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ASML Holding N.V. (NASDAQ:ASML)

Q3 2007 Earnings Call

October 17, 2007 9:00 am ET

Executives

Craig DeYoung - VP of IR

Eric Meurice - Chairman, President and CEO

Peter Wennink - EVP and CFO

Analysts

Simon Schafer - Goldman Sachs

Nicolas Gaudois - UBS

Jim Fontanelli - Arete Research

Mehdi Hosseini - Friedman, Billings, Ramsey

Jay Deahna

Satya Kumar

Jonathan Crossfield - Merrill Lynch

Francois Meunier - Cazenove

Sandy Deshpande - JP Morgan

Robert Maire - Needham & Co.

Harlan Sur - Morgan Stanley

Timothy Arcuri - Citigroup

Peter Testa - One Investment

Robert Sanders - Dresdner Kleinwort

Peter Knox - Pali International

Operator

Good afternoon ladies and gentlemen, and welcome to the ASML 2007 Third Quarter Results Conference Call on October 17, 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. Craig DeYoung. Go ahead please, sir.

Craig DeYoung

Thank you, operator. Good afternoon and good morning, ladies and gentlemen. This is Craig DeYoung of the Investor Relations Department at ASML. I would like to welcome our investors to our investor call and webcast. The subject of today's call is ASML's 2007 third 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, and you may find the press release and presentation on our website at www.asml.com. The length of the call will be 60 minutes.

And now, I would like to turn the call over to Eric Meurice for a brief introduction.

Eric Meurice

Thank you, Craig. Good afternoon, good morning and thank you for attending our Q3 results conference call. As it is now our habit in our quarterly conference calls, we will split the introduction in two parts. Peter will start with a review of our Q3 financial performance, with added comments on our short-term outlook. I will complete the introduction with a longer-term view and following this introduction, we will open the call to questions. Peter, please.

Peter Wennink

Thank you, Eric, and welcome to everyone. First of all, I would like to review, like Eric said, our Q3 result highlights, and, in that regard, I am pleased to report that again the quarter developed as we anticipated. And in reviewing our results in detail, you've seen that we reported healthy revenues, operating margins and net profit for the quarter.

Q3 revenues were recorded at EUR940 million, which is roughly the average of what we have achieved in the past six quarters. A 41.2% gross margin and operating expenses of EUR176 million, R&D at EUR120 million and SG&A at EUR56 million, resulted in an operating margin on the quarter of 22.4% versus 22.2% in Q2.

ASML remains highly flexible and adapted to market cycles. Although, we have continued to grow our operational cost base to support our future growth, in both our R&D spend and SG&A costs. We keep focusing on creating cost variability, such as we can match profitability in any market conditions. As a reminder, about 30% of our R&D costs are variable within one quarter's time and approximately 10% of the SG&A costs are variable.

Cash flow also remains well above our operational needs, with net cash from operations in Q3 at EUR169 million. Also in an ongoing commitment to return excess cash to shareholders, we returned EUR1 billion in cash to our shareholders on October 4th. This is part of the capital restructuring, which we announced on the May 31st. The cumulative amount returned to shareholders since June 2006 stands currently at EUR1.9 billion.

In addition, we limited the dilutive impact of the 86% conversion of our 2010 Bond that took place in Q3, by using approximately 7 million ASML treasury shares.

Furthermore, and consistent with the terms of the convertible bond, we decided to call the remaining 14% of the bond that had not yet been converted.

We will also start the new share buyback program for a maximum of 14 million shares to cover for outstanding employee stock options to be funded out of our cash flow and our ample liquidity buffer. The purchasing of those shares will take place at anytime during the nine months period ending July 17, 2008.

We ended Q3 with EUR2.4 billion in cash and we maintained cash reserve target of between EUR1 billion and EUR1.5 billion.

As guided at the end of last quarter, we expected an increase in net bookings from the 30 systems booked in Q2. We've clearly seen a rebound in our net bookings number to the quarter to a level of 40 units.

More importantly, the third quarter bookings confirmed a shift in demand towards our leading-edge immersion products. We booked 22 1900i immersion systems, driving the total net value of our order intake to EUR863 million. That's more than 200% increase as compared to the Q2 order intake value. We ended the quarter with an increase in the backlog to a level of EUR1.77 billion, that's a 61%, of which reflects the value of our immersion products.

Both the backlog average selling prices and the booking systems average selling prices are at record levels this quarter. This shift towards immersion is significant and will be sustained as our NAND and DRAM customers are transitioning to new process nodes. As we predicted, NAND capacity at the large manufacturers became tighter in Q3. This and the forecast of an improved NAND supply/demand balance for the remainder of the year have resulted in 55-nanometer node capacity orders in this segment.

In addition, prompted by the pricing environment, major NAND players are aggressively pursuing device shrinks to 45-nanometer.

With respect to DRAM, the continued price pressure pushes memory makers to more cost effective systems, the immersion systems get at 5x nanometer node for more affordable and more competitive 1 and 2-gigabit DRAM devices.

Our foundry customers continue to see improvements in their factory utilization. Although, at levels that could trigger significant 300-millimeter capacity orders, they are holding off ordering until they can better read the 2008 application needs, so far, of their end customers.

But all-in-all, Q3 saw the return of NAND orders, with DRAM technology transition orders and foundry capacity orders expected to fall over in the next few quarters, that is confirming our secular growth trend.

