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ASML Holding NV (NASDAQ:ASML)

Q2 2007 Earnings Call

July 18, 2007 9:00 am ET

Executives

Franki D'Hoore - Director European IR

Eric Meurice - Chairman, President and CEO

Peter Wennink - EVP and CFO

Analysts

Mathew Stevens - Dow Jones

Clare Sieffert

Jérôme Ramel - Exane BNP Paribas

Jay Deahna - JP Morgan

Mehdi Hosseini - Friedman, Billings, Ramsey

Mark FitzGerald - Banc of America Securities

Andrew Gardner - Lehman Brothers.

Rudolf Dreyer - Morgan Stanley

Michael Nordach

Satish Kumar

Matt Gable - Millennium Partners

Timothy Arcuri - Citigroup

Peter Testa - One Investment

Jim Fontanelli

Presentation

Operator

Good afternoon ladies and gentlemen, thank you for standing by and welcome to the ASML 2007 Second Quarter Results Conference Call on July 18, 2007. 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 call over to Mr. Franki D'Hoore, go ahead please, sir.

Franki D'Hoore

Thank you, operator and good afternoon and good morning, ladies and gentlemen. This is Franki D'Hoore from ASML Investor Relations, welcome to our conference call and web cast. The subject of today's call is ASML's 2007 second quarter results, hosting this call today are ASML's CEO, Eric Meurice and CFO, Peter Wennink.

I would like to draw your attention to the safe harbor statement contained in today's press release and presentation. You can find our press release and presentation on our web site at asml.com. The length of this call will be 60 minutes and now at this point I would like to turn the call over to Eric Meurice for brief introduction.

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Eric Meurice

Thank you, Franki. Good afternoon, good morning and thank you all for attending our Q2 results conference call. As it was the case in last quarter's conference call, we will split the introduction in two parts. Peter will start with a review of our Q2 financial performance, which I will comment on our short-term outlook, and that will complete the introduction. With a longer term view following this introduction, we will open up the call for questions. Please Peter.

Peter Wennink

Thank you, Eric and welcome to everyone. First of all, I would like to review the highlights of our Q2 results and in that regard, I am pleased to report that the second quarter developed as we anticipated. In reviewing our results in detail, you have seen that we again reported healthy revenues, operating margins, and net profit for the quarter.

Second quarter revenues were recorded at EUR935 million, roughly averaging what we achieved in the past five quarters. As announced earlier, we have taken a deliberate decision to invest further in R&D and that’s why the operating cost increased in Q2 by EUR4 million to EUR177 million, while keeping our SG&A flat. Posting 41.1% gross margin that resulted in an operating margin in the quarter of 22.2% versus 20.5%, in Q1.

We do remain highly flexible and adaptive to market cycles and although we continue to grow our operational cost base to support our future growth in both our R&D spending and SG&A costs. We keep focusing on creating cost scalability such that we can manage the profitability in any market condition. As a reminder, about 30% of R&D costs are variable within a quarter's time, and approximately 10% of SG&A costs are variable.

Cash flows - cash flow for the second quarter remained well above our operating needs, with net cash from operations in the second quarter at EUR260 million versus EUR173 million in Q1. Also in Q2, we made an announcement on our plan to optimize our capital structure with the issuance of our benchmark Eurobond, followed by a capital repayment and a reverse stock split, which in essence is a synthetic share buyback. And this will result in an 11% reduction in outstanding shares count.

We successfully completed the Eurobond issuance on June 13, raising a total of about EUR600 million to be used to fund, and a EUR960 million return of capital to shareholders. This was approved yesterday at the shareholders meeting. This resulted in a quarter-end cash balance of EUR2.3 billion and a EUR960 million return of capital, which we expect to be completed before the end of the third quarter, or by the end of the third quarter. A gross cash balance of EUR1.3 billion will remain.

Following four strong order quarters, we experienced an expected drop in net bookings in Q2. Total system orders of 30 units, with a value of EUR400 million, left us with a backup value of EUR1.7 billion. And as we predicted, our memory customers hit the peak in terms of older capacity in Q2 and did need to order after several quarters of strong capacity ordering.

Our foundry customers have seen clear improvements in their factory utilization, although an object at the level that they needed to place orders in Q2. All in all, Q2 was a quarter of order digestion, a clear pause in an otherwise, healthy secular trend. Order intakes for leading-edge technology was good especially focusing on our immersion product offering.

But this has left in Q2, to a record order at a selling price of close to EUR17 million per system for new systems. And the total number of immersion systems in the backlog is 25, with a total value of EUR728 million. That is all being to the outlook, with regard to Q3, it is still difficult to call the exact timing of our bookings.

At the exact speed of the order ramp, we will indeed be dependent on the semiconductor Christmas season poll and the resulting framing up of the memory pricing. However, we do believe that we have seen the bottom of the order cycle and our belief is based on several data points.

First, our internal simulation of excess capacity in the memory segment for both DRAM and flash as indicated for sometime now, and supply the remaining balance by the end of the year. We do see additional external evidence of this: a fair pricing for DRAM and flash products; higher than expected DRAM unit growth; and recent increased customer inquiries into our ability to serve their additional capacity needs towards the end of the year.

