20-F 1 u53858e20vf.htm FORM 20-F e20vf
 

United States
Securities and Exchange Commission
Washington, D.C. 20549
 
Form 20-F
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
for the fiscal year ended December 31, 2007
 
Commission file number 025566
 
 
ASML HOLDING N.V.
(Exact Name of Registrant as Specified in Its Charter)
 
THE NETHERLANDS
(Jurisdiction of Incorporation or Organization)
 
DE RUN 6501
5504 DR VELDHOVEN
THE NETHERLANDS
(Address of Principal Executive Offices)
 
Securities registered or to be registered pursuant to
Section 12(b) of the Act:
 
     
Title of each class
 
Name of each exchange on which registered
 
Ordinary Shares
  The NASDAQ Stock Market LLC
(nominal value EUR 0.09 per share)
   
 
Securities registered or to be registered pursuant to
Section 12(g) of the Act:
None
(Title of Class)
 
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
None
(Title of Class)
 
Indicate the number of outstanding shares of each of the issuer’s classes of
capital or common stock as of the close of the period covered by the annual report.
 
435,625,934 Ordinary Shares
(nominal value EUR 0.09 per share)
 
Indicate by check mark if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act.
Yes (ü) No ( )
 
If this report is an annual or transition report, indicate by check mark if the registrant
is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
Yes ( ) No (ü)
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
Yes (ü) No ( )
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.
See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer (ü) Accelerated filer ( ) Non-accelerated filer ( )
 
Indicate by check mark which financial statement item the registrant has elected to follow
Item 17 ( ) Item 18 (ü)
 
If this is an annual report, indicate by check mark whether the registrant is a
shell company (as defined in Rule 12b-2 of the Exchange Act)
Yes ( ) No (ü)
 
Name and address of person authorized to receive notices and communications
from the Securities and Exchange Commission:
 
Richard A. Ely
Skadden, Arps, Slate, Meagher & Flom (UK) LLP
40 Bank Street, Canary Wharf
London E14 5DS England
 
ASML ANNUAL REPORT 2007


 

Contents
 
 
         
       
         
       
         
       
         
       
       
       
       
     D. Risk Factors
       
         
       
       
       
       
       
         
       
         
       
       
       
       
       
       
       
     G. Safe Harbor
       
         
       
       
     B. Compensation
       
       
     D. Employees
       
       
         
       
       
       
       
         
       
       
       
         
       
       
       
     C. Markets
       
       
 
ASML ANNUAL REPORT 2007


 

         
     E. Dilution
       
       
         
       
     A. Share Capital
       
       
       
       
     E. Taxation
       
       
       
       
       
         
       
         
       
         
       
         
       
         
       
         
       
         
       
       
     B. Code of Ethics
       
       
       
       
         
       
         
       
         
       
         
       
 
ASML ANNUAL REPORT 2007


 

 
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 selected financial data for the years ended December 31, 2003, 2004 and 2005 presented in this annual report on Form 20-F present these businesses as discontinued operations, instead of as a separate segment as they had been reported prior to the divestiture announcement.
 
 
Item 1 Identity of Directors, Senior Management and Advisors
 
 
Not applicable.
 
 
Item 2 Offer Statistics and Expected Timetable
 
 
Not applicable.
 
 
Item 3 Key Information
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 2007
1


 

 
 
Five-Year Financial Summary
                                             

Year ended December 31
  2003
    2004
    2005
    2006
    2007
     
(in thousands, except per share data)   EUR1     EUR1     EUR1     EUR     EUR      
Consolidated statements of operations data
                                           
Net sales
    1,542,737       2,465,377       2,528,967       3,597,104       3,808,679      
Cost of sales
    1,173,955       1,559,738       1,554,772       2,135,086       2,248,335      
                                             
Gross profit on sales
    368,782       905,639       974,195       1,462,018       1,560,344      
Research and development costs
    305,839       352,920       347,901       413,708       510,503      
Amortization of in-process research and development costs
                            23,148      
Research and development credits
    (19,119 )     (21,961 )     (24,027 )     (27,141 )     (24,362 )    
Selling, general and administrative costs
    212,609       201,629       201,204       204,799       225,668      
Restructuring and merger and acquisition costs (credits)
    24,485       (5,862 )                      
                                             
Income (loss) from operations
    (155,032 )     378,913       449,117       870,652       825,387      
Interest income (expense), net
    (29,149 )     (16,073 )     (14,094 )     (854 )     33,451      
                                             
Income (loss) from continuing
operations before income taxes
    (184,181 )     362,840       435,023       869,798       858,838      
(Provision for) benefit from income taxes
    59,675       (127,380 )     (123,559 )     (245,109 )     (170,995 )    
                                             
Income (loss) from continuing operations
    (124,506 )     235,460       311,464       624,689       687,843      
Loss from discontinued operations before income taxes
    (59,026 )                            
Benefit from income taxes
    23,316                              
                                             
Loss from discontinued operations
    (35,710 )                            
                                             
Net income (loss)
    (160,216 )     235,460       311,464       624,689       687,843      
                                             
Earnings per share data2
                                           
Basic net income (loss) from continuing
operations per ordinary share
    (0.26 )     0.49       0.64       1.32       1.49      
Basic and diluted net loss from discontinued
operations per ordinary share
    (0.07 )                            
Basic net income (loss) per ordinary share
    (0.33 )     0.49       0.64       1.32       1.49      
Diluted net income (loss) per ordinary share
    (0.33 )     0.49       0.64       1.27       1.44      
                                             
Number of ordinary shares used in
computing per share amounts (in thousands)
                                           
Basic
    482,240       483,380       484,103       474,860       462,406      
Diluted
    482,240       484,661       542,979       503,983       485,643      
                                             
 
 
The selected consolidated data for 2003, 2004 and 2005 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 2003 and 2004 does not assume conversion of ASML’s outstanding Convertible Subordinated Notes and (ii) in 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 2007
2


 

 
                                             

As of December 31
  2003
    2004
    2005
    2006
    2007
     
(in thousands)   EUR     EUR     EUR     EUR     EUR      
Consolidated balance sheets data
                                           
Cash and cash equivalents
    1,027,806       1,228,130       1,904,609       1,655,857       1,271,636      
Working capital3
    1,463,308       1,868,871       1,785,836       2,244,625       2,014,601      
Total assets
    2,868,282       3,243,766       3,756,023       3,951,035       4,067,752      
Long-term liabilities
    1,040,556       1,039,023       624,203       613,167       855,367      
Total shareholders’ equity
    1,141,207       1,391,602       1,711,837       2,156,455       1,907,617      
Capital stock
    9,651       9,675       9,694       10,051       39,206      
                                             
Consolidated statements of cash flows data
                                           
Purchases of property, plant and equipment
    (48,567 )     (74,979 )     (72,660 )     (70,619 )     (179,152 )    
Depreciation, amortization and impairment
    156,900       93,144       98,881       104,446       135,366      
Net cash provided by continuing operating activities
    532,659       257,147       713,511       477,507       670,295      
Net cash provided by (used in) discontinued operating activities
    12,736       (5,880 )     (2,018 )                
Net cash provided by total operating activities
    545,395       251,267       711,493       477,507       670,295      
Acquisition of subsidiary (net of cash acquired)
                            (188,011 )    
Net cash used in total investing activities
    (49,028 )     (60,398 )     (60,803 )     (65,523 )     (347,942 )    
Net cash provided by (used in) continuing financing activities
    (68,156 )     18,871       2,879       (647,957 )4     (698,857 )4    
Net increase (decrease) in cash and cash equivalents
    359,046       200,324       676,479       (248,752 )     (384,221 )    
                                             
Ratios and other data
                                           
Increase (decrease) net sales (in percent)
    (21.2 )     59.8       2.6       42.2       5.9      
Gross profit as a percentage of net sales
    23.9       36.7       38.5       40.6       41.0      
Income (loss) from operations as a percentage of net sales
    (10.0 )     15.4       17.8       24.2       21.7      
Net income (loss) as a percentage of net sales
    (8.1 )     9.6       12.3       17.4       18.1      
Shareholders’ equity as a percentage of total assets
    39.8       42.9       45.6       54.6       46.9      
Average selling price systems sales
    7.6       7.7       11.4       12.1       13.0      
Backlog of new systems (in units) at year end
    103       119       86       153       79      
Backlog of used systems (in units) at year end
    21       12       9       10       10      
Backlog of systems (in units) at year end
    124       131       95       163       89      
Sales of systems (in units)
    169       282       196       266       260      
Number of employees at year end for continuing operations
    5,059       5,071       5,055       5,594       6,582      
Number of ordinary shares outstanding (in thousands) at year end
    482,514       483,676       484,670       477,099       435,626 5    
Share price ASML at year end6
    15.72       11.81       16.90       18.84       21.66      
Volatility % ASML shares (260 days)7
    60.9       37.4       26.0       28.08       27.52      
                                             
 
 
Working capital is calculated as the difference between total current assets, including cash and cash equivalents, and total current liabilities.
Net cash used in financing activities includes an amount of EUR 678 million with respect to share buyback programs in 2006 and EUR 360 million with respect to share buyback programs and EUR 1,012 million with respect to the return of capital to shareholders in 2007.
In 2007, as part of a capital repayment program, EUR 1,012 million of share capital was repaid to our shareholders and the number of outstanding ordinary shares was reduced by 11 percent (synthetic share buyback).
Closing price of ASML’s ordinary shares listed on the Official Segment of the stock market of Euronext Amsterdam (source: Bloomberg Finance LP). In 2007, as part of a capital repayment program, EUR 1,012 million of share capital was repaid to our shareholders and the number of outstanding ordinary shares was reduced by 11 percent (synthetic share buyback).
Volatility represents the variability in our share price on the Official Segment of the stock market of Euronext Amsterdam as measured over the last 260 business days of each year presented (source: Bloomberg Finance LP).
 
ASML ANNUAL REPORT 2007
3


 

 
 
Exchange Rate Information
We publish our consolidated financial statements in euro. In this Annual Report, references to “€”, “EUR” or “euro” are to euro, and references to ‘‘$”, “dollars”, “U.S. dollars”, “U.S. dollar”, “USD” or “US$” are to United States dollars. Solely for the convenience of the reader, certain U.S. dollar amounts have been translated into euro amounts using an exchange rate in effect on December 31, 2007 of US $1.00 = EUR 0.67986.
 
 
A portion of our net sales and expenses is, and historically has been, denominated in currencies other than the euro. For a discussion of the impact of exchange rate fluctuations on our financial condition and results of operations, see Item 5.A. “Operating Results, Foreign Exchange Management” and Note 1 to our consolidated financial statements.
 
 
The following are the Noon Buying Rates certified by the Federal Reserve Bank of New York for customs purposes (the “Noon Buying Rate”) expressed in U.S. dollars per euro.
 
                                     

                        January 2008 (through
Calendar year   2003   2004   2005   2006   2007   January 23, 2008)
Period End
    1.26     1.35     1.18     1.32     1.46     1.46
Average1
    1.13     1.24     1.24     1.26     1.37     1.47
High
    1.26     1.36     1.35     1.33     1.49     1.49
Low
    1.04     1.18     1.17     1.19     1.29     1.46
 
 
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 2008 (through
Months of   2007   2007   2007   2007   2007   2007   January 23, 2008)
High
    1.38     1.38     1.42     1.45     1.49     1.48     1.49
Low
    1.36     1.34     1.36     1.41     1.44     1.43     1.46
 
 
 
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
 
ASML ANNUAL REPORT 2007
4


 

meet customer demand. Our ability to predict the timing and magnitude of industry fluctuations is limited and our products require significant lead time to complete. Accordingly, we may not be able to effectively increase our production capacity to respond to an increase in customer demand in an industry upturn resulting in lost revenues and damage to customer relationships.
 
 
Conversely, in an industry downturn, our ability to maintain profitability will depend substantially on whether we are able to lower our costs and break-even level, which is the number of lithography systems we must sell in a year to achieve net income. If we are unable to lower costs in an industry downturn, our net income may decline significantly or we may suffer losses. As we need to keep certain levels of inventory on hand to meet anticipated product demand, we also incur increased costs related to inventory obsolescence in an industry downturn. In addition, industry downturns generally result in overcapacity, resulting in downward pressure on prices, which has had in the past, and could have in the future, a material adverse effect on our business, financial condition and results of operations.
 
 
Our Business Will Suffer If We Do Not Respond Rapidly to Commercial and Technological Changes in the Semiconductor Industry
The semiconductor manufacturing industry is subject to:
•  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 or alternative new technologies and products or for other reasons, we would not recoup any return on our investments in these technologies or products, which may result in charges to our statement of operations and materially and adversely affect the future growth of the Company.
 
 
We Face Intense Competition
The semiconductor equipment industry is highly competitive. The principal elements of competition in our market segments are:
•  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 15 to our consolidated financial statements.
 
 
The costs to develop new systems, in particular photolithography systems, are extremely high and accordingly, the photolithography equipment industry is characterized by fierce competition among a few suppliers. ASML’s primary competitors are Nikon Corporation (“Nikon”) and Canon Kabushika Kaisha (“Canon”). Nikon and Canon are the leading suppliers in Japan, which accounts for a significant portion of worldwide semiconductor production. This region historically has been difficult for non-Japanese companies to penetrate.
 
 
Both Nikon and Canon have substantial financial resources and broad patent portfolios. Each continues to introduce new products with improved price and performance characteristics that compete directly with our products, and may cause a decline in our sales or loss of market acceptance for our photolithography systems. In addition, adverse market conditions, industry overcapacity or a decrease in the value of the Japanese yen in relation to the euro or the U.S. dollar could further intensify price-based competition in those regions that account for the majority of our sales, resulting in lower prices and margins and a material adverse effect on our business, financial condition and results of operations.
 
ASML ANNUAL REPORT 2007
5


 

 
 
Industry Alliances May Not Select our Equipment
Increasingly, our customers are entering into alliances or other forms of cooperation with one another to expedite the development of processes and other manufacturing technologies. One of the results of such a form of cooperation may be the definition of a system or particular tool set for a certain function or a series of process steps that use a specific set of manufacturing equipment. These decisions could work to our disadvantage if a competitor’s equipment becomes the standard equipment for such function or process. Even if ASML’s equipment was previously used by a customer, that equipment may be displaced in current and future applications by the equipment standardized by the form of cooperation. These forms of cooperation may have a material adverse effect on our business, financial condition and results of operations.
 
 
Risks Related to ASML
 
The Number of Systems We Can Produce Is Limited by Our Dependence on a Limited Number of Suppliers of Key Components
We rely on outside vendors for the components and subassemblies used in our systems, each of which is obtained from a single supplier or a limited number of suppliers. Our reliance on a limited group of suppliers involves several risks, including a potential inability to obtain an adequate supply of required components and the risk of untimely delivery of these components and subassemblies.
 
 
The number of photolithography systems we have been able to produce has occasionally been limited by the production capacity of Carl Zeiss SMT AG (“Zeiss”). Zeiss is our single supplier of lenses and other critical optical components. If Zeiss were unable to maintain and increase production levels or if we are unable to maintain our business relationship with Zeiss in the future we could be unable to fulfill orders, which could damage relationships with current and prospective customers and have a material adverse effect on our business, financial condition and results of operations. If Zeiss were to terminate its relationship with us or if Zeiss were unable to maintain production of lenses over a prolonged period, we would effectively cease to be able to conduct our business. See Item 4.B. “Business Overview, Manufacturing, Logistics and Suppliers”.
 
 
In addition to Zeiss’ current position as our single supplier of lenses, the excimer laser illumination systems that provide the ultraviolet light source, referred to as “deep UV”, used in our high resolution steppers and Step & Scan systems are available from only a limited number of suppliers. In particular, we rely both on Cymer, Inc., a United States based company, and Gigaphoton, Inc., a Japanese based company, to provide excimer laser illumination systems.
 
 
Although the timeliness, yield and quality of deliveries to date from our other subcontractors generally have been satisfactory, manufacturing of certain of these components and subassemblies that we use in our manufacturing processes is an extremely complex process and delays caused by suppliers may occur in the future. A prolonged inability to obtain adequate deliveries of components or subassemblies, or any other circumstance that requires us to seek alternative sources of supply, could significantly hinder our ability to deliver our products in a timely manner, which could damage relationships with current and prospective customers and have a material adverse effect on our business, financial condition and results of operations.
 
 
A High Percentage of Net Sales Is Derived from a Few Customers
Historically, we have sold a substantial number of lithography systems to a limited number of customers. While the identity of our largest customers may vary from year to year, we expect sales to remain concentrated among relatively few customers in any particular year. In 2007, sales to our largest customer accounted for EUR 833 million, or 21.9 percent of net sales, compared to EUR 730 million, or 20 percent of net sales, in 2006. The loss of any significant customer or any significant reduction in orders by a significant customer may have a material adverse effect on our business, financial condition and results of operations.
 
 
Additionally, as a result of the limited number of our customers, credit risk on our receivables is concentrated. Our three largest customers accounted for 40.1 percent of accounts receivable at December 31, 2007, compared to 35 percent at December 31, 2006. As a result, business failure or insolvency of one of our main customers may have a material adverse effect on our business, financial condition and results of operations.
 
 
The Pace of Introduction of Our New Products Is Accelerating and Is Accompanied by Potential Design and Production Delays and by Significant Costs
The development and initial production, installation and enhancement of the systems we produce is often accompanied by design and production delays and related costs of a nature typically associated with the introduction and transition to full-scale manufacturing of complex capital equipment. While we expect and plan for a corresponding learning curve effect in our product development cycle, we cannot predict with precision the time and expense required to overcome these initial problems and to ensure full performance to specifications. There is a risk that we may not be able to introduce or bring to full-scale production new products as quickly as we expected in our product introduction plans, which could have a material adverse effect on our business, financial condition and results of operations.
 
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In order for the market to accept technology enhancements, our customers, in many cases, must upgrade their existing technology capabilities. Such upgrades from established technology may not be available to our customers to enable volume production using our new technology enhancements. This could result in our customers not purchasing, or pushing back or canceling orders for our technology enhancements, which could negatively impact our business, financial condition and results of operations.
 