And as usual it remains difficult to pull the exact timing and level of bookings. However, we do believe that the trends that I just described will translate into another incremental increase in unit orders in Q4. This positive view is supported by our internal global utilization model, combined with full cash for market independent research analysts for 2008 semiconductor growth.

Our model predicts growth through our lithography business in the first three quarters of 2008, on an assumption of a growth of 51% for NAND units, less than 10% for Logic units, and 18% for DRAM units. In particular for DRAM, technology transitions to immersion will compensate fully anticipated reduction of the unit capacity growth rate as compared to 2007.

Now, this ends my part of the introduction, and I will turn back to you Eric.

Eric Meurice

Thank you, Peter. So, basically Peter confirmed that ASML is proving successful in managing through the cycle, because we are sustained by a long-term growth trajectory, which in fact dampens this cycle.

At this time, in fact the dampened part or the reason of the growth is in fact the fact that we are sustained by a significant acceleration of technology transition in Flash and DRAM to immersion lithography.

This transition required by the current very aggressive memory price competitive drive and compensating therefore, the lower planned chip unit growth. This trend is very important, and plays very much to our strengths as a technology leader. And to further develop this technology leadership, we are increasing our R&D spend further to EUR125 million per quarter, from EUR120 million this quarter.

The focuses of our R&D funds are the development of next generation platforms for dry and immersion applications, allowing a continuous increase of the total throughputs across ArF, KrF and i-line products, as well as enabling double patterning 2D, 3D designs, as well as EUV.

Regarding immersion, our products are becoming the industry standards. So with 60 tools shipped to date, and the latest XT:1900i unit backlog currently exceeding our advanced drive XT:1400 unit backlog, which is a significant event, as you can see.

We expect to ship about 35 immersion tools in 2007, with approximately 20 XT: 1900i system in the first six month after its introduction. We are encouraged by the fact that the XT:1900i is the only immersion tool in the market, capable of exposing sub-40 nanometer node, and that we have now processed more than 3.5 million wafers on our immersion platforms, thus creating a significant experience base for the customers transitioning into production.

We have now 20 customers with active immersion manufacturing or process development programs in place.

On the lower scale of our product range, our latest XT:400 and XT:450 i-Line systems enable the fastest and most cost-effective solutions for processing non critical layer. As you know, we have announced record performance output of over 3,500 wafers in a single day and one million wafers processed per year on a single machine.

Not surprisingly with these statistics, we've been able to grow our i-Line business by approximately 250% in the past two years.

In the mid range side of the business, our TWINSCAN XT:1000, the new high-NA KrF machine to be introduced in H2, 2008, will be capable of imaging 18 nanometer features at an unparalleled 165, 300 millimeter wafer per hour. With this tool our customers will save 30% cost or more versus today.

We are currently also closing our fourth order for an EUV pilot production tool, with the first of the series to be delivered late in 2009. This is a clear indication of the strong acceptance of EUV as a most technically capable and cost effective solution for imaging 32 nanometer and below. This acceptance is reinforced by the passing of an important development milestone on our alpha tool by imaging the first ever 14 nanometer dense lines using a thin source.

Operationally, we continue to drive down our cycle times and cost. In 2007, we have reduced our average cycle times by another 15% to 30% depending on the product line, and increased our value of ownership, a combination of cost and performance rendered or delivered to the customer by depending again on the product by 10% or 15%.

Our factory expansion needed for further improvement of these numbers, but as well as for capacity increases is on target to deliver product by mid 2008.

So in summary, we confirm our customer value generation proposition through leadership and technology in value of ownership and in operation or efficiency. In view of our progress on these, we feel confident in our ability to continue to grow our market share, while delivering finance for result through the cycles, and as we say would say, swings of which are shallower and shorter than ever before.

So now, on this summary of our messages, Peter and I would be available for your questions.

Craig DeYoung

Ladies and gentleman, the operator will instruct you momentary on the protocol for the Q&A session. But before hand, I would like ask that you kindly limit your questions to one with one short follow-up if necessary, and this will allow us to give as many colors in as possible. Now operator, can we have your instructions and then the first question please.

Question-and-Answer Session

Operator

Yes, thank you, sir. (Operator Instructions). Today's first question is from Mr. Simon Schäfer, please state your company name followed by your question, sir.

Simon Schäfer - Goldman Sachs

Yeah, hi, thanks very much. It's, with Goldman Sachs. I was wondering on the immersion print on the order intake 22 units, in your opinion is that represent a pull in, or do you think, can the book- to-bill for the immersion systems to be above one again in the fourth quarter?

Eric Meurice

Yes, it is a pull in, in the sense that the NAND orders have come a bit earlier than we expected, because in fact of this drive towards this new technology and cost. Whether we can project the same performance in Q4, I would say we've messaged very clearly today that the technology transitions are accelerating in NAND, and this is now proven, but in DRAM and it is in progress. And therefore, this acceleration will definitively generate growth in the first three quarter of 2008.

However, we will remain very cautious as to coding exactly when the booking are coming, we are not cautious. I mean we are able to call with the billings, it is when the customer absolutely required the capacity to achieve the different transition they want to do, but we are still cautious as to the timing of the orders.

Simon Schafer - Goldman Sachs

May be I can try and get that another way. In terms of order projection, are you thinking number of units up sequentially or how should we think about mix on an order side?

Eric Meurice

We have yes lifted to bit on certain, by saying Q4 will see a better unit number than Q3. Obviously, Q3 has been exceptional in ASP, the average ASP.

