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, 2008

 

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)

 

Craig DeYoung

Telephone: +1 480 383 4005

Facsimile: +1 480 383 3978

Email: craig.deyoung@asml.com

8555 South River Parkway,

Tempe, AZ 85284, USA

(Name, telephone, E-mail, and / or Facsimile number and Address of Company Contact Person)

 

Securities registered or to be registered pursuant to Section 12(b) of the Act:

 

 

Securities registered or to be registered pursuant to Section 12(g) of the Act:

None

(Title of Class)

 

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

None

(Title of Class)

 

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

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

 

432,073,534 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 basis of accounting the registrant has used to prepare

the financial statements included in this filing:

U.S. GAAP (ü) International Financial Reporting Standards as issued by the

International Accounting Standards Board ( ) Other ( )

 

If “Other” has been checked in response to the previous question, indicate by checkmark

which financial statement item the registrant has elected to follow.

Item 17 ( ) Item 18 ( )

 

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 2008

Contents

 

 

 

ASML ANNUAL REPORT 2008

 

ASML ANNUAL REPORT 2008

 

ASML ANNUAL REPORT 2008

 

 

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.

 

 

Not applicable.

 

 

Not applicable.

 

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

 

ASML ANNUAL REPORT 2008

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Five-Year Financial Summary

 

 

ASML ANNUAL REPORT 2008

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ASML ANNUAL REPORT 2008

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Exchange Rate Information

We publish our consolidated financial statements in euro. In this Annual Report, references to “€”, “EUR” or “euro” are to euro, and references to ‘‘$”, “dollars”, “U.S. dollars”, “U.S. dollar”, “USD” or “US$” are to United States dollars. Solely for the convenience of the reader, certain U.S. dollar amounts have been translated into euro amounts using an exchange rate in effect on December 31, 2008 of US$1.00 = EUR 0.70.

 

 

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

 

 

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

 

 

 

Not applicable.

Not applicable.

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

 

 

Risks Related to the Semiconductor Industry

 

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

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:

 

 

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 an industry downturn, including the downturn associated with the current global financial market crisis, our ability to maintain profitability will depend substantially on whether we are able to lower our costs and break-even level, which is the level of sales

 

ASML ANNUAL REPORT 2008

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that we must reach in a year to achieve net income. If sales levels decrease significantly as a result of an industry downturn and we are unable to adjust our cost over the same period, 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 and impairment of machinery and equipment, which in the past has had, and in the future could have, a material adverse effect on our business, financial condition and results of operations. Moreover, the current financial crisis affecting the banking system and global financial markets is in many respects unprecedented in the history of our Company. There could be a number of follow-on effects from the financial crisis on our business, including declining business and consumer confidence resulting in reduced, delayed or shorter-term capital expenditures on our products; insolvency of key suppliers resulting in product delays; the inability of customers to obtain credit to finance purchases of our products, delayed payments from our customers and/or customer insolvencies; and other adverse effects that neither we, nor industry analysts generally, can currently anticipate. If global economic and market conditions remain uncertain or deteriorate further, we are likely to experience continuing material adverse impacts on our business, financial condition and results of operations.

 

 

Conversely, in anticipation of periods of increasing demand for semiconductor manufacturing equipment, we must maintain sufficient manufacturing capacity and inventory, and we must attract, hire, integrate and retain a sufficient number of qualified employees to meet customer demand. Our ability to predict the timing and magnitude of industry fluctuations is limited and our products 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.

 

 

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

The semiconductor manufacturing industry is subject to:

 

 

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

 

 

In addition, we are investing 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 consolidated statements of operations and have a materially adverse effect on the future growth of the Company.

 

 

We Face Intense Competition

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

 

 

Our competitiveness increasingly depends upon our ability to develop new and enhanced semiconductor equipment that is competitively priced and introduced on a timely basis, as well as our ability to protect and defend our intellectual property rights. See Item 4.B. “Business Overview, Intellectual Property” and Note 18 to our consolidated financial statements.

 

 

ASML’s primary competitors are Nikon Corporation (“Nikon”) and Canon Kabushika Kaisha (“Canon”). Nikon and Canon are important 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.

 

ASML ANNUAL REPORT 2008

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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 further 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.

 

 

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 are able to produce is 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 2008, sales to our largest customer accounted for EUR 754 million, or 25.5 percent of net sales, compared to EUR 818 million, or 21.7 percent of net sales, in 2007. 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 42.2 percent of accounts receivable at December 31, 2008, compared to 40.1 percent at December 31, 2007. 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.

 

 

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 (151 units in 2008; 260 units in 2007), with an average selling price (“ASP”) in 2008 of EUR 16.7 million (EUR 20.4 million for new systems and EUR 4.8 million for used systems) and an ASP in 2007 of EUR 12.9 million (EUR 13.8 million for new systems and EUR 3.9 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 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:

 

ASML ANNUAL REPORT 2008

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

 

 

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

 

 

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.

 

 

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 cancelling orders for our technology enhancements, which could negatively impact our business, financial condition and results of operations.

 

 

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

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

 

 

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

 

 

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

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

 

 

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

 

 

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

 

 

We Are Subject to Risks in Our International Operations

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

 

ASML ANNUAL REPORT 2008

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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 12.2 percent of our 2008 revenues and approximately 21.1 percent of our 2007 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 Work force 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 work force 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 work force reductions. For example, in the Netherlands, if our Works Council renders adverse advice in connection with a proposed work force 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 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.

 

 

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

 

 

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

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

 

 

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

 

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

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

 

 

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

 

 

Risks Related to Our Ordinary Shares

 

The Price of Our Ordinary Shares is Volatile

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

 

 

Restrictions on Shareholder Rights May Dilute Voting Power

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

 

 

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

 

 

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

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

 

 

In May 2001, we merged with Silicon Valley group (SVG) (now part of ASML US, Inc.), a company that was active in Lithography, as well as in the Track and Thermal businesses, which we subsequently divested or discontinued.

 

 

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”.

 

 

Significant Effects of the Current Global Financial Market Crisis and Economic Downturn on ASML

As a result of the sharp decreases in demand in the fourth quarter of 2008 and in anticipated demand in 2009 caused by the current global financial market crisis and economic downturn, ASML has recognized impairment charges of EUR 20.8 million on property, plant and equipment and inventory obsolescence charges of EUR 94.6 million.