 
We Derive Most of Our Revenues from the Sale of a Relatively Small Number of Products
We derive most of our revenues from the sale of a relatively small number of lithography equipment systems (260 units in 2007; 266 units in 2006), with an average selling price (“ASP”) in 2007 of EUR 13.0 million (EUR 14.0 million for new systems and EUR 3.9 million for used systems) and an ASP in 2006 of EUR 12.1 million (EUR 14.0 million for new systems and EUR 3.2 million for used systems). As a result, the timing of recognition of revenue from a small number of product sales may have a significant impact on our net sales and other operating results for a particular reporting period. Specifically, the failure to receive anticipated orders, or delays in shipments near the end of a particular reporting period, due, for example, to:
•  a downturn in 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 such measures could prove to be inadequate because:
•  intellectual property laws may not sufficiently support our proprietary rights or may change in the future in a manner adverse to us;
•  patent rights may not be granted or construed as we expect;
•  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 to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Any such litigation may result in substantial costs and diversion of resources, and, if decided unfavorably to us, could have a material adverse effect on our business, financial condition and results of operations.
 
 
Defending Against Intellectual Property Claims Brought by Others Could Harm Our Business
In the course of our business, we are subject to claims by third parties alleging that our products or processes infringe upon their intellectual property rights. If successful, such claims could limit or prohibit us from developing our technology and manufacturing our products, which could have a material adverse effect on our business, financial condition and results of operations.
 
 
In addition, our customers may be subject to claims of infringement from third parties, alleging that our products used by such customers in the manufacture of semiconductor products and/or the processes relating to the use of our products infringe one or more patents issued to such parties. If such claims were successful, we could be required to indemnify customers for some or all of any losses incurred or damages assessed against them as a result of such infringement, which could have a material adverse effect on our business, financial condition and results of operations.
 
 
We may also incur substantial licensing or settlement costs where doing so would strengthen or expand our intellectual property rights or limit our exposure to intellectual property claims brought by others, which may have a material adverse effect on our business, financial condition and results of operations.
 
 
We Are Subject to Risks in Our International Operations
The majority of our sales are made to customers outside Europe. There are a number of risks inherent in doing business in some of those regions, including the following:
•  potentially adverse tax consequences;
•  unfavorable political or economic environments;
•  unexpected legal or regulatory changes; and
•  an inability to effectively protect intellectual property.
 
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If we are unable to manage successfully the risks inherent in our international activities, our business, financial condition and results of operations could be materially and adversely affected.
 
 
In particular, approximately 21 percent of our 2007 revenues and approximately 20 percent of our 2006 revenues were derived from customers in Taiwan. Taiwan has a unique international political status. The People’s Republic of China asserts sovereignty over Taiwan and does not recognize the legitimacy of the Taiwan government. Changes in relations between Taiwan and the People’s Republic of China, Taiwanese government policies and other factors affecting Taiwan’s political, economic or social environment could have a material adverse effect on our business, financial condition and results of operations.
 
 
We Are Dependent on the Continued Operation of a Limited Number of Manufacturing Facilities
All of our manufacturing activities, including subassembly, final assembly and system testing, take place in one clean room facility located in Veldhoven, the Netherlands, and one clean room facility in Wilton, Connecticut, the United States. These facilities are subject to disruption for a variety of reasons, including work stoppages, fire, energy shortages, flooding or other natural disasters. We cannot ensure that alternative production capacity would be available if a major disruption were to occur or that, if it were available, it could be obtained on favorable terms. Such a disruption could have a material adverse effect on our business, financial condition and results of operations.
 
 
Because of Labor Laws and Practices, Any Workforce Reductions That We May Wish to Implement in Order to Reduce Costs Company-Wide May Be Delayed or Suspended
The semiconductor market is highly cyclical and as a consequence we may need to implement workforce reductions in case of a downturn, in order to adapt to such market changes. In accordance with labor laws and practices applicable in the jurisdictions in which we operate, a reduction of any significance may be subject to certain formal procedures, which can delay, or may result in the modification of our planned workforce reductions. For example, in the Netherlands, if our Works Council renders adverse advice in connection with a proposed workforce reduction in the Netherlands, but we nonetheless determine to proceed, we must temporarily suspend any action while the Works Council determines whether to appeal to the Enterprise Chamber of the Amsterdam Court of Appeal. This appeal process can cause a delay of several months and may require us to address any procedural inadequacies identified by the Court in the way we reached our decision. Such delays could impair our ability to reduce costs company-wide to levels comparable to those of our competitors. See Item 6.D. “Employees”.
 
 
Fluctuations in Foreign Exchange Rates Could Harm Our Results of Operations
We are exposed to currency risks. We are particularly exposed to fluctuations in the exchange rates between the U.S. dollar, Japanese yen and the euro as we incur manufacturing costs and price our systems predominantly in euro while a portion of our net sales and cost of sales is denominated in U.S. dollars and Japanese yen.
 
 
In addition, a substantial portion of our assets and liabilities and operating results are denominated in U.S. dollars, and a small portion of our assets, liabilities and operating results are denominated in currencies other than the euro and the U.S. dollar. Our consolidated financial statements are expressed in euro. Accordingly, our results of operations and assets and liabilities are exposed to fluctuations in various exchange rates.
 
 
Furthermore, a strengthening of the euro particularly against the Japanese yen could lead to intensified price-based competition in those regions that account for the majority of our sales, resulting in lower prices and margins and a material adverse effect on our business, financial condition and results of operations.
 
 
Also see Item 5.A. “Operating Results, Foreign Exchange Management”, Item 5.F. “Tabular Disclosure of Contractual Obligations”, Item 11 “Quantitative and Qualitative Disclosures About Market Risk” and Note 4 to our consolidated financial statements.
 
 
We May Be Unable to Make Desirable Acquisitions or to Integrate Successfully Any Businesses We Acquire
Our future success may depend in part on the acquisition of businesses or technologies intended to complement, enhance or expand our current business or products or that might otherwise offer us growth opportunities. Our ability to complete such transactions may be hindered by a number of factors, including potential difficulties in obtaining government approvals.
 
 
Any acquisition that we do make would pose risks related to the integration of the new business or technology with our business. We cannot be certain that we will be able to achieve the benefits we expect from a particular acquisition or investment. Acquisitions may also strain our managerial and operational resources, as the challenge of managing new operations may divert our staff from monitoring and improving operations in our existing business. Our business, financial condition and results of operations may be materially and adversely affected if we fail to coordinate our resources effectively to manage both our existing operations and any businesses we acquire.
 
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Our Business and Future Success Depend on Our Ability to Attract and Retain a Sufficient Number of Adequately Educated and Skilled Employees
Our business and future success significantly depends upon our employees, including a large number of highly qualified professionals, as well as our ability to attract and retain employees. Competition for such personnel is intense, and we may not be able to continue to attract and retain such personnel, which could adversely affect our business, financial condition and results of operations.
 
 
In addition, the increasing complexity of our products results in a longer learning curve for new and existing employees leading to an inability to decrease cycle times and incurring significant additional costs, which could adversely affect our business, financial condition and results of operations.
 
 
Risks Related to Our Ordinary Shares
 
The Price of Our Ordinary Shares is Volatile
The current market price of our ordinary shares may not be indicative of prices that will prevail in the future. In particular, the market price of our ordinary shares has in the past experienced significant fluctuation, including fluctuation that is unrelated to our performance. This fluctuation may continue in the future.
 
 
Restrictions on Shareholder Rights May Dilute Voting Power
Our Articles of Association provide that we are subject to the provisions of Netherlands law applicable to large corporations, called “structuurregime”. These provisions have the effect of concentrating control over certain corporate decisions and transactions in the hands of our Supervisory Board. As a result, holders of ordinary shares may have more difficulty in protecting their interests in the face of actions by members of our Supervisory Board than if we were incorporated in the United States or another jurisdiction.
 
 
Our authorized share capital also includes a class of cumulative preference shares and ASML has granted “Stichting Preferente Aandelen ASML”, a Netherlands foundation, an option to acquire, at their nominal value of EUR 0.02 per share, such cumulative preference shares. Exercise of the cumulative preference share option would effectively dilute the voting power of our outstanding ordinary shares by one-half, which may discourage or significantly impede a third party from acquiring a majority of our voting shares.
 
 
See further Item 6.C. “Board Practices” and Item 10.B. “Memorandum and Articles of Association”.
 
 
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, Israel and India. In 2001, we changed our name from ASM Lithography Holding N.V. to ASML Holding N.V. Our registered office is located at De Run 6501, 5504 DR Veldhoven, the Netherlands, telephone +31 40 268 3000.
 
 
In May 2001, we merged with SVG (now part of ASML US, Inc.), a company that was active in the Lithography, Track and Thermal businesses. In December 2002, we announced the termination of our manufacturing activities in the Track business and the divestiture of our Thermal business. In October 2003, we substantially completed the divestiture of our Thermal business.
 
 
From time to time, ASML pursues acquisitions of smaller businesses that it believes will complement or enhance ASML’s core lithography business. Acquisitions have included the acquisition of MaskTools in July, 1999 and the acquisition of Brion Technologies, Inc. (“Brion”) in March 2007. See Item 4.B. “Business Overview, Market and Technology Overview”.
 
 
Capital Expenditures and Divestitures
Our capital expenditures for 2007, 2006 and 2005 amounted to EUR 232.2 million, EUR 99.4 million and EUR 79.8 million, respectively. The related cash outflows for 2007, 2006 and 2005 amounted to EUR 179.2 million, EUR 70.7 million and EUR 74.0 million, respectively. Our capital expenditures in these years generally related to the construction of new facilities in Veldhoven and Taiwan, purchases of machinery and equipment mainly from our own product portfolio (e.g. prototypes, demonstration and training systems), information technology investments, leasehold improvements to our facilities and licenses of patents related to lithography equipment. See Item 4.D. “Property, Plants and Equipment” for capital expenditures currently in progress.
 
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Divestitures within continued operations, principally comprising machinery and equipment (more specifically prototypes, demonstration and training systems), amounted to EUR 20.4 million for 2007, EUR 5.6 million for 2006 and EUR 30.3 million for 2005. See Note 10 to our consolidated financial statements.
 
 
B. Business Overview
We are one of the world’s leading providers of advanced technology systems for the semiconductor industry, based on revenue. We offer an integrated portfolio of lithography systems mainly for manufacturing complex integrated circuits (“semiconductors” or “ICs”). We supply lithography systems to IC manufacturers throughout the United States, Asia and Europe and also provide our customers with a full range of support from advanced process and product applications knowledge to complete round-the-clock service support.
 
 
Our Business Model
Our business model is derived from our “Value of Ownership” concept which is based on the following principles:
•  offering ongoing improvements in productivity, imaging and overlay by introducing advanced technology based on modular platforms resulting in lower costs per product for our customers;
•  providing customer services that ensure rapid, efficient installation and superior on-site support and training to optimize manufacturing processes of our customers 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 of our customers through ongoing field upgrades of key value drivers (productivity, imaging and overlay) based on further technology developments;
•  reducing the cycle time between a customer’s 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 faster speeds and with reduced power consumption. We believe that these long-term trends will continue for the foreseeable future and will be accompanied by a continuing demand, subject to ongoing cyclical variations, for production equipment that can accurately produce advanced ICs in high volumes at the lowest possible cost. Photolithography is used to print complex circuit patterns onto the wafers that are the primary raw material for ICs and is one of the most critical and expensive steps in their fabrication. It is therefore a significant focus of the IC industry’s demand for cost-efficient enhancements to production technology.
 
 
We primarily design, manufacture, market and service semiconductor processing equipment used in the fabrication of ICs. Our photolithography equipment includes Step & Scan systems, which combine stepper technology with a photoscanning method.
 
 
Our TWINSCAN product platform was introduced in July 2000 and applies the production-proven elements of our PAS 5500 product family to the industry shift toward larger (300 millimeter (“mm”)) wafers. In 2003, the TWINSCAN platform became the vehicle to introduce improved resolution products both for 300 mm and 200 mm wafer size factories. Our PAS 5500 product family, which supports a maximum wafer size of 200 mm in diameter, comprises advanced wafer steppers and Step & Scan systems suitable for i-line and deep UV (including 248 nanometer (“nm”) and 193 nm wavelengths) processing of wafers. In the fourth quarter of 2007, we shipped our 750th TWINSCAN system, demonstrating the acceptance of the TWINSCAN platform as the semiconductor industry’s standard for 300 mm lithography.
 
 
In 2005, we intensified our research and development in immersion lithography as we believed this was the most probable solution to reduce the manufacturing cost per wafer while increasing resolution. In 2007 we shipped over 35 immersion systems compared to 23 in 2006 and 13 in 2005.
 
 
In 2006, we shipped the industry’s first EUV Alpha Demo Tools to two research institutions, which work closely with most of the world’s major IC manufacturers in developing manufacturing processes and materials. EUV combines a wavelength of 13.5 nm and a lens system with a numerical aperture (“NA”) of 0.25 to provide imaging at a resolution of 32 nm. EUV will provide a large process window compared to current approaches and we expect it to be a multi-generation lithography solution. Through the end of 2007, ASML received four orders for a total of four next generation EUV systems, the first of which is scheduled for shipment in late 2009 and targeted for production of ICs down to 32 nm. In 2007, we significantly increased development resources to support the development of this product.
 
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In March 2007, we completed the acquisition of Brion, a manufacturer of computational lithography products used for the implementation of optical proximity correction “OPC” to design data and verification before mask (reticle) manufacture. The acquisition of Brion is expected to enable ASML to improve the implementation of OPC and resolution enhancement techniques such as Double Patterning in the masks to be used on ASML systems. These improvements in turn are expected to enable the extension of the practical resolution limits of ASML ArF immersion products. Use of Brion’s computational lithography capability is also expected to enable us to offer products to further improve the set-up and control of ASML lithography systems.
 
 
We are also performing research on maskless lithography (the mask contains the pattern which is imaged onto the wafer). Maskless lithography is one of the possible solutions for managing increasing mask costs or to increase the flexibility of the imaging. Designs resulting in small quantities of wafers, designs with many changes or designs that require a fast time-to-market will particularly benefit from maskless technology. In December 2004, Micronic Laser Systems AB (“Micronic”) and ASML agreed to a license agreement relating to the development of optical maskless lithography technology for semiconductor manufacturing.
 
 
Products
We develop lithography systems and related products for the semiconductor industry and related patterning applications. Our product development strategy focuses on the development of product families based on a modular, upgradeable design.
 
 
Our older PAS 2500 and PAS 5000 lithography systems, which we no longer manufacture but refurbish, are used for g-line and i-line processing of wafers up to 150 mm in diameter and are employed in manufacturing environments and in special applications for which design resolutions no more precise than 0.5 microns are required.
 
 
Our PAS 5500 product family comprises advanced wafer steppers and Step & Scan systems suitable for i-line and deep Ultra Violet (“UV”) processing of wafers up to 200 mm in diameter. In mid-1997, we introduced the PAS 5500 Step & Scan systems with improved resolution and overlay. Since then, we have further developed and expanded this Step & Scan product family. This modular upgradeable design philosophy has been further refined and applied in the design of our most advanced product family, the TWINSCAN platform, which is the basis for our current and next generation Step & Scan systems, producing wafers up to 300 mm in diameter and capable of extending shrink technology down to 40 nm.
 
 
The PAS 5500 series is the most suitable product range for processing of 200 mm wafers using step-and-scan technology. We offer PAS 5500 systems based on i-line (using light with a 365 nm wavelength), KrF (using light with a 248 nm wavelength) and ArF (using light with a 193 nm wavelength) technology. For high end 200 mm applications we also offer TWINSCAN ArF tools.
 
 
We are the leader in the innovation of immersion technologies and we were the world’s first producer of dual-stage design (TWINSCAN) systems. Wafer measurement, including focus and alignment, is completed on the dry stage, while the imaging process, using water applied between the wafer and the lens, is completed on the wet stage. The dual-stage advantage of TWINSCAN systems enables our customers to gain the process enhancements of immersion and to continue with familiar and proven metrology technology.
 
 
For processing of 300 mm wafers, we offer TWINSCAN systems based on i-line, KrF and ArF technology. In 2003, we introduced the second generation of TWINSCAN systems based on the XT body with a reduced footprint and a 50 percent reduction in the main production area occupied by our system. In 2004, we shipped our first lithography systems based on immersion technology. These shipments marked the delivery of the industry’s first high productivity immersion scanners for production applications.
 
 
In the second quarter of 2006, we started volume production of the TWINSCAN XT:1700i, a 193 nm immersion scanner capable of imaging at the 45 nm node in volume production environments. This system featured an NA of 1.2, substantially higher than the XT:1400’s NA of 0.93, exceeding the pre-immersion barrier of 1.0, which is enabled by a new catadioptric lens design. The XT:1700i has enabled chipmakers to improve resolution by 30 percent and has been employed in the development and manufacturing of the latest advanced generation of ICs.
 
 
In July 2006, we announced plans to introduce a next generation immersion system, the XT:1900i, with a new industry benchmark of 1.35 NA, which we believe is close to the practical limit for water-based immersion technology. In the third quarter of 2007, ASML began volume shipment of the XT:1900i. This new optical lithography system is capable of volume production of ICs down to 40 nm and below and has already been deployed by several of our advanced manufacturing customers. In 2007 we shipped over 18 XT:1900i systems.
 
 
In July 2007, ASML announced plans for a new product, the XT:1000, which will use the new catadioptric lens technology developed for the XT:1700i and XT:1900i to extend the maximum numerical aperture (NA) of the previous generation of 248 nm wavelength, KrF, systems to 0.93 NA from the previous maximum available of 0.8 NA. The XT:1000’s high NA of 0.93 can resolve 80 nm device features, far smaller than the 100 nm of today’s KrF systems. The XT:1000 also improves value to customers, with
 
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an increased throughput of 165-300 mm wafers per hour under volume manufacturing conditions while maintaining the same industry-leading 6 nm overlay as leading-edge ArF systems. ASML expects to ship XT:1000 systems from mid-2008.
 
 
We also continually develop and sell a range of product options and enhancements designed to increase productivity, imaging and overlay to optimize value of ownership over the entire life of our systems. The table below sets forth our current product portfolio of Steppers and Scan & Step Systems by resolution and wavelength.
 