Simon Schafer - Goldman Sachs

EUR222 million.

Eric Meurice

EUR222 million. So we do expect this average ASP not to be sustainable and therefore we left it a bit to uncertainty at what the average ASP will be in Q4. So unit-wise, yes, we clearly see and confirm that the bookings unit will be higher in Q4 than in Q3, whether the ASP will be strong enough to match the Euro bookings of Q3, at this moment we would not know.

Simon Schafer - Goldman Sachs

Understood, that's very helpful. And then my follow-up question would be, when I look at the segment of your order intake, obviously the foundry element is extremely low, the logic portion effectively being characterized by some scrubbing of the backlog. Would you expect orders in the foundry segment to rebound materially in Q4, or is this really a first half of '08 returnable to growth?

Eric Meurice

Yes, this is very important question. We are mentioning now for the past, where there were three years, there are multiple cycles in this business and, in fact, we are fortunate that at this moment the cycle seems to be let's say compensating each other. So we've seen now the flash cycle back on, we are now sniffing the DRAM cycle, not in unit, but in ASP, in technologies on exchange to showing its nose very much so as we have already some bookings and it's starting.

We do not see the foundry business to rebound in Q4 at this moment. It may happen because as we say there is no inefficiency in capacity utilization, that is, utilization is at the good number, in fact it is at the good numbers since now about three to six months, you can even argue with this. What is happening, however, is the foundry customers are not fully comfortable as to the volume outlook of 2008, so they are waiting, if and when the Christmas season proves to be favorable then there will be immediate bookings.

Simon Schafer - Goldman Sachs

Understood, thanks so much, great. Fantastic quarter, thanks.

Eric Meurice

Thank you.

Operator

Next question is from Mr. Nicolas Gaudois. Please state your company name followed by your question.

Nicolas Gaudois - UBS

Yeah. Hi, it's Nicolas Gaudois for UBS. Just thought to your question looking at the mix just, you quantified that you would see the first nine months of the year up year-over-year for your addressable markets. Could you maybe try to quantify a bit the delta of the addressable market for ASML could be vis-à-vis semiconductor capital spending taking into accomplished shrinks trends you will portrait, and also, if you could give some color by segments where you would see whether NAND, DRAM, foundries or IDMs will be up or down for this first nine months? Thank you.

Eric Meurice

I think, except your future adds to this, but I think it's going to be difficult for us to say what lithography does versus others. I don't think we can color that, we don't know. It is not our expertise. Regarding, however, Litho, obviously you've seen this fundamental message we gave today which in fact translates into this, this is a very positive call is we are moving in terms of the technology content, so ASP increase. So that's where it is happening and we see this happen for the next six to nine months through flash and through DRAM.

So that is what creates obvious growth, but as we usually say, we base our estimates on the basic assumptions from the semiconductor analyst as to the numbers of semiconductor units which sustain this. And the current numbers that you see more or less in the market calls for a flash unit growth of about 60%, 61%, as Peter said, and DRAM at about 18%, 18% is much lower than what happened last year which is going to be in 2007.

So it's going to be about 50% so 18% is much lower. So even on an 18% lower unit growth, DSP is so big, large that it will compensate this, and therefore we call for growth in the first six to nine months of the year 2008.

Nicolas Gaudois - UBS

Okay. So just to clarify you are saying that for DRAM, for instance, the ASP increase or the number of tools required for a given unit output by number of layers may be offset the decline in effective capacity investments, is what you believe?

Peter Wennink

We believe that that will offset, yes.

Eric Meurice

We believe, in fact, that because you transition from basically 55 or say 65 to 55 and 45 in DRAM, sorry in flash, and the transfer say 70 issues, 7x to 6x in DRAM, that it will create obviously less tools at the beginning, but much more expensive. But in addition, there are going to be more critical layers.

This is an area where there would be probably 10% to 15% more critical layers. So, these numbers of layers again will push for a much richer mix. So, you've got two reasons of our mix richness for these during these transitions.

Nicolas Gaudois - UBS

Okay, understood.

Peter Wennink

Nick, we are going to have to move on. Sorry about that. I am sure we'll have more discussion on.

Nicolas Gaudois - UBS

Sure.

Peter Wennink

Thanks.

Operator

The next question is from Mr. Jim Fontanelli. Please state your company name followed by your question.

Jim Fontanelli - Arete Research

It's Arete Research. I was just wondering, how you see the '09 immersion mark? And then what do you think the DRAM opportunity for immersion in '09 will be greater than that for NAND in '09?

Eric Meurice

Guiding '09 is an art. Yes, technically DRAMs are going to ramp slower in immersion than NAND because of the complexity of the production challenges. Everybody who manufactures DRAM will tell you how difficult it is to achieve the yield necessary. And therefore, we expect that customers in DRAM will of course converge into immersion, but will have a slower ramp if you compare unit-to-unit to Flash.

But DRAM is much bigger. DRAM is double the size. So, we therefore expect this DRAM cycle to have a, how do you call this, a damping effect on the crazy Flash cycle. So, in other terms we expect this Flash to continue growing by major than CapEx purchase six months, every 12 months.

Then we expect this to dampen a bit because the unit growth will not be as good. But that will be compensated by the larger and more stable DRAM business. And as I say it's larger and more stable, because it is more difficult to achieve the [UMS] effect. In other terms, compensation in 2009 was more DRAM and less Flash, and probably it's going to happen.

Jim Fontanelli - Arete Research

Okay. Thank you.

