37.1       38.5  
ASP for systems (EUR million)
    7.2       8.2       7.7       11.9       10.6       11.4  
ASP for new systems (EUR million)
    8.7       9.8       9.3       13.5       13.6       13.5  
ASP for used systems (EUR million)
    2.3       2.9       2.6       2.8       2.9       2.9  
 
Consolidated net sales increased by 2.6 percent from EUR 2,465 million in 2004 to EUR 2,529 million in 2005. Net system sales increased by 2.4 percent from EUR 2,175 million in 2004 to EUR 2,228 million in 2005. Net service and field option sales increased by 3.8 percent from EUR 290 million to EUR 301 million in 2005. The 2.4 percent increase in net system sales was mainly driven by an increase in ASP partially offset by a decrease in the number of systems sold.
The ASP of systems recognized in net system sales in 2005 increased by 48.1 percent from EUR 7.7 million in 2004 to EUR 11.4 million in 2005. This increase in ASP was mainly driven by an increased share of 300 mm ArF TWINSCAN systems with higher ASPs and a decreased share of 200 mm KrF systems, reflecting a shift in market demand from manufacturing capacity in 2004 to leading edge technology in 2005.
The number of systems recognized in net system sales decreased from 282 systems in 2004 (216 new systems and 66 used systems) to 196 systems in 2005 (156 new systems and 40 used systems). The decrease in the number of systems shipped in 2005 reflected the large number of 200 mm systems shipped in 2004 that increased our customers’ manufacturing capacity and were not yet fully utilized. Demand in 2005 was mainly driven by leading edge technology.
The number of used systems sold in 2005 decreased to 40 from 66 in 2004. This decrease was driven by lower utilization of the lithography equipment in 2005 compared to 2004 which lowered to demand for capacity. The ASP for used systems increased from EUR 2.6 million in 2004 to EUR 2.9 million in 2005, reflecting a further shift from our older PAS 2500 towards our newer PAS 5500 family, including scanner systems.
Service sales showed a 3.8 percent increase from EUR 290 million in 2004 to EUR 301 million in 2005. This increase was mainly due to an increase in option sales to customers to enhance system performance.
Gross profit as a percentage of sales increased from 36.7 percent in 2004 to 38.5 percent in 2005. The increased gross profit was mainly driven by increased ASPs (2.4 percent positive impact on gross profit) and decreased cost of sales (1.6 percent positive impact on gross profit) reflecting the results of our continuous cost of sales reduction program. This increase in gross profit was offset by the change in 2005 product mix (2.0 percent negative impact on gross profit). Furthermore lower charges for obsolete inventory (0.5 percent positive impact on gross profit) and lower cost of freight (0.4 percent positive impact on gross profit), offset by the negative effect of currency exchange rate fluctuations (1.1 percent negative impact on gross profit) also contributed to the increase in gross margin.
We started 2005 with an order backlog of 131 systems (119 new and 12 used). In 2005, we booked orders for 178 systems and received order cancellations or push-outs beyond 12 months of 18 systems and recognized sales for 196 systems. This resulted in an order backlog of 95 systems (86 new and 9 used) as of December 31, 2005. The total value of our backlog as of
ASML ANNUAL REPORT 2006
30


Table of Contents

December 31, 2005 amounted to EUR 1.4 billion, compared with a backlog of approximately EUR 1.7 billion as of December 31, 2004.
Research and development
Research and development costs decreased from EUR 353 million in 2004 to EUR 348 million in 2005. This decrease in research and development costs is primarily due to a charge in 2004 of EUR 49 million with respect to a cross-license agreement entered into with Nikon (see Note 8 to our consolidated financial statements for more information). Excluding this one-time charge in 2004 there was an increase in research and development spending in 2005 of 15 percent intended to further accelerate our investment in technological leadership. Our primary investments in research and development in 2005 related to the newest versions of our high resolution TWINSCAN systems and our next generation TWINSCAN systems based on immersion and EUV.
Research and development credits increased from EUR 22 million in 2004 to EUR 24 million in 2005 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 remained stable on a level of approximately EUR 201 million for both 2004 and 2005. Selling, general and administrative costs as a percentage of net sales decreased from 8.2 percent in 2004 to 8.0 percent in 2005, primarily due to higher net sales.
Restructuring costs (credits)
Restructuring credits of EUR 6 million in 2004 are adjustments to the 2003 restructuring plans. In 2005 we did not record any restructuring expenses or credits.
Net interest expense
Net interest expense decreased from EUR 16 million in 2004 to EUR 14 million in 2005 due to an increase in interest income, partially offset by an increase in interest expense. Our interest income related primarily to interest earned on our cash and cash equivalents, which had higher balances in 2005 as a result of an increase in cash flows from operations. Our interest expense related primarily to our convertible subordinated notes.
Income taxes
Income taxes represented 28.4 percent of income before taxes in 2005, compared to 35.1 percent in 2004. The decrease in income taxes in 2005 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 FSP FAS 123R-4, “Classification of Options and Similar Instruments Issued as Employee Compensation That Allow for Cash Settlement Upon the Occurrence of a Contingent Event”. SFAS No. 123 (R) originally required liability classification for options or similar instruments if the entity can be required under any circumstances to settle the options or similar instruments by transferring cash or other assets. This FSP clarifies that equity classification is appropriate, if the occurrence of a contingent event that could require a cash settlement feature is not probable. If the contingent event is within the control of the employee, liability classification is required regardless of the probability. An option or similar instrument that is classified as equity, but subsequently becomes a liability because the contingent cash settlement event is considered probable, shall be accounted for similar to a modification from an equity to liability award. The guidance in this FSP shall be applied upon initial adoption of Statement 123 (R) on January 1, 2006. In 2006, the impact of this FSP was insignificant on our consolidated financial statements.
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 remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation. SFAS No. 155 has to be adopted for all financial instruments acquired, issued, or subject to a remeasurement (new basis) event occurring after the beginning of an entity’s first fiscal year that begins after September 15, 2006. We do not expect that the adoption of SFAS No. 155 will 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 uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109,
ASML ANNUAL REPORT 2006
31


Table of Contents

“Accounting for Income Taxes”. FIN 48 prescribes a two step approach for recognizing and measuring tax positions taken or expected to be taken in tax return(s). Prior to recognizing the benefit of a tax position in the financial statements, the tax position must be more-likely-than-not to be sustained based solely on its technical merits. Once this recognition threshold has been met, tax positions are recognized at the largest amount that is more-likely-than-not to be sustained. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 will be effective for fiscal years beginning after December 15, 2006. Any differences between the amounts recognized in the financial statements prior to the adoption of FIN 48 and the amounts reported after adoption will be accounted for as a cumulative-effect adjustment recorded to the beginning balance of retained earnings. We are currently in the process of determining the impact of adopting the provisions of Interpretation 48 on our consolidated financial statements.
In June 2006, the FASB ratified the consensus reached by the 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 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 will be effective for interim and annual financial statements issued for periods beginning after December 15, 2006. We believe that the adoption of EITF No. 06-03 will have no material impact on our consolidated financial statements.
The SEC issued Staff Accounting Bulletin No. 108 (“SAB 108”) regarding the process of quantifying financial statement misstatements on September 13, 2006. SAB 108 states that registrants should use both a balance sheet (iron curtain) approach and an income statement (rollover) approach when quantifying and evaluating the materiality of a (prior year) misstatement. The bulletin furthermore contains guidance on correcting errors. The bulletin is effective for financial statements for fiscal years ending after November 15, 2006. We adopted SAB 108 in 2006. SAB 108 did not have a material impact on our (previous) consolidated financial statements.
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 the Statement is initially applied. We do not believe that the adoption of SFAS No. 157 will have a material impact on our consolidated financial statements.
B. Liquidity and Capital Resources
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.”
Our balance of cash and cash equivalents amounted to EUR 1,905 million and EUR 1,656 million as of December 31, 2005 and 2006, respectively.
We generated cash from operating activities of EUR 711 million and EUR 478 million for 2005 and 2006, respectively. The primary components of cash provided by operating activities in 2006 were net income (EUR 625 million) plus non-cash expenses including unpaid taxes (EUR 189 million) mainly related to depreciation, impairment charges and inventory obsolescence partially offset by a cash outflow of EUR 337 million due to investments in working capital. The investments in working capital mainly relate to higher accounts receivable of EUR 362 million, higher inventories of EUR 85 million, partly offset by higher accrued liabilities of EUR 154 million.
We used EUR 61 million for investing activities in 2005 and EUR 66 million in 2006. The majority of the 2005 and 2006 expenditures was spent on machinery and equipment and information technology investments.
Net cash used by financing activities was EUR 648 million in 2006 compared to a cash inflow of EUR 3 million in 2005. Cash used for share buyback programs (including the costs of call options bought on own shares) was approximately EUR 678 million in 2006. See also Item 16.E “Purchases of Equity Securities by the Issuer and Affiliated Purchasers”. In addition, proceeds from financing activities included EUR 38 million with respect to proceeds from the exercise of stock options in 2006.
Our principal sources of liquidity consist of EUR 1,656 million of cash and cash equivalents as of December 31, 2006, EUR 400 million of available credit facilities as of December 31, 2006 and cash flows from operations. For further details of our credit facilities, see Note 11 to our consolidated financial statements. In addition to cash and available credit facilities, we may from time to time 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 which relate to the uncertainties of global
ASML ANNUAL REPORT 2006
32


Table of Contents

economies and the semiconductor industries. Although our cash requirements will 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 to steadily improve our cash conversion cycle during 2007 although we expect substantial cash outflow from operations due to income taxes and from investing activities due to our intended acquisition of Brion and other capital expenditures. We expect an increase in cash outflow in 2007 with respect to income taxes as our tax losses carried forward in the Netherlands were substantially utilized at the end of 2006. In addition, we intend to acquire 100 percent of the outstanding shares of Brion subject to approval by regulatory authorities, for a total consideration of USD 270 million (approximately EUR 203 million) in cash. Other capital expenditures in 2007 are expected to be approximately EUR 250 million, up EUR 150 million above the level in 2006. A significant part of the additional 2007 capital expenditures will be allocated to construction and upgrades of production facilities in the Netherlands. See also Item 4.D.“Property, Plants and Equipment”.
We intend to execute a program to buy back the remaining 1.7 percent of a maximum of 10 percent of outstanding ordinary shares as authorized by the Annual General Meeting of Shareholders on March 23, 2006. These shares will either be used to cover outstanding stock options or be cancelled.
We reiterate our commitment to return excess cash to our shareholders by reducing the number of shares outstanding: we will prepare for additional potential share buyback programs to be executed, subject to authorization by the Annual General Meeting of Shareholders on March 28, 2007.
We have repayment obligations in 2010, amounting to EUR 380 million, on our 5.50 percent Convertible Subordinated Notes due 2010 issued in May 2003, assuming no conversions occur. These notes are convertible into an aggregate of 26,573,426 ordinary shares at a conversion price of EUR 14.30 per share at any time prior to maturity. We currently intend to fund any future repayment obligations under our convertible notes primarily with cash on hand and cash generated through operations. A description of our convertible notes, lines of credit and borrowing arrangements is provided in Note 11 to our consolidated financial statements. See also Item 3.D. “Risk Factors.”
Our contractual obligations and commercial commitments are disclosed in further detail in Item 5.F. “Tabular Disclosure of Contractual Obligations” and Note 12 to our consolidated financial statements.
See Notes 4 and 11 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 and other borrowing arrangements.
C. Research and Development, Patents and Licenses
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.”
D. Trend Information
In 2006, ASML revenues saw strong growth due to significant growth in semiconductor unit demand among other things due to a strong capacity build-up by our customers, especially in flash memory. The number of systems shipped was higher due to a change in market demand from leading edge in 2005 to both high-volume production and leading-edge (65nm and 45nm IC manufacturing) in 2006. The ASPs were higher due to product mix changes reflecting the continuous shift in market demand to our leading edge technology systems with higher ASPs driven by the shrink roadmaps of our customers. See also Item 5 “Operating and Financial Review and Prospects, Semiconductor equipment industry update”.
Operational outlook
In view of current market forecasts by semiconductor industry analysts, our strong position in immersion and our potential for further market share gains across all segments, we expect 2007 to be another year of increased sales, confirming the company’s growth path towards our goal of a level of 5 billion euros in sales by 2010. Our expectation is supported by our strong backlog and the expected industry ramp-up of immersion volume manufacturing in 2007. We expect front-loading of flash memory capacity build-up in the first half of 2007 and a strong uptake of the TWINSCAN XT:1900i in the second half of 2007. This new immersion system will serve as a development and production vehicle for the sub-45-nanometer node. Although exact first quarter 2007 unit bookings are difficult to predict, due to customer lead-time variability, we expect a healthy first quarter 2007 order level to sustain our growth outlook for 2007.
ASML ANNUAL REPORT 2006
33


Table of Contents

Financial outlook
The following table sets forth our backlog of systems as of December 31, 2005 and 2006.
                 
 
As of December 31   2005   2006
 
Backlog sales of new systems (units)
    86       153  
Backlog sales of used systems (units)
    9       10  
Backlog sales of total systems (units)
    95       163  
Value of backlog new systems (EUR million)
    1,411       2,120  
Value of backlog used systems (EUR million)
    23       26  
Value of backlog of total systems (EUR million)
    1,434       2,146  
ASP for new systems (EUR million)
    16.4       13.9  
ASP for used systems (EUR million)
    2.6       2.6  
ASP for total systems (EUR million)
    15.1       13.2  
 
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.
We plan to ship 70 systems in the first quarter of 2007 with an ASP of EUR 12.0 million for all systems, reflecting a mix favoring i-line and KrF products compared with the previous quarter, while supporting a gross margin in the first quarter of 2007 between 40 and 41 percent. Also 67 percent of the unit backlog has shipment dates in the first and second quarter of 2007.
We expect that the first quarter 2007 research and development expenditures will increase to EUR 115 million net of credit, an investment that continues to strengthen our technological leadership and expand lithography growth.
SG&A expenses in the first quarter of 2007 are expected to be EUR 55 million.
E. Off-Balance Sheet Arrangements
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. Furthermore, 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.
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 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 ANNUAL REPORT 2006
34


Table of Contents

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, 2006, we had purchase commitments for a total amount of approximately EUR 995 million, compared to EUR 676 million as of December 31, 2005, reflecting our increased backlog level at the end of 2006. 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.
Intended acquisition Brion
We intend to acquire 100 percent of the outstanding shares of Brion, subject to approval by regulatory authorities, for a total consideration of USD 270 million (approximately EUR 203 million) in cash.
F. Tabular Disclosure of Contractual Obligations
Our contractual obligations as of December 31, 2006 can be summarized as follows:
                                         
 
    Less than       After
Payments due by period   Total   1 year   1-3 years   3-5 years   5 years
(in thousands)   EUR   EUR   EUR   EUR   EUR
 
Long Term Debt Obligations, including interest expense
    455,214       21,516       42,754       390,944       0  
Operating Lease Obligations
    187,742       31,210       50,511       35,893       70,128  
Purchase Obligations
    995,047       991,292       3,546       209       0  
Other Liabilities1
    30,793       6,834       23,959       0       0  
 
 
Total Contractual Obligations
    1,668,796       1,050,852       120,770       427,046       70,128  
 
Other liabilities relate to the additional payment to Nikon due in 2007 with respect to a cross-license of patents related to lithography equipment. (See Item 10.C. “Material Contracts” for a summary of the Nikon-ASML Cross License Agreement and the ASML/ Zeiss Sublicense Agreement) and system repurchase commitments.
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, 2006 as follows:
                                         
 
    Less than       After
    Total   1 year   1-3 years   3-5 years   5 years
(in thousands)   EUR   EUR   EUR   EUR   EUR
 
Purchase options
    61,362       0       5,627       8,250       47,485  
 
G. Safe Harbor
See “Special Note regarding Forward-Looking Statements.”
ASML ANNUAL REPORT 2006
35


Table of Contents

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:
                     
 
Name   Title   Year of Birth   Term Expires
 
Henk Bodt1, 2, 3
  Chairman of the Supervisory Board     1938       2007  
Jan A. Dekker1, 4
  Member of the Supervisory Board     1939       2009  
Jos W.B. Westerburgen2, 3
  Member of the Supervisory Board     1942       2009  
Fritz W. Fröhlich1
  Member of the Supervisory Board     1942       2008  
Arthur P.M. van der Poel 3,4
  Member of the Supervisory Board     1948       2008  
Ieke C.J. van den Burg2
  Member of the Supervisory Board     1952       2009  
OB Bilous4
  Member of the Supervisory Board     1938       2009  
Eric Meurice
  President, Chief Executive Officer and Chairman of the Board of Management     1956       2008  
Peter T.F.M. Wennink
  Executive Vice President, Chief Financial Officer and Member of the Board of Management     1957       N/A5  
Martin A. van den Brink
  Executive Vice President Marketing & Technology and Member of the Board of Management     1957       N/A5  
Klaus P. Fuchs
  Executive Vice President Operations and Member of the Board of Management     1958       2010  
 
