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ASML Holding N.V. (NASDAQ:ASML)

Q2 2009 Earnings Call

July 15, 2009; 10:00 am ET

Executives

Eric Meurice - Chief Executive Officer

Peter Wennink - Chief Financial Officer

Craig DeYoung - Vice President of Investor Relations & Corporate Communications

Analysts

Nicolas Gaudois - UBS

Simon Schafer - Goldman Sachs

Sandeep Deshpande - JP Morgan

Mehdi Hosseini - FBR Capital Markets

Tim Arcuri - Citi

Kai Korschelt - Deutsche Bank

Francois - Casanov

Andrew Gardiner - Barclays Capital

Jerome - Unidentified Company

Jonathan Crossfield - Bank of America/Merrill Lynch

Operator

Welcome to the ASML 2009 second quarter results conference call, on July 15, 2009. Throughout today’s introduction all participants will be in a listen-only mode. After ASML’s introduction, there will be an opportunity to ask questions. (Operator Instructions)

I would now like to turn the conference over to Mr. Craig DeYoung. Go ahead please, sir.

Craig DeYoung

Thank you, operator and good morning and good afternoon ladies and gentlemen. This is Craig DeYoung, Vice President of Investor Relations and Corporate Communications at ASML, and I’d like to welcome you to our investor call and webcast.

As the operator mentioned, the subject of today’s call is of course ASML’s 2009 second quarter results. With me today at SEMICON West venue in San Francisco, California and co-hosting today’s call is Mr. Eric Meurice, ASML’s CEO and joining us from our headquarters in Veldhoven, the Netherlands is our CFO Peter Wennink.

At this time I’d like to draw your attention to the Safe Harbor statement contained in today’s press release and fourth quarter results presentation, both of which you can find on our website at www.asml.com, and which will apply to this call and all associated presentation materials. I’ll remind you that the length of the call will be 60 minutes.

Now, I’d like to turn the call over to Eric Meurice for a brief introduction.

Eric Meurice

Thank you, Craig. Good morning, good afternoon. Thank you everyone for attending our second quarter results conference call. Peter and I will as usual provide an overview and some commentary on the quarter. Peter will start with the review of the Q2 financial performance and we’ll add some comments on the short term outlook and I will complete the introduction with some further details on our current position and strategy, how we’ll act over the year 2009. Following this introduction, we will open up for questions.

So Peter, please if you will.

Peter Wennink

Thank you, Eric and welcome to everyone. As usual, I would like to take a small amount of time to review some of the events of last quarter, as well as some details on our second quarter results. We closed the second quarter with higher than expected sales; however, they were weak in comparison to this time last year and also week compared to what we consider for the coming quarters.

Our second quarter sales were above our guided range at EUR 277 million. We shipped a total of 10 systems, four of which were new. All new tools shipped were immersion systems causing a new system ASP of EUR 31.1 million, which is very high. The ASP of all systems was around EUR 80 million, but that was helped by the high ASP of used systems over our EUR 10 million, and that was due to the sale of two used immersion tools in a quarter. Our sales revenues rebounded a bit and we reported EUR 94 million services and field option sales.

The company’s second quarter gross margin was 12.5% versus 6.7% in Q1 and this reflects an increase in sales from the old first quarter levels. We maintained our focus on R&D with a spend of EUR 180 million in the second quarter, which has then changed from Q1; and as predicted, the very weak first half of the year did not impact our cash balance. As a matter of fact, we generated cash and even including our dividend payment, we managed to stay virtually even, compared to our cash balance at the beginning of the year. Net cash from operations was EUR 71 million in the quarter.

We ended the second quarter with around EUR 1.1 billion in cash. Like I said, cash flow in the first half was impacted by dividend payments of around EUR 86 million, and capital expenditures of EUR 87 million, mainly relating to the new manufacturing facilities which were finalized in the second quarter.

As for the outlook, Q2 net bookings of 15 systems were valued at close to EUR 400 million. Net immersion bookings were 13 systems and they demonstrated the focus on technology investments. This bookings level pushed our backlog again over EUR 1.1 billion as of the end of the year. The backlog now contains a total of 43 systems, 32 of which are immersion systems, and this includes new and used XT immersion systems, as well as our newest product, the NXT.

We believe investments in leading-edge technologies has resumed in the second quarter and is indicative of a pattern of technology spend that will result in a minimum quarterly net average sales level of between EUR 400 million and EUR 500 million for the next quarters. This range could certainly increase as a result of a need for capacity, in particular for leading-edge technologies traded by a potential recovery of semiconductor growth, even if this recovery is limited, as it is currently little to know excess capacity at the leading-edge.