Operator

The next question is from Mr. Mehdi Hosseini. Please state your company name followed by your question.

Mehdi Hosseini - Friedman, Billings, Ramsey

Yes, Friedman, Billings, Ramsey. My first question has to do with your commentary regarding NAND and the pulling. Can you help me to understand of the three to five NAND manufacturers out there to what extent you have been able to gain market share on immersion. And many you could offer a qualitative way of helping us understand, how many of those NAND producers have moved on in adopting immersion.

And a second or a short follow-up question is, help us understand the immersion opportunities between DRAM, NAND, Logic and foundries? How does the market changes, either in terms of dollars or revenue opportunity or units, among these various device type markets?

Eric Meurice

That's a good question, difficult ones of course. Our market share in immersions are good, thank you. Of course we have shipped a lot of units and we have created this, I would say experience of 3.5 million wafers. That’s a lot of wafers going through those machines.

So we think that our market share in most of our customers in fact our traditional are obviously in the usual 100% of the critical layers, and on the new customers that you know who they are, the ramp is faster than any ramp we ever had.

So that's obvious that in immersion, our market share is above our average market share, which is today in the 60ish percent range. So we probably are in the 80is percent range or more in this environment.

Mehdi Hosseini - Friedman, Billings, Ramsey

So if you have 80% market share and if they have pulled in, my concern is, then you can have a large void in the overall immersion booking in Q4, Q1 if foundry doesn’t come back, because NAND is already behind us.

Eric Meurice

No, the current bookings for NAND is not at all. They don't need for 2008. I would not tell voluntarily at this moment, how much we've [improved] from the NAND business, but this is why we’ve told you that we expect growth in 2008 in the first nine months, compared to 2007. So 2007 was really a big year for us, so 2008 is going to be even bigger.

So no, we've not booked.

Peter Wennink

We have not booked everything that our NAND customers need for next year.

Eric Meurice

In fact I could not tell you of these two very large accounts which are not yet [build]. So you asked about immersion adoptions by customer in NAND, and I think and I am trying to avoid telling you the wrong thing, but I guess 100% NAND customers are in immersion at of course different level of production.

Mehdi Hosseini - Friedman, Billings, Ramsey

I was just trying to understand up market opportunities between DRAM, NAND and Logic.

Eric Meurice

So in DRAM, I think it's about the same question that Jim asked is, we expect DRAM to be slower, but because they are bigger, they will catch up on NAND immersion in 2009 environment.

But this is directional information, and so I would say, obviously NAND Flash was most of the immersion in to 2007. In 2008, they will be towards the say 75ish percent, 60-75ish percent. And in 2009, if you could make a case then DRAM could be equal to NAND in terms of Flash need.

But you are asking me, I mean this is very early simulation activities which I will probably have to come back to at some point. Now, Logic in general will be much later than that. Logic immersion will be a fairly small part of the business of immersion for the next two years. Again you force me to guess, I would say in a directional fashion in the 10%ish of the business or less would be a Logic immersion in the next year and a half or so.

Peter Wennink

Just as -- I mean you really need the immersion technology when you go down lower than 60 nanometer feature size, which is currently the case for the NAND product. NAND will move from 55 to 45 next year. DRAM will grow from 70, which is above 62, lower than 60 next year, so that creates a new market opportunity.

And you will see when Logic feature sizes will need 45 nanometers which is not foreseen next year like Eric said; it's probably two years out. That’s where they will need the immersion solution. So it's a kind of gradual increase in the market opportunity driven by NAND, followed by DRAM, followed by, I would say Logic.

But you could say, in the first instance, DRAM being a year behind NAND for first introduction and then fall out year to year and a half by Logic.

Mehdi Hosseini - Friedman, Billings, Ramsey

Great. Thank you for the detail answer.

Peter Wennink

Thanks.

Eric Meurice

Thank you.

Operator

Next question is from Jay Deahna. Please state your company name followed by your question.

Jay Deahna

Thanks, can you hear me?

Craig DeYoung

Yeah.

Peter Wennink

Very well.

Jay Deahna

Good afternoon. In the past you've had three, four, five quarter. Can you hear me okay?

Craig DeYoung

Yeah.

Jay Deahna

Okay. In the past you've had three, four, five quarter order cycles. Your unit order declined from the third quarter of last year to the second quarter of this year, 66%, pretty high amplitude cyclical decline. Do you believe that with up orders in 3Q and expectation for up unit orders at least in 4Q, that you are in the midst of one of these three to five quarter upswings, and if so, why?

And sort of a follow-on to that. Do you expect the total lithography market to be up, down or flat for units in 2008 and what does that mean for overall wafer fab equipment spending?

Eric Meurice

Okay. Why an upswing of three, four quarters, because the memory business in general is basically taking now a dominant position in the CapEx of this industry. And memory, there is economics in to buying in one big shot early in a new technology. So you would try to have all those customers who competes on one given technology to try to buy everything on the same day, which translate in nine months.

So they are trying basically to swing this way, and therefore you have today two quarters where they basically digest and then the rest they built up. So you have two digestion quarter, three quarters of built up and that type of thing. And this is I would say typical from aggressive CapEx technology needs which are necessarily memory business.

So we would, at this moment see the same thing happen for the foreseeable future.

Regarding, according to the fall of 2008, so we will not do, we've only guided on nine months and this is the first time we do so by the way, because we feel very comfortable about the mechanics behind the cycle within the next nine months. I mean we can't really call Q4, '08 at this moment.

