Final Results - Part 2

8th Mar 2007 07:03

Drax Group PLC08 March 2007 DRAX GROUP PLC (Symbol: DRX) PRELIMINARY RESULTS FOR THE YEAR ENDED 31 DECEMBER 2006 - PART TWO Chief Executive's review Introduction We entered 2006 as a newly refinanced and listed company with the creditstrength to implement a forward-looking strategy for the business founded on theeffective alignment of production, trading and investment strategies. Ourachievements in 2006 are borne out by our strong financial results anddemonstrate well the value of having a sound capital base. They also reflect thebenefit derived from our strategy of: delivering excellence in plant operationsand trading performance; enhancing and diversifying the business, with a focuson fuel optionality and carbon abatement; and ensuring we have the appropriatefinancial and human resources. We are a power generation business operating in commodity markets. Against abackdrop of volatile power prices, increasing fuel costs and erratic prices forcarbon dioxide ("CO2") emissions allowances we have delivered strong andimproved revenue and earnings compared with 2005. Key to the delivery of theseresults is the seamless interaction between our production and trading functionswhich work together to exploit opportunities as they arise. The resulting strongcash flow has allowed us to make significant distributions to our shareholders,fully in line with the commitments we made at Listing. Production strategy Above all, the principal foundation for our operating philosophy is that we mustensure safe, high integrity operations before we consider anything else.Improvements in our safety record have taken us to leading performance levelshelping us to collect, for the second year running, the Royal Society for thePrevention of Accidents' Gold Award. We continue to operate our "Spotlight on Safety" ("SOS") behaviour-based safetyprogramme for employees and contractors and we have strengthened the safetycommunication and feedback process. Our production strategy for the year focused on two key areas: securing thetargeted improvements in the fundamentals of plant operation, a programme thatwas initiated in 2004; and developing and executing projects that will improvethe operating efficiency and environmental performance of the Drax plant andequipment. Our Forced Outage Rate ("FOR") performance has improved for the second yearrunning, both for the full year and during the critical Winter quarters, whenreliability of the plant is an essential contributor to the security of supplyof the UK electricity system. This improved operating performance has led to the high availability of all sixunits at the Drax Power Station and places us as the industry leader forcoal-fired plant by a clear margin - we achieved 90% compared to an average of71% for the remainder of the sector - confirming the competitiveness andreliability of our operations. We pride ourselves on our environmental leadership position within the sectorand are pleased to report that, through focused effort on our operations, 2006was the third consecutive year in which we recorded zero environmental breachesof our operating licence as issued by the Environment Agency. Trading strategy Our credit rating and strong market presence have enabled us to deliver ourprogressive hedging strategy targeting market or better dark green spreadsthrough making full use of the good liquidity available to us in the forwardpower markets. During 2006, value was significantly enhanced through a substantial growth inour forward sales portfolio, which more than doubled. In April, we wereparticularly pleased to announce our contract with Centrica, through which wewere able to secure power sales into the term market for the five-and-a-quarteryear period to December 2012. In addition, we have continued to contract powerthrough smaller structured deals and the liquid traded market, which now extendsthrough to Winter 2010. During the course of 2006, we diversified our coal procurement strategy toincrease our fuel flexibility and choice. We expanded our access to portcapacity and we also worked with our rail freight suppliers to improve logisticsbetween Drax and the ports and the mines from which our coal is delivered. Our revenue during the year was enhanced through the sale of by-products,National Grid support, or ancillary services and other products. We moved closerto our target of "zero ash landfill" through selling some 80% of our ash to theconstruction industry. We are working on reducing further this figure through anagreement with Lafarge Cement, under which we will construct an ash rail loadingfacility to improve our ash export capability and allow greater and moreefficient access to construction markets, particularly in the South East ofEngland. In addition, during the year we signed a new gypsum supply contractwith British Gypsum to continue to sell all of the gypsum we produce, as aby-product of our flue gas desulphurisation process, to the plasterboard andrelated products market. Investment strategy Through continuing investment, Drax has maintained its position as the mostefficient coal-fired generator in the UK with the lowest amount of CO2 emissionsper unit of output. However, we are not complacent and economic carbon abatementis a key driver for our forward investment programme. In December, we announced our decision to proceed with a major, £100 millionturbine upgrade - the largest steam turbine modernisation in UK history. Oncecomplete, it will improve the overall efficiency of the plant taking it close to40%, and strengthen further our position as the UK's most efficient coal-firedgenerator. The efficiency improvement feeds through to environmental improvementand will result in a saving of one million tonnes of CO2 each year. The 2006 Energy Review and the expected changes in the co-firing regime haveresulted in us formalising our target to produce 10% of our output from burningbiomass by 2009. Achievement of this target will result in a saving of over twomillion tonnes of CO2 each year. During 2006, our biomass co-firing activitieswere constrained by the regulatory regime. However, towards the end of the yearand in the light of encouraging regulatory developments, we started work on thegrowth of our biomass handling and co-firing facilities and plan to invest up to£47 million in an expansion project commencing in 2007. Biomass material can be purchased in various forms, from untreated topre-processed. We are considering supplementing our existing and alreadysizeable biomass programme, through which we have entered into energy cropsupply contracts with local farmers, with an on-site rape seed crushing plant,at a cost of up to £20 million, which will deliver processed biomass material.Where appropriate we will consider further investments depending on the"make-or-buy" economics. Final implementation of these projects is reliant on the Government deliveringagainst its proposals for regulatory change to the co-firing regime through theEnergy Review. Environmental and regulatory landscape The major challenge facing Drax, and the coal-fired generation sector, isenvironmental and carbon is the single biggest constraint. We firmly believethat we have an important part to play in the UK's transition towards a lowcarbon economy, whilst, at the same time, delivering reliable supplies ofelectricity. It is for this reason that our primary environmental goal is toreduce our emissions of CO2. The year started with the launch of a timely Energy Review by the Government.Today, the UK is served well by a diverse and well proportioned energy mix; acircumstance that is widely recognised as making a valuable contribution tosecurity of supply. Environmental legislation, in particular the LargeCombustion Plant Directive ("LCPD"), is hastening the closure of somefossil-fuelled power stations, that combined with decommissioning of nuclearplant will, over the next ten to 15 years, have a dramatic effect on the energymix, the capacity margin and, without early and significant new build, securityof supply. A certain and predictable energy policy framework is essential toencouraging the level of investment needed to ensure long-term, reliableelectricity supplies. Coal-fired generation generally meets around one-third of the electricity needsof the UK, but, during the Winter of 2005/06 it met around half of the demand; atimely reminder of its importance in the UK energy mix. Through the Energy Review we were able to make our voice heard on the continuingrole for coal-fired generation and the prospects for clean coal technology.Existing coal-fired power stations have considerable scope to make a realdifference to their environmental performance through significant reductions inemissions of CO2. We have long advocated the role of co-firing renewable biomassmaterials with coal in the fight against global warming. At Drax, we havepioneered co-firing technology and it has emerged as a cost effective andcredible renewable technology with huge potential. We were delighted when the Government's report on the Energy Review, publishedin July, reported their findings of "a broad consensus that co-firing should beencouraged to play a long-term role in reducing CO2 emissions". The report wenton to present proposals that, once implemented, will enable us to develop fullythe co-firing potential of Drax. We stand ready to invest in this technology andto deliver considerable savings in our CO2 emissions. Through the Energy Review the Government identified the need for, and has nowconvened, the Coal Forum. Working together, Government, coal-fired generators,coal producers and suppliers, power plant suppliers, infrastructure owners andoperators, trade unions and other parties are aiming to secure the long-termcontribution of coal-fired power generation and optimise the use of economiccoal reserves in the UK. Drax is wholly supportive of this approach and isparticipating fully in the process. We are, however, constantly reminded that regulatory change in the UK isincreasingly being driven by EU legislation. During 2006, there were severaldevelopments with implications for the UK electricity industry. The key onesinvolved further clarification on the future control of emissions of pollutantssuch as sulphur dioxide ("SO2"), oxides of nitrogen ("NOX"), and CO2. The UK Government made