 
Current ASML lithography product portfolio of Steppers and Step & Scan Systems1
 
                 

    Resolution   Wavelength   lightsource   NA
PAS 5500 SYSTEMS
               
PAS 5500/4X0
  280 nm   365 nm   i-line   0.48-0.65
PAS 5500/750
  130 nm   248 nm   KrF   0.50-0.70
PAS 5500/850
  110 nm   248 nm   KrF   0.55-0.80
PAS 5500/1150
  90 nm   193 nm   ArF   0.50-0.75
                 
TWINSCAN SYSTEMS
               
TWINSCAN XT:400
  350 nm   365 nm   i-line   0.48-0.65
TWINSCAN XT:450
  220 nm   365 nm   i-line   0.48-0.65
TWINSCAN XT:760
  130 nm   248 nm   KrF   0.50-0.70
TWINSCAN XT:8X0
  110 nm   248 nm   KrF   0.55-0.80
TWINSCAN XT:875
  90 nm   248 nm   KrF   0.55-0.80
TWINSCAN XT:1000
  80 nm   248 nm   KrF   0.50-0.93
TWINSCAN XT:14X0
  65 nm   193 nm   ArF   0.65-0.93
TWINSCAN XT:1700 immersion
  45 nm   193 nm   ArF   0.75-1.20
TWINSCAN XT:1900 immersion
  40 nm   193 nm   ArF   0.85-1.35
 
 
This table does not include the older (including pre-used) products sold on the PAS 2500, PAS 5000 and PAS 5500 platforms
 
–  XT is a TWINSCAN system for wafer sizes of up to 200 and 300 mm;
–  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;
–  The X in the number represents different models in the product portfolio within the same resolution. For example XT:8X0 can either represent XT:800 or XT:850;
–  NA is the abbreviation of numerical aperture.
 
 
Sales and Customer Support
We market and sell our products principally through our direct sales staff.
 
 
We support our customers with a broad range of applications, services, and technical support products to maintain and maximize the performance of our systems at customer sites. We also offer refurbished and remanufactured tools, system upgrades and enhancements, and technical training.
 
 
Our field engineers and applications, service and technical support specialists are located throughout the United States, Europe and Asia.
 
 
In 2006, ASML started an initiative to establish the ASML Center of Excellence (“ACE”) in Asia. The primary goal of ACE is to serve as a supplementary engine to propel ASML’s long term growth. ACE will feature customer support, training, logistics, development and engineering, refurbishment and semiconductor application development. ACE will also enable sourcing of selected equipment modules, components and services in the region. Finally, ACE will be used as a training center to develop worldwide talent for ASML’s workforce. In the fourth quarter of 2007, we started construction of the building and facility that will house ACE near Taipei, Taiwan. Construction is expected to be finished at the end of 2008. See Item 4.D. “Property, Plants and Equipment”.
 
 
Customers and Geographic Regions
In 2007, sales to our largest customer accounted for EUR 833 million, or 21.9 percent of net sales, compared to EUR 730 million, or 20 percent of net sales, in 2006. We expect that sales to relatively few customers will continue to account for a high percentage of our net sales in any particular period for the foreseeable future. See Item 3.D. “Risk Factors – A High Percentage of Net Sales Is Derived from a Few Customers” and Note 17 to our consolidated financial statements for a breakdown of our sales by geographic location.
 
 
Manufacturing, Logistics and Suppliers
Our business model is based on outsourcing production of a significant part of the components and modules that comprise our lithography systems, working in partnership with suppliers from all over the world. Our manufacturing activities comprise the
 
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assembly, fine tuning and testing of a finished system from components and subassemblies that are manufactured to our specifications by third parties and by us, and which we test prior to assembly. All of our manufacturing activities (subassembly, final assembly and system testing) are performed in one clean room facility located in Veldhoven, the Netherlands, and one clean room facility in Wilton, Connecticut, United States. We procure stepper and scanner system components and subassemblies from a single supplier or a limited group of suppliers in order to ensure overall quality and timeliness of delivery. We jointly operate a formal strategy with suppliers known as “value sourcing” which is based on competitive performance in quality, logistics, technology and total cost. The essence of value sourcing is to maintain a supply base that is world class, globally competitive and globally present.
 
 
Our value sourcing strategy is based on the following strategic principles:
•  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.
 
 
Value sourcing is intended to align the performance of our suppliers with our requirements on quality, logistics, technology and total costs.
 
 
Zeiss is our sole external supplier of main optical systems and one of the suppliers of other components. In 2007, approximately 40 percent of our aggregate cost of sales was purchased from Zeiss.
 
 
Zeiss is highly dependent on its manufacturing and testing facilities in Oberkochen and Wetzlar, Germany, and its suppliers. Moreover, Zeiss has a finite production capacity for production of lenses and optical components for our stepper and scanner systems. The expansion of this production capacity may require significant lead time. From time to time, the number of systems we have been able to produce has been limited by the capacity of Zeiss to provide us with lenses and optical components. During 2007, we were in some cases constrained by the number of lenses that Zeiss could produce.
 
 
If Zeiss is unable to maintain or increase production levels, we might not be able to respond to customer demand. As a result, our relationships with current and prospective customers could be harmed, which would have a material adverse effect on our business, financial condition and results of operations.
 
 
Our relationship with Zeiss is structured as a strategic alliance pursuant to several agreements executed in 1997 and later years. These agreements define an exclusive framework for cooperation in all areas of our joint business. The partnership between ASML and Zeiss is focused on continuous improvement of operational excellence.
 
 
Pursuant to these agreements, ASML and Zeiss will continue their strategic alliance until either party provides at least three years’ notice of its intent to terminate. Although we believe such an outcome is unlikely, if Zeiss were to terminate its relationship with us, or if Zeiss were unable to produce lenses and optical components over a prolonged period, we would effectively cease to be able to conduct our business.
 
 
In addition to Zeiss, we also rely on other outside vendors for the components and subassemblies used in our systems, each of which is obtained from a single supplier or a limited number of suppliers. Our reliance on a limited group of suppliers involves several risks, including a potential inability to obtain an adequate supply of required components and the risk of untimely delivery of these components and subassemblies.
 
 
See Item 3.D. “Risk Factors, The Number of Systems We Can Produce Is Limited by Our Dependence on a Limited Number of Suppliers of Key Components”.
 
 
Research and Development
The semiconductor manufacturing industry is subject to rapid technological changes and new product introductions and enhancements. We believe that continued and timely development and introduction of new and enhanced systems are essential for us to maintain our competitive position. As a result, we have historically devoted a significant portion of our financial resources to research and development programs and we expect to continue to allocate significant resources to these efforts. In addition, we have established and are currently establishing sophisticated development centers in the Netherlands, the United States and Taiwan, respectively. We also work jointly with independent research centers in nano-electronics and nano-technology. Those research centers focus on the next generations of chips and systems.
 
 
We apply for subsidy payments in connection with specific development projects under programs sponsored by the Netherlands government, the European Union, the United States and Taiwanese government. Amounts received under these programs
 
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generally are not required to be repaid. See our discussions of research and development in Item 5 “Operating and Financial Review and Prospects”, and Note 1 to our consolidated financial statements.
 
 
We invested EUR 511 million in research and development in continuing operations in 2007, compared to EUR 414 million in 2006 and EUR 348 million in 2005. The amount invested in 2007 includes a one-off charge related to the Brion acquisition of EUR 23 million (amortization of in-process research and development). We are also involved in joint research and development programs with both public and private partnerships and consortiums, involving independent research centers, leading chip manufacturers and governmental programs. We aim to own or license our jointly developed technology and designs of critical components.
 
 
In 2007, our research and development efforts drove further development of the TWINSCAN platform along with several leading-edge technologies, including 248 nm, 193 nm, immersion and EUV. The continuous drive by our customers for cost reductions has led us to significantly increase the commonality of components of the different models of the TWINSCAN platform. Our research and development activities in 2007 have also led to productivity and performance enhancements for our other product families. We also started developing technology to support applications of “double patterning”. Double patterning is a resolution enhancement technique that involves splitting a dense circuit pattern into multiple, less-dense patterns. These simplified patterns are then printed sequentially on a target wafer. Between the exposures, the wafer is removed from the exposure system for additional processing. Double patterning improves the achievable resolution and enables the printing of smaller features.
 
 
Intellectual Property
We rely on intellectual property rights such as patents, copyrights and trade secrets to protect our proprietary technology. We aim to obtain ownership rights on technology developed by or for us or, alternatively, to have license rights in place with respect to such technology. However, we face the risk that such measures will be inadequate. Intellectual property laws may not sufficiently support our proprietary rights, our patent applications may not be granted and our patents may not be construed as we expect. Also, competitors may be able to develop or protect similar technology earlier and independently.
 
 
Litigation may be necessary to enforce our intellectual property rights, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement. Any such litigation may result in substantial costs and diversion of management resources, and, if decided unfavorably to us, could have a material adverse effect on our business, financial condition and results of operations. We also may incur substantial licensing or settlement costs where doing so would strengthen or expand our intellectual property rights or limit our exposure to intellectual property claims of third parties.
 
 
Patent cross-license with Canon
In December 2007, we announced that ASML and Zeiss have signed an agreement with Canon for the global cross-license of patents in their respective fields of semiconductor lithography and optical components, used to manufacture integrated circuits, or chips. There will be no transfer of technology and no payment was made among the parties. The cross-license helps the three companies to compete more freely in the area relevant to their customers, which is technology expertise and implementation, rather than on intellectual property (IP) rights. ASML and Zeiss are strongly committed to investing in research and development and will continue their build-up of know-how and IP.
 
 
Patent litigation with Nikon
From 2001 through late 2004, we were a party to a series of civil litigations and administrative proceedings in which Nikon alleged ASML’s infringement of Nikon patents relating to photolithography. ASML in turn filed claims against Nikon.
 
 
Pursuant to agreements executed on December 10, 2004 (effective November 12, 2004), ASML, Zeiss and Nikon agreed to settle all pending worldwide patent litigation between the companies. The settlement included an agreement to dismiss all pending patent litigation between the companies, an exchange of releases, a cross-license of patents related to lithography equipment used to manufacture semiconductor devices and payments to Nikon by ASML and Zeiss. In connection with the settlement, ASML made an initial payment to Nikon of US$ 60 million in 2004 and further payments of US$ 9 million in 2005, 2006 and 2007. Zeiss also made settlement payments to Nikon from 2004 to 2007. See Item 18 “Financial Statements” for a description of the accounting treatment.
 
 
Patent litigation with Ultratech Stepper, Inc
In May 2000, Ultratech Stepper, Inc. (“Ultratech”) filed a lawsuit against ASML. Ultratech alleged that ASML infringed Ultratech’s rights under a United States patent in connection with its manufacture and commercialization in the United States of advanced photolithography equipment embodying technology that, in particular, is used in Step & Scan equipment.
 
 
Ultratech’s patent infringement claims were tried before a jury in Oakland, California, in May and June of 2005. On June 21, 2005 the jury unanimously determined that each of the patent claims that Ultratech had asserted against ASML was invalid, and thus
 
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that ASML was not liable for patent infringement, notwithstanding the jury’s finding that each of these claims was infringed by ASML and certain of its customers. The court entered judgment in favor of ASML following receipt of the jury verdict.
 
 
Ultratech filed motions with the court seeking to overturn the jury’s finding that its asserted patent claims are invalid or, in the alternative, seeking a new trial. The court denied each of Ultratech’s motions. Ultratech then filed an appeal with the United States Court of Appeals for the Federal Circuit challenging the finding that its asserted patent claims are invalid. On May 14, 2007, the Federal Circuit rejected Ultratech’s arguments on appeal, affirming the lower court’s order that Ultratech’s asserted patent claims are invalid. The time for Ultratech to file an appeal with the United States Supreme Court has lapsed.
 
 
Arbitration with Aviza Technology
On December 1, 2006, Aviza Technology (“Aviza”) initiated arbitration proceedings against ASML Holding N.V., ASML U.S., Inc. and certain of its affiliates and subsidiaries (collectively, the “ASML parties”). Aviza’s arbitration demand alleges that the ASML parties engaged in fraud and made negligent misrepresentations or omissions in connection with a 2002 License Agreement between ASML and IPS, Ltd. That agreement was assigned to Aviza in connection with the 2003 divestiture of ASML’s Thermal Division.
 
 
We believe that there are meritorious defenses to Aviza’s allegations.
 
 
Although we believe the ultimate outcome of the dispute with Aviza will not have a material adverse effect on our business, financial condition or result of operations (taking into account the defenses available to ASML), given the inherently uncertain nature of arbitration, our defenses may not succeed. If Aviza were to prevail, it could have a material adverse effect on ASML’s business, financial condition or results of operations.
 
 
Dividend withholding tax
In May and June 2006 ASML entered into forward purchase agreements with a broker acting as principal to effect the share repurchases under its share buyback program.
 
 
The aggregate number of shares bought back up to and including July 13, 2006 was 25,450,296 and represented 100 percent of the announced objective of maximum EUR 400 million to be repurchased during the term of the program.
 
 
The Netherlands tax authorities have challenged the fiscal interpretation of the share program and are seeking to recast the repurchase as a dividend payment to unidentifiable shareholders. As a result the Netherlands tax authorities have issued a dividend withholding tax assessment of approximately EUR 24 million, payable by ASML. ASML management is of the opinion that the case of the Netherlands tax authorities is without merit and will contest the position of the Netherlands tax authorities in court. Based on this, ASML management believes that there is no reason to set up a liability for this dividend withholding tax assessment.
 
 
Competition
The semiconductor equipment industry is highly competitive. The principal elements of competition in our market segments are the technical performance characteristics of a photolithography system and the value of ownership of that system based on its purchase price, maintenance costs, productivity and customer service and support. In addition, we believe that an increasingly important factor affecting our ability to compete is the strength and breadth of our portfolio of patent and other intellectual property rights. We believe that the market segment for photolithography systems and the investments required to be a significant competitor in this market segment have resulted in increased competition for market share through the aggressive prosecution of patents. Our competitiveness will increasingly depend upon our ability to protect and defend our patents, as well as our ability to develop new and enhanced semiconductor equipment that is competitively priced and introduced on a timely basis. See Item 3.D. “Risk Factors, We Face Intense Competition”.
 
 
Government Regulation
Our business is subject to direct and indirect regulation in each of the countries in which our customers or we do business. As a result, changes in various types of regulations could affect our business adversely. The implementation of new technological or legal requirements could impact our products, or our manufacturing or distribution processes, and could affect the timing of product introductions, the cost of our production, and products as well as their commercial success. Moreover, environmental and other regulations that adversely affect the pricing of our products could adversely affect our results of operation. The impact of these changes in regulation could adversely affect our business even where the specific regulations do not directly apply to us or to our products.
 
 
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 wholly-owned subsidiary, are as follows:
 
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(CHART)
 
 
See Exhibit 8.1 for a list of our material subsidiaries.
 
 
D. Property, Plants and Equipment
We principally obtain and operate our facilities under operating leases. However, we also own a limited number of buildings. We are currently constructing new facilities as part of the expansion of our worldwide capacity. The book value of the buildings used in our continuing operations and owned by us amounted to EUR 136 million as of December 31, 2007 compared to EUR 59 million as of December 31, 2006.
 
 
During 2007, our facilities were generally utilized at and in some cases above normal capacity.
 
 
Subject to market developments we expect that our capital expenditures in 2008 could be up to approximately EUR 250 million, an increase of EUR 18 million compared to 2007. We expect that a significant part of 2008 expenditures will be allocated to construction and upgrades of production facilities in the Netherlands and Taiwan. This expansion would offer the additional space and facilities necessary to accommodate our current production levels as well as support continued growth in the long term. We intend to fund the related capital expenditures primarily with cash on hand and/or cash generated through operations.
 
 
See also Item 4.A. “History and Development of the Company, Capital Expenditures and Divestitures” and Item 5.B. “Liquidity and Capital Resources” and Note 10 to our consolidated financial statements.
 
 
Facilities in Europe
Our headquarters, applications laboratory and research and development facilities are located in a 120 thousand square meter state-of-the-art facility in the Netherlands, of which 65 thousand square meters is used as office space and 55 thousand square meters is used for manufacturing and research and development activities. We lease the majority of these facilities through long-term operating leases that contain purchase options. Some of our office facilities at our headquarters in Veldhoven are financed through a special purpose vehicle that is a variable interest entity. See Item 5.E. “Off-Balance Sheet Arrangements” and Note 13 to our consolidated financial statements. We also lease several sales and service facilities at locations across Europe.
 
 
Facilities in the United States
Our American headquarters and American training facilities are located in two buildings, comprising a nine thousand square meter office building space and a ten thousand square meter training space in Tempe, Arizona. We maintain lithography research, development and manufacturing operations in a 27 thousand square meter facility in Wilton, Connecticut and a six thousand square meter facility in Santa Clara, California. We also lease several sales and service facilities at locations across the United States.
 
 
Facilities in Asia
Our Asian headquarters is located in a 425 square meter office space in Hong Kong. We also lease and own several sales and service / training facilities at locations across Asia.
 
 
During 2007 we started the construction of our new ACE facility located in Linkou, Taiwan. This project comprises both clean room (approximately two thousand square meters) and office space (approximately six thousand square meters) in order to support customers in the Asia-Pacific region by focusing on technology and applications development, equipment support, training, logistics and refurbishment. ACE will also enable local sourcing of equipment models, components and services.
 
 
Item 4A Unresolved Staff Comments
 
 
Not applicable.
 
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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 2007, we generated net sales of EUR 3,809 million and income from operations of EUR 825 million or 21.7 percent of net sales. Net income in 2007 amounted to EUR 688 million or 18.1 percent of net sales, representing EUR 1.49 per share.
 
 
As of December 31, 2007 we employed approximately 6,500 employees and operated in 16 countries through over 63 sales and service locations.
 
 
In the executive summary below we provide an update of the semiconductor equipment industry, followed by our business strategy and a discussion of our key performance indicators.
 
 
Semiconductor equipment industry update
Historically the semiconductor industry has experienced significant growth largely due to the continual reduction of cost per function performed by ICs. Improvement in the design and manufacture of ICs with higher circuit densities has resulted in smaller and cheaper ICs capable of performing a larger number of functions at higher speeds with lower power consumption. We believe that these long term trends will continue for the foreseeable future and will be accompanied by a continuing demand for production equipment that is capable of accurate production of advanced ICs in high volumes at the lowest possible cost.
 
 
Lithography equipment is used to print complex circuit patterns onto silicon wafers, which are the primary raw materials for ICs. The printing process is one of the most critical and expensive steps in wafer fabrication. Lithography equipment is therefore a significant focus of the IC industry’s demand for cost efficient enhancements to production technology.
 
 
The costs to develop new lithography equipment are high. Accordingly, the lithography equipment industry is characterized by the presence of only a few primary suppliers: ASML, Nikon and Canon. ASML is the world’s leading provider of lithography equipment with a market share based on revenue of 65 percent in 2007 up from 63 percent in 2006 according to the latest available data up to and including November 2007 as reported by SEMI, an independent semiconductor industry organization.
 
