United States

Securities and Exchange Commission

Washington, D.C. 20549

 

Form 20-F

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)

OF THE SECURITIES EXCHANGE ACT OF 1934

for the fiscal year ended December 31, 2010

 

Commission file number 025566

 

ASML HOLDING N.V.

(Exact Name of Registrant as Specified in Its Charter)

 

THE NETHERLANDS

(Jurisdiction of Incorporation or Organization)

 

DE RUN 6501

5504 DR VELDHOVEN

THE NETHERLANDS

(Address of Principal Executive Offices)

Craig DeYoung

Telephone: +1 480 383 4005

Facsimile: +1 480 383 3978

E-mail: craig.deyoung@asml.com

8555 South River Parkway,

Tempe, AZ 85284, USA

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

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

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

None

(Title of Class)

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

None

(Title of Class)

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

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

436,592,972 Ordinary Shares

(nominal value EUR 0.09 per share)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes (ü) No ( )

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

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

Yes ( ) No (ü)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the

Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant

was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes (ü) No ( )

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive

Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the

preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes (ü) No ( )

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

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

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

Indicate by check mark which basis of accounting the registrant has used to prepare

the financial statements included in this filing:

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

International Accounting Standards Board ( ) Other ( )

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

which financial statement item the registrant has elected to follow.

Item 17 ( ) Item 18 ( )

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

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

Yes ( ) No (ü)

Name and address of person authorized to receive notices and communications

from the Securities and Exchange Commission:

Richard A. Ely

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

40 Bank Street, Canary Wharf

London E14 5DS England

 

ASML ANNUAL REPORT 2010

 

Contents

 

 

 

ASML ANNUAL REPORT 2010

 

ASML ANNUAL REPORT 2010

 

 

ASML ANNUAL REPORT 2010

 

 

Special Note Regarding Forward-Looking Statements

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

 

 

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

 

 

Not applicable.

 

 

Not applicable.

 

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

 

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Five-Year Financial Summary

 

 

ASML ANNUAL REPORT 2010

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ASML ANNUAL REPORT 2010

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Exchange Rate Information

We publish our consolidated financial statements in euros. In this Annual Report, references to ‘‘€”, “euro” or “EUR” are to euros, and references to “$”, “U.S. dollar”, “USD” or “US$” are to United States dollars.

 

 

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”, Note 1 and Note 3 to our consolidated financial statements.

 

 

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

 

 

 

Not applicable.

Not applicable.

In conducting our business, we face many risks that may interfere with our business objectives. Some of these risks relate to our operational processes, while others relate to our business environment. It is important to understand the nature of these risks and the impact they may have on our business, financial condition and results of operations. Some of the more relevant risks are described below. These risks are not the only ones that ASML faces. Some risks may not yet be known to ASML and certain risks that ASML does not currently believe to be material could become material in the future.

 

 

Risks Related to the Semiconductor Industry

 

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

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

 

 

Reductions or delays in capital equipment purchases by our customers could have a material adverse effect on our business, financial condition and results of operations.

 

ASML ANNUAL REPORT 2010

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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 level of sales that we must reach in a year to achieve net income. If sales decrease significantly as a result of an industry downturn and we are unable to adjust our costs over the same period, our net income may decline significantly or we may suffer losses. As we need to keep certain levels of inventory on hand to meet anticipated product demand, we may also incur increased costs related to inventory obsolescence in an industry downturn. In addition, industry downturns generally result in overcapacity, resulting in downward pressure on prices and impairment of machinery and equipment, which in the past has had, and in the future could have, a material adverse effect on our business, financial condition and results of operations.

 

 

The financial crisis affecting the banking system and global financial markets was in many respects unprecedented in the history of our Company. Remaining concerns over the instability of the financial markets and the global economy could result in a number of follow-on effects on our business, including: declining business and consumer confidence resulting in reduced, delayed or shorter-term capital expenditures for our products; insolvency of key suppliers resulting in product delays; the inability of customers to obtain credit to finance purchases of our products, delayed payments from our customers and/or customer insolvencies; and other adverse effects that we cannot currently anticipate. If global economic and market conditions deteriorate, we are likely to experience material adverse impacts on our business, financial condition and results of operations.

 

 

Conversely, in anticipation of periods of increasing demand for semiconductor manufacturing equipment, we must maintain sufficient manufacturing capacity and inventory, and we must attract, hire, integrate and retain a sufficient number of qualified employees to meet customer demand. Our ability to predict the timing and magnitude of industry fluctuations is limited and our products require significant lead-time to complete. Accordingly, we may not be able to effectively increase our production capacity to respond to an increase in customer demand in an industry upturn resulting in lost revenues, damage to customer relationships and we may lose market share.

 

 

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

The semiconductor manufacturing industry is subject to:

 

 

Our products could become obsolete sooner than anticipated because of a faster than anticipated change in one or more of the technologies related to our products or in market demand for products based on a particular technology. Our success in developing new products and in enhancing our existing products depends on a variety of factors, including the successful management of our research and development (“R&D”) 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 production facilities and upgrades of existing facilities, which would have a material adverse effect on our business, financial condition and results of operations.

 

 

In addition, we are investing considerable financial and other resources to develop and introduce new products and product enhancements, such as Extreme Ultraviolet lithography (“EUV”), that our customers may not fully adopt. If our customers do not adopt these new technologies, products or product enhancements that we develop due to a preference for more established or alternative new technologies and products or for other reasons, we would not recoup any return on our investments in these technologies or products, which would result in the recording of impairment charges on these investments and could have a material adverse effect on our business, financial condition and results of operations.

 

 

The success of EUV will be particularly dependent on light source (laser) availability and continuing technical advances as well as infrastructure developments in masks and resists, without which the tools cannot achieve the productivity and yield that are required to justify their capability economically.

 

 

We Face Intense Competition

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

 

ASML ANNUAL REPORT 2010

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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 17 to our consolidated financial statements.

 

 

ASML’s primary competitors are Nikon Corporation (“Nikon”) and Canon Kabushiki Kaisha (“Canon”). 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, which may cause a decline in our sales or a loss of market acceptance for our lithography systems. In addition, adverse market conditions, industry overcapacity or a decrease in the value of the Japanese yen in relation to the euro or the U.S. dollar could further intensify price-based competition in those regions that account for the majority of our sales, resulting in lower prices and margins and a material adverse effect on our business, financial condition and results of operations. In addition, to competitors in lithography, ASML may face competition with respect to alternative technologies for the non-critical layers and from alternative technologies for all layers. In the event the delivery of new technology is delayed, ASML’s customers may turn to alternative technology equipment and/or their own installed base as a substitute for purchasing ASML’s products.

 

 

Risks Related to ASML

 

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

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

 

 

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

 

 

In addition to Zeiss’ current position as our single supplier of lenses, the excimer laser illumination systems that provide the ultraviolet light source, referred to as “deep UV”, used in our high resolution steppers and Step & Scan systems, and the extreme ultraviolet light source, referred to as “EUV”, used in our second-generation EUV systems, are available from only a very limited number of suppliers.

 

 

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

 

 

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

Historically, we have sold a substantial number of lithography systems to a limited number of customers. We expect customer concentration to increase because of continuing consolidation in the semiconductor manufacturing industry. Consequently, 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 2010, sales to our largest customer accounted for EUR 1,270.8 million, or 28.2 percent of net sales, compared with EUR 348.8 million, or 21.9 percent of net sales, in 2009. The loss of any significant customer or any significant reduction in orders by a significant customer may have a material adverse effect on our business, financial condition and results of operations.

 

 

Additionally, as a result of our limited number of customers, credit risk on our receivables is concentrated. Our three largest customers (based on net sales) accounted for 42.4 percent of accounts receivable at December 31, 2010, compared with 44.0 percent at December 31, 2009. As a result, business failure or insolvency of one of our main customers may have a material adverse effect on our business, financial condition and results of operations.

 

 

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

We derive most of our revenues from the sale of a relatively small number of lithography equipment systems (197 units in 2010 and 70 units in 2009), with an average selling price (“ASP”) in 2010 of EUR 19.8 million (EUR 24.1 million for new systems and EUR 4.4 million for used systems) and an ASP in 2009 of EUR 16.8 million (EUR 21.1 million for new systems and EUR 7.9 million

 

ASML ANNUAL REPORT 2010

6

for used systems). As a result, the timing of recognition of revenue from a small number of product sales may have a significant impact on our net sales and operating results for a particular reporting period. Specifically, the failure to receive anticipated orders, or delays in shipments near the end of a particular reporting period, due, for example, to:

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

 

 

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

 

 

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

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

 

 

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

 

 

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

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

 

 

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

 

 

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

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

 

 

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

 

 

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

 

ASML ANNUAL REPORT 2010

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We Are Subject to Risks in Our International Operations

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

 

 

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, 30.6 percent of our 2010 revenues and 27.6 percent of our 2009 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 Taiwanese government. Changes in relations between Taiwan and the People’s Republic of China, Taiwanese government policies and other factors affecting Taiwan’s political, economic or social environment could have a material adverse effect on our business, financial condition and results of operations.

