Securities and Exchange CommissionWashington, D.C. 20549Form 20-FANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)OF THE SECURITIES EXCHANGE ACT OF 1934for the fiscal year ended December 31, 2006Commission file number 025566ASML HOLDING N.V.(Exact Name of Registrant as Specified in Its Charter)THE NETHERLANDS(Jurisdiction of Incorporation or Organization)DE RUN 65015504 DR VELDHOVENTHE NETHERLANDS(Address of Principal Executive Offices)Securities registered or to be registered pursuant toSection 12(b) of the Act:
Contents
Part I" -->
Five-Year Financial Summary
Exchange Rate InformationWe publish our consolidated financial statements in euro. In this Annual Report, references to “€”, “EUR” or “euro” are to euro, and references to “$”, “dollars”, “U.S. dollars”, “U.S. dollar”, “USD” or “US$” are to United States dollars. Solely for the convenience of the reader, certain U.S. dollar amounts have been translated into euro amounts using an exchange rate in effect on December 31, 2006 of US$ 1.00 = EUR 0.75930.A portion of our net sales and expenses is, and historically has been, denominated in currencies other than the euro. For a discussion of the impact of exchange rate fluctuations on our financial condition and results of operations, see Item 5.A. “Operating Results, Foreign Exchange Management” and Note 1 to our consolidated financial statements.The following are the Noon Buying Rates certified by the Federal Reserve Bank of New York for customs purposes (the “Noon Buying Rate”) expressed in U.S. dollars per euro.
require significant lead time to complete. Accordingly, we may not be able to effectively increase our production capacity to respond to an increase in customer demand in an industry upturn resulting in lost revenues and damage to customer relationships.Conversely, in an industry downturn, our ability to maintain profitability will depend substantially on whether we are able to lower our costs and break-even level, which is the number of lithography systems we must sell in a year to achieve net income. If we are unable to lower costs in an industry downturn, our net income may decline significantly. As we need to keep certain levels of inventory on hand to meet anticipated product demand, we also incur increased costs related to inventory obsolescence in an industry downturn. In addition, industry downturns generally result in overcapacity, resulting in downward pressure on prices, which has had in the past, and could have in the future, a material adverse effect on our business, financial condition and results of operations.Our Business Will Suffer If We Do Not Respond Rapidly to Commercial and Technological Changes in the Semiconductor IndustryThe semiconductor manufacturing industry is subject to:• rapid change towards more complex technologies;• frequent new product introductions and enhancements;• evolving industry standards;• changes in customer requirements; and• continued shortening of product life cycles.Our products could become obsolete sooner than anticipated because of a faster than anticipated change in one or more of the technologies related to our products or in market demand for products based on a particular technology. Our success in developing new products and in enhancing our existing products depends on a variety of factors, including the successful management of our research and development programs and timely completion of product development and design relative to competitors. If we do not develop and introduce new and enhanced systems at competitive prices and on a timely basis, our customers will not integrate our systems into the planning and design of new fabrication facilities and upgrades of existing facilities, which would have a material adverse effect on our business, financial condition and results of operations.In addition, we may invest considerable financial and other resources to develop and introduce new products and product enhancements, such as Extreme Ultraviolet lithography (“EUV”), that our customers may not ultimately adopt. If our customers do not adopt these new technologies, products or product enhancements that we develop due to a preference for more established technologies and products or for other reasons, we would not recoup any return on our investments in these technologies or products, which may result in charges to our statement of operations and materially and adversely affect the future growth of the Company.We Face Intense CompetitionThe semiconductor equipment industry is highly competitive. The principal elements of competition in our markets are:• the technical performance characteristics of a photolithography system;• the value of ownership of that system based on its purchase price, maintenance costs, productivity and customer service and support; and• the strength and breadth of our portfolio of patents and other intellectual property rights.Our competitiveness increasingly depends upon our ability to develop new and enhanced semiconductor equipment that is competitively priced and introduced on a timely basis, as well as our ability to protect and defend our intellectual property rights. See Item 4.B. “Business Overview, Intellectual Property” and Note 14 to our consolidated financial statements.The costs to develop new systems, in particular photolithography systems, are extremely high and accordingly, the photolithography equipment industry is characterized by fierce competition among a few suppliers. ASML’s primary competitors are Nikon Corporation (“Nikon”) and Canon Kabushika Kaisha (“Canon”). Nikon and Canon are the dominant suppliers in the Japanese market, which accounts for a significant portion of worldwide semiconductor production. This market historically has been difficult for non-Japanese companies to penetrate.Both Nikon and Canon have substantial financial resources and broad patent portfolios. Each continues to introduce new products with improved price and performance characteristics that compete directly with our products, and may cause a decline in our sales or loss of market acceptance for our photolithography systems. In addition, adverse market conditions, industry overcapacity or a decrease in the value of the Japanese yen in relation to the euro or the U.S. dollar could further intensify price-based competition in those markets that account for the majority of our sales, resulting in lower prices and margins and a material adverse effect on our business, financial condition and results of operations.ASML ANNUAL REPORT 20068
Industry Alliances May Not Select our EquipmentIncreasingly, our customers are entering into alliances or other forms of cooperation with one another to expedite the development of processes and other manufacturing technologies. One of the results of such a form of cooperation may be the definition of a system or particular tool set for a certain function or a series of process steps that use a specific set of manufacturing equipment. These decisions could work to our disadvantage if a competitor’s equipment becomes the standard equipment for such function or process. Even if ASML’s equipment was previously used by a customer, that equipment may be displaced in current and future applications by the equipment standardized by the form of cooperation. These forms of cooperation may have a material adverse effect on our business, financial condition and results of operations.Risks Related to ASMLThe Number of Systems We Can Produce Is Limited by Our Dependence on a Limited Number of Suppliers of Key ComponentsWe rely on outside vendors for the components and subassemblies used in our systems, each of which is obtained from a single supplier or a limited number of suppliers. Our reliance on a limited group of suppliers involves several risks, including a potential inability to obtain an adequate supply of required components and the risk of untimely delivery of these components and subassemblies.The number of photolithography systems we have been able to produce has occasionally been limited by the production capacity of Carl Zeiss SMT AG (“Zeiss”). Zeiss is our single supplier of lenses and other critical optical components. If Zeiss were unable to maintain and increase production levels or if we are unable to maintain our business relationship with Zeiss in the future we could be unable to fulfill orders, which could damage relationships with current and prospective customers and have a material adverse effect on our business, financial condition and results of operations. If Zeiss were to terminate its relationship with us or if Zeiss were unable to maintain production of lenses over a prolonged period, we would effectively cease to be able to conduct our business. See Item 4.B. “Business Overview, Manufacturing, Logistics and Suppliers.”In addition to Zeiss’ current position as our single supplier of lenses, the excimer laser illumination systems that provide the ultraviolet light source, referred to as “deep UV,” used in our high resolution steppers and Step & Scan systems, are available from only a limited number of suppliers. In particular, we rely heavily on Cymer, Inc., a United States based company, to provide excimer laser illumination systems.Although the timeliness, yield and quality of deliveries to date from our other subcontractors generally have been satisfactory, manufacturing of certain of these components and subassemblies that we use in our manufacturing processes is an extremely complex process and delays caused by suppliers may occur in the future. A prolonged inability to obtain adequate deliveries of components or subassemblies, or any other circumstance that requires us to seek alternative sources of supply, could significantly hinder our ability to deliver our products in a timely manner, which could damage relationships with current and prospective customers and have a material adverse effect on our business, financial condition and results of operations.A High Percentage of Net Sales Is Derived from a Few CustomersHistorically, we have sold a substantial number of lithography systems to a limited number of customers. While the identity of our largest customers may vary from year to year, we expect sales to remain concentrated among relatively few customers in any particular year. In 2006, sales to one customer accounted for EUR 730 million, or 20 percent of net sales, compared to EUR 609 million, or 24 percent of net sales, in 2005. The loss of any significant customer or any reduction in orders by a significant customer may have a material adverse effect on our business, financial condition and results of operations.Additionally, as a result of the limited number of our customers, credit risk on our receivables is concentrated. Our three largest customers accounted for 35 percent of accounts receivable at December 31, 2006, compared to 49 percent at December 31, 2005. As a result, business failure or insolvency of one of our main customers may have a material adverse effect on our business, financial condition and results of operations.The Pace of Introduction of Our New Products Is Accelerating and Is Accompanied by Potential Design and Production Delays and by Significant CostsThe development and initial production, installation and enhancement of the systems we produce is often accompanied by design and production delays and related costs of a nature typically associated with the introduction and transition to full-scale manufacturing of complex capital equipment. While we expect and plan for a corresponding learning curve effect in our product development cycle, we cannot precisely predict the time and expense required to overcome these initial problems and to ensure full performance to specifications. There is a risk that we may not be able to introduce or bring to full-scale production new products as quickly as we expected in our product introduction plans, which could have a material adverse effect on our business, financial condition and results of operations.ASML ANNUAL REPORT 20069
In order for the market to accept technology enhancements, our customers, in many cases, must upgrade their existing technology capabilities. Such upgrades from established technology may not be available to our customers to enable volume production using our new technology enhancements. This could result in our customers not purchasing, or pushing back or canceling orders for our technology enhancements, which could negatively impact our business, financial condition and results of operations.We Derive Most of Our Revenues from the Sale of a Relatively Small Number of ProductsWe derive most of our revenues from the sale of a relatively small number of lithography equipment systems (266 units in 2006; 196 units in 2005), with an average selling price (“ASP”) in 2006 of EUR 12.1 million (EUR 14.0 million for new systems and EUR 3.2 million for used systems) and ASP in 2005 of EUR 11.4 million (EUR 13.5 million for new systems and EUR 2.9 million for used systems). As a result, the timing of recognition of revenue from a small number of transactions may have a significant impact on our net sales and other operating results for a particular reporting period. Specifically, the failure to receive anticipated orders, or delays in shipments near the end of a particular reporting period, due, for example, to:• the highly cyclical semiconductor business industry;• unanticipated shipment rescheduling;• cancellation or order push back by customers;• unexpected manufacturing difficulties; and• delays in deliveries by suppliers,may cause net sales in a particular reporting period to fall significantly below net sales in previous periods or our expected net sales, and would have a material adverse effect on our operating results for that period.In particular our published quarterly earnings have varied significantly from quarter to quarter and may vary in the future for the reasons discussed above.Failure to Adequately Protect the Intellectual Property Rights upon Which We Depend Could Harm Our BusinessWe rely on intellectual property rights such as patents, copyrights and trade secrets to protect our proprietary technology. However, we face the risk that these measures will be inadequate:• intellectual property laws may not sufficiently support our proprietary rights or may adversely change in the future;• patent rights may not be granted or construed as intended;• patent rights will expire;• the steps we take to prevent misappropriation or infringement of our proprietary rights may not be successful; and• third parties may be able to develop or obtain patents for similar competing technology.In addition, litigation may be necessary in order to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Any such litigation may result in substantial costs and diversion of resources, and, if decided unfavorably to us, could have a material adverse effect on our business, financial condition and results of operations.Defending Against Intellectual Property Claims by Others Could Harm Our BusinessIn the course of our business, we are subject to claims by third parties alleging that our products or processes infringe upon their intellectual property rights. If successful, such claims could limit or prohibit us from developing our technology and manufacturing our products, which could have a material adverse effect on our business, financial condition and results of operations.In addition, our customers may be subject to claims of infringement from third parties, alleging that our products used by such customers in the manufacture of semiconductor products and/or the processes relating to the use of our products infringe one or more patents issued to such parties. If such claims were successful, we could be required to indemnify customers for some or all of any losses incurred or damages assessed against them as a result of such infringement, which could have a material adverse effect on our business, financial condition and results of operations.We may also incur substantial licensing or settlement costs where doing so would strengthen or expand our intellectual property rights or limit our exposure to intellectual property claims by others, which may have a material adverse effect on our business, financial condition and results of operations.We Are Subject to Risks in Our International OperationsThe majority of our sales are made to customers outside Europe. There are a number of risks inherent in doing business in some of those markets, including the following:• potentially adverse tax consequences;• unfavorable political or economic environments;• unexpected legal or regulatory changes; and• an inability to effectively protect intellectual property.ASML ANNUAL REPORT 200610
If we are unable to manage successfully the risks inherent in our international activities, our business, financial condition and results of operations could be materially and adversely affected.In particular, approximately 20 percent of our 2006 revenues and approximately 18 percent of our 2005 revenues were derived from customers in Taiwan. Taiwan has a unique international political status. The People’s Republic of China asserts sovereignty over Taiwan and does not recognize the legitimacy of the Taiwan government. Changes in relations between Taiwan and the People’s Republic of China, Taiwanese government policies and other factors affecting Taiwan’s political, economic or social environment could have a material adverse effect on our business, financial condition and results of operations.We Are Dependent on the Continued Operation of a Limited Number of Manufacturing FacilitiesAll of our manufacturing activities, including subassembly, final assembly and system testing, take place in one clean room facility located in Veldhoven, the Netherlands, and one clean room facility in Wilton, Connecticut, United States. These facilities are subject to disruption for a variety of reasons, including work stoppages, fire, energy shortages, flooding or other natural disasters. We cannot ensure that alternative production capacity would be available if a major disruption were to occur or that, if it were available, it could be obtained on favorable terms. Such a disruption could have a material adverse effect on our business, financial condition and results of operations.Because of Labor Laws and Practices, Any Workforce Reductions That We May Wish to Implement In Order To Reduce Costs Company-Wide May Be Delayed or SuspendedThe semiconductor market is highly cyclical and as a consequence we may need to implement workforce reductions in case of a downturn, in order to adapt to such market changes. In accordance with labor laws and practices applicable in the jurisdictions in which we operate, a reduction of any significance may be subject to certain formal procedures, which can delay, or may result in the modification of our planned workforce reductions. For example, in the Netherlands, if our Works Council does not agree with a proposed workforce reduction in the Netherlands, but we nonetheless determine to proceed, we must temporarily suspend any action while the Works Council determines whether to appeal to the Netherlands Court. This appeal process can cause a delay of several months and may require us to address any procedural inadequacies identified by the Court in the way we reached our decision. Such delays could impair our ability to reduce costs company-wide to levels comparable to those of our competitors. See Item 6.D. “Employees.”Non-compliance with or a Change in Environmental Laws and Regulations Could Harm Our Results of OperationsWe are subject to Netherlands and foreign environmental regulations in areas such as energy resource management, use, storage, discharge and disposal of hazardous substances, recycling, clean air, water protection and waste disposal. Although we believe that we are in general compliance with these regulations and do not use large quantities of hazardous substances in our manufacturing processes, if we do not take adequate measures to comply with these regulations in the course of our ordinary business operations, or if there is a significant change in the environmental laws or regulations that affect our business, there could be a material adverse effect on our business, financial condition and results of operations.Fluctuations in Foreign Exchange Rates Could Harm Our Results of OperationsWe are exposed to currency risks. We are particularly exposed to fluctuations in the exchange rates between the U.S. dollar, Japanese yen and the euro as we incur manufacturing costs and price our systems predominantly in euro while a portion of our net sales and cost of sales is denominated in U.S. dollars and Japanese yen.In addition, a substantial portion of our assets and liabilities and operating results are denominated in U.S. dollar, and a small portion of our assets, liabilities and operating results are denominated in currencies other than the euro and the U.S. dollar. Our consolidated financial statements are expressed in euro. Accordingly, our results of operations and assets and liabilities are exposed to fluctuations in various exchange rates.Furthermore, a strengthening of the euro particularly against the Japanese Yen could lead to intensified price-based competition in those markets that account for the majority of our sales, resulting in lower prices and margins and a material adverse effect on our business, financial condition and results of operations.Also see Item 5.A. “Operating Results, Foreign Exchange Management,” Item 5.F. “Tabular Disclosure of Contractual Obligations,” Item 11 “Quantitative and Qualitative Disclosures About Market Risk” and Note 4 to our consolidated financial statements.We May Be Unable to Make Desirable Acquisitions or to Integrate Successfully Any Businesses We AcquireOur future success may depend in part on the acquisition of businesses or technologies intended to complement, enhance or expand our current business or products or that might otherwise offer us growth opportunities. Our ability to complete such transactions may be hindered by a number of factors, including potential difficulties in obtaining government approvals.ASML ANNUAL REPORT 200611
Any acquisition that we do make would pose risks related to the integration of the new business or technology with our business. We cannot be certain that we will be able to achieve the benefits we expect from a particular acquisition or investment. Acquisitions may also strain our managerial and operational resources, as the challenge of managing new operations may divert our staff from monitoring and improving operations in our existing business. Our business, financial condition and results of operations may be materially and adversely affected if we fail to coordinate our resources effectively to manage both our existing operations and any businesses we acquire.Our Business and Future Success Depend on Our Ability to Attract and Retain Sufficient, Educated and Skilled EmployeesOur business and future success significantly depends upon our employees, including a large number of highly qualified professionals, as well as our ability to attract and retain employees. Competition for such personnel is intense, and we may not be able to continue to attract and retain such personnel, which could adversely affect our business, financial condition and results of operations.Risks Related to Our Ordinary SharesThe Price of Our Ordinary Shares is Very VolatileThe 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 PowerOur Articles of Association provide that we are subject to the provisions of Netherlands law applicable to large corporations, called “structuurregime”. These provisions have the effect of concentrating control over certain corporate decisions and transactions in the hands of our Supervisory Board. As a result, holders of ordinary shares may have more difficulty in protecting their interests in the face of actions by members of our Supervisory Board than if we were incorporated in the United States.We also have a class of protective cumulative preference shares (the “Preference Shares”) and have granted to “Stichting Preferente Aandelen ASML”, a Netherlands foundation, an option to acquire from us, at their nominal value of EUR 0.02 per share, a number of preference shares equal to the number of ordinary shares outstanding at the time of option exercise. This effectively would dilute by one half the voting power of our outstanding ordinary shares, which may discourage or significantly impede a third party from acquiring a majority of our voting shares.See further Item 6.C. “Board Practices” and Item 10.B. “Memorandum and Articles of Association”.Item 4 Information on the Company" -->
Our Veldhoven headquarters is financed through a special purpose vehicle that is a variable interest entity. See Item 5.E.“Off-Balance Sheet Arrangements” and Note 12 to our consolidated financial statements. All other current capital expenditures are financed internally.Divestitures within continued operations, principally comprising machinery and equipment (more specifically, demonstration systems and training systems), amounted to EUR 5.6 million for 2006, EUR 30.3 million for 2005 and EUR 36.2 million for 2004. See Note 9 to our consolidated financial statements.B. Business Overview" -->