We expect Q3 2009 sales to be around EUR 450 million with a gross margin of about 30%. Expenses are expected to decrease to EUR 115 million for R&D and EUR 39 million for SG&A. As previously indicated, we manage the company towards breakeven at a quarterly sales level of around EUR 450 million by the end of this year. The targeted cost structure will support all of our strategic R&D programs and allows appropriate upside for sufficient production capacity.

Our cash balance in the second half of 2009 is expected to fall moderately below our EUR 1 billion target as we prepare for shipments of the first NXT systems starting in Q3 of this year and that will accelerate in 2010; as well as we prepare to build UV systems separate for delivery in the second half of 2010. Now all of these products initially carry longer production lead times, which temporarily require more working capital.

Now I’d like to turn it back over to Eric, and Eric will provide more strategy for the coming quarters.

Eric Meurice

Thank you, Peter. So as Peter said, we are indeed recovering to quarterly sales level, which we consider somewhat safe, as these levels are linked to necessary technology transitions buys by our customers, which have to happen even during tough recession. The question is, “When the capacity buys will add-up to the current sale to bring us back to our secular growth trajectory?”

At this point, there are no sustained indications of the world moving out of recession as you know. All our semiconductor units are recovering to at-least the level of 2008 historical peak. We will have to wait for further signs before being able to forecast such recovery, which will translate in lithography sales significantly above the current EUR 450 million quarterly levels that we are guiding at this moment.

We can however note the certain numbers of positive factors. First, the semiconductor industry has significantly shrunk, a total wafer out capacity, in particular by shutting down all 200 millimeter lines which will not come back, and by transitioning to new technologies on the 300 millimeter, which are much more capital oriented. So this reduction of capacity makes a return to unit growths translate quickly to capacity buys, in particular in the leading-edge segment.

Second point, is that the new technologies I’m talking about, which comes from these technology transition buy, are necessary for the DRAM/NAND logic sectors and are very lithography ongoing numbers of players for instance when using double patterning, and they are also lithography critical in terms of overlay, lens resolution, CD control. All this allows us to project a very rich product mix and therefore a high product ASP.

This is a case for the current push, by leading DRAM manufacturers to going through DDR3 memory devices as they provide higher performance, speed and power consumption at lower costs; and the need to differentiate by driving technology even faster to 40 nanometers will support a very healthy high end immersion market in the DRAM business in 2010.

The NAND Flash memory segment, currently ramping 30 nanometer technology, will begin preparation of the 20 or 2X node in 2010, to hit the very important $1 per gigabit target price in order to start significant penetration in the laptop computer market, with solid space drives to replace hard disk drives.

In the third segment, logic and foundry, growth will be sustained by the current aggressive chip transition to 40 or 45 nanometer nodes, which now represent a significant share of the total business. SMS strategy and the ability to invest heavily in multiple technologies in parallel, namely, the XT platform for cost effective solution.

Number two, the NXT platform for clinical application with no equivalent performance on the market today; number three, a suite of litho enablers called Holistic Lithography; and number four, the next generation EUV technology. All these, the four efforts that we do in R&D, they are starting to show its strategic value as the current technology transitions have to rely on the most aggressive technologies, and can no longer be compromised.

In summary, we believe that this recession is allowing us to focus on our technology execution for significant market creditability gain, and will allow us enough sales to manage around the breakeven level, until our semiconductor customers own unit demand from us.

So with this, Peter and I would be pleased to take your questions. Thank you.

Craig DeYoung

Thanks Eric. Ladies and gentlemen, the operator will instruct you momentarily on the protocol for the Q-and-A session, but beforehand, I’d like to ask that you kindly limit yourself to one question with one short follow-up if necessary. This will allow us to get as many callers in as possible.

Now operator, if we could have your instructions and then the first question please.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Nicolas Gaudois - UBS.

Nicolas Gaudois - UBS

First question is on NAND Flash. I mean, you sound a little bit more positive on I guess some of your discussions you have with these two key customers of that; and if we’re looking at such addition rates in NAND Flash beginning pretty much close to saturation as of now, Intel committing on drive acceptance yesterday also improving.

I guess one can construct for the beyond shrink investment of major requirements for capacity as well going back next year? So, if you could give us your view on that as a turning point, it would be great. I will have one follow-up for Peter on margins. Thank you.

Eric Meurice

We had to prioritize the segments which have more gross potential. At this moment we would still position DRAM first. At this moment there is much more activity in the DRAM sector, but closely commend in a sense that there has been significant overcapacity built up in 2008 or so, and you can see that the market demand has been catching up on this overcapacity and therefore main customers are at this moment starting to plan for the restart of their business.

I would guess at this moment, most of the shipments that we will do in the next six months will be going to DRAM and Logic and that the Flash business will start late into the year and into 2010. Added to this, you are starting to see a conversion discussion of NAND from 30 nanometer which is the current new technology to 20 nanometer, which again will start in 2010.