 
Nikon and Canon are the leading suppliers in Japan, which accounts for a significant portion of worldwide semiconductor production. This region historically has been difficult for non-Japanese companies to penetrate. Since 2004, we have been increasing our service, sales and marketing operations in Japan to serve our growing customer base. In 2007, we further strengthened our long term market development strategy in Japan, and our net system sales there grew from EUR 139 million in 2006 to EUR 269 million.
 
 
Total lithography equipment shipped by the industry as a whole in the five years ended December 31, 2006 is set forth in the following table:
 
                     

Year ended December 31   2002   2003   2004   2005   2006
Total units shipped
  413   456   694   536   633
Total value (in millions USD)
  2,817   3,229   5,268   4,988   6,386
 
 
(Source: Gartner Dataquest)
 
 
 
In 2007, the semiconductor industry experienced another year of growth due to growth in semiconductor units by 11 percent and the continuing technology drive of our customers among other things resulting in continued strong capacity build-up by our customers, especially in memory. During this period, our customers began ramp-up of volume manufacturing for 45 nm Flash and 55 nm DRAM with our advanced immersion systems.
 
 
Business strategy
Our business strategy is based on achieving and reinforcing technological leadership in semiconductor lithography, resulting in the delivery of superior value of ownership for our customers while achieving top financial performance in our segment. We implement this strategy through customer focus, aggressive investment in research and development, and operational excellence.
 
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Customer focus
We serve different types of chipmakers by ensuring that our products provide premium value for the various semiconductor market segments, including memory, integrated device manufacturers, and foundries or made-to-order chip contractors.
 
 
Of the top 20 chipmakers worldwide, in terms of semiconductor capital expenditure, 18 are our customers. We also have a significant market share of customers below the top 20. We strive for continued growth in both segments.
 
 
In 2007, we achieved top customer satisfaction ratings among large suppliers of semiconductor wafer processing equipment, according to VLSI Research, an independent industry research firm that surveyed customers representing 95 percent of the world’s total semiconductor market. Our satisfaction ratings by customers surpassed every lithography competitor for the fifth year in a row.
 
 
In July 2007, we announced a new KrF lithography system that significantly reduces operating costs for our customers. The ASML TWINSCAN XT:1000 scanner extends cost efficient KrF technology to resolutions that previously required more expensive ArF technology. Customers can realize savings of 30 percent or more per layer as a result of the lower operating costs for KrF technology, particularly its use of less expensive lasers and lower material costs for KrF resists and other materials.
 
 
We are making additional investments in Japan, where historically the leading positions have been held by our competitors and where ASML is increasing sales and customers.
 
 
From time to time, we seek to expand our business scope as ASML pursues hardware technologies and new product opportunities in fields adjacent or complementary to our core semiconductor lithography competence. In March 2007, ASML completed the acquisition of Brion Technologies, Inc., a leading provider of semiconductor design and wafer manufacturing optimization solutions for advanced lithography.
 
 
Aggressive investment in research and development
Our product range for steppers and advanced Step & Scan systems spans all the industry’s current wavelengths for both 200- and 300-mm wafers.
 
 
Supported by our financial performance, research and development expenses in 2007 increased by 25.8 percent compared with 2006 (which excludes a one-off charge of EUR 23 million in 2007 of in-process research and development relating to the Brion acquisition), as we accelerated new developments and advanced our development of immersion and EUV technologies. This operating decision was made possible by leveraging our outsourcing strategy, which continues to enable us to rapidly and efficiently adjust our cost structure throughout a cycle while making use of leading-edge capabilities in our supply chain.
 
 
Since 2000, we have offered a dual-stage wafer imaging platform – the TWINSCAN system – which allows exposure of one wafer while simultaneously measuring the wafer that will be exposed next. ASML’s strong leadership in this capability has allowed it to achieve the industry’s highest throughput, enabling reduced cost-per-exposure per wafer. ASML is the only lithography manufacturer that has volume production based on dual stage systems.
 
 
In the third quarter of 2007, we shipped our first new TWINSCAN XT:1900i system, the only immersion lithography machine in the world capable of imaging chip features down to 40 nm. Our innovative immersion lithography replaces air over the wafer with fluid, enhancing focus on enabling circuit line-width to shrink to even smaller dimensions. ASML experienced strong demand for this machine, driven initially by memory chip makers that need more cost effective technology transitions to the 4x and 5x nm nodes that are enabled by immersion systems. With more than 70 immersion systems shipped to date, our immersion technology is now widely accepted as the standard for critical layer high volume chip manufacturing, solidifying our technology leadership position worldwide and supporting our significant growth in Japan.
 
 
In parallel, we are developing EUV technology. We received four orders for preproduction tools during 2007, the first of which is scheduled for shipment in late 2009. We have two Alpha Demo Tools at research and development institutions located in Albany, New York (United States) and Leuven (Belgium), where potential customers can conduct early stage research and development, and where the first 30 nm images with a Sn light source were produced.
 
 
Operational excellence
We strive to sustain our business success based on our technological leadership by continuing to execute our fundamental operating strategy well, including reducting in lead time while improving our cost competitiveness. Lead time is the time from a customer’s order to a tool’s delivery.
 
 
Our business strategy includes outsourcing the majority of components and subassemblies that make up our products. We work in partnership with suppliers, collaborating on quality, logistics, technology and total cost. By operating our strategy of value
 
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sourcing, we strive to attain flexibility and cost efficiencies from our suppliers through mutual commitment and shared risk and reward. Value sourcing also allows the necessary flexibility to adapt to the cyclicality of the world market for semiconductor lithography systems.
 
 
ASML has a flexible labor model in its manufacturing facilities located in Veldhoven which reinforces our ability to adapt more quickly to semiconductor market cycles, including support for potential 24-hour, seven days-a-week production activities. By maximizing the flexibility of our high tech work force, we can shorten lead time: a key driver of added value for customers. Flexibility also reduces our working capital requirements.
 
 
We continuously strive to improve efficiencies in our operations: addressing our cost structure and strengthening our capability to generate cash. We have been successful at progressively enhancing the value of ownership of our products while increasing margins and boosting cash generation through gains in manufacturing productivity and reductions in cycle time.
 
 
ASML operations update on key performance indicators
The following table presents the key performance indicators used by our Board of Management and senior management to measure performance in our monthly operational review meetings.
 
                                       

Year ended December 31                          
(in millions, except market
  2005
      2006
      2007
     
share and systems)   EUR       EUR       EUR      
Growth
                                     
Market share (based on revenue)1
    57%           63%           65%        
                                       
Net sales
    2,529           3,597           3,809        
Increase in net sales
    2.6%           42.2%           5.9%        
                                       
Systems shipped (value)
    2,228           3,229           3,392        
Systems shipped (number)
    196           266           260        
Average selling price
    11.4           12.1           13.0        
Systems backlog (value)
    1,434           2,146           1,697        
Systems backlog (number)
    95           163           89        
Average selling price
    15.1           13.2           19.1        
                                       
Technical achievement:
                                     
Immersion systems shipped
    10           23           38        
                                       
Profitability
                                     
Gross profit
    974     38.5%     1,462     40.6%     1,560       41.0%
Income from operations
    449     17.8%     871     24.2%     825 2     21.7%
Net income
    311     12.3%     625     17.4%     688 2     18.1%
                                       
Liquidity
                                     
Cash and cash equivalents
    1,905           1,656           1,272        
Operating cash flow
    711           478           670        
 
 
According to the latest available data up to and including November 2007 as reported by SEMI, an independent semiconductor industry organization.
The 2007 figures for income from operations and net income include a one-off charge of EUR 23 million relating to the Brion acquisition for amortization of in-process research and development.
 
 
Growth
We are seeking to grow to a net sales level of EUR 5 billion in 2010, based on three growth drivers: market growth, market share growth and a broadening of our product and services scope.
 
 
In 2007, we achieved growth in net sales of 5.9 percent to EUR 3,809 million from EUR 3,597 million in 2006. The increase in net sales mainly resulted from a continued high demand for lithography equipment with higher ASPs in 2007 ultimately driven by a continuing increase in unit demand for semiconductors of 11 percent (2006: 9 percent; 2005: 9 percent). In addition we achieved market share growth from 63 percent in 2006 to 65 percent in 2007 (according to the latest available data up to and including November 2007 as reported by SEMI, an independent semiconductor industry organization) as a result of our sustained technological leadership.
 
 
The ASP of our systems increased by 7.4 percent from EUR 12.1 million in 2006 to EUR 13.0 million in 2007. This increase was mainly driven by a change in the product mix reflecting the continued shift in market demand to our leading-edge technology systems with higher ASPs driven by the shrink roadmaps of our customers. This increase was partly offset by a growing number of i-line systems, with relatively low ASPs, sold in 2007, reflecting our market share gains in this segment of the market.
 
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As of December 31, 2007, our order backlog was valued at EUR 1,697 million and included 89 systems with an ASP of EUR 19.1 million. As of December 31, 2006, the order backlog was valued at EUR 2,146 million and included 163 systems with an ASP of EUR 13.2 million. The increase in ASP of 44.8 percent was mainly due to a high number of leading-edge ArF-immersion systems in the backlog of 2007 pursuant to the continued ramp-up of volume manufacturing with our leading-edge immersion systems in 2008. The decrease in the total value of backlog was primarily the result of increased uncertainty about future global economic market conditions and the impact on the semiconductor industry.
 
 
Profitability
We seek to achieve an average income from operations to net sales of 17 percent over the industry’s business cycle with 10-15 percent at the downturn point and 20-25 percent at the upturn point.
 
 
Operating income decreased by 5.2 percent from EUR 871 million or 24.2 percent of sales in 2006 to 825 million or 21.7 percent of sales in 2007. This EUR 46 million decrease was substantially the result of the increase in operating expenses of EUR 144 million or 24.3 percent which was partially offset by an increase of gross profit of EUR 98 million or 6.7 percent.
 
 
Gross profit on sales increased compared to 2006, showing a growth of 6.7 percent from EUR 1,462 million or 40.6 percent of net sales in 2006 to 1,560 million or 41.0 percent of net sales in 2007. The higher gross profit was principally attributable to an increase in net sales (see above) and a decrease in the cost of sales as a percentage of net sales.
 
 
Operating expenses were EUR 144 million higher in 2007 compared to 2006 due to an increase of both research and development costs by 123 million, or 31.7 percent and selling, general and administrative costs by EUR 21 million, or 10.2 percent. The increase in research and development costs included a one-off charge of EUR 23 million related to the Brion acquisition (in-process research and development). The remaining increase in research and development costs by EUR 100 million, or 25.8 percent was mainly related to our decision to further accelerate investments in our technological leadership in a time of strong financial performance. For further details regarding research and development see Item 4.B “Business Overview” and Item 5 “Operating and Financial Review and Prospects, Business Strategy”.
 
 
Net income in 2007 amounted to EUR 688 million, representing EUR 1.49 per share compared with net income of EUR 625 million or EUR 1.32 per share in 2006.
 
 
Liquidity
We seek to maintain our strategic target level of cash and cash equivalents between EUR 1.0 and 1.5 billion. To the extent that our cash and cash equivalents exceeds this target and there are no investment opportunities that we wish to pursue, we intend to return excess cash to our shareholders. As of December 31, 2007 our cash and cash equivalents amounted to EUR 1.3 billion.
 
 
Our cash and cash equivalents decreased from EUR 1,656 million as of December 31, 2006 to EUR 1,272 million as of December 31, 2007. We generated cash from operations of EUR 670 million in 2007, which was offset by a cash outflow of EUR 699 million from financing activities, mainly as a result of our 2007 share buyback programs (EUR 1,372 million) which was offset by the net proceeds from issuance of a Eurobond in June 2007 (EUR 594 million), and EUR 348 million cash used in investing activities mainly related to the acquisition of Brion (EUR 188 million), production facilities in Veldhoven and, to a lesser extent, equipment and information technology.
 
 
In an ongoing commitment to return excess cash to shareholders, ASML returned EUR 1,372 million in cash to its shareholders in 2007. The cumulative amount returned to shareholders between May 2006 and December 2007 was EUR 2,050 million.
 
 
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, contingencies and litigation, income tax and share-based compensation expenses. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. While we regularly evaluate our estimates and assumptions, actual results may differ from these estimates if these assumptions prove incorrect. To the extent there are material differences between actual results and these estimates, our future results of operations could be materially and adversely affected. We believe that the accounting policies described below require us to make significant judgments and estimates in the preparation of our consolidated financial statements.
 
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Revenue recognition
In general, we recognize the revenue from the sale of a system upon shipment and the revenue from the installation of a system upon completion of that installation at the customer site. Each system undergoes, prior to shipment, a “Factory Acceptance Test” in our clean room facilities, effectively replicating the operating conditions that will be present on the customer’s site, in order to verify whether the system will meet its standard specifications and any additional technical and performance criteria agreed with the customer. A system is shipped, and revenue is recognized, only after all specifications are met and customer sign-off is received or waived. Although each system’s performance is re-tested upon installation at the customer’s site, we have never failed to successfully complete installation of a system at a customer’s premises.
 
 
We anticipate that, in connection with future introductions of new technology, we will initially defer revenue recognition until completion of installation and acceptance of the new technology at customer premises. This deferral would continue until we are able to conclude that installation of the technology in question would occur consistently within a predetermined time period and that the performance of the new technology would not reasonably be different from that exhibited in the pre-shipment Factory Acceptance Test. Any such deferral of revenues, however, could have a material effect on our results of operations for the fiscal period in which the deferral occurred and on the succeeding fiscal period. At December 31, 2007 and 2006, we had no deferred revenue from shipments of new technology. During the three years ended December 31, 2007, no revenue from new technology was recorded that had been previously deferred. As our systems are based largely on two product platforms that permit incremental, modular upgrades, the introduction of genuinely “new” technology occurs infrequently, and has occurred on only one occasion since 1999.
 
 
A portion of our revenue is derived from contractual arrangements with our customers that have multiple deliverables, such as installation and training services, prepaid service contracts and prepaid extended optic warranty contracts. The revenue relating to the undelivered elements of the arrangements is deferred at fair value until delivery of these elements. The fair value is determined by vendor specific objective evidence (“VSOE”). VSOE is determined based upon the prices that we charge for installation and comparable services (such as relocating a system to another customer site) on a stand-alone basis, which are subject to normal price negotiations. Revenue from installation and training services is recognized when the services are completed. Revenue from prepaid service contracts and prepaid extended optic warranty contracts is recognized over the term of the contract.
 
 
The deferred revenue balance from installation and training services amounted to approximately EUR 9 million and EUR 28 million, respectively, as of December 31, 2007.
 
 
The deferred revenue balance from prepaid service contracts and prepaid extended optic warranty contracts amounted to approximately EUR 149 million and EUR 38 million, respectively, as of December 31, 2007.
 
 
We offer customers discounts in the normal course of sales negotiations. These discounts are directly deducted from the gross sales price at the moment of revenue recognition. From time to time, we offer volume discounts to a limited number of customers. In some instances these volume discounts can be used to purchase field options (system enhancements). The related amount is recorded as a reduction in revenue at time of shipment. Generally, there are no other credits or adjustments recognized at shipment. From time to time, we offer free products or services in connection with the sale of a system, which are earned by the customer at a future date only if the customer completes a specified cumulative level of revenue transactions. As the value of these free products or services is insignificant in relation to the value of the transactions necessary to earn these free products or services, a liability is recorded for the cost of these free products or services at the time of revenue recognition.
 
 
Warranty
We provide standard warranty coverage on our systems for 12 months and on certain optic parts for 60 months, providing labor and parts necessary to repair systems and optic parts during the warranty period. The estimated warranty costs are accounted for by accruing these costs for each system upon recognition of the system sale. The estimated warranty costs are based on historical product performance and field expenses. Based upon historical service records, we calculate the charge of average service hours and parts per system to determine the estimated warranty charge. We update these estimated charges periodically. The actual product performance and/or field expense profiles may differ, and in those cases we adjust our warranty reserves accordingly. Future warranty expenses may exceed our estimates, which could lead to an increase in our cost of sales.
 
 
Business combinations
Acquisitions of subsidiaries are accounted for using the ‘purchase accounting’ method. The costs of an acquired subsidiary are assigned to the assets and the liabilities assumed on the basis of their fair values at the date of acquisition. The determination of fair values of assets and liabilities acquired requires us to make estimates and use valuation techniques when market value is not readily available. The excess of the costs of an acquired subsidiary over the net of the amounts assigned to assets acquired and liabilities assumed is capitalized as goodwill.
 
ASML ANNUAL REPORT 2007
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Evaluation of long-lived assets for impairment and costs associated with exit or disposal activities
Long-lived assets include goodwill, other intangible assets and property, plant and equipment.
 
 
Goodwill is tested at least annually for impairment. Goodwill is considered to be impaired if the fair value based on discounted future cash flows expected to be generated by the reporting unit is less than the carrying amount. The impairment to be recognized is measured as the excess of the carrying amount of goodwill over its implied fair value.
 
 
Other intangible assets and property, plant and equipment are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of those assets may not be recoverable. Recoverability of these assets is measured by a comparison of the carrying amount of the asset to future undiscounted net cash flows expected to be generated by the asset. If those assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the asset. Assets held for sale are reported at the lower of the carrying amount or fair value less the costs to sell.
 
 
In determining the fair value of a reporting unit or the recoverable amount of an asset, the Company makes estimates about future cash flows. These estimates are based on the financial plan updated with the latest available projection of the semiconductor market conditions and our sales and cost expectations which are consistent with the plans and estimates that we use to manage our business. We also make estimates and assumptions concerning Weighted Average Cost of Capital (WACC) and future inflation rates. It is possible that the outcome of the plans, estimates and assumptions used may differ from our estimates, which may require impairment of certain long-lived assets. Future adverse changes in market conditions may also require impairment of certain long-lived assets.
 
 
During 2007, we recorded impairment charges of EUR 8.0 million in property, plant and equipment and EUR 1.0 million in other intangible assets of which we recorded EUR 8.6 million in cost of sales, EUR 0.2 million in research and development costs and EUR 0.2 million in selling, general and administrative costs. The impairment charges mainly relate to buildings and constructions and machinery and equipment. The impairment charges with respect to buildings and constructions mainly relate to a building in Veldhoven that was abandoned in 2007 and will be demolished in 2008 to create space for the clean room and central utilities which are currently under construction. The impairment was determined based on the difference between the building’s estimated fair value (being EUR 0.0) and its carrying amount. The impairment charges with respect to machinery and equipment mainly relate to development, production and field service tooling, which were no longer used because the tools no longer met current technology requirements. The impairment charges were determined based on the difference between the assets’ estimated fair value (being EUR 0.0) and their carrying amount. See Notes 9 and 10 to our consolidated financial statements.
 