Member of the Audit Committee
Member of the Remuneration Committee
Member of the Selection and Nomination Committee
Member of the Technology and Strategy Committee
There are no specified terms for members of the Board of Management appointed prior to March 2004
Effective March 23, 2006, Mr. Grassmann retired by rotation from the Supervisory Board. On that same date, Mr. Dekker was reappointed as member of the Supervisory Board. Mr. Bodt will retire by rotation from the Supervisory Board on March 28, 2007.
There are no family relationships among the members of our Supervisory Board and Board of Management.
Starting from the Annual General Meeting of Shareholders of 2005, the Works Council of ASML Netherlands B.V. has the right to recommend for nomination (which recommendation may be rejected by the Supervisory Board in limited circumstances) a member for each vacancy in the Supervisory Board unless and until members of the Supervisory Board appointed pursuant to this recommendation right represent one-third of the members of the Supervisory Board. See Item 6.C. “Board Practices, Supervisory Board”. In the General Meeting of Shareholders of 2005, Ms. Van den Burg was appointed pursuant to this recommendation right and the appointment of another member pursuant to this right will be on the agenda of the General Meeting of Shareholders of 2007.
Director and Officer Biographies
Henk Bodt
Mr. Bodt was appointed as Chairman of our Supervisory Board in 1995. Mr. Bodt is a former Executive Vice President of Royal Philips Electronics. In addition to other positions, including Chairman and Chief Executive Officer of the Consumer Electronics Division, he also served on the Board of Management of Philips and on the Group Management Committee of Philips. He currently serves on the Supervisory Boards of DSM N.V., Delft Instruments N.V. and Neo-Post SA.
Jan A. Dekker
Mr. Dekker has served on our Supervisory Board since 1997. Mr. Dekker is a former Chief Executive Officer of TNO from which he retired in November 2003. He currently serves on the Supervisory Boards of Koninklijke BAM Group N.V. and Syntens and he is also President of the Royal Institute of Engineers (KIVI NIRIA).
Jos W.B. Westerburgen
Mr. Westerburgen was appointed to our Supervisory Board in March 2002. Mr. Westerburgen has extensive experience in the field of corporate law and tax. Mr. Westerburgen is former Company Secretary and Head of Tax of Unilever. Mr. Westerburgen
ASML ANNUAL REPORT 2006
36


Table of Contents

currently serves as a member of the Supervisory Board of Rodamco Europe N.V. and is also Vice-Chairman of the Board of the Association Aegon.
Fritz W. Fröhlich
Mr. Fröhlich was appointed to our Supervisory Board in March 2004. He is the former Deputy Chairman and Chief Financial Officer of Akzo Nobel N.V. Mr. Fröhlich is the Chairman of the Supervisory Boards of Randstad Holding N.V. and Draka Holding N.V. and serves as a member of the Supervisory Boards of Allianz Nederland N.V. and Gamma Holding N.V.
Arthur P.M. van der Poel
Mr. Van der Poel was appointed to our Supervisory Board in March 2004. Until 2001 he was the Chief Executive Officer of Philips Semiconductors. Mr. Van der Poel is a former member of the Board of Management (until April 2003) and a former member of the Group Management Committee of Royal Philips Electronics. Mr. Van der Poel is the chairman of the Board of MEDEA+, a member of the Board of Directors of Gemalto Holding N.V., a director of the Public Utility Fund (PUF-NRE) and serves as a member of the Supervisory Boards of PSV N.V. and DHV Holding B.V.
Ieke C.J. van den Burg
Ms. Van den Burg was appointed to our Supervisory Board in March 2005. She is a former member of the Dutch Social and Economic Council and of the EU Economic and Social Committee. Ms. Van den Burg also held various positions in Dutch and international trade union and labor organizations. Ms. Van den Burg has been a member of the European Parliament (“EP”) since 1999 and has served on the EP’s Committee on Economic and Monetary Affairs since 1999 and on the Committee on the Internal Market and Customer Protection since 2004.
OB Bilous
Mr. Bilous was appointed to our Supervisory Board in March 2005. From 1960 until 2000 Mr. Bilous held various management positions at IBM, including General Manager and VP Worldwide Manufacturing of IBM’s Microelectronics Division. He also served on the Boards of SMST, ALTIS Semiconductor and Dominion Semiconductor. Mr. Bilous currently serves as Chairman of the Board of Directors of International Sematech and as Board member of Nantero, Inc.
Eric Meurice
Mr. Meurice joined ASML on October 1, 2004 as President, Chief Executive Officer and Chairman of the Board of Management. Prior to joining ASML, and since March 2001, he was Executive Vice President — Thomson Television Worldwide. Between 1995 and 2001, Mr. Meurice served as Vice President for Dell Computer, where he ran the Western, Eastern Europe and Dell’s Emerging Markets business within EMEA. Before 1995, he gained extensive technology experience in the semiconductor industry at ITT Semiconductors Group and Intel Corporation, in the micro-controller group. Mr. Meurice is currently a member of the Board of Directors of Verigy Inc.
Peter T.F.M. Wennink
Mr. Wennink was appointed as Executive Vice President and Chief Financial Officer of ASML in 1999. Mr. Wennink has an extensive background in finance and accounting. Prior to his employment with ASML, Mr. Wennink worked as a partner at Deloitte Accountants, specializing in the high technology industry with an emphasis on the semiconductor equipment industry. Mr. Wennink is a member of the Netherlands Institute of Registered Accountants. Mr. Wennink is currently a member of the Supervisory Board of Bank Insinger de Beaufort N.V.
Martin A. van den Brink
Mr. Van den Brink was appointed as Executive Vice President Marketing & Technology in 1999. Before that, he served as Vice President Technology since 1995. Mr. Van den Brink was appointed as a member of our Board of Management in July 1999.
Klaus P. Fuchs
Mr. Fuchs was appointed as Executive Vice President Operations in 2006. Since 2003, Mr. Fuchs has served as Vice President of Linde AG in Wiesbaden, Germany where he was responsible for strategic direction and operations of its industrial sector. Before that he was technical director and member of the executive board at TRW Aerospace and he also gained experience at Daimler Benz Aerospace as Vice President of electronic systems.
ASML ANNUAL REPORT 2006
37


Table of Contents

B. Compensation
For details on Board of Management and Supervisory Board remuneration as well as benefits upon termination of executive employment, see Note 17 to our consolidated financial statements.
Bonus and Profit-sharing plans
For details on our bonus and profit sharing plans for our employees, see Note 13 to our consolidated financial statements.
Pension plans
For details on our pension plans for our employees, see Note 13 to our consolidated financial statements.
C. Board Practices
Board Practices
General
We endorse the importance of good corporate governance, in which independent oversight, accountability and transparency are the most significant elements. Within the framework of corporate governance, it is important that a relationship of trust exists between the Board of Management, the Supervisory Board, our employees and our shareholders.
In addition to the exchange of ideas at the General Meeting of Shareholders, other important forms of communication include the publication of our annual and quarterly financial results as well as press releases and publications posted on our website. In addition, we pursue a policy of active communication with our shareholders. Our corporate governance structure is intended to:
•  provide shareholders with regular, reliable and relevant transparent information regarding our activities, structure, financial condition, performance and other information, including information on our social, ethical and environmental records and policies;
•  apply high quality standards for disclosure, accounting and auditing; and
•  apply stringent rules with regard to insider securities trading.
Two-tier structure
ASML is incorporated under Netherlands law and has a two-tier board structure. Responsibility for the management of ASML lies with the Board of Management. Independent, non-executive members serve on the Supervisory Board, which supervises and advises the members of the Board of Management in performing their management tasks. The Board of Management has the duty to keep the Supervisory Board informed, consult with the Supervisory Board on important matters and submit certain important decisions to the Supervisory Board for its prior approval. The supervision of the Board of Management by the Supervisory Board includes (i) achievement of ASML’s objectives, (ii) corporate strategy and management of risks inherent to ASML’s business activities, (iii) the structure and operation of internal risk management and control systems, (iv) the financial reporting process and (v) compliance with applicable legislation and regulations.
Supervisory Board members are prohibited from serving as officers or employees of ASML, and members of the Board of Management cannot serve on the Supervisory Board.
Board of Management
The Board of Management consists of at least two members or such larger number of members as determined by the Supervisory Board. Members of the Board of Management are appointed by the Supervisory Board. The Supervisory Board must notify the General Meeting of Shareholders of the intended appointment of a member of the Board of Management. As a result of our compliance with the Netherlands Corporate Governance Code, members of the Board of Management that are appointed in 2004 or later shall be appointed for a maximum period of four years, but may be re-appointed. Members of the Board of Management serve until the end of the term of their appointment, voluntary retirement, or suspension or dismissal by the Supervisory Board. In the case of dismissal, the Supervisory Board must first inform the General Meeting of Shareholders of the intended removal.
The Supervisory Board determines the remuneration of the individual members of the Board of Management, in line with the remuneration policy adopted by the General Meeting of Shareholders, upon a proposal of the Supervisory Board. ASML’s remuneration policy is posted on its website.
Supervisory Board
The Supervisory Board consists of at least three members or such larger number as determined by the Supervisory Board. The Supervisory Board prepares a profile in relation to its size and composition; ASML’s Supervisory Board profile is posted on ASML’s website.
ASML ANNUAL REPORT 2006
38


Table of Contents

Members of the Supervisory Board are appointed by the General Meeting of Shareholders from nominations of the Supervisory Board. Nominations must be reasoned and must be made available to the General Meeting of Shareholders and the Works Council simultaneously. Before the Supervisory Board presents its nominations, both the General Meeting of Shareholders and the Works Council may make recommendations (which the Supervisory Board may reject). In addition, the Works Council has an enhanced right to make recommendations for nomination of at least one-third of the members of the Supervisory Board, which recommendation may only be rejected by the Supervisory Board: (i) if the relevant person is unsuitable or (ii) if the Supervisory Board would not be duly composed if the recommended person were appointed as a Supervisory Board member. If no agreement can be reached between the Supervisory Board and the Works Council on these recommendations, the Supervisory Board may request the Enterprise Chamber of the Amsterdam Court to declare its objection legitimate. Any decision of the Enterprise Chamber on this matter is non-appealable.
Nominations of the Supervisory Board may be overruled by the General Meeting of Shareholders by an absolute majority of the votes representing at least one third of the total outstanding capital. If the votes cast in favour of such resolution do not represent at least one third of the total outstanding capital, a new meeting can be convened at which the nomination can be overruled by an absolute majority. If a nomination is overruled, the Supervisory Board must make a new nomination. If a nomination is not overruled and the General Meeting of Shareholders do not appoint the nominated person, the Supervisory Board will appoint the nominated person.
Members of the Supervisory Board serve for a maximum term of four years from the date of their appointment, or a shorter period as set forth in the rotation schedule as adopted by the Supervisory Board, and may be re-appointed, provided that their entire term of office does not exceed twelve years. The General Meeting of Shareholders may, by an absolute majority of the votes representing at least one-third of the total outstanding capital, dismiss the Supervisory Board in its entirety for lack of confidence. In such event, the Enterprise Chamber of the Amsterdam Court shall appoint one or more members of the Supervisory Board at the request of the Board of Management.
Upon the proposal of the Supervisory Board, the General Meeting of Shareholders determines the remuneration of the members of the Supervisory Board. A member of the Supervisory Board shall not be granted any shares or option rights by way of remuneration.
Approval of Board of Management Decisions
The Board of Management requires prior approval of the General Meeting of Shareholders for resolutions concerning an important change in the identity or character of ASML or its business, including in any case:
•  a transfer of all or substantially all of the business of ASML to a third party;
•  entering into or the termination of a long-term joint venture between ASML and a third party, if this joint venture is material to ASML; and
•  an acquisition or divestment by ASML of an interest in the capital of a company with a value of at least one third of ASML’s assets (determined by reference to ASML’s most recently adopted annual accounts).
Rules of Procedure
The Board of Management and the Supervisory Board have adopted Rules of Procedure for each of the Board of Management, Supervisory Board and the four Committees of the Supervisory Board. These Rules of Procedure are posted on ASML’s website.
Directors and Officers Insurance and Indemnification
Members of the Board of Management and Supervisory Board, as well as certain senior management members, are insured under the ASML’s Directors and Officers Insurance Policy. Although the insurance policy provides for a wide coverage, our directors and officers may incur uninsured liabilities. ASML has indemnified its Board of Management and Supervisory Board against any claims arising in connection with their position as director and officer of the Company, provided that such claim is not attributable to willful misconduct or intentional recklessness of such officer or director.
Corporate Governance Developments
ASML continuously monitors and assesses applicable corporate governance rules, including recommendations and initiatives regarding principles of corporate governance. These include rules that have been promulgated in the United States both by the NASDAQ Global Select Market (“Nasdaq”) and by the SEC pursuant to the Sarbanes-Oxley Act of 2002.
The Netherlands Corporate Governance Code (the “Code”) came into effect on January 1, 2004. A full report on ASML’s compliance with the Code is required to be included in a company’s statutory annual report. Netherlands listed companies are required to either comply with the principles and the best practice provisions of the Code, or to explain on which points they deviate from these best practice provisions and why.
ASML ANNUAL REPORT 2006
39


Table of Contents

Pursuant to the Code’s recommendations, ASML has included a separate chapter on corporate governance in both its annual reports. The Code contains recommendations with regard to corporate governance, including on the following topics:
•  strengthening the role of the Supervisory Board and its committees and increasing its independence, quality and expertise;
•  strengthening the role of the shareholders with respect to control on the functioning of the Board of Management and the Supervisory Board, as well as with respect to nomination and remuneration of members of the Board of Management and with respect to the nomination of members of the Supervisory Board;
•  facilitating and encouraging shareholders to use their voting power and to actively participate in the General Meeting of Shareholders; and
•  defining the role of the external auditor vis-à-vis the Supervisory Board as its principal contact.
Committees of ASML’s Supervisory Board
The Supervisory Board has an Audit Committee, a Remuneration Committee, a Selection and Nomination Committee and a Technology and Strategy Committee. Members of these committees are appointed from among the Supervisory Board members.
Audit Committee
ASML’s Audit Committee is composed of three members of the Supervisory Board. The current members of our Audit Committee are Fritz Fröhlich (chairman), Henk Bodt and Jan Dekker, each of whom is an independent, non-executive member of the Supervisory Board. The Supervisory Board has determined that Fritz Fröhlich qualifies as the Audit Committee financial expert pursuant to Section 407 of the Sarbanes-Oxley Act of 2002 and the rules promulgated thereunder. Our external auditor, our Chief Executive Officer, our Chief Financial Officer, our Corporate Controller as well as other ASML employees invited by the chairman of the Audit Committee may also attend the meetings of the Audit Committee.
The Audit Committee assists the Supervisory Board in:
•  overseeing the integrity of our financial statements and related non-financial disclosure;
•  overseeing the qualifications, independence and performance of the external auditor; and
•  overseeing the integrity of our systems of disclosure controls and procedures and the system of internal controls regarding finance and accounting.
The Audit Committee held six meetings in 2006. At these meetings the Audit Committee, reviewed our quarterly earnings announcements and our audited annual consolidated financial statements, discussed the system of internal controls over financial reporting and related audit findings, approved the internal and external audit plan and related audit fees and pre-approved any audit and non-audit services to be rendered by our external auditor.
Remuneration Committee
ASML’s Remuneration Committee is composed of three members of the Supervisory Board. The current members of our Remuneration Committee are Jos Westerburgen (chairman), Henk Bodt and Ieke van den Burg. The Remuneration Committee is responsible for the preparation of the remuneration policy for the Board of Management.
The Remuneration Committee prepares and the Supervisory Board establishes ASML’s general compensation philosophy for members of the Board of Management, and oversees the development and implementation of compensation programs for members of the Board of Management. The Remuneration Committee reviews and proposes to the Supervisory Board corporate goals and objectives relevant to the compensation of members of the Board of Management. The Committee further evaluates the performance of members of the Board of Management in view of those goals and objectives, and makes recommendations to the Supervisory Board on the compensation levels of the members of the Board of Management based on this evaluation.
In proposing to the Supervisory Board the actual remuneration elements and levels applicable to the members of the Board of Management, the Remuneration Committee considers, among other factors, the remuneration policy, the desired levels of and emphasis on particular aspects of ASML’s short and long-term performance, as well as current compensation and benefits structures and levels benchmarked against relevant peers. External compensation survey data and, where necessary, external consultants are used to benchmark ASML’s remuneration levels and structures.
In 2006, the Remuneration Committee held five regularly scheduled meetings.
Selection and Nomination Committee
ASML’s Selection and Nomination Committee is composed of three members of the Supervisory Board. The current members of our Selection and Nomination Committee are Jos Westerburgen (chairman), Henk Bodt and Arthur van der Poel.
ASML ANNUAL REPORT 2006
40