Secondly, the increasing utilization trend of our foundry customers' is most noticeable in the 200 millimeter segment, where we believe capacity is currently tight. This is reflected in an increased customer attention for used equipment that will translate into orders.

For 300 millimeter capacity, we have seen utilization clearly trending upwards, making the need for additional capacity in the Q4 to Q1 timeframe, very plausible. And thirdly, we have strong confidence in the execution of our leading-edge technology roadmap.

Our 1900i has shown solid performance, clearly meeting our expectations. 2008 technology transition for NAND customer to sub-50-nanometer features, and DRAM and foundry customers to sub-60-nanometer features, will be a strong driver for leading-edge technology orders.

So in summary, we believe that we have seen the order thrive in Q2, and we are looking at an increased order momentum, accelerating in the second half of this year.

With this, I would like to end my part of the introduction. And I would like to turn back to you, Eric.

Eric Meurice

Thank you, Peter. Peter basically confirmed that ASML is proving successful in managing through the cycle, as our activity is sustained by a long-term growth trajectory, the famous secular growth curve.

This growth trajectory is supported among other things by our execution on technology, value of ownership, and lead time.

Regarding technology, we continue to reinforce our market-leading position, in particular, in immersion. To date, over 2 million wafers have been imaged on ASML immersion systems, almost double the total at the end of the first quarter.

This confirms our customers' cheap 6x and 5x nanometer nodes production ramps. It also solidifies our position as market leader, through the significant experience accumulated in the industry on the ASML architecture.

To reinforce further our position in immersion, we shipped our new TWINSCAN XT:1900 immersion tool, as planned, in early July. This 1.35 NA machine is the worlds' first 36.5 nanometer half pitch exposure capable tool at a unique 131 wafer per hour throughput, a major accomplishment.

We expect to ship about 35 immersion tools this year, including more than 15, 1900 machines. This is supported by a strong immersion portion of our total backlog, at about 42% in value.

To further strengthen our technology leadership, ASML has again increased its R&D, this time by EUR220 million per quarter. This will support the development of next generation machines like double patterning and EUV machines, but it also supports lower cost of ownership, ArF, KrF and i-line machines.

We have, for instance, announced the TWINSCAN XT:1000 at SEMICON West, in fact, two days ago. This new high NA KrF machine can save our customers up to 30%, in fact, 30% or more, when processing less critical layers, like layers up to 90-Nanometers features at an unparalleled 165 wafers per hour. And these are awesome numbers.

We are also making good progress on the development of our famous XT body, which is a current product in production. And this concept will address customer requirements for double patterning, such as productivity and overlay.

Regarding cycle time, which is a key driver to reduce our working capital, while offering customers short lead time and capability to ramp up or ramp down fast with the cycle, we are making continued progress.

We are now able to assemble our products between 10% and 25% faster than last year. This, in combination with our renewing fast installed time is helping customers manage the market uncertainties, while allowing us to react quickly to business turns.

So in summary, we confirm our customer value generation proposition, to a technology, value of ownership, and cycle time dealership. We, therefore, feel confident in our ability to continue to grow market share. We also believe that this strong proposition helps us deliver financial results for the cycles, swings of which are shallower and shorter than before.

On this point, we believe that our order momentum is set to rise as Peter explained on H2 2007, and we confirm our expected revenue growth forecast for the total year 2007.

So now Peter and I will take your questions.

Franki D'Hoore

Ladies and gentleman, when asking a question, please identify yourself and your organization. And we also kindly ask you, that you would limit your question to one with one short follow up. And this would allow us to get as many callers as possible. So operator, could we please have the first question now.

Question-and-Answer Session

Operator

Of course, thank you sir. Ladies and gentleman at this time we will begin the Q&A session. (Operator Instructions). One moment please for the first question. Today's first question is from Mr. [Segos]. Please announce your company name sir. Go ahead please.

Mathew Stevens - Dow Jones

Good afternoon and this is [Mathew Stevens] from Dow Jones. I have a question regarding the sales development, now you expect orders to increase in the second half of this year what does this mean for the sales projection of 2008 compared to 2007. Can you just tell me little bit more about that? And I would like to know what the market share is at the moment?

Peter Wennink

To answer your last question the market share is first; we anticipate between 63% and 65%. And for 2008 Eric shall.

Eric Meurice

Yes 2008, difficult to call, early to call, we never call so early, but I can give you a certain number of facts so that you can position 2008. First important fact is the one that says we are confident that we are going to get out of 2007 with a balanced capacity demand. So in other terms, we have often said that we are building a lot of capacity in the DRAM and flash businesses, which will take until the end of year 2007, to be fully in balanced with demand. So we expect that to happen, so we expect to get into 2008 with a, obviously get fully utilized, optimum capacity level. So it's a clear plate.

Factor number two, if you read all the analysis from Gartner, VLSI, Insight etcetera, they all plan for a semiconductor unit growth in 2008, which would be higher than the one of 2007. We go and so the latest number I think call for all of them for above 10% unit semiconductor gross and this is the driver of our business. So we therefore expect, if those analyst are correct on IC business, we expect it to be, therefore a good year on litho.

Third point of importance, is one that concerned to technologies. We, as we have said, we are ramping immersion very quickly as of now. Immersion is getting into production for the flash nodes at the 5x level that is 50-nanometer and above.