Nicolas Gaudois - UBS

On the cost side, your gross margin guidance for Q3 was probably a third side versus expectations. If you could try five reasons for that and how should we think about gross margins going into the back end of the year towards your breakeven target, in particular for valuable cost accounts? Thank you.

Peter Wennink

With respect to the third quarter, two reasons why the gross margin is a touch life and it has to do with the fact that; one, we are still shipping tools out of all the inventory we purchased in 2008, where we are going to replenish that in Q3 for shipment in Q4. So cost reduction for modules have possibly only entered income statements towards the end of the year, that’s one; and number two is, the cost reduction initiatives that we have started are going to see effect in Q3, but increasingly in Q4.

Those are the two reasons and that bring us to the point where we’ve reached that 450 breakeven point by the end of the year, which is then your driver, what we call the direct material margin, which is currently just a touch over 55%, which you’d go to 60%; and with our current cost structure of lets say 275 per quarter, you can calculate that; that will bring us to a breakeven point by the end of the year.

Operator

Your next question comes from Simon Schafer - Goldman Sachs

Simon Schafer - Goldman Sachs

Just coming back to this question about NAND flash, I’m just wondering what the famous ASML model says about under overcapacity in that segment, because clearly it seems as if the variability towards the end of the year could be coming from that customer base and as to whether that supply and demand is more in balance? Thank you.

Eric Meurice

First of all, thank you very much for calling our model the famous model, which I’ll take as a compliment. The famous model, lets say is basically saying that [will turn] the reduction of capacity in the world because of the retirement of 200 millimeter capacity, as well as the transition to 3X and 4X. We estimate the total worldwide capacity between 2008 and currently 2009 to have shrunk by about 20% at this moment.

So again, the numbers of wafers per month, that the installed capacity the world allows is 20% less wafer per month. So that 20% down in capacity is now hitting the demand curve, which has always been sustained. We think that the demand curve for NAND flash has been about stable’ish to minus 3% to 5%, 2009 to 2008. So this demand has not been shrinking as much as the capacity it has, which again leads us to believe that more than that is why we start seeing some activity.

Booking activity is clearly as I said not for immediate shipment, so there is not a full urgency. The customers are still willing to wait a bit until they see the famous Christmas season that will confirm that we are back into a gross situation, which again will lead us to new shipments into the NAND sector.

Simon Schafer - Goldman Sachs

My second question would be, just of this assumption of the 450 I think you’re saying is or I think you’re still characterizing, is an investment cycle that is really for technology purchases.

So I was wondering whether that means that your mix is still very much skewed towards the margin deliveries, partly because the NXT is kicking off in Q3, but does that mean that your average selling price can be sustain ably as high now, just at least over the near term as it was in Q2? I know that will change once capacity comes back into the picture, but does that mean in the next couple of quarters it stays roughly around the same level? Thanks.

Eric Meurice

Yes, that is correct. Our famous 450 level is based on about 10 to 12 machines and as you can see, you need to be around, on average 25 million to 30 million to get to this level. So we do expect this to be sustained. We expect even the ASP to start growing up a bit more as our mix increases in NXTs versus XTs. The XT as I said is 25 million to 70 million, the NXT will be in the 35 million to 40 million. So you will start seeing this ASP going up to avoid a sort of mix between XTs and NXTs into I would say Q4 and Q1, Q2 next year.

Operator

Your next question comes from [Philips Holter – Unidentified Company].

Philips Holter - Unidentified Company

A short follow-up on the NAND Flash markets; does your guidance assume actually that you will see some orders kicking in already in the second half of this year from the NAND Flash market, or could that be on top of your current sales guidance?

The second question would be maybe a short indication on raw material margins. If I make the right calculation in terms of your cost savings kicking in, I would say that your next cycle peak margins would be close to 30%; is that something you could confirm?

Eric Meurice

I will leave the margin question to Peter. Regarding the bookings, yes there will be bookings of NAND into the second half. Those bookings will translate into sales in 2010 and yes, there is potential for upside above 450 per quarter on demand, but then I would call it capacity drive if I’m right; and the business will recover and you will go back to a curve of growth of unit in Flash. Then it will add-up above 450. Peter, regarding margin.

Peter Wennink

Yes. Clearly, what you would say, the big operating margin is of course very much dependant to what you believe the peak sales will be, but to make things easier for you, you can do your own calculations, we have a direct material margin target of 60% that we will get there.

So if you take a 60% direct material margin on a sales level that you regard the next peak, then you need to subtract per quarter and I talk about quarterly cost, between EUR 290 million to EUR 295 million of cost per quarter; and that is true up to and including a sales level of around EUR 800 million. So when we’re at EUR 800 million, 60% direct material margin between EUR 290 million to EUR 295 million cost level and you can make your own calculation, it’s actually quite easy.

