Annual report 2006 Report of the Management Board Analysis of Results

Analysis of Results

Over the past two years the results of Nuon were strongly influenced by incidental items and movements in the fair value of financial instruments (hereinafter referred to as fair value movements), notably energy commodity contracts. The analysis of the results provides insight into the development of the underlying operating results by differentiating between the reported results on the one hand and the results excluding incidental items and fair value movements on the other hand.
The term ‘reported result’ as used in this report refers to the total result including the incidental items and fair value movements. ‘Result excluding incidental items’ or ‘result adjusted for incidental items and fair value movements’ refers to the reported result excluding incidental items and fair value movements. The incidental items and fair value movements included in the reported results are discussed later in this report.
It should be noted that the terms ‘incidental items’ and ‘result excluding incidental items’ are not derived from, or prescribed by, International Financial Reporting Standards (IFRS) or the International Accounting Standards Board (IASB).

Incidental items are defined as items which – in the opinion of the management – do not stem directly from ordinary operating activities and/or whose nature and size are so significant that these need to be considered separately in order to enable proper analysis. Nuon uses a threshold of approximately € 20 million for incidental items. This threshold is not applied in relation to (reversals of) impairments and fair value movements of energy commodity contracts as these items occur frequently and the total amount of these items over the whole year may consequently exceed the threshold of € 20 million as defined by Nuon.
The overview below contains an overview of the reported results and the results excluding fair value movements and incidential items.

Reported results and the results excluding incidental items and fair value movements
	Reported		Incidental items and fair value movements		Excluding incidental items
In millions of euros	2006	2005	2006	2005	2006	2005

Net turnover	5,598	5,017	208	276	5,390	4,741
- Electricity	2,659	2,486	208	276	2,451	2,210
- Gas	2,012	1,712			2,012	1,712
- Heating and other	927	819			927	819

Gross margin	2,244	2,086	158	63	2,086	2,023
- Electricity	1,251	1,173	158	63	1,093	1,110
- Gas	340	316			340	316
- Heating and other	653	597			653	597

Other income	129	251		120	129	131
OPEX	-1,276	-1,030	-48	266	-1,228	-1,296
Depreciation and impairments	-350	-324	-34	-3	-316	-321
Capitalised own production	102	115			102	115

Operating profit (EBIT) from continuing operations	849	1,098	76	446	773	652
Financing costs	-53	-99			-53	-99
Profit before taxation from continuing operations	796	999	76	446	720	553

Taxation	-339	-308	-100	-134	-239	-174
Share in result of associates and joint ventures	6		-4		10
Profit after taxation from continuing operations	463	691	-28	312	491	379
Profit after taxation from discontinued operations	301	449	296	410	5	39
Profit after taxation	764	1,140	268	722	496	418

Profit after taxation attributable to minority interests	1	2			1	2
Profit after taxation attributable to Nuon shareholders	763	1,138	268	722	495	416

The incidental items and fair value movements included in the results over the past two years are discussed later in this report.

Net turnover from continuing operations In millions of euros

Net turnover for 2006 increased to € 5,598 million (2005: € 5,017 million). Excluding incidental items, the net turnover increased 14% to € 5,390 million (2005: € 4,741 million).

Net electricity turnover, excluding incidental items, increased in 2006 to € 2,451 million (2005: € 2,210 million). Virtually all activities contributed to this increase. The total volume of electricity that Nuon supplied over the full financial year 2006 to its customers in the three core countries increased by about 9% compared to last year. In addition, from 1 January 2006 price increased in the consumer market in the Netherlands in response to the price increases of electricity and raw materials for the generation of electricity during 2005 and 2006. The number of consumers in the Netherlands who purchase electricity from Nuon remained virtually stable. Customer satisfaction in this market segment increased during 2006. Nuon invests a lot in timely and customer-focused complaints handling, which is reflected in this increase. The activities in the business market developed favourably throughout 2006. In 2004, Nuon adopted a strategy where margin improvement prevails over market share. Both market share and supplied volume increased compared to 2005. In the business customer segment, customer satisfaction improved compared to last year. The turnover of the Grid Management segment increased, particularly due to positive volume and price differences and the final settlement of sales to be invoiced as estimated at the end of 2005. The activities in Belgium and Germany also showed turnover growth. In Germany, sales to consumers commenced in Berlin and Hamburg.