We expect in 2008, that the flash customers are willing to ramp 4x nodes to another completely different node in high volume and we expect the DRAM customers to start ramp for the first time, immersion into their business. And as you know DRAM today is still a business, which is twice the size of flash, so if they do ramp immersion into this business we obviously feel very comfortable and optimistic.

So you add the fact that the foundries, and this my five points, the foundries haven’t been I would say fairly aggressive in capacity building in 2007 and this is in Japan and is still within the numbers that we are coding, which are good numbers. But we would accept that foundries may become more aggressive, because the utilization rate is now already in good level.

So that another we would call that says, if they do buy they may buy end of year or beginning of 2008 and that also we would call 2008 as a good year. So I think that’s all facts I know that tells you at this point we are fairly optimistic.

Mathew Stevens - Dow Jones

Thank you

Operator

Your next question is from [Ms. Clare Sieffert]. Please state your company name followed by your question.

Clare Sieffert

Hi. The question, the earlier range for immersion for 2007 was about 35 to 40, now its about 35, does it means the range has been narrowed so to just interpret it that way?

Eric Meurice

No its reading of uncertainties of life, the nearer you get to reality the more you get conservative in the fact that you can always slip to three machines from one year to the other. Remember we are ramping the 1900, it’s a new machine, the first machine shipped two weeks ago.

We are now going to commit 15 machines or more of that caliber. This would be the first time ever we are able to ship so many, if I remember in six month we shipped less than that with 1700, which is a predecessor, so you’re about technicalities here, complexity to do this. But demand-wise, we have a demand above 35.

Clare Sieffert

Okay, thank you. And a follow-up, can you elaborate on a new platform development, what are the key franchises you are trying to establish within the new platform and how are you progressing on it?

Eric Meurice

Cheaper, better, nicer.

Clare Sieffert

Okay.

Eric Meurice

Yeah, that is faster. Clearly, we have a new concept that can run faster and better overlay, if you do double patterning, that is you have to imagine very tight designs, very near each other, one on top of the other, you need an overlay capability, which is effective magnitude better than what we do today. Today, we do 7 nanometer overlay, we’d need to reach 4 or 3 nanometer overlay to do double patterning. So, there is a significant precision requirement. In addition to that, we also want to add to our structures, our platform a cost incentive, we are moving our costs down. We have some ideas about using sensors which are cheaper etcetera, etcetera. So, that is basically what we are putting in that. How do we progress? Well, thank you. We cannot yet say when we will introduce those.

Clare Sieffert

Okay, and the pilot.

Peter Wennink

Can we go to the next question?

Clare Sieffert

Okay, sir. Thank you.

Eric Meurice

Thank you.

Operator

The next question is from Mr. Jérôme Ramel, please state your company followed by your question.

Jérôme Ramel - Exane BNP Paribas

Yeah, good afternoon. Jérôme Ramel from Exane BNP Paribas. I got one question concerning the 1900 you mentioned, so it’s shipping now in Q3, and I was just wondering what could be the time lag between, I am just wondering if we can have a kind of let's say one year, three year of timeframe between the 1900 you mentioned in EUV with no real new innovation in term of tools because in terms of resolution you are going to be limited. I was just about wondering how that will fit into your road map.

Eric Meurice

Well two questions the overall call it product road map. You are going to have the 1900 which you just we said is probably the most aggressive water-based machine ever scientifically possible what we call 1.35 NA may we can get to 1.37 or something but that's a limit of technology.

The next technology is double patterning that is you use the same NA but you are able to expose twice. The masks are cut in two and you expose nearer each of the pattern, you expose them nearer to each other and this is why I say that you do not have anymore CD requirements which comes from the numerical aperture but you have an overlay requirement and that's what we are going to create with this new architecture we just talked about and this will be the next machine. And then comes the EUV machine which is the solution to the CD and for the next generation as low as say 15 nanometer or even lower.

Now these road maps of machines 1900, the double patterning machine and then EUV machine will be used differently at different times by the different segments of the market. You're going to have people jumping immediately or as fast as they can on EUV because EUV will give them what they need in terms of cost and throughput and simplicity of design. But some others may just say no, I can do business with double patterning, because double patterning it would be cheaper in those types of applications or will help them design. So, we expect for a period of time between say 2009, '10, '11, '12 a significant overlap of the different technologies. And additionally we will cover all the grounds, we will cover these different technologies and we are not going to be thinking that one is going to win against the other, they will all cohabit.

Jérôme Ramel - Exane BNP Paribas

Okay, and in terms of follow-up on this, of double exposure is an acceptable solution for the industry, when we talk about the throughput?

Eric Meurice

Well this is in fact the issue, it is more expensive because you have to double pass, but the good news is we are raising the throughput of our machine to reduce in fact the cost of each pass. So, you can say on one hand, we are going to increase or reduce, no increase the speed of these machines, so the double patterning itself will be less costly then double passing. But these machines are also going to be used in single pass and that will cost reduce the single pass. So, if you try to understand, what I am trying to say is when they double pass it's going to cost a bit more, when they only single pass the rest of the layers it would be much cheaper. So, in total it's not a bad proposition.

Jérôme Ramel - Exane BNP Paribas

Okay, thank you very much.