But, if you therefore only focus on these nine months that we called, I would say we would expect less units and much higher ASP, which is why you can compensate. And therefore the spend will be higher value factor and the unit will be low. Yeah.

Jay Deahna

Just so unclear. Are you saying that you do believe that you are in one of these sort of standard cycles that we've seen over the last half decade or whatever. And also in terms of the fact that your orders in the third quarter were so heavily skewed towards immersion, would we expect to see the mid-critical and non-critical tools to plug in to that capacity ordered over the next one or two quarters, which would probably be more units but a lower mix of ASP?

Eric Meurice

In fact yes. This is a very good point. So first of all, yes we expected this 2008 to be about similar to 2007 in terms of cycles. Yes we are a bit more positive and optimistic about this one because we see multiple nodes at the same time in different segments.

So there is good news for us because we have the technology leadership edge with a high market share on this level. So the more new nodes in transaction the better. So obviously we are much better positioned in 2008 than we were even in 2007. So obviously ASML is privileged in this current set of transitions.

Yes, you could be bullish, and I’m trying to hint this as a possibility that the capacity orders will come back in the Logic arena. We didn't call it, we said they have to come theoretically at some point, and foundry and the rest of the Logic including microprocessor business may come up during the period of time I talked about, and yes it will create much more KrF business and dry ArF. And this would be an upside. In particular if you are talking about this to happen in the next nine months. But we did not even call that.

Jay Deahna

Okay, thank you.

Operator

Next question is from Mr. Satya Kumar. Please state your company name, followed by your question. Please go ahead, Mr. Kumar

Satya Kumar

Hello.

Operator

You may state your question.

Craig DeYoung

Next caller please?

Operator

The next question is from Jonathan Crossfield. Please state you company name followed by your question.

Jonathan Crossfield - Merrill Lynch

Yeah hi, it's Merrill Lynch. Eric, you mentioned that the non-players also they are one-fourth of the new equipment from the same day and receive it from the same day. Do you think the same is still true with the DRAM companies, or are you seeing a sort of polarization between the sort of first tier vendors and the second tier vendors at the moment?

Eric Meurice

That is correct. In fact I hinted the fact that DRAM is more complicated, and therefore there is much more differentiation in the DRAM business as to how fast, each of them can really ramp the difficult new technologies.

So, yes, you would be able to probably position all the players on a time scale of say one year to even 18 months time difference, when they succeed to introduce the technology at the appropriate yield.

Jonathan Crossfield - Merrill Lynch

Okay. And then just as a follow-up. Inventories increased about 168 days, is that a level that you expect to maintain or could we see it increase further, or would you like to bring that down, as you ship the immersion tools that you just had ordered?

Peter Wennink

Yeah. I think when you talk about the inventory levels at ASML which are driven by the success of our immersion product. The 1900i when we first introduced, that had cycle times, which are of course longer than the average cycle time of our matured products.

And given the increase, 61% of the value in the backlog is immersion, which are still under longer cycle times than the average. It means that, that will have an impact on inventory. But like Eric said in his introduction, we are currently executing programs that are focused on reducing cycle time from between 15% and 30% that will also apply to the immersion products.

So in six to nine months from now, the immersion products are scheduled to be at the average of what we see for our current raw material products and as we will bring the investment in inventory down. So, it's really a function of the fact that we are heavily loaded towards our leading-edge products with lower cycle time. Okay.

Operator

Does that answer your question, sir?

Jonathan Crossfield - Merrill Lynch

Yes, that's very helpful. Thanks.

Operator

The next question is from Francois Meunier. Please state your company name followed by your question.

Francois Meunier - Cazenove

This is Francois from Cazenove. I just wanted to know what's your base case assumptions for the inventory situation in Semis at the end of Q4 which is driving your guidance for the next quarter.

Eric Meurice

We know what the inventory levels today and at this moment, the statistics that we have been reviewed which are industry statistics says, that we are a bit, in fact, lower-ish as last year in the same situation but basically call it normal. But nobody knows how Q4 looks like in terms of end product sales and this is the big question about the season and everybody has its own bet.

I just mentioned that the foundry sector is conservative and is not calling anything until they see exactly what's happening. And you are starting to see Intel who have started to call that they are doing a bit better than they expected and therefore they probably -- I am seeing their inventory going down a bit faster than expected.

But we are not calling these things, we are just reading the analyst estimate and based on that we make a case which then becomes our guidance which is what we tell you. So we are basing everything on the Gartner Dataquest et cetera analysts, which call consensus, but not at all our own statistics. We do not have the capability to do so.

Peter Wennink

Which by the way is corroborated by the fact that we talk to our customers and our customers place orders and we clearly have pipeline of orders that we think we can book over in the foreseeable future and those things need to match, and our view that they do. So that's why we are confident about say the first three quarters of 2008.

Francois Meunier - Cazenove

Okay. And in terms of gross margins, it's been a few growth sales that you are above your guidance, is it because you are a bit cautious, or is it because you are doing extremely well in terms of execution?

Eric Meurice

We have a great CFO, I mean it's one of those things.

Peter Wennink

Both, I think, we are doing good in execution, but we don't want to preempt that also, so we are a bit cautious, yes.

Francois Meunier - Cazenove

Okay. Thank you.

Operator

The next question is from Sandy Deshpande. Please state your company name followed by your question.