Table of Contents

The Selection and Nomination Committee assists the Supervisory Board in:
•  preparing the selection criteria and appointment procedures for members of the Company’s Supervisory Board and Board of Management;
•  periodically evaluating the scope and composition of the Board of Management and the Supervisory Board and proposing the profile of the Supervisory Board in relation thereto;
•  periodically evaluating the functioning of individual members of the Board of Management and the Supervisory Board and reporting the results thereof to the Supervisory Board; and
•  proposing (re-)appointments of members of the Board of Management and the Supervisory Board and supervising the policy of the Board of Management in relation to the selection and appointment criteria for senior management.
The Selection and Nomination Committee held three regularly scheduled meetings in 2006.
Technology and Strategy Committee
ASML’s Technology and Strategy Committee is composed of three members of the Supervisory Board. The current members of our Technology and Strategy Committee are Arthur van der Poel (chairman), Jan Dekker and OB Bilous. In addition, the Technology and Strategy Committee may appoint one or more advisors from within the Company and/or from outside the Company. The advisors to the Technology and Strategy Committee may be invited as guests to (parts of) the meetings of the Committee, but are not entitled to vote in the meetings.
The Technology and Strategy Committee advises the Supervisory Board in relation to the following responsibilities and may prepare resolutions of the Supervisory Board related thereto:
•  familiarization with and risk assessment and study of potential strategies, required technical resources, technology roadmaps and product roadmaps; and
•  providing advice to the Supervisory Board with respect to matters related thereto.
The Technology and Strategy Committee holds at least two meetings per year and held three regularly scheduled meetings in 2006.
Disclosure Committee
ASML has a Disclosure Committee to ensure compliance with applicable disclosure requirements arising under US and Netherlands law and applicable Stock Exchange Rules. The Disclosure Committee reports to and assists our Chief Executive Officer and Chief Financial Officer in the maintenance and evaluation of disclosure controls and procedures. The Audit Committee is kept informed about the outcome of the Disclosure Committee meetings. The Disclosure Committee gathers all relevant financial and non-financial information and assesses materiality, timeliness and necessity for disclosure of such information. The Disclosure Committee comprises various members of senior management, including our Chief Financial Officer. Furthermore, members of the Disclosure Committee are in close contact with our external legal counsel and our external auditor.
During 2006, the Disclosure Committee reviewed our quarterly earnings announcements and our audited annual consolidated financial statements and other public announcements containing financial information. During various meetings, the Disclosure Committee assessed ASML’s disclosure controls and procedures and internal control over financial reporting. In order to assist the Disclosure Committee in preparing its advice to our CEO and CFO in their assessment of ASML’s disclosure controls and procedures and internal control over financial reporting, we have an Internal Control Committee, comprising among others three members of the Disclosure Committee.
Variations from Certain Nasdaq Corporate Governance Rules
Nasdaq rules provide that foreign private issuers may follow home country practice in lieu of the Nasdaq corporate governance standards subject to certain exceptions and except to the extent that such exemptions would be contrary to US federal securities laws. The practices followed by ASML in lieu of Nasdaq rules are described below:
•  ASML does not follow Nasdaq’s quorum requirements applicable to meetings of ordinary shareholders. In accordance with Netherlands law and Netherlands generally accepted business practice, ASML’s Articles of Association provide that there are no quorum requirements generally applicable to General Meetings of Shareholders.
•  ASML does not follow Nasdaq’s requirements regarding the provision of proxy statements for General Meetings of Shareholders. Netherlands law does not have a regulatory regime for the solicitation of proxies and the solicitation of proxies is not a generally accepted business practice in the Netherlands. ASML does provide shareholders with an agenda and other relevant documents for the General Meeting of Shareholders.
•  ASML does not follow Nasdaq’s requirement regarding distribution to shareholders of copies of an annual report containing audited financial statements prior to the Company’s Annual General Meeting of Shareholders. The distribution of annual reports to shareholders is not required under Netherlands corporate law, Netherlands securities laws, or by Euronext Amsterdam. Furthermore, it is generally accepted business practice for Netherlands companies not to distribute annual
ASML ANNUAL REPORT 2006
41


Table of Contents

reports. In part, this is because the Netherlands system of bearer shares has made it impractical to keep a current list of holders of the bearer shares in order to distribute the annual reports. Instead, we make our annual report available at our corporate head office in the Netherlands (and at the offices of our Netherlands listing agent as stated in the convening notice for the meeting) as from the day of convocation of the Annual General Meeting of Shareholders. In addition, we post a copy of our annual report on our website prior to the Annual General Meeting of Shareholders.

D. Employees
As of December 31, 2006, we had 5,594 employees in our operations employed primarily in manufacturing, product development and customer support activities. As of December 31, 2003, 2004 and 2005, the total number of employees in continued operations was 5,059, 5,071 and 5,055, respectively. In addition, during 2006 we had an average of 1,290 temporary employees. For a more detailed description of employee information, including a breakdown of our employees by function, see Notes 13 and 18 to our consolidated financial statements, which are incorporated herein by reference. We rely on our ability to vary the number of temporary employees to respond to fluctuating market demand for our products.
Our future success will depend on our ability to attract, train, retain and motivate highly qualified, skilled and educated employees, who are in great demand. We are particularly reliant for our continued success on the services of several key employees, including a number of systems development specialists with advanced university qualifications in engineering, optics and computing.
ASML Netherlands B.V., our operating subsidiary in the Netherlands, has a Works Council, as required by Netherlands law. A Works Council is a representative body of the employees of a Netherlands company elected by the employees. The Board of Management of any Netherlands company that runs an enterprise with a Works Council must seek the non-binding advice of the Works Council before taking certain decisions with respect to the company, such as those related to a major restructuring, a change of control, or the appointment or dismissal of a member of the Board of Management. Other decisions directly involving employment matters that apply either to all employees, or certain groups of employees, may only be taken with the Works Council’s approval. Such a decision may be taken without the prior approval of the Works Council only with the approval of the District Court.
In early 2005, a dispute arose between the Company and the Works Council regarding the question whether the establishment of and amendments to bonus plans for management (the “ASML Senior and Executive Bonus Plan”) should be subject to the approval of the Works Council. In May 2005, the Works Council initiated legal proceedings on this matter. In July 2006, ASML and the Works Council entered into an agreement on the matter and each party agreed to no longer pursue the court case.
E. Share Ownership
Information with respect to share ownership of members of our Supervisory Board and Board of Management is included in Item 7 “Major Shareholders and Related Party Transactions” and Note 17 to our consolidated financial statements, which are incorporated herein by reference. Information with respect to the grant of shares and stock options to employees is included in Note 13 to our consolidated financial statements which is incorporated herein by reference.
Item 7 Major Shareholders and Related Party Transactions
A. Major Shareholders
The following table sets forth the total number of ordinary shares owned by each shareholder whose beneficial ownership of ordinary shares exceeds 5 percent of the ordinary shares issued and outstanding, as well as the ordinary shares (including options) owned by the members of the Supervisory Board and members of the Board of Management (which includes those persons specified in Item 6 “Directors, Senior Management and Employees”), as a group, as of December 31, 2006. The information set forth below is solely based on public filings with the SEC and AFM at December 31, 2006.
ASML ANNUAL REPORT 2006
42


Table of Contents

                 
 
    Shares   Percent of
Identity of Person or Group   Owned   Class
 
Capital Group International, Inc1
    55,842,520       11.7%  
FMR Corp.2
    70,721,194       14.8%  
Capital Research and Management Company3
    49,577,150       10.4%  
Members of ASML’s Supervisory Board and Board of Management, as a group (4 persons)4
    1,157,046       *  
 
Less than 1 percent.
Based solely on the Schedule 13-G/ A filed by Capital Group International, Inc. with the Commission on February 1, 2006.
Based solely on the Schedule 13-G/ A filed by FMR Corp. with the Commission on February 14, 2006.
Based solely on the Schedule 13-G/ A filed by Capital Research and Management Company with the Commission on February 6, 2006.
Four members of our Board of Management own a total of 602,275 unconditional options to purchase ASML shares. These members of our Board of Management together are also entitled to 257,263 conditional performance stock options and 87,507 and 210,001 conditional performance stock for 2005 and 2006, respectively. The number of performance stock that are ultimately awarded will be determined in the financial year 2008 and 2009, respectively, and is conditional upon the achievement of performance targets. See Note 17 to our consolidated financial statements for information on options held by and conditional performance stock conditionally awarded to members of our Board of Management on an individual basis. One member of our Board of Management owns 22,000 of our outstanding shares. None of the members of the Supervisory Board hold any of our outstanding shares or options on shares. Certain members of our Board of Management have deposited their stock options with an independent fund manager who has authority to exercise these options and dispose of the underlying shares without instructions from, or consultation with, the respective member of the Board of Management.
According to SEC filings, (i) Capital Group International, Inc. increased its shareholding (including as a holder of convertible notes) from 51,528,140 shares as of February 2005 to 55,842,520 shares as of February 2006, (ii) Capital Research and Management Company decreased its shareholding (including as a holder of convertible notes) from 50,572,880 shares as of February 2005 to 49,577,150 shares as of February 2006 and (iii) FMR Corp. increased its shareholding (including as a holder of convertible notes) from 54,662,612 shares as of February 2005 to 70,721,194 shares as of February 2006.
Our major shareholders do not have voting rights different from other shareholders. We do not issue share certificates, except for registered New York Shares. For more information see Item 10.B. “Memorandum and Articles of Association.”
As of December 31, 2006, our ordinary shares were held by 577 registered holders with a registered address in the United States. Since certain of our ordinary shares were held by brokers and nominees, the number of record holders in the United States may not be representative of the number of beneficial holders or of where the beneficial holders are resident.
Obligations of Shareholders to Disclose Holdings under Netherlands Law
Holders of our shares may be subject to reporting obligations under the Act on the supervision of financial markets (Wet op het financieel toezicht, the “Act”).
The disclosure obligations under the Act apply to any person or entity that acquires or disposes of an interest in the voting rights and/or the capital of a public limited company incorporated under the laws of the Netherlands whose shares are admitted to trading on a regulated market within the European Union. Disclosure is required when, as a result of an acquisition or disposal, the percentage of voting rights or capital interest acquired or disposed of by a person or an entity reaches, exceeds or falls below 5, 10, 15, 20, 25, 30, 40, 50, 60, 75 or 95 percent. With respect to ASML, the Act would require any person or entity whose interest in the voting rights and/or capital of ASML reached, exceeded or fell below those percentage interests to notify the Netherlands Authority for the Financial Markets (Autoriteit Financiële Markten, the “AFM”) immediately.
ASML is required to notify the AFM immediately if the Company’s voting rights and/or capital have changed by one percent or more since its previous notification on outstanding voting rights and capital. In addition, ASML must notify the AFM of changes of less than one percent in ASML’s outstanding voting rights and capital at least once per calendar quarter, within eight days after the end of the quarter. Any person whose direct or indirect voting rights and/or capital interest meets or passes the thresholds referred to in the previous paragraph as a result of a change in the outstanding voting rights or capital must notify the AFM no later than the fourth trading day after the AFM has published such a change.
Once every calendar year, within four weeks after the end of the calendar year, holders of an interest of five percent or more in ASML’s voting rights or capital must notify the AFM of a change in the composition of their interest resulting from certain acts (including, but not limited to, the exchange of shares for depositary receipts and vice versa, and the exercise of rights to acquire shares).
Subsidiaries, as defined in the Act, do not have independent reporting obligations under the Act, as interests held by them are attributed to their (ultimate) parents. Any person may qualify as a parent for purposes of the Act, including an individual. A person who disposes of an interest of five percent or more in ASML’s voting rights or capital and who ceases to be a subsidiary must immediately notify the AFM. As of that moment, all notification obligations under the Act will become applicable to the former subsidiary.
ASML ANNUAL REPORT 2006
43


Table of Contents

For the purpose of calculating the percentage of capital interest or voting rights, the following interests must, among other arrangements, be taken into account: shares and votes (i) directly held by any person, (ii) held by such person’s subsidiaries, (iii) held by a third party for such person’s account, (iv) held by a third party with whom such person has concluded an oral or written voting agreement (including on the basis of an unrestricted power of attorney) and (v) held by a third party with whom such person has agreed to temporarily transfer voting rights against payment. Interests held jointly by multiple persons are attributed to those persons in accordance with their entitlement. A holder of a pledge or right of usufruct in respect of shares can also be subject to these reporting obligations if such person has, or can acquire, the right to vote on the shares or, in case of depositary receipts, the underlying shares. The managers of certain investment funds are deemed to hold the capital interests and voting rights in the funds managed by them.
For the same purpose, the following instruments qualify as “shares”: (i) shares, (ii) depositary receipts for shares (or negotiable instruments similar to such receipts), (iii) negotiable instruments for acquiring the instruments under (i) or (ii) (such as convertible bonds), and (iv) options for acquiring the instruments under (i) or (ii).
The AFM keeps a public registry of and publishes all notifications made pursuant to the Act.
Non-compliance with the reporting obligations under the Act could lead to criminal fines, administrative fines, imprisonment or other sanctions. In addition, non-compliance with the reporting obligations under the Act may lead to civil sanctions, including (i) suspension of the voting rights relating to the shares held by the offender, for a period of not more than three years, (ii) nullification of any resolution of the General Meeting of Shareholders of the company to the extent that such resolution would not have been approved if the votes at the disposal of the person or entity in violation of a duty under the Act had not been exercised and (iii) a prohibition on the acquisition by the offender of our shares or the voting on our ordinary shares for a period of not more than five years.
B. Related Party Transactions
There have been no transactions during our most recent fiscal year, nor are there presently any proposed material transactions, between ASML or any of its subsidiaries, and any significant shareholder and any director or officer or any relative or spouse thereof. During our most recent fiscal year, there has been no, and at present there is no, outstanding indebtedness to ASML owed or owing by any director or officer of ASML or any associate thereof, other than the virtual financing arrangement with respect to stock options described under Note 13 to our consolidated financial statements.
C. Interests of Experts & Counsel
Not applicable.
Item 8 Financial Information
A. Consolidated Statements and Other Financial Information
Consolidated Statements
See Item 18 “Financial Statements”.
Export Sales
See Note 16 to our consolidated statements included in Item 18 “Financial Statements”, which is incorporated herein by reference.
Legal Proceedings
See Item 4.B. “Business Overview, Intellectual Property” and Note 14 to our consolidated financial statements, which are incorporated herein by reference.
Dividend Policy
We have no current intention to pay dividends on our ordinary shares. We strive to maintain our strategic target level of EUR 1 billion in net cash, which is comprised of total cash and cash equivalents minus convertible subordinated bonds. In case our net cash exceeds EUR 1 billion and there are no alternative investment opportunities, we intend to return excess cash to our shareholders. As of December 31, 2006 our net cash amounts to EUR 1.3 billion. For more information see Item 10.B. “Memorandum and Articles of Association” and Item 10.D. “Exchange Controls.”
B. Significant Changes
No significant changes have occurred since the date of our consolidated financial statements. See Item 5.D. “Trend Information.”
ASML ANNUAL REPORT 2006
44


Table of Contents

Item 9 The Offer and Listing
A. Listing Details
Our ordinary shares are listed for trading in the form of New York Shares on Nasdaq and in the form of registered shares (“Amsterdam Shares”) on the Eurolist by Euronext Amsterdam. The principal trading market of our ordinary shares is Eurolist by Euronext Amsterdam. For more information see Item 10.B “Memorandum and Articles of Association.”
The following table sets forth, for the periods indicated, the high and low closing prices of our ordinary shares on Nasdaq, as well as on Eurolist by Euronext Amsterdam.
                                 
 
    Nasdaq   Euronext Amsterdam
    US$   EUR
    High   Low   High   Low
 
Annual Information
                               
2002
    25.80       4.95       29.79       5.13  
2003
    20.39       6.11       17.04       5.39  
2004
    22.32       12.41       17.50       10.26  
2005
    20.13       14.44       17.12       11.11  
2006
    25.83       18.46       19.90       14.49  
 
 
Quarterly Information
                               
1st quarter 2005
    18.72       14.48       14.15       11.19  
2nd quarter 2005
    16.91       14.44       13.97       11.11  
3rd quarter 2005
    18.09       15.60       14.70       13.06  
4th quarter 2005
    20.13       16.29       17.12       13.58  
 
 
1st quarter 2006
    23.57       19.42       19.29       16.23  
2nd quarter 2006
    22.41       18.70       17.63       14.49  
3rd quarter 2006
    23.39       18.46       18.44       14.64  
4th quarter 2006
    25.83       22.30       19.90       17.75  
 
 
Monthly Information
                               
July 2006
    20.42       18.46       15.99       14.64  
August 2006
    22.06       19.40       17.06       15.20  
September 2006
    23.39       21.82       18.44       16.96  
October 2006
    24.29       22.30       19.31       17.75  
November 2006
    25.83       22.64       19.90       17.84  
December 2006
    25.37       23.98       19.28       18.17  
January (through Jan. 24), 2007
    25.55       25.14       19.67       19.11  
 
(Source: Bloomberg)
B. Plan of Distribution
Not applicable.
C. Markets
See Item 9.A. “Listing Details.”
D. Selling Shareholders
Not applicable.
E. Dilution
Not applicable.
F. Expenses of the Issue
Not applicable.
ASML ANNUAL REPORT 2006
45


Table of Contents

Item 10 Additional Information
A. Share Capital
Not applicable.
B. Memorandum and Articles of Association
The information required by Item 10.B. is incorporated by reference to ASML’s Report on Form 6-K, filed with the Commission on June 28, 2006.
Current Authorizations to Issue and Repurchase Ordinary Shares
Our Board of Management has the power to issue ordinary shares and preference shares if and to the extent the Board of Management has been authorized to do so by the General Meeting of Shareholders (whether by means of a resolution or by an amendment to our Articles of Association). However, the Supervisory Board must approve any issuance of ordinary shares or preference shares.
At our annual General Meeting of Shareholders, held on March 23, 2006, the Board of Management was granted the authorization to issue shares and/or rights thereto representing up to a maximum of 10 percent of our issued share capital as of the date of authorization, plus an additional 10 percent of our issued share capital as of the date of authorization that may be issued in connection with mergers and acquisitions. At our annual General Meeting of Shareholders to be held on March 28, 2007, our shareholders will be asked to authorize the Board of Management (subject to the approval of the Supervisory Board) to issue shares and/or rights thereto through September 28, 2008.
Holders of our ordinary shares have a pro rata preemptive right of subscription to any issuance of ordinary shares for cash, which right may be restricted or excluded. Ordinary shareholders have no pro rata preemptive right of subscription to any ordinary shares issued for consideration other than cash or ordinary shares issued to employees. If authorized for this purpose by the General Meeting of Shareholders (whether by means of a resolution or by an amendment to our Articles of Association), the Board of Management has the power, with the approval of the Supervisory Board, to restrict or exclude the preemptive rights of holders of ordinary shares. A designation may be renewed. At our annual General Meeting of Shareholders, held on March 23, 2006, the Board of Management was granted the authorization, subject to the aforementioned approvals, to restrict or exclude preemptive rights of holders of ordinary shares. At our annual General Meeting of Shareholders to be held on March 28, 2007, our shareholders will be asked to grant this authority through September 28, 2008. At this annual General Meeting of Shareholders, the shareholders will be asked to grant authority to the Board of Management to issue shares or options separately. These authorizations will each be granted for a period of 18 months.
We may repurchase our issued ordinary shares at any time, subject to compliance with the requirements of Netherlands law and provided the aggregate nominal value of the ordinary shares held by ASML or a subsidiary at any time amounts to no more than one-tenth of our issued share capital. Any such purchases are subject to the approval of the Supervisory Board and the authorization (whether by means of a resolution or by an amendment to our Articles of Association) of shareholders at our General Meeting of Shareholders, which authorization may not be for more than 18 months. The Board of Management is currently authorized, subject to Supervisory Board approval, to repurchase through September 23, 2007 up to a maximum of 10 percent of our issued share capital as of the date of authorization (March 23, 2006) at a price between the nominal value of the ordinary shares purchased and 110 percent of the market price of these securities on Euronext Amsterdam or Nasdaq. At our annual General Meeting of Shareholders to be held on March 28, 2007, our shareholders will be asked to extend this authority through September 28, 2008.
Shareholder Approval for Share and Share Option Arrangements for Board of Management
In 2006, ASML submitted to the General Meeting of Shareholders for approval a proposal regarding plans to issue shares or rights to acquire shares to members of the Board of Management, in accordance with the Code. We have not in the past established and do not intend to establish in the future stock option or purchase plans or other equity compensation arrangements for members of our Supervisory Board.
Nasdaq rules require shareholder approval of stock option plans available to officers, directors or employees. However, Nasdaq has granted ASML an exemption from this requirement (foreign private issuers are no longer required to obtain an exemption, but may follow home country practice in lieu of Nasdaq corporate governance rules, subject to exceptions).
Cancellation of Priority Shares
On January 18, 2006, ASML announced its decision to cancel all issued priority shares and to dissolve the “Stichting Prioriteitsaandelen ASML Holding N.V.”. The cancellation of the priority shares became effective as per an amendment to ASML’s Articles of Association effective on April 13, 2006.
ASML ANNUAL REPORT 2006
46