Operator

The next question is from Mr. Jay Deahna, please state your company name followed by your question.

Jay Deahna - JP Morgan

Can you here me?

Eric Meurice

Yes.

Jay Deahna - JP Morgan

Okay, JP Morgan. Good afternoon, gentlemen. I think it's pretty clear at this point that a lot of DRAM companies, because of price weakness it was pretty sharp in the first half of the year have accelerated their node to 70 nanometer process technology this year, which means probably that the next half node shrink, is into the 55 or 60 nanometer range next year. Which I believe, would require the start of using immersion tools.

So over the last 90 days or so, has your expectation for the number of immersion tools that we are shipping at the markets, specifically the DRAM companies in the first half of next year change at all?

Eric Meurice

Yes, this is a very good point. And you can see now an acceleration of the immersion capacity discussions at this very moment. And it is driven by the three segments. Flash obviously they want to do more at 5x, but they also want to develop 4x and introduce 4x probably in the mid of 2008.

Then you have the DRAM people, as you said, who are going to really ramp the new nodes early into 2008. But obviously, the logic people are starting also to be ramping and foundry people are getting aggressive. So yes, 2008 looks a bit more aggressive at this moment then we planned originally.

Jay Deahna - JP Morgan

Okay. Just a follow up on that, Eric. In light of that change, have you provided an increase in your procurement forecast for immersion sub-systems to your supply chain recently to get ready for that? And lastly you mentioned something about better than expected unit demand for DRAM this year. Could you expand on that comment please?

Eric Meurice

Excuse me, the last two question Jay, I could not hear.

Jay Deahna - JP Morgan

Okay the first part is

Eric Meurice

Is the supply chain, yeah.

Jay Deahna - JP Morgan

Why is the fact that immersion tools might shift more than you thought 90 days ago in the first half next year. Have you begun to move your supply chain, in terms, given them a higher forecast for procurement of subsystems for immersion this year to start setting up for the ramp in the first half of next year, that's the first question. And the second one is, you mentioned earlier that DRAM units are running stronger than expected this year. I was wondering if you could put some more details behind that comment.

Eric Meurice

So on the supply chain, yes of course. We are at this very moment moving up capacities at our fairly long term component builders, in particular lengths. And yes, at this moment we received a positive feedback that there is capacity. So this plus our own build up of our new factories, for which you can see a photograph on the website, will allow us to be hopefully not capacity limited in 2008, our own as well as suppliers.

Regarding DRAM, I think the official statistics says that DRAM units has grown by in fact 50% to 60% year-to-year in the past four months or so. This is higher than what anybody expected. This was hidden basically by the fact that the price went down. So the total value DRAM business didn't go as fast, but the unit DRAM business was tremendous, 50% to 60% unit gross year-to-year.

Gartner and others think that the growth curve is going to be reduced a bit, and that would be I would say natural, from this 50%-60% to levels of 40%ish. If you talk to others, it would go 35 or 30%. But in total, still a significant growth on the total year.

So in other terms, all our calculations where we say we are going to have a capacity field by the end of the year are based on the lower number, that is the lower collection of numbers of the DRAM sold at the end of the year and not a projected Q1 number which is very high.

Jay Deahna - JP Morgan

Just last follow-up, do you have

Franki D'Hoore

Please, can we move it fast?

Jay Deahna - JP Morgan

Thanks a lot.

Franki D'Hoore

Thanks Jay.

Operator

Our next question comes from Mehdi Hosseini. Please state your company name followed by your question. Mr. Hosseini?

Mehdi Hosseini - Friedman, Billings, Ramsey

While you were talking about semiconductor unit growth of more than 10%, that is projected for 10%. And looking at what the immersion unit bookings growth from the 2006 into 2007, which was around more than 50%. Would you expect that kind of a gross in immersion unit shipment from ’07 to ’08, given those kind of a semi unit growth?

Eric Meurice

Yes, we expect high growth, but I would prefer you do not ask me so much at this moment. We don’t want to guide precisely at this time. But, yes, obviously there will be a higher mix of immersion next year than there would be this year and if you overlay this to the fact that there will be more units in general than you concur.

Peter Wennink

Just like Eric said, it's DRAM and NAND that we’ll use it for ramping up in our volume production as opposed to only being basically NAND or the other flash makers in 2007.

Mehdi Hosseini - Friedman, Billings, Ramsey

Given the prospect of those kinds of revenue growth from '07 to '08, would it be fair to say that there may not be as much margin expansion, it's just that the revenue growth prospects look good?

Peter Wennink

As we have said in the previous calls also margin expansion is driven by the fact that, yes, we do have a higher top line that contributes to a better coverage of our fixed cost. Now, as you know, the impact of that is limited in the sense that more than 90% of our cost of goods is outsourced. And so it means that our fixed cost has substantial, total cost of goods is not that high.

So there is some positive impact on that, but the longer term margin expansion, as we have said during the previous calls is also driven by the fact that we are going forward and looking at our extend lithography strategy are going to focus more on integrating, metrology solutions for our customers and also the computational lithography, competencies that we have now in house to the Brion acquisition that are going to lead to product offerings that can have the, have a higher gross profit. Those will include more software year related sales, and that will over next couple of years have a positive impact on the gross profit.

