Strong performance commercial business operations in first half 2008

- Volume growth and cost control drive profit growth of commercial business
- Increasing capital expenditure and lower tariffs put pressure on results network operations
- Essent remains leading in sustainable energy

Notes to the 2008 half-year results
The strategy laid down in 2003 for the creation of value through growth and operational excellence is still fully in force. Business processes have been streamlined, customer satisfaction is back at its pre-deregulation level, profitability targets have been met, and Essent’s restructuring - including the sale of Kabelcom and disposal of various minor assets - is proving successful.

Consolidated results
Profit before interest and tax (EBIT) grew by EUR 36 million (6%) in the first half of 2008 to reach EUR 648 million. The increase is entirely attributable to the commercial operation, where expansion of trading activities, greater uptime of energy generation units and lower operating expenses produced a EUR 69 million (18%) increase in EBIT, lifting it to EUR 442 million. At Essent Networks, increased operating expenses resulting from the set up of the organisation, higher depreciation and amortisation, and lower tariffs were responsible for its profit before interest and tax declining from EUR 239 million for the first half of 2007 to EUR 206 million for the same period of 2008.

Due to higher interest expenses and no corresponding tax credits, which were available for the first half of 2007, profit for the first half of 2008 from continuing operations was 4% down on the same period of the previous year. Earnings per share from continuing operations attributable to equity holders of Essent N.V. fell from EUR 3.23 for the first half of 2007 to EUR 3.08 for the first half of 2008.

Capital employed rose because of capital expenditure and expansion of trading activities. Rising market prices for coal, biomass, oil and gas caused the market value of the derivative financial instruments to increase and hence the corresponding capital requirement as well. For the same reason, the guarantee deposits received and paid by Essent Trading also showed a material increase. During the first half of 2008, net cash converted into net borrowings (EUR 258 million).

Since the commercial operation and the network operation conduct business independently, their results are presented separately. A point to note is that Group overheads are fully allocated to the commercial operation, with the costs of services provided to the network operation being passed on to it. 

Commercial operation

The revenue of the commercial operation climbed by 27% in the first half of 2008 to reach EUR 3,769 million, the increase being mainly organic (19%) and split more or less 50-50 between electricity and gas. Both main products generated higher volumes in sales to consumers, as well as increased trading volumes.

Gross profit as a percentage of revenue declined from 35% for the first half of 2007 to 28% for the same period of 2008. In the case of electricity, the margin reduction was the result of higher prices for commodities consumed by the power stations. The uptime of the power stations was significantly better than in the same period of 2007. Concerning gas, its margin was also down, due to a relatively higher proportion of trading activities.

To properly understand the financial contribution of the trading activities, the portion of the market value gains on our portfolio that are not yet realised by the reporting date, but recognised under equity in the IAS 39 reserve, should also be taken into account. In this context, Essent’s method of cash flow hedge accounting required the withholding of EUR 615 million from profit during the first half of 2008. At 30 June 2008, the IAS 39 reserve amounts to EUR 881 million.

The plans launched at the end of 2007 for reducing overheads, a move necessitated by the ownership unbundling, were fleshed out further in the first half of 2008. By the end of 2009, we expect overheads to have declined by approximately 25% compared with mid-2007. We are also working hard to further reduce other operating costs. Apart from the customer processes of Service & Sales, this also concerns improved harmonisation of the business units, integration of related processes, simplification of corporate governance, and initiatives for decentralised working to mitigate the effect of poor traffic flows on work effectiveness. Operating expenses as a percentage of revenue dropped from 26% in the first half of 2007 to 20% in the same period of 2008. In absolute terms, they fell from EUR 769 million to EUR 749 million. From an organic perspective - adjusted for the costs of the Westland and ANO acquisitions - operating expenses shrank by 6%.

Ownership unbundling
Commencing 1 January 2009, Essent’s network operation will conduct business as ENEXIS. On the same date, ENEXIS will take occupancy of its new head office, by the A2 near Rosmalen.

The Independent Network Management Act, which came into force by the end of 2006, has three major stipulations. Essent now satisfies two of them. Essent’s network operation complies since the end of 2007 with the requirements of the so-called ‘fat’ network manager and the management of the 110-150 kV grid has been transferred to TenneT (the Dutch national transmission system operator). Essent is making preparations to satisfy the third stipulation concerning group prohibition: ownership unbundling of the commercial generation, trading and supply operations from the regulated energy transport operations. As stated in its 2007 annual report, Essent intends to complete as much as possible of this operational unbundling by the end of 2008, which means that, commencing 1 January 2009, the commercial operation and the network operation will actually function independently of each other. In this connection, it can be stated that the separation into two IT infrastructures and the dismantling of the service centre shared by Essent Networks and Essent Service & Sales will certainly continue into 2009.

Essent is currently preparing an unbundling plan that, following its review by the Netherlands Competition Authority, will be submitted to the Minister for Economic Affairs for approval. Essent intends to unbundle the network company, which’ shares have to remain in government hands. 

Regarding the network operation, the shareholders of Essent N.V. (who will also be the direct shareholders in the network company) have stated that it will need to have the means available for all necessary capital expenditure. The actual ownership unbundling will be effected later than the operational unbundling. 

Network operation

In the first six months of 2008, the network operation progressed further with setting up an independent organisation that will be able to perform its statutory tasks, in managerial as well as operational terms. The composition of the Supervisory Board has changed and a second director been appointed to the Executive Board. The managers who will report directly to the Board have been appointed, a list of the competencies needed has been drawn up and a start made on putting these in place.

At EUR 668 million, revenue for the first half of 2008 was EUR 30 million (4%) down on the same period of 2007, mainly the result of lower permitted tariffs. The gross margin as a percentage of revenue was 83%, representing a rise of one percentage point.

In absolute terms, expenses rose by EUR 21 million (6%) to EUR 356 million, the main causes being the setting up of a new organisation and higher depreciation from regular capital expenditure. It should be noted that, to facilitate comparison, the figures for the first half of 2007 have been adjusted to match the new situation of being a so-called ‘fat’ network manager. The adjustment relates to the operation of the electricity and gas networks, which were only acquired at the end of 2007 from Essent Nederland B.V., a holding company within the commercial operation. Because of formal reporting requirements, the adjustment is not reflected in the financial statements.

Outlook
Essent is operating in a turbulent environment. Apart from the international consolidation in the European energy sector, major changes are also taking place in the Netherlands. The shape of a new market model is slowly coming into focus, with the slow pace of political decision-making putting heavy pressure on companies like Essent to have their systems ready by the starting date.

Besides working on a new market model requiring considerable investment, Essent is occupied with the issue of mandatory ownership unbundling. The risk profiles of the unbundling of the operating activities themselves and of the corresponding legal steps both require proceeding with a high degree of caution. 

The network operation is progressing further with setting up its organisation and gradually eliminating more and more of the competency gap. Preparations for a future without a network operation, although possibly with a new international partner, are demanding much attention from the organisation of the commercial operation. Nevertheless, the core activity of ensuring a reliable, affordable and sustainable supply of energy remains Essent's most important task.

In the first half of 2008, we showed once again that we are skilled in our trade and able to keep turning a higher profit, despite all the uncertainties and conflicting priorities. However, the prudently framed outlook we presented earlier this year remains the backdrop to all our normal business operations. Exceptional circumstances can always upset the picture. 

Barring unforeseen circumstances and ignoring unbundling, the profit from continuing operations for 2008 attributable to the equity holders of Essent N.V. is expected not to be less than the comparable profit for 2007.