Net gas turnover for 2006 showed an increase of 18% to € 2,012 million compared to the previous year (2005: € 1,712 million). Temperatures followed an erratic pattern in the year 2006: the first six months were extremely cold while the second half was unprecedentedly mild. The total volume supplied in the three core countries decreased slightly as a result of this. The number of customers in the Dutch consumer market remained virtually stable, partly thanks to the improvement in customer satisfaction and the measures to improve the customer and operational processes. However, the decrease in the supplied volume was more than offset by the increase in the price of gas from 1 January 2006 following the increase in the gas purchase price at GasTerra, the former Gasunie Trade & Supply. The volume supplied in the Dutch business market increased. The turnover of the Grid Management segment remained stable thanks to an unchanged amount of transported gas. The turnover of Nuon Belgium and Nuon Germany increased due to a combination of higher prices compared to last year and the entry of Nuon into new markets in Hamburg and Berlin.

Net heating and other products turnover for 2006 increased to € 927 million (2005: € 819 million) and was mainly caused by the increase in the turnover from heating as a result of higher prices – in response to the increase in the price of raw materials and fuels – and a larger customer base. In addition, turnover growth was realised across all the other turnover categories, including the security activities, public lighting, metering activities and installation activities.

Gross margin from continuing operations In millions of euros

The gross margin for 2006 increased to € 2,244 million (2005: € 2,086 million). Excluding incidental items, the gross margin increased in 2006 by 3% from € 2,023 million in 2005 to € 2,086 million in 2006. The gross margin expressed as a percentage of the turnover decreased, however, to 39% in 2006 (2005: 43%), reflecting the increase in the average purchase costs of electricity, gas and raw materials compared to last year which were not fully passed on to the customer.

The electricity gross margin for 2006 increased to € 1,251 million (2005: € 1,173 million). Excluding incidental items, the electricity gross margin decreased 2% to € 1,093 million (2005: € 1,110 million). The gross margin, expressed as a percentage of the turnover, decreased from 50% to 45%, partly as a result of increased purchase prices of electricity and raw materials for the generation of electricity. The gross margin, excluding incidental items, of the Production & Trade segment decreased due to lower settled trading results. However, the total result from trading activities, including the unrealised fair value movements, increased compared to last year. The gross margin was also affected by a lower production of Nuon’s power stations and a higher production of renewable energy (notably wind farms). Against this, there was an increase in the gross margin on the activities in the Dutch consumer market. The increase in turnover in this market segment was caused by the higher average prices of electricity and raw materials compared to 2005 and had a positive impact on the gross margin in absolute terms. The gross margin of the Grid Management segment increased, notably due to positive volume and price differences and the final settlement of sales to be invoiced as estimated at the end of 2005. The gross margin of Nuon Belgium is under pressure due to the difficult market, in which retail prices are not moving synchronously with wholesale prices, and decreased compared to 2005.

The gas gross margin for 2006 increased 8% to € 340 million (2005: € 316 million). However, the gross margin, expressed as a percentage of the net turnover, decreased from 18% in 2005 to 17% in 2006 due to the higher average purchase prices. The volume supplied to customers in the three core countries decreased by 1% compared to 2005. This decrease is mainly visible in the Dutch consumer and business markets and reflects a lower number of degree days compared to 2005, which was caused by the relatively mild second half of 2006.

The gross margin on heating and other products for 2006 increased by 9% to € 653 million (2005: € 597 million). The increase was visible across the entire chain of activities. The installation activities, the services to industrial estates and activities in the field of the supply of heating and cooling all contributed towards this increase.

Operating expenses from continuing operations In millions of euros

Operating expenses for 2006 increased to € 1,276 million (2005: € 1,030 million). Excluding incidental items, there was a decrease of 5% to € 1,228 million in 2006 (2005: € 1,296 million).