its final decisions on the implementation of the LCPD. AtDrax, we have decided to implement the Directive through the National EmissionReduction Plan ("NERP") option, which involves compliance with annual limits forSO2, NOX and particulates. We anticipate that these limits will be incorporatedwithin the site's Pollution Prevention and Control ("PPC") permit, which willreplace the existing Integrated Pollution Control ("IPC") authorisations in2007. In addition, the UK Government determined, and the European Commission approved,the level of CO2 emissions allowances for the National Allocation Plan ("NAP")for Phase II (2008 to 2012) of the EU Emissions Trading Scheme ("EU ETS"). Underthe new "benchmarked" methodology, it is anticipated that Drax will be allocatedaround 9.5 million tonnes of allowances each year over the Phase II period. Thisallocation will be supplemented by allowances already purchased for Phase II aspart of our forward hedging strategy, including the 4.7 million tonnes to bedelivered each year through the Centrica contract. Going forward, the EU ETS is pivotal to providing the much needed certainty toinstil investor confidence. We saw a precipitous fall in the price of CO2emissions allowances for Phase I when it became apparent, from 2005 emissionsdata, that EU Member State governments had allocated more allowances toparticipants than they needed to cover their actual emissions. However, we werepleased to see the European Commission ("EC") taking a much firmer stance onallocations for Phase II. Market outlook Throughout most of 2006, gas-fired power stations were the price-setting plantin the power market, with marginal costs of production above the equivalent costfor coal-fired generation and nuclear generation. As a result, power prices wereprincipally driven by gas prices and CO2 emissions allowances prices - the twokey input costs of gas-fired power generation. It is expected that in the coming years power prices will continue to bestrongly influenced by gas prices and CO2 emissions allowances prices, but, itis also to be expected that power plant capacity issues will become anincreasingly important driver due to the emerging capacity gap. Addressingregulatory uncertainty is key to creating the investor confidence to bridge thisgap. Looking ahead In 2007, our overriding aim will be to continue to create added value and todeliver on our promises to shareholders. We fully expect that we will continueto have good access across relevant commodity markets as a result of our creditstrength. We expect the markets in which we trade to continue to display high levels ofvolatility. We are fortunate in that our capital structure takes account of thisvolatility and fully recognise the desirability of maintaining an investmentgrade rating in support of our operational and trading strategies. However, wewill continue to keep our capital structure under active review and, whenappropriate, we will consider raising additional debt to ensure we maintain anefficient structure which is compatible with our trading needs. We plan tocontinue with our progressive hedging strategy targeting market or better darkgreen spreads and to expand the areas in which our trading function adds valueto the business. Given current trading expectations and the continued development of our hedgeposition coupled with effective cash management, we expect to continue todeliver on our commitment to return substantial excess cash to our shareholders.As always, we will remain alert to sector opportunities and be consistent in ourdrive to build shareholder value through good operational strategies andjudicious investment. During 2007, as well as commencing the major turbine upgrade project, we willcontinue to identify projects to enhance the value of the plant through improvedperformance in reliability, fuel optionality and efficiency. We believe that it is important to identify economic routes to reduce the CO2emissions from our operations at Drax. We are confident that the turbine upgradeproject will deliver significant CO2 savings and we are equally confident thatthe Government will implement changes to the regulatory framework for renewablesthat will enable the economic co-firing of biomass at Drax. With this in mind,we will work towards developing and implementing projects to deliver our targetof 10% of renewable energy through Drax by the end of 2009. We will continue to be active in the regulatory debate - we strongly believecoal-fired generation is critical to the UK energy mix going forward if theGovernment is to achieve its objectives of delivering security of supply,affordability and tackling climate change, where co-firing biomass with coal hasmuch to contribute. Excellence in safety and operations performance will continue to be an importantdriver for the business and, in particular, the two major outages planned forthis year. Much management focus will be devoted to delivering solid resultsacross the production function through operational improvements to consolidateour recent advances in reliability and availability. Our people Last, but, by no means least, a mention of the real asset of our business - ourpeople. The employees of Drax are the backbone of our business and their driveand enthusiasm are fundamental to delivering against our strategy and deliveringvalue to shareholders. Throughout 2006, we continued to recruit specialists topopulate our workforce with the experience, skills and foresight to take ourbusiness forward. During the year, around 50 people were recruited to Draxacross all disciplines from training, through trading to craftsmen andengineers. In September, for the fourth year running, we welcomed engineeringapprentices and saw our 2003 intake enter into their final year. Throughout 2007, we intend to place particular emphasis on the development ofthe staff at Drax with implementation of a new approach to training anddevelopment. We will also place additional emphasis on building the engineeringcapability within Drax, both to deliver the projects already identified and toinform our strategic options going forward. We will continue to invest intrading, recognising the importance of improving and growing our tradingcapability across all the commodities we trade, and of particular note is thegrowth in our biomass trading function to support the corporate strategy. Results of operations Year ended Year ended 31 December 31 December 2006 2005 £m £mTotal revenue 1,387.0 928.6Fuel costs(1)Fuel costs in respect of generation (547.5) (459.7)Costs of power purchases (93.8) (79.8) ----------------------- (641.3) (539.5) -----------------------Gross profit 745.7 389.1Other operating expenses excluding depreciation,amortisation, unrealised gains/(losses) onderivative contracts and exceptional items(2) (162.7) (149.7) ----------------------- EBITDA(3) 583.0 239.4 ----------------------- Depreciation and amortisation (34.9) (31.2)Other operating income - net exceptional credit 19.0 263.3Unrealised gains/(losses) on derivative contracts 90.8 (117.0) ----------------------- Operating profit 657.9 354.5Interest payable and similar charges (37.1) (114.4)Interest receivable 13.4 23.5 ----------------------- Profit before tax 634.2 263.6Tax (charge)/credit (170.7) 18.8 ----------------------- Profit for the year attributable to equityshareholders from continuing operations 463.5 282.4 ----------------------- Earnings per share from continuing operations pence pence per share per share- Basic and diluted 126 108 Notes:(1) Fuel costs comprise the fuel costs incurred in the generation process, predominantly coal and CO2 emissions allowances, together with oil and biomass. Fuel costs also include the cost of power purchased to meet power sales commitments. (2) Other operating expenses excluding depreciation, amortisation, unrealised gains/(losses) on derivative contracts and exceptional items principally include salaries, maintenance costs, grid connection and use of system charges (TNUoS), balancing services use of system charges (BSUoS) and business rates. (3) EBITDA is defined as profit before interest, tax, depreciation and amortisation, exceptional items and unrealised gains/(losses) on derivative contracts. EBITDA for the year ended 31 December 2006 was £583 million compared to £239million in 2005 and operating profit was £658 million (£548 million excludingexceptional items and unrealised gains on derivative contracts), compared to£355 million in 2005 (£208 million excluding exceptional items and unrealisedlosses on derivative contracts). Total revenue for the year ended 31 December 2006 was £1,387 million compared to£929 million in 2005. The increase reflected an improvement in our averageachieved electricity price (see Price of electricity below) and an increase innet power sold to 25.2TWh, compared to 23.2TWh in 2005. Included within totalrevenue is income from the sale of by-products (ash and gypsum), the provisionof ancillary services, and the sale of ROCs, LECs and SO2 emissions allowances.In the year ended 31 December 2006, these revenues increased to £60 millioncompared to £32 million in 2005, reflecting higher ancillary services and ROCsales. Fuel costs in respect of generation during the year ended 31 December 2006 were£548 million, compared to £460 million in 2005, an increase of £88 million. Thedifference was primarily due to increased generation, the impact of higherprices for CO2 emissions allowances, and an increase in the cost of coal andother fuels (see Price of coal and other fuels and CO2 emissions allowancesbelow). We purchase power in the market when the cost of power in the market is belowour marginal costs of production in respect of power previously contracted forgeneration and delivery by us, and to cover any shortfall in generation. Thecosts of power purchased are treated as fuel costs. For the year ended 31December 2006, the cost of purchased power increased to £94 million compared to£80 million in 2005, primarily due to higher market prices. Reflecting the above factors, gross profit for the year ended 31 December 2006was £746 million compared to £389 million in 2005. Other operating expenses excluding depreciation, amortisation, unrealised gains/(losses) on derivative contracts and exceptional items were £163 million for theyear ended 31 December 2006 compared to £150 million in 