 

 

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

All of our manufacturing activities, including subassembly, final assembly and system testing, take place in clean room facilities in Veldhoven, the Netherlands, in Wilton, Connecticut, the United States and in Linkou, Taiwan. 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 Seek to Implement in Order to Reduce Costs Company-Wide May Be Delayed or Suspended

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

 

 

Fluctuations in Foreign Exchange Rates Could Harm Our Results of Operations

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

 

 

In addition, a substantial portion of our assets and liabilities and operating results are denominated in U.S. dollars, and a small portion of our assets, liabilities and operating results are denominated in currencies other than the euro and the U.S. dollar. Our consolidated financial statements are expressed in euros. Accordingly, our results of operations and assets and liabilities are exposed to fluctuations in exchange rates between the euro and various currencies. In general, our customers run their businesses in U.S. dollars, and therefore a further weakening of the U.S. dollar against the euro might impact the ability of our customers to purchase our products.

 

 

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

 

 

Also see Item 5.A. “Operating Results, Foreign Exchange Management”, Item 5.F. “Tabular Disclosure of Contractual Obligations”, Item 11 “Quantitative and Qualitative Disclosures About Market Risk” and Note 3 to our consolidated financial statements.

 

 

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

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

 

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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 a Sufficient Number of Adequately Educated and Skilled Employees

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

 

 

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

 

 

Risks Related to Our Ordinary Shares

 

We may not declare cash dividends at all or in any particular amounts in any given year

Our policy is to pay a sustainable annual dividend in an amount that is stable or grows over time. However, the decision by our Board of Management in any given year to propose to our Supervisory Board that a dividend be proposed to our Annual General Meeting of Shareholders in any given year will be subject to the availability of distributable profits or retained earnings and may be affected by, among other factors: the Board of Management’s views on our potential future funding requirements, including for investments in production capacity and the funding of our research and development programs, as well for acquisition opportunities that may arise from time to time; and by future changes in applicable income tax and corporate laws. Correspondingly, our dividend payments could decline or be eliminated with respect to any particular year in the future. Such a reduction or elimination in our dividend payments could have a negative effect on our share price.

 

 

The Price of Our Ordinary Shares is Volatile

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

 

 

Restrictions on Shareholder Rights May Dilute Voting Power

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

 

 

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

 

 

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

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

 

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In May 2001, we merged with Silicon Valley Group (“SVG”) (now part of ASML US, Inc.), a company that was active in lithography, as well as in track and thermal businesses, which we subsequently divested or discontinued.

 

 

From time to time, we pursue acquisitions of smaller businesses that we believe will complement or enhance our core lithography business. These have included the acquisition of MaskTools in July 1999 and the acquisition of Brion Technologies, Inc. (“Brion”) in March 2007.

 

 

Capital Expenditures and Divestitures

Our capital expenditures (purchases of property, plant and equipment) for 2010, 2009 and 2008 amounted to EUR 128.7 million, EUR 105.0 million and EUR 259.8 million, respectively. Our capital expenditures in these years generally related to the construction of new facilities in Veldhoven, the Netherlands, for our latest technologies such as EUV and NXT (in 2010, 2009 and 2008) and in Taiwan for our ASML Center of Excellence (“ACE”, in 2008), purchases of machinery and equipment, information technology investments, and leasehold improvements to our facilities (in 2010, 2009 and 2008).

 

 

Divestitures mainly consisting of machinery and equipment (more specifically prototypes, demonstration and training systems) amounted to EUR 6.7 million for 2010, EUR 10.9 million for 2009 and EUR 4.3 million for 2008. See Note 11 to our consolidated financial statements.

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

 

 

Our Business Model

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

 

 

Market and Technology Overview

 

Introduction

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

 

 

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

 

 

Our systems use a mask to achieve the required chip pattern. A mask is a flat, transparent quartz plate containing an opaque microscopic pattern: an image of the electronic circuitry for one layer of a chip. The mask is placed in a scanner where intense

 

ASML ANNUAL REPORT 2010

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light passing through it projects the pattern, via a series of reducing lenses, onto part of the wafer. Before exposure, the wafer is coated with photo resist and positioned so that the projected pattern aligns with existing features on the chip/wafer. After exposure and developing, the pattern left on the wafer surface is used to selectively process and build up the next layer.

 

 

Customer Roadmaps

The three major customer sectors to which the Company sells its products are NAND-Flash memory chip makers, DRAM memory chip makers and Logic processor chip makers.

 

 

Supported by their technology roadmaps, IC manufacturers continue to show interest in shrinking resolution as a means to lower manufacturing costs per unit. We believe that the leading IC manufacturers for both NAND-Flash and DRAM memory, as well as Logic (including Foundry and IDM) and microprocessor units have plans to migrate their production capabilities in the foreseeable future to resolutions close to or beyond 20 nm, for which they will require state-of-the-art lithography equipment.

 

 

Products

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

 

 

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

 

 

Our PAS 5500 product family comprises advanced wafer steppers and Step & Scan systems suitable for i-line, Krypton Fluoride (“KrF”) and Argon Fluoride (“ArF”) processing of wafers up to 200 mm in diameter and is employed in volume manufacturing to achieve design nodes requiring resolutions down to 90 nm.

 

 

We offer TWINSCAN systems, based on i-line, KrF and ArF processing of wafers up to 300 mm in diameter for manufacturing environments for which design resolutions down to 38 nanometer (“nm”) are required. The modular upgradeable design philosophy of the Step-and-Scan product family has been further refined and applied in the design of our most advanced product family. The TWINSCAN platform, introduced in 2000, is the basis for our current and next-generation Step-and Scan systems, which are capable of extending shrink technology down to 38 nm.

 

 

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 benefit from the process enhancements of immersion while continuing to use familiar and proven metrology technology.

 

 

Furthermore, we continuously develop and sell a range of product options and enhancements designed to increase productivity and improve imaging and overlay to optimize value of ownership over the entire life of our systems.

 

 

We are working on an evolved TWINSCAN platform for EUV that extends the industry proven modularity of the NXT system with new innovative technologies to support EUV imaging in several system critical areas, including the EUV light source, the reflective mirror optical system and all encompassed within a vacuum system. The NXE (EUV) platform is equipped with a completely new EUV light source technology, based upon tin plasma, producing light at a wavelength of 13.5 nm. In addition, the NXE (EUV) system has a completely new optical technology utilizing reflective mirrors rather than the traditional refractive optics with a numerical aperture (“NA”) of 0.25. The NXE (EUV) platform operates with a vacuum environment for the light from light source, through the entire optical train to wafer level. With the combination of these revolutionary technologies, EUV offers the potential to provide ASML’s customers a roadmap for future shrink, and we expect it to become the Lithography technology for the next decade.

 

 

Product Development

In 2003, we introduced the second-generation of TWINSCAN systems based on the XT body with a 50 percent reduction in the main production area occupied by our system.

 

 

In 2004, we shipped our first lithography systems based on immersion technology. These shipments marked the delivery of the industry’s first high productivity immersion scanners for mainstream production.

 

 

In 2006, we shipped the industry’s first EUV Alpha Demo Tools to two research institutions, which work closely with most of the world’s major IC manufacturers in developing manufacturing processes and materials.

 

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

 

 

The acquisition of Brion in 2007 enabled ASML to improve the implementation of optical proximity correction (“OPC”) technology and resolution enhancement techniques (“RET”) such as double patterning Technology (“DPT”) and Source-Mask Optimization (“SMO”) for masks. These improvements are extending the practical resolution limits of ASML ArF immersion products. Brion’s computational lithography capabilities enable us to offer products that further improve the set-up and control of ASML lithography systems.

 

 

Brion’s current computational lithography portfolio comprises not only traditional products (such as RET/OPC/DPT/SMO), but also solutions that directly interface with the numerous calibration controls in an ASML scanner to optimize performance. Our computational lithography products capture detailed knowledge of scanner design and real performance, which enables them to accurately predict real-life manufacturing performance. Such predictions are essential in addressing possible ramp-up and yield problems in advance, potentially avoiding months of delay in time-to-market for our customers. The same prediction capabilities allow the ASML scanners to be optimally calibrated for improved performance in production, given specific chip designs or masks, thereby achieving improved yield.

 

 

Once a scanner is optimally set-up for a given application, ASML also offers scanner control solutions that ensure that the performance of the lithographic process remains optimal and stable throughout production. These scanner control solutions also leverage the scanner controls to compensate for potential performance drifts in the scanner itself, as well as in other steps of the device manufacturing process, such as mask deterioration, resist coating fingerprints, etching fingerprints, or chemical-mechanical planarization fingerprints. To ensure optimal control performance, ASML’s scanner control solutions use ASML’s own advanced wafer metrology technology, Yieldstar.

 

 

In 2007, ASML began volume shipment of the XT:1900i, with a new industry benchmark of 1.35 NA, which is close to the practical limit for water-based immersion technology. This optical lithography system is capable of volume production of ICs down to 40 nm and below and is used for high volume IC manufacturing at multiple customers worldwide.

 

 

In 2008, we discontinued research into optical maskless lithography due to the reduced market opportunity for this technology. Research studies on alternative technologies continue for both mask-based and maskless lithography.

 

 

In 2009, we started shipments of XT:1950i systems, the enhanced version of the XT:1900i, with improved throughput of 148 wafers per hour, resolution of 38 nm and a scheduled overlay of 4 nm. This system extended the performance, imaging and overlay specifications of the successful XT:1900i system.

 

 

In 2009, Brion announced Tachyon SMO, a new product that provides the industry with improved manufacturable imaging solutions and is a major advancement of Brion’s industry standard source-mask optimization (“SMO”) technology, which was currently in use by leading logic and memory manufacturers.