ASML shipped the industry’s first EUV Alpha Demo Tools to research and development institutions located in Albany, New York (United States of America) and Leuven (Belgium), where potential customers can conduct early research and development. The launch of systems for volume applications is planned for 2009.We are also performing research and development on maskless lithography (the mask contains the pattern which is imaged onto the wafer). Maskless lithography is one of the possible solutions for managing increasing mask cost, which is becoming a dominant factor in bringing new semiconductor designs to market for advanced technology nodes. Designs resulting in small quantities of wafers produced, designs with many changes or designs that require a fast time-to-market will particularly benefit from this technology. In December 2004, Micronic Laser Systems AB (“Micronic”) and ASML agreed to a license agreement relating to the development of optical maskless lithography technology for semiconductor manufacturing.ProductsWe develop lithography systems for the semiconductor industry and related technologies. Our product development strategy focuses on the development of product families based on a modular, upgradeable design.Our older PAS 2500 and PAS 5000 systems, which we no longer manufacture but refurbish, are used forg-line and i-line processing of wafers up to 150 millimeters (“mm”) in diameter and are employed in manufacturing environments and in special applications for which design resolutions no more precise than 0.5 microns are required.Our PAS 5500 product family comprises advanced wafer steppers and Step & Scan systems suitable fori-line and deep Ultra Violet (“UV”) processing of wafers up to 200 mm in diameter. In mid-1997, we introduced the PAS 5500 Step & Scan systems with improved resolution and overlay. Since then, we have further developed and expanded this Step & Scan product family. This modular upgradeable design philosophy has been further refined and applied in the design of our most advanced product family, the TWINSCAN platform, which is the basis for our current and next generation Step & Scan systems, producing wafers up to 300 mm in diameter and capable of extending shrink technology beyond 45 nm.For processing of 200 mm wafers using step-and-scan technology, the PAS 5500 series is the most suitable product range. We offer PAS 5500 systems based oni-line (using light with a 365-nmwavelength), KrF (using light with a248-nm wavelength) and ArF (using light with a 193-nm wavelength) technology. For 200 mm high end applications we also offer TWINSCAN ArF tools.For processing of 300 mm wafers, we offer TWINSCAN systems based on i-line, KrF and ArF technology. In 2003, we introduced the second generation of TWINSCAN systems based on the XT body with a reduced footprint and a 50 percent reduction in the main production area occupied by our system. In 2004, we shipped our first lithography systems based on immersion technology. These shipments marked the delivery of the industry’s first high productivity immersion scanners for production applications. We are the leader in the innovation of immersion technologies and we were the world’s first producer of dual-stage design (TWINSCAN) systems. Wafer measurement, including focus and alignment, is completed on the dry stage, while the imaging process, using water applied between the wafer and the lens, is completed on the wet stage. The dual-stage advantage of TWINSCAN systems enables our customers to gain the process enhancements of immersion and to continue with familiar and proven metrology technology.In July 2005, we announced the TWINSCAN XT:1700i, a 193-nm immersion scanner capable of imaging at the45-nm node in volume production environments. This new system has an NA of 1.2, which is substantially higher than the XT:1400 with an NA of 0.93, exceeding the previously perceived, pre-immersion barrier of 1.0. We started volume production of this system in the second quarter of 2006. The XT:1700i allows chipmakers to improve resolution by 30 percent. We believe this new system increases the value of each wafer since better resolution will likely result in more chips being produced per wafer or more functionality per chip. Additionally, we believe the XT:1700i has the highest throughput currently available, 122 wafers per hour, for the 45-nm node.In July 2006, we announced plans to introduce a next generation immersion system the XT:1900i which set a new industry benchmark of 1.35 NA, which we believe is close to the practical limit for water-based immersion technology. This new system extends optical lithography for volume production to 40 nm and below. ASML expects to begin shipping the XT:1900i by mid 2007.We also continually develop and sell a range of product options and enhancements designed to increase productivity, imaging and overlay to optimize value of ownership over the entire life of our systems. The table below sets forth our current product portfolio of Steppers and Scan & Step Systems by resolution and wavelength.ASML ANNUAL REPORT 200614
Current ASML Lithography product portfolio of Steppers and Step & Scan Systems1
Value sourcing is intended to align the performance of our suppliers with our requirements on quality, logistics, technology and total costs.Zeiss is our sole external supplier of main optical systems and one of the suppliers of other components. Total purchased value from Zeiss accounted for between 20 percent and 50 percent of our cost of goods sold, depending on product type. In 2006 approximately 34 percent of our aggregate cost of goods sold was purchased from Zeiss.Zeiss currently is capable of manufacturing a limited number of lenses and optical components for our stepper and scanner systems and is highly dependent on its manufacturing and testing facilities in Oberkochen and Wetzlar, Germany, and its suppliers. From time to time, the number of systems we have been able to produce has been limited by the capacity of Zeiss to provide us with lenses and optical components. During 2006, we were in some cases constrained by the number of lenses that Zeiss could produce.If Zeiss is unable to maintain or increase production levels, we might not be able to respond to customer demand. As a result, our relationships with current and prospective customers could be harmed, which would have a material adverse effect on our business, financial condition and results of operations.Our relationship with Zeiss is structured as a strategic alliance pursuant to several agreements executed in 1997 and later years. These agreements define an exclusive framework for cooperation in all areas of our joint business. The partnership between ASML and Zeiss is focused on continuous improvement of operational excellence.Pursuant to these agreements, ASML and Zeiss will continue their strategic alliance until either party provides at least three years’ notice of its intent to terminate. Although we believe such an outcome is unlikely, if Zeiss were to terminate its relationship with us, or if Zeiss were unable to produce lenses and optical components over a prolonged period, we would effectively cease to be able to conduct our business.In addition to Zeiss, we also rely on other outside vendors for the components and subassemblies used in our systems, each of which is obtained from a single supplier or a limited number of suppliers. Our reliance on a limited group of suppliers involves several risks, including a potential inability to obtain an adequate supply of required components and the risk of untimely delivery of these components and subassemblies. During 2006, we were in some cases constrained by the number of excimer laser illumination systems that we could obtain from Cymer.See Item 3.D. “Risk Factors — The Number of Systems We Can Produce Is Limited by Our Dependence on a Limited Number of Suppliers of Key Components.”Research and DevelopmentThe semiconductor manufacturing industry is subject to rapid technological changes and new product introductions and enhancements. We believe that continued and timely development and introduction of new and enhanced systems are essential for us to maintain our competitive position. To meet this ongoing requirement, we have historically devoted a significant portion of our financial resources to research and development programs and we expect to continue to allocate significant resources to these efforts. In addition, we have established and are currently establishing sophisticated development centers in the Netherlands and the United States of America and Taiwan, respectively. We also work jointly with independent research centers in nano-electronics and nano-technology. Those research centers focus on the next generations of chips and systems.We apply for subsidy payments in connection with specific development projects under programs sponsored by the Netherlands government, the European Union, the United States and Taiwanese government. Amounts received under these programs generally are not required to be repaid. See our discussions of research and development in Item 5 “Operating and Financial Review and Prospects”, and Note 1 to our consolidated financial statements.We invested EUR 414 million on research and development in continuing operations in 2006, compared to EUR 348 million in 2005 and EUR 353 million in 2004 (including a charge of EUR 49 million with respect to a cross-license agreement entered into between ASML and Nikon). We are also involved in joint research and development programs with both public and private partnerships and consortiums, involving independent research centers, leading chip manufacturers and governmental programs. We aim to own or license, our jointly developed technology and designs of critical components.In 2006, our research and development efforts propelled further development of the TWINSCAN platform along with several leading edge technologies, including 248 nm, 193 nm, immersion and EUV. These efforts enabled us to ship the first EUV system to research and development institutions in 2006, a milestone achievement. The continuous drive by our customers for cost reductions has led us to significantly increase the commonality of components of the different models of the TWINSCAN platform. Our research and development activities in 2006 have also led to productivity and performance enhancements for our other product families. Moreover, we have continued our research into the feasibility of maskless technology and startedASML ANNUAL REPORT 200616
research on extension of ArF immersion with higher index fluid and optical materials. We also started developing technology to support applications of “double patterning”. Double patterning is a resolution enhancement technique that involves splitting a dense circuit pattern into multiple, less-dense patterns. These simplified patterns are then printed sequentially on a target wafer. In between the exposures, the wafer is removed from the exposure system for additional processing. Double patterning improves the achievable resolution and enables the printing of smaller features.Intellectual PropertyWe rely on intellectual property rights such as patents, copyrights and trade secrets to protect our proprietary technology. We aim to obtain ownership rights on technology developed by or for us or, alternatively, to have appropriate licensing in place with respect to such technology. However, we face the risk that such measures will be inadequate. Intellectual property laws may not sufficiently support our proprietary rights, our patent applications may not be granted and our patents may not be construed as intended. Also, competitors may be able to develop or protect similar technology earlier and independently.Litigation may be necessary in order to enforce our intellectual property rights, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement. Any such litigation may result in substantial costs and diversion of resources, and, if decided unfavorably to us, could have a material adverse effect on our business, financial condition and results of operations. We also may incur substantial licensing or settlement costs where doing so would strengthen or expand our intellectual property rights or limit our exposure to intellectual property claims of third parties.Patent litigation with NikonFrom 2001 through late 2004, we were a party to a series of civil litigations and administrative proceedings in which Nikon alleged ASML’s infringement of Nikon patents relating to photolithography. ASML in turn filed claims against Nikon.Pursuant to agreements executed on December 10, 2004 (effective November 12, 2004), ASML, Zeiss and Nikon agreed to settle all pending worldwide patent litigation between the companies. The settlement included an agreement to dismiss all pending patent litigation between the companies, an exchange of releases, a cross-license of patents related to lithography equipment used to manufacture semiconductor devices and payments to Nikon by ASML and Zeiss. In connection with the settlement, ASML made an initial payment to Nikon of US$ 60 million (approximately EUR 49 million) in 2004, further made payments of US$ 9 million (approximately EUR 8 million) in both 2005 and 2006, and is obligated to make an additional payment to Nikon of US$ 9 million in 2007. Zeiss made an initial payment to Nikon of US$ 40 million (approximately EUR 32 million) in 2004, further made required payments of US$ 6 million (approximately EUR 4 million) in both 2005 and 2006, and is required to make an additional payment to Nikon of US$ 6 million in 2007. See Item 18 “Financial Statements” for a description of the accounting treatment and Item 10.C. “Material Contracts” for a summary of the ASML-Nikon patent Cross-License Agreement and the ASML-Zeiss Sublicense Agreement.Patent litigation with Ultratech Stepper, IncIn May 2000, Ultratech Stepper, Inc. (“Ultratech”) filed a lawsuit against ASML. Ultratech alleges that ASML is infringing Ultratech’s rights under a United States patent in connection with its manufacture and commercialization in the United States of advanced photolithography equipment embodying technology that, in particular, is used in Step & Scan equipment.Ultratech’s patent infringement claims were tried before a jury in Oakland, California, in May and June of 2005. On June 21, 2005 the jury unanimously determined that each of the patent claims that Ultratech had asserted against ASML was invalid, and thus that ASML was not liable for patent infringement, notwithstanding the jury’s finding that each of these claims was infringed by ASML and certain of its customers. The Court entered judgment in favor of ASML following receipt of the jury verdict.Ultratech filed motions with the Court seeking to overturn the jury’s finding that the asserted claims of its patent are invalid or, in the alternative, seeking a new trial. The Court denied each of Ultratech’s motions. Ultratech then filed an appeal with the United States Court of Appeals for the Federal Circuit challenging the finding that the asserted claims of Ultratech’s patent are invalid. Briefing is ongoing in connection with this appeal, and no hearing date has been set yet. In the event the appeals court overturns the jury’s finding that the asserted claims of Ultratech’s patent are invalid and ASML is held to infringe any valid claims of Ultratech’s patent, it could result in a substantial damages award and an injunction that could substantially restrict or prohibit ASML’s sales in the United States, either of which could have a material adverse effect on the Company’s financial position and results of operations.Arbitration with Aviza TechnologyOn December 1, 2006, Aviza Technology (“Aviza”) initiated arbitration proceedings against ASML Holding N.V., ASML U.S., Inc. and various other affiliates and subsidiaries (collectively, the “ASML parties”). Aviza’s arbitration demand alleges that the ASML parties engaged in fraud and made negligent misrepresentations or omissions in connection with a 2002 license agreement between ASML and IPS, Ltd. that was assigned to Aviza in connection with the 2003 divestiture of ASML’s Thermal Division.ASML ANNUAL REPORT 200617
We believe that there are meritorious defenses to Aviza’s allegations, and we intend to vigorously defend ourself in the arbitration proceeding, and accordingly, that the outcome of the proceeding will not have a material adverse effect on our financial position or results of operations. However, there can be no assurance that ASML will prevail, given the inherently uncertain nature of arbitration proceedings. If Aviza were to prevail, it could result in a substantial damages award and have a material adverse effect on our financial position and results of operations.CompetitionThe semiconductor equipment industry is highly competitive. The principal elements of competition in our markets are the technical performance characteristics of a photolithography system and the value of ownership of that system based on its purchase price, maintenance costs, productivity and customer service and support. In addition, we believe that an increasingly important factor affecting our ability to compete is the strength and breadth of our portfolio of patent and other intellectual property rights. We believe that the market for photolithography systems and the investments required to be a significant competitor in this market have resulted in increased competition for market share through the aggressive prosecution of patents. Our competitiveness will increasingly depend upon our ability to protect and defend our patents, as well as our ability to develop new and enhanced semiconductor equipment that is competitively priced and introduced on a timely basis. See Item 3.D. “Risk Factors, We Face Intense Competition.”Government RegulationOur business is subject to direct and indirect regulation in each of the countries in which our customers or we do business. As a result, changes in various types of regulations could affect our business adversely. The implementation of new technological or legal requirements could impact our products, or our manufacturing or distribution processes, and could affect the timing of product introductions, the cost of our production, and products as well as their commercial success. Moreover, environmental and other regulations that adversely affect the pricing of our products could adversely affect our results of operation. The impact of these changes in regulation could adversely affect our business even where the specific regulations do not directly apply to us or to our products.Share Purchase Agreement Brion Technologies, Inc.On December 19, 2006 we announced the intended acquisition of 100 percent of the outstanding shares of Brion Technologies, Inc. (“Brion”). Subject to approval by regulatory authorities, closing is expected in the first quarter of 2007. Pursuant to the sale and purchase agreement, Brion shareholders will receive total consideration of USD 270 million (approximately EUR 203 million) in cash.Brion was incorporated in 2002 and is a leader in the field of computational lithography which encompasses design verification, reticle enhancement technologies and optical proximity correction. Brion designs, develops and markets computational lithography technology enabling semiconductor manufacturers to simulate the realized pattern of integrated circuits and to correct the mask pattern that could compromise the manufacturing process and reduce yield. The software technology behind its products is a hardware accelerated, image-based data and simulation engine which has been designed for the tasks of lithography modeling and database handling.Brion’s largest customers are principally semiconductor manufacturers in Asia, Europe and North America. Brion currently employs approximately 130 employees worldwide which are mainly located in the United States and China.Brion has its headquarter in Santa Clara, California (United States) with subsidiaries in Cayman Islands, Japan and China.C. Organizational Structure" -->
D. Property, Plants and Equipment" -->
Semiconductor equipment industry updateHistorically the semiconductor industry has experienced significant growth largely due to the continual reduction of cost per function performed by ICs. Improvement in the design and manufacture of ICs with higher circuit densities has resulted in smaller and cheaper ICs capable of performing a larger number of functions at higher speeds with lower power consumption. We believe that these long term trends will continue for the foreseeable future and will be accompanied by a continuing demand for production equipment that is capable of accurate production of advanced ICs in high volumes at the lowest possible cost.Lithography equipment is used to imprint complex circuit patterns onto silicon wafers, which are the primary raw materials for ICs. The imprinting process is one of the most critical and expensive steps in wafer fabrication. Lithography equipment is therefore a significant focus of the IC industry’s demand for cost efficient enhancements to production technology.The costs to develop new lithography equipment are high. Accordingly, the lithography equipment industry is characterized by the presence of only a few primary suppliers: ASML, Nikon and Canon. ASML is the world’s leading provider of lithography equipment with a market share based on revenue of 61 percent in 2006 up from 57 percent in 2005 according to the latest available data up to and including November 2006 as reported by SEMI, an independent semiconductor industry organization.Nikon and Canon are the dominant suppliers in the Japanese market-segment, which accounts for a significant portion of worldwide semiconductor production. This market-segment historically has been difficult for non-Japanese companies to penetrate. Since 2004, we have been increasing our service, sales and marketing operations in Japan to serve our growing customer base. In 2006, we further strengthened our long term market development strategy in Japan. Our customer base there grew from 6 customers in 2005 to 8 customers in 2006. In 2006, 7 percent of our net system sales was generated by Japanese customers.Total lithography equipment shipped by the industry as a whole in the five years ended December 31, 2005 is set forth in the following table:
We also intend to expand our business scope as ASML pursues hardware technologies and new product opportunities in fields adjacent to and complementary with our core semiconductor lithography competence.Aggressive investment in research and developmentOur product range for steppers and advanced Step & Scan systems spans all the industry’s current wavelengths for both 200- and300-millimeter wafers.Supported by our financial performance, research and development expenses in 2006 increased by 19 percent compared with 2005, as we accelerated new developments and advanced our development of immersion and EUV technologies. This operating decision was made possible by leveraging our outsourcing strategy, which continues to enable us to rapidly and efficiently adjust our cost structure throughout a cycle while making use of leading edge capabilities in our supply chain.Since 2000, we have offered the industry’s only dual-stage wafer imaging platform — the TWINSCANtmsystem — which allows exposure of one wafer while simultaneously measuring the wafer that will be exposed next. This unique capability translates into the industry’s highest throughput, enabling reduced cost-per-exposure per wafer. In the third quarter of 2006, we shipped our 500th TWINSCAN system, demonstrating the acceptance of the TWINSCAN platform as the semiconductor industry’s standard for 300 mm lithography.In 2006, we expanded our immersion product suite by introducing the industry’s most advanced lithography system, the ASML TWINSCAN XT:1900i. Our innovative immersion lithography replaces the air over the wafer with fluid, enhancing focus and enabling circuit line-width to shrink to even smaller dimensions. The new XT:1900i system extends optical lithography for volume production to 40nm and below. Since the fourth quarter of 2004, we have shipped 36 immersion systems to customers in three continents, marking our continued immersion technological leadership.In December 2006, we announced ASML’s newest TWINSCAN system, the XT:1450, an advanced193-nm exposure tool targeted for high volume manufacturing that extends dry193-nm technology tosub-60-nm. It can also be used by customers to support development of32-nm node processes using double patterning techniques. Double patterning represents a bridge between current lithography technology and next generation extreme ultra violet (EUV) technology.In parallel, we are developing EUV technology. In the third quarter of 2006, we shipped the industry’s first EUV Alpha Demo Tools to research and development institutions located in Albany, New York (United States) and Leuven (Belgium) where potential customers can conduct early stage research and development.Operational excellenceWe strive to sustain our business success based on our technological leadership by continuing to execute well on our fundamental operating strategy, including reduction in lead time while improving our cost competitiveness. Lead time is the time from a customer’s order to a tool’s delivery.Our business strategy includes outsourcing the majority of components and subassemblies that make up our products. We work in partnership with suppliers, collaborating on quality, logistics, technology and total cost. By operating our strategy of value sourcing, we strive to attain flexibility and cost efficiencies from our suppliers through mutual commitment and shared risk and reward. Value sourcing also allows the necessary flexibility to adapt to the cyclicality of the world market for semiconductor lithography systems.We strive to improve efficiencies in our own operations on an ongoing basis: addressing our cost structure and strengthening our capability to generate cash. We have been successful at progressively enhancing the value of ownership of our products while increasing margins and boosting cash generation through gains in manufacturing productivity and reductions in cycle time.In the first quarter of 2006, we expanded our capability to manufacture lithography systems in Veldhoven, the Netherlands, by introducing a flexible labor model. It reinforces our ability to adapt more quickly to semiconductor market cycles, including support for potential 24-hour, seven days-a-week production activities. By maximizing the flexibility of our high tech work force in manufacturing facilities located in Veldhoven, we can shorten lead time: a key driver of added value for customers. It also reduces our working capital requirements.ASML ANNUAL REPORT 200621
ASML operations update on key performance indicatorsThe 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.
