Annual Reports

  • 20-F (Apr 16, 2014)
  • 20-F (Apr 12, 2013)
  • 20-F (Jun 8, 2012)
  • 20-F (Apr 13, 2012)
  • 20-F (Jun 7, 2011)
  • 20-F (Apr 18, 2011)

 
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Veolia Environnement 20-F 2007
VEOLIA FORM 20-F



As filed with the Securities and Exchange Commission on June 29, 2007

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 20-F



REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(g)

OF THE SECURITIES EXCHANGE ACT OF 1934

OR

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

for the fiscal year ended December 31, 2006

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

OR

SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934


Commission File Number: 001-15248


VEOLIA ENVIRONNEMENT

(Exact name of Registrant as specified in its charter)

N/A
(Translation of Registrant’s
name into English)

36/38, avenue Kléber,
75116 Paris,
France

Republic of France
(Jurisdiction of incorporation
or organization)

(Address of principal executive offices)

Securities registered or to be registered pursuant to Section 12(b) of the Act:

Title of each class

Name of each exchange on which registered

————

————

Ordinary shares, nominal value €5 per share represented by American Depositary Shares
(as evidenced by American Depositary Receipts),
each American Depositary Share representing one ordinary share*

The New York Stock Exchange


Securities registered or to be registered pursuant to Section 12(g) of the Act:
None

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
None

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report:

410,795,840 ordinary shares, nominal value €5 per share

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act:

Yes No

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934:

Yes No

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:

Yes No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer Accelerated filer Non-accelerated filer

Indicate by check mark which financial statement item the registrant has elected to follow:

Item 17 Item 18

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):

Yes No

*Listed, not for trading or quotation purposes, but only in connection with the registration of the American Depositary Shares pursuant to the requirements of the Securities and Exchange Commission.

 







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FORWARD-LOOKING STATEMENTS

We make some forward-looking statements in this document. When we use the words “aim(s),” “expect(s),” “feel(s),” “will,” “may,” “believe(s),” “anticipate(s)” and similar expressions in this document, we are intending to identify those statements as forward-looking.  Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. You should not place undue reliance on these forward-looking statements, which speak only as of the date of this document. In particular, from time to time in this document we state our expectations in terms of revenue to be generated under new contracts recently won or awarded or from new investments made and new assets or operations acquired, though we may have not yet commenced operations under these new contracts nor begun operating these new assets and operations at the time we make these statements. Some of these revenue estimates are based on our management’s current assumptions regarding future sales volumes and prices, which are subject to a number of risks and uncertainties that may cause actual sales volumes and prices to differ materially from those projected. As a result, actual revenue recorded under these new contracts or from these new investments, assets and operations may differ materially from those set forth in this document. Other than in connection with applicable securities laws, we undertake no obligation to publish revised forward-looking statements to reflect events or circumstances after the date of this document or to reflect the occurrence of unanticipated events. We urge you to carefully review and consider the various disclosures we make concerning the factors that may affect our business, including the disclosures made in “Item 3. Key Information—Risk Factors,” “Item 5. Operating and Financial Review and Prospects,” and “Item 11. Quantitative and Qualitative Disclosures About Market Risk.”

Unless otherwise indicated, information and statistics presented herein regarding market trends and our market share relative to our competitors are based on our own research and various publicly available sources.



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TABLE OF CONTENTS

ITEM 1.

IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

1

ITEM 2.

OFFER STATISTICS AND EXPECTED TIMETABLE

1

ITEM 3.

KEY INFORMATION

1

ITEM 4.

INFORMATION ON THE COMPANY

8

ITEM 4A.

UNRESOLVED STAFF COMMENTS

53

ITEM 5.

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

54

ITEM 6.

DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

84

ITEM 7.

MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

111

ITEM 8.

FINANCIAL INFORMATION

114

ITEM 9.

THE OFFER AND LISTING

120

ITEM 10.

ADDITIONAL INFORMATION

123

ITEM 11.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

134

ITEM 12.

DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

140

ITEM 13.

DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

141

ITEM 14.

MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS
AND USE OF PROCEEDS

141

ITEM 15.

CONTROLS AND PROCEDURES

141

ITEM 16A.

AUDIT COMMITTEE FINANCIAL EXPERT

141

ITEM 16B.

CODE OF ETHICS

142

ITEM 16C.

PRINCIPAL ACCOUNTANT FEES AND SERVICES

142

ITEM 16D.

EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES

142

ITEM 16E.

PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS

143

ITEM 17.

FINANCIAL STATEMENTS

144

ITEM 18.

FINANCIAL STATEMENTS

144

ITEM 19.

EXHIBITS

144





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PART I

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

Not Applicable.

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

Not Applicable.

ITEM 3. KEY INFORMATION

SELECTED FINANCIAL DATA

You should read the following selected financial data together with “Item 5. Operating and Financial Review and Prospects” and our consolidated financial statements. Our consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (“IFRS”) adopted by the European Union as of December 31, 2006 and with IFRS issued by the International Accounting Standards Board (“IASB”) as of the same date. IFRS differ in certain significant respects from U.S. generally accepted accounting principles (“U.S. GAAP”).  For a description of the principal differences between IFRS and U.S. GAAP as they relate to us and to our consolidated subsidiaries, and for a reconciliation of our shareholders’ equity and net income to U.S. GAAP, see Note 51 to our consolidated financial statements included in Item 18 of this annual report. See also “Item 5. Operating and Financial Review and Prospects” for a discussion of accounting changes, business combinations and dispositions of business operations that affect the comparability of the information provided below.

Concession contracts are accounted for in the 2006 consolidated financial statements in accordance with IFRIC Interpretation 12, Service Concession Arrangements (IFRIC 12), published in November 2006. This interpretation, which is pending adoption by the European Union following a favorable vote of the EFRAG in March 2007, is applicable to accounting periods commencing on or after January 1, 2008. We have elected early adoption of this interpretation, and the change in accounting method has been applied retrospectively.  As such, our consolidated financial statements as of and for the year ended December 31, 2005, and 2004 financial information have been adjusted accordingly for the retrospective adoption of IFRIC 12.




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At and for the year ended December 31

 

(in US$)(1)

  

(in €)

  
 

————

————

————

————

————

————

(millions, except per share amounts)

2006

2006

2005
adjusted*

2004 adjusted*

2003

2002

 

————

————

————

————

————

————

INCOME STATEMENT DATA:

      

Amounts in accordance with IFRS

      

Revenue

37,693.1

28,620.4

25,570.4

22,792.4

--

--

Operating income

2,809.3

2,132.9

1,892.9

1,489.6

--

--

Net income from continuing operations

1,309.5

994.3

794.4

640.0

--

--

Net income (expense) from discontinued operations

0.79

0.6


0.7


(38.1)

--

--

Minority interest

311.1

236.2

172.9

212.1

--

--

Net income attributable to equity holders of the parent

999.2

758.7


622.2


389.8

--

--

Net income attributable to equity holders of the parent per share—Basic(2)

2.54

1.93


1.59


0.98

--

--

Net income attributable to equity holders of the parent per share—Diluted(3)

2.52

1.91


1.59


0.98

--

--

Net income from continuing operations per share—Basic(2)

2.54

1.93


1.59


1.47

--

--

Net income from continuing operations per share—Diluted(3)

2.52

1.91


1.58



1.47

--

--

Dividends per share

1.38

1.05

  

--

--

Number of shares (adjusted to reflect changes in capital)

412,626,550

412,626,550(4)

407,872,606

406,421,983

--

--


Amounts in accordance with U.S. GAAP

      

Net income attributable to equity holders of the parent

964.2

732.1

555.7

145.2

(1,826.9)

(1,988.8)

Basic earnings per share

2.45

1.86

1.42

0.37

(4.56)

(5.45)

Diluted earnings per share

2.42

1.84

1.42

0.37

(4.56)

(5.45)

       

BALANCE SHEET DATA (AT PERIOD END):

      

Amounts in accordance with IFRS

      

Equity attributable to equity holders of the parent

5,743.2

4,360.8

3,790.2

3,211.2

--

--

Minority interest

2,887.7

2,192.6

1,888.0

1,728.7

--

--

Total assets

52,843.0

40,123.7

36,381.0

35,899.3

--

--

Total non-current assets

33,056.8

25,100.0

22,834.9

20,733.3

--

--

Total non-current liabilities

23,780.2

18,056.3

16,934.0

14,836.4

--

--

       

Amounts in accordance with U.S. GAAP

      

Equity attributable to equity holders of the parent

4,185.2

3,177.8

2,832.9

2,255.5

2,378.1

4,923.2

       

CASH FLOW DATA:

      

Amounts in accordance with IFRS

      

Net cash flow from operating activities

4,464.1

3,389.6

3,163.7

3,384.3

--

--

Net cash from (used in) investing activities

(3,824.6)

(2,904.0)


(2,407.6)


318.9

--

--

Net cash used in financing activities

(94.2)

(71.5)

(3,152.8)

(1,795.5)

--

--

Purchases of property, plant and equipment

(2,657.2)

(2,017.6)


(1,837.1)


(1,723.0)

--

--


________________________________


(1)

For your convenience, we have converted the euro amounts of our selected financial data into U.S. dollars using the December 31, 2006 rate of $1.00 = €0.7593. This does not mean that we actually converted, or could have converted, those amounts into U.S. dollars on this or any other date.

(2)

Based on the weighted average number of shares outstanding in each period for the calculation of basic earnings per share, equal to 393.8 million shares in 2006, 390.4 million shares in 2005 and 396.2 million shares in 2004.

(3)

Based on the weighted average number of shares outstanding in each period for the calculation of diluted earnings per share, equal to 397.6 million shares in 2006, 392.4 million shares in 2005 and 396.3 million shares in 2004.

(4)

The number of shares as of December 31, 2006 mentioned above includes the exercise of options to subscribe for shares of our company which occurred from July 1 to December 31, 2006.  The share capital increase and the creation of shares resulting from such exercise of stock options was formally recorded by our board of directors on March 7, 2007.

*

Accounts as of December 31, 2005 and December 31, 2004 were adjusted for the application of IFRIC12 standards for the treatment of concessions, so as to ensure the comparability of the fiscal years.



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Dividends

Under French law and our articles of association (statuts), our statutory net income in each fiscal year, as increased or reduced, as the case may be, by any profits or losses carried forward from prior years, less any contributions to legal reserves, is available for distribution to our shareholders as dividends, subject to other applicable requirements of French law and our statuts.

At our general shareholders’ meeting on May 10, 2007, our shareholders approved a dividend payment of €1.05 per share in respect of our 2006 fiscal year, which was paid on May 15, 2007.  On May 29, 2006, we paid a dividend of €0.85 per share in respect of the 2005 fiscal year.  On May 27, 2005, we paid a dividend of €0.68 per share in respect of the 2004 fiscal year. On May 28, 2004, we paid a dividend of €0.55 per share in respect of the 2003 fiscal year. On May 7, 2003, we paid a dividend of €0.55 per share in respect of the 2002 fiscal year.  

Dividends paid to holders of our ADSs and non-French resident holders of our shares normally are subject to a 25% French withholding tax.  However, non-resident holders that are entitled to and comply with the procedures for claiming benefits under an applicable tax treaty may be subject to a reduced rate of withholding tax (15% for holders who are residents of the United States) and be entitled to certain benefits. See “Item 10. Additional Information—Taxation” for a summary of the material U.S. federal and French tax consequences to holders of shares and ADSs.  Holders of shares or ADSs should consult their own tax advisers with respect to the tax consequences of an investment in the shares or ADSs.  In addition, dividends paid to holders of ADSs will be subject to a charge by the depositary for any expenses incurred by the depositary of the ADSs in the conversion of euro to dollars.

Exchange Rate Information

Share capital in our company is represented by ordinary shares with a nominal value of €5 per share (generally referred to as “our shares”). Our shares are denominated in euro. Because we intend to pay cash dividends denominated in euro, exchange rate fluctuations will affect the U.S. dollar amounts that shareholders will receive on conversion of dividends from euro to dollars.

The following table shows the euro/U.S. dollar exchange rate from 2002 through May 2007 based on the noon buying rate expressed in U.S. dollars per euro. The information concerning the U.S. dollar exchange rate is based on the noon buying rate in New York City for cable transfers in foreign currencies as certified for customs purposes by the Federal Reserve Bank of New York (the “Noon Buying Rate”). We provide the exchange rates below solely for your convenience. We do not represent that euros were, could have been, or could be, converted into U.S. dollars at these rates or at any other rate. For information regarding the effect of currency fluctuations on our results of operations, see “Item 5. Operating and Financial Review and Prospects.”

Month

Period

Average

  

U.S. dollar/Euro

End

rate*

High

Low

 

————

————

————

————

May 2007

1.36

1.35

1.36

1.34

April 2007

1.36

1.35

1.36

1.34

March 2007

1.33

1.32

1.34

1.31

February 2007

1.32

1.31

1.32

1.29

January 2007

1.30

1.30

1.33

1.29

December 2006

1.32

1.32

1.33

1.31

     

Year

    

U.S. dollar/Euro

    
     

2006

1.32

1.26

1.33

1.19

2005

1.18

1.24

1.35

1.17

2004

1.35

1.24

1.36

1.18

2003

1.26

1.13

1.26

1.04

2002

1.05

0.95

1.05

0.86

     


________________________________

*

The average of the Noon Buying Rates on the last business day of each month (or portion thereof) during the relevant period for year average; on each business day of the month (or portion thereof) for monthly average.


Solely for the convenience of the reader, this annual report contains translations of certain euro amounts into U.S. dollars. These translations should not be construed as representations that the converted amounts actually represent such U.S. dollar amounts or could have been or will be converted into U.S. dollars at the rate indicated or at all. The translations from euro to U.S. dollars in this annual report are based on $1.00 = € 0.7593, the Noon Buying Rate on December 31, 2006. On June 28, 2007, the Noon Buying Rate was U.S.$1.3466 per euro.



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RISK FACTORS

You should carefully consider the risk factors described below in addition to the other information presented in this document.

Risks Relating to Our Operations

We may suffer reduced profits or losses as a result of intense competition.

Our business is highly competitive and requires substantial human and capital resources. Large international competitors and local niche companies serve each of the markets in which we compete.  Accordingly, we must make constant efforts to remain competitive and convince potential clients of the quality and cost value of our service offerings. Competitors may also introduce new technology or services that we would have to match in order to remain competitive, which could result in significant development costs for us.  

In addition, we perform a substantial portion of our business under contracts, often of a long-term nature, with governmental authorities and clients from the industrial and commercial sectors. These contracts are often awarded through competitive bidding, at the end of which we may not be retained even though we may have incurred significant expenses in order to prepare the bid.

Over the course of performing certain contracts, we may also be requested by our public or private clients to modify the terms of these contracts, whether called for under the contract or not. These modifications may alter the services provided under the contract, related expenses or billing terms.

Finally, our contracts may not be renewed at the end of their term, which in the case of important contracts may oblige us to engage in a costly reorganization or restructuring of assets and operations covered by the contract when the contract does not provide for the transfer of the related assets and employees to the succeeding operator and/or adequate indemnification to cover our costs of termination.

Our business operations in some countries may be subject to additional risks.

While our operations are concentrated mainly in Europe and North America, we conduct business in markets around the world. Sales generated in countries outside of Europe and North America represented approximately 10.14% of our total revenue in 2006. The risks associated with conducting business in some countries outside of Europe, the United States and Canada can include slower payment of invoices, which is sometimes aggravated by the absence of legal recourse for non-payment, nationalization, social, political and economic instability, increased currency exchange risk and currency repatriation restrictions, among other risks. We may not be able to insure or hedge against these risks. Furthermore, we may not be able to obtain sufficient financing for our operations in these countries. The establishment of public utility fees and their structure can depend on political decisions that may impede for several years any increase in fees that no longer allow coverage of service costs and appropriate compensation for a private operator. The occurrence of unfavorable events or circumstances in certain countries may lead us to record exceptional provisions or depreciation charges in connection with our operations in these countries, which could have a material adverse effect on our results.

Changes in the prices of fuel and other commodities may reduce our profits.

The prices of our supplies of fuel and other commodities, which are significant operating expenses for our businesses, are subject to marked fluctuations. Although most of our contracts contain tariff adjustment provisions that are intended to reflect possible variations in prices of our supplies using certain pricing formulas, such as price index formulas, there may be developments that could prevent us from being fully protected against such increases, such as delays between fuel price increases and the time we are allowed to raise our prices to cover the additional costs, or our failure to update an outdated cost structure formula.  In addition, a sustained increase in supply costs beyond the price levels provided for under our adjustment clauses could reduce our profitability to the extent that we are not able to increase our prices sufficiently to cover the additional costs.

Our business operations are subject to geopolitical, criminal and terrorist risks.

Water is a strategic resource in terms of public health. Accordingly, our activities must comply with laws and regulations that seek to safeguard water resources, production sites and treatment facilities against criminal or terrorist acts. Our activities in the areas of waste management, energy services and public transportation are also subject to similar risks.  We may also have employees who work or travel in areas where the risk of criminal acts, kidnapping or terrorism is either temporarily or permanently elevated. As a result, despite the safety measures that we have attempted to implement, any one of our activities may fall victim to criminal or terrorist acts in the future.  If an attack were to occur, it could negatively affect our image and have a material adverse effect on our results.



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We have pursued and may continue to pursue strategic acquisitions, which may have a less favorable impact than expected on our activities or affect our financial condition.

As part of our business strategy, we have conducted and continue to conduct acquisitions of varying sizes, some of which are significant at the Group level.  These acquisitions involve numerous risks, including the following: (i) the assumptions used in the underlying business plans may not prove to be accurate, in particular with respect to synergies and expected commercial demand; (ii) we may not integrate acquired businesses, technologies, products, personnel and operations effectively; (iii) we may fail to retain key employees, customers and suppliers of the companies acquired; (iv) we may have or wish to terminate pre-existing contractual relationships, which could be costly and/or on unfavorable terms; and (v) we may raise additional debt to finance these acquisitions.

As a result, it is possible that the contemplated benefits of completed or future acquisitions may not materialize within the time periods or to the extent anticipated or that such acquisitions may affect our financial condition.

Our long-term contracts may limit our capacity to quickly and effectively react to unfavorable general economic changes.

The initial circumstances or conditions under which we enter into a contract may change over time, which may result in adverse economic consequences.  Such changes vary in nature and foreseeability.  Certain contractual mechanisms may help to address the changes and restore the initial balance of the contract.  Their implementation may be triggered more or less automatically by the occurrence of a given event (price adjustment clauses for instance), or they may require a contract revision or amendment procedure requiring the agreement of both parties or of a third party.  In any case, however, our actions must remain within the scope of the contract and we cannot terminate unilaterally and suddenly a business that we believe to be unprofitable, or change its features.  Our compensation, whether it consists of a price paid by the client or a fee levied from end users based on an agreed-upon schedule, may not be changed at any time in line with changes in our costs and demand.  These constraints have an impact on our behavior as an economic agent, and are particularly meaningful because our contracts are often entered into for long periods of time.

The rights of governmental authorities to terminate or modify our contracts could have a negative impact on our revenue and profits.

Contracts with governmental authorities make up a significant percentage of our revenue. In numerous countries, including France, governmental authorities may modify or terminate contracts under certain circumstances, but generally with indemnification.  In some countries, however, we may not be entitled to or be able to obtain full indemnification in the event our contracts are terminated by governmental counterparties.  

We may make significant investments in projects without being able to obtain the required approvals for the project.

To engage in business, we must in most cases obtain a contract and sometimes obtain, or renew, various permits and authorizations from regulatory authorities. The competition and/or negotiation process that must be followed in order to obtain such contracts is often long, complex and hard to predict.  The same applies to the authorization process for activities that may harm the environment which are often preceded by increasingly complex studies and public investigations.  We may invest significant resources in a project or public tender without obtaining the right to engage in the desired business or sufficient compensation or indemnities to cover the cost of our investments, for instance as a result of a failure to obtain necessary permits or authorizations, or approvals from antitrust authorities, or because authorizations are subject to conditions that force us to abandon certain of our development projects.  These situations increase the overall cost of our activities and, if we do not obtain the desired business or are forced to withdraw from a public tender, our business may not grow as much or as profitably as we hope.

We must comply with various environmental, health and safety laws and regulations, which is costly and may, in the event of any failure to comply on our part, cause us to incur liability under these laws and regulations.

We incur significant costs of compliance with various environmental, health and safety laws and regulations.

We have made and will continue to make significant capital and other expenditures to comply with our environmental, health and safety obligations as well as to ensure sanitary protection of the services we provide. We are continuously required to incur expenditures to ensure that the installations that we operate comply with applicable legal, regulatory and administrative requirements, including general precautionary or preventative measures, or to advise our clients so that they undertake the necessary actions for the compliance of their installations. The costs related to these preventative measures are recorded as either operating expenses or as industrial investments. Our industrial investments totaled €2.197 billion in 2006.



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Each of our operations, moreover, may become subject to stricter general or specific laws and regulations, and correspondingly greater compliance expenditures, in the future. If we are unable to recover these expenditures through higher tariffs, this could adversely affect our operations and profitability. Moreover, the scope of application of environmental, health, safety and other laws and regulations is becoming increasingly broad.  These laws and regulations now govern any discharge in a natural environment, the collection, transport, treatment and disposal of all types of waste, the rehabilitation of old sites at the end of operations, as well as ongoing operations at new or old facilities.

Our operations and activities may cause us to incur liability or other damages that we might be required to compensate.

The increasingly broad laws and regulations expose us to the risk of liability, including in connection with assets that we no longer own and activities that have been discontinued. For example, a French law dated July 30, 2003, relating to the prevention of technological and environmental risks and the conduct of remediation activities, has strengthened the regulatory framework that applies to discontinued operations and closed sites and installations. In some instances, reserves must be established in respect of such discontinued operations. In addition, we may be required to pay fines, repair damage or undertake improvement works, even when we have conducted our activities with care and in total conformity with operating permits. Regulatory authorities may also require us to conduct investigations and undertake remedial activities, curtail operations or close facilities temporarily in connection with applicable laws and regulations, including to prevent imminent risks or in light of expected changes in those laws and regulations.

In addition, we often operate installations that do not belong to us, and therefore do not always have the power to make the investment decisions required to bring these installations into compliance with new regulatory norms. In instances where the client on whose behalf these installations are operated refuses to make the required investments, we may be forced to terminate our operations.

In the event of an accident or other incident, we could also become subject to claims for personal injury, property damage or damage to the environment (including natural resources). These potential liabilities may not always be covered by insurance, or may be only partially covered. The obligation to compensate for such damages might have a material adverse effect on our activities or resources.

Specific measures are required in connection with certain technological risks (article L. 225-102-2 of the French Commercial Code regarding “Seveso” facilities).

Among the facilities that we own and operate in France, one has been categorized a “Seveso” facility.  “Seveso” facilities are places where dangerous substances are present in quantities equal to or above thresholds specified in European Union Directive 96/82/EC (also known as the Seveso II Directive), relating to the control of major accident hazards involving dangerous substances.  As such, these facilities are the subject of special concern and heightened regulation. Our “Seveso” facility is a hazardous waste incineration factory at Limay (Yvelines). The manipulation of waste and hazardous products in this facility can, in the case of an accident, cause serious damage to the environment, neighbors or employees, exposing us to potentially substantial liabilities.

As part of our outsourcing contracts, our subsidiaries may also be involved in the operation of Seveso sites (or the foreign equivalent) by industrial clients (particularly petroleum or chemical industry sites).  In these instances, we must handle the provision of services with even greater care, given the more dangerous nature of the products, waste, effluents and emissions to be treated, as well as the close proximity of the installations we manage to client sites.

Finally, while the regulatory regime governing Seveso facilities applies only within the European Union, we operate several similar sites outside of this region which are often subject to the same level of heightened regulation by foreign governments.

Currency exchange and interest rate fluctuations may negatively affect our financial results and the price of our shares.

We hold assets, earn income and incur expenses and liabilities in a variety of currencies. Our financial statements are presented in euro. Therefore, when we prepare our financial statements, we must translate our assets, liabilities, income and expenses in other currencies into euro at then-applicable exchange rates. Consequently, increases and decreases in the value of the euro in respect of these other currencies can affect the value of these items in our financial statements, even if their value has not changed in their original currency. For example, an increase in the value of the euro may result in a decline in the reported value, in euro, of our interests held in foreign currencies.

At December 31, 2006, our net financial debt excluding revaluation of hedging instruments amounted to €14.7 billion, of which 25.7% was subject to variable rates and 74.3% to fixed interest rates, including 12.1% subject to variable rates with caps. Our results of operations and financial condition may be affected by changes in prevailing market rates of interest. Fluctuations in interest rates may also affect our future growth and investment strategy, since a rise in interest rates may force us to finance acquisitions or investments or refinance existing debt at a higher cost in the future.

Risks Relating to Our Shares and ADSs

Because preemptive rights may not be available for U.S. persons, the ownership percentages of our U.S. shareholders may be diluted in the event of a capital increase of our company.

Under French law, shareholders have preemptive rights (droits préférentiels de souscription) to subscribe, on a pro rata basis, for cash issuances of new shares or other securities giving rights to acquire additional shares. U.S.  holders of our shares may not be able to exercise preemptive rights for our shares unless a registration statement under the U.S. Securities Act of 1933, as amended (“Securities Act”), is effective with respect to those rights or an exemption from the registration requirements imposed by the Securities Act is available.  We are not required to file registration statements in connection with issues of new shares or other securities giving rights to acquire shares to our shareholders.  As a result, we may from time to time issue new shares or other securities giving rights to acquire additional shares at a time when no registration statement is in effect.  For example, in June 2007 we launched a capital increase through the issuance of rights to acquire new shares to all of our shareholders, but those rights were generally exercisable only by persons located



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outside the United States.  Holders of our ADSs were not permitted to exercise the rights corresponding to the shares underlying the ADSs.

We are permitted to file less information with the U.S. Securities and Exchange Commission (SEC) than a company incorporated in the United States.

As a “foreign private issuer,” we are exempt from rules under the U.S. Securities Exchange Act of 1934, as amended (“Exchange Act”), that impose some disclosure and procedural requirements for proxy solicitations under Section 14 of the Exchange Act. Additionally, our officers, directors and principal shareholders are exempt from the reporting and “short-swing” profit recovery provisions of Section 16 of the Exchange Act and related rules with respect to their purchases and sales of our shares. Moreover, we are not required to file periodic reports and financial statements with the SEC as frequently or as promptly as U.S. companies with securities registered under the Exchange Act. Accordingly, there may be less information concerning our company publicly available from time to time than there is for U.S. companies at those times.

The ability of holders of our ADSs to influence the governance of our company may be limited.

Holders of our ADSs may not have the same ability to influence corporate governance with respect to our company as would shareholders in some U.S. companies. For example, the ADS depositary may not receive voting materials in time to ensure that holders of our ADSs can instruct the depositary to vote their shares. In addition, the depositary’s liability to holders of our ADSs for failing to carry out voting instructions or for the manner of carrying out voting instructions is limited by the deposit agreement. Finally, except under limited circumstances, our shareholders do not have the power to call shareholders’ meetings.



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ITEM 4. INFORMATION ON THE COMPANY

HISTORY AND DEVELOPMENT OF THE COMPANY

We are a leading global provider of environmental management services, which include water and wastewater services, waste management services, energy services (excluding the production, trading and sale of electricity, other than production through co-generation) and transportation services.  Our clients include a wide range of public authorities, industrial and commercial customers and individuals around the world.

The legal and commercial name of our company is “Veolia Environnement.” Our company is a société anonyme, a form of stock corporation, incorporated in 1995 pursuant to the French commercial code for a term of 99 years.  Our registered office is located at 36/38, avenue Kléber, 75116 Paris, France, and the phone number of that office is (+33 1) 71 75 00 00.  Our agent in the United States is Brian Sullivan. He can be reached at Veolia Environnement, 700 East Butterfield Road, Suite 201, Lombard, IL 60148.

Historical Background

Our company traces its roots back to the creation of Compagnie Générale des Eaux by Imperial decree on December 14, 1853.  During the same year, Compagnie Générale des Eaux won its first public service concession for the distribution of water in the city of Lyon, France.  Early on, it commenced developing its municipal water distribution activities in France by obtaining concessions in Nantes (1854), Nice (1864), Paris (1860) and its suburbs (1869).

In 1980, Compagnie Générale des Eaux reorganized its water activities by regrouping all of its design, engineering and execution activities relating to drinking water and wastewater treatment facilities under its subsidiary Omnium de Traitement et de Valorisation (OTV). At the same time, Compagnie Générale des Eaux expanded its business during the 1980s with the acquisition of Compagnie Générale d’Entreprises Automobiles (CGEA, which would become Connex and Onyx, and later Veolia Transport and Veolia Propreté) and Compagnie Générale de Chauffe and Esys-Montenay (which would merge to become Dalkia).  It also began significant international expansion.

In 1998, Compagnie Générale des Eaux changed its name to “Vivendi” and renamed its main water subsidiary “Compagnie Générale des Eaux.”

In April 1999, in order to better distinguish the separate existence of its two main businesses, communications and environmental services, Vivendi created our company under the name “Vivendi Environnement” to conduct all of its environmental management activities, which were then conducted under the names Vivendi Water (water), Onyx (waste management), Dalkia (energy services) and Connex (transportation).

On July 20, 2000, our shares were listed on the Premier Marché of Euronext Paris, which became the Eurolist of Euronext Paris on February 21, 2005.

In August 2001, our shares were included in the CAC 40, the main equity index published by Euronext Paris, and in October 2001 were listed in the form of American Depositary Shares for trading on The New York Stock Exchange.

From 2002 to 2004, Vivendi (formerly known as Vivendi Universal) progressively decreased its stake in our company, and has held only 5.3% of our shares since December 2004.  See “Item 7. Major Shareholders and Related Party Transactions—Major Shareholders.”  Since July 26, 2006, Vivendi no longer holds shares in our company.

In 2002, we began conducting a significant restructuring in order to refocus on our core environmental services activities. This restructuring was completed in 2004 with the sale of various U.S. subsidiaries within our water division conducting certain non-core activities, and with the sale of our indirect interest in Fomento de Construcciones y Contratas (FCC), a Spanish company whose activities include construction and cement services, as well as other services related to the environment.

In April 2003, we changed our name to “Veolia Environnement.”  On November 3, 2005, we unveiled a new branding system for our group. Our water, waste management and transportation divisions currently operate under the same name: “Veolia.”



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Major Developments in 2006  

Below we discuss the main developments in our business during 2006.  The discussion below and in the remainder of Item 4 includes the revenue amounts that we expect to earn from various contracts (most of which are long-term contracts), including total revenue expected to be generated from all services under combined contracts to build and operate facilities.  These revenue amounts take into account updates to our volume and price assumptions since the date these contracts were publicly announced.  In addition, revenue amounts expected under foreign contracts won during 2006 have been converted into euro at the rate of exchange prevailing on December 31, 2006.  As a result, publicly announced revenue amounts may differ from the amounts of expected revenue included in this document.  In addition, these expected revenue amounts constitute forward-looking statements that involve risks and uncertainties, including, but not limited to, those described under “Item 3. Key Information–Risk Factors.”  Actual revenue amounts may differ materially from those anticipated in the forward-looking statements.  See “Forward-Looking Statements” at the beginning of this document for a more detailed discussion of the risks and uncertainties to which our forward-looking statements are subject.

Deployment of the “Veolia” Brand

Since 2005, we have been rolling out a new branding program. Today our water, waste management and transportation divisions have been brought together under a single name: “Veolia.” The energy services division continues to operate under the brand name “Dalkia.”

In connection with the roll-out of the “Veolia” brand, the holding companies of water, waste management and transportation divisions, as well as most of our operating companies, have changed their names to include “Veolia”.

The brand roll-out, which was initiated by the executive committee, illustrates our determination to unite our divisions and heighten our public profile. This change also aims to reinforce our corporate identity and culture, as well as to strengthen the commitment of our employees to our strong service-oriented values. Over time, the Veolia brand is expected to become a benchmark worldwide for trust, reliability and expertise in environmental solutions.

At the same time, a publicity campaign was launched in June 2006 (written press, public displays, television). This campaign asserts Veolia’s industrial commitment to reconciling human activities and environmental preservation, a commitment that is expressed in the slogan “the environment is an industrial challenge.”


This campaign was launched in the written press in France, the United Kingdom, Germany, the Czech Republic and Romania, and through public displays in airports across the world (Paris, London, Shanghai, Hong Kong, New York, Chicago and Los Angeles) and in the Eurostar station in Brussels.


It was completed by an adverstising film focusing on the human and urban aspects of our activities, which was broadcast from October 2006 through various hertzian and cable channels in France and Europe.