 

 

In order to lower its cost and break-even level, ASML announced in December 2008 a reduction in work force of approximately 1,000 employees or 12 percent of the total work force, mainly contract employees. ASML also announced the shutdown of its production facilities for two weeks in the fourth quarter of 2008 and four weeks in the first half of 2009. Furthermore, ASML announced a restructuring that resulted in the discontinuation of its training center in the United States, the downsizing of its United States headquarters and the closure of several other service locations, reflecting the continuing migration of semiconductor

 

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manufacturing activities to Asia which has been accelerated by the current global financial market crisis and economic downturn. The restructuring resulted in the recognition of a provision for employee contract termination benefits of EUR 2.4 million, reflecting the elimination of approximately 90 jobs in the United States and approximately 15 jobs at service locations in other parts of the world. As part of this restructuring, ASML ceased the use of its training facility in Tempe, United States, incurring lease contract termination costs of EUR 20.0 million in 2008.

 

 

As a result of the actions taken to respond to the current global financial market crisis and economic downturn the following charges have been recognized in ASML’s consolidated statements of operations in 2008:

 

 

 

These costs are recognized as follows in the consolidated statements of operations:

 

 

 

Notwithstanding the restructuring, ASML intends to maintain its key research and development programs for the development of next generation lithography systems. Furthermore, ASML will maintain a level of production capacity to be able to ramp up production to meet customer requirements without lengthy lead times as demand picks up in the future.

 

 

Capital Expenditures and Divestitures

Our capital expenditures for 2008, 2007 and 2006 amounted to EUR 322.0 million, EUR 232.2 million and EUR 99.4 million, respectively. The related cash outflows for 2008, 2007 and 2006 amounted to EUR 259.8 million, EUR 179.2 million and EUR 70.7 million, respectively. Our capital expenditures in these years generally related to the construction of new facilities in Veldhoven for our latest technologies such as EUV and double patterning and in Taiwan for our Asian Center of Excellence, purchases of machinery and equipment mainly from our own product portfolio (e.g. prototypes, demonstration and training systems), information technology investments, and leasehold improvements to our facilities. See Item 4.D. “Property, Plant and Equipment” for capital expenditures currently in progress.

 

 

Divestitures within continued operations, principally comprising machinery and equipment (more specifically prototypes, demonstration and training systems), amounted to EUR 32.0 million for 2008, EUR 20.4 million for 2007 and EUR 5.6 million for 2006. See Note 12 to our consolidated financial statements.

We are one of the world’s leading providers of advanced technology systems for the semiconductor industry. We offer an integrated portfolio of lithography systems mainly for manufacturing complex integrated circuits (“semiconductors”, “ICs” or “chips”). 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 services 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:

 

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Market and Technology Overview

Chipmaking is all about “shrink” or reducing the size of chips designs. The worldwide electronics and computer industries have experienced significant growth since the commercialization of ICs in the 1960’s, 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. Despite the current global financial market crisis and economic downturn, 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 variation, 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 photo-scanning 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 2008, we shipped our 806th TWINSCAN system, demonstrating the acceptance of the TWINSCAN platform as the semiconductor industry’s standard for 300 mm lithography. In the third quarter of 2008, we shipped the first XT:1000, featuring a new 0.93 NA projection lens capable of extending imaging at the wavelength of 248 nm down to 80 nm. Further we announced plans to start shipment in 2009 of an enhanced ArF immersion system, XT:1950i, extending the performance, imaging and overlay performance of the successful XT:1900i system.

 

 

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 2008 we shipped 56 immersion systems compared to 38 in 2007 and 23 in 2006. In October 2008, we announced an enhanced version of the TWINSCAN platform called NXT which features new planar wafer stage technology and grid plate position control systems to address market requirements for increased productivity and tighter overlay control especially for Double Patterning approaches. Initial shipments of NXT are scheduled for 2009.

 

 

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 27 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 2008, ASML has received five orders for next generation EUV systems, the first of which is scheduled for shipment in 2010. The EUV platform is targeted for production of ICs down to 22 nm and beyond. In 2008, we continued to increase resources significantly to support the development of this product.

 

 

A mask is a flat, transparent quartz plate containing an opaque microscopic pattern: an image of the electronic circuitry for one layer of a chip. The mask is placed in a scanner where intense light passing through it projects the pattern, via a series of reducing lenses, onto part of the wafer. Before exposure, the wafer is coated with photoresist and positioned very accurately – the projected pattern must align with existing features on the chip/wafer. After exposure and developing, the pattern left on the wafer surface is used to selectively process and build up the next layer.

 

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The acquisition of Brion in 2007 enabled ASML to improve the implementation of optical proximity correction (“OPC”) technology and resolution enhancement techniques such as Double Patterning and Source-Mask Optimization for masks used on ASML systems and otherwise. These improvements in turn are expected to extend the practical resolution limits of ASML ArF immersion products. We also expect Brion’s computational lithography capability will enable us to offer products that further improve the set-up and control of ASML lithography systems.

 

 

In 2008, we discontinued research into optical maskless lithography due to the reduced market opportunity for this technology. This discontinuation did not result in any impairments during 2008. Research studies on alternative technologies continue for both mask-based and maskless lithography.

 

 

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 38 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.

 

 

Management believes that the current global financial market crisis and economic downturn will accelerate the process of the PAS systems becoming technical obsolete. Reference is made to Note 2, Note 8 and Note 12 to the consolidated financial statements.

 

 

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 mainstream production.

 

 

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 non-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 the third quarter of 2007, ASML began volume shipment of the XT:1900i, with a new industry benchmark of 1.35 NA, which is close to the practical limit for water-based immersion technology. This new optical lithography system is capable of volume production of ICs down to 40 nm and below and is used for high volume IC manufacturing at multiple customers world-wide. In 2008 we shipped 53 XT:1900i systems. In July 2008, ASML announced an enhanced version of the XT:1900i system, the XT:1950i, with improved throughput of 148 wafers per hour, resolution of 38 nm and overlay of 4 nm scheduled to start shipment in 2009. In October 2008, we also announced an improved version of the successful TWINSCAN platform called NXT featuring new stage and position control technology to enable increased productivity and overlay performance for immersion. Initial shipments of NXT are targeted for 2009 with volume production expected in 2010.

 

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In the third quarter of 2008, ASML commenced shipment of the XT:1000, which uses the new catadioptric lens technology developed for the XT:1700i and XT:1900i to extend the maximum NA of the previous generation of 248 nm wavelength, KrF, systems to 0.93 NA from the previous maximum available of 0.80 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 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.

 

 

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

 

 

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

 

 

 

 

Sales and Customer Support

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

 

 

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

 

 

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

 

 

In 2006, ASML started an initiative to establish the ASML Center of Excellence (“ACE”) in Asia. The primary goal of ACE is to serve as a supplementary engine to propel ASML’s long-term growth. ACE will feature customer support, training, logistics, refurbishment, technology and 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 work force. In the fourth quarter of 2008, we completed construction of the building and facility that will house ACE near Taipei, Taiwan and the ACE organization moved into the new building. See Item 4.D. “Property, Plant and Equipment”.