Table of Contents

C. Material Contracts
Employment Agreement with Klaus Fuchs
On September 19, 2005, the Company entered into an employment agreement with Klaus Fuchs, to be ASML’s Chief Operating Officer, commencing on November 1, 2005 and terminable by the Company on not less than six months’ notice and by Mr. Fuchs on not less than three months’ notice. The employment agreement has a term of four years, but can be extended with the consent of both parties. Mr. Fuchs is entitled to receive a payment equal to one year’s base salary in the event his employment agreement is terminated by the Company. The employment agreement contains confidentiality and non-competition provisions to which Mr. Fuchs is subject.
The agreement entitles Mr. Fuchs to a base salary of EUR 400,000 per year, plus an annual cash bonus of up to 50 percent of base salary if certain performance targets are met. Pursuant to the agreement, Mr. Fuchs received 22,000 sign-on stock as well as 22,000 sign-on stock options at the first possible moment of grant and is entitled to receive annually, if certain performance targets are met, (i) stock options with a value equal to up to 25 percent of base salary and (ii) stock with a value equal to up to 25 percent of base salary. Mr. Fuchs is also entitled to pension benefits under a defined contribution plan. For additional information on Mr. Fuchs’ remuneration, see Note 17 to our consolidated financial statements.
Consultancy Agreement with David Chavoustie
Effective December 31, 2005, Mr. Chavoustie retired from our Board of Management. ASML and Mr. Chavoustie entered into a consultancy agreement, effective January 1, 2006, whereby Mr. Chavoustie will perform consulting services for ASML, including services relating to certain activities of ASML in the United States and our operations in Asia. Under the terms of the agreement, ASML will pay Mr. Chavoustie a fee of $800 per half day segment. The agreement has a term of one year and may be extended with the consent of both parties.
D. Exchange Controls
There are currently no limitations, either under the laws of the Netherlands or in the Articles of Association of ASML, to the rights of non-residents to hold or vote ordinary shares. Cash distributions, if any, payable in euro on Amsterdam registered shares and on ASML’s Amsterdam shares may be officially transferred from the Netherlands and converted into any other currency without being subject to any Netherlands legal restrictions. However, for statistical purposes, such payments and transactions must be reported by ASML to the Netherlands Central Bank. Furthermore, no payments, including dividend payments, may be made to jurisdictions subject to certain sanctions, adopted by the government of the Netherlands, implementing resolutions of the Security Council of the United Nations. Cash distributions, if any, on New York Shares shall be paid in US dollars, converted at the rate of exchange on Euronext Amsterdam at the close of business on the date fixed for that purpose by the Board of Management in accordance with the Articles of Association. ASML has no current intention to pay dividends on its ordinary shares.
E. Taxation
Netherlands Taxation
The statements below represent a summary of current Netherlands tax laws, regulations and judicial interpretations thereof. The description is limited to the material tax implications for a holder of ordinary shares who is not, or is not deemed to be, a resident of the Netherlands for Netherlands tax purposes (a “Non-resident Holder”). This description does not address special rules that may apply to special classes of holders of ordinary shares and should not be read as extending by implication to matters not specifically referred to herein. As to individual tax consequences, each investor in ordinary shares should consult his or her tax counsel.
General
The acquisition of ordinary shares by a non-resident of the Netherlands should not be treated as a taxable event for Netherlands tax purposes. The income consequences in connection with owning and disposing of our ordinary shares are discussed below.
Substantial Interest
A person that, directly or indirectly, owns 5 percent or more of our share capital, or holds options to purchase 5 percent or more of our share capital, is deemed to have a substantial interest in our shares, respectively, our options, as applicable. A deemed substantial interest also exists if (part of) a substantial interest has been disposed of, or is deemed to be disposed of, in a transaction where no taxable gain has been recognized. Special attribution rules exist in determining the presence of a substantial interest.
ASML ANNUAL REPORT 2006
47


Table of Contents

Income Tax Consequences for Individual Non-resident Holders on Owning and Disposing of the Ordinary Shares
An individual who is a Non-resident Holder will not be subject to Netherlands income tax on received income in respect of our ordinary shares or capital gains derived from the sale, exchange or other disposition of our ordinary shares, provided that such holder:
•  does not carry on and has not carried on a business in the Netherlands through a permanent establishment or a permanent representative to which the ordinary shares are attributable;
•  does not hold and has not held a (deemed) substantial interest in our share capital or, in the event the Non-resident Holder holds or has held a (deemed) substantial interest in our share capital, such interest is, respectively was, a business asset in the hands of the holder;
•  does not share and has not shared directly (through the beneficial ownership of ordinary shares or similar securities) in the profits of an enterprise managed and controlled in the Netherlands which (is deemed to) own(s), respectively (is deemed to have) has owned, our ordinary shares;
•  does not carry out and has not carried out any activities which generate taxable profit or taxable wages to which the holding of our ordinary shares was connected;
•  does not carry out and has not carried out employment activities in the Netherlands, does not serve and has not served as a director or board member of any entity resident in the Netherlands, and does not serve and has not served as a civil servant of a Netherlands public entity with which the holding of our ordinary shares is or was connected; and
•  is not an individual that has elected to be taxed as a resident of the Netherlands.
Corporate Income Tax Consequences for Corporate Non-resident Holders
Income derived from ordinary shares or capital gains derived from the sale, exchange or disposition of ordinary shares by a corporate Non-resident Holder is taxable if:
•  the holder carries on a business in the Netherlands through a permanent establishment or a permanent agent in the Netherlands (Netherlands enterprise) and the ordinary shares are attributable to this permanent establishment or permanent agent, unless the participation exemption (discussed below) applies; or
•  the holder has a substantial interest in our share capital, which is not allocable to his enterprise; or
•  certain assets of the holder are deemed to be treated as a Netherlands enterprise under Netherlands tax law and the ordinary shares are attributable to this Netherlands enterprise.
To qualify for the Netherlands participation exemption, the holder must generally hold at least 5 percent of our nominal paid-in capital and meet certain other requirements.
Dividend Withholding Tax
In general, a dividend distributed by us in respect of our ordinary shares will be subject to a withholding tax imposed by the Netherlands at the statutory rate of 25 percent.
Dividends include:
•  dividends in cash and in kind;
•  deemed and constructive dividends;
•  consideration for the repurchase or redemption of ordinary shares (including a purchase by a direct or indirect ASML subsidiary) in excess of qualifying average paid-in capital unless such repurchase is made for temporary investment purposes or is exempt by law;
•  stock dividends up to their nominal value (unless distributed out of qualifying paid-in capital);
•  any (partial) repayment of paid-in capital not qualifying as capital for Netherlands dividend withholding tax purposes; and
•  liquidation proceeds in excess of qualifying average paid-in capital for Netherlands dividend withholding tax purposes.
A reduction of Netherlands dividend withholding tax can be obtained if:
•  the participation exemption applies and the ordinary shares are attributable to a business carried out in the Netherlands;
•  the dividends are distributed to a qualifying EU corporate holder satisfying the conditions of the EU Parent-Subsidiary Directive; or
•  the rate is reduced by a tax treaty.
A Non-resident Holder of ordinary shares can be eligible for a partial or complete exemption or refund of all or a portion of the above withholding tax under a tax treaty that is in effect between the Netherlands and the Non-resident Holder’s country of residence. The Netherlands has concluded such treaties with the United States, Canada, Switzerland, Japan, most European Union member states, as well as many other countries. Under the Treaty between the United States of America and the Netherlands for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (the “Tax Treaty”), dividends paid by us to a Non-resident Holder that is a resident of the United States as defined in the Tax Treaty (other than an exempt organization or exempt pension trust, as discussed below) are generally eligible for a reduction of the 25 percent Netherlands withholding tax to 15 percent or, in the case of certain United States corporate shareholders owning at
ASML ANNUAL REPORT 2006
48


Table of Contents

least 10 percent of our voting power, to 5 percent, provided that it does not have an enterprise or an interest in an enterprise that is, in whole or in part, carried on through a permanent establishment or permanent representative in the Netherlands to which the dividends are attributable. The Tax Treaty provides for a complete exemption from tax on dividends received by exempt pension trusts and exempt organizations, as defined therein. Except in the case of exempt organizations, the reduced dividend withholding tax rate (or exemption from withholding) can be applied at the source upon payment of the dividends, provided that the proper forms have been filed in advance of the payment. Exempt organizations remain subject to the statutory withholding rate of 25 percent and are required to file for a refund of such withholding.
A Non-resident Holder may not claim the benefits of the Tax Treaty unless (i) it is a resident of the United States as defined therein, or (ii) it is deemed to be a resident on the basis of the provisions of article 24(4) of the Tax Treaty, and (iii) its entitlement to those benefits is not limited by the provisions of article 26 (limitation on benefits) of the Tax Treaty.
In this respect it is noted that the United States and the Netherlands have agreed on a protocol to the Tax Treaty. It provides for (among others) a 0 percent dividend withholding tax rate on dividends, provided certain requirements are met. In addition, abovementioned article 26 (limitation on benefits) has been adjusted. Some requirements to the various tests mentioned in article 26 will become more severe and others will be moderated.
Dividend Stripping Rules
Under Netherlands tax legislation regarding anti-dividend stripping, no exemption from, or refund of, Netherlands dividend withholding tax is granted if the recipient of dividends paid by us is not considered the beneficial owner of such dividends.
Gift or Inheritance Taxes
Netherlands gift or inheritance taxes will not be levied on the transfer of ordinary shares by way of gift, or upon the death of a Non-resident Holder, unless:
(1) the transfer is construed as an inheritance or as a gift made by or on behalf of a person who, at the time of the gift or death, is deemed to be, resident of the Netherlands; or
(2) the ordinary shares are attributable to an enterprise or part thereof that is carried on through a permanent establishment or a permanent representative in the Netherlands.
For purposes of Netherlands gift and inheritance tax, an individual of Netherlands nationality is deemed to be a resident of the Netherlands if he has been a resident thereof at any time during the ten years preceding the time of the gift or death. For purposes of Netherlands gift tax, a person not possessing Netherlands nationality is deemed to be a resident of the Netherlands if he has resided therein at any time in the twelve months preceding the gift.
Value Added Tax
No Netherlands value added tax is imposed on dividends in respect of our ordinary shares or on the transfer of our shares.
Residence
A Non-resident Holder will not become resident, or be deemed to be resident, in the Netherlands solely as a result of holding our ordinary shares or of the execution, performance, delivery and/or enforcement of rights in respect of our ordinary shares.
United States Taxation
The following is a discussion of the material United States federal income tax consequences relating to the acquisition, ownership and disposition of ordinary shares by a United States Holder (as defined below). This discussion deals only with ordinary shares held as capital assets and does not deal with the tax consequences applicable to all categories of investors, some of which (such as tax-exempt entities, passive foreign investment companies, banks, broker-dealers, investors owning directly, indirectly or constructively 10 percent or more of our outstanding voting shares, investors who hold ordinary shares as part of hedging or conversion transactions and investors whose functional currency is not the U.S. dollar) may be subject to special rules. In addition, the discussion does not address any alternative minimum tax or any state, local or non-United States tax consequences. The following discussion is based on United States tax laws, and judicial and administrative interpretations thereof as in effect on the date hereof, all of which are subject to change, potentially retroactively.
This discussion is based on the Internal Revenue Code of 1986, as amended to the date hereof, final, temporary and proposed Treasury Department regulations promulgated, and administrative and judicial interpretations thereof, changes to any of which subsequent to the date hereof, possibly with retroactive effect, may affect the tax consequences described herein. In addition, there can be no assurance that the Internal Revenue Service will not challenge one or more of the tax consequences described herein, and we have not obtained, nor do we intend to obtain, a ruling from the Internal Revenue Service or an opinion of counsel with respect to the United States federal income tax consequences of acquiring or holding shares. Prospective
ASML ANNUAL REPORT 2006
49


Table of Contents

purchasers of ordinary shares are advised to consult their tax advisers with respect to their particular circumstances and with respect to the effects of United States federal, state, local or non-United States tax laws to which they may be subject.
As used herein, the term “United States Holder” means a beneficial owner of ordinary shares that for United States federal income tax purposes is:
•  an individual citizen or resident of the United States;
•  a corporation or other entity treated as a corporation for United States federal income tax purposes created or organized in or under the laws of the United States or of any political subdivision thereof;
•  an estate of which the income is subject to United States federal income taxation regardless of its source;
•  a trust whose administration is subject to the primary supervision of a court within the United States and which has one or more United States persons who have the authority to control all of its substantial decisions.
If an entity treated as a partnership for United States federal income tax purposes owns ordinary shares, the United States federal income tax treatment of a partner in such partnership will generally depend upon the status of the partner and the activities of the partnership. A partnership that owns ordinary shares and the partners in such partnership should consult their tax advisors about the United States federal income tax consequences of holding and disposing of the ordinary shares.
Taxation of Dividends
United States Holders will include in gross income as foreign-source dividend income the gross amount of any distribution (before reduction for Netherlands withholding taxes) ASML makes out of its current or accumulated earnings and profits (as determined for United States federal income tax purposes) when the distribution is actually or constructively received by the United States Holder. Distributions will not be eligible for the dividends-received deduction generally allowed to United States corporations in respect of dividends received from other United States corporations. The amount of the dividend distribution includible in income of a United States Holder should be the U.S. dollar value of the foreign currency (e.g. euro) paid, determined by the spot rate of exchange on the date of the distribution, regardless of whether the payment is in fact converted into U.S. dollars. Distributions in excess of current and accumulated earnings and profits, as determined for United States federal income tax purposes, will be treated as a non-taxable return of capital to the extent of the United States Holder’s basis in the ordinary shares and thereafter as taxable capital gain. ASML does not maintain calculations of its earnings and profits under United States federal income tax principles.
Subject to limitations provided in the United States Internal Revenue Code, a United States Holder may generally deduct from its United States federal taxable income, or credit against its United States federal income tax liability, the amount of qualified Netherlands withholding taxes. However, Netherlands withholding tax may be deducted only if the United States Holder does not claim a credit for any Netherlands or other non-United States taxes paid or accrued in that year. In addition, Netherlands dividend withholding taxes will likely not be creditable against the United States Holder’s United States tax liability to the extent ASML is not required to pay over the amount withheld to the Netherlands Tax Administration. Currently, a Netherlands corporation that receives dividends from qualifying non-Netherlands subsidiaries may credit source country tax withheld from those dividends against Netherlands withholding tax imposed on a dividend paid by a Netherlands corporation, up to a maximum of 3 percent of the dividend paid by the Netherlands corporation. The credit reduces the amount of dividend withholding that ASML is required to pay to the Netherlands Tax Administration but does not reduce the amount of tax ASML is required to withhold from dividends.
Recently enacted United States tax legislation (the “2003 Tax Act”) reduces to 15 percent the maximum tax rate for certain dividends received by individuals through taxable years beginning on or before December 31, 2008, so long as the stock has been held for more than 60 days during the 120 day period beginning 60 days before the ex-dividend date. Dividends received from “qualified foreign corporations” generally qualify for the reduced rate. A non-United States corporation (other than a foreign personal holding company, foreign investment company, or passive foreign investment company) generally will be considered to be a qualified foreign corporation if (i) the shares of the non-United States corporation are readily tradable on an established securities market in the United States or (ii) the non-United States corporation is eligible with respect to substantially all of its income for the benefits of a comprehensive income tax treaty with the United States which contains an exchange of information program. The Tax Treaty has been identified as a qualifying treaty. Individual United States Holders should consult their tax advisors regarding the impact of the provisions of the 2003 Tax Act on their particular situations.
Taxation on Sale or Other Disposition of Ordinary Shares
Upon a sale or other disposition of ordinary shares, a United States Holders will generally recognize capital gain or loss for United States federal income tax purposes in an amount equal to the difference between the amount realized, if paid in U.S. dollars, or the U.S. dollar value of the amount realized (determined at the spot rate on the settlement date of the sale) if proceeds are paid in currency other than the U.S. dollar, as the case may be, and the United States Holder’s tax basis (determined in U.S. dollars) in such ordinary shares. Generally, the capital gain or loss will be long-term capital gain or loss if the holding period of the United States Holder in the ordinary shares exceeds one year at the time of the sale or other disposition. The deductibility of capital losses is subject to limitations for United States federal income tax purposes. Gain or
ASML ANNUAL REPORT 2006
50