Costs borne by us in 2006 for the development of the brand and the publicity campaign amounted to approximately €26 million.


Acquisition of Cleanaway UK


In 2006, we improved our market position by carrying out targeted acquisitions, designed to generate growth and costs synergies.


On June 30, 2006, one of our divisions, Veolia Propreté, a division of Veolia Environnement, announced the acquisition of Cleanaway Holdings Limited (Cleanaway UK) from the Brambles group for €744.7 million. This acquisition significantly reinforced our position in the British industrial and local waste management sector. With estimated annual consolidated revenues of €684 million, Cleanaway UK is a major operator in the United Kingdom within the industrial and municipal waste collection services sector, and the waste management sector. The transaction, which was submitted for approval by the European competition authorities, was finalized on September 28, 2006.  


Agreements Relating to the Société Nationale de Maritime Corse Méditerranée (SNCM)


On May 31, 2006, we signed agreements with Butler Capital Partners and the CGMF relating to the acquisition of the Société Nationale de Maritime Corse Méditerranée (SNCM).  These agreements were part of a transaction to open SNCM’s capital to outside investment, a decision made by the French government at the beginning of 2005, and the restructuring of the company.  The transaction is still subject to a cancellation clause relating to the European Commission’s agreement on state aid.  As a result of this acquisition, we hold 28.29% of SNCM’s share capital.




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SNCM’s principal business is the operation of a public service concession for transportation to Corsica from the port of Marseille.  It has ten ships at its disposal and contributed approximately €200 million to Veolia Transport’s revenues in 2006.  As a result of this transaction, Veolia Transport has significantly reinforced its position as an operator of maritime lines in high growth markets, after many years as an operator in Northern Europe.

Validation of a Strong Business Model

Since our initial public offering, we have gone through a series of stages in establishing our business model and independence, which in 2004 culminated in the sale of non-strategic assets in the U.S. as well as the sale of our interest in FCC.  Our refocusing of our activities on services related to the environment should enable us to strengthen our position as a leader in this market going forward, by relying on the same consistent strategy for growth.

 “Veolia Skills” Program

In September 2005, we engaged in a large and innovative recruiting campaign in France referred to as “Veolia Skills.” This campaign allowed for the the recruitment of 4,879 new employees in 2006.  The objective for the third campaign is to recruit 8,000 new employees in 2007.

All of these recruitments will be professional skills-oriented.  Training will last between 9 and 24 months, leading to a diploma recognized by the French Education Ministry.  Once a diploma has been obtained, candidates will be offered indefinite-term employment.

This recruiting campaign is open to persons of all ages. It is also open to existing employees, in order to afford them greater mobility in the spirit of ongoing skills development. Through this campaign, we hope to encourage the hiring of members of certain sectors of the public, including handicapped persons, seniors and the long term unemployed.


In the long term, the goal is to make mobility our preferred means of recruitment.  Internally, the expected increase in staff must be accompanied by the strengthening of mobility, focusing on the professionalism of partners, the true actors in our development.


“Veolia Environnement 2006” Efficiency Plan

We announced in September 2003 the plan called “Veolia Environnement 2005,” which we hoped would generate €300 million in annual savings beginning in 2006. This objective was achieved one year in advance, with €304 million in savings recorded in 2005.  This plan continued in 2006 and generated €406 million in savings excluding exceptional and non-recurring costs relating to its implementation. This program which ended at the end of this fiscal year will have mobilized all of our operational units and more than 1,000 contributors. More than 700 projects were carried out across all themes (operational, optimization of structures, purchasing and staff). In 2007 and for the following years, our objective is to capitalize on the gains from the plan to achieve continuous improvement of an ongoing transversal performance program.  

Greenhouse Gases

An increase of greenhouse gases in the atmosphere has led certain countries, as well as the international community, to implement regulatory measures in order to limit their progression.  At the international level, the Kyoto Protocol, which came into force in February 2005, as well as the European directive of October 13, 2003 has created a European Union for gas emissions, the “Emission Trading Scheme”.

The system was put in place on a European level in parallel to that of the Kyoto Protocol, which was started in 2005 and which led to the creation of the national allocation quota plan (PNAQ). In 2006, a revision of the October 13, 2003 directive was launched in order to increase its jurisdiction, to reinforce the controls and to establish a commercial quota system linked to the Kyoto Protocol.


We are already active in this field on a national, European, and global level.

·

At the European Union level, Dalkia, which operates close to 250 combustion installations in Europe that are affected by the new quota system, has been awarded quotas representing approximately 1% of all European quotas awarded, and has taken an active role in working with clients to manage carbon emissions and quotas.


·

At the international level, we have begun trying to generate emissions credits that are tradable on the market, by participating in projects with other countries that help to reduce greenhouse gases. Veolia Propreté and Dalkia completed two projects, which were registered as clean development facilities (“mécanisme de développement propre", or MDP) by the MDP Executive Council, while six others are in the process of being completed. Dalkia completed a project of joint development (“Mise en Oeuvre Conjointe”, or MOC). Veolia Transport is actively involved in developing an initial tool that would apply to business transportation, in collaboration with EpE and ADEME.



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BUSINESS OVERVIEW

Our Market

The market for environmental management services has emerged only recently, including water treatment and distribution, wastewater treatment and collection, waste treatment and management, energy services (excluding the production, trading and sale of electricity, other than production through co-generation) and transportation. Traditionally, these services were, and often remain, considered as independent services outsourced to individual providers.  Public authorities and industrial and commercial companies, moreover, typically met many of their own environmental needs without looking to private firms that specialize in these areas. This situation has changed fundamentally in recent years.  Recent awareness regarding environmental demands and the necessity of a global approach to the management of activities having an environmental impact, as well as the updating of solutions allowing interaction and optimization between these services, has prompted a demand for integrated environmental management services.  This phenomenon has been emphasized by the continued global expansion of industrial and commercial companies that have generated a need for environmental management services providers with a global reach.

We believe that demand for integrated, customized packages of environmental management services is likely to grow around the world for the following reasons:

·

In a world that combines accelerated urbanization with demographic growth, major investments in environmental projects and services as well as effective management are needed to meet increasingly stringent environmental standards, provide growing urban populations with adequate environmental services and replace existing environmental infrastructure.  In addition, there is also an increase in public demand for high-quality and reliable environmental products and services.


·

Governments throughout the world face budgetary constraints and often lack the technical and operational skills of private sector firms to address environmental issues efficiently.  As a result, public authorities are increasingly turning to the private sector to address their environmental needs.


·

Public and private entities are increasingly attempting to simplify the administration of their complex operations by outsourcing a wide variety of responsibilities to a single partner.  This tendency creates a business opportunity for companies capable of offering a broad range of environmental management services in an integrated fashion.


·

Large private firms and public authorities increasingly recognize that a “one size fits all” approach will not meet their unique and changing needs. As a result, demand for customized environmental management services has grown.


·

The increasingly multinational profile of many large industrial and commercial firms encourages them to outsource non-core activities to companies with similar geographic reach in order to simplify administration and ensure they receive consistent service at each of their facilities.


We think that each of these trends, taken individually, creates significant opportunities for companies with our expertise, and, taken as a whole, they allow our company, in particular, to provide innovative and integrated environmental management services in markets around the world.


Our Clients


We provide environmental management services to a wide range of public authorities, industrial and commercial customers and individuals around the world.


Public Authorities


Demand by public authorities (often small localities that are increasingly joining forces together) has been influenced and strengthened by trends relating to the search for quality, efficiency, innovation and reduced costs, as well as a heightened sensitivity to environmental issues, including the management of water resources, air pollution, mass transportation policies and energy consumption. These trends, combined with a movement towards greater urbanization, are increasing the need for essential environmental services.


As a result, we believe that our historical business model—most often taking the form of “delegated management contracts” in France and of “concessions” in most places outside of France—is more relevant than ever. Depending on the country, the actual contract may take several legal forms, but remains characterized by a public authority delegating to private operators the exclusive right, with or without an investment obligation, to operate services or support facilities, or to manage an activity, for which the authority is responsible.  The public authorities retain the role of defining, organizing and overseeing the services provided to inhabitants or other users. At the same time, the private operator charged with the provision of these services uses its expertise to deliver them more efficiently, resulting in a mutually beneficial relationship between the private operator and public authority. Public authorities can assume a larger or less prominent role in the management of public services, depending on their needs. We believe that we can adapt to the different needs and expectations of public authorities around the world in order to assist them in (i) responding to the need for heightened efficiency and productivity in the provision of public services in order to control costs, (ii) accessing more sophisticated technical skills in order to resolve complex environmental problems, and (iii) responding to the demand for prompt and professional service expressed by end users.


In France in particular, we intend to take advantage of a French ordonnance dated June 17, 2004 allowing for the creation of a new form of partnership contract.  The ordonnance allows public authorities to entrust private operators (who may be associated with



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financial organizations) with the entire responsibility for building and/or financing an installation and operating the services related thereto, in exchange for compensation that is paid by the public authority as a function of performance.


This model of delegated management or concession is widely used for the provision of collective services, but is not the only one.  Public authorities may decide that they should not be directly involved in the provision of certain public services.  In these instances, they are often not the owner of facilities or networks, and do not enter into contracts with a preferred private operator; instead, they leave the provision of the public service to market forces. They may nonetheless occasionally verify the abilities of private operators by issuing operating licenses and regulating service conditions and prices.  This situation rarely arises with respect to water services, but is more common in the fields of energy services, waste management and transportation. Public authorities may also hold an ownership interest in the private operator in these instances; we may seek to acquire a stake as well.


Services Sold Directly to Individuals


We also offer services directly to individuals through our specialized subsidiaries. These services include assistance and maintenance relating to water (including meter-reading), heating and gas services.


Industrial or Commercial Companies


We offer our industrial and commercial clients a large range of services, which generally aim to achieve the following two main goals in relation to the environment:


·

furnishing clients with the services necessary for their industrial processes (steam, industrial heating and cooling, processed water, demineralized water, compressed air, etc.) and optimizing their consumption thereof, and


·

reducing the impact of their industrial processes on the environment, which may include treating effluents, recycling and recovering waste, and maintaining durable and efficient waste elimination channels.


We often partner with such clients over the long term, and offer innovative solutions adapted to the needs of each industrial site.


We believe that the further development of our industrial client base will be a significant area of growth.  In particular, multiservice contracts entered into with industrial clients have assumed an increasingly important role and are expected to continue to do so.  See “—Development of Synergies: Multiservice Contracts to Benefit Industrial and Commercial Clients” below.


Our Overall Strategy

Our aim is to continue to reinforce our position as world leader in environmental services. Our strategy focuses on developing the most appropriate environmental service solutions for our local and industrial clients; the maintenance of a geographically diverse area of activity; the development of a significant presence in growth markets with high potential and an acceleration of synergies between our different businesses.    

While strengthening our position as a worldwide leader in the provision of environmental services, we continue to implement our growth business model aimed at improving our solid economic and financial condition.  This solidity is a result of economies of scale, constantly evolving technology and know-how (supported by ever-growing research investment), long-term commitments to clients and risk management.



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The most appropriate solutions in environmental services ensure that we develop our client relationships.


While preserving the local character of our business, we have become a major actor in each of our main businesses, whether in the services business or in the concessions business. We have forged a unique position within these two client segments.


Within the municipal area, we have completed our portfolio of existing French and European clients (Prague, Bucarest, Nottingham, Braunschweig), but have also had a number of commercial successes in the United States (Indianapolis, Chicago, Boston …) and in the Asia Pacific region (Canton, Shanghai, Incheon, Melbourne).  Thus, we have illustrated our ability to win large privatizations and bids for large projects.


Historically we have conducted an important part of our business through our industrial and commercial clients, particularly in energy and waste management services.  We have also created a new business portfolio made up of large industrial accounts (Peugeot, Novartis, Renault…), with a significant contribution coming from multi-service contracts.


Successful Geographic Diversification


Our international business continues to increase alongside the volume of business in France, which has continued to grow at an average annual rate of over 5% per year since 2000.


The European market has become our domestic market, but we have forged strong positions in the United States and Asia. Our presence in developed countries presents relatively little risk of decreasing as it is largely unaffected by relocations and restructurings.


We have developed a significant business presence in emerging and developing countries. Our economic position within these areas of the world is much more significant than appears from the proportion of our revenues earned in these areas.


A strategy focused on the growth and high-potential markets


Our strategy focuses on growth markets.  Our markets are divided into categories by business and client type.


The industrial markets are currently growing rapidly: as a result of increasingly restrictive regulations and with the objective of improving their competitiveness, industrial companies are increasingly outsourcing environmental services through long-term partnerships. These partners, who generally work on all of the industrial sites of the client, tend to provide global services.


The growth in the municipal markets principally results from the combination of several demographic factors: an increase in population size on the one hand, and the urban development rate on the other. Growth is also tied to economic activity and living standards. The tightening of environmental constraints and related regulations have proven to be key factors in our growth.


Economic constraints affecting our industrial clients, as well as our municipal clients, tend to increase their need to reduce water and energy consumption and waste production. Our position as a service provider, as opposed to utility provider, generally allows us to take advantage of this trend.  


Synergies between our different businesses accelerate our growth


Within our environmental services business to public authorities and industrial clients, we enjoy important synergies between water, waste management, transportation and energy services. By offering a complete range of services, we have become an environmental partner with our clients who resort to all of our business services.


This synergy is particularly evident within countries or municipalities where demographic changes, urbanization and economic development have significantly accelerated; in these cases, we have been called upon to find solutions to growing environmental problems.




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Strong economic and financial capabilities


Our strong position results from market growth trends, but also from our competitive assets, for example our technological and technical expertise, our financial situation, our geographic presence, and our experience and know-how in providing environmental services, all in compliance with regulatory requirements.


Size advantages


Our size alone provides us with significant synergies.  In addition, our presence in all segments of the value chain means that our vertically integrated structures allow us to retain the benefits of added value.


Support of technological developments and improved know-how


We have long been developing our Research and Development. Research and Development are essential to accomplishing our missions, while allowing us to address the needs of our clients. Since 2000, we have unified our R&D business under one unique organization which is backed up by the strategic research, innovation and sustainable development committee created in 2006 by our Board of Directors.


We also benefit from the sharing of techniques in areas such as prevention of the risk of legionella, treatment and valorization of sediment, bioenergy, and management of high environmental quality buildings.


Long-term contracts


We commit to our clients for the long term. Our human resources policy centered on training allows us to focus on long term contracts, in particular through the considerable efforts of Veolia Expertise, an initiative that was renewed in 2007, after having led to significant hirings in 2005 and 2006.  


Moreover, aside from its social, environmental and ethical aspects, sustainable development directly influences the needs of clients, thus forming a crucial element within the commercial dialogue. Sustainable development trends have led to changes in our economic model in order to move from a volume-maximizing model to a resource-optimizing model.


Managed risks


Within this growth context, we have enacted a management and risk measurement policy, which was marked in 2006 by the roll out of a mapping of major risks at the Group and division levels.  By putting in place a coordinated risk prevention and management plan, we are addressing this issue of fundamental concern to our future development.


These various strategic factors have allowed us to develop a profitable growth platform with room for future accelerated growth.


Our Strategy by Division

Water

Our water division intends to further pursue the development of its water services throughout the world.  In doing so, it will strive to ensure the health, security and safety of the water it provides, the conservation of natural resources and the protection of the environment.

The market for water services has the potential to grow worldwide, supported by four factors in particular:

·

population growth and higher urban density,


·

the strengthening of environmental and sanitary norms and regulations,


·

the growing acceptance of delegated public service management and public-private partnerships as alternatives to public management, and

·

the attempt by industrial clients to refocus on their core businesses.


Given this growth potential, we will selectively pursue our development in the water sector in order to optimize our use of resources, operating costs and profitability. As we do so, we will rely on our technical expertise, our experience in managing client relations and the mobilization of local teams on the ground in order to anticipate the future needs of public authorities. We will also continue to train our employees to meet future challenges.  Veolia Eau’s increased technical expertise in various desalination methods and wastewater recycling in particular represents a major effort to adapt to ongoing changes in market conditions.



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Going forward, Veolia Eau will seek to capitalize on the sustained opportunities for development worldwide, the maturing of its larger contracts and the productivity gains resulting from efficiency programs that have been in place since 2003 (relating to purchases, information systems and sharing of best practices).  

Environmental Services

Through our environmental services division, we seek to pursue our development as one of the world leaders in the waste management sector.  As is the case with our other businesses, the waste management sector is showing signs of consistent and lasting demand, which has been reinforced by the tightening of environmental rules and regulations coupled with increased public demand in a number of countries.  As a result, experts who can provide long-term services under cost-effective conditions and in accordance with environmental regulations are becoming more highly sought after.

Within this favorable market environment in Europe, the United States and the Asia-Pacific region, we have the following priorities for our waste management division:

·

developing our waste treatment capabilities and widening our technological lead in waste treatment and recovery;


·

strengthening the offering to industrial clients by capitalizing on our mastery of the entire waste management chain, while seeking to generate synergies with our other operating divisions; and


·

increasing the profitability of our activities by renegotiating tariffs, maximizing productivity and reducing structural costs and ensuring that all of our activities contribute to the development of high value-added services.


Energy Services

Through our energy services division (Dalkia), we are the European leader in the energy services sector. In 2000, we entered into a strategic partnership in the energy services sector with EDF, a European leader in the production, distribution and sale of electricity, in order to offer clients comprehensive energy services at the best possible price.

The opportunities in the sector are significant, due to increases in energy prices and public awareness of environmental problems, which have led to research solutions such as Dalkia’s initiatives to reduce the effects of greenhouse gases and encourage energy conservation.

Our development strategy for this division includes the following geographical priorities:

·

pursuing growth in Southern Europe (Italy, Spain etc.) by participating in the trend toward market consolidation and by developing our multiservices offers to the private sector;


·

pursuing development in the area of large heating networks, particularly in France and in Central and Eastern Europe; and


·

pursuing growth in North America by developing our presence in the management of networks, industrial utilities and shopping malls.


These development priorities will depend on our ability, in the context of deregulated energy markets in Europe, to offer innovative technical solutions focused on energy efficiency that often combine our expertise in several areas. We will also attempt to promote our integrated outsourcing services to public clients as well as commercial and industrial clients, by combining optimized services for facilities management (heating, air-conditioning, utilities, electricity, lighting).

Transportation

Through our transport division, we seek to be a major transportation service provider on a worldwide scale.

Between 2000 and 2020, the proportion of the world population living in urban areas is expected to increase from 50% to 60%, and urban transport needs are expected to increase by 50% (source: International Association of Public Transport).  These demographic changes will likely increase concerns relating to the environment and urban congestion, with public transportation services constituting a foremost concern for the local authorities and inhabitants of large cities.  Accordingly,transportation always has some impact on the image and identity of a large city, its economic development, urban renovation projects, and local solidarity.

We aim to establish ourselves, within this sector, as the force behind local transport alongside the community, through the establishment of subcontracts that will later evolve into partnerships.




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Veolia Transport’s strategy for being the leading private operator of public transportation services and improving its performance and growth is the following:


·

Innovation and marketing so as to offer more services of higher quality: integrated computer ticketing, traveler information;


·

The implementation of new contracts within the community, tailored to previous methods and their needs, with performance guarantees and including, if the need arises, direct investment;  


·

The continuation of our geographic growth in Europe, North America and Australia, and our opening up to China and India as well as certain large cities in Latin America;


·

The diversification in the transportation business, often during the early stages of the opening of markets to competition: railway freight, maritime links, transport on demand and taxis.


Our Services

Our company is a unique actor in the field of services related to the environment, offering a comprehensive array of services.  We have the expertise, for example, to supply treated water and to recycle wastewater at a customer’s facility, to collect, treat and recover waste generated in the facility, and to supply heating and cooling services and optimize industrial processes used in such facility, all in an integrated service package designed to address the customer’s unique circumstances.

Our operations are conducted primarily through four divisions, each of which specializes in a single business: water, environmental services, energy services and transportation. Through these divisions, we currently provide water to more than 67 million people and 49 million people in the world with clean water, treat nearly 58 million tons of waste, satisfy the energy requirements of hundreds of thousands of buildings for our industrial, municipal and individual customers and transport approximately 2.5 billion passengers per year.  We strive to offer services to clients that span our four divisions, which are either packaged in the form of a single multiservices contract, or negotiated separately in the form of several contracts.

The following table breaks down our consolidated revenue for 2006 by geographic market and division, after elimination of all inter-company transactions.

 (in millions of euro)*

Water

Environmental Services

Energy Services

Transportation

Total

Europe

7,916.6

5,216.4

5,924.0

3,843.6

22,900.6

of which:

 France

4,802.4

3,112.1

3,535.4

1,953.1

13,403.0

Other Europe

3,114.2

2,104.3

2,388.6

1,890.5

9,497.6

Americas

763.5

1,585.5

137.2

688.9

3,175.1

Rest of the World

1,407.5

661.0

57.2

419.0

2,544.7

of which:

Africa-Middle East

704.7

91.1

32.2

14.4

842.4

Asia-Pacific

702.8

569.9

25.0

404.6

1,702.3

Total

10,087.6

7,462.9

6,118.4

4,951.5

28,620.4

*

Revenue from ordinary activities under IFRS.



The dates set forth below relating to new contracts we have won or renewed correspond to the date of announcement or signing of such contracts, or to the date of our commencement of operations under such contracts, depending on the circumstances.


Water

Through our water division, the lead company of which is Veolia Eau – Compagnie Générale des Eaux, we are the world’s leading provider of water and wastewater services for public authorities and industrial companies. Further, Veolia Eau, through its subsidiary Veolia Water Solutions & Technologies (formerly known as Veolia Water Systems) is the world leader in the design of technological solutions and the construction of structures necessary to perform such services.



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With approximately 77,840 employees around the world1, Veolia Water Eau provides drinking water to  more than 67  million people around the world and 49 million people in the world with clean water, and operates more than 4,400 contracts. Veolia Eau has a permanent presence in 59 countries, principally in France for historical reasons, but also in the United Kingdom, Germany, Italy, Belgium, the Netherlands, the Czech Republic, Slovakia and Romania. It is pursuing targeted growth in Russia, Armenia, and Hungary. Asia (mainly in China, South Korea and Japan) also remains an important target for development following the award of significant contracts with municipal and industrial clients during the past several years. Veolia Eau has a presence in the United States through its contracts for the operation and maintenance of water and wastewater treatment plants, including its contract with the city of Indianapolis. Finally, Veolia Water has established a presence in the Middle East and Africa, primarily in Morocco and Gabon.

With a network of research centers in France and abroad, Veolia Eau has mastered numerous technologies and tools within the water sector.  As a result, Veolia Eau is able to offer highly skilled services in the areas of sanitary protection, spillage reduction, productivity enhancement of water networks and plants and resource preservation.  

Combined with a strong local presence on the ground and more than 150 years of experience in the provision of services to public authorities and industrial clients, Veolia Eau’s technical aptitude provides it with an important advantage in the water services market, which is extremely competitive.

Increased demand within the water services market has been driven substantially by clients seeking to optimize the management of their existing resources, whether they be public authorities seeking to respond to the trend towards urbanization or industrial clients.  New solutions, such as desalination (demonstrated by a key new supply contract in 2006 with a sea water desalination plant in Bahrain) or re-use of treated water, may also be called for depending on an individual client’s circumstances.

The following table shows the consolidated revenue and operating income of our water operations in each of the last two fiscal years, after elimination of all inter-company transactions.

(in millions of euros)*

2006

2005 adjusted ***

Change
2006/2005

    

Revenue**

10,087.6

9,134.2

10.4%

Operating income

1,160.6

1,002.3

15.8%

*

Includes our share in the results of the water activities of Proactiva, our joint venture with FCC.

**

Revenue from ordinary activities under IFRS.

***

Accounts as of December 31, 2005 were adjusted for the application of IFRIC12 standards for the treatment of concessions, so as to ensure the comparability of the fiscal years.



Overview of Water Division


Our water division manages municipal drinking water and/or wastewater services on five continents thanks to a geographical organization with a strong local presence.  Contracts with public authorities are typically long-term and range from 10 to 20 years in length, but may extend up to 50 years in certain circumstances. These contracts take various forms, all adapted to the needs and goals of the public authority, and may include outsourcing contracts, public-private partnerships, concessions, BOT (Build, Operate & Transfer) contracts, DBO (Design, Build & Operate) contracts and others (discussed further under “—Contracts” below). They are generally contracts that involve the operation, design or construction of installations, with the public authority usually remaining the owner of assets (except in the United Kingdom) and the head of water policy.  Further, recent legislative changes will allow us to integrate more elaborate mechanisms into our contracts to address increases in value produced under the contract and the division thereof (e.g., productivity gains, improvement in the level of services, efficiency criteria, etc.). Public authorities often call upon Veolia Eau to manage customer relations; it has implemented specific services and information systems in response, which it continuously strives to improve.  


In certain countries where public authorities wish either to implement new water and wastewater treatment systems or to improve the functioning of existing ones, Veolia Eau also offers feasibility studies and technical assistance, which may include research plans, network modeling and financial analysis.


Veolia Eau’s outsourcing contracts with industrial and commercial customers generally last from 3 to 10 years, although certain contracts have terms of up to 20 years.


1

As of December 31, 2006, including Proactiva’s 1,975 employees who are active in water activities.



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Service Contracts for Public Authority and Industrial Clients


The main focus of our water business is on water and wastewater management services for public authorities and industrial clients.  Our water division provides integrated services that cover the entire water cycle. Its activities include the management and operation of large-scale, customized drinking water plants, wastewater decontamination and recycling plants, drinking water distribution networks and wastewater collection networks. Veolia Eau also manages customer relations, providing billing services and call centers.


Veolia Eau and its subsidiaries have provided outsourced water services to public authorities in France and in the rest of the world for more than 150 years under long-term contracts adapted to local environments. Currently, Veolia Eau and its subsidiaries are attempting to capitalize on the worldwide trend towards delegated management of municipal drinking water and wastewater treatment services.


Veolia Eau continues to develop its service offerings for industrial clients using its local presence in various areas and its adapted service organization. It has accordingly become active within this market in France, the United Kingdom, Germany and the Czech Republic, as well as in Asia (South Korea and China in particular) and the United States. Veolia Eau also contributes within VE Industries (as discussed further below) to the development of common service offerings of our group, in particular in Europe.


Engineering and Technological Solutions for the Treatment of Water


Through Veolia Water Solutions & Technologies, Veolia Eau is one of the world’s leading designers of technological solutions and of the construction of facilities necessary to provide water services on behalf of public authorities and industrial and commercial clients. In addition, Veolia Eau Solutions & Technologies designs, assembles, manufactures, installs and operates modular standardized and semi-standardized water and wastewater equipment and systems designed to treat water for municipal and industrial uses. A local technical assistance network is available at all times for the upkeep, maintenance and after-sale service of these installations.


Veolia Eau treats groundwater, surface water, brackish or seawater, wastewater and refined sludge. Thanks to the combination of physical, chemical or biological treatments, Veolia Eau develops a complete range of specific solutions for the purification of water or the reduction or elimination of impurities in effluents.  Veolia Eau’s recycle/re-use systems provide customers with the ability to circulate part or all of their treated water back into plant processes, thereby reducing their water usage, operating costs and environmental damage.


Through Sade, Veolia Eau also designs, builds, renovates and recovers urban and industrial drinking water and wastewater networks and conducts related work in France and around the world.  Sade’s services cover each stage of the water cycle, from its collection to its release, and its public and industrial customers benefit from Sade’s experience in this domain.


Description of Activities in 2006


Our water division’s revenues increased by 10.4% in 2006 compared to 2005, thanks to a high level of contract renewal in France, sustained organic growth outside of France, in particular in Asia and strong growth in the engineering and construction business in France and internationally.

In France, Veolia Eau provides approximately 24.1 million inhabitants with drinking water supply and 16.2 million with wastewater services. Contracts renewed in 2006 represent expected total cumulative revenues of more than €955 million. Among the contracts renewed, the more important are the drinking water and wastewater contracts agreed for a duration of 18 years with the city of Narbonne, which has implemented measures regarding sustainable development for the Community, and also the drinking water contracts with the city of Saint Omer and the wastewater contracts with Menton.  Veolia Eau continues its development efforts in order to further increase its service offering to reach new clients in areas such as:  the management of wastewater treatment plants, the management and maintenance of rainwater networks, the maintenance of non-collective wastewater installations, the wholesale sale of water, and the monitoring of swimming water.

In the rest of Europe, growth was especially strong, in particular in the Czech Republic, where Veolia Eau began providing water distribution and wastewater management services to the cities of Prostejov (25-year contract) and Slany (15-year contract);  in Slovakia, where Veolia Eau signed two 30-year contracts with the municipality of Banska Bystrica on the one hand and Poprad on the other, for drinking water production and distribution, management of customer relations, and wastewater collection and treatment. In Denmark, Veolia Eau signed an eight-year contract for the management of wastewater installations for the city of Alleröd. In 2006 Veolia Eau began operating water services in the capital of Armenia, Erevan. Moreover, in 2006 Veolia Eau signed partnership agreements, including with the Russian companies Evraziysky and Eurasian Water Partnership for the development of water and wastewater projects in Russia. In Bucharest, Romania, Veolia Eau began operating a new water treatment plant for drinkable water in Crivina.  

In the United States, Veolia Eau, following a call for tenders, signed a contract for the design, construction and management of a wastewater treatment plant in Rockland County (State of New York). At the same time, Veolia Eau signed a contract in 2006 extending its agreement in Vancouver (Washington) for 5 years, for the management of a used water treatment plant. At the end of 2005, Veolia Eau actively participated in the repair of wastewater treatment plants in New Orleans following the damage caused by Hurricane Katrina. In July 2006, the city of Atlanta terminated its 10-year contract, signed in 2002, for the management of a sediment and discharge treatment plant for the city, following differing interpretations of each party’s contractual obligations.

In the Middle East, Veolia Eau signed several important contracts in 2006 in the Gulf states, in particular with the Emirates of Ajman for the management of wastewater services for the city of Ajman for 27 years, including the construction of a water purification plant and access for inhabitants.  A five-year performance contract was signed, with an extension option of three years, with the public company Oman Wastewater Services Company, operating all wastewater services for the capital, Muscat.  



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In Asia, Veolia Eau pursued its development with several major new contracts. In the municipal domain, Veolia Eau signed contracts to manage water services for the cities of Luizhou in China (the second largest city in the Guangxi province); a contract to manage two used water treatment plants in Japan, situated in the Saitama district (close to Tokyo) and in Hiroshima. In Australia, a contract was signed to be consultant to the State of Queensland to recycle water produced by treatment installations in the region of Brisbane in an effort to combat drought, and another contract was signed for the design, construction and management of a desalination by reverse osmosis unit designed to sustain, in particular, the Gold Coast. In the industrial sector in China, Veolia Eau signed an important partnership agreement with a subsidiary of Sinopec, the leading Chinese refining group, for the operating of collection, treatment and recycling of industrial waste water from the Yanshan site. In South Korea, Veolia Eau signed two 15-year contracts for the operation of industrial water treatment works with the group Kumho. In Singapore, Veolia Eau signed a six-year contract for the construction and operation with Showa Denko, a subsidiary of the Japanese group Showa, of an industrial water treatment unit. In Australia, Veolia Eau signed a contract for the modernization of the water treatment plants for Bayswater, one of the most important electrical centers in Australia, which belongs to the leader in local electricity production, Macquarie Generation.  

In 2006, Veolia Water Solutions & Technologies recorded significant growth, due to the consolidation for one full year of a portion of the British group Weir’s activities linked to water desalination (mainly the company Westgarth based in Scotland), which were purchased in the second half of 2005.  There were also some important commercial successes during 2006. In France, Veolia Eau signed a contract to repair and enlarge a drinking water treatment plant from Lucien Grand to Saint Hippolyte and signed a contract with the city of Angers Loire-Métropole for the design and construction of a new water treatment plant for the city of Angers. In the Middle East, the technical solutions business, excluding design-construction, benefited from very favorable developments, with the supply contract for a new thermal desalination plant in Al Hidd in Bahrain and a contract for the design and construction of a discharge treatment plant for the complex Pearl GTL of Shell Qatar, in partnership with Saïpem.  Activity relating to technology solutions (aside from conception-construction) also performed well.

Finally, Veolia Eau recorded solid earnings in 2006 due to the good performance of existing contracts across all geographical areas and in all business segments.  This success was also due to the continued pursuit of measures to enhance productivity (sharing of best practices, better use of information technology, etc.) and to the progress generated by the implementation of new technology during past years.