How much above the 800 million you want to go is up to you? That is your own insight, but then you can use that math, whereby cost levels will go up somewhat above that level, but that will be based on variable costs. So we would need some more people, but those will be flex.

Now, how do we come to EUR 290 million to EUR 295 million? We’re currently at EUR 275 million, which is just over EUR 50 million, lower than where we were in the second half of 2008. Actually the cost reduction program has now confirmed that we will sustain 75% of that 50 billion per quarter going forward, even at 800 million sales levels, which would then bring our cost level down to that 290 maximum to 295 levels.

Now, if you run your numbers and you would take let say a peak sales level that is above 4 billion, then you could get to the numbers that you just mentioned. That’s pure mathematics.

Operator

Your next question comes from Sandeep Deshpande - JP Morgan.

Sandeep Deshpande - JP Morgan

Just a question again regarding your famous model; given that semiconductor, there is some [Inaudible] among investors whether this semiconductor equipment market itself will grow in the next five years versus the past five years? What does your model say in terms of, if the NAND Flash market is going to penetrate the notebook as well as server markets? I mean what would be the size of the opportunity for you?

Eric Meurice

Now you can use the term very famous, because your colleague said famous. Now we’ll go up and the very famous model is clearly confirming our target sales of EUR 5 billion to EUR 6 billion in the next three to four years and this is based on an average semiconductor unit growth of about 8% to 9% per year. So we would have to get back to that.

In order to get back to about 8% to 9%, if I remember by-heart, we had a growth of NAND to be in the, I think it was 25% to 30%, and that would correspond to solid state drive reaching a total market share of 10% of all laptops. So if you do, and this happens in the next three to four years, then we get towards our EUR 5 billion to EUR 6 billion sales, which is based on a 70% market share, so you can recreate the total market from there.

So we are doing this simulation on a regular basis, based on what we learn from the different technology mix, because as you imagine, the simulation tool is as good as the assumptions we put in technology transition, multiplied by the price of each of the tools.

So, if what we have today in the next three years or so is a significant growth of technology double patterning of some sort, whether it is a spaced double patterning or more sophisticated double patterning, was a big usage of the NXT machine, which is a machine that offers double patterning to an overlay level of 3 nanometer, which is like half of what is happening today.

We’ve confirmed from the customers that double patterning will require such aggressive overlay. We are the only one offering this type of overlay. We therefore believe that we enable the market to do this aggressive technology and it reinforces our market.

So in conclusion, the simulation tool is always telling us about the same result. Sometimes we change the assumptions on technologies. We still come up with the same numbers, because at the end of the day, the lithography is blest by the fact that this technology transition requires ASP increase and we are supported all the time by either the units or the ASP, but if you multiply both, you get to about the same number.

Sandeep Deshpande - JP Morgan

Just one follow up Peter, when actually following up from the previous question; if you look back at previous cycles for ASML, the two cycles in the 90s saw tropic EBIT margin for the company at only about 20%, whereas in 2007 you saw over 24% in 2006 EBIT margin. Clearly a market share again related thing associated with your revenues.

So I mean, when you talk about this 30% EBIT margin, you didn’t give this figure yourself, but is this because of new cost cuts which you are implementing now or are you talking about, that it is a function of your market share which will be higher as discussed, in the upcoming cycle?

Peter Wennink

Yes, I think the ledger is certainly true. When you talk about 2006, 2007 we have between 55% and 60%. I think we are closer to 70%, so that is share volume and as you know, there’s always a high leverage in the income statement. Like I said, they were over our breakeven point and we would have 60% direct material margin until the EUR 800 million per quarter sealing.

There is an incremental addition to the operating income line of 60% of every 100 million, which is 60 million per every 100 million that you will add, so that goes quick. So I think pure sales volume will indeed help and that will be driven by what Eric said the growth of the market and our 70% market share as compared to the previous cycle where it was any lower; that is a big driver.

The other driver is the cost structure. I think we are focusing on the 60% direct material margin, which we were not at in previous cycles. Also, the addition of more software related products driven by solutions we have in the Holistic Lithography space will also help and those three things. So basically it’s a new suite of products, with more software like margins. Cost reductions that will come through, plus the market share are drivers for the higher EBIT, the margins as going back to the previous cycle.

Operator

Your next question comes from Mehdi Hosseini - FBR Capital Markets.

Mehdi Hosseini - FBR Capital Markets

I have a question going back to your model and I apologize if I’m repeating the question, I joined in late. With migration 2X node for Flash, what kind of dollars of CapEx are we looking at and I will also like to ask the same question about DRAM. I do understand the $5 billion to $6 billion revenue opportunity several years from now, but what happens with Flash and DRAM spending over the next 12 to 18 months? Any color would be appreciated.