 

 

In 2009, ASML introduced FlexRay^tm programmable illumination and BaseLiner^tm scanner matching technology. Together, they offer scanner stability optimization and stabilize manufacturing process windows.

 

 

Also in 2009, ASML announced an improved version of the successful TWINSCAN platform called NXT featuring new stage and position control technology, providing improved imaging and overlay performance for immersion. Initial shipments started in the third quarter of 2009 and volume production and shipments commenced in 2010.

 

 

In the second half of 2010, ASML shipped the first second-generation EUV system. EUV will provide a large “process window” and much greater shrink compared with current approaches and we expect it to become the lithography solution for the next decade. The second-generation of these systems combines a wavelength of 13.5 nm and an optical system with a NA of 0.25 to provide imaging at a resolution of 27 nm. The EUV platform is targeted for production of ICs down to 16 nm and beyond. For revenue recognition considerations, refer to Item 5.A. “Operating Results, Critical Accounting Policies using Significant Estimates”.

 

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The table below outlines our current product portfolio of Stepper and Scanner Systems by resolution and wavelength.

 

 

Current ASML lithography product portfolio of Step & Scan Systems

 

 

Notes:

 

 

 

Sales, Customer Support and Customers

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

 

 

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

 

 

Our field engineers and applications, service and technical support specialists are located throughout Asia, the United States and Europe. ASML has established the ASML Center of Excellence (“ACE”) in Asia. The primary goal of ACE is to serve as a supplementary engine to propel ASML’s long-term growth. ACE features customer support, training, logistics, refurbishment, technology and application development. ACE also enables sourcing of selected equipment modules, components and services in the region. Finally, ACE is used as a training center to develop worldwide talent for ASML’s workforce.

 

 

Customers and Geographic Regions

In 2010, sales to our largest customer accounted for EUR 1,270.8 million, or 28.2 percent of net sales, compared with EUR 348.8 million, or 21.9 percent of net sales, in 2009 (2008: EUR 754.4 million or 25.5 percent of net sales). We expect that sales to relatively few customers will continue to account for a high percentage of our net sales in any particular period for the foreseeable future.

 

 

In 2010, we derived 80.5 percent of net sales from Asia, 15.0 percent from the United States and 4.5 percent from Europe. In general, since ASML’s founding in 1984, the percentage of our sales derived from Asia has increased and the percentage of our sales derived from the United States and Europe has decreased. See Note 19 to our consolidated financial statements.

 

 

Manufacturing, Logistics and Suppliers

Our business model is based on outsourcing production of a significant part of the components and modules that comprise our lithography systems, working in partnership with suppliers from all over the world. Our manufacturing activities comprise the subassembly and testing of certain modules and the final assembly and fine tuning / testing of a finished system from components

 

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

 

 

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

 

 

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

 

 

Zeiss is our sole external supplier of main optical systems and one of the suppliers of other components. In 2010, 31.4 percent of our aggregate cost of sales was purchased from Zeiss (2009: 25.6 percent; 2008: 32.3 percent).

 

 

Zeiss is highly dependent on its manufacturing and testing facilities in Oberkochen and Wetzlar, Germany, and its suppliers. Moreover, Zeiss has a finite capacity for production of lenses and optical components for our stepper and scanner systems. The expansion of this production capacity may require significant lead-time. From time to time, the number of systems we have been able to produce has been limited by the capacity of Zeiss to provide us with lenses and optical components. During 2010, our sales were not limited by the deliveries from Zeiss.

 

 

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

 

 

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

 

 

Pursuant to these agreements, ASML and Zeiss have agreed to 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.

 

 

ASML has a flexible labor model with a mix of fixed and flexible contracted labor in its manufacturing and R&D facilities in Veldhoven, the Netherlands, and payroll employees compensated under a partly variable salary structure through ASML’s profit sharing plan. This reinforces our ability to adapt more quickly to semiconductor market cycles, including support for potential 24-hour, seven days-a-week production activities. By maximizing the flexibility of our high-tech workforce, we can shorten lead-times: a key driver of added value for customers. Flexibility also reduces our working capital requirements.

 

 

Research and Development

The semiconductor manufacturing industry is subject to rapid technological changes and new product introductions and enhancements. We believe that continued and timely development and introduction of new and enhanced systems are essential for us to maintain our competitive position. As a result, we have historically devoted a significant portion of our financial resources to R&D programs, and we expect to continue to allocate significant resources to these efforts. In addition, we have established sophisticated development centers in the Netherlands, the United States and Taiwan. We are also involved in joint R&D 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.

 

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We apply for subsidy payments in connection with specific development projects under programs sponsored by the Dutch government, the European Union, the United States government and the Taiwanese government. Amounts received under these programs generally are not required to be repaid.

 

 

ASML has one of the highest private R&D budgets invested in the Netherlands. We invested EUR 523.4 million in R&D in 2010, compared with EUR 466.8 million in 2009 and EUR 516.1 million in 2008. A significant part of this budget was used for R&D jointly with our suppliers and technology partners. Through direct government grants designed to stimulate high-risk research for the medium and long term future, ASML received R&D credits of EUR 29.5 million in 2010. The Company expects that these R&D credits to ASML will decline significantly over coming years.

 

 

In 2010 we focused our R&D investments on three core programs: immersion, double patterning and EUV.

 

 

Our innovative immersion lithography systems place a fluid between the wafer and a system’s projection lens to enhance focus and enable circuit line-width to shrink to smaller dimensions than what is possible with “dry” lithography systems. ASML pioneered this “wet” technology and has experienced strong demand for immersion-based systems, which have been adopted by most of our customers in all semiconductor market segments, including NAND-Flash memory chip, DRAM memory chip, as well as the Logic processor chip segment.

 

 

We have developed different immersion systems for different customer needs. We have optimized our TWINSCAN XT immersion systems for cost-effective imaging down to 38 nm patterning, and have developed a new dual wafer stage system called TWINSCAN NXT with improved positioning (“overlay”) and imaging. The TWINSCAN NXT platform enables next generations of semiconductors through the so-called double patterning technique which requires two exposures per layer on a chip, enabling precise imaging patterns and lines by using our TWINSCAN NXT planar wafer stage and breakthrough grid metrology. ASML sold 34 TWINSCAN NXT systems in 2010.

 

 

Also in 2010, we achieved a major milestone with EUV lithography when we shipped our first second-generation system to a customer’s manufacturing site. This system will be used by the customers to develop its EUV manufacturing process before high-volume EUV systems will become available, which we expect to occur in 2012, subject to successful implementation of a number of new technologies specific to EUV, including the light source. We anticipate that five additional second-generation systems will be shipped to other customers in 2011. As of December 31, 2010, we had received nine orders for its successor, the third-generation, high-volume EUV systems which are scheduled to ship from 2012 onwards. The NXE (EUV) system, built on an evolved TWINSCAN platform, enables our customers to extend their roadmap towards smaller chip features. EUV permits chip makers to expose a critical layer in just one single step — as opposed to double patterning which requires multiple steps. EUV also has a roadmap from the initial 27 nm resolution down to 16 nm and beyond. We have published a roadmap to develop a range of EUV models, offering the greatest extendibility at the lowest cost of ownership for the future of lithography.

 

 

We complement our scanner products with a rapidly expanding holistic lithography portfolio of software and metrology products to help our customers optimize semiconductor scanner performance, provide a faster start to chip production and achieve better imaging at higher resolutions. Our customers optimize their scanner performance by taking into account the entire chip creation process, from design to volume manufacturing — we call this approach “holistic lithography”. During 2010 we announced broad customer adoption of holistic lithography products as all of ASML’s leading-edge scanners were sold with one or more holistic lithography components. Semiconductor manufacturers face increasingly smaller margins of error as they shrink chip features. Holistic lithography provides a way to shrink within these margins, offering significant revenue-generating and cost-saving opportunities to our customers.

 

 

Intellectual Property

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

 

 

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

 

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In 2007, ASML and Zeiss signed an agreement with Canon for the global cross-license of patents in their respective fields of semiconductor lithography and optical components, used to manufacture ICs. There was no transfer of technology and no payment was made among the parties.

 

 

From late 2001 through 2004, we were party to a series of civil litigations and administrative proceedings in which Nikon alleged ASML’s infringement of Nikon patents relating to lithography. ASML in turn filed claims against Nikon. Pursuant to agreements executed on December 10, 2004, ASML, Zeiss and Nikon agreed to settle all pending worldwide patent litigation between the companies. The settlement included an exchange of releases and a patent cross-license agreement related to lithography equipment used to manufacture semiconductor devices (the “Nikon Cross-License Agreement”) and payments to Nikon by ASML and Zeiss. In connection with the settlement, ASML and Zeiss made settlement payments to Nikon from 2004 to 2007. The license period for certain patents subject to the Nikon Cross-License Agreement, which were not perpetually licensed, ended on December 31, 2009. Pursuant to the terms of the Nikon Cross-License Agreement, the parties have agreed, from January 1, 2010 to December 31, 2014 (the “Cross-License Transition Period”), not to bring suit for claims related to infringement of those patents or for claims related to infringement of patents issued during the Cross-License Transition Period. However, beginning on January 1, 2015, the parties may bring suit for infringement of patents subject to the Nikon Cross-License Agreement, including any infringement that occurred during the Cross-License Transition Period. Damages related to claims for patent infringement occurring during the Cross-License Transition Period are limited to three percent of the net sales price of products utilizing patents that are valid and enforceable.