Operating income grew by 94.0 percent from EUR 449 million or 17.8 percent of sales in 2005 to 871 million or 24.2 percent of sales in 2006. This EUR 422 million growth was substantially the result of the increase of gross profit of EUR 488 million or 50.1 percent which was partially offset by an increase in operating expenses of EUR 67 million or 12.6 percent.Gross profit increased compared to 2005, showing a growth of 50.1 percent from EUR 974 million or 38.5 percent of net sales in 2005 to 1,462 million or 40.6 percent of net sales in 2006. The higher gross profit was principally attributable to an increased market demand for lithography equipment with higher ASPs, decreased product costs resulting from our continuous cost of goods reduction programs and increased manufacturing volumes and related absorption partially offset by a change in product mix.Operating expenses were EUR 67 million higher in 2006 compared to 2005 due to an increase of both R&D expenses by 63 million and SG&A expenses by EUR 4 million. The increase in R&D expenses by EUR 63 million or 19.4 percent was mainly related to our decision to further accelerate investments in our technological leadership in a time of strong financial performance. For further details regarding Research and development see also Item 4.B “Business Overview” and Item 5 “Operating and Financial Review and Prospects, Business Strategy”.Net income in 2006 amounted to EUR 625 million, representing EUR 1.32 per share compared with net income of EUR 311 million or EUR 0.64 per share in 2005.LiquidityWe strive to maintain our strategic target level of EUR 1 billion in net cash, which is comprised of total cash and cash equivalents minus convertible subordinated bonds. To the extent that our net cash exceeds EUR 1 billion and there are no alternative investment opportunities, we intend to return excess cash to our shareholders. As of December 31, 2006 our net cash amounted to EUR 1.3 billion.Our net cash decreased from EUR 1,905 million as of December 31, 2005 to EUR 1,656 million as of December 31, 2006. We generated cash from operations of EUR 478 million in 2006 offset by a negative cash flow of EUR 648 million from financing activities mainly as result of our 2006 share buy back programs (EUR 678 million) and EUR 66 million cash used in investing activities mainly related to production facilities, equipment and information technology.A. Operating Results" -->
was recorded that had been previously deferred. As our systems are based largely on two product platforms that permit incremental, modular upgrades, the introduction of genuinely “new” technology occurs infrequently, and has occurred on only one occasion since 1999.A portion of our revenue is derived from contractual arrangements with our customers that have multiple deliverables, such as installation and training services and prepaid service contracts. The revenue relating to the undelivered elements of the arrangements is deferred at fair value until delivery of these elements. The fair value is determined by vendor specific objective evidence (“VSOE”). VSOE is determined based upon the prices that we charge for installation and comparable services (such as relocating a system to another customer site) on a stand-alone basis, which are subject to normal price negotiations. Revenue from installation and training services is recognized when the services are completed. Revenue from prepaid service contracts is recognized over the term of the contract.The deferred revenue balance from installation and training services amounted to approximately EUR 13 million and EUR 27 million, respectively, at December 31, 2006. The deferred revenue balance from prepaid service contracts amounted to approximately EUR 121 million as of December 31, 2006.We offer customers discounts in the normal course of sales negotiations. These discounts are directly deducted from the gross sales price at the moment of revenue recognition. These discounts do not relate to future purchases or trade-ins with the exception of volume discounts. From time to time, we offer volume discounts to a limited number of customers. In some instances these volume discounts can be used to purchase field options. The related amount is recorded as a reduction in revenue at time of shipment. Generally, there are no other credits or adjustments recognized at shipment. From time to time, we offer free or discounted products or services in connection with a current revenue transaction, which are earned by the customer at a future date only if the customer completes a specified cumulative level of revenue transactions. As the value of these free products or services is insignificant in relation to the value of the transactions necessary to earn these free products or services, a liability is recorded for the cost of these free products or services.WarrantyWe provide standard warranty coverage on our systems for 12 months, providing labor and parts necessary to repair systems during the warranty period. The estimated warranty costs are accounted for by accruing these costs for each system upon recognition of the system sale. The estimated warranty costs are based on historical product performance and field expenses. Based upon historical service records, we calculate the charge of average service hours and parts per system to determine the estimated warranty charge. We update these estimated charges periodically. The actual product performance and/or field expense profiles may differ, and in those cases we adjust our warranty reserves accordingly. Future warranty expenses may exceed our estimates, which could lead to an increase in our cost of sales.Evaluation of long-lived assets for impairment and costs associated with exit or disposal activitiesWe evaluate our long-lived assets, including intellectual property, for impairment whenever events or changes in circumstances indicate that the carrying amount of those assets may not be recoverable. If an impairment test is warranted, we assess whether the undiscounted cash flows expected to be generated by our long-lived assets exceed their carrying value. If this assessment indicates that the long-lived assets are impaired, the assets are written down to their fair value. These assessments are based on our judgment, which includes the estimate of future cash flows from long-lived assets and the estimate of the fair value of an asset if it is impaired. In determining impairments of long-lived assets, we must make judgments and estimates to determine whether the cash flows generated by those assets are less than their carrying value. These estimates are based on financial plans updated with the latest available projections of the semiconductor market evolution, our sales expectations and our costs evaluation, and are consistent with the plans and estimates that we use to manage our business. It is possible, however, that the outcome of the plans and estimates used may differ, and future adverse changes in market conditions, may require impairment of certain long-lived assets.During 2006 we recorded impairment charges of EUR 17.4 million of which we recorded EUR 14.1 million in cost of sales, EUR 2.0 million in research and development expenses and EUR 1.3 million in selling, general and administrative costs. The impairment charges recorded in 2006 mainly relate to buildings and construction (EUR 10.2 million) and machinery and equipment (EUR 7.1 million). The impairment charges with respect to buildings and construction mainly relate to a subleased building in Japan for which there are insufficient cash flows to support its carrying amount, mainly as a result of a drop in rental income. This drop is caused by a cancellation of one of the subleases and unfavorable real estate market conditions at the location of our Japan building. The impairment was determined based on the difference between the building’s estimated fair value and its carrying amount. The impairment charges with respect to machinery and equipment mainly relate to development, production and field service tooling which were no longer used because the tools no longer meet the today’s technology requirements. The impairment charges were determined based on the difference between the assets’ estimated fair value and their carrying amount.See Notes 2, 3 and 9 to our consolidated financial statements.ASML ANNUAL REPORT 200624
InventoriesInventories are stated at the lower of cost (first-in, first-out method) or market value. Cost includes net prices paid for materials purchased, charges for freight and customs duties, production labor cost and factory overhead. Inventory provisions are made for slow moving, obsolete or unsaleable inventory and are reviewed on a quarterly basis. Our methodology involves matching our on-hand and on-order inventory with our manufacturing forecast. In determining inventory provisions, we evaluate inventory in excess of our forecasted needs on both technological and economical criteria and make appropriate provisions to reflect the risk of obsolescence. This methodology is significantly affected by our forecasted needs for inventory. If actual demand or usage were to be lower than estimated, additional inventory provisions for excess or obsolete inventory may be required, which could have a material adverse effect on our business, financial condition and results of operations. See Note 6 to our consolidated financial statements.Accounts receivableA majority of our accounts receivable are derived from sales to large multinational semiconductor manufacturers throughout the world. In order to monitor potential credit losses, we perform ongoing credit evaluations of our customers’ financial condition. An allowance for doubtful accounts is maintained for potential credit losses based upon management’s assessment of the expected collectibility of all accounts receivable. The allowance for doubtful accounts is reviewed periodically to assess the adequacy of the allowance. In making this assessment, we take into consideration (i) any circumstances of which we are aware regarding a customer’s inability to meet its financial obligations; and (ii) our judgments as to potential prevailing economic conditions in the industry and their potential impact on the Company’s customers. Where we deem it prudent to do so, we may require some form of credit enhancement, such as a letter of credit or bank guarantee, before shipping systems to a customer that presents a credit risk. We have not incurred any material accounts receivable credit losses during the past three years. However, we sell a substantial number of systems to a limited number of customers. Our three largest customers accounted for 35 percent of accounts receivable at December 31, 2006, compared to 49 percent at December 31, 2005. An unanticipated business failure of one of our main customers could result in a substantial credit loss in respect to amounts owed to the Company by that customer, which could adversely affect our results of operations and financial condition. See Note 19 to our consolidated financial statements.RestructuringWe apply the criteria defined in SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” and SFAS No. 112, “Employers’ Accounting for Postemployment Benefits,” in order to determine when a liability for restructuring or exit costs should be recognized.With respect to employee termination costs, we apply SFAS No. 146 in the case of benefit arrangements that, in substance, do not constitute an ongoing benefit arrangement. We apply SFAS No. 112 for termination benefits that are provided under an ongoing benefit arrangement. SFAS No. 146 provides that a liability for a cost associated with an exit or disposal activity that does not constitute an ongoing benefit arrangement shall be recognized and measured initially at its fair value in the period in which the liability is incurred; that is when a detailed exit or disposal plan exists, has been committed to by management and has been communicated to the employees. SFAS No. 112 provides that a liability for termination benefits provided under an ongoing benefit arrangement covered by SFAS No. 112 shall be recognized when the likelihood of future settlement is probable and can be reasonably estimated. As a result, whether an employee termination plan constitutes an ongoing benefit arrangement or not, and accordingly, whether SFAS No. 146 or SFAS No. 112 is applied, will affect the timing of recognition of employee termination costs, as well as the amounts recognized. In 2003, we announced workforce reductions of approximately 550 positions worldwide due to the continuing downturn in the semiconductor equipment industry. During 2003, we recorded a provision of EUR 15.3 million as an ongoing benefit arrangement. The amount of the provision was based upon severance arrangements agreed with our Works Council in the Netherlands for the previous workforce reductions announced in December 2002. Our Board of Management and our Works Council then commenced a joint study on implementing these workforce reductions in the Netherlands, which delayed the workforce reductions until the beginning of 2004. Thereafter, in response to a sharp improvement in market conditions during 2004, we decreased the reductions to approximately 300 positions worldwide, of which 150 were contract employees with limited rights upon termination. As a result, in 2004 we recorded a restructuring credit of EUR 12.1 million, EUR 3.8 million of which was recorded in cost of sales and EUR 8.3 million of which was recorded under restructuring expenses.Other exit costs include purchase and other commitments to be settled or fulfilled. These costs are estimated based on expected settlement fees and committed payments, taking into account future potential benefits, if any, from those commitments. We apply the criteria defined in SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” and SFAS No. 112, “Employers’ Accounting for Postemployment Benefits,” in order to determine when a liability for restructuring or exit costs should be recognized.Contingencies and litigationWe are party to various legal proceedings generally incidental to our business, as disclosed in Note 14 to the consolidated statements. In connection with these proceedings and claims, our management evaluated, based on the relevant facts and legalASML ANNUAL REPORT 200625
principles, the likelihood of an unfavorable outcome and whether the amount of the loss could be reasonably estimated. In each case, management determined that either a loss was not probable or was not reasonably estimable. As a result, no estimated losses were recorded as a charge to our statement of operations in 2004, 2005 and 2006. Significant subjective judgments were required in these evaluations, including judgments regarding the validity of asserted claims and the likely outcome of legal and administrative proceedings. The outcome of these proceedings, however, is subject to a number of factors beyond our control, most notably the uncertainty associated with predicting decisions by courts and administrative agencies. In addition, estimates of the potential costs associated with legal and administrative proceedings frequently cannot be subjected to any sensitivity analysis, as damage estimates or settlement offers by claimants may bear little or no relation to the eventual outcome. Finally, in any particular proceeding, we may agree to settle or to terminate a claim or proceeding in which it believes it would ultimately prevail where we believe that doing so, when taken together with other relevant commercial considerations, is more cost-effective than engaging in an expensive and protracted litigation, the outcome of which is uncertain. Such a decision occurred when we determined to enter into a cross-license agreement as an alternative to continuing our intellectual property dispute with Nikon. See Item 10.C. “Material Contracts” for a summary of the Nikon-ASML Cross License Agreement and the ASML/ Zeiss Sublicense Agreement and Item 18 “Financial Statements”.We accrue for legal costs related to litigation in our statement of operations at the time when the related legal services are actually provided to us.Share-based compensation expensesOn January 1, 2006, we implemented the provisions of SFAS No. 123(R), “Share-Based Payment”, using the modified prospective transition method. SFAS No.123(R) requires companies to recognize the cost of employee services received (compensation expenses) in exchange for awards of equity instruments based upon the grant-date fair value of those instruments. The grant-date fair value of these instruments was estimated using a Black-Scholes option valuation model. This Black-Scholes pricing model requires the use of assumptions, including expected stock price volatility and the estimated life of each award. The risk-free interest rate used in the model is determined, based on a Euro government bond with a life equal to the expected life of the equity-settled share-based payments. Our income before income taxes and net income was negatively impacted with EUR 8.8 million and EUR 7.4 million respectively due to the adoption of SFAS No. 123(R).Using the modified prospective transition method, we began recognizing compensation expenses for equity-based awards granted, modified, repurchased, or cancelled after the required effective date of January 1, 2006. Additionally, compensation expenses for the portion of equity-based awards for which the requisite service has not been rendered and that are outstanding as of January 1, 2006 are also recognized as the requisite service is rendered on or after that date. Compensation expenses are then amortized on a straight-line basis over the requisite service period of the awards, which is generally the vesting period. The total gross amount of recognized expenses associated with share based payments was EUR 9.7 million in 2006.Under the modified prospective transition method, no restatement of prior interim periods and fiscal years has been made. Prior to January 1, 2006, we measured compensation expenses for our stock option plans using the intrinsic value method under APB 25 “Accounting for Stock Issued to Employees” and related interpretations. As the exercise price of all stock options granted under these plans was not below the fair market price of the underlying common stock on the grant date, no compensation expenses were recognized in the consolidated statements of operations.The grant-date fair value for awards for which the requisite service has not been rendered and that are outstanding as of January 1, 2006 is based on the grant-date fair value of those awards as calculated under SFAS No.123, “Accounting for Stock-Based Compensation” for pro forma disclosures under the assumption of historical volatility. Since January 1, 2006 we are adopting implied volatility of our actively-traded options for new issued stock options as one of the assumptions in the Black-Scholes pricing model. As the semiconductor industry is becoming more mature, resulting in a decreasing cyclicality, we believe that implied volatility is currently a better assumption for the valuation model than historical volatility.We make quarterly assessments of the adequacy of the (hypothetical) tax pool to determine whether there are tax deficiencies that require recognition in the consolidated statements of operations. We have selected the alternative transition method (under FSP FAS 123(R)-3) in order to calculate the tax pool.We did not modify outstanding stock option plans in anticipation of the adoption of SFAS No.123(R). Our current stock option plans do not provide for cash settlement of options.See Note 1 to our consolidated financial statements.Income taxWe operate in various tax jurisdictions in the United States, Europe and Asia and must comply with the tax laws of each of these jurisdictions.ASML ANNUAL REPORT 200626