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Principal Contracts 2006

The following table shows the principal contracts signed or renewed in 2006 with either public authorities or industrial or commercial companies.1  

Public Authority

or

Company and Location thereof

Month of Signature of Contract

New Contract or Renewal

Duration of Contract


Estimated Total Cumulative Revenue

(in euros)

Services to be Provided

France

     

Public Authorities

     

City of Narbonne
and its suburbs

August

Renewal

18 years

170 million

Management of water and waste water services.

City of Angers Loire Métropole and its suburbs

June

New

5 years

21 million

Design and construction of a new plant for the clean-up of Angers’ wastewater.

The metropolitan
area of Saint Omer

July

Renewal

12 years

26 million

Operation of drinking water services.

Europe
(outside France)

     

Public Authorities

     

City of Prostejov
(The Czech Republic)

January

New

25 years

139 million

Production and distribution of water, collection and treatment of wastewater, management of customer relations.

Banska Bystrica

(Slovakia)

May

New

30 years

1.4 billion

Production and distribution of water, collection and treatment of wastewater, management of customer relations.

Poprad

(Slovakia)

May

New

30 years

566 million

Production and distribution of water, collection and treatment of wastewater, management of customer relations.

Limerick

(Ireland)

December

New

20 years

71 million

Repair, enlargement, and operation of a wastewater treatment plant.

Asia

     

Public Authorities

     

City of Luizhou (China)

September

New

30 years

330 million

Management of water services.

Victoria

(Australia)

May

New

15 years

43 million

Construction and operation of a wastewater treatment unit in North Ballarat.



1

Revenues expected under foreign contracts won during 2006 have been converted into euros at the rate of exchange prevailing on December 31, 2006 and represent the portion due to Veolia Eau under such contracts. Accordingly, these amounts may differ from the amounts announced in earlier press releases.



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Public Authority

or

Company and Location thereof

Month of Signature of Contract

New Contract or Renewal

Duration of Contract


Estimated Total Cumulative Revenue

(in euros)

Services to be Provided

Asia

     

Companies

     

Sinopec

(China)

January

New

25 years

249 million

Operation of collection, treatment, and recycling units for industrial wastewater from the Yanshan site.

Showa Denko

(Singapore)

April

New

6 years

53 million

Operation of ultra pure water production unit

North America

     

Public Authorities

     

Rockland County

(State of New York)

May

New

7 years

34 million

Design, construction and operation of a wastewater treatment plant.

Middle East

     

Public Authorities

     

Al Hidd

(Bahrain)

April

New

1 year

255 million

Construction of a seawater desalination plant.

Ajman

(United Arab Units)

March

New

27 years

151 million

Management of purification services.


Acquisitions and Divestitures in 2006

On April 10, 2006, Veolia Eau sold its interest in the English company Southern Water to Southern Water Capital Limited, the current major shareholder of Southern Water. In December 2006, Veolia Eau signed an agreement to sell its interest in the company Bonifacio Water Corporation, which, since 1998, has managed the construction and the operations of the drinking water facilities for a residential and business center in Fort Bonaifacio (Phillipines). This sale was finalized on January 2, 2007.

The sale of the company Berliner Wasser International (BWI) was not realized in 2006 as had been projected, as a result of the conditions precedent in the agreement signed at the end of 2005 not having been fulfilled.

Veolia Eau created, acquired or integrated 68 companies during 2006, and liquidated or sold 23 companies. As of December 31, 2006, Veolia Eau’s group (excluding Proactiva) included 636 companies, compared to 591 in 2005. The principal changes included the purchase or creation of new companies with contracts which were effective as of the beginning of 2006.

Environmental Services

Through our environmental services division, we are the second largest operator in the world (in terms of revenue) in the area of waste collection, recycling and treatment. Veolia Propreté is the only company that handles waste in all its forms and at all stages of activity.  For example, Veolia Propreté manages liquid and solid waste and non-hazardous and hazardous waste (with the exception of nuclear waste) from collection to energy recovery, on behalf of both public authority and industrial clients.  

At the end of September 2006, Veolia Propreté once again reinforced its position by acquiring Cleanaway Holdings Limited (Cleanaway UK) from the Brambles group for €744.7 million (after adjustment).  With annual revenues estimated at €684 million, Cleanaway UK is a principal operator in the United Kingdom of municipal and industrial waste collection and management services.

With approximately 89,500 employees around the world,1 Veolia Propreté operates in 36 countries. Veolia Propreté has partnered with more than 552,000 industrial and commercial clients2 and serves nearly 53.4 million inhabitants on behalf of public authorities.

1

As of December 31, 2006, including Proactiva’s 6,107 employees who are active in waste management activities.   

2

The commercial figures provided in this section (in terms of number of clients, number of inhabitants served, tons of waste collected, etc.) do not take into account Proactiva’s activities, unless otherwise indicated, but do take into account Cleanaway for the fourth quarter of 2006.



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During 2006, Veolia Propreté collected nearly 34.9 million tons of waste and treated nearly 58 million tons of waste (of which 54.4 million tons were non-hazardous household and industrial waste and 3.6 million tons were hazardous waste). As of December 31, 2006, Veolia Propreté managed approximately 698 waste treatment units.

The duration of Veolia Propreté’s waste management contracts usually depends upon the nature of the services provided, applicable local regulations and the level of capital expenditure required under the contract. Collection contracts usually last from 1 to 5 years, while treatment contracts can range from 1 year (for services provided on sites belonging to Veolia Propreté) to 30 years (for services involving the financing, construction, installation and operation of new infrastructure).

The following table shows the consolidated revenue and operating income of our environmental services operations in each of the last two fiscal years, after elimination of all inter-company transactions.

(in millions of euros*)

2006

2005
adjusted ***

Change

2006/2005

    

Revenue**

7,462.9

6,748.7

10.6%

Operating income

648.3

543.6

19.3%

*

Includes our share in the results of the waste management activities of Proactiva, our joint venture with FCC.

**

Revenue from ordinary activities under IFRS.

***

Accounts as of December 31, 2005 were adjusted for the application of IFRIC12 standards for the treatment of concessions, so as to ensure the comparability of the fiscal years.


Overview of Environmental Services


Our environmental services division furnishes waste management and logistical services, which include waste collection, waste treatment, cleaning of public spaces, offices and factories, maintenance of production equipment, treatment of polluted soil, and management of waste discharge at industrial sites.


In addition, Veolia Propreté conducts basic or more complex waste treatment operations in order to reduce pollution and transform waste for the following uses:


·

Veolia Propreté sorts and treats waste in order to create new primary materials, otherwise referred to as recycling or material recovery;


·

Veolia Propreté transforms organic material into compost to be returned to the soil, otherwise referred to as composting or agronomic recovery;


·

Veolia Propreté returns waste to the natural environment in the least damaging way possible, through landfilling or incineration;


·

Veolia Propreté produces electricity or heat through landfilled or incinerated waste, otherwise referred to as waste-to-energy recovery.


The services referred to above fall into one of three large categories of activity conducted by Veolia Propreté:  waste management services and logistics for local authorities and industrial companies, sorting and recycling of materials, and waste recovery and treatment through composting, incineration and landfilling.




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Environmental Services and Logistics for Local Authorities and Industrial Companies  


Maintenance of Public Spaces and Urban Cleaning


Veolia Propreté provides urban cleaning services in a large number of cities throughout the world, including London (U.K.), Paris (France), Alexandria (Egypt), Rabat (Morocco), Singapore and Chennai (India).  Veolia Propreté’s services include mechanized street cleaning and treatment of building facades.


Cleaning and Maintenance of Industrial Sites


Veolia Propreté provides cleaning services to its industrial and commercial clients’ installations, including cleaning of offices and maintenance of production lines. In the commercial sector, it provides these services in train stations, subway networks, airports, museums and commercial centers.


In the industrial sector, cleaning services extend to food-processing plants, heavy industry and high-tech sites, where Veolia Propreté offers specialized cleaning services (high pressure or extreme high pressure cleaning).  Veolia Propreté also offers cryogenic cleaning, and reservoir cleaning at refineries and petro-chemical sites in particular.  Finally, Veolia Propreté has developed emergency services to treat site contamination upon the occurrence of an accident or other incident.


Liquid Waste Management


Through its subsidiary SARP, Veolia Propreté provides liquid waste management services that consist primarily of pumping and transporting sewer network liquids and oil residues to treatment centers.  Veolia Propreté can also provide services following accidents and other incidents involving liquid waste.


Veolia Propreté has developed liquid waste management procedures that emphasize environmental protection, such as the on-site collection, recycling and reuse of water during the provision of its liquid waste management services.  Used chemicals, which are hazardous to the environment, are collected before treatment and transferred to one of Veolia Propreté’s subsidiaries that is specialized in the management of hazardous waste.  


Treatment of Polluted Soil


Land redevelopment and the expansion of residential or commercial areas may occur in areas where the soil has been polluted through prior use. Veolia Propreté has specific techniques for treating each site, which include treating polluted soil and rehabilitating temporarily inactive industrial areas, cleaning up accidental spills and restoring active industrial sites to be in compliance with applicable environmental regulations.  


Collection


In 2006, Veolia Propreté collected approximately 34.9 million tons of waste on behalf of individuals, local authorities and commercial and industrial sites.  More than 53.4 million people around the world benefited from Veolia Propreté’s waste collection services.


Veolia Propreté collects household waste through door-to-door pickup or through pickup at designated drop-off sites, and collects commercial and non-hazardous industrial waste.  It maintains the cleanliness of green spaces and carries away “green” waste, such as dead leaves and grasses.


Veolia Propreté also collects hazardous waste on behalf of its commercial and industrial clients, including hospital waste, laboratory waste and oil residue (ships, gas stations and drilling platforms).  In 2006, Veolia Propreté collected approximately 1.85 million tons of hazardous waste.


Veolia Propreté offers related services to its commercial and industrial clients, such as preliminary studies of future waste collection needs and waste tracking after collection.


Transfer and Grouping of Waste


When waste is of the same type, it is transported either to transfer stations in order to be carried in large capacity trucks, or to grouping centers where it is separated by type and then sorted before being sent to an adapted treatment center. Hazardous waste is usually transported to specialized physico-chemical treatment centers, recycling units, special industrial waste incineration units or landfills designed to receive inert hazardous waste.




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Sorting and Recycling of Materials


Veolia Propreté treats waste with a view towards reintroducing such waste into the industrial production cycle.  Veolia Propreté's recycling activities generally involve the selective collection of paper, cardboard, glass, plastic, wood and metal that customers either separate into different containers or mingle with other recyclable materials. As the use of separate containers has become more widespread, selective collection services have become well developed.


Veolia Propreté received approximately 7.4 million tons of solid waste at its 243 sorting and recycling units in 2006, of which 4.6 million tons were recovered, including 2.2 million tons of paper.  Veolia Propreté also provides decomposition services for complex waste products at specialized treatment centers, such as electric and electronic products and fluorescent lamps.  Veolia Propreté works in partnership with upstream industrial customers and with Veolia Environnement’s CREED research center in order to develop new recycling activities.  Veolia Propreté sells or distributes recycled material to intermediaries or directly to industrial and commercial clients.


Veolia Propreté designs and develops recycling systems that enable its industrial and commercial customers to optimize their production chains by reusing certain waste by-products generated in the manufacturing process, thereby reducing waste management costs.


Recovery and Treatment through Composting, Incineration and Landfilling


In 2006, Veolia Propreté treated nearly 58 million tons of waste in its sorting and recycling centers, composting units, hazardous waste treatment centers, incineration units and landfills.


Composting and Recovery of Organic Material from Fermentable Waste


Veolia Propreté and Veolia Eau work together to recover sludge from wastewater treatment plants.  In 2006, Veolia Propreté recovered almost 2 million tons of waste at its 102 composting units. 224,000 tons of urban and industrial sludge were reintegrated by Veolia Propreté into the agricultural cycle through manure spreading.


Veolia Propreté’s “Biodiv” service includes an adapted container offer for the frequent collection and nearby composting treatment of organic waste produced by industrial companies, while guaranteeing the complete traceability of waste from its collection to its recovery in the form of high quality compost.


Waste-to-Energy and Incineration


Veolia Propreté treats approximately 10.3 million tons of non-hazardous solid waste (consisting mainly of urban waste) per year at its 72 waste-to-energy recovery and incineration plants.  Energy is generated from the heat created by incinerating waste at these plants.  Veolia Propreté uses this energy to supply district thermal networks or for sales to electricity providers. Waste-to-energy recovery is often the favored treatment solution in areas of high population density where there is insufficient space to construct landfills.


Landfilling and Energy Recovery from Waste


In 2006, Veolia Propreté treated approximately 34.4 million tons of non-hazardous waste in 146 landfills.  Veolia Propreté has developed the expertise to treat waste through methods that reduce emissions of liquid and gas pollutants.  Veolia Propreté currently has 142 landfills that accept or have accepted biodegradable waste and that are equipped to retrieve and treat biogas emissions from the anaerobic fermentation of waste, of which 64 landfills have recovery systems to transform biogas emissions into alternative energies.


Treatment of Hazardous Waste


In 2006, Veolia Propreté treated 3.6 million tons of hazardous waste, of which 1,006,000 tons were incinerated in 22 incineration units for specialized industrial waste,679,000 tons were landfilled in 13 class 1 landfills and 1.55 million tons were treated in 57 units by physico-chemical or stabilization methods.  The remaining 361,000 tons were treated in 32 specialized recycling centers.


The principal methods used for treating industrial hazardous waste are incineration (for organic liquid waste, salt-water and sludge), solvent recycling, waste stabilization followed by treatment in specially-designed landfills, and physico-chemical treatment of inorganic liquid waste.


Through its specialized subsidiaries SARP Industries and VES Technical Solutions (in the United States), and thanks to its acquisition at the end of 2005 of the hazardous waste management activities of the Shanks group in the United Kingdom, as well as the reinforcement of its position in Europe and Asia with recent interest acquisitions and the repurchase of business in Switzerland, India and Singapore, Veolia Propreté has a worldwide network of experts enabling it to become one of today’s world leaders in treating, recycling and recovering hazardous waste.


Description of Activities in 2006


In 2006, Veolia Propreté’s revenues increased by 10.6% compared to 2005. French revenues increased by 4.1% (of which 3.7% was internal) as a result of the increased power of new incineration plants and the growth in quantity of solid waste collected and treated. Internationally, excluding Proactiva, organic growth was 10.8%. It was particularly marked in the United States in all business sectors, with a growth rate of 13.2%. In the United Kingdom, total growth was 34.2% (of which 6.9% was internal). This growth resulted from the acquisition of Cleanway UK and from the general development of business in a robust market. In Asia, the initiation of the



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Foshan (storage) and Guangzou-Likeng (incineration) contracts largely contributed to the 14% growth in business. Veolia Propreté did not lose any major contracts in 2006. Among the significant developments during the year were the following:


In France, Veolia Propreté continued to develop its treatment capacities. In January, with the SNPE (Société Nationale des Poudres et Explosifs), Veolia Propreté created the company Pyrotechnis, which is specialized in demilitarization and cleaning of floors polluted by pyrotechnic substances, as well as the destruction of expired pyrotechnic substances. Veolia Propreté was chosen for the construction of a biodiesel production unit in Limay (78). This project is part of a program put in place by the French government for the development of biofuels, designed to promote renewable energy and counter the greenhouse effect. The plant will be able to produce 60,000 tons of biodiesel per year. Furthermore, Veolia Propreté has taken over management of the incineration plant in Antibes for a 20 year term, launched its new waste treatment industry in the Marne (Auréade), opened a new industrial waste sorting center in Villeneuve Tolosanne (Haute Garonne) and put into service the first mechanized D3E (Déchets d’Equipments Electriques et Electroniques) dismantlement and sorting unit in France on its Gonesse site (95), thus reinforcing its new generation sorting center installations.


In the United Kingdom, Veolia Propreté, while managing the acquisition and integration of Cleanaway UK, has won or renewed several contracts and initiated, at the end of June, a 26-year PFI (“Private Finance Initiative”) contract for the integrated management of household waste in the County of Nottinghamshire (estimated total cumulative revenue of €1.2 billion).


In Europe, Veolia Propreté continued to reinforce its commercial positions and its treatment capabilities in all countries, particularly Norway, Germany, Belgium, Switzerland, Italy, Denmark, Poland and Romania.


In North America, Veolia Propreté won or renewed large municipal contracts and reinforced its position in industrial services, winning, in particular, several contracts for the maintenance and industrial underwater cleaning of oilrigs in the Gulf of Mexico.


In Australia, Veolia Propreté continued its growth in industrial services and managed the development of the waste storage center at Woodlawn. Furthermore, Veolia was chosen to undertake the planning and implementation of the management and recycling of all waste for the Commonwealth Games 2006, which began in March in Melbourne.


In Asia, Veolia Propreté strengthened its position in the treatment and recovery of ordinary and hazardous waste in several countries.


In Brazil and in Egypt, Veolia Propreté won two “MDP” (Mécanisme de Développement Propre) projects, representing a total of 4.4 million equivalent tons of CO2, in terms of credit generated. Veolia Propreté thus participates in worldwide efforts to limit greenhouse gases and combats global warming.


Principal Contracts


The following table shows the principal contracts signed or renewed in 2006 with either public authorities or industrial or commercial companies.1  

Public Authority

or

Company and Location thereof

Month of Signature of Contract

New Contract or Renewal

Duration of Contract


Estimated Total Cumulative Revenue

(in euros)

Services to be Provided

France

     

Public Authorities

     

Romainville (Syctom Paris area)

June

Renewal

2 years

35 million

Operation of waste sorting and transfer centers and of the waste collection center of Romainville.

Syctom (Paris area)

April

New

8 years and 5 months

20 million

Transport, processing and marketing of clinkers.

Bil Ta Garbi Union (Bayonne)

February (initiation)

New

5 years

24-36 million

Transfer, transport and treatment of household and hospital waste.

Europe (outside France)

     

1

Revenues expected under foreign contracts won during 2006 have been converted into euros at the rate of exchange prevailing on December 31, 2006 and represent the portion due to Veolia Propreté under such contracts.  Accordingly, these amounts may differ from the amounts announced in earlier press releases.  



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Public Authorities

     

London Borough of Brent (United Kingdom)

November

Renewal

7 years

150 million

Collection and recycling of municipal waste, urban cleaning.

Hastings Borough Council (United Kingdom)

May

Renewal

7 years

27 million

Collection of municipal waste and urban cleaning.

Municipality of New Esbjerg (Denmark)

July

New

5 years

14 million

Collection of municipal waste.

North America

     

Public Authorities

     

New York City

January

Renewal

3 years

51 million

Transfer stations.

Port Orange

August

Renewal

5 years

26 million

Collection and treatment of household and commercial waste, and urban cleaning.

Companies

     

ExxonMobil

October

Renewal

5 year

15 million

Hazardous waste.

Asia

     

Companies

     

Public Authorities

     

Tomago Aluminium (Australia)

July

New

5 years

39 million

Industrial services and global management of waste.

General Motors Holden (Australia)

February

Renewal

3 years

18 million

Industrial services.


Acquisitions and Divestitures in 2006

On September 28, 2006, Veolia Propreté finalized the acquisition of Cleanaway Holdings Limited (Cleanaway UK) from the Australian group Brambles, significantly reinforcing its position in the waste management sector in the United Kingdom (for industrial markets, as well as local municipality markets).  In addition, on June 30, 2006, Veolia Propreté acquired Biffa Belgique, number 4 in the Belgian waste market.  Other acquisitions, of a less significant size, occurred at the end of 2006. They will contribute to the growth of Veolia Propreté’s treatment and recovery capacities in various European countries.


Taking into account all foundings, acquisitions and integrations of companies (a total of 58) and liquidations, sales, and mergers (a total of 42), the scope of consolidation of Veolia Propreté (excluding Proactiva) included 625 companies at December 31, 2006, compared to 609 in 2005.  The acquisitions of Cleanaway and Biffa Belgique accounted for the principal changes in scope of consolidation.


Energy Services

Our energy services division conducts its activities through Dalkia, the leading European provider of energy services to companies and municipalities.  Dalkia provides services relating to heating and cooling networks, thermal and multi-technical systems, industrial utilities, installation and maintenance of production equipment, integrated facilities management and street lighting. It seeks to profit from opportunities presented by the development of energy and greenhouse gas markets. Dalkia becomes a partner to its clients, helping them to optimize their energy purchases and improve the energy efficiency of their installations (both in terms of cost and atmospheric emissions).




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With approximately 48,800 employees around the world (as of December 31, 2006), Dalkia has a permanent presence in  35 countries, located principally in France and the rest of Europe.


The following table shows the consolidated revenue and operating income of our energy services operations in each of the last two fiscal years, after elimination of all inter-company transactions.


(in millions of euros)

2006

2005
adjusted**

Change

2006/2005

    

Revenue*

6,118.4

5,463.6

12.0%

Operating income

377.7

315.3

19.8%

*

Revenue from ordinary activities under IFRS.

**

Accounts as of December 31, 2005 were adjusted for the application of IFRIC12 standards for the treatment of concessions, so as to ensure the comparability of the fiscal years.


Overview of Energy Services


Dalkia’s activity focuses on optimal energy management.  Dalkia has progressively established a range of activities linked to energy management, including heating and cooling systems, thermal and multi-technical services, industrial utilities, installation and maintenance of production equipment, integrated facilities management and electrical services on public streets and roads.


Dalkia provides energy management services to public and private clients with whom it has formed long-term partnerships. Dalkia’s contracts to operate urban heating systems are typically long-term, lasting up to 25 or 30 years, while its contracts to operate thermal and multi-technical installations for public or private clients may last up to 16 years.  Contracts to provide industrial utilities services generally have shorter terms (6 to 7 years on average), while contracts in the facilities management sector generally last 3 to 5 years.


When possible, Dalkia offers its clients solutions utilizing renewable or alternative energy sources such as geothermal energy, biomass (organic material), heat recovered from household waste incineration, “process” heat (heat produced by industrial processes) and thermal energy produced by co-generation projects.  A combination of energy sources may also be selected so as to take advantage of the complementarity of each source.


For instance, in 2006, Dalkia put into service a biomass plant in the Lithuanian capital.  This allows Vilniaus Energija to reduce its dependence on fossil fuels and favors local development.  Vilniaus Energija’s boiler is the largest biomass installation ever built by Dalkia.


Heating and Cooling Networks


Dalkia is one of Europe’s leading operators of large “district” heating and cooling networks.  Dalkia currently manages 682 district heating and cooling networks in the world, particularly in France, the United Kingdom, Italy, Germany, Eastern and Central Europe and the Baltic states.  Dalkia does not ordinarily own the networks it operates.  Rather, in most cases, public authorities own the networks and delegate to Dalkia the responsibility of managing, maintaining and repairing them.  The networks operated by Dalkia provide heating, sanitary hot water and air conditioning to a wide variety of public and private facilities, including schools, health centers, office buildings and residences.


Thermal and Multi-Technical Services


Thermal services consist of operating heating, sanitary hot water and air conditioning systems to provide comfortable living and working environments, as well as improving the operation of existing systems to optimize their efficiency.  Dalkia provides public, industrial and commercial customers with integrated energy services, which include installation design, construction and improvement, energy supply, installation management and maintenance. Dalkia provides customers with a large range of technical services and manages approximately 110,000 energy installations throughout the world.


Industrial Utilities, Installation and Maintenance of Production Equipment


Dalkia has become a leading provider of industrial utilities services in France and the United Kingdom. It has thereby developed expertise regarding the analysis of industrial processes, the enhancement of productivity and the operation, maintenance and servicing of equipment.  


Integrated Facilities Management


Facilities management contracts integrate a range of services, from thermal, electrical and mechanical equipment maintenance to logistics, into one global service.  As a result, the client can meet its need for different services through one company.  Dalkia provides facilities management services for its industrial or commercial customers such as business premises, corporate offices or health establishment sites.


Street Lighting Services


Citélum, a subsidiary of Dalkia, has acquired a worldwide reputation for the management of urban street lighting, the regulation of urban traffic and the lighting of monuments and other structures.  In France, Citélum operates and maintains the lighting for a number



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of cities in France and abroad and provides artistic lighting services for important architectural works and sites. 2006 saw the opening of an establishment in Chile and the signing of a contract in Asia with Ho Chi Minh City.  Citélum also renewed and won several contracts in France (with the city of Paris, for example) in Spain with the city of Almeria and in Latin America (Brazil, Mexico and Chile).


Services to Individuals


Dalkia provides residential services to individuals through Proxiserve, a joint subsidiary of Dalkia and Veolia Eau, including maintenance of heating, air conditioning and plumbing systems and meter-reading services.


Description of Activities in 2006


Veolia Énergie Services’ (Dalkia) revenues increased by 12% in 2006 compared to 2005, due to the combination of solid growth, rising energy prices, and a renewal of interest in the heating industry in France (Cergy-Pointoise, Sarcelles), as well as international developments.


In 2006, Dalkia won several contracts:


·

On November 21, 2006, Dalkia and OPAC inaugurated Cellia in Paris, the first fuel cell for public housing. From 2007, Cellia will contribute to providing heat and clean warm water to 283 OPAC housing units in Paris. With this project, Dalkia and OPAC in Paris will contribute to the research of eco-friendly solutions. The application of this innovative technology in the public housing sector is a first in Europe regarding its strength and technology (180 kW thermic and 230 kW electric).  


·

Furthermore, on January 1, 2006, Dalkia began the operation of a contract for a hospital center in Valenciennes, signed at the end of December 2005. This 15-year contract, which represents estimated cumulative revenues of €30 million, covers a large scope of services, including the management of heating, ventilation, air conditioning, and sanitary warm water production, and steam production and electrical and technical maintenance.  


·

Dalkia first entered the Bulgarian market in August 2006, by acquiring 55% of the capital of KES, a Bulgarian energy saving company. Moreover, Dalkia won the call for tenders at the end of last year for the privatization of “Toploficacia Varna,” a company that produces and distributes heat to the city of Varna in Bulgaria.  


·

In Israel, Dalkia won a contract for the operation of a co-generation plant of 82 Mwe in Ashkelon. This plant will supply electricity and thermal energy to the Ashkelon seawater desalination plant operated by Veolia Water on the Israeli coast. This 23-year contract represents for Dalkia consolidated revenues of €3.6 million per year. The co-generation plant will be linked to the seawater desalination plant and operational as of the second quarter of 2007.  


·

In China (Chongqing), Dalkia signed a contract, in May 2006, under which it will ensure the financing, construction and operation, as of November 2006, of the trigeneration plant that will provide air conditioning and heat for the Jiahe Yumao property program in Chongqing. The plant will serve a shopping center of 75,000 m² and a hotel of 35,000 m². The program includes six apartment buildings, a hotel, shopping center, office block and a tramway station, on a land plot of 65,000 m². This 20-year contract represents consolidated revenues of approximately €1 million per year.


·

In Canada, Dalkia, signed a partnership agreement with Gaz Metro for the creation of a corporate joint venture (joint venture with CDH Solutions s.e.c.) to develop a heating business network in Canada and to operate a heating and cooling distribution network in Montreal to serve 1.5 million m² in the center of Montreal (office blocks, shopping centers, hotels, train stations…).


In 2006, Dalkia renewed approximately 86% of its contracts due to expire during the fiscal year, including the maintenance contract for electricity pylons, antennae and other relays for the SFR network. Among those not renewed were contracts with Smurfit in Vernon, resulting from the closure of the site, and with Unibiens in Saint-Quentin-en-Yvelines and the Centre National d’Art et de la Culture in Paris following their restructuring. In 2006, Dalkia lost contracts representing approximately 2% of its consolidated revenues.  


Principal Contracts in 2006

The following table shows the principal contracts signed or renewed in 2006 with either public authorities or industrial or commercial companies.1


1

Revenues expected under foreign contracts have been converted into euros at the rate of exchange prevailing on December 31, 2006. Accordingly, these amounts may differ from the amounts announced in earlier press releases.  



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Public Authority

or

Company and Location thereof

Month of Signature of Contract or of Renewal

New Contract or Renewal

Duration of Contract

Estimated Total Cumulative Revenue

(in euros)

Services to be Provided

France

     

Public/Local Authorities

     

Cergy-Pontoise and its suburbs

November

New

16 years

268.7 million

Management of public urban heating services.

Saint-Joseph Hospital
(Paris)

November

New

7 years

74.6 million

All technical and hotel services, regarding the unifying project for the hospitals of St Joseph, St Michel and Notre Dame du Bon Secours.

Manufacturers

     

SPM (Berre)

March

New

11 years

41.1 million

Industrial utility supply contract with SPM, a subsidiary of the group Shell.  

Atomic Energy Commission (Saclay)

March

New

15 years

48 million

Multi-technical services: renovation and construction for the sites thermic installations.

ST Microelectronics (Grenoble)

September

New

2 years (renewable)

8.4 million

Management of industrial utilities (warm water, steam, air conditioning, compressed air, demineralized water), the running and maintenance of electrical, heating, cooling equipment industrial equipment.

Rest of World
(outside France)

     

Public/Local Authorities

     

PaikInjie University Hospital of Islan

(South Korea)

May

New

3 years

5.8 million

Energy management of the installations.

Cona and Careggi Hospital

(Italy)

November1 and May

New

30 and 17 years

211 million

PPP contract for the construction and management of the Cona Hospital in Ferrara and the Careggi Hospital in Florence.

      



1

Official awarding of contract in May 2006.



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Public Authority

or

Company and Location thereof

Month of Signature of Contract or of Renewal

New Contract or Renewal

Duration of Contract

Estimated Total Cumulative Revenue

(in euros)

Services to be Provided

Industrial and Tertiary

     

TM Retail

(United Kingdom)

March

New

5 years

34.5 million

Multi-technical contract with the news agency TM Retail at 1,304 sites.

Vodafone

(United Kingdom)

April

New

5 years

43.5 million

Multi-technical contract on the global management of 78 Vodafone buildings, including its headquarters and several call centers.

Petrom

(Romania)

August

New

2 years

12 million

Contract with Petrobrazi (Petrom Group – OMV) for the supply of steam to one of the largest refineries in the Balkan region.

Malteries Peroni Saplo

(Italy)

August

New

9 years

30.8 million

The installation and operation by Siram of four co-generation plants (a total of 9 WMe), with a guarantee of availability and performance, for a consortium of 22 manufacturers in the Lazio and Latina regions.


Acquisitions and Divestitures in 2006

In 2006, Dalkia made a number of acquisitions in Italy with the aim of developing its private and industrial utilities management client base. In Latin America, the Group purchased the EDF services business in Argentina and 30% of the capital of Dalkia Brasil, which was held by Ticket Servicios, a subsidiary of Accor in Brazil.


At the end of 2006, the Group bought TDU in Australia, a company specialized in the distribution, installation, servicing and maintenance of heating systems, ventilation and air conditioning, with both private and public clients. TDU employs nearly 500 people and had consolidated revenues of €84 million in 2006.  


In total, over the course of 2006, Dalkia created or purchased 45 companies, and sold, liquidated or merged 16 companies. As a result, at December 31, 2006, Dalkia held 417 consolidated companies including 206 foreign companies.


Transportation

Through our transportation division, we are one of the world’s leading private operators of public ground transportation. Veolia Transport operates road and rail passenger transportation networks under contract with national, regional and local transit authorities. Veolia Transport has been managing and operating urban, regional and inter-regional road and rail networks and maritime transport for more than a century, having won its first tramway concessions at the end of the 19th century.

Veolia Transport estimates that the portion of the worldwide transportation market presently open to competition stands at €70 billion, and that the portion not yet open to competition (thereby offering development potential) stands at €390 billion. The opening of transportation markets that has occurred over the past several years has been particularly pronounced in Europe, but has occurred on other continents as well.

Moreover, the worldwide trend of population movement towards urban areas increases the need for collective transportation services, thereby strengthening the market potential of areas that Veolia Transport seeks to service.

At the end of 2006, Veolia Transportation had approximately 81,900 employees around the world.  It has a presence in 30 countries, and conducts its activity mainly in Europe, North America and Australia. While continuing to strengthen its position in France, Veolia Transportation benefits from a strong presence outside of France as well, where it earns approximately 60.5% of its revenues. In 2006, Veolia Transport pursued development in North America and Europe.  

Veolia Transport estimates that it provided transportation to approximately 2.5 billion travelers in 2006, and that it managed contracts with approximately 5,000 public authorities.



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The following table shows the consolidated revenue and operating income of our transportation operations in each of the last two fiscal years, after elimination of all inter-company transactions.

(in millions of euros)

2006

2005
adjusted**

Change

2006/2005

    

Revenue*

4,951.5

4,223.9

17.2%

Operating income

13.6

116.8

-88.3%

*

Revenue from ordinary activities under IFRS.

**

Accounts as of December 31, 2005 were adjusted so as to ensure the comparability of the fiscal years in accordance with IFRIC12 standards for the treatment of concessions.  Revenues and operating income of Veolia Transport in Denmark were accounted for in 2006 under IFRS5 as discontinued operations.