Peter Wennink

You take me a bit back, because I would have to answer you a bit scientifically on the standing, reminding myself of all those numbers. I guess that in our model we probably have I think a total conversation to another technology in Flash is in the order of $1 billion to $1.5 billion, but to be honest I would have to confirm that to you. I don’t want to give you wrong numbers.

We are very disciplined as to what we call technology transitions, which we define a certain way and then on top of that you have capacity added. So, I have to be cautious that the technology transition is like recession independent, which is why it was very strong segment that it is 450 million, we have seen this ten times.

The additional capacity built up on the node depend on the numbers of units that this node is going to go far and that depends on the recession or the getting out of recession. I don’t want to talk about that at this moment without coming back to my lawyer; they will incur.

Eric Meurice

Also, I think you need to remember that those transitions don’t take place all at the same time. Customers have different investment patterns, so that is also spent over a certain period and like he is very clear in the DRAM space where you have leaders and you have followers, and it could be easily 12 to 18 months in between.

Mehdi Hosseini - FBR Capital Markets

Sure. Let me rephrase the question; back in 2006, 2007, DRAM spending was between USD 25 billion to USD 30 billion. Given this technology migration, do you think that over the next couple of year we can meet or exceed the 2006, 2007 DRAM CapEx spending?

Eric Meurice

I think we probably are going to meet it, but not for the same reason. In 2006, 2007 there was an actually overspend. Everyone of us were surprised if you remember, even our model of this would go as fast as this. 2007 at the end was probably 50% of the spend when compared, it was a natural growth, but we are pretty optimistic as to DRAM rebuild up of CapEx, mainly because they are ramping now major technology difficulties.

Their transition to 50 nanometer is not easy. This is being done by guaranteed two leaders. Those guys are now running towards 40 nanometer and they are discovering how complicated it is to do these new nodes. So they are ready to go for 40 and 30 type nanometer with double patterning until the transition to EUV, which again is an expensive transition. So through the ASP, the node through the units, we are going to reach the same type level of sale that we had in 2007.

Operator

Your next question comes from Tim Arcuri - Citi.

Tim Arcuri - Citi

How confident are you that you can sustain order growth through the end of the year, if in fact utilization at foundries begins to rollover in Q4 as there are some signs that that will happen. Do you think that the upgrade cycle going on right now and DRAM and later on in NAND, is that actually strong enough to sustain bookings growth in the phase of rolling over utilization at the foundries?

Eric Meurice

Definitely. The current slight pickup that you saw in bookings has been done, based that the halfway through one foundry and the halfway through the second tire DRAM’s. So the next batch of orders in the next six months will be the foundry business as competitors are catching up a bit, as well as in the first year DRAM and as we just discussed, NAND.

There is therefore much more opportunities, more segments, which will pickup in the second half, than the current ones who’ve made our current bookings a bit better. So I would say the current bookings at 394 million and something, 400 million of system, is in the lower side of the equation, as I could project in the second half.

Peter Wennink

On the top of that Eric, if I may add; when you talk about foundry utilization, you have to realize that the leading-edge utilization on 45 nanometers has been very, very high and the introduction of new 40 to 45 nanometer products is now ramping, which the installed capacity at 45 nanometer is still extremely lower as compared to total installed capacity.

So you could indeed see, that if total installed capacity utilization would go done, it doesn’t mean at the leading-edge, which is basically like Eric said only one foundry, that that would go down also with the ramping introduction of new 40 to 45 nanometer products.

Tim Arcuri - Citi

Agreed. I just asked because, we’ve never before seen a cycle where utilization has kind of rolled back over and bookings have not rolled back over. So I’m just kind of wondering why that would be different this time.

Eric Meurice

Tim, the only thing that we are shipping is 45 nanometer technology. We aren’t shipping any additional capacity.

Tim Arcuri - Citi

Right. Just as a quick follow-up; do you think that you’re going to grow immersion backlog in both the September and December quarters?

Eric Meurice

Yes.

Operator

Your next question comes from Kai Korschelt - Deutsche Bank.

Kai Korschelt - Deutsche Bank

My first question is, when you talk about the timing and magnitude potentially of the 40 nanometer or 4X migration in DRAM with the Korean vendors, what are they telling you roughly about those two aspects of it and then I have a follow up, please.

Eric Meurice

What I think we are getting is a lot of load. They have realized that it is strategically important for them to run this new node a bit earlier than planned for obvious strategic reason. At this moment while DRAM business is somehow consolidating, in other terms, where the leaders have to show the colors.