Sandy Deshpande - JP Morgan

Hi, JP Morgan. Congratulations. Just a couple of questions, firstly on this immersion order intake, I mean if you look at your immersion order intake in the first three quarters of this year, it's already higher than it was last year. Do you have any idea from your customer base, how the timing of the immersion orders into 2008 is going to be and on based on that, do you think your immersion orders in '08 are going to be higher than they are in '07?

Eric Meurice

The second question is easy. Yes, it will be higher in 2008 than 2007, and this first question, the timing is, we don't know.

Peter Wennink

But the only thing we can say is that when we look back three months ago or a quarter ago and say when we look at when, customers are now asking for a immersion orders to be shipped, if anything, it's sooner and more. That's what we are seeing.

Sandy Deshpande - JP Morgan

Okay. And regarding the immersion orders you took in the third quarter, does it already include DRAM related immersion orders and based on that, when do you think that the early movers in DRAM will start moving to the 5x node?

Eric Meurice

Yes. There is a significant part of our Q3 orders which are for DRAM to be honest, I'd not say if it's 5x or whatever node. I don't want to tell you because then you would know which customer it is. And so I would say the two customers, who we have received orders, yes, are planning to ramp production of this new generation nodes. I would say in the Q1ish timeframe.

Sandy Deshpande - JP Morgan

Sorry. I didn't hear that?

Peter Wennink

Q1.

Sandy Deshpande - JP Morgan

Q1. Okay. Thank you.

Operator

The next question is from Mr. Robert Maire. Please state your company name followed by your questions.

Robert Maire - Needham & Co.

Yes, the company is Needham & Co. Congratulations on the nice report. By the way, you had two questions. Number one, we've had a significant move of the dollar versus the Euro, if you could just update us as to its impact on ASML and pricing and that and such. And given that we are sort of coming off of the bottom here in terms of business and we are looking at an uptick going forward.

Historically, one of your limiting factors has been lenses and I would assume that you may have perhaps a few more lenses in inventory or maybe the ability to ramp a little bit faster coming off of the bottom here. Is there a possibility that you would be willing to increase shipments at a faster rate, or is it your view that you'd prefer to keep it at sort of moderated rate and maintain backlog at a more steady state basis?

Peter Wennink

Well, yes, to the last question, I think we'll ship when the customer needs it. And so, it is up for us to manage the backlog just when the customer needs we will ship the tools. Now, you are right that you want to be able to move and expect customer demand comes up.

So, yes, we are keeping a certain number of lenses in what we call buffer, but those are buffers which are not at our balance sheet, which are at the suppliers' balance sheet. And that's where we have good agreement on what we think is reasonable under the circumstances. So, yes, we have that ability for Trans business.

On the dollar-Euro impact, it has two elements to it. I think from a competitive point of view, we are more concerned about Euro-Yen clearly, because our two competitors are not in dollar denominated areas. For our clusters, clearly industry is calculating in U.S. dollar so that hasn't impacted our true price in dollars, they go up, so it's more the relative movement of the Euro against the YEN, that is from the competitive point of view, something that we look at.

From an operational point of view, we do source in U.S. dollars. We source lasers in U.S. dollars. We source some mechanical modules from the U.S. to our Wilton operation and that actually has a positive effect on the cost of goods.

Robert Maire - Needham & Co.

Okay. So, overall, the impact would be positive.

Peter Wennink

Yeah.

Robert Maire - Needham & Co.

Okay, thank you. Congrats again.

Eric Meurice

Thank you.

Operator

The next question is from Harlan Sur. Please state your company name followed by your question.

Harlan Sur - Morgan Stanley

Hi, Morgan Stanley, and congratulation on a well executed quarter. On the product side, and in keeping with your competitive leadership on the technology side, may be can you just provide us with an update on the development status of your high throughput, high accuracy over the immersion system for double patterning?

Eric Meurice

Yes. But, I am going to make a bit of an editorial comment, I don't know if it is helpful for everybody. In the road map of semiconductor to make more as low, it is now obvious that there will be multiple ways of doing it. You can do a double patterning, which is a way of passing twice a piece of lithography to get to the next node.

You can do what we call 3D geometry designs, where you succeed to pack basically the bits on top of the other, and therefore you don’t need to shrink as bad or you can do EUV.

The position that we now are thinking that is highly clear in the industry is that the three technologies will be needed. There is no issues about that. It all depends about who needs it when. And as we've said, in fact for the DRAM people for instance, there is a difference of 12 months to 18 months between the leader and the follower. There is going to be multiple opportunities to use any of those technologies.

So it is important for ASML to use its muscle in R&D, basically to put differentiated machines, superior machines on the three segments. And therefore we've put significant effort in building up machines for EUV. As you know, we are putting machines also in action for the double patterning. And in order to do double patterning, you need to have extreme precision of what you call overlay, from today an overlay of 6 nanometer to 7 nanometer, to an overlay of say two or three.

Because you are going to pass twice. In order to make this technology economical, it would be a good thing if you succeed to pass a lot of wafers per hour, so that you reduce a cost of the system. So therefore, we need to go north of 165 wafer per hour.

So yes we are in progress of building up these machines, and at this moment we have also added the possibility to upgrade some of the machine that we have in the field to double patterning and high speed.

So that's a new news which is due to the fact that we'll put a bit of R&D on the subject and this is extremely powerful as you can see selling possibility, to say, to a customer, you buy a machine capable of one technology but within two years or so, we will be able to upgrade it to the next one. This is highly powerful.