 
Inventories
Inventories are stated at the lower of cost (first-in, first-out method) or market value. Costs include net prices paid for materials purchased, charges for freight and customs duties, production labor cost and factory overhead. Inventory provisions are made for slow moving, obsolete or unsaleable inventory and are reviewed on a quarterly basis. Our methodology involves matching our on-hand and on-order inventory with our manufacturing forecast. In determining inventory provisions, we evaluate inventory in excess of our forecasted needs on both technological and economical criteria and make appropriate provisions to reflect the risk of obsolescence. This methodology is significantly affected by our forecasted needs for inventory. If actual demand or usage were to be lower than estimated, additional inventory provisions for excess or obsolete inventory may be required, which could have a material adverse effect on our business, financial condition and results of operations. See Note 6 to our consolidated financial statements.
 
 
Accounts receivable
A majority of our accounts receivable are derived from sales to large multinational semiconductor manufacturers throughout the world. In order to monitor potential credit losses, we perform ongoing credit evaluations of our customers’ financial condition. An allowance for doubtful accounts is maintained for potential credit losses based upon management’s assessment of the expected collectability of all accounts receivable. The allowance for doubtful accounts is reviewed periodically to assess the adequacy of the allowance. In making this assessment, we take into consideration (i) any circumstances of which we are aware regarding a customer’s inability to meet its financial obligations; and (ii) our judgments as to potential prevailing economic conditions in the industry and their potential impact on the Company’s customers. Where we deem it prudent to do so, we may require some form of credit enhancement, such as a letter of credit or bank guarantee, before shipping systems to certain customers. We have not incurred any material accounts receivable credit losses during the past three years. However, we sell a substantial number of systems to a limited number of customers. Our three largest customers accounted for 40.1 percent of accounts receivable at December 31, 2007, compared to 35.0 percent at December 31, 2006. An unanticipated business failure of one of our main customers could result in a substantial credit loss in respect to amounts owed to the Company by that customer, which could adversely affect our results of operations and financial condition. See Note 5 and 20 to our consolidated financial statements.
 
ASML ANNUAL REPORT 2007
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Contingencies and litigation
We are party to various legal proceedings generally incidental to our business, as disclosed in Note 15 to the consolidated statements. In connection with these proceedings and claims, our management evaluates, based on the relevant facts and legal principles, the likelihood of an unfavorable outcome and whether the amount of the loss could be reasonably estimated. In each case, management has determined that either a loss was not probable or was not reasonably estimable and, as a result, no estimated losses were recorded as a charge to our statement of operations in 2005, 2006 and 2007. Significant subjective judgments were required in these evaluations, including judgments regarding the validity of asserted claims and the likely outcome of legal and administrative proceedings. The outcome of these proceedings, however, is subject to a number of factors beyond our control, most notably the uncertainty associated with predicting decisions by courts and administrative agencies. In addition, estimates of the potential costs associated with legal and administrative proceedings frequently cannot be subjected to any sensitivity analysis, as damage estimates or settlement offers by claimants may bear little or no relation to the eventual outcome. Finally, in any particular proceeding, even where we believe that we would ultimately prevail, we may agree to settle or to terminate a claim or proceeding where we believe that doing so, when taken together with other relevant commercial considerations, is more cost-effective than engaging in an expensive and protracted litigation, the outcome of which is otherwise uncertain. Such a decision occurred when we determined to enter into a cross-license agreement as an alternative to continuing our intellectual property dispute with Nikon.
 
 
We accrue for legal costs related to litigation in our statement of operations at the time when the related legal services are actually provided to us.
 
 
Share-based compensation expenses
Prior to January 1, 2006, we measured compensation expenses for our stock option plans using the intrinsic value method under APB 25 “Accounting for Stock Issued to Employees” and related interpretations. As the exercise price of all stock options granted under these plans was at or above the fair market price of the underlying ordinary shares on the grant date, no compensation expenses were recognized.
 
 
As of January 1, 2006, we implemented the provisions of SFAS No. 123(R), “Share-Based Payment”, using the modified prospective transition method. Under the modified prospective transition method, no restatement of prior interim periods and fiscal years has been made. SFAS No. 123(R) requires companies to recognize the cost of employee services received in exchange for equity-based awards based upon the grant-date fair value of those awards. The grant-date fair value of these awards was estimated using a Black-Scholes option valuation model. This Black-Scholes valuation model requires the use of assumptions, including the risk-free interest rate, the expected stock price volatility and the estimated life of each award. The risk-free interest rate used in the model is determined, based on a Euro government bond with a life equal to the expected life of the equity-settled share-based payments.
 
 
Using the modified prospective transition method, we began recognizing compensation expenses for equity-based awards granted, modified, repurchased, or cancelled after the required effective date of January 1, 2006. Additionally, we began recognizing compensation expenses for equity-based awards granted before the effective date of January 1, 2006 that were outstanding as of January 1, 2006 and for which the requisite service period has not been rendered. Compensation expenses are recognized on a straight-line basis over the requisite service period of the awards, which is generally the vesting period. The total gross amount of expenses associated with share based payments recognized in 2007 was EUR 16.5 million.
 
 
The grant-date fair value for awards for which the requisite service has not been rendered and that are outstanding as of January 1, 2006 was based on the grant-date fair value of those awards as calculated under SFAS No. 123, “Accounting for Stock-Based Compensation” for pro forma disclosures under the assumption of historical volatility. We changed our method of estimating expected volatility for all stock options granted after January 1, 2006 from the exclusive use of historical volatility to the exclusive use of implied volatility. The primary reason for this change is that historical volatility had showed a significant and consistent downward trend over the five years ended December 31, 2006, which we believe is the result of the semiconductor industry becoming more mature and less cyclical. Within this period, historical share price volatility decreased from 89 percent in 2002 to 28 percent in 2006. The implied volatility as applied by ASML in 2006 was approximately 30 percent, which is significantly lower than historical share price volatility of 55 percent over the five year period then ended, and was much closer to the actual volatility of ASML’s share price over fiscal year 2006 of 28 percent. Consequently, we no longer believe that an average historical volatility over a period commensurate with the expected term of the employee stock options (4-5 years) is likely to be indicative of future stock price behavior. Instead, we believe that the exclusive use of implied volatility results in a more accurate estimate of the expected stock price volatility because it more appropriately reflects market expectations of future stock price volatility. Our stock options are actively traded on Euronext Amsterdam. For this purpose, we use implied volatility as calculated by Bloomberg, which is based on an average of traded stock options:
•  with market prices reasonably close to the date of grant;
•  that have exercise prices close to the exercise price of the employee stock options; and
•  that have a remaining maturity of up to 4 years.
 
ASML ANNUAL REPORT 2007
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We make quarterly assessments of the adequacy of the (hypothetical) tax pool to determine whether there are tax deficiencies that require recognition in the consolidated statements of operations. We have selected the alternative transition method (under FSP FAS 123(R)-3) in order to calculate the tax pool.
 
 
We did not modify outstanding stock option plans in anticipation of the adoption of SFAS No. 123(R). Our current stock option plans do not provide for cash settlement of options. See Note 1 and 14 to our consolidated financial statements.
 
 
Income tax
We operate in various tax jurisdictions in Europe, Asia and the United States and must comply with the tax laws and regulations of each of these jurisdictions.
 
 
We use the asset and liability method in accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for tax consequences attributable to differences between the balance sheet carrying amounts of existing assets and liabilities and their respective tax bases. Furthermore tax assets are recognized for the tax effect of incurred net operating losses. If it is more likely than not that the carrying amounts of deferred tax assets will not be realized, a valuation allowance will be recorded to reduce the carrying amounts of those assets.
 
 
We continuously assess our ability to realize our deferred tax assets resulting from net operating loss carry-forwards. The total amount of loss carry-forwards as of December 31, 2007 was EUR 209 million, which resides completely with ASML US, Inc. We believe that all losses will be offset by future taxable income before our ability to utilize those losses expires. This analysis takes into account our projected future taxable income from operations, possible tax planning alternatives available to us, and a realignment of group assets that we effected during the period 2001 through 2003 that included the transfer of certain tangible and intangible assets of ASML US, Inc. to ASML Netherlands B.V. The value of the assets transferred has resulted and will result in income recognized and to be recognized by ASML US, Inc., which we believe, together with projected future taxable income from operations will be sufficient to absorb the net operating losses that ASML US, Inc. has incurred, prior to the expiry of those losses. In order to determine with certainty the tax consequences and value of the asset transfer and the routine remuneration of ASML US, Inc. for intercompany services rendered, in 2002 we requested a bilateral advance pricing agreement (“APA”) from the United States and Netherlands tax authorities which resulted in September 2007 in two duly signed APAs between certain ASML subsidiaries and the tax authorities of the United States and the Netherlands. The APAs will be valid through 2009 with the possibility of extension (see also Note 16 to our consolidated financial statements).
 
 
Until December 31, 2006, we accounted for income tax contingencies in accordance with SFAS No. 5, “Accounting for Contingencies”. The tax contingencies mainly related to transfer pricing positions, operational activities in countries where we are not tax registered and tax deductible costs. We provided for these tax contingencies for the duration of the statute of limitation which differs per tax jurisdiction and generally ranges up to seven years. As of December 31, 2006, the tax contingencies amount to EUR 130.7 million and are included in deferred tax and other liabilities in the consolidated balance sheet.
 
 
On January 1, 2007, we adopted the provisions of FIN 48 “Accounting for Uncertainty in Income Taxes”. FIN 48 clarifies the accounting for income taxes, by prescribing a minimum recognition threshold a tax position is required to meet, before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods and disclosure regarding income taxes. The cumulative effect of adopting FIN 48 was an increase in the liability for unrecognized tax benefits and a decrease in retained earnings of EUR 7.6 million at January 1, 2007. Upon adoption, the liability for unrecognized tax benefits amounted to EUR 138.3 million. The amount of unrecognized tax benefits, if recognized, would have a favorable effect on the Company’s effective tax rate.
 
 
In addition, consistent with the provisions of FIN 48, we classified EUR 138.3 million as non-current liabilities because payment of cash was not anticipated within one year of the balance sheet date. These non-current income tax liabilities are recorded in deferred tax and other liabilities in the consolidated balance sheet.
 
 
Expected interest and penalties related to income tax liabilities have been accrued for and are included in the liability for unrecognized tax benefits and in the provision for income taxes. The balance of accrued interest and penalties recorded in the consolidated balance sheet of January 1, 2007 amounted to EUR 10.5 million and as of December 31, 2007 amounted to EUR 32.0 million; these amounts were also classified as non-current liabilities consistent with the provisions of FIN 48.
 
 
A reconciliation of the beginning and ending balance of the liability for unrecognized tax benefits is as follows:
 
 
ASML ANNUAL REPORT 2007
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        2007
 
(in millions)       EUR  
Balance, January 1
          138.3  
Gross increases – tax positions in prior period
          17.7  
Gross decreases – tax positions in prior period
          (30.3 )
Gross increase – in tax positions in current period
          26.6  
Gross decrease – tax positions in current period
           
Settlements
          (35.5 )
Lapse of statute of limitations
          (6.5 )
               
Balance, December 31
          110.3  
 
 
 
For the 12 month period ending December 31, 2007, there were material changes related to the liability for unrecognized tax benefits that impacted the Company’s effective tax rate. This was due to the settlement of a number of unrecognized tax benefits recorded in prior years in the various jurisdictions. The settlement of the unrecognized tax benefits in the Netherlands jurisdiction was the result of discussions held with the Netherlands tax authorities. As a result of these discussions clarity was obtained on substantially all uncertain tax positions relating to the Netherlands unrecognized tax benefits through fiscal year 2006. The total tax liability related to resolved uncertain tax positions in 2007 amounted to EUR 72.3 million of which EUR 36.8 million was released to the tax provision and EUR 35.5 million was reclassified from deferred tax and other liabilities to current tax liabilities.
 
 
The Company estimates that the total liability of unrecognized tax benefits will change with EUR 15.8 million within the next 12 months. The estimated changes to the liability for unrecognized tax benefits within the next 12 months are mainly due to expected settlements and expiration of statute of limitations which are expected to have a favorable effect on the Company’s effective tax rate.
 
 
On December 5, 2007, ASML Holding entered into a Supervision Agreement, or ‘Handhavingsconvenant’ with the Netherlands tax authorities, which provides for cooperation between ASML and the Netherlands tax authorities. The purpose of this agreement is that parties base their mutual relationship on transparency, understanding and trust. This should result in accelerated settlement of uncertain tax positions for ASML in the Netherlands, where ASML reports the vast majority of its taxable income.
 
 
Results of Operations
The following discussion and analysis of results of operations should be viewed in the context of the risks affecting our business strategy, described in Item 3.D. “Risk Factors”.
 
 
Set forth below are our consolidated statements of operations data for the three years ended December 31, 2007:
 
                         

 
Year ended December 31
  2005
    2006
    2007
 
(in millions)   EUR     EUR     EUR  
Total net sales
    2,529       3,597       3,809  
Cost of sales
    1,555       2,135       2,248  
Gross profit on sales
    974       1,462       1,561  
Research and development costs
    348       414       511  
Amortization of in-process research and development costs
                23  
Research and development credits
    (24 )     (28 )     (24 )
Selling, general and administrative costs
    201       205       226  
Income from operations
    449       871       825  
Interest income (expense), net
    (14 )     (1 )     34  
Income from operations before income taxes
    435       870       859  
Provision for income taxes
    124       245       171  
Net income
    311       625       688  
 
 
 
Set forth below are our consolidated statements of operations from continuing operations data for the three years ended December 31, 2007, expressed as a percentage of our total net sales:
 
 
ASML ANNUAL REPORT 2007
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Year ended December 31   2005     2006     2007  
Total net sales
    100.0 %     100.0 %     100.0 %
Cost of sales
    61.5       59.4       59.0  
Gross profit on sales
    38.5       40.6       41.0  
Research and development costs
    13.8       11.5       13.4  
Amortization of in-process research and development costs
                0.6  
Research and development credits
    (1.0 )     (0.8 )     (0.6 )
Selling, general and administrative costs
    8.0       5.7       5.9  
Income from operations
    17.8       24.2       21.7  
Interest income (expense), net
    (0.6 )           0.9  
Income from operations before income taxes
    17.2       24.2       22.6  
Provision for income taxes
    4.9       6.8       4.5  
Net income
    12.3       17.4       18.1  
 
 
 
Results of operations from continuing operations 2007 compared with 2006
 
Consolidated sales and gross profit
The following table shows a summary of sales (revenue and units sold), gross profit on sales and ASP data on an annual and semi-annual basis for the years ended December 31, 2007 and 2006.
 
                                     

        2006
          2007
   
    First
  Second
  Full
  First
  Second
  Full
    half year   half year   year   half year   half year   year
Net sales (EUR million)
    1,571     2,026     3,597     1,895     1,914     3,809
Net system sales (EUR million)
    1,394     1,835     3,229     1,690     1,702     3,392
Net service and field option sales (EUR million)
    177     191     368     206     211     417
Total systems recognized
    123     143     266     146     114     260
Total new systems recognized
    97     123     220     131     104     235
Total used systems recognized
    26     20     46     15     10     25
Gross profit on sales (% of sales)
    40.3     40.9     40.6     41.0     40.9     41.0
ASP for systems (EUR million)
    11.3     12.8     12.1     11.6     14.9     13.0
ASP for new systems (EUR million)
    13.6     14.3     14.0     12.6     15.9     14.0
ASP for used systems (EUR million)
    2.8     3.7     3.2     2.8     5.5     3.9
 
 
 
We achieved growth in net sales of EUR 212 million or 5.9 percent from EUR 3,597 million in 2006 to EUR 3,809 million in 2007. The increase in net sales mainly relates to an increase in net system sales of EUR 163 million or 5.0 percent, from EUR 3,229 million in 2006 to EUR 3,392 million in 2007 mainly attributable to increased ASPs partly offset by a lower number of systems shipped and to an increase in net service and field option sales of EUR 49 million or 13.3 percent from EUR 368 million in 2006 to EUR 417 million in 2007.
 
 
The number of systems shipped decreased by 2.3 percent from 266 systems in 2006 to 260 systems in 2007, following a year of significant growth of systems shipped (35.7 percent) in 2006. The continued high market demand for lithography equipment was driven by a continuing increased market demand for semiconductor revenue by 11 percent in 2007 following two years of semiconductor unit growth by 9 percent in 2005 and 2006. Furthermore the 2007 strong market demand was related to the continued drive from our customers to follow or accelerate their technology shrink roadmaps.
 
 
The ASP of our systems increased by 7.4 percent from EUR 12.1 million in 2006 to EUR 13.0 million in 2007. This increase was mainly driven by a change in product mix reflecting the continued shift in market demand to our leading-edge technology systems (as customers commenced their ramp-up of volume manufacturing with our leading-edge immersion systems for 45 nm Flash and 55 nm DRAM) with higher ASPs driven by the shrink roadmaps of our customers. This increase was partly offset by a growing number of i-line systems sold, with relatively low ASPs, in 2007 reflecting our market share gains in this segment of the market.
 
 
From time to time, ASML repurchases systems that it has manufactured and sold and, following factory-rebuild or refurbishment, resells those systems to other customers. This repurchase decision is mainly driven by market demand for capacity expressed by other customers and not by explicit or implicit contractual arrangements relating to the initial sale. The number of used systems sold in 2007 decreased to 25 from 46 in 2006, reflecting decreased demand for older systems to produce less complex ICs following two years of significant capacity growth. The ASP for used systems increased from EUR 3.2 million in 2006 to
 
ASML ANNUAL REPORT 2007
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EUR 3.9 million in 2007, reflecting a further shift from our older PAS 2500 towards our newer PAS 5500 family and TWINSCAN family.
 
 
Net service and field option sales showed a 13.3 percent increase from EUR 368 million in 2006 to EUR 417 million in 2007, resulting from increased service as well as field option sales. The increase in service sales was mainly driven by the growth of our system installed base at customers. The growth of field option sales is positively impacted by the customer demand for system upgrade packages that further enhance system performance.
 