Table of Contents

loss from the sale or other disposition of ordinary shares generally will be treated as United States source income or loss for United States foreign tax credit purposes. Generally, any gain or loss resulting from currency fluctuations during the period between the date of the sale of the ordinary shares and the date the sale proceeds are converted into U.S. dollars will be treated as ordinary income or loss from sources within the United States. Each United States Holder should consult its tax advisor with regard to the translation rules of its adjusted basis and the amount realized upon a sale or other disposition of its ordinary shares if purchased in, or sold or disposed of for, a currency other than U.S. dollar.
Information Reporting and Backup Withholding
Information returns may be filed with the Internal Revenue Service (“IRS”) in connection with payments on the ordinary shares or proceeds from a sale, redemption or other disposition of the ordinary shares. A “backup withholding” tax may apply to these payments if the beneficial owner fails to provide a correct taxpayer identification number to the paying agent and to comply with certain certification procedures or otherwise establish an exemption from backup withholding. Any amounts withheld under the backup withholding rules might be refunded (or credited against the beneficial owner’s United States federal income tax liability, if any) depending on the facts and provided that the required information is furnished to the IRS.
The discussion set forth above is included for general information only and may not be applicable depending upon a holder’s particular situation. Holders should consult their tax advisors with respect to the tax consequences to them of the purchase, ownership and disposition of shares including the tax consequences under state, local and other tax laws and the possible effects of changes in United States federal and other tax laws.
F. Dividends and Paying Agents
Not applicable.
G. Statement by Experts
Not applicable.
H. Documents on Display
We are subject to certain of the reporting requirements of the US Securities Exchange Act of 1934 (the “Exchange Act”). As a “foreign private issuer”, we are exempt from the rules under the Exchange Act prescribing certain disclosure and procedural requirements for proxy solicitations, and our officers, directors and principal shareholders are exempt from the reporting and “short-swing” profit recovery provisions contained in Section 16 of the Exchange Act, with respect to their purchases and sales of shares. In addition, we are not required to file reports and financial statements with the Commission as frequently or as promptly as companies that are not foreign private issuers whose securities are registered under the Exchange Act. However, we are required to file with the Commission, within six months after the end of each fiscal year, an annual report on Form 20-F containing financial statements audited by an independent accounting firm. We publish unaudited interim financial information after the end of each quarter. We furnish this quarterly financial information to the Commission under cover of a Form 6-K.
You may read and copy any document we file with the Commission at its public reference facilities at 450 Fifth Street, N.W., Washington, DC 20549, Woolworth Building, 233 Broadway, New York, New York 10048 and Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661-2511. You may also obtain copies of the documents at prescribed rates by writing to the Public Reference Section of the Commission at 450 Fifth Street, N.W., Washington DC 20549. The Commission also maintains a website that contains reports and other information regarding registrants that are required to file electronically with the Commission. The address of this website is http://www.sec.gov. Please call the Commission at 1-800-SEC-0330 for further information on the operation of the public reference facilities.
I. Subsidiary Information
See Item 4.C. “Organizational Structure.”
Item 11 Quantitative and Qualitative Disclosures About Market Risk
We are subject to market risks including changes in foreign exchange rates and interest rates. In order to hedge the risks of changes in foreign exchange rates and interest rates, we use derivative instruments in accordance with established policies. None of these transactions are entered into for trading purposes.
Foreign currency exchange rate risk
We operate globally and are thus exposed to foreign exchange risk arising from volatility in currency exchange rates.
We price most of our product sales in euro. However, a portion of our sales, cost of sales and expenses are denominated in U.S. dollars and Japanese Yen, and we expect that this will continue to be so for the foreseeable future. We hedge material foreign exchange transaction risk exposure, such as sales transactions, forecasted purchase transactions, accounts receivable
ASML ANNUAL REPORT 2006
51


Table of Contents

and accounts payable. This exposure is mainly hedged with financial instruments such as foreign exchange forward contracts and foreign exchange options. We closely monitor the effectiveness of our outstanding hedge contracts throughout the life of the hedges. The majority of financial instruments that we use to hedge foreign exchange risk have a duration of less than one year.
As of December 31, 2006, we anticipate other comprehensive gain of EUR 4.1 million (December 31, 2005: EUR 9.9 million loss) to represent the total anticipated gain to be released to sales and other comprehensive loss of EUR 2.1 million (December 31, 2005: EUR 1.2 million loss) to represent the total anticipated loss to be charged to cost of sales over the next 12 months as the forecasted sales and purchase transactions occur.
Since we have subsidiaries outside the euro-zone, a part of our shareholder’s equity is denominated in foreign currency and, as a result, exposed to fluctuations in exchange rates. It is our policy to manage material translation exposures resulting predominantly from ASML’s U.S. dollar net investments. Throughout 2004 and 2005 a proportion of our USD 575 million 5.75 percent Convertible Subordinated Notes due 2006 was assigned to hedge a certain part of our U.S. dollar net investments. As from December 2005 onwards, forward contracts have been assigned to hedge this exposure. The related foreign currency translation amounts (gross of taxes) included in cumulative translation adjustment for the years ended December 31, 2004, 2005 and 2006 were EUR 10.8 million gain, EUR 28.2 million loss and EUR 16.0 million gain, respectively.
Interest rate risk
Our exposure to the market risk of changes in interest rates relates primarily to our debt obligations and our cash balance. Interest rate swaps that we use to hedge the fair value of fixed loan coupons payable are designated as fair value hedges, with changes in fair value recorded under interest income and expense in our statement of operations. The accumulated change in fair value is intended to offset the change in the fair value of the underlying fixed loan coupons, which is recorded accordingly. Interest rate swaps that we use to hedge changes in the variability of future interest receipts are designated as cash flow hedges. The critical terms of the hedging instruments are the same as those for the underlying assets. Accordingly, all changes in fair value of these derivative instruments are recorded as other comprehensive income. The accumulated changes in fair value of the derivatives are intended to offset changes in future interest cash flows on the assets. The hedging relationship between interest rate swaps and hedged fixed loan coupons is highly effective.
As of December 31, 2006 we had two EUR interest rate swaps outstanding with nominal values of EUR 380 million in total on which we pay a floating interest of 3.59 percent. These interest rate swaps, which are designated as cash flow hedges, have fixed interest receipts at an average of 3.69 percent for periods up until May 2010 and have floating interest payments at 3 months EURIBOR.
See Notes 1, 4 and 11 to our consolidated financial statements, which are incorporated herein by reference.
Credit risk
Financial instruments that potentially subject us to significant concentrations of credit risk consist principally of cash and cash equivalents, accounts receivable and derivative financial instruments used in hedging activities.
Financial instruments contain an element of risk of the counterparties being unable to meet their obligations. This financial credit risk is monitored and minimized per type of financial instrument by limiting our counterparties to a sufficient number of major financial institutions and issuers of commercial paper. We do not expect the counterparties to default given their high credit quality.
Our customers consist of integrated circuit manufacturers located throughout the world. We perform ongoing credit evaluations of its customers’ financial condition and generally requires no collateral to secure accounts receivable, we maintain an allowance for potentially uncollectible accounts receivable. We regularly review the allowance by considering factors such as historical payment experience, credit quality, age of the accounts receivable balances, and current economic conditions that may affect a customer’s ability to pay. In addition, we utilize letters of credit to mitigate credit risk when considered appropriate.
Sensitivity analysis derivative financial instruments
We use foreign exchange derivatives to manage our foreign exchange rate risk and interest rate swaps to manage our interest rate risk.
The following table summarizes our derivative financial instruments, their fair values and their sensitivity to an instantaneous 10 percent decrease of the euro against other currencies and an instantaneous 1 percent non-favorable increase in interest rates from their levels of December 31, 2005 and 2006 respectively, with all other variables held constant.
ASML ANNUAL REPORT 2006
52


Table of Contents

                                 
 
    Fair Value change
        10%
    1% non-   weakening of
    favorable   euro against
    Notional       increase in   other
    Amount2   Fair Value   interest rate   currency
(in thousands)   EUR   EUR   EUR   EUR
 
As of December 31, 2005
                               
Forward contracts1
    93,260       (6,508 )     N/A       (8,942 )
Currency options
    (29,843 )     (1,369 )     N/A       3,002  
Interest rate swaps
    917,395       (4,896 )     (3,283 )     (500 )
 
Year ended December 31, 2006
                               
Forward contracts1
    480,489       1,642       N/A       (53,388 )
Currency options
    73,049       2,740       N/A       (3,227 )
Interest rate swaps
    429,900       (4,447 )     (10,481 )     N/A  
 
(Source: Bloomberg)
Includes forward contracts on U.S. Dollars, Hong Kong Dollars, British Pounds, Swiss Francs, Israeli Shekel, Japanese Yen, Singapore Dollars, Taiwanese Dollars and Korean Wons.
Net amount of forward and option contracts assigned as a hedge to sales and purchase transactions, to monetary assets and liabilities and to net investments in foreign operations.
The fair value of forward contracts (used for hedging purposes) is the estimated amount that a bank would receive or pay to terminate the forward contracts at the reporting date, taking into account the current interest rates, current exchange rates and current creditworthiness of the counterparties.
The fair value of currency options (used for hedging purposes) is the estimated amount that a bank would receive or pay to terminate the option agreements at the reporting date, taking into account the current interest rates, current exchange rates, volatility and current creditworthiness of the counterparties.
The fair value of interest rate swaps (used for hedging purposes) is the estimated amount that a bank would receive or pay to terminate the swap agreements at the reporting date, taking into account the current interest rates and current creditworthiness of the counterparties.
Item 12 Description of Securities Other Than Equity Securities
Not applicable.
ASML ANNUAL REPORT 2006
53


Table of Contents

Part II
Item 13 Defaults, Dividend Arrearages and Delinquencies
None.
Item 14 Material Modifications to the Rights of Security Holders and Use of Proceeds
None.
Item 15 Controls and Procedures
Disclosure Controls and Procedures
As of the end of the period covered by this report, management of ASML conducted an evaluation, under the supervision and with the participation of ASML’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of ASML’s disclosure controls and procedures (as defined in 17 CFR 240.13a-15(e) or 240.15d-15(e)) based on the evaluation of these controls and procedures required by paragraph (b) of 17 CFR 240.13a-15 or 240.15d-15.
Management’s Report on Internal Control over Financial Reporting
ASML’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in 17 CFR 240.13a-15(f)for ASML. Under the supervision and with the participation of ASML’s Chief Executive Officer and Chief Financial Officer, ASML’s management conducted an evaluation of the effectiveness of ASML’s internal control over financial reporting based upon the framework in “Internal Control — Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission as of the end of the period covered by this report. Based on that evaluation, management has concluded that ASML’s internal control over financial reporting was effective as of December 31, 2006 at providing reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.
Deloitte Accountants B.V., an independent registered public accounting firm, has audited the consolidated financial statements included in this annual report on Form 20-F and, as part of the audit, has issued a report, included herein, on ASML’s management’s assessment of the effectiveness of ASML’s internal control over financial reporting and the effectiveness of ASML’s internal control over financial reporting.
Changes in Internal Control over Financial Reporting
During the year ended December 31, 2006 there have been no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Inherent Limitations of Disclosure Controls and Procedures in Internal Control over Financial Reporting
It should be noted that any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system will be met. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events.
Item 16
A. Audit Committee Financial Expert
Our Supervisory Board has determined that effective March 18, 2004, Mr. Fritz Fröhlich, an independent member of the Supervisory Board, qualifies as the Audit Committee Financial Expert.
B. Code of Ethics
ASML’s Code on Ethical Business Conduct
ASML has adopted its “Principles of Ethical Business Conduct”, which contain ASML’s ethical principles in relation to various subjects. These Principles have been developed into day-to-day guidelines (the “Internal Guidelines on Ethical Business Conduct”). The Internal Guidelines on Ethical Business Conduct apply to ASML employees worldwide, including ASML’s
ASML ANNUAL REPORT 2006
54


Table of Contents

Supervisory Board and Board of Management. Our Principles of Ethical Business Conduct and Internal Guidelines on Ethical Business Conduct are posted on our website (www.asml.com).
The Internal Guidelines on Ethical Business Conduct contain, among others, written standards that are reasonably designed to deter wrongdoing and to promote:
•  honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships;
•  full, fair, accurate, timely, and understandable disclosure in reports and documents that ASML files with, or submits to, the SEC and in other public communications made by ASML;
•  compliance with applicable governmental laws, rules and regulations;
•  prompt internal reporting of violations on the Internal Guidelines on Ethical Business Conduct to an appropriate person or persons identified in these guidelines; and
•  accountability for adherence to the guidelines.
C. Principal Accountant Fees and Services
Deloitte Accountants B.V. has served as our independent registered public accounting firm for each of the three years in the period ended December 31, 2006. The following table sets forth the aggregate fees for professional audit services and other services rendered by Deloitte Accountants B.V. in 2005 and 2006.
                 
 
Year ended December 31   2005   2006
(in thousands)   EUR   EUR
 
Audit Fees
    1,333       1,438  
Audit-related Fees
    92       266  
Tax Fees
    448       216  
 
Total
    1,873       1,920  
 
Audit fees
Audit fees primarily relate to the audit of our annual financial statements set forth in our Annual Report on Form 20-F, agreed upon procedures work on our quarterly financial results, services related to statutory and regulatory filings of ASML Holding N.V. and its subsidiaries and services in connection with accounting consultations on U.S. GAAP.
Audit-related fees
Audit-related fees mainly comprise services in connection with intended acquisitions, services in connection with consultations on implementing the requirements of Section 404 of the Sarbanes-Oxley Act and services in connection with accounting consultations on IFRS (2005).
Tax fees
Tax fees can be detailed as follows:
                 
 
Year ended December 31   2005   2006
(in thousands)   EUR   EUR
 
Corporate Income Tax compliance services
    185       59  
Tax assistance for expatriate employees
    186       70  
Other tax advisory and compliance
    77       87  
 
Total
    448       216  
 
The Audit Committee has approved the internal and external audit plan and related audit fees for the year 2006. The Audit Committee has adopted a policy regarding audit and non-audit services, in consultation with Deloitte Accountants B.V. This policy ensures the independence of our auditors by expressly setting forth all services that the auditors may not perform and reinforcing the principle of independence regardless of the type of work performed. Certain non-audit services, such as certain tax-related services and acquisition advisory services, are permitted. The Audit Committee pre-approves all audit and non-audit services not specifically prohibited under this policy and reviews the annual external audit plan and any subsequent engagements.
ASML ANNUAL REPORT 2006
55


Table of Contents

D. Exemptions from the Listing Standards for Audit Committees
Not applicable.
E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers
At March 23, 2006 the General Meeting of Shareholders authorized the Board of Management, subject to approval of the Supervisory Board, to repurchase up to a maximum of 10 percent of our issued shares through September 23, 2006 at a price between the nominal value of the ordinary shares purchased and 110 percent of the market price of these securities on Euronext Amsterdam or Nasdaq.
Pursuant to this authorization by the annual General Meeting of Shareholders, we executed two share buy back programs in 2006 to return excess cash to shareholders through the reduction of the number of outstanding shares. The aggregate number of shares bought back under these programs was 40,385,139 or 8.3 percent of outstanding shares. For more details about the two programs, see below.
We intend to execute a program to buy back the remaining 1.7 percent of the maximum of 10 percent of outstanding shares in 2007. These shares shall either be used to cover outstanding stock options or be cancelled.
Share buyback program I
The aggregate number of shares bought back in this Repurchase Program was 25,450,296, representing 100 percent of the announced objective of maximum EUR 400 million and 5.25 percent of outstanding shares. This 2006 Repurchase Program was completed in the third quarter of 2006. Shares repurchased have been recorded at cost and are classified within shareholders’ equity. ASML intends to cancel these repurchased shares.
The following table provides a summary of shares repurchased by the Company in 2006 under this program:
                                 
 
    Total Number of   Total Value of Shares
    Shares Purchased as   Purchased as Part of
    Part of Publicly   Publicly Announced
    Total Number of   Average Price Paid   Announced Plans or   Plans or Programs
Period   Shares purchased   per Share (EUR)   Programs   (In EUR million)
 
May 17-26, 2006
    6,412,920       15.59       6,412,920       100  
June 7-30, 2006
    13,517,078       15.81       19,929,998       314  
July 3-13, 2006
    5,520,298       15.62       25,450,296       400  
 
Share buyback program II
In addition, in order to mitigate the dilution due to the issuance of shares upon conversion of its convertible bonds due October 2006, ASML repurchased a further 14,934,843 shares pursuant to a call option transaction announced on October 9, 2006. These shares were subsequently reissued in order to satisfy the conversion rights of holders of ASML’s 5.75 percent Convertible Subordinated Notes. The Company paid an aggregate of EUR 277 million in cash for these shares. This repurchase program was completed in the fourth quarter of 2006. These shares were purchased from a third party which issued the call option.
The following table sets forth the details of the shares repurchased pursuant to the call option transaction described above:
                                 
 
    Total Number of   Total Value of Shares
    Shares Purchased as   Purchased as Part of
    Part of Publicly   Publicly Announced
    Total Number of   Average Price Paid   Announced Plans or   Plans or Programs
Period   Shares purchased   per Share (EUR)   Programs   (In EUR million)
 