2005, an increase of £13million. The increase reflected planned investments in people and systems whichcommenced in 2005 (most notably in trading) and which continued during 2006, andhigher balancing services use of systems costs (BSUoS), which were effectivelyoffset by income earned from ancillary services provided to the National Gridand which is reported within total revenue. EBITDA (defined as profit before interest, tax, depreciation, amortisation,exceptional items and unrealised gains/(losses) on derivative contracts) for theyear ended 31 December 2006 was £583 million compared to £239 million in 2005. Exceptional operating income of £19 million for the year ended 31 December 2006related to a further distribution received under the TXU Claim in July 2006.Exceptional operating income for the year ended 31 December 2005 of £263 millionincluded £311 million received under the TXU Claim and a credit of £19 milliondue to the reversal of provisions relating to impairment of tangible fixedassets. Exceptional operating income in 2005 was partially offset by a chargeunder the LTIP of £38 million, as well as costs incurred with respect to theRefinancing and Listing of £29 million. Additional information relating to theseexceptional items is included in the Notes to the consolidated financialstatements. IAS 32 and IAS 39, the International Accounting Standards in respect ofderivatives and financial instruments, were applicable to the Group for theperiod from 1 January 2005. As a result of applying these standards, unrealisedgains of £351 million and unrealised losses of £7 million on derivativecontracts were recognised within assets and liabilities respectively at 31December 2006, as compared to unrealised gains of £8 million and unrealisedlosses of £223 million at 31 December 2005. The unrealised gains and lossesprincipally relate to the mark-to-market of our forward contracts for power yetto be delivered, which meet the definition of derivatives under IAS 39. Movements between the balance sheet position reported at 31 December 2006 and 31December 2005 are mainly the result of unwinding mark-to-market movementsrelating to power delivered during 2006, and recording mark-to-market movementson power yet to be delivered. As a consequence of the recent decline in powerprices, the average price relating to power which had been contracted but hadyet to be delivered at 31 December 2006 was higher than current market prices,resulting in the recognition of a net unrealised gain in the balance sheet at 31December 2006. Conversely, increases in power prices during 2005 led to theaverage price relating to power which had been contracted but had yet to bedelivered at 31 December 2005 being lower than market prices at that time,resulting in the recognition of a net unrealised loss in the balance sheet at 31December 2005. For the period from 1 January 2005 to 30 June 2005, mark-to-market movements onderivative contracts were reflected directly in the income statement, asappropriate hedge accounting documentation was not in place. This resulted in acharge of £117 million relating to unrealised losses on derivative contractsbeing recognised in the income statement for the year ended 31 December 2005.Subsequently, a credit of £91 million was recognised in the income statement forthe year ended 31 December 2006, primarily representing the unwinding of theDecember 2005 position, as power was delivered in accordance with the underlyingderivative contracts for which mark-to-market movements were originallyreflected in the 2005 income statement. From 1 July 2005, we put in placeappropriate documentation to permit hedge accounting for a large proportion ofour commodity contracts. As a result, from 1 July 2005 mark-to-market movementson contracts considered to be effective hedges have been recognised through thehedge reserve. Operating profit for the year ended 31 December 2006 was £658 million comparedto £355 million in 2005. Interest payable and similar charges in the year ended 31 December 2006 were £37million compared to £114 million in 2005. The decrease principally reflected areduction in interest payable on borrowings as a result of lower debt andinterest rates following the Refinancing and Listing. The tax charge for the year ended 31 December 2006 was £171 million, compared toa tax credit of £19 million in 2005. The tax credit in 2005 resulted from theutilisation of previously unrecognised tax losses brought forward from earlieryears, which more than offset the taxable profit for the year. All recognisedtrading losses brought forward from earlier years have now been utilised. Reflecting the above factors, profit attributable to equity shareholders for theyear ended 31 December 2006 was £464 million compared to £282 million in 2005,and basic earnings per share was 126 pence compared to 108 pence in 2005. Key factors affecting the business Price of electricityThe table below shows the average achieved price realised for the years ended 31December 2005 and 31 December 2006, together with the market closing price onthe last day each season illustrated was traded as a product. Year ended Year ended 31 December 31 December 2006 2005Average achieved price (£/MWh) 48.9 35.2 2006 2005Summer baseload market close (£/MWh) 45.5 29.0 2006/2007 2005/2006Winter baseload market close (£/MWh) 51.7 49.2 Average achieved price for the year ended 31 December 2006 was £48.9 per MWhcompared to £35.2 per MWh in 2005. Average capture price (being the priceattained prior to Balancing Mechanism activity) for the year ended 31 December2006 was £47.7 per MWh compared to £33.9 per MWh in 2005. The forward baseloadpower prices for Summer 2007 and Winter 2007/2008 were approximately £24.1 perMWh and £40.0 per MWh respectively as at 1 March 2007. Price of coal and other fuelsWe burnt approximately 10.2 million tonnes of coal in the year ended 31 December2006 compared to approximately 9.3 million tonnes in 2005. This coal waspurchased from a variety of domestic and international sources under eitherfixed or variable priced contracts with different maturities. Spot prices forinternationally traded coal delivered into North West Europe (as reflected bythe TFS API 2 index) continue to be volatile. For example, prices per tonne fellfrom US$60 at the end of June 2005 to US$54 at the end of December 2005, butthen increased to US$68 at the end of December 2006. We also burn biomass, petroleum coke ("petcoke") and fuel oil, although coalcomprises more than 90% of total fuel costs (excluding CO2 emissionsallowances). The average cost of fuel per MWh (excluding CO2 emissionsallowances) for the year ended 31 December 2006 was £17.1 compared to £16.0 in2005. CO2 emissions allowancesOur CO2 emissions allowances requirement for the year ended 31 December 2006, inexcess of those allocated under the UK NAP, was approximately 8.2 million tonnescompared to approximately 6.3 million tonnes in 2005, with the increase largelydue to higher generation. During 2006, the price for CO2 emissions allowances was volatile, beginning theyear at approximately €22 per tonne and rising to a high of €31 per tonne inApril. Towards the end of April and early May the price fell dramatically,reaching a low of €8 per tonne. After recovering to approximately €20 per tonneby mid-May, the price fell steadily over the remainder of the year, closing at • 6.6 per tonne on 31 December 2006. The average price expensed for CO2 emissions allowances during the year ended 31December 2006 was £14.3 per tonne compared to £13.8 per tonne in 2005. Outages and plant utilisation levels Year ended Year ended 31 December 31 December 2006 2005Forced outage rate (%) 5.8 6.1Planned outage rate (%) 4.8 7.1Total outage rate(1) (%) 10.4 12.8Availability (%) 89.6 87.2Electrical output (net sales) (TWh) 25.2 23.2Load factor (%) 75.9 70.1 Notes:(1) The forced outage rate is expressed as a percentage of planned capacity available (that is, it includes a reduction for planned losses). The planned outage rate is expressed as a percentage of registered capacity. Accordingly, the aggregation of the forced outage rate and planned outage rate will not equate to the total outage rate. Lost generation capacity in the year ended 31 December 2006 from forced outageswas 1.8TWh compared to 1.9TWh in 2005, resulting in a forced outage rate of 5.8%(2005: 6.1%). We have targeted improvements in forced outage rates by focusingon preventing minor predictable failures and seeking to avoid major failures byusing historical Drax operating data together with original equipmentmanufacturer and industry experience. We believe further progress can be made inboth areas and will continue the programmes to improve performance, with theobjective of achieving a sustainable average forced outage rate of 4.5% by theend of 2007. Our maintenance regime includes a major planned outage for each unit every fouryears. Consequently, there is an irregular pattern of planned outages andassociated expenditure, since in two of the four years, two units will undergo amajor outage. A major planned outage (unit 4) was completed mostly in the secondquarter of 2006, whereas a major planned outage (unit 6) took place largely inthe third quarter of 2005. The planned outage rate achieved for the year ended31 December 2006 was 4.8% compared to 7.1% in 2005. Two units are scheduled toundergo a major planned outage in 2007. TXU claimWe received £19 million under the TXU Claim in July 2006 bringing the totalreceived to date to £330 million. All amounts are net of VAT and costs, and allproceeds have been used to prepay debt secured against the claim. At the time of approving the financial statements we had approximately £5million (excluding VAT) outstanding under the TXU Claim. The directors have reasonable expectations that the Group will receive repaymentof this amount broadly in full in 2007. However, due to the contingent nature ofinsolvency proceedings, there remains uncertainty over the timing and amount offurther distributions to be determined by the TXU Supervisors, and consequentlythese further amounts have not been recognised in the financial statements at 31December 2006. Business enhancements EBITDA enhancement projectsWe advised investors in March 2005 that we had identified a range of projectswhich had the potential to improve EBITDA by £30 million to £50 million