So you are getting much more pressure than those guys saying, “Well, let’s accelerate those nodes,” but as I said, the technology is now extremely complicated and therefore they need the latest technology. So, you get much more interest in our high end machine and with also Holistic Lithography, which enables them to do those designs, so you see that happening.

Clearly, there is going to be a second wave of activities by then, when they are finishing up the recipes and depending on the success of their yield, that we will have a different rank. So in other terms, I expect the first wave of orders and then followed by another one and again the other one; we don’t know yet how successful it will be.

Kai Korschelt - Deutsche Bank

My second question would be, when do you expect sort of government paid out funded DRAM vendors sort of speak in Japan and Taiwan to comeback with orders?

Eric Meurice

That is also a very good question. So, I would try to avoid the specifics of course in our customer data, but you have heard from Japanese side that there is interest to invest the money they have received by the government into also 40 nanometer type technology, and that will be very much done, very near, in parallel with the first tier; so in other terms a ramping into Q1 and Q2 of 2010.

Regarding the Taiwanese part, of course as you know two Taiwanese; part one is the one aligned with the American vendor and the other one aligned with the Japanese vendor. The one aligned with the American vendor, is at this moment planning a ramp of 50 nanometer, which is I would say more of a volume question rather than a technology question. The 4X at this moment is not yet in discussion.

Operator

Your next question comes from Francois – [Casanov]

Francois – Casanov

A quick question on the margins; I’m looking at your accounts, IFRS, and I was wondering when you would officially move to a preview on the IFRS reporting, maybe next year and do we have to mother something like EUR 25 million to EUR 70 million of incremental EBIT per quarter, which it’s linked to a bit of options accountings, but also mostly to amortization of R&D and that things not cash, but probably your headline numbers in the coming years will be around EUR 100 million to EUR 120 million higher at the EBIT line?

Peter Wennink

Yes. I think clearly we don’t run the company or the accounting rules in this antenna, we would just pick the most favorable one. I think we are on US GAAP for the simple reason that ORP is on US GAAP and as you’ve rightly pointed out, I mean, if we would go through IFRS, we would have to capitalize a big part of our R&D spend and then amortize that over the expected lifetime, which would mean that our R&D cost in the IFRS income statement would be significantly lower than we currently show in our US GAAP.

Now my personal view is that, I don’t think that is the right thing to do. I think that given the uncertainly in this industry and IFRS profile, it is good to expense the R&D. So for this particular reason, but also for the reason of comparability with our US piers we stay on US GAAP and we have also a very large contingent of US shareholders.

So you are right, that the EBIT is indeed higher because of the R&D capitalization and the resulting amortization, and since our R&D will go up going forward to a certain level where the capitalization will be higher than the amortization, therefore over a certain period of time we will then have a positive impact on the IFRS results, but that’s something we’re focusing on. Like I said, we’re focusing on comparability and I think also from a company point of view, it’s better to get rid of the R&D spend and not take this in as an asset.

Francois – Casanov

So when you’re talking about big margins, you’re talking US GAAP.

Eric Meurice

US GAAP, yes.

Francois – Casanov

Another question; you’re talking about de-booking in the presentation; I guess that’s all the consolidations. Could you give us a bit of more flavor about those EUR 71 million of orders which have been de-booked? Where are they coming from?

Peter Wennink

This is something which is not an official de-booking. It’s basically a scrubbing of the backlog that we’re doing. We are looking at certain orders where we think, “Will the probability of those orders shipping fall outside the 12 month window?”

If it falls outside the 12 month window we take them out, so it’s our own choice and that has to do with some orders that we received out of Taiwan, where as Eric alluded to, that the financing situation has not improved the government funding; we aren’t seeing yet the results of that. So that’s why we’ve taken a more conservative approach on backlog.

Francois – Casanov

That should be cleaned up by the end of this quarter?

Peter Wennink

Yes or by the end of the year.

Eric Meurice

To be clear, these orders still exist and the customer still expects. It’s just that it’s a delayed shipment and we want to be conservative as a measure of that.

Operator

Your next question comes from Andrew Gardiner - Barclays Capital.

Andrew Gardiner - Barclays Capital

I’d just like a little more detail on the NAND division; is you’re sounding quite confident about the ramp in NXT tools and the interest from the NAND side of the space and in particular regarding the move to solid state drives and that $1 per gig target. I was just wondering, if the lead customers and the lead vendors and that sort of things are giving you any indication as to when they might like to start shipping at those kinds of levels and therefore what kind of confidence you have in terms of the potential of the ramp?

Eric Meurice

No, unfortunately I will be disappointing you. We’re not the specialist of that, so I give you those pieces of data mainly based on editorial comment from our customers, but they do not share with us a product strategy; they just kick us because we are not shipping technology fast enough. So therefore we know they want the machine, then we try to make logic of why they want this, and why they drive technology so hard, but I can’t really tell you much more than that.