Employee compensation and benefit expenses increased from € 340 million in 2005 to € 617 million 2006. In 2005, the expenses were largely influenced by the release of provisions for post-employment medical benefits and the recognition of a provision for shorter working hours for elderly employees. Excluding these incidental items, the employee compensation and benefit expenses increased 2% from € 606 million in 2005 to € 617 million in 2006. The number of own personnel increased 1% compared to last year. This increase is related to the increased turnover from the installation activities (Feenstra), the higher level of activities of Network Services, the unit responsible for the infrastructure, and a strengthening of various supporting functions such as ICT and the Customer Care Center (CCC).

The external costs amounted to € 249 million in 2006 (2005: € 275 million). Savings were realised on the hiring of external employees. This was only partly offset by the costs of preparation for the intended construction of the new power plant in Eemshaven (Groningen). Further, additional costs were incurred in 2005 to solve the problems with the administrative backlogs and to improve the operational and customer processes. In addition, various cost control measures were successfully implemented in 2006.

The other costs decreased from € 415 million in 2005 to € 410 million in 2006. This is principally due to lower bad debt impairments and the release of a number of provisions for various obligations, including claims and disputes. In 2006, ‘precario’ tax was levied after all in the light of the imminent abolition of this tax. Besides this, marketing costs increased due to various campaigns in the Dutch consumer market and the launch of commercial activities in Hamburg and Berlin. Finally, various strategic projects led to an increase of legal and advisory costs.

Depreciation, amortisation and impairments from continuing operations

Depreciation, amortisation and impairments amounted to € 350 million in 2006 (2005: € 324 million). In 2006, impairments were recognised for a number of heating projects, CHP plants and power stations as a result of changes in market conditions and the assumptions in relation to their future use for electricity production. In addition, a number of previously recognised impairments were reversed. Excluding these incidental items, depreciation charges for 2006 decreased to € 316 million (2005: € 321 million).

Operating profit by segment In millions of euros

Operating profit from continuing operations

Operating profit from continuing operations decreased in 2006 to € 849 million (2005: € 1,098 million). Excluding incidental items, the operating profit increased 19% to € 773 million in 2006 (2005: € 652 million). The increase in the gross margin and the decrease in the operating expenses are the most important causes of this increase.

Financial income and expenses

The balance of the financial income and expenses for 2006 amounted to net charges of € 53 million compared to net charges of € 99 million in the previous year. This decrease was attributable to the decrease in average net debt over 2006 compared to 2005. However, this decrease was partly offset by the costs arising from the early repayment of a number of loans.

Taxation on the profit from continuing operations

The effective tax rate (the tax charge expressed as a percentage of the profit before taxation from continuing operations) amounted to 42.6% in 2006 compared to 30.8% in 2005. The effective tax rate in 2006 was negatively impacted by the effect of the future change in the income tax rate from 1 January 2007 onwards and by tax losses of activities outside the fiscal unit for which no deferred tax assets were recognised.

Profit after taxation from continuing operations

Profit after taxation from continuing operations decreased from € 691 million in 2005 to € 463 million in 2006. Excluding incidental items, the profit after taxation from continuing operations for 2006 increased to € 491 million (2005: € 379 million).

Profit after taxation from discontinued operations

Profit after taxation from the activities that Nuon has sold or intends to sell amounted to € 301 million (2005: € 449 million). The profit for 2006 includes the release of the convertible subordinated loans of € 91 million and the release of the provision for the sale of an interest in a power generation company of € 128 million as well as the book profits on the sale of non-core activities of € 78 million. This latter item comprises the book profits on the sales of Vitens, the wind farms in Germany and China, Utilities Inc., Cascal and Paques. In 2005, this item contained the book profit of € 410 million on the sale of the wind energy activities in Spain that were included in Nuon Espana S.L. Excluding these incidental items, the profit after taxation from discontinued operations for 2006 decreased to € 5 million (2005: € 39 million).

Profit after taxation

Profit after taxation for 2006 attributable to the shareholders of Nuon decreased to € 763 million (2005: € 1,138 million). Excluding incidental items, the profit after taxation increased from € 416 million in 2005 to € 495 million in 2006.