 

 

Competition

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

 

 

We believe that the market segment for lithography systems and the investments required to be a significant competitor in this market segment have resulted in increased competition for market share through the aggressive prosecution of patents. Our competitiveness will increasingly depend upon our ability to protect and defend our patents, as well as our ability to develop new and enhanced semiconductor equipment that is competitively priced and introduced on a timely basis.

 

 

Government Regulation

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

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

 

 

 

The chart above excludes intermediate subsidiaries; see Exhibit 8.1 for a complete list of our subsidiaries.

We lease a number of our facilities under operating leases. We also own a number of buildings, mainly consisting of the new production facilities in the Netherlands and Taiwan. The book value of land, buildings and constructions owned by us amounted to EUR 399.3 million as of December 31, 2010 compared with EUR 390.2 million as of December 31, 2009.

 

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Subject to market conditions, we expect that our capital expenditures (purchases of property, plant and equipment) in 2011 will be approximately EUR 350.0 million, exceeding 2010 capital expenditures of EUR 128.7 million. Capital expenditures in 2011 will mainly consist of investments in capacity expansion of EUV and NXT production facilities as a result of customer commitments. We expect to finance 2011 capital expenditures out of our cash flow from operations and available cash and cash equivalents.

 

 

Facilities in Europe

Our headquarters, main manufacturing facilities, applications laboratory and R&D facilities are located at a single site in Veldhoven, the Netherlands. This state-of-the-art facility includes 45 thousand square meter of office space and 33 thousand square meter of buildings used for manufacturing and R&D activities. We lease the majority of these facilities through long-term operating leases that contain purchase options. Some of our office facilities at our headquarters in Veldhoven, the Netherlands, are financed through a special purpose vehicle that is a variable interest entity (“VIE”). As of January 1, 2010, we adopted Accounting Standards Codification (“ASC”) 810 “Amendments to FIN 46(R)”, which resulted in the consolidation of the VIE. See Notes 1 and 11 to our consolidated financial statements. We also lease several sales and service facilities at locations across Europe.

 

 

Facilities in the United States

Our United States head office is located in a nine thousand square meter office building in Tempe, Arizona. We maintain lithography research, development and manufacturing operations in a 27 thousand square meter facility in Wilton, Connecticut, and a six thousand square meter facility in Santa Clara, California. We also lease several sales and service facilities at locations across the United States.

 

 

Facilities in Asia

Our Asian headquarters is located in a 425 square meter office space in Hong Kong, Republic of China. In addition, our ACE facility in Linkou, Taiwan comprises clean room (approximately two thousand square meter) and office space (approximately six thousand square meter). The ACE facility supports customers in the Asia-Pacific region by focusing on technology and applications development, equipment support, training, logistics and refurbishment. ACE also enables local sourcing of equipment, components and services. Our new facility in Korea comprises a clean room (approximately 80 square meter) and office space (approximately 4 thousand square meter). The purpose of this new facility is to support a closer working relationship with ASML’s customers in Korea. We also lease and own several sales and service and training facilities at locations across Asia.

 

 

Not applicable.

 

 

Item 5 Operating and Financial Review and Prospects

 

 

Introduction

ASML is one of the world’s leading providers of lithography equipment that is critical to the production of ICs or chips. Headquartered in Veldhoven, the Netherlands, ASML operates globally, with activities in Europe, the United States and Asia. As of December 31, 2010 we employed more than 7,100 payroll employees (2009: 6,500) and more than 2,000 temporary employees (2009: 1,100), measured in full-time employees (“FTEs”). ASML operates in 16 countries through over 55 sales and service locations.

 

 

In 2010, we generated net sales of EUR 4,507.9 million and income from operations of EUR 1,250.7 million or 27.7 percent of net sales. Net income in 2010 amounted to EUR 1,021.8 million or 22.7 percent of net sales, representing net income per ordinary share of EUR 2.35.

 

 

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

 

 

Semiconductor equipment industry conditions

The chip-making business is focused on “shrink” or reducing the size of chip designs. Historically the semiconductor industry has experienced significant growth largely due to the continual reduction of cost per function performed by ICs. Improvement in the design and manufacture of ICs with higher circuit densities resulted in smaller and cheaper ICs capable of performing a larger number of functions at higher speeds with lower power consumption. We believe that these long-term trends will continue for the

 

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foreseeable future and will be accompanied by a continuing demand for production equipment that is capable of accurate production of advanced ICs in high volumes at the lowest possible cost.

 

 

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

 

 

The costs to develop new lithography equipment are high. Accordingly, the lithography equipment industry is characterized by the presence of only a few primary suppliers: ASML, Nikon and Canon. In 2010, ASML was one of the world’s leading providers of lithography equipment (measured in revenues).

 

 

Total lithography equipment shipped by the industry as a whole in the six years ended December 31, 2010, is set out in the following table:

 

 

(Source: Gartner Dataquest)

 

 

For the year 2010, the latest indications of independent market analysts show an increase in total lithography equipment shipped to the market by the industry of 123.4 percent in unit volume and 153.5 percent in value. The year 2010 was characterized by the recovery of the semiconductor equipment industry and resulting higher overall end-demand for a broad mix of systems for all chip layers. In order to meet the increased demand for our advanced technology products as well as for our capacity tools, we almost tripled the output of our factory in 2010 compared with 2009. In the course of 2010, ASML expanded its fixed and flexible workforce and structurally improved cycle times in the second half of 2010.

 

 

Business strategy

The long-term growth of the semiconductor industry is the result of the principle that the power, cost and time required for every computation on a digital electronic device can be reduced by shrinking the size of transistors on chips. Today, chip makers can image electronic circuits and features that are over 6,000 times smaller than they were in the early 1970s. This trend was first observed by Intel co-founder Gordon Moore in 1965, and is referred to as ’Moore’s Law’. Moore’s Law has resulted in our information society with fast wired and wireless communications – built on affordable chips. Moore’s Law also has an impact on the energy usage of chips. Smaller geometries allow for much lower electrical currents to operate the chip. This has helped to contain the world’s energy consumption despite the proliferation of affordable computing. Using advanced semiconductors in industrial and consumer products often provides economic benefits, user-friendliness and increased safety. The technology revolution powered by semiconductors has brought many advantages: not only can information be more widely disseminated than ever before, affordable chip intelligence has also enabled industry and service sectors to create and distribute products and ideas at lightning speed.

 

 

Smarter, smaller and more energy-efficient chips are made with increasingly sophisticated lithography systems produced by ASML. Lithography systems are crucial to the roadmaps of chipmakers to make smaller transistors on chips. ASML’s business strategy is based on maintaining and further developing its position as a technology leader in semiconductor lithography. When executed, this strategy results in the delivery of lithography systems which enable customers to produce highest performance and lowest cost chips. The superior value of ownership offered to customers as a result of ASML’s strategy also maximizes ASML’s own financial performance, aligning the interests of ASML and our customers.

 

 

Sustainability Governance

At the end of 2009, ASML decided to strengthen significantly its policy in the domain of Sustainability and a number of stringent objectives to be reached by 2015. In 2010, the ASML Board of Management expanded the Sustainability Board and assigned a new department Corporate Sustainability to coordinate and execute the sustainability policies. The mandate given by the Board of Management to the Sustainability Board is to review and recommend sustainability policies and management systems, authorize plans or recommend Board of Management, provide guidance to management on objectives and targets; provide oversight and guidance on sustainability performance & targets, monitor and oversee sustainability risk management review and monitor stakeholder relations, and review and make recommendations on Sustainability impacts of major business decisions. The Sustainability Board also determines the scope, provides input, and recommends board adoption of the Sustainability Report.

 

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Sustainability Strategy

ASML’s business strategy is based on maintaining and further developing its position as a technology leader in semiconductor lithography. ASML executes its strategy through customer focus, strategic investment in R&D and operational excellence with a responsibility for sustainability towards our stakeholders. To effectively manage the execution of this responsibility, the sustainability strategy rests on four strategic domains:

 

 

Customer focus

Ensuring customers are served with the right products at the right time, supported by excellent service, is key to ASML’s commitment to a long-term relationship. With high-valued products, customers expect high-quality support customized to their specific requirements. This support includes service engineers, equipped with the latest technical information, to ensure the highest levels of system performance, as well as applications specialists who support optimal system processing and new product implementation.

 

 

ASML aims to deliver lithography systems with the lowest cost of ownership and highest earnings.

 

 

Customer satisfaction is a critical objective of ASML. We have Account Teams that are specifically dedicated to customer satisfaction throughout the lifecycle of our products.

 

 

Through 2010, all of the top 10 chip makers worldwide, in terms of semiconductor capital expenditure, were our customers. We also have a significant share of customers outside the top 10 and we strive for continued business growth with all our customers. We expect customer concentration to increase because of continuing consolidation in the semiconductor manufacturing industry.

 

 

In 2010, our satisfaction ratings by customers surpassed every lithography competitor for the eighth successive year, according to VLSI Research, an independent industry research firm that surveyed customers representing 95.0 percent of the world’s total semiconductor market.