October 12, 2006
    14,934,843       18.55       14,934,843       277  
 
ASML ANNUAL REPORT 2006
56


Table of Contents

Part III
Item 17 Financial Statements
Not applicable.
Item 18 Financial Statements
In response to this item, the Company incorporates herein by reference the consolidated financial statements of the Company set forth on pages F-2 through F-46 hereto.
Item 19 Exhibits
     
 
Exhibit No.   Description
 
1
  Articles of Association of ASML Holding N.V. (English translation) (Incorporated by reference to Amendment No. 9 to the Registrant’s Registration Statement on Form 8-A/A, filed with the Commission on June 28, 2006)
2.1
  Paying Agent, Conversion Agent and Registrar Agreement between ASML Holding N.V. and the Bank of New York relating to the Registrant’s 5.50 percent Convertible Subordinated Notes due 2010 (Incorporated by reference to the Registrant’s Annual Report on Form 20-F for the fiscal year ended December 31, 2003)
4.1
  Agreement between ASML Lithography B.V. and Carl Zeiss, dated March 17, 2000 (Incorporated by reference to the Registrant’s Annual Report on Form 20-F for the fiscal year ended December 31, 2000) #
4.2
  Agreement between ASML Holding N.V. and Carl Zeiss, dated October 24, 2003 (Incorporated by reference to the Registrant’s Annual Report on Form 20-F for the year ended December 31, 2003) #
4.3
  Form of Indemnity Agreement between ASML Holding N.V. and members of its Board of Management (Incorporated by reference to the Registrant’s Annual Report on Form 20-F for the year ended December 31, 2003)
4.4
  Form of Indemnity Agreement between ASML Holding N.V. and members of its Supervisory Board (Incorporated by reference to the Registrant’s Annual Report on Form 20-F for the year ended December 31, 2003)
4.5
  Employment Agreement between ASML Holding N.V. and Klaus Fuchs (Incorporated by reference to the Registrant’s Annual Report on Form 20-F for the fiscal year ended December 31, 2005)
4.6
  Employment Agreement between ASML Holding N.V. and Eric Meurice (Incorporated by reference to the Registrant’s Annual Report on Form 20-F for the fiscal year ended December 31, 2004)
4.7
  Form of Employment Agreement for members of the Board of Management (Incorporated by reference to the Registrant’s Annual Report on Form 20-F for the fiscal year ended December 31, 2003)
4.8
  Nikon-ASML Patent Cross License Agreement, dated December 10, 2004, between ASML Holding N.V. and Nikon Corporation (Incorporated by reference to the Registrant’s Annual Report on Form 20-F for the fiscal year ended December 31, 2004) #
4.9
  ASML/Zeiss Sublicense Agreement, 2004, dated December 10, 2004, between Carl Zeiss SMT AG and ASML Holding N.V. (Incorporated by reference to the Registrant’s Annual Report on Form 20-F for the fiscal year ended December 31, 2004) #
4.10
  ASML New Hires and Incentive Stock Option Plan For Management (Version 2003) (Incorporated by reference to exhibit 4.4 to the Registrant’s Statement on Form S-8, filed with the Commission on September 2, 2003) (file No. 333-109154)
4.11
  ASML Option Plan for Management of ASML Holding Group Companies (Incorporated by reference to the Registrant’s Registration Statement on Form S-8 filed with the Commission on June 30, 2005 (file No. 333-126340))
4.12
  Consultancy Agreement between David Chavoustie and ASML Holding N.V. (Incorporated by reference to the Registrant’s Annual Report on Form 20-F for the fiscal year ended December 31, 2005)
4.13
  ASML Stock Option Plan for New Hire Options granted to Members of the Board of Management (Version April 2006) (Incorporated by reference to the Registrant’s Registration Statement on Form S-8 filed with the Commission on August 7, 2006 (file No. 333-136362))
4.15
  ASML Stock Option Plan for Incentive or New Hire Options granted to Senior and Executive Management (Version April 2006) (Incorporated by reference to the Registrant’s Registration Statement on Form S-8 filed with the Commission on August 7, 2006 (file No. 333-136362))
4.16
  ASML Stock Option Plan for Incentive or New Hire Options granted to Senior and Executive Management (Version July 2006) (Incorporated by reference to the Registrant’s Registration Statement on Form S-8 filed with the Commission on August 7, 2006 (file No. 333-136362))
4.17
  ASML Stock Option Plan for Incentive or New Hire Options granted to Senior and Executive Management (Version October 2006) (Incorporated by reference to the Registrant’s Registration Statement on Form S-8 filed with the Commission on August 7, 2006 (file No. 333-136362))
8.1
  List of Material Subsidiaries*
12.1
  Certification of CEO and CFO Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934*
13.1
  Certification of CEO and CFO Pursuant to Rule 13a-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
15.1
  Consent of Deloitte Accountants B.V.*
 
* Filed at the Commission herewith
# Certain information omitted pursuant to a request for confidential treatment filed separately with the Securities and Exchange Commission
ASML ANNUAL REPORT 2006
57


Table of Contents

Signatures
ASML Holding N.V. hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.
ASML Holding N.V.
(Registrant)
/s/ Eric Meurice
President, Chief Executive Officer and Chairman of the Board of Management
Dated: January 26, 2007
/s/ Peter T.F.M. Wennink
Executive Vice President, Chief Financial Officer and Member of the Board of Management
Dated: January 26, 2007
ASML ANNUAL REPORT 2006
58


Table of Contents

Index to Financial Statements
     
F-2
  Consolidated Statements of Operations for the years ended December 31, 2004, 2005 and 2006
F-3
  Consolidated Statements of Comprehensive Income for the years ended December 31, 2004, 2005 and 2006
F-3
  Consolidated Balance Sheets as of December 31, 2005 and 2006
F-4
  Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2004, 2005 and 2006
F-5
  Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2005 and 2006
F-6
  Notes to the Consolidated Financial Statements
F-39
  Report of Independent Registered Public Accounting Firm
ASML ANNUAL REPORT 2006
F- 1


Table of Contents

Consolidated Statements of Operations
                             
 
    Year ended December 31   2004   2005   2006
Notes   (in thousands, except per share data)   EUR   EUR   EUR
 

16
  Net system sales     2,174,908       2,227,678       3,229,065  
    Net service and field option sales     290,469       301,289       368,039  
 
 
    Total net sales     2,465,377       2,528,967       3,597,104  
    Cost of system sales     1,372,056       1,366,026       1,911,362  
    Cost of service and field option sales     187,682       188,746       223,724  
 
 

3
  Total cost of sales     1,559,738       1,554,772       2,135,086  
 
 
    Gross profit on sales     905,639       974,195       1,462,018  
    Research and development costs     352,920       347,901       413,708  
    Research and development credits     (21,961 )     (24,027 )     (27,141 )
    Selling, general and administrative costs     201,629       201,204       204,799  

3
  Restructuring charges (credits)     (5,862 )     0       0  
 
 
    Income from operations     378,913       449,117       870,652  
    Interest income     27,998       38,429       49,634  
    Interest expense     (44,071 )     (52,523 )     (50,488 )
 
 
    Income from operations before income taxes     362,840       435,023       869,798  
15
  Provision for income taxes     (127,380 )     (123,559 )     (245,109 )
 
 
    Net income     235,460       311,464       624,689  
    Basic net income per ordinary share     0.49       0.64       1.32  
    Diluted net income per ordinary share     0.49       0.64       1.27  
    Number of ordinary shares used in computing per share amounts (in thousands)                        
    Basic     483,380       484,103       474,860  
    Diluted     484,661       542,979       503,983  
 
ASML ANNUAL REPORT 2006
F- 2


Table of Contents

Consolidated Statements of Comprehensive Income
                         
 
Year ended December 31   2004   2005   2006
(in thousands)   EUR   EUR   EUR
 
Net income
    235,460       311,464       624,689  
Foreign currency translation, net of taxes
    (21,832 )     25,389       (20,104 )
Gain (loss) on derivative instruments
    16,736       (38,365 )     11,240  
 
 
Comprehensive income
    230,364       298,488       615,825  
 
Consolidated Balance Sheets
                     
 
    As of December 31   2005   2006
Notes   (in thousands, except share and per share data)   EUR   EUR
 
    Assets                
    Cash and cash equivalents     1,904,609       1,655,857  
5
  Accounts receivable, net     302,572       672,762  
6
  Inventories, net     777,200       808,481  
15
  Deferred tax assets short term     95,636       141,255  
7
  Other current assets     125,802       147,683  
 
 
    Total current assets     3,205,819       3,426,038  
 
15
  Deferred tax assets     206,884       200,378  
7
  Other assets     39,796       35,653  
8
  Intangible assets, net     24,943       18,076  
9
  Property, plant and equipment, net     278,581       270,890  
 
 
    Total assets     3,756,023       3,951,035  
 
    Liabilities and Shareholders’ Equity                
    Accounts payable     343,962       326,995  
3, 10
  Accrued liabilities and other     985,621       665,842  
15
  Deferred tax liabilities short term     390       825  
    Current tax liabilities     90,010       187,751  
 
 
    Total current liabilities     1,419,983       1,181,413  
 
15
  Deferred tax and other liabilities     224,219       223,463  
12, 13
  Other deferred liabilities     17,426       8,271  
11
  Convertible subordinated debt     380,238       380,000  
11
  Other long term debt     2,320       1,433  
 
 
    Total liabilities     2,044,186       1,794,580  
 
12, 14
  Commitments and contingencies                
    Cumulative Preference Shares, EUR 0.02 nominal value;
900,000,000 shares authorized; none outstanding at December 31, 2005 and 2006
    0       0  
 
    Priority Shares, EUR 0.02 nominal value; 23,100 shares authorized, issued and outstanding at December 31, 2005 and 0 at December 31, 2006     1       0  
 
    Ordinary Shares, EUR 0.02 nominal value; 900,000,000 shares authorized; 484,670,183 shares issued and outstanding at December 31, 2005 and 477,099,245 at December 31, 2006     9,693       10,051  
 
    Share premium     917,564       1,195,034  
    Treasury shares at cost     0       (401,000 )
    Retained earnings     663,034       1,239,689  
    Accumulated other comprehensive income     121,545       112,681  
 
 
20
  Total shareholders’ equity     1,711,837       2,156,455  
    Total liabilities and shareholders’ equity     3,756,023       3,951,035  
 
 
ASML ANNUAL REPORT 2006
F- 3


Table of Contents

Consolidated Statements of Shareholders’ Equity
                                                         
 
            Accumulated    
    Issued and outstanding       Treasury   Other    
    Shares   APIC/Share   Retained   Shares at   Comprehensive    
    Number   Amount   Premium   Earnings   cost   Income   Total
(in thousands)       EUR   EUR   EUR   EUR   EUR   EUR
 
Balance at January 1, 2004
    482,514       9,651       875,829       116,110       0       139,617       1,141,207  
 
Components of comprehensive income:
                                                       
Net income
                            235,460                       235,460  
Foreign Currency Translation
                                            (21,832 )     (21,832 )
Gain (loss) on derivative instruments
                                            16,736       16,736  
Issuance of Shares
    1,162       24       20,007               0               20,031  
 
 
Balance at December 31, 2004
    483,676       9,675       895,836       351,570       0       134,521       1,391,602  
 
Components of comprehensive income:
                                                       
Net income
                            311,464                       311,464  
Foreign Currency Translation
                                            25,389       25,389  
Gain (loss) on derivative instruments
                                            (38,365 )     (38,365 )
 
Tax benefit from stock options
                    5,919                               5,919  
 
Issuance of Shares
    994       19       15,809                               15,828  
 
 
Balance at December 31, 2005
    484,670       9,694       917,564       663,034       0       121,545       1,711,837  
 
Components of comprehensive income:
                                                       
Net income
                            624,689                       624,689  
Foreign Currency Translation
                                            (20,104 )     (20,104 )
Gain (loss) on derivative instruments
                                            11,240       11,240  
 
Purchase of treasury shares
    (25,450 )1                             (401,000 )             (401,000 )
Purchase of shares in conjunction with conversion rights of bond holders
    (14,935 )2     (299 )                     (277,235 )             (277,534 )
Issuance of shares in conjunction with convertible bonds
    30,811       616       238,862       (48,034 )     277,235               468,679  
 
Tax benefit from stock options
                    2,906                               2,906  
 
Issuance of shares and stock options
    2,003       40       35,702                               35,742  
 
 
Balance at December 31, 2006
    477,099       10,051       1,195,034       1,239,689       (401,000 )     112,681       2,156,455  
 
ASML intends to cancel its repurchased shares.
In 2006 14,934,843 shares were bought back which have subsequently been reissued in order to satisfy the conversion rights of holders of our 5.75 percent Convertible Subordinated Notes. We paid EUR 278 million in cash for these shares in total.
As of December 31, 2006 the number of issued shares is 502,550. This includes the number of issued and outstanding shares of 477,099 and treasury shares of 25,450.
ASML ANNUAL REPORT 2006
F- 4


Table of Contents

Consolidated Statements of Cash Flows
                         
 
Year ended December 31   2004   2005   2006
(in thousands)   EUR   EUR   EUR
 
Cash Flows from Operating Activities
                       
Net income
    235,460       311,464       624,689  
 
Adjustments to reconcile net income to net cash flows from operating activities:
                       
Depreciation and amortization
    90,215       90,531       87,092  
Impairment charges
    2,929       8,350       17,354  
Allowance for doubtful debts
    3,085       1,871       249  
Allowance for obsolete inventory
    34,336       11,811       54,181  
Deferred income taxes
    114,701       17,830       (69,451 )
Changes in assets and liabilities that provided (used) cash:
                       
Accounts receivable
    (192,819 )     203,488       (362,388 )
Inventories
    (149,215 )     (41,397 )     (85,213 )
Other assets
    1,127       (20,088 )     (31,366 )
Accrued liabilities
    (5,507 )     46,272       153,536  
Accounts payable
    121,998       3,406       (8,916 )
Income taxes payable
    837       79,973       97,740  
 
Net cash provided by operating activities from continuing operations
    257,147       713,511       477,507  
 
Net cash used in operating activities from discontinued operations
    (5,880 )     (2,018 )     0  
 
Net cash provided by operating activities from total operations
    251,267       711,493       477,507  
 
Cash Flows from Investing Activities
                       
Purchases of property, plant and equipment
    (74,979 )     (72,660 )     (70,619 )
Proceeds from sale of property, plant and equipment
    15,137       13,235       5,216  
Purchase of intangible assets
    (556 )     (1,378 )     (120 )
 
Net cash used in investing activities from operations
    (60,398 )     (60,803 )     (65,523 )
 
Cash Flows from Financing Activities
                       
Purchase of treasury shares
    0       0       (401,000 )
Purchase of shares in conjunction with conversion rights of bond holders
    0       0       (277,385 )
Net proceeds from issuance of shares and stock options
    20,031       15,828       35,840  
Excess tax benefits from stock options
    0       0       2,906  
Redemption and/or repayment of debt
    (1,160 )     (12,949 )     (8,318 )
 
Net cash provided by (used in) financing activities from operations
    18,871       2,879       (647,957 )
 
Net cash flows
    209,740       653,569       (235,973 )
Effect of changes in exchange rates on cash
    (9,416 )     22,910       (12,779 )
 
Net increase (decrease) in cash and cash equivalents
    200,324       676,479       (248,752 )
Cash and cash equivalents at beginning of the year
    1,027,806       1,228,130       1,904,609  
 
Cash and cash equivalents at end of the year
    1,228,130       1,904,609       1,655,857  
 
Supplemental Disclosures of Cash Flow Information:
                       
Cash paid for:
                       
Interest
    45,866       45,141       48,656  
Taxes
    7,430       15,335       217,466  
 
Supplemental non-cash investing and financing activities:
                       
Conversion of Bonds into 0, 0 and 30,811,215 ordinary shares respectively
in 2004, 2005 and 2006
    0       0       459,087  
 
ASML ANNUAL REPORT 2006
F- 5


Table of Contents

Notes to the Consolidated Financial Statements
1. General information/Summary of significant accounting policies
ASML Holding N.V., having its corporate seat in Veldhoven, the Netherlands, is a worldwide company engaged in the development, production, marketing, sale and servicing of advanced semiconductor equipment systems mainly consisting of lithography systems. ASML’s principal operations are in the Netherlands, the United States of America and Asia.
The Company’s shares are listed for trading in the form of New York Shares on Nasdaq (Nasdaq Global Select Market) and in the form of registered shares (“Amsterdam Shares”) on the Eurolist by Euronext Amsterdam. The principal trading market of the Company’s ordinary shares is Eurolist by Euronext Amsterdam.
The accompanying consolidated financial statements include the Financial Statements of ASML Holding N.V. Veldhoven, the Netherlands, and its consolidated subsidiaries (together referred to as “ASML” or the “Company”).
ASML follows accounting principles generally accepted in the United States of America (“U.S. GAAP”). ASML’s reporting currency is the euro. The accompanying consolidated financial statements are stated in thousands of euro (“EUR”) unless otherwise indicated.
Principles of consolidation
The consolidated financial statements include the accounts of ASML Holding N.V. and all of its majority-owned subsidiaries. Subsidiaries are all entities over which ASML has the power to govern the financial and operating policies generally accompanying a shareholding of more than one half of the voting rights. All intercompany profits, balances and transactions have been eliminated in the consolidation.
Use of estimates
The preparation of ASML’s consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities on the balance sheet dates and the reported amounts of revenue and expense during the reported periods. Actual results could differ from those estimates.
Foreign currency translation
The financial information for subsidiaries outside the euro-zone is generally measured using local currencies as the functional currency. The financial statements of those foreign subsidiaries are translated into euro in the preparation of ASML’s consolidated financial statements. Assets and liabilities are translated into euro at the exchange rate in effect on the respective balance sheet dates. Income and expenses are translated into euro based on the average exchange rate for the corresponding period. The resulting translation adjustments are recorded directly in shareholders’ equity. Currency differences on inter-company loans that have the nature of a long-term investment are also accounted for directly in shareholders’ equity.
Derivative financial instruments
The Company principally uses derivative foreign currency hedging instruments for the management of foreign currency risks. In accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” and SFAS No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities an amendment of SFAS No. 133”, the Company measures all derivative foreign currency hedging instruments based on fair values derived from market prices of the instruments. The Company adopts hedge accounting for all hedges that are highly effective in offsetting the identified hedged risks as required by the SFAS No. 133 effectiveness criteria.
On the date the derivative contract is entered into, ASML designates the derivative as either a hedge of the fair value of a recognized asset or liability in non-functional currencies (“fair value” hedge), or a hedge of cash flows related to sales transactions or purchase transactions in non-functional currencies (“cash flow” hedge), or a hedge of the foreign currency exposure of a net investment in a foreign operation. ASML formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedge transactions. ASML also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. When it is determined that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge (e.g. because of the sale, expiration and/or termination of the derivative), ASML discontinues hedge accounting prospectively. Changes in the fair value of a derivative that is designated and qualifies as a fair-value hedge, along with the loss or gain on the hedged asset or liability that is attributable to the hedged risk, are recorded in the statement of operations. Changes in the fair value of a derivative that is designated and qualifies as a cash flow hedge are recorded in other comprehensive income, until underlying hedged transaction is recognized in the statement of operations. In the event that the underlying hedge transaction does not occur, or it
ASML ANNUAL REPORT 2006
F- 6