We use the asset and liability method in accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for tax consequences attributable to differences between the balance sheet carrying amounts of existing assets and liabilities and their respective tax bases. Furthermore tax assets are recognized for the tax effect of incurred net operating losses. If it is more likely than not that the carrying amounts of deferred tax assets will not be realized, a valuation allowance will be recorded to reduce the carrying amounts of those assets.We assess our ability to realize our deferred tax assets resulting from net operating loss carry-forwards on an ongoing basis. The total amount of loss carry-forwards as of December 31, 2006 was EUR 276 million, which resides completely with ASML US, Inc. We believe that it is more likely than not that all losses will be offset by future taxable income before our ability to utilize those losses expires. This analysis takes into account our projected future taxable income from operations, possible tax planning alternatives available to us, and a realignment of group assets that we affected during the period 2001 through 2003 that included the transfer of certain tangible and intangible assets of ASML US, Inc. to ASML Netherlands B.V. The value of the assets transferred is expected to result in additional income to ASML US, Inc., which we believe, together with projected future taxable income from operations, will, more likely than not, be sufficient to absorb the net operating losses that ASML US, Inc. has incurred, prior to the expiry of those losses. In order to determine with certainty the tax consequences and value of this asset transfer, in 2002 we requested a bilateral advance pricing agreement (“APA”) from the United States and Netherlands tax authorities. Since December 2002, management has held numerous meetings with representatives of those authorities. The most recent meetings with the United States and Netherlands tax authorities took place in June and July 2006. Based on these meetings, and feedback from both authorities, we are confident that our APA request will be successful. The specific timing for completion of the APA however remains in the control of those tax authorities. See Note 15 to our consolidated financial statements.The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws. Our estimate for the potential outcome of any uncertain tax issue is highly judgmental. However, we believe that we have adequately reserved for tax contingencies. Settlement of these uncertainties in a manner inconsistent with our expectations could have a material impact on our results of operations, financial condition and cash flows. We account for the income tax contingencies in accordance with SFAS No. 5, “Accounting for Contingencies”. The tax contingencies mainly relate to transfer pricing positions, operational activities in countries where we are not tax registered and tax deductible costs. We provide for these tax contingencies for the duration of the statue of limitation which differs per tax jurisdiction and generally ranges up to 7 years. As of December 31, 2006 the tax contingencies amount to EUR 130.7 million (December 31, 2005: EUR 127.9 million) and are included in Deferred tax and other liabilities on the consolidated balance sheets.Results of OperationsThe following discussion and analysis of results of operations should be viewed in the context of the risks affecting our business strategy, described in Item 3.D. “Risk Factors.”Set forth below are our consolidated statements of operations data for the three years ended December 31, 2006 (in thousands):
Set forth below are our consolidated statements of operations from continuing operations data for the three years ended December 31, 2006, expressed as a percentage of our total net sales:
From time to time, ASML repurchases systems that it has manufactured and sold and, following factory-rebuild or refurbishment, resells those systems to other customers. This repurchase decision is mainly driven by market demand for capacity expressed by other customers and not by explicit or implicit contractual arrangements relating to the initial sale. The number of used systems sold in 2006 increased to 46 from 40 in 2005, reflecting increased demand for older systems to produce less complex ICs. The ASP for used systems increased from EUR 2.9 million in 2005 to EUR 3.2 million in 2006, reflecting a further shift from our older PAS 2500 towards our newer PAS 5500 family and TWINSCAN family.Net service and field option sales showed a 22.3 percent increase from EUR 301 million in 2005 to EUR 368 million in 2006, resulting from increased service as well as field option sales. The increase in service sales was mainly driven by the growth of our system installed base at customers. The growth of field option sales is positively impacted by the availability and customer demand for system upgrade packages that further enhance system performance.Of the top 20 chipmakers worldwide, in terms of semiconductor capital expenditures, 16 are customers of ASML. In 2006, sales to one customer accounted for EUR 730 million, or 20 percent of our net sales. In 2005, sales to one customer accounted for EUR 609 million, or 24 percent of our net sales.Gross profit increased compared to 2005, showing a growth of 50.1 percent from EUR 974 million or 38.5 percent of net sales in 2005 to 1,462 million or 40.6 percent of net sales in 2006. The increased gross margin was positively impacted by decreased cost of goods (5.2 percent positive impact on gross profit) reflecting the results of our continuous cost of goods reduction program, partly offset by a change in the product mix (2.1 percent negative impact on gross profit) and slightly decreased prices (0.8 percent negative impact on gross profit). The positive impact on gross profit of the higher production volumes (0.6 percent) and currency effects (0.4 percent) was offset by the negative impact on gross profit of the higher cost for obsolete inventories (0.4 percent) and the higher costs for lens swaps (0.9 percent).We started 2005 with an order backlog of 95 systems. In 2006, we booked orders for 347 systems, received order cancellations or push-outs beyond 12 months of 13 systems and recognized sales for 266 systems. This resulted in an order backlog of 163 systems as of December 31, 2006. The total value of our backlog as of December 31, 2006 amounted to EUR 2.1 billion, compared with a backlog of approximately EUR 1.4 billion as of December 31, 2005. See also Item 5.D. “Trend Information.”Research and developmentResearch and development costs increased by 19.0 percent from EUR 348 million in 2005 to EUR 414 million in 2006. We further accelerated our investment in technology leadership in 2006 through the investments in the newest versions of our high resolution TWINSCAN systems and enhancements of the next generation TWINSCAN systems based on immersion, double patterning, EUV and the development of optical mask less lithography. In the second quarter of 2006 we shipped the first XT:1700i and the third quarter we introduced the XT:1900i, both enhanced immersion systems. Also in the second quarter of 2006, we shipped the industry’s first EUV Alpha Demo Tools to two research and development institutions.Research and development credits increased from EUR 24 million in 2005 to EUR 28 million in 2006 due to an increased volume of research and development projects that qualified for credits under governmental funding programs.Selling, general and administrative costsSelling, general and administrative costs increased by only 2 percent from EUR 201 million in 2005 to EUR 205 million in 2006 while sales grew by 42 percent. Cost reduction and efficiency programs contributed to maintaining a near constant level of selling, general and administrative costs.Net interest expenseNet interest expense decreased from EUR 14 million in 2005 to EUR 1 million in 2006 due to decreased interest expenses and increased interest income. Interest expense mainly relate to our convertible subordinated notes, which had lower average balances in 2006 mainly due to the conversion of the USD 575 million 5.75 percent convertible notes which were due October 15, 2006. Our interest income relates primarily to interest earned on our cash and cash equivalents. Our interest income increased in 2006 mainly as a result of higher short term interest rates.ASML ANNUAL REPORT 200629
Income taxesIncome taxes represented 28.2 percent of income before taxes in 2006, compared to 28.4 percent in 2005. The decrease in income taxes in 2006 is mainly related to a corporate tax rate reduction in the Netherlands.Results of operations from continuing operations 2005 compared with 2004Consolidated sales and gross profitThe following table sets forth a summary of sales (by revenue and units sold), gross profit on sales and ASP data on an annual and semi-annual basis for the years ended December 31, 2005 and 2004.
December 31, 2005 amounted to EUR 1.4 billion, compared with a backlog of approximately EUR 1.7 billion as of December 31, 2004.Research and developmentResearch and development costs decreased from EUR 353 million in 2004 to EUR 348 million in 2005. This decrease in research and development costs is primarily due to a charge in 2004 of EUR 49 million with respect to a cross-license agreement entered into with Nikon (see Note 8 to our consolidated financial statements for more information). Excluding this one-time charge in 2004 there was an increase in research and development spending in 2005 of 15 percent intended to further accelerate our investment in technological leadership. Our primary investments in research and development in 2005 related to the newest versions of our high resolution TWINSCAN systems and our next generation TWINSCAN systems based on immersion and EUV.Research and development credits increased from EUR 22 million in 2004 to EUR 24 million in 2005 due to an increased volume of research and development projects that qualified for credits under governmental funding programs.Selling, general and administrative costsSelling, general and administrative costs remained stable on a level of approximately EUR 201 million for both 2004 and 2005. Selling, general and administrative costs as a percentage of net sales decreased from 8.2 percent in 2004 to 8.0 percent in 2005, primarily due to higher net sales.Restructuring costs (credits)Restructuring credits of EUR 6 million in 2004 are adjustments to the 2003 restructuring plans. In 2005 we did not record any restructuring expenses or credits.Net interest expenseNet interest expense decreased from EUR 16 million in 2004 to EUR 14 million in 2005 due to an increase in interest income, partially offset by an increase in interest expense. Our interest income related primarily to interest earned on our cash and cash equivalents, which had higher balances in 2005 as a result of an increase in cash flows from operations. Our interest expense related primarily to our convertible subordinated notes.Income taxesIncome taxes represented 28.4 percent of income before taxes in 2005, compared to 35.1 percent in 2004. The decrease in income taxes in 2005 is mainly related to a corporate tax rate reduction in the Netherlands.Foreign Exchange ManagementSee Item 3.D. “Risk Factors, Fluctuations in Foreign Exchange Rates Could Harm Our Results of Operations”, Item 11 “Quantitative and Qualitative Disclosures About Market Risk” and Note 4 to our consolidated financial statements.New U.S. GAAP Accounting PronouncementsIn February 2006, the FASB issued FSP FAS 123R-4, “Classification of Options and Similar Instruments Issued as Employee Compensation That Allow for Cash Settlement Upon the Occurrence of a Contingent Event”. SFAS No. 123 (R) originally required liability classification for options or similar instruments if the entity can be required under any circumstances to settle the options or similar instruments by transferring cash or other assets. This FSP clarifies that equity classification is appropriate, if the occurrence of a contingent event that could require a cash settlement feature is not probable. If the contingent event is within the control of the employee, liability classification is required regardless of the probability. An option or similar instrument that is classified as equity, but subsequently becomes a liability because the contingent cash settlement event is considered probable, shall be accounted for similar to a modification from an equity to liability award. The guidance in this FSP shall be applied upon initial adoption of Statement 123 (R) on January 1, 2006. In 2006, the impact of this FSP was insignificant on our consolidated financial statements.In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments”. This Statement amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” and SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” and permits, among other things, fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation. SFAS No. 155 has to be adopted for all financial instruments acquired, issued, or subject to a remeasurement (new basis) event occurring after the beginning of an entity’s first fiscal year that begins after September 15, 2006. We do not expect that the adoption of SFAS No. 155 will have a material impact on our consolidated financial statements.In June 2006, the FASB issued Interpretation 48, “Accounting for Uncertainty in Income Taxes”. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109,ASML ANNUAL REPORT 200631
“Accounting for Income Taxes”. FIN 48 prescribes a two step approach for recognizing and measuring tax positions taken or expected to be taken in tax return(s). Prior to recognizing the benefit of a tax position in the financial statements, the tax position must be more-likely-than-not to be sustained based solely on its technical merits. Once this recognition threshold has been met, tax positions are recognized at the largest amount that is more-likely-than-not to be sustained. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 will be effective for fiscal years beginning after December 15, 2006. Any differences between the amounts recognized in the financial statements prior to the adoption of FIN 48 and the amounts reported after adoption will be accounted for as a cumulative-effect adjustment recorded to the beginning balance of retained earnings. We are currently in the process of determining the impact of adopting the provisions of Interpretation 48 on our consolidated financial statements.In June 2006, the FASB ratified the consensus reached by the EITF on Issue No. 06-03,“How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation)”. EITF No. 06-03 permits registrants to elect to present vendor taxes imposed concurrently on a specific revenue-producing transaction between a seller and a customer on either a gross or net basis. The scope of EITF No. 06-03 includes government assessed taxes that are directly imposed on revenue-producing transactions between a seller and a customer and may include, but is not limited to, sales, use, value added and some excise taxes. Registrants are to be required to disclose their policies for presenting the taxes and would disclose any amounts presented on a gross basis. EITF No. 06-03 will be effective for interim and annual financial statements issued for periods beginning after December 15, 2006. We believe that the adoption of EITF No. 06-03 will have no material impact on our consolidated financial statements.The SEC issued Staff Accounting Bulletin No. 108 (“SAB 108”) regarding the process of quantifying financial statement misstatements on September 13, 2006. SAB 108 states that registrants should use both a balance sheet (iron curtain) approach and an income statement (rollover) approach when quantifying and evaluating the materiality of a (prior year) misstatement. The bulletin furthermore contains guidance on correcting errors. The bulletin is effective for financial statements for fiscal years ending after November 15, 2006. We adopted SAB 108 in 2006. SAB 108 did not have a material impact on our (previous) consolidated financial statements.The FASB issued SFAS No. 157, “Fair Value Measurements” on September 15, 2006. The Statement defines fair value, provides guidance on how to measure assets and liabilities using fair value and expands disclosures about fair value measurements. The Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007 and should be applied prospectively (with a limited form of retrospective application) as of the beginning of the fiscal year in which the Statement is initially applied. We do not believe that the adoption of SFAS No. 157 will have a material impact on our consolidated financial statements.B. Liquidity and Capital Resources" -->
economies and the semiconductor industries. Although our cash requirements will fluctuate based on the timing and extent of these factors, we believe that cash generated from operations, together with the liquidity provided by existing cash balances, are sufficient to satisfy our present requirements.We expect to steadily improve our cash conversion cycle during 2007 although we expect substantial cash outflow from operations due to income taxes and from investing activities due to our intended acquisition of Brion and other capital expenditures. We expect an increase in cash outflow in 2007 with respect to income taxes as our tax losses carried forward in the Netherlands were substantially utilized at the end of 2006. In addition, we intend to acquire 100 percent of the outstanding shares of Brion subject to approval by regulatory authorities, for a total consideration of USD 270 million (approximately EUR 203 million) in cash. Other capital expenditures in 2007 are expected to be approximately EUR 250 million, up EUR 150 million above the level in 2006. A significant part of the additional 2007 capital expenditures will be allocated to construction and upgrades of production facilities in the Netherlands. See also Item 4.D.“Property, Plants and Equipment”.We intend to execute a program to buy back the remaining 1.7 percent of a maximum of 10 percent of outstanding ordinary shares as authorized by the Annual General Meeting of Shareholders on March 23, 2006. These shares will either be used to cover outstanding stock options or be cancelled.We reiterate our commitment to return excess cash to our shareholders by reducing the number of shares outstanding: we will prepare for additional potential share buyback programs to be executed, subject to authorization by the Annual General Meeting of Shareholders on March 28, 2007.We have repayment obligations in 2010, amounting to EUR 380 million, on our 5.50 percent Convertible Subordinated Notes due 2010 issued in May 2003, assuming no conversions occur. These notes are convertible into an aggregate of 26,573,426 ordinary shares at a conversion price of EUR 14.30 per share at any time prior to maturity. We currently intend to fund any future repayment obligations under our convertible notes primarily with cash on hand and cash generated through operations. A description of our convertible notes, lines of credit and borrowing arrangements is provided in Note 11 to our consolidated financial statements. See also Item 3.D. “Risk Factors.”Our contractual obligations and commercial commitments are disclosed in further detail in Item 5.F. “Tabular Disclosure of Contractual Obligations” and Note 12 to our consolidated financial statements.See Notes 4 and 11 to our consolidated financial statements for discussion of our funding, treasury policies and currencies in which cash and cash equivalents are held and convertible notes and other borrowing arrangements.C. Research and Development, Patents and Licenses" -->
Financial outlookThe following table sets forth our backlog of systems as of December 31, 2005 and 2006.