perannum by the end of 2007. The projects were focused on the following areas:trading; operations (planned and forced outages); alternative fuels (petcoke);by-product sales; procurement savings; and exploiting the Drax site. We arepleased to report that good progress has been made with an estimated £45 millionof EBITDA realised in the year ended 31 December 2006 attributable to theenhancement projects (including an estimated £5 million resulting from changesin commodity prices). Greatest progress has been made in trading, where we have invested in bothpeople and systems and have been able to take advantage of the increasingreliability of the plant. Management initiated a series of programmes at the endof 2004 aimed at reducing forced outage, with a target of achieving asustainable average forced outage rate of 4.5% by the end of 2007. Weestablished an interim target of 5.7% for 2006 with the actual forced outageoutturning at 5.8%. The results from the test burning of a blend of coal and petcoke on one unithave been positive, with emissions within the permitted range, and we areconfident of the environmental case submitted to the Environment Agency. Thecharacteristics of petcoke vary depending on the source, and we are extendingthe trial to June 2007 to enable us to widen the range of petcokes and hence toprovide maximum operational flexibility. Although the price differential betweenpetcoke and coal has narrowed since the trial commenced (and, if sustained, willreduce the benefits from extending burning petcoke to the other five units,assuming consent is given by the Environment Agency), we believe that thereremains significant benefit in burning this fuel. To date this narrowing of theprice differential has been more than offset by higher than planned benefitsachieved elsewhere (particularly in trading and plant availability). Goodprogress has been made in securing procurement savings from contract renewals,by reducing the number of contracts and by concentrating our expenditure with asmaller number of suppliers. Plans to exploit the Drax site and to secureadditional revenues from by-product sales continue to progress. The benefits derived from the EBITDA enhancement projects are now substantiallyincluded within business as usual and with the targeted contribution to EBITDAlargely attained 12 months earlier than originally anticipated, progress againstthe programme identified in 2005 will not be separately reported in future. Other enhancements and investmentsIn addition to the EBITDA enhancement projects advised to investors in March2005, we continue to evaluate other value enhancing opportunities, some of whichmay involve significant investment in excess of the £100 million of core capitalexpenditure previously announced for the period 2006 to 2008. For example,during 2006 we committed £17 million to condenser and feed system plantimprovements to enhance efficiency and reliability. The work will be undertakenduring planned outages in 2007 and 2008 with an expected payback of four to fiveyears. In December 2006, we announced that we had decided to proceed with a £100million investment project to upgrade the high pressure and low pressure turbinemodules on all six generating units to improve efficiency. Using proventechnology we expect to achieve an overall baseload efficiency (that is, theratio of energy out to energy in when operating at full capacity) approaching40%. This represents a 5% improvement on current baseload efficiency of 38%.Installation, which will be undertaken during the planned outage programme, isexpected to take place between 2008 and 2011 (although some work may beundertaken in 2007). Total costs of £100 million are expected to be incurred onthis project over the next five years. When complete the project is expected todeliver annual savings of one million tonnes of CO2 emissions allowances andapproximately half a million tonnes of coal. The 2006 Energy Review and the expected changes in the co-firing regime haveallowed us to formalise our target to produce 10% of our output from burningbiomass by the end of 2009. Achievement of this target is expected to result insavings of over two million tonnes of CO2 emissions allowances, the displacementof approximately one million tonnes of coal and the generation of in excess oftwo and a half million ROCs per annum. To achieve the target will requireadditional investment in people and infrastructure. Specifically the Board hasrecently approved the investment of up to £47 million over the next three yearsto extend our direct injection capability from one generating unit to all sixgenerating units and to install the necessary processing and handlinginfrastructure to ensure we are able to handle up to 1.5 million tonnes ofbiomass material per annum. Biomass material can be provided in various forms, from untreated topre-processed. Drax will evaluate the "make-or-buy" economics of alternativesources and forms of biomass material and where appropriate will consideradditional investment where this produces added value. For example, the Boardhas recently approved in principle an investment of up to £20 million to build arape seed crusher plant to produce rape meal and rape oil and which will alsoprovide a valuable insight into rape seed market dynamics. Liquidity and capital resourcesNet debt was £321 million as at 31 December 2006 compared to £462 million at 31December 2005, a reduction of £141 million. Cash and cash equivalents were £155 million as at 31 December 2006 compared to£88 million at 31 December 2005, an increase of £67 million. The increase incash and cash equivalents is analysed in the following table. Analysis of cash flows Year ended Year ended 31 December 31 December 2006 2005Net cash generated from operatingactivities 525.1 348.5Net cash used in investing activities (27.0) (25.0)Net cash used in financing activities (431.1) (273.2) --------------------------- Net increase in cash and cash equivalents (1) 67.0 50.3 --------------------------- Notes:(1) For the purposes of the cash flow statements, cash and cash equivalents excludes amounts held in escrow and debt service reserve accounts. The movements in these accounts are included as a component of net cash generated from operating activities. Net cash generated from operating activities was £525 million in the year ended31 December 2006 compared to £349 million in 2005, an increase of £176 million.The increase reflected the impact of improved business performance, EBITDAhaving increased by £344 million in 2006, and a reduction of £108 million ininterest payments following the Refinancing and Listing. These amounts werepartially offset by a reduction in cash received under the TXU Claim (£74million cash received under the claim in the year ended 31 December 2006compared to £256 million in 2005), an increase of £47 million in income taxespaid and a payment of £23 million into the employee pension scheme to reduce theactuarial deficit. Net cash used in investing activities, which represented capital expenditure inboth periods, was £27 million for the year ended 31 December 2006 compared to£25 million in 2005. Net cash used in financing activities was £431 million in the year ended 31December 2006 compared to £273 million in 2005. The 2006 amounts included newdebt raised of £100 million, offset by equity dividends paid of £342 million(see Distribution policy below), Bridge loan prepayments of £55 million and £19million in January and July 2006 respectively, and Term loan repayments of £57.5million in June 2006 and £57.5 million in December 2006. The 2005 amountsincluded repayment of borrowings under the Group's previous debt facilitiesprior to the Refinancing and Listing of £268 million, being primarily arepayment of B Debt of £256 million funded out of distributions under the TXUClaim. Also included in 2005 is repayment of borrowings on Refinancing andListing of £583 million, largely offset by new debt issued on Refinancing andListing of £577 million. The increase in cash and cash equivalents was £67 million in the year ended 31December 2006, compared to £50 million in 2005. Drax's policy is to investavailable cash in short-term bank and building society deposits. Capital resourcesOn 15 December 2005, the Group's then existing debt was replaced by new debtfacilities comprising a £500 million five year amortising Term loan facility, a£200 million Letter of Credit facility, a £100 million Revolving Creditfacility, and a £77 million Bridge loan facility. The Term loan facility issecured on a pari passu basis with the Letter of Credit facility and theRevolving Credit facility and any other permitted secured indebtedness. TheGroup's debt is guaranteed and secured directly by each of the principalsubsidiaries within the Group. Drax Group plc is not a guarantor of the Group'sdebt, but has granted a charge over the shares in its subsidiary, Drax FinanceLimited. Standard & Poor's Ratings Group ("S&P") has assigned a BBB seniorsecured debt rating with a recovery rating of "1" to the Term loan facility, theLetter of Credit facility and the Revolving Credit facility. We are required tofund a debt service reserve account if we do not meet the specified historicannual debt service cover ratio on any of the six-monthly calculation dates,with the first calculation date being on 31 December 2006. No such requirementexists at this present time. The Letter of Credit facility can be used to provide letters of credit tocounterparties or exchanges in relation to our trading business. The finalmaturity date of the Letter of Credit facility is 15 December 2012. The Groupguarantees the obligations of a number of banks in respect of the letters ofcredit issued by those banks to counterparties of the Group. As at 31 December2006, the Group's contingent liability in respect of these guarantees amountedto £154 million compared to £77 million in 2005. The Revolving Credit facility can be used to finance working capitalrequirements. It may also be used to provide letters of credit up to a maximumof £100 million or provide cash collateral, to the extent that counterparties donot accept letters of credit, up to a maximum of £20 million. The final maturitydate is 15 December 2010. The Bridge loan facility must be repaid in full by 31 December 2008. Proceedsunder the TXU Claim must be applied to repay the Bridge loan