The 10% market share target is a well known target by most of those NAND players as you may have heard. I now understand also that they think you will reach that type of 10% range, with a target price of X. I don’t remember for as big as the drive of 60 gig and 120 gig and obviously will be made on 20 nanometer type technology, but again, don’t look at us as the specialty for the application; I can’t really help.

Andrew Gardiner - Barclays Capital

Perhaps on as far as a slightly different angel as it relates to the customers then. You highlighted in the presentation, keeping capacity in your system or your manufacturing side at around the EUR 800 million revenue levels on the quarterly basis.

You’ve clearly recorded ways below that, but I presume you wouldn’t be keeping it at that kind of level, if say over the next three, four maybe five quarters you didn’t think you could get somewhere close to that. So what you’re thinking around that sort of things at the moment?

Eric Meurice

Well, this is a very important question, because we are asking our self that question to manage the company. “How fast a move back to EUR 800 million or more can happen?” The message that I gave in the speech at the beginning was as follows: it says well, we have a base of 450 million. We think that’s a base and kept us for a long time and on top of which will be a capacity buy. Those capacity buys could happen within a quarter. We can get a surprised set of orders, that could definitively be towards EUR 800 million so in a Flash.

So, we absolutely need to have this capacity of EUR 800 million in the book in lieu of that. The reason we think it can be very quick is first of all, we just had one or two flash’s of that already, where we had questions about shipping within lead time or in fact within six months basically, a certain number of tools for capacity reasons; and we know why these things happen within a short time is, there is no excess capacity anymore.

It seems that most of our customers have reached the level of utilization, in particular in the areas where its hot, which is in a new technology, which is too high for taking up side, and therefore if there is anything that happens in the industry, in the world, where you go back to a level of sales of 2008, which would be about 150 billion of unit, if you go back to that level we are 170 billion unit, then we’ll go to 80 billion very quickly.

Operator

Your next question comes from [Inaudible]

Unidentified Participant

I just have a couple of questions, starting with the provisions that you took again on obsolete inventories in the quarter. If you could just indicate whether you booked any of that in the cost of sales in the quarter, because that would add back this EUR 43 million, your gross margins would be closest to 28% rather than 12.5. So I was just wondering why you booked that in the P&L and whether that’s come in already. That’s my first question and I’ve got a quick follow up.

Eric Meurice

As you have seen, not only looking at this quarter but the previous quarters, we always books a certain level of positioning. So taking it all briefly out would be great, because it means we would have absolutely zero obsolescence waste in this company which is not realistic.

You’re right, we have a conservative policy. We are taking provisioning on some of the IRFS that we are doing. We are taking provisioning also on some of the inventories that we are having against the current low level of sales that we are seeing. So yes, we have a conservative policy there. You could say, “Well, if you would have been more aggressive, would the gross margin have been high?” Yes, it would have been higher. How much is difficult to say, because we are consistent in the application of this policy.

Unidentified Participant

That’s quiet interesting. If I basically summarize what we saw it today, are we talking about sort of ballpark, back of the envelope, peak EPS of EUR 2 on US GAAP. If I add that EUR 120 million that you were talking about on the IFRS, if I get another $0.20 and if I taking into account the provisioning that you have on probably capacity related tools that will come in, in the course of 2010, you could easily issue another 5%, at least a five point on gross margins once you reverse those provisions. Your EBIT margins could be quite spectacularly, your above 30% in fact in the next peak.

Eric Meurice

It’s interesting following the line of conclusions, but we cannot comment of course on that, but I think you can probably write something quite interesting on the pieces.

Operator

Your next question comes from Jerome – Unidentified Company.

Jerome – Unidentified Company

First question, do you expect more bankruptcy among DRAM players?

Eric Meurice

There is a possibility that in Taiwan one or two players will go and the understanding that we have is that’s one of the case. The assets maybe transferred to one of the four key players that’s remaining at this moment in this industry.

As you know the four key players are at this moment considered the survivors of all the current consideration and again, the others are going to be aligned to one of the four attempts. They can be aligned with a contract of some sort or they can be aligned just because their assets are being transferred after bankruptcy. So either/or doesn’t change much in what exactly is happening, which I’ll repeat is four key players, four larger companies are now going to go over for a control of this business.

Jerome - Unidentified Company

Okay. Just one follow-up concerning the NAND; how do you see the cost curve of your NAND customer going forward? Because in the past the NAND guide were able to cut the costs by roughly 60% per year and it seem it is slowing down to roughly 30% per year. With dual exposure of tools requiring more lead to steps for the 32 nanometer node, it seems that actually the cost curve declined for the NAND player. It will definitely compare to what happened over the last five years. So, how do you see that going forward?