Table of Contents

becomes probable that it will not occur, the gain or loss on the related cash flow hedge is immediately released from accumulated other comprehensive income and included in the statement of operations. Changes in the hedge of the foreign currency exposure of a net investment in a foreign operation are recorded in other comprehensive income.
Interest rate swaps that are being used to hedge changes in the variability of future interest receipts are designated as cash flow hedges. The critical terms of the hedging instruments are the same as those for the underlying assets. Accordingly, all changes in fair value of these derivative instruments are recorded as other comprehensive income. The accumulated changes in fair value of the derivatives are intended to offset changes in future interest cash flows on the assets.
The maximum length of time of cash flow hedges is the time elapsed from the moment the exposure is generated until the actual settlement.
Interest rate swaps that are being used to hedge the fair value of fixed loan coupons payable are designated as fair value hedges. The change in fair value is intended to offset the change in the fair value of the underlying fixed loan coupons, which is recorded accordingly.
The Company records any ineffective portion of foreign currency hedging instruments in sales or cost of sales in the statement of operations. Ineffectiveness of hedging instruments had a positive impact of EUR 0.3 million, EUR 0 million and EUR 0 million in 2004, 2005 and 2006, respectively.
The ineffective portion of interest rate swaps is recorded in interest income (expense). The Company did not have benefits or costs due to ineffectiveness of interest rate swaps in 2004, 2005 and 2006.
Cash and cash equivalents
Cash and cash equivalents consist primarily of highly liquid investments, such as bank deposits, commercial paper and Money Market Funds, with insignificant interest rate risk and remaining maturities of three months or less at the date of acquisition.
Inventories
Inventories are stated at the lower of cost (first-in, first-out method) or market value. Cost includes net prices paid for materials purchased, charges for freight and customs duties, production labor cost and factory overhead. Allowances are made for slow moving, obsolete or unsaleable inventory.
Intangible assets
Intangible assets include acquired intellectual property rights that are valued at cost or estimated fair value and are amortized on a straight-line basis over the term of the rights ranging from three to ten years.
Property, plant and equipment
Property, plant and equipment are stated at cost, less accumulated depreciation and any accumulated impairment losses. Depreciation is calculated using the straight-line method based on the estimated useful lives of the related assets. In the case of leasehold improvements, the estimated useful lives of the related assets do not exceed the remaining term of the corresponding lease. The following table presents the assigned economic lives of ASML’s property, plant and equipment:
         
 
Category   Assigned economic life
 
Buildings and constructions
  5 – 40 years
Machinery and equipment
  2 – 5 years
Furniture, fixtures and other equipment
  3 – 5 years
Leasehold improvements
  5 – 10 years
 
Certain internal and external costs associated with the purchase and/or development of internally used software are capitalized when both the preliminary project stage is completed and management has authorized further funding for the project, which it has deemed probable to be completed and to be usable for the intended function. These costs are amortized on a straight-line basis over the period of related benefit, which ranges primarily from two to five years.
Evaluation of long-lived assets for impairment
The Company evaluates its long-lived assets, which include property, plant and equipment and intangible assets, 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
ASML ANNUAL REPORT 2006
F- 7


Table of Contents

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 cost to sell.
Revenue recognition
ASML recognizes revenue when all four revenue recognition criteria are met: persuasive evidence of an arrangement exists; delivery has occurred or services have been rendered; seller’s price to buyer is fixed or determinable; and collectibility is reasonably assured. At ASML, this policy generally results in revenue recognition from the sale of a system upon shipment. The revenue from the installation of a system is generally recognized upon completion of that installation at the customer site. Each system undergoes, prior to shipment, a “Factory Acceptance Test” in ASML’s 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, ASML has 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 ASML’s results of operations for the fiscal period in which the deferral occurred and on the succeeding fiscal period. At December 31, 2006 and 2005 we had no deferred revenue from shipments of new technology. During the three years ended December 31, 2006, 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.
ASML has no significant repurchase commitments in its general sales terms and conditions. From time to time, the Company repurchases systems that it has manufactured and sold and, following refurbishment, resells those systems to other customers. This repurchase decision is driven by market demand expressed by other customers and not by explicit or implicit contractual arrangements relating to the initial sale. The Company considers reasonable offers from any vendor, including customers, to repurchase used systems so that it can refurbish, resell and install these systems as part of its normal business operations. Once repurchased, the repurchase price of the used system is recorded in work-in-process inventory during the period it is being refurbished, following which the refurbished system is reflected in finished products inventory until it is sold to the customer. As of December 31, 2006 ASML has repurchase commitments for an amount of EUR 24 million.
A portion of our revenue is derived from contractual arrangements with our customers that have multiple deliverables, such as installation and training services and prepaid service 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 is recognized over the term of the contract.
The deferred revenue balance from installation and training services amounted to approximately EUR 13 million and EUR 27 million, respectively, at December 31, 2006. The deferred revenue balance from prepaid service contracts amounted to approximately EUR 121 million as of December 31, 2006.
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. These discounts do not relate to future purchases or trade-ins with the exception of volume discounts. 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. 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 or discounted products or services in connection with a current revenue transaction, 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.
Accounting for shipping and handling fees and costs
ASML bills the customer for, and recognizes as revenue, any charges for shipping and handling costs. The related costs are recognized as cost of sales.
ASML ANNUAL REPORT 2006
F- 8


Table of Contents

Cost of sales
Costs of system sales comprise direct product costs such as materials, labor, cost of warranty, depreciation, shipping and handling costs and related overhead costs. ASML accrues for the estimated cost of the warranty on its systems, which includes the cost of labor and parts necessary to repair systems during the warranty period. The amounts recorded in the warranty accrual are estimated based on actual historical expenses incurred and on estimated probable future expenses related to current sales. Actual warranty costs are charged against the accrued warranty reserve. Costs of service sales comprise direct service costs such as materials, labor, depreciation and overhead costs.
Restructuring
ASML applies the criteria defined in SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” and SFAS No. 112, “Employers’ Accounting for Postemployment Benefits”, in order to determine when a liability for restructuring or exit costs should be recognized. With respect to employee termination costs, the Company applies SFAS No. 146 in the case of benefit arrangements that, in substance, do not constitute an ongoing benefit arrangement. SFAS No. 112 is applied when termination benefits are provided under an ongoing benefit arrangement. SFAS No. 146 establishes that a liability for a cost associated with an exit or disposal activity shall be recognized and measured initially at its fair value in the period in which the liability is incurred; that is, when a detailed plan exists, has been committed to by management and communicated to employees. SFAS No. 112 establishes that a liability for termination benefits provided under an ongoing benefit arrangement covered by SFAS No. 112 is recognized when the likelihood of future settlement is probable and can be reasonably estimated.
Other exit costs include purchase and other commitments to be settled or fulfilled. Related costs are estimated based on expected settlement fees and committed payments, taking into account future potential benefits, if any, from those commitments.
The allocation of restructuring expenses to either cost of sales or restructuring expenses is determined by reference to the workforce to which the restructuring expenses relate. Restructuring expenses relating to the Company’s manufacturing and service workforce are allocated to cost of sales, while restructuring expenses relating to research and development and selling, general and administrative activities are presented as restructuring charges. Restructuring credits are also recorded in the same line of the statement of operations as used when the original expenses were initially recognized.
Research and development costs and credits
Costs relating to research and development are charged to operating expense as incurred. ASML receives subsidies and other credits only from governmental institutes. These subsidies and other governmental credits to cover research and development costs relating to approved projects are recorded as research and development credits in the period when such costs occur.
Stock options
On January 1, 2006, we implemented the provisions of SFAS No. 123 (R), “Share-Based Payment”, using the modified prospective transition method. SFAS No. 123 (R) requires companies to recognize the cost of employee services received (compensation expenses) in exchange for awards of equity instruments based upon the grant-date fair value of those instruments. The grant-date fair value of these instruments was estimated using a Black-Scholes option valuation model. This Black-Scholes pricing model requires the use of assumptions, including 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. Our income before income taxes and net income was negatively impacted with EUR 8.8 million and EUR 7.4 million, respectively due to the adoption of SFAS No. 123 (R).
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, compensation expenses for the portion of equity-based awards for which the requisite service has not been rendered and that are outstanding as of January 1, 2006 are also recognized as the requisite service is rendered on or after that date. Compensation expenses are then amortized on a straight-line basis over the requisite service period of the awards, which is generally the vesting period. The total gross amount of recognized expenses associated with share based payments was EUR 9.7 million in 2006.
Under the modified prospective transition method, no restatement of prior interim periods and fiscal years has been made. 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 not below the fair market price of the underlying common stock on the grant date, no compensation expenses were recognized in the consolidated statements of operations.
ASML ANNUAL REPORT 2006
F- 9


Table of Contents

Had compensation expenses been determined based upon the fair value at the grant date for awards under the plan consistent with the methodology prescribed under SFAS No. 123, ASML’s net income and calculation for net income per ordinary share would have been as follows (net of related tax effects):
                 
 
Year ended December 31   2004   2005
(in thousands, except per share data)   EUR   EUR
 
Net income (loss)
               
As reported
    235,460       311,464  
Compensation expenses
    (12,437 )     (10,022 )
Pro forma
    223,023       301,442  
 
 
Basic net income (loss) per ordinary share
               
As reported
    0.49       0.64  
Pro forma
    0.46       0.62  
 
 
Diluted net income (loss) per ordinary share
               
As reported
    0.49       0.64  
Pro forma
    0.46       0.62  
 
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 is 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. Since January 1, 2006 we are adopting implied volatility of our actively-traded options for new issued stock options as one of the assumptions in the Black-Scholes pricing model. As the semiconductor industry is becoming more mature, resulting in a decreasing cyclicality, we believe that implied volatility is currently a better assumption for the valuation model than historical volatility.
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.
The estimated weighted average fair value of options granted during 2004, 2005 and 2006 was EUR 7.35, EUR 6.87 and EUR 5.69, respectively, on the date of grant. ASML estimates this fair value using the Black-Scholes option-pricing model. The Black-Scholes option-pricing model is based on the following assumptions:
                         
 
Year ended December 31   2004   2005   2006
 
Weighted average share price (in EUR)
    12.35       11.52       17.81  
Volatility (in percentage)
    68.3       65.6       30.0  
Expected life (in years)
    5       5       5  
Risk free interest rate
    3.65       3.10       3.8  
Expected dividend yield
    0       0       0  
Forfeiture rate1
    0       0       0  
 
As per year end 2006 we estimate forfeitures to be nil.
When establishing the expected life assumption we annually take into account the contractual terms of the options as well as historical employee exercise behavior.
The weighted average share price at the date of exercise for stock options was EUR 18.26 (2005: EUR 15.36).
Total compensation expenses related to nonvested awards to be recognized in future periods amounts to EUR 9.7 million as per December 31, 2006. The weighted average period over which these costs are expected to be recognized is calculated at 1.3 years.
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.
ASML ANNUAL REPORT 2006
F- 10


Table of Contents

Income taxes
The asset and liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the tax effect of incurred net operating losses and for tax consequences attributable to differences between the balance sheet carrying amounts of existing assets and liabilities and their respective tax bases. 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.
Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date.
Contingencies and litigation
We are party to various legal proceedings generally incidental to our business, as disclosed in Note 14 to the consolidated statements. In connection with these proceedings and claims, our management evaluated, 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 determined that either a loss was not probable or was not reasonably estimable. As a result, no estimated losses were recorded as a charge to our statement of operations in 2004, 2005 and 2006. 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, we may agree to settle or to terminate a claim or proceeding in which it believes it would ultimately prevail 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 uncertain.
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.
Net income per ordinary share
Basic net income per share is computed by dividing net income by the weighted average ordinary shares outstanding for that period. Diluted net income per share reflects the potential dilution that could occur if options issued under ASML’s stock compensation plan were exercised, and if ASML’s convertible notes were converted, unless the exercise of the stock options or conversion of the convertible notes would have an anti-dilutive effect. The dilutive effect is calculated using the if-converted method. Following this method, ASML’s convertible bonds are considered dilutive in 2006 and 2005 and anti-dilutive in 2004. Excluded from the diluted weighted average share outstanding calculation are cumulative preference shares contingently issuable to the preference share foundation, since they represent a different class of stock than the ordinary shares. See further discussion in Note 20.
ASML ANNUAL REPORT 2006
F- 11


Table of Contents

The earnings per share (EPS) data have been calculated in accordance with the following schedule:
                         
 
Year ended December 31   2004   2005   2006
(in thousands, except per share data)   EUR   EUR   EUR
 
Basic EPS computation:
                       
Weighted average number of shares outstanding (after deduction of treasury stock) during the year
    483,380       484,103       474,860  
 
Net income available to holders of common shares
    235,460       311,464       624,689  
 
Basic earnings per share
    0.49       0.64       1.32  
 
Diluted EPS computation:
                       
Net income available to holders of common shares
    235,460       311,464       624,689  
Plus interest on assumed conversion of convertible subordinated notes, net of taxes
    0       33,518       14,714  
 
 
Net income available to holders of common shares plus effect of assumed conversions
    235,460       344,982       639,403  
 
Weighted average number of shares:
    483,380       484,103       474,860  
Plus shares applicable to:
                       
Stock options
    1,281       1,488       2,550  
Convertible subordinated notes, net of taxes
    0       57,388       26,573  
 
 
Dilutive potential common shares
    1,281       58,876       29,123  
 
 
Adjusted weighted average number of shares
    484,661       542,979       503,983  
 
Diluted earnings per share
    0.49       0.64       1.27  
 
Comprehensive income
Comprehensive income consists of net income and other comprehensive income. Other comprehensive income refers to revenues, expenses, gains and losses that are not included in net income, but recorded directly in shareholders’ equity. For the years ended December 31, 2004, 2005 and 2006, comprehensive income consists of net income, unrealized gains and losses on derivative financial instruments and foreign currency translation adjustments.
New U.S. GAAP Accounting Pronouncements
In February 2006 the FASB issued FSP FAS 123R-4, “Classification of Options and Similar Instruments Issued as Employee Compensation That Allow for Cash Settlement Upon the Occurrence of a Contingent Event”. SFAS No. 123(R) originally required liability classification for options or similar instruments if the entity can be required under any circumstances to settle the options or similar instruments by transferring cash or other assets. This FSP clarifies that equity classification is appropriate, if the occurrence of a contingent event that could require a cash settlement feature is not probable. If the contingent event is within the control of the employee, liability classification is required regardless of the probability. An option or similar instrument that is classified as equity, but subsequently becomes a liability because the contingent cash settlement event is considered probable, shall be accounted for similar to a modification from an equity to liability award. The guidance in this FSP shall be applied upon initial adoption of Statement 123(R) on January 1, 2006. In 2006, the impact of this FSP was insignificant to our consolidated financial statements.
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 SAFS 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 has 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. We do not expect that the adoption of SFAS No. 155 will 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 uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes”. FIN 48 prescribes a two step approach for recognizing and measuring tax positions taken or expected to be taken in tax return(s). Prior to recognizing the benefit of a tax position in the financial statements, the tax position must be more-likely-than-not of being sustained based solely on its technical merits. Once this recognition threshold
ASML ANNUAL REPORT 2006
F- 12