 

 

Customers and Geographic Regions

In 2008, sales to our largest customer accounted for EUR 754 million, or 25.5 percent of net sales, compared to EUR 818 million, or 21.7 percent of net sales, in 2007. 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

 

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of Net Sales Is Derived from a Few Customers” and Note 20 to our consolidated financial statements for a breakdown of our sales by geographic location. In 2008 we derived 68.8 percent of net sales from Asia, 21.7 percent from the United States and 9.5 percent from Europe. In general, since ASML’s founding in 1984 sales derived from Asia have increased and sales derived from United States and Europe have decreased. Management believes that this trend will be accelerated by the current financial market crisis and economic downturn. Reference is made to Note 20 to the consolidated financial statements.

 

 

Manufacturing, Logistics and Suppliers

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

 

 

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

 

 

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

 

 

Zeiss is our sole external supplier of main optical systems and one of the suppliers of other components. In 2008, approximately 32 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 2008, our sales were not limited by the deliveries from Zeiss.

 

 

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 a 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

 

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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. We also work jointly with independent research centers in nanoelectronics and nanotechnology. 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 government and the Taiwanese government. Amounts received under these programs generally are not required to be repaid. See our discussions of research and development in Item 5. “Operating and Financial Review and Prospects”, and Note 1 to our consolidated financial statements.

 

 

We invested EUR 538 million in research and development in continuing operations in 2008, compared to EUR 511 million in 2007 and EUR 414 million in 2006. In addition, the research and development costs invested in 2007 include 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 2008, 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 increase significantly the commonality of components of the different models of the TWINSCAN platform. Our research and development activities in 2008 have also led to productivity and performance enhancements for our other product families. We continue to develop 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 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.

 

 

Next to the development of the TWINSCAN platform, we put more and more resources to the development of EUV technology. This technology promises a means for cost effective extendibility of our customers’ roadmaps. An important milestone was that in 2008 both EUV Alpha Demo Tools (ADT) have passed site acceptance testing. Our key customers now have direct access to EUV technology, which we expect will result in the acceptance of this technology as well as driving the development of EUV infrastructure, including mask fabrication and processes.

 

 

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. Furthermore, 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 2007, ASML and Zeiss 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. There was no transfer of technology and no payment was made among the parties.

 

 

Patent litigation with Nikon

From 2001 through late 2004, we were 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, ASML, Zeiss and Nikon agreed to settle all pending worldwide patent litigation between the companies. The settlement included 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 and Zeiss made settlement payments to Nikon from 2004 to 2007. See Note 11 to our consolidated financial statements for a description of the accounting treatment.

 

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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 ASML Holding N.V.’s affiliates (collectively, the “ASML parties”). Aviza’s arbitration demand alleged 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.

 

 

On March 24, 2008, the arbitrator in the Aviza case ruled in ASML’s favor holding that Aviza failed to establish a cause of action against ASML. On June 19, 2008, the arbitrator awarded ASML its legal fees and costs associated with the case.

 

 

Dividend withholding tax

In May and June 2006, ASML entered into forward purchase agreements with a broker acting as principal to effect share repurchases under its share buyback program. The aggregate number of shares bought back under these agreements through July 13, 2006 was 25,450,296.

 

 

The Netherlands tax authorities challenged ASML’s fiscal interpretation of the forward purchase agreements and sought to recast the repurchase as a dividend payment to unidentifiable shareholders. Accordingly, the Netherlands tax authorities assessed ASML for dividend withholding tax such that an (additional) amount of approximately EUR 24 million would be payable by ASML. In June 2008, as a result of objections lodged by ASML, the matter was settled. ASML paid an insignificant (additional) amount in connection with the settlement.

 

 

Competition

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

 

 

In addition, we believe that an increasingly important factor affecting our ability to compete is the strength and breadth of our portfolio of patent and other intellectual property rights. We believe that the market segment for photolithography systems and the investments required to be a significant competitor in this market segment have resulted in increased competition for market share through the aggressive prosecution of patents. Our competitiveness will increasingly depend upon our ability to protect and defend our patents, as well as our ability to develop new and enhanced semiconductor equipment that is competitively priced and introduced on a timely basis. See Item 3.D. “Risk Factors, We Face Intense Competition”.

 

 

Government Regulation

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

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

 

 

See Exhibit 8.1 for a list of our material subsidiaries.

 

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We principally obtain our facilities under operating leases. However, we also own a limited number of buildings, mainly consisting of the new facilities we are building in The Netherlands and Taiwan. The book value of the buildings owned by us amounted to EUR 302 million as of December 31, 2008 compared to EUR 136 million as of December 31, 2007.

 

 

During 2008, some of our leased facilities were utilized below normal capacity. As a result of its restructuring, announced in December 2008, ASML has ceased using its training facility in Tempe, United States, for which lease contract termination costs of EUR 20.0 million were recognized in 2008. In addition, the Company recognized impairment charges related to machinery and equipment of EUR 22.3 million, mainly due to a decrease in utilization of facilities as a result of lower than expected demand and sales in 2009 and as a result of the closure of several service locations, in each case due to the current global financial market crisis and economic downturn.

 

 

Depending on market conditions, we expect that our capital expenditures in 2009 will be approximately EUR 200 million, a decrease of EUR 122 million compared to 2008. We expect that a significant part of the 2009 expenditures will be allocated to construction and upgrades of production facilities in the Netherlands as we will finalize the production facilities for our latest technologies, such as EUV and double patterning. 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 12 to our consolidated financial statements.

 

 

Facilities in Europe

Our headquarters, applications laboratory and research and development facilities are located at a single site in Veldhoven, the Netherlands. This state-of-the-art facility includes 65 thousand square meters of office space and 30 thousand square meters of buildings 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 16 to our consolidated financial statements. We also lease several sales and service facilities at locations across Europe.

 

 

Facilities in the United States

Our United States headquarters is located in a nine thousand square meter office space building in Tempe, Arizona. As a result of its restructuring announced in December 2008, ASML has ceased using its training facility in Tempe, for which a provision for lease contract termination costs was recognized in 2008. 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 and training facilities at locations across Asia.

 

 

During the fourth quarter of 2008, we finalized the construction of our new ACE facility located in Linkou, Taiwan, for which construction commenced in 2007. This project comprises both clean room (approximately two thousand square meters) and office space (approximately six thousand square meters) in order to support customers in the Asia-Pacific region by focusing on technology and applications development, equipment support, training, logistics and refurbishment. ACE will also enable local sourcing of equipment models, components and services.