Overview of Transportation


Veolia Transport primarily operates road and rail passenger transportation networks under contracts won through auction with various public authorities. The public authorities with which Veolia Transport contracts generally own the heavy infrastructure. Veolia Transport uses and typically establish schedules, routes and fare structures for the networks that Veolia Transport operates and manages. Veolia Transport primarily conducts its business through outsourced management under conditions and structures that differ from one country to another due to varying legal and regulatory requirements.  Each contract between a public authority and Veolia Transport determines the relationships between the two parties, including payment to Veolia Transport and the risks to be borne by each party, and typically lasts for a set period.  Because the fares Veolia Transport charges passengers on its transportation networks are usually insufficient to cover its costs, the public authority typically provides Veolia Transport with a payment or other compensation for services rendered. Moreover, in the case of certain contracts, Veolia Transport is paid a flat fee for its transportation services; consequently, it does not bear the risks associated with lower receipts or decreased passenger use (such contracts being referred to as “Public Market” contracts in France).  Veolia Transport’s management contracts generally last from 2 to 12 years, except for those that take the form of “operating concessions”, which last approximately 30 years on average.


Veolia Transport’s activities can be broken down into four principal categories: (i) city transportation (urban, urban beltway and other supplementary transportation services), (ii) intercity and regional transportation, (iii) transportation management (passenger information services, clearinghouses, central telephone operator), and (iv) industrial markets.


City Transportation


Veolia Transport operates a number of bus networks, suburban trains, tramways and metros and provides customized transportation services as well.  Veolia Transport is either partially or fully responsible for designing, planning and operating services, managing personnel, inspecting vehicles and stations it uses in its networks (including obtaining various permits), conducting marketing efforts and managing customer service.


In many urban areas, Veolia Transport provides interconnected bus, tramway, metro and train transportation services through a ticketing system coordinated by the principal transportation provider or transportation authority for a region.  Veolia Transport also offers special integrated transportation services within networks managed by several different operators in an urban area, including, particularly, the suburbs of Paris, Bordeaux, Stockholm, Sydney and Düsseldorf.


Veolia Transport operates ferry services to complement its bus services in various urban areas.  It does so in Toulon (France) and Göteborg (Sweden), for example.


Urban and Urban Beltway Transportation


In France, Veolia Transport operates the tramways, bus networks and light rail networks in Rouen, Saint-Etienne, Nancy and Bordeaux.  Veolia Transport is also the operator of the bus networks in Nice, Toulon (where tramway infrastructure is currently being installed as well) and approximately 40 other French cities.  Veolia Transport has a strong presence in the Ile-de-France region, where it operates numerous bus lines.  It is the main private operator in the region, operating the networks of Melun, Rambouillet, Argenteuil, St. Germain-en-Laye and Seine-Saint-Denis.


In Europe, Veolia Transport operates tramways and light rail networks in Görlitz and Berlin (Germany), Dublin (Ireland), Trondheim (Norway) and Norrköping and Stockholm (Sweden). Veolia Transport also operates the Stockholm metro, as well as bus lines in Scandinavia, the Netherlands, Switzerland, Czech Republic, and numerous cities in Poland.


Veolia Transport operates transportation services in several cities in Spain and Portugal through FCC Connex Corporación SL, which is jointly-owned by Veolia Transport and CGT (a subsidiary of FCC).  Through this entity, Veolia Transport operates the Barcelona tramway and the urban transport network for the city of Pampelune. It is also a 10% shareholder of the company that was awarded the concession for the direct operation of the tramway in Parla (in the suburbs of Madrid).


In the United States, Veolia Transport provides bus transportation services principally in California, Arizona, Nevada (Las Vegas), Colorado, Texas, Maryland and Virginia. Veolia Transport and its partners in the Massachusetts Bay Commuter Railroad Company (the Bombardier group and a local partner, ACI) manage suburban trains in the Boston area. Veolia Transport also manages suburban trains in Los Angeles (Metrolink).




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In Canada, Veolia Transport provides transportation services in the south suburbs of Montreal, as well as bus services in York (Ontario).


In Australia, Veolia Transport operates the entire suburban rail network of Melbourne as well as the monorail and light rail network of Sydney.  It also operates bus services in Perth, Brisbane and Sydney. In New Zealand, Veolia Transport operates trains in the suburbs of Auckland.


In the rest of the world, Veolia Transport operates through partnership with other operators a high-frequency right-of-way bus system (BRT: Bus Rapid Transit) in Bogota (Colombia), a network of bus lines in Santiago in Chile and bus lines in Israel and Lebanon. In Jerusalem, Israel, Veolia Transport is also part of the consortium that has been awarded the concession for the operating of a future tramway.


Supplementary Services


Veolia Transport offers innovative transportation services in certain cities that supplement traditional transportation networks.  For example, in France, Veolia Transport offers Créabus, an on-demand minibus service that is tracked by a Global Positioning System, or GPS, which operates in Dieppe, Montluçon, Vierzon, Bourges, Bordeaux, Ile-de-France and Fairfax (United States).  Veolia Transport also manages all of the on-demand transportation services in the Nord Brabant region of the Netherlands.


Veolia Transport manages taxi services in the Netherlands and the United States, in particular in Baltimore and Denver.  It provides transport for persons with reduced mobility in Bordeaux and other regions of France, in Canada and in the United States (“paratransit”), in particular California, Arizona, Nevada, Texas, Maryland and South Carolina.


Intercity and Regional Transportation


Veolia Transport provides regional transportation services through the operation of road and rail networks. As with urban transportation services, Veolia Transport is responsible for designing, planning, operating, maintaining and providing security on the vehicles and stations it uses in its regional networks, as well as for ticket sales and customer service.


In France, Veolia Transport has a strong presence in the intercity and student transportation markets, involving more than 60 French departments across the country.  Veolia Transport also operates a number of regional rail networks, covering approximately 850 kilometers, through contracts with regional public authorities or sub-contracts with the Société Nationale des Chemins de Fer (SNCF), the French national railroad company, particularly in the regions of Brittany, Provence, the Alps and the French Riviera.  


In Europe, Veolia Transport has a strong presence in Germany, Denmark, the United Kingdom, Norway, Sweden, Finland, Slovenia, Slovakia, Belgium, Spain, the Czech Republic, the Netherlands and, since the end of 2006, Serbia and Croatia. Through its subsidiary, Eurolines, Veolia Transport provides transport by motorcoach on regular international routes serving 1,470 cities throughout Europe.


Veolia Transport continues to develop ferry transport service in areas such as Finnmark and Norrland (Norway) and Zeeland province (Netherlands), as well as through its 28% shareholding in the Société Nationale Maritime Corse Méditerranée (SNCM), which manages passenger and freight maritime transportation services between Marseille, Nice, Corsica and North Africa.


Veolia Transport is a shareholder of SNCM along with Butler Capital Partners (38%) and the French State (25%).  SNCM is fully consolidated in our consolidated financial statements. This consolidation method has been analyzed under norm IAS27 and reflects the rules of governance of SNCM. Specifically, Veolia Transport appoints all of the members of the Management Board (directoire) of SNCM, has broad operational and financial management powers and exercises control over SNCM within the meaning of IFRS.

Passenger Information Services


Growth in Veolia Transport’s business depends on increased use of public transportation networks, which in turn is closely related to the quality of service provided by these networks. To increase passenger usage of its networks, Veolia Transport’s efforts focus on adequately matching service offerings with demand for these services, and developing local information services relating to transportation systems for travelers.


Accordingly, Veolia Transport has developed the “Optio” system, a service that provides anyone who wants to use public transport in a region (regardless of the operator) with the information that they need.  The service involves use of a central telephone operator, internet site, wireless text messages, such as SMS, and wireless internet access, such as WAP. The “Optio” system currently operates in the department of Oise in France.


In addition, Veolia Transport has developed “Connector Plus”, a real-time information system installed in the rail network of Melbourne (Australia), which notifies users of service interruptions or delays through wireless text messages on their mobile phones. Veolia Transport has also installed the “Connector Plus” system in Stockholm.


Veolia Transport has also recently created several internet sites that allow users to find their itineraries on local transportation systems in France and Australia.




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Industrial Markets


Beyond the personnel transport services provided by numerous subsidiaries in France and the rest of Europe, Veolia Transport is present in two areas of industrial activity which represent nearly 4% of its revenues: rail transport (freight transport and management of industrial rail junctions with related logistics) and airport services.


Rail Transport


The activities in this sector are carried out in Europe through Veolia Cargo, assisted supported by specialized, national subsidiaries in France, Germany and the Netherlands.


In the area of freight transport, Veolia Transport operates a number of regional and international freight trains in France, and offers rail transport services for long distance freight in Germany.  2006 was marked by the inititation of Veolia Cargo’s business in the Netherlands and the reinforcement of its position in Germany as the top private competitive operator of the DeutscheBahn.


In the area of industrial rail junctions and related logistics, Veolia Cargo, through its subsidiaries in France and Germany, manages junctions for large industrial customers (in particular in the steel and refining industries) with factories that are linked to a national rail network.


Airport Services


This activity covers a range of services to airlines (freight transport at Charles de Gaulle airport, baggage handling, maintenance of vehicles, etc.). It is conducted by VE Airport, 60% of the share capital of which is owned by Veolia Transport. Veolia Transport also manages transport services within airports for airline passengers.


Veolia Transport intends to develop its industrial market activities by relying on Veolia Environnement’s existing client network.  It will focus in particular on those industrial market activities that will help to enrich the Group’s offerings and constitute a growth area for Veolia Transport.


Description of Activities in 2006


Veolia Transport’s revenues increased by 17.2% in 2006 compared to 2005, due to strong growth in the areas of urban and intercity transport abroad resulting from recent developments in Europe and particularly in the United Kingdom (acquisition of Dunn-Line PLC), marking the return of Veolia Transport in the country, and in the United States (acquisition of SuperShuttle International in October 2006).  


Despite the loss of a contract involving the operation of part of a network of bus lines in Stockholm, Veolia Transport renewed or won a large number of medium-sized contracts in 2006 as well as in France, including relating to the towns of Valence, Menton, Roanne and Arcachon and their suburbs, Europe, the United States, and Asia. The following were some of the highlights of 2006:


·

In France, in the Languedoc Roussillon region, Veolia Transport won a contract for the operation of the public areas at the airport in Nîmes. The five-year contract was signed on December 19, 2006 and will be effective as from January 2007. It is expected to create annual revenues on the order of €5 million. This project represents a new air transportation infrastructure management business for our group, with the overall operation of a site accommodating 250,000 travelers per year.


Veolia Transport also signed its first contract relating to the internal French rail market with the O-I group, a world leader in bottle manufacturing, which became effective in July 2006. Its cumulative revenues are estimated at €13.5 million over 5 years. Thus, Veolia Transport is the first private operator to take advantage of the opening of the French domestic market, effective since March 31, 2006.


·

In the Netherlands, Veolia Transport won the call for tender issued by the Limbourg province for the operation of the integrated public transportation network of the south, north and center of the region (train, bus, and taxi). The ten-year contract, signed in December 2006, will mobilize 1,025 employees, 242 buses and 26 trains. Its cumulative revenues should amount to €1.1 billion.


·

In Germany, Veolia Transport won a contract for rail transport service for travelers in the town of Augsburg in the Munich region in Bavaria.  The eleven-year contract was signed in October 2006, and provides for the operation of three rail lines mobilizing 80 employees. Its cumulative revenues are estimated at €286.4 million.


·

In the United States, Veolia Transport Inc. signed a five-year contract in June 2006, for the operation of an urban bus network in San Diego, California. This contract, which will take effect in January 2007, will mobilize about 620 employees and 380 buses. Its cumulative revenues should amount to €167.2 million.


·

In India, following an international call for tenders for the construction for the first subway line in Mumbai, a contract was awarded in June 2006 to the “Mumbai Metro One” consortium, consisting of the Indian company Reliance (69%), Mumbai Metropolitan Regional Development Authority (MMRDA) (26%) and Veolia Transport (5%). The line should be operational as of 2010. The operation and maintenance of the line will be undertaken by a subsidiary subcontracted by the consortium, 70% of which will be held by Veolia Transport. The 35-year operating contract represents estimated cumulative revenues of €53 million for Veolia Transport.


In 2006, Veolia Transport also pursued its growth in Eastern and South-Eastern Europe (Croatia and Serbia).  




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Principal Contracts

The following table shows the principal contracts signed or renewed in 2006 with either public authorities or industrial or commercial companies.1

Public Authority

or

Company and Location thereof

Month of Signature of Contract or of Renewal

New Contract or Renewal

Duration of Contract


Estimated Total Cumulative Revenue

(in euros)

Services to be Provided

France

     

Marseille

July

New

8 years

145 million

Operation of tramway network for Marseille.

Valence

May

New

6 years

76 million

Operation of urban bus network for the metropolitan area of Valence.

Europe
(outside France)

     

Germany

August

New

10 years

170 million

Urban public transportation network for Pforzheim in the Bade-Wurtemberg Land.

Germany

October

New

11 years

286.4 million

Rail services in the Bavière (Augsburg) Land.

Netherlands

December

New

10 years

1.1 billion

Operation of integrated public transportation network in the province of Limbourg.

North America

     

Orange County

February

New

3 years

73.1 million

Operation of a public transportation network (bus and paratransit).

San Diego (U.S.)

September

New / partial Renewal

5 years

167.2 million

Operation of an urban and beltway urban public transportation bus network.

Mesa

March

New

6 years

122.9 million

Urban and customized transportation in Phoenix, Arizona.


Acquisitions and Divestitures in 2006

In July 2006, Veolia Transport and CMA-CGM partnered to develop new rail transportation between principal ports and economic regions in Europe. This alliance emerged, with European competition authorities’ agreement, from the creation of two distinct, operational companies in December 2006: a combined transportation operator, “Rail Link Europe,” in charge of organizing and marketing sea freight container transport (held 49% by Veolia Cargo, and 51% by Rail Link), and a rail company, “Veolia Cargo Link” (held 51% by Veolia Cargo, and 49% by Rail Link), uniting industrial means and providing rail transportation of these containers. In December 2006, the first line was opened between France and Germany.

In May 2006, at the end of the process of privatization of the Société Nationale Maritime Corse Méditerranée (SNCM), Veolia Transport acquired 28% of the company’s share capital and currently retains management of operations. SNCM’s principal business is the operation of a service concession to provide ferry service to Corsica from the port of Marseille. It holds ten vessels, and its contribution to the revenues of Veolia Transport was approximately €200 million in 2006.

1

Revenues of contracts have been converted into euros at the rate of exchange prevailing on December 31, 2006 and represent the portion due to Veolia Propreté under such contracts.  Accordingly, these amounts may differ from the amounts announced in our groups’ press releases.  



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In May 2006, the European Bank for the Reconstruction and Development (EBRD) obtained a 35% shareholding in Veolia Transport Central Europe Gmbh, combining Veolia Transport’s business in Central and Eastern Europe. This alliance is expected to enable Veolia Transport to accelerate its growth in these new markets and to establish a strong presence in countries where the EBRD can offer its expertise and experience.

In January 2006, in the United States, Veolia Transport’s North American subsidiary acquired Shuttleport, specialized in the servicing of airports, city-centers and car-rental lots. The company comprises 761 employees and its revenues in 2006 were €45.4 million. In addition, in October, Veolia Transport acquired SuperShuttle, one of the world leaders in customized airport transportation in the United States. Equipped with 1,200 vehicles, SuperShuttle provides service to 23 airports in 17 US cities. The company has 765 employees and transports about 6 million passengers each year. Its revenues in 2006 were €56.9 million.

In total, over the course of 2006, Veolia Transport created or purchased 85 companies, merged 20 companies, sold one company and liquidated 8. At December 31, 2006, Veolia Transport held 520 consolidated companies (compared to 455 in 2005).

Development of Synergies: Multiservice Contracts to Benefit Industrial and Commercial Clients

Outsourcing and Multiservices Market

We believe that our position in the environmental services market for industrial and commercial customers has allowed us to take advantage of the synergies that exist among our four divisions. The growth in this market, estimated to be greater than 10% per year, was initially driven by the development of outsourcing, as industrial companies sought to outsource certain peripheral activities to external service providers.  This outsourcing trend covers all of our businesses, including energy services, water services, waste management services, on-site management of rail junctions and rail freight transport.

We offer a “multiservices” alternative to our customers, which involves the provision of services by several of our divisions under a single contract.  This allows us to better respond to the expectations of certain customers who wish to outsource a range of services to a single service provider.  This relationship also allows for greater technical synergies, economies of scale and commercial complementarity.

Our largest multiservices contract, signed in 2003 with PSA Peugeot Citroën, provides a good illustration of the synergies that are possible.  The subsidiary created to service this contract, Société d’Environnement et de Services de l’Est, manages all environmental services at Peugeot’s sites in eastern France, involving more than twenty different activities. By delegating such a broad range of activities to us, PSA Peugeot Citroën is able to ensure the regulatory compliance of its sites, while realizing significant savings. These savings largely result from an overhaul of the previous organization and work plan, the implementation of skill training programs, the reassumed management of activities that were previously subcontracted, and the implementation of a new energy policy.  In 2005, the economic and operational success of this partnership led the PSA group to grant to us the same perimeter of services for its new facility in Trnava (Slovakia).

Our Organization for the Provision of Multiservices

To develop this multiservices activity, we have established a specific organization, VE Industries (“VEI”), to coordinate our various activities.  While VEI plays a coordinating role, each of our divisions remains responsible for the ultimate performance of services falling within its expertise.

VEI prepares our bids for multiservice contracts, with a project manager from VEI appointed for each multiservices contract.  Commercial projects and bids are prepared in coordination with our divisions, and are then submitted to a commitments committee before their submission to clients.

Later, contract performance may be entrusted to a dedicated, special purpose company formed by the divisions involved in the project, particularly when we decide to utilize the personnel of one of our industrial clients.

Multiservices Business Activity

Our activities within the multiservices market are principally organized around eleven major contracts, which together generate revenues of more than €440 million annually and are expected to generate total revenue over the life of such contracts estimated at over €1.9 billion. The average length of these contracts is seven years.

The multiservices market has a strong international dimension, in particular with respect to our industrial clients, such as Arcelor in Brazil and PSA Peugeot Citroën in Trnava (Slovakia), which have sought to construct new plants outside of France.

In 2006, the most significant multiservice contract was signed in France with Renault and involves the management of general and environmental services of all of the automobile construction sites in the Paris region (Boulogne-Billancourt, Guyancourt and Reuil-Malmaison). For this five-year contract, we will draw upon the expertise of our Energy, Environmental Services and Transportation divisions to provide a wide range of services for 1 million m² of real estate on which Renault employs more than 20,000 people. This contract aims to reduce expenditures by 20%. The range of services includes the management of electrical, heating and air conditioning technical equipment, management and disposal of waste, management of open spaces and developed sites, logistics and transportation (management of all employee vehicles and their garages, management of the stock supply, transport of mail, etc.) as well as commercial services (the reception of visitors). This is the most significant contract that we have signed to date concerning commercial sites. It represents consolidated revenues of €600 million.  




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In 2006, we were awarded the management of all the energy production and services for Socata, a subsidiary of the group EADS, at its Tarbes site. This contract incorporates the expertise of several of our businesses. The range of services includes the production of gas, electricity and water for all of the buildings, as well as for the industrial processes, including Lipofit2, a “clean” fuel. Also included are all services concerning the technical maintenance of the plant and of the buildings, environmental services for the site and services for users including mail, caretaking, and reception.  This is a three-year contract extendable to five years and representing estimated annual revenues of €3.4 million.  Work on this contract began in January 2007.


We continue to operate contracts previously entered into with Arcelor (in Montataire-France and in Brazil), Novartis (in Basel-Switzerland), Futuroscope (in Poitiers-France), Visteon (in Germany), Corus Packaging (in the United Kingdom), PSA Peugeot Citroën (in Mulhouse, Sochaux, Vesoul, Belfort and in Trnava in Slovakia), and Schenectady (in Béthune, France).

Multiservices Contracts Signed in 2006:1


Company

Location

Month of Signature of Contract

Duration of Contract


Estimated Total Cumulative Revenue

(in euros)

Services to be Provided

Renault

Guyancourt

Rueil-Malmaison

Boulogne-Billancourt

(France)

December

5 years

600 million

General and environmental services for 1 million m² of real estate: management of electrical heating and air conditioning installations, management and disposal of waste, management of open spaces and developed sites, management of all vehicles and garages, management of stock supply and the transport of mail.


Competition

Most markets for environmental services are very competitive and are characterized by increasing technological challenges arising from regulatory changes, as well as the presence of experienced competitors.  

Competition in each of the markets we serve occurs primarily on the basis of the quality of the products and services provided, reliability, customer service, financial strength, technology, price, reputation and experience in providing services. Additional considerations include the ability to adapt to changing legal and regulatory environments, as well as the ability to manage employees accustomed to working for governmental authorities or non-outsourced divisions of industrial or commercial enterprises.  In each of the markets in which we operate, our competitive strengths are our high level of technological and technical expertise, our financial position, our geographical reach and our experience in providing environmental management services, managing privatized and outsourced employees and meeting regulatory requirements.

With regard to the provision of environmental services to industry in particular, our main competitor is Suez, which provides a range of services including energy, water and waste management. Certain actors in the industrial sector are also trying to enlarge the scope of their business to include the provision of environmental services. In particular, the subsidiaries of certain energy producers (such as Cofatech, a subsidiary of GDF, as well as subsidiaries of RWE) have been active in doing so. Companies specialized in electronic installation, such as Cegelec, have also expanded their environmental services offering.  In the area of facilities management, companies such as Johnson Controls seek to provide multi-service offers to their commercial clients. Cleaning companies, such as ISS, look to expand their offerings and to provide solutions outside of the cleaning business. Finally, among new competitors, GE announced its intention of developing its business in the water sector. However, the majority of competitors do not cover the same spectrum of technical expertise regarding environmental services as we do. Therefore, in a certain number of cases, our competitors are forced to set up ad-hoc arrangements to respond to clients’ demands.  


We expect that other enterprises that compete with us in individual sectors will, in the coming years, seek to expand their activities to become integrated environmental management services providers. This change has been prompted by clients’ desire to outsource a larger scope business.


A new form of competition has developed over the last few years with the growing role of financial groups such as infrastructure funds (for instance Macquarie Bank) or private equity funds.  Although they are not global or strategic competitors, they are often present in privatization tenders and asset sales and can occasionally deprive us of growth opportunities.


It is important to note that our major competitor is often the client itself. Clients systematically compare the benefits and advantages of outsourcing compared to maintaining the status quo.


With regard to the provision of environmental services to public authorities, there has been a tendency in France over the last few years to return the provision of such services to local government control, which has reduced the number of delegated management contracts available in the market. Nevertheless, this tendency has remained fairly limited. In Germany, Stadtwerke plays a strong role in

1

Revenues expected under foreign contracts won during 2006 have been converted into euros at the rate of exchange prevailing on December 31, 2006.  Accordingly, these amounts may differ from the amounts announced in earlier press releases.  



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the environmental services market (in the areas of water, waste management and energy services). In numerous countries in Eastern Europe, however, markets are slowly opening to competition, albeit partially.

Finally, new actors from the public works and building sectors may begin to offer services in the market following completion of large and/or extensive investments, which in turn require the provision of services (e.g., construction of a hospital which then requires ongoing maintenance of technical services). These new actors may provide services within the context of a BOT or concession contract or, in France, as part of a “partnership contract” authorized by a new regulation of June, 2004. The emergence of such new actors is a natural outgrowth of a market in which ownership of infrastructure constructed to support the provision of comprehensive environmental services often reverts back to the client at the end of a contract’s term.  For the moment, however, these new actors have acted on a project-by-project basis, and do not seem to have a global strategy for establishing a true competitive presence in the market.

Water

The principal competitors of Veolia Eau in the water sector in 2006 were Suez (through its subsidiary Ondeo) and RWE. RWE entered into a process of reorganization to focus on its energy businesses, with the divestiture of Thames Water Holdings plc, the most significant water management company in Great Britain, to the consortium Kemble Water Limited, managed by Macquarie, and the announcement in March 2006 of the listing of RWE’s American subsidiary American Water. On the other hand, General Electric (through Ionics) and Siemens (through Siemens Water Technologies) have announced their international ambitions in the area of water treatment technology.


At both the national and regional level, Veolia Eau has a number of local competitors, particularly in the building and public works sectors.  Examples of such competitors include Saur in France, FCC (which is pursuing further development internationally) and Agbar in Spain. In the United States, competitors include American Water and United Water (a subsidiary of Suez).  In Asia, various conglomerates (Marubeni, Mitsui, Kerry Utilities, Beijing Capital, Cheung Kong Infrastructure) have attempted to form partnerships in order to conduct water activities. Further, Veolia Eau faces competition locally from public establishments and local mixed public-private companies such as Acea and Amga in Italy, Gelsenwasser in Germany, Canal Isabel II in Spain, or governmental control in Brisbane, Australia or régies départementales in France.


Environmental Services


The principal competitors of Veolia Propreté in the environmental services sector are either solely regional, or they cover only one part of the sector in which Veolia Propreté operates.


In Europe, where Veolia Propreté conducts the majority of its waste management activities, and in the Eastern European zone, its principal competitors are Suez, acting through its subsidiary SITA, Remondis, FCC and Biffa.


Veolia Propreté may expand further in North America as well, where its principal competitor is Waste Management, along with Allied Waste and Republic Services.


In Latin America, Veolia Propreté’s operations are concentrated in Brazil and Mexico, where it primarily competes with Suez and a variety of local companies.


In the Asia/Pacific region, Veolia Propreté’s main competitors are Suez as well as various local companies. The Australian group Brambles (operating under Cleanaway) has withdrawn from the waste management business.


Energy Services


The energy services market has many actors and Veolia Environnement, through its division Veolia Énergie Services (Dalkia), therefore faces very dispersed competition. We believe that the three only companies with a strong international presence and a diversified and complete range of services in this market similar to our own presence and services are Suez (Elyo), RWE and Cofatech (Gaz de France).




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Dalkia is also confronted with the active presence of local competitors such as EnBW, ENEL, Vattenfall, Fortum or ATEL.


In the commercial sector, competition takes many forms, and comes from specialized companies (in the areas of cleaning, restoration, etc.) seeking to expand their offering to include multi-technical services, and from technical maintenance companies focusing on electronic installation in particular.


In addition, we face growing competition from municipally or publicly-run companies, principally in Central Europe, Germany, Austria and Italy.


Transportation


Through Veolia Transport, our principal competitors in the transportation market are large private operators, primarily French or British, and public companies, controlled locally or nationally, operating public monopolies. Our principal private operator competitors at the international level are the British groups FirstGroup, National Express, Stagecoach, Arriva and Go Ahead, and French groups Kéolis (which counts the SNCF as an industrial partner and shareholder, though 53% of its share capital is held by Axa Private Equity and la Caisse de Dépot et Placement du Québec, following the transfer by 3i an investment fund, of its interest in the group) and Transdev (a subsidiary of the Caisse des Dépôts et Consignations, which has an alliance with the French metro operator, RATP). FirstGroup, which results from the purchase of Laidlaw, is the largest American transport operator. It has become the largest world group for public and private transportion. Among Veolia Transport’s largest public competitors are Deutsche Bahn (the national rail operator in Germany) and, in France, the RATP and SNCF.  


In North America, the competitive market has evolved, particularly as a result of the partial withdrawal of the British groups National Express and Stagecoach, and the purchase of FirstGroup.  In the area of rail transport, Amtrak’s persistent budget difficulties have further opened the market to delegated private management.


In Asia, companies with international objectives could become new competitors in the European and Asian markets. These companies include ComfortDelgro, the transport network operator in Singapore, 40% of the reserves of which result from international business, especially in China and the United Kingdom, and MTRC, the subway operator in Hong Kong, which is present at several calls for tenders for rail franchises in Asia and Europe.

 

Contracts

We provide a range of services either directly to the customer making the request—for example, in connection with an outsourcing agreement we have with a public authority or industrial or commercial company—or indirectly on behalf of such customer for the benefit of a third party—for example, in connection with the delegated public service management of a drinking water production and distribution service or management of an urban heating and cooling network.  The services we provide are often vast and multi-functional, requiring adequate employee infrastructure and specialized resources. They may also require management of works or infrastructure that are technically complex—an example would be a wastewater treatment network and purification plant or an industrial co-generation facility.  These works or infrastructure may either be provided by the client, or we may finance and build the infrastructure ourselves.


Our services to the public provided on behalf of public authorities include water distribution, wastewater treatment, collection and treatment of household waste, public transport, production and distribution of heating and cooling through urban networks and energy services.  In numerous countries, the provision of such services, often referred to as general economic interest or public services, is considered to be the responsibility of the local public authority. Accordingly, the public authority is charged not only with implementing regulations or controls over the provision of public services, but must also implicate itself more directly in their management, through one of the following means:  


·

the public authority can decide to directly manage and provide public services on its own (“direct” or “internal” management) ;


·

the public authority can decide to provide the service itself, but to use private operators as subcontractors to manage the service on its behalf, or to provide limited services ;


·

the public authority may prefer to confer on a third party the entire responsibility for providing the public services, in which case the third party, depending on the specifications of the contract, would be responsible for providing the human resources, materials and finances necessary to provide the services.  The public authority may also request that the third party finance and construct any required infrastructure under the contract. Third parties to whom the public authority resorts may be either private operators, mixed public-private companies  or other public entities.




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Based on the different ways in which public authorities choose to manage the provision of public services, we have developed various types of contracts to respond to their specific requirements.  The contracts we employ generally fall into one of three categories, depending on whether we are entrusted with total responsibility for provision of a public service and whether we have a financial and commercial relationship with end users:


·

The public authority chooses to directly manage and provide public services on its own (direct management), but has only limited means and therefore calls upon a private operator to provide certain limited services or works.  It pays the operator a set price under contract.  


·

The public authority may prefer a more expansive contract involving construction and management of services, which may include financing of required infrastructure.  These are known as public market contracts under municipal law, also referred to as Build, Operate, Transfer contracts or since 2004 in France as “partnership contracts”, or


·

The public authority entrusts a company with the responsibility for the full provision of a public service, with the company assuming all or part of the operational risks. Generally, the provision of the service is then financed by the end user of the service. The contractor is thus responsible for the business, on an operational and financial level, but must do so in accordance with the terms set by the public authority in respect of expected performances and prices charged to end users. This is the logic of “delegated management”, or “concession” in a global sense (also known as a Public Private Partenship – PPP) , which means that the entity assumes the “risks and perils” or “risks and advantages” to the extent its compensation is linked to the operating results.


In certain countries, public authorities may also choose to be as little involved as possible in the provision of public services to inhabitants, choosing instead only to regulate the activities of the private provider. This creates opportunities for us as well, most often through acquisition of the private operator that is already serving a given region.

The historic traditions of the various countries in which we operate tend to favor one of the above-mentioned general contract types over the other.  In France, for example, where there is a long tradition of granting concessions, delegated public service management contracts are often the preferred choice.  

Current practices in various countries have tended to converge, with public authorities resorting to one or the other contract types depending on the situation.  All such contracts have, in most cases, the common feature of being long-term agreements.

We also enter into outsourcing contracts for the management of complex services with our industrial and commercial clients, which are analogous to the contracts entered into with public authorities above.

Despite differences related to the nature of clients, the services contracted for and the nature of the legal systems in which we operate, the expectations of our clients have tended to converge towards a demand for transparency during the bid process and during contract performance, formation of a real partnership in search of ways to improve productivity and performance, and a desire for clear performance targets and variable compensation depending on achievement.

We are also very attentive to contractual provisions, in particular when we must finance the investments called for under a contract. Given the complexity of management agreements and their generally longer term, we possess skills regarding contract analysis and control.  The legal departments of our divisions are involved in the preparation of contracts, and controls are imposed on the implementation of our main contracts.  Each year, our internal audit department includes a review of the contractual and financial stakes of our most significant contracts in its annual program.

Environmental Regulation, Policies and Compliance

Environmental Regulation

Our businesses are subject to extensive, evolving and increasingly stringent environmental regulations in developing countries as well as in the European Union and North America.

Water

Water and wastewater services activities are highly sensitive to governmental regulation. In Europe and North America, governments have enacted significant environmental laws at the national and local level in response to public concern over the environment. The quality of drinking water and the treatment of wastewater are increasingly subject to regulation in developing countries as well, both in urban and rural areas.