 
Of the top 20 chipmakers worldwide, in terms of semiconductor capital expenditures, 18 are customers of ASML. In 2007, sales to the largest customer accounted for EUR 833 million, or 21.9 percent of our net sales. In 2006, sales to the largest customer accounted for EUR 730 million, or 20 percent of our net sales.
 
 
Gross profit increased 6.7 percent from EUR 1,462 million or 40.6 percent of net sales in 2006 to 1,560 million or 41.0 percent of net sales in 2007. The gross margin was positively impacted by a changed product mix (0.2 percent) and, more important, by decreased cost of sales (2.4 percent) reflecting the results of our continuous cost of sales reduction programs. Gross margin was negatively impacted by decreased ASPs of mature technology (−2.4 percent). In addition gross margin was positively impacted by currency effects (0.4 percent) partly offset by various other items including lower service gross margin as a result of investments in spare parts related to the introduction of immersion systems for volume manufacturing as well as investments in our ASML Center of Excellence (ACE) in Asia.
 
 
We started 2006 with an order backlog of 163 systems. In 2007, we booked orders for 203 systems, received order cancellations or push-outs beyond 12 months of 17 systems and recognized sales for 260 systems. This resulted in an order backlog of 89 systems as of December 31, 2007. The total value of our backlog as of December 31, 2007 amounted to EUR 1,697 million with an ASP of EUR 19.1 million, compared with a backlog of EUR 2,146 million with an ASP of EUR 13.2 million as of December 31, 2006. See also Item 5.D. “Trend Information”.
 
 
Research and development
Research and development costs increased by EUR 97 million or 23.4 percent from EUR 414 million in 2006 to EUR 511 million in 2007. The increase reflected further investment in technology leadership in 2007 through investments in the development of the newest versions of our high resolution TWINSCAN systems and enhancements of the next generation TWINSCAN systems based on immersion, double patterning and EUV. In the third quarter of 2007 we shipped the first XT:1900i, capable of imaging features down to 40 nm.
 
 
Amortization of in-process research and development costs of EUR 23 million in 2007 relates to a one-off charge related to the Brion acquisition.
 
 
Research and development credits are EUR 24 million in 2007 compared to EUR 27 million in 2006.
 
 
Selling, general and administrative costs
Selling, general and administrative costs increased by 10.2 percent from EUR 205 million in 2006 to EUR 226 million in 2007 reflecting the increased activity level to support sales growth. Over the past two years selling, general and administrative costs increased by 12.2 percent, while net sales grew by 50.6 percent. Continuing cost reduction and efficiency programs contributed to maintaining a relatively low increase in the level of selling, general and administrative costs compared to the increase in net sales and related activity over the two year period ended December 31, 2007.
 
 
Net interest expense
Net interest changed from EUR 1 million net interest expense in 2006 to EUR 33 million net interest income in 2007. Our interest income relates to interest earned on our cash and cash equivalents. In 2007 interest income increased mainly as a result of higher short-term interest rates and a higher average cash balance. The average cash balance was higher as a result of the cash provided by operating activities and the issuance of a EUR 600 million Eurobond. Interest expense in 2007 was lower due to the conversion of substantially all the U.S. dollar 575 million 5.75 percent Convertible Subordinated Notes in October 2006 (with the unconverted notes redeemed) and the conversion of substantially all the EUR 380 million 5.50 percent Convertible Subordinated Notes, in October 2007 (with the unconverted notes redeemed). This was partly offset by the issuance of a EUR 600 million Eurobond in June 2007.
 
 
Income taxes
Income taxes represented 19.9 percent of income before taxes in 2007, compared to 28.2 percent in 2006. The decrease in income taxes in 2007 is mainly related to a favorable settlement of unrecognized tax benefits. In addition a corporate tax rate reduction in the Netherlands also contributed to a decrease in income taxes. As of January 1, 2007, we implemented FIN 48
 
ASML ANNUAL REPORT 2007
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“Accounting for uncertainty in income taxes”. The cumulative effect of implementing FIN 48 was an increase in the tax liability for uncertain tax positions against retained earnings of EUR 7.6 million at January 1, 2007.
 
 
Results of operations from continuing operations 2006 compared with 2005
 
Consolidated sales and gross profit
The following table sets forth a summary of sales (by revenue and units sold), gross profit on sales and ASP data on an annual and semi-annual basis for the years ended December 31, 2006 and 2005.
 
                                     

        2005
          2006
   
    First
  Second
  Full
  First
  Second
  Full
    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.
 
 
The number of used systems sold in 2006 increased to 46 from 40 in 2005, reflecting increased demand for older systems to produce less complex ICs. The ASP for used systems increased from EUR 2.9 million in 2005 to EUR 3.2 million in 2006, reflecting a further shift from our older PAS 2500 towards our newer PAS 5500 family and TWINSCAN family.
 
 
Net service and field option sales showed a 22.3 percent increase from EUR 301 million in 2005 to EUR 368 million in 2006, resulting from increased service as well as field option sales. The increase in service sales was mainly driven by the growth of our system installed base at customers. The growth of field option sales is positively impacted by the availability and customer demand for system upgrade packages that further enhance system performance.
 
 
Of the top 20 chipmakers worldwide, in terms of semiconductor capital expenditures, 16 were customers of ASML. In 2006, sales to the largest customer accounted for EUR 730 million, or 20 percent of our net sales. In 2005, sales to the largest customer accounted for EUR 609 million, or 24 percent of our net sales.
 
 
Gross profit increased compared to 2005, increasing by 50.1 percent from EUR 974 million or 38.5 percent of net sales in 2005 to 1,462 million or 40.6 percent of net sales in 2006. The increased gross margin was positively impacted by decreased cost of sales as a percentage of net sales (5.2 percent positive impact on gross profit) reflecting the results of our continuous cost of sales reduction program, partly offset by a change in the product mix (2.1 percent negative impact on gross profit) and slightly decreased prices (0.8 percent negative impact on gross profit). The positive impact on gross profit of the higher production volumes (0.6 percent) and currency effects (0.4 percent) was offset by the negative impact on gross profit of the higher cost for obsolete inventories (0.4 percent) and the higher costs for lens swaps (0.9 percent).
 
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We started 2005 with an order backlog of 95 systems. In 2006, we booked orders for 347 systems, received order cancellations or push-outs beyond 12 months of 13 systems and recognized sales for 266 systems. This resulted in an order backlog of 163 systems as of December 31, 2006. The total value of our backlog as of December 31, 2006 amounted to EUR 2.1 billion, compared with a backlog of approximately EUR 1.4 billion as of December 31, 2005.
 
 
Research and development
Research and development costs increased by 19.0 percent from EUR 348 million in 2005 to EUR 414 million in 2006. We further accelerated our investment in technology leadership in 2006 through the investments in the newest versions of our high resolution TWINSCAN systems and enhancements of the next generation TWINSCAN systems based on immersion, double patterning, EUV and the development of optical maskless lithography. In the second quarter of 2006 we shipped the first XT:1700i and the third quarter we introduced the XT:1900i, both enhanced immersion systems. Also in the second quarter of 2006, we shipped the industry’s first EUV Alpha Demo Tools to two research and development institutions.
 
 
Research and development credits increased from EUR 24 million in 2005 to EUR 27 million in 2006 due to an increased volume of research and development projects that qualified for credits under governmental funding programs.
 
 
Selling, general and administrative costs
Selling, general and administrative costs increased by only 2 percent from EUR 201 million in 2005 to EUR 205 million in 2006 while sales grew by 42 percent. Cost reduction and efficiency programs contributed to maintaining a near constant level of selling, general and administrative costs.
 
 
Net interest expense
Net interest expense decreased from EUR 14 million in 2005 to EUR 1 million in 2006 due to decreased interest expenses and increased interest income. Interest expense mainly relate to our convertible subordinated notes, which had lower average balances in 2006 mainly due to the conversion of the USD 575 million 5.75 percent convertible notes which were due October 15, 2006. Our interest income relates primarily to interest earned on our cash and cash equivalents. Our interest income increased in 2006 mainly as a result of higher short term interest rates.
 
 
Income taxes
Income taxes represented 28.2 percent of income before taxes in 2006, compared to 28.4 percent in 2005. The decrease in income taxes in 2006 is mainly related to a corporate tax rate reduction in the Netherlands.
 
 
Foreign Exchange Management
See Item 3.D. “Risk Factors, Fluctuations in Foreign Exchange Rates Could Harm Our Results of Operations”, Item 11 “Quantitative and Qualitative Disclosures About Market Risk” and Note 4 to our consolidated financial statements.
 
 
New U.S. GAAP Accounting Pronouncements
In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments”. This Statement amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” and SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” and permits, among other things, fair value re-measurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation. SFAS No. 155 had to be adopted for all financial instruments acquired, issued, or subject to a re-measurement (new basis) event occurring after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The adoption of SFAS No. 155 did not have a material impact on our consolidated financial statements.
 
 
In June 2006, the FASB issued Interpretation 48, “Accounting for Uncertainty in Income Taxes”. FIN 48 clarifies the accounting for income taxes, by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. On January 1, 2007 we adopted FIN 48. See Note 16 to the consolidated financial statements for additional information, including the effect of adoption on the Company’s consolidated financial statements.
 
 
In June 2006, the FASB ratified the consensus reached by the FASB’s Emerging Issues Task Force (“EITF”) on Issue No. 06-03, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That is, Gross versus Net Presentation)” (“EITF No. 06-03”). EITF No. 06-03 permits registrants to elect to present vendor taxes imposed concurrently on a specific revenue-producing transaction between a seller and a customer on either a gross or net basis. The scope of EITF No. 06-03 includes government assessed taxes that are directly imposed on revenue-producing transactions between a seller and a customer and may include, but is not limited to, sales, use, value added and some excise taxes. Registrants are to be required to disclose their policies for presenting the taxes and would disclose any amounts presented on a gross basis. EITF No. 06-03 is effective for interim and annual financial statements issued for periods beginning after
 
ASML ANNUAL REPORT 2007
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December 15, 2006. The adoption of EITF No. 06-03 did not have a material impact on our consolidated financial statements. ASML continues to recognize revenues excluding the taxes levied on revenues (net basis).
 
 
The FASB issued SFAS No. 157, “Fair Value Measurements” on September 15, 2006. The Statement defines fair value, provides guidance on how to measure assets and liabilities using fair value and expands disclosures about fair value measurements. The Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007 and should be applied prospectively (with a limited form of retrospective application) as of the beginning of the fiscal year in which this Statement is initially applied. We believe that the adoption of SFAS No. 157 will have no material impact on our consolidated financial statements.
 
 
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115” (“SFAS 159”). SFAS 159 is expected to expand the use of fair value accounting but does not affect existing standards which require certain assets or liabilities to be carried at fair value. The objective of SFAS 159 is to improve financial reporting by providing companies with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. Under SFAS 159, a company may choose, at specified election dates, to measure eligible items at fair value and report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. SFAS 159 is effective for interim and annual financial statements issued for fiscal years beginning after November 15, 2007. We are currently assessing the impact that SFAS 159 may have on our consolidated financial statements.
 
 
In June 2007, the FASB ratified the consensus reached by the EITF on Issue No. 06-11, “Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards”. EITF No. 06-11 requires that a realized income tax benefit from dividends or dividend equivalents that are charged to retained earnings and are paid to employees for equity classified nonvested equity shares, nonvested equity share units, and outstanding equity share options should be recognized as an increase to additional paid-in capital. The amount recognized in additional paid-in capital for the realized income tax benefit from dividends on those awards should be included in the pool of excess tax benefits available to absorb tax deficiencies on share-based payment awards. EITF No. 06-11 is effective for interim and annual financial statements issued for periods beginning after December 15, 2007. We believe that the adoption of EITF 06-11 will have no material impact on our consolidated financial statements.
 
 
In December 2007, the FASB issued SFAS 141(R), “Business Combinations”. This statement replaces FASB Statement No. 141 “Business Combinations”. SFAS 141(R) improves the relevance, representational faithfulness and comparability of the information that a reporting entity provides in its financial reports about a business combination and its effects. This FASB statement applies prospectively to business combination for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. We are currently assessing the impact that SFAS 141(R) may have on our consolidated financial statements.
 
 
In December 2007, the FASB issued SFAS 160, “Noncontrolling Interests in Consolidated Financial Statements”. This statement amends ARB No. 51 “Consolidated Financial Statement”. This Statement establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. This Statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Adoption of SFAS 160 will have no impact on our consolidated financial statements since all subsidiaries are wholly owned and no subsidiaries are deconsolidated.
 
 
In December 2007, the SEC issued Staff Accounting Bulletin No. 110 (“SAB 110”) regarding the use of a “simplified” method in developing an estimate of expected term of “plain vanilla” share options. In particular, the staff indicated in SAB 107 that it will accept a company’s election to use the simplified method, regardless of whether the company has sufficient information to make more refined estimates of expected term. At the time SAB 107 was issued, the SEC staff believed that more detailed external information about employee exercise behavior (e.g. employee exercise patterns by industry and/or other categories of companies) would, over time, become readily available to companies. Therefore, the SEC staff stated in SAB 107 that it would not expect a company to use the simplified method for share option grants after December 31, 2007. The SEC staff stated that it understands that such detailed information about employee exercise behavior may not be widely available by December 31, 2007. Accordingly, the SEC staff stated that it will continue to accept, under certain circumstances, the use of the simplified method beyond December 31, 2007. We believe that the adoption of SAB 110 will have no material adverse effect on our consolidated financial statements.
 
 
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”.
 
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Our balance of cash and cash equivalents amounted to EUR 1,656 million and EUR 1,272 million as of December 31, 2006 and 2007, respectively.
 
 
We generated cash from operating activities of EUR 478 million and EUR 670 million in 2006 and 2007, respectively. The primary components of cash provided by operating activities in 2007 were net income (EUR 688 million) plus non-cash expenses (EUR 215 million) mainly related to depreciation, impairment charges and inventory obsolescence partially offset by a cash outflow of EUR 233 million due to investments in working capital. The investments in working capital mainly relate to higher inventories of EUR 439 million and higher other assets of EUR 86 million, partly offset by higher accrued liabilities of EUR 263 million. The higher inventories relate to the increased complexity of our systems resulting in higher costs of components for our systems and higher ASPs.
 
 
We used EUR 66 million for investing activities in 2006 and EUR 348 million in 2007. The majority of the 2007 expenditures was spent on the ongoing construction of a new production facility, the acquisition of Brion and, to a lesser extent, machinery and equipment and information technology investments.
 
 
Net cash used by financing activities was EUR 648 million in 2006 compared to EUR 699 million in 2007. In 2007, cash provided by financing activities mainly included EUR 594 million net proceeds from the issuance in June 2007 of a Eurobond, EUR 80 million from the issuance of shares in connection with the exercise of employee stock options. In 2007, cash used by financing activities mainly included EUR 1,372 million for share buyback programs (including the synthetic share buyback) and EUR 10 million for the redemption of debt. See also Item 16.E. “Purchases of Equity Securities by the Issuer and Affiliated Purchasers”.
 
 
Our principal sources of liquidity consist of EUR 1,272 million of cash and cash equivalents as of December 31, 2007, EUR 500 million of available credit facilities as of December 31, 2007 and cash flows from operations. For further details of our credit facilities, see Note 12 to our consolidated financial statements. In addition to cash and available credit facilities, from time to time we raise additional capital in debt and equity markets. Our liquidity needs are affected by many factors, some of which are based on the normal ongoing operations of the business, and others that relate to the uncertainties of global economies and the semiconductor industries. Although our cash requirements fluctuate based on the timing and extent of these factors, we believe that cash generated from operations, together with the liquidity provided by existing cash balances, are sufficient to satisfy our present requirements.
 
 
We expect substantial cash outflow from investing activities in 2008 due to our planned capital expenditures. Subject to market developments we expect that our capital expenditures in 2008 could be up to approximately EUR 250 million, an increase of EUR 18 million compared to 2007. We expect that a significant part of the 2008 expenditures will be allocated to construction and upgrades of production facilities in the Netherlands and Taiwan. See also Item 4.D. “Property, Plants and Equipment”. We expect to finance 2008 capital expenditures out of our cashflow from operations and available cash and cash equivalents.
 
 
We reiterate our commitment to return excess cash to our shareholders and will consider all available opportunities to return this cash to shareholders, including share buybacks, dividend and capital repayment. Accordingly, we intend to seek authorization for additional share buyback programs at the Annual General Meeting of Shareholders on April 3, 2008.
 
 
We have repayment obligations in 2017, amounting to EUR 600 million, on our 5.75 percent senior notes due 2017. We currently intend to fund any future repayment obligations primarily with cash on hand and cash generated through operations. A description of our senior bond, lines of credit and other borrowing arrangements is provided in Note 12 to our consolidated financial statements.
 
 
Our contractual obligations and commercial commitments are disclosed in further detail in Item 5.F. “Tabular Disclosure of Contractual Obligations” and Note 13 to our consolidated financial statements.
 
 
See Notes 4 and 12 to our consolidated financial statements for discussion of our funding, treasury policies and currencies in which cash and cash equivalents are held and convertible notes, senior bonds and other borrowing arrangements.
 
 
C. Research and Development, Patents and Licenses, etc
 
 
Research and Development
See Item 4.B. “Business Overview, Research and Development” and Item 5.A. “Operating Results”.
 
 
Intellectual Property Matters
See Item 3.D. “Risk Factors, Defending Against Intellectual Property Claims by Others Could Harm Our Business” and Item 4.B. “Business Overview, Intellectual Property”.
 
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D. Trend Information
Within the current sentiment of global economic weakness and an overall 2008 semiconductor capital investment slowdown forecast by some analysts and customers, ASML believes that it is nonetheless well positioned for robust revenues in the first half of 2008. With 60 percent of our EUR 1,697 million backlog covered by immersion technology tools, and 26 percent of the backlog ordered by manufacturers of logic ICs, we have a relatively low exposure to the currently more volatile capital spend at second tier memory manufacturers. Our immersion products are designed to enable rapid technology transfers down to 4x nm nodes, which are being executed by our customers to reach appropriate integration and cost targets that are needed in the current environment. We expect to almost double our net sales from immersion systems in 2008 from 2007. Although independent market researchers still expect a double digit increase in demand for integrated circuit units in 2008, which we expect will translate into lithography market expansion in 2008, we are awaiting confirmation of this potential growth through the level of first and second quarter bookings. We remain optimistic, in view of our customers’ large immersion technology needs, their high level of capacity utilization, and the current IC inventory levels in the market.
 
 
The trends discussed in this Item 5.D. are subject to risks and uncertainties. See “Part I — Special Note Regarding Forward Looking Statements”.
 