 

 

Not applicable.

 

 

Executive Summary

 

 

Introduction

ASML is the world’s leading provider of lithography equipment that are critical to the production of ICs or chips. This leading position is determined by a market share based on revenue, which was approximately 65 percent in 2008 (2007: 65 percent). Headquartered in Veldhoven, the Netherlands, ASML operates globally, with activities in Europe, the United States and Asia.

 

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In 2008, we generated net sales of EUR 2,954 million and income from operations of EUR 287 million or 9.7 percent of net sales. Net income in 2008 amounted to EUR 322 million or 10.9 percent of net sales, representing EUR 0.75 per share.

 

 

As of December 31, 2008 we employed approximately 6,900 payroll and approximately 1,300 temporary employees (measured in full-time employees “FTE’s”). ASML operated in 15 countries through over 60 sales and service locations.

 

 

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

 

 

Semiconductor equipment industry conditions

Chip making is all about shrink or reducing the size of the chip designs.

 

 

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 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 one of the world’s leading providers of lithography equipment with a market share based on revenue of 65 percent in 2007 and approximately 65 percent in 2008. This is according to the latest available data up to and including November 2008 as reported by SEMI, an independent semiconductor industry organization.

 

 

Nikon and Canon are important 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 2008, we further strengthened our long-term market development strategy in Japan, and our net system sales there increased to EUR 413 million from EUR 269 million in 2007.

 

 

Total lithography equipment shipped by the industry as a whole in the five years ended December 31, 2007 is set forth in the following table:

 

 

(Source: Gartner Dataquest)

 

 

The year 2008 was characterized by significant overall economic uncertainty fuelled by the worldwide financial turmoil. This has led to lower than expected overall semiconductor end-demand. Against this background, our customers started to re-assess their strategic alliances and their investments to match production capacity to end-demand, resulting in a delay of non-leading-edge production capacity additions. While lithography equipment buyers are reducing standard production capacity, their willingness to invest in leading-edge immersion technology, however has remained strong as this technology enables lithography equipment buyers to reduce their costs aggressively. For the year 2008, the latest indications of independent market analysts show a drop in total lithography equipment shipped to the market by the industry of 40 percent in unit volume and 22 percent in value.

 

 

Business strategy

Our business strategy is based on achieving and further developing a position as a technology leader in semiconductor lithography, resulting in the delivery of superior value of ownership for our customers, as well as maximizing our financial performance. We implement this strategy through customer focus, strategic 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 customers in the various semiconductor market segments, including memory makers, integrated device manufacturers, and foundries or made-to-order chip contractors.

 

 

Through 2008, 17 of the top 20 chipmakers worldwide, in terms of semiconductor capital expenditure, were our customers. Our leadership position in the semiconductor equipment market was strengthened during 2008 by our continued growth in the Japanese market. We also have a significant share of customers outside the top 20 and we strive for continued business growth with all customers.

 

 

In 2008, we achieved a top four position in customer satisfaction rankings amongst large suppliers of semiconductor 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 sixth year in a row.

 

 

In 2008, we made major inroads with new technologies focusing on value. We announced a new ArF lithography system that significantly reduces operating costs for our customers. The ASML TWINSCAN XT:1950i scanner extends advanced ArF technology to even smaller resolutions and boosts the overall performance of high-end systems by 25 percent. In April 2008, ASML also shipped its 1,000th KrF system. This technology is used for 30-40 percent of the layers in high-end chips.

 

 

Strategic investment in research and development

Supported by our strong financial performance in recent years, we increased research and development expenses in 2008 by 5.4 percent compared with 2007, as we accelerated development of immersion and EUV technologies. This operating decision to continue to invest during the downturn and prepare for the future was made possible by leveraging our outsourcing strategy, which continues to enable us to rapidly and efficiently adjust our cost structure throughout the 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 which will be exposed next. Our strong leadership in this capability has allowed us 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.

 

 

Our innovative immersion lithography replaces air over the wafer with fluid, enhancing focus and enabling circuit line-width to shrink to even smaller dimensions. ASML has experienced strong demand for immersion-based systems, driven initially by memory chip makers that need more cost effective technology transitions that are enabled by immersion systems. With 128 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 July 2008, we introduced our new TWINSCAN XT:1950i system, the only immersion lithography system in the world capable of imaging chip features down to 38 nm with a single exposure. Furthermore, in October 2008 we announced ASML’s new TWINSCAN NXT immersion lithography platform. With new wafer stage and positioning technology, the TWINSCAN NXT offers significant improvements in overlay and productivity, enabling the semiconductor industry to continue its shrink roadmap for more advanced and affordable chips. The TWINSCAN NXT platform is also suited for emerging double patterning techniques required by manufacturers to shrink the smallest chip features by up to 42 percent over the current most advanced production systems. The first product based on the new platform, the NXT:1950i, was introduced in December 2008.

 

 

Also in 2008, we made significant progress in our EUV lithography program, completing the design of our first NXE production system. The NXE system, which will be built on an evolved TWINSCAN platform will enable our customers to extend their roadmap to chip features down to 22 nm and smaller. We have two Alpha Demo Tools at CNSE in Albany, New York (United States) and IMEC in Leuven (Belgium), both leading research and development institutions, where potential customers can conduct infrastructure development, and where the first functional devices were made using EUV lithography on full-field chips in February 2008. As a single-exposure, multi-node technology, EUV offers the greatest extendibility at the lowest cost of ownership for the future of lithography. ASML currently has orders for five of these systems, the first of which is scheduled for shipment in 2010.

 

 

From time to time, we seek to expand the scope of our business, pursuing hardware technologies and new product opportunities in fields adjacent or complementary to our core semiconductor lithography competence. Our March 2007 acquisition of Brion was an example of such an expansion. Through Brion, ASML has developed a range of new resolution enhancement techniques which our customers are implementing to reduce cost per chip, both currently and as they transition to EUV lithography.

 

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In the fourth quarter of 2008, ASML introduced its LithoTuner^tm Pattern Matcher products which enable cost and yield improvements ranging from 30 to 70 percent over current scanner matching techniques. ASML is alone in offering this capability. We refer to our efforts in this area as “holistic lithography”, the improvement of the entire chip-imaging process by optimizing wafer lithography, computational lithography and layout, thereby providing our customers with better performance and value of ownership.

 

 

Operational excellence

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

 

 

Our business strategy includes outsourcing the majority of components and subassemblies that make up our products. We work in partnership with suppliers, collaborating on quality, logistics, technology and total cost. By operating our strategy of value sourcing, we strive to attain flexibility and cost efficiencies from our suppliers through mutual commitment and shared risk and reward. Value sourcing also allows the flexibility to adapt to the cyclicality of the world market for semiconductor lithography systems.