 

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Strategic investment in research and development

Our customer-base relies on ASML to deliver the right technology at the right time to meet long-term roadmaps which often extend many years into the future. To meet these demands, ASML is committed to significant long-term investments in R&D that are not significantly impacted by short-term cyclical swings. ASML has one of the highest private R&D budgets invested in the Netherlands. In 2010, our R&D investments (net of credits) amounted to EUR 523.4 million, an increase from previous years to accommodate the rapid introduction of newly developed platforms which are in demand by customers (2009: EUR 466.8 million; 2008: EUR 516.1 million). A significant part of this budget was used for R&D jointly with our suppliers and technology partners. Through direct government grants designed to stimulate high-risk research for the medium and long term future, ASML received R&D credits of EUR 29.5 million in 2010. The Company expects that these R&D credits to ASML will decline significantly over coming years.

 

 

The foundation of our lithography scanners is our dual-stage wafer imaging platform – the TWINSCAN system – which we introduced in 2000 and which allows exposure of one wafer while simultaneously measuring the wafer which will be exposed next. Our strong leadership in this capability has allowed us to achieve the industry’s highest throughput, enabling reduced cost-per-exposure per wafer. ASML is the only lithography manufacturer that enables volume production based on dual-stage systems.

 

 

We have focused our R&D investments on three core programs: immersion, double patterning and EUV.

 

 

Our innovative immersion lithography systems place a fluid between the wafer and a system’s projection lens to enhance focus and enable circuit line-width to shrink to smaller dimensions than what is possible with “dry” lithography systems. ASML pioneered this “wet” technology and has experienced strong demand for immersion-based systems, which have been adopted by most of our customers in all semiconductor market segments, including NAND-Flash memory chip, DRAM memory chip, as well as the Logic processor chip segment.

 

 

We have developed different immersion systems for different customer needs. We have optimized our TWINSCAN XT immersion systems for cost-effective imaging down to 38 nm patterning, and have developed a new dual wafer stage system called TWINSCAN NXT with improved positioning (“overlay”) and imaging. The TWINSCAN NXT platform enables next generations of semiconductors through the so-called double patterning technique which requires two exposures per layer on a chip, enabling precise imaging patterns and lines by using our TWINSCAN NXT planar wafer stage and breakthrough grid metrology. ASML sold 34 TWINSCAN NXT systems in 2010.

 

 

Also in 2010, we achieved a major milestone with EUV lithography when we shipped our first second-generation EUV system to a customer’s manufacturing site. This system will be used by the customer to develop its EUV manufacturing process before high-volume EUV systems will become available, which we expect to occur in 2012. We anticipate that five additional second-generation systems will be shipped to other customers in 2011. As of December 31, 2010, we had received nine orders for its successor, the third-generation, high-volume EUV systems which are scheduled to ship from 2012 onwards. The NXE (EUV) system, built on an evolved TWINSCAN platform, enables our customers to extend their roadmap towards smaller chip features. EUV permits chip makers to expose a critical layer in just one single step – as opposed to double patterning which requires multiple steps. EUV also has a roadmap from the initial 27 nm resolution down to 16 nm and beyond. We have published a roadmap to develop a range of EUV models, offering the greatest extendibility at the lowest cost of ownership for the future of lithography.

 

 

We complement our scanner products with a rapidly expanding holistic lithography portfolio of software and metrology products to help our customers optimize semiconductor scanner performance, provide a faster start to chip production and achieve better imaging at higher resolutions. Our customers optimize their scanner performance by taking into account the entire chip creation process, from design to volume manufacturing – we call this approach “holistic lithography”. During 2010 we announced broad customer adoption of holistic lithography products as all of ASML’s leading-edge scanners were sold with one or more holistic lithography components. Semiconductor manufacturers face increasingly smaller margins of error as they shrink chip features. Holistic lithography provides a way to shrink within these margins, offering significant revenue-generating and cost-saving opportunities to our customers.

 

 

Operational excellence

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

 

 

Our business strategy includes outsourcing the manufacturing of 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

 

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shared risk and reward. Value sourcing also allows the flexibility to adapt to the cyclicality of the world market for semiconductor lithography systems.

 

 

ASML has a flexible labor model with a mix of fixed and flexible contracted labor in its manufacturing and R&D facilities in Veldhoven, the Netherlands, and payroll employees compensated under a partly variable salary structure through ASML’s profit sharing plan. This reinforces our ability to adapt more quickly to semiconductor market cycles, including support for potential 24-hour, seven days-a-week production activities. By maximizing the flexibility of our high-tech workforce, we can shorten lead-times: a key driver of added value for customers. Flexibility also reduces our working capital requirements.

 

 

In view of the economic volatility of the semiconductor industry, we continue to strive to improve efficiencies in our operations: addressing our cost structure and strengthening our capability to generate cash.

 

 

ASML operations update on key performance indicators

 

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

 

 

 

 

 

Sales

For the longer term, and based on industry analysts IC growth forecasts, we expect our sales level to grow. Our sales levels depend on three growth drivers: market growth, market share growth and a broadening of our product and services scope.

 

 

In 2010, net sales increased by 182.4 percent to EUR 4,507.9 million from EUR 1,596.1 million in 2009 (2008: EUR 2,953.7 million). The increase in net sales was caused by an increase in the number of systems sold and an increase in ASP, reflecting the recovery of the semiconductor equipment industry, started in the second half of 2009 and continued in 2010, as customers invested in KrF systems for basic capacity growth and new leading-edge immersion technology in order to enable new technology ramp-ups. In contrast, the first half of 2009, was characterized by the collapse of the semiconductor equipment demand as a result of the crisis that began in the second half of 2008 and continued in 2009 (“financial and economic crisis”).

 

 

The ASP of our systems increased by 17.9 percent to EUR 19.8 million in 2010 from EUR 16.8 million in 2009 (2008: EUR 16.7 million) resulting from a shift to more leading-edge systems. The ASP of our new systems increased by 14.2 percent to EUR 24.1 million in 2010 from EUR 21.1 million in 2009 (2008: EUR 20.4 million) which was mainly driven by increased sales of our leading-edge technology products (such as XT:1950i and NXT:1950i systems) compared with 2009. The ASP of our used systems decreased by

 

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44.3 percent to EUR 4.4 million in 2010 from EUR 7.9 million in 2009 (2008: EUR 4.8 million) which was the result of a shift in the mix of used systems sold toward more low-end system types.

 

 

As of December 31, 2010, our systems backlog was valued at EUR 3,855.7 million and included 157 systems with an ASP of EUR 24.6 million. As of December 31, 2009, the systems backlog was valued at EUR 2,113.7 million and included 69 systems with an ASP of EUR 30.6 million. The significant increase in our systems backlog reflects our customers’ NAND Flash memory investments for the high volume ramp-up of new technologies and Foundry/Logic commitments for new strategic fab projects, offset by weakening DRAM lithography demand (albeit at a rate less than originally anticipated). The increase will support both technology shrink as well as an increase in manufacturing capacity. ASP decreased in 2010 compared to 2009 because the systems backlog as of December 31, 2010, includes a broad mix of systems for all chip layers, whereas the systems backlog as of December 31, 2009, mainly included new leading-edge immersion technology.

 

 

In 2010, our most advanced volume production immersion system TWINSCAN NXT:1950i, with improved overlay and imaging compared with the TWINSCAN XT immersion systems, continued to ramp-up. The NXT platform enables new generations of semiconductors through the so-called double patterning technique which requires two exposures per layer on a chip. During 2010, 34 TWINSCAN NXT systems were sold.

 

 

Profitability

Our general strategy is to seek to achieve income from operations to net sales of 10.0 to 15.0 percent at the downturn point and 25.0 to 30.0 percent at the upturn point over the industry’s business cycle. However in exceptional circumstances, as evidenced by the financial and economic crisis, we could see periods with results from operations that are substantially below our minimum target level.

 

 

Income from operations increased to EUR 1,250.7 million, or 27.7 percent of net sales, in 2010 from a loss from operations of EUR 163.1 million, or 10.2 percent of net sales, in 2009 (2008: EUR 289.2 million income from operations, or 9.8 percent of net sales). This EUR 1,413.8 million increase was the result of an increase in sales and the resulting increase in gross profit of EUR 1,496.8 million which was partly offset by an increase in operating expenses (consisting of SG&A and R&D costs) of EUR 83.0 million.

 

 

Gross profit increased to EUR 1,955.2 million or 43.4 percent of net sales in 2010 from EUR 458.4 million or 28.7 percent of net sales in 2009 (2008: EUR 1,015.5 gross profit or 34.4 percent of net sales). The higher gross profit was mainly attributable to a significant increase in net sales as a result of the recovery of the semiconductor equipment industry, which started in the second half of 2009 and continued in 2010 as customers invested in KrF systems for basic capacity growth and in new leading-edge immersion technology, in order to enable new technology ramp-ups. The increase in gross profit was partly offset by increased manufacturing costs as a result of longer lead-times in the first half of 2010. Furthermore, our manufacturing facilities were fully utilized in 2010. In contrast, the first half of 2009 was characterized by the collapse of semiconductor equipment demand as a result of the financial and economic crisis. Although the recovery of the semiconductor equipment industry started in the second half of 2009, the full year 2009 gross margin was negatively impacted by very low net sales and underutilization of capacity in the first half of 2009.

 

 

Operating expenses showed an increase of EUR 83.0 million in 2010 compared with 2009. R&D costs increased by EUR 56.7 million, or 12.1 percent resulting from increased spending on our strategic programs, in particular immersion, double patterning and EUV. SG&A costs increased by EUR 26.3 million, or 17.0 percent as a result of both higher sales levels and increased costs to implement and support IT solutions and costs for improvement programs (mainly employee development costs).