 
The following table sets forth our backlog of systems as of December 31, 2006 and 2007.
 
             

Year ended December 31   2006   2007
Backlog sales of new systems (units)
    153     79
Backlog sales of used systems (units)
    10     10
Backlog sales of total systems (units)
    163     89
Value of backlog new systems (EUR million)
    2,120     1,650
Value of backlog used systems (EUR million)
    26     47
Value of backlog of total systems (EUR million)
    2,146     1,697
ASP for new systems (EUR million)
    13.9     20.9
ASP for used systems (EUR million)
    2.6     4.7
ASP for total systems (EUR million)
    13.2     19.1
 
 
 
Our backlog includes only system orders for which written authorizations have been accepted and shipment dates within 12 months have been assigned. Historically, orders have been subject to cancellation or delay by the customer. Due to possible customer changes in delivery schedules and to cancellation of orders, our backlog at any particular date is not necessarily indicative of actual sales for any succeeding period.
 
 
ASML expects to ship 50 systems in the first quarter of 2008 with an average selling price of EUR 18.9 million for new systems and an average selling price for all systems of EUR 16.3 million. We expect a gross profit margin in the first quarter of 2008 of between 40 to 41 percent, research and development costs of EUR 127 million net of credits and selling, general and administrative costs of EUR 58 million.
 
 
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. The shareholders each granted a loan of EUR 11.6 million and a fourth bank granted a loan of EUR 12.3 million to the lessor. ASML provided the lessor with a subordinated loan of EUR 5.4 million and has a purchase option that is exercisable either at the end of the lease in 2018, at a pre-determined price of EUR 24.5 million, or during the lease at the book value of the assets. The total assets of the lessor entity amounted to approximately EUR 54 million at inception of the lease.
 
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ASML believes that it holds a variable interest in this entity and that the entity is a variable interest entity (“VIE”) because it is subject to consolidation in accordance with the provisions of paragraph 5 of FIN 46(R). The total equity investment at risk is approximately 3.6 percent of the lessor’s total assets and is not considered and cannot be demonstrated, qualitatively or quantitatively, to be sufficient to permit the lessor to finance its activities without additional subordinated financial support provided by any parties, including the shareholders.
 
 
ASML has determined that it is not appropriate to consolidate the VIE as it is not the primary beneficiary. To make this determination, the expected losses and expected residual returns of the lessor were allocated to each variable interest holder based on their contractual right to absorb expected losses and residual returns. The analysis of expected losses and expected residual returns involved determining the expected negative and positive variability in the fair value of the lessor’s net assets exclusive of variable interests through various cash flow scenarios based upon the expected market value of the lessor’s net assets. Based on this analysis, ASML determined that other variable interest holders will absorb the majority of the lessor’s expected losses, and as a result, ASML is not the primary beneficiary.
 
 
ASML’s maximum exposure to the lessor’s expected losses is estimated to be approximately EUR 5.4 million.
 
 
Purchase Obligations
We enter into purchase commitments with vendors in the ordinary course of business to ensure a smooth and continuous supply chain for key components. Purchase obligations include medium to long-term purchase agreements. These contracts differ and may include certain restrictive clauses. Any identified losses that result from purchase commitments that are forfeited are provided for in our financial statements. As of December 31, 2007, we had purchase commitments for a total amount of approximately EUR 1,405 million, compared to EUR 995 million as of December 31, 2006. This increase is mainly due to costs of components for our systems as ASPs have increased. In our negotiations with suppliers we continuously seek to align our purchase commitments with our business objectives. See also Item 5.F. “Tabular Disclosure of Contractual Obligations”.
 
 
Other Off-Balance Sheet Arrangements
We have certain additional commitments and contingencies that are not recorded on our balance sheet but may result in future cash requirements.
 
 
We provide guarantees to third parties in connection with transactions entered into in the ordinary course of business from time to time.
 
 
F. Tabular Disclosure of Contractual Obligations
Our contractual obligations as of December 31, 2007 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 expenses1
    948,222     35,706     71,412     69,000     772,104
Operating Lease Obligations
    189,293     36,040     55,581     40,586     57,086
Purchase Obligations
    1,405,283     1,375,334     29,945     4    
Unrecognized tax benefits (FIN 48)
    110,346     15,750     28,941     13,402     52,253
Other Liabilities2
    53,259     40,459     12,800        
 
Total Contractual Obligations
    2,706,403     1,503,289     198,679     122,992     881,443
 
 
We refer to Note 12 to the consolidated financial statements for the amounts excluding interest expenses.
Other liabilities relate to system repurchase commitments.
 
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Several operating leases for our buildings contain purchase options, exercisable at the option of the Company at the end of the lease, and in some cases, during the term of the lease. The amounts to be paid if ASML should exercise these purchase options at the end of the lease can be summarized as of December 31, 2007 as follows:
 
                               

Purchase options
      Less than
          After
due by period
  Total
  1 year
  1-3 years
  3-5 years
  5 years
(in thousands)   EUR   EUR   EUR   EUR   EUR
Purchase options
    61,362     3,358     2,269     8,250     47,485
 
 
 
G. Safe Harbor
See “Special Note regarding Forward-Looking Statements”.
 
 
Item 6 Directors, Senior Management and Employees
 
 
A. Directors and Senior Management
The members of our Supervisory Board and our Board of Management are as follows:
 
                 

Name   Title   Year of Birth   Term Expires
Arthur P.M. van der Poel1, 3, 4
  Chairman of the Supervisory Board     1948     2008
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
Ieke C.J. van den Burg2
  Member of the Supervisory Board     1952     2009
OB Bilous3, 4
  Member of the Supervisory Board     1938     2009
William T. Siegle4
  Member of the Supervisory Board     1939     2011
Rolf Deusinger2
  Member of the Supervisory Board     1957     2011
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 28, 2007, Mr. Bodt retired by rotation from the Supervisory Board. On that same date, Mr. Siegle was appointed as member of the Supervisory Board and, on July 17, 2007, Mr. Deusinger was appointed as member of the Supervisory Board. Mr. Van der Poel and Mr. Fröhlich will retire by rotation from the Supervisory Board on April 3, 2008.
 
 
There are no family relationships among the members of our Supervisory Board and Board of Management.
 
 
Since 2005, the Works Council of ASML Netherlands B.V. has an enhanced right to make recommendations (which recommendation may be rejected by the Supervisory Board in limited circumstances) for nomination of at least one-third of the members of the Supervisory Board. See Item 6.C. “Board Practices, Supervisory Board”. At the 2005 General Meeting of Shareholders, Ms. Van den Burg was appointed pursuant to this recommendation right and, at the Extraordinary General Meeting of Shareholders held on July 17, 2007, Mr. Deusinger was appointed pursuant to this recommendation right. In accordance with our Articles of Association, the appointments of Ms. Van den Burg and Mr. Deusinger satisfy the Works Council’s current recommendation right.
 
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Director and Officer Biographies
 
Arthur P.M. van der Poel
Mr. Van der Poel was appointed to our Supervisory Board in March 2004 and was appointed as Chairman in 2007. Until 2001 he was the Chief Executive Officer of Philips Semiconductors. Mr. Van der Poel is a former member of the Board of Management (through May 2003) and a former member of the Group Management Committee (through April 2004) of Royal Philips Electronics. Mr. Van der Poel is the chairman of the Board of the Dutch Innovation Program Point-One, 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.
 
 
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 currently serves as a member of the Supervisory Board of Unibail-Rodamco S.A. 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., Draka Holding N.V. and Altana A.G. and serves as a member of the Supervisory Boards of Allianz Nederland N.V. and Rexel S.A.
 
 
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 Sematech and as Board member of Nantero, Inc.
 
 
William T. Siegle
Mr. Siegle was appointed to our Supervisory Board in March 2007. From 1964 until 1990 Mr. Siegle held various technical, management and executive positions at IBM, including Director of the Advanced Technology Center. From 1990 until 2005 Mr. Siegle served as SVP and Chief Scientist at AMD, responsible for the development of technology platforms and manufacturing operations worldwide. He was also chairman of the Board of Directors of SRC, member of the Board of Directors of Sematech and Director of Etec, Inc. and DuPont Photomask, Inc. Currently, Mr. Siegle is a member of the Advisory Boards of Toppan Photomasks, Inc. and Acorn Technologies, Inc.
 
 
Rolf Deusinger
Mr. Deusinger was appointed to our Supervisory Board in July 2007. Mr. Deusinger is the Executive Vice President Human Resources of ICI plc in London, which position he has held since 2002. Before Mr. Deusinger joined ICI plc, he held several senior human resources management functions with various international companies in the US and Europe, including Pepsi Cola Corporation and Messer Griesham GmbH.
 
 
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.
 
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Peter T.F.M. Wennink
Mr. Wennink joined ASML on January 1, 1999 and was appointed as Executive Vice President, Chief Financial Officer of ASML and member of our Board of Management on July 1, 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 1999.
 
 
Klaus P. Fuchs
Mr. Fuchs was appointed as Executive Vice President Operations and member of the Board of Management in 2006. Between 2003 and 2005, Mr. Fuchs 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.
 
 
B.  Compensation
For details on Board of Management and Supervisory Board remuneration as well as benefits upon termination of executive employment, see Note 18 to our consolidated financial statements.
 
 
ASML has not in the past established and does not intend to establish in the future stock option or purchase plans or other equity compensation arrangements for members of our Supervisory Board.
 
 
Bonus and Profit-sharing plans
For details on our bonus and profit sharing plans for our employees, see Note 14 to our consolidated financial statements.
 
 
Pension plans
For details on our pension plans for our employees, see Note 14 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 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.
 
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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.
 
 
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 favor 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 does 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.
 
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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 agreed to indemnify 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 Stock Market LLC (“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 the 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.
 
 
Pursuant to the Code’s recommendations, ASML has included a separate chapter on corporate governance in its statutory annual report. 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), Arthur van der Poel 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 seven meetings in 2007. 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), Ieke van den Burg and Rolf Deusinger. 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
 
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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 2007, the Remuneration Committee held four 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), Arthur van der Poel and OB Bilous.
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 the Board of Management and the Supervisory Board and the individual members of those boards 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 two scheduled meetings and several ad hoc meetings in 2007.
 
 
Technology and Strategy Committee
ASML’s Technology and Strategy Committee is composed of four members of the Supervisory Board. The current members of our Technology and Strategy Committee are Jan Dekker (chairman), Arthur van der Poel, OB Bilous and William Siegle. 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 held three meetings in 2007.
 
 
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 comprises various members of senior management, including our Chief Financial Officer, and 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. Furthermore, members of the Disclosure Committee are in close contact with our external legal counsel and our external auditor.
 
 
During 2007, 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 Chief Executive Officer and Chief Financial Officer in their assessment of ASML’s disclosure controls and procedures and internal control over financial reporting, we also have an Internal Control Committee, comprising among others three members of the Disclosure Committee.
 
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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 or Netherlands securities laws, or by Euronext Amsterdam. Furthermore, it is generally accepted business practice for Netherlands companies not to distribute annual 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.
•  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).
 
 
D. Employees
As of December 31, 2007, we had 6,582 employees in our operations employed primarily in manufacturing, product development and customer support activities. As of December 31, 2005 and 2006, the total number of employees in continued operations was 5,055 and 5,594 respectively. In addition, during 2007 we had an average of 3,218 temporary employees. For a more detailed description of employee information, including a breakdown of our employees by sector, see Notes 14 and 19 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.
 
 
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 18 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 14 to our consolidated financial statements which are 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, 2007. The
 
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information set forth below is solely based on public filings with the SEC and AFM (Autoriteit Financiële Markten) at December 31, 2007.
 
             

    Shares
  Percent of
Identity of Person or Group   Owned   Class
Capital Group International, Inc.1
    37,251,670     7.7%
FMR LLC2
    28,506,903     5.9%
PRIMECAP Management Company3
    26,144,100     5.4%
Barclays Global Investors4
    23,037,699     5.2%
Capital Research and Management Company5
    22,884,943     5.2%
Members of ASML’s Supervisory Board and Board of Management, as a group (4 persons)6
    1,405,343     *
 
 
Less than 1 percent.
Based solely on the Schedule 13-G/A filed by Capital Group International, Inc. with the Commission on February 12, 2007.
Based solely on the Schedule 13-G/A filed by FMR LLC with the Commission on October 10, 2007 (includes shares owned by affiliates).
Based solely on the Schedule 13-G/A filed by PRIMECAP Management Company with the Commission on March 8, 2007.
Based solely on the report of substantial ownership filed by Barclays Global Investors with the AFM on December 11, 2007.
Based solely on the report of substantial ownership filed by Capital Research and Management Company with the AFM on December 5, 2007.
Four members of our Board of Management own a total of 456,998 unconditional options to purchase ASML shares. These members of our Board of Management together are also entitled to 463,034 conditional performance stock options and 87,507, 210,001 and 187,803 conditional performance stock for 2005, 2006 and 2007 respectively. The number of performance stock that are ultimately awarded will be determined in the financial year 2008, 2009 and 2010 respectively, and is conditional upon the achievement of performance targets. See Note 18 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. None of the members of the Supervisory Board holds any of our outstanding shares or options on shares.
 
 
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 and decreased to 37,251,670 as of February 2007, (ii) FMR LLC 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 and decreased to 57,681,794 as of February 2007 and to 28,506,903 as of October 2007 and (iii) PRIMECAP Management Company decreased its shareholding from 24,218,000 shares as of September 2006 to 23,825,400 as of October 2006 and increased its shareholding to 26,144,100 as of March 2007. According to SEC and AFM filings, 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 to 22,884,943 as of December 2007.
 
 
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, 2007, 146.5 million ordinary shares were held by 516 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 (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
 
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(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.
 
 
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 transactions, which are material to ASML or any transactions that are unusual in their nature or conditions, involving goods, services, or tangible or intangible assets between ASML or any of our 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 14 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 17 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 15 to our consolidated financial statements, which are incorporated herein by reference.
 
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Dividend Policy
We have historically not paid dividends on our ordinary shares. We strive to maintain our strategic target level of cash and cash equivalents between EUR 1.0 billion and EUR 1.5 billion. Should cash and cash equivalents exceed this target and there are no investment opportunities that we wish to pursue, we intend to return excess cash to our shareholders, which may be in the form of share buybacks, capital distributions or dividends. As of December 31, 2007 our cash and cash equivalents amounts to EUR 1,272 million. 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”.
 
 
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 on Euronext Amsterdam (“Amsterdam Shares”). The principal trading market of our ordinary shares is 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 Euronext Amsterdam.
 
                         

    NASDAQ
  Euronext Amsterdam
    USD   EUR
    High   Low   High   Low
Annual Information
                       
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
2007
    35.79     22.89     24.99     17.15
                         
                         
Quarterly Information
                       
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
                         
                         
1st quarter 2007
    26.29     22.89     20.39     17.15
2nd quarter 2007
    27.91     24.69     20.83     18.34
3rd quarter 2007
    33.03     26.64     23.40     19.73
4th quarter 2007
    35.79     30.70     24.99     21.62
                         
                         
Monthly Information
                       
July 2007
    30.60     27.67     22.26     20.24
August 2007
    29.72     26.64     21.73     19.73
September 2007
    33.03     29.56     23.40     21.30
October 2007
    35.79     30.70     24.99     21.97
November 2007
    34.75     32.21     24.00     22.06
December 2007
    35.17     31.29     24.00     21.62
January (through Jan. 23), 2008
    30.47     25.51     20.97     17.15
 
 
(Source: Bloomberg Finance LP)
 
 
B. Offer and Plan of Distribution
Not applicable.
 
 
C. Markets
See Item 9.A. “Listing Details”.
 
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D. Selling Shareholders
Not applicable.
 
 
E. Dilution
Not applicable.
 
 
F. Expenses of the Issue
Not applicable.
 
 
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 November 2, 2007.
 
 
Current Authorizations to Issue and Repurchase Ordinary Shares
Our Board of Management has the power to issue ordinary shares and cumulative preference shares insofar as the Board of Management has been authorized to do so by the General Meeting of Shareholders (either by means of a resolution or by an amendment to our Articles of Association). The Board of Management requires approval, however, of the Supervisory Board must for such an issue.
 
 
At our annual General Meeting of Shareholders, held on March 28, 2007, the Board of Management was authorized for a period of 18 months, to issue shares and/or rights thereto representing up to a maximum of 5 percent of our issued share capital as of the date of authorization, plus an additional 5 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 April 3, 2008, 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 October 3, 2009.
 
 
Holders of our ordinary shares have a preemptive right of subscription in proportion to the aggregate nominal amount of the ordinary shares held by them 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 (either 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 28, 2007, the Board of Management was authorized, subject to the aforementioned approval, to restrict or exclude preemptive rights of holders of ordinary shares. At our annual General Meeting of Shareholders to be held on April 3, 2008, our shareholders will be asked to grant this authority through October 3, 2009. 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 requested to 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 28, 2008 up to a maximum of 30 percent of our issued share capital as of the date of authorization (March 28, 2007) 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 April 3, 2008, our shareholders will be asked to extend this authority through October 3, 2009.
 
 
C. Material Contracts
Not applicable.
 
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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 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 U.S. 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. See also Item 8.A. “Consolidated Statements and Other Financial Information, Dividend Policy”.
 
 
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 five percent or more of our share capital, or holds options to purchase five 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.
 
 
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
 
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•  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 five 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 15 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 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 liable to 15 percent Netherlands withholding tax or, in the case of certain United States corporate shareholders owning at least ten percent of our voting power, a reduction 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 15 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, above mentioned 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:
 
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(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 of filing of this Annual Report on Form 20-F, 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 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
 
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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 credited only if the United States Holder does not claim a deduction 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 Holder 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 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.
 
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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 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, 2007, EUR 0.2 million gain (2006: EUR 0.0) was recognized in cost of sales relating to ineffective hedges. As of December 31, 2007 EUR 3.8 million gain (2006: EUR 4.1 million gain) of other comprehensive income represents the total anticipated gain to be released to sales, and EUR 3.1 million loss (2006: EUR 2.1 million loss) 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 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, 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, 2006 and 2007 were EUR 16.0 million gain and EUR 15.0 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 the interest typical terms of interest bearing liabilities. The Company still retains residual financial statement exposure risk to the
 
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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.
 
 
See Notes 1 and 12 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 the customers’ financial condition and generally require no collateral to secure accounts receivable. We maintain an allowance for potentially uncollectable 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, 2006 and 2007 respectively, with all other variables held constant.
 