 

 

ASML has a flexible labor model with a mix of fixed and flexible contracted labor in its manufacturing, and research and development facilities located in Veldhoven. This 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.

 

 

In view of the current global financial market crisis and economic downturn, we continue to strive to improve efficiencies in our operations: addressing our cost structure and strengthening our capability to generate cash. We have used the flexibility in our business model to quickly reduce costs in response to the global economic downturn without impacting our key technology development roadmap. Also, we are maintaining a level of capacity at our factory to ramp up production to meet customer needs without lengthy lead-times, since the lithography market may pick up quickly once product end-demand recovers. 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.

 

 

 

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Sales

For the longer term, and based on industry analysts IC growth forecasts, we expect our sales level to grow. Based on these forecasts and our current market share, our general strategy is to seek to grow net sales to a EUR 5 billion level. The timing of such level depends on three growth drivers: market growth, market share growth and a broadening of our product and services scope. See also Item 4.A. “History and Development of the Company.”

 

 

In 2008, net sales decreased by 21.6 percent to EUR 2,954 million from EUR 3,768 million in 2007. The decrease in net sales mainly resulted from a lower demand for lithography equipment partly offset by higher ASPs in 2008. The lower overall semiconductor end-demand was caused by a significant economic uncertainty resulting from the current global financial market crisis and economic downturn. Against this background our customers started to re-assess their strategic alliances and their investments to match the industry’s production capacity to end-demand. This situation created a wait-and-see attitude resulting in delay of non leading-edge production capacity additions. While customers reduced standard production capacity, their willingness to invest in leading-edge immersion technology, however, remained strong as this technology enables lithography equipment buyers to reduce their costs.

 

 

ASML is one of the world’s leading providers of lithography equipment with a market share based on revenue of 65 percent in 2007 and approximately 65 percent in 2008. This is according to the latest available data up to and including November 2008 as reported by SEMI, an independent semiconductor industry organization.

 

 

The ASP of our systems increased by 29.5 percent from EUR 12.9 million in 2007 to EUR 16.7 million in 2008. 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. In 2008, this general trend was accentuated by our customers delaying non-leading-edge capacity additions in view of the rationalization of the industry’s production capacity to match end-demand.

 

 

As of December 31, 2008, our order backlog was valued at EUR 755 million and included 41 systems with an ASP of EUR 18.4 million. As of December 31, 2007, the order backlog was valued at EUR 1,697 million and included 89 systems with an ASP of EUR 19.1 million. The continued high ASP reflected a high number of leading-edge immersion systems in the backlog of 2007 and 2008 pursuant to the continued ramp-up of volume manufacturing with our leading-edge immersion systems in 2008 and 2009. The decrease in the total value of the backlog was primarily the result of increased uncertainty about future global economic market conditions and the impact on the overall semiconductor end-demand. As a result we currently see a trend in customer order behavior toward ordering on a system by system basis when needed rather than ordering systems on a 12-month rolling capacity planning basis.

 

 

Profitability

Our general strategy is to seek to achieve average income from operations to net sales of 10-15 percent at the downturn point and 20-25 percent at the upturn point over the industry’s business cycle. However in periods of serious recessionary pressure, as evidenced by the current global financial market crisis and economic downturn, we could see periods with income from operations that are substantially below our minimum target level.

 

 

Operating income decreased from EUR 815 million or 21.6 percent of sales in 2007 to 287 million or 9.7 percent of sales in 2008. This EUR 528 million decrease was substantially the result of a decrease in gross profit of EUR 534 million or 34.5 percent which was partially offset by a decrease in operating expenses of EUR 6 million or 0.9 percent.

 

 

Gross profit on sales decreased from EUR 1,550 million or 41.1 percent of net sales in 2007 to 1,016 million or 34.4 percent of net sales in 2008. The lower gross profit was principally attributable to a decrease in net sales (see above) and to an increase in the cost of sales as a percentage of net sales. The increase in cost of sales as a percentage of sales was principally attributable to lower coverage of our fixed manufacturing costs consistent with the lower production levels in 2008 compared with 2007. Furthermore, we recorded restructuring and impairment charges of EUR 138 million in the fourth quarter of 2008, anticipating a sharp decrease in demand resulting from the current global financial market crisis and economic downturn. See Item 5. A. Operational Results, for the impact of the current global financial market crisis and economic downturn.

 

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Net research and development costs in 2007 included a one-off charge of EUR 23 million relating to amortization of in-process research and development in connection with the Brion acquisition. Excluding this one-off charge research and development costs net of credits increased by EUR 30 million or 6.2 percent mainly as a result of the decision to continue strategic investments in technology leadership. Although we strived to be as efficient as possible in research and development spending we did not want to impact any of the strategic programs, in particular immersion, double patterning and EUV, in order to further develop our position as a technology leader. For further details regarding research and development see Item 4.B. “Business Overview” and Item 5 “Operating and Financial Review and Prospects, Business Strategy”.

 

 

Operating expenses were EUR 6 million lower in 2008 compared to 2007 due to a decrease of selling, general and administrative costs by 13 million, or 5.9 percent partially offset by an increase in net research and development costs by EUR 7 million, or 1.3 percent. The selling, general and administrative costs were reduced in anticipation of the lower sales level.

 

 

ASML has a flexible labor model with a mix of payroll and temporary employees, which enables the company to quickly adapt its costs to the semiconductor market cycles.

 

 

Net income in 2008 amounted to EUR 322 million or 10.9 percent of sales, representing EUR 0.75 per share compared with net income of EUR 671 million or 17.8 percent of sales, representing EUR 1.45 per share in 2007.

 

 

Liquidity

Our general strategy is to seek to maintain our strategic target level of cash and cash equivalents between EUR 1.0 billion and EUR 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 will consider returning excess cash to our shareholders. As of December 31, 2008 our cash and cash equivalents amounted to EUR 1.1 billion.

 

 

At December 31, 2008, the Company has an available credit facility for a total of EUR 500 million, which will expire in May 2012.

 

 

Our cash and cash equivalents decreased from EUR 1,272 million as of December 31, 2007 to EUR 1,109 million as of December 31, 2008. We generated cash from operations of EUR 281 million in 2008, which was offset by a cash outflow of EUR 184 million from financing activities, mainly as a result of our 2008 dividend payment (EUR 108 million) and share buyback programs (EUR 88 million), and EUR 260 million cash used in investing activities mainly related to the production facilities in Veldhoven and Taipei and, to a lesser extent, equipment and information technology.