 

 

ASML has a flexible labor model with a mix of fixed and flexible contracted labor in its manufacturing and R&D facilities in Veldhoven, the Netherlands, and payroll employees compensated under a partly variable salary structure through ASML’s profit sharing plan. This reinforces our ability to adapt more quickly to semiconductor market cycles.

 

 

Net income in 2010 amounted to EUR 1,021.8 million, or 22.7 percent of net sales, representing EUR 2.35 net income per ordinary share, compared with net loss in 2009 of EUR 150.9 million, or 9.5 percent of net sales, representing EUR 0.35 net loss per ordinary share (2008: net income of EUR 322.4 million or 10.9 percent of net sales, representing EUR 0.75 net income per ordinary share).

 

 

Liquidity

As part of our financing policy we seek to maintain a strategic level of cash and cash equivalents of between EUR 1.0 and 1.5 billion. In addition to dividend payments, to the extent the level of cash and cash equivalents exceeds this target level and there are no investment opportunities that we wish to pursue, we intend to return cash to our shareholders through share buybacks or repayment of capital.

 

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Our cash and cash equivalents increased to EUR 1,949.8 million as of December 31, 2010 from EUR 1,037.1 million as of December 31, 2009. We generated cash from operating activities of EUR 940.0 million in 2010. Furthermore, we generated cash from financing activities of EUR 92.7 million, mainly reflecting deposits from customers of EUR 150.0 million and net proceeds from issuance of shares and stock options of EUR 31.0 million, partly offset by a cash outflow from our 2010 dividend payment (EUR 87.0 million). An amount of EUR 124.9 million of cash was used in investing activities mainly related to machinery and equipment and the start of the second part of the EUV and NXT production facilities in Veldhoven, the Netherlands.

 

 

The Company’s available credit facilities amount to EUR 700.0 million and consist of two facilities: a EUR 500.0 million credit facility and a EUR 200.0 million loan facility. No amounts were outstanding under these facilities during 2010.

 

 

ASML did not repurchase any shares in 2010.  The cumulative amount returned to shareholders in the form of share buybacks and capital repayment between May 2006 and December 2010 was EUR 2,137.7 million. As announced on January 19, 2011, ASML intends to repurchase up to EUR 1.0 billion of its own shares within the next two years and to increase dividend pay-out in respect of 2010 to EUR 0.40 per ordinary share of EUR 0.09 (subject to approval of the 2011 Annual General Meeting of Shareholders).

 

 

In April 2010, the Company paid a dividend of EUR 0.20 per outstanding ordinary share of EUR 0.09 or EUR 87.0 million in total. A proposal will be submitted to the Annual General Meeting of Shareholders on April 20, 2011, to declare a dividend for 2010 of EUR 0.40 per outstanding ordinary share of EUR 0.09.

 

 

Critical accounting policies using significant estimates

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of our consolidated financial statements requires us 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 expenses during the reported periods. Actual results could differ from those estimates. We evaluate our estimates continually and we base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates if the assumptions prove incorrect. To the extent there are material differences between actual results and these estimates, our future results of operations could be materially and adversely affected. We believe that the accounting policies described below require us to make significant judgments and estimates in the preparation of our consolidated financial statements.

 

 

Revenue recognition

ASML recognizes revenue when all four revenue recognition criteria are met: persuasive evidence of an arrangement exists; delivery has occurred or services have been rendered; seller’s price to buyer is fixed or determinable; and collectability is reasonably assured. At ASML, this policy generally results in revenue recognition from the sale of a system upon shipment. The revenue from the installation of a system is generally recognized upon completion of that installation at the customer site. Each system undergoes, prior to shipment, a “Factory Acceptance Test” in ASML’s clean room facilities, effectively replicating the operating conditions that will be present on the customer’s site, in order to verify whether the system will meet its standard specifications and any additional technical and performance criteria agreed with the customer, if any. A system is shipped, and revenue is recognized, only after all specifications are met and customer sign-off is received or waived. In case not all specifications are met and the remaining performance obligation is not essential to the functionality of the system but is substantive rather than inconsequential or perfunctory, a portion of the sales price is deferred. 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.

 

 

In 2010, we shipped our first second-generation EUV system to a customer’s manufacturing site, and as a result, we deferred revenue from new technology systems for an amount of EUR 38.5 million as of December 31, 2010 (2009 and 2008: no revenue from new technology was deferred). During 2010, 2009 and 2008, the Company did not recognize any revenue from new technology that had previously been deferred.

 

 

In connection with the introduction of new technology, such as our second-generation EUV systems, we initially defer revenue recognition until completion of installation and acceptance of the new technology based system at customer premises. Any such deferral of revenues, however, could have a material effect on ASML’s results of operations for the period in which the deferral occurred and on the succeeding periods. As our systems are based largely on two product platforms that permit incremental, modular upgrades, the introduction of genuinely “new” technology occurs infrequently, and in the past 12 years, has occurred on only two occasions: 2010 (EUV) and 1999 (TWINSCAN).

 

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With respect to the third-generation EUV systems which are expected to be available for shipment to customers from 2012 onwards, the Company is currently assessing the conditions upon which revenue would be recognized and whether or not amounts should be deferred. Any such deferral of revenues could have a material effect on ASML’s results of operations for the period in which the deferral occurred and on the succeeding periods.

 

 

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, 2010 and 2009 ASML had no repurchase commitments.

 

 

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

 

 

The deferred revenue balance from installation and training services as of December 31, 2010 amounted to EUR 10.1 million (2009: EUR 3.0 million) and EUR 12.7 million (2009: EUR 10.4 million), respectively.

 

 

The deferred revenue balance from prepaid extended and enhanced (optic) warranty contracts as of December 31, 2010, amounted to EUR 243.4 million (2009: EUR 125.9 million).

 

 

We offer customers discounts in the normal course of sales negotiations. These discounts are directly deducted from the gross sales price at the moment of revenue recognition. From time to time, we offer volume discounts to certain customers. In some instances these volume discounts can be used to purchase field options (system enhancements). The related amount is recorded as a reduction in revenue at time of shipment. From time to time, we offer free or discounted products or services (award credits) to our customers as part of a volume purchase agreement. The sales transaction that gives rise to these award credits is accounted for as a multiple element revenue transaction as the agreements involve the delivery of multiple products. The consideration received from the sales transaction is allocated between the award credits and the other elements of the sales transaction. The consideration allocated to the award credits is recognized as deferred revenue until award credits are delivered to the customer. The amount allocable to a delivered item is limited to the amount that is not contingent upon the delivery of additional items or meeting other specified performance conditions (the non-contingent amount).

 

 

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

 

 

Warranty

We provide standard warranty coverage on our systems for 12 months and on certain optic parts for 60 months, providing labor and parts necessary to repair systems and optic parts during the warranty period. The estimated warranty costs are accounted for by accruing these costs for each system upon recognition of the system sale. The estimated warranty costs are based on historical product performance and field expenses. Based upon historical service records, we calculate the charge of average service hours and parts per system to determine the estimated warranty charge. On a semi-annual basis, the Company assesses, and updates if necessary, its accounting estimates used to calculate the standard warranty reserve based on the latest actual historical warranty costs and expected future warranty costs. The actual product performance and/or field expense profiles may differ, and in those cases we adjust our warranty reserves accordingly. Future warranty costs may exceed our estimates, which could lead to an increase in our cost of sales. In 2010 and 2009, the reassessments of the warranty reserve, and resulting change in accounting estimate, did not have a material effect on the Company’s consolidated statements of operations and per

 

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share amounts. For 2008, the impact of the change in accounting estimate on the consolidated statements of operations and per share amounts was as follows:

 

 

 

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

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

 

 

Goodwill is tested for impairment annually on September 30 and whenever events or changes in circumstances indicate that the carrying amount of the goodwill may not be recoverable. The test is based on a two-step approach for each reporting unit in which goodwill has been recorded. First, recoverability is tested by comparing the carrying amount of the reporting unit including goodwill with the fair value of the reporting unit, being the sum of the discounted future cash flows. If the carrying amount of the reporting unit is higher than the fair value of the reporting unit, the second step should be performed. Goodwill impairment is measured as the excess of the carrying amount of the goodwill over its implied fair value. The implied fair value of goodwill is determined by calculating the fair value of the various assets and liabilities included in the reporting unit in the same manner as goodwill is determined in a business combination.

 

 

All of ASML’s goodwill as of December 31, 2010 relates to the acquisition of Brion in March 2007. For the purpose of impairment testing, goodwill is allocated to the reporting unit Brion. The fair value of the reporting unit Brion is calculated based on the discounted cash flow method (income approach). These calculations use after-tax discounted cash flow projections based on a strategic plan approved by management.

 

 

The material assumptions used by management for the fair value calculation of the reporting unit (based on past experience) are:

 

 

Management believes that the fair value calculated reflects the amount a market participant would be willing to pay. Based on this analysis management believes that the fair value of the reporting unit substantially exceeded its carrying value and that, therefore, goodwill was not impaired as of December 31, 2010 and December 31, 2009.