ASML’s maximum exposure to the lessor’s expected losses is estimated to be approximately EUR 5.4 million.Purchase ObligationsWe enter into purchase commitments with vendors in the ordinary course of business to ensure a smooth and continuous supply chain for key components. Purchase obligations include medium to long-term purchase agreements. These contracts differ and may include certain restrictive clauses. Any identified losses that result from purchase commitments that are forfeited are provided for in our financial statements. As of December 31, 2006, we had purchase commitments for a total amount of approximately EUR 995 million, compared to EUR 676 million as of December 31, 2005, reflecting our increased backlog level at the end of 2006. In our negotiations with suppliers we continuously seek to align our purchase commitments with our business objectives. See also Item 5.F. “Tabular Disclosure of Contractual Obligations.”Other Off-Balance Sheet ArrangementsWe have certain additional commitments and contingencies that are not recorded on our balance sheet but may result in future cash requirements.We provide guarantees to third parties in connection with transactions entered into in the ordinary course of business from time to time.Intended acquisition BrionWe intend to acquire 100 percent of the outstanding shares of Brion, subject to approval by regulatory authorities, for a total consideration of USD 270 million (approximately EUR 203 million) in cash.F. Tabular Disclosure of Contractual Obligations" -->
Item 6 Directors, Senior Management and Employees" -->
currently serves as a member of the Supervisory Board of Rodamco Europe N.V. and is also Vice-Chairman of the Board of the Association Aegon.Fritz W. FröhlichMr. Fröhlich was appointed to our Supervisory Board in March 2004. He is the former Deputy Chairman and Chief Financial Officer of Akzo Nobel N.V. Mr. Fröhlich is the Chairman of the Supervisory Boards of Randstad Holding N.V. and Draka Holding N.V. and serves as a member of the Supervisory Boards of Allianz Nederland N.V. and Gamma Holding N.V.Arthur P.M. van der PoelMr. Van der Poel was appointed to our Supervisory Board in March 2004. Until 2001 he was the Chief Executive Officer of Philips Semiconductors. Mr. Van der Poel is a former member of the Board of Management (until April 2003) and a former member of the Group Management Committee of Royal Philips Electronics. Mr. Van der Poel is the chairman of the Board of MEDEA+, a member of the Board of Directors of Gemalto Holding N.V., a director of the Public Utility Fund (PUF-NRE) and serves as a member of the Supervisory Boards of PSV N.V. and DHV Holding B.V.Ieke C.J. van den BurgMs. Van den Burg was appointed to our Supervisory Board in March 2005. She is a former member of the Dutch Social and Economic Council and of the EU Economic and Social Committee. Ms. Van den Burg also held various positions in Dutch and international trade union and labor organizations. Ms. Van den Burg has been a member of the European Parliament (“EP”) since 1999 and has served on the EP’s Committee on Economic and Monetary Affairs since 1999 and on the Committee on the Internal Market and Customer Protection since 2004.OB BilousMr. Bilous was appointed to our Supervisory Board in March 2005. From 1960 until 2000 Mr. Bilous held various management positions at IBM, including General Manager and VP Worldwide Manufacturing of IBM’s Microelectronics Division. He also served on the Boards of SMST, ALTIS Semiconductor and Dominion Semiconductor. Mr. Bilous currently serves as Chairman of the Board of Directors of International Sematech and as Board member of Nantero, Inc.Eric MeuriceMr. Meurice joined ASML on October 1, 2004 as President, Chief Executive Officer and Chairman of the Board of Management. Prior to joining ASML, and since March 2001, he was Executive Vice President — Thomson Television Worldwide. Between 1995 and 2001, Mr. Meurice served as Vice President for Dell Computer, where he ran the Western, Eastern Europe and Dell’s Emerging Markets business within EMEA. Before 1995, he gained extensive technology experience in the semiconductor industry at ITT Semiconductors Group and Intel Corporation, in the micro-controller group. Mr. Meurice is currently a member of the Board of Directors of Verigy Inc.Peter T.F.M. WenninkMr. Wennink was appointed as Executive Vice President and Chief Financial Officer of ASML in 1999. Mr. Wennink has an extensive background in finance and accounting. Prior to his employment with ASML, Mr. Wennink worked as a partner at Deloitte Accountants, specializing in the high technology industry with an emphasis on the semiconductor equipment industry. Mr. Wennink is a member of the Netherlands Institute of Registered Accountants. Mr. Wennink is currently a member of the Supervisory Board of Bank Insinger de Beaufort N.V.Martin A. van den BrinkMr. Van den Brink was appointed as Executive Vice President Marketing & Technology in 1999. Before that, he served as Vice President Technology since 1995. Mr. Van den Brink was appointed as a member of our Board of Management in July 1999.Klaus P. FuchsMr. Fuchs was appointed as Executive Vice President Operations in 2006. Since 2003, Mr. Fuchs has served as Vice President of Linde AG in Wiesbaden, Germany where he was responsible for strategic direction and operations of its industrial sector. Before that he was technical director and member of the executive board at TRW Aerospace and he also gained experience at Daimler Benz Aerospace as Vice President of electronic systems.ASML ANNUAL REPORT 200637
B. Compensation" -->
Members of the Supervisory Board are appointed by the General Meeting of Shareholders from nominations of the Supervisory Board. Nominations must be reasoned and must be made available to the General Meeting of Shareholders and the Works Council simultaneously. Before the Supervisory Board presents its nominations, both the General Meeting of Shareholders and the Works Council may make recommendations (which the Supervisory Board may reject). In addition, the Works Council has an enhanced right to make recommendations for nomination of at least one-third of the members of the Supervisory Board, which recommendation may only be rejected by the Supervisory Board: (i) if the relevant person is unsuitable or (ii) if the Supervisory Board would not be duly composed if the recommended person were appointed as a Supervisory Board member. If no agreement can be reached between the Supervisory Board and the Works Council on these recommendations, the Supervisory Board may request the Enterprise Chamber of the Amsterdam Court to declare its objection legitimate. Any decision of the Enterprise Chamber on this matter is non-appealable.Nominations of the Supervisory Board may be overruled by the General Meeting of Shareholders by an absolute majority of the votes representing at least one third of the total outstanding capital. If the votes cast in favour of such resolution do not represent at least one third of the total outstanding capital, a new meeting can be convened at which the nomination can be overruled by an absolute majority. If a nomination is overruled, the Supervisory Board must make a new nomination. If a nomination is not overruled and the General Meeting of Shareholders do not appoint the nominated person, the Supervisory Board will appoint the nominated person.Members of the Supervisory Board serve for a maximum term of four years from the date of their appointment, or a shorter period as set forth in the rotation schedule as adopted by the Supervisory Board, and may be re-appointed, provided that their entire term of office does not exceed twelve years. The General Meeting of Shareholders may, by an absolute majority of the votes representing at least one-third of the total outstanding capital, dismiss the Supervisory Board in its entirety for lack of confidence. In such event, the Enterprise Chamber of the Amsterdam Court shall appoint one or more members of the Supervisory Board at the request of the Board of Management.Upon the proposal of the Supervisory Board, the General Meeting of Shareholders determines the remuneration of the members of the Supervisory Board. A member of the Supervisory Board shall not be granted any shares or option rights by way of remuneration.Approval of Board of Management DecisionsThe Board of Management requires prior approval of the General Meeting of Shareholders for resolutions concerning an important change in the identity or character of ASML or its business, including in any case:• a transfer of all or substantially all of the business of ASML to a third party;• entering into or the termination of a long-term joint venture between ASML and a third party, if this joint venture is material to ASML; and• an acquisition or divestment by ASML of an interest in the capital of a company with a value of at least one third of ASML’s assets (determined by reference to ASML’s most recently adopted annual accounts).Rules of ProcedureThe Board of Management and the Supervisory Board have adopted Rules of Procedure for each of the Board of Management, Supervisory Board and the four Committees of the Supervisory Board. These Rules of Procedure are posted on ASML’s website.Directors and Officers Insurance and IndemnificationMembers of the Board of Management and Supervisory Board, as well as certain senior management members, are insured under the ASML’s Directors and Officers Insurance Policy. Although the insurance policy provides for a wide coverage, our directors and officers may incur uninsured liabilities. ASML has indemnified its Board of Management and Supervisory Board against any claims arising in connection with their position as director and officer of the Company, provided that such claim is not attributable to willful misconduct or intentional recklessness of such officer or director.Corporate Governance DevelopmentsASML continuously monitors and assesses applicable corporate governance rules, including recommendations and initiatives regarding principles of corporate governance. These include rules that have been promulgated in the United States both by the NASDAQ Global Select Market (“Nasdaq”) and by the SEC pursuant to the Sarbanes-Oxley Act of 2002.The Netherlands Corporate Governance Code (the “Code”) came into effect on January 1, 2004. A full report on ASML’s compliance with the Code is required to be included in a company’s statutory annual report. Netherlands listed companies are required to either comply with the principles and the best practice provisions of the Code, or to explain on which points they deviate from these best practice provisions and why.ASML ANNUAL REPORT 200639
Pursuant to the Code’s recommendations, ASML has included a separate chapter on corporate governance in both its annual reports. The Code contains recommendations with regard to corporate governance, including on the following topics:• strengthening the role of the Supervisory Board and its committees and increasing its independence, quality and expertise;• strengthening the role of the shareholders with respect to control on the functioning of the Board of Management and the Supervisory Board, as well as with respect to nomination and remuneration of members of the Board of Management and with respect to the nomination of members of the Supervisory Board;• facilitating and encouraging shareholders to use their voting power and to actively participate in the General Meeting of Shareholders; and• defining the role of the external auditor vis-à-vis the Supervisory Board as its principal contact.Committees of ASML’s Supervisory BoardThe Supervisory Board has an Audit Committee, a Remuneration Committee, a Selection and Nomination Committee and a Technology and Strategy Committee. Members of these committees are appointed from among the Supervisory Board members.Audit CommitteeASML’s Audit Committee is composed of three members of the Supervisory Board. The current members of our Audit Committee are Fritz Fröhlich (chairman), Henk Bodt and Jan Dekker, each of whom is an independent, non-executive member of the Supervisory Board. The Supervisory Board has determined that Fritz Fröhlich qualifies as the Audit Committee financial expert pursuant to Section 407 of the Sarbanes-Oxley Act of 2002 and the rules promulgated thereunder. Our external auditor, our Chief Executive Officer, our Chief Financial Officer, our Corporate Controller as well as other ASML employees invited by the chairman of the Audit Committee may also attend the meetings of the Audit Committee.The Audit Committee assists the Supervisory Board in:• overseeing the integrity of our financial statements and related non-financial disclosure;• overseeing the qualifications, independence and performance of the external auditor; and• overseeing the integrity of our systems of disclosure controls and procedures and the system of internal controls regarding finance and accounting.The Audit Committee held six meetings in 2006. At these meetings the Audit Committee, reviewed our quarterly earnings announcements and our audited annual consolidated financial statements, discussed the system of internal controls over financial reporting and related audit findings, approved the internal and external audit plan and related audit fees and pre-approved any audit and non-audit services to be rendered by our external auditor.Remuneration CommitteeASML’s Remuneration Committee is composed of three members of the Supervisory Board. The current members of our Remuneration Committee are Jos Westerburgen (chairman), Henk Bodt and Ieke van den Burg. The Remuneration Committee is responsible for the preparation of the remuneration policy for the Board of Management.The Remuneration Committee prepares and the Supervisory Board establishes ASML’s general compensation philosophy for members of the Board of Management, and oversees the development and implementation of compensation programs for members of the Board of Management. The Remuneration Committee reviews and proposes to the Supervisory Board corporate goals and objectives relevant to the compensation of members of the Board of Management. The Committee further evaluates the performance of members of the Board of Management in view of those goals and objectives, and makes recommendations to the Supervisory Board on the compensation levels of the members of the Board of Management based on this evaluation.In proposing to the Supervisory Board the actual remuneration elements and levels applicable to the members of the Board of Management, the Remuneration Committee considers, among other factors, the remuneration policy, the desired levels of and emphasis on particular aspects of ASML’s short and long-term performance, as well as current compensation and benefits structures and levels benchmarked against relevant peers. External compensation survey data and, where necessary, external consultants are used to benchmark ASML’s remuneration levels and structures.In 2006, the Remuneration Committee held five regularly scheduled meetings.Selection and Nomination CommitteeASML’s Selection and Nomination Committee is composed of three members of the Supervisory Board. The current members of our Selection and Nomination Committee are Jos Westerburgen (chairman), Henk Bodt and Arthur van der Poel.ASML ANNUAL REPORT 200640
The Selection and Nomination Committee assists the Supervisory Board in:• preparing the selection criteria and appointment procedures for members of the Company’s Supervisory Board and Board of Management;• periodically evaluating the scope and composition of the Board of Management and the Supervisory Board and proposing the profile of the Supervisory Board in relation thereto;• periodically evaluating the functioning of individual members of the Board of Management and the Supervisory Board and reporting the results thereof to the Supervisory Board; and• proposing (re-)appointments of members of the Board of Management and the Supervisory Board and supervising the policy of the Board of Management in relation to the selection and appointment criteria for senior management.The Selection and Nomination Committee held three regularly scheduled meetings in 2006.Technology and Strategy CommitteeASML’s Technology and Strategy Committee is composed of three members of the Supervisory Board. The current members of our Technology and Strategy Committee are Arthur van der Poel (chairman), Jan Dekker and OB Bilous. In addition, the Technology and Strategy Committee may appoint one or more advisors from within the Company and/or from outside the Company. The advisors to the Technology and Strategy Committee may be invited as guests to (parts of) the meetings of the Committee, but are not entitled to vote in the meetings.The Technology and Strategy Committee advises the Supervisory Board in relation to the following responsibilities and may prepare resolutions of the Supervisory Board related thereto:• familiarization with and risk assessment and study of potential strategies, required technical resources, technology roadmaps and product roadmaps; and• providing advice to the Supervisory Board with respect to matters related thereto.The Technology and Strategy Committee holds at least two meetings per year and held three regularly scheduled meetings in 2006.Disclosure CommitteeASML has a Disclosure Committee to ensure compliance with applicable disclosure requirements arising under US and Netherlands law and applicable Stock Exchange Rules. The Disclosure Committee reports to and assists our Chief Executive Officer and Chief Financial Officer in the maintenance and evaluation of disclosure controls and procedures. The Audit Committee is kept informed about the outcome of the Disclosure Committee meetings. The Disclosure Committee gathers all relevant financial and non-financial information and assesses materiality, timeliness and necessity for disclosure of such information. The Disclosure Committee comprises various members of senior management, including our Chief Financial Officer. Furthermore, members of the Disclosure Committee are in close contact with our external legal counsel and our external auditor.During 2006, the Disclosure Committee reviewed our quarterly earnings announcements and our audited annual consolidated financial statements and other public announcements containing financial information. During various meetings, the Disclosure Committee assessed ASML’s disclosure controls and procedures and internal control over financial reporting. In order to assist the Disclosure Committee in preparing its advice to our CEO and CFO in their assessment of ASML’s disclosure controls and procedures and internal control over financial reporting, we have an Internal Control Committee, comprising among others three members of the Disclosure Committee.Variations from Certain Nasdaq Corporate Governance RulesNasdaq rules provide that foreign private issuers may follow home country practice in lieu of the Nasdaq corporate governance standards subject to certain exceptions and except to the extent that such exemptions would be contrary to US federal securities laws. The practices followed by ASML in lieu of Nasdaq rules are described below:• ASML does not follow Nasdaq’s quorum requirements applicable to meetings of ordinary shareholders. In accordance with Netherlands law and Netherlands generally accepted business practice, ASML’s Articles of Association provide that there are no quorum requirements generally applicable to General Meetings of Shareholders.• ASML does not follow Nasdaq’s requirements regarding the provision of proxy statements for General Meetings of Shareholders. Netherlands law does not have a regulatory regime for the solicitation of proxies and the solicitation of proxies is not a generally accepted business practice in the Netherlands. ASML does provide shareholders with an agenda and other relevant documents for the General Meeting of Shareholders.• ASML does not follow Nasdaq’s requirement regarding distribution to shareholders of copies of an annual report containing audited financial statements prior to the Company’s Annual General Meeting of Shareholders. The distribution of annual reports to shareholders is not required under Netherlands corporate law, Netherlands securities laws, or by Euronext Amsterdam. Furthermore, it is generally accepted business practice for Netherlands companies not to distribute annualASML ANNUAL REPORT 200641
reports. In part, this is because the Netherlands system of bearer shares has made it impractical to keep a current list of holders of the bearer shares in order to distribute the annual reports. Instead, we make our annual report available at our corporate head office in the Netherlands (and at the offices of our Netherlands listing agent as stated in the convening notice for the meeting) as from the day of convocation of the Annual General Meeting of Shareholders. In addition, we post a copy of our annual report on our website prior to the Annual General Meeting of Shareholders.D. Employees" -->
For the purpose of calculating the percentage of capital interest or voting rights, the following interests must, among other arrangements, be taken into account: shares and votes (i) directly held by any person, (ii) held by such person’s subsidiaries, (iii) held by a third party for such person’s account, (iv) held by a third party with whom such person has concluded an oral or written voting agreement (including on the basis of an unrestricted power of attorney) and (v) held by a third party with whom such person has agreed to temporarily transfer voting rights against payment. Interests held jointly by multiple persons are attributed to those persons in accordance with their entitlement. A holder of a pledge or right of usufruct in respect of shares can also be subject to these reporting obligations if such person has, or can acquire, the right to vote on the shares or, in case of depositary receipts, the underlying shares. The managers of certain investment funds are deemed to hold the capital interests and voting rights in the funds managed by them.For the same purpose, the following instruments qualify as “shares”: (i) shares, (ii) depositary receipts for shares (or negotiable instruments similar to such receipts), (iii) negotiable instruments for acquiring the instruments under (i) or (ii) (such as convertible bonds), and (iv) options for acquiring the instruments under (i) or (ii).The AFM keeps a public registry of and publishes all notifications made pursuant to the Act.Non-compliance with the reporting obligations under the Act could lead to criminal fines, administrative fines, imprisonment or other sanctions. In addition, non-compliance with the reporting obligations under the Act may lead to civil sanctions, including (i) suspension of the voting rights relating to the shares held by the offender, for a period of not more than three years, (ii) nullification of any resolution of the General Meeting of Shareholders of the company to the extent that such resolution would not have been approved if the votes at the disposal of the person or entity in violation of a duty under the Act had not been exercised and (iii) a prohibition on the acquisition by the offender of our shares or the voting on our ordinary shares for a period of not more than five years.B. Related Party Transactions" -->
Item 9 The Offer and Listing" -->
Item 10 Additional Information" -->
C. Material Contracts" -->
Income Tax Consequences for Individual Non-resident Holders on Owning and Disposing of the Ordinary SharesAn individual who is a Non-resident Holder will not be subject to Netherlands income tax on received income in respect of our ordinary shares or capital gains derived from the sale, exchange or other disposition of our ordinary shares, provided that such holder:• does not carry on and has not carried on a business in the Netherlands through a permanent establishment or a permanent representative to which the ordinary shares are attributable;• does not hold and has not held a (deemed) substantial interest in our share capital or, in the event the Non-resident Holder holds or has held a (deemed) substantial interest in our share capital, such interest is, respectively was, a business asset in the hands of the holder;• does not share and has not shared directly (through the beneficial ownership of ordinary shares or similar securities) in the profits of an enterprise managed and controlled in the Netherlands which (is deemed to) own(s), respectively (is deemed to have) has owned, our ordinary shares;• does not carry out and has not carried out any activities which generate taxable profit or taxable wages to which the holding of our ordinary shares was connected;• does not carry out and has not carried out employment activities in the Netherlands, does not serve and has not served as a director or board member of any entity resident in the Netherlands, and does not serve and has not served as a civil servant of a Netherlands public entity with which the holding of our ordinary shares is or was connected; and• is not an individual that has elected to be taxed as a resident of the Netherlands.Corporate Income Tax Consequences for Corporate Non-resident HoldersIncome derived from ordinary shares or capital gains derived from the sale, exchange or disposition of ordinary shares by a corporate Non-resident Holder is taxable if:• the holder carries on a business in the Netherlands through a permanent establishment or a permanent agent in the Netherlands (Netherlands enterprise) and the ordinary shares are attributable to this permanent establishment or permanent agent, unless the participation exemption (discussed below) applies; or• the holder has a substantial interest in our share capital, which is not allocable to his enterprise; or• certain assets of the holder are deemed to be treated as a Netherlands enterprise under Netherlands tax law and the ordinary shares are attributable to this Netherlands enterprise.To qualify for the Netherlands participation exemption, the holder must generally hold at least 5 percent of our nominal paid-in capital and meet certain other requirements.Dividend Withholding TaxIn general, a dividend distributed by us in respect of our ordinary shares will be subject to a withholding tax imposed by the Netherlands at the statutory rate of 25 percent.Dividends include:• dividends in cash and in kind;• deemed and constructive dividends;• consideration for the repurchase or redemption of ordinary shares (including a purchase by a direct or indirect ASML subsidiary) in excess of qualifying average paid-in capital unless such repurchase is made for temporary investment purposes or is exempt by law;• stock dividends up to their nominal value (unless distributed out of qualifying paid-in capital);• any (partial) repayment of paid-in capital not qualifying as capital for Netherlands dividend withholding tax purposes; and• liquidation proceeds in excess of qualifying average paid-in capital for Netherlands dividend withholding tax purposes.A reduction of Netherlands dividend withholding tax can be obtained if:• the participation exemption applies and the ordinary shares are attributable to a business carried out in the Netherlands;• the dividends are distributed to a qualifying EU corporate holder satisfying the conditions of the EU Parent-Subsidiary Directive; or• the rate is reduced by a tax treaty.A Non-resident Holder of ordinary shares can be eligible for a partial or complete exemption or refund of all or a portion of the above withholding tax under a tax treaty that is in effect between the Netherlands and the Non-resident Holder’s country of residence. The Netherlands has concluded such treaties with the United States, Canada, Switzerland, Japan, most European Union member states, as well as many other countries. Under the Treaty between the United States of America and the Netherlands for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (the “Tax Treaty”), dividends paid by us to a Non-resident Holder that is a resident of the United States as defined in the Tax Treaty (other than an exempt organization or exempt pension trust, as discussed below) are generally eligible for a reduction of the 25 percent Netherlands withholding tax to 15 percent or, in the case of certain United States corporate shareholders owning atASML ANNUAL REPORT 200648