Table of Contents

has been met, tax positions are recognized at the largest amount that is more-likely-than-not to be sustained. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 will be effective for fiscal years beginning after December 15, 2006. Any differences between the amounts recognized in the financial statements prior to the adoption of FIN 48 and the amounts reported after adoption will be accounted for as a cumulative-effect adjustment recorded to the beginning balance of retained earnings. We are currently in the process of determining the impact of adopting the provisions of Interpretation 48 on its consolidated financial statements.
In June 2006, the FASB ratified the consensus reached by the 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 will be effective for interim and annual financial statements issued for periods beginning after December 15, 2006. We believe that the adoption of EITF No. 06-03 will have no material impact on our consolidated financial statements.
The SEC issued Staff Accounting Bulletin No. 108 (“SAB 108”) regarding the process of quantifying financial statement misstatements on September 13, 2006. SAB 108 states that registrants should use both a balance sheet (iron curtain) approach and an income statement (rollover) approach when quantifying and evaluating the materiality of a (prior year) misstatement. The bulletin furthermore contains guidance on correcting errors. The bulletin is effective for financial statements for fiscal years ending after November 15, 2006. We do not believe that the adoption of SAB 108 has had a material impact on our (previous) consolidated financial statements.
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 do not believe that the adoption of SFAS No. 157 will have a material impact on our consolidated financial statements.
2. Discontinued operations
On December 18, 2002 ASML announced the proposed sale of its Thermal business and the termination of its manufacturing activities in the Track business. As of December 31, 2005, ASML has completed the discontinuation of the Track business and the divesture of the Thermal business.
3. Restructuring
Restructuring Plan 2001
On October 16, 2001, as a consequence of the downturn in the semiconductor industry, ASML announced cost reductions and a restructuring plan (“Restructuring plan 2001”) which resulted in the consolidation of manufacturing facilities and discontinuance of certain product lines related to SVG that overlapped with products of ASML. As of December 31, 2005, this plan had been fully effectuated.
Restructuring Plan 2003
The worldwide slowdown in the semiconductor industry continued into 2003 and, on July 16, 2003, ASML announced further workforce reductions of approximately 550 positions worldwide, of which the majority was planned for the Netherlands (“Restructuring plan 2003”). During 2003, ASML recorded a provision of EUR 15.3 million as an ongoing benefit arrangement, of which EUR 3.9 million was included in cost of sales and EUR 11.4 million was included in restructuring costs. The amount of the provision was based upon the severance arrangements as agreed with our Works Council in the Netherlands for the workforce reductions included in ASML’s Restructuring Plan 2002. The estimated initial annual cost savings were EUR 47 million. ASML’s Board of Management and ASML’s Works Council then commenced a joint study on implementing these workforce reductions in the Netherlands, which delayed the reductions until the beginning of 2004. Thereafter, in response to a sharp improvement in market conditions during 2004, the Company decreased the reductions to approximately 300 positions worldwide, of which 150 were contract employees with limited rights upon termination.
As a result, ASML recorded a restructuring credit of EUR 12.1 million, EUR 3.8 million of which was recorded in cost of sales and EUR 8.3 million of which was recorded under restructuring expenses. The Company’s payments associated with these
ASML ANNUAL REPORT 2006
F- 13


Table of Contents

workforce reductions were EUR 0.5 million in 2005 and EUR 2.5 million in 2004 and ASML’s initially anticipated cost savings were reduced to approximately EUR 24 million.
Also during 2003, ASML recorded restructuring costs of approximately EUR 6.8 million relating to the consolidation of its office and warehouse facilities at the headquarters in Veldhoven as the Company ceased using certain of its facilities. The facility exit charges included estimated future obligations for non-cancelable lease payments and the impairment of property and equipment (primarily leasehold improvements) for which there are insufficient cash flows to support the carrying cost. During 2004, ASML recorded adjustments to the related restructuring provision due to postponed commencement dates of sublease agreements and higher exit costs than originally estimated. This resulted in an additional charge of EUR 3.5 million, EUR 1.0 million of which was recorded in cost of sales and EUR 2.5 million of which was recorded under restructuring charges. The Restructuring plan 2003 did not impact any processes or products. As of December 31, 2005, this plan had been substantially effectuated.
Tabular Disclosures of Restructuring
All restructuring charges are recorded in our statements of operations either in cost of sales or in restructuring charges, as summarized in the following table for the years ended December 31, 2004, 2005 and 2006:
                         
 
Year ended December 31   2004   2005   2006
(in thousands)   EUR   EUR   EUR
 
Cost of sales
    (2,694 )     0       0  
Restructuring Charges
    (5,862 )     0       0  
 
Total
    (8,556 )     0       0  
 
The following table summarizes, per restructuring plan, the movement in the restructuring provision for the three years ended December 31, 2006:
                         
 
Restructuring plan announced in   2001   2003   Total
(in thousands)   EUR   EUR   EUR
 
Balance as of December 31, 2003
    2,794       19,771       22,565  
Utilization of the year
    (2,323 )     (7,774 )     (10,097 )
Adjustments
    0       (8,556 )     (8,556 )
Effect of foreign currency translation
    114       0       114  
 
Balance as of December 31, 2004
    585       3,441       4,026  
Utilization of the year
    (637 )     (1,122 )     (1,759 )
Effect of foreign currency translation
    52       0       52  
 
Balance as of December 31, 2005
    0       2,319       2,319  
Utilization of the years
    0       (574 )     (574 )
 
Balance as of December 31, 2006
    0       1,745       1,745  
 
ASML ANNUAL REPORT 2006
F- 14


Table of Contents

The following table summarizes, per category, the movement in the restructuring provision for the three years ended December 31, 2006:
                                 
 
    Purchase   Building   Severance    
Category   commitments   closure costs   payments   Total
(in thousands)   EUR   EUR   EUR   EUR
 
Balance as of December 31, 2003
    878       6,416       15,271       22,565  
Utilization of the year
    (914 )     (6,705 )     (2,478 )     (10,097 )
Adjustments
    0       3,546       (12,102 )     (8,556 )
Effect of foreign currency translation
    36       78       0       114  
 
Balance as of December 31, 2004
    0       3,335       691       4,026  
Utilization of the year
    0       (1,289 )     (470 )     (1,759 )
Effect of foreign currency translation
    0       52       0       52  
 
Balance as of December 31, 2005
    0       2,098       221       2,319  
Utilization of the year
    0       (476 )     (98 )     (574 )
 
Balance as of December 31, 2006
    0       1,622       123       1,745  
 
ASML’s net cash outflows in 2004, 2005 and 2006 for exit plans were EUR 10.1 million, EUR 1.8 million and EUR 0.6 million respectively.
4. Market risk and derivatives
Market risk represents the risk of a change in the value of a financial instrument, derivative or non derivative, caused by fluctuations in currency exchange rates and interest rates. The Company addresses market risk in accordance with established policies and thereby enters into various derivative transactions. No such transactions are entered into for trading purposes.
Foreign currency management
The Company uses the euro as its invoicing currency in order to limit the exposure to foreign currency movements. Exceptions may occur on a customer by customer basis. To the extent that invoicing is done in a currency other than the euro, the Company is exposed to foreign currency risk.
It is the Company’s policy to hedge material transaction exposures, such as sales transactions, forecasted purchase transactions and accounts receivable/accounts payable. The Company hedges these exposures through the use of foreign exchange options and forward contracts. The use of a mix of foreign exchange options and forwards is aimed at reflecting the likelihood of the transactions occurring. The effectiveness of all outstanding hedge contracts is monitored closely throughout the life of the hedges.
During the twelve months ended December 31, 2006, no gain or loss was recognized in cost of sales relating to ineffective hedges. As of December 31, 2006 EUR 4.1 million (December 31, 2005: EUR 9.9 million) of other comprehensive income represents the total anticipated gain to be released to sales, and EUR 2.1 million (December 31, 2005: EUR 1.2 million) is the total anticipated loss to be charged to cost of sales over the next twelve months as the forecasted revenue and purchase transactions occur.
It is the Company’s policy to hedge material remeasurement exposures. These net exposures from certain monetary assets and liabilities in non-functional currencies are hedged with forward contracts.
It is the Company’s policy to manage material translation exposures resulting predominantly from ASML’s U.S. dollar net investments. Throughout 2004 and 2005 a proportion of our USD 575 million 5.75 percent Convertible Subordinated Notes due 2006 was assigned to hedge a certain part of our U.S. dollar net investments. As from December 2005 onwards, forward contracts have been assigned to hedge this exposure.
The related foreign currency translation amounts (gross of taxes) included in cumulative translation adjustment for the years ended December 31, 2005 and 2006 were EUR 28.2 million loss and EUR 16.0 million gain, respectively.
Interest rate management
The Company has both assets and liabilities that bear interest, which expose the Company to fluctuations in the prevailing market rate of interest. The Company uses interest rate swaps to align the interest typical terms of interest bearing assets with
ASML ANNUAL REPORT 2006
F- 15


Table of Contents

the interest typical terms of interest bearing liabilities. The Company still retains residual financial statement exposure risk to the extent that the asset and liability positions do not fully offset. It is the Company’s policy to enter into interest rate swaps to hedge this residual exposure. For this purpose, the Company uses interest rate swaps, both to hedge changes in market value of fixed loan coupons payable due to changes in interest rates as well as to hedge the variability of future interest receipts as a result of changes in market interest rates.
As of December 31, 2006, we had two EUR interest rate swaps outstanding with nominal values of EUR 380 million in total on which we pay a floating interest of 3.59 percent. These interest rate swaps, which are designated as cash flow hedges, have fixed interest receipts at an average of 3.69 percent for periods up until May 2010 and have floating interest payments at 3 months EURIBOR.
Financial instruments as of December 31, 2006
The Company uses foreign exchange derivatives to manage its currency risk and interest rate swaps to manage its interest rate risk. Most derivatives, except for the interest rate swaps, will mature in one year or less after the balance sheet date. The following table summarizes the notional amounts and estimated fair values of the Company’s financial instruments:
                                 
 
    2005       2006    
    Notional       Notional    
As of December 31   Amount2   Fair Value   Amount2   Fair Value
(in thousands)   EUR   EUR   EUR   EUR
 
Forward contracts1
    93,260       (6,508 )     480,489       1,642  
Currency options
    (29,843 )     (1,369 )     73,049       2,740  
Interest rate swaps
    917,395       (4,896 )     429,900       (4,447 )
 
(Source: Bloomberg)
Includes forward contracts on U.S. Dollars, Hong Kong Dollars, British Pounds, Swiss Francs, Israeli Shekel, Japanese Yen, Singapore Dollars, Taiwanese Dollars and Korean Wons.
Net amount of forward and option contracts assigned as a hedge to sales and purchase transactions, to monetary assets and liabilities and to net investments in foreign operations.
The fair value of forward contracts (used for hedging purposes) is the estimated amount that a bank would receive or pay to terminate the forward contracts at the reporting date, taking into account current interest rates, current exchange rates and the current creditworthiness of the counterparties.
The fair value of currency options (used for hedging purposes) is the estimated amount that a bank would receive or pay to terminate the option agreements at the reporting date, taking into account current interest rates, current exchange rates, volatility and the current creditworthiness of the counterparties.
The fair value of interest rate swaps (used for hedging purposes) is the estimated amount that a bank would receive or pay to terminate the swap agreements at the reporting date, taking into account current interest rates and the current creditworthiness of the counterparties.
Credit risk
Financial instruments that potentially subject ASML to significant concentrations of credit risk consist principally of cash and cash equivalents, accounts receivable and derivative financial instruments used in hedging activities.
Financial instruments contain an element of risk of the counterparties being unable to meet their obligations. This financial credit risk is monitored and minimized per type of financial instrument by limiting ASML’s counterparties to a sufficient number of major financial institutions and issuers of commercial paper. ASML does not expect the counterparties to default given their high credit quality.
ASML’s customers consist of integrated circuit manufacturers located throughout the world. ASML performs ongoing credit evaluations of its customers’ financial condition and generally requires no collateral to secure accounts receivable, ASML maintains an allowance reserve for potentially uncollectible accounts receivable. ASML regularly reviews the allowance by considering factors such as historical payment experience, credit quality, age of the accounts receivable balances, and current economic conditions that may affect a customer’s ability to pay. In addition, ASML utilizes letters of credit to mitigate credit risk when considered appropriate.
ASML ANNUAL REPORT 2006
F- 16


Table of Contents

5. Accounts receivable
Accounts receivable consist of the following:
                 
 
As of December 31   2005   2006
(in thousands)   EUR   EUR
 
Gross accounts receivable
    306,847       675,150  
Allowance for doubtful debts
    (4,275 )     (2,388 )
 
Net accounts receivable
    302,572       672,762  
 
A summary of activity in the allowance for doubtful debts:
                 
 
As of December 31   2005   2006
(in thousands)   EUR   EUR
 
Balance at beginning of year
    (4,817 )     (4,275 )
Utilization of the provision
    2,413       2,136  
Addition of the year1
    (1,871 )     (249 )
 
Balance at end of year
    (4,275 )     (2,388 )
 
Addition of the year is recorded in cost of sales.
6. Inventories
Inventories consist of the following:
                 
 
As of December 31   2005   2006
(in thousands)   EUR   EUR
 
Raw materials
    163,817       201,471  
Work-in-process
    482,801       442,513  
Finished products
    246,774       279,915  
 
Total inventories, gross
    893,392       923,899  
Allowance for obsolescence and/or lower market value
    (116,192 )     (115,418 )
 
Total inventories, net
    777,200       808,481  
 
A summary of activity in the allowance for obsolescence is as follows:
                 
 
As of December 31   2005   2006
(in thousands)   EUR   EUR
 
Balance at beginning of year
    (163,066 )     (116,192 )
Addition of the year1
    (11,811 )     (54,181 )
Effect of exchange rates
    (8,461 )     5,268  
Utilization of the provision
    67,146       49,687  
 
Balance at end of year
    (116,192 )     (115,418 )
 
Addition of the year is recorded in cost of sales.
The higher addition to and utilization of the inventory provision in 2006 reflect our increased focus on inventory control management.
ASML ANNUAL REPORT 2006
F- 17


Table of Contents

7. Other assets
Other non-current assets consist of the following:
                 
 
As of December 31   2005   2006
(in thousands)   EUR   EUR
 
Compensation plan assets1
    9,605       8,087  
Prepaid expenses
    7,923       4,293  
Subordinated loan granted to lessor in respect of Veldhoven headquarters2
    5,445       5,445  
Loan to Micronic3
    13,000       13,000  
Other
    3,823       4,828  
 
Total other non-current assets
    39,796       35,653  
 
For further details on compensation plan refer to Note 13.
For further details on loan granted to lessor in respect of Veldhoven headquarters refer to Note 12.
Pursuant to a license agreement between Micronic and ASML, ASML has paid to Micronic in 2005 an amount of EUR 20 million, of which EUR 13 million (December 31, 2005: EUR 13 million) is non-current.
Other current assets consist of the following:
                 
 
As of December 31   2005   2006
(in thousands)   EUR   EUR
 
Advance payments to Zeiss
    61,502       78,412  
VAT
    27,047       22,413  
Loan to Micronic1
    7,000       3,500  
Prepaid expenses
    16,583       18,404  
Other
    13,670       24,954  
 
Total other current assets
    125,802       147,683  
 
Pursuant to a license agreement between Micronic and ASML, ASML has paid to Micronic in 2005 an amount of EUR 20 million, of which EUR 3.5 million (December 31, 2005: EUR 7 million) is current.
Zeiss is the our sole supplier of lenses and, from time to time, receives non-interest advance payments from us that assist in financing Zeiss’ work in progress and thereby secure lens deliveries to us. Amounts owed under these advance payments are repaid through lens deliveries. We do not maintain a loss allowance against these advances, but periodically monitor Zeiss’ financial condition to confirm that no provision is necessary.
8. Intangible assets
In connection with a settlement of worldwide patent litigation between Nikon, ASML and Zeiss, on December 10, 2004, ASML entered into a patent cross-license agreement with Nikon, effective November 12, 2004, pursuant to which (i) ASML granted Nikon a non-exclusive license to manufacture and sell lithography equipment under patents owned or otherwise sublicensable by ASML and (ii) Nikon granted ASML a non-exclusive license to manufacture and sell lithography equipment (other than optical components) under patents owned or otherwise sublicensable by Nikon.
The licenses under the agreement are perpetual for patents having an effective application date before 2003 (“Class A Patents”) and all other patents (“Class B Patents”) will terminate at the end of 2009. At any time until June 30, 2015, either party has a limited right to designate up to 5 Class B patents (or patents related to lithography issued from 2010 to 2015) of the other party as Class A Patents. Any patents acquired after the date of the agreement are deemed Class B Patents.
In connection with the settlement, ASML made an initial payment to Nikon of US$ 60 million (approximately EUR 49 million) in 2004, further made payments of US$ 9 million (approximately EUR 8 million) in both 2005 and 2006, and is obligated to make an additional payment to Nikon of US$ 9 million in 2007. Based upon a royalty valuation method (using a royalty structure which was determined through an analysis of royalty agreements that involve transfers of technologies broadly comparable to ASML’s technology), an amount of EUR 21 million of the EUR 70 million of charges relating to the settlement was determined to pertain to future sales and was capitalized under intangible assets. The intangible asset is amortized over a period of 5 years under cost of sales, which equals the remaining estimated useful life of Class A Patents and the contractual life of Class B Patents. The remaining EUR 49 million was determined to relate to past conduct, i.e., components of products that had been affected by the patents covered by the patent cross-license agreement and that had been installed prior to effectiveness of the cross-license
ASML ANNUAL REPORT 2006
F- 18


Table of Contents

agreement. This amount was expensed as research and development expenses in ASML’s statement of operations for the year ended December 31, 2004.
                 
 
Year ended December 31   2005   2006
(in thousands)   EUR   EUR
 
Cost
               
Balance, January 1
    45,717       47,095  
Additions
    1,378       120  
 
 
Balance, December 31
    47,095       47,215  
 
Accumulated amortization
               
Balance, January 1
    13,899       22,152  
Amortization
    8,253       6,987  
 
 
Balance, December 31
    22,152       29,139  
 
Carrying amount, December 31
    24,943       18,076  
 
Estimated amortization expenses relating to intangible assets for the next five years are as follows:
         
 
2007:
    6,798  
2008:
    6,576  
2009:
    4,495  
2010:
    207  
2011:
    0  
 
Total
    18,076  
 
ASML ANNUAL REPORT 2006
F- 19


Table of Contents

9. Property, plant and equipment
Property, plant and equipment consist of the following:
                                         
 
    Furniture,    
    Machinery       fixtures and    
    Buildings and   and   Leasehold   other    
    constructions   equipment   improvements   equipment   Total
(in thousands)   EUR   EUR   EUR   EUR   EUR
 
Cost