So for 2008, yes there will be some impact. It won’t be significant, because of the higher level of sales at longer term, it is the product differentiation lets say as part of the extend litho strategy that is going to take care of that.

Mehdi Hosseini - Friedman, Billings, Ramsey

Alright, thank you.

Operator

Next question comes from Mark FitzGerald. Please state your company name followed by your question.

Mark FitzGerald - Banc of America Securities

Banc of America Securities. When you look at the order recovery in the second half this year, is it strong enough particularly on a value basis to support year-over-year growth into the first half of next year, so when we look at the January and April quarters next year, are you confident enough that the bookings in the second half of this year will drew year-over-year growth.

Peter Wennink

We know, because any of these, as you said, returned back of those plans, you retake some time with the customers to be negotiated, understood etcetera. So it’s always a gradual thing. And remember, we are on the fairly high backlog, nobody, I mean, it is last two quarters ago 1.7 billion, would have been considered anyway top of the range.

So you need, we already covering a lot of this growth we are talking about an optimism in 2008 with some orders, which are already in house. So we expect to gradually phase in more orders into Q3, which will also, which could be parallel to the customers taking their usual decisions about which product they take etcetera, etcetera.

Eric Meurice

And that means that the total size of the order in taking in the second half of this year is still a bit unknown and with that it’s also I think a bit too early to give you an exact guidance on how our sales levels will be as a result of that, in the first time of 2008. So it’s a bit too early to answer that question, it’s probably more capable of answering that in next one or two quarters.

Mark FitzGerald - Banc of America Securities

And just a second follow on. Can you us some guidance in terms of 2008 for the R&D and some idea what short comings are going to happen here with the changes that you just identify today.

Eric Meurice

That’s very good question, because we are giving our surface litho number scenarios. We clearly can develop a lot of our programs with 120 million per quarter, but of course we have some appetite for even a stronger market share gain, as well as, development into I will call it software business around lithography, what we call diversified lithography, the true expanding Brion and online metrology.

So these things may require a bit more money and at this moment we are assessing the best timing, for that. Obviously, if we grow our top line well and fast we will put much more money in R&D, faster than if we don’t. So there is a bit of a discussion at this moment internally about all these good ideas about diversified lithography and when we can afford it to maintain a significant financial performance.

Peter Wennink

And on the share count, I would say Mark, we have in 2006 and 2007, the one we have completed by the end of this quarter, the synthetic share buy back that I have been talking about. We have bought back, more than 20% of the outstanding share capital on a fully diluted basis.

Now that was done on the back of, strong operating cash flows, but also let’s say restructuring the balance sheet of the company, still leaving us by the end of the year with a cash balance that is right in the middle of our target. So that means, that any positive cash flow and cash generation in the years to come we have said that earlier, we will use for further share buybacks. Now how much that will be is off course dependent on the operational performance next year and the years to come that direction of the company is quite clear.

Mark FitzGerald - Banc of America Securities

Thank you.

Operator

And next questions comes from Mr. Andrew Gardner please state your company name followed by your question.

Andrew Gardner - Lehman Brothers.

Hi. Good afternoon, Andrew Gardner from Lehman. During some of your comments you have given us some color on the memory orders you have had as well on the foundry side and where you think things maybe trending for the second half of the year.

I was just wondering if you could give us a little more insight into the third lag of the business on the IDM side based on the shipment date provided and the backlog, it looks as though orders did in fact weaken in that area in a second quarter after what was quite a strong Q1.

I am just wondering whether that's anything you are concerned about particularly given you have highlighted in the past that the IDM’s are some of your most predictable customers, is that second quarter weakness more reflection of the very high levels of orders you saw in the first quarter and should it as that works through, should we see more stable trends in the second half of the year or any other incremental information you can give us that will be very helpful. Thank you.

Eric Meurice

Yes, very good question also unfortunately it's going to be harder and harder for us to answer and for the following reason. IDM does not exist any more as of Q1 you have basically Intel and AMD on one hand and then you have the other guys who now are using more and more foundry.

So, in other terms, we are now seeing more foundry activities because they are ramping and building capacities for the new customers who are making use of them more, TI official, Freescale, ST, etcetera are at this very moment discussing the appropriate capacity to be reserved at their privileged partner foundries. So, you are going to see the IDM sectors, this sector become smaller that was a legacy products and some duplicate products, because some of them we want to have a fab replicating what the foundry does, but at much lower level.

So, this transition is happening at this moment and it is very difficult for me to make a trend, at this very moment. But we don’t care too much, because it would be either there or at the foundry place.

Regarding Intel and AMD, now that is difficult for me to talk about because we are not giving the information on customers plan. So, we want to give you as much information as possible. So, the only thing I can say at this moment is as you have heard from Intel directly is that the PC business vendor and products are doing good. So volume-wise this business is highly sustained. Obviously, the two companies AMD and Intel are working hard on their own efficiencies and we are helping them build up an efficient capacity in the production environment. So, the only I can say, again is, volume is sustained in their business, which is good and we are very working closely with them to build up and add more chips out of whatever we ship them.

Andrew Gardner - Lehman Brothers.

Okay, thank you, guys. And just to confirm what you were saying about those vendors that are moving towards more of a foundry model. I mean, that is something that you actually started to see in the second quarter then, and is expected to slump, did that continue to the second half?