 

 

ASML repurchased 5 million shares (EUR 88 million) in February 2008. The cumulative amount returned to shareholders in the form of share buybacks and capital repayment between May 2006 and February 2008 was EUR 2,137 million. In May 2008 the Company paid a dividend of EUR 0.25 per ordinary share of EUR 0.09, or EUR 108 million in total. A proposal will be submitted to the Annual General Meeting of Shareholders on March 26, 2009 to declare a dividend for 2008 of EUR 0.20 per ordinary share of EUR 0.09.

 

 

Significant Effects of the Current Global Financial Market Crisis and Economic Downturn on ASML

As a result of the sharp decreases in demand in the fourth quarter of 2008 and in anticipated demand in 2009 caused by the current global financial market crisis and economic downturn, ASML has recognized impairment charges of EUR 20.8 million on property, plant and equipment and inventory obsolescence charges of EUR 94.6 million.

 

 

In order to lower its cost and break-even level, ASML announced in December 2008 a reduction in work force of approximately 1,000 employees or 12 percent of the total work force, mainly contract employees. ASML also announced the shutdown of its production facilities for two weeks in the fourth quarter of 2008 and four weeks in the first half of 2009. Furthermore, ASML announced a restructuring that resulted in the discontinuation of its training center in the United States, the downsizing of its United States headquarters and the closure of several other service locations, reflecting the continuing migration of semiconductor manufacturing activities to Asia which has been accelerated by the current global financial market crisis and economic downturn. The restructuring resulted in the recognition of a provision for employee contract termination benefits of EUR 2.4 million, reflecting the elimination of approximately 90 jobs in the United States and approximately 15 jobs at service locations in other parts of the world. As part of this restructuring, ASML ceased the use of its training facility in Tempe, United States, incurring lease contract termination costs of EUR 20.0 million in 2008.

 

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As a result of the actions taken to respond to the current global financial market crisis and economic downturn the following charges have been recognized in ASML’s consolidated statements of operations in 2008:

 

 

 

These costs are recognized as follows in the consolidated statements of operations:

 

 

 

Notwithstanding the restructuring, ASML intends to maintain its key research and development programs for the development of next generation lithography systems. Furthermore, ASML will maintain a level of production capacity to be able to ramp up production to meet customer requirements without lengthy lead times as demand picks up in the future.

 

 

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, business combinations, long-lived assets, inventories, accounts receivable, provisions, contingencies and litigation, share-based compensation expenses and income tax. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. While we regularly evaluate our estimates and assumptions, actual results may differ from these estimates if these assumptions prove incorrect. To the extent there are material differences between actual results and these estimates, our future results of operations could be materially and adversely affected. We believe that the accounting policies described below require us to make significant judgments and estimates in the preparation of our consolidated financial statements.

 

 

Revenue recognition

ASML recognizes revenue when all four revenue recognition criteria are met: persuasive evidence of an arrangement exists; delivery has occurred or services have been rendered; seller’s price to buyer is fixed or determinable; and collectability is reasonably assured. At ASML, this policy generally results in revenue recognition from the sale of a system upon shipment. The revenue from the installation of a system is generally recognized upon completion of that installation at the customer site. Each system undergoes, prior to shipment, a “Factory Acceptance Test” in ASML’s clean room facilities, effectively replicating the operating conditions that will be present on the customer’s site, in order to verify whether the system will meet its standard specifications and any additional technical and performance criteria agreed with the customer. A system is shipped, and revenue is recognized, only after all specifications are met and customer sign-off is received or waived. Although each system’s performance is re-tested upon installation at the customer’s site, ASML has never failed to successfully complete installation of a system at a customer’s premises.

 

 

We anticipate that, in connection with future introductions of new technology, we will initially defer revenue recognition until completion of installation and acceptance of the new technology at customer premises. This deferral would continue until we are able to conclude that installation of the technology in question would occur consistently within a predetermined time period and that the performance of the new technology would not reasonably be different from that exhibited in the pre-shipment Factory Acceptance Test. Any such deferral of revenues, however, could have a material effect on ASML’s results of operations for the

 

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fiscal period in which the deferral occurred and on the succeeding fiscal period. At December 31, 2008 and 2007, we had no deferred revenue from shipments of new technology. During the three years ended December 31, 2008, no revenue from new technology was recorded that had been previously deferred. As our systems are based largely on two product platforms that permit incremental, modular upgrades, the introduction of genuinely “new” technology occurs infrequently, and has occurred on only one occasion since 1999.

 

 

ASML has no significant repurchase commitments in its general sales terms and conditions. From time to time the Company repurchases systems that it has manufactured and sold and, following refurbishment, resells those systems to other customers. This repurchase decision is driven by market demand expressed by other customers and not by explicit or implicit contractual arrangements relating to the initial sale. The Company considers reasonable offers from any vendor, including customers, to repurchase used systems so that it can refurbish, resell and install these systems as part of its normal business operations. Once repurchased, the repurchase price of the used system is recorded in work-in-process inventory during the period it is being refurbished, following which the refurbished system is reflected in finished products inventory until it is sold to the customer. As of December 31, 2008 ASML has no repurchase commitments.

 

 

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”) except the fair value of the prepaid extended optic warranty which is based on the list price. 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 3 million and EUR 15 million, respectively, as of December 31, 2008.

 

 

The deferred revenue balance from prepaid service contracts and prepaid extended optic warranty contracts amounted to approximately EUR 118 million and EUR 55 million, respectively, as of December 31, 2008.

 

 

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. From time to time, we offer free or discounted products or services (award credits) to our customers as part of a volume purchase agreement. The sales transaction that gives rise to these award credits is accounted for as a multiple element revenue transaction. The consideration received from the sales transaction is allocated between the award credits and the other elements of the sales transaction. The consideration allocated to the award credits is recognized as deferred revenue until award credits are delivered to the customer. Generally, there are no other credits or adjustments recognized at shipment.

 

 

Revenues are recognized excluding the taxes levied on revenues (net basis).

 

 

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.

 

 

In 2008, we completed the purchase price allocation of Brion. No adjustments were made to the initial allocation of the purchase price.

 

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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 annually for impairment and whenever events or changes in circumstances indicate that the carrying amount of the goodwill may not be recoverable. Goodwill is tested for impairment based on a two-step approach for each reporting unit. First, the recoverability is tested by comparing the carrying amount of the reporting unit including goodwill with the fair value of the reporting unit, being the sum of the discounted future cash flows.