facility. Followingdistributions under the TXU Claim of £55 million and £19 million in January andJuly 2006 respectively, £74 million of the Bridge loan has been repaid, leavinga balance of £3 million outstanding. Under our debt facilities, we can enter into additional finance leases up to anaggregate value of £10 million, and subject to certain other restrictions, incuroverdraft and other short-term borrowings not to exceed £15 million. The newdebt facilities may be prepaid without penalty. As permitted under our debt facilities, on 11 May 2006 the Group entered into anew credit facility agreement providing a further £100 million Term loanfacility on similar terms and with a similar repayment profile to the existingterm borrowings. The facility was drawn down in full on 3 July 2006 andpartially utilised to make the payment of £23 million into the employee pensionscheme to reduce the actuarial deficit. The remainder of the facility wasutilised to partially fund the interim and special dividends paid on 25 October2006 (see Distribution policy below). S&P has assigned a BBB senior secured debtrating with a recovery rating of "1" to the new Term loan facility. The S&Pcredit and recovery ratings in relation to the existing Term loan facility,Letter of Credit facility and Revolving Credit facility remain unchanged. Following repayments of £115 million in 2006, £473 million (net of deferredfinancing costs) remains outstanding under the Term loans at 31 December 2006. Seasonality of borrowingOur business is seasonal with higher economic despatch in the Winter period andlower economic despatch in the Summer months. Accordingly, cash flow during theSummer months is materially reduced due to the combined effect of lower pricesand output, while maintenance expenditures are increased during this period dueto major planned outages. The Group's £100 million Revolving Credit facilityassists in managing the cash low points in the cycle where required. TheRevolving Credit facility was undrawn at 31 December 2006. Contractual commitmentsThe following table illustrates our contractual obligations, excluding interest,as they fall due as at 31 December 2006: Payments due by period -------- -------- -------- -------- -------- Total 2007 2008 2009 2010-16 £m £m £m £m £m -------- -------- -------- -------- --------Debt 487.9 20.0 12.9 75.0 380.0Coal purchases 906.8 337.8 217.0 165.5 186.5Contracted capital expenditure 19.7 10.9 7.4 0.8 0.6Support contract payments 72.6 32.7 25.4 8.0 6.5---------------------- -------- -------- -------- -------- --------Total 1,487.0 401.4 262.7 249.3 573.6---------------------- -------- -------- -------- -------- -------- Subsequent to 31 December 2006, the Group entered into contractual commitmentswith an estimated value of £100 million with respect to the major turbineupgrade (see Business enhancements above). Capital expenditureWe previously announced that we expected to incur capital expenditure in supportof current operations of approximately £100 million over the period 2006 to2008. Capital expenditure was £27 million in the year ended 31 December 2006(compared to £25 million in 2005) leaving a balance of £63 million for theremaining two years 2007 and 2008. At the time of the announcement we alsostated that we intended to evaluate other investment opportunities to enhancevalue which may result in additional expenditure. We have identified a number of value enhancing investments (see Businessenhancements above) and total capital expenditure is currently estimated ataround £260 million over the three years 2007 to 2009. Of this around £150million specifically relates to the turbine upgrade project and condenser andfeed system plant improvements (both previously announced) and investments inextending our biomass capability, with the remainder comprising smaller valueenhancing investments, the balance of the original £100 million programme andexpected expenditure for 2009 in support of current operations. We plan to fundthese investments from a combination of operational cash flows and debt. Wecontinue to evaluate other opportunities which may result in additionalexpenditure. In addition, investment will also be required beyond 2009 and priorto 2016 to meet the requirements of the Large Combustion Plant Directive. Share-based incentive plansDuring 2006, we introduced two all-employee share plans, the Share IncentivePlan ("SIP") and the Savings-Related Share Option Plan ("SAYE") and an ExecutiveShare Incentive Plan ("ESIP"), to provide long-term incentives for executivedirectors, senior managers and all other employees. Under the SIP, the Company issued a total of 157,734 ordinary shares to a truston behalf of qualifying employees, equating to 254 shares with a cash value ofapproximately £2,000 per employee based on our share price at the time of theawards in May 2006. The fair value of the SIP awards (determined at the grantdate) of £1.3 million was charged to the income statement in full in 2006, onthe basis that employees obtained certain rights in relation to shares issued tothe trust on their behalf. In July 2006, participation in the SAYE was offered to all qualifying employees.Options were granted for employees to acquire shares at a price of £6.36(representing a discount of 20% to the prevailing market price determined inaccordance with the scheme rules), exercisable at the end of the three and fiveyear savings contracts. The fair value of the 899,396 options that are expectedto be issued in connection with the SAYE of £0.5 million is being charged to theincome statement over the life of the respective plans. Under the ESIP, annual awards of performance shares are made to executivedirectors and other senior staff up to a normal maximum of 100% of salary (200%in exceptional circumstances). Shares vest according to whether Drax's TSRmatches or outperforms an index (determined in accordance with the scheme rules)over three years. The first conditional ESIP awards over 390,213 ordinary shareswere granted in September 2006, with performance measured over the three yearsto 30 June 2009 and potential vesting in September 2009. The fair value of theESIP awards (determined at the grant date) of £1.9 million, which takes intoaccount the estimated probability of different levels of vesting, is beingcharged to the income statement on a straight-line basis over the three yearvesting period. No shares have been issued or repurchased to date with respect to the SAYE orESIP. EBITDA forecast for the year ended 31 December 2006 and closing cash positionguidance We issued a Trading Update on 13 December 2006 which reported our contractedposition for 2006, 2007 and 2008 in respect of power, coal and CO2 emissionsallowances. In addition, we reported management's expectation that EBITDA forthe year ended 31 December 2006 would be in the range £578 million to £585million and that the cash position as at 31 December 2006 would be in the range£150 million to £155 million (together the "Forecast"). EBITDA was defined asprofit before interest, tax, depreciation and amortisation, exceptional itemsand unrealised gains/(losses) on derivative contracts. In arriving at the Forecast, we took account of market prices as of 6 December2006 for the uncontracted portion of power sales, and coal and CO2 emissionsallowances purchases for the period to 31 December 2006. The Forecast alsoassumed that there would be no significant unplanned outages for the period to31 December 2006. Reported EBITDA of £583 million includes the impact on gross margin of a declinein market prices between 6 December 2006 and 31 December 2006. The reported cashposition as at 31 December 2006 was £155 million. Contracted position for 2007 and 2008Since issuing the Trading Update on 13 December 2006, we have continued to tradein line with expectations and to follow our stated trading strategy of makingsteady forward power sales with corresponding CO2 emissions allowances and coalpurchases. Our aim is to deliver market level or better dark green spreadsacross all traded market periods and, as part of this strategy, we retain powerto be sold into the prompt (within season) power markets. As at 1 March 2007, the contracted power sales for 2007, and 2008 were asfollows: 2007 2008--------------------------------------------------- -------- ---------Output - expected annual production hedged 80% 61%Comprising:- Fixed price power sales at an average achieved 75% at £47.6 40% at £46.8price per MWh- Fixed margin power sales 5% 21%CO2 emissions allowances - expected annualrequirement 84% 66%(including UK NAP allocation, market purchases andstructured contracts) Coal - expected annual requirement hedged 81% 66%--------------------------------------------------- -------- --------- Fixed margin power sales include approximately 1.3TWh in 2007 and 5.3TWh in 2008under the five-and-a-quarter year baseload contract with Centrica whichcommences on 1 October 2007. Under this contract Drax will supply power on termswhich include Centrica paying for coal, based on international coal prices, anddelivering matching CO2 emissions allowances. The contract provides us with aseries of fixed dark green spreads. We expect to issue a further Trading Update on or around 29 June 2007. Distribution policyThe Board has previously stated that the Group will pay a stable amount (£50million) by way of ordinary dividends each year (the base dividend) subject toavailability of cash and appropriate reserves. In addition to the base dividend,the Board has also previously stated that substantially all of any remainingcash flow, subject to the availability of reserves and after making provisionfor debt payments, debt service requirements (if any), capital expenditure andother expected business requirements, will be distributed to shareholders. On 11 September 2006, the Board resolved to pay an interim dividend for the sixmonths ended 30 June 2006 of 4 pence per share (equivalent to £16 million). Alsoon 11 September 2006, the Board resolved, subject to the approval byshareholders of a resolution to effect a share consolidation considered at anExtraordinary General Meeting on 6 October 2006, to pay a further interimdividend as a special dividend of 80 pence per share (equivalent to £326million). The interim and special dividends were subsequently paid on 25 October2006. Following approval at