Eric Meurice

Well, it started in terms of discussions and negotiations and understanding of compatibilities and etcetera, yes. Did it start in terms of our shipping, no.

Andrew Gardner - Lehman Brothers.

Okay, thank you very much.

Operator

Next question is from Rudolf Dreyer. Please state your company name followed by your question.

Rudolf Dreyer - Morgan Stanley

Yes, Rudolf Dreyer from Morgan Stanley, good afternoon, gentlemen. Just a further question on gross margins, you did talk about a bit about the capacity expansion and the impact on gross margins. How it seems second quarter of last year you've managed to actually be above your 40% or stock of 40% target. You perhaps spoke about what's being driving that whether that's purely volume related or where they have been changes in the pricing environment or mix kind of helped you a few margins?

Peter Wennink

It's all a bit of what you said but you forgot one thing it has cost of goods reductions. So it's a rate of mix, cost of goods reductions it's been pricing because of the fact that we have come out with the products that have a better value of ownership propositions to our customers which we get a better price for. It's basically all a bit of that.

Now the capacity expansion going forward will of course add to our fixed cost base, but also we will create the opportunity to sell more tools. And like we said on the previous call when we had run the numbers the capacity additions here the fixed cost will not have an impact on our regular point for December, reason that we have a selling price increase is going to pay for that. So, the absolute amount or the absolute amount of gross margin that we will get from the higher ASPs will cover our fixed cost than our extra result of this capacity expansion.

So, it's a bit of all of it and as you've seen it's been let's say it's been a gradual increase. Which a couple of you can say with 20 to 30 basis points per quarter. That is all the result of all the things that you've just mentioned. So, it's a bit of everything.

Rudolf Dreyer - Morgan Stanley

Excellent, and then just a follow-up on M&I, may I, sorry for you said probably about EUR0.5 billion of cash has been held in your chase for M&A, and is that changed and what you are thinking, you will just update us on your thinking regarding M&A?

Peter Wennink

That has not changed and I think it's still there and what Eric said we will talk more about an extended bit of strategy or at which is really focusing on the competition with every side of Brion and the online metrology solutions. In that area we are, of course, consistently looking for smaller, more technology-driven type of the potential acquisitions. Not that we have anything serious on the radar screen, but that is an area where that particular word is for.

Rudolf Dreyer - Morgan Stanley

Thanks.

Operator

Next question is from Mrs. [Michael Nordach] please state your company name follow up by your question.

Michael Nordach

Good afternoon, gentlemen or good morning I think. I just had a question on your sales target for 2007. Is that still standing?

Eric Meurice

It is good afternoon. And yes.

Michael Nordach

Okay, you are still holding on to that.

Eric Meurice

Yes.

Michael Nordach

Okay, that's all, thanks.

Eric Meurice

No other questions?

Franki D'Hoore

Any more questions operator?

Operator

Yes, the next question is from Mr. [Satish Kumar], go ahead please. Please state your company name, followed by your question.

Satish Kumar

Yeah hi, thanks for taking my question. Can you here me?

Eric Meurice

Yes, loud and clear.

Satish Kumar

Yeah Eric, I was hoping, if you can give me some perspective on how this recovery looks. I jumped on a little late, so I might have missed a part of the discussion, I apologize. If I look at ASML's orders, the last decline was back in Q4 of '04 when you had the foundries pulling back then. Your orders went from 70 units to 19 units in a quarter. Orders were up in the next quarter in Q1, but it wasn't until Q2 of '06 that your orders actually exceeded the prior peak. When you think of it, we know] there is still an association that at least some of your products have longer lead time, so perhaps customers tend to pull in their orders up. When you think about that dynamic, can you give us a sense as to how the trajectory of the order recovery looks like this cycle as you are seeing this pick up from Q3?

Eric Meurice

Now what I have seen myself, but my history is not as long most of you guys. So you have to correct me if I am out of luck, but

Peter Wennink

Really.

Eric Meurice

Hey really. I think we are more in a gradual situation. Because customers when they think their plan will give us indication about what they need forecast wise and then they will negotiate their bookings. So they will force us to built capacity, so that we then will be able to accept orders with very, very short lead time.

So the restart after a digestion which is what we see in the DRAM and flash business is happening is some way in a controlled fashion, where we have -- in fact that’s why we show positive caller today, as we have already some conversation with customers to say the train is coming which is why we are so guided for higher bookings in Q3 and Q2.

So, we know the train is coming, but the train takes time to negotiate and get the right orders in and right products and these things. But in the meantime they force us to be sure that we have enough components for activity. So, if it happens the same way it happened in 2005 I think, and when I arrived in 2004, when there was a bit of digestion for two quarter or so, it will be gradual I guess.

Peter Wennink

And if I may add to that. I think you do mention that yes the lead times of course are pretty long. But if you look at what we've done on lead time reduction it is quite significant. I mean over two years' time, we have brought back that average lead time from 8 to 9 months back to 6.

Now that also has an impact on the timing when our customers can place this particular order. Now like Eric says, we are preparing for what we are seeing, like he says, we are preparing for this training because it is coming. And all the things that we have done to make sure that, at least we will be able to meet that lead time ramp up is that we have created already some buffers in the chain towards the end of the year, to be able to deal with lead times that might be shorter than six months.