Net profit after taxation In millions of euros

Incidental items included in the results for 2006

To permit a better comparison of the results across the periods and to provide better insight into the development of the underlying operating results, the incidental items and fair value movements are specifically named in the analysis. The table below shows the incidental items included in the results for 2005 and 2006:

Incidental items included in the results
In millions of euros	Classification in the income statement
In millions of euros	Classification in the income statement	2006	2005

Fair value movements financial instruments and derivatives	Net turnover	158	276
Settlement of a long-term purchase contract for emission rights	Net turnover	50
Transfer of InterGen-contract to Eneco	Other income		120
Costs from prior years relating mainly to renewable energy	Purchase costs energy/gross margin	-50	-116
Settlement of and movement in provision for onerous contracts	Purchase costs energy/gross margin		-97
Start-up costs for construction of new power station	Operating expenses	-29
Precario tax levy costs	Operating expenses	-19
Provision for shorter working hours of elderly employees	Operating expenses		-48
Release from provision for post-employment medical benefits	Operating expenses		314

Impairments	Depreciation and impairments	-58	-82
Reversals of previously recognised impairments	Depreciation and impairments	24	79
Total impact on operating profit from continuing operations		76	446

Tax impact on incidental items	Taxation	-29	-104
Impact on deferred tax assets and liabilities of change in income tax rate	Taxation	-71	-30
Write-down of associated company in connection with impairment of CHP plant in Germany	Share in result of associated companies	-4
Total impact on profit after taxation from continuing operations		-28	312

Release of provision for sale of associated companies	Result discontinued operations	128
Release of convertible subordinated loans	Result discontinued operations	91
Book profit on sale of non-core activities	Result discontinued operations	77	410
Total impact on profit after taxation from discontinued operations		296	410

Total impact on profit after taxation		268	772

In 2006 the results were positively impacted by incidental items of € 268 million (2005: a net gain of € 722 million).

In 2006, fair value movements of € 158 million (gain) were included in the profit compared to € 276 million (gain) in 2005. Under IAS 39, financial instruments and derivatives, including energy commodity contracts, must be recognised at fair value and value movements must in principle be recognised in income. Strong fluctuations in the prices for raw materials and electricity have a strong influence on (the volatility of) the results and the derivative positions on the balance sheet. In the analysis of the underlying results, the fair value movements are treated separately due to the fact that the value movements of, notably, energy commodity contracts are partly beyond Nuon’s control and due to the fact that the fair value movements concern unrealised (unsettled) results. The settled positions, adjusted for additions to the hedge reserve, are included in the results excluding incidental items and fair value movements.

As part of its normal operations, Nuon trades in energy commodity contracts. These activities take place under strict conditions, policies and limits which are set by the Management Board and, among other things, demarcate the maximum risk Nuon may be exposed to. The monitoring of risks and positions and verification of compliance with the internal procedures and controls on limits take place continuously on behalf of the Management Board. Under IAS 39, energy commodity contracts (e.g. oil, coal, gas, electricity and CO2 emission rights and related exposures in foreign currency) are classified as derivatives and recognised at fair value with the movements in the fair value of these contracts recognised in income. In 2006 the total fair value result on the commodity contracts that are classified as derivatives amounted to a gain of € 337 million.
Alongside trading activities, Nuon also enters into energy commodity contracts to cover its demand for energy to supply customers and to produce electricity at the power stations. These contracts are not measured at fair value but at cost because they are intended for the company’s own use. However, continuous optimisation takes place in view of the uncertainties surrounding the future production. As a result, the expected and covered purchase, sale and production differ from the actual purchase, sale and production. On these grounds, despite the fact that the position is fully hedged from an economic point of view, part of the energy commodity contracts that are intended for the company’s own use are recognised for IFRS reporting purposes at fair value with the fair value movements of these contracts recognised in income. Due to the strong decline in the oil and gas prices in 2006 and the positive result reported in this connection in 2005, this led to a negative fair value movement of € 179 million, where the capacity was sold forward in the market at a positive margin.