least 10 percent of our voting power, to 5 percent, provided that it does not have an enterprise or an interest in an enterprise that is, in whole or in part, carried on through a permanent establishment or permanent representative in the Netherlands to which the dividends are attributable. The Tax Treaty provides for a complete exemption from tax on dividends received by exempt pension trusts and exempt organizations, as defined therein. Except in the case of exempt organizations, the reduced dividend withholding tax rate (or exemption from withholding) can be applied at the source upon payment of the dividends, provided that the proper forms have been filed in advance of the payment. Exempt organizations remain subject to the statutory withholding rate of 25 percent and are required to file for a refund of such withholding.A Non-resident Holder may not claim the benefits of the Tax Treaty unless (i) it is a resident of the United States as defined therein, or (ii) it is deemed to be a resident on the basis of the provisions of article 24(4) of the Tax Treaty, and (iii) its entitlement to those benefits is not limited by the provisions of article 26 (limitation on benefits) of the Tax Treaty.In this respect it is noted that the United States and the Netherlands have agreed on a protocol to the Tax Treaty. It provides for (among others) a 0 percent dividend withholding tax rate on dividends, provided certain requirements are met. In addition, abovementioned article 26 (limitation on benefits) has been adjusted. Some requirements to the various tests mentioned in article 26 will become more severe and others will be moderated.Dividend Stripping RulesUnder Netherlands tax legislation regarding anti-dividend stripping, no exemption from, or refund of, Netherlands dividend withholding tax is granted if the recipient of dividends paid by us is not considered the beneficial owner of such dividends.Gift or Inheritance TaxesNetherlands gift or inheritance taxes will not be levied on the transfer of ordinary shares by way of gift, or upon the death of a Non-resident Holder, unless:(1) the transfer is construed as an inheritance or as a gift made by or on behalf of a person who, at the time of the gift or death, is deemed to be, resident of the Netherlands; or(2) the ordinary shares are attributable to an enterprise or part thereof that is carried on through a permanent establishment or a permanent representative in the Netherlands.For purposes of Netherlands gift and inheritance tax, an individual of Netherlands nationality is deemed to be a resident of the Netherlands if he has been a resident thereof at any time during the ten years preceding the time of the gift or death. For purposes of Netherlands gift tax, a person not possessing Netherlands nationality is deemed to be a resident of the Netherlands if he has resided therein at any time in the twelve months preceding the gift.Value Added TaxNo Netherlands value added tax is imposed on dividends in respect of our ordinary shares or on the transfer of our shares.ResidenceA Non-resident Holder will not become resident, or be deemed to be resident, in the Netherlands solely as a result of holding our ordinary shares or of the execution, performance, delivery and/or enforcement of rights in respect of our ordinary shares.United States TaxationThe following is a discussion of the material United States federal income tax consequences relating to the acquisition, ownership and disposition of ordinary shares by a United States Holder (as defined below). This discussion deals only with ordinary shares held as capital assets and does not deal with the tax consequences applicable to all categories of investors, some of which (such as tax-exempt entities, passive foreign investment companies, banks, broker-dealers, investors owning directly, indirectly or constructively 10 percent or more of our outstanding voting shares, investors who hold ordinary shares as part of hedging or conversion transactions and investors whose functional currency is not the U.S. dollar) may be subject to special rules. In addition, the discussion does not address any alternative minimum tax or any state, local or non-United States tax consequences. The following discussion is based on United States tax laws, and judicial and administrative interpretations thereof as in effect on the date hereof, all of which are subject to change, potentially retroactively.This discussion is based on the Internal Revenue Code of 1986, as amended to the date hereof, final, temporary and proposed Treasury Department regulations promulgated, and administrative and judicial interpretations thereof, changes to any of which subsequent to the date hereof, possibly with retroactive effect, may affect the tax consequences described herein. In addition, there can be no assurance that the Internal Revenue Service will not challenge one or more of the tax consequences described herein, and we have not obtained, nor do we intend to obtain, a ruling from the Internal Revenue Service or an opinion of counsel with respect to the United States federal income tax consequences of acquiring or holding shares. ProspectiveASML ANNUAL REPORT 200649
purchasers of ordinary shares are advised to consult their tax advisers with respect to their particular circumstances and with respect to the effects of United States federal, state, local or non-United States tax laws to which they may be subject.As used herein, the term “United States Holder” means a beneficial owner of ordinary shares that for United States federal income tax purposes is:• an individual citizen or resident of the United States;• a corporation or other entity treated as a corporation for United States federal income tax purposes created or organized in or under the laws of the United States or of any political subdivision thereof;• an estate of which the income is subject to United States federal income taxation regardless of its source;• a trust whose administration is subject to the primary supervision of a court within the United States and which has one or more United States persons who have the authority to control all of its substantial decisions.If an entity treated as a partnership for United States federal income tax purposes owns ordinary shares, the United States federal income tax treatment of a partner in such partnership will generally depend upon the status of the partner and the activities of the partnership. A partnership that owns ordinary shares and the partners in such partnership should consult their tax advisors about the United States federal income tax consequences of holding and disposing of the ordinary shares.Taxation of DividendsUnited States Holders will include in gross income as foreign-source dividend income the gross amount of any distribution (before reduction for Netherlands withholding taxes) ASML makes out of its current or accumulated earnings and profits (as determined for United States federal income tax purposes) when the distribution is actually or constructively received by the United States Holder. Distributions will not be eligible for the dividends-received deduction generally allowed to United States corporations in respect of dividends received from other United States corporations. The amount of the dividend distribution includible in income of a United States Holder should be the U.S. dollar value of the foreign currency (e.g. euro) paid, determined by the spot rate of exchange on the date of the distribution, regardless of whether the payment is in fact converted into U.S. dollars. Distributions in excess of current and accumulated earnings and profits, as determined for United States federal income tax purposes, will be treated as a non-taxable return of capital to the extent of the United States Holder’s basis in the ordinary shares and thereafter as taxable capital gain. ASML does not maintain calculations of its earnings and profits under United States federal income tax principles.Subject to limitations provided in the United States Internal Revenue Code, a United States Holder may generally deduct from its United States federal taxable income, or credit against its United States federal income tax liability, the amount of qualified Netherlands withholding taxes. However, Netherlands withholding tax may be deducted only if the United States Holder does not claim a credit for any Netherlands or other non-United States taxes paid or accrued in that year. In addition, Netherlands dividend withholding taxes will likely not be creditable against the United States Holder’s United States tax liability to the extent ASML is not required to pay over the amount withheld to the Netherlands Tax Administration. Currently, a Netherlands corporation that receives dividends from qualifying non-Netherlands subsidiaries may credit source country tax withheld from those dividends against Netherlands withholding tax imposed on a dividend paid by a Netherlands corporation, up to a maximum of 3 percent of the dividend paid by the Netherlands corporation. The credit reduces the amount of dividend withholding that ASML is required to pay to the Netherlands Tax Administration but does not reduce the amount of tax ASML is required to withhold from dividends.Recently enacted United States tax legislation (the “2003 Tax Act”) reduces to 15 percent the maximum tax rate for certain dividends received by individuals through taxable years beginning on or before December 31, 2008, so long as the stock has been held for more than 60 days during the 120 day period beginning 60 days before the ex-dividend date. Dividends received from “qualified foreign corporations” generally qualify for the reduced rate. A non-United States corporation (other than a foreign personal holding company, foreign investment company, or passive foreign investment company) generally will be considered to be a qualified foreign corporation if (i) the shares of the non-United States corporation are readily tradable on an established securities market in the United States or (ii) the non-United States corporation is eligible with respect to substantially all of its income for the benefits of a comprehensive income tax treaty with the United States which contains an exchange of information program. The Tax Treaty has been identified as a qualifying treaty. Individual United States Holders should consult their tax advisors regarding the impact of the provisions of the 2003 Tax Act on their particular situations.Taxation on Sale or Other Disposition of Ordinary SharesUpon a sale or other disposition of ordinary shares, a United States Holders will generally recognize capital gain or loss for United States federal income tax purposes in an amount equal to the difference between the amount realized, if paid in U.S. dollars, or the U.S. dollar value of the amount realized (determined at the spot rate on the settlement date of the sale) if proceeds are paid in currency other than the U.S. dollar, as the case may be, and the United States Holder’s tax basis (determined in U.S. dollars) in such ordinary shares. Generally, the capital gain or loss will be long-term capital gain or loss if the holding period of the United States Holder in the ordinary shares exceeds one year at the time of the sale or other disposition. The deductibility of capital losses is subject to limitations for United States federal income tax purposes. Gain orASML ANNUAL REPORT 200650
loss from the sale or other disposition of ordinary shares generally will be treated as United States source income or loss for United States foreign tax credit purposes. Generally, any gain or loss resulting from currency fluctuations during the period between the date of the sale of the ordinary shares and the date the sale proceeds are converted into U.S. dollars will be treated as ordinary income or loss from sources within the United States. Each United States Holder should consult its tax advisor with regard to the translation rules of its adjusted basis and the amount realized upon a sale or other disposition of its ordinary shares if purchased in, or sold or disposed of for, a currency other than U.S. dollar.Information Reporting and Backup WithholdingInformation returns may be filed with the Internal Revenue Service (“IRS”) in connection with payments on the ordinary shares or proceeds from a sale, redemption or other disposition of the ordinary shares. A “backup withholding” tax may apply to these payments if the beneficial owner fails to provide a correct taxpayer identification number to the paying agent and to comply with certain certification procedures or otherwise establish an exemption from backup withholding. Any amounts withheld under the backup withholding rules might be refunded (or credited against the beneficial owner’s United States federal income tax liability, if any) depending on the facts and provided that the required information is furnished to the IRS.The discussion set forth above is included for general information only and may not be applicable depending upon a holder’s particular situation. Holders should consult their tax advisors with respect to the tax consequences to them of the purchase, ownership and disposition of shares including the tax consequences under state, local and other tax laws and the possible effects of changes in United States federal and other tax laws.F. Dividends and Paying Agents" -->
and accounts payable. This exposure is mainly hedged with financial instruments such as foreign exchange forward contracts and foreign exchange options. We closely monitor the effectiveness of our outstanding hedge contracts throughout the life of the hedges. The majority of financial instruments that we use to hedge foreign exchange risk have a duration of less than one year.As of December 31, 2006, we anticipate other comprehensive gain of EUR 4.1 million (December 31, 2005: EUR 9.9 million loss) to represent the total anticipated gain to be released to sales and other comprehensive loss of EUR 2.1 million (December 31, 2005: EUR 1.2 million loss) to represent the total anticipated loss to be charged to cost of sales over the next 12 months as the forecasted sales and purchase transactions occur.Since we have subsidiaries outside the euro-zone, a part of our shareholder’s equity is denominated in foreign currency and, as a result, exposed to fluctuations in exchange rates. It is our policy to manage material translation exposures resulting predominantly from ASML’s U.S. dollar net investments. Throughout 2004 and 2005 a proportion of our USD 575 million 5.75 percent Convertible Subordinated Notes due 2006 was assigned to hedge a certain part of our U.S. dollar net investments. As from December 2005 onwards, forward contracts have been assigned to hedge this exposure. The related foreign currency translation amounts (gross of taxes) included in cumulative translation adjustment for the years ended December 31, 2004, 2005 and 2006 were EUR 10.8 million gain, EUR 28.2 million loss and EUR 16.0 million gain, respectively.Interest rate riskOur exposure to the market risk of changes in interest rates relates primarily to our debt obligations and our cash balance. Interest rate swaps that we use to hedge the fair value of fixed loan coupons payable are designated as fair value hedges, with changes in fair value recorded under interest income and expense in our statement of operations. The accumulated change in fair value is intended to offset the change in the fair value of the underlying fixed loan coupons, which is recorded accordingly. Interest rate swaps that we use to hedge changes in the variability of future interest receipts are designated as cash flow hedges. The critical terms of the hedging instruments are the same as those for the underlying assets. Accordingly, all changes in fair value of these derivative instruments are recorded as other comprehensive income. The accumulated changes in fair value of the derivatives are intended to offset changes in future interest cash flows on the assets. The hedging relationship between interest rate swaps and hedged fixed loan coupons is highly effective.As of December 31, 2006 we had two EUR interest rate swaps outstanding with nominal values of EUR 380 million in total on which we pay a floating interest of 3.59 percent. These interest rate swaps, which are designated as cash flow hedges, have fixed interest receipts at an average of 3.69 percent for periods up until May 2010 and have floating interest payments at 3 months EURIBOR.See Notes 1, 4 and 11 to our consolidated financial statements, which are incorporated herein by reference.Credit riskFinancial instruments that potentially subject us to significant concentrations of credit risk consist principally of cash and cash equivalents, accounts receivable and derivative financial instruments used in hedging activities.Financial instruments contain an element of risk of the counterparties being unable to meet their obligations. This financial credit risk is monitored and minimized per type of financial instrument by limiting our counterparties to a sufficient number of major financial institutions and issuers of commercial paper. We do not expect the counterparties to default given their high credit quality.Our customers consist of integrated circuit manufacturers located throughout the world. We perform ongoing credit evaluations of its customers’ financial condition and generally requires no collateral to secure accounts receivable, we maintain an allowance for potentially uncollectible accounts receivable. We regularly review the allowance by considering factors such as historical payment experience, credit quality, age of the accounts receivable balances, and current economic conditions that may affect a customer’s ability to pay. In addition, we utilize letters of credit to mitigate credit risk when considered appropriate.Sensitivity analysis derivative financial instrumentsWe use foreign exchange derivatives to manage our foreign exchange rate risk and interest rate swaps to manage our interest rate risk.The following table summarizes our derivative financial instruments, their fair values and their sensitivity to an instantaneous 10 percent decrease of the euro against other currencies and an instantaneous 1 percent non-favorable increase in interest rates from their levels of December 31, 2005 and 2006 respectively, with all other variables held constant.ASML ANNUAL REPORT 200652
Part II" -->
Supervisory Board and Board of Management. Our Principles of Ethical Business Conduct and Internal Guidelines on Ethical Business Conduct are posted on our website (www.asml.com).The Internal Guidelines on Ethical Business Conduct contain, among others, written standards that are reasonably designed to deter wrongdoing and to promote:• honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships;• full, fair, accurate, timely, and understandable disclosure in reports and documents that ASML files with, or submits to, the SEC and in other public communications made by ASML;• compliance with applicable governmental laws, rules and regulations;• prompt internal reporting of violations on the Internal Guidelines on Ethical Business Conduct to an appropriate person or persons identified in these guidelines; and• accountability for adherence to the guidelines.C. Principal Accountant Fees and Services" -->
D. Exemptions from the Listing Standards for Audit Committees" -->
Part III" -->
SignaturesASML Holding N.V. hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.ASML Holding N.V.(Registrant)/s/ Eric MeuricePresident, Chief Executive Officer and Chairman of the Board of ManagementDated: January 26, 2007/s/ Peter T.F.M. WenninkExecutive Vice President, Chief Financial Officer and Member of the Board of ManagementDated: January 26, 2007ASML ANNUAL REPORT 200658
Index to Financial Statements
Consolidated Statements of Operations
Consolidated Statements of Comprehensive Income
Consolidated Statements of Shareholders’ Equity
Consolidated Statements of Cash Flows
Notes to the Consolidated Financial Statements1. General information/Summary of significant accounting policiesASML Holding N.V., having its corporate seat in Veldhoven, the Netherlands, is a worldwide company engaged in the development, production, marketing, sale and servicing of advanced semiconductor equipment systems mainly consisting of lithography systems. ASML’s principal operations are in the Netherlands, the United States of America and Asia.The Company’s shares are listed for trading in the form of New York Shares on Nasdaq (Nasdaq Global Select Market) and in the form of registered shares (“Amsterdam Shares”) on the Eurolist by Euronext Amsterdam. The principal trading market of the Company’s ordinary shares is Eurolist by Euronext Amsterdam.The accompanying consolidated financial statements include the Financial Statements of ASML Holding N.V. Veldhoven, the Netherlands, and its consolidated subsidiaries (together referred to as “ASML” or the “Company”).ASML follows accounting principles generally accepted in the United States of America (“U.S. GAAP”). ASML’s reporting currency is the euro. The accompanying consolidated financial statements are stated in thousands of euro (“EUR”) unless otherwise indicated.Principles of consolidationThe consolidated financial statements include the accounts of ASML Holding N.V. and all of its majority-owned subsidiaries. Subsidiaries are all entities over which ASML has the power to govern the financial and operating policies generally accompanying a shareholding of more than one half of the voting rights. All intercompany profits, balances and transactions have been eliminated in the consolidation.Use of estimatesThe preparation of ASML’s consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities on the balance sheet dates and the reported amounts of revenue and expense during the reported periods. Actual results could differ from those estimates.Foreign currency translationThe financial information for subsidiaries outside the euro-zone is generally measured using local currencies as the functional currency. The financial statements of those foreign subsidiaries are translated into euro in the preparation of ASML’s consolidated financial statements. Assets and liabilities are translated into euro at the exchange rate in effect on the respective balance sheet dates. Income and expenses are translated into euro based on the average exchange rate for the corresponding period. The resulting translation adjustments are recorded directly in shareholders’ equity. Currency differences on inter-company loans that have the nature of a long-term investment are also accounted for directly in shareholders’ equity.Derivative financial instrumentsThe Company principally uses derivative foreign currency hedging instruments for the management of foreign currency risks. In accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” and SFAS No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities an amendment of SFAS No. 133”, the Company measures all derivative foreign currency hedging instruments based on fair values derived from market prices of the instruments. The Company adopts hedge accounting for all hedges that are highly effective in offsetting the identified hedged risks as required by the SFAS No. 133 effectiveness criteria.On the date the derivative contract is entered into, ASML designates the derivative as either a hedge of the fair value of a recognized asset or liability in non-functional currencies (“fair value” hedge), or a hedge of cash flows related to sales transactions or purchase transactions in non-functional currencies (“cash flow” hedge), or a hedge of the foreign currency exposure of a net investment in a foreign operation. ASML formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedge transactions. ASML also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. When it is determined that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge (e.g. because of the sale, expiration and/or termination of the derivative), ASML discontinues hedge accounting prospectively. Changes in the fair value of a derivative that is designated and qualifies as a fair-value hedge, along with the loss or gain on the hedged asset or liability that is attributable to the hedged risk, are recorded in the statement of operations. Changes in the fair value of a derivative that is designated and qualifies as a cash flow hedge are recorded in other comprehensive income, until underlying hedged transaction is recognized in the statement of operations. In the event that the underlying hedge transaction does not occur, or itASML ANNUAL REPORT 2006F- 6