 

 

ASML performed sensitivity analyses on each of these assumptions and concluded that any reasonably likely change in these assumptions would not have caused the carrying amount of Brion to exceed its fair value. A discussion of the sensitivity analysis is set out below:

 

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Other intangible assets and property, plant and equipment are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of those assets may not be recoverable. Other intangible assets and property, plant and equipment are tested for impairment based on a two-step approach. First, the recoverability is tested by comparing the carrying amount of the other intangible assets and property, plant and equipment with the fair value being the sum of the undiscounted future cash flows. Second, if the carrying amount of the other intangible assets and property, plant and equipment is higher than the fair value the assets are considered to be impaired. The impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the asset.

 

 

In determining the fair value of a reporting unit or an asset, the Company makes estimates about future cash flows. These estimates are based on the financial plan updated with the latest available projection of the semiconductor market conditions and our sales and cost expectations, which are consistent with the plans and estimates that we use to manage our business. We also make estimates and assumptions concerning WACC and future inflation rates.

 

 

It is possible that the outcome of the plans, estimates and assumptions used may differ from our estimates, which may require impairment of certain long-lived assets, including goodwill. Future adverse changes in market conditions may also require impairment of certain long-lived assets, including goodwill.

 

 

During 2010, we recorded impairment charges of EUR 8.6 million in property, plant and equipment of which we recorded EUR 7.3 million in cost of sales, EUR 0.7 million in R&D costs and EUR 0.6 million in SG&A costs. We did not record any impairment charges in other intangible assets. The Company impaired several technical infrastructure items which will cease to be used during the expected economic life due to technical changes relating to NXE (EUV) development. The impairment charges were determined based on the difference between the assets’ value in use (being EUR 0.4 million) and their carrying amount.

 

 

Inventories

Inventories, including spare parts and lenses, are stated at the lower of cost (first-in, first-out method) or market value. Costs include net prices paid for materials purchased, charges for freight and customs duties, production labor cost and factory overhead. Allowances are made for slow moving, obsolete or unsellable inventory and are reviewed on a quarterly basis. Our methodology involves matching our on-hand and on-order inventory with our requirements based on the expected demand and resulting manufacturing forecast. In determining inventory allowances, we evaluate inventory in excess of our forecasted needs on both technological and economical criteria and make appropriate provisions to reflect the risk of obsolescence. This methodology is significantly affected by our forecasted needs for inventory. If actual requirements were to be lower than estimated, additional inventory allowances for excess or obsolete inventory may be required, which could have a material adverse effect on our business, financial condition and results of operations. As of December 31, 2010, the allowance for inventory obsolescence amounted to EUR 189.2 million (2009: EUR 205.2 million).

 

 

In 2010, additions to the allowance mainly relate to certain obsolete parts due to technological developments and design changes. This was more than offset by the utilization of the provision which mainly relates to sale and scrap of impaired inventories. In 2010, ASML made EUR 68.7 million profit on the sale of inventories that had been previously written down (2009: EUR 64.8 million).

 

 

In 2009, the increase was mainly due to a reassessment by the Company of expected future demand based on the unexpected customers’ response to the financial and economic crisis.

 

 

Accounts receivable

A majority of our accounts receivable are derived from sales to a limited number of large multinational semiconductor manufacturers throughout the world. In order to monitor potential credit losses, we perform ongoing credit evaluations of our customers’ financial condition. An allowance for doubtful accounts is maintained for potential credit losses based upon management’s assessment of the expected collectability of all accounts receivable. The allowance for doubtful accounts is reviewed periodically to assess the adequacy of the allowance. In making this assessment, management takes 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 letters of credit, down payments and retention of ownership provisions in contracts, before shipping systems to certain customers, which are intended to recover the systems in the event a customer defaults on payment. We have not incurred any material accounts receivable credit losses during the past three years. Our three largest customers (based on net sales) accounted for 42.4 percent of accounts receivable at December 31, 2010, compared with 44.0 percent at December 31, 2009. A business failure of one of our main customers could result in a substantial credit loss in respect to amounts owed to the Company by that customer, which could adversely affect our business, financial condition and results of operations.

 

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Provisions

Employee contract termination benefits are payable when employment is terminated before an eligible employee’s normal retirement date, or whenever an employee accepts voluntary redundancy in exchange for these benefits. ASML recognizes employee contract termination benefits when ASML is demonstrably committed to either terminating the employment of current employees according to a detailed formal plan where there is no possibility of withdrawal, or when ASML provides termination benefits as a result of an offer made to encourage voluntary redundancy. The timing of recognition and measurement of the provision for employee contract termination benefits depends on whether employees are required to render service until their employment is terminated in order to receive the termination benefits. If employees are not required to render services beyond the minimum retention period, the provision will be recognized at the communication date. If employees are required to render services beyond the minimum retention period the provision will be recognized ratably over the future service period. The provisions are measured at fair value. As of December 31, 2010, the provision for employee contract termination benefits was fully utilized.

 

 

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

 

 

As of December 31, 2010, the provision for lease contract termination costs amounted to EUR 14.1 million (2009: EUR 15.2 million) and relates to an operating lease contract for a building for which no economic benefits are expected.

 

 

Contingencies and litigation

We are party to various legal proceedings generally incidental to our business, as disclosed in Note 17 to our consolidated financial statements. In connection with these proceedings and claims, 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 most cases, management determined that either a loss was not probable or was not reasonably estimable. In 2010, an amount of EUR 1.5 million loss was recorded as a charge to the Company’s consolidated statements of operations (2009 and 2008: no estimated losses were recorded). Significant subjective judgments were required in these evaluations, including judgments regarding the validity of asserted claims and the likely outcome of legal and administrative proceedings. The outcome of these proceedings, however, is subject to a number of factors beyond our control, most notably the uncertainty associated with predicting decisions by courts and administrative agencies. In addition, estimates of the potential costs associated with legal and administrative proceedings frequently cannot be subjected to any sensitivity analysis, as damage estimates or settlement offers by claimants may bear little or no relation to the eventual outcome. Finally, in any particular proceeding, even where we believe that we would ultimately prevail, we may agree to settle or to terminate a claim or proceeding where we believe that doing so, when taken together with other relevant commercial considerations, is more cost-effective than engaging in expensive and protracted litigation, the outcome of which is uncertain.

 

 

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

 

 

Share-based compensation expenses

The cost of employee services received (compensation expenses) in exchange for awards of equity instruments are recognized based upon the grant-date fair value of stock options and stock. The grant-date fair value of stock options is estimated using a Black-Scholes option valuation model. This Black-Scholes model requires the use of assumptions, including expected share price volatility, the estimated life of each award and the estimated dividend yield. The risk-free interest rate used in the model is determined, based on a euro government bond with a life equal to the expected life of the equity-settled share-based payments. The grant-date fair value of shares is determined based on the closing price of the Company’s ordinary shares on Euronext Amsterdam by NYSE Euronext (“Euronext Amsterdam”) on the grant-date.

 

 

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

 

 

We make quarterly assessments of the adequacy of the (hypothetical) tax pool to determine whether there are tax deficiencies that require recognition in the consolidated statements of operations. We have selected the alternative transition method (under ASC 718) in order to calculate the tax pool.

 

 

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

 

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Income taxes

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

 

 

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

 

 

We continuously assess our ability to realize our deferred tax assets resulting, among others, from net operating loss carry-forwards. The total amount of tax effect of the loss carry-forward as of December 31, 2010 was EUR 27.8 million (2009: EUR 107.1 million), which resides with ASML US, Inc. and US based subsidiaries of ASML US Inc. We believe that all losses will be offset by future taxable income before our ability to utilize those losses expires. This analysis takes into account our projected future taxable income from operations and possible tax planning alternatives available to us.

 

 

Consistent with the provisions of ASC 740, as of December 31, 2010, ASML has a liability for unrecognized tax benefits of EUR 162.1 million (2009: EUR 133.3 million). An amount of EUR 143.9 million of this liability for unrecognized tax benefits is classified as non-current deferred and other tax liabilities because payment of cash is not expected within one year, while an amount of EUR 18.2 million of this liability for unrecognized tax benefits is classified as current deferred and other tax liabilities because payment of cash is expected within one year. The 2009 liability for unrecognized tax benefits was classified as non-current deferred and other tax liabilities since at that time, payment of cash was not expected within one year. The total liability for unrecognized tax benefits, if reversed, would have a favorable effect on the Company’s effective tax rate.

 

 

Expected interest and penalties related to income tax liabilities have been accrued for and are included in the liability for unrecognized tax benefits and in the (provision for) benefit from income taxes. The balance of accrued interest and penalties recorded in the consolidated balance sheets of December 31, 2010 amounted to EUR 33.8 million (2009: EUR 28.5 million). Accrued interest and penalties recorded in the consolidated statements of operations of 2010 amounted to EUR 5.3 million (2009: EUR 4.9 million; 2008: EUR 2.1 million) and are included under (provision for) benefit from income taxes.

 

 

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

 

 

 

For the year ended December 31, 2010, there were no material changes compared to 2009 related to the liability for unrecognized tax benefits that impacted the Company’s effective tax rate.

 

 

The Company estimates that the total liability for unrecognized tax benefits will decrease by EUR 30.0 million within the next 12 months. The estimated changes to the liability for unrecognized tax benefits within the next 12 months are mainly due to a cash payment in order to be able to contest the assessment, expected settlements and expiration of statute of limitations.

 

 

The Company is subject to tax audits in its major tax jurisdictions for years from and including 2007 onwards in the Netherlands, for years from and including 2004 onwards for Hong Kong, and for years from and including 2001 onwards for the United States. In the course of such audits, local tax authorities may challenge the positions taken by the Company. For the years 2004 and 2005, the applicable tax rate of taxable profits is subject to tax audits in certain tax jurisdictions.