 

 

If the carrying amount of the reporting unit is higher than the fair value of the reporting unit, the second step should be performed. The goodwill impairment is measured as the excess of the carrying amount of the goodwill over its implied fair value. The implied fair value of goodwill is determined by calculating the fair value of the various assets and liabilities included in the reporting unit in the same manner as goodwill is determined in a business combination.

 

 

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. Other intangible assets and property, plant and equipment are tested for impairment based on a two-step approach. First the recoverability is tested by comparing the carrying amount of the other intangible assets and property, plant and equipment with the fair value being the sum of the undiscounted future cash flows. If the carrying amount of the other intangible assets and property, plant and equipment is lower than the fair value the 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.

 

 

In determining the fair value of a reporting unit or 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 2008, we recorded impairment charges of EUR 24.6 million in property, plant and equipment and EUR 0.6 million in other intangible assets of which we recorded EUR 21.4 million in cost of sales, EUR 2.2 million in research and development costs and EUR 1.6 million in selling, general and administrative costs. The impairment charges mainly relate to machinery and equipment of EUR 22.3 million mainly relating to a decrease in utilization as a result of lower expected demand and sales in 2009 and as a result of the closure of several locations due to the current global financial market crisis and economic downturn. The impairment charges were determined based on the difference between the assets’ estimated fair value (being EUR 5.4 million) and their carrying amount. In determining the fair value 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. See Notes 11 and 12 to our consolidated financial statements.

 

 

Inventories

Inventories, including spare parts and lenses, 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. Allowances 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 allowances, 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 allowances 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 8 to our consolidated financial statements.

 

 

As of December 31, 2008, the allowance for inventory obsolescence amounts to EUR 189.9 million (2007: EUR 129.0 million). The increase in the allowance for inventory obsolescence mainly reflects the higher obsolescence due to lower expected demand and sales in 2009 as a result of the current global financial market crisis and economic downturn.

 

 

Accounts receivable

A majority of our accounts receivable are derived from sales to a limited number of 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

 

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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 letters of credit, down payments and retention of ownership, before shipping systems to certain customers. We have not incurred any material accounts receivable credit losses during the past three years. Our three largest customers accounted for 42.2 percent of accounts receivable at December 31, 2008, compared to 40.1 percent at December 31, 2007. A 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.

On January 23, 2009, Qimonda AG and Qimonda Dresden OHG (together “Qimonda”), a German memory chipmaker, filed for insolvency. Qimonda has amounts outstanding to ASML of approximately EUR 37 million in respect of two systems delivered, of which EUR 21 million is reflected in accounts receivable and EUR 16 million is reflected in finance receivables. ASML believes that the outstanding amounts receivable from Qimonda are collectible or the value of the receivables can be realized through the retention of title of the two systems. In case the trustee in bankruptcy will not honour the contracts with ASML, we will execute our right to retrieve these systems, in order to substantially cover the financial risk for ASML. The timing of such potential retrieval of the systems is uncertain.

 

 

Provisions

Employee contract termination benefits are payable when employment is terminated before the normal retirement date, or whenever an employee accepts voluntary redundancy in exchange for these benefits. ASML recognizes employee contract termination benefits when ASML is demonstrably committed to either terminating the employment of current employees according to a detailed formal plan where there is no possibility of withdrawal, or when ASML provides termination benefits as a result of an offer made to encourage voluntary redundancy. The timing of recognition and measurement of the provision for employee contract termination benefits depends on whether employees are required to render service until they are terminated in order to receive the termination benefits. If this period of continued employment extends beyond the minimum retention period, the provision shall be determined at the communication date based on the fair value as of the termination date and is recognized ratably over the future service period.

 

 

Provisions for lease contract termination costs are recognized when costs will continue to be incurred under a contract for its remaining term without economic benefit to the Company and the Company ceases using the rights conveyed by the contract. The provisions are measured at fair value which is determined based on the remaining lease payments reduced by the estimated sublease payment that could be reasonably obtained for the building.

 

 

Provision for employee contract termination benefits relates mainly to the restructuring that was initiated in 2008 to achieve further reduction in costs. The provision for employee contract termination benefits comprises only personnel costs.

 

 

Provision for lease contract termination costs relates to an operating lease contract for a building for which no economic benefits are expected.

 

 

Contingencies and litigation

We are party to various legal proceedings generally incidental to our business, as disclosed in Note 18 to the consolidated financial statements. In connection with these proceedings and claims, our management evaluated, based on the relevant facts and legal principles, the likelihood of an unfavorable outcome and whether the amount of the loss could be reasonably estimated. In each case, management determined that either a loss was not probable or was not reasonably estimable. As a result, no estimated losses were recorded as a charge to our consolidated statements of operations in 2006, 2007 and 2008. 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 expensive and protracted litigation, the outcome of which is uncertain.

 

 

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

 

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Share-based compensation expenses

The cost of employee services received (compensation expenses) in exchange for awards of equity instruments are recognized based upon the grant-date fair value of stock options and stock. The grant-date fair value of stock options is estimated using a Black-Scholes option valuation model. This Black-Scholes model requires the use of assumptions, including expected stock price volatility, the estimated life of each award and the estimated dividend yield. 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. The fair value of stock is determined based on the closing price of the Company’s ordinary shares on the Euronext Amsterdam on the grant date.

 

 

The fair value determined at the grant date of the equity-settled share-based payments is expensed on a straight-line basis over the vesting period, based on the Company’s estimate of equity instruments that will eventually vest. At each balance sheet date, the Company revises its estimate of the number of equity instruments expected to vest. The impact of the revision of the original estimates, if any, is recognized in the consolidated statements of operations in the period in which the revision is determined, with a corresponding adjustment to equity.

 

 

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.

 

 

Our current share-based payment plans do not provide for cash settlement of options.

 

 

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 is 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 tax effect of the loss carry-forwards as of December 31, 2008 was EUR 57.8 million, which resides completely with ASML US, Inc. and US based subsidiaries of 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 effectuated 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 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 19 to our consolidated financial statements).

 

 

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.

 

 

Consistent with the provisions of FIN 48, as of December 31, 2008 we classified the liability for unrecognized tax benefits amounting to EUR 124.2 million as non-current liabilities because payment of cash was not anticipated within one year of the balance sheet date, which compares to EUR 110.3 million as at December 31, 2007. These non-current income tax liabilities are recorded in deferred tax and other tax liabilities in the consolidated balance sheets. The total liability for unrecognized tax benefits, if recognized, would have a favorable effect on the Company’s effective tax rate.

 

 

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

 

ASML ANNUAL REPORT 2008

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consolidated balance sheets of December 31, 2007 amounted to EUR 21.5 million and as of December 31, 2008 amounted to EUR 23.6 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:

 

 

 

For the year ended December 31, 2008, there were no material changes compared to 2007 related to the liability for unrecognized tax benefits that impacted the Company’s effective tax rate.