The quality of drinking water is strictly regulated at the European Union level by Directive 98/83/EC of November 3, 1998, relating to the quality of water destined for human consumption, which was transposed into EU member states and French law by a decree on December 20, 2001 (certain provisions of which have also been incorporated into the French public health code). This directive introduces, beyond quality control, the concept of evaluating risks on an ongoing basis. The collection, treatment and discharge of urban, industrial and commercial wastewater is governed by Directive 91/271 of May 21, 1991, the objectives of which were further reinforced and expanded by water Directive 2000/60/EC of October 23, 2000. Public authorities also impose strict regulations upon industrial and commercial wastewater that enters collection systems and the wastewater and sludge from urban wastewater treatment plants.  Directive 2006/118/CE of December 12, 2006 concerning the quality fo ground water imposes oversight obligations and a limit regarding the amount of chemical substances that may be released in water by 2015.



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France has numerous laws and regulations concerning water pollution, as well as numerous administrative agencies involved in the enforcement of those laws and regulations. Certain discharges, disposals, and other actions with a potentially negative impact on the quality of surface or underground water sources require authorization or notification. For instance, public authorities must be notified of any facility that pumps groundwater in amounts that exceed specified volumes and French law prohibits or restricts release of certain substances in water. Individuals and companies are subject to civil and criminal penalties under these laws and regulations.  The law of December 30, 2006 relating to water and aquatic environments addresses community demands for high quality water and significantly modifies the French legislation on water, also addressing community objectives concerning water quality until 2015.

Government authorities also strictly regulate industrial wastewater that are liable to enter the water supply and wastewater and mud refuse from urban water treatment plants.

In the United States, the primary federal laws affecting the provision of water and wastewater treatment services are the Water Pollution Control Act of 1972, the Safe Drinking Water Act of 1974 and related regulations promulgated by the Environmental Protection Agency (EPA). These laws and regulations establish standards for drinking water and liquid discharges. Each U.S. state has the right to establish criteria and standards stricter than those established by the EPA and a number of states have done so.

Environmental Services

In numerous countries, waste treatment facilities are subject to laws and regulations that require us to obtain permits to operate most of our facilities from governmental authorities. The permitting process requires us to complete environmental and health impact studies and risk assessments with respect to the relevant facility. Operators of landfills must provide specific financial guarantees (which typically take the form of bank guarantees) that cover in particular the monitoring and recovery of the site during, and up to 30 years after, its operation.  In addition, landfills must comply with a number of standards, and incineration plants are usually subject to rules that limit the emission of pollutants. Waste may also be subject to various regulations depending upon the type of waste. For example, sludge produced at wastewater treatment stations that will be composted must comply with strict regulations relating to its content of organic materials and trace metals (heavy metals like cadmium, mercury or led). Further, the NFU 44-095 standard, established in 2002 and henceforth applicable in France, strictly regulates the composting of material that results from the treatment of wastewater.

In France, pursuant to the provisions of the Environment Code (articles L. 511-1 et seq.) relating to registered installations for the protection of the environment, several decrees and ministerial and administrative orders establish rules applicable to landfills for household, industrial, commercial and hazardous waste. These orders govern, among other things, the design and the construction of waste treatment centers. Hazardous waste is subject to strict monitoring at all stages of the treatment process. Waste-to-energy centers are subject to numerous restrictions, including in particular limitations on the amount of pollutant emissions: for example, directive 2000/76/EC of December 4, 2000 on the incineration of waste fixes emission thresholds for dioxins and NOX in particular. In connection with the application of this directive in France, conformity studies were submitted to local French authorities in charge of the supervision of each relevant installation in June 2003, in order to determine the necessary corrective measures to be implemented by the end of 2005.

At the European Union level, the framework for waste management regulation is provided by directives that set overall regulatory goals of waste prevention, collection, recycling and reuse. European Union member states are required to prohibit the uncontrolled discarding, discharge and treatment of waste pursuant to these directives. Several existing European regulations seek to have member states define a national strategy that allows for the progressive reduction of dumping of biodegradable waste. The regulations are intended to promote recycling, composting and energy recovery of household waste. Further, the European Union has, through directive 2003/87/EC of October 13, 2003, implemented a quota system for the emission of greenhouse gases targeting carbon dioxide in particular. Our waste management business is excluded from the first and second phases (2005-2007 and 2008-2012) of this directive, but may be targeted subsequently, and may as a result establish procedures to reduce methane and carbon dioxide emissions.

The major statutes governing our waste management activities in the United States include the Resource Conservation and Recovery Act of 1976, the Clean Water Act, the Toxic Substances Control Act, the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (also known as “CERCLA” or “Superfund”), and the Clean Air Act, all of which are administered either by the EPA or state agencies to which the EPA delegates enforcement powers. Each state in which we operate also has its own laws and regulations governing the generation, collection and treatment of waste, including, in most cases, the design, operation, maintenance, closure and post-closure maintenance of landfills and other hazardous and non-hazardous waste management facilities.

Energy Services

Our energy-related activities in Europe (primarily the supply of energy services involving thermal and independent energy) are subject to directives and regulations that seek to control environmental impact and risks. One such directive of October 23, 2001 establishes emission limits for sulfur dioxide, nitrogen oxides and dust and regulates the construction of large combustion plants. It requires the implementation of national emission ceilings for certain atmospheric pollutants such as sulfur dioxide, nitrogen oxide and volatile organic compounds.

European regulation 2037/2000/EC of June 29, 2000 sets a timetable for the elimination of substances that destroy the ozone layer, in particular refrigerating fluids such as chlorofluorocarbon and hydro chlorofluorocarbon that are used in cooling plants.

European directive 97/23/EC of May 29, 1997, aimed at harmonizing member state legislation in the area of pressure equipment, imposes various security requirements for the design and manufacturing of such equipment, and requires that it be inspected for proper use.

With respect to European directive 2003/87/EC of October 13, 2003 on greenhouse gases and carbon dioxide quotas, Dalkia’s combustion installations of more than 20 MW have been part of the national plans of EU member states for the allocation of quotas since February 2005.



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Finally, with respect to its production of sanitary hot water, Dalkia is directly affected by European directive 98/83/EC of November 3, 1998, which addresses the quality of water destined for human consumption. Eighteen states, including France, believe that this directive applies to cold and to hot water and to all types of management systems for production and distribution.

All of the directives and regulations mentioned above have been subsequently implemented in each member state of the European Union. In France, this primarily means compliance with a July 19, 1976 law and its implementing decrees relating to the environmental protection of designated installations. Under this law, Dalkia must obtain various permits and authorizations from regulatory authorities in order to operate its facilities, and ensure that its operations comply strictly with the terms of such permits. For large combustion installations (output greater than 20 MW), new regulations were imposed in 2002 (for new installations) and in 2003 (for existing installations) with respect to emission limits, in application of European Union directive 2001/80/EC of October 23, 2001.

With regard to pressure equipment, directive 97/23/EC of May 29, 1997 (which applies to material constructed since 2002) has modified the regulatory regimes of member states in relation to procedure and inspection, and has helped to harmonize the operation of all installations that use such equipment.  In France, a decree of March 15, 2000, as modified by a more recent decree of March 30, 2005, has transposed this directive into national law.

In relation to managing the risk of legionella disease, the European Working Group for Legionella Infections (EWGLI) has, with the support and approval of the European Commission, published new European guidelines for the control and prevention of travel associated legionella disease. In general, texts on the issue are issued in Europe and around the world by public health authorities and associations for the protection of travelers. Very often, these texts are presented in the form of recommendations for prevention, which take into account the physico-chemical and biological nature of water and prescribe corrective actions when certain indicators are present. Various professional associations have also issued their own guidelines for prevention.

In France, the health ministry has recommended, since 1997, that health professionals and managers of establishments implement best practices for the maintenance of sanitary hot water networks, air climate systems and other installations at risk. In December 2004, there were also newly issued guidelines for the design and operation of cooling facilities using vapor processes (cooling towers).

In Spain, decree 865/2003 of July 4, 2003 establishes criteria for the quality of water and the frequency of inspection procedures, as well as for when action must be taken once certain limits are exceeded. A Spanish association has issued a guide on the subject (100030IN). In the United Kingdom, an approved code of practice (ACOP L8) issued by the Health and Safety Executive is the authoritative text, which has also inspired similar procedures in Belgium, the Netherlands, Ireland and at EWGLI.  In the United States, the Occupational Safety and Health Administration (OSHA) issues its own guidelines and action plans. The American Society of Heating, Refrigerating and Air-Conditioning Engineers (ASHRAE) and the Cooling Technology Institute (CTI) have issued guidelines as well. Italy and Portugal have partially adopted the ASHRAE guidelines relating to the protection of tourists.

Transportation

Our transportation service activities are subject to a number of national and European regulations and particularly European Union directives that limit emissions from petrol and diesel engines and require us to obtain certain permits.

In the European Union, standards called “EURO” have been established for polluting emissions from thermal engines. All new vehicles currently constructed in the European Union are in compliance with “EURO 3” standards and Veolia Transport’s networks are renewing their fleets with “EURO 3” vehicles. In 2005, a “EURO 4” standard took effect with even stricter requirements for the reduction of polluting emissions.

Further, Veolia Transport has made a commitment, in connection with its environmental management system, to lower its total emissions globally and to prepare for the new standards by testing and experimenting with emission reduction systems which will eventually be sold, thereby reaffirming its role as expert and consultant to client collectivities.

Finally, Veolia Transport is subject to the environmental standards applicable to depots, garages and underground cisterns whose activities may present a danger or inconvenience to the environment.  For this reason, the majority of sites in France are subject to the regulations governing classified facilities for the protection of the environment, more generally in the form of a simple notification.

Finally, in France, the law of February 11, 2005 concerning equal rights and opportunities, the involvement and citizenship of handicapped persons requires that all public transport must be accessible to handicapped persons within 10 years.

Environmental Policies

We strive to contribute to the enhancement of quality of life in places where we operate, and have placed the challenges of sustainable development at the heart of our strategy.  To this end, we do not focus only on the preservation of the environment and the protection of natural resources and biodiversity, but also assume our economic and social responsibilities, particularly at a local level where we are committed to stimulating progress.



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Our action regarding greenhouse gases


An increase in greenhouse gases in the atmosphere has led certain countries, as well as the international community, to implement regulatory measures in order to limit this trend.  At the international level, the Kyoto Protocol, finalized in 1997, came into force in February 2005. At the European level, the European Union has implemented, through Directive 2003/87/EC of October 13, 2003, a quota exchange system for carbon gas emissions, the ETS ("Emission Trading System").  This system is similar to that of the Kyoto Protocol in place since the beginning of 2005 which has led to the creation of national systems of quota allocation (PNAQ).  In France, the PNAQ1 was adopted for the 2005-2007 period, and the PNAQ2 for the 2008-2012 period.  In 2006, a an initiative was launched within the European Union to revise Directive 2003/87/EC, the goal of which is to expand the Directive's application, reinforce its control mechanisms and implement a quota trading system similar to that of the Kyoto Protocol.


We are already active in this field at the European Union level and internationally, as well as at the national level.


·

At the European Union level, all large combustion installations with thermal output greater than 20 MW fall under the new quota exchange system. For us, this primarily affects our Energy Services division, which manages almost 250 such installations in Europe (i.e., more than 2% of total installations). Quotas awarded to Veolia Énergie (Dalkia) represent approximately 1% of all European quotas awarded. Veolia Énergie (Dalkia) has worked with customers to help keep carbon dioxide emissions within quota limits, and has established an organization dedicated to this endeavor.  This has enabled us to be an early participant in the quota exchange market, and through our participation we have optimized the profitability of our contracts and in some cases assisted clients in financing new investments that help to reduce greenhouse gas emissions. Some of Veolia Eau’s sites in Germany are also affected, following the gain of certain municipal contracts (Stadtwerke).


·

At the international level (Kyoto Protocol), we have begun trying to generate emission credits that would be tradable on the market, by participating in projects with other countries that help to reduce greenhouse gases. Veolia Propreté and Veolia Énergie (Dalkia) have already tested this in practice, through projects in Brazil and Egypt, along with six other South American projects.  Veolia Énergie has also enacted a joint project in Lithuania. By using dedicated teams, they intend to pursue this activity in the future.  Regarding transportation services, the first challenge in reducing greenhouse gas emissions is to establish reliable measurement tools.  Veolia Transport is actively involved in developing an initial tool that would apply to business transportion, in collaboration with EpE and ADEME.


·

At the national level, a number of countries have designed mechanisms to reduce greenhouse gas emissions, either in the form of a set of targeted incentives (as France has done under its Plan Climat) or in the form of “domestic projects” that allow selected projects to benefit from emission credits (as New Zealand, Canada, Australia, and some U.S. states have done). The latter method is currently being studied by France as well. Our teams are following all of these developments and attempting to integrate them into our planning.


Direct greenhouse emissions on sites that we managed in 2006 reached 36.5 million tons of CO2 (carbon dioxide) equivalents (compared to 33.7 million tons in 2005).


We are generally contributing to a reduction in greenhouse gas emissions, both through the daily management of sites that it operates and through the use of renewable and alternative energies (in particular biomass, landfill gas, geothermal energy).  We are actively following regulatory developments that will undoubtedly become more restrictive in the future, viewing them as new opportunities to develop our environmental management skills.

Preserving ecological balances

Whether through the limitation of water evaporation, the enhancement of the quality of our waste, the effort to optimize energy consumption in connection with our water distribution and treatment activities, the use of alternative energies in our heating operations, the recovery and treatment of biogas emissions at our landfills or the use of low-emission fuels in our fleet of public or private transport vehicles, we get involved in the main environmental problems currently affecting our planet by applying our know-how, technological capabilities and research potential to these problems. We contribute to the enhancement of quality of life and sanitary conditions of local populations in our day-to-day operations. For example, by supplying drinking water to impoverished areas we help to reduce infant mortality. In developed countries we have implemented plans to protect against the risk of the presence of legionella in public or industrial facilities, thereby improving public and environmental sanitation.  

Preserving economic and social balances

We also consider the economic and social factors that underlie the course of development in the countries in which we operate, and we work to develop solutions that are adapted to local constraints and know-how transfers. For example, we have instituted a program in Shanghai to educate employees about safety at work. In Romania, Alexandria and Gabon, we have developed programs that have allowed local employees and consumers to better understand the challenges in the provision of water and waste management services. The launch of the company in Alexandria was subsidized by the UN-Habitat agency of the United Agencies (Scroll of Honor 2006).  We give preference to a partnership approach with non-governmental organizations (NGOs), local authorities and associations in the implementation of action plans for the population of emerging countries, which permits the development of model plans that can be reproduced.  In each of our projects, we seek to create a beneficial and educational dimension for the improvement of public health and the protection of the environment. We also try to assist in the development of areas where we provide services.

Moreover, we continue to participate in an initiative for developing a charter on public-private partnerships (PPP) in order to improve public access to essential services, which is being supported by the French Ministry of Foreign Affairs and pursued by several agencies of the United Nations. We testified as to best practices in this area during the Urban World Forum in Vancouver in June 2006.  



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This initiative forms part of the United Nations’ Millennium Development Goals, which were announced in 2000 by the U.N. Secretary General.  The initiative aims at defining the role of private operators with respect to local public service management, while emphasizing the principles of transparency and the sharing of technology and know-how, principles to which we already adhere in connection with our adherence to the U.N. Global Compact. This sharing of know-how occurs in particular through our participation in the cooperation program for sustainable urbanization implemented by the United Nations Institute for Training and Research (UNITAR) and the World Bank (using research centers based in Poland, Malaysia, Brazil and Africa).

Our cooperation with UN agencies on multi-year programs as well as our sharing of know-how have led to our being nominated as an associate member of the congress of Asian cities (Citynet).

Since May 2004, we have also pursued a charity program through a corporate foundation created under the new provisions of a law dated August 1, 2003 relating to charitable actions. This initiative is part of a long and strong tradition of charity by our company, which attempts to encourage solidarity, environmental protection and professional employment.

In 2006, the Veolia Environnement Foundation crossed the 400-project threshold. Each action is sponsored by one of the Group’s partners. The Foundation received the Oscar Admical du mécénat d’entreprise 2006 for its actions. The continuity of the commitments, the originality of approaches, the involvement of partners, and the importance of means were all relevant criteria in the award. The notoriety of the Foundation continues to grow and more than half of its projects are outside of France. Australian, Israeli, Armenian and Latin American subsidiaries have all started their first projects. Among the 178 selected projects in 2006, 53% dedicated to sustainable development in communities, 27% employment, and 20% with environmental protection, the three action areas of the Foundation.


·

With regards to sustainable development in communities, the Foundation supports several programs in Mali, Burkina Faso, Nigeria, Madagascar and Vietnam which also benefit from the support of Veolia Waterforce/Waterdev through the free provision of expertise.


·

Regarding employment, the Foundation has committed itself to a three-year partnership with the Association for the Development of Economic Initiatives (ADIE), in order to develop micro-credit within the disadvantaged suburbs of Paris.


·

Regarding the environment, the Foundation is a partner in the expedition launched at the end of 2006 on the Island of Santo (the Vanuatu archipelago) by the National Natural History Museum, the Research Institute for sustainable development and the nonprofit Pro Natura International. For 5 months, close to 150 researchers from 20 nations will inventory the land and marine wildlife and plants.


We have two humanitarian aid and international cooperation departments: Veolia Water Force and Veolia Waterdev.


Veolia Waterforce was created in 1998 to following the crises cyclone Mitch (Nicaragua) and the flood of the Yangtze river in China. Its main purpose is to share expertise, thanks to a network of 400 volunteer employees. Since its creation, Veolia Waterforce has carried out nearly 50 projects in emergency and development activities, in partnership with the United Nations, government institutions, local communities, NGO’s and private companies. In 2006 Waterforce helped with the deployment of six emergency humanitarian operations, with French and foreign volunteers, in Indonesia, Kenya, Lebanon, Uganda, the Philippines and Serbia. Waterfoce was also called upon by its main partners, the Ministry of Foreign Affairs and emergency medical care NGOs, to join forces in order to provide community action capabilities (tests of materials, coordination, development and unified procedures).


In addition, we also participates in development projects through Veolia Waterdev, an international cooperation department whose objective is to share experiences and imagine, together with public entities, civil society representatives and NGOs, solutions that will facilitate access to local public water and sanitation services. Waterdev can intervene in these circumstances to call upon French municipalities to cooperate in a decentralized fashion. For example, in 2006, Waterdev contributed to a drilling project in Cameroon and the perpetuation of new water production and distribution systems, in a project aimed at improving water quality in Ho Chi Minh city (Vietnam), and sent two teams to south-east Cambodia to evaluate the capacity and the fonctioning of technical installations and to work on the organization of partnerships with local authorities and actors with a view to reinforcing the organization of field teams’ work.


The Veolia Environnement Institute: a scientific approach dedicated to the prospective tools for the environment and sustainable development

Human management of the environment represents a major challenge that requires the mobilization of a large number of resources, the support of the public at large and close cooperation among international, national and local participants. To address this challenge, we created the Veolia Environnement Institute, or VEI, in 2001 to encourage prospective reflection on a number of issues relating to sustainable development, as well as to progressively shed light on the principal trends that will influence the provision of environmental management services over the next decade.  

Through its Prospects Committee, which is exclusively composed of individuals of international reputation and standing, VEI benefits from the contribution of leading external expertise on different key subjects (including public health, economy and human sciences) while maintaining a presence in the daily realities of our different activities. This dual capability represents both the originality and the strength of VEI, which intends to be at the heart of the main environmental debates and issues of the 21st century.  In 2007, the Institute’s objectives are to reinforce the scientific aspect of its actions: enriching its research programs through partnerships with prestigious universities and/or institutions, especially internationally. Initial partnerships have been put in place with the university of Hong Kong relating to the study, monitoring and analysis of actions to be taken concerning transmittable diseases; with the Development Research Center (DRC) in Pekin, relating to the environmental service needs within large Chinese cities in the coming 10 years. At the same time VEI is developing a high level scientific policy. From the first semester of 2007, the Surveys and Perspectives Integrating



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Environment and Society (S.A.P.I.E.N.S), a multidisciplinary review, will publish articles from top specialists in order to set forth the latest advancements within sustainable development.  


The main themes to be considered by VEI in 2006, which are defined by the members of the Prospects Committee, will include the economic and social dimensions of environmental change, the relationship between health and the environment, and the consequences of climatic change on ways of life and urban growth.

As of the date hereof, the members of VEI’s Prospects Committee are: Amartya Sen (India), economist, winner of the Nobel Prize for Economics in 1998, professor of political economics and economics at Lamont University and professor of philosophy at Harvard University; Hélène Ahrweiler, historian, president of the University of Europe and an expert for UNESCO on human and social sciences; Philippe Kourilsky, biologist, member of the Académie des Sciences and professor at the Collège de France; Pierre-Marc Johnson (Canada), attorney, physician, ex-prime minister of Quebec, Canada, and expert on environmental matters; Harvey Fineberg (USA), President of the Institute of Medicine of the United States; and Ms. Mamphela Ramphele (South Africa), physician and anthropologist, previously Chairman of the University of Cape Town and Chairman of the World Bank.


VEI also organizes international conferences in France and abroad. In 2006 two conferences were held in Toulouse (France) in January with the Institut d’Economie Industrielle (IDEI) relating to public private partnerships, and in Bangalore (India) with the Energy and Resources Institute (TERI/Delhi) relating to “Energy, Environment and Development: the analysis of opportunities to reduce poverty”. In 2007 a conference is planned in Montreal concerning “The climate 2050 – technological and political solutions”, the Table Center on Global Climate Change (USA) and the National Round Table on the Economy and the Environment (Canada).


Environmental Compliance


As a specialist in environmental management services, we are concerned about the environmental consequences of each of our activities, both in France and worldwide.  In this respect, we consistently endeavor to comply with applicable regulations, to meet the needs and requests of our clients and to optimize the techniques we implement. To illustrate our commitment, we highlight below some of the more significant environmental actions that we have undertaken regardless of any regulatory or contractual obligation to do so.

The following sets forth a summary of use of water resources, raw material and energy, measures implemented to improve the energy efficiency and the development and use of renewable energies, conditions of use of soils, air, water and soils pollutions, noise pollution:

Water

Use of Water Resources

We preserve water resources by working to prevent wasteful usage in our own installations and in those of our clients. In this respect, the continued implementation of our environmental management system provides, in particular, for the monitoring of water consumption and quality in all of our activities. Our action plan reflects two primary concerns: increased monitoring of the health quality of water destined for human consumption, and control of leaks in cold water distribution networks (raw or treated) and leaks in domestic hot water production networks. During 2004, we installed an indicator to monitor the quality and compliance with regulatory standards of our drinking water. Our industrial water consumption amounted to 390 million cubic meters in 2006.

Climatic developments in certain regions of the world heighten stresses on water resources.  We study and promote techniques through which alternative resources are used, such as the production of drinking water by desalination of seawater and production of water for industry or farm irrigation by recycling wastewater. These developments are done strictly in association with local authorities, regulatory proceedings and the scientific community.

Water Pollution

98% of Veolia Propreté’s landfills are equipped with treatment stations for leachate (water that percolates through stored waste).  

Waste Water

Our wastewater treatment facility efficiency, measured at biological treatment stations with a capacity greater than 50,000 EH, reached 90% in 2006.

Energy – Energy efficiency and the use of renewable energies

We contribute to the reduction of energy consumption. Dalkia optimizes energy management for close to 80,000 energy installations in the world, from municipal heating networks to public housing, commercial or industrial building boilers. Optimizing the energy efficiency of such thermal installations relies upon the quality of their operations and maintenance, as well as upon their modernization.

Dalkia’s strong growth emphasizes the use of heating networks that offer optimized energy performances by concentrating production on a single site and involving co-generation.  Efforts in this field include all of our activities. We are not only developing the use of renewable energies, like biomass and solar energy (Dalkia), but we are also capturing energy from incineration factories and biogas from landfills (Veolia Propreté).

Veolia Transport continues to pursue its objective for the provision of environmental performance training to 90% of its public transport drivers during the first five years of their careers.  This training effort enables us not only to enhance passengers’ comfort and limit polluting emissions, but also to achieve significant fuel economy.  In 2006, 64% of our employees participated in training activities.



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Our total energy consumption amounted to 111 million MWh in 2006, given the development of the group’s activities.

Use of soils

In 2003, we integrated all activities relating to the treatment and recovery of sludge in a single entity (SEDE Environment).  This integration continued during 2004, resulting in the implementation during 2005 of indicators to measure the quality of sludge. This has resulted in our having a specific and integrated overview of sludge management options, allowing us to optimize our agricultural recovery in particular.

In this way we have pursued our efforts to manage the quality of waste in the sewage networks and acted upstream to enhance the quality of sludge produced by implementing pollutant controls in our wastewater treatment networks (through our Actipol method).  Veolia Eau has finalized a reference and certification system defining the applicable requirements for a sewage system for the production of quality sludge to be used as compost.  As a second step, we promote the agricultural recovery of sludge through composting and engage an independent certifying body to audit our composting and agricultural recovery networks.  This recovery is done in conjunction with the agricultural recovery of the fraction usable for fertilization from household waste.

We produced 852 tons of compost in 2006, 47% of which was eligible to be used in agricultural activities.

We have initiated a quality enhancement program for organic material produced from organic waste and a program to evaluate their agricultural impact (the Quali-Agro program led by CREED – our center for research on waste energy services) in coordination with the INRA.  We are also active in the rehabilitation of polluted soils. Relying on several processes, including thermal absorption, Veolia Propreté processes almost all of the pollutants present in the soil at industrial sites.

Air

Limiting Greenhouse Gas Emissions

Certain of Dalkia’s activities (in particular its combustion installations with thermal output greater than 20 MW) are subject to the provisions of European Directive 2003/87/EC of October 13, 2003, which establishes a quota exchange system for carbon gas emissions. This system has been in place among EU member states since the beginning of 2005. In addition, we are generally contributing to a reduction in greenhouse gas emissions, and have developed an action plan to improve the energy efficiency of our services. The action plan also calls for us to participate actively in the flexibility mechanisms set forth under the Kyoto protocol, which entered into force on February 16, 2005.

Direct greenhouse gas emissions (including biogas discharges) on sites that we managed in 2006 reached 36.5 million tons of CO2 (carbon dioxide) equivalent, due to development of the group’s activities. Given the differing national and international methods for measuring the production and emission of methane at waste landfills, we are unable to provide a reliable measure at this time. We are participating in a working group that is attempting to reconcile the different methods.  We are also contributing to a reduction in CH4 emissions through the implementation of collection and burning systems, as well as biogas recovery systems in its landfills. 64 waste landfills over which we control investments are equipped with collection and biogas recovery systems.

Other Emissions

Installations that we operate mainly emit sulfur and nitrogen oxides (SOX and NOX), carbon monoxide (CO), volatile organic compounds and dust.  The method of calculating emissions of SOX from waste incineration units (hazardous and non-hazardous) was improved in 2006 and allowed us to estimate that these emissions amounted to approximately 106 grams per ton of incinerated waste in 2006.  We are still working towards the development of an indicator for NOX emissions.  For example, Veolia Transportation, in partnership with ADEME, is pursuing a study to identify and assess the market systems capable of reducing the NOX emissions of its buses and coaches.  Dalkia has also been conducting an evaluation program for several years on the various techniques available for reducing emissions (low emission burners, smoke recirculation, air staging, combustion modeling, etc.).

We attempt to reduce our emissions, in addition to complying with regulatory standards, by:

·

enhancing air pollution treatment and developing more effective treatment technologies, including treating smoke from our waste incineration units, enhancing the quality of emissions of our transport vehicles and utilizing low NOx combustion technology in the case of Dalkia’s activities, and


·

reducing consumption and favoring the use of clean fuels, such as fuel oil or low sulfur coal, natural gas, natural gas for combustion installations or vehicles, and electric or dual-mode vehicles.


We have developed a semi-continuous method to monitor emissions of dioxins during waste incineration, allowing for control of the aggregate flow of such pollutants emitted throughout the year.  We offer this reliable and efficient measurement technique to all of our clients.


Noise pollution


We have also developed new treatment and storage techniques for odors, particularly in wastewater treatment plants and landfills for household waste.  We also use new and more silent technologies in some of our installations, including special wall coatings, sound traps and exhaust gas exit silencers for cogeneration installations or transport vehicles. The permanent increase in waste quantities around the world presents major risks for the environment.




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Preserving biological balance, natural environments and protected species

In France, numerous activities fall under the control of either the ICPE (facilities classified for environmental protection) or its equivalent.  Therefore, all business development is conducted in connection with the realization of environmental impact studies concerning very precise facets of flora and fauna.  The control of these impacts therefore comprises a constant preoccupation for our different business operations (waste treatment, decontamination stations, combustion facilities, railway depositories, etc.) In addition, our researchers closely follow the evolution of scientific debates on biodiversity in order to be able to identify the most pertinent indicators in our areas of activity.

Evaluation or certification regarding the environment

Our activities have been subject to environmental certification, both external (ISO) and internal, for a long time.  The number of our ISO 14001 certified sites has increased continuously since 1999.  In addition, we seek to achieve the targets set by our environmental management system on close to 80% for all of our installations, which lead, subject to the circumstances of each of the entities concerned, to the general application of the ISO 14001 certification standards. We currently have 853 sites covered by an ISO 14001 certification.

Compliance with applicable legal and regulatory provisions

Our environmental management system includes, among other things, an environmental audit program that allows us to monitor our sites’ regulatory compliance, as well as their compliance with contractual obligations and group standards. We have defined a general framework to ensure consistency of the audit systems developed by our divisions, and each of our divisions remains responsible for the definition and implementation of its own system.  We surpassed our goal of conducting audits for 80% of priority sites in 2005.  Priority sites are drinking water production sites and urban treatment stations, waste treatment sites, Dalkia’s classified installations and several of Veolia Transport’s transportation centers.  As of December 31, 2006, 80% of our primary facilities were subject to a regulatory compliance audit.  These facilities are the most sensitive to environmental impacts.  As of December 31, 2006, 87% of the primary facilities were subject to a statutory auditing for compliance.

Expenses incurred to preserve the environment

Given the nature of our services, a large majority of our expenditures and investments have a direct impact on the environment. Our industrial investments amounted to €2.197 billion in 2006, which includes not only investments of a contractual nature, but also expenses incurred for research and development, employee training, our certification program and the implementation of our environmental management system.

Internal environmental management services, training and information for employees on the environment, methods for reducing environmental risks and organization for handling accidents that may have public ramifications.

Prevention of environmental risks

In addition to the measures described above to reduce environmental risks, we have established an environmental department.  This department ensures that the objectives and actions of our divisions are consistent, particularly in connection with the implementation of the environmental management system, and encourages information sharing and best practices.  It leads an environmental committee, composed of representatives of all of our divisions and departments (particularly our sustainable development, legal and communication departments).

We have also established crisis management procedures that cover environmental crisis management, including, in particular, on-call and alarm systems at national and international levels that would allow any necessary measures to be taken as soon as possible.

Reserves and guarantees for environmental risks

As of December 31, 2006, our accrued reserves for site remediation amounted to €457.7 million.

Indemnities and damages paid in 2006 for environmental claims pursuant to court orders

Reserves for litigation consummated in 2006 amounted to €105 million, including all types of litigations (fiscal, social and other litigation).

International environmental targets

We apply our Environment Management System, as described above, to nearly 80% of our subsidiaries, in France and outside of France.

Intellectual Property

We own a significant number of patents and trademarks in France and other countries around the world that are of value to our business.  However, we believe that the diversity of our patents and trademarks does not make any of our activities dependent on any one of these patents or trademarks individually.

Moreover, we believe that our activities are not materially dependent on any one license that we may own.  We also believe that we are not materially dependent upon any particular contract or customer.



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Marketing

We market our products and services by continuously offering to provide a more comprehensive range of environmental services to clients.  We often sell our products and services by responding to requests for consultations. These may be highly regulated events when it comes to a public authority conducting a public bid tender, but generally we are able in such situations to take advantage of our reputation and know-how and propose a solution that is best adapted to a client’s needs.  In the absence of a formal bidding procedure, which is generally the rule for commercial clients, we analyze the environmental service needs of prospective clients and demonstrate to them how our services could improve the efficiency of their operations.  See “—  Contracts.” For more information regarding marketing efforts by each of our divisions, see “—  Our Services.”

Seasonality

Because of the diverse nature of our operations and our worldwide presence, our business is typically not subject to material seasonal variations. Our results are only slightly affected globally, with the exception of Veolia Energie (Dalkia), which realizes the bulk of its operating results in the first and fourth quarters of the year, corresponding to periods in which heating is used in Europe. In the water sector, household water consumption and the related treatment services required tend to be more elevated between May and September in the northern hemisphere, where Veolia Eau conducts the majority of its activity.  In transportation, SNCM’s activity is strongest in the summer season.