the Extraordinary General Meeting on 6 October 2006, theshare consolidation under which shareholders received 29 new ordinary shares of11 1/29 pence each for every 32 existing ordinary shares of 10 pence, becameeffective on 9 October 2006. At the forthcoming Annual General Meeting the Board is recommending toshareholders that a resolution is passed to approve payment of a final dividendfor the year ended 31 December 2006 of 9.1 pence per share (equivalent to £34million) payable on or before 16 May 2007. Shares will be marked ex-finaldividend on 25 April 2007. The Board is also proposing, subject to the approval by shareholders of aresolution to effect a share consolidation to be considered at the AnnualGeneral Meeting on 26 April 2007, to pay a further interim dividend (payable asa special dividend) of 32.9 pence per share (equivalent to £121 million), alsopayable on or before 16 May 2007. Shares will be marked ex-special dividend on30 April 2007. The Board intends to keep under review the most appropriate method of returningany further surplus cash. Consolidated income statements Years ended 31 December Notes 2006 2005 £m £m -------- -------- --------Continuing operationsRevenue 1,387.0 928.6Fuel costs (641.3) (539.5) -------- -------- -------- Other operating expenses excludingexceptional items 4 (197.6) (180.9)Other exceptional operating income 3 19.0 329.9Other exceptional operating expenses 3 - (66.6)--------------------------------- -------- -------- -------- Total other operating (expenses)/income (178.6) 82.4Unrealised gains/(losses) on derivativecontracts 90.8 (117.0)--------------------------------- -------- -------- --------Operating profit 4 657.9 354.5Interest payable and similar charges (37.1) (114.4)Interest receivable 13.4 23.5--------------------------------- -------- -------- --------Profit before tax 634.2 263.6Tax (charge)/credit 5 (170.7) 18.8--------------------------------- -------- -------- --------Profit for the year attributable to equityshareholders from continuing operations 463.5 282.4--------------------------------- -------- -------- -------- Earnings per share from continuing operations pence pence per share per share--------------------------------- -------- -------- --------- Basic and diluted 7 126 108--------------------------------- -------- -------- -------- Consolidated statements of recognised income and expense Years ended 31 December Notes 2006 2005 £m £m -------- -------- --------Profit for the year 463.5 282.4Actuarial gains/(losses) on defined benefitpension schemes 8.6 (8.2)Deferred tax on actuarial gains/losses on definedbenefit pension schemes 5 (2.6) 2.5Initial recognition of net mark-to-marketliability on adoption of IAS 32 and IAS 39 - (5.6)Deferred tax recognised on adoption of IAS 32 andIAS 39 5 - 1.7Fair value gains/(losses) on cash flow hedges 468.2 (109.7)Deferred tax recognised on fair valuegains/losses on cash flow hedges 5 (140.5) 32.9---------------------------------- -------- -------- --------Net gains/(losses) not recognised in incomestatement 333.7 (86.4)---------------------------------- -------- -------- --------Total recognised income for the year attributableto equity shareholders 797.2 196.0---------------------------------- -------- -------- -------- Consolidated balance sheets At 31 December Notes 2006 2005 £m £m -------- -------- -------AssetsNon-current assetsProperty, plant and equipment 1,042.2 1,050.5Derivative financial instruments 93.9 0.3---------------------------------- -------- -------- -------- 1,136.1 1,050.8 -------- -------- --------Current assetsInventories 76.9 67.8Trade and other receivables 171.4 192.9Derivative financial instruments 257.2 7.7Cash at bank and in hand 8 154.8 99.1---------------------------------- -------- -------- -------- 660.3 367.5 -------- -------- --------LiabilitiesCurrent liabilitiesFinancial liabilities:- Borrowings 9 19.8 101.4- Derivative financial instruments 6.8 173.0Trade and other payables 166.8 176.1Current tax liabilities 63.2 5.2---------------------------------- -------- -------- -------- 256.6 455.7 -------- -------- --------Net current assets/(liabilities) 403.7 (88.2)Non-current liabilitiesFinancial liabilities:- Borrowings 9 456.4 460.1- Derivative financial instruments - 49.6Deferred tax liabilities 390.9 185.3Retirement benefit obligations 12.5 44.7Other non-current liabilities 0.7 0.7Provisions 2.2 2.0---------------------------------- -------- -------- -------- 862.7 742.4 -------- --------Net assets 677.1 220.2---------------------------------- -------- -------- -------- Shareholders' equityIssued equity 40.7 40.7Share premium 420.7 420.7Merger reserve 710.8 710.8Hedge reserve 250.9 (76.8)Retained losses (746.0) (875.2)---------------------------------- -------- -------- --------Total shareholders' equity 10 677.1 220.2---------------------------------- -------- -------- -------- Consolidated cash flow statements Years ended 31 December Notes 2006 2005 £m £m -------- -------- --------Cash generated from operations 11 586.5 462.3Income taxes paid (50.0) (2.8)Decrease in restricted cash 11.2 26.9Interest paid in 2005 prior to the Refinancingand Listing - (57.5)Interest paid in 2005 on the Refinancing andListing 9 - (86.2)Interest paid in 2006 (36.1) -Interest received 13.5 5.8---------------------------------- -------- -------- --------Net cash generated from operating activities 525.1 348.5---------------------------------- -------- -------- --------Cash flows from investing activitiesPurchase of property, plant and equipment (27.0) (25.0)---------------------------------- -------- -------- --------Net cash used in investing activities (27.0) (25.0)---------------------------------- -------- -------- --------Cash flows from financing activitiesEquity dividends paid 6 (342.0) -Repayment of borrowings in 2005 prior to theRefinancing and Listing - (267.6)Repayment of borrowings in 2005 on theRefinancing and Listing 9 - (582.6)Debt issued as a result of the Refinancing andListing 9 - 577.0Repayment of borrowings in 2006 9 (189.1) -Debt issued in 2006 9 100.0 ----------------------------------- -------- -------- --------Net cash used in financing activities (431.1) (273.2)---------------------------------- -------- -------- --------Net increase in cash and cash equivalents 67.0 50.3Cash and cash equivalents at 1 January 87.8 37.5---------------------------------- -------- -------- --------Cash and cash equivalents at 31 December 8 154.8 87.8---------------------------------- -------- -------- -------- Notes to the consolidated financial information 1. General information The consolidated financial information for Drax Group plc (the "Company") andits subsidiaries (together "the Group") set out in this preliminary announcementhas been derived from the audited consolidated financial statements of the Groupfor the year ended 31 December 2006 (the "financial statements"). Thispreliminary announcement does not constitute the financial statements. Thefinancial statements were approved by the Board of directors on 7 March 2007. The report of the auditors on the financial statements was unqualified and didnot contain a statement under Section 237 (2) or (3) of the Companies Act 1985. The Annual Report will be posted to shareholders by the end of March 2007 andwill be available on request from the Company Secretary, Drax Group plc, DraxPower Station, PO Box 3, Selby, North Yorkshire, YO8 8PQ. The Annual GeneralMeeting will be held at The City Presentation Centre, 4 Chiswell Street, LondonEC1Y 4UP at 11am on 26 April 2007. The financial statements will be delivered tothe Registrar of Companies following the Annual General Meeting. 2. Basis of preparation The financial statements have been prepared in accordance with the prior yearaccounting policies and International Financial Reporting Standards ("IFRSs").The financial statements have also been prepared in accordance with IFRSsadopted by the European Union and therefore the consolidated financialstatements comply with Article 4 of the EU IAS Regulations. The financial statements have been prepared under the historical cost basis,except for the revaluation of financial assets and liabilities under IAS 39"Financial Instruments: Recognition and measurement". 3. Other exceptional operating income and expenses Years ended 31 December 2006 2005 £m £m -------- --------Other exceptional operating income:Distributions under the TXU Claim 19.0 310.9Reversal of impairment of tangible fixed assets - 19.0--------------------------------------- -------- --------Total other exceptional operating income 19.0 329.9--------------------------------------- -------- --------Other exceptional operating expenses:LTIP expenses arising on cash and share-basedtransactions - (37.6)Refinancing and Listing fees and expenses - (29.0)--------------------------------------- -------- --------Total other exceptional operating expenses - (66.6)--------------------------------------- -------- -------- Distributions under the TXU ClaimThe Group received £19.0 million under the TXU Claim in July 2006, bringing thetotal received to date to £329.9 million. All amounts are net of VAT and costsand all proceeds have been used to prepay debt secured against the claim. At the time of approving the financial statements the Group had approximately £5million (excluding VAT) outstanding under the TXU Claim. The directors havereasonable expectations that the Group will receive repayment of this amountbroadly in full during 2007. However, due to the contingent nature of insolvencyproceedings, there remains uncertainty over the timing and amount of furtherdistributions to be determined by the TXU Supervisors, and consequently thesefurther amounts have not been recognised in the financial statements at 31December 2006. Reversal of impairment of tangible fixed assetsIn accordance with IAS 36 "Impairment of Assets", the Group assessed at eachreporting date whether there was any indication that impairment lossesrecognised following the loss of the TXU Contract and its related income streamsin 2002 should be reversed. As a result of an assessment performed during theyear ended 31 December 2005, the Group recorded a reversal of a tangible fixedasset impairment of £19.0 million (£13.3 million net of tax). This represented areversal of the total impairment loss recognised in respect of tangible fixedassets at 31 December 2002 after adjusting for depreciation. Refinancing and Listing fees and expensesThe total costs of the Refinancing and Listing amounted to £44.7 million. Ofthese costs, £29.0 million (£20.3 million net of tax) were included within otherexceptional operating expenses in the income statement for the year ended 31December 2005. The remaining £15.7 million were deducted from debt and are beingamortised to interest payable over the duration of the Group's new debtfacilities. 