 

 

The Company estimates that the total liability of unrecognized tax benefits will change with EUR 5.2 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.

 

 

There were three main topics on which we reached agreement with the fiscal authorities in 2008 that have affected our effective tax rate. For these three main topics and their related tax positions the more-likely-than-not recognition threshold of FIN 48 was not met as of December 31, 2007.

 

 

In the course of 2008, we reached agreement with the Netherlands tax authorities on determination of the tax benefits resulting from application of the so-called “Royalty Box”, a Netherlands tax measure intended to stimulate innovation. The Royalty Box mechanism partly exempts income attributable to research efforts and protected by patents from taxation, resulting in taxation of so called patent income at an effective corporate income tax rate of 10.0 percent instead of 25.5 percent. This agreement covered the Royalty Box for the years 2007, 2008 and the years thereafter.

 

 

We also reached agreement with the Netherlands tax authorities on the valuation of intellectual property rights acquired in the United States against a fixed historical U.S. dollar exchange rate.

 

 

Finally, we reached agreement with the Netherlands tax authorities on the balance of the temporarily depreciated investment in ASML’s United States subsidiary. This depreciated amount has to be added back to taxable income in the period 2006-2010 in five equal installments.

 

 

The benefit of the Royalty Box for both 2007 and 2008, the benefit of the recognized deferred tax asset for intellectual property rights and the benefit of the temporarily depreciated investment have all been recorded in the provision for income taxes for 2008. As a result, ASML booked a tax income of approximately EUR 70 million.

 

 

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”.

 

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Set forth below our consolidated statements of operations data for the three years ended December 31, 2008:

 

 

 

 

Set forth below are our consolidated statements of operations from operations data for the three years ended December 31, 2008, expressed as a percentage of our total net sales:

 

 

 

ASML ANNUAL REPORT 2008

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Results of operations 2008 compared with 2007

 

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 2008.

 

 

 

 

Net sales decreased by EUR 814 million or 21.6 percent from EUR 3,768 million in 2007 to EUR 2,954 million in 2008. The decrease in net sales mainly relates to a decrease in net system sales of EUR 834 million, from EUR 3,351 million in 2007 to EUR 2,517 million in 2008 mainly attributable to a lower number of systems shipped (-41.9 percent), partly offset by an increased ASP (+29.5 percent). Net service and field option sales increased from EUR 417 million in 2007 to EUR 437 million in 2008.

 

 

The number of systems shipped decreased by 41.9 percent from 260 systems in 2007 to 151 systems in 2008. The year 2008 was characterized by significant overall economic uncertainty fuelled by the current global financial market crisis and economic downturn. This led to lower overall semiconductor end-demand. Against this background our customers started to re-assess their strategic alliances and their investments to match production capacity to end-demand, resulting in a delay of non leading-edge production capacity additions. While lithography equipment buyers are reducing standard production capacity, their willingness to invest in leading-edge immersion technology, however, remained strong as this technology enables lithography equipment buyers to reduce their cost aggressively.

 

 

The ASP of our systems increased by 29.5 percent from EUR 12.9 million in 2007 to EUR 16.7 million in 2008. 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 continued 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.

 

 

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 2008 increased to 36 from 25 in 2007, reflecting increased demand for older systems to produce less complex ICs following the lower overall semiconductor end-demand than anticipated. The ASP for used systems increased from EUR 3.9 million in 2007 to EUR 4.8 million in 2008, reflecting a further shift from our older PAS 2500 towards our newer PAS 5500 family and TWINSCAN family.

 

 

Through 2008, 17 of the top 20 chipmakers worldwide, in terms of semiconductor capital expenditure, were our customers. In 2008, sales to the largest customer accounted for EUR 754 million, or 25.5 percent of our net sales. In 2007, sales to the largest customer accounted for EUR 818 million, or 21.7 percent of our net sales.

 

 

Gross profit decreased from EUR 1,550 million or 41.1 percent of net sales in 2007 to 1,016 million or 34.4 percent of net sales in 2008. Gross margin was negatively impacted by restructuring and impairment charges (-4.6 percent), by capacity losses consistent with lower production levels (-4.3 percent) and by a changed product mix (-0.8 percent) partly offset by increased ASPs (1.7 percent) and decreased cost of goods (1.9 percent) reflecting the results of our continuous cost of goods reduction programs.

 

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We started 2008 with an order backlog of 89 systems. In 2008, we booked orders for 115 systems, received order cancellations or push-outs beyond 12 months of 12 systems and recognized sales for 151 systems. This resulted in an order backlog of 41 systems as of December 31, 2008. The total value of our backlog as of December 31, 2008 amounted to EUR 755 million with an ASP of EUR 18.4 million, compared with a backlog of EUR 1,697 million with an ASP of EUR 19.1 million as of December 31, 2007. See also Item 5.D. “Trend Information”.

 

 

Research and development

Research and development costs increased by EUR 27 million or 5.4 percent from EUR 511 million in 2007 to EUR 538 million in 2008. This increase reflects continued investment in technology in 2008 through investments in the development of enhancements of the next generation TWINSCAN systems based on immersion, double patterning and EUV.

 

 

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 22 million in 2008 compared to EUR 24 million in 2007.

 

 

Selling, general and administrative costs

Selling, general and administrative costs decreased by 5.9 percent from EUR 226 million in 2007 to EUR 212 million in 2008. In anticipation to the lower sales level we reduced selling, general and administration costs

 

 

Net interest income

Net interest income decreased from EUR 33 million in 2007 to EUR 23 million in 2008. Our interest income relates to interest earned on our cash and cash equivalents. In 2008 interest income decreased mainly as a result of a lower average cash balance and slightly lower interest rates. While operating cash flows remained positive, the average cash balance decreased mainly as a result of the share buyback programs implemented in the fourth quarter of 2007 and in the first quarter of 2008, the dividend paid in 2008 and cash used for capital expenditures.

 

 

Income taxes

Income taxes represented -4.1 percent of income before taxes in 2008, compared to 20.9 percent in 2007. The decrease in income taxes in 2008 is mainly related to three main items on which we reached agreement with the Netherlands tax authorities. These items are the treatment of taxable income related to ASML’s patent portfolio, the valuation of intellectual property rights acquired in the past against historical exchange rates, and the treatment of taxable income related to a temporarily depreciated investment in ASML’s United States subsidiary, all of which had a favorable impact on the Company’s effective tax rate. As a result of these three items, ASML recognized exceptional tax income of approximately EUR 70 million in 2008.

 

 

Results of 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, 2006 and 2007.