Raw Materials

Energy prices have fluctuated widely in the past few years.  After rising by over 45 % in 2005, the reference Brent oil price increased by almost 20% in 2006.  Even if prices have started to decrease since the start of the 2007 fiscal year, price fluctuations remain difficult to anticipate.

In 2006, we recorded a net charge of approximately €36 million related to the increase in energy prices (€6 million for Veolia Transport, €13 million for Dalkia, €11 million for Veolia Propreté and €6million for Veolia Eau).  We were able to limit our additional charges to this amount since our contracts typically contain price adjustment and/or indexing provisions designed to compensate us for increases in the cost of providing our services.  Such provisions include indexing clauses that take into account the variation of certain parameters, review clauses in the case of a rise in certain parameters above a given level, hardship clauses (unforeseeable changes due to extraordinary circumstances) or re-equilibrium clauses. These provisions therefore assist us in passing along a portion of any rise in energy or raw material prices to clients (subject to a possible time period in which we would have to await the impact of price adjustment).

In the transportation division, numerous contracts contain indexing clauses that take variations in fuel costs into account, which significantly reduces the impact of a rise or fall in fuel prices. In certain contracts, especially those involving the United States, we are entitled to full compensation in the event of rising fuel prices.

In the waste management division, collection services involving non-hazardous solid and liquid waste are the most sensitive to fluctuations in fuel prices.  However, for clients that have contracts with us, indexing clauses in those contracts generally allow us to pass along a good portion of our increase in such costs in the prices we charge to clients.  For clients not bound by contract, increases in fuel costs are either fully or partially passed along to clients through an updating of tariffs or through commercial negotiation.

In the energy services division, the situation with respect to combustible materials used for activities is similar to the description above. With respect to gas supplies in particular, the deregulation of the market has not altered our use of indexing clauses in our contracts. We have developed the skills necessary to manage and optimize our gas supplies within the new market environment.

Insurance

Objectives of Insurance Procurement Policy

Our insurance procurement policy for all of our operating divisions has the following objectives:

·

maintaining common insurance policies to establish a coherent risk transfer policy and maximize economies of scale, while taking into account the specificities of our businesses and legal or contractual constraints; and

·

optimizing the thresholds and the means for accessing the insurance or reinsurance markets through use of varying deductibles or acceptance of a primary layer of retention through our insurance subsidiary located in Ireland, Codeve Insurance Company Limited.


In 2006, we continued to seek to optimize the amount of insurance premiums we paid to outside insurers.

Implementation of Insurance Procurement Policy

Policy

Our strategy with respect to insurance procurement is to (i) establish a global insurance procurement policy to cover our activities, based on the needs expressed by our subsidiaries in particular, (ii) select and sign contracts with outside providers (brokers, insurers, loss adjusters, etc.), (iii) manage consolidated subsidiaries specializing in insurance or reinsurance coverage, and (iv) lead and coordinate the network of insurance managers present among our principal subsidiaries.



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Implementation

The implementation of an insurance procurement policy aimed at covering risk is effected in coordination with our global risk management process.  Implementation takes into account the insurability of risks related to our activities, by the market availability of insurance and reinsurance, and by the relationship between premiums and the level of coverage, exclusions, limits, sub-limits and deductibles.

We undertook actions in 2006 principally related to:

·

the determination of retention levels on the basis of an analysis of risks and loss history and an evaluation of the costs and coverage proposed by insurers;


·

the continuation of efforts to identify, prevent and protect against risks thanks in particular to a rating system for the “property damage and business interruption” risk profile for our most important facilities;


·

the communication of detailed information regarding our company to the insurance and reinsurance markets;


·

the renegotiation of contracts, in particular to strengthen our civil and pollution liability coverage;


·

extending the adoption of the group’s coverage; and


·

the organization of broker services for placement and administration of our programs.


Main Insurance Policies

Civil Liability

A civil liability and environmental damage program was subscribed to on July 1, 2005, around the world (excluding the U.S. and Canada) for a period of three years.  Principal coverage is up to €50 million per claim and per year. For the U.S. and Canada, different contracts cover civil liability and damage to the environment on behalf of group subsidiaries, based on local conditions, in an amount of up to US$50 million per claim and per year.

For all group subsidiaries worldwide, an insurance program provides excess coverage for up to US$450 million, thereby giving us total coverage of US$500 million throughout the insurance period. This program includes coverage for environmental liability for damage sustained by third parties as a result of a sudden and accidental event.

Finally a civil liability for terrorism policy was subscribed under the civil liability program on July 1, 2006 for total coverage of US $165 million per claim per year.

Further, certain activities, such as a maritime transport, automobile and construction, have their own specific insurance policies.

Property Damages and Business Interruption Policies  

All four of our divisions maintain property damage insurance policies to cover assets that they own as well as those that they operate on behalf of clients.  Some policies, whether or not they are included in our global insurance company provide either “business interruption” coverage or “additional cost of working” coverage depending on such subsidiaries’ exposure and their capacity to use internal or external solutions to ensure service continuity.  These policies contain standard market terms.  The level of premiums, deductibles and sub-limits for exceptional socio-political or natural events reflects the terms proposed, or sometimes imposed, by insurers in the markets in which the risk is underwritten. Group insurance coverage implemented on January 1, 2006 carries a limit per claim of up to €300 million.  Some of this coverage contains further underlying limits per claim or per year.

Self-Insured Retention and Deductibles

For any insured claim or loss, we remain liable for the deductible amount.  The amount may range from several thousand euros to more than one million euros.

In 2006, Codeve Insurance Company Limited has underwritten, our insurance subsidiary, had a conservation (retained risk) of €10 million per claim for property damage and consequent financial losses, and €5 million for insurance of civil liabilities.

Regarding both damages and civil liability, Codeve Insurance Company Limited has put in place reinsurance contracts in order to limit its exposure to frequency risks (“stop loss”-type contracts) and risks tied to intensity (excess claim-type contracts).

In general, the insurance coverage described above constantly evolves as a function of ongoing risk evaluation, market conditions and insurance coverage available. We attempt to have our known accidental or operating risks covered by the insurance markets when this market exists when it is economically feasible to do so. However, we cannot guarantee that we will not suffer damages or losses that are not fully or partially covered by insurance.



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ORGANIZATIONAL STRUCTURE

Our company is divided into four operating divisions corresponding to each of our four business segments and a number of centralized corporate departments that lead and coordinate the actions of teams present in each of the four operating divisions. We believe that this organizational structure encourages the coherent development of our group by reinforcing its identity, maintaining solidarity and cohesion, favoring economies of scale and encouraging professionalism through the sharing of best practices.

See “— History and Development of the Company” for a description of the history of the creation of our organizational structure.

PROPERTY, PLANTS AND EQUIPMENT

We use various assets and equipment in order to conduct our activities, with respect to which we have very different rights.  

We have relatively little real estate that we own outright.  Most of the time, the buildings and installations that we use do not belong to us; instead, their use is governed by fixed-term contracts pursuant to which we agree to provide various services to clients. At the outset of the contract, the client generally grants us the right to use any pre-existing buildings and installations for the duration of the contract. In the event that we initially invest in the construction of certain facilities, the contract generally calls for the facility to be returned to the client or to our successor upon completion of the contract term. During the contract term, we may or may not be the legal owner of assets, depending on the legal system involved, however, we are nearly always responsible for these assets, which we are required to maintain and sometimes rehabilitate.  

We are occasionally the full owner of real property, including industrial installations, in particular for activities undertaken outside global contracts. In our waste management division, for example (CSDUs, storage centers for ultimate waste), and in our energy services (co-generation plants).

We strive not to be the owner of any office buildings. Accordingly, we rent a building located at 36/38, avenue Kléber, 75116, Paris, France that we use as our corporate headquarters.  Our and our divisions’ senior management have maintained their offices in this building since May 2002, where certain central functions are performed.

RESEARCH AND DEVELOPMENT (R&D)

We have identified three main elements in its Research and Development (R&D) strategy relating to the quality of life of populations on a worldwide scale (demographic, urban and energy challenges):  (i) anticipating the needs of clients, (ii) managing security and (iii) promoting environmental protection and preservation.  


R&D plays an important role in the evolution of our business and its business model through our global, yet specialized vision of the environment. The responsibility of R&D is to devise and put in place technological developments which will considerably modify the concepts and the implementation of our businesses in the coming years.


For us, the challenges of tomorrow concerning the environment are industrial challenges in the sense of technological developments. The responsibility of R&D is to identify these industrial challenges and to allow us to stay at the cusp of technological developments.  


In order to respond to today’s problems as well as those of tomorrow, our R&D focuses its efforts on the protection of water resources, future energy sources and the future of transportation, with a budget, means and expertise that will continue to grow into the future.


Research and Development Resources

Research and Development is not simply an objective but also a financial and human commitment, put into place by us to act practically and effectively.

Our R&D activities are overseen by our Research, Development and Technology department, or “Research Department”. In 2006, this department consisted of nearly 700 experts worldwide (including 350 researchers and 350 on-site developers) with a total budget of about €115 million.1

The research department works on behalf of all of our group’s divisions, given that their needs are similar.  In particular, all seek to solve environmental and health problems with the aid of numerous tools, such as modeling and chemical and bacteriological analysis.  By working on behalf of all divisions, the research department helps to ensure a better consistency within the R&D activities with our group’s strategy.

1

For the fiscal year ended December 31, 2006, research costs totaled €66.4 million, which, when added to operational development costs, totaled an estimated budget of  €115 million.



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We have four main research centers in France with branches abroad:

·

The environmental services and energy research center (Creed), based in Limay, with branches in the United Kingdom and Australia;


·

The transportation, environmental and health research center, based in Paris;


·

The water research center,1 based in Maisons-Laffitte, with branches in Germany, the United States and Australia; and


·

The analysis research center, based in Saint-Maurice. The central laboratory, named the Environmental Analysis Center (CAE), has a microbiology and chemistry analysis research laboratory.

We established an international Research and Development correspondent network in 2003 in order to identify and analyze specific local technical development and innovation needs.  Certain research centers abroad have acquired specialized expertise and are partners with centers in France.  These research units help to highlight our technological expertise. In the area of water for example, the Berlin Center of Competence for Water (KompetenzZentrum Wasser) is the reference point for the protection of water resources. Australia has become the reference point for information relating to the recycling of water.

A strategic committee for research, innovation and sustainable development was created by the board of directors of the Company in September 2006. This committee evaluates the long-term Research and Development policies proposed by the relevant departments of the Company and the Group and advises the board of directors of the Company. The committee is informed of important programs and businesses and evaluates the results. In particular, it evaluates the budget and workforce and advises on the allocation of the means and resources and their adequacy for the Group’s strategy in this area.

Main activities in the domains of Research and Development

Our Research and Development focuses on the following seven main areas:


·

Water: preservation of water resources, drinking water (from its production to distribution), water and wastewater treatment (treatment of urban and sediment wastewater, odor treatment) and industrial water.


·

Energy: optimization of energy services, including alternative or renewable energy (fuel cells, the timber industry and solar sensors).


·

Environmental Services: sorting and treatment of waste (incineration, co-incineration and technical landfill sites) and valorization of waste.


·

Transport: logistics, ticketing, monetics, design of a zero emission vehicle, new services linked to public transport (informational systems, for both operator and passenger).


·

Analysis: development of analytical techniques in microbiology and chemistry that are faster and more precise, and improvement of already existing methods.


·

Health: evaluation of risks linked to environmental pollution and the sanitary benefits linked to our businesses, identification of emerging sanitary dangers and establishement of sanitary indicators. The health department is also a recognized partner for public health bodies and institutions such as the Institut de Veille Sanitaire, Direction Générale de la Santé, AFSSE or INSERM.


·

Environment: assessment of the environmental impact of our activities and conduct of our Environmental Management System (follow-up, monitoring and reporting of the Group’s environmental data and contribution to commercial offers).  


Each of these activities helps to anticipate the needs and constraints linked to regulatory changes. For us, the objective of the organization as implemented is not only to satisfy current sanitary and environmental requirements, but also to follow sanitary and environmental authorities concerns which will necessarily impact reglementation in the future.

A network of information experts within the research department manages our group’s scientific and technical information and places at employees’ disposal tools for technical, commercial and regulatory monitoring.

1

The Water Research Center is the historical center of Veolia Eau – Compagnie Générale des Eaux. The European Commission was awarded the “Marie Curie Center of Excellence” label for its membrane, disinfecting and modeling technology. The Anjou research center includes an expert center on membranes (ARAMIS), which evaluates the performance of membranes so as to improve operating conditions.



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Innovation: a rationalized method

The research team aims to provide innovative practical solutions, which are crucial for the competitiveness of our group. Research and Development is driven by a rationalized method allowing technological risks to be mastered, and allowing rapid progress and the creation of successful commercial applications that are both reliable and effective.

The main steps1 in the innovation process are:

·

Strict regulatory, technological and commercial monitoring that enables us to anticipate future needs and proceed with the launch of new research programs as quickly as possible.  Laboratory or field tests are then carried out to verify the feasibility of the research.  At this stage, analytical modeling may be carried out, depending on the circumstances (i.e., exploring functionality and cost containment potential).


·

If the tests are successful, a prototype is built in the laboratory or on site in order to evaluate and refine the technology.


·

The next phase is the development of a pre-industrial unit to be installed on a site and operated by personnel.


For each of the steps in the innovation process, various entities (research teams, university or private laboratories) are called upon to collaborate.

Our researchers are part of an international network of researchers. They forge fundamental links with other research teams, each taking advantage of the expertise of the others. While these collaborations enrich the knowledge of the research group and keep it up to date, they also provide effective prospects for scientific advancement and return on our partners experience. Research and Development also works with several top universities and participates in research programs for national and international institutions. Researchers also shares their technological knowledge with industrial actors.   

Certain principal research themes

Today, new environmental issues, especially in the energy sector, call for the creation of significant and innovative technological solutions. Approximately 30 to 40% of the investment  in Research will henceforth be allocated to a smaller number of programs, with a view to achieving major technological improvements. These different programs will enable us to remain at the forefront of technological developments.

Desalination: a largely available alternative resource  

Several regions around the world consider the desalination of seawater the major method of producing drinking water. Desalination consists of producing fresh water from seawater or brackish water. As a result of difficulties facing countries with water problems (a lack of a fresh water source), this market is being developed in particular for the processes of desalination, which use the membranous process (a process involving reverse osmosis). The main problem facing the membranes is the risk of clogging.

The objective of Research and Development regarding desalination by reverse osmosis relates to the pretreatment of seawater to limit clogging of the membrane and on the reduction in energy consumption in order to further reduce the cost of desalination (which has already been divided by 4 in 10 years) and to contribute to environmentally friendly developments. Research is carried out at the Centre d’Expertise Membrane of our Water Research Center to identify what causes clogging and to recommend solutions regarding the treatment of water. Moreover, a pilot scheme has been installed at the Toulon Cap Sicié site which will allow for the optimization of the filtering process for the pretreatment of seawater. R&D has also developed a pilot platform in the Persian Golf, which will be operational in the second half of 2007, which will allow for the comparison of different pretreatment options and validate new ideas.  

Sorting and Recycling: a strategic step in waste management

Sorting is a strategic step in waste management, and especially in recycling. The efficiency of the treatments and the possibility of revalorization (product, agronomical and energy valorization) is dependent on the quality of sorting. The sorting processes of our group must be optimized, in addition to the separation carried out by cleaners and companies.

Our research aims to automate sorting plants, to secure procedures of waste treatment, and to make the manufacturing and utilization of CSR (Combustibles Solides de Recuperation) viable. A pilot plant reproducing a sorting machine’s conditions has been built on the site at Rillieux-la-Pape (69). This plant has already allowed for a measurement to be taken of the performance of an optical sorting machine in order to research possible improvements and to simulate results.

The European bus of the future: a clean, intelligent and modern bus

Buses must evolve so that passengers are offered a wide range of quality services, adapted to contemporary living. This is indispensable for the reinforcement of a positive image of buses and public transportation. Areas of focus of improvement include new designs (the future European bus program), improving commercial speed (bus lanes, importance of clean sites and buses), air quality improvement (Euro4), decrease in gas consumption (hybridization), and reduction of greenhouse gas emissions.

Over the past five years our research has aimed to define, with several European transport operators, its functional innovations, while maintaining comfort, traveler information, accessibility, driving assistance and maintenance. The results of this research were

1

At each step of the innovation process, researchers implement sophisticated tools, such as digital fluid mechanics.  This technology enables researchers to simulate the running of installations and test a greater number of scenarios to improve efficiency.  Over a shorter period, such software enables researchers to optimize test protocols.



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communicated to constructors with the UITP (Union Internationale de Transports Publics), with Predit (Programme de Recherche et d’Innovation dans les transpors terrestres) and the CEN (Commission Européenne de Normalisation) and has enabled an exchange of ideas with manufactures.

Bioenergy: making waste an energy resource

The use of waste (solid and liquid) as an energy resource represents a concrete solution in conserving fossil fuels and promoting renewable energy sources while minimizing environmental and sanitation risks.


One of our fixed R&D objectives is to develop, evaluate and confirm the viability of bioenergy sources such as a biogas emitted from storage centers, sediment from wastewater treatment plants, biofuel… Thanks to research carried out on food oil waste, SARP Industrie (a subsidiary of Veolia) has implemented a biodiesel project with a production unit of approximately 50,000 t/year.



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ITEM 4A. UNRESOLVED STAFF COMMENTS

Not Applicable.




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ITEM 5.

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

The following discussion of our operations should be read together with our consolidated financial statements and related notes included elsewhere in this report. Our consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS), as issued by the International Accounting Standards Board (IASB) and adopted by the European Union.

Concession contracts are accounted for in the 2006 consolidated financial statements in accordance with IFRIC Interpretation 12, Service Concession Arrangements (IFRIC 12), published in November 2006. This interpretation, which is pending adoption by the European Union following a favorable vote of the EFRAG in March 2007, is applicable to accounting periods commencing on or after January 1, 2008. We have elected early adoption of this interpretation, and the change in accounting method has been applied retrospectively.  As such, our consolidated financial statements as of and for the year ended December 31, 2005, and 2004 have been adjusted accordingly for the retrospective adoption of IFRIC 12.

Unless otherwise indicated, the following discussion relates to our IFRS financial information as adjusted for the retrospective adoption of IFRIC 12.

IFRS differ in certain significant respects from U.S. GAAP. Note 51 to our consolidated financial statements provides a description of the principal differences between IFRS and U.S. GAAP for 2004, 2005 and 2006, as they relate to our company, and reconciles our shareholders’ equity and net income to U.S. GAAP as of and for each of the years ended, December 31, 2004, 2005 and 2006.

The following discussion also contains forward-looking statements that involve risks and uncertainties, including, but not limited to, those described under “Item 3. Key Information–Risk Factors.” Our results may differ materially from those anticipated in the forward-looking statements.  See “Forward-Looking Statements” at the beginning of this document for a more detailed discussion of the risks and uncertainties to which our results and financial condition are subject.

OVERVIEW

Major Developments in 2006

A strong business model

Our strategy of developing environmental services through long-term contracts produced led to significant growth of activities and to an increase in revenue of 11.9% in 2006 compared to 2005.  This growth was accompanied by continued improvements in profitability.  Adjusted operating income increased by 16.7% in 2006 compared to 2005, and adjusted net income attributable to equity holders of the parent increased by more than 20% over the same period.  Total operating income increased by 12.7% in 2006 compared to 2005, and total net income attributable to equity holders of the parent increased by 21.9%.  

Adjusted operating income and adjusted net income attributable to equity holders of the parent are non-GAAP measures used by management to evaluate the performance of our business.  These terms are defined and reconciled to the nearest IFRS measures under “—Presentation of Information in this Section -- Non-GAAP measures” below and the sections referred to therein.

These performances are the result of our decision to grow our business in Europe, Asia and North America for each line of business, and of our ability to generate savings and synergies and to renew contracts.

Increase in synergies between businesses

Our strategic choices have resulted in the acquisition of new Water and Energy contracts, targeted acquisitions aimed at strengthening positions (Environmental Services in Great Britain and Belgium) and the development of new business activities, directly linked to our expertise, such as the acquisition of an interest in SNCM and the signing of a framework agreement with CMA CGM in combined rail transport.

Our ability to generate savings and synergies has resulted in €104 million in new net annual savings in 2006  within the Veolia 2005 efficiency plan.  In total, the efficiency plan generated €406 million in annual savings.  Based on their nature, we expect these savings to continue in the future.  These savings and synergies were completed through programs designed to strengthen our organization.

Forward-looking choices

We believe that our forward-looking choices in terms of training, research and development, give us a strong base for long-term profitable growth.  Thus, in 2006 we decided to accelerate our training programs by deciding to create regional campus in France. We strengthened our research projects through the optimization and the management of resources.



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Commercial success within growth markets

We won several important contracts during 2006:

·

At the beginning of the year, Veolia Eau won a management contract for water services granted by the Prostejov water company, the public water authority of the Moravia Region in the Czech Republic. This is a 25-year contract representing total cumulative revenues for the period of €139 million.  

·

At the end of January, Veolia Eau signed an important partnership agreement with a subsidiary of Sinopec, the largest Chinese refining group. Through this 25-year contract the two entities created a joint venture, which will be managed by Veolia Eau, to ensure the operation collection treatment and recycling of industrial wastewater from the Yanshan site (in the suburbs of Beijing). This joint venture will generate estimated total cumulative revenue of approximately €249 million.

·

On February 9, 2006, Veolia Eau won the management contract for a wastewater facility in the Ajman Emirates (United Arab Emirates). This 27-year contract represents total cumulative revenue of approximately €151 million.

·

On March 16 and 29, 2006, Veolia Transport won two urban and para-transit transport contracts in the United States. The first contract relates to Orange County in California and came into effect July 1, 2006. This three-year contract represents estimated total cumulative revenue of approximately €73 million. The second contract relates to the city of Mesa in Arizona. This is a six-year contract representing estimated total cumulative revenue of €123 million.

·

On April 12, 2006, following an international call for tenders, Veolia Eau won a construction contract for a new seawater desalination plant in Bahrain for a total amount of approximately €255 million. Operations will start between April 2007 and November 2007 for the first two units.

·

In May 2006, Veolia Eau successively won the first two international calls for tenders by the Slovak authorities, both 30-year contracts. The first contract relates to the central region of Slovakia and represents estimated total cumulative revenue for the period of €1.4 billion; the second contract relates to the Poprad region in northern Slovakia and represents estimated total cumulative revenues for the period of €566 million.

·

On June 29, 2006, Veolia Energie won two public-private partnership contracts in Italy for the construction and the management of hospitals. The contracts are for 17 and 30 years respectively, with estimated total cumulative operating and maintenance revenues of €211 million.

·

In July 2006, Veolia Transport won a management contract for public transport in the Limbourg region, in southeast Holland. This 10-year contract, effective as of December 16, 2006, represents total cumulative revenues of approximately €1.1 billion.

·

In early September 2006, Veolia Eau strengthened its position in Asia by winning a new 30-year contract in China for the management of water services in Liuzhou. This contract represents estimated total cumulative revenues of more than €330 million.

·

At the beginning of December 2006, Veolia Eau was selected for two major projects in Australia. For the first project, Veolia Eau will act as consultant to the State of Queensland for the development of all installations and infrastructure, and will then operate these installations. This project, whose completion is anticipated for the end of 2008, represents a global investment of €1 billion for the State of Queensland. The second project relates to the design, construction and management of a desalination by reverse osmosis plant. The plant will be operational as of the end of 2008.

·

In December 2006, Veolia Energie won a public service management contract for district heating for Cergy-Pontoise and its suburbs. This 16-year contract represents total cumulative revenues of €268.7 million.

We also reinforced our position as market leader through targeted acquisitions, generating strength and cost synergies:

·

On January 2, 2006, Veolia Transport carried out the acquisition of Shuttleport, an airport shuttle service, in the United States of America for €28.1 million;

·

In May 2006, Veolia Propreté purchased Biffa Belgium, fourth in the Belgian waste market, for an amount of €62.4 million, reinforcing its development base in Northern Europe and the Benelux countries. Estimated annual sales figures are €85.5 million.



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·

On September 28, 2006, the most important of these transactions was realized with the acquisition of Cleanaway Holding Limited by Veolia Propreté for a price of €745 million. This company operates in Great Britain in the area of municipal and industrial waste collection services and integrated service of waste management. Annual sales figures are estimated at €684 million.

·

On October 19, 2006, Veolia Transport acquired SuperShuttle in the United States (customized transportation for American airports), for €72 million. SuperShuttle’s annual revenues are estimated at €55.2 million.

Development strategy focused on new businesses linked to our commercial expertise

We pursued our development strategy within new businesses linked directly to our expertise:

·

On May 31, 2006, Veolia Environnement, Butler Capital Partners and CGMF signed agreements relating to the Société Nationale Maritime Corse Méditerranée (SNCM).  These agreements were part of a transaction to open SNCM’s capital to outside investment, a decision made by the French government at the beginning of 2005, and the restructuring of the company.  The transaction is still subject to a cancellation clause relating to the European Commission’s agreement on state aid.  Veolia Environnement holds 28.29% of the SNCM’s share capital. As a result of this acquisition, Veolia Transport has significantly strengthened its position as a ship line operator, which has been set up for a few years in northern Europe, in markets with strong growth. This deal represents an investment of €72.2 million.

·

On September 11, 2006, Veolia Transport and Rail Link, a subsidiary of CMA CGM, the third largest freight carrier worldwide, joined together to develop a new European rail transport and sea freight container company.  This partnership creates two new distinct companies:  a combined transport operator with a mission to organize and market the transport of freight containers between the harbor and the industrial site of the final client, and a railway company that combines industrial means and ensures rail transport of the freight containers.  These two companies will be operational by the end of 2006, with anticipated cumulative revenues for 2010 of approximately €100 million for combined transport operations and approximately €50 million for the railway company.

·

At the end of November 2006, the Total and Veolia Environnement groups joined together to construct and operate an oil recycling plant in France, through their joint subsidiary Osilub. This project is part of the sustainable development programs for both companies and contributes to the optimization of the life of industrial products and preserves non-renewable natural resources.

·

In 2006, Dalkia opened a biomass center in the Lithuanian capital through which Vilniaus Energija reduces its dependence on fossil energy and encourages local development. The Vilniaus Enegija networks boiler is the largest biomass installation built by Dalkia.  

The thorough review of assets continued in 2006

During the 2006 fiscal year we carried out a review of our assets and proceeded with several total or partial sales, without affecting our operating capacities:

·

During the first quarter of 2006, the Energy Services division disposed of 34% of the company that holds the Lodz contract to the IFM (Industry Funds Management) for a price of €70.0 million.

·

On April 10, 2006, Veolia Environnement disposed of its interest in Southern Water to Southern Water Capital Limited, the major shareholder of Southern Water. The total amount of the transaction was €89.6 million net of the exercise of the put option.

·

On June 1, 2006, the European Bank for Reconstruction and Development (EBRD) took a 35% interest in Veolia Transport Central Europe GmbH, which groups together the activities of Veolia Transport in Central and Eastern Europe, for an amount of €59.8 million.

A thorough review of assets has also led us to take measures to ensure better efficiency:

·

We decided to dispose of the Transportation Division’s Danish business, which will occur occurred in 2007, and recorded an impairment charge in respect of assets for an amount of €44 million.

·

Difficulties encountered with a contract in Germany within the Transportation business resulted in asset impairments and provisions of €86 million.



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Presentation of Information in this Section

Definition of “organic” and “external” growth

As used in this report, the term “organic growth” includes growth resulting from new contracts won, the expansion of existing contractual arrangements through increases in prices and/or volumes delivered or processed, and the acquisition of operating assets attributed to a particular contract or project.  

The term “external growth” relates to growth resulting from acquisitions (net of divestitures) of entities that hold multiple contracts and/or assets used in one or more markets.

Discontinued Operations

In accordance with IFRS 5, we record income and loss from our discontinued operations on a separate line in our consolidated income statement.   “Net income (loss) on discontinued operations” is the total of income and expenses, net of tax, related to lines of businesses sold or in the process of being sold. It is the income or expense generated over the period by the assets and liabilities included in the specific, balance-sheet line items “Non-current assets held for sale” and “Non-current liabilities held for sale.”

Non-GAAP Measures

We use a number of non-GAAP financial measures to manage our business and to supplement our financial information presented in accordance with IFRS.  Non-GAAP financial measures exclude amounts that are in the nearest IFRS measures, or include amounts that are not in the nearest IFRS measures.  We discuss below the non-GAAP financial measures that we use, the reasons why we believe they provide useful information and the location in this Section where they are reconciled to the nearest IFRS measures.  You should not place undue reliance on non-GAAP financial measures or regard them as a substitute for the nearest IFRS measures.  Further, these non-GAAP financial measures may not be comparable to similarly titled measures used by other companies.

The non-GAAP financial measures that we use in this Section are the following:

Adjusted operating income” and “adjusted net income attributable to equity holders of the parent” are equal to operating income and net income attributable to equity holders of the parent, respectively, adjusted to exclude the impact of impairment charges and certain items that are “non-recurring.”   An item is “non-recurring” if it is unlikely to recur during each period and if it substantially changes the economics of one or more cash-generating units.  We do not classify an item as “non-recurring” if the nature of the relevant charge or gain is such that it is reasonably likely to recur within two years, or there was a similar charge or gain within the prior two years.  We believe that adjusted operating income and adjusted net income attributable to equity holders of the parent are useful measurement tools because they show the results of our operations without regard to:

·

impairment charges, which we record when we determine that the value of a cash generating unit is less than its carrying value (as discussed under “—Critical Accounting Policies – Asset Impairment”), and which are different from our other items of revenues and expenses used to determine operating income as they depend on management’s assessment of the future potential of a cash generating unit, rather than its results of operations in the period in question, and

·

non-recurring items,w hich by their nature are unlikely to be indicative of future trends in our results of operations.  


In addition, we use adjusted operating income as a tool to manage our business, for purposes of  evaluating our performance, allocating resources internally and as one factor in determining the variable compensation of our senior executives.  See “Item 6. Directors, Senior Management and Employees – Compensation.” “Adjusted operating income” and “Adjusted net income attributable to equity holders of the parent” are reconciled to operating income and net income attributable to equity holders of the parent, in each case for the years ended December 31, 2005 and 2006, under “—Results of Operations – Year ended December 31, 2006 compared to Year ended December 31, 2005.”  

 “Net financial debt,” which represents gross financial debt (long-term borrowings, short-term borrowings, bank overdrafts), net of cash and cash equivalents and excluding revaluation of hedging instruments.  We use net financial debt as an indicator to monitor our overall liquidity position, and as one factor in determining the variable compensation of our senior executives.  Our net financial debt is reconciled to our gross financial debt in “—Liquidity and Capital Resources – Sources of Funds – Financings.”

 “ROCE” or “Return on Capital Employed” is a measurement tool that we use to manage the profitability of our contracts globally and to make investment decisions.  ROCE is the ratio of (i) our results of operations, net of tax, and our share of net income of associates excluding revenue from operational financial assets, divided by (ii) the average amount of capital employed in our business during the same year.  Each of these terms is defined, and is reconciled to the nearest IFRS measure, under “—Liquidity and Capital Resources – Capital Expenditures – Return on Capital Employed (ROCE).”

Critical Accounting Policies

We prepare our consolidated financial statements in conformity with IFRS as published by the IASB and adopted by the European Union (with the exception of IFRIC 12, which we have chosen to adopt early pending its approval by the European Union). Our consolidated financial statements are affected by the accounting policies used and the estimates, judgments and assumptions made by management during their preparation. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the periods presented.



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The principal significant estimates and assumptions made by management during the preparation of our consolidated financial statements relate to the accounting policies used in connection with pension liabilities, asset impairment, deferred taxes and derivative financial instruments.

Pension Liabilities  

We maintain several pension plans, and measure our obligations under these plans using a projected unit credit method, which requires to estimate our employees turnover, expected future changes in employees’ compensation and the present value of our liability on the basis of the appropriate discount rate for each country in which we maintain a pension plan.  As a result, we record pension-related assets or liabilities in our accounts and record the related net expenses over the estimated term of service of our employees.

In accordance with IFRS requirements, we use market yields of high quality corporate bonds with a maturity similar in duration to the pension liabilities to determine the discount rate at the balance sheet date when available.  If no such market yields are available, then we use the yields on government bonds with a maturity similar in duration to the liabilities. We estimate future compensation based on inflation rates estimated using a combination of the spread between index linked and non-index linked bonds, current inflation rates, and published statements of central banks and economists with respect to inflation prospects. We use mortality tables published by national statistical agencies in our evaluations, reviewed periodically to ensure that the latest available tables are being used.  The assumptions used to measure our pension liabilities as of December 31, 2006 are described in Note 34-c to our consolidated financial statements.