4. Operating profit Years ended 31 December 2006 2005 £m £m -------- --------The following charges have been included in arriving atoperating profit:Staff costs 34.6 29.1Depreciation of property, plant and equipment (allowned assets) 34.9 31.0Loss on the disposal of property, plant andequipment - 0.2Repairs and maintenance expenditure on property,plant and equipment 34.1 32.0Other operating expenses 94.0 88.6--------------------------------------- -------- --------Total other operating expenses excluding exceptionalitems and unrealised gains/losses on derivativecontracts 197.6 180.9--------------------------------------- -------- -------- 5. Taxation Years ended 31 December 2006 2005 £m £m -------- --------Tax (charged)/credited comprises:Current tax (108.2) (5.5)Deferred tax (62.5) 24.3-------------------------------------- -------- -------- (170.7) 18.8 -------- -------- Years ended 31 December 2006 2005 £m £m Tax on items (charged)/credited to equity:Deferred tax recognised on actuarial gains/losses ondefined benefit pension scheme (2.6) 2.5Deferred tax recognised on adoption of IAS 32 andIAS 39 - 1.7Deferred tax recognised on fair value gains/losseson cash flow hedges (140.5) 32.9--------------------------------------- -------- -------- (143.1) 37.1 -------- -------- The tax differs from the standard rate of corporation tax in the UK (30% forboth years). The differences are explained below: ears ended 31 December 2006 2005 £m £m -------- --------Profit before tax 634.2 263.6--------------------------------------- -------- --------Profit before tax multiplied by rate of corporationtax in the UK (30% for both years) 190.3 79.1Effects of:Adjustments in respect of prior periods 1.2 (6.2)LTIP tax deduction - (9.4)Expenses not deductible for tax purposes 0.5 2.9Tax effect of funding arrangements (20.9) (0.8)Other (0.4) (0.1)Tax losses utilised - (84.3)--------------------------------------- -------- --------Total taxation (continuing operations) 170.7 (18.8)--------------------------------------- -------- -------- Under the current financing structure, Drax Holdings Limited ("Holdings"), awholly-owned subsidiary undertaking of the Company, is partially funded by aEurobond payable to another group company, with a tax deduction being claimedfor all of the corresponding interest charged in the Holdings income statement.Were HM Revenue & Customs to successfully challenge the deductions claimed inrespect of the Eurobond coupons for open years to 31 December 2006, it isestimated that the additional tax liability would be up to £40 million, togetherwith interest and penalties. 6. Dividends Years ended 31 December 2006 2005 £m £m Amounts recognised as distributions to equity holders in theyear (based on the number of shares in issue at the recorddate):Interim dividend for the year ended 31 December 2006of 4 pence 16.3 -(2005: nil) per share--------------------------------------- -------- --------Special interim dividend for the year ended 31December 2006 of 80 pence 325.7 -(2005: nil) per share--------------------------------------- -------- -------- 342.0 - -------- -------- Years ended 31 December 2006 2005 £m £m Amounts not recognised as distributions to equity holders inthe year:Proposed final dividend for the year ended 31December 2006 of 9.1 pence 33.6 -(2005: nil) per share--------------------------------------- -------- --------Proposed special interim dividend for the year ended31 December 2006 of 121.4 -32.9 pence (2005: nil) per share--------------------------------------- -------- -------- 155.0 - -------- -------- At the forthcoming Annual General Meeting, the Board is recommending toshareholders that a resolution is passed to approve payment of a final dividendfor the year ended 31 December 2006 of 9.1 pence per share (equivalent to £33.6million) payable on or before 16 May 2007. The Board is also proposing, subjectto the approval by shareholders of a resolution to effect a share consolidationto be considered at the Annual General Meeting on 26 April 2007, to pay afurther interim dividend (payable as a special dividend) of 32.9 pence per share(equivalent to £121.4 million), also payable on or before 16 May 2007. The final dividend of 9.1 pence per share and the special dividend of 32.9 penceper share have not been included as liabilities as at 31 December 2006. 7. Earnings per share Basic earnings per share is calculated by dividing the earnings attributable toordinary shareholders by the weighted average number of ordinary sharesoutstanding during the year. In calculating diluted earnings per share theweighted average number of ordinary shares outstanding during the year isadjusted to take account of outstanding share options in relation to the Group'sSavings-Related Share Option Plan ("SAYE") and contingently issuable sharesunder the Group's Executive Share Incentive Plan ("ESIP"). Both the SAYE and theESIP commenced in 2006. The calculation of weighted average number of ordinary shares outstandingassumes that the ordinary shares in Drax Group plc issued to the existingshareholders of Drax Group Limited (the previous holding company) on Refinancingand Listing were in issue either at 1 January 2005 (to the extent that therelated Drax Group Limited shares were in issue at 1 January 2005), or from thedate of issue of Drax Group Limited shares (to the extent that the related DraxGroup Limited shares were issued after 1 January 2005). In accordance with IAS33 "Earnings per Share", calculation of the weighted average number of ordinaryshares outstanding also assumes that the share consolidation which becameeffective on 9 October 2006 had taken place on 1 January 2005. Reconciliations of the earnings and weighted average number of shares used inthe calculation are set out below. Years ended 31 December 2006 2005 £m £m -------- --------Earnings attributable to equity holders of theCompany for the purposes of basic 463.5 282.4and diluted earnings--------------------------------------- -------- -------- Years ended 31 December 2006 2005 £m £m -------- --------Number of shares:Weighted average number of ordinary shares for the purposesof basic earningsper share (millions) 368.9 261.2Effect of dilutive potential ordinary shares undershare options 0.1 -Effect of dilutive contingently issuable shares - ---------------------------------------- -------- --------Weighted average number of ordinary shares for thepurposes of diluted earnings per share (millions) 369.0 261.2--------------------------------------- -------- -------- 8. Cash at bank and in hand As at 31 December 2006 2005 £m £m Cash at bank and in hand:Unrestricted cash at bank and in hand 154.8 87.8Escrow account - 11.3--------------------------------------- -------- -------- 154.8 99.1 -------- -------- The escrow account represented cash paid into escrow prior to 31 December 2005with respect to certain fees and expenses related to the Refinancing andListing. Cash and cash equivalents includes the following for the purposes of the cashflow statement: As at 31 December 2006 2005 £m £mCash and cash equivalents:Cash at bank and in hand per above 154.8 99.1Less: escrow account - (11.3)--------------------------------------- -------- -------- 154.8 87.8 -------- -------- 9. Financial liabilities - borrowings As at 31 December 2006 2005 £m £m Current:Term loans 19.8 46.3Bridge loan - 55.1--------------------------------------- -------- -------- 19.8 101.4 -------- -------- As at 31 December 2006 2005 £m £m Non-current:Term loans 453.5 438.2Bridge loan 2.9 21.9--------------------------------------- -------- -------- 456.4 460.1 -------- -------- Maturity of borrowings The maturity profile of the carrying amount of the Group's non-currentborrowings at the balance sheet dates were as follows: As at 31 December 2006 2005 £m £m Non-current:In more than one year but not more than two years 12.8 31.6In more than two years but not more than five years 443.6 428.5--------------------------------------- -------- -------- 456.4 460.1 -------- -------- Refinancing and ListingPursuant to the schemes of arrangement under which the Refinancing and Listingwas implemented, the Group's debt was restructured on 15 December 2005. Theparticular elements of the restructuring relating to the Group's debt areillustrated below: As at 15 December Principal Interest £m £m Previous debt facilities:A1 Debt prepayment 388.2 12.8B Debt prepayment 82.4 28.1A2 Debt cash consideration 112.0 -A2/A3 Debt interest payment - 22.2Interest rate swap termination payment - 23.1--------------------------------------- -------- -------- 582.6 86.2 -------- --------New debt facilities:Term loan 500.0 -Bridge loan 77.0 ---------------------------------------- -------- -------- 577.0 - -------- -------- Outstanding principal and interest in relation to A1 and B Debt was repaid infull. In addition, interest rate swap contracts with a notional value of £400million, principally related to A1 Debt, were terminated. A2/A3 Debt holders contributed their A2/A3 Debt in exchange for cash andordinary shares of 10 pence each in Drax Group plc. In total, A2 Debt holdersreceived cash consideration of £112.0 million and A2/A3 Debt holders received124,164,221 ordinary shares of 10 pence each in Drax Group plc. Outstandinginterest on A2/A3 Debt was repaid in full. The total cash outflows related to the Refinancing and Listing were partiallyfunded by a new Term loan of £500.0 million and a Bridge loan of £77.0 millionas described below. On 11 May 2006, the Group entered into a new credit facility agreement providinga further £100.0 million Term loan on similar terms and with a similar repaymentprofile to the existing term borrowings. The facility was drawn down in full on3 July 2006 and partially used to make a payment of £22.5 million into theemployee pension scheme to reduce the actuarial deficit. Analysis of borrowingsBorrowings