Satish Kumar

Okay, just a quick follow up. I apologize again if it’s a repeat, I missed a part of the call. Did you talk about what your expectation is for the size of the immersion market, assuming CapEx is say flat next year? Could you give us a sense as to what the range might be for immersion systems for the industry and also what you think the systems are for this year?

Eric Meurice

No, in fact, someone of you already tried that one and we said big, bigger and we'll come back to you.

Satish Kumar

Okay. Thank you so much.

Eric Meurice

No problem.

Operator

The next question is from Mr. Matt Gable] go ahead please. Please state your company name followed by your question.

Matt Gable - Millennium Partners

Hi, Millennium Partners. Just wanted to be more clear on the pulse of the environment in the memory sector amongst your memory customers. It seems like they’ve pretty much digested what they have now, and now they are getting ready for a reload in the second half in terms of bookings. Is there any nervousness amongst any of your memory customers, and that they might not get the equipment they need in the time that they need it?

Eric Meurice

Well, first of all, an important statement here is that, it takes a bit of time for our machines to be digested. So, anytime we talk about end of year things being digested. So, anytime we talk about end of year the things being digested, that means some machines that we have shipped in Q1, Q2 and Q3 will be in full ramp in December. So in December, on the assumption that the numbers of DRAMs and Flash are according to the analyst then those machines will be fully loaded I would say economic load, which means at a good a price.

So that’s what we say. So, because the customers are seeing this and they are able to project this six months of capacity gradual loading, they start talking about orders. That’s dynamic of things, that’s why it’s happening and that’s why they’re starting to talk about us.

So, if you are negative, you would say, yeah, well, if your Christmas season is bad, then the analyst like Gartner are wrong and then those machines installed are not going to be fully loaded economically. And therefore the customers, when they see this during the Christmas season will ask for not having so many units. So, that would be the negative view of life.

But the normal view of life is, this evolution of memory units growth is there. So, it’s about 40% and it happens for the DRAM/flash people that will have new machine in action as early as January 1st, if not they will lose market share. And that’s the way they see at this moment and you’re starting to have some people thinking that they should not lose market share.

Peter Wennink

And Matt just to add to that, in terms of nervousness, if you would have asked us, level of nervousness a month ago as to now, I would say, they are less nervous.

Matt Gable - Millennium Partners

Exactly. Okay. Thank you very much.

Operator

Next question is from Timothy Arcuri. Please state your company name followed by your question.

Timothy Arcuri - Citigroup

Citi. Hi guys. You guys are saying things like the train is coming next year, I guess regarding that train, have you done? You have a very read given that you have huge market share in litho. You look pretty good, you know what the capacity adds will be, so if you look at where you are shipping today and you pretty much know what you are going to ship, probably into Q1 next year at this juncture.

So that’s going to account for capacity through probably the first half of next year, so you have probably kind of pretty good visibility on what capacity adds will be at least to the middle of next year. So what do you think given your shipment outlook that we will add in terms of raw wafer capacity in 2008 versus 2007.

Peter Wennink

Just a little question, we have 84% of our backlog shippable this year. So our visibility is really limited to till the end of year, because that’s what we ship now. We might have marketing forecast for the first half of next year, but in terms of what we ship and we add in capacity that’s basically 84% of the backlog and that’s our real visibility and so anything beyond that is speculation, that’s it.

Timothy Arcuri - Citigroup

Okay. But that, if you shipped me a tool in the December quarter it wouldn’t become capacity for me probably until the march or even the June quarter, so?

Eric Meurice

We install those tools in three to four weeks and then they are signed off and then they run in production. So it’s faster than you think, that is probably not the case for leading edge tools, but for capacity related tools, when we ship them we can install them in four weeks time.

Timothy Arcuri - Citigroup

Okay, but given…

Eric Meurice

So there is a reasonable short time period between when we ship them and when they are actually producing wafers

Timothy Arcuri - Citigroup

Okay. Well being that as it is, do you have a view as to what the capacity will grow based upon your tools shipments, at least what their trajectory will be in ’08 versus ’07. It seems to me several companies at Semicom were suggesting that capacity will grow in excess of 20% if you look at the SIRCUS data we are going to probably growing 18% probably year-over-year exiting the year and now the shipments really aren’t coming down much at all. So that argues that, if bookings are going to reaccelerate than shipments will also reaccelerate and therefore we are going to have more than 20% wafer capacity next year.

Eric Meurice

Well the numbers, because it’s a complex mix issue when you grow up your nodes you need more machines, because you have more layers. So if you say what is your capacity increase in numbers of units, we would think we finish a year 2007 with an increased capacity of about 10 to 12%, so that’s what we seen in litho.

Now, Gartner says they expect next year or so they expect to be at about 12% I guess, unit growth or something of this nature. So you could imagine that 2008 would be on a higher level, because 2007 is showing an 8% unit growth IC’s. We would have done a 10% to 12% capacity, litho capacity which is no more to have more, because there is never an efficient use of capacity. If 2008 you have more unit growth of IC’s in 2007 then you would probably project even the higher litho capacity growth in 2008. It would be a bit complicated here.