As of December 31, 2006, a 1% increase in the discount rate would have decreased our aggregate pension benefit obligation by €248 million and our current service costs by €8 million.  A 1% decrease in the discount rate would have increased the benefit obligation by €300 million and the current service costs by €11 million.

As of December 31, 2006, a 1% increase in the inflation rate would have increased our aggregate pension benefit obligation by €310 million and our current service costs by €11 million.  A 1% decrease in the inflation rate would have decreased the benefit obligation by €251 million and the current service costs by €8 million.

Asset Impairment

We perform an annual review of our goodwill and other intangible assets during our long-term planning in mid-year, or more frequently when there is an indication of an impairment loss. If the long-term prospects of an activity appear durably downgraded, we estimate the value of the impairment based either on the fair value less selling costs of the assets related to this activity in cases where we decide to dispose of the activity, or on the higher of fair value less selling costs or value in use, in cases where we decide to retain the activity.  We then record a one-time write-off or write-down of the carrying value of our goodwill to bring it in line with our estimates.    

When we use fair value less selling costs, we estimate the fair value based on earnings multiples appearing in brokers’ reports or on published information regarding similar transactions.  Our estimate could be significantly different from the actual sales price that we could receive in connection with the disposal of the activity.  In addition, actual selling costs could be greater or less than our estimate.

When we use the discounted future cash flows method to estimate value in use, we estimate future cash flows of business units known as “cash generating units,” and we apply a discount rate to the estimated future cash flows.   A cash-generating unit is generally a business segment (i.e., water, waste, energy or transport) in a given country.  Our future cash flow estimates are based on the forecasts in our latest long-term plan, plus an appropriate growth rate applied after the period covered by the plan.   The discount rate is equal to the risk free rate plus a risk premium weighted for business-specific risks relating to each asset, cash-generating unit or group of cash-generating units.  

As of December 31, 2006, a 1% increase in the discount rate applied to each cash generating unit would have resulted in an increased goodwill impairment charge of approximately €240 million euros, and a 1% decrease in the perpetual growth rate applied to each cash generating unit with a perpetual growth rate of at least 2% would have resulted in an increased goodwill impairment charge of approximately €55 million euros.   

Deferred Taxes  

We recognize deferred tax assets for deductible temporary differences, tax loss carry-forwards and/or tax credit carry-forwards.  We recognize deferred tax liabilities for taxable temporary differences. We adjust our deferred tax assets and liabilities for the effects of changes in tax laws and rates on the enactment date. Deferred tax balances are not discounted.

A deferred tax asset is recognized to the extent that we are likely to generate sufficient future taxable profits against which the asset can be offset. Deferred tax assets are impaired to the extent that it is no longer probable that sufficient taxable profits will be available.

Derivative Financial Instruments

We use various derivative instruments to manage our exposure to interest rate and foreign exchange risks resulting from our operating, financial and investment activities. Certain transactions performed in accordance with our management policy do not satisfy hedge accounting criteria and are recorded as trading instruments.

Derivative instruments are recognized in the balance sheet at fair value. Other than the exceptions detailed below, changes in the fair value of derivative instruments are recorded through the income statement. The fair value of derivatives is estimated using standard valuation models which take into account active market data.



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Derivative instruments may be classified as one of three types of hedging relationship: fair value hedge, cash flow hedge or net investment hedge in a foreign operation:

·

a fair value hedge is a hedge of exposure to changes in fair value of a recognized asset or liability, or an identified portion of such an asset or liability, that is attributable to a particular risk (in particular interest rate or foreign exchange risk), and could affect net income for the period;

·

a cash flow hedge is a hedge of exposure to variability in cash flows that is attributable to a particular risk associated with a recognized asset or liability or a highly probable forecast transaction (such as a planned purchase or sale) and could affect net income for the period;

·

a net investment hedge in a foreign operation hedges the exposure to foreign exchange risk of the net assets of a foreign operation including loans considered part of the investment (IAS 21).

An asset, liability, firm commitment, future cash-flow or net investment in a foreign operation qualifies for hedge accounting if:

·

the hedging relationship is precisely defined and documented at the inception date;

·

the effectiveness of the hedge is demonstrated at inception and by regular verification of the offsetting nature of movements in the market value of the hedging instrument and the hedged item. The ineffective portion of the hedge is systematically recognized in financial items.

The use of hedge accounting has the following consequences:

·

in the case of fair value hedges of existing assets and liabilities, the hedged portion of these items is measured at fair value in the balance sheet. The gain or loss on remeasurement is recognized in the income statement, where it is offset against matching gains or losses arising on the fair value remeasurement of the hedging financial instrument, to the extent it is effective;

·

in the case of cash flow hedges, the portion of the gain or loss on the fair value remeasurement of the hedging instrument that is determined to be an effective hedge is recognized directly in equity, while the gain or loss on the fair value remeasurement of the underlying item is not recognized in the balance sheet. The ineffective portion of the gain or loss on the hedging instrument is recognized. Gains or losses recognized in equity are released to the income statement in the same period or periods in which the assets acquired or liabilities impact the income statement;

·

in the case of net investment hedges, the effective portion of the gain or loss on the hedging instrument is recognized in translation reserves in equity, while the ineffective portion is recognized in the income statement. Gains and losses recognized in translation reserves are released to the income statement when the foreign operation is sold.

Accounting for concessions

Concession agreements are accounted for in accordance with IFRIC12, “Service Concession Arrangements” published in November 2006.  This interpretation, which is pending adoption by the European Union following a favorable vote by the EFRAG in March 2007 is applicable starting January 1, 2008.  We elected to adopt IFRIC12 early, and this new accounting method was treated retrospectively in accordance with IAS8 concerning changes in accounting principles.  As a result, our financial statements as of and for the year ended December 31, 2005 were also adjusted so as to take into account retrospectively the adoption of IFRIC12.

The application of IFRIC 12 is complex and is described in detail in Note 1.20 to our consolidated financial statements.  As a general matter, a contract is considered a concession agreement under IFRIC 12 if a public sector customer (the “grantor”) controls or regulates the services that we must provide with the infrastructure that we use, to whom the services must be provided and at what price, and if the grantor controls a significant residual interest in the infrastructure.  Pursuant to IFRIC 12, the infrastructure used in a concession is not considered to be part of our property, plant and equipment, but instead we recognize financial assets or intangible assets (depending on the nature of our payment rights) in respect of the concession contracts.  



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U.S. GAAP Reconciliation

Our consolidated financial statements have been prepared in accordance with IFRS, which differs in certain respects from U.S. GAAP. The following table shows our net income (loss) and shareholders’ equity under IFRS (adjusted for IFRIC 12 for 2004 and 2005, in the case of the IFRS figures) and U.S. GAAP for the periods indicated:  

 

At and for the year ended

December 31,

 

————

————

————

(millions of euros)

2006

2005
(IFRS adjusted)

2004
(IFRS adjusted)

 

————

————

————

Net Income (Loss)

   

IFRS

758.7

622.2

389.8

U.S. GAAP

732.1

555.7

145.2

    

Shareholders’ Equity

   

IFRS

4,360.8

3,790.2

3,211.2

U.S. GAAP

3,177.8

2,832.9

2,255.5


The most significant items in reconciling our shareholders’ equity under IFRS and U.S. GAAP in 2006, as reflected in Note 51 to our consolidated financial statements, were:

·

goodwill recorded at market value in connection with the transfer of certain subsidiaries and affiliates to our group in 1999 by Vivendi, our former parent company. Under U.S. GAAP, assets relating to these transfers were recorded at Vivendi’s historical cost basis. In addition, under IFRS, goodwill has not been amortized since January 1, 2004, while under U.S. GAAP goodwill has not been amortized since January 1, 2002.  The net effect on goodwill amounted to (€979.6) million at December 31, 2006;

·

amortization of tangible assets by component under IFRS, which has an effect of (€252.0 million);

·

provisions including contractual commitments and significant provisions for onerous contracts whose recognition criteria are different, the impact on shareholders’ equity amounted to € 187.1 million at December 31, 2006;

·

some contracts are recorded under IFRS in accordance with IFRIC4 "Determining whether an arrangement contains a lease" or IFRIC12 "Service Concession arrangements". Under U.S. GAAP, Emerging Issues Task Force (EITF) 01-08 “Determining whether an arrangement contains a lease” is applied for contracts entered into or significantly modified after January 1, 2004. Under U.S. GAAP, IFRIC12 is not recognized. The impact on shareholders' equity amount to (€109.7) million at December 31, 2006 for IFRIC 4 and (€81.9) million; for IFRIC12;

·

difference in accounting for of pensions plans and share based compensation. The difference between IFRS and U.S. GAAP amounted to  (€37.5) million.

The most significant items in reconciling our net income (loss) under IFRS and U.S. GAAP in 2006, as reflected in Note 51 to our consolidated financial statements, were:

·

tangible asset components for (€45.1) million;

·

pension plans and stock options for (€34.1) million;

·

changes resulting from analysis under IFRIC 4 and EITF 1.08 of (€21.8) million;

·

income tax for €105.9 million.


For a more detailed discussion of the significant differences between IFRS and US GAAP as applied to our company, see Note 51 to our consolidated financial statements.



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RESULTS OF OPERATIONS

Year ended December 31, 2006 compared to year ended December 31, 2005

The following discussion compares our results of operations in 2006 with our adjusted results of operations (reflecting the retroactive application of IFRIC 12 accounting for concessions) in 2005.  In addition, following a decision taken in 2006 to dispose of the Danish business of the Transportation Division in 2007, the results of this business were classified as discontinued operations in accordance with IFRS5 addressing activities held for sale, and the accounts for 2005 were adjusted accordingly.  The disposal of Southern Water was also treated according to IFRS5, and the accounts for 2005 were adjusted accordingly.

Revenue

Overview

Our consolidated revenue for the year ending December 31, 2006 grew 11.9% to €28,620.4 million, compared to €25,570.4 million for the year ended December 31, 2005. Organic growth was 8.1%.

External growth of 3.8% was primarily the result of acquisitions made by Veolia Transport in France and the United States (a combined contribution of around €443 million) and Veolia Propreté in the United Kingdom (a contribution of around €215 million). Revenue from outside France stood at €15,217.4 million, or 53.2% of the total, compared with 51.3% in 2005.

The currency effect was neutral, with a weakening of the U.S. dollar (negative impact of €53.5 million) offset by a strengthening of the Czech koruna (positive impact of €44.7 million).

The following table shows a breakdown of our revenue:

2006

(in € millions)

2005 adjusted

(in € millions)

% change 2006/2005

of which organic growth

of which external growth

of which currency fluctuation

28,620.4

25,570.4

11.9%

8.1%

3.8%

-


The following table shows a breakdown of our revenue by division:


(in € millions, except for %)

2006

2005 (adjusted)

% change 2006/2005

    

Water

10,087.6

9,134.2

10.4%

Environmental Services

7,462.9

6,748.7

10.6%

Energy Services

6,118.4

5,463.6

12.0%

Transportation

4,951.5

4,223.9

17.2%

Total revenue

28,620.4

25,570.4

11.9%

Total revenue at constant 2005 exchange rate

28,631.0

25,570.4

11.9%


Water


The following table shows a breakdown of our revenue within the water division:


2006

(in € millions)

2005 adjusted

(in € millions)

% change 2006/2005

of which organic growth

of which external growth

of which currency fluctuation

10,087.6

9,134.2

10.4%

9.1%

1.2%

0.1%


In France, organic revenue growth was 3.6%, excluding Veolia Water Solutions & Technologies, due to a good performance of the distribution businesses as well as further growth in the water network building and renovation business.

Outside France, excluding Veolia Water Solutions & Technologies and Proactiva, revenue grew 13.6% (11.8% at constant scope and exchange rates).  In Europe, revenue growth of 11.4% was driven by the start-up of new contracts, in particular in Germany (the Braunschweig municipal contract), in the Czech Republic (Hradec Kralove and Prostejov) and in Slovakia (Poprad and Banska Bystrica). In the Asia-Pacific region, strong revenue growth of 36.2% (of which 26.9% was organic growth) was mainly driven by new contracts signed in China (Hohhot, Changzhou, Kunming and Urumqui in the municipal sector). External growth in this region was the result of Veolia Water’s increased stake in the Adelaide contract in Australia and small acquisitions in Japan. We are continuing  our expansion in Africa and the Middle East where growth exceeded 12%. In North America, revenue grew 6.7% for the full-year on a like-for-like basis.  



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Veolia Water Solutions and Technologies posted revenue growth of 17.8% at constant scope and exchange rates, driven in particular by a sharp upturn in the engineering and construction businesses in France, the Middle East and the United States.  Including acquisitions made during the year, revenue growth totaled 21.8%.

Environmental Services


The following table shows a breakdown of our revenue within the Environmental Services (waste management) division:


2006

(in € millions)

2005 adjusted

(in € millions)

% change 2006/2005

of which organic growth

of which external growth

of which currency fluctuation

7,462.9

6,748.7

10.6%

7.6%

3.5%

(0.5)%


In the Environmental Services (waste management) business, revenue in France grew 4.1% (of which 3.7% was organic growth), driven by the combined effect of the growing contribution of new incineration plants and the increased tonnages of solid waste collected and treated under high value added service contracts.

Outside France, excluding Proactiva, organic growth was 10.8%. It was particularly strong (13.2%) in the United States in all business lines. In the United Kingdom, overall growth totaled 34.2% (of which 6.9% was organic growth), driven by the acquisition of Cleanaway UK, completed on September 28, 2006 and by the general development of the business within a growing market. In Asia, the start-up of the Foshan and Guanghzou-Likeng contracts made a significant contribution to revenue growth of 14%.

Energy Services


The following table shows a breakdown of our revenue within the energy services division:


2006

(in € millions)

2005 adjusted

(in € millions)

% change 2006/2005

of which organic growth

of which external growth

of which currency fluctuation

6,118.4

5,463.6

12.0%

10.0%

1.5%

0.5%


Our Energy Services division generated revenue of €6.1 billion in 2006, an increase of 12% over 2005, of which 10% was organic growth. The full-year impact of the rise in energy prices was €260 million, of which €226 million was realized during the first nine months of 2006.  The fourth quarter represents a new heating season, during which prices stabilized or declined compared to the first three quarters, although our Energy Services business continued to grow during this period.  Excluding the full year price effect, organic revenue growth was 7.2%.

The business was subject to contrasting weather conditions over the course of the year.  While the beginning of the year had experienced more harsh temperatures than the average, the end of the year, on the contrary, was warmer than the seasonal standards.

In France, organic growth of 8.2% resulted primarily from the increase in energy prices in the first quarter of the year, the start-up of new contracts and an upturn in the engineering business.

Outside France, revenue growth totaled 17.0% of which 12.6% was organic growth. It was primarily driven by the full effect of the Lodz contract (Poland), favorable pricing in Central Europe as well as acquisitions in Italy and Brazil.

Transportation


The following table shows a breakdown of our revenue within the transportation division:


2006

(in € millions)

2005 adjusted

(in € millions)

% change 2006/2005

of which organic growth

of which external growth

of which currency fluctuation

4,951.5

4,223.9

17.2%

4.7%

12.9%

(0.4)%


In France, revenue growth was 12.7%, driven by the contribution of SNCM (2006 revenue contribution of approximately €200 million). The end of the Toulouse contract was offset by the positive impact of new contracts in the field of urban and intercity transit systems, and by the good performance of other business lines.

Outside France, revenue advanced by 20.4% of which 7.6% was organic growth. External growth was mainly due to acquisitions made in the United States (ATC and Shuttleport) and in Norway (Helgelandske).



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Revenue by geographical region


The following table shows a breakdown of our revenue by geographical region:


(€ millions, except %)

2006

2005

(adjusted)

% change
2006/2005

France

13,403.0

12,439.2

7.7%

United Kingdom

2,186.8

1,727.1

26.6%

Germany

1,992.9

1,817.3

9.7%

Other European countries

5,317.9

4,708.6

12.9%

United States

2,650.3

2,183.3

21.4%

Oceania

931.4

878.0

6.1%

Asia

770.9

597.3

29.1%

Rest of the world

1,367.2

1,219.6

12.1%

Revenue

28,620.4

25,570.4

11.9%


France

In France revenue growth of 7.7% was driven by Veolia Energie as a result of rising energy prices (an impact of 5.5% in the revenues of Veolia Energie France), by Veolia Eau as a result of continued strong growth in the engineering and construction sectors as well as continued solid results of the distribution business, by Veolia Propreté due to the combined effect of the increased efficiency of incineration plants and the increase in tonnage of solid waste collected and treated under high value-added service contracts and by the acquisition of SNCM by Veolia Transport.

United Kingdom

The strong growth of 26.6% in the United Kingdom resulted from the acquisition of Cleanaway UK (three month effect), the full impact of the acquisition of Shanks in 2005 by the Environmental Services division, Veolia Énergie due to commercial development and an increase in energy prices, and the impact of five-year tariff reviews at Veolia Eau in 2005.

Germany

Growth in Germany was 9.7%, largely due to new contracts, particularly the contract between Braunschweig and Veolia Eau for a wastewater plant and rail transport contracts (Nordharz-Netz and Marschbahn).  

Other European countries

The 12.9% growth in revenues was due to full-year effect of the Lodz contract in Poland and to the impact of prices in the Energy Division, as well as new contracts and small acquisitions in our other sectors.

United States

Growth in the United States, 21.4% overall, was particularly significant in Veolia Propreté’s business and in Veolia Transport due to the impact of recent developments, including the acquisitions of ATC and Shuttleport, and the signing of new contracts.  

Oceania

Growth of 6.1% in the Oceania region was due to the signing of new contracts in 2005 within Veolia Propreté and sustained activity within Veolia Transport.

Asia

Growth in Asia was 29.1%, which was due to recent developments in Veolia Eau (contracts in China and acquisitions in Japan) and to the start of new contracts for Veolia Propreté.



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Rest of the world

Growth in the rest of the world was 12.1%, marked by the continued growth of Veolia Eau in North Africa and the Middle East.

Operating Income


Overview


Our operating income increased by 12.7%, from €1,892.9 million in 2005 to €2,132.9 million in 2006. The following table shows a breakdown of our operating income by division:

 (in € millions, except %)

2006

2005 (adjusted)

% change

Water

1,160.6

1,002.3

15.8%

Environmental Services

648.3

543.6

19.3%

Energy Services

377.7

315.3

19.8%

Transportation

13.6

116.8

(88.3)%

Holding companies

(67.3)

(85.1)

20.9%

Total

2,132.9

1,892.9

12.7%

Total at constant 2005 exchange rate

2,126.8

1,892.9

12.4%


As discussed above under “Presentation of Information in this Section – Non-GAAP Measures,” we use adjusted operating income, in addition to operating income, to evaluate our results of operations and otherwise as a management tool.  The following table shows a breakdown of our adjusted operating income by division:

(in € millions, except %)

2006

2005 (adjusted)

% change

Water

1,163.4

997.1

16.7%

Environmental Services

648.3

553.6

17.1%

Energy Services

377.7

321.2

17.6%

Transportation

100.1

116.8

(14.3)%

Holding companies

(67.3)

(85.1)

20.9%

Total

2,222.2

1,903.6

16.7%

Total at constant 2005 exchange rate

2,216.1

1,903.6

16.4%


The following tables provide a reconciliation of adjusted operating income to operating income for 2005 and 2006:


2006

Total Operating
Income

Adjustments

Adjusted

Operating Income

(€ millions)

Impairment

Other

Water

1,160.6

2.8

-

1,163.4

Environmental Services

648.3

-

-

648.3

Energy Services

377.7

-

-

377.7

Transportation

13.6

86.5

-

100.1

Holding companies

(67.3)

-

-

(67.3)

Total

2,132.9

89.3

-

2,222.2


2005 (adjusted)

Total operating
income

Adjustments

Adjusted operating income

(€ millions)

 Impairment

Other

Water

1,002.3

(5.2)

-

997.1

Environmental Services

543.6

10.0

-

553.6

Energy Services

315.3

4.7

1.2

321.2

Transportation

116.8

-

-

116.8

Holding companies

(85.1)

-

-

(85.1)

Total

1,892.9

9.5

1.2

1,903.6


Operating income grew by 12.7% in 2006 compared to 2005, or by 12.4% at constant exchange rates. Adjusted operating income grew by 16.7%, or by 16.4% at constant exchange rates.  The increases reflect primarily growth in our revenues and overall business and, in the case of adjusted operating income, an increase in margins resulting from the factors described in the division-by-division analysis below, as well as the continued benefits of our “Veolia Environnement 2005” efficiency plan, which resulted in selling, general and administrative expenses declining from 11.3% of revenues in 2005 to 10.9% of revenues in 2006.  Restructing costs increased marginally in 2006 compared to 2005, while capital gains on asset sales decreased marginally.



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Operating income in 2006 represented 7.5% of revenues compared to 7.4% in 2005.  Adjusted operating income represented 7.8% of revenues in 2006 and 7.4% in 2005.  In 2006, the only adjustments between operating income and adjusted operating income were impairment charges, primarily resulting from difficulties with a German contract in the Transport division (as discussed below).  In 2005, our impairment charges related to Environmental Services activities in Israel and Sterience in the Energy Services division.  We also recorded negative goodwill in the Water division.  

Water


Operating income from the Water division totaled €1,160.6 million in 2006, a 15.8% increase from €1,002.3 million recorded in 2005. Adjusted operating income grew by 16.7%, or by 16.3% at constant exchange rates.

In France, the distribution and waterwork businesses performed well, boosting operating income, which also benefited from the continuing implementation of the program to improve operating performance.

Outside France, we recorded an increase in operating income that resulted from developments of the Stadtwerke in Braunschweig (including a positive adjustment to fair market value of an electricity supply contract), and from the beginning of new contracts in China and the impact of BOT contracts in Brussels and The Hague.  In addition, the effect of contractual price increases, including in the United Kingdom, Central Europe, Romania and Morocco, had a positive impact on operating income. Finally, engineering and technology solutions took another step toward recovery.

The ratio of adjusted operating income to revenue from ordinary activities increased by 0.6 points, from 10.9% in 2005 to 11.5% in 2006.  The ratio of operating income to revenue from ordinary activities increased from 11.0% in 2005 to 11.5% in 2006.

Environmental Services


Operating income from the Environmental Services division increased by 19.3%, from €543.6 million in 2005 to €648.3 million in 2006.

In France, operating income increased as a result of an increase in volume, primarily in the incineration sec tor and in the landfill business.

Outside France, we recorded an increase in operating income, which was was especially strong in the UK market due to the integration of Cleanaway United Kingdom in the fourth quarter of 2006 and the strong performance of integrated waste management contracts.  In the United States, the operating margin noticeably increased in the industrial services that are experiencing strong growth and in the solid waste activities due to increased prices.

The ratio of adjusted operating income to revenue increased from 8.2% in 2005 to 8.7% in 2006. The ratio of operating income to revenue from ordinary activities increased from 8.1% in 2005 to 8.7% in 2006.

Energy Services


Operating income from the Energy Services division increased by 19.8%, from €315.3 million in 2005 to €377.7 million in 2006. At constant exchange rates adjusted operating income grew by 16.2%.

In France, profitability benefited from improvements in construction activities (both the level of activity and better efficiency). Given the overall balanced nature of the contract portfolio, the rise in energy prices had only a slight effect on profitability. As in 2005, rising gas prices have caused the selling prices of electricity produced through co-generation to reach their ceiling. This phenomenon had limited effect, and the opportunity loss was offset by an upturn in energy management margins on other contracts and by the sale of surplus greenhouse gas emission rights generated by activities.

In the rest of Europe, we recorded a strong rise in operating income in Central European countries that resulted notably from prices and a favorable climate in the Czech Republic and Poland and from the commencement of new contracts, such as the Lodz contract. A decrease in profit margin recorded in various countries following the increase in gas prices was more than offset by the sale of surplus greenhouse gas emission rights generated by activities.  

Given these items, the ratio of adjusted operating income to revenue increased, from 5.9% in 2005 to 6.2% in 2006.  The ratio of operating income to revenue from ordinary activities increased from 5.8% in 2005 to 6.2% in 2006.

Transportation


Operating income from the Transportation division was €13.6 million in 2006, compared to  €116.8 million in 2005. Due to persistent difficulties relating to a contract, Veolia Transport carried out a review of its activities in Germany and accounted for losses of €86.5 million, which were classified as non-recurring.  Excluding this non-recurring item, operating income decreased by 14.3% (14.5% at constant exchange rates) to €100.1 million.

In France, the profitability of the Passengers Transportation business is improving, resulting mainly from interurban activities and services in Ile de France, as well as the integration of the SNCM, whose results conform to expectations from its privatization.  



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Outside France, solid performances were recorded in the Benelux countries and Australia.  Operating income was also affected by acquisitions in North America, particularly ATC and Shuttleport, and by a dilution profit of €18.7 million resulting from the EBRD’s acquisition of an interest in Central European activities.

Because of the negative impact of rising energy prices, the ratio of adjusted operating income to revenue decreased from 2.8% in 2005 to 2.0% in 2006. The ratio of operating income to revenue from ordinary activities declined from 2.8% in 2005 to 0.3% in 2006.

Finance costs, net


Finance costs, net, decreased from €710.7 million in 2005 to €701.0 million in 2006.  Finance costs, net represent the cost of gross financial fair value debt, including profit and loss on related interest rate and exchange rate hedging, less income on cash and cash equivalents.  The following table shows a breakdown of our finance costs, net:


(€ millions)

2006

2005
(adjusted)

Income

82.8

63.3

Expense

(783.8)

(774.0)

Total finance costs, net

(701.0)

(710.7)


In 2006, the financing rate, defined as the ratio between the cost of net financial debt (equal to finance costs, net, excluding fair value adjustments to non-qualifying for hedge instruments) to average net indebtedness (based on a quarterly weighted average), was stable at 5.07% in both 2005 and 2006.

This stability, which was maintained despite an increase in short-term euro interest rates, was due to the increase in the portion of fixed rate debt in our indebtedness and the maturity of certain high interest rate debt.  The €26 million redemption premium paid in 2005 in connection with the redemption fo €1,150 million of convertible bonds was not included in the 2005 financing rate, although the relatively low interest rate did affect the 2005 financing rate.

In addition, fair value adjustments on derivative instruments not qualifying for hedge accounting totaled €6.4 million, compared to €10.1 million in 2005. These adjustments, which are calculated in accordance with IAS 39 and which depend on market conditions at the end of the period, are highly volatile in nature.




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Other Financial Income and Expenses


The following table shows a breakdown of our other financial income (expenses):


(€ millions)

2006

2005
(adjusted)

Loan income

29.9

37.0

Dividends

9.7

6.5

Foreign exchange gains (losses)

(14.3)

14.3

Financial provisions

(8.4)

24.2

Other income (expenses)

(50.9)

(53.9)

Total

(34.0)

28.1


Other net financial income and expenses were positive €28.1 million in 2005 and negative €34.0 million in 2006.  The decline in other financial income and expenses principally resulted from the impact of the foreign exchange gains and losses (negative impact of €28.6 million), the revaluation of embedded derivatives negtative impact of €13.8 million) and provisions of €8.4 million in 2006 linked to guarantees issued by the subsidiaries of Veolia Propreté in Asia.

In 2006, the unwinding of discounts of long term provisions had a negative impact of €15.9 million, compared with  a negative impact of €17.3 million in 2005.  The revaluation of embedded derivatives had a negative impact of €16.3 million in 2006, compared with a negative impact of €2.5 million in 2005.


Income Tax Expense


Income tax expense totaled €409.6 million in 2006, consisting of €330.9 million in current income taxes and €78.7 million in deferred income taxes, compared to a total expense of €422.4 million in 2005, consisting of €309.4 million in current income taxes and a deferred income tax benefit of €113.0 million.

The decrease in tax expense in 2006 was due to the restructuring of our U.S. tax group, which generated a deferred tax credit of €86.2 million (included in “Other countries” in the deferred tax expense in the notes to our consolidated financial statements).  Apart from this credit, an increase in our scope of consolidation and pre-tax income increased both the current and deferred tax expense.  

We have classified the non-recurring U.S. credit as an adjustment item in calculating our adjusted net income attributable to equity holders of the parent, as discussed below.  Excluding this item, income tax expenses increased from €422.4 million to €495.8 million, and the effective tax rate was 33.34%.

Share of Net Income of Associates


The share of net income of associates decreased from €6.5 million for the year ended December 31, 2005 to €6.0 million for the year ended December 31, 2006.  This near-stability reflects the first-time equity accounting of Compagnie Méridionale de Navigation (shares of which are held by the SNCM) whose results in 2006 were €5.1 million, as well as provisions of €7.4 million relating to project company shares in the Environmental Services sector in Asia, due to the client’s repudiation of the related agreements.


Net Income (Loss) from Discontinued Operations


Net income from discontinued operations was €0.6 million for the year ended December 31, 2006, compared with €0.7 million for 2005.  Income relating to Southern Water was €52.5 million for the year ended December 31, 2006 (including €51.2 million of capital gains from the disposal), compared to €8.4 million for 2005.  The loss relating to the Danish Transportation business was €51.9 million for the year ended December 31, 2006 (of which €43.9 million was an asset impairment charge), compared to €7.7 million for 2005.


Net income for the year attributable to minority interests


Net income attributable to minority interests for the year ended December 31, 2006 was €236.2 million, compared to €172.9 million for the year ended December 31, 2005. This line item reflected minority interests in the Water segment (€115.7 million), the Environmental Services segment (€18.6 million), the Energy Services segment (€87.1 million) and the Transportation segment (€14.7 million). The increase between 2005 and 2006 is mainly attributable to developments in international activities of Dalkia in partnership with EDF, the Water segment in Germany (€19.3 million) and the Transportation segment with the consolidation of SNCM (€7.9 million).

Net income attributable to minority interests for the year ended December 31, 2005 was €172.9 million. This line item reflected minority interests in the Water segment (€83.1 million), the Environmental Services segment (€25.7 million), the Energy segment (€54.7 million) and the Transportation segment (€9.7 million).



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Net income attributable to equity holders of the parent


Net income attributable to equity holders of the parent was €758.7 million in 2006, compared to €622.2 million in 2005.  The weighted average number of shares outstanding was 393.8 million for the year ended December 31, 2006 and 390.4 million for the year ended December 31, 2005. On this basis, net earnings per share attributable to the equity holders was €1.93 in 2006 compared to €1.59 in 2005.

As discussed under “—Presentation of Information in this Section – Non-GAAP Measures,” we use adjusted net income attributable to equity holders of the parent as an important management tool.  Adjusted net income attributable to equity holders of the parent was €762.0 million in 2006, compared to €630.2 million in 2005.  The following table presents a reconciliation of adjusted net income attributable to equity holders of the parent, to net income attributable to equity holders of the parent, for 2005 and 2006.

2006

(€ millions)

Net income

Adjustments

Adjusted net income

Operating income

2,132.9

89.3

2,222.2

Finance costs, net

(701.0)

-

(701.0)

Other financial income and expenses

(34.0)

-

(34.0)

Income tax expense

(409.6)

(86.2)

(495.8)

Share of net income of associates

6.0

-

6.0

Net income from discontinued operations

0.6

(0.6)

-

Minority interests

(236.2)

0.8

(235.4)

Net income attributable to equity holders of the parent

758.7

3.3

762.0


2005 adjusted

(€ millions)

Net income

Adjustments

Adjusted net income

Operating income

1,892.9

10.7

1,903.6

Finance costs, net

(710.7)

-

(710.7)

Other financial income and expenses

28.1

-

28.1

Income tax expense

(422.4)

-

(422.4)

Share of net income of associates

6.5

-

6.5

Net income from discontinued operations

0.7

(0.7)

-

Minority interests

(172.9)

(2.0)

(174.9)

Net income attributable to equity holders of the parent

622.2

8.0

630.2


In 2006, the principal adjustment item (other than the adjustment to operating income, which is discussed above) was the non-recurring deferred tax credit relating to the tax restructuring of our U.S. operations, which is discussed above.  In 2005, the only significant adjustment item was the adjustment to operating income, which is discussed above.

Year ended December 31, 2005 compared to year ended December 31, 2004

The following discussion compares our results of operations in 2005 with our results of operations in 2004, in each case reflecting the retroactive application of IFRIC 12 accounting for concessions, as well as the treatment of certain businesses as discontinued operations in accordance with IFRS 5 (those businesses are described below under “Net income (loss” from discontinued operations”).




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Revenue

Overview

We generated revenue of €25,570.4 million in 2005, an increase of 12.2% from revenue of €22,792.4 million in 2004. Positive currency effects of €180.9 million resulted from appreciation in the currencies of certain Eastern European countries (€89.2 million), the U.S. dollar (€13.9 million) and certain Asian currencies. Organic growth was 9.2%. Revenue from outside France amounted to €13,131.2 million, or 51.4% of total revenue.