Based on the above, the fair value movements of € 158 million can be analysed as follows:

Fair value movements
In millions of euros	2006	2005

Fair value movement of the commodity contracts that are classified as derivatives	337	260
Contracts for own use of power stations which are measured at fair value under IFRS	-179	16

Total fair value movements included in the result	158	276

In 2006, Nuon settled a long-term purchase contract for emission rights, leading to a gain of € 50 million.

The gross margin contains an expense of € 50 million for costs for prior years relating to renewable energy. In 2005, a similar expense of € 116 million was recognised.

The operating expenses include expenses of € 29 million relating to the development of the new power station at Eemshaven in Groningen and precario tax levies of € 19 million which were levied despite the imminent abolition of precario tax.

In 2006, impairments of € 58 million and reversals of earlier impairments of € 24 million were recognised. The impairments relate to various heating projects, power stations, combined heat and power plants (CHP) in the Netherlands and Germany and impairments on goodwill. The reversals of earlier impairments relate to impairments recognised in the past in respect of several power stations which, in view of the most recent insights in relation to the use and future production and margins, had ceased to exist.

The tax effect on the incidental items amounted to a charge of € 29 million. In addition, the deferred tax assets were written down for an amount of € 71 million as a result of the announced reduction of the income tax rates with effect from 1 January 2007 from 29.6% to 25.5%.

The share in results of associates and joint ventures contained a loss of € 4 million relating to the write-down of a CHP in a foreign associated company.

In 2006, the item Profit after taxation from discontinued operations in the income statement included various gains relating to the results on the disposal of non-core activities and the settlement of obligations from the past in relation to activities sold. In 2006, the profit from discontinued operations included a gain of € 91 million. This relates to the release to income of the item convertible subordinated loans. These loans were concluded in the past with shareholders of Nuon in connection with guarantees issued on the sale of non-strategic investments (Dattel, Multikabel, Gelrevision, UTH, EZH and EPON). In 2006, the loans matured and this amount was released to income. In addition, the provision for the sale of an associated company of € 128 million was released to income from discontinued operations. This release relates to a provision for possible obligations for costs that are not in line with market and results from guarantees issued by Nuon upon the sale of its interest in the power-generation company EPON. During 2006, it was established that the obligations had ceased to exist.
Finally, the item profit after taxation from discontinued operations contains the book profits on the sale of non-core activities, i.e. Vitens, the wind farms in Germany and China, Utilities Inc., Cascal and Paques, of € 77 million in total.

Incidental items included in the results for 2005

The 2005 results were positively impacted by incidental items of € 722 million. The fair value movements amounted to € 276 million (gain) in 2005. In addition, the other operating income includes a gain item of € 120 million in relation to the transfer to Eneco of a long-term electricity purchase contract with the InterGen power plant at Rijnmond.
In 2005, the gross margin contained a loss of € 116 million for costs from prior years relating to renewable energy, including Regulating Energy Tax (REB). In addition, the gross margin included a charge of € 97 million relating to the settlement of and additions to the provision for onerous contracts for green certificates of Norwegian wind farms. This contract became onerous in 2004, as these certificates could no longer be used in the Netherlands, due to changes in legislation. Nuon settled the last purchase obligations in relation to the Norwegian wind contracts of CEPVA/Statkraft at the end of 2005.

The new healthcare system launched on 1 January 2006 led to the release of the provision for post-employment medical benefits of € 314 million in 2005. In addition, the CAO (Collective Labour Agreement) concluded at the end of 2005 provides for a transitional measure enabling elderly employees to opt for shorter working hours in the future. This arrangement led to the recognition of a provision of € 48 million.

In 2005, Nuon recognised impairment losses and reversals of previously recognised impairments of, on balance, a charge of € 3 million. These impairments and reversals relate mainly to power stations. Changes in market conditions, prices, business plans and developments in the field of CO2 emission rights as well as assumptions in relation to the use and realisation of savings have led to these impairments and – in a number of cases – to the reversal of previously recognised impairments.

The tax effect on the incidental items amounted to a charge of € 104 million. In addition, a tax charge of € 30 million was recognised in 2005 in relation to the effect of the reduction in the income tax rates that was announced in 2005.

Reporting 2006