becomes probable that it will not occur, the gain or loss on the related cash flow hedge is immediately released from accumulated other comprehensive income and included in the statement of operations. Changes in the hedge of the foreign currency exposure of a net investment in a foreign operation are recorded in other comprehensive income.Interest rate swaps that are being used to hedge changes in the variability of future interest receipts are designated as cash flow hedges. The critical terms of the hedging instruments are the same as those for the underlying assets. Accordingly, all changes in fair value of these derivative instruments are recorded as other comprehensive income. The accumulated changes in fair value of the derivatives are intended to offset changes in future interest cash flows on the assets.The maximum length of time of cash flow hedges is the time elapsed from the moment the exposure is generated until the actual settlement.Interest rate swaps that are being used to hedge the fair value of fixed loan coupons payable are designated as fair value hedges. The change in fair value is intended to offset the change in the fair value of the underlying fixed loan coupons, which is recorded accordingly.The Company records any ineffective portion of foreign currency hedging instruments in sales or cost of sales in the statement of operations. Ineffectiveness of hedging instruments had a positive impact of EUR 0.3 million, EUR 0 million and EUR 0 million in 2004, 2005 and 2006, respectively.The ineffective portion of interest rate swaps is recorded in interest income (expense). The Company did not have benefits or costs due to ineffectiveness of interest rate swaps in 2004, 2005 and 2006.Cash and cash equivalentsCash and cash equivalents consist primarily of highly liquid investments, such as bank deposits, commercial paper and Money Market Funds, with insignificant interest rate risk and remaining maturities of three months or less at the date of acquisition.InventoriesInventories are stated at the lower of cost (first-in, first-out method) or market value. Cost includes net prices paid for materials purchased, charges for freight and customs duties, production labor cost and factory overhead. Allowances are made for slow moving, obsolete or unsaleable inventory.Intangible assetsIntangible assets include acquired intellectual property rights that are valued at cost or estimated fair value and are amortized on a straight-line basis over the term of the rights ranging from three to ten years.Property, plant and equipmentProperty, plant and equipment are stated at cost, less accumulated depreciation and any accumulated impairment losses. Depreciation is calculated using the straight-line method based on the estimated useful lives of the related assets. In the case of leasehold improvements, the estimated useful lives of the related assets do not exceed the remaining term of the corresponding lease. The following table presents the assigned economic lives of ASML’s property, plant and equipment:
recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the asset. Assets held for sale are reported at the lower of the carrying amount or fair value less the cost to sell.Revenue recognitionASML recognizes revenue when all four revenue recognition criteria are met: persuasive evidence of an arrangement exists; delivery has occurred or services have been rendered; seller’s price to buyer is fixed or determinable; and collectibility is reasonably assured. At ASML, this policy generally results in revenue recognition from the sale of a system upon shipment. The revenue from the installation of a system is generally recognized upon completion of that installation at the customer site. Each system undergoes, prior to shipment, a “Factory Acceptance Test” in ASML’s clean room facilities, effectively replicating the operating conditions that will be present on the customer’s site, in order to verify whether the system will meet its standard specifications and any additional technical and performance criteria agreed with the customer. A system is shipped, and revenue is recognized, only after all specifications are met and customer sign-off is received or waived. Although each system’s performance is re-tested upon installation at the customer’s site, ASML has never failed to successfully complete installation of a system at a customer’s premises.We anticipate that, in connection with future introductions of new technology, we will initially defer revenue recognition until completion of installation and acceptance of the new technology at customer premises. This deferral would continue until we are able to conclude that installation of the technology in question would occur consistently within a predetermined time period and that the performance of the new technology would not reasonably be different from that exhibited in the pre-shipment Factory Acceptance Test. Any such deferral of revenues, however, could have a material effect on ASML’s results of operations for the fiscal period in which the deferral occurred and on the succeeding fiscal period. At December 31, 2006 and 2005 we had no deferred revenue from shipments of new technology. During the three years ended December 31, 2006, no revenue from new technology was recorded that had been previously deferred. As our systems are based largely on two product platforms that permit incremental, modular upgrades, the introduction of genuinely “new” technology occurs infrequently, and has occurred on only one occasion since 1999.ASML has no significant repurchase commitments in its general sales terms and conditions. From time to time, the Company repurchases systems that it has manufactured and sold and, following refurbishment, resells those systems to other customers. This repurchase decision is driven by market demand expressed by other customers and not by explicit or implicit contractual arrangements relating to the initial sale. The Company considers reasonable offers from any vendor, including customers, to repurchase used systems so that it can refurbish, resell and install these systems as part of its normal business operations. Once repurchased, the repurchase price of the used system is recorded in work-in-process inventory during the period it is being refurbished, following which the refurbished system is reflected in finished products inventory until it is sold to the customer. As of December 31, 2006 ASML has repurchase commitments for an amount of EUR 24 million.A portion of our revenue is derived from contractual arrangements with our customers that have multiple deliverables, such as installation and training services and prepaid service contracts. The revenue relating to the undelivered elements of the arrangements is deferred at fair value until delivery of these elements. The fair value is determined by vendor specific objective evidence (“VSOE”). VSOE is determined based upon the prices that we charge for installation and comparable services (such as relocating a system to another customer site) on a stand-alone basis, which are subject to normal price negotiations. Revenue from installation and training services is recognized when the services are completed. Revenue from prepaid service contracts is recognized over the term of the contract.The deferred revenue balance from installation and training services amounted to approximately EUR 13 million and EUR 27 million, respectively, at December 31, 2006. The deferred revenue balance from prepaid service contracts amounted to approximately EUR 121 million as of December 31, 2006.We offer customers discounts in the normal course of sales negotiations. These discounts are directly deducted from the gross sales price at the moment of revenue recognition. These discounts do not relate to future purchases or trade-ins with the exception of volume discounts. From time to time, we offer volume discounts to a limited number of customers. In some instances these volume discounts can be used to purchase field options. The related amount is recorded as a reduction in revenue at time of shipment. Generally, there are no other credits or adjustments recognized at shipment. From time to time, we offer free or discounted products or services in connection with a current revenue transaction, which are earned by the customer at a future date only if the customer completes a specified cumulative level of revenue transactions. As the value of these free products or services is insignificant in relation to the value of the transactions necessary to earn these free products or services, a liability is recorded for the cost of these free products or services.Accounting for shipping and handling fees and costsASML bills the customer for, and recognizes as revenue, any charges for shipping and handling costs. The related costs are recognized as cost of sales.ASML ANNUAL REPORT 2006F- 8
Cost of salesCosts of system sales comprise direct product costs such as materials, labor, cost of warranty, depreciation, shipping and handling costs and related overhead costs. ASML accrues for the estimated cost of the warranty on its systems, which includes the cost of labor and parts necessary to repair systems during the warranty period. The amounts recorded in the warranty accrual are estimated based on actual historical expenses incurred and on estimated probable future expenses related to current sales. Actual warranty costs are charged against the accrued warranty reserve. Costs of service sales comprise direct service costs such as materials, labor, depreciation and overhead costs.RestructuringASML applies the criteria defined in SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” and SFAS No. 112, “Employers’ Accounting for Postemployment Benefits”, in order to determine when a liability for restructuring or exit costs should be recognized. With respect to employee termination costs, the Company applies SFAS No. 146 in the case of benefit arrangements that, in substance, do not constitute an ongoing benefit arrangement. SFAS No. 112 is applied when termination benefits are provided under an ongoing benefit arrangement. SFAS No. 146 establishes that a liability for a cost associated with an exit or disposal activity shall be recognized and measured initially at its fair value in the period in which the liability is incurred; that is, when a detailed plan exists, has been committed to by management and communicated to employees. SFAS No. 112 establishes that a liability for termination benefits provided under an ongoing benefit arrangement covered by SFAS No. 112 is recognized when the likelihood of future settlement is probable and can be reasonably estimated.Other exit costs include purchase and other commitments to be settled or fulfilled. Related costs are estimated based on expected settlement fees and committed payments, taking into account future potential benefits, if any, from those commitments.The allocation of restructuring expenses to either cost of sales or restructuring expenses is determined by reference to the workforce to which the restructuring expenses relate. Restructuring expenses relating to the Company’s manufacturing and service workforce are allocated to cost of sales, while restructuring expenses relating to research and development and selling, general and administrative activities are presented as restructuring charges. Restructuring credits are also recorded in the same line of the statement of operations as used when the original expenses were initially recognized.Research and development costs and creditsCosts relating to research and development are charged to operating expense as incurred. ASML receives subsidies and other credits only from governmental institutes. These subsidies and other governmental credits to cover research and development costs relating to approved projects are recorded as research and development credits in the period when such costs occur.Stock optionsOn January 1, 2006, we implemented the provisions of SFAS No. 123 (R), “Share-Based Payment”, using the modified prospective transition method. SFAS No. 123 (R) requires companies to recognize the cost of employee services received (compensation expenses) in exchange for awards of equity instruments based upon the grant-date fair value of those instruments. The grant-date fair value of these instruments was estimated using a Black-Scholes option valuation model. This Black-Scholes pricing model requires the use of assumptions, including expected stock price volatility and the estimated life of each award. The risk-free interest rate used in the model is determined, based on a Euro government bond with a life equal to the expected life of the equity-settled share-based payments. Our income before income taxes and net income was negatively impacted with EUR 8.8 million and EUR 7.4 million, respectively due to the adoption of SFAS No. 123 (R).Using the modified prospective transition method, we began recognizing compensation expenses for equity-based awards granted, modified, repurchased, or cancelled after the required effective date of January 1, 2006. Additionally, compensation expenses for the portion of equity-based awards for which the requisite service has not been rendered and that are outstanding as of January 1, 2006 are also recognized as the requisite service is rendered on or after that date. Compensation expenses are then amortized on a straight-line basis over the requisite service period of the awards, which is generally the vesting period. The total gross amount of recognized expenses associated with share based payments was EUR 9.7 million in 2006.Under the modified prospective transition method, no restatement of prior interim periods and fiscal years has been made. Prior to January 1, 2006, we measured compensation expenses for our stock option plans using the intrinsic value method under APB 25 “Accounting for Stock Issued to Employees” and related interpretations. As the exercise price of all stock options granted under these plans was not below the fair market price of the underlying common stock on the grant date, no compensation expenses were recognized in the consolidated statements of operations.ASML ANNUAL REPORT 2006F- 9
Had compensation expenses been determined based upon the fair value at the grant date for awards under the plan consistent with the methodology prescribed under SFAS No. 123, ASML’s net income and calculation for net income per ordinary share would have been as follows (net of related tax effects):
Income taxesThe asset and liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the tax effect of incurred net operating losses and for tax consequences attributable to differences between the balance sheet carrying amounts of existing assets and liabilities and their respective tax bases. If it is more likely than not that the carrying amounts of deferred tax assets will not be realized, a valuation allowance will be recorded to reduce the carrying amounts of those assets.Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date.Contingencies and litigationWe are party to various legal proceedings generally incidental to our business, as disclosed in Note 14 to the consolidated statements. In connection with these proceedings and claims, our management evaluated, based on the relevant facts and legal principles, the likelihood of an unfavorable outcome and whether the amount of the loss could be reasonably estimated. In each case, management determined that either a loss was not probable or was not reasonably estimable. As a result, no estimated losses were recorded as a charge to our statement of operations in 2004, 2005 and 2006. Significant subjective judgments were required in these evaluations, including judgments regarding the validity of asserted claims and the likely outcome of legal and administrative proceedings. The outcome of these proceedings, however, is subject to a number of factors beyond our control, most notably the uncertainty associated with predicting decisions by courts and administrative agencies. In addition, estimates of the potential costs associated with legal and administrative proceedings frequently cannot be subjected to any sensitivity analysis, as damage estimates or settlement offers by claimants may bear little or no relation to the eventual outcome. Finally, in any particular proceeding, we may agree to settle or to terminate a claim or proceeding in which it believes it would ultimately prevail where we believe that doing so, when taken together with other relevant commercial considerations, is more cost-effective than engaging in an expensive and protracted litigation, the outcome of which is uncertain.We accrue for legal costs related to litigation in our statement of operations at the time when the related legal services are actually provided to us.Net income per ordinary shareBasic net income per share is computed by dividing net income by the weighted average ordinary shares outstanding for that period. Diluted net income per share reflects the potential dilution that could occur if options issued under ASML’s stock compensation plan were exercised, and if ASML’s convertible notes were converted, unless the exercise of the stock options or conversion of the convertible notes would have an anti-dilutive effect. The dilutive effect is calculated using the if-converted method. Following this method, ASML’s convertible bonds are considered dilutive in 2006 and 2005 and anti-dilutive in 2004. Excluded from the diluted weighted average share outstanding calculation are cumulative preference shares contingently issuable to the preference share foundation, since they represent a different class of stock than the ordinary shares. See further discussion in Note 20.ASML ANNUAL REPORT 2006F- 11
The earnings per share (EPS) data have been calculated in accordance with the following schedule:
has been met, tax positions are recognized at the largest amount that is more-likely-than-not to be sustained. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 will be effective for fiscal years beginning after December 15, 2006. Any differences between the amounts recognized in the financial statements prior to the adoption of FIN 48 and the amounts reported after adoption will be accounted for as a cumulative-effect adjustment recorded to the beginning balance of retained earnings. We are currently in the process of determining the impact of adopting the provisions of Interpretation 48 on its consolidated financial statements.In June 2006, the FASB ratified the consensus reached by the EITF on Issue No. 06-03,“How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation)” (“EITF No. 06-03”).EITF No. 06-03permits registrants to elect to present vendor taxes imposed concurrently on a specific revenue-producing transaction between a seller and a customer on either a gross or net basis. The scope of EITF No. 06-03 includes government assessed taxes that are directly imposed on revenue-producing transactions between a seller and a customer and may include, but is not limited to, sales, use, value added and some excise taxes. Registrants are to be required to disclose their policies for presenting the taxes and would disclose any amounts presented on a gross basis. EITF No. 06-03 will be effective for interim and annual financial statements issued for periods beginning after December 15, 2006. We believe that the adoption of EITF No. 06-03 will have no material impact on our consolidated financial statements.The SEC issued Staff Accounting Bulletin No. 108 (“SAB 108”) regarding the process of quantifying financial statement misstatements on September 13, 2006. SAB 108 states that registrants should use both a balance sheet (iron curtain) approach and an income statement (rollover) approach when quantifying and evaluating the materiality of a (prior year) misstatement. The bulletin furthermore contains guidance on correcting errors. The bulletin is effective for financial statements for fiscal years ending after November 15, 2006. We do not believe that the adoption of SAB 108 has had a material impact on our (previous) consolidated financial statements.The FASB issued SFAS No. 157, “Fair Value Measurements” on September 15, 2006. The Statement defines fair value, provides guidance on how to measure assets and liabilities using fair value and expands disclosures about fair value measurements. The Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007 and should be applied prospectively (with a limited form of retrospective application) as of the beginning of the fiscal year in which this Statement is initially applied. We do not believe that the adoption of SFAS No. 157 will have a material impact on our consolidated financial statements.2. Discontinued operationsOn December 18, 2002 ASML announced the proposed sale of its Thermal business and the termination of its manufacturing activities in the Track business. As of December 31, 2005, ASML has completed the discontinuation of the Track business and the divesture of the Thermal business.3. RestructuringRestructuring Plan 2001On October 16, 2001, as a consequence of the downturn in the semiconductor industry, ASML announced cost reductions and a restructuring plan (“Restructuring plan 2001”) which resulted in the consolidation of manufacturing facilities and discontinuance of certain product lines related to SVG that overlapped with products of ASML. As of December 31, 2005, this plan had been fully effectuated.Restructuring Plan 2003The worldwide slowdown in the semiconductor industry continued into 2003 and, on July 16, 2003, ASML announced further workforce reductions of approximately 550 positions worldwide, of which the majority was planned for the Netherlands (“Restructuring plan 2003”). During 2003, ASML recorded a provision of EUR 15.3 million as an ongoing benefit arrangement, of which EUR 3.9 million was included in cost of sales and EUR 11.4 million was included in restructuring costs. The amount of the provision was based upon the severance arrangements as agreed with our Works Council in the Netherlands for the workforce reductions included in ASML’s Restructuring Plan 2002. The estimated initial annual cost savings were EUR 47 million. ASML’s Board of Management and ASML’s Works Council then commenced a joint study on implementing these workforce reductions in the Netherlands, which delayed the reductions until the beginning of 2004. Thereafter, in response to a sharp improvement in market conditions during 2004, the Company decreased the reductions to approximately 300 positions worldwide, of which 150 were contract employees with limited rights upon termination.As a result, ASML recorded a restructuring credit of EUR 12.1 million, EUR 3.8 million of which was recorded in cost of sales and EUR 8.3 million of which was recorded under restructuring expenses. The Company’s payments associated with theseASML ANNUAL REPORT 2006F- 13
workforce reductions were EUR 0.5 million in 2005 and EUR 2.5 million in 2004 and ASML’s initially anticipated cost savings were reduced to approximately EUR 24 million.Also during 2003, ASML recorded restructuring costs of approximately EUR 6.8 million relating to the consolidation of its office and warehouse facilities at the headquarters in Veldhoven as the Company ceased using certain of its facilities. The facility exit charges included estimated future obligations for non-cancelable lease payments and the impairment of property and equipment (primarily leasehold improvements) for which there are insufficient cash flows to support the carrying cost. During 2004, ASML recorded adjustments to the related restructuring provision due to postponed commencement dates of sublease agreements and higher exit costs than originally estimated. This resulted in an additional charge of EUR 3.5 million, EUR 1.0 million of which was recorded in cost of sales and EUR 2.5 million of which was recorded under restructuring charges. The Restructuring plan 2003 did not impact any processes or products. As of December 31, 2005, this plan had been substantially effectuated.Tabular Disclosures of RestructuringAll restructuring charges are recorded in our statements of operations either in cost of sales or in restructuring charges, as summarized in the following table for the years ended December 31, 2004, 2005 and 2006:
The following table summarizes, per category, the movement in the restructuring provision for the three years ended December 31, 2006:
the interest typical terms of interest bearing liabilities. The Company still retains residual financial statement exposure risk to the extent that the asset and liability positions do not fully offset. It is the Company’s policy to enter into interest rate swaps to hedge this residual exposure. For this purpose, the Company uses interest rate swaps, both to hedge changes in market value of fixed loan coupons payable due to changes in interest rates as well as to hedge the variability of future interest receipts as a result of changes in market interest rates.As of December 31, 2006, we had two EUR interest rate swaps outstanding with nominal values of EUR 380 million in total on which we pay a floating interest of 3.59 percent. These interest rate swaps, which are designated as cash flow hedges, have fixed interest receipts at an average of 3.69 percent for periods up until May 2010 and have floating interest payments at 3 months EURIBOR.Financial instruments as of December 31, 2006The Company uses foreign exchange derivatives to manage its currency risk and interest rate swaps to manage its interest rate risk. Most derivatives, except for the interest rate swaps, will mature in one year or less after the balance sheet date. The following table summarizes the notional amounts and estimated fair values of the Company’s financial instruments:
5. Accounts receivableAccounts receivable consist of the following:
7. Other assetsOther non-current assets consist of the following:
agreement. This amount was expensed as research and development expenses in ASML’s statement of operations for the year ended December 31, 2004.