The following table shows a breakdown of our revenue:

2005 adjusted

(in € millions)

2004 adjusted

(in € millions)

% change 2005/2004

of which organic growth

of which external growth

of which currency fluctuation

25,570.4

22,792.4

12.2%

9.2%

2.2%

0.8%


The following table shows a breakdown of our revenue by division:


(in € millions, except for %)

2005 adjusted

2004 adjusted

% change 2005/2004

Water

9,134.2

7,976.9

14.5%

Environmental Services

6,748.7

6,380.6

5.8%

Energy Services

5,463.6

4,974.9

9.8%

Transportation

4,223.9

3,460.0

22.1%

Total revenue

25,570.4

22,792.4

12.2%

Total revenue at constant 2004 exchange rate

25,389,5

22,792,4

11.4%


Water


The following table shows a breakdown of our revenue within the water division:


2005 adjusted

(in € millions)

2004 adjusted

(in € millions)

% change 2005/2004

of which organic growth

of which external growth

of which currency fluctuation

9,134.2

7,976.9

14.5%

10.9%

2.8%

0.8%


Our water network building and renovation business generated revenue of €9.1 billion in 2005, an increase of 14.5% compared with 2004.  Organic growth was 10.9%, which is primarily attributable to the following:


·

In France, the distribution business performed well, despite slightly lower volumes, and the works business continued to grow. As a result, organic growth in revenue totaled 4.5%.


·

Outside France, excluding Veolia Water Solutions & Technologies, revenue was up strongly (19.7% at constant scope and exchange rates). In Europe, strong revenue growth (28.4% at constant exchange rates) was driven by the Braunschweig contract in Germany, other new contracts signed in the last few months of 2005, in particular in the Czech Republic, as well as a five-year contract extension in the United Kingdom. In North America, revenue advanced by more than 8.3% at constant exchange rates, due to favorable revenue levels in general and the commencement of operations under a contract in Indianapolis. In the Asia-Pacific region, the start-up of the Shenzhen, Qingdao, Lugouqiao, Baoji and other contracts in China and the services business in Japan resulted in revenue growth of more than 25%.


·

The commencement of operations under several large construction and engineering contracts in France and abroad, plus the acquisition of companies in Germany and the United Kingdom, enabled Veolia Water Solutions & Technologies to record growth in revenue of nearly 24% (+8.8% at constant scope and exchange rates).


Our water division recorded external growth of 2.8% during 2005, which was due to several factors. We made acquisitions in the engineering sector in Germany at the end of 2004 and in the United Kingdom in the third quarter of 2005, while also increasing our stake in certain Italian water companies in the second quarter of 2005.




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Environmental Services


The following table shows a breakdown of our revenue within the Environmental Services (waste management) division:


2005 adjusted

(in € millions)

2004 adjusted

(in € millions)

% change
2005/2004

of which organic growth

of which external growth

of which currency fluctuation

6,748.7

6,380.6

5.8%

4.9%

0.1%

0.8%


Our Environmental Services (waste management) division generated revenue of €6.7 billion in 2005, an increase of 5.8% compared with 2004. Organic growth was 4.9%, which is primarily attributable to the following:


·

In France, organic growth in revenue totaled 3.5%. This growth was achieved despite a relatively unfavorable economic context, which put pressure on the industrial non-hazardous waste segment.


·

Outside France, organic growth accelerated and reached 6.1%. Large integrated contracts began to contribute greater revenues, tonnage collection increased in the United Kingdom and growth was strong in the Asia-Pacific region in particular (18.9%). In North America, new contracts were signed, toxic waste volumes were elevated and revenue was high in industrial services, leading to  revenue growth of 8.5% at constant exchange rates.


Energy Services


The following table shows a breakdown of our revenue within the energy services division:


2005 adjusted

(in € millions)

2004 adjusted

(in € millions)

% change
2005/2004

of which organic growth

of which external growth

of which currency fluctuation

5,463.6

4,974.9

9.8%

8.9%

-

0.9%


Our energy services division generated revenue of €5.5 billion in 2005, an increase of 9.8% compared with 2004.  Organic growth was 8.9%, which is primarily attributable to the following:


·

In France, revenue was up 7.6% organically and continued to benefit from the increase in energy prices in thermal services.


·

Outside France, revenue increased by 14.6% (organic growth of 11.0%). Growth was especially high in Central Europe (increase of 37.8%), driven, in particular, by the full impact of new contracts in Poland (in particular Poznan and start-up at Lodz), Hungary and Romania. In Southern Europe (Spain, Italy) revenue grew by 14.9% (organic growth of 8.3%).


We worked on strengthening our business portfolio by disposing of certain assets, resulting in no net external growth. We expanded in Spain, but sold the nuclear industry construction business of our specialized French subsidiaries. We also sold our German facilities management business.

 

Transportation


The following table shows a breakdown of our revenue within the transportation division:


2005 adjusted

(in € millions)

2004 adjusted

(in € millions)

% change 2005/2004

of which organic growth

of which external growth

of which currency fluctuation

4,223.9

3,460.0

22.0%

13.0%

8.2%

0.8%



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Our transportation division generated revenue of €4.2 billion in 2005, a 22.0% increase compared with 2004. Organic growth was 13.0%, which is primarily attributable to the following:


·

In France, passenger transportation revenues increased strongly by 18.0%, due in particular to the full impact of urban transit contracts renewed in 2004 as well as the impact of the contract in Toulouse, which was awarded for 2005.


·

Outside France, passenger transportation revenues grew by 24.6%, due in particular to the full impact of the Melbourne contract and new operations in the United States (Denver, Metrolink contract) and Europe (Dublin tramway, Helsinki bus contract).


Separately, the freight transportation business recorded growth in revenues of 26.8%, amounting to €151.7 million in 2005.


External growth (8.2%) was due in particular to the acquisition of ATC in the United States in September 2005.


Revenue by geographical region


The following table shows a breakdown of our revenue by geographical region:


(in € millions, except %)

2005 adjusted

2004 adjusted

% change 2005/2004

France

12,439.2

11,607.4

7.2%

United Kingdom

1,727,1

1,629.2

6.0%

Germany

1,817.3

1,341.3

35.5%

Other European countries

4,708.6

4,131.4

14.0%

United States

2,183.3

1,883.2

15.9%

Oceania

878.0

644,0

36.3%

Asia

597.3

505,6

18.1%

Rest of the world

1,219.6

1 050.3

16.1%

Total revenue

25,570.4

22,792.4

12.2%


France


The increase in revenue in France was driven primarily by an increase at our transportation division, which recorded strong organic growth of 15.3%. This increase was in turn primarily related to growth in the urban transportation business, where revenue strongly increased on an organic basis by 34.1% in 2005.


United Kingdom


The increase in revenue in the United Kingdom was due in particular to growth in our water division, which benefited from the impact of a five-year contract extension, as well as growth in our waste management division, which recorded higher revenues from integrated service contracts.


Germany


The increase in revenue in Germany was mostly due to the integration of the Braunschweig water contract, which generated revenue of €349.6 million in 2005.


Other European countries


The contribution to revenues from Central and Eastern Europe rose significantly, in particular in our water division in the Czech Republic and in our energy services division in Poland, where we acquired the company that holds the Lodz contract. In addition, the Poznan contract contributed for the full year in 2005.




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United States


Apart from favorable currency fluctuations, the increase in revenue in the United States was primarily due to an increase in revenues recorded in our waste management division and our transportation division.  Revenue in our waste management division increased at year-end in particular, while revenue in our transportation division increased due to the acquisition of ATC, which generated €74.8 million in revenue over four months in 2005.


Oceania


Apart from favorable currency fluctuations of €34.5 million, the increase in revenue was due mainly to increased contributions from our transportation division and waste management division in Australia. The transportation division benefited from the full impact of the Melbourne and Auckland contracts, while the waste management division recorded strong growth in industrial services and landfilling.


Asia


The increase in revenue in Asia was due primarily to growth in our water division, which recorded organic growth of 9.9%. The Shenzhen contract went into production, generating €35 million in revenue in 2005, and operations commenced under several other Chinese contracts signed in 2003 and 2004. In South Korea, revenue declined by €23 million due to completion of construction of installations relating to the Incheon contract, which was only partially offset by the €10 million increase generated by the start-up of the Mansu and Songdo plants.


Rest of the world


There was a favorable currency effect in South America of €18.1 million. This principally affected Proactiva, which manages water and waste management contracts in the region. In Israel, our energy services division acquired Kalorit Israel, which generated €14.7 million in revenue from ordinary activities in 2005.


Operating Income


Overview


Our operating income increased by 27.1%, from €1,489.6 million in 2004 to €1,892.9 million in 2005.  The principal reasons for the increase was growth in our revenues,  an improvement in margins that reflected the impact of our “Veolia Environnement 2005” efficiency plan (which resulted in selling, general and administrative expenses declining from 11.7% of our revenues in 2004 to 11.3% in 2005), and a number of other items described in the next paragraph.  Our operating income represented 6.5% of revenues in 2004 and 7.4% in 2005.   


The change in operating income was also impacted by items we record as “other operating revenue and expenses,” which by their nature can be subject to significant fluctuations.  Other operating revenue and expenses reflected the realization of €57.9 million of capital gains on asset sales (primarily PCP Holding and Acque Potabilite in 2005), compared to capital losses of €102.1 million in 2004 (primarily Berlikomm). This net increase was partially offset by a decline of €72.2 million in other components of “other operating  revenue and expense,” the most significant component of which reflected the impact of writing down goodwill in connection with the sale of a unit of the Energy Services division.  Our goodwill impairment charges included in operating income declined from €71.9 million in 2004 (primarily relating to our Scandanavian transport business) to €28.0 million in 2005 (of which €20.8 million related to divested businesses in the Energy Services division).  In addition, our restructuring costs were €30.6 million lower in 2005 (€16.2 million) than in 2004 (€46.8 million).  


Operating income grew significantly in each of our divisions.  The following table shows a breakdown of our operating income by division:


(in € millions, except %)

2005 adjusted

2004 adjusted

% change

2005/2004

Water

1,002.3

798.6

25.5%

Environmental Services

543.6

480.6

13.1%

Energy Services

315.3

239.6

31.6%

Transportation

116.8

38.9

200.3%

Holding companies

(85.1)

(68.1)

(25.0)%

Total

1,892.9

1,489.6

27.1%

Total at constant 2004 exchange rate

1,867.6

1,489.6

25.4%





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Water


The operating income of our water division amounted to €1,002.3 million in 2005, a 25.5% increase from the €798.6 million recorded in 2004. In 2004, operating income was negatively affected by a €55.2 million loss relating to the sale of Berlikomm.

In France, the program to improve operating performance continued to be implemented, and the distribution and construction businesses performed well, boosting operating income.

In the rest of Europe, the rise in operating income was largely due to the integration of the Braunschweig contract. In addition, contracts were renewed in the United Kingdom, there were positive developments in the Czech Republic and Italy, and the BOT contracts in Brussels and The Hague delivered their first positive contributions. In Asia-Pacific, operating income improved due to the commencement of operations in China and South Korea. Finally, engineering and technology solutions took another step toward recovery after refocusing on profitable activities.


Environmental Services


The operating income of our Environmental Services (waste management) division increased by 13.1%, from €480.6 million in 2004 to €543.6 million in 2005.

In France, the increase in operating income was primarily the result of action plans initiated in previous years, in particular with respect to waste collection and landfills. In the rest of Europe, operating income increased primarily because integrated contracts posted strong growth and, more generally, as a result of strong performance in the waste collection business and increased tonnage amounts in UK landfills. In the United States, the profitability of toxic waste, industrial services and  solid waste activities increased.


Energy Services


The operating income of our energy services division increased by 31.6%, from €239.6 million in 2004 to €315.3 million in 2005. In 2004, operating income was negatively affected by a €13.8 million payment to settle a dispute in Italy, while in 2005 the operating income of the Energy Services division was negatively impacted by the impairment charges described above.  See Note 25 to our consolidated financial statements for further information relating to these impairment losses.


In France, the profitability of thermal services in the areas of installation and services improved. Operating income was also enhanced by proceeds from the sale of greenhouse gas emission rights. Given the overall balanced nature of the contract portfolio, the rise in energy prices during 2005 had no net effect on profitability. Rising gas prices have caused the selling prices of electricity produced through co-generation to reach their ceiling. Legislative changes at the end of 2005 limited this phenomenon, and the opportunity loss was offset by an upturn in energy management margins on other contracts. In the rest of Europe, the rise in operating income resulted directly from new contracts in Central Europe (Lodz and Poznan). This region was only marginally exposed to the rise in fuel prices in 2005, given the energy sources used. Finally, measures to improve energy efficiency were successful in the various regions where this division operates.


Transportation


The operating income of our transportation division increased substantially, from €38.9 million in 2004 to €116.8 million in 2005. Excluding impairment losses on Scandinavian goodwill in 2004, operating income increased by 7.3% (5.9% at constant exchange rates). This result was achieved despite the negative impact of the rise in fuel prices, which totaled €17 million outside France. Price increases outside of France could not be fully passed on to the customer.


In France, operating income increased in both the urban and inter-city transportation segments. Outside France, the Scandinavian business posted recovery in line with a profit improvement plan. In other regions, operating income in the transportation division benefited from new contracts and increased in accordance with  business plans.




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Finance costs, net


Finance costs, net, decreased from €741.1 million in 2004 to €710.7 million in 2005.  The following table shows a breakdown of our finance costs, net:


(in € millions)

2005 adjusted

2004 adjusted

   

Income

63.3

91.8

Expense

(774.0)

(832.9)

Total finance costs, net

(710.7)

(741.1)


The financing rate was 5.07% in 2005, compared to 5.1% in 2004. This slight decrease in the financing rate mainly reflects the appreciation of several currencies against the euro and in particular the U.S. dollar, and the cost of extending the maturity of borrowings. In addition, net finance costs in 2005 include €26.0 million related to our partial early redemption (in the amount of €1,150 million) of bonds due to mature in June 2008. This early redemption was conducted in order to optimize the maturity and future cost of borrowings. In addition, fair value movements on derivative instruments not qualifying for hedge accounting totaled  a gain of €12.0 million, compared to €7.6 million in 2004. These movements, which are calculated in accordance with IAS 39, are highly volatile in nature.


Other Financial Income (Expenses)


The following table shows a breakdown of our other financial income (expenses):

  

(in € millions)

2005 adjusted

2004 adjusted

Loan income

37.0

55.4

Dividends

6.5

5.9

Foreign exchange gains (losses)

14.3

(13.9)

Financial provisions

24.2

-

Other income (expenses)

(53.9)

(3.0)

Total

28.1

44.4


We recorded net other financial income of €28.1 million in 2005, compared to €44.4 million in 2004.  In 2004, other financial income included a capital gain realized on the sale of Vinci shares of €44.4 million. Excluding this capital gain, other financial income (expenses) increased by €28.1 million in 2004, mainly due to foreign exchange gains.   


In 2005:


·

loan income and dividends fell to €43.5 million;

·

foreign exchange gains totaled €14.3 million;

·

the reverse discounting of site restoration provisions had a negative impact of €15.7 million; and

·

the revaluation of embedded derivatives had an impact of -€2.5 million.


In 2004, other financial income (expenses) was affected by a capital gain of €44.4 million realized on the sale of Vinci shares by the energy services division, foreign exchange losses of €13.9 million, the revaluation of embedded derivatives (negative impact of €12.9 million), loan income and dividends of €61.3 million, and the reverse discounting of site restoration provisions (negative impace of €10.8 million).


Income Tax Expense


Our income tax expense totaled €422.4 million in 2005, compared to €174.9 million in 2004.  Our 2005 income tax expense consisted of €309.4 million in current income taxes and €113.5 million in deferred income taxes, compared to €225.1 million in current income taxes and a deferred income tax benefit of €50.2 million in 2004.


The increase in income tax in 2005 was primarily due to an increase in operating income. In addition, in 2004 the prospect of future profits prompted us to capitalize additional tax-loss carry forwards, limiting deferred tax expense for that year.




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Share of Net Income of Associates


Our share of net income of associates decreased from €22 million in 2004 to €14.9 million in 2005, following the transfer of certain investments in associates to non-consolidated investments. The largest net income shares in 2005 were generated by water segment associates (€10.8 million).


Net Income (loss) from Discontinued Operations


In 2005, income from discontinued operations related to Danish transportation activities and to Southern Water net income. In 2004, discontinued operations generated a loss of €38.1 million. This loss broke down as follows: a €162.2 million loss from U.S. water businesses, a €132.7 million gain from FCC and a €13.1 million loss from UKand Danish transportation activities and profit from Southern Water.


Minority Interests


Our net income attributable to minority interests in 2005 was €172.9 million, compared to €212.1 in 2004. The principal minority interests in 2005 are related to our water division (€83.0 million), our waste management division (€25.8 million), our energy services division (€54.7 million) and our transportation division (€97 million). The decrease in net income attributable to minority interests in 2005 compared to 2004 is primarily attributable to our water division following the consolidation of the Braunschweig contract (€9.8 million), and the improvement in the results of the Berlin water companies (€31.7 million), the 2004 results of which were affected by the capital loss generated by the sale of Berlikomm and by the contribution of FCC for €78.8 million which was disposed at the end of 2004.

 

Net income attributable to minority interests in 2004 was €212.1 The principal minority interests in 2004 were related to our water division (€47.6 million, mainly related to Berlin water companies), our energy services division (€50.7 million), our waste management division (€21.6 million) and our transportation division (€13.6 million) and FCC for €77.8 million.


Net income attributable to equity holders of the parent


Net income attributable to equity holders of the parent was €622..2 million in 2005, compared to €389.8 million in 2004. The increase was primarily due to the increase in operating income and control over financial interest expense during 2005.


The weighted average number of shares outstanding was 390.4 million on December 31, 2005 and 396.2 million on December 31, 2004. On this basis, net earnings per share attributable to the equity holders of parent was €159 in 2005 compared to €0.98 in 2004.



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LIQUIDITY AND CAPITAL RESOURCES

Our operations generate significant cash flow.  In 2006, our operating cash flow was more than sufficient to cover our investment requirements.  We also have access to sources of liquidity that include bank financing, international bond markets and international equity markets.  We believe that our working capital is sufficient for our present requirements.

Cash Flows

Operating cash flow before changes in working capital increased by 8.5%, from €3,541.9 million in 2005 to €3,844.4 million in 2006. Excluding the cash flow of discontinued operations in 2005 (cash generation of €4.3 million) and in 2006 (use of cash of €8.0 million), operating cash flow, before changes in working capital increased by 8.9%, reflecting our improved operating performance. The definition of operating cash flow before changes in working capital recommended by the Conseil national de la comptabilité (French Accounting standard setter) excludes the impact of financing activities and taxation.

Net cash flow from operating activities improved from €3,163.7 million in 2005 to €3,389.6 million in 2006. This increase is principally due to the improvement in operating cash flow before changes in working capital.  The slight increase in working capital requirements during 2006 (€111.8 million) was the result of growth in the Company’s business.

Net cash used in investing activities totaled €2,904.0 million in 2006, compared to €2,407.6 million in 2005. The €496.4 million increase in net cash used in 2006 was mainly due to the €738 million investment (net of acquired cash) in Cleanaway in the United Kingdom.

Net cash used in financing activities were €3,152.8 million in 2005 and €71.5 million in 2006.  We recorded a decrease in interest paid, from €738.8 million in 2005 to €596.4 million in 2006.  In addition, we received cash from new borrowings that exceeded our principal payments in 2006, and we also received €246.5 million in proceeds from the issue of shares, primarily in connection with our employee share purchase plan.  We increased dividend payments from €374.0 million in 2005 to €479.2 million in 2006.  

In 2005:

·

€1,535 million was paid to redeem outstanding convertible bonds (known by their French acronym as OCEANEs);

·

€500 million was paid to redeem outstanding euro-medium term notes in  November 2005;

·

borrowings to finance sales of receivables declined by €547 million;

·

€1,150 million was paid to partially redeem a bond issue maturing in 2008;

·

€300 million was paid to redeem subordinated notes redeemable in shares (TSARs).


As a result of the cash flows described above and the effects of exchange rates and other movements resulting in a net cash outflow of €41.4 million, cash and cash equivalents totaled €2,202.0 million at December 31, 2006, compared to €1,829.3 million at December 31, 2005.

Sources of Funds

Financings

As of December 31, 2006, Moody’s and Standard & Poor's rated the Company as follows:


 

Short-term

Long term

Outlook

Recent events

Moody’s

P-2

A3

Stable

Moody’s confirmed its rating of Veolia Environnement given on July 10, 2006.

Standard and Poor’s(1)

A-2

BBB+

Stable

Standard & Poor’s confirmed, in October 2006, its ratings on Veolia Environnement on October 3, 2005.


(1) The EMTN program is rated BBB by S&P.


In 2006, Veolia Environnement pursued an active refinancing policy aimed at strengthening its financial condition and extending its debt maturities.



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The principal debt items that matured in 2006 and that were either repaid or refinanced were as follows:

·

Optional credit line of €150 million with Natixis (renewable every year for 4 years), which can be put in place at any time by Veolia Environnement until November 29, 2007.

·

EMTN (series 3) for €20 million expiring August 23, 2006 was repaid in full at the date of expiration.


All of the 2006 financing transactions, both on the capital markets and with banks, were intended to optimize the Company’s debt profile with an emphasis on:  achieving a better match between assets and liabilities, extending the average maturity of long-term debt, smoothing out the debt repayment schedule, diversifying financing sources and taking best advantage of market conditions.

Our main financing activities in 2006 were as follows:

·

FRN €150 million private placement from January 18, 2006 to July 18, 2007 – EURIBOR 3M coupon.

·

FRN €300 million private placement from February 15, 2006 to February 15, 2008 – EURIBOR 3M +0.06% coupon.

·

EMTN €1,000 million from November 24, 2006 until January 16, 2017 – 4.375% fixed rate coupon.


Our principal refinancing activities in bank debt were as follows in 2006:

·

New bilateral line of credit of €100 million with CALYON from January 2, 2006 to January 4, 2010.


The syndicated credit documentation and credit lines contain no financial ratio covenants (although in some cases they limit the proportion of our group’s debt that may be incurred by subsidiaries, rather than by our company).  We have outstanding privately placed notes in the amount of €309 million that require compliance with the following covenants at December 31 of each year:

·

ICR (Interest Coverage Ratio) > 3.2 and

·

DPR (Debt Payout Ratio) < 5.3.

The Interest Coverage Ratio in respect of any given date is the ratio of adjusted cash flow (generally cash flow from operations plus certain cash flow from IFRIC 4 loans) for the twelve-month period then ended to cost of financing for such period.  The Debt Payout Ratio in respect of any given date is the ratio of adjusted net debt (generally, financial debt less cash and cash equivalents and marketable securities, and plus or minus fair value adjustments in respect of derivative instruments) at such date to adjusted cash flow for the twelve month period then ended.

These ratios were defined based on IFRS accounts prior to application of IFRIC 12 and will be updated to take account of IFRIC 12. As of December 31, 2006, we were in compliance with these covenants.  If we fail to meet these covenants, the noteholders could require us to repay these notes in full.

In addition, substantially all of our debt agreements contain standard restrictions, such as negative pledge clauses that limit our ability to pledge our assets to secure our debt, as well as events of default in case of non-payment, failure to comply with covenants, acceleration of other debts in amounts exceeding specified thresholds, and other customary circumstances.

As of December 31, 2006, net financial debt broke down as follows:


(€ millions)

December 31, 2006

December 31, 2005 (adjusted)

Long-term borrowings

14,001.6

13,722.8

Short-term borrowings

2,904.1

2,138.2

Bank overdrafts

456.0

506.8

Sub-total, financial debt

17,361.7

16,367.8

Cash and cash equivalents

-2,658.0

-2,336.1

Less fair value on hedging instruments

-28.8

-161.1

Net financial debt

14,674.9

13,870.6





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The table below shows the Company’s maturity schedule for long-term borrowings, as of December 31, 2006:


 

Total

Payments due by period

(€ millions)

 

2 years

3-5 years   

> 5 years   

Bank loans

5,584.1

1,622.9

1,653.8

2,307.4

Bonds

8,417.5

1,059.3

128.7

7,229.5

Total

14,001.6

2,682.2

1,782.5

9,536.9


Divestitures and Disposals of Assets

Asset divestitures totaled €354.9 million in 2006, and €348.0 million net of the cash of companies sold.

Financial divestitures in 2006, which totaled €213.6 million excluding cash of companies sold, included the following items:

·

shares of Southern Water for €89.6 million.

·

a 34% stake of the company which holds the Lodz contract in Poland in the Energy segment at IFM for €70 million.

·

a 35% stake in Osilub (Veolia Waste Management France) for €4.2 million.

·

the company Connex Transport UK to Bombardier for €8.9 million.


Cash related to financial divestitures totaled negative €6.9 million.

The principal industrial divestitures in 2006, which totaled €141.3 million, included the following items:

·

The disposal of assets in New Zealand in Environmental Services for €43.5 million

·

The disposal of vehicles in Denmark within the Transportation segment for €18.9 million.

·

other industrial assets with individual values of less than €10 million and essentially representing rotation of operating assets.


Capital Expenditures

The following table shows a breakdown of our capital expenditures during 2005 and 2006:

(€ millions)

Industrial investments (1)

Financial investments (2)

New operating financial assets

 

2006

2005

(adjusted)

2006

2005

(adjusted)

2006

2005

(adjusted)

       

Water

853

771

214

614

262

307

Environmental Services

692

639

875

105

20

100

Energy Services

318

252

102

204

63

96

Transportation

302

193

253

175

16

10

Other

32

29

8

1

-

-

Total

2,197

1,884

1,452

1,099

361

513

(2)

Including those financed through capital leases.

(2)

Excluding cash and cash equivalents of acquired companies.




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Industrial Investments

Industrial investments, excluding investments through capital leases, totaled €2,018 million in 2006, compared to €1,837.0 million in 2005, representing an increase of 10%.  Industrial investments including those financed through capital leases totaled €2,197 million and broke down as follows:

·

Water: €853 million, an increase of 10.6% from 2005, of which €355 million were for growth-related spending and €498 million were for maintenance spending.

·

Environmental Services: €692 million, an increase of 8.3% from 2005, of which €173 million were for growth-related spending and €519 million were for maintenance spending.

·

Energy Services: €318 million, an increase of 26.2% from 2005, of which €118 million were for growth-related spending and €200 million were for maintenance spending.

·

Transportation: €302 million, an increase of 56.5% from 2005, of which €123 million were for growth-related spending and €179 million were for maintenance spending. These investments exclude the call option concerning the acquisition in 2007 of a boat for €112 million.

The increase in maintenance spending resulted principally from the increase in business and the scope of consolidation.  

Financial Investments

Financial investments, including net cash of acquired companies of €161 million in 2006, totaled €1,291 million in 2006, compared to €994 million in 2005.

In 2005, financial investments included the acquisition of the company which holds the Braunschweig contract by Veolia Eau for €374 million, of the company which holds the Lodz contract in Poland by Veolia Énergie for €171 million and of ATC Vancom in the United States for €77 million by Veolia Transport.

Financial investments in 2006 (excluding cash of acquired companies) totaled €1,452 million and broke down as follows:

·

Water: €214 million, compared to €614 million in 2005. The principal financial investments in 2006 related to the acquisition of Banska Bystrica and Poprad in Slovakia for €53 million and €18 million respectively and the acquired contracts of Kunming and Liuzhou in China for €44 million and €16 million, respectively.

·

Environmental Services: €875 million, compared to €105 million in 2005. The principal financial investments in 2006 related to the acquisition of Cleanaway in the United Kingdom for €745 million and of Biffa in Belgium for €63 million.

·

Energy Services: €102 million, compared to €204 million in 2005. The principal financial investments  in 2006 related to the acquisition of a company in Italy for €18 million and TDU in Australia for €16 million.

·

Transportation: €253 million, compared to €175 million in 2005. The principal financial investments in 2006 related to the acquisition of an interest in SNCM for €72 million, of Shuttleport and Supershuttle in the United States for €28 million and €72 million respectively, of Dunn Line in the United Kingdom for €15 million and the acquisition of the company which holds the contract of Nordtrafikk in Norway for €12 million.


Cash related to financial investments totaled €161 million, related essentially to SNCM (€101 million) and Biffa Belgium (€24 million) companies.

New Operating Financial Assets (IFRIC 12 and IFRIC 4 loans)

As discussed above under “Critical Accounting Policies – Accounting for Concessions,” when we enter into concession agreements under IFRIC 12 we record an asset in our consolidated balance sheet that is treated as either a financial asset or an intangible asset, depending on the nature of our compensation arrangements. See Note 1.20 to our Consolidated Financial Statements for further details.  Certain contracts qualify for treatment as lease contracts pursuant to IAS17 and its interpretation IFRIC4.  We also record operating financial assets in respect of those contracts.  See Note 1.21 to our consolidated statements for further details.  



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New operating financial assets were €361 million in 2006, compared to €513 million in 2005, breaking down as follows:

·

Water: €262 million, down 14.7%.

·

Environmental Services: €20 million, down 80.0%.

·

Energy Services: €63 million, down 34.4%.

·

Transportation: €16 million, an increase of 60.0%.


Research and Development; Patents and Licenses

See “Information on the Company—Business Overview—Research and Development” and “Information on the Company—Business Overview—Intellectual Property” for a description of our investments in these areas.

Goodwill

Goodwill amounted to €5,705.0 million at December 31, 2006, compared to €4,752.3 million at December 31, 2005. The increase of €952.7 million reflects our growth during fiscal year 2006: €784.1 million of the increase relates to the Cash Generating Unit (“CGU”) Waste Management United Kingdom, following the acquisition of Cleanaway, €86 million relates to the CGU Central Europe Water following the securing of contracts in Slovakia, and €64.7 million relates to the CGU North America Transport following the acquisitions of Superhuttle International and Shuttleport.  Given these developments, the CGUs of each division are concentrated in France, the United States, Germany, Great Britain and the Czech Republic.

The CGUs carrying the most significant amounts of goodwill at December 31, 2006 were Waste Management United Kingdom (€894 million), Water France (€729 million) and Solid Waste Management North America (€610 million).

Return on Capital Employed (ROCE)

Our investment policy requires us to analyze different criteria in making investment decisions, including decisions relating to capital expenditures and financial investments.  In order to manage the profitability of our contracts globally, we use a measure of performance, which we refer to as “return on capital employed” or “ROCE,” that measures our ability to provide a return on the capital invested in our business.  We define ROCE as the ratio of (i) our results of operations, net of tax, and our share of net income of associates excluding revenue from operating financial assets, divided by (ii) the average amount of capital employed in our business during the same year.

Since the shift to IFRS in 2005, for purposes of our ROCE calculation, capital employed excludes financial operating assets, and operating income excludes the related income. The implementation of IFRIC12 in 2006 introduced important modifications affecting financial operating assets, which are accounted for in the adjusted financial statements.  

Net results of operations are calculated as follows:

 (€ millions)

2006

2005
(adjusted)

Adjusted operating income

2,222.2

1,903.6

+ Share of net income of associates

6.0

6.5

- Income tax expense (1)(2)

(463.2)

(401.6)

- Revenues of operational financial assets

(351.0)

(325.8)

+ Income tax concerning operational financial assets

54.5

44.7

Net results of operations

1,468.5

1,227.4

(1)

In 2004, the financial restructuring transactions that followed the divestiture of US businesses in the Water Division generated tax-loss carry forwards recognized in the consolidated balance sheet. Given its exceptional character, an amount of €138.4 million, representing the gain in earnings, was eliminated from the calculation of ROCE. In 2005 and 2006, the use of these carry forwards led to a €20.8 million and €32.7 million charge respectively, which was also eliminated from the ROCE calculation.

(2)

In 2006, the non-recurring deferred tax benefit of €86.3 million, linked to the restructuring of the U.S. tax group, was excluded from the ROCE calculation.


Average capital employed during the year is defined as the average between capital employed at the beginning and the end of the year.   Capital employed is defined as the sum of all net tangible and intangible assets, goodwill net of impairment, investments in associates, net operating and non-operating working capital requirements and net derivatives after deduction of provisions and other non-current liabilities.



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Capital employed is calculated in the following manner:

 (€ millions)

December
31, 2006

December
31, 2005
(adjusted)

December
31, 2004

Net tangible and intangible assets

11,644.1

10,258.9

8,975.9

Goodwill net of impairment

5,705.0

4,752.3

4,246.8

Investments in associates

241.0

201.5

219.2

Net operating and non-operating working capital requirement(1)

198.8