Eric Meurice

This is a very complicated question, because in this business as know, cost is a factor of volume and excess capacity. So obviously the NAND guides have been burnt significantly by excess capacity, due to the fact that there were too many players and too much expectation. So now it seems that the players have agreed to be less aggressive than the DRAM guys, so they have been more selective as to the build-up of capacity and I explained that in fact we see shrinking of our capacity more than anything else.

We do not see crazy investments, we only see technology investments. So, we therefore expect the Intel base to correspond to the demand and therefore by conclusion, the full cost per chip is going to be under control. Further to that, the design of the chips allows the shrink level, which on paper justifies the price points that would be allowing new applications like the solid state drug.

So those guys seem at this moment to be under control of their cost care. As you said yourself, technology goes down, and helps them not to go down, but mainly they seem to be investing to demand; they don’t invest to market share if you know what I mean.

Operator

Your next question comes from Jonathan Crossfield - Bank of America/Merrill Lynch.

Jonathan Crossfield - Bank of America/Merrill Lynch

I guess my first question would just be on the sort of longer term strategy, which is that as you see sort of margin expansion going forward and we hear increasingly that your competitors are struggling or falling further behind, what do you say is the key challenges for ASML on the sort of five year view to maintain customer relationships as the competitor environment becomes potentially more beneficial to you?

Eric Meurice

It is a very insightful question. If you haven’t guessed it; in fact the last six months for us has been reinforcement of what you said, which is, that our technology over investment I would say is starting to pay.

The technology requirements are very, very strong concerning to the customers and now we’re coming up with products which are absolutely ahead of our competition, whether it is in double patterning or it is in EUV. So, this creates an aspiration by every customer to have a significant strategic relationship with us and a strategic relationship is usually a better thing than the commodity type relationship.

So we are thrilled by this way, but it’s a beginning and we have to execute on it, and executing means making sure the machine works and making sure we do not bring any fear to our customers that we will take advantage of the situation. So, we have to be always on our toes to offer them the technology, with of course the best cost.

You’ve heard Peter spending time explaining that we want our cost structure to be extremely under control. You’ve heard him say, we don’t want to be going for any inflation above the current recession level cost of more than say 10%. If we achieve that, we will offer to our customers the cost a which also allows us to improve a bit of our margin.

The big negative, the concern I have as usual in vocal is, we are a Euro based company and therefore if the macroeconomic trends makes euro good and got overvalued due to financial imbalances in the world, we will be having not such an easy time to enrich our margin, and that is our concern obviously.

We’ve been able to live through this in the past five years. I think if you remember, I mentioned the fact that our competitors have been privileged by a depreciation of the yen by about 60% in four years or something. We’ve been able to manage that and we’re still improving our margin and market share, but we would appreciate that it doesn’t continue in that sense that the euro stabilizes or weakens it would be good. If the euro again gets too strong, then we’ll comeback at this call and continue with a bit of a problem.

Jonathan Crossfield - Bank of America/Merrill Lynch

Just as a follow-up perhaps, could you talk a little bit about the impact of FlexRay and the BaseLiner announcements that came out yesterday on the financials, on the sort of one or two year view? How should we think about that as a margin effect and pricing?

Eric Meurice

I will follow into our relieve remaining contractual, because the whole Holistic Lithography which comes from our acquisition of Brion is mixed into three things. It’s mixed into the price of our machines that we do not discount as we use to. So we strengthened our margins through stronger pricing where we said “No, if that machine is compatible or port the software of Brion, then dear customer you cannot get the same discount.”

The second point is that, we are selling of course Brion’s stuff and our maturity stuff etc, so there is a bit of sales, which at this moment is still under EUR 100 million, but it will start to be visible. In some of the aspects, if it makes our machines more competitive, these options like as you said, the new illuminator which is a completely picologht illuminator maintenance machine, another level above our competition.

So, the three factors are currently reinforcing demand, and this is why Peter was starting to say “Well, we are going to try to improve our material margin by two to three or four points and part of it is included into this value generation thing,” but again it’s hidden in those three factors.

Craig DeYoung

Ladies and gentlemen, I think our time has expired. So if you were unable to get through on the call, we apologize for that, and if you still have questions, feel free to contact ASML’s Investor Relations department with those questions. Now operator, I ask that you close out the call and I’d like to thank everybody for joining us today. We look forward to talking to you through the quarter and look forward to talking to you again at the end of the next quarter.

Operator

Ladies and gentlemen, this concludes the ASML 2009 second quarter results conference call. Thank you for participating, you may disconnect now.

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Source: ASML Holding N.V. Q2 2009 Earnings Call Transcript
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