9. Property, plant and equipmentProperty, plant and equipment consist of the following:
production and field service tooling which were no longer used because the tools did no longer meet the today’s technology requirements. The impairment charges were determined based on the difference between the assets’ estimated fair value and their carrying amount.10. Accrued liabilities and otherAccrued liabilities and other consist of the following:
Convertible subordinated debtThe following table summarizes the Company’s outstanding convertible notes as of December 31, 2006 and 2005, including fair value of interest rate swaps used to hedge the fair value of the interest bearing convertible debts:
Lines of creditAt December 31, 2006, the Company had available credit facilities for a total of EUR 400 million (2005: EUR 400 million), all of which expire in November 2009.No amounts were outstanding under these credit facilities at the end of 2006 and 2005. The credit facilities contain certain restrictive covenants, including a requirement that the Company maintains a minimum financial condition ratio, calculated in accordance with a contractually agreed formula. ASML was in compliance with these covenants at December 31, 2006 and 2005. ASML does not currently anticipate any difficulty in continuing to meet these covenant requirements.Outstanding amounts under these credit facilities will bear interest at the European Interbank Offered Rate (EURIBOR) or the London Interbank Offered Rate (LIBOR) plus a margin that is dependent on the Company’s liquidity position.12. Commitments, contingencies and guaranteesThe Company has various contractual obligations, some of which are required to be recorded as liabilities in the Company’s consolidated financial statements, including long- and short-term debt. Others, namely operating lease commitments, purchase obligations and guarantees, are generally not required to be recognized as liabilities on the Company’s balance sheet but are required to be disclosed.Lease Commitments and Variable InterestsThe Company leases equipment and buildings under various operating leases. Operating leases are charged to expense on a straight-line basis. See Tabular Disclosure of Contractual Obligations below.In December 2003, the FASB issued FIN 46 (R), “Consolidation of Variable Interest Entities”. Under FIN 46 (R), an enterprise must consolidate a variable interest entity if that enterprise has a variable interest (or combination of variable interests) that will absorb a majority of the entity’s expected losses if they occur, receive a majority of the entity’s expected residual returns if they occur, or both.In 2003, ASML moved to its current Veldhoven headquarters. The Company is leasing these headquarters for a period of 15 years from an entity (the “lessor”) that was incorporated by a syndicate of 3 banks (“shareholders”) solely for the purpose of leasing this building. The lessor’s shareholders equity amounts to EUR 1.9 million. Furthermore the shareholders each granted a loan of EUR 11.6 million and a fourth bank granted a loan of EUR 12.3 million. ASML provided the lessor with a subordinated loan of EUR 5.4 million and has a purchase option that is exercisable either at the end of the lease in 2018, at a pre-determined price of EUR 24.5 million, or during the lease at the book value of the assets. The total assets of the lessor entity amounted to approximately EUR 54 million at inception of the lease.ASML believes that it holds a variable interest in this entity and that the entity is a variable interest entity (“VIE”) because it is subject to consolidation in accordance with the provisions of paragraph 5 of FIN 46 (R). The total equity investment at risk is approximately 3.6 percent of the lessor’s total assets and is not considered and cannot be demonstrated, qualitatively or quantitatively, to be sufficient to permit the lessor to finance its activities without additional subordinated financial support provided by any parties, including the shareholders. ASML determined that it is not appropriate to consolidate the VIE as it is not the primary beneficiary. To make this determination, the expected losses and expected residual returns of the lessor were allocated to each variable interest holder based on their contractual right to absorb expected losses and residual returns. The analysis of expected losses and expected residual returns involved determining the expected negative and positive variability in the fair value of the lessor’s net assets exclusive of variable interests through various cash flow scenarios based upon the expected market value of the lessor’s net assets. Based on this analysis, ASML determined that other variable interest holders will absorb the majority of the lessor’s expected losses, and as a result, ASML is not the primary beneficiary.ASML’s maximum exposure to the lessor’s expected losses is estimated to be approximately EUR 5.4 million.Purchase ObligationsThe Company enters into purchase commitments with vendors in the ordinary course of business to ensure a smooth and continuous supply chain for key components. Purchase obligations include medium to long-term purchase agreements. These contracts differ and may include certain restrictive clauses. Any identified losses that result from purchase commitments that are forfeited are provided for in the Company’s financial statements. As of December 31, 2006, the Company had purchase commitments for a total amount of approximately EUR 995 million (December 31, 2005: EUR 676 million), reflecting its backlog level at the end of 2006. In its negotiations with suppliers the Company continuously seeks to align its purchase commitments with its business objectives. See Tabular Disclosure of Contractual Obligations below.ASML ANNUAL REPORT 2006F- 23
Tabular Disclosure of Contractual ObligationsThe Company’s contractual obligations with respect to long term debt, operating lease obligations, purchase obligations and other deferred liabilities as of December 31, 2006 can be summarized as follows:
investments available in the plan. Participants elect to receive their funds in future periods after the earlier of their employment termination or their withdrawal election, at least 5 years after deferral. There were minor plan expenses in 2006. On December 31, 2004, 2005 and 2006, the Company’s liability under the deferred compensation plan was EUR 3 million, EUR 3 million and EUR 5 million, respectively.Pension plansASML maintains various pension plans covering substantially all of its employees. The Company’s approximately 2,800 employees in the Netherlands participate in a multi-employer union plan (“Bedrijfstakpensioenfonds Metalektro”) determined in accordance with the collective bargaining agreements effective for the industry in which ASML operates. This multi-employer plan spans approximately 1,300 companies and 147,000 contributing members. The plan monitors its risks on a global basis, not by company or employee, and is subject to regulation by Dutch governmental authorities. By law (the Dutch Pensions and Savings Act), a multi-employer union plan must be monitored against specific criteria, including the coverage ratio of the plan’s assets to its obligations. This coverage ratio must exceed 100 percent for the total plan. Every company participating in a Dutch multi-employer union plan contributes a premium calculated as a percentage of its total pensionable salaries, with each company subject to the same percentage contribution rate. The pension rights of each employee are based upon the employee’s average salary during employment.ASML’s net periodic pension cost for this multi-employer plan for any fiscal period is the amount of the required contribution for that period. However, a contingent liability may arise from, for example, possible actuarial losses relating to other participating entities because each entity that participates in a multi-employer plan shares in the actuarial risks of every other participating entity or any responsibility under the terms of a plan to finance any shortfall in the plan if other entities cease to participate.ASML also participates in several defined contribution pension plans, with ASML’s expenses for these plans equaling the contributions made in the relevant fiscal period.The Company’s pension costs for all employees for the three years ended December 31, 2006 were:
Profit-sharing planASML has a profit-sharing plan covering all employees, who are not members of the Board of Management or senior management. Under the plan, eligible employees receive an annual profit-sharing bonus, based on a percentage of net income relative to sales ranging from 0 to 20 percent of annual salary. The profit-sharing percentage for the years 2004, 2005 and 2006 was 5 percent, 8 percent and 12 percent, respectively. This profit-sharing bonus is accrued for in the statement of operations for the year ended December 31, 2006 for an amount of EUR 27.8 million, expected to be paid in the first quarter of 2007.Stock optionsThe Company has adopted various stock option plans for its employees. Each year, the Board of Management determines, by category of ASML personnel, the total available number of stock options that can be granted in that year. The determination is subject to the approval of the Supervisory Board of the Company. Options granted under ASML’s stock option plans have fixed exercise prices equal to the closing price of the Company’s ordinary shares on Euronext on the applicable grant dates. Granted stock options generally vest over a three-year period with any unexercised stock options expiring ten years after the grant date.Stock option transactions are summarized as follows:
Details with respect to stock options are set forth in the following table:
payments of US$ 9 million (approximately EUR 8 million) in both 2005 and 2006, and is obligated to make an additional payment to Nikon of US$ 9 million in 2007. Zeiss made an initial payment to Nikon of US$ 40 million (approximately EUR 32 million) in 2004, further made payments of US$ 6 million (approximately EUR 4 million) in both 2005 and 2006, and is required to make an additional payment to Nikon of US$ 6 million in 2007.Patent litigation with Ultratech Stepper, IncIn May 2000, Ultratech Stepper, Inc. (“Ultratech”) filed a lawsuit against ASML. Ultratech alleges that ASML is infringing Ultratech’s rights under a United States patent in connection with its manufacture and commercialization in the United States of advanced photolithography equipment embodying technology that, in particular, is used in Step & Scan equipment.Ultratech’s patent infringement claims were tried before a jury in Oakland, California, in May and June of 2005. On June 21, 2005 the jury unanimously determined that each of the claims of Ultratech’s patent that Ultratech had asserted against ASML was invalid, and thus that ASML was not liable for patent infringement, notwithstanding the jury’s finding that each of these claims was infringed by ASML and certain of its customers. The Court entered judgment in favor of ASML following receipt of the jury verdict.Ultratech filed motions with the Court seeking to overturn the jury’s finding that the asserted claims of its patent are invalid or, in the alternative, seeking a new trial. The Court denied each of Ultratech’s motions. Ultratech then filed an appeal with the United States Court of Appeals for the Federal Circuit challenging the finding that the asserted claims of Ultratech’s patent are invalid. Briefing is ongoing in connection with this appeal, and no hearing date has been set yet. In the event the appeals court overturns the jury’s finding that the asserted claims of Ultratech’s patent are invalid and ASML is held to infringe any valid claims of Ultratech’s patent, it could result in a substantial damages award and an injunction that could substantially restrict or prohibit ASML’s sales in the United States, either of which could have a material adverse effect on the Company’s financial position and results of operations.Arbitration with Aviza TechnologyOn December 1, 2006, Aviza Technology (“Aviza”) initiated arbitration proceedings against ASML Holding N.V., ASML U.S., Inc. and various other affiliates and subsidiaries (collectively, the “ASML parties”). Aviza’s arbitration demand alleges that the ASML parties engaged in fraud and made negligent misrepresentations or omissions in connection with a 2002 license agreement between ASML and IPS, Ltd. that was assigned to Aviza in connection with the 2003 divestiture of ASML’s Thermal Division.ASML believes that there are meritorious defenses to Aviza’s allegations, and it intends to vigorously defend itself in the arbitration proceeding, and accordingly, that the outcome of the proceeding will not have a material adverse effect on its financial position or results of operations. However, there can be no assurance that ASML will prevail, given the inherently uncertain nature of arbitration proceedings. If Aviza were to prevail, it could result in a substantial damages award and have a material adverse effect on ASML’s financial position and results of operations.15. Income taxesThe components of income before income taxes are as follows:
The reconciliation between the provision for income taxes shown in the consolidated statement of operations, based on the effective tax rate, and expense based on the domestic tax rate, is as follows:
The deferred tax position is classified in the consolidated financial statements as follows:
Pursuant to Netherlands tax laws, we have temporarily depreciated part of our investment in our United States group companies. This depreciation has been deducted from the taxable base in the Netherlands and resulted in a temporary tax refund of EUR 152 million. This temporary depreciation must be added back on a straight-line basis to the taxable base in the period 2006 through 2010. As of December 31, 2006, the remaining net tax effect of this repayment obligation amounted to EUR 10 million, of which EUR 90 million is recorded as a long-term deferred tax liability and EUR 80 million as a current tax asset in the Company’s financial statements.We are subject to tax audits in the various tax jurisdictions we operate in. During such audits, local tax authorities may challenge the positions taken by us.16. Segment disclosureSegment information has been prepared in accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.”ASML operates in one reportable segment for the development, manufacture, marketing and servicing of lithography equipment. In accordance with SFAS No. 131 (“SFAS 131”), “Disclosures about Segments of an Enterprise and Related Information,” ASML’s chief operating decision-maker has been identified as the Chief Executive Officer, who reviews operating results to make decisions about allocating resources and assessing performance for the entire company.Since the beginning of 2005, management reporting includes net system sales figures of our product lines: 300 millimeter new systems, 200 millimeter new systems and used systems. Net sales for these product lines in 2005 and 2006 were as follows:
For geographical reporting, net sales are attributed to the geographic location in which the customers’ facilities are located. Identifiable assets are attributed to the geographic location in which they are located. Net sales and identifiable assets by geographic region were as follows:
Base salary, benefits and short-term performance cash bonusThe remuneration in euros of the members of the Board of Management was as follows:
Performance Stock OptionsDetails of options held by members of the Board of Management to purchase ordinary shares of ASML Holding N.V. are set forth below:
The actual number of performance stock options which will be awarded in 2007 in relation to performance achievements over 2006 are as follows:
At our annual General Meeting of Shareholders held on March 25, 2003, our shareholders adopted a new remuneration package for Supervisory Board members. The annual remuneration for individual members is EUR 25,000 and for the Chairman EUR 40,000. Additionally, the membership of committees of the Supervisory Board is compensated by an amount of EUR 10,000 per Committee. At our annual General Meeting of Shareholders held on March 24, 2005, our shareholders adopted an additional remuneration package of EUR 5,000 for the Chairman of the Audit Committee and EUR 10,000 for the US Supervisory Board Member.During 2005 and 2006, ASML paid out the following amounts to the individual members of the Supervisory Board (in euro):
The average number of employees from continuing operations during 2004, 2005 and 2006 was 4,949, 4,972 and 5,320 respectively. The total number of personnel employed per sector was:
the Board of Management to issue shares or options separately. These authorizations will each be granted for a period of 18 months.The Company may repurchase its issued ordinary shares at any time, subject to compliance with the requirements of Netherlands law and provided the aggregate nominal value of the ordinary shares held by ASML or a subsidiary at any time amounts to no more than one-tenth of our issued share capital. Any such purchases are subject to the approval of the Supervisory Board and the authorization (whether by means of a resolution or by an amendment to our Articles of Association) of shareholders at our General Meeting of Shareholders, which authorization may not be for more than 18 months. The Board of Management is currently authorized, subject to Supervisory Board approval, to repurchase through September 23, 2007 up to a maximum of 10 percent of our issued share capital as of the date of authorization (March 23, 2006) at a price between the nominal value of the ordinary shares purchased and 110 percent of the market price of these securities on Euronext Amsterdam or Nasdaq. At our annual General Meeting of Shareholders to be held on March 28, 2007, our shareholders will be asked to extend this authority through September 28, 2008.Cumulative preference sharesIn 1998, the Company granted to the preference share foundation, “Stichting Preferente Aandelen ASML” (the “Foundation”) an option to acquire cumulative preference shares in the capital of the Company (the “Preference Share Option”). This option was amended and extended in 2003. The object of the Foundation is to protect the interests of the Company and the enterprises maintained by it. The cumulative preference shares have the same voting rights as ordinary shares but are entitled to dividends on a preferential basis at a percentage based on EURIBOR plus 2 percent.The Preference Share Option gives the Foundation the right to acquire a number of cumulative preference shares equal to the number of ordinary shares outstanding at the time of exercise of the Preference Share Option for a subscription price equal to their EUR 0.02 nominal value. Only one-fourth of this subscription price is payable at the time of initial issuance of the cumulative preference shares. The cumulative preference shares may be cancelled and repaid by the Company upon the authorization by the General Meeting of Shareholders of a proposal to do so by the Board of Management approved by the Supervisory Board. Exercise of the Preference Share Option would effectively dilute the voting power of the ordinary shares then outstanding by one-half. The practical effect of any such exercise could be to prevent attempts by third parties to acquire control of the Company.Declaration of IndependenceThe Board of Directors of the Foundation and the Board of Management of the Company together declare that the Foundation is independent of the Company as defined in article A. of “Appendix X to A-2.7 of the General Rules of Euronext Amsterdam.” The Board of the Foundation comprises three voting members from the Netherlands business and academic communities, Mr. R.E. Selman, Mr. F.H.M. Grapperhaus and Mr. M.W. den Boogert, and one non-voting member, the Chairman of the Company’s Supervisory Board, Mr. H. Bodt.Veldhoven, the NetherlandsJanuary 26, 2007/s/ Eric Meurice,Chief Executive Officer/s/ Peter T.F.M. Wennink,Chief Financial OfficerASML ANNUAL REPORT 2006F- 38
Report of Independent Registered Public Accounting FirmTo the Supervisory Board and Shareholders of ASML Holding N.V.:We have audited the accompanying consolidated balance sheets of ASML Holding N.V. and its subsidiaries (collectively, the “Company”) as of December 31, 2006 and 2005, and the related consolidated statements of operations, comprehensive income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2006 (all expressed in euros). We also have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that the Company maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on these financial statements, an opinion on management’s assessment, and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audits.We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.ASML ANNUAL REPORT 2006F- 39
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of ASML Holding N.V. and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission./s/ Deloitte Accountants B.V.Eindhoven, The NetherlandsJanuary 26, 2007ASML ANNUAL REPORT 2006F- 40
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