Timothy Arcuri - Citigroup

Okay. And then I guess just one more quick follow-up. A, have you seen any signs if you are going to add a lot of wafer capacity next year that’s okay if you are actually removing wafer capacity so if that you are decommissioning some old 8 inch factories. A, have you seen any signs of that happening. And B, can you give me some sense as to what your bookings in terms of systems, will you book more systems in September than you will ship. Thanks.

Eric Meurice

We will not answer the second question we are not going to guide on the booking number at the beginning before we said we are not, its difficult to call the timing of those negotiations, but regarding your first question which I was --

Timothy Arcuri - Citigroup

Capacity been taken out of the market.

Eric Meurice

We haven’t seen it happening today but we are in the process of discussing with multiple customers in the DRAM arena who have lots of 200 millimeter capacity and we will not convert the 200 millimeter capacity to the new nodes. So, it's another way of saying they are looking at what to do with it and decommissioning question is being asked. So, it's not yet executed but I could imagine that in fact I should have mentioned this at the beginning, it is also a potential engine for growth in 2008, but it's a bit too early to say it’s going to happen it’s a discussion item at this moment.

Timothy Arcuri - Citigroup

I see and the orders to replace that capacity aren't even placed or not?

Eric Meurice

Let’s move on to the next question, please.

Timothy Arcuri - Citigroup

Alright, thanks.

Operator

Next question is from Mr. Peter Testa. Please state your company name followed by your question.

Peter Testa - One Investment

Peter Testa, One Investment. You mentioned in the release that your success in Japan and getting visible repeat orders from multiple customers. I was wondering if you can give us some feel for how broad that was in Japan and maybe also a feel for how rapidly the Japanese customers are adopting ASML's next generation technology maybe compared to customers in the similar segment outside of Japan. And a short question the follow-up, historically when the mix is shifted significantly towards new technology on the gross margins temporarily come down a bit which you expect that to happen this time or not? Thank you

Eric Meurice

Okay we will let Peter talk about the margin evolution with new technology and I will focus on the Japanese thing. How wide exceptions do we have, in Japan I would say at this moment we are not working with two Japanese customers. We are not working with these only two, and that means we are working with the others. What's the speed of activity of ramping within it is naturally slow at the beginning but then they ramp pretty fast.

Peter Testa - One Investment

Okay, but did you compare their adoption and ramping versus outside of Japan some of the segments which you said they are on par or thereof?

Eric Meurice

They are on par because they are in a competitive environment. So they have no choice than going with the same rate of acceptance than their competitors.

Peter Testa - One Investment

Great.

Eric Meurice

New technology --

Peter Wennink

Now on the gross margin new technology, the new technology is well within a bandwidth of corporate average. So, it's a small bandwidth and there is no big difference with the other new technologies.

Peter Testa - One Investment

Okay, that’s good to hear. Okay, thanks very much.

Peter Wennink

Thank you. Operator one last question, may be.

Operator

Last question from [Jim Fontanelli]. Please state your company name followed by your question.

Jim Fontanelli

Yeah, hi. I had a question on service revenues and the extent to which you think in service revenue part or either on a percentage base or absolute basis steps up as you move greater immersion shipments, whether that's a structural move in your service revenue opportunity as we ramp immersion?

Eric Meurice

It’s more expensive, but the machine is more expensive, so the percentage is not too different. To be honest at this moment it’s -- Peter, do you have better,

Peter Wennink

Well I think the answer is you had seen service revenues over the years growing, but that’s basically the result of the installed base that is growing and customers signing up service contracts for those tools. What you are seeing is that, the more complex tools need more service, and you see service contract for the more matured tools, let’s say, tapering off. But that's being replaced then by service contracts towards the more expensive tools. And the biggest driver like I said, is the installed base. Like two years ago we had about 80 million on average in service sales and now we are at 100 million. So, that’s the biggest driver.

Jim Fontanelli

So, there is no new level of -- because I guess, you have been looking to ramp the service option revenue and equally profitability over the last couple years, and I was wondering whether, that’s a new opportunity, particularly as you start shipping 1900i, where do you have a series of options on the service contracts sitting around those tools that allows greater profitability per tool?

Peter Wennink

The first one or two years the tools are under the service warranty that we gave, so that doesn’t give service revenue. But afterwards like I said, it’s more complex. But on the other hand we are also trying to help our customers in reducing the cost of running that perhaps. So, there is always a natural pressure on the service revenue once the tools become more mature tools. So the way that we are improving the service top line is coming up with service options, that is, the enhancements of systems to make the tools run better.

And that is really with the increased complexity of the new tools, we have some more opportunities to do application types of sales, where it's very often software driven which are better gross margin products. But that's for the future, a potential. We are working on that. And that is also part of what we call the extended litho strategy.

Jim Fontanelli

And secondly on the option program, have you seen any step of in the take off of options in the second quarter. What was the difference quarter-on-quarter?

Peter Wennink

They were largely taken in Q1.

Jim Fontanelli

Thank you.

Peter Wennink

Thank you.

Franki D'Hoore

Can we here conclude operator?

Operator

Yes, of course we can. Thank you sir. Well ladies and gentlemen, this concludes the ASML 2007 second quarter results conference call. Thank you for participating. You may now disconnect.

Eric Meurice

Thank you very much everybody.

Franki D'Hoore

Thank you. Bye.

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