 

 

In December 2010, ASML reached agreement with the Dutch fiscal authorities regarding the application of the “Innovation Box”, a facility under Dutch corporate tax law pursuant to which income associated with R&D is partially exempted from taxation. This tax

 

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ruling has retroactive effect to January 1, 2007 and is valid through December 31, 2016. Thereafter the validity of this ruling may be extended or this ruling may be adapted depending on a possible change of circumstances. While the Company’s domestic nominal rate was 25.5 percent in 2010, for the ASML entities in the Dutch fiscal group, the tax rate is effectively reduced as a result of the Innovation Box effect for current and prior years. As a result certain Dutch deferred tax assets, Dutch deferred tax liabilities and other taxes will be realized in future years against the reduced effective tax rate resulting from the Innovation Box. The net effect amounts to EUR 26.8 million (loss) or 2.2 percent of income from operations before income taxes. The Innovation Box effect for the current year amounts to EUR 93.5 million (gain) or 7.5 percent of income from operations before income taxes.

 

 

In 2010, ASML recognized tax benefit of EUR 25.6 million or 2.1 percent of income from operations before income taxes mainly attributable to the application of the Innovation Box for prior years, which had a favorable effect on the effective tax rate for 2010 (EUR 37.5 million including interest or 3.0 percent).

 

 

At the end of 2010, the Dutch government enacted a tax rate reduction from 25.5 percent in 2010 to 25.0 percent in 2011. As a result, the value of certain Dutch deferred tax assets and liabilities was reduced by EUR 0.4 million (loss).

 

 

Results of Operations

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

 

 

Set out below our consolidated statements of operations data for the three years ended December 31, 2010:

 

 

 

 

Set out below are our consolidated statements of operations from operations data for the three years ended December 31, 2010, expressed as a percentage of our total net sales:

 

 

 

ASML ANNUAL REPORT 2010

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Results of operations 2010 compared with 2009

 

Net sales and gross profit

The following table shows a summary of net sales (revenue and units sold), gross profit on sales and ASP data on an annual and semi-annual basis for the years ended December 31, 2009 and 2010.

 

 

 

Net sales increased by EUR 2,911.8 million, or 182.4 percent to EUR 4,507.9 million in 2010 from EUR 1,596.1 million in 2009. The increase in net sales mainly resulted from an increase in net system sales of EUR 2,719.8 million, or 231.5 percent to EUR 3,894.7 million in 2010 from EUR 1,174.9 million in 2009. Net service and field option sales increased to EUR 613.2 million in 2010 from EUR 421.2 million in 2009. The number of systems sold increased by 181.4 percent to 197 systems in 2010 from 70 systems in 2009. This increase was caused by the recovery of the semiconductor equipment industry, which started in the second half of 2009 and continued in 2010, as customers invested in KrF systems for basic capacity growth and new leading-edge immersion technology in order to enable new technology ramp-ups. In contrast, the first half of 2009, was characterized by the collapse of the semiconductor equipment demand as a result of the financial and economic crisis.

 

 

The ASP of our systems increased by 17.9 percent to EUR 19.8 million in 2010 from EUR 16.8 million in 2009 (2008: EUR 16.7 million) resulting from a shift to more leading-edge systems. The ASP of our new systems increased by 14.2 percent to EUR 24.1 million in 2010 from EUR 21.1 million in 2009 (2008: EUR 20.4 million) which was mainly driven by increased sales of our leading-edge technology products (such as XT:1950i and NXT:1950i systems) compared with 2009.

 

 

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 2010 increased to 43 from 23 in 2009. The ASP of our used systems decreased by 44.3 percent to EUR 4.4 million in 2010 from EUR 7.9 million in 2009 which was the result of a shift in the mix of used systems sold toward more low-end system types.

 

 

Through 2010, all of the top 10 chipmakers worldwide, in terms of semiconductor capital expenditure, were our customers. In 2010, sales to our largest customer accounted for EUR 1,270.8 million, or 28.2 percent of our net sales. In 2009, sales to our largest customer accounted for EUR 348.8 million, or 21.9 percent of our net sales.

 

 

Gross profit increased to 1,955.2 million or 43.4 percent of net sales in 2010 from EUR 458.4 million or 28.7 percent of net sales in 2009 (2008: EUR 1,015.5 gross profit or 34.4 percent of net sales). The higher gross profit was mainly attributable to the significant increase in net sales resulting from the recovery of the semiconductor equipment industry, which started in the second half of 2009 and continued in 2010 as customers invested in KrF systems for basic capacity growth and in new leading-edge immersion technology, in order to enable new technology ramp-ups. The increase in gross profit was partly offset by increased manufacturing costs as a result of longer lead-times in the first half of 2010. Our manufacturing facilities were fully utilized. In contrast, the first half of 2009, was characterized by the collapse of the semiconductor equipment demand as a result of the financial and economic crisis. Although the recovery of the semiconductor equipment industry started in the second half of 2009, the full year 2009 gross margin was negatively impacted by very low net sales and underutilization of capacity in the first half of 2009.

 

 

We started 2010 with a systems backlog of 69 systems. In 2010, we booked orders for 285 systems, received order cancellations or push-outs beyond 12 months for 0 systems and recognized sales for 197 systems. This resulted in a systems backlog of 157

 

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as of December 31, 2010. The total value of our systems backlog as of December 31, 2010 amounted to EUR 3,855.7 million with an ASP of EUR 24.6 million, compared with a systems backlog of EUR 2,113.7 million with an ASP of EUR 30.6 million as of December 31, 2009.

 

 

The significant increase in our systems backlog reflects our customers’ NAND Flash memory investments for the high volume ramp-up of new technologies and Foundry/Logic commitments for new strategic fab projects, offset by weakening DRAM lithography demand (albeit at a rate less than originally anticipated). The increase will support both technology shrink as well as an increase in manufacturing capacity. The systems backlog as of December 31, 2010, includes a broad mix of systems for all chip layers.

 

 

Research and development costs

R&D costs (net of credits) increased by EUR 56.7 million, or 12.1 percent to EUR 523.4 million in 2010, or 11.6 percent of net sales, from EUR 466.8 million in 2009, or 29.2 percent of net sales. This increase reflects the acceleration of strategic investment in technology leadership in 2010 through investments in the development and enhancement of the next-generation TWINSCAN systems based on immersion, double patterning and EUV.

 

 

Selling, general and administrative costs

SG&A costs increased by EUR 26.3 million, or 17.0 percent as a result of both a higher sales level and costs to implement and support IT solutions and costs for improvement programs (mainly employee development costs).

 

 

Interest income (expense), net

Net interest expense in 2010 was largely unchanged compared with 2009 (2010: EUR 8.2 million; 2009: EUR 8.4 million). Interest income relates to interest earned on our cash and cash equivalents and was more than offset by net interest expense on our outstanding debt in both 2010 and 2009.

 

 

Income taxes

The effective tax rate was 17.8 percent of income from operations before income taxes in 2010, compared with 12.0 percent of loss from operations before income taxes in 2009. In 2009, ASML recognized tax expense of EUR 36.3 million or 21.2 percent of loss from operations before income taxes attributable to the reversal of the 2007 Royalty Box benefit which had an unfavorable impact on the effective tax rate for 2009 (EUR 43.5 million including interest or 25.4 percent). In 2009, based on a tax law change effective January 1, 2010, ASML decided to reverse the Royalty Box benefits of 2007, as management at that time expected that a clean start of the Innovation Box (which under Dutch law replaced the Royalty Box as of January 1, 2010) in 2010 would result in a higher cumulative benefit for ASML.

 

 

In December 2010, ASML reached agreement with the Dutch fiscal authorities regarding the application of the “Innovation Box”, a facility under Dutch corporate tax law pursuant to which income associated with R&D is partially exempted from taxation. This tax ruling has retroactive effect to January 1, 2007 and is valid through December 31, 2016. Thereafter the validity of this ruling may be extended or this ruling may be adapted depending on a possible change of circumstances. While the Company’s domestic nominal rate was 25.5 percent in 2010, for the ASML entities in the Dutch fiscal group, the tax rate is effectively reduced as a result of the Innovation Box effect for current and prior years. As a result certain Dutch deferred tax assets, Dutch deferred tax liabilities and other taxes will be realized in future years against the reduced effective tax rate resulting from the Innovation Box, the effect amounts to EUR 26.8 million (loss) or 2.2 percent of income from operations before income taxes.

 

 

In 2010, ASML recognized tax benefit of EUR 25.6 million or 2.1 percent of income from operations before income taxes mainly attributable to the application of the Innovation Box for prior years, which had a favorable effect on the effective tax rate for 2010 (EUR 37.5 million including interest or 3.0 percent). The Innovation Box effect for the current year amounts to EUR 93.5 million (gain) or 7.5 percent of income from operations before income taxes.

 

 

At the end of 2010, the Dutch government enacted a tax rate reduction from 25.5 percent in 2010 to 25.0 percent in 2011. As a result, the value of certain Dutch deferred tax assets and liabilities was reduced by EUR 0.4 million (loss).

 

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Results of operations 2009 compared with 2008

 

Net sales and gross profit

The following table shows a summary of sales (revenue and units sold), gross profit on sales and ASP data on an annual and semi-annual basis for the years ended December 31, 2008 and 2009.