at 31 December 2006 and 31 December 2005 consisted of bank loans heldby the Company's subsidiary Drax Finance Limited as follows: As at 31 December 2006 Borrowings Deferred Net before deferred finance costs borrowings finance costs £m £m £m --------------------------------- -------- -------- --------Term loans 485.0 (11.7) 473.3Bridge loan 2.9 - 2.9--------------------------------- -------- -------- --------Total borrowings 487.9 (11.7) 476.2--------------------------------- -------- -------- --------Less currentportion of debt (20.0) 0.2 (19.8)--------------------------------- -------- -------- --------Non-currentborrowings 467.9 (11.5) 456.4--------------------------------- -------- -------- -------- As at 31 December 2005 Borrowings Deferred Net before deferred finance costs borrowings finance costs £m £m £m --------------------------------- -------- -------- -------Term loan 500.0 (15.5) 484.5Bridge loan 77.0 - 77.0--------------------------------- -------- -------- -------Total borrowings 577.0 (15.5) 561.5--------------------------------- -------- -------- -------Less currentportion of debt (105.1) 3.7 (101.4)--------------------------------- -------- -------- -------Non-current borrowings 471.9 (11.8) 460.1--------------------------------- -------- -------- ------- The Term loans are subject to a fixed amortisation profile ending on 31 December2010 and debt service payments are made semi-annually on 30 June and 31December. Payment profiles for repayment of debt set out above are based on thefixed minimum repayment profile. Repayments above the fixed minimum repaymentprofile are permitted subject to the amount of cash available for debt service.£57.5 million of the Term loan was repaid on 30 June 2006 and £57.5 million ofthe Term loan was repaid on 29 December 2006, in line with the target repaymentprofile as a result of the levels of cash available for debt service. The Bridge loan has a first priority over the TXU Claim and the proceedsthereof, which are its primary source of repayment. The Bridge loan has no fixedamortisation profile, with the timing of repayments determined by receipts underthe TXU Claim. Following distributions under the TXU Claim in January and July2006, £55.1 million of the Bridge loan was repaid on 23 January 2006 and afurther £19.0 million was repaid on 25 July 2006. Any outstanding principalbalance falls due for payment on 31 December 2008. Ultimately, the Group's ability to make repayments of the Term loan is entirelydependent on the successful operation of the business. The ability of the Groupto make repayments of the Bridge loan is dependent on: i) the timing and quantumof recoveries under the TXU Claim; and ii) the extent that such recoveries areinsufficient to pay amounts under the Bridge loan when due, the successfuloperation of the business. The Group's debt is guaranteed and secured directly by each of the principalsubsidiary undertakings of the Company. Drax Group plc is not a guarantor of theGroup's debt, but has granted a charge over the shares in its subsidiary, DraxFinance Limited. 10. Shareholders' funds and statement of changes in shareholders' equity Share capital Share premium Merger reserve Capital reserve Hedge reserve Retained losses Total £m £m £m £m £m £m £mAt 1 January2005 - 0.5 445.1 293.5 - (1,173.2) (434.1)Profit for theyear - - - - - 282.4 282.4Actuariallosses ondefinedbenefitpensionschemes - - - - - (8.2) (8.2)Deferred taxon actuariallosses ondefinedbenefitpensionschemes - - - - - 2.5 2.5Initialrecognition ofnetmark-to-marketliability onadoption ofIAS 32 and IAS39 - - - - - (5.6) (5.6)Deferred taxrecognised onadoption ofIAS 32 and IAS39 - - - - - 1.7 1.7Fair valuelosses on cashflow hedges - - - - (109.7) - (109.7)Deferred taxrecognised onfair valuelosses on cashflow hedges - - - - 32.9 - 32.9Share capitalissued onRefinancingand Listing 40.7 - - - - - 40.7Share premiumarising onRefinancingand Listing - 420.7 - - - - 420.7Reverseacquisitionadjustments:- Share forshare exchange - (0.5) (27.8) - - - (28.3)- Transfer ofcapitalreserve - - 293.5 (293.5) - - -LTIP - creditto equity forshare-basedpayments - - - - - 25.2 25.2At 31 December2005 40.7 420.7 710.8 - (76.8) (875.2) 220.2Profit for theyear - - - - - 463.5 463.5Equitydividends paid - - - - - (342.0) (342.0)Actuarialgains ondefinedbenefitpensionschemes - - - - - 8.6 8.6Deferred taxon actuarialgains ondefine benefitpensionschemes - - - - - (2.6) (2.6)Fair valuegains on cashflow hedges - - - - 468.2 - 468.2Deferred taxrecognised onfair valuegains on cashflow hedges - - - - (140.5) - (140.5)Credit toequity forshare-basedpayments - - - - - 1.7 1.7At 31 December2006 40.7 420.7 710.8 - 250.9 (746.0) 677.1 11. Cash flow from operating activities Years ended 31 December 2006 2005 £m £m -------- --------Profit for the year 463.5 282.4Adjustments for:Interest payable and similar charges 37.1 114.4Interest receivable (13.4) (23.5)Tax charge/(credit) 170.7 (18.8)Depreciation 34.9 31.0Reversal of impairment of tangible fixed assets - (19.0)Loss on disposal of property, plant and equipment - 0.2Unrealised (gains)/losses on derivative contracts (90.8) 117.0LTIP - credit to equity for share-based payments - 25.2Credit to equity for share-based payments 1.7 ---------------------------------------- -------- --------Operating cash flows before movement in workingcapital 603.7 508.9Changes in working capital:Increase in inventories (9.1) (22.6)Decrease/(increase) in receivables 19.7 (123.4)(Decrease)/increase in payables (4.4) 99.8Decrease in pensions (23.6) -Increase/(decrease) in provisions 0.2 (0.4)--------------------------------------- -------- --------Cash generated from operations 586.5 462.3--------------------------------------- -------- -------- Glossary Availability - Average percentage of time the units were available forgeneration. Average achieved price - Power revenues divided by volume of net sales (includesimbalance charges). Average capture price - Revenue derived from bilateral contracts divided byvolume of net merchant sales. Bilateral contracts - Contract with counterparties and power exchange trades. Balancing Mechanism - The period during which the System Operator can call uponadditional generation/consumption or reduce generation/consumption, throughmarket participants' bids and offers, in order to balance the system minute byminute. Baseload - Running 24 hours per day, seven days per week remaining permanentlysynchronised to the system. Dark green spread - The difference between the price available in the market forsales of electricity and the marginal cost of production (being the cost of coaland other fuels including CO2 emissions allowances). EBITDA - Profit before interest, tax, depreciation and amortisation, exceptionalitems and unrealised gains/(losses) on derivative contracts. EBITDA enhancements - EBITDA enhancement projects advised to investors in March2005. EU ETS - The EU Emissions Trading Scheme is a policy introduced across Europe toreduce emissions of carbon dioxide ("CO2"); the scheme is capable of beingextended to cover all greenhouse gas emissions. ESIP - The Drax Group plc Restricted Share Plan, also known as the Drax Groupplc Executive Share Incentive Plan. Forced Outage - Any reduction in plant availability excluding planned outages. Forced Outage Rate - The capacity which is not available due to forced outagesor restrictions expressed as a percentage of the maximum theoretical capacity,less planned outage capacity. IASs - International Accounting Standards. IFRSs - International Financial Reporting Standards. LECs - Levy Exemption Certificates. Evidence of Climate Change Levy exemptelectricity supplies generated from qualifying renewable sources. Load factor - Percentage of actual net sales to potential maximum netgeneration. LTIP - The Drax Group Limited Long-Term Incentive Plan. Net Balancing Mechanism - Net volumes attributable to accepted bids and offersin the Balancing Mechanism. Net merchant sales - Net volumes attributable to bilateral contracts and powerexchange trades. Net sales - The aggregate of net merchant sales and net Balancing Mechanism. Planned Outage - A period during which scheduled maintenance is executedaccording to the budget set at the outset of the year. Planned Outage Rate - The capacity not available due to planned outagesexpressed as a percentage of the maximum theoretical capacity. Power revenues - The aggregate of bilateral contracts and Balancing Mechanismincome/expense. Refinancing and Listing - The financial restructuring of the Group effective on15 December 2005 resulting in the creation of a new holding company, Drax Groupplc. Pursuant to the schemes of arrangement under which the Refinancing andListing was implemented, the existing debt of the Group was settled partiallythrough the issue of new debt and partially through the issue of ordinary sharesin Drax Group plc. Also on 15 December 2005, Drax Group plc was introduced tothe Official List of the UK Listing Authority and its ordinary shares commencedtrading on the London Stock Exchange. ROCs - Renewables Obligation Certificates. One ROC is issued to eligiblegenerators for every MWh of electricity generated from renewable sources. SAYE Plan - The Drax Group plc Approved Savings-Related Share Option Plan. SIP - The Drax Group plc Approved Share Incentive Plan. Summer - The calendar months April to September. Summer baseload market close - Market price on the last day that the season wastraded as a product. Technical Availability - Total availability after planned and forced outages. The Company - Drax Group plc. The Group - Drax Group plc and its subsidiaries. TXU - TXU Europe Energy Trading Limited (in administration and subject to acompany voluntary arrangement). TXU Claim - The claim issued by the Group, ultimately agreed by theAdministrators of TXU at approximately £348 million (including VAT) in respectof unpaid power purchased by TXU and liquidated damages under the TXU Contract. TXU Contract - A 15-year power purchase agreement with TXU. UK NAP - UK National Allocation Plan. Winter - The calendar months October to March. Winter baseload market close - Market price on the last day that the season wastraded as a product. --- ENDS --- This information is provided by RNS The company news service from the London Stock Exchange

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