 
                             
 
            Fair Value change  
                  10%
 
            1% non-
    weakening of
 
            favorable
    euro against
 
            increase in
    other
 
    Notional Amount
  Fair Value
  interest rate
    currency
 
(in thousands)   EUR   EUR   EUR     EUR  
As of December 31, 2006
                           
Forward contracts1,2
    482,131     2,150     N/A       (53,388 )
Currency options2
    73,049     3,827     N/A       (3,227 )
Interest rate swaps
    429,900     2,584     (10,481 )     N/A  
                             
                             
As of December 31, 2007
                           
Forward contracts1,2
    283,881     528     N/A       (31,402 )
Currency options2
    90,000     4,887     N/A       (3,706 )
Interest rate swaps3
    1,029,900     16,553     (51,727 )     N/A  
 
 
(Source: Bloomberg Finance LP)
Mainly includes forward contracts on U.S. dollar and Japanese yen.
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 2007 notional amount of the interest rate swaps mainly consists of EUR 380 million relating to cash and cash equivalents and of EUR 600 million relating to a Eurobond of EUR 600 million. The fair value of interest rate swaps includes accrued interest and mainly consists of the fair value of the interest rate swaps relating to a Eurobond of EUR 600 million.
 
 
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.
 
ASML ANNUAL REPORT 2007
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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 2007
51


 

 
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 Rule 13a-15(e) under the Exchange Act). Based on such evaluation, ASML’s Chief Executive Officer and Chief Financial Officer have concluded that, as of December 31, 2007, ASML’s disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by ASML in the reports that it files or submits under the Exchange Act and are effective in ensuring that information required to be disclosed by ASML in the reports that it files or submits under the Exchange Act is accumulated and communicated to ASML’s management, including ASML’s Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
 
 
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 Rule 13a-15(f) under the Exchange Act, 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, 2007 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.
 
 
ASML’s management’s evaluation of the effectiveness of ASML’s internal control over financial reporting as of December 31, 2007 excluded the internal control over financial reporting of Brion Technologies, Inc., which was acquired by ASML on March 7, 2007 and whose financial statements constitute 8.9 percent and 4.4 percent of net and total assets, respectively, 0.2 percent of net sales and −6.5 percent of net income of the consolidated financial statement amounts as of and for the year ended December 31, 2007. If adequately disclosed, companies are allowed to exclude acquisitions for their assessment of internal control over financial reporting during the first year of an acquisition while integrating the acquired company under guidelines established by the SEC.
 
 
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 the effectiveness of ASML’s internal control over financial reporting.
 
 
Changes in Internal Control over Financial Reporting
During the year ended December 31, 2007 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.
 
ASML ANNUAL REPORT 2007
52


 

 
 
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 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 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 of 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, 2007. The following table sets forth the aggregate fees for professional audit services and other services rendered by Deloitte Accountants B.V. in 2006 and 2007:
 
             

Year ended December 31
  2006
  2007
(in thousands)   EUR   EUR
Audit fees
    1,438     1,297
Audit-related fees
    266     188
Tax fees
    216     237
             
Total
    1,920     1,722
 
 
 
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 and services in connection with consultations on implementing the requirements of Section 404 of the Sarbanes-Oxley Act.
 
 
Tax fees
Tax fees can be detailed as follows:
 
             

Year ended December 31
  2006
  2007
(in thousands)   EUR   EUR
Corporate Income Tax compliance services
    59     146
Tax assistance for expatriate employees
    70     62
Other tax advisory and compliance
    87     29
             
Total
    216     237
 
 
ASML ANNUAL REPORT 2007
53


 

 
 
The Audit Committee has approved the internal and external audit plan and related audit fees for the year 2007. 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.
 
 
D. Exemptions from the Listing Standards for Audit Committees
Not applicable.
 
 
E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers
 
 
2006-2007 Share program
On March 23, 2006, the General Meeting of Shareholders authorized the repurchase of up to a maximum of 10 percent of our issued shares through September 23, 2007.
 
 
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 were recorded at cost and classified within shareholders’ equity. ASML cancelled these repurchased shares in 2007.
 
 
In order to mitigate the dilution due to the issuance of shares upon conversion of its convertible bond due October 2006, ASML repurchased 14,934,843 shares pursuant to a call option transaction announced on October 9, 2006. These shares were subsequently used 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 who issued the call option.
 
 
In February 2007, ASML bought back 8,000,000 shares, representing 100 percent of the announced objective of the remaining 1.7 percent of outstanding shares. The share program was announced on February 14, 2007 and was completed in the first quarter of 2007. Shares repurchased have been used to cover exercised stock options and to partly satisfy the conversion rights of ASML’s 5.50 percent Convertible Subordinated Notes.
 
 
The following table provides a summary of shares repurchased by the Company in 2007 under the 2006-2007 program:
 
                               

            Total Number of
      Total Value of Shares
            Shares Purchased as
  Maximum Number of
  Purchased as Part of
            Part of Publicly
  Shares that May
  Publicly Announced
    Total Number of
  Average Price Paid
  Announced Plans or
  Yet be Purchased
  Plans or Programs
Period   Shares purchased   per Share (EUR)   Programs   Under the Program   (In EUR million)
February 14-23, 2007
    8,000,000     19.53     8,000,000         156
 
 
 
2007-2008 Share program
On March 28, 2007, the General Meeting of Shareholders authorized the repurchase of up to a maximum of three times 10 percent of our issued shares through September 28, 2008.
 
 
In 2007, the aggregate number of shares bought back under the 2007-2008 share program was 9,000,000, representing 64.3 percent of the announced objective of 14,000,000 shares to be repurchased during a period ending on September 28, 2008. The share program was announced on October 17, 2007. Shares repurchased will be used to cover outstanding stock options.
 
ASML ANNUAL REPORT 2007
54


 

 
 
The following table provides a summary of shares repurchased by the Company in 2007 under the 2007-2008 program:
 
                               

            Total Number of
      Total Value of Shares
            Shares Purchased as
  Maximum Number of
  Purchased as Part of
            Part of Publicly
  Shares that May
  Publicly Announced
    Total Number of
  Average Price Paid
  Announced Plans or
  Yet be Purchased
  Plans or Programs
Period   Shares purchased   per Share (EUR)   Programs   Under the Programs   (In EUR million)
November 14-26, 2007
    9,000,000     22.62     14,000,000     5,000,0001     204
 
 
In January 2008, ASML bought back 5,000,000 shares. The aggregate number of shares bought back up to and including January 2008 represents 100 percent of the announced objective of 14 million ordinary shares.
 
 
Capital repayment program 2007
On July 17, 2007 the Extraordinary General Meeting of Shareholders approved three proposals to amend the Company’s Articles of Association. The first amendment involved an increase of share capital by an increase in the nominal value per ordinary share from EUR 0.02 to EUR 2.12 and a corresponding reduction in share premium. The second amendment was a reduction of the nominal value per ordinary share from EUR 2.12 to EUR 0.08 resulting in the payment to shareholders of EUR 2.04 per ordinary share. The third amendment involved a reduction in stock, whereby 9 ordinary shares with a nominal value of EUR 0.08 each were consolidated into 8 ordinary shares with a nominal value of EUR 0.09 each. As a result of these amendments, which in substance constitute a synthetic share buyback, EUR 1,012 million was repaid to our shareholders and the outstanding number of ordinary shares was reduced by 55,093,409 shares or 11 percent. The capital repayment program was completed in October 2007.
 
ASML ANNUAL REPORT 2007
55


 

 
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-44 hereto.
 
 
Item 19 Exhibits
 
     

Exhibit No.   Description
1
  Articles of Association of ASML Holding N.V. (English translation) (Incorporated by reference to Amendment No. 11 to the Registrant’s Registration Statement on Form 8-A/A, filed with the Commission on November 2, 2007)
2.1
  Fiscal Agency Agreement between ASML Holding N.V., Deutsche Bank AG, London Branch and Deutsche Bank Luxembourg S.A. relating to the Registrant’s 5.75 percent Notes due 2017*
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 the Registrant’s Statement on Form S-8, filed with the Commission on September 2, 2003 (File No. 333-109154))
4.11
  ASML Incentive and New Hire Option Plan for Board of Management (Incorporated by reference to the Registrant’s Registration Statement on Form S-8, filed with the Commission on June 9, 2004 (File No. 333-116337))
4.12
  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))
4.13
  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))
4.14
  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))
4.15
  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))
4.16
  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))
4.17
  ASML Restricted Stock Plan (Incorporated by reference to the Registrant’s Registration Statement on Form S-8 filed with the Commission on March 7, 2007 (file No. 333-141125))
4.18
  Brion Technologies, Inc., 2002 Stock Option Plan (as amended on March 25, 2005; March 24, 2006; and November 17, 2006) (Incorporated by reference to the Registrant’s Registration Statement on Form S-8 filed with the Commission on April 20, 2007 (file No. 333-142254))
4.19
  ASML Stock Option Plan for Incentive or New Hire Options granted to Senior and Executive Management (Version January 2007) (Incorporated by reference to the Registrant’s Registration Statement on Form S-8 filed with the Commission on July 5, 2007 (file No. 333-144356))
 
ASML ANNUAL REPORT 2007
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Exhibit No.   Description
4.20
  ASML Stock Option Plan for Incentive or New Hire Options granted to Senior and Executive Management (Version April 2007) (Incorporated by reference to the Registrant’s Registration Statement on Form S-8 filed with the Commission on July 5, 2007 (file No. 333-144356))
4.21
  ASML Stock Option Plan for Incentive or New Hire Options granted to Senior and Executive Management (Version July 2007) (Incorporated by reference to the Registrant’s Registration Statement on Form S-8 filed with the Commission on July 5, 2007 (file No. 333-144356))
4.22
  ASML Stock Option Plan for Incentive or New Hire Options granted to Senior and Executive Management (Version October 2007) (Incorporated by reference to the Registrant’s Registration Statement on Form S-8 filed with the Commission on July 5, 2007 (file No. 333-144356))
4.23
  ASML Performance Stock Plan for Members of the Board of Management (Version 1) (Incorporated by reference to the Registrant’s Registration Statement on Form S-8 filed with the Commission on July 5, 2007 (file No. 333-144356))
4.24
  ASML Performance Stock Option Plan for Members of the Board of Management (Version 2) (Incorporated by reference to the Registrant’s Registration Statement on Form S-8 filed with the Commission on July 5, 2007 (file No. 333-144356))
4.25
  ASML Stock Option Plan from Base Salary for Senior & Executive Management (Version October 2007) (Incorporated by reference to the Registrant’s Registration Statement on Form S-8 filed with the Commission on November 2, 2007 (file No. 333-147128))
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 2007
57


 

 
 
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 25, 2008
 
 
/s/ Peter T.F.M. Wennink
Executive Vice President, Chief Financial Officer and Member of the Board of Management
Dated: January 25, 2008
 
ASML ANNUAL REPORT 2007
58


 

Index to Financial Statements
 
     
F-2
  Consolidated Statements of Operations for the years ended December 31, 2005, 2006 and 2007
F-3
  Consolidated Statements of Comprehensive Income for the years ended December 31, 2005, 2006 and 2007
F-3
  Consolidated Balance Sheets as of December 31, 2006 and 2007
F-4
  Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2005, 2006 and 2007
F-5
  Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2006 and 2007
F-6
  Notes to the Consolidated Financial Statements
F-43
  Report of Independent Registered Public Accounting Firm
 
ASML ANNUAL REPORT 2007
F-1


 

 
 
Consolidated Statements of Operations
 
                             

 
    Year ended December 31
  2005
    2006
    2007
 
Notes   (in thousands, except per share data)   EUR     EUR     EUR  
17
  Net system sales     2,227,678       3,229,065       3,391,775  
    Net service and field option sales     301,289       368,039       416,904  
                             
                             
                             
    Total net sales     2,528,967       3,597,104       3,808,679  
    Cost of system sales     1,366,026       1,911,362       1,973,588  
    Cost of service and field option sales     188,746       223,724       274,747  
                             
                             
                             
    Total cost of sales     1,554,772       2,135,086       2,248,335  
                             
                             
                             
    Gross profit on sales     974,195       1,462,018       1,560,344  
    Research and development costs     347,901       413,708       510,503  
2
  Amortization of in-process research and development costs                 23,148  
    Research and development credits     (24,027 )     (27,141 )     (24,362 )
    Selling, general and administrative costs     201,204       204,799       225,668  
                             
                             
                             
    Income from operations     449,117       870,652       825,387  
    Interest income     38,429       49,634       78,165  
    Interest expense     (52,523 )     (50,488 )     (44,714 )
                             
                             
                             
    Income from operations before income taxes     435,023       869,798       858,838  
16
  Provision for income taxes     (123,559 )     (245,109 )     (170,995 )
                             
                             
                             
    Net income     311,464       624,689       687,843  
    Basic net income per ordinary share     0.64       1.32       1.49  
    Diluted net income per ordinary share     0.64       1.27       1.44  
    Number of ordinary shares used in computing per share amounts (in thousands)                        
    Basic     484,103       474,860       462,406  
    Diluted     542,979       503,983       485,643  
 
 
ASML ANNUAL REPORT 2007
F-2


 

 
 
Consolidated Statements of Comprehensive Income
 
                         

 
Year ended December 31
  2005
    2006
    2007
 
(in thousands)   EUR     EUR     EUR  
Net income
    311,464       624,689       687,843  
Foreign currency translation, net of taxes
    25,389       (20,104 )     (31,975 )
Gain (loss) on derivative instruments
    (38,365 )     11,240       (3,450 )
                         
                         
                         
Comprehensive income
    298,488       615,825       652,418  
 
 
 
Consolidated Balance Sheets
 
                     

 
    As of December 31
  2006
    2007
 
Notes   (in thousands, except share and per share data)   EUR     EUR  
    Assets                
    Cash and cash equivalents     1,655,857       1,271,636  
5
  Accounts receivable, net     672,762       637,975  
6
  Inventories, net     808,481       1,102,210  
16
  Deferred tax assets short term     141,255       73,019  
7
  Other current assets     147,683       234,529  
                     
    Total current assets     3,426,038       3,319,369  
                     
16
  Deferred tax assets     200,378       141,032  
7
  Other assets     35,653       59,991  
8
  Goodwill           128,271  
9
  Other intangible assets, net     18,076       38,195  
10
  Property, plant and equipment, net     270,890       380,894  
                     
    Total assets     3,951,035       4,067,752  
                     
    Liabilities and shareholders’ equity                
    Accounts payable     326,995       282,953  
11
  Accrued liabilities and other     665,842       917,133  
16
  Deferred tax liabilities short term     825       50  
16
  Current tax liabilities     187,751       104,632  
                     
                     
                     
    Total current liabilities     1,181,413       1,304,768  
                     
16
  Deferred tax and other liabilities     223,463       245,415  
14
  Other deferred liabilities     8,271       7,936  
12
  Convertible subordinated debt     380,000        
12
  Other long term debt     1,433       602,016  
                     
                     
                     
    Total liabilities     1,794,580       2,160,135  
                     
13, 15
  Commitments and contingencies            
    Cumulative Preference Shares, EUR 0.02 nominal value;
900,000,000 shares authorized; none outstanding at December 31, 2006 and 2007
           
                     
    Ordinary Shares, EUR 0.02 nominal value at December 31, 2006 and EUR 0.09 nominal value at December 31, 2007 900,000,000 shares authorized; 477,099,245 outstanding at December 31, 2006 and 435,625,934 at December 31, 2007     10,051       39,206  
                     
    Share premium     1,195,034       463,847  
    Treasury shares at cost     (401,000 )     (198,893 )
    Retained earnings     1,239,689       1,526,201  
    Accumulated other comprehensive income     112,681       77,256  
                     
                     
                     
21
  Total shareholders’ equity     2,156,455       1,907,617  
    Total liabilities and shareholders’ equity     3,951,035       4,067,752  
 
 
ASML ANNUAL REPORT 2007
F-3


 

 
 
Consolidated Statements of Shareholders’ Equity
 
                                                         

 
                                  Accumulated
       
    Issued and outstanding
                Treasury
    Other
       
    Shares     APIC/Share
    Retained
    Shares at
    Comprehensive
       
          Amount
    Premium
    Earnings
    cost
    Income
    Total
 
(in thousands)   Number1
    EUR     EUR     EUR     EUR     EUR     EUR  
Balance at January 1, 2005
    483,676       9,675       895,836       351,570             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             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 )                       (401,000 )           (401,000 )
Purchase of shares in conjunction with conversion rights of bond holders
    (14,935 )     (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  
                                                         
Components of
comprehensive income:
                                                       
Net income
                      687,843                   687,843  
Foreign Currency Translation
                                  (31,975 )     (31,975 )
Gain (loss) on derivative instruments
                                  (3,450 )     (3,450 )
                                                         
Cumulative effect of applying the provisions of FIN 48
                      (7,648 )                 (7,648 )
Purchase of shares in conjunction with conversion rights of bond holders and stock options
    (17,000 )2     (970 )                 (358,886 )           (359,856 )
Issuance of shares in conjunction with convertible bonds
    26,232       718       288,360       (35,366 )     130,317             384,029  
Capital repayment3
    (55,093 )     29,748       (1,041,605 )                       (1,011,857 )
Cancellation of treasury shares
          (509 )     (48,563 )     (351,928 )     401,000              
Tax benefit from stock options
                9,006                         9,006  
Issuance of shares and stock options
    4,388       168       61,614       (6,388 )     29,676             85,070  
                                                         
Balance at December 31, 2007
    435,626       39,206       463,846       1,526,202       (198,893 )     77,256       1,907,617  
 
 
As of December 31, 2007, the number of issued shares is 444,452,864. This included the number of issued and outstanding shares of 435,625,934 and treasury shares of 8,826,930. As of December 31, 2006, the number of issued shares was 502,549,541. This included the number of issued and outstanding shares of 477,099,245 and treasury shares of 25,450,296.
In 2007, 17,000,000 shares were bought back which were partly reissued in order to cover exercised stock options and to satisfy the conversion rights of holders of our 5.50 percent Convertible Subordinated Notes. We paid EUR 360 million in cash for these shares in total. See Note 22 for further information.
In 2007, as part of a capital repayment program, EUR 1,012 million of equity was repaid to our shareholders and the number of outstanding ordinary shares was reduced by 11 percent. See Note 22 for further information.
 
ASML ANNUAL REPORT 2007
F-4


 

 
 
Consolidated Statements of Cash Flows