So yes we are doing for the current machinery upgrade pass, and we are also developing a revolution concepts, which will replace in fact those machine in due time with another leap of technology.

Harlan Sur - Morgan Stanley

Great, thank you that answer. And then as a follow-up, on the immersion order in Q3, can you just let us know roughly what percent of the immersion order mix was DRAM?

Eric Meurice

Do we have that? That might be less because --. I would say 40-60 because we have what we call still the hybrid guys. It’s a bit difficult for us to know what they are going to use with them forward, I would say.

Harlan Sur - Morgan Stanley

So its 60 NAND as you would say in 40 DRAM max?

Eric Meurice

Yeah.

Harlan Sur - Morgan Stanley

Okay. But nevertheless, it was fairly significant which is the good start I guess, for the DRAM suppliers.

Eric Meurice

Correct? Yeah.

Harlan Sur - Morgan Stanley

Thank you very much

Operator

The next question is come from Timothy Arcuri. Please state your company name followed by your question.

Timothy Arcuri - Citigroup

Citi. Hi, got a couple of things. First, do you guys have any estimates as to what lithography is in '07 as a percentage of overall CapEx? And also moving into '08, it looks like Litho was gaining a much, much bigger share of the overall CapEx budget. So I am wondering whether you had any estimates there?

Eric Meurice

Again, we are not expert in understanding the rest of the business. We know that they have, on one hand, growth opportunities, because as you heard from the market is, if they go towards double patterning, there is significant opportunities for Lam Research, for Applied etcetera, for KLA.

So there is a growth opportunity. I do not know if their growth opportunity is as big as ours. Ours is fundamental, as you know, in a sense of, if you double patterning you multiply lithography by two. So these are big things, but I can’t really comment on the other areas.

Peter Wennink

Overall average, Tim it’s around 20% of CapEx spent, but that could be 21, it could be 19, and that is probably for you too big of a difference. So, of the equipment, not of the total CapEx sales, of the equipment CapEx. And also CapEx for us, the CapEx numbers that customers give out for us, we take it as a data point, but we don’t really focus on it. We focus on what our customer feel that they need, where they shrink growth maps.

And we also know that, and history has actually shown that very, very clearly that CapEx number is almost as fluid as the water we use in our tools. I mean, it goes up when customers need it, and it goes down when they really don’t need it. But what they do need and that’s what we know, is the shrink capability, and that is very clear, the road maps for that are very clear for our NAND customers and DRAM customers, and also for the Logic customers following late next year. And that will happen.

Timothy Arcuri - Citigroup

I guess my point is that, you could grow 15% next year, but that doesn’t necessarily mean that CapEx will be up. You could grow 15% even if CapEx is down 10% because it --

Peter Wennink

Absolutely.

Timothy Arcuri - Citigroup

Because a disproportionate piece of the CapEx is actually going now towards the Litho. So, and that was my point. I guess, the follow-up would be, how much of your orders, or do you have any sense of how much of your orders for NAND are going to replace old capacity?

Eric Meurice

That’s a very good question, and it is not a NAND question I guess, it’s a DRAM 200 millimeter question. I think we passed it on the silence, and there is also another engine of growth in 2008, is the DRAM people who cannot continue doing business on 200 millimeter at these price points.

So, now what will they do? Do they stop the factories? Is the price going to go up or are they going to buy ASML tools? So there is a transition in DRAM from 200 to 300 which is economically required. In the fresh environment, no, I think there is going to be zero --

Peter Wennink

Capacity replacement.

Eric Meurice

Capacity replacement. No they will be used on multiple layers or layers which were critical, become less critical.

Craig DeYoung

Next question.

Operator

The next question is from Peter Testa. Please state your company name followed by your question.

Peter Testa - One Investment

It’s Peter Testa from One Investment. Sorry, there's some construction just to see (inaudible) put me on, excuse me for the noise. Two questions please. First one was; if you look at the orders for execution over the next few quarters, and compare them either to percentage of sales or an absolute. There seems to be somewhat less on-the-go for the next two quarters than you have had say for Q3, Q4 when you spoke last time.

And also, you make a comment on 2008 that for the first three quarters you expect some increase. Does that imply that you would expect, sort of, up and down phasing or whether you are not entirely sure of when the capacity expansion orders will come which is somewhat absent from the order intake at the moment?

Peter Wennink

You can look at the data, but also on the presentation on the website.

Peter Testa - One Investment

I have seen it, yes.

Peter Wennink

69% of our order backlog is now currently for shipping in the next six months, which is low as compared to what we have seen in the last two years. But that has also been driven by the fact that the content of our leading-edge immersion tools is very high. And when you are a customer and you want to know all that you want to have those immersion tools which are absolutely vital for your product growth map, you want to secure those.

So, that actually means that and I think one of the questions I think Jay Deahna asked a question. We would expect that some of the units that are KrF and there are mid-critical layers that they would be ordered going forward to this quarter or the quarter to come.

So, yes, this is particular to the situation that customers want to secure the supply of their leading-edge tools, and it is my expectation that when unit orders go up, as we've guided for this quarter that you could see a -- and you probably, we will see a different mix in the order intake because sustaining a over EUR22 million ASP in order intake that is not very likely.

Peter Testa - One Investment

Okay. And then as a follow-up that's just on the KrF XT:1000 machine being launched, if you could just give some comments as your perception of the market opportunity for that tool please?

Eric Meurice

Yes, it is a tool in fact that allows people to go and do in KrF some layers which used to be done in ArF. So, you can say it's a bit of a cannibalization of the ArF business or you can say its way for ASML to take much more market share on KrF business, which belong to others. And we think that we have a chance on the other one.

Peter Testa - One Investment

Right, okay. Thank you.

Operator

Next question is from Robert Sanders. Please state your company name followed by your question.

Robert Sanders - Dresdner Kleinwort

Yeah, hi, it's a Dresdner Kleinwort. Just for a follow-up quick question on EUV actually. I see you've recently dropped Phillips and moved to Cymer as a light source supplier. I am asking really just a longer term question how do you see your technology lead in months, maybe today against Nikon and Canon just from chatting to your customers.

Eric Meurice

Also in terms of source no, we always welcome multi sources and at this moment, I understand there are field for players and they have different sense of urgency, and target, and spec, and timeframe, and et cetera. So, my understanding is it is still of Philips's interest to get into the business. But it is true that Cymer is coming up with a new technology called laser-induced plasma, which shows how you potential power faster. But again, at this moment it is a good thing that multiple players are trying different technology to achieve cost and performance.

Regarding our own performance, well it is not bad to have two tools at different place on which people work on, you may know that those two tools are extremely difficult to make work and there's a lot of problems with them but this is exactly why they are called alpha tools and there's a lot of learning and remember in this business, this is a business of learning. So, the more learning you have and experience you built, you create in fact an advance on your own platform and architecture.

So, whatever customers are going to invest like years one to two years or three years of R&D on to ASML platform, it will be extremely difficult for them then to transfer this knowledge onto something else.

And now, obviously the something else looks like another ASML platform because we think are the only one who first have committed end of '09 for shipment of the pre-production tools and we have already four orders and at this moment I don't think we'll be finished with the numbers of orders that we will announce. So that's not a bad leadership position to be in and we do expect our competition to come at some point, but as I say it is difficult to come late in the game of experience building.

Robert Sanders - Dresdner Kleinwort

Okay. Just a follow-up, just on the lengthening backlog you had at the end of September. I mean, what led your customers to place so many orders for delivery in Q2 and Q3 next year. Is it really just a question of securing capacity, if it is, is there a limit that you might be getting close to exceeding in terms of your capacity that you can support next year, is it 70 the sort of number that you could support theoretically in 2008?

Eric Meurice

No when we say the timing of orders, timing of orders is a difficult science. We said there are multiple reasons to have orders early or late or whether in that and the reason why we had a bit of early start on things is that because the decisions made by the customers are strategic. When you do a technology transition, you do a technology transition; you don't do short-term technology transition.

You don't think of this like tomorrow, when you all foundry and you wait for Christmas season, you are going to wait for the Christmas season and then you want the order because you are going to have orders for your chip, but when you are a guy who says I'm going to go and do a 55 or 45-nanometer and I have decided that's my only way to gain or to get profitability into DRAM, you are doing it, and at this moment you put the order.

So what we just discovered there was (inaudible) of course we expected something to happen but not as big. It is a way that the world has decided that the only way to make money on DRAM and flash is two accelerate moves and guess what this is kind of helping ASML, it helps Litho and it is solid because it's not a cycle question, its' a question of building up the infrastructure that is necessary.

And that's also not an overspend in a sense of building too much capacity, because again it's a transition base thing, I think it's not a capacity thing. So it's a sound decision and therefore they could be longer, I mean, if we done with the restructure [lead time].

Robert Sanders - Dresdner Kleinwort

And sorry, can you just update us then on your capacity for next year in terms of the amount of tools, immersion tools you could potentially ship or…?

Eric Meurice

We have a new factory, who will be online in Q2, with delivery in Q3 and this factory is giving us plenty of opportunity for growth.

Robert Sanders - Dresdner Kleinwort

Thanks a lot.

Craig DeYoung

Ladies and gentlemen, we are going to take one more call. If you didn't get through and you would like to ask, you call the Investor Relations Department in the Netherlands, we would be glad to receive your call and the number could be found in our website or at the top of the press release. So, operator, if we can have one more call please, one more question.

Operator

Yes. The last question is from Mr. Peter Knox. Please state your company name followed by your question.

Peter Knox - Pali International

Yeah, I am Peter Knox from Pali International. Just in terms the Q4 delivery schedule, from Bloomberg it was noted that you are expecting to ship more than 10 or more than 1900s in the Q4 period. Does that mean to say you are looking at the potential and first movements in the sales mix if you exclude the 1900i in Q4 over Q3?

Eric Meurice

If you would want a clear answer on that question you would have exclude all technology shipments from all the previous quarters also. Because clearly 1900i is the leading-edge product today, but a few quarters ago, it was 1700i and six quarters ago, it was the 1400i, that is a part of our business.

So, you cannot exclude let say number of shipments and let say the remainder is high, the remainder indeed low. It is part of where we are, and where we are in the cycle is that our customers are in need of the shrink, the shrink from 55 to 45 in NAND and from 70 to 55 in DRAM, that's what the industry is.

So, it's very difficult to answer that question because you don't want to eliminate the technology, the leading-edge technology tools from our shipment base because that's what we are all about. We are the technology leader.

Peter Knox - Pali International

Okay. Thank you.

Craig DeYoung

Okay. Thank you. Operator, if you close the call first, we would appreciate it.

Operator

Yes, of course. Ladies and gentlemen, this concludes the ASML 2007 third quarter results conference call. Thank you for participating. And you may disconnect your line now.

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